78 T.C. 291">*291 OPINION

Respondent determined a deficiency in the amount of $ 40,913 in petitioners' Federal income tax for 1976. The only issue for decision is whether the exchange of "guaranty stock" in a State-chartered savings and loan association for passbook accounts and time certificates of deposit in a federally chartered mutual savings and loan 78 T.C. 291">*292 association qualifies as a tax-free exchange under section 354(a). ¹

This case was submitted fully stipulated.

At the time the petition was filed, 1982 U.S. Tax Ct. LEXIS 130">*134 petitioners Harold T. and Marie B. Paulsen, husband and wife at all times material herein, resided in Tacoma, Wash. They filed a joint Federal income tax return for 1976 with the Internal Revenue Service Center, Ogden, Utah.

During the 12-month period preceding June 30, 1976, petitioner Harold T. Paulsen was the president and a director of Commerce Savings & Loan Association of Tacoma (Commerce). Commerce, a State-chartered savings and loan association, was incorporated and operated under the laws of the State of Washington.

Under its articles of incorporation and bylaws, Commerce was authorized to issue "guaranty stock" and several classes of savings accounts. Each holder of a savings account or guaranty stock, as well as each borrower, was a "member" of Commerce. With respect to all questions requiring action by the members, holders of savings accounts received one vote for each $ 100 in their accounts, and guaranty stockholders received one vote per share of stock. Each borrower from Commerce was also entitled to one vote. A majority of the board of directors of Commerce were required to be owners of guaranty stock.

A minimum amount of guaranty stock, specified by a formula, 1982 U.S. Tax Ct. LEXIS 130">*135 was required to be "maintained as fixed and permanent nonwithdrawable capital" of Commerce. Guaranty stockholders had a proportionate proprietary interest in the assets and net earnings of Commerce subordinate to the claims of its creditors; no other member had such an interest. ² Guaranty stock was not eligible as security for loans from Commerce, 78 T.C. 291">*293 and it could not be "withdrawn" until the claims of all creditors and holders of savings accounts had been satisfied upon liquidation or dissolution. Dividends on guaranty stock could not be declared unless certain reserves had been accumulated, and they could not be paid or credited during any period in which dividends had not been declared and paid upon withdrawable savings. The rate of dividends on guaranty stock was to be fixed by the board of directors.

1982 U.S. Tax Ct. LEXIS 130">*136 On June 30, 1976, petitioners owned 17,459 shares of guaranty stock in Commerce. Of these shares, 1,390 shares were acquired on that day pursuant to a qualified stock option plan of Commerce. All of petitioners' stock in Commerce was held as community property.

Citizens Federal Savings & Loan Association of Seattle (Citizens or the association) is a federally chartered mutual savings and loan association which was authorized, organized, and chartered by the Federal Home Loan Bank Board under the provisions of 12 U.S.C. sec. 1461 et seq., and the regulations promulgated thereunder. Citizens has no capital stock. It is owned by its members who consist solely of savings account holders and borrowers. In the consideration of questions requiring action by its members, each holder of a savings account has one vote for each $ 100 (or fraction thereof) of the withdrawal value of his savings account, and each borrower has one vote.

The charter of Citizens states in part that the "objects of the association are to promote thrift by providing a convenient and safe method for people to save and invest money and to provide for the sound and economical 1982 U.S. Tax Ct. LEXIS 130">*137 financing of homes." Under the charter, Citizens has the power to raise capital only "by accepting payments on savings accounts representing share interests in the association." Generally speaking, requests for withdrawals from savings accounts must be honored within 30 days of the request. In this connection, Citizens' charter provides that: "Holders of savings accounts for which application for withdrawal has been made shall remain holders of savings accounts until paid and shall not become creditors." All savings accounts of Citizens are "nonassessable."

The Citizens charter further provides that as of June 30 and December 31 of each year, after provision has been made for 78 T.C. 291">*294 payment of expenses, credits to general reserves and surplus, and bonuses on savings accounts as authorized by Federal Home Loan Bank Board regulations, any remaining net earnings are to be distributed in proportion to the withdrawal value of savings accounts. In lieu of or in addition to such net earnings, any surplus of the association may be similarly distributed. In the event of voluntary or involuntary liquidation, dissolution, or winding up of Citizens, all holders of savings accounts are "entitled1982 U.S. Tax Ct. LEXIS 130">*138 to equal distribution of assets, pro rata to the value of their savings accounts." Citizens has the power to redeem all or any part of its savings accounts at a price equivalent to "the full value thereof, as determined by the board of directors, but in no event shall the redemption price be less than the withdrawal amount" of any savings account.

On or about July 1, 1976, the guaranty stockholders of Commerce exchanged all of their stock for passbook accounts and time certificates of deposit in Citizens. This exchange was made in accordance with the provisions and intent of a "Plan for Merger" of Commerce and Citizens dated November 7, 1975.

Pursuant to the provisions of the plan for merger, each share of guaranty stock in Commerce was to be exchanged for a $ 12 deposit in a regular passbook savings account in Citizens, subject to the restriction that such deposits could not be withdrawn for a period of 1 year. Alternatively, Commerce shareholders had the option of exchanging their stock (at the same dollar rate per share) for time certificates of deposit in Citizens with maturities ranging from 1 to 10 years. ³ The plan for merger further provided that each prior shareholder1982 U.S. Tax Ct. LEXIS 130">*139 of Commerce would have borrowing privileges against the deposits resulting from the exchange of stock at an interest rate 1.5 percent above the passbook rate. ⁴

Upon completion of the exchange, Commerce was merged 78 T.C. 291">*295 into Citizens and the combined business activity of the two was continued in the name of Citizens. ⁵ The exchange and merger were treated by Citizens and Commerce as a reorganization under section 368(a)(1)(A) resulting in no recognized gain or loss to Commerce shareholders pursuant to section 354(a).

1982 U.S. Tax Ct. LEXIS 130">*140 On July 1, 1976, in accordance with the above-described plan for merger, petitioners exchanged the following shares of guaranty stock in Commerce for passbook accounts and time certificates of deposit in Citizens:

Petitioners treated this exchange as one requiring the recognition of the gain realized only upon the withdrawal of moneys from the passbook accounts or upon the maturity of the time certificates of deposit. Therefore, they reported no gain from the exchange on their Federal income tax return for 1976. ⁶

1982 U.S. Tax Ct. LEXIS 130">*141 Respondent determined in the notice of deficiency that petitioners were required to recognize in 1976 the gain realized from the exchange of the Commerce stock for Citizens passbook accounts and time certificates of deposit.

Under section 1001, ⁷1982 U.S. Tax Ct. LEXIS 130">*142 the entire amount of any gain realized 78 T.C. 291">*296 on the sale or exchange of property must be recognized for income tax purposes unless it is otherwise provided in the Code. Section 354(a)⁸ provides in part that no gain shall be recognized if, pursuant to a plan of reorganization, stock or securities in a corporation that is a party to the reorganization are exchanged for stock or securities in another corporation that is a party to the reorganization.

As used in section 354(a), the term "reorganization" includes a merger or consolidation effected under applicable State or Federal law. Sec. 368(a)(1)(A); sec. 1.368-2(b)(1), Income Tax Regs. It is undisputed1982 U.S. Tax Ct. LEXIS 130">*143 that the merger of Commerce and Citizens was effected as authorized by law. However, treatment of the merger as a "reorganization" for tax purposes does not necessarily follow from the fact that it was formally conducted in accordance with applicable law. There is an additional requirement, judicially created and now set forth in section 1.368-1(b), Income Tax Regs., that there be a "continuity of interest" on the part of those persons who owned the enterprise prior to the merger. ⁹1982 U.S. Tax Ct. LEXIS 130">*144 Generally speaking, this 78 T.C. 291">*297 means that the owners of an acquired corporation must receive a proprietary interest ¹⁰ in the modified enterprise resulting from a transaction which purports to be a "reorganization." ¹¹ For purposes of this case, it means that, in order for us to find a "reorganization" and for section 354(a) to apply, the consideration received by petitioners in exchange for Commerce guaranty stock must be characterized as stock in Citizens. ¹² See Capital S. & L. Ass'n v. United States, 221 Ct. Cl. 557">221 Ct. Cl. 557, 607 F.2d 970">607 F.2d 970, 607 F.2d 970">973-974 (1979).

Not surprisingly, petitioners contend that they exchanged guaranty stock in Commerce for "stock" in Citizens pursuant to a plan of reorganization and that, under section1982 U.S. Tax Ct. LEXIS 130">*145 354(a), no gain was required to be recognized on the exchange. They emphasize that, like shareholders in a corporation that does issue "stock" in the traditional sense, holders of savings accounts in Citizens have voting rights, the right to pro rata distributions of earnings and surplus, and the right to share in Citizens' assets upon liquidation. See B. Bittker & J. Eustice, supra par. 14.31, at 14-94 and 14-95. In support of their position, petitioners also point out that section 7701(a)(7) and (8) defines the terms "stock" and "shareholder" as follows: ¹³

(7) Stock. -- The term "stock" includes shares in an association, joint-stock company, or insurance company.

(8) Shareholder. -- The term "shareholder" includes a member in an association, joint-stock company, or insurance company.

1982 U.S. Tax Ct. LEXIS 130">*146 Respondent's position is that the merger of Commerce into Citizens was not a "reorganization" for tax purposes because petitioners and the other guaranty stockholders of Commerce 78 T.C. 291">*298 did not receive a significant proprietary interest in Citizens and that, therefore, section 354(a) has no application here. Respondent acknowledges that, to some extent, the savings accounts received by petitioners represent an equity interest in Citizens, but he emphasizes that they are not the equivalent of ordinary shares of stock. Rather, respondent argues, a savings account in Citizens is the equivalent of cash; he views the relationship between a savings account holder and Citizens as basically one of creditor and debtor because, he contends, for all practical purposes a Citizens savings account is withdrawable upon written demand. ¹⁴1982 U.S. Tax Ct. LEXIS 130">*147 Respondent would thus characterize a savings account in Citizens as "a hybrid interest, representing debt which is the equivalent of cash while, at the same time, having certain equity features" which are not sufficient to meet the requirements of the continuity-of-interest test in the circumstances of this case. ¹⁵

The question whether savings accounts in a federally chartered mutual savings and loan association may be characterized as "stock" for purposes of the provisions of the Internal Revenue Code relating to tax-free reorganizations has not heretofore been considered by this Court. 1982 U.S. Tax Ct. LEXIS 130">*148 However, the issue has been decided by a number of other courts, and they have uniformly rejected the position here taken by respondent.

In Everett v. United States, 448 F.2d 357">448 F.2d 357 (10th Cir. 1971), a State-chartered building and loan association with both "permanent shares" and "savings shares" outstanding had transferred its assets to a federally chartered mutual savings and loan. Holders of savings shares in the State association received like shares in the Federal association. In addition, $ 65,000 was paid to the State association and distributed to its permanent shareholders in a complete liquidation. The taxpayers 78 T.C. 291">*299 treated the transaction as a reorganization within the meaning of section 368(a)(1)(C) and (2)(B), and the correctness of their so doing turned on the question whether savings shares in the Federal association constituted "voting stock" within the meaning of that section. The court held that they did, noting that although "such shares have some of the indicia of a creditor-debtor relationship, nevertheless at the same time such shares also possess many of the attributes of a proprietary type interest." ¹⁶448 F.2d 357">Everett v. United States, supra at 360.1982 U.S. Tax Ct. LEXIS 130">*149 The court went on to hold that the transaction met the continuity-of-interest test ¹⁷ even though the permanent shareholders of the State association had been "cashed out."

A similar conclusion was reached in West Side Fed. S. & L. Ass'n of Fairview Pk. v. United States, 494 F.2d 404">494 F.2d 404 (6th Cir. 1974) (hereinafter West Side), which in all material respects is identical to the case before us. There, the1982 U.S. Tax Ct. LEXIS 130">*150 issue was whether the statutory merger of a State-chartered savings and loan into a federally chartered mutual savings and loan was a "reorganization" within the meaning of section 368(a)(1)(A). Each savings account in the State association had been exchanged for a savings account of equal value in the Federal association, and each share of capital stock in the State association had been converted into a savings account in the Federal association with a withdrawal value of $ 2,500. The Government argued that this transaction failed to meet the requirement of a continuity of proprietary interest, stressing the fact that prior to the merger, the State association had two distinct classes of contributors to its capital. It also emphasized the fact that (1) savings accounts in the Federal association were withdrawable at any time with little or no restriction, (2) such savings accounts were federally insured, and (3) voting rights attaching to such savings accounts were more restricted 78 T.C. 291">*300 than the rights enjoyed by the former shareholders of the State association.

The court in West Side emphasized that cases dealing with the continuity-of-interest requirement have focused1982 U.S. Tax Ct. LEXIS 130">*151 upon the nature of the interest received and that it need not be identical to the interest given in an exchange. ¹⁸ This being so, and because a savings account is the only proprietary interest available in a Federal mutual savings and loan association, the court stated that "it is improper to ignore the proprietary rights * * * [of holders of these savings accounts] and concentrate only on their rights as creditors." 494 F.2d 404">494 F.2d at 411. The court held that the exchange of savings accounts and stock in the State association for savings accounts in the Federal association satisfied the continuity-of-interest test. Specifically, it found that each owner of a proprietary interest in the State association had acquired a proprietary interest in the Federal association which was definite and material and which represented a substantial part of the value of the stock that was given up.

1982 U.S. Tax Ct. LEXIS 130">*152 The same result was reached by the Court of Claims in Capital S. & L. Ass'n v. United States, 221 Ct. Cl. 557">221 Ct. Cl. 557, 607 F.2d 970">607 F.2d 970 (1979) (hereinafter Capital), also involving the question whether the merger of a savings and loan association having guaranty stock into a mutual savings and loan association ¹⁹ qualified as a reorganization under section 368(a)(1)(A). Pursuant to an agreement of merger, all savings accounts and guaranty stock of the acquired association were converted into voting withdrawable savings accounts in the mutual association. The Government argued that the holders of guaranty stock had "cashed in" or sold their equity interest by accepting withdrawable savings accounts in exchange for the stock and that, therefore, the merger failed to meet the continuity-of-interest test.

1982 U.S. Tax Ct. LEXIS 130">*153 The Court of Claims observed that there were several 78 T.C. 291">*301 problems with the Government's argument that savings accounts in mutual savings and loan associations should be treated simply as debt interests, "beginning with the fact that these accounts are hybrid interests having the seemingly inapposite characteristics of both equity interests and debt interests." Capital S. & L. Ass'n v. United States, 221 Ct. Cl. 557">221 Ct. Cl. at 564, 607 F.2d 970">607 F.2d at 974. As in 494 F.2d 404">West Side Fed. S. & L. Ass'n of Fairview Pk. v. United States, supra, the court noted that in cases involving the continuity-of-interest doctrine the focus must be on the nature of the interest received in an exchange and that savings accounts are the only interests with proprietary and equity rights available in a mutual savings and loan. In holding that the merger in question did qualify as a reorganization under section 368(a)(1)(A), the Court of Claims stated ( Capital S. & L. Ass'n v. United States, 221 Ct. Cl. 557">221 Ct. Cl. at 567, 607 F.2d 970">607 F.2d at 976):

As the law assumes that someone must own an association or corporation, we1982 U.S. Tax Ct. LEXIS 130">*154 join the courts in 494 F.2d 404">West Side, supra, and 448 F.2d 357">Everett, supra, in refusing to reach a decision which illogically implies that * * * [a mutual savings and loan association is] without owners and which may unduly hinder otherwise desirable reorganizations. Though savings accounts are easily converted into cash, as long as the account remains unliquidated, its holders continue their equity investment in the association in the form of share accounts. * * * [Fn. ref. omitted.]

Thus, in these and other cases, ²⁰1982 U.S. Tax Ct. LEXIS 130">*156 the courts have uniformly rejected respondent's argument that the receipt of savings accounts in a mutual savings and loan association in exchange for stock will not satisfy the continuity-of-interest test. The courts have recognized the hybrid nature of accounts in mutual savings and loan associations but have concluded that such proprietary rights as the right to vote, the right to receive pro rata distributions of earnings, and the right to share in distributions of assets upon liquidation are sufficient to cause such accounts to meet the continuity-of-interest requirement. 78 T.C. 291">*302 Respondent cites only one case involving1982 U.S. Tax Ct. LEXIS 130">*155 this question in support of his position, Home Savings & Loan Ass'n v. United States, 514 F.2d 1199">514 F.2d 1199 (9th Cir. 1975), and that case -- involving guaranty stock associations on both sides of the merger transaction -- is readily distinguishable from cases like the instant one where stock in a savings and loan association was exchanged for savings accounts in a mutual savings and loan. ²¹

1982 U.S. Tax Ct. LEXIS 130">*157 We recognize that respondent is not without arguments and that treating savings accounts as "stock" for purposes of the "tax-free" reorganization provisions of the Internal Revenue Code raises a number of logical and practical administrative problems. ²²1982 U.S. Tax Ct. LEXIS 130">*159 If this were a question of first impression, we 78 T.C. 291">*303 would feel free to give greater weight to those problems in reaching our decision. Given the long outstanding and unbroken line of holdings of the several cited judicial authorities, however, that savings accounts in a mutual savings and loan association qualify as "stock," we feel constrained to follow the guidance of those decisions, the first of which is now over 10 years old. A corporate reorganization, in which the stakes are usually very high, requires careful advance planning and, consequently, the need for certainty in the law is great. The practicality of many reorganizations is materially affected, if not determined, by the tax consequences, and the participants need to know the ground rules. The current plight of the savings and loan industry ²³ brings to mind Justice Powell's statement in United States v. Byrum, 408 U.S. 125">408 U.S. 125, 408 U.S. 125">135 (1972):1982 U.S. Tax Ct. LEXIS 130">*158 ²⁴

When a principle of taxation requires re-examination, Congress is better equipped than a court to define precisely the type of conduct which results in tax consequences. When courts readily undertake such tasks, taxpayers may not rely with assurance on what appear to be established rules lest they be subsequently overturned. Legislative enactments, on the other hand, although not always free from ambiguity, at least afford the taxpayers advance warning.

We hold for petitioners. ²⁵

1982 U.S. Tax Ct. LEXIS 130">*160 78 T.C. 291">*304 To reflect the foregoing,

Decision will be entered for the petitioners.