2002 Tax Ct. Memo LEXIS 174">*174 Respondent's motion for partial summary judgment with respect to bad debts will be granted; petitioner's motion for summary judgment will be denied.
MEMORANDUM OPINION
COHEN, Judge: These consolidated cases are before the Court on respondent's Motion for Partial Summary Judgment With Respect to Reserve for Bad Debts and on petitioner's Motion for Summary Judgment pursuant to
Docket No. 4256-98:
Additions to Tax
Sec. 6653 Sec. 6653 Penalty
Year Deficiency (a)(1)(A) (a)(1)(B) Sec. 6661
____ __________ _________ _________ _________
12/31/83 $ 2,406,964 -- -- --
12/31/84 21,943 -- -- --
12/31/85 472,1842002 Tax Ct. Memo LEXIS 174">*175 -- -- --
12/31/86 8,322,020 $ 468,607 * $ 2,098,710
12/31/87 17,295,902 980,439 * --
* 50 percent of the interest due on $ 8,394,838 and $ 15,047,884 for 1986 and 1987, respectively.
Docket No. 4866-98:
Year Deficiency
____ __________
12/31/88 $ 452,426
12/31/89 1,983,005
12/31/90 404,620
12/31/91 772,825
12/31/92 8,017,277
12/31/93 4,300,188
12/31/94 2,900,914
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure. The issue for decision is whether petitioner is entitled to use the reserve method of accounting for bad debts under
Summary judgment is intended to expedite litigation and avoid unnecessary and expensive trials.
Background
During the taxable years 1986 through 1994, Barnett Banks, Inc. (Barnett), 2002 Tax Ct. Memo LEXIS 174">*177 was an accrual basis bank holding company organized and existing under the laws of the State of Florida, with its principal place of business in Jacksonville, Florida. On January 9, 1998, Barnett merged into NB Holdings, a subsidiary of NationsBank Corp., and thereafter was a wholly owned subsidiary of NationsBank Corp. On September 30, 1998, Bank America Corp. merged into NationsBank Corp., and, as the surviving entity, NationsBank Corp. changed its name to Bank America Corp. In April 1999, Bank America Corp. changed its name to Bank of America Corp. Bank of America Corp. & Subsidiaries is the successor in interest to Barnett Banks, Inc. & Subsidiaries.
United First Federal Savings and Loan Association (United First Federal) was a Federal stock savings and loan association, organized under the Home Owners' Loan Act (HOLA), ch. 64, 48 Stat. 128 (1933), and its principal place of business was in Sarasota, Florida. Home Federal Bank of Florida, F.S.B. (Home Federal), was a Federal stock savings bank, organized under the HOLA, and its principal place of business was in St. Petersburg, Florida.
On December 22, 1986, Barnett Bank of Southwest Florida became the successor to United First2002 Tax Ct. Memo LEXIS 174">*178 Federal by conversion of corporate charters under the laws of the State of Florida and became a subsidiary of Barnett. Barnett Bank of Southwest Florida had its principal place of business in Jacksonville, Florida.
On July 26, 1987, Barnett Bank of Pinellas County became the successor to Home Federal by conversion of corporate charters under the laws of the State of Florida and became a subsidiary of Barnett. Barnett Bank of Pinellas County had its principal place of business in Jacksonville, Florida. On September 28, 1996, Barnett Bank of Southwest Florida and Barnett Bank of Pinellas County were merged into Barnett Bank, N. A., a subsidiary of Barnett.
Barnett's Strategic Plan for Increased Market Share in Florida
During the taxable years 1985 to 1988, the stated mission of Barnett, a bank holding company, was to provide the highest quality of services and to use every opportunity to enhance its position as the preeminent financial institution in the State of Florida and as one of the leading financial institutions in the Southeast. The State of Florida was Barnett's primary focus for expansion and growth. One of Barnett's strategic goals in 1985, 1986, and 1987 was to increase2002 Tax Ct. Memo LEXIS 174">*179 its market share of total deposits in all Florida financial institutions. In 1983 and 1984, savings and loan institutions accounted for more than 50 percent of the deposit market share in the 10 largest counties in Florida, including Pinellas County, Hillsborough County, and Sarasota County. In 1985, the savings and loan institutions accounted for more than 50 percent of the deposit market share statewide. In 1985 and 1986, 11 of Florida's top 15 largest financial institutions in terms of total assets were savings and loan institutions.
In the first quarter of 1986, Barnett announced that it had reached separate agreements to acquire United First Federal and Home Federal in transactions that would be significantly larger than any of its prior acquisitions. Barnett, as a bank holding company, could not make a direct acquisition of the stock of United First Federal or Home Federal because of the Federal Reserve Board's policy that precluded a bank holding company from making a direct acquisition of a healthy savings and loan association or Federal savings bank. As a result, United First Federal and Home Federal were required to convert from a Federal savings and loan association and2002 Tax Ct. Memo LEXIS 174">*180 a Federal savings bank, respectively, to State banking corporations in multistep transactions as a condition to obtaining the Federal Reserve Board's approval for the acquisitions.
Barnett's Acquisition of United First Federal
As of June 30, 1986, United First Federal had 38 branch offices in seven Florida counties, with total assets of $ 1.6 billion, total deposits of $ 1.5 billion, and shareholders' equity of $ 80 million.
United First Federal was a member of the Federal Home Loan Bank System (FHLBS) and was subject to supervision and examination by the Federal Home Loan Bank Board (FHLBB). United First Federal's deposits were insured by the Federal Savings and Loan Insurance Corporation (FSLIC).
Pursuant to the plan for merger, United First Federal completed a two-step conversion of corporate charters under the laws of the State of Florida on December 22, 1986. First, United First Federal converted from a Federal stock savings and loan association into a Florida stock savings and loan association. Second, United First Federal converted from a Florida stock savings and loan association into a Florida banking corporation known as Barnett Bank of Southwest Florida.
On December 22, 1986, Barnett2002 Tax Ct. Memo LEXIS 174">*181 Bank of Southwest Florida, N. A., a wholly owned subsidiary of Barnett, merged into Barnett Bank of Southwest Florida (Southwest). Thereafter, Southwest became a subsidiary of Barnett and a member of its consolidated group for Federal income tax purposes.
Southwest's deposits were insured by the Federal Deposit Insurance Corporation (FDIC) and, after enactment of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), Pub. L. 101-73, sec. 301, 103 Stat. 277 (1989), by the Banking Insurance Fund (BIF).
Southwest was the leader in residential lending in its Florida markets and, from 1992 to 1995, was awarded the Sarasota Herald-Tribune's "Reader's Choice Award" as the best mortgage lender. Southwest's board of directors was composed entirely of persons who served as directors of either Barnett Bank of Southwest Florida, N. A., or United First Federal. In addition, Southwest's executive officers included a combination of the senior management of these two financial institutions.
Immediately after the merger, Southwest conducted its business in United First Federal's facilities using the personnel of both United First Federal and Barnett Bank of Southwest Florida, 2002 Tax Ct. Memo LEXIS 174">*182 N.A.
Barnett's Acquisition of Home Federal
As of March 31, 1987, Home Federal had 28 branch offices in four Florida counties and total assets of $ 1.4 billion, total deposits of $ 1.3 billion, and shareholders' equity of $ 115 million. Home Federal was the largest residential mortgage lender in Pinellas County, and, on the basis of total assets, it was the twenty-first largest savings institution in the State of Florida.
Home Federal was a member of the FHLBS and was subject to supervision and examination by the FHLBB. Home Federal's deposits were insured by the FSLIC.
Pursuant to the plan for merger, Home Federal completed a two-step conversion of corporate charters under the laws of the State of Florida on July 26, 1987. First, Home Federal converted from a Federal savings bank into a Florida stock savings and loan association. Second, Home Federal converted from a Florida stock savings and loan association into a Florida banking corporation known as Barnett Bank of Pinellas County.
On July 26, 1987, Barnett Bank of Pinellas County, N. A., a wholly owned subsidiary of Barnett, merged into Barnett Bank of Pinellas County (Pinellas). Thereafter, Pinellas became a subsidiary of2002 Tax Ct. Memo LEXIS 174">*183 Barnett and a member of its consolidated group for Federal income tax purposes.
Pinellas's board of directors consisted of the current directors of Barnett Bank of Pinellas County, N. A., and Home Federal. In addition, Alfred T. May, the president and chief executive officer of Home Federal, served as the president and chief operating officer of Pinellas. Pinellas also continued to use all employees in the combined organization.
Pinellas's deposits were insured by the FDIC and, after FIRREA, by the BIF.
Bad Debt Reserve Method of Accounting
After their acquisitions by Barnett, Southwest and Pinellas were members of Barnett's consolidated group for Federal income tax purposes. Barnett timely filed (pursuant to extensions) a Form 1120, U.S. Corporation Income Tax Return, for each of its taxable years 1986 through 1994. For all relevant years, petitioner used a fiscal year ended December 31.
For each of the taxable years in issue, Barnett took the position that Southwest and Pinellas qualified as "domestic building and loan associations" within the meaning of
On December 11, 1997, a notice of deficiency was issued for petitioner's taxable years 1983 through 1987. In this notice of deficiency, respondent proposed adjustments to Barnett's taxable income to reverse Southwest's and Pinellas's bad debt reserves, which were calculated under
Year Pinellas Southwest Total
____ ________ _________ _____
12/31/86 -- $ 15,848,132 $ 15,848,123
12/31/87 $ 37,408,897 -- 37,408,897
On December 22, 1997, a notice of deficiency was issued for petitioner's taxable years 1988 through 1994. In this notice of deficiency, respondent disallowed Barnett's deductions claimed for Southwest's and Pinellas's bad debt reserves under
Year Pinellas 2002 Tax Ct. Memo LEXIS 174">*185 Southwest Total
____ ________ _________ _____
12/31/88 ($ 1,597,859) $ 2,006,462 $ 408,603
12/31/89 2,369,843 934,603 3,304,446
12/31/90 (1,713,509) 20,778 (1,692,731)
12/31/91 2,196,073 (192,019) 2,004,054
12/31/92 1,854,512 1,544,816 3,399,328
12/31/93 643,535 (914,984) (271,449)
12/31/94 599,905 (151,366) 448,539
Regulation and Supervision
During the taxable years 1986 through 1994, chapter 655 of title XXXVIII of the Florida Code provided the Florida Department of Banking and Finance with the authority to supervise and examine all financial institutions chartered under State law, including savings and loan associations, banks, industrial savings banks, trust companies, international bank agencies or representative offices, and credit unions. Banks and trust companies were subject to the statutory provisions set forth in 2002 Tax Ct. Memo LEXIS 174">*186 chapter 658 of title XXXVIII of the Florida Code. Savings, savings and loan, and building and loan associations were subject to the statutory provisions set forth in chapter 665 of title XXXVIII of the Florida Code. After FIRREA, the FDIC insured the deposits of banking corporations and of savings and loan associations.
Statutory and Regulatory Provisions
The applicable statutory and regulatory provisions are former
(a) Reserve for bad debts. --
(1) In general. -- Except as provided in paragraph
(2), in the case of --
(A) any domestic building and loan association,
(B) any mutual savings bank, or
(C) any cooperative bank without capital stock
organized and operated for mutual purposes and
without2002 Tax Ct. Memo LEXIS 174">*187 profit, there shall be allowed a
deduction for a reasonable addition to a reserve
for bad debts. Such deduction shall be in lieu of
any deduction under section 166(a).
(2) Organization must meet 60-percent asset test of
association or bank referred to in paragraph (1) only
if it meets the requirements of section
7701(a)(19)(C).
(a) When used in this title, where not otherwise distinctly
expressed or manifestly incompatible with the intent
thereof --
* * * * * *
(19) Domestic building and loan association. -- The
term "domestic building and loan association"
means a domestic building and loan association, a
domestic savings and loan association, and a Federal
2002 Tax Ct. Memo LEXIS 174">*188 savings and loan association --
association. -- (a) In general. For taxable years beginning
after July 11, 1969, the term "domestic building and loan
association" means a domestic building and loan association,
a domestic savings and loan association, a Federal savings and
loan association, and any other savings institution chartered
and supervised as a savings and loan or similar association
under Federal or State law which meets the supervisory test
(described in paragraph (b) of this section), the business
operations test (described in paragraph (c) of this section),
and the assets test (described in paragraph (d) of this
section). * * *
Discussion
The nature of the transactions leading to the dispute in these cases is described by petitioner as follows:
The acquisitions of United First Federal and Home Federal were
undertaken pursuant to Barnett's strategic plan to expand its
market share2002 Tax Ct. Memo LEXIS 174">*189 of deposits and real estate lending in the State of
Florida. Barnett would have preferred to acquire these two
thrifts pursuant to their existing charters and continue to
conduct their business without modification. However, a
misguided Federal Reserve Board policy effective at the time of
the acquisitions (but subsequently withdrawn) precluded a bank
holding company from owning an entity chartered as a stock
savings and loan association unless the entity was failing.
Therefore, Barnett was precluded from directly acquiring the
stock of United First Federal and Home Federal. In order to
obtain the Federal Reserve Board's approval of the acquisitions,
United First Federal and Home Federal were required to convert
to state banking corporations. United First Federal was
immediately merged with a newly organized subsidiary of Barnett
that was chartered as a bank under Florida law and continued its
residential lending business in Florida as Southwest. Similarly,
Home Federal was immediately merged with a newly organized
subsidiary of Barnett that was chartered2002 Tax Ct. Memo LEXIS 174">*190 as a bank under Florida
law and continued its residential lending business in Florida as
Pinellas. [Citations omitted.]
The question presented is whether, in carrying out its strategic plan to acquire Southwest and Pinellas, Barnett gave up the favorable tax treatment of accounting for bad debt reserves under
Simply stated, respondent's position is that Southwest and Pinellas lost qualification to use the reserve method of
Petitioner contends that the language of the applicable statutes allows for use of the reserve method of accounting under former
Addressing first the language of
The definition of a "building and loan association" under
Congress again altered the rules for calculating bad debt reserves for building and loan associations by deleting the reference to "loans to members" and replacing it with the supervisory test, business operations test, and assets test, codified in
Respondent asserts that, throughout the evolution of the definition of a domestic building and loan association, the introductory language quoted supra p. 12 has remained in the statute, demonstrating congressional intent to distinguish between entities classified as domestic building and loan associations and banks.
The introductory language of
Petitioner's interpretation of the regulation would have the effect of substituting "any financial institution" for the introductory language in the regulation. The regulation may have been intended to give some flexibility to institutions chartered in States that do not apply the same labels for "building and loan association"; however, to interpret the phrase "similar association" to include any financial institution that meets the supervisory test, business operations test, and assets test of the regulation would require us to ignore the introductory language. We decline to do so in light of the clear intent of Congress to distinguish among financial institutions by incorporating2002 Tax Ct. Memo LEXIS 174">*195 the term "domestic building and loan association" in
Respondent also points to the relationship among
For purposes of sections 582 and 584, the term
"bank" means a bank or trust company incorporated
and doing business under the laws of the United States
(including laws relating to the District of Columbia) or of
any State, a substantial part of the business of which
consists of receiving deposits and making loans and
discounts, or of exercising fiduciary powers similar to
those permitted to national banks under the authority of
the Comptroller of the Currency, and which is subject by
law to supervision and examination by State, or Federal
2002 Tax Ct. Memo LEXIS 174">*196 authority having supervision over banking institutions.
Such term also means a domestic building and loan
association.
(a) Reserve for Bad Debts. --
(1) In general. -- Except as provided in subsection
(c), a bank shall be allowed a deduction for a
reasonable addition to a reserve for bad debts. Such
deduction shall be in lieu of any deduction under
section 166(a).
(2) Bank. -- For purposes of this section --
(A) In general. -- The term "bank"
means any bank (as defined in
than an organization to which
applies. [Emphasis added.]
a domestic or foreign corporation, a substantial portion of
whose business consists of receiving deposits and making loans
and discounts, or of exercising fiduciary powers similar to
those permitted national banks, and who are subject by law to
supervision and examination by State or Federal Authority having
supervision over banking institutions (
purpose of determining the deductions for bad debts, the
term "commercial bank" does not include domestic
building and loan associations, mutual savings banks or
cooperative nonprofit mutual banks (" thrift
institutions"). [H. ConF. Rept. 99-426 (1985), 1986-3
C.B. (Vol. 2) 574; H. ConF. Rept. 99-841 (1986), 2002 Tax Ct. Memo LEXIS 174">*198 1986-3 C.B.
(Vol. 4) 326; emphasis added.]
Although, historically, thrift institutions enjoyed more favorable tax treatment than other financial institutions, Congress recognized in the Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2376, that changes in regulatory policies had expanded the activities of thrift institutions and encouraged other institutions to expand their activities in areas that were traditionally serviced by the thrift industry. H. ConF. Rept. 99-426, supra, 1986-3 C.B. at 581. Acknowledging that other financial institutions were in direct competition with thrift institutions, Congress substantially reduced the bad debt deduction available to thrift institutions. By reducing rather than eliminating the bad debt deduction, "the committee continues to believe that there should be some incentive for thrift institutions to provide residential mortgage loans".
Petitioner relies on several decided cases that, according to petitioner, establish that the laws in this area have been more concerned with the substance of an institution's activities than with the form of its State charter. For example, in
Respondent distinguishes2002 Tax Ct. Memo LEXIS 174">*201 the cases on which petitioner relies and argues that
In Cambridge, the taxpayer was incorporated in Ohio and was recognized and conducted its business as a building and loan association in accordance with the laws of the State of Ohio. The Revenue Act of 1918, ch. 18, sec. 231, 40 Stat. 1076, and the Revenue Act of 1921, ch. 136, sec. 231, 42 Stat. 253, provided an exemption from income tax for building and loan associations but did not further define such an entity. The U.S. Supreme Court accepted the State's classification of a building and loan association in the absence of a definition in the Federal statute, provided that there had not been a "gross misuse of the name".
if a corporation does not substantially meet the generally
recognized criteria of a bona fide building and loan
association, it is not such a tax exempt association as is
contemplated by the statute, regardless of what name it may have
or how it may be designated or classified by the State statute
under2002 Tax Ct. Memo LEXIS 174">*203 which it was organized. [
Respondent asserts that, under the Cambridge analysis, when the Federal statute does not provide a definition, we must rely on the law of the chartering jurisdiction to determine the appropriate definition. Respondent argues that the chartering jurisdiction provides for the separate treatment of entities classified as building and loan associations from that afforded to other financial institutions. Both Southwest and Pinellas were chartered as Florida banking corporations and were, therefore, subject to and operated under the regulatory authority of the Florida Department of Banking and Finance, as were all financial institutions chartered in the State of Florida.
Under the Florida financial institutions code, chapter 655 applies to financial institutions generally and provides for "general regulatory powers to be exercised by the Department of Banking and Finance in relation to the regulation of financial institutions".
2002 Tax Ct. Memo LEXIS 174">*205 Alternatively, petitioner argues that Southwest and Pinellas qualify as "mutual savings banks" as defined in
(a) In General. -- In the case of mutual savings banks,
cooperative banks, domestic building and loan associations,
and other savings institutions chartered and supervised as
savings and loan or similar associations under Federal or
State law, there shall be allowed as deductions in
computing taxable income amounts paid to, or credited to
the accounts of, depositors or holders of accounts as
dividends or interest on their deposits or withdrawable
accounts, if such amounts paid or credited are withdrawable
on demand subject only to customary notice of intention to
withdraw.
(b) Mutual Savings Bank to Include Certain Banks With
Capital Stock. -- For purposes of this part, the term
2002 Tax Ct. Memo LEXIS 174">*206 "mutual savings bank" includes any bank- -
(1) which has capital stock represented by shares, and
(2) which is subject to, and operates under, Federal
or State laws relating to mutual savings bank.
Petitioner argues that Pinellas and Southwest qualify as mutual savings banks because they were chartered as banks with capital stock represented by shares, as required by
As previously discussed, although chapter 655 applies to financial institutions generally, Florida law distinguishes between institutions chartered as mutual savings banks under chapter 665 and those chartered as banks under chapter 658.
The nature of the disputes between the parties in these cases convinces us that the emphasis that respondent places on a charter is justified. If any financial institution were permitted to use the reserve method of accounting under
Petitioner's strategic decision to expand its2002 Tax Ct. Memo LEXIS 174">*209 market share in Florida was undertaken with the knowledge that the acquisition of thrift institutions would require their conversion to banking corporations under Florida law. As the U.S. Supreme Court has often stated: "while a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not, * * * and may not enjoy the benefit of some other route he might have chosen to follow but did not."
Based on the statutory framework and relevant legislative history, we conclude that a financial institution chartered as a bank cannot meet the threshold requirements of
To reflect the foregoing,
An appropriate2002 Tax Ct. Memo LEXIS 174">*210 order will be issued.