2000 Decisions

Opinions of the United

States Court of Appeals

for the Third Circuit

5-19-2000

PNC Bancorp Inc. v. IRS Commissioner

Precedential or Non-Precedential:

Docket 99-6020

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Recommended Citation

"PNC Bancorp Inc. v. IRS Commissioner" (2000). 2000 Decisions. Paper 103.

http://digitalcommons.law.villanova.edu/thirdcircuit_2000/103
Filed May 19, 2000 

UNITED STATES COURT OF APPEALS 

FOR THE THIRD CIRCUIT 

No. 99-6020 

PNC BANCORP, INC., 

Successor to First National Pennsylvania Corporation 

v. 

COMMISSIONER OF INTERNAL REVENUE 

(Tax Court No. 95-16002) 

PNC BANCORP, INC., 

Transferee of Assets of First National Pennsylvania

Corporation 

v. 

COMMISSIONER OF INTERNAL REVENUE 

(Tax Court No. 95-16003) 

PNC BANCORP, INC., 

Successor to United Federal Bancorp, Inc., and 

Subsidiaries 

v. 

COMMISSIONER OF INTERNAL REVENUE 

(Tax Court No. 96-16109) 

PNC BANCORP, INC., 

Transferee of Assets of United Federal Bancorp, Inc., and 

Subsidiaries 

v. 

COMMISSIONER OF INTERNAL REVENUE 

(Tax Court No. 96-16110) 
PNC Bancorp, Inc., as (i) Successor to First National 

Pennsylvania Corporation, (ii) Transferee of Assets of First 

National Pennsylvania Corporation, (iii) Successor to 

United Federal Bancorp, Inc., and Subsidiaries, and (iv) 

Transferee of Assets of United Federal Bancorp, Inc., 

and Subsidiaries, 

 Appellant 

On Appeal from the Commissioner of Internal Revenue, 

Decision of the United States Tax Court 

(Tax Court Nos. 95-16002, 95-16003, 96-16109, 

and 96-16110) 

Tax Court Judge: Honorable Robert P. Ruwe 

Argued October 21, 1999 

Before: SLOVITER, RENDELL, Circuit Judges, 

and BYRNE, District Judge* 

(Filed: May 19, 2000) 

 Robert J. Jones, Esq. (ARGUED) 

 Roger P. Colinvaux, Esq. 

 Arnold & Porter 

 555 12th Street, N.W. 

 Washington, DC 20004 

 Attorneys for Appellant 

 Richard Farber, Esq. 

 Annette M. Wietecha, Esq. 

 (ARGUED) 

 U.S. Department of Justice 

 Tax Division 

 P.O. Box 502 

 Washington, DC 20044 

 Attorneys for Appellee 

_________________________________________________________________ 

* The Honorable Wm. Matthew Byrne, Jr., United States Senior District 

Judge for the Central District of California, sitting by designation. 

 2 
 Michael F. Crotty, Esq. 

 American Bankers Association 

 1120 Connecticut Avenue, N.W. 

 Washington, DC 20036 

 Attorney for Amicus-Appellant 

 American Bankers Association 

 Maureen E. Mahoney, Esq. 

 Latham & Watkins 

 1001 Pennsylvania Avenue, N.W. 

 Suite 1300 

 Washington, DC 20004 

 Attorney for Amicus-Appellant 

 National Association of 

 Manufacturers 

 Ronald W. Blasi, Esq. 

 Georgia State University 

 College of Law 

 P.O. Box 4037 

 Atlanta, GA 30302 

 Attorney for Amicus-Appellant 

 Ronald W. Blasi 

OPINION OF THE COURT 

RENDELL, Circuit Judge. 

In this appeal from a decision of the Tax Court, we are 

asked to determine whether certain costs incurred by 

banks for marketing, researching and originating loans are 

deductible as "ordinary and necessary expenses" as 

provided by section 162 of the Internal Revenue Code, 26 

U.S.C. S 162 (1988), or whether these expenses must be 

capitalized under section 263 of the Code. Two banks that 

were predecessors in interest of appellant PNC Bancorp, 

Inc. deducted these costs as ordinary business expenses. 

The Internal Revenue Service disallowed the deductions and 

issued statutory notices of deficiency. PNC filed petitions for 

redetermination with the Tax Court. The Tax Court 

determined that the expenses in question were not 

deductible, but, instead, must be capitalized and amortized 

 3 
over the life of the subject loans. PNC now appeals from 

this determination. 

We hold that the costs at issue were deductible as 

"ordinary and necessary" expenses of the banking business 

within the meaning of Internal Revenue Code section 162, 

and that these costs do not fall within the purview of 

section 263. Accordingly, we will reverse the judgment of 

the Tax Court. 

I. Genesis of the Dispute 

The costs that the banks seek to deduct are the internal 

and external costs that they incur in connection with the 

issuance of loans to their customers. These costs, 

discussed in more detail below, are a routine part of the 

banks' daily business, and the services procured with these 

outlays have been integral to the basic execution of the 

banking business for decades. 

The general contours of banks' involvement in making 

loans have not changed dramatically in recent years, and 

the relevant sections of the Tax Code have remained largely 

unchanged. Historically, the costs at issue have been 

deductible in the year that they are incurred; however, the 

Commissioner rejected this tax treatment by PNC. Why is 

the Commissioner now insisting upon capitalization of 

these costs? 

There are two relatively recent developments that appear 

to have emboldened the Internal Revenue Service to pursue 

capitalization of such costs. One of these developments is 

the Supreme Court's opinion in INDOPCO, Inc. v. 

Commissioner, 503 U.S. 79 (1992), in which the Court held 

that expenses incurred by a target corporation in the 

course of its friendly acquisition by another entity were not 

currently deductible. See id. at 90. INDOPCO, which

signaled that the Supreme Court's previously announced 

tests for capitalization were not exhaustive, may well have 

been viewed by the IRS as a green light to seek 

capitalization of costs that had previously been considered 

deductible in a number of businesses and industries. This 

phenomenon has not escaped comment from observers. 

See, e.g., W. Curtis Elliott Jr., Capitalization of Operating 

 4 
Expenses After INDOPCO: IRS Strikes Again, S.C. Law., 

Sept./Oct. 1993, at 29, 29, 30 (commenting on the IRS's 

"recently aggressive posture on capitalization" after 

INDOPCO, and noting that while the INDOPCO decision 

itself was not "necessarily troubling," the IRS's 

interpretation of it has stretched far beyond the scenario 

presented in INDOPCO); IRS Loses Battle in INDOPCO War: 

Advertising Remains Deductible, Taxes on Parade, July 16, 

1998, at 1 (describing the "IRS's INDOPCO-fueled 

juggernaut"). Thus, INDOPCO ushered in an era of generally 

more aggressive IRS pursuit of capitalization. 

An additional development may have prompted the IRS's 

assertive posture in the more specific case of the loan 

origination costs at issue here. This second development 

was the Financial Accounting Standards Board's 

promulgation of a new standard for financial accounting 

treatment of loan origination costs, Statement of Financial 

Accounting Standards No. 91 ("SFAS 91").1 Beginning in the 

late 1980s, SFAS 91 required for the first time that, for 

financial accounting purposes, loan fee income and the 

costs incurred in connection with loan origination should 

be deferred and recognized over the life of the loan, rather 

than being recognized in full in the year the loan closed.2 

The FASB's authority extends only to financial accounting 

standards and not to tax accounting standards. For the 

first few years of SFAS 91's existence, the IRS did not 

require capitalization of the loan origination costs described 

in this financial accounting standard. However, the IRS 

apparently viewed INDOPCO as a reason to pursue 

capitalization of the costs that SFAS 91 requires to be 

deferred.3 Thus, the stage for this litigation was set. 

_________________________________________________________________ 

1. The Financial Accounting Standards Board ("FASB") is an independent 

private sector organization that establishes standards for financial 

accounting and reporting. The Securities and Exchange Commission 

recognizes the FASB's financial accounting standards as authoritative. 

See UAW Local No. 1697 v. Skinner Engine Co., 188 F.3d 130, 136 n.4 

(3d Cir. 1999). 

2. SFAS 91 became effective for accounting years that began after 

December 15, 1987. 

3. Although the Commissioner and the Tax Court both claimed that they 

were not relying on the financial accounting standards of SFAS 91 in 

 5 
II. Factual Background 

PNC Bancorp, Inc. (PNC) is a bank holding company 

incorporated in Delaware. See A. at 102. Two smaller 

banking entities, First National Pennsylvania Corporation 

(FNPC) and United Federal Bancorp, Inc. (UFB), were

merged into PNC in 1992 and 1994, respectively, and PNC 

succeeded to the liabilities of both these companies. See A. 

at 103, 105. The activities at issue in this case occurred 

before the mergers and were performed by FNPC and UFB 

or their subsidiaries.4 

The costs challenged in this appeal were incurred by both 

banks in connection with the origination of loans. 5 There 

are two categories of such "loan origination costs," as they 

have been called.6 The first category includes payments 

made to third parties for activities that help the bank 

determine whether to approve a loan (credit screening, 

property reports, and appraisals) and for the recording of 

security interests when the bank decides to issue a secured 

_________________________________________________________________ 

determining the tax treatment of the costs at issue, the IRS appears to 

have imported the result of these financial accounting standards into the 

tax arena without engaging in independent analysis of why these costs 

should be subject to different tax treatment than the majority of 

everyday business costs, and without considering the secondary tax 

ramifications that would flow from a requirement of capitalization. See 

infra note 16; see also Tr. of Oral Argument at 27 (conceding that SFAS 

91 effectively determined where the IRS would "draw the line" between 

deductibility and capitalization in this case). 

4. For FNPC, the tax years at issue are 1988 and 1990; for UFB, the 

years at issue are 1990, 1991, 1992 and 1993. 

5. The IRS contested FNPC's claimed deductions for origination of both 

consumer and commercial loans, but contested UFB's deductions only 

for costs incurred in originating consumer loans. See A. at 137. The Tax 

Court opinion noted that it was unclear why the IRS pursued 

commercial loan activities only in the case of one of the two banks. See 

PNC Bancorp, Inc. v. Commissioner, 110 T.C. 349, 355 n.9 (1998). 

6. The parties disagree as to the appropriate name for this collection of 

costs -- the Commissioner prefers "loan origination expenses," while PNC 

prefers "risk management and marketing costs." However, as there is no 

dispute about which costs are included in this group, the disagreement 

is largely semantic. In this opinion, we will use the terms "loan 

origination costs" or "loan marketing costs" to denote the costs at issue. 

 6 
loan. The second category consists of internal costs, namely 

that portion of employee salaries and benefits that can be 

attributed to time spent completing and reviewing loan 

applications, and to other efforts connected with loan 

marketing and origination.7 The Commissioner pursued 

capitalization of loan origination costs only when those 

costs were incurred in connection with a loan that was later 

approved; the Commissioner allowed the banks to deduct 

origination costs expended in connection with loans that 

were not successfully approved. See PNC Bancorp, Inc. v. 

Commissioner, 110 T.C. 349, 359, 362 (1998); see also Tr. 

of Oral Argument at 7. 

Loan interest constituted the largest source of revenue 

for each bank during the relevant time period, and interest 

on deposits and other borrowing constituted the largest 

expense. See A. at 108.8 It is undisputed that banks 

generally can be profitable only if they successfully manage 

their "net interest margin" -- the difference between 

interest earned and interest paid. A profitable bank's net 

interest margin plus its revenues from fees and other 

sources must exceed its losses on loans and investments. 

See A. at 108. 

Bank personnel routinely undertook loan marketing 

activities in tandem with other marketing and customer 

service functions. Both tellers and "platform employees" 

(those bank employees who have desks apart from the teller 

windows) were encouraged to "cross-sell," that is, to sell 

multiple products to existing and new customers who came 

to the bank in search of a particular product or service. For 

example, if a new customer opened a checking and savings 

account, the bank representative might also suggest a 

certificate of deposit or a loan. Likewise, when a consumer 

applied for a loan, the employee taking the application was 

_________________________________________________________________ 

7. The parties have stipulated to most of the facts concerning the loan 

origination activities and the role that loan origination plays in the 

banking business. 

8. As the Tax Court put it, the banks' "principal businesses . . . 

consisted of accepting demand and time deposits and using the amounts 

deposited, together with other funds, to make loans." PNC, 110 T.C. at 

351. 

 7 
also expected to sell other bank products and services 

(such as checking accounts, credit lines, or ATM cards) 

during that same session. The banks provided financial 

incentives to their tellers and platform employees for each 

successful "cross-sale," see A. at 110, and such "crosssales" were a routine part of each bank's daily business.9 

Before 1988, FNPC and UFB treated their loan 

origination costs in the same manner as their other routine 

expenses, both for tax accounting and financial accounting 

purposes. That is, they reported these costs for the tax year 

(and the fiscal year) in which the costs were incurred. This 

practice was apparently standard in the banking industry 

at that time. See A. at 169. In 1988, following the

promulgation of SFAS 91, FNPC and UFB began to separate 

out their loan origination costs for financial accounting and 

reporting purposes in order to conform with SFAS 91's 

requirements. However, both banks continued to deduct 

loan origination costs for tax purposes in the tax year in 

which the loan closed. See A. at 124, 134. It is these 

deductions that the Commissioner and the Tax Court 

disallowed. 

III. Jurisdiction and Standard of Review 

The Tax Court had jurisdiction over PNC's petitions for 

redetermination pursuant to 26 U.S.C. SS 6213 and 7442. 

We have appellate jurisdiction pursuant to 26 U.S.C. 

S 7482(a)(1), which states that "[t]he United States Courts of 

Appeals . . . shall have exclusive jurisdiction to review the 

decisions of the Tax Court . . . in the same manner and to 

the same extent as decisions of the district courts in civil 

actions tried without a jury." Thus, we have plenary review 

over the Tax Court's findings of law, including its

construction and application of the Internal Revenue Code. 

See National Starch & Chem. Corp. v. Commissioner, 918 

F.2d 426, 428 (3d Cir. 1990), aff 'd, INDOPCO, Inc. v. 

Commissioner, 503 U.S. 79 (1992). We review the Tax

Court's factual findings and inferences for clear error. See 

_________________________________________________________________ 

9. At UFB, the average number of products and services sold to a new 

customer at a loan session was six, including the loan. See A. at 53. 

 8 
id.; see also Pleasant Summit Land Corp. v. Commissioner, 

863 F.2d 263, 268 (3d Cir. 1988). 

IV. Discussion 

There is a fundamental distinction between business

expenses and capital outlays. The primary consequence of 

characterizing a payment as a business expense or a

capital outlay "concerns the timing of the taxpayer's cost 

recovery," INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 83 

(1992): business expenses are deductible in the year in 

which they are incurred, whereas a capital outlay is 

generally "amortized and depreciated over the life of the 

relevant asset, or, where no specific asset or useful life can 

be ascertained, is deducted upon dissolution of the

enterprise," id. at 83-84. 

Two sections of the Internal Revenue Code address the 

deductibility vel non of expenditures such as those incurred 

by FNPC and UFB. Section 162 of the Internal Revenue 

Code provides in pertinent part: "There shall be allowed as 

a deduction all the ordinary and necessary expenses paid 

or incurred during the taxable year in carrying on any trade 

or business . . ." 26 U.S.C. S 162(a). Section 263 of the 

Code states that capital expenditures, i.e.,"amount[s] paid 

out for new buildings or for permanent improvements or 

betterments made to increase the value of any property or 

estate," cannot be currently deducted. 26 U.S.C.S 263(a)(1). 

It is true that these two sections are neither all-inclusive 

nor mutually exclusive. See General Bancshares Corp. v. 

Commissioner, 326 F.2d 712, 716 (8th Cir. 1964) (written 

by then-Judge Blackmun). For example, it is possible that 

an expense that might appear to be deductible under

section 162(a) might instead be required to be capitalized 

because it also properly falls under the description provided 

by section 263(a). If an expense were to fall under the 

language of section 263(a), that section would "trump" the 

deductibility provision of section 162(a) and the expense 

would have to be capitalized. Thus, in order to be 

deductible, the expense must both be "ordinary and 

necessary" within the meaning of section 162(a) and fall 

outside the group of capital expenditures envisioned by 

 9 
section 263(a).10 Nonetheless, the two sections represent the 

archetypes of the two opposing alternatives for tax

treatment of expenditures -- deduction and capitalization 

-- and, ordinarily, an expenditure will fall under one or the 

other section, not both. 

The taxpayer bears the burden of showing that a given 

expenditure is deductible. See Interstate Transit Lines v. 

Commissioner, 319 U.S. 590, 593 (1943), quoted in 

INDOPCO, 503 U.S. at 84. In order to demonstrate 

deductibility under section 162(a) of the Code, the taxpayer 

must meet a five-part test. "To qualify as an allowable 

deduction under S 162(a) . . . , an item must (1) be `paid or 

incurred during the taxable year,' (2) be for `carrying on any 

trade or business,' (3) be an `expense,' (4) be a`necessary' 

expense, and (5) be an `ordinary' expense." Commissioner v. 

Lincoln Sav. & Loan Ass'n, 403 U.S. 345, 352 (1971). It is 

clear that PNC's loan origination expenses can satisfy the 

first four parts of this test.11 The question before us under 

S 162, then, is whether these expenses qualify as "ordinary" 

business expenses within the meaning of that section. 

In determining what expenditures qualify as "ordinary," 

we must look to the particular facts of the case before us, 

including the particular puzzle posed by the circumstances 

of the banking industry. As Justice Cardozo stated nearly 

seventy years ago in interpreting an earlier version of this 

long-standing Code provision, ordinariness is "a variable 

affected by time and place and circumstance." Welch v. 

Helvering, 290 U.S. 111, 113-14 (1933). In interpreting the 

_________________________________________________________________ 

10. Section 161 of the Code provides the appropriate method for reading 

the two provisions in sequence: "In computing taxable income [ ], there 

shall be allowed as deductions the items specified in this part, subject 

to the exceptions provided in part IX (sec. 261 and following, relating to 

items not deductible)." 26 U.S.C. S 161. Therefore, an expense that is 

judged ordinary and necessary under section 162 can be deducted only 

if it also does not trigger any of the capitalization provisions beginning 

in section 261. 

11. The requisite showing that an expense is"necessary" is a minimally 

burdensome one; to meet it, a taxpayer need show only that the 

expenditures were "appropriate and helpful." Welch v. Helvering, 290 

U.S. 111, 113 (1933) (citing McCulloch v. Maryland, 17 U.S. (4 Wheat.) 

316 (1819)). 

 10 
Code, we should not stray from the moorings of the 

"natural and common meaning" of the term "ordinary," id. 

at 114, and in doing so must examine the nature of the 

day-to-day operations of the particular business being 

considered. See also Deputy v. du Pont, 308 U.S. 488, 495- 

96 (1940) (stating that each case "turns on its special 

facts," and that an expense that is ordinary-- "normal, 

usual, or customary" -- in one business may not be 

ordinary in another). Justice Cardozo's oft-quoted words 

regarding the heavily case-specific nature of this inquiry are 

no less appropriate today than they were in 1933: 

 Here, indeed, as so often in other branches of the law, 

 the decisive distinctions are those of degree and not of 

 kind. One struggles in vain for any verbal formula that 

 will supply a ready touchstone. The standard set up by 

 the statute is not a rule of law; it is rather a way of life. 

 Life in all its fullness must supply the answer to the 

 riddle. 

Welch, 290 U.S. at 114-15; see also Commissioner v. Lincoln 

Sav. & Loan Ass'n, 403 U.S. 345, 353 (1971). Accordingly, 

we pursue a real-life inquiry into whether the expenditures 

associated with loan marketing and origination are 

"ordinary" expenses incurred in the day-to-day 

maintenance of a bank's business. 

The Commissioner has conceded that loan interest was 

the banks' largest revenue source during the period in 

question, and that interest payments on deposits and other 

borrowing were their largest expense. There is no reason to 

suppose that this time period was any different from any 

other in this regard. Further, maximizing the "net interest 

margin" -- the difference between interest received and 

interest paid out -- is the principal manner in which banks 

earn their keep. As the Tax Court stated, "[t]he principal 

businesses of [the banks] consisted of accepting demand 

and time deposits and using the amounts deposited, 

together with other funds, to make loans." PNC, 110 T.C. at 

351. Modern banks are essentially dealers in money. See 

United States v. Philadelphia Nat'l Bank, 374 U.S. 321, 326, 

327 n.5 (1963). 

Given this context, the ordinary nature of the costs at 

issue, routinely incurred in the banks' businesses, would 

 11 
seem clear. In order to ensure deductibility, however, we 

must also ascertain whether these costs were expended for 

betterments to increase the value of property in a way that 

would require these costs' capitalization underS 263. We 

cannot conclude that in performing credit checks, 

appraisals, and other tasks intended to assess the 

profitability of a loan, the banks "stepped out of [their] 

normal method of doing business" so as to render the 

expenditures at issue capital in nature. Encyclopaedia 

Britannica, Inc. v. Commissioner, 685 F.2d 212, 217 (7th 

Cir. 1982). As we stated in National Starch, an important 

determination is whether given expenditures "relate to the 

corporation's operations and betterment into the indefinite 

future," indicating the need for capitalization, or are instead 

geared toward "income production or other current needs," 

suggesting deductibility. National Starch & Chem. Corp. v. 

Commissioner, 918 F.2d 426, 433 (3d Cir. 1990), aff 'd, 

INDOPCO, Inc. v. Commissioner, 503 U.S. 79 (1992). The 

facts before us demonstrate that loan operations are the 

primary method of income production for the subject

banks. We have no doubt that the expenses incurred in 

loan origination were normal and routine "in the particular 

business" of banking. See Deputy v. du Pont , 308 U.S. at 

496. 

The Commissioner argues, and the Tax Court found, that 

the Supreme Court's decision in Lincoln Savings requires a 

different result. We disagree. In Lincoln Savings, the 

Supreme Court concluded that payments made by Lincoln 

Savings and Loan Association into a "Secondary Reserve" 

fund at the Federal Savings and Loan Insurance 

Corporation (FSLIC) were not deductible as ordinary

business expenditures. See Lincoln Savings, 403 U.S. at 

354, 359. In so holding, the Court upheld the IRS's

distinction between payments that Lincoln made into the 

FSLIC's "Primary Reserve," which the IRS had found to be 

deductible as ordinary and necessary expenses, and those 

payments made into the "Secondary Reserve," found to be 

capital expenditures. The Court engaged in an extensive 

analysis of the nature of each reserve fund and the

premium payments made into each by Lincoln Savings and 

other similarly situated FSLIC-insured institutions. The 

Court noted that the "only concern" was whether the

 12 
premium payment to the Secondary Reserve "was an 

expense and an ordinary one within the meaning ofS 162(a) 

of the Code." Lincoln Savings, 403 U.S. at 354. The Court 

noted that the fact that many institutions were required to 

make such a Secondary Reserve premium did not render 

that premium an ordinary expense, see id. at 358; nor did 

the fact that the premium could have some ensuing benefit 

to Lincoln Savings, in and of itself, render the premium a 

capital expenditure, see id. at 354 ("many expenses

concededly deductible have prospective effect beyond the 

taxable year"). Rather, the Court focused on what the 

payment represented in the context of Lincoln Savings' 

business and of the "structure and operation of FSLIC's 

reserves": 

 What is important and controlling, we feel, is that the 

 [Secondary Reserve] payment serves to create or 

 enhance for Lincoln what is essentially a separate and 

 distinct additional asset and that, as an inevitable 

 consequence, the payment is capital in nature and not 

 an expense, let alone an ordinary expense, deductible 

 under S 162(a) in the absence of other factors not 

 established here. 

Id.12 Whereas Lincoln Savings and the other insured

institutions had no property interest in the Primary 

Reserve, each did have an earmarked property interest in 

the Secondary Reserve that was carried as an asset on each 

institution's books, was enhanced by each institution's 

contribution, and was refundable to that institution in 

certain circumstances. 

In the case at bar, the Tax Court concluded without any 

elaboration that the consumer and commercial loans 

"clearly" were separate and distinct assets of the banks, see 

PNC, 110 T.C. at 364, and that the costs incurred in 

originating and processing the loans "created" these 

_________________________________________________________________ 

12. Interestingly, while the Court did not discuss the issue in terms of 

the provisions of S 263, in determining that the asset was "capital in 

nature," the Court necessarily engrafted its thinking on the meaning of 

capital assets under that section of the Code. In fact, the Supreme Court 

has subsequently described Lincoln Savings' holding as stemming from 

an analysis of S 263 as well as S 162. See INDOPCO, 503 U.S. at 86-87. 

 13 
separate and distinct assets, see id. at 366. We believe that 

the Tax Court took too broad a reading of what Lincoln 

Savings meant by "separate and distinct assets," as well as 

an overbroad reading of what can be said to "create" such 

assets. 

The Secondary Reserve fund in Lincoln Savings was a 

"separate and distinct asset" in two important ways that 

distinguish it from FNPC's and UFB's loans, the assets in 

question here. First, the Secondary Reserve fund was an 

asset that existed quite apart from Lincoln's main daily 

business of taking deposits and making loans; second, the 

fund was an asset that, although it existed within the 

FSLIC, was nonetheless separate from the FSLIC's other 

revenues and distinctly earmarked as Lincoln's property. 

The Tax Court's broad reading of Lincoln Savings essentially 

treats the term "separate and distinct asset" as if it extends 

to cover any identifiable asset. We do not subscribe to this 

reading of Lincoln Savings. 

Furthermore, we do not agree that the marketing and

origination activities actually "created" the banks' loans in 

the same way that the activities in Lincoln Savings created 

the Secondary Reserve fund. In the instant case, the Tax 

Court proceeded from the clearly accurate premise that the 

expenses in question were associated with the loans, 

incurred in connection with the acquisition of the loans, or 

"directly related to the creation of the loans," PNC, 110 T.C. 

at 368, to the faulty conclusion that these expenses 

themselves created the loans. See id. at 364-68. We

conclude that the term "create" does not stretch this far. In 

Lincoln Savings, it was the payments themselves that 

formed the corpus of the Secondary Reserve; therefore, it 

naturally follows that these payments "created" the reserve 

fund. In PNC's case, however, the expenses are merely 

costs associated with the origination of the loans; the 

expenses themselves do not become part of the balance of 

the loan. PNC argues persuasively that the Tax Court's 

interpretation of the Lincoln Savings language is 

inappropriately expansive: 

 While purporting to apply the Lincoln Savings 

 language, both the Tax Court and the government 

 effectively have transformed that language, by subtle 

 14 
 but significant degrees, from a test based on whether 

 a cost "creates" a separate and distinct asset, into a 

 much more sweeping test that would mandate 

 capitalization of costs incurred "in connection with" or 

 "with respect to" the acquisition of an asset. 

PNC Reply Br. at 4. We decline to follow the Tax Court's 

broad interpretation, for to do so would be to expand the 

type of costs that must be capitalized so as to drastically 

limit what might be considered as "ordinary and necessary" 

expenses. We conclude, therefore, that the loan origination 

expenses were ordinary expenses and that they did not 

"create or enhance a separate and distinct asset" within the 

meaning of Lincoln Savings. 

A line of federal appellate opinions subsequent to Lincoln 

Savings, involving factual scenarios not that different from 

the one before us, supports our finding that Lincoln Savings 

does not compel a conclusion that FNPC's and UFB's costs 

should be capitalized. These cases, from the Fourth, Eighth 

and Tenth Circuit Courts of Appeals, address the 

deductibility of costs incurred in connection with credit 

card issuance. In Iowa-Des Moines National Bank v. 

Commissioner, 592 F.2d 433 (8th Cir. 1979), the Eighth 

Circuit Court of Appeals found that payments by banks to 

third parties who provided the banks with credit 

information on prospective credit card customers were 

deductible expenses under S 162. See id. at 436. The court 

found that "[p]erhaps the most significant factor is that the 

payments were for a service (credit screening) that could 

have been performed by personnel employed by the 

[banks]." Id. Because "[c]redit screening is a necessary and 

ordinary part of the banking business . . . not a capital 

expenditure," the Eighth Circuit Court of Appeals found 

that fees paid to third parties for credit screening were 

deductible. Id. The Iowa-Des Moines court seemed to

assume that such expenditures would a fortiori be 

deductible if the bank's personnel were to perform the 

credit screens themselves.13 The Fourth and Tenth Circuit 

_________________________________________________________________ 

13. The Eighth Circuit Court of Appeals also emphasized the "short 

useful life" of this credit information as a factor weighing in favor of 

deductibility. Iowa-Des Moines, 592 F.2d at 436. 

 15 
Courts of Appeals have reached similar conclusions. In First 

National Bank of South Carolina v. United States, 558 F.2d 

721 (4th Cir. 1977) (per curiam), the Fourth Circuit Court 

of Appeals permitted the taxpayer bank to deduct start-up 

assessments paid to a nonprofit association formed to 

enable banks to combine their efforts in entering the credit 

card field. See id. at 723. The association was charged with 

centralizing billing and recordkeeping for the banks. The 

Fourth Circuit Court of Appeals characterized the credit 

card accounts that were the focus of this activity as being 

a type of loan. See id. at 722. In Colorado Springs National 

Bank v. United States, 505 F.2d 1185 (10th Cir. 1974), the 

Tenth Circuit Court of Appeals allowed the deduction of 

pre-operation expenditures for a nonprofit credit cardrelated association that would cover expenses such as 

computer costs, advertising, credit screening, and clerical 

services. See id. at 1193. The Colorado Springs court found 

that these expenses did not "create or enhance . . . a 

separate and distinct additional asset," reasoning as 

follows: 

 The start-up expenditures here challenged did not 

 create a property interest. They produced nothing 

 corporeal or salable. They are recurring. At the most 

 they introduced a more efficient method of conducting 

 an old business. . . . 

 . . . [T]he use of bank credit cards in consumer 

 transactions is a normal part of the banking business. 

 The challenged expenditures were for the continuation 

 of an existing business and for the preservation and 

 improvement of existing income. Hence, they were 

 ordinary expenses. 

Id. at 1192-93. 

In the case before us, the Tax Court distinguished these 

"credit card" cases, stating that they were inapposite to our 

fact pattern because in those cases, no "separate and 

distinct asset" was created, while in PNC's case, such an 

asset was created. As we have discussed above, we do not 

agree that the loan origination expenditures created distinct 

assets, any more so than did the expenditures incurred in 

entering into the credit card business. In fact, wefind that 

 16 
PNC's situation presents an even stronger case for 

deductibility than do the credit card cases. In the credit 

card cases, the taxpayers were starting up new programs 

within their businesses, or at the very least, new methods 

of performing old tasks. In contrast, FNPC and UFB 

incurred the challenged costs in their routine selling and 

marketing of normal loans in the traditional ways that 

banks have been using for many decades.14 Thus, FNPC's 

and UFB's costs bear far more of the indicia of 

"ordinariness," and fewer of the indicia of"creating" 

something, than do the start-up costs described in the 

credit card cases. 

The remaining question, then, is whether either the

Financial Accounting Standards Board's adoption of SFAS 

91 or the Supreme Court's pronouncement on deductibility 

in INDOPCO, both of which developments occurred after the 

decisions in Lincoln Savings and the credit card cases, 

would alter the calculus of deductibility versus 

capitalization in PNC's case. We conclude that the existence 

of SFAS 91 has little, if any, bearing on the appropriate tax 

analysis, and that the Supreme Court's decision in 

INDOPCO, while clearly relevant, does not change the result 

in the case at bar. 

The Supreme Court has held that financial accounting 

standards such as SFAS 91 do not dictate tax treatment of 

income and expenditures. See Thor Power Tool Co. v.

Commissioner, 439 U.S. 522, 542-43, 544 (1979) 

(discussing the "vastly different objectives thatfinancial and 

tax accounting have" and stating that "[g]iven this diversity, 

even contrariety, of objectives, any presumptive equivalency 

between tax and financial accounting would be 

unacceptable" and would "create insurmountable 

difficulties of tax administration"). The IRS concedes that 

"financial accounting rules are not controlling for federal 

_________________________________________________________________ 

14. As the Tax Court decision that was affirmed by the Eighth Circuit 

Court of Appeals in Iowa-Des Moines stated, costs that are "merely 

related to the active conduct of an existing business and [do] not create 

or enhance a separate and distinct asset or property interest" are 

appropriate for deduction. Iowa-Des Moines Nat'l Bank v. Commissioner, 

68 T.C. 872, 879 (1977), cited in PNC, 110 T.C. at 365. 

 17 
tax purposes," IRS Br. at 28 n.4 (citing PNC , 110 T.C. at 

364 n.15), and states that "[n]either the Commissioner's 

deficiency determination nor the Tax Court decision was 

based on the provisions of SFAS 91," id. Although SFAS 91 

may have served as a catalyst for the IRS's desire to seek 

capitalization of the costs at issue here, and may have been 

considered by the IRS in determining where to draw the 

line between current-year and deferred costs, see supra 

note 3, the IRS disavows any argument that the financial 

accounting standards should dictate tax treatment, see IRS 

Br. at 27-28 & n.4. Further, as with the financial 

accounting standards at issue in Thor Power, it is clear that 

the reasons for SFAS 91's requirement that loan origination 

costs be deferred are reasons wholly specific to the realm of 

financial accounting,15 and thus those financial accounting 

standards do not affect our tax analysis.16 

_________________________________________________________________ 

15. SFAS 91 was motivated by a concern that the structure of certain 

banks' loan agreements could lead to the illusion that these banks and 

their customers were in better financial condition than they actually 

were. Specifically, SFAS 91 was designed to address the practices of 

banks that charged unusually high fees up front as conditions for the 

closing of a loan (e.g., high "points" on a mortgage) in exchange for 

lower 

interest rates later on; these practices were known as "teaser" rate 

financing. See A. at 173. These practices"arguably allowed individuals 

to qualify for loans in greater amounts than they would otherwise be 

able to secure," id., and also overstated the income from a loan in its 

first year and understated its income in later years. The Financial 

Accounting Standards Board, concerned about these ramifications, 

therefore required companies to defer fees over the life of the loan. SFAS 

91 was worded to include the deferral of costs only after industry 

representatives protested that it would be unfair to the industries to 

have to defer the fees they received without also being allowed to defer 

the costs they incurred. See A. at 174. 

16. In fact, we conclude that the IRS's wholesale importation of the line 

drawn by the financial accounting standards creates tax consequences 

that the Commissioner appears not to have considered. For example, if 

the loan origination costs were required to be capitalized, it would seem 

to follow that these costs would have to be included in the basis of each 

loan. Such inclusions would apparently be a departure from current 

practice. Cf. Rev. Rul. 89-122, 1989-2 C.B. 200 (apparently assuming 

that the bank's basis in a loan is equal to the money advanced by the 

bank, without any adjustments for origination costs). The calculations 

 18 
Nor do we view the Supreme Court's decision in INDOPCO 

as requiring a different result regarding the deductibility of 

the banks' costs. In INDOPCO, the Supreme Court required 

capitalization of the expenditures incurred by the target 

corporation during a planned friendly takeover by another 

company. See INDOPCO, 503 U.S. at 90. The Supreme 

Court was careful to emphasize in INDOPCO, as it had in 

Lincoln Savings, that the capitalization versus deductibility 

inquiry was heavily fact-based. See id. at 86 (citing Welch 

v. Helvering, 290 U.S. 111, 114 (1933) and Deputy v. du 

Pont, 308 U.S. 488, 496 (1940)). The Supreme Court in 

INDOPCO downplayed the importance of the "creation of a 

separate and distinct asset" described in Lincoln Savings, 

clarifying that it was not an exclusive test: 

 Lincoln Savings stands for the simple proposition that 

 a taxpayer's expenditure that "serves to create or 

 enhance . . . a separate and distinct" asset should be 

 capitalized under S 263. It by no means follows, 

 however, that only expenditures that create or enhance 

 separate and distinct assets are to be capitalized under 

 S 263. 

INDOPCO, 503 U.S. at 86-87. The Court reasoned that, 

while in the Lincoln Savings setting the Court had seemed 

to attach limited significance to the concept of"benefit," see 

INDOPCO, 503 U.S. at 87 (quoting Lincoln Savings, 403 

U.S. at 354), in the merger situation presented in INDOPCO 

a "future benefit" analysis was relevant and appropriate 

since the "resource-related benefits" to be reaped from the 

merger were of considerable importance, INDOPCO , 503 

U.S. at 88. In the INDOPCO context of a friendly takeover, 

_________________________________________________________________ 

involved would presumably complicate the transfer of loans from one 

lending institution to another. However, the IRS conceded at oral 

argument that a requirement of capitalization of loan origination costs 

would probably mean that these complex basis adjustments would need 

to be made. See Tr. of Oral Argument at 34. The IRS's apparent failure 

to consider these and other tax ramifications of capitalization suggests 

that the IRS's borrowing of the line that the SFAS 91 standards draw 

between current-year costs and deferred costs was not based on any 

independent tax analysis, but was simply a "bootstrapping" of the 

financial accounting standards into the tax arena. 

 19 
the Court found that one key inquiry was whether the 

money that the target corporation had spent on takeoverrelated expenditures was spent primarily for a "future 

benefit" extending beyond the tax year, rather than for the 

needs of current income production. The Court stated: 

 Although the mere presence of an incidental future 

 benefit -- "some future aspect" -- may not warrant 

 capitalization, a taxpayer's realization of benefits 

 beyond the year in which the expenditure is incurred is 

 undeniably important in determining whether the 

 appropriate tax treatment is immediate deduction or 

 capitalization. 

Id. at 87. 

As was recognized in several of the "credit card" cases 

discussed above, these circumstances are simply not

presented by a bank's credit-issuing activities. The Eighth 

Circuit Court of Appeals in Iowa-Des Moines, anticipating 

the "future benefit" concerns later stated in INDOPCO, 

emphasized the "short useful life" of credit information as a 

reason for deductibility. Iowa-Des Moines, 592 F.2d at 436. 

The Iowa court stated that the prospective future benefit 

that could accrue beyond the taxable year as a result of 

credit screening was "very slight," and thus capitalization 

was "not easily supported." Id. In National Starch, the 

decision that the Supreme Court affirmed in INDOPCO, we 

found that these credit card cases contained the seed of the 

"future benefit" analysis, citing these cases as evidence that 

several Courts of Appeals "look[ed] to whether an ensuing 

benefit was created to determine whether the expense was 

ordinary and necessary," National Starch, 918 F.2d at 431, 

and that these courts found that future benefit was not 

substantial in situations similar to the case at bar. See id. 

(citing Iowa-Des Moines and Colorado Springs). We conclude 

that the credit card cases not only continue to have vitality 

after INDOPCO, but in fact anticipated some of the concerns 

addressed by INDOPCO. 

We also conclude that the Tax Court erred in its 

interpretation of the "future benefit" analysis by relying on 

the fact that the loan itself was usually of several years' 

duration and by reasoning that the loan origination costs 

 20 
were, thus, essentially directed at future benefit. The Tax 

Court stated: "While the useful life of a credit report and 

other financial data may be of short duration, the useful life 

of the asset they serve to create is not." PNC, 110 T.C. at 

371. However, that analysis depends on the Tax Court's 

earlier assumption that the loan origination expenses 

actually created a "separate and distinct asset." Stripped of 

this assumption, the Tax Court's analysis is not 

supportable.17 

In addition, we must remember that the "future benefit" 

analysis adopted in INDOPCO is not meant as a talismanic, 

bright-line test. See A.E. Staley Mfg. Co. v. Commissioner, 

119 F.3d 482, 489 (7th Cir. 1997) ("[T]he Court did not 

purport to be creating a talismanic test that an expenditure 

must be capitalized if it creates some future benefit."). 

Rather, the INDOPCO analysis demonstrates the contextual, 

case-by-case approach to determining whether an 

expenditure better fits under the "ordinary and necessary" 

language of section 162(a) or the "permanent improvements 

or betterments" language of 263(a). We conclude that the 

loan origination expenses incurred by UFB and FNPC have 

the characteristics of the former, rather than the latter, 

statutory language. 

As described above, the loan marketing activities at issue 

here lie at the very core of the banks' recurring, routine 

day-to-day business. The Commissioner has not been able 

to articulate a principled reason why these normal costs of 

doing business must be capitalized, while other ordinary 

banking costs need not be. Instead, the Commissioner 

relies on the line drawn by SFAS 91, a standard whose 

rationale we conclude is far removed from the concerns of 

the tax system. See, e.g., IRS Br. at 27 ("It should be noted 

_________________________________________________________________ 

17. The Tax Court's "future benefit" discussion also reflects another 

problematic assumption, i.e., that the capitalization requirement is 

contingent on the loan's ultimately being approved. It cannot possibly be 

true, as the Tax Court and the Commissioner would have it, that the 

existence of a subsequent loan-derived revenue stream is the trigger for 

the capitalization requirement. (If a company were to undertake research 

and development to investigate new product lines, would it have to 

capitalize only those R&D costs that led to product lines that were 

ultimately successful and profitable? We think not.) 

 21 
. . . that SFAS 91 itself, which the banks have followed, 

expressly distinguishes direct loan origination costs, which 

must be deferred, from all other loan-related costs, such as 

advertising, soliciting potential borrowers, and servicing 

existing loans, which may be currently deducted for

financial accounting purposes."); Tr. of Oral Argument at 

27 (statement by IRS's counsel that "[w]here we draw the 

line is -- actually the Financial Accounting Standards 

Board made it very easy for us."). Similarly, the Tax Court, 

while professing not to find the financial standards 

dispositive, see PNC, 110 T.C. at 364 n.15, id. at 368 n.18, 

used SFAS 91 as the sole source of an explanation as to 

why these loan origination costs, but not other costs 

associated with the banks' lending business, must be 

capitalized, see id. at 368-69. We remain unconvinced that 

the line drawn by the FASB in SFAS 91 has any relevance 

here for tax purposes. 

The Supreme Court has noted that "capitalization 

prevents the distortion of income that would otherwise 

occur if depreciation properly allocable to asset acquisition 

were deducted from gross income currently realized." 

Commissioner v. Idaho Power Co., 418 U.S. 1, 14 (1974). In 

the case of the costs at issue here, there need be no 

concern about a distortion of income because of the

regularity of these expenses. 

Finally, we emphasize that the key to the deductibility 

inquiry remains the statutory language of sections 162(a) 

and 263(a). See Erwin N. Griswold, Cases and Materials on 

Federal Taxation, at 15 (5th ed. 1960) ("There is no use in 

thinking great thoughts about a tax problem unless the 

thoughts are firmly based on the controlling statute."). The 

analyses set forth in INDOPCO and Lincoln Savings provide 

us with two applications of that statutory language. Like 

the Supreme Court in INDOPCO and Lincoln Savings, we do 

not here attempt to define once and for all a bright line 

between deduction and capitalization that will hold true for 

all factual situations. We can only heed Justice Cardozo's 

admonition that we should always keep the factsfirmly in 

view, as well as Dean Griswold's advice that we remain 

cognizant of the language of the Code. Resorting to that 

language, we find the case before us today to be much 

 22 
farther from the heartland of the traditional capital 

expenditure (a "permanent improvement or betterment") 

than are the scenarios at issue in INDOPCO and Lincoln 

Savings. We will not mechanistically apply phrases from 

those precedents in ignorance of the realities of the facts 

before us. We see no principled distinction between the 

costs at issue here and other costs incurred as"ordinary 

expenses" by banks. 

V. Conclusion 

For the foregoing reasons, we find that the loan 

origination expenses are deductible as "ordinary and 

necessary business expenses" under section 162(a) of the 

Internal Revenue Code, and are not subject to the 

capitalization provision of section 263(a). Accordingly, we 

will reverse the judgment of the Tax Court. 

A True Copy: 

Teste: 

 Clerk of the United States Court of Appeals 

 for the Third Circuit 

 23