111 T.C. No. 8

UNITED STATES TAX COURT

SECURITY STATE BANK, Petitioner v. COMMISSIONER OF INTERNAL

REVENUE, Respondent

Docket No. 15478-96. Filed September 3, 1998. 

P is a bank that uses the cash method of

accounting. During 1989, P made short-term loans to

customers. The principal and interest on the loans

were payable at maturity. R determined that P must

accrue interest and/or original issue discount on the

loans pursuant to sec. 1281(a)(1) and (2), I.R.C.

Held: Sec. 1281(a)(2), I.R.C., does not require a

bank to accrue interest on short-term loans made in the

ordinary course of its business. Security Bank Minn.

v. Commissioner, 98 T.C. 33 (1992), affd. 994 F.2d 432

(8th Cir. 1993).

Held, further: Sec. 1281(a)(1), I.R.C., does not

require a bank to accrue original issue discount on

short-term loans made in the ordinary course of

business.

Martin J. Peck, for petitioner.

Charles M. Berlau, for respondent.
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1Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the year in issue.

OPINION

RUWE, Judge: Respondent determined a deficiency of

$29,972.41 in petitioner's 1989 Federal corporate income tax. 

The issue for decision is whether section 1281(a)1 requires

petitioner, a cash basis taxpayer, to accrue interest and/or

original issue discount earned on short-term loans. 

Background

The parties submitted this case fully stipulated. The

stipulation of facts and supplemental stipulation of facts are

incorporated herein by this reference. Petitioner is a

corporation whose principal place of business was in Wellington,

Kansas, at the time it filed the petition. 

Petitioner is a commercial bank that makes a variety of

loans in the ordinary course of its business. These loans are of

varying duration, including loans of less than 1 year, loans of 1

year, and loans of more than 1 year. Petitioner had, and still

has, business reasons for using notes with a term of 1 year or

less.

 During 1989, petitioner made some loans that were

documented by promissory notes with a stated maturity date that

was 1 year from the date the notes were issued. Such loans will
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be referred to as category X loans. Petitioner held the category

X loans on December 31, 1989. During 1989, petitioner also made

some loans that were documented by promissory notes with a stated

maturity date that was less than 1 year from the date the notes

were issued. Such loans will be referred to as category Y loans. 

Petitioner held the category Y loans on December 31, 1989. The

interest and principal payable on all categories X and Y loans

were due at maturity. 

Petitioner reported its taxable income using the cash method

of accounting. Petitioner reported interest income from its

categories X and Y loans as it was received pursuant to the cash

method of accounting. 

Petitioner had interest income of $60,086.89 during 1989

that had accrued, but was not yet paid, on its category X loans. 

Petitioner had interest income of $65,687.11 during 1989 that had

accrued, but was not yet paid, on its category Y loans. 

Discussion

Petitioner uses the cash method of accounting to report its

taxable income. Consistent with that method, it did not report

as income on its 1989 return any accrued interest or original

issue discount that was earned but unpaid at the end of 1989. 

Respondent does not contest petitioner's general use of the cash
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2Although it is not explicitly indicated in the record, it

appears that petitioner was allowed to use the cash method of

accounting in 1989 because it had gross income of less than $5

million. See secs. 446(a), (c)(1), 448(b)(3).

method.2 Rather, respondent relies on the specific provisions of

section 1281 requiring the accrual of income earned on short-term

obligations. 

The pertinent provisions of section 1281(a) are as follows:

SEC. 1281. CURRENT INCLUSION IN INCOME OF DISCOUNT ON

 CERTAIN SHORT-TERM OBLIGATIONS.

(a) General Rule.--In the case of any short-term

obligation to which this section applies, for purposes of

this title--

(1) there shall be included in the gross income of

the holder an amount equal to the sum of the daily

portions of the acquisition discount for each day

during the taxable year on which such holder held such

obligation, and

(2) any interest payable on the obligation (other

than interest taken into account in determining the

amount of the acquisition discount) shall be included

in gross income as it accrues.

(b) Short-Term Obligations to Which Section Applies.--

(1) In general.--This section shall apply to any

short-term obligation which--

* * * * * * *

(C) is held by a bank (as defined in section 581),

* * * * * * *

(c) Cross Reference.--For special rules limiting the

application of this section to original issue discount in

the case of nongovernmental obligations, see section

1283(c).
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Certain pertinent provisions of section 1283 are as follows:

SEC. 1283. DEFINITIONS AND SPECIAL RULES.

(a) Definitions.--For purposes of this subpart--

(1) Short-term obligation.--

(A) In general.--Except as provided in

subparagraph (B), the term "short-term obligation"

means any bond, debenture, note, certificate, or

other evidence of indebtedness which has a fixed

maturity date not more than 1 year from the date

of issue.

(B) Exceptions for tax-exempt obligations.--

The term "short-term obligation" shall not include

any tax-exempt obligation (as defined in section

1275(a)(3)).

* * * * * * *

(c) Special Rules for Nongovernmental Obligations.--

(1) In general.--In the case of any short-term

obligation which is not a short-term Government

obligation (as defined in section 1271(a)(3)(B))--

(A) sections 1281 and 1282 shall be applied

by taking into account original issue discount in

lieu of acquisition discount, and

(B) appropriate adjustments shall be made in

the application of subsection (b) of this section.

Respondent's first argument is that petitioner is required

to accrue interest income from its categories X and Y loans

pursuant to section 1281(a)(2). This is not an issue of first

impression. Indeed, respondent recognizes that in Security Bank

Minn. v. Commissioner, 98 T.C. 33, 42 (1992), affd. 994 F.2d 432

(8th Cir. 1993), we held that section 1281(a)(2) does not apply
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to short-term loans made by banks in the ordinary course of

business. Respondent recognizes that our prior opinion precludes

application of section 1281(a)(2) to the facts in the instant

case, unless we choose to overrule it. Respondent urges us to do

just that.

Security Bank Minn. v. Commissioner, supra, was a Courtreviewed opinion. The majority opinion contains an extensive

analysis of the statute, its evolution, the context in which it

appears, and its legislative history. There was a dissenting

opinion which was joined by five Judges. In affirming our

opinion, the Court of Appeals for the Eighth Circuit also made an

extensive analysis of the same factors. One of the judges on the

Court of Appeals panel dissented.

No purpose would be served by repeating the statutory

analysis that led this Court and the Court of Appeals to decide

that section 1281(a)(2) does not apply to loans made by banks in

the ordinary course of business. Suffice it to say that this

matter has been thoroughly considered and decided. The doctrine

of stare decisis generally requires that we follow the holding of

a previously decided case, absent special justification. This

doctrine is of particular importance when the antecedent case

involves statutory construction. Hesselink v. Commissioner, 97

T.C. 94, 99-100 (1991). While respondent has skillfully

rearticulated his arguments in support of a different

interpretation of the statute, we find nothing therein that would
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3Respondent has made no argument that the issues presented

are of great overall significance. Sec. 448 generally precludes

corporations with more than $5 million in gross receipts from

using the cash method of accounting. Thus, our holdings appear

to have application only to small banks.

cause us to refrain from applying the doctrine of stare decisis

with respect to the section 1281(a)(2) issue.3

Respondent alternatively argues that the loans in question

were made in return for notes that contained "original issue

discount" within the purview of sections 1281(a)(1) and 1283. 

According to respondent, section 1281(a)(1) requires petitioner

to accrue the daily portion of that discount during the year in

which the note was held, regardless of whether petitioner

actually received anything in that year.

In Security Bank Minn. v. Commissioner, supra at 37, the

Commissioner refrained from arguing that section 1281(a)(1)

applied, although he stated on brief that it "arguably does." It

was therefore not necessary for us to make a specific holding

regarding the application of section 1281(a)(1). In a technical

sense, respondent's proposed application of section 1281(a)(1)

presents an issue of first impression. However, we believe that

the analysis upon which the holding in Security Bank Minn. was

based compels us to hold against respondent's argument that

section 1281(a)(1) applies in the instant case. 

Our holding in Security Bank Minn. that section 1281(a)(2)

did not apply to loans made by banks in the ordinary course of
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business was based on our interpretation of section 1281 as

originally enacted in 1984. As originally enacted, section

1281(a) applied only to acquisition discount or original issue

discount. Deficit Reduction Act of 1984, Pub. L. 98-369, sec.

41, 98 Stat. 548. Section 1281 was amended in 1986 to add the

provisions of section 1281(a)(2). Tax Reform Act of 1986, Pub.

L. 99-514, sec. 1803, 100 Stat. 2791. In Security Bank Minn., we

first analyzed section 1281 in its original form. On the basis

of that analysis, we stated:

We conclude that the legislative history supports

petitioner's interpretation of section 1281, i.e., that

it was enacted in 1984 to deal with problems associated

with purchased debt instruments involving a discount

and not with loans made by a bank in the ordinary

course of its business. Accordingly, we hold that the

loans here in dispute are not the sort of obligations

or instruments to which section 1281 applied as enacted

in 1984. [Security Bank Minn. v. Commissioner, supra

at 42.]

We then concluded that the addition of section 1281(a)(2) in 1986

was not intended to cover loans made by banks.

We do not believe that the 1986 amendment, which

originated as a technical correction, was intended to

increase the coverage of section 1281(a) to loans made

if, as we have concluded, such loans were not covered

by the 1984 Act. The amendment, in our view, was

intended to express the amounts to be taken into

current income and not to expand the category of

instruments covered by section 1281(a). [Id. at 43.]

Our analysis in Security Bank Minn. v. Commissioner, supra,

makes clear that we have interpreted section 1281 as having no
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4Because of our legal conclusion, there is no need to decide

whether respondent is correct in characterizing the loans in

issue as generating original issue discount.

application to loans made by banks in the ordinary course of

business, regardless of whether the loans are characterized as

generating interest or original issue discount.4 We, therefore,

hold that section 1281(a)(1) does not apply to the loans in

issue.

Decision will be entered

for petitioner.