Case Name: Pacific First Federal Savings Bank, Petitioner v. Commissioner of Internal Revenue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1990-02-27
Citations: 94 T.C. 101
Docket Number: Docket No. 27606-87
Parties: Pacific First Federal Savings Bank, Petitioner v. Commissioner of Internal Revenue, Respondent
Judges: Nims, Chabot, Kórner, Shields, Hamblen, Cohen, Clapp, Swift, Wright, Williams, and Colvin, JJ., agree with the majority opinion.
Reporter: Reports of the Tax Court of the United States
Volume: 94
Pages: 101–126

Head Matter:
Pacific First Federal Savings Bank, Petitioner v. Commissioner of Internal Revenue, Respondent
Docket No. 27606-87.
Filed February 27, 1990.
Alan S. Kaden and John F. Coverdale, for the petitioner.
Fera Wagner and Richard Osborne, for the respondent.

Opinion:
OPINION
WELLS, Judge:
Respondent determined the following deficiencies in petitioner's Federal income tax:
Year Deficiency
1978 . $1,743,066
1979 . 5,057,885
1980 . 2,512,321
After concessions, the issue presented is whether certain portions of section 1.593-6A(b)(5)(vi) and (vii), Income Tax Regs., are valid. For certain financial institutions, including petitioner, the deduction for addition to bad debt reserve is generally equal to a percentage of the financial institution's taxable income. The challenged portions of the regulation require that taxable income reflect any net operating loss carrybacks before the deduction for addition to bad debt reserve is calculated.
The facts are fully stipulated. We incorporate by reference the stipulation of facts and attached exhibits.
Petitioner is a corporation formed and existing under the laws of the State of Washington and having as its principal place of business when it filed its petition Tacoma, Washington.
From 1971 through 1980, petitioner used the calendar year as its taxable year and deducted amounts added to a reserve for bad debts. Petitioner calculated those amounts by using the "percentage of taxable income method" set forth in section 593(b)(2)(A). For those years, section 166(c) permitted taxpayers to deduct a "reasonable addition" to bad debt reserve, in lieu of specific debts as they became worthless. Section 593(b) defined the term "reasonable addition" for certain financial institutions, including petitioner. Under that subsection, the deduction for addition to reserve with respect to "qualifying real property loans" (generally those loans secured by improved real property (sec. 593(d))) was subject to various limits, one of which was set forth in section 593(b)(2)(A). That provision limited the deduction to "the applicable percentage of the taxable income" for the year.
In 1981 and 1982, petitioner had net operating losses (NOLs) within the meaning of section 172(c) in the amounts of $43,459,246 and $27,748,382, respectively. Under section 172(b)(1)(F), those NOLs may be carried back to each of the 10 taxable years preceding the loss years.
Central to resolution of the instant case is the interplay between NOL carrybacks and the deduction for addition to bad debt reserve calculated under the percentage of taxable income method. Respondent contends that petitioner's NOL carrybacks from 1981 and 1982 reduce petitioner's deductions under section 593(b)(2)(A) for 1971 through 1977 by reducing the "taxable income" base used in calculating the deduction for each of those years. As a consequence, according to respondent, a larger portion of the 1981 and 1982 NOLs are "absorbed" by the increase in taxable income for 1971 through 1977, and a smaller portion of the NOLs remains available for the years in issue, i.e., 1978, 1979, and 1980. Deficiencies result for these years, according to respondent, because section 172(a) deductions are reduced or eliminated. In other words, respondent advocates an ordering rule which, under the facts of this case, results in faster absorption of NOLs.
Subdivisions (vi) and (vii) of section 1.593-6A(b)(5), Income Tax Regs., support respondent's position. The provisions generally require that taxable income reflect any NOL carrybacks before the deduction for addition to bad debt reserve is calculated. Specifically, the pertinent portions of the regulation provide as follows:
(5) Computation of taxable income. For purposes of [calculating the deduction for addition to bad debt reserve under the percentage of taxable income method], taxable income is computed—

(vi) For taxable years beginning before January 1, 1978, without regard to any deduction the amount of which is computed upon, or may be subject to a limitation computed upon, the amount of taxable income, and without regard to any net operating loss carryback to such year from a taxable year beginning before January 1, 1979. (For purposes of this subparagraph, a net operating loss deduction under section 172 is not a deduction the amount of which may be subject to a limitation computed upon the amount of taxable income.)
(vii) For taxable years beginning after December 31, 1977, by taking into account any deduction the amount of which is computed upon, or may be subject to a limitation computed upon, the amount of taxable income, and any other deduction or loss allowed under subtitle A of the Code, such as any deduction allowable under section 172 or any loss allowable under section 1212(a), unless otherwise provided in this subparagraph.
For taxable years beginning after December 31, 1977, subdivision (vii) expressly requires that taxable income reflect the section 172(a) deduction prior to calculating the deduction for addition to bad debt reserve. For taxable years beginning before January 1, 1978, subdivision (vi) requires, by negative implication, that taxable income reflect NOL carrybacks from years beginning after December 31, 1978, prior to calculating the deduction. As originally promulgated on May 17, 1978, the ordering rule was to affect only taxable years beginning after December 31, 1977. T.D. 7549, 1978-1 C.B. 185, 186. Proposed amendments to the regulation would have required retroactive use of the ordering rule for NOL's occurring after 1977 (43 Fed. Reg. 60964 (Dec. 29, 1978)), but the regulation was amended on May 31, 1979, to have retroactive effect only for NOL's occurring after 1978. T.D. 7626, 1979-2 C.B. 239, 240.
Petitioner argues that the foregoing provisions are invalid and that it should be permitted to use the ordering rule in effect prior to publication of the regulation containing the challenged provisions on May 17, 1978. The ordering rule proposed by petitioner requires calculation of the deduction for addition to bad debt reserve before any NOL carrybacks are reflected in the calculation of taxable income.
Prior to May 17, 1978, the applicable Treasury regulations were consistent with petitioner's method. They required or were interpreted to require that NOL carrybacks be disregarded when using the percentage of taxable income method to calculate the deduction for addition to bad debt reserve. The first regulations interpreting section 593 provided as follows:
the reasonable addition to a reserve for bad debts shall be an amount determined by the taxpayer which does not exceed the lesser of:
(1) The amount of its taxable income for the taxable year, computed without regard to section 593 and without regard to any section providing for a deduction the amount of which is dependent upon the amount of taxable income (such as section 170, relating to charitable, etc., contributions and gifts), [Sec. 1.593-l(b)(l), Income Tax Regs. (1956).]
Respondent cited the foregoing regulation in a revenue ruling which required that NOL carrybacks be disregarded when computing the deduction for addition to bad debt reserve. Rev. Rui. 58-10, 1958-1 C.B. 246, 247.
After the Revenue Act of 1962 amended section 593, a new regulation was published that was more explicit than the original regulation. The new regulation provided that taxable income (for the purpose of calculating the deduction for addition to bad debt reserve under the percentage of taxable income method) should be calculated "without regard to any net operating loss carryback to such year under section 172." Sec. 1.593-6(b)(2)(iv), Income Tax Regs. (1964).
Thus, the provisions challenged by petitioner reversed an ordering rule that had been in effect for approximately 20 years. The following hypothetical example highlights the difference between the positions of the parties:
1971 1972 1981
(1) Income before percentage method deduction 1,000,000 1,000,000 (1,000,000)
(2) Percentage method deduction at 54% for 1971 and 51% for 1972 (540,000) (510,000)
1971 1972 1981
(3) Taxable income before carrybacks 460,000 490,000 (1,000,000)
(4) Tax at 46% 211,600 225,400
Carryback Effect Under Prior Regs. (Petitioner's Position):
(5) Taxable income before carryback 460,000 490,000
(6) NOL carryback absorbed (460,000) (490,000)
(7) Tax — —
(8) Refund due to carryback 211,600 225,400
(9) NOL carried to next year (540,000) (50,000)
Carryback Effect Under Challenged Rule (Respondent's Position):
(10) Taxable income before carryback 460,000 Loss fully absorbed in
(11)Add back percentage method deduction 540,000 1971. Lines (l)-(4) above are unaffected.
(12) Subtotal 1,000,000
(13) NOL carryback absorbed (1,000,000)
(14) Tax —
(15) Refund 211,600
(16) NOL carried to next year
The challenged provisions were promulgated under the authority of section 7805(a), which authorizes the Secretary of the Treasury to "prescribe all needful rules and regulations for the enforcement of this title." Consequently, while the challenged provisions are entitled to deference, they are not entitled to as much deference as that owed to "legislative regulations," which are promulgated under more specific grants of authority. United States v. Vogel Fertilizer Co., 455 U.S. 16, 24 (1982).
In National Muffler Dealers Assn., Inc. v. United States, 440 U.S. 472, 477 (1979), the Supreme Court set forth the following guidelines for adjudging the validity of an interpretative regulation:
In determining whether a particular regulation carries out the congressional mandate in a proper manner, we look to see whether the regulation harmonizes with the plain language of the statute, its origin, and its purpose. A regulation may have particular force if it is a substantially contemporaneous construction of the statute by those presumed to have been aware of congressional intent. If the regulation dates from a later period, the maimer in which it evolved merits inquiry. Other relevant considerations are the length of time the regulation has been in effect, the reliance placed on it, the consistency of the Commissioner's interpretation, and the degree of scrutiny Congress has devoted to the regulation during subsequent re-enactments of the statute.
With the foregoing precepts in mind, we hold that the challenged portions of section 1.593-6A(b)(5)(vi) and (vii), Income Tax Regs., are invalid.
Plain Language of the Statute
Respondent contends that the plain language of the statute compels the ordering rule set forth in the challenged provisions. Respondent points out that section 593(b)(2)(A) limits the deduction for addition to bad debt reserve to a percentage of "taxable income"; that "taxable income" is defined in section 63 as gross income less the deductions allowed by Chapter 1, including the section 172(a) deduction for NOL's; that section 593(b)(2)(E) prescribes certain modifications to "taxable income," none of which involve section 172(a); and that, therefore, taxable income must reflect NOL carrybacks before the deduction for addition to bad debt reserve is calculated. Respondent also points out that various sections other than section 593, such as sections 170, 246, and 613A, expressly modify the section 63 definition of taxable income by excluding NOL carrybacks, while section 593(b)(2)(E) does not.
Respondent's argument presumes that section 593(b)(2)(E) sets forth an exclusive list of modifications to the section 63 definition of taxable income. Legislative history, however, can be used as an aid to construing even those statutes that appear clear. United States v. American Trucking Assns., 310 U.S. 534, 543-544 (1940) ("When aid to construction of the meaning of words, as used in the statute, is available, there certainly can be no 'rule of law' which forbids its use, however clear the words may appear on 'superficial examination.' " (fn. ref. omitted)). The legislative history of section 593 discussed infra indicates that respondent's interpretation is incorrect and that the statute is not free of ambiguity.
Origin and Purpose of the Statute
Moreover, we reject any suggestion that our inquiry is limited to the statutory language. National Muffler Dealers Assn., Inc. v. United States requires that a challenged regulation be examined for consistency with "the statute, its origin, and its purpose." Supra at 477 (emphasis supplied). When assessing the validity of a regulation, the Supreme Court has focused upon the will of Congress, rather than limiting the inquiry to the statutory language. In United States v. Vogel Fertilizer Co., supra at 26, the Supreme Court stated, "This Court has firmly rejected the suggestion that a regulation is to be sustained simply because it is not 'technically inconsistent' with the statutory language, when that regulation is fundamentally at odds with the manifest Congressional design."
Prior to 1952, certain financial institutions were exempt from Federal income tax. Exempt from taxation were "a mutual savings bank not having capital stock represented by shares," "a domestic building and loan association," and "a cooperative bank without capital stock organized and operated for mutual purposes and without profit" (Hereafter, we refer to the foregoing types of financial institutions as mutual institutions.). Secs. 101(2), (4), (15), I.R.C. 1939.
The Revenue Act of 1951 repealed the tax-exempt status of mutual institutions, but also granted them a generous deduction for addition to bad debt reserve. In fact, Congress amended section 23(k)(l) of the Internal Revenue Code of 1939 to permit mutual institutions to deduct as much as "net income for the taxable year, computed without regard to [the deduction]," so long as the resulting reserve combined with surplus and undivided profits did not exceed 12 percent of "total deposits or withdrawable accounts." Sec. 313(e), ch. 521, 65 Stat. 490. Thus, Congress wanted to terminate the "substantial tax savings" enjoyed by mutual institutions, but, at the same time, sought to encourage ample reserves through the deduction for addition to bad debt reserve. S. Rept. 781, 82nd Cong., 1st Sess. (1951), 1951 C.B. 458, 474.
The Revenue Act of 1962 somewhat curtailed the available deduction. Congress amended section 593 to permit mutual institutions to deduct "reasonable addition[s]" to reserves for "nonqualifying loans" (generally those loans not secured by improved real property (sec. 593(d))) as well as additions to reserves for "qualifying real property loans." The latter amount generally could equal the greater of (1) 60 percent of taxable income less the amount added to the reserve for nonqualifying loans, (2) an amount necessary to increase the reserve for qualifying real property loans to 3 percent of such loans, or (3) an amount based upon loss experience. For purposes of calculating the deduction under the percentage of taxable income method, the amended statute provided,
taxable income shall be computed (i) by excluding from gross income any amount included therein by reason of subsection (f) [pertaining to distributions from reserve to shareholders], and (ii) without regard to any deduction allowable for any addition to the reserve for bad debts.
The addition calculated under the percentage of taxable income method could not produce a reserve for qualifying real property loans greater than 6 percent of such loans. As before, total reserves combined with surplus and undivided profits could not exceed 12 percent of deposits. Pub. L. 87-834, sec. 6(a), 76 Stat. 977.
The House Report expresses Congress' dual concerns in enacting the foregoing changes. On one hand, Congress sought to tax mutual institutions. The report states, "Congress repealed [in 1951] the exemption of these mutual savings institutions . At the same time, however, these institutions were allowed a special deduction for additions to bad-debt reserves which proved to be so large that they have remained virtually tax exempt since 1951." On the other hand, Congress wanted to ensure that ample reserves would be maintained and therefore preserved a generous deduction for additions to reserve. The report states, "The bill provides reserves consistent with the proper protection of the institution and its policyholders in the light of the peculiar risks of long-term lending on residential real estate which is the principal function of these institutions." H. Rept. 1447, 87th Cong., 2d Sess. (1962), 1962-3 C.B. 405, 436-437.
The Tax Reform Act of 1969 further curtailed the available deduction. Amendments to section 593 eliminated the method of calculating the deduction that had permitted mutual institutions to deduct an addition necessary to bring the bad debt reserve for qualifying real property loans to 3 percent of such loans. The percentage of taxable income method was modified by reducing the allowable deduction from 60 to 40 percent of taxable income over a 10-year period. Congress also further modified the method of calculating taxable income for section 593 purposes. Amendments required the exclusion of (1) net gain from dealings in corporate stock or tax-exempt obligations, (2) the lesser of 3/8 of net long-term capital gain or 3/8 of such gain from dealings in property other than that described in the first exclusion, and (3) dividends giving rise to a dividends-received deduction less the "applicable percentage" of the deduction. Meanwhile, Congress extended the NOL car-ryback period from 3 to 10 years for mutual institutions and commercial banks. Pub. L. 91-172, secs. 431(b), 432(a), 83 Stat. 619, 620.
Legislative history indicates that Congress again struggled with competing considerations in enacting the foregoing changes. As in 1962, Congress believed that mutual institutions were paying less than a fair amount of tax. The House Report states:
Your committee has reviewed the tax treatment of these mutual institutions. It has concluded that the present bad-debt reserve provisions are unduly generous as they have allowed these institutions to pay a much lower average effective rate of tax than the average effective rate for all corporations. [H. Rept. 91-413, 1969-3 C.B. 200, 278.]
Yet, as in 1962, Congress' desire to ensure that mutual institutions pay taxes was counterbalanced to some extent by Congress' goal of encouraging reserves. Thus, the House Report explains:
Your committee believes, that, notwithstanding a larger tax liability because of these changes in the bad-debt reserve deductions, there will still be reserves consistent with the proper protection of the institution and its policyholders in the light of the peculiar risks of long-term lending on residential real estate which is the principal function of these institutions. Furthermore, to provide for unusually large losses, your committee has extended the net operating loss carryback from 3 to 10 years for all financial institutions, which allows the spreading of losses over 15 years — 10 years back and 5 years forward. Your committee believes that this is a better means to provide for large unexpected losses than to allow such institutions to build up their reserves tax free. [H. Rept. 91-413, 1969-3 C.B. at 278.]
The House Report also contains a number of statistics, including the following:
Tax as a percent of economic income: 1966
A. Commercial banks 23.2
B. Mutual savings banks 6.1
C. Savings and loan associations 16.9
In response to the foregoing statistics, the House Report comments:
Since your committee's bill increases appreciably the 23.2 percent effective rate of tax for commercial banks, it is your committee's intention not only to bring the level of taxation of mutual savings banks (presently 6.1 percent) up to the level of savings and loan, associations (16.9 percent), but also to provide an increase in the 16.9 percent rate somewhat comparable to the increase in the 23.2 percent rate for commercial banks. For this reason, the percentage deduction for additions to bad-debt reserves is being reduced from 60 percent to 30 percent, but this reduction is to take effect over a 10-year period. This percentage reduction in the formula will raise the effective rate of tax for these institutions, but will still leave some margin of tax advantage for them over commercial banks, which should preserve the inducement for them to continue investing in real estate mortgages. [H. Rept. 91-413, 1969-3 C.B. at 278.]
Thus, the House was cognizant of the effective rate of tax paid by mutual institutions and intended to raise, but only to a specific and limited extent, that effective rate by reducing the deduction for addition to bad debt reserve.
Moreover, while the House proposed to reduce the applicable percentage used under the percentage of taxable income method from 60 to 30 percent over 10 years, the Senate proposed a reduction to only 50 percent over 4 years. The Senate, like the House, was aware of the effective rate of tax paid by mutual institutions (S. Rept. 91-552, 1969-3 C.B. 423, 526) and felt that a smaller increase in that effective rate was proper. The Senate Report states, "The committee believes that the reduction to 50 percent represents a sufficient increase in taxes for these mutual institutions at this time." S. Rept. 91-552, 1969-3 C.B. at 526. As noted, Congress ultimately decided to reduce the applicable percentage to 40 percent over 10 years.
The ordering rule found in the challenged portions of section 1.593-6A(b)(5)(vi) and (vii), Income Tax Regs., does not harmonize with Congressional intent. First, the effect of the new ordering rule (proposed in 1971 (36 Fed. Reg. 15050 (Aug. 12, 1971))) is to curtail the deduction for addition to bad debt reserve after Congress had already curtailed the deduction in 1969 and consciously rejected a proposal for a greater curtailment. In 1969, both the House and the Senate were aware of the effective rate of the tax paid by mutual institutions and sought to increase that effective rate to different, specific extents. In conference, Congress reached a compromise, deciding upon an increase greater than that proposed by the Senate but less than that sought by the House. The new ordering rule curtails the deduction for addition to bad debt reserve by contracting the taxable income base to which the applicable percentage is applied. The new ordering rule thereby increases the effective rate of tax for mutual institutions beyond the extent intended by Congress.
Second, the new ordering rule reduces the value of NOL carrybacks and is therefore plainly at odds with Congress' intent to ameliorate the effects of the 1969 curtailment by granting mutual institutions a "more generous net operating loss carryback." H. Rept. 91-413, 1969-3 C.B. at 280. When Congress extended the NOL carryback period from 3 to 10 years in 1969, it was well established that NOL carrybacks had no effect on deductions for additions to bad debt reserve for carryback years. The regulations so provided and there was no contrary authority specifically addressing the interplay between NOL carrybacks and the sections 166 and 593 deduction. Congress amended both (1) the bad debt reserve deduction provisions and (2) the net operating loss carryback provisions in order to achieve a limited increase in the income tax levels of mutual institutions. In order to determine the effect of proposed changes and, if necessary, to modify the changes, Congress must have examined the then-effective regulations and concluded that those regulations correctly reflected Congress' intent as to how NOL carrybacks were to affect deductions for additions to bad debt reserve. Under the ordering rule of the later regulations, however, a carryback results in a "recapture," in effect, of a portion of the deduction for addition to bad debt reserve for the carryback year. As much as 60 percent (the applicable percentage for 1969) of a carryback is offset by a corresponding reduction in the deduction for addition to bad debt reserve. The full benefit Congress intended by its action in 1969 is thereby denied.
The legislative history also indicates that Congress did not intend that section 593(b)(2)(E) provide the exclusive list of modifications to the section 63 definition of taxable income. In both 1962 and 1969, Congress modified the method of calculating taxable income for section 593(b)(2)(A) purposes. In both years, Congress specified certain modifications to the section 63 definition of taxable income. Congress never, however, expressed any indication that pre-existing, regulatory, or administrative modifications to the section 63 definition (such as the prior ordering rule) were to be repealed and replaced by an exclusive, statutory list. Prior to the 1962 amendments, Revenue Ruling 58-10, 1958-1 C.B. 246, had construed section 1.593-l(b)(l), Income Tax Regs. (1956), as requiring the disregard of NOL car-rybacks when calculating the deduction for addition to bad debt reserve. Prior to the 1969 amendments, section 1.593-6(b)(2)(iv), Income Tax Regs. (1964), had explicitly required that NOL carrybacks be ignored when calculating the deduction. Had Congress intended to supplant those and other administrative and regulatory modifications of the section 63 definition, we believe that some definite indication of such intent would appear in the legislative history. The complete absence of any indication that Congress intended to supplant such modifications of the section 63 definition is proof that Congress merely intended to enact the modifications specifically dealt with in the statutory language.
Further proof that Congress intended that pre-existing modifications remain in effect is the fact that any modification of the taxable income base would upset the legislative compromise reached in 1969. Contracting the base would result in a greater curtailment of the deduction for addition to bad debt reserve, while expanding the base would neutralize in whole or in part the curtailment approved by Congress.
Finally, the statute itself does not state that its list of modifications is exclusive. We also note that when Treasury initially proposed the new ordering rule, it supported the change by arguing that Congress had enacted an exclusive, statutory list of modifications to the section 63 definition in 1969. Respondent, however, has essentially discarded this argument, perhaps because of lack of confidence in its merit.
Other Considerations
Other factors set forth in National Muffler Dealers Assn., Inc. v. United States support our conclusion. 440 U.S. at 477. Although neither the challenged provisions nor the earlier ordering rule fairly can be characterized as "substantially contemporaneous constructions" of section 593 (see United States Trust Co. v. Internal Revenue Service, 803 F.2d 1363, 1370 (5th Cir. 1986)), the earlier ordering rule was promulgated much closer to the enactment of section 593's predecessor in 1951. The 1956 regulation had been proposed in 1955. 20 Fed. Reg. 7992 (Oct. 25, 1955). Although section 593's predecessor based the deduction on "net income," the regulation promulgated in 1964 expressly provided for the disregard of NOL carrybacks when calculating the deduction and was promulgated after the statute had been changed to refer to "taxable income." The manner in which the challenged provisions evolved also supports our conclusion, as the provisions reversed a long-standing, consistent interpretation of the relevant statute.
We are mindful of the rule enunciated in cases such as United States v. Southwestern Cable Co., 392 U.S. 157, 170 (1968): "the views of one Congress as to the construction of a statute adopted many years before by another Congress have 'very little, if any, significance.' " Accord United States v. American College of Physicians, 475 U.S. 834, 846-847 (1986); Rainwater v. United States, 356 U.S. 590, 593 (1958); Mars, Inc. v. Commissioner, 88 T.C. 428, 435 (1987) (refusing to consider Congressional intent behind amendments to section 367 which were not effective for transaction in issue). We do not believe, however, that the rule affects our conclusion. We do not rely upon the views of Congress in 1969 to construe an earlier enactment. Rather, our inquiry has been whether the challenged provisions harmonize with the intent behind section 593(b)(2), as amended by the Tax Reform Act of 1969, and in effect from 1971 through 1980, the years petitioner deducted additions to bad debt reserve.
That a regulation harmonizes with an extinct ancestor of a statute, and its purpose, should not suffice. In National Muffler Dealers Assn., Inc. v. United States, the Court considered a 1966 amendment to section 501(c)(6) in attempting to decide whether regulations interpreting "business league," a term first used in the Tariff Act of October 3, 1913, comported with Congressional intent. 440 U.S. at 478-479, 487. Also in United States v. Vogel Fertilizer Co., 455 U.S. at 35, the Court stated, "it is the intent of the Congress that amended section 1563(a), not the views of the subsequent Congress that enacted section 414, that are controlling." (Emphasis supplied.) Thus, while the views of Congress respecting earlier enactments are given little weight, regulations must square with the purpose of a statute as it exists for the period in issue.
Respondent points out that the challenged provisions had been in effect for approximately 8 years when Congress amended section 593 as part of the Tax Reform Act of 1986. Respondent argues that Congress approved the ordering rule prescribed by the challenged provisions by reducing the applicable percentage to 8 percent without reverting back to the old ordering rule. Pub. L. 99-514, sec. 901(b), 100 Stat. 2378. We find respondent's argument unconvincing. Assuming arguendo that the reenactment doctrine gave the challenged provisions the force of law in 1986, there is no indication that Congressional approval was retroactive. In Helvering v. R.J. Reynolds Tobacco Co., supra, the Court faced a scenario very similar to the one before us. A longstanding regulation provided that corporations did not recognize income from dealings in their own stock. Treasury then reversed its position, and respondent attempted to apply the new rule retroactively. The Court held for the taxpayer, reasoning that the earlier regulation had acquired the force of law. In response to respondent's argument that the new rule also had received Congressional approval, the Court stated:
But we have no occasion to decide this question since we are of opinion that the reenactment of the section, without more, does not amount to sanction of retroactive enforcement of the amendment, in the teeth of the former regulation which received Congressional approval, by the passage of successive Revenue Acts including that of 1928. [306 U.S. at 117.]
Respondent argues that unless NOL-adjusted taxable income is the basis for computing the deduction for addition to bad debt reserve, mutual institutions will create reserves out of deposits, rather than income, as contemplated by Congress. Respondent has failed to demonstrate that Congress was concerned that additions to reserve be made from income. In fact, section 593, as in effect for the relevant period, refutes respondent's contention, as it permitted additions to bad debt reserve based upon loss experience, without regard to taxable income. Sec. 593(b)(4).
Furthermore, the prior ordering rule does not enable petitioner or other mutual institutions to obtain "double deductions." Under the reserve method of accounting for bad debts, additions to a reserve for bad debts are deducted from income. No deduction is made, however, when an individual debt is deemed worthless. Rather, the reserve is charged in the amount of the debt. Conversely, the reserve is credited for debts collected after having been deemed worthless. Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 547 (1979); Black Motor Co. v. Commissioner, 41 B.T.A. 300, 302 (1940), affd. 125 F.2d 977 (6th Cir. 1942). To the extent mutual institutions receive some untoward benefit by using the percentage of income method for calculating their deductible addition in profitable years while shifting to a loss experience method after suffering losses, we respond by noting that Congress has given mutual institutions such latitude. Sec. 593(b)(1)(B).
To reflect the foregoing and concessions,
Decision will be entered under Rule 155.
Reviewed by the Court.
Nims, Chabot, Kórner, Shields, Hamblen, Cohen, Clapp, Swift, Wright, Williams, and Colvin, JJ., agree with the majority opinion.
WHALEN, J., concurs in the result only.
Unless otherwise indicated, ail section references are to the Internal Revenue Code as amended and in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
During relevant times, the portions of section 593 pertinent to the instant case provided as follows:
SEC. 593(b). Addition to Reserve for Bad Debts.—
(1) In general. — For purposes of section 166(c), the reasonable addition for the taxable year to the reserve for bad debts shall be an amount equal to the sum of—
(B) the amount determined by the taxpayer to be a reasonable addition to the reserve for losses on qualifying real property loans, but such amount shall not exceed the amount determined under paragraph (2), (3), or (4) whichever amount is the largest, *
(2) Percentage op taxable income method.—
(A) In general.— the amount determined under this paragraph for the taxable year shall be an amount equal to the applicable percentage of the taxable income for such year (determined' under the following table):
For a taxable year beginning in— The applicable percentage under this paragraph shall be-
1971 54%
1972 51
1973 49
1974 47
For a taxable year beginning in— The applicable percentage under this paragraph shall be-
1975 45
1976 43
1977 42
1978 41
1979 or thereafter 40
The example ignores, for the sake of simplicity, that the taxpayer may be entitled to a deduction under an alternative method, such as the experience method, even if lack of "taxable income" prevents a deduction under the percentage method.
Technical corrections to the Revenue Act of 1978 increased the percentage to 18/46. Pub. L. 96-222, sec. 104(a)(3)(C), 94 Stat. 215.
Because petitioner did not argue the reenactment doctrine (Helvering v. Winmill, 305 U.S. 79, 83 (1938)), we do not address the impact of the doctrine on Treasury's authority to promulgate the challenged provisions. Compare Helvering v. R.J. Reynolds Tobacco Co., 306 U.S. 110 (1939) (Congressional approval of long-standing regulation precluded retroactive enforcement of amended regulation taking contrary position) and Helvering v. Griffiths, 318 U.S. 371 (1943) (reenactment doctrine cannot invalidate reasonable, prospective amendments to regulations).