Court Opinion

ID: 4331914
Source: CourtListenerOpinion
Date Created: 2018-11-14 00:24:28.089086+00
Date Added: 2024-06-11T14:47:46.112620
License: Public Domain

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.
                                 - 2 -

                                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

     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue.
                                - 3 -

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
                                 - 4 -

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).

     2
      Although 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).
                                 - 5 -

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
                                - 6 -

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 Court-

reviewed 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
                              - 7 -

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

     3
      Respondent 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.
                                - 8 -

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
                              - 9 -

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.

     4
      Because 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.