Appendix — Pacific First Bank v. Commissioner
Supreme Court brief1992
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Buprema Court, US
92-279° FIDED
AUG 12 1992
No. } GFFICE OF THE CLERK
IN THE
Supreme Court of the United States
OCTOBER TERM, 1992
Pacific First Bank,
Petitioner,
¥.
Commissioner of Internal Revenue,
Respondent.
PETITION FOR A WRIT OF CERTIORARI TO THE
UNITED STATES COURT OF APPEALS FOR THE
NINTH CIRCUIT
APPENDIX
MARTIN D. GINSBURG
Counsel of Record
MARTIN D. GINSBURG, P.C.
ALAN S. KADEN
JOHN F. COVERDALE
FRIED, FRANK, HARRIS,
SHRIVER
& JACOBSON
1001 Pennsylvania Avenue, N.W.
Suite 800
Washington, D.C. 20004
(202) 639-7000
Attorneys for Petitioner
APPENDIX
TABLE OF CONTENTS
Page
Pacific First Federal Savings Bank v.
Commissioner, 961 F.2d 800 (9th Cir. 1992) ..... la
Pacific First Federal Savings Bank v.
Commissioner, 94 T.C. 101 (1990) .......... 26a
I I a 52a
DRED ene wee as ceeseuaewe 55a
§1.593-6(b)(2)(iv) (1964) .. 2.2.2.2... 2.2.2.0... ee. 56a
§1.593-6A(b)(5)(vi) (1979) 2... ee ee ee eee eee 57a
rgi r vings B F.S.B. v
Commissioner, 98 T.C. 105 (1992) .......... 59a
‘amauta
FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
PACIFIC FIRST FEDERAL SAVINGS No. 91-70116
BANK, Tax Ct. No.
Petitioner-Appellee, 27606-87
V. ORDER
COMMISSIONER INTERNAL REVENUE | AMENDING
SERVICE, OPINION
AND
Respondent-Appellant. DENYING
REHEARING
Appeal from a Decision of the
United States Tax Court
Argued and Submitted
October 9, 1991-Seattle, Washington
Filed February 7, 1992
Amended May 21, 1992
Before: J. Clifford Wallace, Chief Judge, Procter Hug, Jr.
and Pamela Ann Rymer, Circuit Judges.
Opinion by Chief Judge Wallace; Dissent by Judge Hug
la
SUMMARY
Income Taxes
Reversing and remanding a decision of the Tax Court, the
court of appeals held that although the Tax Court erred in
invalidating Treasury Regulation §1.593,6A(b)(S)(vi) and (vii),
concerning the recalculation of mutual institutions’ reserve
deductions because of the carry-back of net operating losses, the
Tax Court had to also determine whether the retroactive
application of the regulation was invalid.
The Commissioner of Internal Revenue challenged the Tax
Court’s invalidation of Treasury Regulation §1.593-6A(b)(5)(vi)
and (vii). Under that regulation, the Commissioner of Revenue
determined that Pacific First Federal Savings Bank’s net operating
loss deduction reduced its taxable income for the carry-back years
in question, thus Pacific was required to recalculate its reserve
deductions. A previous regulation did not require that the reserve
deduction be recalculated. The Tax Court determined that the
regulation was invalid.
[1] The court believed much of the Sixth Circuit’s reasoning
in upholding the regulation was persuasive but wrote separately
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only to clarify the analysis supporting the validity of the
regulation. [2] The court therefore concluded that where the tax
court decision has been thoroughly considered and rejected by
another circuit, no special deference should be given to the tax
court’s conclusions of law. [3] The court did not need to decide
whether Chevron applied to the regulations in this case, because
the traditional rule of deference to Treasury regulations supported
the decision to uphold the challenged regulation. [4] The
Treasury’s explanation for the regulatory change in this case was
also sufficient to warrant deference.
[5] The regulation in question was a reasonable construction of
the statute. Since section 172 net operating losses are deductions
allowed by the Internal Revenue Code, Pacific’s reserve deduction
appeared to be limited by the amount of taxable income remaining
after section 172 losses have been deducted. [6] The challenged
regulation was also a reasonable interpretation of the legislative
history. The prior regulations did not require the reserve
deduction to be recalculated when a section 172 loss was deducted
from taxable income. [7] Although Congress did not explicitly
state an intention to ameliorate all of the consequences of taxing
individuals on an annual basis, the Treasury’s regulatory shift
avoids inequitable windfalls based on the timing of income and
losses. [8] The regulation merely required that the taxpayer who
selected the percent of taxable income method to calculate the
reserve deduction take into account the new taxable income figure
in the carry-back year. The regulation was thus upheld as a rea-
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sonable exercise of the responsibility delegated by Congress to the
Treasury. [9] However, the case was remanded to the Tax Court
for a determination of whether the retroactive application of the
regulation is valid.
Dissenting, Judge Hug would have affirmed the judgment of
the Tax Court.
4a
COUNSEL
Bruce R. Ellisen, Tax Division, United States Department of
Justice, Washington, D.C., for the respondent-appellant.
John F. Coverdale, Fried, Frank, Harris, Shriver & Jacobson,
Washington, D.C., for the petitioner-appellee.
ORDER
The opinion filed in the above case on February 7, 1992, is
amended as follows:
Slip op. 1287, line 9: delete ", which we follow here";
Slip op. 1294, last paragraph, lines 6-12: delete sentence
beginning "For example, . . ." and substitute the following: "For
example, the argument that the Treasury’s regulatory shift violates
congressional intent because it decreases the incentives to
accumulate reserves and threatens depositor safety is premised
upon the belief that Congress carefully considered all of the effects
of allowing taxpayers to disregard section 172 losses when
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calculating their reserve deduction."
A majority of the panel has voted to deny the petition for
rehearing and to reject the suggestion for rehearing en banc.
The full court has been advised of the suggestion for rehearing
en banc, and no judge of the court has requested a vote on the
suggestion for rehearing en banc. Fed. R. App. P. 35(b).
The petition for rehearing is denied, and the suggestion for
rehearing en banc is rejected.
OPINION
WALLACE, Chief Judge:
The Commissioner of Internal Revenue (Commissioner)
appeals the tax court’s decision that Treasury Regulation § 1.593-
6A(b)(5)(vi), (vii) is invalid because it does not implement the
congressional mandate in a reasonable manner. The tax court had
jurisdiction pursuant toI.R.C. §§ 6214, 7442. (All references are
to the Internal Revenue Code of 1954 (Code or I.R.C.), unless
otherwise indicated.) We have jurisdiction over this timely appeal
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pursuant to IL.R.C. § 7482. We reverse and remand to the tax
court for further proceedings.
During the relevant period, Pacific First Federal Savings Bank
(Pacific) was a mutual savings and loan association with its
principal place of business in Tacoma, Washington. Pacific
claimed deductions for reasonable additions to a reserve for bad
debts for the taxable years 1971 through 1980. The Code provides
special rules for determining reasonable additions to reserves for
domestic building and loan associations, mutual savings banks, and
certain cooperative banks (collectively referred to as "mutual
institutions"). Jd. § 593(a). In general, mutual institutions may
deduct "the amount determined by the taxpayer to be a reasonable
addition to the reserve for losses on qualifying real property
loans,” but that amount may not exceed a cap determined under
one of three alternative methods: (1) the percentage of taxable
income method, under which the deduction is equal to a specified
percentage of the institution’s taxable income; (2) the percentage
of loans method, under which the deduction is based on a specified
percentage of the relevant loans; and (3) the experience method,
under which the deduction is based on the taxpayer’s bad debt
history. Id. §§ 593(b), 585(b). The mutual institution may choose
the method that provides the highest deduction. Id. § 593(b)(1)(B).
7a
During the relevant years, Pacific used the percentage of
taxable income method to compute its reserve deduction. Pursuant
to section 593, the percentage rate used to determine the deduction
for 1971 was 54 percent. The rate was gradually reduced each
year until it reached 40 percent for 1979 and each year thereafter.
Id. § 593(b)(2)(A).
During the taxable years 1981 and 1982, Pacific sustained net
operating losses in the amounts of $43,459,246 and $27,748,382,
respectively. At that time, the Code permitted mutual institutions
to carry back net operating losses to each of the ten taxable years
preceding the year of the loss. Jd. § 172(b)(1)(F). The net
operating loss is first carried back to the earliest permissible year,
with any unabsorbed amount carried forward chronologically until
fully absorbed. See id. § 172(b)(2). When carried back, the net
operating loss is treated as a deduction, thereby reducing taxable
income for that year. The taxpayer then receives an appropriate
refund. Pacific carried its 1981 net operating loss back to the
years 1971 through 1978 and carried its 1982 net operating loss
back to the years 1978 and 1979. Pacific did not make any
adjustment to its bad debt reserve deductions for the years 1971
through 1979, even though taxable income for those years was
reduced by the loss carry-backs.
During an audit, the Commissioner determined that because
the net operating loss deduction reduced taxable income for the
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carry-back years, Pacific was required to recalculate its reserve
deductions. Although earlier regulations issued by the Secretary
of the Treasury (Treasury) indicated that the reserve deduction did
not need to be recalculated, the regulation in effect when Pacific’s
net operating losses occurred provides that deductions for section
172 losses reduce taxable income for purposes of determining the
allowed reserve deduction. Compare Treas. Reg. § 1.593-
6(b)(2)(iv) (1971) (taxable income for purposes of section 593 is
not reduced by section 172 losses) with Treas. Reg. § 1.593-
6A(b)(5)(vi), (vii) (1982) (for the relevant years, taxable income
for purposes of section 593 is reduced by section 172 losses). The
Commissioner contended that pursuant to the applicable
regulations, Pacific was required to recompute its reserve
deductions for the loss carry-back years. According to the
Commissioner, Pacific’s income taxes for 1978, 1979, and 1980
were deficient in the amounts of $1,743,066, $5,057,885, and
$2,512,321, respectively.
Pacific petitioned the tax court seeking redetermination of the
deficiencies. Pacific argued that Treasury Regulation § 1.593-
6A(b)(5)(vi), (vii) is an unreasonable interpretation of the statute
and, therefore, invalid. The tax court, in a 13-5 reviewed decision,
held that the regulation was invalid. See Pacific First Federal
Savings Bank v. Commissioner, 94 T.C. 101, 107 (1990) (Pacific
First).
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ii
[1] The Commissioner argues that the tax court erred in
invalidating Treasury Regulation § 1.593-6A(b)(5)(vi), (vii). The
only other circuit court to address this issue has criticized and
rejected the tax court’s decision in Pacific First. See Peoples
Federal Savings & Loan Association of Sidney v. Commissioner,
No. 90-1939, slip op. at 2, 28-31 (6th Cir. Nov. 6, 1991)
(Peoples Federal); see also First Federal Savings Bank of
Washington v. United States, 766 F. Supp. 897, 899-900 (E.D.
Wash. 1991), appeal docketed, No. 91-35690 (9th Cir. May 21,
1991) (rejecting the tax court’s decision in Pacific First and
upholding the regulation). “Uniformity among the circuits is
especially important in tax cases to ensure equal and certain
administration of the tax system. We would therefore hesitate to
reject the view of another circuit." First Charter Financial Corp.
v. United States, 669 F.2d 1342, 1345 (9th Cir. 1982) (First
Charter). We believe much of the Sixth Circuit’s reasoning is
persuasive, and write separately only to clarify the analysis
supporting the validity of the regulation.
ili
In the past, there has been some ambiguity in our circuit over
the proper scope of review of tax court decisions. Estate of
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Schnack v. Commissioner, 848 F.2d 933, 935 (9th Cir. 1988)
(Estate of Schnack). The parties have stipulated to the facts in this
case. Therefore, we are only faced with a question of law
concerning the validity of the regulation, which we review de
novo. Id. Some of our earlier decisions, however, appear to
indicate that deference should be given to decisions of the tax
court. See, e.g., First Charter, 669 F.2d at 1345. In Vukasovich,
Inc. v. Commissioner, 790 F.2d 1409, 1411-13 (9th Cir. 1986),
we recognized the difficulty with some of our previous decisions
and concluded that, in general, no special deference should be
given the tax court when reviewing a pure question of law. See
also Lynch v. Commissioner, 801 F.2d 1176, 1178-79 (9th Cir.
1986) (no deference to tax court’s conclusions of law). This
interpretation of our circuit's case law history was followed in
Estate of Schnack, 848 F.2d at 935.
[2] Even if deference to the tax court on a legal question is
proper in certain circumstances, such deference would be
inappropriate in this appeal. The purpose of deferring to legal
decisions of the tax court is to foster the value of tax law uni-
formity. As we pointed out in Vukasovich, in the realm of national
tax law, “it is more important that the applicable rule of law be
settled than it be settled right." 790 F.2d at 1413, quoting Burnet
v. Coronado Oil & Gas Co., 285 U.S. 393, 406 (1932) (Brandeis,
J., dissenting). Therefore, we conclude that in cases such as this
one, where the tax court decision has been thoroughly considered
lla
ee
and rejected by another circuit, no special deference should be
given to the tax court’s conclusions of law.
[3] The parties also disagree over the degree of deference to
be given to the Treasury’s regulation. The challenged regulation
was issued under the Treasury’s authority to “prescribe all needful
rules and regulations.... I.R.C. § 7805. The Sixth Circuit
concluded that the rule of deference established by Chevron U.S.A.
Inc. v. Natural Resources Defense Council, 467 U.S. 837 (1984)
(Chevron), should be applied to this interpretive regulation. See
Peoples Federal, No. 90-1939, slip op. at 18-19. We need not
decide whether Chevron applies to the regulations in this case,
however, because the traditional rule of deference to Treasury
regulations supports our decision to uphold the challenged
regulation. The Supreme Court has consistently held that courts
must defer to the Treasury’s interpretive regulations if they
"implement the congressional mandate in some reasonable
manner." National Muffler Dealers Association v. United States,
440 U.S. 472, 476 (1979) (National Muffler) (internal quotations
omitted); see also Cottage Savings Association v. Commissioner,
111 S. Ct. 1503, 1508 (1991) (Treasury’s interpretations of the
Code should be upheld “so long as they are reasonable").
In determining whether the regulation is consistent with the
congressional mandate, “we look to see whether the regulation
harmonizes with the plain language of the statute, its origin, and
its purpose." National Muffler, 440 U.S. at 477. The majority of
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eee
the tax court apparently determined that this "harmony" s_andard
requires the reviewing court to engage in a plenary review of the
statute and legislative history to determine the appropriate meaning
of the Code. Pacific First, 94 T.C. at 115. However, National
Muffler only requires that the court determine whether the
challenged regulation is a reasonable interpretation of the statute’s
plain language, its origin, and its purpose." First Charter, 669
F.2d at 1348.
Pacific contends that an interpretation that is neither long-
standing nor consistent with previous interpretations is not entitled
to deference. The cases cited by Pacific, however, do not address
the deference to be given to a Treasury regulation. See, e.g.,
Lynch v. Dawson, 820 F.2d 1014, 1020 (9th Cir. 1987); United
Transportation Union v. Lewis, 711 F.2d 233, 242 (D.C. Cir.
1983). While recognizing that the consistency and
contemporaneity of the Treasury’s interpretation are relevant, the
Supreme Court in National Muffler deferred to a regulation that
reversed the Treasury’s previous interpretation that was in force
for ten years. National Muffler, 440 U.S. at 484-86. National
Muffler is consistent with recent Supreme Court decisions that
have also "rejected the argument that an agency’s interpretation "is
not entitled to deference because it represents a sharp break with
prior interpretations’ of the statute in question." Rust v. Sullivan,
111 S. Ct. 1759, 1769 (1991), quoting Chevron, 467 U.S. at 862.
Thus, we follow National Muffler and reject “the rigid view that
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= ———— —
an agency may not alter its interpretation in light of administrative
experience." National Muffler, 440 U.S. at 485.
Pacific also contends that we should not defer to the regulation
because the Treasury did not supply an adequate justification for
the regulatory shift. However, a 1978 memorandum written by
the Acting Assistant Secretary for Tax Policy to the Secretary of
the Treasury clearly indicates that the Treasury was convinced that
"the position with respect to taxable income taken in the prior
regulation was mistaken and without statutory authority.” The
memorandum states that the previous regulation “permitted thrift
institutions to take unwarranted bad debt deductions through a
liberal definition of the term "taxable income’, which is contrary
to the definition provided in the Code." This is the same reason the
Commissioner has advanced in this case for upholding challenged
regulation.
[4] Pacific argues that a different rationale for the new reg-
ulation was provided by the Treasury in public notices proposing
the regulation and adopting the final regulations. These notices
stated that the regulations were being amended to conform to
amendments to the Code made by the Tax Reform Act of 1969,
Pub. L. No. 91-172, § 432, 83 Stat. 487, 620-23. See 36 Fed.
Reg. 15050 (1971); T.D. 7549, 1978-1 C.B. 185, 185-86. These
notices, however, addressed numerous changes in the regulations,
and the justification for the changes was not linked to any single
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amendment. The justification for each amendment to the
regulations would have been clearer had the Treasury published
specific reasons for each regulatory change. Nonetheless, the
Supreme Court has deferred to a regulation when "[nJothing in the
regulations or case law directly explain[ed] the regulatory shift,"
see National Muffler, 440 U.S. at 485 (citation omitted), conclud-
ing that it was sufficient that an otherwise apparent change in
regulations “incorporated an interpretation thought necessary to
match the statute’s construction to the original congressional
intent." Jd. Therefore, the Treasury’s explanation for the
regulatory change in this case is also sufficient to warrant def-
erence.
Although we reject Pacific’s argument that the regulation
should be given no deference, we recognize that the challenged
regulation is less persuasive than would be a contemporaneous,
long-standing Treasury regulation that had remained in force after
Congress considered and reenacted the pertinent Code provisions.
However, we cannot usurp the Treasury’s authority and invalidate
the regulation unless it is an unreasonable construction of the
statute and its legislative history. See id. at 488-89.
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A.
[5] The Treasury’s regulation is a reasonable construction of
the text of sections 593 and 172. Section 593(b)(2) limits the
reserve deduction taken by Pacific to a specified percentage of
taxable income. Although taxable income is not defined in section
593, it is defined in section 63(a) as “gross income minus the
deductions allowed by this chapter." I.R.C. § 63(a). Since section
172 net operating losses are deductions allowed by this chapter,
Pacific’s reserve deduction appears to be limited by the amount of
taxable income remaining after section 172 losses have been
deducted.
The Commissioner points out that although section 593 does
not expressly state whether deductions for section 172 losses
should be excluded from taxable income, the section does exclude
certain items normally included within the concept of taxable
income. Jd. § 593(b)(2)(E). In addition, several other Code
sections that require computations based on taxable income contain
an explicit provision stating that taxable income is calculated
without regard to section 172 loss deductions. See id. §§
170(b)(2)(C); 246(b)(1). Applying the principle of expressio unius
est exclusio alterius, the Commissioner argues that if Congress
intended the reserve deduction not to be affected by section 172
losses, Congress would have so provided in the text of the
amendment.
16a
Pacific, however, argues that the text can also be construed as
supporting the argument that the reserve deduction should not be
recalculated when a net operating loss is carried back. Section 172
provides that "[t]he portion of such loss which shall be carried to
each of the other taxable years shall be the excess, if any, of the
amount of such loss over the sum of the taxable income for each
of the prior taxable years to which such loss may be carried." Id.
§ 172(b)(2) (emphasis added). Taxable income is defined as
"gross income minus the deductions allowed by this chapter." Jd.
§ 63(a). Since the deduction for reasonable reserves is a deduction
allowable under this chapter, the amount of the net operating loss
that may be absorbed in a given year is arguably calculated after
the reserve deduction is subtracted from taxable income. There-
fore, since both the reserve deduction and the net operating loss
deduction are affected by the amount of taxable income, it is
necessary to determine which deduction will reduce taxable income
first.
The interpretations offered by the Treasury and Pacific both
appear reasonable. However, “the choice among reasonable
interpretations is for the Commissioner, not the courts." National
Muffler, 440 U.S. at 488. Therefore, we defer to the Treasury’s
interpretation of the statute.
17a
a
[6] The challenged regulation is also a reasonable interpretation
of the legislative history. Neither party has provided any evidence
that Congress specifically addressed the question whether the
reserve deduction should be recalculated after a section 172 loss is
deducted from taxable income. Treasury was forced to balance
two competing legislative policies underlying section 593. One
purpose for allowing bad debt reserve deductions is to encourage
mutual institutions to accumulate bad debt reserves. See Arcadia
Savings & Loan Association v. Commissioner, 300 F.2d 247, 251
(9th Cir. 1962) (Arcadia). Congressional tax reform, however,
has reduced the benefit that section 593 confers upon mutual
institutions in order to further a policy of taxing mutual institutions
and other corporate taxpayers at a similar rate. See, e.g., Tax
Reform Act of 1969, Pub. L. No. 91-172, § 432(a), 83 Stat. 487,
620 (codified at I.R.C. § 593) (reducing the allowable deduction
from 60 to 40 percent over a ten-year period); H.R. Rep. No. 413,
91st Cong., Ist Sess., pt. 1, at 125, reprinted in 1969-3 C.B. 200,
278 (previous reserve deduction allowed “these institutions to pay
a much lower average effective rate of tax than the average
effective rate for all corporations"). The Treasury amended its
regulations to treat mutual institutions more like other taxpayers
and to reflect what it perceived was the proper balance between
these two competing congressional objectives.
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eateries iaaiaaiaiiiiiialiiliai aia I
The Treasury was also required to consider the purposes
underlying section 172 when amending the regulation. One
purpose of section 172 is to improve the equity of the tax system
between taxpayers with fluctuating and relatively stable incomes.
See Aetna Casualty & Surety Co. v. United siates, 568 F.2d 811,
819 (2d Cir. 1976). Although the purpose of section 172 is clear,
the application of the prior regulatory scheme, which was adopted
by the tax court majority, results in a windfall to taxpayers with
fluctuating income and losses. The prior regulations did not
require the reserve deduction to be recalculated when a section 172
loss was deducted from taxable income. See Treas. Reg. § 1.593-
6(b)(2)(iv) (1971). For example, an institution with $2,000,000
income evenly divided over two years would be taxed as follows:
1979 1980
Income before percentage
method deduction 1,000,000 1,000,000
Percentage method reserve
deduction at 40% (400,000) (400,000)
Taxable Income 600,000 600,000
Tax at 46% 276,000 276,000
However, an institution with an uneven distribution of income
would pay significantly less taxes:
19a
i
1979 1980
Income before percentage
method deduction 3,000,000 (1,000,000)
Percentage method reserve
deduction at 40% (1,200,000) -0-
Net operating loss
carry-back (1,000,000) -0-
Taxable Income 800,000 0-
Tax at 46% 368,000 -)-
Both hypothetical taxpayers experienced a gain of $2,000,000 over
two years, but the prior regulatory scheme allows the second
taxpayer to pay a tax of only $368,000 while the first taxpayer
pays $552,000. The second taxpayer receives a windfall of
$184,000 because its income was distributed unevenly between the
two years.
[7] Under the challenged regulation, the first taxpayer pays the
same tax as before. The second institution, however, now pays the
Same tax as the first taxpayer:
20a
| | j
1979 1980
Income before percentage
method deduction 3,000,000 (1,000,000)
Net operating loss
carry-back (1,000,000) -0-
Taxable income before
reserve deduction 2..000,000 4-
Percentage method reserve
deduction at 40% (800,000) -
Taxable Income 1,200,000 -
Tax at 46% 552,000 --
Although Congress did not explicitly state an intention to
ameliorate all of the consequences of taxing individuals on an
annual basis, the Treasury’s regulatory shift avoids inequitable
windfalls based on the timing of income-and losses. The
regulation, therefore, can hardly be deemed unreasonable.
Pacific argues that the Treasury’s regulation violates the
general purpose of sections 593 and 172 in several ways. First,
Pacific contends that the amended regulation undermines depositor
safety by essentially repealing the reserve deduction for some
taxpayers. Second, Pacific contends that in 1969 the House and
Senate specifically considered the effect of the prior regulations on
the tax rate in reaching a compromise on how much to curtail the
reserve deduction benefit. See H.R. Conf. Rep. No. 782, 91st
Cong., Ist Sess. 311, reprinted in 1969-3 C.B. 644, 664. Pacific
2la
ny
asserts that the Treasury’s regulatory shift upsets this compromise.
Third, Pacific argues that the Treasury’s reinterpretation
effectively nullifies the ten year carry-back provision by reducing
the benefit of carrying back losses.
Although Pacific does not argue that the traditional reenact-
ment doctrine applies in this case, each of Pacific’s arguments
depends on the assumption that in amending the Code, Congress
considered the effect of the prior regulatory scheme, or the
desirability of recalculating the reserve deduction when section 172
losses are carried back. For example, the argument that the
Treasury's regulatory shift violates congressional intent because it
decreases the incentives to accumulate reserves and threatens
depositor safety is premised upon the belief that Congress carefully
considered all of the effects of allowing taxpayers to disregard
section 172 losses when calculating their reserve deduction.
Pacific has presented no persuasive evidence that Congress gave
any scrutiny to the prior regulations or otherwise considered
whether requiring taxpayers to recalculate reserve deductions when
seccion 172 losses are carried back would threaten depositor safety.
The prior regulations were complex and, as discussed above,
resulted in differing levels of taxation depending upon the timing
of income and losses. Absent clearer evidence that Congress
considered the effect of the prior regulations, or the need to
disregard section 172 losses when calculating the reserve
deduction, we cannot usurp the Treasury’s congressionally
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delegated authority to interpret this complex scheme.
[8] In addition, Pacific has mischaracterized the effect of the
regulation. The regulation does not repeal the percentage of
taxable income method or the generous carry-back period allowed
for mutual institutions. The regulation merely requires that the
taxpayer who selected the percent of taxable income method to
calculate the reserve deduction take into account the new taxable
income figure in the carry-back year. We hold that the regulation
is a reasonable exercise of the responsibility delegated by Congress
to the Treasury. National Muffler, 440 U.S. at 477.
Pacific also contends that the regulation is inconsistent with
our decisions holding that "[e]stimates fairly made at the time may
not be enlarged in the light of subsequent events . . . .” See, e.g.,
Rogan v. Commercial Discount Co., 149 F.2d 585, 590 (9th Cir.)
(internal quotations omitted), cert. denied, 326 U.S. 764 (1945).
The Treasury, however, is not requiring mutual institutions to
revise an estimate. Section 593 provides a deduction for “the
amount determined by the taxpayer to be a reasonable addition to
the reserve... ." L.R.C. § 593(b)(1)(B). The percentage of
taxable income method is merely a means of calculating the cap on
what the taxpayer may estimate as a reasonable deduction. The
23a
Treasury’s regulation only requires a permissible adjustment "of
the formula determining the limits of the reserve allowable." See
Rio Grande Building & Loan Association v. Commissioner, 36
T.C. 657, 668 (1961) (dicta).
Pacific contends that section 593(b)(2) is more than a method
of calculating the limit on the deduction. Pacific relies on Arcadia
for the proposition that the percentage of taxable income method
"furnishes a formula for measuring a reasonable addition to a
reserve for bad debts.... Arcadia, 300 F.2d at 251. In Arcadia,
however, we were not asked to decide whether the percentage of
taxable income method is (1) a formula for calculating what is a
reasonable addition to reserves, or (2) a formula for determining
the limit on what a taxpayer may deem to be a reasonable addition.
Thus, Arcadia is not dispositive here.
Moreover, Pacific’s reliance on United States v. Foster Lumber
Co., 429 U.S..32.(1976), is also misplaced. Foster Lumber only
addresses -whether capital gains income must be included in the
taxable income offset by net operating loss deductions. Jd. at 33-
36. The Court did not decide the scope of the term "taxable
income” in light of the purposes behind sections 172 and 593.
24a
[9] Pacific contends that even if the regulation is upheld as a
reasonable construction of the statute, the retroactive application of
the regulation is invalid. Pacific raised this issue below, but the
tax court did not reach the retroactivity question because it
invalidated the regulation. We remand this case to allow the tax
court to address this issue in the first instance. We express no
view the question whether the Commissioner is applying the
regulation retroactively in this case.
REVERSED AND REMANDED.
HUG, Circuit Judge, Dissenting:
I respectfully dissent. I would affirm the judgment of the Tax
Court based upon the well-reasoned opinion of Judge Wells writing
for the majority of the Tax Court. Pacific First Federal Savings
Bank v. CIR, 94 U.S. Tax Court Reports 96 (1990).
25a
(96) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 101
PACIFIC FIRST FEDERAL SAVINGS BANK, PETITIONER Vv.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 27606-87. Filed February 27, 1990.
From 1971 through 1980, P deducted additions to its bad
debt reserve. The amounts deducted were calculated with
reference to P’s taxable income for each year. In 1981 and
1982, P had net operating lossee (NOLs). Held, subdivisions -
(vi) and (vii) of sec. 1.593-6A(bN5), Income Tax Regs., are
invalid to the extent they require that taxable income reflect
any NOL carrybacks before the deduction for addition to bad
debt reserve is calculated for certain financial institutions.
Alan S. Kaden and John F. Coverdale, for the petitioner.
Fera Wagner and Richard Osborne, for the respondent.
OPINION
WELLS, Judge: Respondent determined the following
deficiencies in petitioner’s Federal income tax:
26a
102 94 UNITED STATE TAX COURT REPORTS (101)
Year Deficiency
EOFS oo sc 0 00:5 0 x 5:5 6.in oa ic $1,743,066
|, mre Mr heh Ee 5,057,885
BOD on nos uc ccuenaesd dele hen eee 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-mamd having as its principal
place of business when it -filed its petition Tacoma, Wash-
ington.
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 peti-
tioner. 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.?
‘Unless otherwise indicated, all section references are to the Internal Reverne 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). Apprrion To Reserve ron Bap Dests—
(1) IN GentraL—For purposes of section 166ic), the reasonable addition for the taxable
year to the reserve for bad debts * * * shall be an amount equal to the sum of—
a
(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 103
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 deduc-
tions under section 593(b)(2A) 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 order-
ing 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
(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 OF 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}: a
For a taxable year The applicable percentage
beginning in— under this paragraph shall be—
1971 54%
1972 51
1973 49
1974 47
For a taxable year The appticable percentage
beginning in— under this paragraph shall be—
1975 45
1976 43
1977 42
1978 41
1979 or thereafter 40
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ABLE COPY
104 94 UNITED STATES TAX COURT REPORTS (101)
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 amend-
ments 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
29a
(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 105
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 regula-
tions were consistent with petitioner's method. They re
quired 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 pro
vided 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 taxabie 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 charitabie,
etc., contributions and gifts), * * * [Sec. 1.593-1(b)(1), 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. Rul. 5& 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). ng
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)
106 94 UNITED STATES TAX COURT REPORTS (101)
1971 1972 1981
(3) Taxable income before
carrybacks 460,000 490,000 (1,000,000)
(4) Tax at 46% 211,600 225,400 ie
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 *-- ae
(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* 1971. Lines
method deduction 540,000 (1)-(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 regula-
tions 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 “‘legisla-
tive regulations,’ which are promulgated under more spe
cific 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 inter-
pretative regulation:
In determining whether a particular regulation carries out the congres-
sional mandate in a proper manner, we look to see whether the regulation
*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.
3la
(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 107
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 manner 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 interpre
tation, 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 modifi-
cations 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, how-
ever, 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 legisla-
tive history of section 593 discussed infra indicates that
32a
108 94 UNITED STATES TAX COURT REPORTS (101)
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 statu-
tory 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’’ (Hereaf-
ter, we refer to the foregoing types of financial institutions
as mutual institutiens.). 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, Con-
gress amended section 23(k}(1) 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
33a
(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 109
debt reserve. S. Rept. 781, 82nd Cong., 1st Sess. (1951),
1951 C.B. 458, 474.
The Revenue Act of 1962 somewhat curtailed the avail-
able 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
34a
110 94 UNITED STATES TAX COURT REPORTS (101)
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. Amend-
ments required the exciusion 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 strug:
gled with competing considerations in enacting the forego
ing 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 provi-
sions 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
“Technical corrections to the Revenue Act of 1978 increased the percentage to 18/46. Pub. L.
96-222, sec. i04ian3NC), 94 Stat. 215.
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(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 1ll
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 addi-
tions 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.) ve
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 appli-
cable 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
36a
112 94 UNITED STATES TAX COURT REPORTS (101)
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 operat-
ing 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 pro-
vided 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
37a
KKK LL
(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 113
operating loss carryback provisions in order to achieve a
limited increase in the income tax levels of mutual institu-
tions. 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 modifi-
cations 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 1.593-1(b)(1), 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 indica-
tion 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
38a
114 94 UNITED STATES TAX COURT REPORTS (101)
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 modifica-
tion 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 ‘‘substan-
tially 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 carry’»acks when calculat-
ing 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
‘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 Heivering v. RJ. 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).
39a
(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 115
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 provi-
sions 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
Mu/fler Dealers Assn. Inc. v. United States, the Court
considered a 1966 amendment to section 501(c)(6) in at-
tempting to decide whether regulations interpreting “busi-
ness 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 order-
ing rule prescribed by the challenged provisions by reducing
the applicable percentage to 8 percent without reverting
40a
116 94 UNITED STATES TAX COURT REPORTS (101)
back to the old ordering rule. Pub. L. 99-514, sec. 901(b),
100 Stat. 2378. We find respondent’s argument unconvinc-
ing. 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 long:
standing 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 in-
come 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 Con-
gress 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).
4la
———
(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 117
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, KORNER, SHIELDS, HAMBLEN, COHEN,
CLAPP, SWIFT, WRIGHT, WILLIAMS, and COLVIN, JJ., agree
with the majority opinion.
WHALEN, J., concurs in the result only.
GERBER, J., dissenting. I respectfully disagree with those
who support the majority’s opinion because they have
chosen to invalidate a regulation which is a literal, accurate,
and reasonable interpretation of unambiguous statutory
provisions. This matter arose in circumstances under which
respondent issued new regulations contrary to his original
regulations and position. The superseded regulations had
permitted the result being sought by petitioner. Although
the majority has not shown that the new regulations are
incompatible with the statutory structure, it has invalidated
the regulation because of its perception of congressional
intent. I cannot support the majority’s holding because: (1)
The regulations are unambiguous and in complete accord
with an unambiguous statutory framework; (2) the effect of
the majority’s invalidation of the regulations will not carry
out the congressionally intended result described~in the
majority opinion; (3) it permits a congressionally unintended
benefit to a specific class of taxpayers, which is not
available to any other class of taxpayers; and (4) the
majority has failed to consider the Supreme Court’s analysis
and approach in an analogous and similarly situated case.
Background
The salient factors in this case are as follows:
42a
118 94 UNITED STATES TAX COURT REPORTS (101)
(1) Petitioner is a savings bank which computes its
reserve for losses under section 593. ‘“‘This section * * *
permits a taxpayer broad discretion to determine the
amount of the addition to [its] reserve, not to exceed the
limits set forth in section 593(b).’’ The Home Group, Inc. v.
Commissioner, 91 T.C. 265, 266 (1988), affd. on other -
grounds 875 F.2d 377 (2d Cir. 1989). |
(2) Petitioner, during the taxable years 1971 through
1977, could have chosen any of several statutorily permitted
methods of computing its loss reserve. Some of the methods
provide for computation of the reserve based upon actual
experience. Another permits the use of an artificial statuto-
rily permitted percentage of taxable income without regard
to a taxpayer’s actual loss experience. Petitioner, for its
1971 through 1977 taxable years, used the artificial percent-
age of taxable income method without regard to its actual
loss experience to produce the largest permissible reduction
of taxable income—a result envisioned by Congress to
permit the flow of additional capital and provide for
potential losses.
(3) As much as 10 years later, in 1981 and 1982,
petitioner experienced net operating losses which generated
a net operating loss deduction (NOLD), which petitioner
sought to carry back to the taxable years 1971 through
1977. The NOLD reduces taxable income and may produce a
tax refund from the years to which it is carried back. To
the extent that the NOLD is not absorbed in the year to
which it is carried back, it is carried forward to the next
later year with taxable income, and so on. Petitioner wishes
to have the benefit of being able to carry the NOLD further
forward by applying it against an amount of taxable income -
in the carryback year which had been reduced by the
maximum amount of reserve addition based upon a “‘tax-
able income” unreduced by the NOLD. In other words,
petitioner wishes us to ignore the fact that taxable income
had been reduced in the carryback year by an addition to
the loss reserve based upon a percentage of taxable income.
Respondent argues that taxable income must first be
reduced by the NOLD before the reserve addition may be
determined. It should be noted that respondent does not
advocate that petitioner receive no allowance for its loss
43a
(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 119
reserve, but that it is not now feasible to compute it based
upon the now-reduced amount of taxable income under the
computation called for in the questioned regulation. It
should also be noted that section 593 provides for alterna-
tive methods to compute an addition to the loss reserve
without the percentage of taxable income limitation.
The appropriate question posed by these facts is whether
petitioner is entitled to the double benefit of carrying back
the NOLD and also retaining the artificial and purely
mathematical addition to its loss reserve based upon the
‘‘pre-NOLD” or unreduced amount of taxable income.! The
answer to this question is to be found in the definition of
the term ‘taxable income.” ‘Taxable income’”’ is conceptu-
ally the bedrock of our income tax system. We must be
careful not to weaken this structure by an inconsistent use
of the basic principles which have been carefully formulated
over the past 75 years. The majority has not shown or
stated that the regulations? it invalidates do not comport
with statutes (which are unambiguous on their face). The
majority opinion is based upon a view that Congress
intended a result opposite to that promulgated in respon-
dent's regulation, even though the statutory provisions
clearly and unambiguously comport with respondent's regu-
lation. The majority also emphasizes respondent's 20-year
practice of permitting the double benefit prior to promulga-
tion of the regulation in question.®
‘This is a double benefit because it would permit the benefits of the NOLD and the
unreduced loss reserve at the same time. These benefits may both exist only if inconsistent
concepts of taxable income are used. Moreover. as explained infra the NOLD and addition to
the loss reserve represent concepts which Congress intended to be inversely proportional. so
that if one is larger. the other, by design, must be smaller. Here petitioner seeks for them both
to be utilized without considering the other. seat
The record is silent on whether petitioner's particular accounting method with regard to
reporting of actual losses or recoveries could result in the potential for double deductions. For
purposes of this discussion it is assumed that the question of potential double deductions is
not involved and should not be considered.
*The regulations require the reduction of taxable income by NOLD's and the recomputation
of the addition to the reserve based upon the reduced amount of taxable income. In a recent
opinion we held that taxpayers were permitted broad discretion to choose among the various
methods for computing their reserve under sec. 593. The Home Group, Inc. v. Commissioner.
91 T.C. 265 (1988), affd. on other grounds 875 F.2d 377 (2d Cir. 1989). In that Court-reviewed
opinion we permitted a taxpayer to select the method it wished for a 1969 taxable year during
& 1988 controversy over the computation of a deficiency under Rule 155 of our Rules of
Practice and Procedure.
*Respondent’s inconsistent positions. whether expressed in revenue rulings or contained in
supersedec regulations. should be afforded little or no weight. To give credence to
respondent's longstanding positions as a basis for holding a regulation valid or invalid, if
44a
he
Pho
120 94 UNITED STATES TAX COURT REPORTS (101)
Congressional Intent
The majority has expended substantial verbiage attempt-
ing to persuade us that Congress intended certain savings
institutions to enjoy liberal loss reserves, which may result
in the freeing of capital. To that extent, there is no
disagreement. The disagreement concerns the majority’s
reasoning that these intentions are a basis for holding that
certain savings institutions should have a more favorable
definition or concept of ‘“‘taxable income”’ applied to them in
instances where they are carrying back a NOLD. No legisla-
tive history has been advanced by the majority for such a
proposition and the statutes involved, as the majority must
admit, do not provide for such a result. The essence of the
legislative history advanced by the majority tells us that
Congress intended that certain savings institutions, which
were once tax-exempt, should be subject to taxation; and
that said institutions were originally intended to have broad
discretion to enjoy liberal deductions attributable to their
loss reserves.
The majority also refers us to the legislative history for
the undisputed proposition that the 10-year net operating
loss carryback was intended as a substitute for permitting
larger loss reserves. This proposition is more properly cited
in support of this dissenting view that Congress did not
intend to permit both the largest possible reserve and 7
additional years within which to carry back subsequent
losses, as petitioner is seeking and the majority has
approved in this case. The position advanced by petitioner
and approved by the majority is inconsistent with congres-
sional intent: concerning the relationship between the 10-
year carryback and the more generous percentage of taxable
income loss reserve allowance. Therein lies the incongruity
and shortcoming of the majority's logic.
If these institutions are to be subject to tax, the
definition of “taxable income” utilized for them should be
no different than the definition used for other taxpayers,
unless specifically and congressionally mandated otherwise.
equally applied in other settings, may place us in « position of treating respondent's
longstanding positions as correct by means of prescriptive preemption. If the regulations in
question comport with the statute and congressional intent, should they be invalidated
Sinouas db soteuutind? baniihmatin seamen 1 taseaeananed tae eee
45a
(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 121
Here, in the face of unambiguous statutory provisions, the
majority would redefine “taxable income’ based upon its
own rationalized view of inexplicit congressional intent. It is
inappropriate to find an otherwise lucid statute(s) to be
ambiguous based upon legislative history (assuming such
legislative history existed here). Furthermore, it seems
inappropriate to look to legislative history underlying prior
statutory provisions when Congress has reenacted the
provisions in question at a time when the questioned
regulations had been published for nearly 8 years—a point
for which the majority has already provided ample case
support.
Congressional intent to expand or increase reserves or the
amount of capital available for loans was fully served in
this case. Throughout the period that ended with the net
operating loss, petitioner received the benefit of computing
its loss reserve allowance based upon a percentage of
taxable income unreduced by the NOLD now in issue. By
means of the beneficial computation in each of the years
1971 through 1977, petitioner ostensibly reported less
taxable income and had more cash to loan while amassing a
larger reserve for losses. The current recomputation of a
portion of the addition to the reserve does not change the
availability of that cash which was likely received by
borrowers long before petitioner experienced a net operating
loss in the 1980's. The only direct effect of the current
recomputation is to determine the amount of the net
operating loss deduction to be absorbed and, hence, the
amount of any refund due the taxpayer. The recomputation,
as it relates to the allowance for losses and the loss reserve,
has no effect on the congressionally intended result.
Moreover, the congressional intent underlying the net
operating loss deduction is also fully served by the ability
of petitioner to seek refunds or reductions of tax liability
from “‘carryback years” which would be currently available
for the congressionally intended purpose of making capital
“The majority has proceeded a step beyond using the legislative history to assist in
understanding a statutory provision. Indeed. without a supporting statutory provision or an
ambiguity in the one the regulation tracks, the majority has devised a self-serving version of
congressional intent. Commentators have cautioned us to be leery of congressional commen-
tary even where it directly addresses the statutory matter. See Justice Scalia's comments in
his concurring opinion in Blanchard v. Bergeron, 489 U.S. 87, 97 (1989).
46a
122 94 UNITED STATES TAX COURT REPORTS (101)
available to the taxpayer who suffered the net operating
loss. Here, however, petitioner, in addition to the favorable
reserve benefits already received and those still available,
asks us to use differing definitions of ‘‘taxable income’’ to
provide to it benefits beyond those congressionally man-
dated. The concept of net operating losses is not unique to
petitioner, as is the loss reserve addition permitted by
Congress, and we cannot permit special treatment in an
area involving a universal concept (like net operating losses
or taxable income) without a clear and specific congressional
mandate. As pointed out by the majority, the extra benefit
relative to operating losses that Congress conferred upon
these savings institutions was to permit a 10-year, rather
than a 3-year, carryback. No additional benefit is described
or should be inferred, including the one sought by petitioner
in this case.
The Double Benefit Aspect
The circumstances ofthis case have a direct and correla-
tive relationship to the situation we considered in The
Home Group, Inc. v. Commissioner, 91 T.C. 265 (1988), affd.
on other grounds 875 F.2d 377 (2d Cir. 1989). That case also
involved the computation of the addition to the loss reserve
provided for in section 593. In that case, we permitted a
taxpayer to make a choice concerning the amount of loss
reserve to utilize because taxable income had increased due
to a deficiency resulting from another matter decided
adversely to that taxpayer, and hence the possibility for a
larger reserve. Here we are confronted with a mirror image
situation—the taxable income is reduced by a NOLD and the
reserve addition (which is an element necessary to arrive at
taxable income) should also be automatically reduced in
accord with the statutory and regulatory formula for its
computation.
Failure to reduce the loss reserve addition would result in
the anomaly of no taxable income in a particular year and a
large increase to the reserve for losses based upon a
now-fictional amount of taxable income. Because the addi-
tion to the reserve results in a deduction used to arrive at
taxable income, distortion and incongruity must result.
Where a taxpayer’s taxable income increases due to events
47a
EOE
(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 123
occurring subsequent to the taxable year in question, that
taxpayer’s addition to the loss reserve could increase. The
Home Group, Inc. v. Commissioner, supra. Where a taxpay-
er’s taxable income is to be decreased due to events
occurring subsequent to the taxable year in question,
pursuant to the majority’s holding, that taxpayer’s addition
to the loss reserve would not be reduced.
Moreover, the majority has failed to emphasize (having
relegated it to footnote 3 of the majority opinion) that,
under respondent’s computation, petitioner will be entitled
to a deduction for a reserve allowance based upon one of
the other formulae provided in section 593. It is significant
to note that petitioner will be entitled to claim the largest
deduction permissible under the methods which are not
dependent upon gauging the maximum limit upon a percent-
age of taxable income. This will not place petitioner at a
disadvantage in relation to other taxpayers carrying back
net operating losses. Indeed, even after calculating the
absorption of the loss by the method prescribed in the
regulations, petitioner will remain in an advantaged position
because it will not lose the ability to offset some amount of
the NOLD by means of its statutorily compute? addition to
its loss reserve. Taxpayers who might lose the ability to
claim a contribution deduction because of the interplay of a
net operating loss in a particular year are not offered
alternative methods of claiming that deduction. Although
petitioner may lose the ability to claim the maximum
benefit of the more generous percentage of taxable income
method of computing its loss allowance, it would remain
squarely within the intended congressional framework.
The adjustment to taxable income and resulting reduction
to the reserve addition based upon taxable income is
practically no different from the mechanical changes that
affect ‘“‘below the line’’ medical deductions arid charitable
and other percentage limitations based upon changes to
adjusted gross or taxable income. See for example Lustman
v. Commissioner, T.C. Memo. 1960-116, affd. 322 F.zd 253
(3d Cir. 1963). Likewise, on occasion, a change in basis may
generate a concomitant change in depreciation. Commis-
sioner v. Superior Yarn Mills, 228 F.2d 736 (4th Cir. 1955).
48a
OO eo
124 94 UNITED STATES TAX COURT REPORTS (101)
Supreme Court Precedent
In United States v. Foster Lumber Co. 429 U.S. 32
(1976), the Supreme Court considered a strikingly similar
interaction between two relief or benefit provisions of the
Internal Revenue Code. In that case, the focus, as it is here,
centered upon the definition of “taxable income” for pur-
poses of carrying back and applying a NOLD to a prior year.
In Foster Lumber, the taxpayer had used an alternative
computation of tax liability which was intended to insure
that capital gains were not taxed above a certain rate,
which rate may be more favorable than the rates on other
types of income.
The alternative computation is made separately from the
computation of other income, and, for computational pur-
poses only, the amount of taxable income reflected in part
of the computation does not include income from capital
gains. In Foster Lumber, the alternative computation pro
duced a lower tax than the regular computation. But the
interplay of the NOLD from a subsequent year caused the
NOLD before it was carried to other taxable years.5 The
it
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(101) PACIFIC FIRST FEDERAL SAVINGS v. COMMR. 125
computational sense, a part of taxable income when using
the alternative capital gains method of computing the tax
liability. Accordingly, the Supreme Court in Foster Lumber
was forced, as we are in this case, to consider two
competing benefits conferred by Congress. Its holding
resulted in the taxpayer not receiving the full benefit of the
alternative capital gains computation.®
In this case we are also confronted with a situation where
there is interplay between two benefit provisions. As in
Foster Lumber, carryback loss deductions are involved.
Here, however, we consider a provision permitting certain
savings institutions to liberally compute their loss reserves.
Like the beneficial capital gains rates in Foster Lumber,
petitioner had the benefit of a liberal section 593 artificial
computation of the addition to its loss reserve based upon a
percentage of taxable income. Similarly, the introduction of
the net operating loss deduction reduces taxable income,
which under the statutes and regulations would reduce the
amount of the addition to the loss reserve if computed by
the percentage of taxable income method. And finally, and
again similar to Foster Lumber, the question concerns the
concept or definition of ‘taxable income.” Unlike Foster
Lumber, the petitioner here will receive a congressionally
intended deduction which will have the effect of increasing
the amount of the NOLD carried to subsequent years. The
difference is that the amount carried forward will be
somewhat less than the amount petitioner seeks.
As in Foster Lumber, the majority here should have
protected the concept of “‘taxable income” and the internal
harmony of the tax code. As in Foster. Lumber, the majority
should have strived to treat all taxpayers utilizing net
operating losses equally, unless there is a contrary and
express congressional nandate to treat them otherwise. To
have done so would not cayse petitioner any overall
hardship. If the majority had not invalidated the regulation,
petitioner would have been treated, at very least, equal to
other taxpayers who incurred net operating loss deductions.
Instead, the majority's invalidation of the section 593
- “See Justice Blackmun's dissent for further explanation of the benefits involved and the
failure of the taxpayer to recaive part of the benefits congressionally intended. United Stetes
v. Foster Lumber Co., 429 U.S. 32. 49-62 (1976).
50a
126 94 UNITED STATES TAX COURT REPORTS (101)
regulations here will permit petitioner a refund which is
larger than the amount to which it is entitled. Moreover,
the excess refund will not, in all circumstances, be recouped
in some future taxable year. This is not simply a matter of
timing.
I respectfully submit that petitioner should not be
permitted to utilize an addition to its loss reserve based
upon a concept of taxable income not specifically mandated
in the statutes and/or unavailable to all taxpayers equally.
PARKER, JACOBS, PARR, and RUWE, JJ., agree with this
dissent.
5la
STATUTES AND REGULATION INVOLVED
Section 593 of the Internal Revenue Code of 1954, as
amended and in force for the years at issue states in relevant part:
(bo) ADDITION TO RESERVES 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 of any taxpayer described in subsection (a)
shall be an amount equal to the sum of —
(A) the amount determined to be a reasonable
addition to the reserve for losses on nonqualifying
loans, computed in the same manner as is provided
with respect to additions to the reserves for losses on
loans of banks under section 585(b)(3), plus
(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 . . .
52a
(2) PERCENTAGE OF TAXABLE
METHOD.
(A) IN GENERAL. — Subject to subparagraph
(B), (C), and (D), 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 The applicable percentage under
beginning in h_shall be
1969 60 percent
1970 57 percent
1971 54 percent
1972 51 percent
1973 49 percent
1974 47 percent
1975 45 percent
1976 ° 43 percent
1977 42 percent
1978 41 percent
1979 or thereafter 40 percent
53a
(E) COMPUTATION OF TAXABLE INCOME.
— For purposes of this paragraph, taxable income
shall be computed —
(i) by excluding from gross income any
amount included therein by reason of subsection
(e),
(ii) without regard to any deduction
allowable for any addition to the reserve for bad
debts,
(ili) by excluding from gross income an
amount equal to the net gain for the taxable year
arising from the sale or exchange of stock of a
corporation or of obligations the interest on which
is excludable from gross income under section
103,
(iv) by excluding from gross income an
amount equal to the lesser of 18/46 of the net
long-term capital gain for the taxable year or
18/46 of the net long-term capital gain for the
taxable year from the sale or exchange of
property other than property described in clause
(iii), and
54a
(v) by excluding from gross income
dividends with respect to which a deduction is
allowable by part VIII of subchapter B, reduced
by an amount equal to the applicable percentage
(determined under subparagraphs (A) and (B)) of
the dividends received deduction (determined
without regard to section 596) for the taxable
year.
26 U.S.C. § 593(b) (1970).
The Treasury Regulations published in 1956 provided in
pertinent part:
(b) Addition to reserve. Except as otherwise provided in
§1.593-2, the reasonable addition to a reserve for bad
debts shall be any amount determined by the taxpayer
which does not exceed the lesser of:
(iF 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),
Treas. Reg. §1.593-1(6)(1) (1956), T.D. 6188, reproduced in
1956-2 C.B. 310, 321.
55a
The Treasury Regulations published in 1964 provided in
pertinent part: -
(2) Taxable income defined. - For purposes of this
paragraph, taxable income shall be computed —
(i) By excluding from gross income any
amount included therein by reason of the
application of §1.593-10 (relating to certain
distributions to shareholders by a domestic
building, and loan association);
(ii) Without regard to any deduction
allowable under section 166(c) for an addition to
a reserve for bad debts;
(iii) 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), other than sections 243,
- 244 and 245 (relating to deductions for dividends
received); and
(iv) Without regard to any net operating loss
carryback to such year under section 172.
56a
In computing the deductions under sections 243, 244, and
245, section 246(b) (relating to limitation on aggregate
amount of deduction) shall not apply. For purposes of
subdivision (iii) of this subparagraph, a net operating loss
deduction under section 172 is not a deduction the amount
of which is dependent upon the amount of taxable income.
Treas. Reg. §1.593-6(b) (1964), T.D. 6728, reproduced in 1964-1
C.B. 195, 202.
The Treasury Regulation published in 1978, as amended
in 1979, states in pertinent part:
(5) COMPUTATION OF TAXABLE INCOME. For
purposes of this paragraph, 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
57a
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.
Treas. Reg. § 1.593-6A(b)(5) (1979), T.D. 7549, reproduced in
1978-1 C.B. 185, 189-190, as amended by T.D. 7626, reproduced
in 1972-2 C.B. 239, 240.
‘The 1979 amendments merely changed the efiective dates.
: 58a
105
GEORGIA FEDERAL BANK, F.S.B. AND
SUBSIDIARIES, PETITIONER v.
COMMISSIONER OF INTERNAL
REVENUE, RESPONDENT
Docket No. 26870-90. Filed February 4, 1992.
From 1970 through 1982, P deducted additions to its bad debt
reserve. The amounts deducted were calculated with reference
to P’s taxable income for each year. From 1980 through 1984,
P sustained net operating losses (NOL's). Held, subdivisions
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106 98 UNITED STATES TAX COURT REPORTS (105)
(vi) and (vii) of sec. 1.593-6A(bX5), Income Tax Regs. are invalid
to the extent they require that taxable income reflect any NOL
carrybacks before the addition to bad debt reserve is calculated
for certain financial institutions. Pacific First Federal Savings
Bank v. Commissioner, 94 T.C. 101 (1990), on appeal (9th Cir.,
Feb. 8, 1991), followed. Peoples Federal Savings & Loan
Association of Sidney v. Commissioner, 948 F.2d 289 (6th Cir.
1991), revg. T.C. Memo. 1990-129, not followed.
Robert M. Fink and Roger S. Reigner, Jr., for petitioner.
Bonnie L. Cameron, for respondent.
OPINION
WELLS, Judge: The instant case is before us on petitioner's
motion for summary judgment. Respondent determined a
deficiency of $114,193 in petitioner's Federal income tax for its
taxable year ended April 11, 1986. At the time the petition in
the instant case was filed, petitioner's principal place of
business was located in Atlanta, Georgia. From 1970 through
1982, petitioner computed its deduction for the addition to its
bad debt reserves using the percentage of taxable income
method set forth in section 593(bX2\A).’ From 1980 through
1984, petitioner sustained net operating losses (NOL's) within
the meaning of section 172(c), which NOL's may be carried back
under section 172(b)(1XF) to each of the 10 taxable years
preceding the loss years.
The parties agree that the sole issue presented is the
validity of subdivisions (vi) and (vii) of section 1.593-6A(b)(5),
Income Tax Regs., under which respondent seeks to calculate
petitioner's tax liability for its taxable year ending April 11,
1986. The challenged provisions generally provide that taxable
income is to be reduced by any NOL carrybacks before the
deduction for addition to bad debt reserve is calculated. Sec.
1.593-6A(b)5)(vii), Income Tax Regs. Such regulations were
adopted May 17, 1978 (the 1978 regulations). T.D. 7549, 1978-
1 C.B. 185. Taking NOL carrybacks into account in such
manner reduces the base of taxable income on which the bad
debt reserve addition is calculated, and s0 reduces the deduc-
‘Unless otherwise noted, all section references are to the Internal Revenue Code in effect for the
year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
60a
(105) GEORGIA FEDERAL BANK v. COMMISSIONER 107
tion below the amount originally calculated in the taxable year
to which the NOL carryback is applied.
The 1978 regulations changed the method by which a
mutual institution's bad debt reserve addit*»n is calculated in
a year to which an NOL carryback is applied. The first
regulations interpreting section 593 provided that taxable
income is to be computed “without regard to any section
providing for a deduction the amount of which is dependent
upon the amount of taxable income”. Sec. 1.593-1(b)(1),
Income Tax Regs., T.D. 6188, 1956-2 C.B. 310, 321 (the 1956
regulations). The 1956 regulations were cited in Rev. Rul. 58-
10, 1958-1 C.B. 246, which provided that, for purposes of
calculating the bad debt reserve addition, taxable income was
not to be reduced by NOL carrybacks. The 1958 revenue ruling
was incorporated in changes to the regulations adopted in
1964. Sec. 1.593-6(b)\(2)iv), Income Tax Regs., T.D. 6728,
1964-1 C.B. 195, 202 (the 1964 regulations). Thus, the 1978
regulations challenged by petitioner reversed an ordering rule
that had been in effect for approximately 20 years.
The issue of which of the two opposing interpretations
should be sustained was decided by this Court in Pacific First
Federal Savings v. Commissioner, 94 T.C. 101 (1990), on
appeal (9th Cir., Feb. 8, 1991). We held, based on our review
of the structure of section 593(b) and its legislative history,
that the 1978 regulations were invalid because they did not
harmonize with Congressional intent. Recently, the Sixth
Circuit disagreed with our conclusion and upheld the 1978
regulations. Peoples Federal Savings & Loan Association of
Sidney v. Commissioner, 948 F.2d 289 (6th Cir. 1991), revg.
T.C. Memo. 1990-129. In cur Memorandum Opinion in Peoples
Federal, we granted summary judgment on the basis of our
opinion in Pacific First Federal. The Sixth Circuit reversed.
After due consideration and with due respect to the Sixth
Circuit, we conclude that our holding in Pacific First Federal
was correct, and we therefore will follow it in cases not
appealable to the Sixth Circuit. See Golsen v. Commissioner,
54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir. 1971).
In Peoples Federa/, the Sixth Circuit held that we failed to
give proper deference to the 1978 regulations under the
principles set forth in Chevron, U.S.A. v. Natural Res. Def.
Council, 467 U.S. 837 (1984). We therefore will begin our
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108 98 UNITED STATES TAX COURT REPORTS (105)
analysis in the instant case by discussing those principles. In
Chevron, the Supreme Court reviewed the standards courts
must employ in deciding the reasonableness of an agency's
interpretation of statutory law. First the court must decide
whether Congress had an intention on the question in issue.
Chevron, U.S.A. v. Natural Res. Def. Council, 467 U.S. at 842-
843. Such a question is a matter of statutory construction, on
which the judiciary is the final authority. Chevron, U.S.A. v.
Natural Res. Def. Council, 467 U.S. at 843 n.9.
If a court, using the traditional tools of statutory construc-
tion, such as the plain language, structure, and legislative
history of the law, ascertains that-Congress has addressed the
precise question at issue, that is the end of the matter.
Chevron, U.S.A. v. Natural Res. Def. Council, 467 U.S. at 842-
843. Thus, “If Congress has spoken to the issue with which we
are concerned, there is no need for deference” to an agency's
construction of the law. U.S. Mosaic Tile Co. v. N.L.R.B, 935
F.2d 1249, 1255 (11th Cir. 1991).
If, on the other hand, the court concludes that the statute is
silent or ambiguous with respect to the specific issue, the
question for the court is “whether the agency's answer is based
on a permissible construction of the statute.” Chevron, U.S.A.
v. Natural Res. Def. Council, 467 U.S. at 843. The principle of
deference embodied in such standard of review, however, “only
sets ‘the framework for judicial analysis; it does not displace
it.” United States v. Vogel Fertilizer Co., 455 U.S. 16, 24
(1982) (quoting United States v. Cartwright, 411 U.S. 546, 550
(1973)). “(T]he essential function of judicial review, in this
context, is to ensure that the agency engaged in ‘reasoned
decisionmaking’.” United States v. Garner, 767 F.2d 104, 116
(5th Cir. 1985). The courts—
‘have) 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. [United States v. Vogel Fertilizer, 455 U.S. at 26.]
A reviewing court should consider the agency's reaction to
objections raised by the public and how the agency rebutted
vital relevant comments during the regulatory process. Lloyd
Noland Hospital & Clinic v. Heckler, 762 F.2d 1561, 1566-1567
(11th Cir. 1985), citing Western Coal Traffic League v. United
States, 677 F.2d 915, 927 (D.C. Cir. 1982). To guard against
62a
(105) GEORGIA FEDERAL BANK v. COMMISSIONER 109
arbitrary action, a court must engage in a “‘thorough, probing,
in-depth review’ of the agency's asserted basis for [its] decision,
ensuring that ‘the agency [has] * * * examine[d] the relevant
data and [has] articulate[d] a satisfactory explanation for its
action’”. Midtec Paper Corp. v. United States, 857 F.2d 1487,
1498 (D.C. Cir. 1988) (quoting Motor Vehicle Manufacturers
Association v. State Farm Mutual Ins. Co., 463 U.S. 29, 43
(1983), and Citizens to Preserve Overton Park v. Volpe, 401
U.S. 402, 415 (1971)).
Many factors have been applied to aid in the decision as to
whether the agency's interpretation is a reasonable construc-
tion of the statute. A regulation which is a substantially
contemporaneous construction of the statute is entitled to
special weight, as its drafters are presumed to have a greater
awareness of congressional intent, and such construction is
therefore more likely to reflect such intent. Rowan Cos. v.
United States, 452 U.S. 247, 253 (1981); National Muffler
Dealers Association v. United States, 440 U.S. 472, 477 (1979).
Where a contemporaneous construction remains consistent
over a long period of time, it is entitled to special deference.
EEOC v. Associated Dry Goods Corp. 449 U.S. 590, 600 n.17
(1981).
If a regulation dates from a period after the enactment of
the statute which it interprets, or repudiates an earlier
interpretation, the manner in which it evolved merits inquiry.
National Muffler Dealers Association v. United States, 440 U.S.
at 477; State of Washington v. Commissioner, 77 T.C. 656, 671
n.12 (1981), affd. 692 F.2d 128 (D.C. Cir. 1982). Additional
considerations include the length of time it has been in effect,
the consistency of the agency's interpretation, and the degree
of scrutiny which Congress has devoted to the regulation
during subsequent reenactments of the statute. NLRB v. Food
& Commercial Workers Local 23, 484 U.S. 112, 124 n.20
(1987); National Muffler Dealers Association v. United States,
440 U.S. 472, 477 (1979).
An agency has the flexibility to modify its regulations in the
light of experience and to respond to changed circumstances.
Chevron, U.S.A. v. Natural Res. Def. Council, 467 U.S. at 863-
864. If an agency reverses a prior statutory interpretation,
however, its most recent expression may be accorded less
deference than a consistently maintained position. JNS v.
63a
110 98 UNITED STATES TAX COURT REPORTS (105)
Cardoza-Fonseca, 480 U.S. 421, 446 n.30 (1987); Watt v.
Alaska, 451 U.S. 259, 273 (1981); Seldovia Native Association,
Inc. v. Lujan, 904 F.2d 1335, 1345 (9th Cir. 1990). “Sharp
changes of agency course constitute ‘danger signals’ to which
a reviewing court must be alert.” West v. Bowen, 879 F.2d
1122, 1127 (3d Cir. 1989) (quoting Natural Resources Defense
Council v. U.S.E.P.A., 683 F.2d 752, 760 (3d Cir. 1982)).
An agency which changes its position must acknowledge that
its interpretation has shifted, and must supply a persuasively
reasoned explanation for the change. Motor Vehicle Manufac-
turers Association v. State Farm Mutual Ins. Co., 463 U.S. at
48; Vargas v. I.N.S., 938 F.2d 358, 360 (2d Cir. 1991) (agency
changing course must supply “sound reasons for the change”);
GMC v. National Highway Traffic Safety Admin., 898 F.2d 165,
175 (D.C. Cir. 1990); Acadian Gas Pipeline System v. F.E.R.C.,
878 F.2d 865, 870 (5th Cir. 1989); Lloyd Noland Hospital &
Clinic v. Heckler, 762 F.2d 1561, 1567 (livh Cir. 1985). “(T]he
thoroughness, validity, and consistency of an agency's reason-
ing are factors that bear upon the amount of deference to be
given an agency's [interpretation]”. FEC v. Democratic Senato-
rial Campaign Comm., 454 U.S. 27, 37 (1981).
Furthermore, “an agency's action must be upheld, if at all,
on the basis articulated by the agency * * * [at the time of the
rule making].” Motor Vehicle Manufacturers Association v.
State Farm Mutual Ins. Co., 463 U.S. at 50; Chemical Manu-
facturers Association v. E.P.A., 899 F.2d 344, 359 (5th Cir.
1990). “The reviewing court should not attempt itself to make
up for such deficiencies; we may not supply a reasoned basis
for the agency's action that the agency itself has not given.”
Motor Vehicle Manufacturers Association v. State Farm Mutual
Ins. Co., 463 U.S. at 43. Thus, post hoc rationalizations cannot
be offered to buttress an agency's action, as they are unreliable
indicators of the actual basis for an agency's course of action.
Turning to the instant case, as tne foregoing authorities
demonstrate, Chevron’s rule of deference only applies if
Treasury's new interpretation is not contrary to the clear
intent of Congress. Chevron, U.S.A. v. Natural Res. Def.
Council, 467 U.S. at 843-845. In Pacific First Federal, our
review of the legislative history disclosed that Congress
intended that mutual institutions’ reserves be curtailed only
to a point, and not beyond. The Sixth Circuit did not disagree
64a
(105) GEORGIA FEDERAL BANK v. COMMISSIONER 111
with that interpretation. Rather, it characterized our analysis
as a variant of the reenactment doctrine and stated that our
reliance on that doctrine was misplaced, even though we
specifically stated, as noted by the Sixth Circuit, that we did
not rely on the reenactment doctrine.
In Pacific First Federal, after analyzing the legislative
history, we concluded that the legislative history revealed that
Congress reached a compromise on the effective tax rate for
mutual institutions. We also concluded that the new ordering
rule contained in the 1978 regulations increased the effective
tax rate beyond the level Congress intended by contracting the
taxable income base to which the applicable percentage is
applied in computing the deduction under section 593(a)(2).
Moreover, we concluded that the new ordering rule reduced
the value of NOL carrybacks contrary to Congress’ expressed
intent of granting a “more generous net operating loss carry-
back” and that any modification of the taxable income base
would upset the legislative compromise in 1969. Pacific First
Federal Savings Bank v. Commissioner, 94 T.C. at 110-114.
We remain convinced that the 1978 regulations contravene
Congress’ intent. Although Chevron was not cited to us in
Pacific First Federal, Peoples Federal, or the instant case, the
application of Chevron’s rule of deference by the Sixth Circuit
in Peoples Federal suggests that we should consider it in the
context of the instant case.
In Peoples Federal, the Sixth Circuit noted several reasons
advanced by Treasury when it changed its course in 1978,
citing an internal memorandum? prepared for senior officials
of Treasury in 1978 (the 1978 memorandum). The Sixth
Circuit held that the reasons set forth in the 1978 memoran-
dum were “conclusive evidence that the Commissioner's change
was a deliberate one,” i.e., not arbitrary. Peoples Federal
Savings & Loan Association of Sidney v. Commissioner, 948
F.2d at 303. According to the 1978 memorandum, in sub-
stance, Treasury concluded that the 1964 regulations were
“patently wrong” and that adoption of a contrary position was
“Attachment to Memorandum to Secretary Blumenthal from Acting Asst. Secretary (Tax Policy)
Lubick, Joint Exh. 130-DZ in Pacific First Federal Savings Bank v. Commissioner, 94 TC. 101
(1990). Although the 1978 memorandum was a part of the record in Pacific First Federal, we did
not find the statements in the memorandum to be persuasive. We did not feel the need to consider
the reasons for the change once we found that the 1978 regulations contravened Congress’ intent.
65a
112 98 UNITED STATES TAX COURT REPORTS (105)
in order. We respectfully disagree, however, with the Sixth
Circuit's holding that the reasons offered in the 1978 memo-
randum are conclusive of Treasury's lack of arbitrariness.
Before turning to our disagreement with the specific reasons
set forth in the 1978 memorandum, the stage should be set
with a discussion of the reason Treasury initially advanced for
the change made by the 1978 regulations. Treasury's origi-
nal* view was that, by amending section 593(b\(2)E)* in
1969, Congress intended to create an exclusive list of modifica-
tions to the taxable income of savings banks for purposes of
the bad debt deduction. An examination of the manner in
which such provision came to form part of the Code, however,
shows that Congress could not have had the intent ascribed to
it by Treasury and that the Congressional action cannot
possibly bear the weight of inference which Treasury placed
upon it. The 1969 amendments to section 593(b\2\E)
consisted of technical amendments proposed by Treasury to
remove from the taxable income base, upon which the bad debt
reserve addition was calculated, certain types of income which
did not give rise to bad debt losses. H. Rept. 91-413, 1969-3
C.B. 200, 279. The proposed technical amendments were
accepted with little discussion by Congress, and the legislative
history contains no reference to the rule governing NOL
carrybacks. As the 1978 memorandum states “there is no
evidence Congress considered the matter”. Moreover, the
technical amendments generated little controversy when they
were proposed, while the history of the 1951, 1962, and 1969
legislation shows that every other effort to significantly reduce
the percentage method of calculating the bad debt reserve
addition had been attended by substantial controversy,
indicating that, at the time of the 1969 Act, no one considered
that the technical amendments would have the effect of
reversing the established rule regarding NOL carrybacks.
Indeed, the 1978 memorandum admits as much, stating that
“if the industry had known that we [Treasury] would consider
changing the regulations, it would probably have raised the
issue with Congress.”
*Treasury’s orginal justification for the change was set forth in a Technical Memorandum
attached to Transmittal Memorandum from Acting Commissioner Swartz to Assistant Secretary
Cohen, July 7, 1971, Exh. 24-X in Pacific First Federal.
‘The Tax Reform Act of 1986 redesignated such subparagraph as sec. 593(bX2D). Pub. L. 99-
514, sec. 901(bX2B), 100 Stat. 2085, 2378.
66a
(105) GEORGIA FEDERAL BANK vy. COMMISSIONER 113
In summary, the 1969 amendments to section 593(b)(2)(E)
represented a limited modification to the definition of taxable
income and did not represent the result of a comprehensive
Congressional study of the taxable income base, which would
be necessary if we were to accept Treasury's reasoning. The
1969 amendments constituted nothing more than a narrowly
focused and technical modification to the percentage method
which was not expected to have anything more than a minor
impact on the size of the bad debt deduction. Staff of Joint
Committee on Internal Revenue Taxation, Summary of
Testimony on Mutual Savings Institutions, 91st Cong., 2d
Sess. 1-2 (J. Comm. Print 1969). The negative inference which
Treasury drew from the 1969 amendments was clearly an
insufficient basis for Treasury's change in course. Moreover,
we note that, in 1962, Congress had added a limitation to the
definition of taxable income in section 593(b)(2)(E) similar to
the 1969 changes, but Treasury did not infer from that action
that the list of modifications in section 593 was exclusive or
that Congress disapproved of the 1956 regulations or Rev. Rul.
58-10. Rather, in the 1964 regulations, Treasury explicitly
adopted the ordering rule originally permitted under such
authorities. Accordingly, we would have difficulty in accepting
Treasury's view that a similar action by a subsequent Con-
gress prevents the continued application of such rule.
We considered such “exclusive list” justification in Pacific
First Federal Savings v. Commissioner, 94 T.C. at 113-114, but
did not find it persuasive. Moreover, we noted that the
Commissioner appeared to abandon such argument, indicating
a lack of confidence in its merit. Jd. at 114. Furthermore, the
Sixth Circuit did not expressly refute our refusal to accept
such justification for the change contained in the 1978
regulations, and we therefore do not accord any weight to such
justification.
Turning to a consideration of the justifications mentioned in
the 1978 memorandun, the first justification noted by the
Sixth Circuit was the statement that the change was being
made in order to compute taxable income for purposes of
section 593(b) as it “ordinarily” is under the Code. Although
such statement implies that Treasury was attempting to
achieve consistency in the definition of taxable income, in the
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114 98 UNITED STATES TAX COURT REPORTS (105)
1956 and 1964 regulations, Treasury did not find it essential
that the definition of taxable income for purposes of section
593(b) be the same as elsewhere in the Code. Moreover,
Treasury did not explain how such consistency would better
effectuate the Congressional purpose underlying section 593(b).
Furthermore, respondent does not uniformly adhere to the
definition of taxable income inherent in the 1978 regulations,
but in some cases instead has adopted an ordering rule
contrary to that adopted in the 1978 regulations. For instance,
in Rev. Rul. 60-164, 1960-1 C.B. 254, the Commissioner ruled
that in computing percentage depletion under section 613(a),
an NOL is not to be taken into account in determining a
taxpayer's taxable income from the property.
We also note that, by requiring the elimination or reduction
of bad debt reserve additions which were reasonable in the
year they were originally calculated, the 1978 regulations
contravene the well-established principle that additions to bad
debt reserves are not to be altered on account of events
occurring after the year the reserve is calculated. Westchester
Development Co. v. Commissioner, 63 T.C. 198, 212 (1974); Rio
Grande Building & Loan Association v. Commissioner, 36 T.C.
657, 664 (1961); C_P. Ford & Co. v. Commissioner, 28 B.T.A.
156, 159 (1933); sec. 1.166-4(b), Income Tax Regs.
Courts have recognized that section 593 simply provides a
method for calculating an addition to bad debt reserves, a
deduction for which was provided by section 166(c). Arcadia
Savings & Loan Association v. Commissioner, 300 F.2d 247,
251 (9th Cir. 1962), affg. 34 T.C. 679 (1960) (section 593
furnishes a formula for the reserve addition but does not
change the nature of the deduction); Rio Grande Building &
Loan Association v. Commissioner, 36 T.C. at 662. The
position taken in the 1956 and 1964 regulations, as well as in
Rev. Ruls. 58-10, 1958-1 C.B. 246, and 74-188, 1974-1 C.B.
147, was consistent with the well-settled principles governing
additions to bad debt reserves. The 1978 regulations, there-
fore, are contrary to judicial precedents and respondent's own
rulings and their adoption created a greater inconsistency than
they resolved.
The next justification noted by the Sixth Circuit was the
statement in the 1978 memorandum that “the percentage of
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(105) GEORGIA FEDERAL BANK v. COMMISSIONER 115
taxable income method is in substance a technique to lower
the tax rate on thrift institutions.” We are constrained to
point out, however, that Congress has expressly permitted
mutual institutions to use such method in figuring their
deductions. Sec. 593(b)(2). Treasury cannot contravene Con-
gress will by imposing excessive restrictions on the method or
impeding the ability of mutual institutions to make use of it
simply because Treasury perceives it to be a tax reduction
“technique.” If respondent believes that the method is im-
proper, he should apply to Congress for a change in the law,
rather than seek to change tax policy by means of administra-
tive fiat.
The legislative history of section 593 reveals that Treasury
had repeatedly sought to persuade Congress to deny mutual
institutions the right to use the percentage of income method.
In 1351, when Congress first subjected mutual institutions to
the Federal income tax, Treasury proposed that the deduction
for bad debt reserve addition be calculated in the manner
prescribed for commercial banks.* Congress, however, decided
to permit a deduction based on the taxable income of the
mutual institution so as to permit maintenance of reserves
sufficient to absorb losses experienced during downturns in the
economy. 97 Cong. Rec. 11842 (1951) (statement of Sen.
Lehman), 11843 (statement of Sen. Dirksen), 11888 (statement
of Sen. Butler), 11890 (statement of Sen. Capehart).
In connection with Congressional consideration of the 1962
tax legislation, Treasury proposed abolition of the percentage
method, arguing that it improperly allowed mutual institutions
to build up reserves tax-free. Taxation of Mutual Savings
Banks and Savings and Loan Associations: Hearings on
Treasury Department Report on Taxation of Mutual Savings
Bank and Savings and Loan Associations Before the House
Committee on Ways and Means, 87th Cong., Ist Sess. 11-14
(1961). Congress, however, declined to adopt Treasury's
recommendation, although it did cap the deduction at 60
percent of a mutual institution's taxable income. H. Rept.
1447, 87th Cong., 2d Sess., 1962-3 C.B. 405, 437-438.
‘Staffs of the Treasury and Joint Committee on Internal Revenue Taxation, Mutual Savings
Banks and Building & Loan Associations 4 (1951).
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116 98 UNITED STATES TAX COURT REPORTS (105)
Similarly, during the legislative process leading up to the
Tax Reform Act of 1969, Treasury again criticized the percent-
age method and urged its replacement with the bad debt
reserve deduction based on actual experience. Tax Reform
Studies and Proposals, U.S. Treasury Department, 91st Cong.,
lst Sess. 458-475 (J. Comm. Print 1968); Technical Memoran-
dum of Treasury Position, Tax Reform Act of 1969, H. Rept.
13270, 80-84 (J. Comm. Print 1969). Congress again declined
to abolish the method, although it did provide for a phased
reduction in the maximum amount of the deduction to 40
percent of taxable income, while increasing the loss carryback
and carryforward periods to protect institutions in the event of
unusually heavy losses. H. Rept. 91-782, 1969-3 C.B. 644, 664;
H. Rept. 91-413, 1969-3 C.B. 200, 280.
The 1978 regulations, however, contravene the clearly
expressed intent of Congress by denying mutual institutions
the benefit of section 593 to the extent they experience net
operating losses. The 1978 regulations in effect recapture
percentage method deductions to the extent to which NOL
carrybacks are applicable. In the case of mutual institutions
experiencing losses, the 1978 regulations therefore achieve
what Congress repeatedly has denied Treasury: a form of
repeal of the percentage method. The 1978 regulations thwart
Congress’ efforts to assure that mutual institutions would
maintain adequate reserves to protect depositors by transform-
ing reserve additions into little more than loans from the
treasury, to be called in when a mutual institution begins to
suffer the consequences of a downturn in the economy.
Another justification mentioned by the Sixth Circuit was the
statement in the 1978 memorandum that the method of
calculating the bad debt reserve addition prescribed by the
1964 regulations resulted in an inappropriate and unintention-
al “pyramiding” of tax benefits. Evidently, Treasury found it
objectionable that a mutual institution could reduce its taxable
income by NOL carrybacks and still claim a reserve addition
based on the amount of net income originally reported for a
taxable year. Such a result was not found improper in Rev.
Rul. 58-10, 1958-1 C.B. 246, in which the Commissioner ruled
that the bad debt reserve addition should not be affected by
events occurring after the year in which such addition was
calculated. It appears that such a result would be problematic
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(105) GEORGIA FEDERAL BANK v. COMMISSIONER 117
only if the view is taken that a mutual institution applying an
NOL carryback should be treated as if the NOL had actually
been incurred in the carryback year, which is the position that
Treasury apparently adopted in formulating the 1978 regula-
tions. See G.C.M. 39701 (Feb. 25, 1988). We, however, fail to
see why such a view is preferable to or more correct than the
reasoning expressed in the 1958 ruling underpinning the 1964
regulation. Indeed, there is no “pyramiding” if the 1964
regulations are analyzed under the principles applicable to bad
debt reserves, with which such regulations are in accord. As
discussed above, the reasonableness of an addition to bad debt
reserves is decided as of the year it is made, and subsequent
events do not affect such decision. Consequently, a mutual
institution that makes a reasonable addition to its reserves in
one year does not receive an inappropriate or excessive benefit
simply because later occurring events give rise to an NOL
carryback to such year. Furthermore, as we pointed out in
Pacific First Federal, section 593 does not allow a double
deduction on account of bad debt losses, as actual losses are
charged against the reserve and no deduction is obtainable for
such losses. Pacific First Federal Savings v. Commissioner, 94
T.C. 101, 116 (1990). NOL's incurred by mutual institutions
thus have no relationship to the bad debt reserve.
We also note a statement made in the 1978 memorandum
which was not discussed by the Sixth Circuit but which
discloses the apparent arbitrariness of Treasury's action. The
1978 memorandum states that the rule was not changed in the
early 1970s, when initially considered by Treasury, because of
poor economic conditions. If the change were being made
because the rule was “patently wrong”, as suggested by
Treasury, we fail to see why Treasury did not go forward with
its responsibility in carrying out its perception of Congress’
intent. The fact that Treasury waited 7 years to effectuate the
change in assumedly better economic times indicates that
Treasury was usurping Congress’ role in deciding how much
and when to raise the effective tax on mutual institutions.
The Sixth Circuit identified an additional justification that
was not mentioned in the 1978 memorandum. The Sixth
Circuit reasoned that the “trend” in the congressional enact-
ments toward a curtailment of the bad debt reserve deduction
was evidence that Congress intended to reduce the deduction
7la
118 88 UNITED STATES TAX COURT REPORTS (105)
available for addition to bad debt reserves and therefore
Treasury's interpretation was consistent with such intent.
Peoples Federal Savings & Loan Association of Sidney v.
Commissioner, 948 F.2d 289 (6th Cir. 1991). Such a justifica-
tion appears to be a “post hoc rationalization” of the change
that should not be considered. Motor Vehicle Manufacturers
Association v. State Farm Mutual Auto Ins. Co., 463 U.S. 29,
43, 50 (1983). Moreover, we note that the 1962 and 1969
reductions in the amount of the deduction were reached only
after review of the tax situation of the industry and consider-
able negotiation between the two chambers of Congress.
Congress undertook to reduce the size of the deduction in a
measured, deliberate compromise. Congress, however, did not
signal that the deduction was to be further reduced below the
level it prescribed by legislation.
Finally, we are not convinced that Treasury adequately
rebutted the “vital relevant comments” received by it from the
industry during the period the changes were being considered.
Lloyd Noland Hosp. & Clinic v. Heckler, 762 F.2d 1561, 1567-
1568 (11th Cir. 1985).
For the foregoing reasons, we hold that Treasury failed to
offer a cogent, persuasive explanation for the change as
required by Chevron. Given the circumstances surrounding
the 1969 changes to section 593, the 1978 regulations were not
a reasonable interpretation of the statute and were inconsis-
tent with what Congress intended. We must apply the
Internal Revenue Code as Congress has written it, not as
respondent would like it amended. Consequently, we adhere
to our prior holding of Pacific First Federal that the 1978
regulations are invalid, and petitioner's motion for summary
judgment will be granted.
To reflect the foregoing,
An appropriate order will be issued, and decision
will be entered for petitioner.
Reviewed by the Court.
NIMS, CHABOT, KORNER, SHIELDS, HAMBLEN, COHEN, CLAPP,
SWIFT, COLVIN, HALPERN, and BEGHE, JJ., agree with the
majority opinion.
WHALEN, J., concurs in the result only.
72a
(105) GEORGIA FEDERAL BANK v. COMMISSIONER 119
HALPERN, J/., concurring. I write separately to emphasize
the distinction between the reenactment doctrine and the
reasoning of the majority.
As stated by the Court of Appeals for the Sixth Circuit in
People's Federal Savings & Loan Association of Sidney uv.
Commissioner, 948 F.2d 289 (6th Cir. 1991), revg. T.C. Memo.
1990-129, a recent expression of the reenactment doctrine is
found in NLRB v. Bell Aerospace Co., 416 U.S. 267 (1974). In
that case, where the National Labor Relations Board had
consistently interpreted the Taft-Hartley Act of 1947 as
excluding “managerial employees”, the Supreme Court
concluded that Congress’ failure, when it amended the Act in
1959, “to revise or repeal the agency's interpretation is
persuasive evidence that the interpretation is the one intended
by Congress”. Id. at 275. Thus, the reenactment doctrine
would appear to rest upon two assumptions: (1) That when-
ever Congress reenacts a Statute, it is aware of the body of
interpretation regarding that Statute, and (2) that, in such
circumstances, Congress’ failure to countermand some aspect
of that body of interpretation constitutes an affirmative
sanction thereof. Together, those assumptions are capable of
producing an inference that Congress has sanctioned a given
regulation respecting an issue to which Congress has given
litt'e or no thought.
Apparently, it is that potential overbreadth that concerned
the Sixth Circuit in Peoples Federal Saving & Loan Association
of Sidney v. Commissioner.
The re-enactment doctrine is merely an interpretive tool fashioned by the
courts for their own use in construing ambiguous legislation. It is most
useful in situations where there is some indication that Congress noted or
considered the regulations in effect at the time of its action. Otherwise the
doctrine may be as doubtful as the silence of the statutes and legislative
history to which it is applied. [Jd. at 302-303. Fn. ref. omitted).
Unfortunately, the Sixth Circuit faijed to understand that
implicit in the compromise achieved by Congress in 1969 is
some understanding regarding taxable income. As we noted
in Pacific First Federal Savings v. Commissioner, supra at 111:
73a
120 98 UNITED STATES TAX COURT REPORTS (105)
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. * * *
[H. Rept. 91-413, 1969-3 C.B. at 278.]
Undoubtedly, Congress was aware of the definition of
“taxable income” used in computing the percentage-of-taxable-
income bad debt deduction when it considered the existing and
expected percentage of economic income to be paid as taxes by
mutual savings banks. Moreover, there are two readily
apparent ways Congress could have chosen to modify that
deduction to increase the tax paid by mutual savings banks.
The 1969 Congress could have elected (1) to reduce the base
against which the percentage was applied to something less
than what it was understood to be at that time or (2) to reduce
the percentage of taxable income allowed to be deducted. With
respect to the goal of achieving the proper aggregate tax to be
achieved from mutual savings banks overall, it would have
made little difference whether Congress chose the former, the
latter, or some combination of the two. Whether the percent-
age bad debt deduction was to be computed by taking, for
example, two-thirds of 50x or one-third of 100x would have
been, quite logically, immaterial with respect to the total tax
sought to be collected. However, given the relationship
between the definition of taxable income and the percentage
thereof deductible, Congress’ decision to adjust the latter is
only meaningful if it presupposes a particular definition of the
former. Given that there was no discussion of altering the
then established rule of determining taxable income without
respect to NOL's, Congress must have assumed that such rule
would continue to apply.
74a
(105) GEORGIA FEDERAL BANK v. COMMISSIONER 121
Amazingly, however, the Court of Appeals for the Sixth
Circuit has concluded that Congress simply did not care
whether NOL's are to be deducted in arriving at the figure for
taxable income. People’s Federal Savings & Loan Association
of Sidney v. Commissioner, supra at 301 (“there is no evidence
in the legislative history of the statutes in question that
Congress ever had a specific or particular intent with respect
to the ordering rule to be applied in this case”). Pursuing that
logic, Congress’ struggle to determine the most appropriate
extent of the bad debt deduction must seem quite comical. As
the Sixth Circuit sees the matter, Congress was indifferent to
the total percentage of economic income collected, overall, from
the banking institutions in question: all Congress cared about
was that the bad debt deduction be limited to a particular
percentage of an indeterminate income base.
The facts belie the Sixth Circuit's apparent conclusion that
Congress has acted in that irrational a manner. In 1969, it
was settled that taxable income was determined without
taking NOL's into account. Congress’ computations, discus-
sions, and the eventual compromise must necessarily have
been based upon that understanding of what taxable income
meant.' Accordingly, the Commissioner's use of a different
definition of taxable income is, in this context, inconsistent
with the Tax Reform Act of 1969. I respectfully concur with
the majority.
CHABOT, HAMBLEN, and BEGHE, J-J., agree with this concur-
ring opinion.
GERBER, J., dissenting. I respectfully dissent for the reasons
already expressed in the dissenting opinion at Pacific First
Federal Savings v. Commissioner, 94 T.C. 101, 117-126 (1990),
and because the majority has not presented persuasive or
compelling reasons for disagreeing with the rationale of the
Unfortunately, Congress does not appear to have said so explicitly. No code provision or
quotation from the written legislative history can be produced to directly support the point. That
does not mean, however, that Congress was indifferent with respect to the ordering rule at
question in this case. Where logicul reasoning, applied to the sum of the facts and circumstances.
can disclose a clear Congressional intent, we are obliged to utilize that tool.
75a
siete
122 98 UNITED STATES TAX COURT REPORTS (105)
Sixth Circuit Court of Appeals in Peoples Federal Savings &
Loan Association of Sidney v. Commissioner, 948 F.2d 289 (6th
Cir. 1991), revg. T.C. Memo. 1990-129.
The majority's opinion provides us with a large body of
Supreme Court articulations concerning the review of regula-
tions which, irrespective of one's particular leaning, would
adequately support one’s position. The majority's opinion,
however, does not provide an adequate rationale or explana-
tion for invalidating the regulations under consideration.'
That was the shortcoming found by the Court of Appeals in
Peoples Federal Savings & Loan Association of Sidney uv.
Commissioner, supra.
The majority's explanation of the Sixth Circuit's opinion is
substantially more complex than the Sixth Circuit's opinion.
The Circuit Court's opinion addresses the method of review
and the role of the judiciary in reviewing regulatory promulga-
tions. The Circuit Cuurt pointed out that, irrespective of
whether or not the statute is ambiguous, where an administra-
tive agency's regulatory formulation is a permissible and
reasonable interpretation, “a court may not substitute its own
construction.” Peoples Federal Savings & Loan Association of
Sidney v. Commissioner, 948 F.2d at 300. The Circuit Court
also reviewed the reasons for the Secretary's change of position
and admission of an erroneous position (in the earlier regula-
tions) and found the reversal of policy to be reasonable. Some
of the Circuit Court's reasoning is also to be found in the
Pacific First Federal Savings v. Commissioner, supra, dissent-
ing opinion.
In declining to follow the Sixth Circuit's opinion, the
majority evaluated and countered each of the Secretary's
reasons for reversing the regulation policy. Suffice it to note
that the majority's reasons do not negate those of the Circuit
Court, but simply reiterate some of the reasoning from Pacific
First Federal Savings v. Commissioner, supra, and add a few
countervailing reasons where prior opinions of this Court did
not address the Circuit Court's reasoning. In sum and
‘In this regard, the majority's opinion here is no less deficient than the majority's opinion in
Pacific First Federal Savings v. Commissioner, 94 T.C. 101 (1990), or the opinion in Peoples
Federal Savings & Loan Association of Sidney v. Commissioner, T.C. Memo. 1990-129, revd. 948,
F.2d 289 (6th Cir. 1991).
76a
(105) GEORGIA FEDERAL BANK v. COMMISSIONER 123
substance, the majority has, a second time, provided some of
the same and some alternative reasons for its interpretation,
but has not shown the Secretary's interpretation to be an
unreasonable or impermissible one.
The rule, correctly articulated by the Circuit Court, is
intended to keep courts from substituting their judgment for
that of administrative agencies. The majority's holding
violates the rule's proscriptive purpose.
PARKER, JACOBS, WRIGHT, PARR, and RUWE, JJ., agree with
this dissent.
77a
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