DocketNumber: Docket No. 4100-70
Citation Numbers: 31 T.C.M. 1206, 1972 Tax Ct. Memo LEXIS 14, 1972 T.C. Memo. 243
Filed Date: 12/6/1972
Status: Non-Precedential
Modified Date: 11/20/2020
MEMORANDUM FINDINGS OF FACT AND OPINION
@HALL, Judge: Respondent determined a deficiency in petitioner's 1967 Federal income tax in the amount of $23,844.07.
Petitioner claimed a $169,334 net operating loss deduction in its corporate income tax return for the calendar year 1967. Respondent disallowed $115,113 of the deduction, representing deductions claimed for additions to a bad debt reserve for the calendar years 1964, 1965 and 1966 of an acquired corporation, Fidelity Savings and Loan Association (hereinafter "Fidelity"). If Fidelity is entitled to deduct these amounts for the calendar years 1964, 1965 and 1966, petitioner is entitled to the claimed net operating loss.
FINDINGS OF FACT
All the facts have been stipulated and the stipulation and exhibits attached thereto are incorporated by this reference.
Petitioner, Annapolis Federal Savings & Loan Association, is a domestic building and*16 loan association within the meaning of section 593, 1with its principal place of business in Annapolis, Maryland. It timely filed its Federal income tax return for the calendar year 1967 with the district director of internal revenue, Baltimore, Maryland, on which it claimed a $169,334 net operating loss deduction attributable to Fidelity, computed as follows:
Taxable year ended: | |
December 31, 1963 | $ 13,301 |
December 31, 1964 | 83,525 |
December 31, 1965 | 31,785 |
December 31, 1966 | 39,303 |
March 31, 1967 | 1,420 |
$169,334 |
Respondent issued to petitioner a statutory notice of deficiency for 1967 2 which respondent disallowed that portion of Fidelity's net operating loss claimed by petitioner attributable to the bad debt deductions claimed by Fidelity, computed as follows:
Net Operating | Less Unallow- | Corrected Net | |
Taxable | Loss for Tax- | able bad-debt | Operating Loss |
Year Ended | able Year | deduction | for taxable year |
12/31/63 | $ 13,301 | $0 | $ 13,301 |
12/31/64 | 83,525 | (71,684) | 11,841 |
12/31/65 | 31,785 | (25,242) | 6,543 |
12/31/66 | 39,303 | (18,187) | 21,116 |
3/31/67 | 1,402 | 0 | 1,402 |
1967 Math Error | 18 | (18) | 0 |
TOTAL | $169,334 | (115,131) | $ 54,203 |
Fidelity, also a domestic building and loan association within the meaning of section 593, was chartered on December 1, 1963, by the Federal Home Loan Bank Board, and made its first real estate loan during 1964. Its principal place of business was Oxon Hill, Maryland.
In October 1966 a supervisory agent for the Federal Home Loan Bank Board wrote a letter to the directors of Fidelity, enclosing a report of the Board's examination*18 of Fidelity, in which he pointed out to the directors the examiner's comments on policies and practices of Fidelity which adversely affected its financial condition. The letter states in part:
We also direct your attention to the following:
1. Despite assurance to the contrary loans were granted when the association's liquidity was less than the required minimum.
2. Money borrowed from sources other than the Federal Home Loan Bank exceeds the maximum permitted by Section 563.8 of the Insurance Regulations.
3. Loan 37, granted during a previous review period, remains in violation of the lending limitations.
4. Policies and procedures relative to the method of appraising should be reviewed and the necessary changes made that will assure realistic appraised values. Information on the reports should be sufficiently detailed to substantiate the value assigned and also reflect the basis for determining land values. It is our opinion that the compensation of appraisers should not be contingent upon the approval of the loan.
5. Minutes of meetings should be completed and properly signed within a reasonable period subsequent to each meeting.
The number of regulatory violations*19 shown in the report indicates that the persons responsible are either not familiar with the regulations or are unwilling to abide by them.
* * *
The indifference shown to regulations and to the day-to-day operations of the association by the directors and management is appalling.
Fidelity solved its problems by merging into petitioner on March 31, 1967, pursuant to a merger agreement dated January 4, 1967.
Fidelity timely filed original Federal income tax returns with the district director of internal revenue, Baltimore, Maryland, for the taxable years ended December 31, 1963, 1964, 1965 and 1966, and for the short period ended March 31, 1967. Each return disclosed a net operating loss. In none of these returns did Fidelity claim a bad debt deduction, nor did Fidelity make any statement electing the reserve method of accounting for bad debts. Fidelity never established a bad debt reserve on its books for any year.
Petitioner filed amended returns on behalf of Fidelity on October 15, 1968, for the calendar year 1964, and on November 5, 1968, for the calendar years 1965 and 1966, in which petitioner on behalf of Fidelity claimed bad debt deductions (representing additions*20 to a bad debt reserve) of $71,684, $25,242 and $18,187, respectively, or a total of $115,113. On June 14, 1968, petitioner credited the $115,113 in a single journal entry to petitioner's existing reserve for losses on qualifying real property loans on the merged books of Fidelity and petitioner. Petitioner did not attempt to reopen the original books of Fidelity for the calendar years 1964, 1965 and 1966 for the purpose of setting up a reserve for losses on qualifying real property loans or any other bad debt reserve.
OPINION
Section 166(c) provides that a taxpayer may deduct a reasonable addition to a reserve for bad debts in lieu of a deduction under section 166(a) for specific debts which have become wholly or partially worthless within the taxable year. In the case of a domestic building and loan association within the meaning of section 593(a), the specific requirements for deductions allowable under section 166(c) are set out in subsections 593(b) through (f). Section 593(c)(1) requires that such a domestic building and loan association "which uses the reserve method of accounting for bad debts shall establish and maintain a reserve for losses on qualifying real property*21 loans * * *."
In addition, the regulations require that additions to the reserve "must be credited" to the reserve "by the close of the taxable year, or as soon as practicable thereafter."
Use of the reserve method of accounting for bad debts is a privilege which allows a taxpayer a deduction for bad debts in advance of the debts becoming worthless. "Where the Congress has authorized certain tax privileges and has prescribed the conditions to be met in qualifying for them it has been held that strict compliance with the statute is necessary * * *."
Respondent argues that Fidelity*22 has failed to comply with the statute and regulation in that it failed to establish and maintain reserves on its books of account, and credit additions to such reserves by the close of the taxable years 1964, 1965 and 1966, or as soon as practicable thereafter. We agree with respondent.
The claiming of deductions for bad debt losses on Fidelity's amended returns for the years 1964, 1965 and 1966 does not meet the bookkeeping reouirements of section 593 that a domestic savings and loan association must establish and maintain a reserve on its books of account and credit additions thereto.
Fidelity failed not only to establish reserves on its books, but also to credit additions thereto as soon as practicable after the close of its taxable years 1964, 1965 and 1966.
This Court when considering the meaning of the phrase "by the close of the taxable year, or as soon as practicable thereafter" said in
The regulations thus recognize variations in general accounting*24 procedures and, we believe, correctly do not establish an absolute time limit by which the entries must be made on the books. Ordinary business practices necessitate the allowance of a reasonable time after the close of the year for the auditing of the books, the physical notation of the closing entries to profit and loss and the adjusting entries including the entries to the various reserve accounts While we do not intend to establish such a time limit, generally the limit should be not later than the time at which the taxpayer files its income tax return for the year involved. At that time, it is in a position to ascertain what would be a reasonable amount to add to the reserve account, and can determine what the net income is if it is a factor limiting the amount of the allowable reserve deduction.
The Internal Revenue Service recognizes that the phrase "as soon as practicable thereafter" allows some flexibility in making the necessary book adjustments after the close of the taxable year. In
However, when no valid reason is shown for extending the time beyond the filing of the return, the courts have strictly construed this provision of the regulations. See
Petitioner asserts in his brief*26 that Fidelity "either as a result of acts of misfeasances or nonfeasances" failed to make additions to a reserve for losses, and "it is reasonable to assume that such an allowance should have been made in the original returns as filed." These assertions are not well founded. The only benefit Fidelity would have obtained from such deductions would have been an increase in its net operating loss carryover. Petitioner has failed to prove reasonable cause here for extending the time for crediting additions to a reserve beyond the time of the filing of Fidelity's original returns.
Petitioner also contends that
This Court considered this question in
The underlying assumption of
Our case is easier. Fidelity did not even claim a deduction for additions to a bad debt reserve on its original returns, much less make the required entries in its books of account. The regulation on which petitioner relies provides only for subsequent adjustments to preexisting amounts validly claimed on a timely return and properly reflected on the books of account. We can find therein no authority for petitioner to make "additions" to Fidelity's non-existent reserves, and no redemption for Fidelity's failure to comply with the clear prerequisites for the deductions belatedly claimed herein.
Accordingly, we hold that petitioner is not entitled to that portion of Fidelity's net operating loss carryover attributable to the bad debt deductions claimed in Fidelity's amended returns for the calendar*29 years 1964, 1965 and 1966.
Decision will be entered under Rule 50
1. All statutory references are to the Internal Revenue Code of 1954, as in effect during the years in issue.↩
2. Additional issues raised in the statutory notice and petition have been settled by stipulation of the parties, as follows:
(a) Petitioner concedes that $7,680 claimed as expenses for "repairs" represents capital expenditures.
(b) In the statutory notice respondent disallowed the deduction for alleged repairs of $4,285.76 representing "plumbing costs and septic system" with respect to four properties acquired through foreclosure. Petitioner concedes that these expenditures constitute capital improvements made after the acquisition of those properties, and petitioner and respondent agree that the life of these improvements is seven years and that petitioner is entitled to straight-line depreciation computed from July 1, 1967, with respect thereto.↩