Cottage Sav. Assn v. Cir 499 U.S.

554 (1991) Facts: Cottage Savings Association was a savings & loan association (S&L) serving the Greater Cincinnati area. Like many other S&L's, Cottage Savings had a large number of long-term, low-interest mortgages on its books, which declined in value as interest rates increased during the late 1970s. These S&Ls could have achieved a tax savings from selling these mortgages at a loss, but they were dissuaded from doing so because the accounting regulations of the Federal Home Loan Bank Board (FHLBB) would have required them to report these losses on their books, possibly putting them into insolvency. Hoping to find another way for these S&Ls to realize their tax losses, the FHLBB promulgated a new regulation called "Memorandum R-49", under which the S&Ls would not have to show a loss on their books if they exchanged their mortgages for "substantially identical" mortgages held by other lenders. Cottage Savings made a transaction pursuant to this regulation by exchanging 90% participation interests in 252 mortgages to four other S&Ls, receiving in return 90% participation interests in 305 mortgages. All the mortgages involved in the transaction were for homes in the Greater Cincinnati region. The fair market value of the interests exchanged by each side was approximately $4.5 million. The face value of the interests which Cottage Savings relinquished was approximately $6.9 million. On its 1980 federal income tax return, Cottage Savings claimed a loss of $2,447,091, the adjusted difference between the face value of the participation interests it gave up and fair market value of the interests it received. The Commissioner of Internal Revenue disallowed Cottage Savings' deduction, so the S&L filed a petition for redetermination in the United States Tax Court, which reversed the Commissioner's decision and permitted the deduction. The Commissioner appealed to the United States Court of Appeals for the Sixth Circuit, which reversed the decision of the Tax Court, holding that even though Cottage Savings realized a loss in the transaction, it had not actually realized the loss during the 1980 tax year. The U.S. Supreme Court then granted certiorari. Issue: whether the exchange was a "disposition of property." Held: Material difference is a requirement for a disposition under 1001 . Marshall cited Treasury Regulation 1.1001-1 (26 C.F.R. 1.1001-1), which required that an exchange of materially different properties constitutes a

realization under the Tax Code. Congress delegated to the Commissioner the authority to make rules and regulations to enforce the Internal Revenue Code. Because Title 26 of the Code of Federal Regulations represents the Commissioner's interpretation of the Code, the Court deferred to the Commissioner's judgment, holding that the regulation was a reasonable interpretation of the Code and consonant with prior case law. Material difference defined. Marshall defined what constituted a "material difference" in property under 1001 by examination at what point "realization" had been found in past case law. He started with Eisner v. Macomber, which dealt with exchange of stock in corporations. In several cases after Eisner, the court held that an exchange of stock which occurred when a corporation reorganized in another state was a realization, because corporations have different rights and power in different states. Marshall reasoned that properties materially differ for tax purposes when their respective possessors enjoy different legal entitlements from each. As long as the properties being exchanged were not identical, a realization had taken place. This was a simpler, black letter rule, as compared to what the Commissioner was arguing for, which would have examined not just the underlying substance of the transaction, but also the market and other nontax regulations. The properties exchanged were "materially different." Marshall held that the participation interests exchanged by Cottage Savings and the other S&Ls were "materially different" because the loans involved were made to different obligors and secured by different properties. Even though the interests were "substantially identical" for the FHLBB's purposes, that did not mean they were not materially different for taxation purposes. Therefore, the exchange was a "disposition of property," Cottage Savings had realized a loss, and their deduction was appropriate. The Court agreed that "material difference" is the applicable test of realization under Code 1001(a), but it did not agree that that test had been flunked merely because the properties exchanged were economic substitutes or equivalents. While the test for regulatory purposes might indeed be one of economic substance, for tax purposes the question was one of administrative convenience only. As the mortgages exchanged were secured by different homes and involved different mortgage borrowers, the banks on either side emerged with "legally distinct entitlements". More important, the swap itself sufficed to meet the administrative aims that underlie the realization requirement. The transaction was an arms-length deal between unrelated parties. As such, it "put both Cottage Savings and the Commissioner in a position to determine the change in the value of Cottage Savings' mortgages relative to their tax bases" and thus to reckon up gain or loss under 1001(a). Justice Blackmun dissented, joined by Justice White. First, Blackmun wanted to define "material difference" with reference to how the term "materiality" was defined. In TSC Industries, Inc. v. Northway, Inc.,

Justice Marshall himself had stated, in the context of securities fraud, that an omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. By implication, a material difference is a difference capable of influencing the decision made by the parties to the transaction. Second, Blackmun pointed out that the majority created something of an anomaly by allowing the property interests exchanged here to be "identical" for accounting purposes but "different" for tax purposes. Finally, he explained the he felt the substance of the transactions, including the fact that Cottage Savings retained a 10% interest in loans it traded away so it could continue servicing them, did not point to any real difference that should permit the allowance of a deduction. CIR v Mizner We are here concerned with the liability of Sol Minzer and Adele Minzer, his wife, for a federal income tax deficiency for the year 1954. The transactions from which the controversy stems were those of Sol Minzer and he will be referred to as the taxpayer. No issues of fact are presented. In 1954 the taxpayer was an insurance agent or broker. During that year he procured or kept in force policies of insurance upon his life. As a representative of the insurance companies which had issued the policies he became entitled to commissions on the policies to the same extent as though the insurance had been on the life of someone else. He received the commissions, or the benefit of them, upon these policies on his own life either by remitting the premiums, less commissions, to the companies, or by remitting the premiums in their entirety and receiving back from the companies their checks to him for the amounts of the commissions. The taxpayer did not include these commissions as taxable income in his return for 1954. The Commissioner of Internal Revenue recomputed the tax by the inclusion of the commissions as income and made a deficiency determination. The Tax Court held for the taxpayer. Sevenjudges dissented. The Commissioner brings the case to us for review. The Tax Court, or those of the Court who subscribed to the prevailing opinion, placed their decision upon the narrow ground that the taxpayer was a broker and not an employee and hence the transactions were outside the terms of Income Tax Regulations Section 61-2(d) (2). In the prevailing opinion of the Tax Court an unwillingness is expressed to apply the prior 2 administrative rulings holding that commissions received or retained by a life insurance agent on policies upon his own life are income to the agent. This ruling would have been followed by the Tax Court if it had found an employer-employee relationship between the insurance companies and the taxpayer.

The contract between one of the insurance companies, Western States Life Insurance Company, is designated as an agency contract and the taxpayer is therein referred to as "the agent." The contract with the other company, Occidental Life Insurance Company, is called a brokerage agreement. In both contracts the taxpayer was authorized to solicit and submit applications for life insurance and in each contract the percentage of premiums which the taxpayer should receive as commissions was specified. The relationships created by the contracts were substantially the same. It does not seem to us that the tax incidence is dependent upon the tag with which theparties label the connection between them. The agent or broker, or by whatever name he be called, is to receive or retain a percentage of the premiums on policies procured by him, called commissions, as compensation for his service to the company in obtaining the particular business for it. The service rendered to the company, for which it was required to compensate him, was no different in kind or degree where the taxpayer submitted his own application than where he submitted the application of another. In each situation there was the same obligation of the company, the obligation to pay a commission for the production of business measured by a percentage of the premiums. In each situation the result was the same to the taxpayer. The taxpayer obtained insurance which the companies were prohibited by law from selling to him at any discount. 14 Vernon's Tex.Civ.Stat. Insurance Code, Art. 21.21. It cannot be said that the insurance had a value less than the amount of the premiums. It must then be said that a benefit inured to the taxpayer to the extent of his commissions. The benefit is neither diminished nor eliminated by referring, as does the Tax Court, to the word "commission" as a verbal trap. The commissions were, we conclude, compensation for services and as such were income within the meaning of 26 U.S. C.A. (I.R.C.1954) 61(a) (1). While, as we have tried to indicate, the Commissioner's contention is sound in principle, it is also to be supported by the long-standing administrative rulings which are to be given great weight. Lykes v. United States, 343 U.S. 118, 72 S.Ct. 585, 96 L.Ed. 791; Helvering v. R. J. Reynolds Tobacco Co., 306 U.S. 110, 59 S.Ct. 423, 83 L.Ed. 536; Massachusetts Mutual Life Insurance Co. v. United States, 288 U.S. 269, 53 S.Ct. 337, 77 L. Ed. 739. The weight so given is not, in our opinion, lightened by the conclusion in the General Counsel's Memorandum, G.C.M. 10486, that there was an employer-employee relationship existing, and the stress there placed upon such relationship, although we think the ruling is applicable as well to independent contractors and others as to those in a technical common law master and servant category. The Commissioner's position is sustained by precedent as well as upon principle and by administrative ruling. A case such as that before us has recently been decided by the Third Circuit with the result that commissions on insurance paid with respect to policies of the agent were held to be

income taxable to him. Ostheimer v. United States, 3 Cir., 1959, 264 F.2d 789. We are in accord with that court's conclusions that the agent did not receive a bargain purchase and that the commissions were neither discounts nor rebates. It is argued that the doctrine urged by the Commissioner represents an unprecedented extension of the concept of income as is found in Eisner v. Macomber, 252 U.S. 189, 40 S.Ct. 189, 190, 64 L.Ed. 521. There taxable income was characterized as "the gain derived from capital, from labor, or from both combined." We cannot see that our decision in any way expands the Eisner v. Macomber principle. On the contrary we think our determination is within it. But if the Eisner v. Macomber statement is regarded as a deterrent to the decision we have reached, we are taken from under its interdict by a later case from the Supreme Court where it is said that the phrase in Eisner v. Macomber "was not meant to provide a touchstone to all future gross income questions". Commissioner of Internal Revenue v. Glenshaw Glass Co., 348 U.S. 426, 75 S.Ct. 473, 477, 99 L.Ed. 483. See Commissioner of Internal Revenue v. LeBue, 351 U.S. 243, 76 S.Ct. 800, 100 L.Ed. 1142. It follows that the decision of the Tax Court must be and it is hereby

The tax counsel admitted the error in computing the tax liability and tendered to petitioner the sum of $19,941.10 which the petitioner then accepted. In his final determination of petitioner's 1934 tax liability, the respondent included the aforesaid $19,941.10 in income. Respondent contends that the sum $19,941.10 be included as petitioner's gross income (as taxes paid for petitioner by a third party for 1934. Petitioner contends that this payment constituted compensation for damages or loss caused by the error of tax counsel, and that he therefore realized no income from its receipt in 1934.

Issue: Whether petitioner derived income by the payment to him of an amount of $19,941.10, by his tax counsel, to compensate him for a loss suffered on account of erroneous advice given him by the latter Held: No. Court held in favor of petitioner. The losses is not income since it is not derived from capital, from labor or from both combined When the joint return was filed, petitioner became obligated to and did pay the taxes computed on that basis. In paying that obligation, he sustained a loss which was caused by the negligence of his tax counsel. The $19,941.10 was paid to petitioner, not qua taxes, but as compensation to petitioner for his loss. The measure of that loss, and the compensation therefor, was the sum of money which petitioner became legally obligated to and did pay because of that negligence. The fact that such obligation was for taxes is of no moment here.

Edward Clark v. Cir 40 B.T.A. 333 (1939) This is a proceeding to redetermine a deficiency in income tax for the calendar year 1934 in the amount of $10,618.87.

Facts: The petitioner was required to file a Federal ITR for 1932. Petitioner retained experienced tax counsel to prepare the necessary return for him and his wife. Such tax counsel prepared a joint return for petitioner and his wife and advised petitioner to file it instead of two separate returns. In 1934, a duly appointed revenue agent audited the1932 return and recommended an $32,820.14 additional assessment against petitioner. This sum was paid by petitioner. The deficiency of $32,820.14 arose from an error on the part of tax counsel who prepared petitioner's 1932 return. The tax counsel improperly deducted from income the total amount of losses sustained on the sale of capital assets held for a period of more than two years instead of applying the statutory limitation required by Section 101(b) of the Revenue Act of 1932. Recomputations were then made which disclosed that if petitioner and his wife had filed separate returns for the year 1932 their combined tax liability would have been $19,941.10 less than that which was finally assessed against and paid by petitioner.