Frontier Sav. Ass'n & Subsidiaries
v.
Comm'r of Internal Revenue

This case is not covered by Casetext's citator
United States Tax CourtSep 24, 1986
87 T.C. 665 (U.S.T.C. 1986)
87 T.C. 66587 T.C. No. 40

Docket Nos. 16209-81 24559-83.

1986-09-24

FRONTIER SAVINGS ASSOCIATION AND SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Robert A. Schnur, for the petitioner. Mark D. Petersen, for the respondent.


In 1978 and 1979, petitioner, a stockholder of the Federal Home Loan Bank of Chicago (the ‘Chicago Bank‘), received common stock dividends from the Chicago Bank. Also in 1978 and 1979, some of the stockholders requested that a portion of their shares of common stock in the Chicago Bank be redeemed. As it had in prior years, the Chicago Bank redeemed all shares of its common stock it was requested to redeem. HELD, no stockholder had an election within the meaning of sec. 305(b)(1), I.R.C. 1954, to receive cash dividends in lieu of common stock dividends because the Chicago Bank retained discretion over the redemption of its common stock. Petitioner is not taxable on the value of the common stock dividends received in 1978 and 1979. Robert A. Schnur, for the petitioner. Mark D. Petersen, for the respondent.

SWIFT, JUDGE:

In statutory notices of deficiency dated June 3, 1981, and August 12, 1983, respondent determined deficiencies in petitioner's Federal income tax liabilities as follows:

+-------------------+ ¦Years¦Deficiencies ¦ +-----+-------------¦ ¦1977 ¦$1,628.15 ¦ +-----+-------------¦ ¦1978 ¦19,376.14 ¦ +-----+-------------¦ ¦1979 ¦17,887.00 ¦ +-------------------+ These cases have been consolidated for purposes of trial, briefing, and opinion.

Following concessions, the issue remaining for decision is whether stock dividends received by petitioner in 1978 and 1979 from the Federal Home Loan Bank of Chicago are taxable to petitioner under section 305(b)(1). The resolution of this issue will affect the taxability of stock dividends received by the other 496 stockholders of the Federal Home Loan Bank of Chicago which also received stock dividends in 1978 and 1979.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

Petitioner, Frontier Savings Association (‘Frontier Savings‘), is a mutual savings and loan association which was organized on February 19, 1919. It operates as a mutual savings association pursuant to Wisconsin law. The principal corporate office of Frontier Savings is located in Green Bay, Wisconsin. Frontier Savings and its subsidiaries timely filed consolidated Federal Corporation Income Tax Returns (Forms 1120) for each of the years 1978 and 1979.

Frontier Savings has been a member and stockholder of the Federal Home Loan Bank of Chicago (the ‘Chicago Bank‘) at all times since the organization of the Chicago Bank. The Chicago Bank is one of 11 district banks (12 prior to 1946) established pursuant to the Federal Home Loan Bank Act of 1932, 47 Stat. 725, 12 U.S.C. sec. 1421 et seq. The district banks were capitalized with stock subscriptions from member institutions and the U.S. Treasury. District banks operate under the supervision of the Federal Home Loan Bank Board, an administrative agency in the Executive branch of the Federal government. The Federal Home Loan Bank Board also is the chartering and regulatory authority for Federal savings and loan associations and Federal mutual savings banks.

The Federal Home Loan Bank system was designed primarily as a reserve credit facility for savings and loan associations and other home mortgage credit institutions. Savings and loan associations (such as Frontier Savings) and mutual savings banks that are members or stockholders in the district banks (hereinafter referred to as ‘members‘ or ‘member banks‘) are required by Federal law to maintain a certain capital stock ownership in the respective district banks of which they are members. The stock ownership requirements are determined at the end of each calendar year and are calculated with reference to each member bank's net home mortgage loans outstanding and total borrowings of each member from the district bank.

Each member bank generally must maintain a capital stock ownership interest in the district bank in an amount equal to at least one percent of the total outstanding balance of its home mortgage loans and at least equal to one-twelfth of total outstanding borrowings of the member bank from the district bank, as of December 31 of each year. Each share of stock in the district banks is valued by statute at its $100 par value. See 12 U.S.C. sec. 1426(b) and (c) (1978).

Based upon the above year-end calculations, member banks that are required to purchase additional stock of district banks must do so by January 31 of the following year at the par value of $100 per share. Member banks that own stock in district banks in excess of the required number of shares (‘excess shares ‘) may request that excess shares be redeemed by the district banks.

The policy of the Chicago Bank with respect to the redemption of excess shares is reflected in the minutes of a June 18, 1979, meeting of the Chicago Bank's board of directors, as follows:

BE IT RESOLVED, that the President of the Bank or any officer designated by him may from time to time increase or decrease the amount of stock of any member in accordance with Section 6 of the Federal Home Loan Bank Act »i.e., 12 U.S.C. section 1426(c)† and the Regulations for the Federal Home Loan Bank System; provided, however, that in exercising the Bank's discretion whether or not to grant an application by a member to decrease its stock, the President or his designee shall be guided by all applicable statutory and regulatory provisions, all policies and standards adopted from time to time by this Board, including, but not limited to, the Bank's credit standards contained in the ‘Policies Governing Extension of Credit‘ as adopted by this Board and all relevant facts and circumstances.

As of December 31, 1977, Frontier Savings owned 6,721 shares of stock in the Chicago Bank, all of which it had purchased over many years from the Chicago Bank at $100 per share. On that day, the principal amount of Frontier Savings' outstanding mortgage loans and borrowings from the Chicago Bank was such that, prior to January 31, 1978, Frontier Savings was required to increase its stock interest in the Chicago Bank to 9,066 shares. Accordingly, during January of 1978, Frontier Savings purchased 2,345 additional shares of the common stock of the Chicago Bank for $234,500. Frontier Savings neither purchased nor sold any additional shares of common stock in the Chicago Bank in 1978, so that as of December 28, 1978, Frontier Savings owned 9,066 shares of the common stock of the Chicago Bank.

As stockholders in district banks, member banks are entitled to receive dividends that are declared by district banks. Prior to December 29, 1978, dividends were paid by the Chicago Bank to its member banks in the form of cash. On December 29, 1978, dividends were paid by the Chicago Bank to its member banks in the form of additional shares of common stock. On December 31, 1979, dividends were paid by the Chicago Bank to its member banks half in stock and half in cash.

DECEMBER 29, 1978, STOCK DIVIDEND

At a meeting held on November 20, 1978, the board of directors of the Chicago Bank adopted a resolution to pay a 6.58-percent dividend to its stockholders of record as of December 31, 1978. Subject to the approval of the Federal Home Loan Bank Board, the resolution stated that the dividend would be paid in the form of shares of stock in the Chicago Bank. On December 22, 1978, the Director of the Office of District Banks, Federal Home Loan Bank Board, wrote a letter to the President of the Chicago Bank approving the stock dividend.

On December 22, 1978, the Chicago Bank mailed a bulletin to its member banks, informing them that a 6.58-percent stock dividend would be paid, with fractional shares to be paid in cash. The explanation made in the bulletin for paying a stock dividend, rather than a cash dividend, was as follows:

(1) Providing a stock rather than a cash dividend may enable your association to defer the payment of income taxes on the value of the stock dividend. You may wish to consult your tax adviser for the proper handling of a stock dividend.

(2) A stock dividend can be applied toward satisfying the stock investment requirement for members that experienced a growth in assets during 1978 or that will be required to purchase additional stock due to increased borrowings from the Bank. The bulletin also explained that most member banks would be required to increase their stock holdings in the Chicago Bank due to that year's general increase in outstanding home mortgage loans.

On December 29, 1978, the Chicago Bank distributed the 1978 stock dividend by (1) crediting the appropriate number of whole shares of stock to the stock account of each member bank, (2) crediting an appropriate amount of cash with respect to fractional shares to the demand account of each member bank, and (3) issuing a new stock certificate to each member bank. Each new stock certificate reflected the total number of shares of stock held by each member bank before the stock dividend, the number of shares of stock distributed pursuant to the dividend, and the total number of shares of stock owned by each member bank after distribution of the dividend. The Chicago Bank maintained records of the stock ownership accounts of its member banks.

On December 29, 1978, a total of 234,620 shares of common stock was distributed by the Chicago Bank as a stock dividend to its 497 member banks. On December 29, 1978, Frontier Savings received 588 shares of common stock in the Chicago Bank (and cash representing fractional shares in the amount of $51.07) as its share of the 1978 stock dividend.

COMMON STOCK PURCHASES AND REDEMPTIONS RELATING TO DECEMBER 31, 1978 STOCK OWNERSHIP REQUIREMENTS

Enclosed with the December 22, 1978, bulletin mailed by the Chicago Bank to its member banks describing the 1978 stock dividend was a form entitled ‘Calculation of Bank Stock Requirement as of December 31, 1978.‘ Using that form, each member bank could calculate the number of shares of stock it was required, under 12 U.S.C. sec. 1426(c) (1978), to own in the Chicago Bank as of December 31, 1978. If a member bank was required to purchase additional shares of stock, it could submit the form (reflecting the number of shares to be purchased) along with a check in payment therefor to the Chicago Bank. If the member bank held more shares than it legally was required to own, it could use the form to request the redemption of any excess shares. Although the Chicago Bank had no legal obligation to redeem excess shares, in prior years it routinely had done so.

On January 16, 1979, Frontier Savings completed the form calculating the number of shares of common stock in the Chicago Bank it was required to own based on its December 31, 1978, outstanding balance for home mortgage loans. That calculation indicated that Frontier Savings was required to purchase 678 additional shares of common stock in the Chicago Bank (after taking into account the shares received as part of the common stock dividend on December 29, 1978). Frontier Savings, therefore, sent a check in the amount of $67,800 to the Chicago Bank and 678 shares were credited to its stock account at the Chicago Bank. A new stock certificate was issued reflecting the ownership by Frontier Savings of a total of 10,332 shares of common stock in the Chicago Bank. During 1979, none of the shares of common stock in the Chicago Bank owned by Frontier Savings were redeemed or otherwise transferred.

Exclusive of the December 29, 1978, stock dividend received, on December 31, 1978, 195 of the 497 member banks owned sufficient shares of common stock in the Chicago Bank to meet their stock ownership requirements, and 302 member banks did not own sufficient shares to meet their stock ownership requirements. After receipt of the 1978 stock dividend, 69 member banks requested that the Chicago Bank redeem all or some of their excess shares. All such redemption requests were agreed to by the Chicago Bank and the following number of shares of common stock were redeemed by the Chicago Bank from its member banks in the months indicated:

+---------------------------------+ ¦Time Period ¦Shares redeemed¦ +-----------------+---------------¦ ¦December 1978 ¦1,240 ¦ +-----------------+---------------¦ ¦January 1979 ¦62,575 ¦ +-----------------+---------------¦ ¦February 1979 ¦8,249 ¦ +-----------------+---------------¦ ¦Remainder of 1979¦22,256 ¦ +---------------------------------+ During December of 1978 and 1979, 45 member banks redeemed a number of shares of stock in the Chicago Bank that was equal to or that exceeded the number of shares they received as their portion of the 1978 stock dividend.

1979 CASH AND STOCK DIVIDENDS

At a meeting held on November 19, 1979, the board of directors of the Chicago Bank adopted a resolution, subject to the approval of the Federal Home Loan Bank Board, to pay a 10-percent dividend to its stockholders of record as of December 31, 1979, half of which would be paid in cash and half of which would be paid in the form of common stock of the Chicago Bank. On December 13, 1979, the Federal Home Loan Bank Board approved payment by the Chicago Bank of the proposed cash and stock dividends. On December 21, 1979, the Chicago Bank mailed a bulletin to its member banks, informing them that the 10- percent dividend would be paid to the stockholders on December 31, 1979.

On December 31, 1979, the Chicago Bank distributed the 1979 dividends by (1) adding the appropriate number of whole shares of stock to the stock account of each member, and (2) adding to the demand account of each member the amount representing the cash portion of the dividend as well as the amount of cash representing fractional shares of stock distributed as part of the dividend. A total of 209,197 shares of stock were distributed by the Chicago Bank as a stock dividend to its 497 member banks on December 31, 1979. Frontier Savings received 514 shares of Chicago Bank common stock as its portion of the 1979 stock dividend and $51,567.87 in cash as its portion of the cash dividend.

COMMON STOCK PURCHASES, SALES, AND REDEMPTIONS RELATING TO DECEMBER 31, 1979, STOCK OWNERSHIP REQUIREMENTS

The December 21, 1979, bulletin mailed to member banks concerning the 1979 dividends explained that ‘to help preserve the non-taxable characteristics of the stock dividend‘ a new procedure was being adopted for the purchase and disposition of excess shares of stock in the Chicago Bank. Instead of having member banks purchase additional shares of stock from the Chicago Bank and instead of having the Chicago Bank redeem excess shares from member banks, the new procedure called for member banks who had excess shares they wished to dispose of to sell such excess shares to other member banks who wished to buy additional shares.

+---------------------------------+ ¦Time period ¦Shares redeemed¦ +-----------------+---------------¦ ¦February 1980 ¦177,254 ¦ +-----------------+---------------¦ ¦March 1980 ¦61,837 ¦ +-----------------+---------------¦ ¦Remainder of 1980¦43,199 ¦ +---------------------------------+

None of the shares of stock in the Chicago Bank received by Frontier Savings with respect to the 1978 and 1979 stock dividends were redeemed by the Chicago Bank or otherwise disposed of by Frontier Savings prior to 1982. In January of 1982, the Chicago Bank, at the request of Frontier Savings, redeemed 3,584 shares of its stock owned by Frontier Savings.

OPINION

SIMPSON, J., dissents.

GERBER, WRIGHT, and WILLIAMS, JJ., did not participate in the consideration of this case.