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Beneficial Corp. v. United States

Decided: March 26, 1987.

BENEFICIAL CORPORATION AND SUBSIDIARIES, APPELLANT,
v.
THE UNITED STATES, APPELLEE



Markey, Chief Judge, Rich, Circuit Judge, and Baldwin, Senior Circuit Judge.*fn*

Baldwin

BALDWIN, Senior Circuit Judge.

Appeal by Beneficial Corporation and Subsidiaries (Beneficial) from a judgment of the United States Claims Court, 9 Cl. Ct. 119, (Claims Court) in a tax refund case under § 166(c) of the Internal Revenue Code of 1954 (IRC). Though that section was repealed by § 805(a) of the Tax Reform Act of 1986, Pub. L. No. 99-514, 100 Stat. 2085, the repeal was effective as of December 31, 1986 and, hence, is inapplicable to the facts of this case.*fn1 The Claims Court granted summary judgment for the government and denied partial summary judgment for Beneficial. We reverse the judgment and remand for further proceedings consistent herewith.

Background

Beneficial is an accrual basis taxpayer in the consumer finance business and keeps its books on a calendar year basis. In the course of its business, Beneficial makes long term loans that are not always paid back. Section 166(c) of the IRC allowed a deduction for such losses:

§ 166. Bad debts

(a) General rule

(1) Wholly worthless debts

There shall be allowed as a deduction any debt which becomes worthless within the taxable year.

(2) Partially worthless debts

When satisfied that a debt is recoverable only in part, the Secretary may allow such debt, in an amount not in excess of the part charged off within the taxable year, as a deduction.

(c) Reserve for bad debts

In lieu of any deduction under subsection (a), there shall be allowed (in the discretion of the Secretary) a deduction for a reasonable addition to a reserve for bad debts.

Section 166(a) prescribed a specific charge-off method for bad debts that actually became worthless, and were charged off on the taxpayer's books, in the taxable year. Under that section, the amount of deduction reflected the actual charge-off experience during the taxable year.

In lieu of a deduction for specific bad debts incurred during the taxable year, § 166(c) allowed an accrual basis taxpayer to establish a reserve for bad debts and to deduct reasonable additions thereto. The reserve approximated loan amounts presently outstanding but expected to be uncollectable in the future. Each year, the proper amount of reserve was redetermined, and a reasonable addition to the reserve balance necessary to bring it up to the proper level was deductible, subject to the Secretary's discretion.*fn2

Beneficial utilized the reserve method of § 166(c). On audit of Beneficial's tax returns for 1976 and 1977, the Internal Revenue Service ("IRS") found that Beneficial's reserve level reflected an amount exceeding those bad debts reasonably expected to be written off in the next succeeding year. As a result, the IRS disallowed Beneficial's additions to its bad debt reserve. Instead, it applied the " Black Motor formula," which is based on the methodology used in Black Motor Co. v. Commissioner, 41 B.T.A. 300 (1940), aff'd on other grounds, 125 F.2d 977 (6th Cir. 1942).*fn3

The Commissioner's application of the Black Motor formula resulted in Beneficial having deficient tax obligations of $16,037,089 and $4,641,296 for 1976 and 1977, respectively. The difference stems basically from Beneficial including in its reserve all outstanding debts presently expected to become worthless in the next and succeeding years. In contrast, Black ...


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