United States v. Centennial Savings Bank FSB

Syllabus During the 1981 tax year, respondent Centennial Savings Bank FSB exchanged participation interests in a set of mortgage loans for interests in a different set of mortgage loans held by another lender. All of the loans were secured by residential properties and had a face value substantially higher than their fair market value. In a separate set of transactions, Centennial collected early withdrawal penalties from customers who prematurely terminated their certificates of deposit (CD's). In its 1981 federal income tax return, Centennial claimed a deduction for the difference between the face value of the mortgage interests it surrendered and the fair market value of the mortgage interests it received. It also treated the early withdrawal penalties it received as "income by reason of the discharge . . . of indebtedness" excludable from gross income under 26 U.S.C. § 108(a)(1)(C) (1982 ed.). After the Internal Revenue Service disallowed the deduction of the losses associated with the mortgages and determined that Centennial was required to declare the early withdrawal penalties as income, Centennial paid the deficiencies and filed a refund action in the District Court. The court entered a judgment for petitioner United States on the mortgage-exchange issue and for Centennial on the early withdrawal penalty issue. The Court of Appeals reversed the mortgage-exchange ruling, but affirmed the early withdrawal penalty holding.

Held: 1. Centennial realized tax-deductible losses when it exchanged mortgage interests with the other lender. Cottage Savings Assn. v. Commissioner, 499 U.S. 554, 111 S.Ct. 1503, 113 L.Ed.2d 589. Pp. 578-579. 2. The early withdrawal penalties collected by Centennial were not excludable from income under § 108(a)(1). A debtor realizes income from the "discharge of indebtedness" only when the income results from the forgiveness of, or release from, an obligation to repay assumed by the debtor at the outset of the debtor-creditor relationship. Here, the depositors who prematurely closed their accounts and incurred penalties did not forgive or release any repayment obligation on the part of Centennial, which paid exactly what it was obligated to pay according to the terms of the agreements entered into at the time the CD's were established. This reading best comports with § 108's purpose, which is to mitigate the effect of treating a discharge of indebtedness as income so that the prospect of immediate tax liability will not discourage businesses from taking advantage of opportunities to repurchase or liquidate their debts at less than face value. A debtor who negotiates in advance the circumstances in which he will liquidate the debt is in a position to anticipate his need for cash with which to pay the resulting income tax and can negotiate the terms of the anticipated liquidation accordingly. Moreover, in this case, Centennial was committed to releasing the deposits at the sole election of the depositors. Thus, unlike a debtor considering the negotiation of an adjustment of the terms of a duty to repay, Centennial had no discretion to take the tax effects of a transaction into account before liquidating its obligation at less than face value. Pp. 579-584. 887 F.2d 595 (CA5 1989), affirmed in part, reversed in part, and remanded. MARSHALL, J., delivered the opinion of the Court, in which REHNQUIST, C.J., and STEVENS, O'CONNOR, SCALIA, KENNEDY, and SOUTER, JJ., joined, in Parts I and III of which WHITE, J., joined, and in Part III of which BLACKMUN, J., joined. BLACKMUN, J., filed an opinion concurring in part and dissenting in part, in which WHITE, J., joined, post, p.. John G. Roberts, Jr., for petitioner. Michael F. Duhl, for respondent. Justice MARSHALL delivered the opinion of the Court.