Insolvent bank may protect depositor assets from tax unrelated to federal assistance

Plain-English summary

An insolvent bank received federal financial assistance during a receivership transaction and separately reported taxable income from a litigation recovery. The tax liability came entirely from the litigation recovery, not from the federal assistance. Chief Counsel concluded that the regulations denying section 7507 treatment in federal-assistance transactions apply only when the income generating the tax is attributable to that assistance. The receiver may therefore invoke section 7507 to prevent collection of the litigation-recovery tax to the extent collection would reduce assets needed to pay depositors. Even for tax arising from federal assistance, the IRS would first have to determine under the regulations whether the tax would be borne by the regulatory agency.

Ruling snapshot

• Question: Can an insolvent bank use IRC § 7507 to protect depositor assets from collection of tax on income unrelated to federal financial assistance?
• Outcome: Advice given: yes, to the extent collection would diminish assets needed for depositors.
• Key authorities: IRC §§ 597 and 7507; Treas. Reg. §§ 1.597-6 and 301.7507-1(b)(4)(iii); H.R. Rep. No. 101-222

Full text (IRS public release)

ID:      CCA_2016030315450658
UILC:    597.07-00, 7507.00-00

Number: 201614035
Release Date: 4/1/2016
From: --------------------
Sent: Thursday, March 03, 2016 3:45:06 PM
To: ----------------------
Cc:
Bcc:
Subject: Your question about IRC secs. 597 and 7507


You have raised a question about the application of I.R.C. § 7507 in cases in which
Federal Financial Assistance (“FFA”) was provided to a failed bank (“Bank”) that also
reported taxable income unrelated to the receipt of FFA.

Due to its insolvency, Bank was closed and a bank regulatory agency (“Agency”) was
appointed as receiver. Pursuant to this transaction, Bank’s assets and liabilities were
transferred to another bank, and Agency provided FFA to Bank (as set forth in I.R.C. §
597 and the accompanying regulations). Agency, in its fiduciary capacity as Bank’s
receiver, filed Bank’s tax return for the taxable year in issue. Bank reported taxable
income attributable to a “litigation recovery,” which, in turn, generated a tax
liability. None of Bank’s tax liability is attributable to its receipt of FFA. Bank (through
Agency, acting as Bank’s fiduciary) asserts that § 7507 prevents the Service from
pursuing collection on the tax liability. We conclude that Bank’s position is correct, and
you have requested that we clarify our views in writing.

Section 7507(a) provides that in the case of a bank that “has ceased to do business by
reason of bankruptcy or insolvency, no tax shall be assessed or collected . . . on
account of such bank, which shall diminish the assets thereof necessary for the full
payment of all its depositors . . . .” There is no dispute as to whether Bank qualifies as a
“bank” for purposes of § 7507. The regulations under § 7507, however, seem to
preclude application of § 7507 in cases where the bankrupt or insolvent bank has
transferred assets or liabilities to any person in a transaction in which FFA is provided.
See Treas. Reg. § 301.7507-1(b)(4)(iii) (explaining that a bank will not be considered to
have “ceased to do business” under § 7507 on account of a transaction in which FFA is
provided). Thus, it appears that Bank cannot rely upon § 7507 in this case because
Bank transferred assets and liabilities as part of a transaction in which FFA was
provided, and, thus, Bank never “ceased to do business” for purposes of § 7507(a).
This reading, however, is erroneous.

The regulations under § 7507, insofar as they address transactions involving FFA, were
amended to reflect Congressional intent upon enactment of the Financial Institutions
Reform, Recovery and Enforcement Act of 1989, Pub. L. 101-73 (“FIRREA”). The
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legislative history for FIRREA describes the intended application of § 7507 to FFA
transactions as follows:

      [F]inancial assistance received by, or paid with respect to, financially troubled
      financial institutions is generally treated as taxable. Such assistance is deemed
      to be received by the financially troubled financial institution at the time the
      assets of such institution are sold or transferred. As a result, the financial
      assistance generally will be offset by the net operating losses and built-in losses
      of the financially troubled financial institution. Thus, an acquired financially
      troubled financial institution will generally have no net tax liability resulting from
      the receipt (or deemed receipt) of financial assistance.

      [T]he net operating losses and built-in losses of a financially troubled institution
      may not always be sufficient to offset the amount of financial assistance received
      (or deemed received) by the troubled institution. In this regard, the conferees
      intend that the regulatory authority granted by the bill . . . may be exercised to
      limit the potential applicability of section 7507 of the Code in cases where
      financially troubled financial institutions are acquired in transactions in which
      Federal financial assistance is provided. Nonetheless, the conferees understand
      that the Treasury Department may exercise the regulatory authority provided to it
      in this bill to issue regulations or other guidance providing that, in certain
      circumstances, no net tax liability would be payable by financially troubled
      financial institutions as a result of the receipt of Federal financial assistance.

H.R. Rep. No 101-222 (August 4, 1989), at pp. 463-64 [footnotes omitted]. Accordingly,
Congress intended that FFA would be taxable to failed banks, but no net tax liability
would generally result. In instances where inclusion of FFA in a failed bank’s income
resulted in a tax liability, Congress intended that Service would be able to assess and
collect tax even if § 7507 would otherwise apply, and authorized the Service to issue
regulations to determine when assessment would be appropriate. In this regard, the
regulations cited previously under § 301.7507-1 were amended at the same time that
regulations under § 597 were issued. See T.D. 8641, 1996-1 C.B. 103 (final regs.).
Section 1.597-6(a) provides:

      If an Institution . . . is liable for income tax that is attributable to the inclusion in
      income of FFA . . . the tax will not be collected if it will be borne by Agency. The
      final determination of whether the tax would be borne by Agency is within the
      sole discretion of the Commissioner.

The Treasury Department in 1992 proposed the regulations that later became finalized
as Treas. Reg. §§ 1.597-6 and 301.7507-1(b)(4), -9(d). See FI-46-89, 57 Fed. Reg.
14794, 1992-1 C.B. 1037 (proposed regs.). The Notice of Proposed Rulemaking
(“NPRM”) accompanying issuance of the Proposed Regulations explains the
“noncollection policy” eventually finalized in §§ 1.597-6 and 301.7507-1(b), as follows:
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         The proposed amendments to §§ 301.7507-1(b) and 301.7507-9(d) are intended
         to clarify the existing regulations under section 7507 and to reflect the changes
         made by FIRREA that Congress intended to affect section 7507. [Text omitted]

         Section 301.7507-1(b)(4)(iii) is intended to prevent any Institution from avoiding
         the income tax consequences of receipt of FFA.

1992-1 C.B. at 1041.

Thus, the language of § 301.7507-1(b)(4)(iii) must be read to preclude application of §
7507 only in cases where the item of income generating the tax liability is attributable to
FFA. Bank’s income for “litigation recovery” is not FFA income, but merely happens to
arise with respect to a taxpayer that also received FFA. Even if the tax in issue arose
from FFA income, the Service would be required under § 1.597-6 to determine whether
the tax would be borne by Agency before collecting the tax. Therefore, we conclude that
Bank (through Agency acting as Bank’s fiduciary) can raise § 7507 to the extent that
collection of tax would diminish assets necessary for paying Bank’s depositors.


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