Money Services Business Not a Bank; Tax Write Off of Bad Securities Denied.

(Parker Tax Publishing January 28, 2015)

A money services business was not permitted to write off worthless asset-backed securities and incurred long-term capital gains after the Tax Court ruled the business failed to qualify as a "bank" under Code Sec. 581, and therefore was not entitled to deduct such securities as bad debts against ordinary income. MoneyGram Int'l, Inc. v. Comm'r, 144 T.C. No. 1 (2015).

Background

MoneyGram International Inc., (MoneyGram) is a global payment services company that provides consumers and financial institutions with payment services. The services provided by MoneyGram involve the movement of money through money transfers, payment processing services, and money orders. MoneyGram is registered with the Department of the Treasury as a "money services business," which includes money transmitters, check cashing services, issuers and sellers of money orders, and issuers and sellers of travelers checks.

Prior to the 2008 financial crash, MoneyGram held a large amount of high-value asset-backed securities. Due to the precipitous decline in value of these securities, MoneyGram fell out of compliance with state law requirements regarding "permissible assets" and minimum net worth and consequently undertook a recapitalization to satisfy State regulators' demands. The recapitalization included writing down or writing off a substantial volume of partially or wholly worthless asset-backed securities

The IRS challenged MoneyGram's treatment of the asset-backed securities as incurring ordinary losses, not capital losses, and sent a notice of deficiency disallowing the claimed deductions. MoneyGram then petitioned the Tax Court, claiming it was entitled to deductions because it met the definition of a "bank" under Code Sec. 581.

Analysis

Generally, a loss is allowed as a deduction for the tax year in which the loss is sustained (Code Sec. 165(a)). If a security that is a capital asset becomes worthless during the tax year, the resulting loss is treated as a capital loss (Code Sec. 165(g)(1)). Additionally, debts that becomes wholly worthless or recoverable only in part during the taxable year ("bad debts"), are deductible (Code Secs. 166(a)(1) and (2)). Debts that are evidenced by a security as defined in Code Sec. 165(g)(2)(C), such as asset-backed securities, are excluded from the relief provided by the bad debts deduction (Code Sec. 166(e)).

However, banks are entitled to an exception under Code Sec. 582(a), and are permitted to deduct bad debts even when the debts are evidenced by a security. To qualify as a "bank" under this exception, the institution must:

(1) be a bank or trust company incorporated and doing business under Federal or State law,

(2), a substantial part of the institution's business must consist of receiving deposits and making loans and discounts, and

(3), the institution must be subject to supervision and examination by authorities having supervision over banking institutions under Federal or State law (Code Sec. 581).

The Tax Court held that MoneyGram did not qualify as a bank within the meaning of Code Sec. 581 because it lacked the essential characteristics of a bank and a substantial part of its business did not consist of receiving bank deposits or making bank loans. Consequently, the court concluded MoneyGram was ineligible to claim ordinary loss deductions on account of the partial or complete worthlessness of its asset-backed securities under Code Sec. 582 during the years in question.

MoneyGram first argued the initial requirement of Code Sec. 581 that the institution possesses the essential characteristics of a bank didn't exist and instead argued Code Sec. 581 only requires that an institution accept deposits, make loans, and be regulated by a banking authority in order to be considered a "bank." The court dismissed this argument, noting that, as a matter of statutory construction, such an argument would render the principal clause of the first sentence of Code Sec. 581 meaningless. In determining whether MoneyGram possessed the essential characteristics of a bank under this requirement, the court relied heavily on Staunton Indus. Loan Corp. v. Comm'r, 120 F.2d 930 (4th Cir. 1941). Staunton held an entity can be a "bank" for Federal tax purposes, even though it is not chartered as a bank under State law, where the entity manifests three basic features: (1) the receipt of deposits from the general public, repayable to the depositors on demand or at a fixed time; (2) the use of deposit funds for secured loans; and (3) the relationship of debtor and creditor between the bank and depositor.

The court ruled that MoneyGram failed to meet "the bare requisites" enumerated in Staunton for status as a bank; based on its operations and characteristics MoneyGram was not a bank, nor was it regulated as a bank, and therefore MoneyGram was not a "bank" for purposes of Code Sec. 582. The court concluded MoneyGram also failed the second requirement of Code Sec. 581: that a substantial part of the institution's business must consist of receiving deposits and making loans and discounts. The court determined that MoneyGram did not receive "deposits" because MoneyGram's accounts were short-term holding tanks for funds in transit and further concluded that MoneyGram's accounts receivable did not constitute "loans."

MoneyGram also put forth a policy argument, claiming Code Sec. 582 recognizes that certain institutions hold securities because of government regulations and as part of their ordinary course of doing business. Because MoneyGram was required to hold these securities and incurred losses in the ordinary course of its business, it argued ordinary loss deductions should follow. However, the court disagreed and relied upon legislative history to conclude that Congress acted deliberately in limiting the benefits of section 582 to "banks" as opposed to other financial institutions and that Congress never intended an institution such as MoneyGram to qualify as a "bank" within the meaning of Code Sec. 581.

For a discussion on bad debt deductions, see Parker Tax ¶98,400. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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