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Updates

Vainisi Reply Brief Filed in TEFRA Appeal

2/3/2010 On Tuesday, February 2, the Appellants in the TEFRA disallowance appeal, Jerome R. Vainisi, et al. v. Commissioner of Internal Revenue, filed their reply brief with the Seventh Circuit Court of Appeals. Reiterating their argument that Section 291 of the Internal Revenue Code applies to Subchapter S financial institutions only for the first three years after they elect Subchapter S, the Appellants refuted each of the arguments offered by the IRS in its January brief.   The Appellants appropriately clarify that Section 1363(b)(4) is an exception to the general rule that S corporations compute taxable income in the same manner as individuals. It is this exemption, argue the Vainisi Appellants, that causes the TEFRA disallowance to apply at all to Sub S banks and QSubs; absent Section 1363(b)(4) the TEFRA disallowance would apply only to C corporations.   The Vainisi Appellants also note that the Treasury Department has yet to finalize the regulation it proposed back in August of 2006, suggesting that its hesitation may be due in part to the numerous comments it received opposing Treasuryâ€�"�s position. The Association proudly voiced its opposition to the proposed regulation at that time and again thanks all of those Sub S bankers who did so as well.   Oral arguments are scheduled for February 23 at 10:00 a.m. CST. This suggests that a final decision may be forthcoming in late summer.   To view the brief in full, please click here.   The Subchapter S Bank Association once again would like to thank all of our members, associate members, as well as the Community Bankers Associations of Iowa, Illinois and Wisconsin, the Council of Community Banking Associations, The Independent Community Bankers of America, the Independent Bankers Association of Texas and the Wisconsin Bankers Association for supporting the Sub S TEFRA Defense Fund.

IRS Files Brief in TEFRA Appeal

1/14/2010 Shortly after the dawn of the New Year, the Internal Revenue Service (IRS) filed its brief in the TEFRA disallowance appeal, Jerome R. Vainisi, et al. v. Commissioner of Internal Revenue. As anticipated, the IRS raised no new issues before the Seventh Circuit Court of Appeals, relying instead on the same points they argued in the original case before the U.S. Tax Court. The IRS's brief argues that Sections 291(a)(3) and (e)(1)(B) of the Internal Revenue Code (IRC) "which requires the disallowance of 20% of banks' deductions for interest expense attributable to qualified tax-exempt obligations (QTEOs)" apply to all banks regardless of whether they are organized as a C corporation, S corporation or a qualified Subchapter S subsidiary (QSub). The IRS relies on provisions in Section 1361(b)(3) of the IRC and on Treasury Regulation § 1.1361-4(a)(3) which provide that a QSub must apply certain "special bank rules" before the QSub's items of income and deductions are merged with those of its parent corporation. In making this argument however, the IRS dismisses the fact that Section 1363(b)(4) of the IRC clearly states that Section 291 of the IRC applies to an S corporation only for the first three years after it converts from a C corporation. The language of 1363(b)(4), the IRS argues, does not extend to QSub banks because it does not expressly reference QSubs or banks, only S corporations. The Tax Court applied this same logic in reaching its decision, suggesting that the 20% disallowance of Section 291 may apply differently to a QSub bank than it would to a stand-alone S corporation bank. The Vanisi appellants', in their opening brief, argued that in fact there are no bank rules whatsoever that apply only to QSub banks and not to S corporation banks and thus, the Tax Court's ruling must have been incorrect. The IRS attempts to negate this very basic premise, but ultimately fails to reconcile how Section 291 "purportedly a "special bank rule" and thus applicable to all banks "can apply to QSub banks and S corporation banks in the same manner as it does to C corporation banks despite plain language in Section 1363(b)(4) that clearly states the contrary. The next step is for the Vainisi appellants to file their reply brief, which will be due within 14 days of the filing date of the IRS's brief. From there, oral arguments will be heard, which will then be followed by the Court's decision. We anticipate it will be late spring or early summer before the Court's decision is rendered. To view the brief in full, please click here: http://www.subsbanks.org/documents/brief%20of%20the%20appellee.pdf

Appeal Brief Filed in TEFRA Disallowance Case

10/30/2009 The appelants' opening brief has been filed in Jerome R. Vainisi , et al. v. Commissioner of Internal Revenue, the landmark case regarding the TEFRA Disallowance for S corporation financial institutions. The brief, drafted by Debra Koenig of the Milwaukee-based law firm Godfrey & Kahn, SP, is the first step in efforts to overturn the US Tax Court's decision that that banks owned by S corporations must apply the TEFRA disallowance (thereby reducing interest expense deductions) in all tax years (rather than just the first three years). The Subchapter S Bank Association, in partnership with the Community Bankers Associations of Iowa, Illinois and Wisconsin, the Council of Community Banking Associations, The Independent Community Bankers of America, Independent Bankers Association of Texas and the Wisconsin Bankers Association, has led the efforts in raising funds for the appeal. To view the full text of the brief submitted to the 7th Circuit Court of Appeals, please click here. If you are interested in supporting the Subchapter S Bank Association in the appeal of the case, please click here to download a contribution form.

Overview
On January 15, 2009, the United States Tax Court ruled in favor of the IRS in Vainisi v. Commissioner of Internal Revenue Service, the landmark case regarding the TEFRA disallowance.  According to the judge's ruling, Section 291 of the Code which would limit the 20% TEFRA disallowance to three years for S corporations does not apply to qualified Subchapter S subsidiary banks because the term "qualified Subchapter S subsidiary" is not specifically mentioned in Section 291.  The effect of this decision is that banks owned by S corporations must apply the TEFRA disallowance (thereby reducing interest expense deductions) in all tax years (rather than just the first three years). 

If the Tax Court's decision is not appealed, Subchapter S bank shareholders will lose out on tens of millions of dollars in tax deductions each year. 

This appeal will most likely be the final opportunity for the Sub S bank community to challenge the IRS's position on the TEFRA disallowance, as future petitioners would first have to go through an expensive Tax Court appeal to arrive at the point at which the Vainisi petitioners are today.  Fortunately, it is also our best opportunity to get the Tax Court's ruling reversed. The appeal will be heard in the Seventh Circuit Court of Appeals in Chicago, Illinois which, unlike the Tax Court, does not merely hear tax matters.  If Sub S banks are to prevail on this issue, we must make the most of this opportunity.