Originally published on Forbes.com.

The first regular Tax Court decision of the year Moneygram International, Inc. & Subsidiaries v. Commissioner has not attracted much attention. The case has some big dollars and perhaps a breath of scandal.  The issue – whether you are a bank or not – is one that few of us will ever have to deal with, but one of the key points raised by the Tax Court – the choice of NAICS code by the return preparer cropped up earlier this year in a real estate professional case, one of the most litigated issues in the Tax Court and one applicable to many ordinary mortals.

The Issue

Moneygram is in the business of providing cash transfer services.  In 2007 it was the largest issuer of money orders in the United States. I haven’t been able to figure out how much in payments they process but they are getting close to a billion and half in fee revenue and had over three billion in float as of December 31, 2013 according to the 10-K.  So is $80 million or so in tax deficiencies for the years 2005 through 2009 that big a deal?  Possibly.  Net after tax income for 2013 was just over $50 million.

The decision did not determine the entire deficiency, but apparently it is a pretty good chunk of it, even though you can’t tell the exact amount from the decision.

In large part, these deficiencies stem from the disallowance of bad debt deductions that petitioner claimed for 2007 and 2008 under section 166(a) with respect to “non-real-estate mortgage investment conduit” (non-REMIC) asset-backed securities.1 Normally, losses realized upon the worthlessness of such securities are deductible as capital losses under section 165(g)(1) and (2)(C). Under section 582(a), however, petitioner was entitled to bad debt deductions on account of these losses–deductible in full against ordinary income–if it qualified as a “bank” within the meaning of section 581. The parties have filed cross- motions for partial summary judgment on this question.

It turns out that handling all that money is not enough to make your company a bank.

In addition to fees Moneygram makes money on the float.  Remember those commercials where Karl Malden would tell you to save your American Express traveler’s checks for your next trip instead of cashing them in.  Same idea.  It is not that large a part of their earnings nowadays, since money has stopped earning interest.  Anyway, for a while they were big into mortgage based securities.  That did not work out so well.

At the beginning of 2007 MoneyGram held asset-backed securities valued at approximately $4.2 billion. During 2007 and 2008, global financial markets experienced turmoil. In response, ratings agencies undertook reviews of asset-backed securities, especially mortgage-backed securities. Many of these securities, formerly rated A or higher, were suddenly downgraded to “junk bond” status. These securities lost much of their value.

Because its asset-backed securities were no longer rated A or higher and had declined precipitously in value, MoneyGram by yearend 2007 had fallen out of compliance with State law requirements concerning “permissible assets” and minimum net worth. To satisfy State regulators’ demands and ensure sufficient operational liquidity, MoneyGram undertook a recapitalization that included writing down or writing off a substantial volume of partially or wholly worthless asset-backed securities. Upon completion of this recapitalization in March 2008, MoneyGram brought itself back into compliance with State regulatory demands.

The Decision

Moneygram ended up with a loss of over half a billions dollars.  Even though C corporations don’t get a favorable rate on capital gains, they are still limited in their ability to take capital losses, much as individuals are.  Whether Moneygram’s loss was capital or ordinary depended on whether or not it is bank.  Moneygram, of course argued that it was a bank and the IRS argued that it was not.  It turns out that it is not a bank, because —-  Well, because the Tax Court says it is not, but of course there are reasons.

MoneyGram does not meet “the bare requisites” for bank status enumerated in Staunton. 120 F.2d at 934. The amounts that MoneyGram seeks to characterize as “deposits” consist of funds, held by MoneyGram for temporary investment, that are remitted by its money order agents and its 1,900 financial institution customers. These agents and institutions are connected with MoneyGram by preexisting contractual relationships; members of the public who lack these business connections with MoneyGram cannot make the types of payments it seeks to characterize as “deposits.” For this reason, MoneyGram would not appear to “recei *** deposits from the general public.”

MoneyGram does not possess the essential characteristics of a “bank” as that term is commonly understood, and it does not have as a substantial part of its business “receiving deposits” or “making loans.” MoneyGram is not regulated as a bank or regarded as a bank by any Federal or State bank regulator. MoneyGram is a “money services business.” As a consequence of the services it provides, it holds amounts due from its agents as accounts receivable, and it places in temporary investments the funds corresponding to its payment service obligations. Innumerable MSBs and other financial institutions act similarly, but this does not make them “banks.”

So that is that, but there is more.

That Darn NAICS Code

A question on tax returns that generally gets little thought is the Business Activity Code.  The general practice seems to be that some thought is given to it on the initial return and then it is copied over from year to year.  That appears to be what happened with Moneygram’s return

For 2005-2007 MoneyGram filed with the IRS annually Form 1120, U.S. Corporation Income Tax Return. On these returns MoneyGram classified its business as “nondepository credit intermediation” (business activity code 522298). Activities within “nondepository credit intermedia tion” include money transmitting, check clearing, and loan brokering. On none of these returns did MoneyGram classify its business as “depository credit intermediation” (business activity codes 522110, 522120, 522130, and 522190). Activities within “depository credit intermediation” include the activities of commercial banks, savings institutions, credit unions, and other financial institutions that accept deposits.

Given the high stakes and the amount of planning that must have went into crafting this position, you would think that somebody might have alerted the preparer, who may well have been a first year associate or a bright person in India to take a look at that question and make it consistent with the notion that Moneygram is a bank.

Maybe nobody else pays attention, but clearly the Tax Court does.  It came up in real estate tax professional case last year.  If nothing else this case is a wake-up call to preparers to pay attention to the Business Activity Code and make sure it is consistent with positions taken on the return.

A Whiff Of Scandal Or The Irrelevance Of Tax Disclosures?

One of the most arcane areas of generally accepted accounting principles (GAAP) is the provision for income taxes and the disclosures surrounding it.  The stakes in this case were quite material to Moneygram, the deficiency could exceed an entire years net income after taxes. The company already has a stockholders deficit of $77 million (i.e. liabilities exceeding assets).  The deficiency is about a dollar a share.  The litigation is, as you would expect, disclosed in the notes to its financial statements.

The Internal Revenue Service, or the IRS, has issued Notices of Deficiency for 2005-2007 and 2009, and has also issued an Examination Report for 2008. The Company is contesting the adjustments in the Notices of Deficiency, which are related to deductions taken on securities losses. The IRS issued Notices of Deficiency disallowing among other items approximately $900.0 million of deductions on securities losses in the 2007, 2008 and 2009 tax returns. As of December 31, 2013 , the Company had recognized a benefit of approximately $139.9 million relating to these deductions. If our petitions contesting the Notices of Deficiency are denied, the Company would be required to make cash payments of approximately $60.7 million , based on benefits taken and taxable income earned through December 31, 2013 . An unfavorable outcome in these audits or other tax reviews or audits could result in higher tax expense, including interest and penalties, which could adversely affect our results of operations and cash flows. We establish reserves for material known tax exposures; however, there can be no assurance that an actual taxation event would not exceed our reserves.

It appears that there are pretty substantial reserves, so the unfavorable resolution of the case will not result in a large first quarter earnings hit.  Still you would think that the unfavorable resolution represents the loss of a gain contingency (reserves would be reversed on a favorable outcome) that would be factored into the stock price.  This is where the whiff of scandal comes in.

Moneygram has been trading at around $8.00 per share and the release of this decision did not seem to create a ripple.  On the other hand there was a big drop in price around Halloween.  Frankly, as a stock analyst, I make a good tax preparer, so there may be nothing to it, but I have to wonder.  Prior to the decision being issued in January there is not public activity on the case after an August stipulation by Moneygram.  It seems like the Tax Court decision should have affected the share price and the idea that the effect was in advance of the decision’s release is a little disturbing.  As it turns out, I found commentary to the effect that the drop was all about revenue projections.  That is somewhat demoralizing. It seems that CPAs do all that work on the tax provisions and nobody cares.

Other Coverage

Lew Taishoff posted  on the case in a piece titled Don’t Bank on It.  As the title indicates, he focused on the bank definition issue.

So a bank is like pornography. Echoing Justice Potter Stewart’s celebrated remark, we know it when we see it.

Tim Todd’s Tax Litigation Survey  had a similar focus.

What Is Coming?

I try to post every business day morning, but, of late, I find myself missing a day here and there.  I have been spending a lot of time on the Kent Hovind case, which appears to be poised to break out of the tax ghetto as Doctor Dino’s trial approaches and the supporters of Hovindication make a lot of noise and shine a lot of light.  And now tax season looms.  The point is that I have fallen behind in my review of cases and probably won’t catch up for a while.  Generally I will only write about a case that is more than a couple of weeks old if I think I have something unique to offer or it is a topic that I feel a special commitment to like like-kind exchanges or real estate professionals.  So I ask my readers patience if I am a little behind the curve for the next couple of months.