Loan purchase commitment fees upheld as option premiums.

• Author: Gottschalk, Stefan

A recent taxpayer victory in Tax Court is the latest development in a long series of tax authorities addressing amounts paid in connection with credit and loan market transactions. In this case, the taxpayer treated loan purchase commitment fees it received as option premiums; see Federal Home Loan Mortgage Corp. (Freddie Mac), 125 TC No. 12 (2005).The taxpayer successfully argued that receipt of the fees did not trigger their inclusion in gross income.

Commitment Fees

In Freddie Mac, the question was whether the taxpayer properly treated certain payments it received from mortgage sellers. A mortgage originator could either commit to selling a mortgage to Freddie Mac at a specific price and pay a small application fee, or obtain pre-approval for a later purchase of a mortgage at a variable price (along with a degree of interest-rate risk protection) and pay a larger "commitment fee."

The commitment fee included both refundable and nonrefundable portions. Only the latter was at issue in the case. During the years in question (1985-1990), approximately 99% of the mortgage originators paying the commitment fee consummated a sale transaction by delivering a mortgage loan to Freddie Mac. Only approximately 1% failed to deliver a mortgage loan and forfeited the fee's refundable portion.

Fee Income vs. Option Premium

The IRS argued that the nonrefundable portion of the commitment fees should have been included in Freddie Mac's income in the year of receipt, because the taxpayer had met the Sec. 451 "all events" test during that year. This is the rule for accrual-method taxpayers; they generally must include amounts in gross income when "all the events have occurred which fix the right to receive" income, and the amount "can be determined with reasonable accuracy"; see, e.g., Charles Schwab Corp., 161 F3d 1231 (9th Cir. 1998), aff'g 107 TC 282 (1996), cert. den.

Freddie Mac countered that a mortgage originator received an option to sell a mortgage to it in return for the commitment fee; thus, the fee was an option premium. Option premiums are generally not taxable on receipt. Instead, according to Rev. Rul. 58-234, they are tax-deferred until they either are exercised or lapse; see also Old Harbor Native Corp., 104 TC 191 (1995) and Rev. Rul. 78-182.When a taxpayer writes (grants) a put option (an option the holder may exercise, requiring the option writer to purchase something), either (1) the option is exercised, with the option premium being...