## Facts

- Frontier Savings Association and its subsidiaries filed consolidated federal corporate income tax returns for 1977–1979.
- Frontier was a mutual savings and loan association and a member-stockholder of the Federal Home Loan Bank of Chicago (Chicago Bank).
- Federal law required member institutions to maintain minimum Chicago Bank stock ownership levels tied to mortgage loans and borrowings; required holdings were computed annually.
- In 1978 and 1979, the Chicago Bank paid annual dividends to members in the form of its own common stock rather than cash.
- Under the Chicago Bank’s practices, members could request redemption of common stock they held in excess of required levels; historically, the Chicago Bank honored redemption requests.
- The Chicago Bank’s governing provisions left redemption decisions to the Bank’s discretion; it had no legal obligation to redeem upon request and could deny redemption consistent with regulatory and business constraints.
- Frontier received common stock dividends in 1978 and 1979, had no shares redeemed in those years, and did not report the stock dividends as taxable income.
- The Commissioner issued notices of deficiency for 1977–1979, asserting (as the remaining dispute) that the 1978–1979 stock dividends were taxable.

## Issues

1. Whether the 1978–1979 Chicago Bank stock dividends were taxable under IRC § 305(b)(1) because shareholders effectively could elect cash through redemption requests.
2. Whether IRC § 305(a)’s general nonrecognition rule for stock dividends applied because shareholders lacked a legally enforceable right to receive cash or other property in lieu of stock.

## Decision

- The Tax Court held for Frontier on the remaining issue.
- The court found no “election” within the meaning of IRC § 305(b)(1) because the Chicago Bank retained discretion over redemptions and shareholders had no enforceable right to cash.
- The stock dividends received in 1978 and 1979 were treated as nontaxable stock distributions under IRC § 305(a).
- The Tax Court’s decision was affirmed on appeal.

## Legal Principles

- IRC § 305(a) generally excludes from income a corporation’s distribution of its own stock to shareholders with respect to their stock.
- IRC § 305(b)(1) makes a stock distribution taxable when shareholders have an election to receive stock or property (including cash).
- An “election” under § 305(b)(1) requires a legally enforceable shareholder right to choose cash (or other property) instead of stock; a consistent redemption practice, without a legal obligation to redeem, is insufficient.
- Where the issuer retains discretion to redeem and may deny redemption due to regulatory or business constraints, shareholders do not possess the requisite election for § 305(b)(1).

## Conclusion

The Tax Court concluded that Federal Home Loan Bank stock dividends were not taxable to a member institution under IRC § 305(b)(1) when shareholders could not compel cash redemption as a matter of legal right, so IRC § 305(a) governed and the stock dividends produced no taxable income.


Frontier Sav. Ass’n & Subs. v. Comm’r, 87 T.C. 665 (1986)