U.S. Supreme Court Cheek v. United States, 498
U.S. 192 (1991) Cheek v. United
States No. 89-658 Argued Oct. 3, 1990 Decided Jan. 8, 1991 498
U.S. 192 CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE SEVENTH CIRCUIT Syllabus Petitioner Cheek was charged with six counts of willfully
failing to file a federal income tax return in violation of § 7203
of the Internal Revenue Code (Code) and three counts of willfully
attempting to evade his income taxes in violation of § 7201.
Although admitting that he had not filed his returns, he testified
that he had not acted willfully because he sincerely believed,
based on his indoctrination by a group believing that the federal
tax system is unconstitutional and his own study, that the tax laws
were being unconstitutionally enforced and that his actions were
lawful. In instructing the jury, the court stated that an honest
but unreasonable belief is not a defense, and does not negate
willfulness, and that Cheek's beliefs that wages are not income and
that he was not a taxpayer within the meaning of the Code were not
objectively reasonable. It also instructed the jury that a person's
opinion that the tax laws violate his constitutional rights does
not constitute a good-faith misunderstanding of the law. Cheek was
convicted, and the Court of Appeals affirmed. Held: 1. A good-faith misunderstanding of the law or a good-faith
belief that one is not violating the law negates willfulness,
whether or not the claimed belief or misunderstanding is
objectively reasonable. Statutory willfulness, which protects the
average citizen from prosecution for innocent mistakes made due to
the complexity of the tax laws, United States v. Murdock, 290 U. S. 389 , is
the voluntary, intentional violation of a known legal duty. United States v. Pomponio, 429 U. S.
10 . Thus, if the jury credited Cheek's assertion that he
truly believed that the Code did not treat wages as income, the
Government would not have carried its burden to prove willfulness,
however unreasonable a court might deem such a belief.
Characterizing a belief as objectively unreasonable transforms what
is normally a factual inquiry into a legal one, thus preventing a
jury from considering it. And forbidding a jury to consider
evidence that might negate willfulness would raise a serious
question under the Sixth Amendment's jury trial provision, which
this interpretation of the statute avoids. Of course, in deciding
whether to credit Cheek's claim, the jury is free to consider any
admissible evidence showing that he had knowledge of his legal
duties. Pp. 498 U. S.
199 -204. Page 498 U. S. 193 2. It was proper for the trial court to instruct the jury not to
consider Cheek's claim that the tax laws are unconstitutional,
since a defendant's views about the tax statutes' validity are
irrelevant to the issue of willfulness, and should not be heard by
a jury. Unlike the claims in the Murdock-Pomponio line of
cases, claims that Code provisions are unconstitutional do not
arise from innocent mistakes caused by the Code's complexity.
Rather, they reveal full knowledge of the provisions at issue and a
studied conclusion that those provisions are invalid and
unenforceable. Congress could not have contemplated that a
taxpayer, without risking criminal prosecution, could ignore his
duties under the Code and refuse to utilize the mechanisms Congress
provided to present his invalidity claims to the courts and to
abide by their decisions. Cheek was free to pay the tax, file for a
refund, and, if denied, present his claims to the courts. Also,
without paying the tax, he could have challenged claims of tax
deficiencies in the Tax Court. Pp. 498 U. S.
204 -207.

															882 F.2d 1263, (CA7 1989) vacated and remanded.

															WHITE, J., delivered the opinion of the Court, in which
REHNQUIST, C.J., and STEVENS, O'CONNOR, and KENNEDY, JJ., joined.
SCALIA, J., filed an opinion concurring in the judgment, post, p. 498 U. S. 207 .
BLACKMUN, J., filed a dissenting opinion, in which MARSHALL, J.,
joined, post, p. 498 U. S. 209 .
SOUTER, J., took no part in the consideration or decision of the
case.

															Justice WHITE delivered the opinion of the Court.

															Title 26, § 7201 of the United States Code provides that any
person "who willfully attempts in any manner to evade or defeat any
tax imposed by this title or the payment thereof" shall be guilty
of a felony. Under 26 U.S.C. § 7203,

															"[a]ny person required under this title . . . or by regulations
made under authority thereof to make a return . . . who willfully
fails to . . . make such return"

															shall be guilty of a misdemeanor. Page 498 U. S. 194 This case turns on the meaning of the word "willfully" as used
in §§ 7201 and 7203. I Petitioner John L. Cheek has been a pilot for American Airlines
since 1973. He filed federal income tax returns through 1979, but
thereafter ceased to file returns. [ Footnote 1 ] He also claimed an increasing number of
withholding allowances -- eventually claiming 60 allowances by
mid-1980 -- and for the years 1981 to 1984 indicated on his W-4
forms that he was exempt from federal income taxes. In 1983,
petitioner unsuccessfully sought a refund of all tax withheld by
his employer in 1982. Petitioner's income during this period at all
times far exceeded the minimum necessary to trigger the statutory
filing requirement.

															As a result of his activities, petitioner was indicted for 10
violations of federal law. He was charged with six counts of
willfully failing to file a federal income tax return for the years
1980, 1981, and 1983 through 1986, in violation of 26 U.S.C. §
7203. He was further charged with three counts of willfully
attempting to evade his income taxes for the years 1980, 1981, and
1983 in violation of 26 U.S.C. § 7201. In those years, American
Airlines withheld substantially less than the amount of tax
petitioner owed because of the numerous allowances and exempt
status he claimed on his W-4 forms. [ Footnote 2 ] The tax offenses with which petitioner was
charged are specific intent crimes that require the defendant to
have acted willfully.

															At trial, the evidence established that, between 1982 and 1986,
petitioner was involved in at least four civil cases that Page 498 U. S. 195 challenged various aspects of the federal income tax system.
[ Footnote 3 ] In all four of
those cases, the plaintiffs were informed by the courts that many
of their arguments, including that they were not taxpayers within
the meaning of the tax laws, that wages are not income, that the
Sixteenth Amendment does not authorize the imposition of an income
tax on individuals, and that the Sixteenth Amendment is
unenforceable, were frivolous or had been repeatedly rejected by
the courts. During this time period, petitioner also attended at
least two criminal trials of persons charged with tax offenses. In
addition, there was evidence that, in 1980 or 1981, an attorney had
advised Cheek that the courts had rejected as frivolous the claim
that wages are not income. [ Footnote 4 ]

															Cheek represented himself at trial and testified in his defense.
He admitted that he had not filed personal income tax returns
during the years in question. He testified that, as early as 1978,
he had begun attending seminars sponsored Page 498 U. S. 196 by, and following the advice of, a group that believes, among
other things, that the federal tax system is unconstitutional. Some
of the speakers at these meetings were lawyers who purported to
give professional opinions about the invalidity of the federal
income tax laws. Cheek produced a letter from an attorney stating
that the Sixteenth Amendment did not authorize a tax on wages and
salaries, but only on gain or profit. Petitioner's defense was
that, based on the indoctrination he received from this group and
from his own study, he sincerely believed that the tax laws were
being unconstitutionally enforced and that his actions during the
1980-1986 period were lawful. He therefore argued that he had acted
without the willfulness required for conviction of the various
offenses with which he was charged.

															In the course of its instructions, the trial court advised the
jury that, to prove "willfulness," the Government must prove the
voluntary and intentional violation of a known legal duty, a burden
that could not be proved by showing mistake, ignorance, or
negligence. The court further advised the jury that an objectively
reasonable good-faith misunderstanding of the law would negate
willfulness, but mere disagreement with the law would not. The
court described Cheek's beliefs about the income tax system,
[ Footnote 5 ] and instructed the
jury that, if it found that Cheek "honestly and reasonably believed
that Page 498 U. S. 197 he was not required to pay income taxes or to file tax returns,"
App. 81, a not guilty verdict should be returned.

															After several hours of deliberation, the jury sent a note to the
judge that stated in part:

															"We have a basic disagreement between some of us as to if Mr.
Cheek honestly & reasonably believed that he was not required
to pay income taxes."

															" * * * *" "Page 32 [the relevant jury instruction] discusses good faith
misunderstanding & disagreement. Is there any additional
clarification you can give us on this point?" Id. at 85.

															The District Judge responded with a supplemental instruction
containing the following statements:

															"[A] person's opinion that the tax laws violate his
constitutional rights does not constitute a good Page 498 U. S. 198 faith misunderstanding of the law. Furthermore, a person's
disagreement with the government's tax collection systems and
policies does not constitute a good faith misunderstanding of the
law." Id. at 86.

															At the end of the first day of deliberation, the jury sent out
another note saying that it still could not reach a verdict
because

															"[w]e are divided on the issue as to if Mr. Cheek honestly &
reasonably believed that he was not required to pay income
tax." Id. at 87. When the jury resumed its deliberations, the
District Judge gave the jury an additional instruction. This
instruction stated in part that "[a]n honest but unreasonable
belief is not a defense, and does not negate willfulness," id. at 88, and that

															"[a]dvice or research resulting in the conclusion that wages of
a privately employed person are not income or that the tax laws are
unconstitutional is not objectively reasonable, and cannot serve as
the basis for a good faith misunderstanding of the law
defense." Ibid. The court also instructed the jury that
"[p]ersistent refusal to acknowledge the law does not constitute a
good faith misunderstanding of the law." Ibid. Approximately two hours later, the jury returned a verdict finding
petitioner guilty on all counts. [ Footnote 6 ]

															Petitioner appealed his convictions, arguing that the District
Court erred by instructing the jury that only an objectively
reasonable misunderstanding of the law negates the statutory
willfulness requirement. The United States Court of Appeals for the
Seventh Circuit rejected that contention, and affirmed the
convictions. 882 F.2d 1263 (1989). In prior cases, the Seventh
Circuit had made clear that good-faith misunderstanding of the law
negates willfulness only if the defendant's beliefs are objectively
reasonable; in the Seventh Circuit, even actual ignorance is not a
defense unless the defendant's ignorance was itself objectively
reasonable. See, e.g., United States v. Buckner, 830 F.2d
102 (1987). In its opinion in this case, the court noted that
several specified beliefs, including the beliefs that the tax laws
are unconstitutional and that wages are not income, would not be
objectively reasonable. [ Footnote
7 ] Because the Seventh Circuit's Page 498 U. S. 199 interpretation of "willfully" as used in these statutes
conflicts with the decisions of several other Courts of Appeals, see, e.g., United States v. Whiteside, 810 F.2d 1306,
1310-1311 (CA5 1987); United States v. Phillips, 775 F.2d
262, 263-264 (CA10 1985); United States v. Aitken, 755
F.2d 188, 191-193 (CA1 1985), we granted certiorari, 493 U.S. 1068
(1990). II The general rule that ignorance of the law or a mistake of law
is no defense to criminal prosecution is deeply rooted in the
American legal system. See, e.g., 18 U.
S. Smith, 5 Wheat. 153, 18 U. S. 182 (1820) (Livingston, J., dissenting); Barlow v.
United States , 7 Pet. 404, 32 U. S. 411 (1833); Reynolds v. United States, 98 U. S.
145 , 98 U. S. 167 (1879); Shevlin-Carpenter Co. v. Minnesota, 218 U. S.
57 , 218 U. S. 68 (1910); Lambert v. California, 355 U.
S. 225 , 355 U. S. 228 (1957); Liparota v. United States, 471 U.
S. 419 , 471 U. S. 441 (1985) (WHITE, J., dissenting); O. Holmes, The Common Law 47-48
(1881). Based on the notion that the law is definite and knowable,
the common law presumed that every person knew the law. This common
law rule has been applied by the Court in numerous cases construing
criminal statutes. See, e.g., United States v. International
Minerals & Chemical Corp., 402 U.
S. 558 (1971); Hamling v. United States, 418 U. S. 87 , 418 U. S.
119 -124 (1974); Boyce Motor Lines, Inc. v. United
States, 342 U. S. 337 (1952).

															The proliferation of statutes and regulations has sometimes made
it difficult for the average citizen to know and comprehend Page 498 U. S. 200 the extent of the duties and obligations imposed by the tax
laws. Congress has accordingly softened the impact of the common
law presumption by making specific intent to violate the law an
element of certain federal criminal tax offenses. Thus, the Court
almost 60 years ago interpreted the statutory term "willfully" as
used in the federal criminal tax statutes as carving out an
exception to the traditional rule. This special treatment of
criminal tax offenses is largely due to the complexity of the tax
laws. In United States v. Murdock, 290 U.
S. 389 (1933), the Court recognized that:

															"Congress did not intend that a person, by reason of a bona fide
misunderstanding as to his liability for the tax, as to his duty to
make a return, or as to the adequacy of the records he maintained,
should become a criminal by his mere failure to measure up to the
prescribed standard of conduct." Id. at 290 U. S. 396 .
The Court held that the defendant was entitled to an instruction
with respect to whether he acted in good faith based on his actual
belief. In Murdock, the Court interpreted the term
"willfully" as used in the criminal tax statutes generally to mean
"an act done with a bad purpose," id. at 290 U. S. 394 ,
or with "an evil motive." Id. at 290 U. S.
395 .

															Subsequent decisions have refined this proposition. In United States v. Bishop, 412 U. S. 346 (1973), we described the term "willfully" as connoting "a
voluntary, intentional violation of a known legal duty," id. at 412 U. S. 360 ,
and did so with specific reference to the "bad faith or evil
intent" language employed in Murdock. Still later, United States v. Pomponio, 429 U. S.
10 (1976) (per curiam ), addressed a situation in which
several defendants had been charged with willfully filing false tax
returns. The jury was given an instruction on willfulness similar
to the standard set forth in Bishop. In addition, it was
instructed that " [g]ood motive alone is never a defense where
the act done or omitted is a crime.'" Id. at 429 U. S. 11 .
The defendants were convicted, but the Court of Appeals reversed,
concluding that the latter instruction Page 498 U. S. 201 was improper because the statute required a finding of bad
purpose or evil motive. Ibid. We reversed the Court of Appeals, stating that "the Court of
Appeals incorrectly assumed that the reference to an evil
motive' in United States v. Bishop, supra, and prior
cases," ibid., "requires proof of any motive other than an
intentional violation of a known legal duty." Id. at 429 U. S. 12 .
As "the other Courts of Appeals that have considered the question
have recognized, willfulness in this context simply means a
voluntary, intentional violation of a known legal duty." Ibid. We concluded that, after instructing the jury on
willfulness, "[a]n additional instruction on good faith was
unnecessary." Id. at 429 U. S. 13 .
Taken together, Bishop and Pomponio conclusively
establish that the standard for the statutory willfulness
requirement is the "voluntary, intentional violation of a known
legal duty." III Cheek accepts the Pomponio definition of willfulness,
Brief for Petitioner 5, and n. 4, 13, 36; Reply Brief for
Petitioner 4, 6-7, 11, 13, but asserts that the District Court's
instructions and the Court of Appeals' opinion departed from that
definition. In particular, he challenges the ruling that a
good-faith misunderstanding of the law or a good-faith belief that
one is not violating the law, if it is to negate willfulness, must
be objectively reasonable. We agree that the Court of Appeals and
the District Court erred in this respect. A Willfulness, as construed by our prior decisions in criminal tax
cases, requires the Government to prove that the law imposed a duty
on the defendant, that the defendant knew of this duty, and that he
voluntarily and intentionally violated that duty. We deal first
with the case where the issue is whether the defendant knew of the
duty purportedly imposed by the provision of the statute or
regulation he is accused of violating, a case in which there is no
claim that the provision Page 498 U. S. 202 at issue is invalid. In such a case, if the Government proves
actual knowledge of the pertinent legal duty, the prosecution,
without more, has satisfied the knowledge component of the
willfulness requirement. But carrying this burden requires negating
a defendant's claim of ignorance of the law or a claim that,
because of a misunderstanding of the law, he had a good-faith
belief that he was not violating any of the provisions of the tax
laws. This is so because one cannot be aware that the law imposes a
duty upon him and yet be ignorant of it, misunderstand the law, or
believe that the duty does not exist. In the end, the issue is
whether, based on all the evidence, the Government has proved that
the defendant was aware of the duty at issue, which cannot be true
if the jury credits a good-faith misunderstanding and belief
submission, whether or not the claimed belief or misunderstanding
is objectively reasonable.

															In this case, if Cheek asserted that he truly believed that the
Internal Revenue Code did not purport to treat wages as income, and
the jury believed him, the Government would not have carried its
burden to prove willfulness, however unreasonable a court might
deem such a belief. Of course, in deciding whether to credit
Cheek's good-faith belief claim, the jury would be free to consider
any admissible evidence from any source showing that Cheek was
aware of his duty to file a return and to treat wages as income,
including evidence showing his awareness of the relevant provisions
of the Code or regulations, of court decisions rejecting his
interpretation of the tax law, of authoritative rulings of the
Internal Revenue Service, or of any contents of the personal income
tax return forms and accompanying instructions that made it plain
that wages should be returned as income. [ Footnote 8 ] Page 498 U. S. 203 We thus disagree with the Court of Appeals' requirement that a
claimed good-faith belief must be objectively reasonable if it is
to be considered as possibly negating the Government's evidence
purporting to show a defendant's awareness of the legal duty at
issue. Knowledge and belief are characteristically questions for
the factfinder, in this case the jury. Characterizing a particular
belief as not objectively reasonable transforms the inquiry into a
legal one, and would prevent the jury from considering it. It would
of course be proper to exclude evidence having no relevance or
probative value with respect to willfulness, but it is not contrary
to common sense, let alone impossible, for a defendant to be
ignorant of his duty based on an irrational belief that he has no
duty, and forbidding the jury to consider evidence that might
negate willfulness would raise a serious question under the Sixth
Amendment's jury trial provision. Cf. Francis v. Franklin, 471 U. S. 307 (1985); Sandstrom v. Montana, 442 U.
S. 510 (1979); Morissette v. United States, 342 U. S. 246 (1952). It is common ground that this Court, where possible,
interprets congressional enactments so as to avoid raising serious
constitutional questions. See, e.g., Edward J. DeBartolo Corp.
v. Florida Gulf Coast Building and Construction Trades
Council, 485 U. S. 568 , 485 U. S. 575 (1988); Crowell v. Benson, 285 U. S.
22 , 285 U. S. 62 ,
and n. 30 (1932); Public Citizen v. United States Dept. of
Justice, 491 U. S. 440 , 491 U. S.
465 -466 (1989).

															It was therefore error to instruct the jury to disregard
evidence of Cheek's understanding that, within the meaning of the
tax laws, he was not a person required to file a return or to pay
income taxes and that wages are not taxable income, as incredible
as such misunderstandings of and beliefs about the law might be. Of
course, the more unreasonable the asserted Page 498 U. S. 204 beliefs or misunderstandings are, the more likely the jury will
consider them to be nothing more than simple disagreement with
known legal duties imposed by the tax laws, and will find that the
Government has carried its burden of proving knowledge. B Cheek asserted in the trial court that he should be acquitted
because he believed in good faith that the income tax law is
unconstitutional as applied to him, and thus could not legally
impose any duty upon him of which he should have been aware.
[ Footnote 9 ] Such a submission
is unsound, not because Page 498 U. S. 205 Cheek's constitutional arguments are not objectively reasonable
or frivolous, which they surely are, but because the Murdock-Pomponio line of cases does not support such a
position. Those cases construed the willfulness requirement in the
criminal provisions of the Internal Revenue Code to require proof
of knowledge of the law. This was because in "our complex tax
system, uncertainty often arises even among taxpayers who earnestly
wish to follow the law" and " [i]t is not the purpose of the law
to penalize frank difference of opinion or innocent errors made
despite the exercise of reasonable care.'" United States v.
Bishop, 412 U. S. 346 , 412 U. S.
360 -361 (1973) (quoting Spies v. United States, 317 U. S. 492 , 317 U. S. 496 (1943)). Claims that some of the provisions of the tax code are
unconstitutional are submissions of a different order. [ Footnote 10 ] They do not arise from
innocent mistakes caused by the complexity of the Internal Revenue
Code. Rather, they reveal full knowledge of the provisions at issue
and a studied conclusion, however wrong, that those provisions are
invalid and unenforceable. Page 498 U. S. 206 Thus, in this case, Cheek paid his taxes for years, but after
attending various seminars and based on his own study, he concluded
that the income tax laws could not constitutionally require him to
pay a tax.

															We do not believe that Congress contemplated that such a
taxpayer, without risking criminal prosecution, could ignore the
duties imposed upon him by the Internal Revenue Code and refuse to
utilize the mechanisms provided by Congress to present his claims
of invalidity to the courts and to abide by their decisions. There
is no doubt that Cheek, from year to year, was free to pay the tax
that the law purported to require, file for a refund and, if
denied, present his claims of invalidity, constitutional or
otherwise, to the courts. See 26 U.S.C. § 7422. Also,
without paying the tax, he could have challenged claims of tax
deficiencies in the Tax Court, 26 U.S.C. § 6213, with the right to
appeal to a higher court if unsuccessful. § 7482(a)(1). Cheek took
neither course in some years, and, when he did, was unwilling to
accept the outcome. As we see it, he is in no position to claim
that his good-faith belief about the validity of the Internal
Revenue Code negates willfulness or provides a defense to criminal
prosecution under §§ 7201 and 7203. Of course, Cheek was free in
this very case to present his claims of invalidity and have them
adjudicated, but, like defendants in criminal cases in other
contexts who "willfully" refuse to comply with the duties placed
upon them by the law, he must take the risk of being wrong.

															We thus hold that, in a case like this, a defendant's views
about the validity of the tax statutes are irrelevant to the issue
of willfulness, need not be heard by the jury, and if they are, an
instruction to disregard them would be proper. For this purpose, it
makes no difference whether the claims of invalidity are frivolous
or have substance. It was therefore not error in this case for the
District Judge to instruct the jury not to consider Cheek's claims
that the tax laws were unconstitutional. However, it was error for
the court to instruct Page 498 U. S. 207 the jury that petitioner's asserted beliefs that wages are not
income and that he was not a taxpayer within the meaning of the
Internal Revenue Code should not be considered by the jury in
determining whether Cheek had acted willfully. [ Footnote 11 ] IV For the reasons set forth in the opinion above, the judgment of
the Court of Appeals is vacated, and the case is remanded for
further proceedings consistent with this opinion. It is so ordered. Justice SOUTER took no part in the consideration or decision of
this case.

															[ Footnote 1 ]

															Cheek did file what the Court of Appeals described as a
frivolous return in 1982.

															[ Footnote 2 ]

															Because petitioner filed a refund claim for the entire amount
withheld by his employer in 1982, petitioner was also charged under
18 U.S.C. § 287 with one count of presenting a claim to an agency
of the United States knowing the claim to be false and
fraudulent.

															[ Footnote 3 ]

															In March, 1982, Cheek and another employee of the company sued
American Airlines to challenge the withholding of federal income
taxes. In April, 1982, Cheek sued the IRS in the United States Tax
Court, asserting that he was not a taxpayer or a person for
purposes of the Internal Revenue Code, that his wages were not
income, and making several other related claims. Cheek and four
others also filed an action against the United States and the CIR
in Federal District Court, claiming that withholding taxes from
their wages violated the Sixteenth Amendment. Finally, in 1985,
Cheek filed claims with the IRS seeking to have refunded the taxes
withheld from his wages in 1983 and 1984. When these claims were
not allowed, he brought suit in the District Court claiming that
the withholding was an unconstitutional taking of his property and
that his wages were not income. In dismissing this action as
frivolous, the District Court imposed costs and attorneys fees of
$1,500 and a sanction under Rule 11 in the amount of $10,000. The
Court of Appeals agreed that Cheek's claims were frivolous, reduced
the District Court sanction to $5,000 and imposed an additional
sanction of $1,500 for bringing a frivolous appeal.

															[ Footnote 4 ]

															The attorney also advised that, despite the Fifth Amendment, the
filing of a tax return was required and that a person could
challenge the constitutionality of the system by suing for a refund
after the taxes had been withheld, or by putting himself "at risk
of criminal prosecution."

															[ Footnote 5 ]

															"The defendant has testified as to what he states are his
interpretations of the United States Constitution, court opinions,
common law and other materials he has reviewed. . . . He has also
introduced materials which contain references to quotations from
the United States Constitution, court opinions, statutes, and other
sources."

															"He testified he relied on his interpretations and on these
materials in concluding that he was not a person required to file
income tax returns for the year or years charged, was not required
to pay income taxes, and that he could claim exempt status on his
W-4 forms, and that he could claim refunds of all moneys
withheld."

															App. 75-76.

															"Among other things, Mr. Cheek contends that his wages from a
private employer, American Airlines, does not constitute income
under the Internal Revenue Service laws." Id. at 81.

															[ Footnote 6 ]

															A note signed by all 12 jurors also informed the judge that,
although the jury found petitioner guilty, several jurors wanted to
express their personal opinions of the case, and that notes from
these individual jurors to the court were "a complaint against the
narrow & hard expression under the constraints of the law." Id. at 90. At least two notes from individual jurors
expressed the opinion that petitioner sincerely believed in his
cause, even though his beliefs might have been unreasonable.

															[ Footnote 7 ]

															The opinion stated, 882 F.2d 1263, 1268-1269, n. 2 (CA7 1989),
as follows:

															"For the record, we note that the following beliefs, which are
stock arguments of the tax protester movement, have not been, nor
ever will be, considered 'objectively reasonable' in this
circuit"

															"(1) the belief that the sixteenth amendment to the constitution
was improperly ratified, and therefore never came into being;"

															"(2) the belief that the sixteenth amendment is unconstitutional
generally;"

															"(3) the belief that the income tax violates the takings clause
of the fifth amendment;"

															"(4) the belief that the tax laws are unconstitutional;"

															"(5) the belief that wages are not income, and therefore are not
subject to federal income tax laws;"

															"(6) the belief that filing a tax return violates the privilege
against self-incrimination; and"

															"(7) the belief that Federal Reserve Notes do not constitute
cash or income."

															" Miller v. United States, 868 F.2d 236, 239-41 (7th
Cir.1989); Buckner, 830 F.2d at 102; United States v.
Dube, 820 F.2d 886, 891 (7th Cir.1987); Coleman v.
Comm., 791 F.2d 68, 70-71 (7th Cir.1986); Moore, 627
F.2d at 833. We have no doubt that this list will increase with
time."

															[ Footnote 8 ]

															Cheek recognizes that a "defendant who knows what the law is and
who disagrees with it . . . does not have a bona fide
misunderstanding defense," but asserts that "a defendant who has a
bona fide misunderstanding of [the law] does not know' his
legal duty, and lacks willfulness." Brief for Petitioner 29, and n.
13. The Reply Brief for Petitioner, at 13, states: "We are in no way suggesting that Cheek or anyone else is immune
from criminal prosecution if he knows what the law is, but believes
it should be otherwise, and therefore violates it." See also Tr. of Oral Arg. 9, 11, 12, 15, 17.

															[ Footnote 9 ]

															In his opening and reply briefs and at oral argument, Cheek
asserts that this case does not present the issue of whether a
claim of unconstitutionality would serve to negate willfulness, and
that we need not address the issue. Brief for Petitioner 13; Reply
Brief for Petitioner 5, 11, 12; Tr. of Oral Arg. 6, 13. Cheek
testified at trial, however, that "[i]t is my belief that the law
is being enforced unconstitutionally." App. 60. He also produced a
letter from counsel advising him that

															"Finally you make a valid contention . . . that Congress' power
to tax comes from Article I, Section 8, Clause I of the U.S.
Constitution, and not from the Sixteenth Amendment, and that the
[latter], construed with Article I, Section 2, Clause 3, never
authorized a tax on wages and salaries, but only on gain and
profit." Id. at 57. We note also that the jury asked for "the
portion [of the transcript] wherein Mr. Cheek stated he was
attempting to test the constitutionality of the income tax laws,"
Tr. 1704, and that the trial judge later instructed the jury that
an opinion that the tax laws violate a person's constitutional
rights does not constitute a good faith misunderstanding of the
law. We also note that, at oral argument, Cheek's counsel observed
that "personal belief that a known statute is unconstitutional
smacks of knowledge with existing law, but disagreement with it."
Tr. of Oral Arg. 5. He also opined that:

															"If the person believes as a personal belief that known -- law
known to them [ sic ] is unconstitutional, I submit that
that would not be a defense, because what the person is really
saying is I know what the law is, for constitutional reasons I have
made my own determination that it is invalid. I am not suggesting
that that is a defense."

															"However, if the person was told by a lawyer or by an accountant
erroneously that the statute is unconstitutional, and it's my
professional advice to you that you don't have to follow it, then
you have got a little different situation. This is not that
case." Id. at 6.

															Given this posture of the case, we perceive no reason not to
address the significance of Cheek's constitutional claims to the
issue of willfulness.

															[ Footnote 10 ]

															In United States v. Murdock, 290 U.
S. 389 (1933), discussed supra, at 498 U. S. 200 ,
the defendant Murdock was summoned to appear before a revenue agent
for examination. Questions were put to him, which he refused to
answer for fear of self-incrimination under state law. He was
indicted for refusing to give testimony and supply information
contrary to the pertinent provisions of the Internal Revenue Code.
This Court affirmed the reversal of Murdock's conviction, holding
that the trial court erred in refusing to give an instruction
directing the jury to consider Murdock's asserted claim of a
good-faith, actual belief that, because of the Fifth Amendment, he
was privileged not to answer the questions put to him. It is thus
the case that Murdock's asserted belief was grounded in the
Constitution, but it was a claim of privilege not to answer, not a
claim that any provision of the tax laws were unconstitutional, and
not a claim for which the tax laws provided procedures to entertain
and resolve. Cheek's position at trial, in contrast, was that the
tax laws were unconstitutional as applied to him.

															[ Footnote 11 ]

															Cheek argues that applying to him the Court of Appeals' standard
of objective reasonableness violates his rights under the First,
Fifth, and Sixth Amendments of the Constitution. Since we have
invalidated the challenged standard on statutory grounds, we need
not address these submissions.

															Justice SCALIA, concurring in the judgment.

															I concur in the judgment of Court because our cases have
consistently held that the failure to pay a tax in the good-faith
belief that it is not legally owing is not "willful." I do not join
the Court's opinion because I do not agree with the test for
willfulness that it directs the Court of Appeals to apply on
remand.

															As the Court acknowledges, our opinions from the 1930s to the
1970s have interpreted the word "willfully" in the criminal tax
statutes as requiring the "bad purpose" or "evil motive" of
"intentional[ly] violat[ing] a known legal duty." See, e.g.,
United States v. Pomponio, 429 U. S. 10 , 429 U. S. 12 (1976); United States v. Murdock, 290 U.
S. 389 , 290 U. S.
394 -395 (1933). It seems to me that today's opinion
squarely reverses that long-established statutory construction when
it says that a good-faith erroneous belief in the
unconstitutionality of a tax law is no defense. It is quite
impossible to say that a statute which Page 498 U. S. 208 one believes unconstitutional represents a "known legal duty." See Marbury v.
Madison , 1 Cranch 137, 91 Cranch 177177-178
(1803).

															Although the facts of the present case involve erroneous
reliance upon the Constitution in ignoring the otherwise "known
legal duty" imposed by the tax statutes, the Court's new
interpretation applies also to erroneous reliance upon a tax
statute in ignoring the otherwise "known legal duty" of a
regulation, and to erroneous reliance upon a regulation in ignoring
the otherwise "known legal duty" of a tax assessment. These
situations as well meet the opinion's crucial test of

															"reveal[ing] full knowledge of the provisions at issue and a
studied conclusion, however wrong, that those provisions are
invalid and unenforceable," ante at 498 U. S.
205 -206. There is, moreover, no rational basis for
saying that a "willful" violation is established by full knowledge
of a statutory requirement, but is not established by full
knowledge of a requirement explicitly imposed by regulation or
order. Thus, today's opinion works a revolution in past practice,
subjecting to criminal penalties taxpayers who do not comply with
Treasury Regulations that are in their view contrary to the
Internal Revenue Code, Treasury Rulings that are in their view
contrary to the regulations, and even IRS auditor pronouncements
that are in their view contrary to Treasury Rulings. The law
already provides considerable incentive for taxpayers to be careful
in ignoring any official assertion of tax liability, since it
contains civil penalties that apply even in the event of a
good-faith mistake, see, e.g., 26 U.S.C. §§ 6651, 6653. To
impose in addition criminal penalties for misinterpretation of such
a complex body of law is a startling innovation indeed.

															I find it impossible to understand how one can derive from the
lonesome word "willfully" the proposition that belief in the
nonexistence of a textual prohibition excuses liability, but belief
in the invalidity ( i.e., the legal nonexistence) of a
textual prohibition does not. One may say, as the law does Page 498 U. S. 209 in many contexts, that "willfully" refers to consciousness of
the act, but not to consciousness that the act is unlawful. See, e.g., American Surety Co. of New York v. Sullivan, 7
F.2d 605, 606 (CA2 1925) (L. Hand, J.); cf. United States v.
International Minerals and Chemical Co., 402 U.
S. 558 , 402 U. S.
563 -565 (1971). Or alternatively, one may say, as we
have said until today with respect to the tax statutes, that
"willfully" refers to consciousness of both the act and its
illegality. But it seems to me impossible to say that the word
refers to consciousness that some legal text exists, without
consciousness that that legal text is binding, i.e., with
the good-faith belief that it is not a valid law. Perhaps such a
test for criminal liability would make sense (though in a field as
complicated as federal tax law, I doubt it), but some text other
than the mere word "willfully" would have to be employed to
describe it -- and that text is not ours to write.

															Because today's opinion abandons clear and long-standing
precedent to impose criminal liability where taxpayers have had no
reason to expect it, because the new contours of criminal liability
have no basis in the statutory text, and because I strongly suspect
that those new contours make no sense even as a policy matter, I
concur only in the judgment of the Court.

															Justice BLACKMUN, with whom Justice MARSHALL joins,
dissenting.

															It seems to me that we are concerned in this case not with "the
complexity of the tax laws," ante at 498 U. S. 200 ,
but with the income tax law in its most elementary and basic
aspect: Is a wage earner a taxpayer and are wages income?

															The Court acknowledges that the conclusively established
standard for willfulness under the applicable statutes is the
"voluntary, intentional violation of a known legal duty." Ante at 498 U. S. 201 . See United States v. Bishop, 412 U.
S. 346 , 412 U. S. 360 (1963), and United States v. Pomponio, 429 U. S.
10 , 429 U. S. 12 (1976). That being so, it is incomprehensible to me how, in this
day, more than 70 years after the institution of our Page 498 U. S. 210 present federal income tax system with the passage of the
Revenue Act of 1913, 38 Stat. 166, any taxpayer of competent
mentality can assert as his defense to charges of statutory
willfulness the proposition that the wage he receives for his labor
is not income, irrespective of a cult that says otherwise and
advises the gullible to resist income tax collections. One might
note in passing that this particular taxpayer, after all, was a
licensed pilot for one of our major commercial airlines; he
presumably was a person of at least minimum intellectual
competence.

															The District Court's instruction that an objectively reasonable
and good-faith misunderstanding of the law negates willfulness
lends further, rather than less, protection to this defendant, for
it added an additional hurdle for the prosecution to overcome.
Petitioner should be grateful for this further protection, rather
than be opposed to it.

															This Court's opinion today, I fear, will encourage taxpayers to
cling to frivolous views of the law in the hope of convincing a
jury of their sincerity. If that ensues, I suspect we have gone
beyond the limits of common sense.

															While I may not agree with every word the Court of Appeals has
enunciated in its opinion, I would affirm its judgment in this
case. I therefore dissent.


U.S. Supreme Court Cottage Savings Ass'n v. Commissioner, 499
U.S. 554 (1991) Cottage Savings Association v.
Commissioner of Internal Revenue No. 89-1965 Argued Jan. 15, 1991 Decided April 17,
1991 499
U.S. 554 CERTIORARI TO THE UNITED STATES
COURT OF APPEALS FOR THE SIXTH CIRCUIT Syllabus Petitioner Cottage Savings Association simultaneously sold
participation interests in 252 mortgages to four savings and loan
associations and purchased from them participation interests in 305
other mortgages. All of the loans were secured by single family
homes. The fair market value of the package of participation
interests exchanged by each side was approximately $4.5 million.
The face value of the participation interests relinquished by
Cottage Savings was $6.9 million. For Federal Home Loan Bank Board
(FHLBB) accounting purposes, Cottage Savings' mortgages were
treated as having been exchanged for "substantially identical" ones
held by the other lenders. On its 1980 federal income tax return,
Cottage Savings claimed a deduction for the adjusted difference
between the face value of the interests it traded and the fair
market value of the interests it received. Following the
Commissioner's disallowance of the deduction, the Tax Court
determined the deduction was permissible. The Court of Appeals
reversed, finding that Cottage Savings had realized its losses
through the transaction, but that it was not entitled to a
deduction because its losses were not actually sustained for
purposes of § 165(a) of the Internal Revenue Code, which allows
deductions only for bona fide losses. Held: 1. Cottage Savings realized a tax-deductible loss because the
properties it exchanged were materially different. Pp. 499 U. S.
559 -567.

															(a) In order to avoid the cumbersome, abrasive, and
unpredictable administrative task of valuing assets annually to
determine whether their value has appreciated or depreciated, §
1001(a) of the Code defers the tax consequences of a gain or loss
in property until it is realized through the "sale or disposition
of [the] property." This rule serves administrative convenience
because a change in the investment's form or extent can be easily
detected by a taxpayer or an administrative officer. P. 499 U. S.
559 .

															(b) An exchange of property constitutes a "disposition of
property" under § 1001(a) only if the properties exchanged are
materially different. Although the statute and its legislative
history are silent on the subject, Treasury Regulation § 1.1001-1
includes a material difference requirement Page 499 U. S. 555 for realization to occur through a disposition of property.
Treasury Regulation § 1.1001-1 should be given deference as a
reasonable interpretation of § 1001(a). Where, as here, a Treasury
Regulation long continues without substantial change and applies to
a substantially reenacted statute, it is deemed to have
congressional approval. The regulation is also consistent with this
Court's landmark precedents on realization, which make clear that a
taxpayer realizes taxable income only if the properties exchanged
are "materially" or "essentially" different. United States v.
Phellis, 257 U. S. 156 , 257 U. S. 173 ; Weiss v. Stearn, 265 U. S. 242 , 265 U. S.
253 -254; Marr v. United States, 268 U.
S. 536 , 268 U. S.
540 -542. Since these cases were part of the contemporary
legal context in which the substance of § 1001(a) was originally
enacted, and since Congress has left their principles undisturbed
through subsequent reenactments, it can be presumed that Congress
intended to codify these principles in § 1001(a). Pp. 499 U. S.
560 -562.

															(c) Properties are materially different if their respective
possessors enjoy legal entitlements that are different in kind or
extent. As long as the property entitlements are not identical,
their exchange will allow both the Commissioner and the transacting
taxpayer to fix the appreciated or depreciated values of the
property relative to their tax bases. There is no support in Phellis, Weiss, or Marr for the Commissioner's
"economic substitute" concept of material difference, under which
differences would be material only when the parties, the relevant
market, and the relevant regulatory body would consider them so.
Moreover, the complexity of the Commissioner's approach both
ill-serves the goal of administrative convenience underlying the
realization requirement and is incompatible with the Code's
structure. Pp. 499 U. S.
562 -566.

															(d) Cottage Savings' transactions easily satisfy the material
difference test. Since the participation interests exchanged
derived from loans that were made to different obligors and secured
by different homes, the exchanged interests embodied legally
distinct entitlements. Thus, Cottage Savings realized its losses at
the point of the exchange, at which time both it and the
Commissioner were in a position to determine the change in the
value of its mortgages relative to their tax bases. The mortgages'
status under the FHLBB's criteria has no bearing on this
conclusion, since a mortgage can be "substantially identical" to
the FHLBB and still exhibit "differences" that are "material" for
purposes of the Code. Pp. 499 U. S.
566 -567.

															2. Cottage Savings sustained its losses within the meaning of §
165(a) of the Code. The Commissioner's apparent argument that the
losses were not bona fide is rejected, since there is no contention
that the transaction was not conducted at arm's length or that
Cottage Savings Page 499 U. S. 556 retained de facto ownership of the participation
interests it traded. Higgins v. Smith, 308 U.
S. 473 , distinguished. Pp. 499 U. S.
567 -568.

															890 F.2d 848 (CA6 1989), reversed and remanded.

															MARSHALL, J., delivered the opinion of the Court, in which
REHNQUIST, C.J., and STEVENS, O'CONNOR, SCALIA, KENNEDY, and
SOUTER, JJ., joined. BLACKMUN, J., filed a dissenting opinion, in
which WHITE, J., joined, post, p. 499 U. S.
568 .

															JUSTICE MARSHALL delivered the opinion of the Court.

															The issue in this case is whether a financial institution
realizes tax-deductible losses when it exchanges its interests in
one group of residential mortgage loans for another lender's
interests in a different group of residential mortgage loans. We
hold that such a transaction does give rise to realized losses. I Petitioner Cottage Savings Association (Cottage Savings) is a
savings and loan association (S & L) formerly regulated by the
Federal Home Loan Bank Board (FHLBB). [ Footnote 1 ] Like many S & L's, Cottage Savings held
numerous long-term, low-interest mortgages that declined in value
when interest rates surged in the late 1970's. These institutions
would have benefited from selling their devalued mortgages in order
to realize tax-deductible losses. However, they were deterred from
doing so by FHLBB accounting regulations, which required them to
record the losses on their books. Page 499 U. S. 557 Reporting these losses consistent with the then-effective FHLBB
accounting regulations would have placed many S & L's at risk
of closure by the FHLBB.

															The FHLBB responded to this situation by relaxing its
requirements for the reporting of losses. In a regulatory directive
known as "Memorandum R-49," dated June 27, 1980, the FHLBB
determined that S & L's need not report losses associated with
mortgages that are exchanged for "substantially identical"
mortgages held by other lenders. [ Footnote 2 ] The FHLBB's acknowledged purpose for
Memorandum R-49 was to facilitate transactions that would generate
tax losses but that would not substantially affect the economic
position of the transacting S & L's.

															This case involves a typical Memorandum R-49 transaction. On
December 31, 1980, Cottage Savings sold "90 participation" in 252
mortgages to four S & L's. It simultaneously purchased "90
participation interests" in 305 mortgages held by these S &
L's. [ Footnote 3 ] All of the
loans involved Page 499 U. S. 558 in the transaction were secured by single-family homes, most in
the Cincinnati area. The fair market value of the package of
participation interests exchanged by each side was approximately
$4.5 million. The face value of the participation interests Cottage
Savings relinquished in the transaction was approximately $6.9
million. See 90 T.C. 372, 378-382 (1988).

															On its 1980 federal income tax return, Cottage Savings claimed a
deduction for $2,447,091, which represented the adjusted difference
between the face value of the participation interests that it
traded and the fair market value of the participation interests
that it received. As permitted by Memorandum R-49, Cottage Savings
did not report these losses to the FHLBB. After the Commissioner of
Internal Revenue disallowed Cottage Savings' claimed deduction,
Cottage Savings sought a redetermination in the Tax Court. The Tax
Court held that the deduction was permissible. See 90 T.C.
372 (1988).

															On appeal by the Commissioner, the Court of Appeals reversed.
890 F.2d 848 (CA6 1989). The Court of Appeals agreed with the Tax
Court's determination that Cottage Savings had realized its losses
through the transaction. See id. at 852. However, the
court held that Cottage Savings was not entitled to a deduction
because its losses were not "actually" sustained during the 1980
tax year for purposes of 26 U.S.C. § 165(a). See 890 F.2d
at 855.

															Because of the importance of this issue to the S & L
industry and the conflict among the Circuits over whether
Memorandum R-49 exchanges produce deductible tax losses, [ Footnote 4 ] we granted certiorari. 498
U.S. 808. We now reverse. Page 499 U. S. 559 II Rather than assessing tax liability on the basis of annual
fluctuations in the value of a taxpayer's property, the Internal
Revenue Code defers the tax consequences of a gain or loss in
property value until the taxpayer "realizes" the gain or loss. The
realization requirement is implicit in § 1001(a) of the Code, 26
U.S.C. § 1001(a), which defines "[t]he gain [or loss] from the sale
or other disposition of property" as the difference between "the
amount realized" from the sale or disposition of the property and
its "adjusted basis." As this Court has recognized, the concept of
realization is "founded on administrative convenience." Helvering v. Horst, 311 U. S. 112 , 311 U. S. 116 (1940). Under an appreciation-based system of taxation, taxpayers
and the Commissioner would have to undertake the "cumbersome,
abrasive, and unpredictable administrative task" of valuing assets
on an annual basis to determine whether the assets had appreciated
or depreciated in value. See 1 B. Bittker & L. Lokken,
Federal Taxation of Income, Estates and Gifts 115.2, p. 5-16 (2d
ed.1989). In contrast, "[a] change in the form or extent of an
investment is easily detected by a taxpayer or an administrative
officer." R. Magill, Taxable Income 79 (rev. ed.1945).

															Section 1001(a)'s language provides a straightforward test for
realization: to realize a gain or loss in the value of property,
the taxpayer must engage in a "sale or other disposition of [the]
property." The parties agree that the exchange of participation
interests in this case cannot be characterized as a "sale" under §
1001(a); the issue before us is whether the transaction constitutes
a "disposition of property." The Commissioner argues that an
exchange of property can be treated as a "disposition" under §
1001(a) only if the properties exchanged are materially different.
The Commissioner further submits that, because the underlying
mortgages Page 499 U. S. 560 were essentially economic substitutes, the participation
interests exchanged by Cottage Savings were not materially
different from those received from the other S & L's. Cottage
Savings, on the other hand, maintains that any exchange of property
is a "disposition of property" under § 1001(a), regardless of
whether the property exchanged is materially different.
Alternatively, Cottage Savings contends that the participation
interests exchanged were materially different because the
underlying loans were secured by different properties.

															We must therefore determine whether the realization principle in
§ 1001(a) incorporates a "material difference" requirement. If it
does, we must further decide what that requirement amounts to and
how it applies in this case. We consider these questions in
turn.

															Neither the language nor the history of the Code indicates
whether and to what extent property exchanged must differ to count
as a "disposition of property" under § 1001(a). Nonetheless, we
readily agree with the Commissioner that an exchange of property
gives rise to a realization event under § 1001(a) only if the
properties exchanged are "materially different." The Commissioner
himself has, by regulation, construed § 1001(a) to embody a
material difference requirement:

															"Except as otherwise provided . . . the gain or loss realized
from the conversion of property into cash, or from the exchange
of property for other property differing materially either in kind
or in extent, is treated as income or as loss sustained."

															Treas.Reg. § 1.1001-1, 26 CFR § 1.1001-1 (1990) (emphasis
added). Because Congress has delegated to the Commissioner the
power to promulgate "all needful rules and regulations for the
enforcement of [the Internal Revenue Code]," 26 U.S.C. § 7805(a),
we must defer to his regulatory interpretations Page 499 U. S. 561 of the Code so long as they are reasonable, see National
Muffler Dealers Assn., Inc. v. United States, 440 U.
S. 472 , 440 U. S.
476 -477 (1979).

															We conclude that Treasury Regulation § 1.1001-1 is a
reasonable interpretation of § 1001(a). Congress first employed the
language that now comprises § 1001(a) of the Code in § 202(a) of
the Revenue Act of 1924, ch. 234, 43 Stat. 253; that language has
remained essentially unchanged through various reenactments.
[ Footnote 5 ] And since 1934,
the Commissioner has construed the statutory term "disposition of
property" to include a "material difference" requirement. [ Footnote 6 ] As we have recognized,

															"'Treasury regulations and interpretations long continued
without substantial change, applying to unamended or substantially
reenacted statutes, are deemed to have received congressional
approval and have the effect of law.'" United States v. Correll, 389 U.
S. 299 , 389 U. S.
305 -306 (1967), quoting Helvering v. Winmill, 305 U. S. 79 , 305 U. S. 83 (1938).

															Treasury Regulation § 1.1001-1 is also consistent with our
landmark precedents on realization. In a series of early decisions
involving the tax effects of property exchanges, this Court made
clear that a taxpayer realizes taxable income Page 499 U. S. 562 only if the properties exchanged are "materially" or
"essentially" different. See United States v. Phellis, 257 U. S. 156 , 257 U. S. 173 (1921); Weiss v. Stearn, 265 U. S. 242 , 265 U. S.
253 -254 (1924); Marr v. United States, 268 U. S. 536 , 268 U. S.
540 -542 (1925); see also Eisner v. Macomber, 252 U. S. 189 , 252 U. S.
207 -212 (1920) (recognizing realization requirement).
Because these decisions were part of the "contemporary legal
context" in which Congress enacted § 202(a) of the 1924 Act, see Cannon v. University of Chicago, 441 U.
S. 677 , 441 U. S.
698 -699 (1979), and because Congress has left
undisturbed through subsequent reenactments of the Code the
principles of realization established in these cases, we may
presume that Congress intended to codify these principles in §
1001(a), see Pierce v. Underwood, 487 U.
S. 552 , 487 U. S. 567 (1988); Lorillard v. Pons, 434 U.
S. 575 , 434 U. S.
580 -581 (1978). The Commissioner's construction of the
statutory language to incorporate these principles certainly was
reasonable. B Precisely what constitutes a "material difference" for purposes
of § 1001(a) of the Code is a more complicated question. The
Commissioner argues that properties are "materially different" only
if they differ in economic substance. To determine whether the
participation interests exchanged in this case were "materially
different" in this sense, the Commissioner argues, we should look
to the attitudes of the parties, the evaluation of the interests by
the secondary mortgage market, and the views of the FHLBB. We
conclude that § 1001(a) embodies a much less demanding and less
complex test.

															Unlike the question whether § 1001(a) contains a
material difference requirement, the question of what
constitutes a material difference is not one on which we can
defer to the Commissioner. For the Commissioner has not issued an
authoritative, prelitigation interpretation of what property Page 499 U. S. 563 exchanges satisfy this requirement. [ Footnote 7 ] Thus, to give meaning to the material
difference test, we must look to the case law from which the test
derives and which we believe Congress intended to codify in
enacting and reenacting the language that now comprises § 1001(a). See Lorillard v. Pons, supra, at 434 U. S.
580 -581.

															We start with the classic treatment of realization in Eisner
v. Macomber, supra. In Macomber, a taxpayer who owned
2,200 shares of stock in a company received another 1,100 shares
from the company as part of a pro rata stock dividend
meant to reflect the company's growth in value. At issue was
whether the stock dividend constituted taxable income. We held that
it did not, because no gain was realized. See id., 252
U.S. at 252 U. S.
207 -212. We reasoned that the stock dividend merely
reflected the increased worth of the taxpayer's stock, see
id. at 252 U. S.
211 -212, and that a taxpayer realizes increased worth of
property only by receiving "something of exchangeable value
proceeding from the property," see id. at 252 U. S.
207 .

															In three subsequent decisions -- United States v. Phellis,
supra; Weiss v. Stearn, supra; and Marr v. United States,
supra -- we refined Macomber's conception of
realization in the context of property exchanges. In each case, the
taxpayer owned stock that had appreciated in value since its
acquisition. Page 499 U. S. 564 And in each case, the corporation in which the taxpayer held
stock had reorganized into a new corporation, with the new
corporation assuming the business of the old corporation. While the
corporations in Phellis and Marr both changed
from New Jersey to Delaware corporations, the original and
successor corporations in Weiss both were incorporated in
Ohio. In each case, following the reorganization, the stockholders
of the old corporation received shares in the new corporation equal
to their proportional interest in the old corporation.

															The question in these cases was whether the taxpayers realized
the accumulated gain in their shares in the old corporation when
they received in return for those shares stock representing an
equivalent proportional interest in the new corporations. In Phellis and Marr, we held that the transactions
were realization events. We reasoned that, because a company
incorporated in one State has "different rights and powers" from
one incorporated in a different State, the taxpayers in Phellis and Marr acquired through the
transactions property that was "materially different" from what
they previously had. United States v. Phellis, 257 U.S. at 257 U. S.
169 -173; see Marr v. United States, supra, 268
U.S. at 268 U. S.
540 -542 (using phrase "essentially different"). In
contrast, we held that no realization occurred in Weiss. By exchanging stock in the predecessor corporation for stock in the
newly reorganized corporation, the taxpayer did not receive "a
thing really different from what he theretofore had." Weiss v.
Stearn, supra, 265 U.S. at 265 U. S. 254 . As
we explained in Marr, our determination that the
reorganized company in Weiss was not "really different"
from its predecessor turned on the fact that both companies were
incorporated in the same State. See Marr v. United States,
supra, 268 U.S. at 268 U. S.
540 -542 (outlining distinction between these cases).

															Obviously, the distinction in Phellis and Marr that made the stock in the successor corporations materially
different from the stock in the predecessors was minimal. Taken
together, Page 499 U. S. 565 Phellis, Marr, and Weiss stand for the
principle that properties are "different" in the sense that is
"material" to the Internal Revenue Code so long as their respective
possessors enjoy legal entitlements that are different in kind or
extent. Thus, separate groups of stock are not materially different
if they confer "the same proportional interest of the same
character in the same corporation." Marr v. United States, 268 U.S. at 268 U. S. 540 .
However, they are materially different if they are issued by
different corporations, id. at 268 U. S. 541 ; United States v. Phellis, supra, 257 U.S. at 257 U. S. 173 ,
or if they confer "differen[t] rights and powers" in the same
corporation, Marr v. United States, supra, 268 U.S. at 268 U. S. 541 .
No more demanding a standard than this is necessary in order to
satisfy the administrative purposes underlying the realization
requirement in § 1001(a). See Helvering v. Horst, 311 U.S.
at 311 U. S. 116 .
For, as long as the property entitlements are not identical, their
exchange will allow both the Commissioner and the transacting
taxpayer easily to fix the appreciated or depreciated values of the
property relative to their tax bases.

															In contrast, we find no support for the Commissioner's "economic
substitute" conception of material difference. According to the
Commissioner, differences between properties are material for
purposes of the Code only when it can be said that the parties, the
relevant market (in this case the secondary mortgage market), and
the relevant regulatory body (in this case the FHLBB) would
consider them material. Nothing in Phellis, Weiss, and Marr suggests that exchanges of properties must satisfy
such a subjective test to trigger realization of a gain or
loss.

															Moreover, the complexity of the Commissioner's approach
ill-serves the goal of administrative convenience that underlies
the realization requirement. In order to apply the Commissioner's
test in a principled fashion, the Commissioner and the taxpayer
must identify the relevant market, establish whether there is a
regulatory agency whose views should be taken into account, and
then assess how the relevant market Page 499 U. S. 566 participants and the agency would view the transaction. The
Commissioner's failure to explain how these inquiries should be
conducted further calls into question the workability of his
test.

															Finally, the Commissioner's test is incompatible with the
structure of the Code. Section 1001(c) of Title 26 provides that a
gain or loss realized under § 1001(a) "shall be recognized" unless
one of the Code's nonrecognition provisions applies. One such
nonrecognition provision withholds recognition of a gain or loss
realized from an exchange of properties that would appear to be
economic substitutes under the Commissioner's material difference
test. This provision, commonly known as the "like kind" exception,
withholds recognition of a gain or loss realized

															"on the exchange of property held for productive use in a trade
or business or for investment . . . for property of like kind which
is to be held either for productive use in a trade or business or
for investment."

															26 U.S.C. § 1031(a)(1). If Congress had expected that exchanges
of similar properties would not count as realization events under §
1001(a), it would have had no reason to bar recognition of a gain
or loss realized from these transactions. C Under our interpretation of § 1001(a), an exchange of property
gives rise to a realization event so long as the exchanged
properties are "materially different" -- that is, so long as they
embody legally distinct entitlements. Cottage Savings' transactions
at issue here easily satisfy this test. Because the participation
interests exchanged by Cottage Savings and the other S & L's
derived from loans that were made to different obligors and secured
by different homes, the exchanged interests did embody legally
distinct entitlements. Consequently, we conclude that Cottage
Savings realized its losses at the point of the exchange. III The Commissioner contends that it is anomalous to treat
mortgages deemed to be "substantially identical" by the Page 499 U. S. 567 FHLBB as "materially different." The anomaly, however, is merely
semantic; mortgages can be substantially identical for Memorandum
R9 purposes and still exhibit "differences" that are "material" for
purposes of the Internal Revenue Code. Because Cottage Savings
received entitlements different from those it gave up, the exchange
put both Cottage Savings and the Commissioner in a position to
determine the change in the value of Cottage Savings' mortgages
relative to their tax bases. Thus, there is no reason not to treat
the exchange of these interests as a realization event, regardless
of the status of the mortgages under the criteria of Memorandum
R9. III Although the Court of Appeals found that Cottage Savings' losses
were realized, it disallowed them on the ground that they were not
sustained under § 165(a) of the Code, 26 U.S.C. § 165(a). Section
165(a) states that a deduction shall be allowed for "any loss
sustained during the taxable year and not compensated for by
insurance or otherwise." Under the Commissioner's interpretation of
§ 165(a),

															"To be allowable as a deduction under section 165(a), a loss
must be evidenced by closed and completed transactions, fixed by
identifiable events, and, except as otherwise provided in section
165(h) and § 1.165-11, relating to disaster losses, actually
sustained during the taxable year. Only a bona fide loss is
allowable. Substance and not mere form shall govern in determining
a deductible loss."

															Treas.Reg. § 1.165-1(b), 26 CFR § 1.165-1(b) (1990).

															The Commissioner offers a minimal defense of the Court of
Appeals' conclusion. The Commissioner contends that the losses were
not sustained because they lacked "economic substance," by which
the Commissioner seems to mean that the losses were not bona fide.
We say "seems" because the Commissioner states the position in one
sentence in a footnote Page 499 U. S. 568 in his brief, without offering further explanation. See Brief for Respondent 34-35, n. 39. The only authority the
Commissioner cites for this argument is Higgins v. Smith, 308 U. S. 473 (1940). See Brief for United States in No. 89-1926, p. 16,
n. 11.

															In Higgins, we held that a taxpayer did not sustain a
loss by selling securities below cost to a corporation in which he
was the sole shareholder. We found that the losses were not bona
fide, because the transaction was not conducted at arm's length and
because the taxpayer retained the benefit of the securities through
his wholly owned corporation. See Higgins v. Smith, supra, at 308 U. S.
475 -476. Because there is no contention that the
transactions in this case were not conducted at arm's length, or
that Cottage Savings retained de facto ownership of the
participation interests it traded to the four reciprocating S &
L's, Higgins is inapposite. In view of the Commissioner's
failure to advance any other arguments in support of the Court of
Appeals' ruling with respect to § 165(a), we conclude that, for
purposes of this case, Cottage Savings sustained its losses within
the meaning of § 165(a). IV For the reasons set forth above, the judgment of the Court of
Appeals is reversed, and the case is remanded for further
proceedings consistent with this opinion. So ordered. [ Footnote 1 ]

															Congress abolished the FHLBB in 1989. See § 401 of the
Financial Institutions Reform, Recovery, and Enforcement Act of
1989, Pub.L. 101-73, 103 Stat. 354.

															[ Footnote 2 ]

															Memorandum R9 listed 10 criteria for classifying mortgages as
substantially identical.

															"The loans involved must:"

															"1. involve single-family residential mortgages,"

															"2. be of similar type ( e.g., conventionals for
conventionals),"

															"3. have the same stated terms to maturity ( e.g., 30
years),"

															"4. have identical stated interest rates,"

															"5. have similar seasoning ( i.e., remaining terms to
maturity),"

															"6. have aggregate principal amounts within the lesser of 2 1/2%
or $100,000 (plus or minus) on both sides of the transaction, with
any additional consideration being paid in cash,"

															"7. be sold without recourse,"

															"8. have similar fair market values,"

															"9. have similar loan-to-value ratios at the time of the
reciprocal sale, and"

															"10. have all security properties for both sides of the
transaction in the same state."

															Record, Exh. 72-BT.

															[ Footnote 3 ]

															By exchanging merely participation interests, rather than the
loans themselves, each party retained its relationship with the
individual obligors. Consequently, each S & L continued to
service the loans on which it had transferred the participation
interests and made monthly payments to the participation-interest
holders. See 90 T.C. 372, 381 (1988).

															[ Footnote 4 ]

															The two other Courts of Appeals that have considered the tax
treatment of Memorandum R-49 transactions have found that these
transactions do give rise to deductible losses. See Federal
Nat. Mortgage Assn. v. Commissioner, 283 U.S.App.D.C. 53,
56-58, 896 F.2d 580, 583584 (1990); San Antonio Savings Assn.
v. Commissioner, 887 F.2d 577 (CA5 1989).

															[ Footnote 5 ]

															Section 202(a) of the 1924 Act provided:

															"Except as hereinafter provided in this section, the gain from
the sale or other disposition of property shall be the excess of
the amount realized therefrom over the basis provided in
subdivision (a) or (b) of section 204, and the loss shall be the
excess of such basis over the amount realized."

															The essence of this provision was reenacted in § 111(a) of
Revenue Act of 1934, ch. 277, 48 Stat. 703; and then in § 111(a) of
the Internal Revenue Code of 1939, ch. 1, 53 Stat. 37; and finally
in § 1001(a) of the Internal Revenue Code of 1954, Pub.L. 591, 68A
Stat. 295.

															[ Footnote 6 ]

															What is now Treas.Reg. § 1.1001-1 originated as Treas.Reg. 86,
Art. 111-1, which was promulgated pursuant to the Revenue Act of
1934. That regulation provided:

															"Except as otherwise provided, the Act regards as income or as
loss sustained, the gain or loss realized from the conversion of
property into cash, or from the exchange of property for of her
property differing materially either in kind or in
extent. "

															(Emphasis added.)

															[ Footnote 7 ]

															In its brief in United States v. Centennial Savings Bank
FSB, No. 89-1926, the Commissioner cites two Revenue Rulings
that support the position that mortgages exchanged through
reciprocal mortgage sales are not materially different. See Brief for United States 25, n. 21 (citing Rev.Rul.
85-125, 1985-2 Cum.Bull. 180; Rev.Rul. 81-204, 1981-2 Cum.Bull.
157). Perhaps because the two Revenue Rulings postdate the
reciprocal mortgage exchange transaction at issue here and do not
purport to define the "differ materially" language in Treasury
Regulation § 1.1001-1, the Commissioner has not argued that the
position taken in these rulings is entitled to deference. Compare, e.g., National Muffler Dealers Assn., Inc. v. United
States, 440 U. S. 472 , 440 U. S.
483 -484, and nn. 16-19 (1979) (deferring to position
reflected in longstanding series of Revenue Rulings consistently
adhering to same position in a variety of fact patterns). See
generally Udall v. Tallman, 380 U. S. 1 , 380 U. S. 16 -17
(1965) (agency's reasonable interpretation of its own regulations
is entitled to deference).

															JUSTICE BLACKMUN, with whom JUSTICE WHITE joins, concurring in
part and dissenting in part in No. 89-1926, and dissenting in No.
89-1965.

															I agree that the early withdrawal penalties collected by
Centennial Savings Bank FSB do not constitute "income by reason of
the discharge . . . of indebtedness of the taxpayer," within the
meaning of 26 U.S.C. § 108(a)(1) (1982 ed.), and that the penalty
amounts are not excludable from Centennial's gross income. I
therefore join Part III of the Court's opinion in No. 89-1926. Page 499 U. S. 569 I dissent, however, from the Court's conclusions in these two
cases that Centennial and Cottage Savings Association realized
deductible losses for income tax purposes when each exchanged
partial interests in one group of residential mortgage loans for
partial interests in another like group of residential mortgage
loans. I regard these losses as not recognizable for income tax
purposes because the mortgage packages so exchanged were
substantially identical and were not materially different.

															The exchanges, as the Court acknowledges, were occasioned by the
Federal Home Loan Bank Board's (FHLBB) Memorandum R-49 of June
27,1980, and by that Memorandum's relaxation of
theretofore-existing accounting regulations and requirements, a
relaxation effected to avoid placement of "many S & L's at risk
of closure by the FHLBB" without substantially affecting the
"economic position of the transacting S & L's." Aante at 499 U. S. 557 .
But the Memorandum, the Court notes, also had as a purpose "the
facilit[ation of] transactions that would generate tax losses." Ibid. I find it somewhat surprising that an agency not
responsible for tax matters would presume to dictate what is or is
not a deductible loss for federal income tax purposes. I had
thought that that was something within the exclusive province of
the Internal Revenue Service, subject to administrative and
judicial review. Certainly, the Bank Board's opinion in this
respect is entitled to no deference whatsoever. See United
States v. Stewart, 311 U. S. 60 , 311 U. S. 70 (1940); Graff v. Commissioner, 673 F.2d 784, 786 (CA5
1982) (concurring opinion). The Commissioner, of course, took the
opposing position. See Rev.Rul. 85-125, 1985-2 Cum. Bull.
180; Rev.Rul. 81-204, 1981-2 Cum.Bull. 175.

															It long has been established that gain or loss in the value of
property is taken into account for income tax purposes only if and
when the gain or loss is "realized," that is, when it is tied to a
realization event, such as the sale, exchange, or other disposition
of the property. Mere variation in value Page 499 U. S. 570 -- the routine ups and downs of the marketplace -- do not in
themselves have income tax consequences. This is fundamental in
income tax law.

															In applying the realization requirement to an exchange, the
properties involved must be materially different in kind or in
extent. Treas.Reg. § 1.1001-1(a), 26 CFR § 1.1001-1(a) (1990). This
has been the rule recognized administratively at least since 1935, see Treas.Regs. 86, Art. 111-1, issued under the Revenue
Act of 1934, and by judicial decision. See, e.g., Mutual Loan
& Savings Co. v. Commissioner, 184 F.2d 161 (CA5 1950). See also Marr v. United States, 268 U.
S. 536 , 268 U. S. 541 (1925); Weiss v. Stearn, 265 U. S. 242 , 265 U. S. 254 (1924); United States v. Phellis, 257 U.
S. 156 (1921). This makes economic as well as tax sense,
for the parties obviously regard the exchanged properties as having
equivalent values. In tax law, we should remember, substance,
rather than form, determines tax consequences. Commissioner v.
Court Holding Co., 324 U. S. 331 , 324 U. S. 334 (1945); Gregory v. Helvering, 293 U.
S. 465 , 293 U. S.
469 -470 (1935); Shoenberg v. Commissioner, 77
F.2d 446, 449 (CA8), cert. denied, 296 U.S. 586 (1935).
Thus, the resolution of the exchange issue in these cases turns on
the "materially different" concept. The Court recognizes as much. Ante at 499 U. S.
559 -560.

															That the mortgage participation partial interests exchanged in
these cases were "different" is not in dispute. The materiality
prong is the focus. A material difference is one that has the
capacity to influence a decision. See, e.g., Kungys v. United
States, 485 U. S. 759 , 485 U. S.
770 -771 (1988); Basic Inc. v. Levinson, 485 U. S. 224 , 485 U. S. 240 (1988); TSC Industries, Inc. v. Northway, Inc., 426 U. S. 438 , 426 U. S. 449 (1976).

															The application of this standard leads, it seems to me, to only
one answer -- that the mortgage participation partial interests
released were not materially different from the mortgage
participation partial interests received. Memorandum R-49, as the
Court notes, ante, at 499 U. S. 557 ,
n. 2, lists 10 factors that, when satisfied, as they were here,
serve to classify Page 499 U. S. 571 the interests as "substantially identical." These factors assure
practical identity; surely, they then also assure that any
difference cannot be of consequence. Indeed, nonmateriality is the
full purpose of the Memorandum's criteria. The "proof of the
pudding" is in the fact of its complete accounting acceptability to
the FHLBB. Indeed, as has been noted, it is difficult to reconcile
substantial identity for financial accounting purposes with a
material difference for tax accounting purposes. See First
Federal Savings & Loan Assn. v. United
States, 694 F.
Supp. 230 , 245 (WD Tex.1988), aff'd, 887 F.2d 593 (CA5
1989), cert. pending No. 891927. Common sense so
dictates.

															This should suffice, and be the end of the analysis. Other
facts, however, solidify the conclusion: the retention by the
transferor of 10% interests, enabling it to keep on servicing its
loans; the transferor's continuing to collect the payments due from
the borrowers so that, so far as the latter were concerned, it was
business as usual, exactly as it had been; the obvious lack of
concern or dependence of the transferor with the "differences" upon
which the Court relies (as transferees, the taxpayers made no
credit checks and no appraisals of collateral, see 890
F.2d 848, 849 (CA6 1989)); 90 T.C. 372, 382 (1988); 682 F.
Supp. 1389 , 1392 (ND Tex.1988); the selection of the loans by
computer programmed to match mortgages in accordance with the
Memorandum R-49 criteria; the absence of even the names of the
borrowers in the closing schedules attached to the agreements;
Centennial's receipt of loan files only six years after its
exchange, 682 F.Supp., at 1392, n. 5; the restriction of the
interests exchanged to the same State; the identity of the
respective face and fair market values; and the application by the
parties of common discount factors to each side of the transaction
-- all reveal that any differences that might exist made no
difference whatsoever and were not material. This demonstrates the
real nature of the transactions, including nonmateriality of the
claimed differences. Page 499 U. S. 572 We should be dealing here with realities, and not with
superficial distinctions. As has been said many times, and as noted
above, in income tax law we are to be concerned with substance, and
not with mere form. When we stray from that principle, the new
precedent is likely to be a precarious beacon for the future.

															I respectfully dissent on this issue.