Pub. 8 2013-2014 Issue 3

September | October 2013 13 Extraordinary Service for Extraordinary Members. we’re Always CLOSE BY NetWorks is the Electronic Funds Transfer (EFT) service provider that Nebraskans have used and learned to trust like family for over 30 years. Since our offices are right here in Nebraska, you can count on us to provide quick and personalized service for all of your EFT needs. Give us a call and let’s talk about how we can simplify EFT for you. You will talk with a fellow Nebraskan and not some automated system. www.netseft.com Toll Free 800-735-6833 Local 402-434-8202 Deduction For federal income tax purposes, a liability is incurred and generally taken into account in the taxable year in which (a) all the events have occurred that establish the fact of the liability; (b) the amount of the liability can be determined with reasonable accuracy; and (c) economic performance has occurred. 7 Provisions Applicable to Banks While banks are generally taxed as corporations, the tax code contains several special provisions applicable to banks. 8 In general, the section 166 rules govern the bad debt deduction. Section 166 provides a deduction for any debt that becomes worthless within the taxable year. 9 Whether a debt is worthless in whole or in part is a question of fact that must be determined from all the evidence, including the value of any collateral and the financial condition of the debtor. 10 Banks, however, have special rules with respect to bad debt deductions. A bank has different options on its treatment of debt deductions depending on whether, for tax purposes, it is considered a “small bank” or a “large bank.” 11 Small banksmay (a) take a bad debt deduction by using the specific charge-off method; or (b) take a deduction for a reasonable addition to a reserve for bad debts (also known as the reserve method). 12 However, for taxable years since 1987, large banks are no longer allowed to use the reserve method for bad debts. They must use the specific charge-off method. 13 Wh e t h e r t h r o u g h me r g e r , consolidation, or other means, once a bank becomes a large bank, it remains a large bank permanently. 14 In any year in which a bank becomes a large bank, the existing bad debt reserves must be either recaptured or run off. Small banks have the option, and large banks are required, to use the specific charge-off method. Under the specific charge-off method, in order to be deducted for federal tax purposes, specific loans must be identified, determined to be worthless, 15 and charged off. 16 If a bank is required to charge off a loan, or if a bank charges off a loan and the charge off is confirmed on examination or audit, then worthlessness is conclusively  Proposition — continued on page 14 presumed to have existed. 17 The treasury regulations also provide a “conformity election,” pursuant to which the treatment of bad loans on the bank’s regulatory books conclusively 7 Treas. Reg. § 1.446-1(c)(1)(ii)(A). 8 I.R.C. §§ 581 to 597. 9 I.R.C § 166(a)(1). 10 Treas. Reg §1.166-2(a). 11 The difference between a “small bank” and a “large bank” is that a “large bank” is defined as a bank that, for any taxable year after Dec. 31, 1986, has assets the aggregate adjusted basis of which exceed $500 million. Assets of banks in a parent-subsidiary controlled group are aggregated for purposes of this test. See Section 585(c)(2)(A); Treas. Reg. § 1.585-5(b). 12 I.R.C. § 585(b). 13 I.R.C. § 585(c). See Treas. Reg. §-1.585-5 through -8. 14 Treas. Reg. § 1.585-5(b)(3), Example (2). 15 Treas. Reg. § 1.166-2. 16 Treas. Reg. § 1.166-3(a)(2). 17 Treas. Reg. § 1.166-2(d)(1) See also Rev. Rul. 81-18, 1981-1 C.B. 295, and Rev. Rul. 92-14, 1992-1 C.B. 93.