Rev. Rul. 81-18

ISSUES

(1) Is earned but uncollected interest charged off by a savings and loan association in accordance with the regulations of the Federal Home Loan Bank Board conclusively presumed to be worthless under section 1.166-2(d) of the Income Tax Regulations?

(2) Must interest be accrued under section 451 of the Internal Revenue Code if it comes due after the date previous interest due on the loan was in default for more than 90 days?

FACTS

The taxpayer, a savings and loan association, is a calendar year taxpayer that computes its taxable income using the accrual method of accounting. The taxpayer is subject to the regulations of the Federal Home Loan Bank Board. Those regulations provide that all earned but uncollected interest on any conventional loan should be classified as uncollectible if any portion thereof is due but uncollected for a period in excess of 90 days and that appropriate income accounts shall be charged with the amount of uncollectible income and a corresponding amount shall be credited to an account or accounts descriptive of uncollectible income. 12 C.F.R. section 563.c11(b) and (c)(1978).

On October 3, 1978, the taxpayer entered into a one year installment loan. The interest payments due on this loan were due on the last day of each month beginning October 31, 1978. The taxpayer did not receive any interest payments on October 31, November 30, or December 31. Since on January 30, 1979, a portion of the interest on the loan was in default in excess of 90 days the taxpayer charged off as a bad debt in 1979 the previously earned but uncollected interest that was accrued in 1978 and that was included in income for that year.

This charge off was made pursuant to the regulations of the Federal Home Loan Bank Board. Subsequently, for purposes of section 1.166-2(d)(1)(ii) of the regulations, the examiners of the Federal Home Loan Bank Board, upon their first audit of the taxpayer after the charge off, confirmed in writing that the charge-off was made in accordance with their established policies.

LAW AND ANALYSIS

Section 166(a)(1) of the Code provides that there shall be allowed as a deduction any debts that become worthless within the taxable year.

Section 1.166-2(d)(1) of the regulations provides that if a bank or other corporation that is subject to supervision by federal authorities charges off a debt in whole or in part, either (i) in obedience to the specific orders of such authorities, or (ii) in accordance with established policies of such authorities, and, upon their first audit of the bank or other corporation subsequent to the charge-off, such authorities confirm in writing that the charge-off would have been subject to such specific orders if the audit had been made on the date of the charge-off, then the debt shall, to the extent charged off during the taxable year, be conclusively presumed to be worthless, or worthless only in part as the case may be, during such taxable year. But no such debt shall be conclusively presumed to be worthless, or worthless only in part, as the case may be, if the amount so charged off is not claimed as a deduction by the taxpayer at the time of filing the return for the taxable year in which the charge-off takes place.

Section 1.451-1(a) of the regulations provides that under an accrual method of accounting income is includible in gross income when all the events have occurred that fix the right to receive such income and the amount thereof can be determined with reasonable accuracy. However, if the income item is uncollectible when the right to receive the item arises, the fixed right does not require accrual. Jones Lumber Co. v. Commissioner, 404 F.2d 764 (6th Cir. 1968); Atlantic Coast Line Railroad Co. v. Commissioner, 31 B.T.A. 730 (1934), acq., XIV-2 C.B. 2 (1935). On the other hand, if an income item becomes uncollectible after the right to receive it arises, the proper treatment is accrual of the item as income and a deduction thereof. Spring City Foundry Co. v. Commissioner, 292 U.S. 182 (1934), Ct. D. 829, XIII-1 C.B. 281 (1934).

In the present situation, the taxpayer charged off the earned but uncollected interest on the installment loan when the interest on such loan was in default for a period in excess of 90 days in accordance with the Federal Home Loan Bank Board regulations. That regulation is an established policy within the meaning of section 1.166-2(d) of the regulations. Therefore, when the examiners of the Federal Home Loan Bank Board confirmed in writing upon their first audit subsequent to the charge-off that the charge-off would have been subject to such specific orders if the audit had been on the date of the charge-off, the earned but uncollected interest is conclusively presumed to be worthless on the date of the charge-off if claimed as a deduction by the taxpayer at the time of filing the return for the taxable year in which the charge-off takes place.

HOLDINGS

(1) The earned but uncollected interest that was properly accrued and reported in income in 1978 and that was charged off in 1979 by the taxpayer in accordance with the regulations of the Federal Home Loan Bank Board is conclusively presumed worthless under section 1.166-2(d) of the regulations if claimed as a bad debt deduction for federal income tax purposes by the taxpayer for 1979.

(2) The interest that would be conclusively presumed worthless when due after December 31, 1978, under section 1.166-2(d) of the regulations, is not required to be accrued under section 451 of the Code provided the taxpayer does not at any time claim the amount of this interest as a bad debt deduction for federal income tax purposes.