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Final Regs Allow Banks To Elect Conclusive Presumption of Debts' Worthlessness

FEB. 24, 1992

T.D. 8396; 57 F.R. 6291-6296

DATED FEB. 24, 1992
DOCUMENT ATTRIBUTES
Citations: T.D. 8396; 57 F.R. 6291-6296

 [4830-01]

 

 DEPARTMENT OF THE TREASURY

 

 Internal Revenue Service

 

 26 CFR Parts 1 and 602

 

 T.D. 8396

 

 RIN 1545-AP69

 

 

 AGENCY: Internal Revenue Service, Treasury.

 ACTION: Final regulations.

 SUMMARY: This document contains final regulations relating to a bank's determination of worthlessness of a debt. These regulations provide greater certainty in the treatment of bank bad debts, by providing for a conclusive presumption of worthlessness of debts based on the application of a single set of standards for both regulatory and tax accounting purposes.

 EFFECTIVE DATE: These regulations are effective for taxable years ending on or after December 31, 1991.

 FOR FURTHER INFORMATION CONTACT: Bernita L. Thigpen, telephone 202-566-3516 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

PAPERWORK REDUCTION ACT

The collection of information contained in these final regulations has been reviewed and approved by the Office of Management and Budget in accordance with the requirements of the Paperwork Reduction Act of 1980 (44 U.S.C. 3504(h)) under control number 1545-1254. The estimated average annual burden per respondent to complete Form 3115 is 26.96 hours.

 These estimates are an approximation of the average time expected to be necessary for a collection of information. They are based on such information as is available to the Internal Revenue Service. Individual respondents may require greater or less time, depending on their particular circumstances.

 Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be directed to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, T:FP, Washington D.C., 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

BACKGROUND

 On May 29, 1991, the Internal Revenue Service published proposed regulations under section 166 of the Internal Revenue Code of 1986 in the Federal Register (56 FR 24154). Written comments on those proposed regulations were received from the public. On August 9, 1991, a public hearing was held concerning the regulations. After consideration of all of the written comments received and the statements made at the public hearing, the proposed regulations are adopted as modified by this Treasury Decision.

EXPLANATION OF PROVISIONS

 Section 166 of the Internal Revenue Code and the regulations thereunder allow a deduction for a business debt that becomes wholly or partially worthless within the taxable year, if certain requirements are met. All pertinent evidence, including the value of any collateral securing the debt and the financial condition of the debtor, generally is taken into account in determining worthlessness. See section 1.166-2(a).

 The existing regulations provide a special rule (the "existing presumption") for banks (and certain other regulated corporations), under which a debt charged off in a taxable year is conclusively presumed to have become worthless in that year if the charge-off is in obedience to a specific order of the bank's supervisory authority, or in accordance with regulatory policy provided that the supervisory authority confirms in writing upon its first audit subsequent to the charge-off that the charge-off would have been ordered had the bank been audited on the date of the charge-off. See section 1.166-2(d)(1).

 Sections 1.166-2(d)(3) and (4) were proposed to provide new special rules permitting a supervised bank (including a thrift institution) to elect a method of accounting under which it may conform its tax accounting for bad debts to its regulatory accounting, provided certain conditions are satisfied. Under these rules, debts that are charged off pursuant to specific orders of the bank's supervisory authority or that are classified by the bank as loss assets under applicable regulatory standards are conclusively presumed to have become worthless in the taxable year of the charge- offs (the "conformity presumption"). The extent to which the proposed regulations have been modified in response to comments received is described below.

COMMENTS ON SPECIFIC PROVISIONS

PROP. REG. SECTION 1.166-2(d)(3)(i): CONFORMITY ELECTION.

 Under the proposed regulations, the conformity election is available only to banks, as defined in proposed section 1.166-2(d)(4)(i). Several commentators suggested that the election also be made available to non-bank affiliates of a bank, including a bank's subsidiaries and its holding company, because these non-bank affiliates are subject to supervision by the bank's supervisory authority. The commentators argued that these regulated non-banks should be eligible for the conformity presumption because they are eligible for the existing presumption under section 1.166-2(d)(1), which applies more generally to banks and certain other regulated corporations.

 The Treasury Department's study on the appropriate criteria to be used in determining whether a debt is worthless for Federal income tax purposes concludes that the regulatory criteria governing the charge-off of debts by banks are sufficiently similar to the criteria for worthlessness under section 166 to make regulatory criteria and examination by the regulatory authorities an acceptable surrogate for an independent investigation by the Internal Revenue Service. See Report to the Congress on the Tax Treatment of Bad Debts by Financial Institutions at 19-24 (Treasury Department, September 1991). The same degree of acceptability has not been demonstrated overall with respect to regulated corporations other than banks, nor is there any appropriate basis for attempting to distinguish among the various non-banks based on the level of regulatory scrutiny. Moreover, the existing presumption remains available to regulated corporations that are not banks and, thus, do not qualify for the new conformity election. Accordingly, the final regulations retain the rule of the proposed regulations.

PROP. REG. SECTION 1.166-2(d)(3)(ii): CONCLUSIVE PRESUMPTION.

 a. Loss classification

 The proposed regulations generally provide that a debt charged off by a bank, in whole or in part, for regulatory purposes is conclusively presumed to have become worthless for tax purposes in the year it is charged off, provided the charge-off results from a specific order of the bank's supervisory authority or corresponds to the bank's classification of that debt as a loss asset for regulatory purposes. Commentators requested that the conformity presumption also be applied to assets that are treated as debts for tax purposes, even if the assets are not so treated for regulatory purposes and, therefore, are not subject to regulatory loss classification standards. In particular, commentators requested that the conformity presumption apply to loans accounted for on a cost recovery basis, interest accrual reversals, and in-substance foreclosures. Other commentators argued that the conformity presumption should be extended to charge-offs of debts that are classified as substandard or doubtful, rather than loss, or to debts that are classified as doubtful when charged off, but that become loss assets by year-end.

 The final regulations do not adopt these comments. The regulations limit the conformity presumption to debts classified as loss assets for regulatory purposes because the regulatory standards for classification of debts as loss assets are similar to the tax standards for determining worthlessness. See Report to the Congress on the Tax Treatment of Bad Debts by Financial Institutions, supra. If there were no requirement that a debt be classified as a loss asset for regulatory purposes, there would be no assurance that the charge-off was based on criteria that were consistent with Federal income tax principles and the bad debt deduction could be premature or excessive.

 b. Debts charged off in wrong year

 Commentators also asked for guidance on the tax treatment of a debt that is charged off in one year, when a bank's supervisory authority subsequently determines it should have been charged off in an earlier year. The commentators suggested that the debt should be presumed worthless for tax purposes in the year of the charge-off rather than in the earlier year, despite the after-the-fact determination by the supervisory authority.

 It is consistent with the concept of a conclusive presumption that a bank be permitted to claim a tax deduction for a debt charge- off for a year in which the bank satisfies the requirements of the presumption, notwithstanding that its regulator subsequently determines that the charge-off should have been made in an earlier year. Accordingly, the final regulations provide that a charge-off qualifies for the presumption in the year of the charge-off, provided the requirements of the regulations are otherwise satisfied. A pattern of charge-offs in the wrong year, however, may result in revocation of the bank's election.

PROP. REG. SECTION 1.166-2(d)(3)(iii): REQUIREMENTS.

 a. Express determination

 The proposed regulations provide that a bank qualifies for the conformity presumption only if its supervisory authority expressly determines, in connection with its most recent examination involving the bank's loan review process, that the bank maintains and applies loan review and loss classification standards that are consistent with those of the supervisory authority. Commentators requested guidance as to the form of the express determination and suggested that it be a standardized document that is separate from the confidential bank examination report. Commentators also asked that the regulations clarify which of a bank's supervisory authorities is required to provide the express determination in the case of a bank that is regulated by more than one supervisory authority. In addition, commentators suggested that relief be provided if the supervisory authority inadvertently fails to provide the determination.

 In response to these comments, the Internal Revenue Service is releasing concurrently with these regulations a revenue procedure ( Rev. Proc. 92-18, to be published in Internal Revenue Bulletin No. 1992-10, (March 9, 1992) that sets forth the form and content of the express determination required by these regulations. Pursuant to Rev. Proc. 92-18, the determination is to be in the form of a letter, signed by the examiner-in-charge, that is not part of a bank's confidential examination report. In addition, the final regulations clarify that the express determination is to be provided by the supervisory authority that is the "appropriate Federal banking agency" as that term is defined in 12 U.S.C. section 1813(q). (The supervisory authority is the Farm Credit Administration in the case of a bank that is an institution in the Farm Credit System. See the discussion under the subheading "Definition of 'bank'" in this preamble, below.) The regulations, however, do not provide relief for an inadvertent failure of the supervisory authority to issue an express determination letter. Service examiners generally will not know whether the failure to issue the letter was intentional or inadvertent.

 b. Deduction required

 Commentators objected to the requirement that banks claim a deduction for all debts that qualify for the conformity presumption in the year the debts are charged off. More specifically, they requested that this requirement not apply in the case of partially worthless debts because, under existing rules, a bank may claim a deduction for a partially worthless debt in the year it charges off the debt or in a later year until the debt becomes totally worthless.

 The conformity presumption provides greater certainty and consistency in the tax treatment of bank bad debts by permitting a bank to elect to conform its tax accounting for bad debts to its regulatory accounting. Permitting a bank to claim a bad debt deduction for a year subsequent to the year in which a debt is charged off as worthless for regulatory purposes is inconsistent with tax-book conformity. The final regulations, therefore, continue the rule of the proposed regulations on this point.

 In addition, the final regulations provide that, if a conformity election is in effect, a bad debt deduction for a debt that is subject to regulatory loss classification standards is allowed for a taxable year only to the extent that the debt is conclusively presumed to have become worthless under the presumption during that year. Only debt charge-offs that are outside the scope of the conclusive presumption because the debts are not subject to regulatory loss classification standards may be accounted for under the general rules of section 166. The proposed regulations cited reporting standards proposed by the Federal Financial Institutions Examination Council as an example of a situation in which debts would be outside the scope of the conclusive presumption. These proposed standards, however, have been withdrawn. See 56 FR 37214 (8-5-91). Most debts are subject to regulatory loss classification standards. Therefore, if a bank makes the conformity election, deductions will be allowed for such debts only for the year in which the debts are conclusively presumed to become worthless under these regulations.

PROP. REG. SECTION 1.166-2(d)(3)(iv): ELECTION.

 a. Effective date

 The conformity election was proposed to be available for taxable years ending after finalization of the regulations. Commentators requested that the regulations be effective retroactively for taxable years beginning after December 31, 1986. These commentators stated that the repeal of the section 585(b) reserve method of accounting for large banks for taxable years beginning after 1986 placed more of an emphasis on a bank's deductions for specific debts and increased the need for a conclusive presumption of worthlessness. In addition, they argued that the Office of the Comptroller of the Currency (the "OCC") changed its practice during those years and did not provide written letters confirming voluntary charge-offs of specific debts.

 The final regulations are effective for taxable years ending on or after December 31, 1991. Prior to the publication of the regulations, banks presumably did not precisely conform their bad debt deductions and their classification of debts as loss assets. Moreover, their supervisory authorities were not making express determinations that the banks maintained and applied loan review and loss classification standards that were consistent with those of the supervisory authorities. This is an essential element of the regulations and precludes their retroactive application.

 b. Election requirements

 Under the proposed regulations, a bank elects the conformity presumption for a taxable year (and all succeeding taxable years) by attaching a written statement to its return in which it declares that certain requirements of the regulations are satisfied and will continue to be satisfied until the election is revoked. Some commentators objected to the "future compliance" portion of the declaration. Others requested that banks be permitted to make the conformity election on a bank-by-bank basis, rather than on a group basis.

 In response to these comments, the final regulations do not require a bank to represent its future intent when making an election. They do require, however, that the bank represent at the time the election is made that the express determination requirement is met. In addition, the final regulations clarify that the election is to be made on a bank-by-bank basis, rather than on a group basis. This is the approach taken when banks adopt the reserve or specific charge-off method of accounting for bad debts and when large banks that are required to change from the reserve method of accounting pursuant to section 585(c) make elections with respect to that change.

 c. Method of accounting

 Under the proposed regulations, the making or revoking of the conformity election is a change in the bank's method of accounting. Commentators suggested that the making of the conformity election is not a method change but a change in the manner in which the Service audits bad debts.

 The making or revoking of the conformity election affects the treatment of a material item in that it changes the timing of a bank's bad debt deduction. Accordingly, the final regulations continue to treat the making or revoking of the election as a change in method of accounting. Therefore, the regulations require that the bank file a Form 3115 (Application for Change in Accounting Method) when it makes or revokes the election. When making the election, the bank must provide a declaration that it currently satisfies the express determination requirement in the space provided on the form for "Other changes in method of accounting" (Schedule D, Part V of Form 3115, as revised in July of 1991). The form for the initial election must be attached to the bank's income tax return for the year of the election, and the Commissioner's consent will be granted automatically. The final regulations also provide similar rules for a new bank that adopts this method of accounting when it adopts its overall method of accounting for bad debts. To make a conformity election after a previous election has been revoked or to voluntarily revoke the election, the bank must obtain the advance consent of the Commissioner by filing a Form 3115 with the National Office pursuant to section 446(e) and section 1.446-1(e) (including any applicable procedure prescribed thereunder).

 The change in method of accounting that results from making or revoking the conformity election is implemented under a cut-off approach and no adjustment under section 481(a) is required or permitted. The final regulations provide a special rule for the situation in which the book and tax bases of a debt are not equal as a result of there having been a partial charge-off for regulatory purposes for which no tax deduction was claimed by the time of the conformity election. Under this rule, the deduction reflecting the partial charge-off must be claimed in the first post-election year in which there is any further charge-off of the debt for regulatory purposes.

 d. Transition period

 The proposed regulations provide a transition rule that permits a bank to make the conformity election prior to receiving its first express determination from its supervisory authority. The proposed rules require a bank to represent that its internal loan review and loss classification process was not criticized by its supervisory authority on its most recent regulatory examination. Many commentators stated that few banks, for various reasons, would be able to make this representation. In response to this comment, the final regulations replace the "no criticism" representation with a requirement that the bank represent that it maintains and applies loan review and loss classification standards that are consistent with those of its supervisory authority, i.e., its appropriate Federal banking agency.

PROP. REG. SECTION 1.166-2(d)(3)(v): REVOCATION BY COMMISSIONER.

 The proposed regulations authorize the Commissioner to revoke a conformity election, but only if the bank fails to satisfy the conformity requirements for any taxable year or if it has claimed deductions that exceed those warranted by the exercise of reasonable business judgment in applying the regulatory standards. Commentators argued that the Commissioner should not be authorized to revoke a conformity election if a bank substantially complies with the election's requirements. Commentators also requested clarification as to whether a bank's failure to satisfy the conformity requirements or a bank's claiming of excessive deductions automatically revoked the election or were merely grounds for revocation by the Commissioner.

 A supervisory authority's express determination, as described in Rev. Proc. 92-18, permits some flexibility in the application of a bank's loan review and loss classification standards, in that immaterial deviations from regulatory standards in the case of individual loans do not preclude the issuance of an express determination. In view of this flexibility, the final regulations do not adopt a substantial compliance standard.

 The final regulations clarify that a bank's claiming of excessive charge-offs and deductions under the conformity election is merely grounds for revocation of that election by the Commissioner and does not result in automatic revocation. The final regulations also clarify that the Commissioner may revoke a conformity election if a bank fails to follow the method of accounting dictated by the election.

 The final regulations do provide, however, that an election is revoked automatically if a bank fails to obtain the requisite express determination. The revocation generally is effective as of the beginning of the taxable year that includes the date as of which the bank's loans were examined. If the bank relies on the transition rule for making the conformity election prior to its first opportunity to obtain an express determination, the revocation is effective as of the beginning of the taxable year of the bank's conformity election or, if later, the earliest taxable year for which tax may be assessed.

PROP. REG. SECTION 1.166-2(d)(4): DEFINITIONS.

 a. Definition of "bank"

 The proposed regulations define a "bank" with reference to section 581 and, therefore, the term does not include foreign banks. Commentators asked that the definition be broadened to include banks incorporated outside the United States that carry on a banking business effectively connected with the United States, and institutions in the Farm Credit System regulated by the Farm Credit Administration. In response to these comments, the final regulations expand the definition of "bank" to include banks described in section 585(a)(2)(B). Accordingly, foreign banks may qualify for the conformity presumption with respect to loans the interest on which is effectively connected with the conduct of a banking business within the United States. In addition, the final regulations treat institutions in the Farm Credit System as banks for purposes of the conformity election.

 b. Definition of "charge-off"

 A "charge-off" is defined by the proposed regulations to include, for banks regulated by the Office of Thrift Supervision (the "OTS"), the establishment of specific allowances for loan losses in the amount of 100 percent of the portion of the debt classified as loss. Commentators stated that this definition should be expanded to cover specific reserves established by banks that are not regulated by the OTS. Commentators also requested that the definition of charge-off be expanded to cover allocated transfer risk reserves ("ATRRs").

 Because OTS is the only supervisory authority that requires the establishment of specific reserves in lieu of actual write-downs of loans, it is not appropriate that these regulations broaden the definition of charge-off in the manner requested. Revenue Ruling 84-94, 1984-1 C.B. 34, provides that banks that are directed by the Federal banking agencies to establish ATRRs are treated as having been specifically ordered to charge off amounts in the ATRRs for purposes of the existing conclusive presumption under section 1.166-2(d)(1). Because this revenue ruling was issued prior to adoption of the conformity election, the Service is revising and republishing the ruling concurrently with the issuance of these final regulations to extend the holding to banks that make the conformity election. See Rev. Rul. 92-14, released concurrently with these regulations, to be published in Internal Revenue Bulletin 1992-10, (March 9, 1992).

INTEREST ON NONPERFORMING LOANS

 Several commentators requested that the conformity presumption be extended to the nonaccrual of interest on nonperforming loans) This issue is beyond the scope of these regulations. For an in-depth analysis of the appropriateness of applying a tax-book conformity standard to interest accruals on nonperforming loans, see Report to the Congress on the Tax Treatment of Bad Debts by Financial Institutions, supra.

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has also been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to these regulations and, therefore, an initial Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on their impact on small business.

DRAFTING INFORMATION

 The principal author of these regulations is Bernita L. Thigpen, Office of the Assistant Chief Counsel (Financial Institutions and Products), Internal Revenue Service. However, personnel from other offices of the IRS and Treasury Department participated in their development.

LIST OF SUBJECTS

26 CFR 1.161-1 through 1.194-4

 Income taxes, Reporting and recordkeeping requirements. 26 CFR Part 602

 Reporting and recordkeeping requirements.

Treasury Decision 8396

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, title 26, chapter I, parts 1 and 602 of the Code of Federal Regulations are amended as follows:

PART 1 -- INCOME TAX; TAXABLE YEARS BEGINNING AFTER DECEMBER 31, 1953

Paragraph 1. The authority for part 1 continues to read in part:

Authority: Sec. 7805, 68A Stat. 917 (26 U.S.C. 7805) * * *

Par. 2. Section 1.166-2 is amended by adding new paragraphs (d)(3) and (d)(4) to read as follows:

SECTION 1.166-2 EVIDENCE OF WORTHLESSNESS.

* * * * *

(d) * * *

(3) CONFORMITY ELECTION -- (i) ELIGIBILITY FOR ELECTION. In lieu of applying paragraphs (d)(1) and (2) of this section, a bank (as defined in paragraph (d)(4)(i) of this section) that is subject to supervision by Federal authorities, or by state authorities maintaining substantially equivalent standards, may elect under this paragraph (d)(3) to use a method of accounting that establishes a conclusive presumption of worthlessness for debts, provided that the bank meets the express determination requirement of paragraph (d)(3)(iii)(D) of this section for the taxable year of the election.

(ii) CONCLUSIVE PRESUMPTION -- (A) IN GENERAL. If a bank satisfies the express determination requirement of paragraph (d)(3)(iii)(D) of this section and elects to use the method of accounting under this paragraph (d)(3) --

(1) Debts charged off, in whole or in part, for regulatory purposes during a taxable year are conclusively presumed to have become worthless, or worthless only in part, as the case may be, during that year, but only if the charge-off results from a specific order of the bank's supervisory authority or corresponds to the bank's classification of the debt, in whole or in part, as a loss asset, as described in paragraph (d)(3)(ii)(C) of this section; and

(2) A bad debt deduction for a debt that is subject to regulatory loss classification standards is allowed for a taxable year only to the extent that the debt is conclusively presumed to have become worthless under paragraph (d)(3)(ii)(A)(1) of this section during that year.

(B) CHARGE-OFF SHOULD HAVE BEEN MADE IN EARLIER YEAR. The conclusive presumption that a debt is worthless in the year that it is charged off for regulatory purposes applies even if the bank's supervisory authority determines in a subsequent year that the charge-off should have been made in an earlier year. A pattern of charge-offs in the wrong year, however, may result in revocation of the bank's election by the Commissioner pursuant to paragraph (d)(3)(iv)(D) of this section.

(C) LOSS ASSET DEFINED. A debt is classified as a loss asset by a bank if the bank assigns the debt to a class that corresponds to a loss asset classification under the standards set forth in the "Uniform Agreement on the Classification of Assets and Securities Held by Banks" (See Attachment to Comptroller of the Currency Banking Circular No. 127, Rev. 4-26-91, Comptroller of the Currency, Communications Department, Washington, DC 20219) or similar guidance issued by the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Board of Governors of the Federal Reserve, or the Farm Credit Administration; or for institutions under the supervision of the Office of Thrift Supervision, 12 CFR 563.160(b)(3).

(iii) ELECTION -- (A) IN GENERAL. An election under this paragraph (d)(3) is to be made on a bank-by-bank basis and constitutes either the adoption of or a change in method of accounting, depending on the particular bank's facts. A change in method of accounting that results from the making of an election under this paragraph (d)(3) has the effects described in paragraph (d)(3)(iii)(B) of this section.

(B) EFFECT OF CHANGE IN METHOD OF ACCOUNTING. A change in method of accounting resulting from an election under this paragraph (d)(3) does not require or permit an adjustment under section 481(a). Under this cut-off approach --

(1) There is no change in the section 1.1011-1 adjusted basis of the bank's existing debts (as determined under the bank's former method of accounting for bad debts) as a result of the change in method of accounting;

(2) With respect to debts that are subject to regulatory loss classification standards and are held by the bank at the beginning of the year of change (to the extent they have not been charged off for regulatory purposes), and with respect to debts subject to regulatory loss classification standards that are originated or acquired subsequent to the beginning of the year of change, bad debt deductions in the year of change and thereafter are determined under the method of accounting for bad debts prescribed by this paragraph (d)(3);

(3) With respect to debts that are not subject to regulatory loss classification standards or that have been totally charged off prior to the year of change, bad debt deductions are determined under the general rules of section 166; and

(4) If there was any partial charge-off of a debt in a pre- change year, any portion of which was not claimed as a deduction, the deduction reflecting that partial charge-off must be taken in the first year in which there is any further charge-off of the debt for regulatory purposes.

(C) PROCEDURES -- (1) IN GENERAL. A new bank adopts the method of accounting under this paragraph (d)(3) for any taxable year ending on or after December 31, 1991 (and for all subsequent taxable years) when it adopts its overall method of accounting for bad debts, by attaching a statement to this effect to its income tax return for that year. Any other bank makes an election for any taxable year ending on or after December 31, 1991 (and for all subsequent taxable years) by filing a completed Form 3115 (Application for Change in Accounting Method) in accordance with the rules of paragraph (d)(3)(iii)(C)(2) or (3) of this section. The statement or Form 3115 must include the name, address, and taxpayer identification number of the electing bank and contain a declaration that the express determination requirement of paragraph (d)(3)(iii)(D) of this section is satisfied for the taxable year of the election) When a Form 3115 is used, the declaration must be made in the space provided on the form for "Other changes in method of accounting." The words "ELECTION UNDER section 1.166-2(d)(3)" must be typed or legibly printed at the top of the statement or page 1 of the Form 3115.

(2) FIRST ELECTION. The first time a bank makes this election, the statement or Form 3115 must be attached to the bank's timely filed return (taking into account extensions of time to file) for the first taxable year covered by the election. The consent of the Commissioner to make a change in method of accounting under this paragraph (d)(3) is granted, pursuant to section 446(e), to any bank that makes the election in accordance with this paragraph (d)(3)(iii)(C), provided the bank has not made a prior election under this paragraph (d)(3)).

(3) SUBSEQUENT ELECTIONS. The advance consent of the Commissioner is required to make any election under this paragraph (d)(3) after a previous election has been revoked pursuant to paragraph (d)(3)(iv) of this section. This consent must be requested under the procedures, terms, and conditions prescribed under the authority of section 446(e) and section 1.446-1(e) for requesting a change in method of accounting.

(D) EXPRESS DETERMINATION REQUIREMENT. In connection with its most recent examination involving the bank's loan review process, the bank's supervisory authority must have made an express determination (in accordance with any applicable administrative procedure prescribed hereunder) that the bank maintains and applies loan review and loss classification standards that are consistent with the regulatory standards of that supervisory authority. For purposes of this paragraph (d)(3)(iii)(D), the supervisory authority of a bank is the "appropriate Federal banking agency" for the bank, as that term is defined in 12 U.S.C. 1813(q) or, in the case of an institution in the Farm Credit System, the Farm Credit Administration.

(E) TRANSITION PERIOD ELECTION. For taxable years ending before completion of the first examination of the bank by its supervisory authority (as defined in paragraph (d)(3)(iii)(D) of this section) that is after December 31, 1991, and that involves the bank's loan review process, the statement or Form 3115 filed by the bank must include a declaration that the bank maintains and applies loan review and loss classification standards that are consistent with the regulatory standards of that supervisory authority. A bank that makes this declaration is deemed to satisfy the express determination requirement of paragraph (d)(3)(iii)(D) of this section for those years, even though an express determination has not yet been made.

(iv) REVOCATION OF ELECTION -- (A) IN GENERAL. Revocation of an election under this paragraph (d)(3) constitutes a change in method of accounting that has the effects described in paragraph (d)(3)(iv)(B) of this section. If an election under this paragraph (d)(3) has been revoked, a bank may make a subsequent election only under the provisions of paragraph (d)(3)(iii)(C)(3) of this section.

(B) EFFECT OF CHANGE IN METHOD OF ACCOUNTING. A change in method of accounting resulting from revocation of an election under this paragraph (d)(3) does not require or permit an adjustment under section 481(a). Under this cut-off approach --

(1) There is no change in the section 1.1011-1 adjusted basis of the bank's existing debts (as determined under this paragraph (d)(3) method or any other former method of accounting used by the bank with respect to its bad debts) as a result of the change in method of accounting; and

(2) Bad debt deductions in the year of change and thereafter with respect to all debts held by the bank, whether in existence at the beginning of the year of change or subsequently originated or acquired, are determined under the new method of accounting)

(C) AUTOMATIC REVOCATION -- (1) IN GENERAL. A bank's election under this paragraph (d)(3) is revoked automatically if, in connection with any examination involving the bank's loan review process by the bank's supervisory authority as defined in paragraph (d)(3)(iii)(D) of this section, the bank does not obtain the express determination required by that paragraph.

(2) YEAR OF REVOCATION. If a bank makes the conformity election under the transition rules of paragraph (d)(3)(iii)(B) of this section and does not obtain the express determination in connection with the first examination involving the bank's loan review process that is after December 31, 1991, the election is revoked as of the beginning of the taxable year of the election or, if later, the earliest taxable year for which tax may be assessed. In other cases in which a bank does not obtain an express determination in connection with an examination of its loan review process, the election is revoked as of the beginning of the taxable year that includes the date as of which the supervisory authority conducts the examination, even if the examination is completed in the following taxable year.

(3) CONSENT GRANTED. Under the Commissioner's authority in section 446(e) and section 1.446-1(e), the bank is directed to and is granted consent to change from this paragraph (d)(3) method as of the year of revocation (year of change) prescribed by paragraph (d)(3)(iv)(C)(2) of this section.

(4) REQUIREMENTS. A bank changing its method of accounting under the automatic revocation rules of this paragraph (d)(3)(iv)(C) must attach a completed Form 3115 to its income tax return for the year of revocation prescribed by paragraph (d)(3)(iv)(C)(2) of this section. The words "REVOCATION OF section 1.166-2(d)(3) ELECTION" must be typed or legibly printed at the top of page 1 of the Form 3115. If the year of revocation is a year for which the bank has already filed its income tax return, the bank must file an amended return for that year reflecting its change in method of accounting and must attach the completed Form 3115 to that amended return. The bank also must file amended returns reflecting the new method of accounting for all subsequent taxable years for which returns have been filed and tax may be assessed.

(D) REVOCATION BY COMMISSIONER. An election under this paragraph (d)(3) may be revoked by the Commissioner as of the beginning of any taxable year for which a bank fails to follow the method of accounting prescribed by this paragraph. In addition, the Commissioner may revoke an election as of the beginning of any taxable year for which the Commissioner determines that a bank has taken charge-offs and deductions that, under all facts and circumstances existing at the time, were substantially in excess of those warranted by the exercise of reasonable business judgment in applying the regulatory standards of the bank's supervisory authority as defined in paragraph (d)(3)(iii)(D) of this section.

(E) VOLUNTARY REVOCATION. A bank may apply for revocation of its election made under this paragraph (d)(3) by timely filing a completed Form 3115 for the appropriate year and obtaining the consent of the Commissioner in accordance with section 446(e) and section 1.446-1(e) (including any applicable administrative procedures prescribed thereunder). The words "REVOCATION OF section 1.166-2(d)(3) ELECTION" must be typed or legibly printed at the top of page 1 of the Form 3115. If any bank has had its election automatically revoked pursuant to paragraph (d)(3)(iv)(C) of this section and has not changed its method of accounting in accordance with the requirements of that paragraph, the Commissioner will require that any voluntary change in method of accounting under this paragraph (d)(3)(iv)(E) be implemented retroactively pursuant to the same amended return terms and conditions as are prescribed by paragraph (d)(3)(iv)(C) of this section.

(4) DEFINITIONS. For purposes of this paragraph (d) --

(i) BANK. The term "bank" has the meaning assigned to it by section 581. The term "bank" also includes any corporation that would be a bank within the meaning of section 581 except for the fact that it is a foreign corporation, but this paragraph (d) applies only with respect to loans the interest on which is effectively connected with the conduct of a banking business within the United States. In addition, the term "bank" includes a Farm Credit System institution that is subject to supervision by the Farm Credit Administration.

(ii) CHARGE-OFF. For banks regulated by the Office of Thrift Supervision, the term "charge-off" includes the establishment of specific allowances for loan losses in the amount of 100 percent of the portion of the debt classified as loss.

PART 602 -- OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

Par. 3. The authority citation for part 602 continues to read as follows:

Authority: 26 U.S.C. 7805

Section 602.101 [Amended]

Par. 4. Section 602.101(c) is amended by adding the following entry to the table, "1.166-2 . . . 1545-1254".

Michael J. Murphy

 

Acting Commissioner of Internal Revenue

 

Approved: January 15, 1992

 

Kenneth W. Gideon

 

Assistant Secretary of the Treasury
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