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Regs on Bank Bad Debts

OCT. 18, 1993

T.D. 8492; 58 F.R. 53656-53658

DATED OCT. 18, 1993
DOCUMENT ATTRIBUTES
Citations: T.D. 8492; 58 F.R. 53656-53658

 [4830-01-u]

 

 DEPARTMENT OF THE TREASURY

 

 Internal Revenue Service

 

 26 CFR Part 1

 

 [T.D. 8492]

 

 RIN 1545-AQ95

 

 

 AGENCY: Internal Revenue Service (IRS), Treasury.

 ACTION: Final and temporary regulations.

 SUMMARY: This document contains final regulations that clarify the scope of the express determination that is required under section 1.166-2(d)(3) in order for a bank to elect to use a method of accounting that conforms tax accounting for bad debts to regulatory accounting (conformity election). Section 1.166-2(d)(3) provides a conclusive presumption that debts charged off for regulatory purposes are worthless for tax purposes. The final regulations affect banks that have made or intend to make an election under section 1.166-2(d)(3).

 DATES: These regulations are effective October 18, 1993. These regulations apply to taxable years ending on or after December 31, 1991.

 FOR FURTHER INFORMATION CONTACT: Craig Wojay, 202-622-3920 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

BACKGROUND

On October 2, 1992, the Internal Revenue Service published in the Federal Register (57 FR 45568) a notice of proposed rulemaking that, by cross reference to temporary regulations, proposed to amend section 1.166-2(d)(3) of the income tax regulations to clarify the scope of the express determination requirement in section 1.166-2(d)(3)(iii)(D). The language of the uniform express determination letter set forth in Rev. Proc. 92-18, 1992-1 C.B. 684, required similar clarification. Accordingly, Rev. Proc. 92-18 was modified and superseded by Rev. Proc. 92-84, 1992-2 C.B. 489. The revisions did not alter the intended scope of the express determination requirement.

 In addition, an amendment to the transition rules in section 1.166-2(d)(3)(iii)(E) of the regulations was proposed because a bank may have been unable to obtain an express determination letter in connection with a Federal supervisory examination of its loan review process that occurred after December 31, 1991, and before October 2, 1992. Extension of the transitional period for which a bank may make the conformity election without an express determination would prevent the automatic revocation under section 1.166-2(d)(3)(iv) of an election made by a bank for its 1991 taxable year in reliance on the regulations.

 No public hearing on these regulations was requested or held, but written comments were received. After consideration of the written comments, the temporary regulations are adopted as modified by this Treasury decision.

EXPLANATION OF PROVISIONS

 Section 1.166-2(d)(3) of the regulations permits supervised banks to elect a method of accounting under which their debts generally are conclusively presumed to be worthless for Federal income tax purposes when the debts are charged off for regulatory purposes. One of the requirements for this "conformity presumption" is that the bank obtain an express determination letter from its supervisory authority in connection with the most recent examination involving the bank's loan review process.

 Prior to the temporary regulations, section 1.166-2(d)(3)(iii)(D) required an express determination by a bank's supervisory authority that the bank maintains and applies loan review and loss classification standards that are consistent with those of its supervisory authority. Transitional rules in sections 1.166-2(d)(3)(iii)(E) and 1.166-2(d)(3)(iv)(C)(2) permitted a bank to make an election to use the conformity presumption without an express determination letter for taxable years ending on or after December 31, 1991, and before completion of the first examination involving the bank's loan review process that is after December 31, 1991, provided certain requirements are satisfied.

 After the regulations were finalized, a notice of proposed rulemaking by cross reference to temporary regulations was published to alleviate concerns pertaining to the scope of the express determination requirement in section 1.166-2(d)(3). The final regulations contained in this document amend section 1.166-2(d)(3) to require that a bank's supervisory authority expressly determine that the bank maintains and applies "loan loss classification standards," rather than "loan review and loss classification standards" that are consistent with regulatory standards. See section 1.166-2(d)(3)(iii)(D). In addition, the transition rules in section 1.166-2(d)(3) are being amended to allow a bank to make the conformity election without an express determination letter until its first examination (involving the loan review process) that is after October 1, 1992, rather than December 31, 1991. See section 1.166-2(d)(3)(iii)(E) and (d)(3)(iv)(C)(2). Therefore, a bank that made the conformity election for its first taxable year ending on or after December 31, 1991, is not required to obtain an express determination letter until the completion of its first Federal examination that is after October 1, 1992, regardless of possible intervening examinations between December 31, 1991, and October 2, 1992.

 Three comments were received on the regulations. The first comment requested relief for any bank that, because of the delay in resolving issues related to the express determination letters, did not make a conformity election for a taxable year ending on or after December 31, 1991.

 In response to this comment, the Service is releasing concurrently with these regulations Notice 93-50, to be published in Internal Revenue Bulletin No. 1993-34, November 1, 1993, which allows certain banks, on an amended return for a taxable year ending on or after December 31, 1991, to elect to use the conformity method of accounting. The Notice prescribes a period of time in which the election may be made.

 The second comment raised the concern that small State-chartered banks may not be able to rely on the conformity presumption for tax years in which they are examined by State banking agencies. Although a small State-chartered bank may not be examined by a Federal banking agency on an annual basis, this does not prejudice the bank's eligibility to use the conformity presumption. Section 1.166-2(d)(3)(iii)(D) requires an express determination letter only upon an examination of a bank's loan review process by a Federal banking agency. When the letter is issued, it covers all tax years until the next such Federal examination. Although a bank may be examined by its State banking authority in an intervening year, the bank is not required to obtain a new determination letter from that authority.

 The final comment requested that the conformity presumption be extended to debts that are classified as substandard or doubtful, rather than limited to debts that are classified as loss. This issue was carefully considered during the drafting of the final regulations under section 1.166-2(d)(3), which were published in the Federal Register on February 24, 1992 (57 FR 6291), and was not adopted for the reasons expressed at that time. Moreover, this issue is beyond the scope of this regulation project.

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, a Regulatory Flexibility Analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking for the regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

DRAFTING INFORMATION

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

LIST OF SUBJECTS IN 26 CFR PART 1

 Income taxes, Reporting and recordkeeping requirements.

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR part 1 is amended as follows:

PART 1 -- INCOME TAXES

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

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.166-2 is amended by revising paragraphs (d)(3)(iii)(D), (d)(3)(iii)(E), and (d)(3)(iv)(C)(2) to read as follows:

SECTION 1.166-2 EVIDENCE OF WORTHLESSNESS.

* * * * *

(d) * * *

(3) * * *

(iii) * * *

(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 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 October 1, 1992, 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 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) * * *

(C) * * *

(2) YEAR OF REVOCATION. If a bank makes the conformity election under the transition rules of paragraph (d)(3)(iii)(E) 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 October 1, 1992, 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.

* * * * *

Par. 3. Section 1.166-2T is removed.

Margaret Milner Richardson

 

Commissioner of Internal Revenue

 

Approved: Samuel Y. Sessions

 

Assistant Secretary of the Treasury

 

August 19, 1993
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