26 U.S.C. § 585: Reserves for losses on loans of banks

§ 1.585-1 Reserve for losses on loans of banks.§ 1.585-2 Addition to reserve.§ 1.585-3 Special rules.§ 1.585-4 Reorganizations and asset acquisitions.§ 1.585-5 Denial of bad debt reserves for large banks.§ 1.585-6 Recapture method of changing from the reserve method of section 585.§ 1.585-7 Elective cut-off method of changing from the reserve method of section 585.§ 1.585-8 Rules for making and revoking elections under §§ 1.585-6 and 1.585-7.

Cases: First Nat'l Bank v. Commissioner, 83 T.C. 202 (1984)

(a) Reserve for bad debts

Amended 1986

1986 Pub. L. 99-514 Pub. L. 99–514, § 901(a)(1), amended subsec. (a) generally. Prior to amendment, subsec. (a) read as follows: “This section shall apply to the following financial institutions:
“(1) any bank (as defined in section 581) other than an organization to which section 593 applies, and
“(2) any corporation to which paragraph (1) would apply except for the fact that it is a foreign corporation, and in the case of any such foreign corporation this section shall apply only with respect to loans outstanding the interest on which is effectively connected with the conduct of a banking business within the United States.”

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(1) In general Except as provided in subsection (c), a bank shall be allowed a deduction for a reasonable addition to a reserve for bad debts. Such deduction shall be in lieu of any deduction under section 166(a).

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(2) Bank For purposes of this section—

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(A) In general The term “bank” means any bank (as defined in section 581).

Amended 1996

1996 Pub. L. 104-188 Pub. L. 104–188 struck out “other than an organization to which section 593 applies” after “section 581)”.

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(B) Banking business of United States branch of foreign corporation The term “bank” also includes any corporation to which subparagraph (A) would apply except for the fact that it is a foreign corporation. In the case of any such foreign corporation, this section shall apply only with respect to loans outstanding the interest on which is effectively connected with the conduct of a banking business within the United States.

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(b) Addition to reserves for bad debts

Amended 1976, 1990

1990 Pub. L. 101-508 Pub. L. 101–508, § 11801(c)(12)(D), redesignated par. (4) as (3).
1976 Pub. L. 94-455 Pub. L. 94–455 struck out “or his delegate” after “Secretary”.

(1) General rule For purposes of subsection (a), the reasonable addition to the reserve for bad debts of any financial institution to which this section applies shall be an amount determined by the taxpayer which shall not exceed the addition to the reserve for losses on loans determined under the experience method as provided in paragraph (2).

Amended 1986, 1990

1990 Pub. L. 101-508 Pub. L. 101–508, § 11801(c)(12)(C), substituted “shall not exceed the addition to the reserve for losses on loans determined under the experience method as provided in paragraph (2).” for “shall not exceed the greater of—
“(A) for taxable years beginning before 1988 the addition to the reserve for losses on loans determined under the percentage method as provided in paragraph (2), or
“(B) the addition to the reserve for losses on loans determined under the experience method as provided in paragraph (3).”
1986 Pub. L. 99-514 Pub. L. 99–514, § 901(d)(1), substituted “subsection (a)” for “section 166(c)”.

(2) Experience method The amount determined under this paragraph for a taxable year shall be the amount necessary to increase the balance of the reserve for losses on loans (at the close of the taxable year) to the greater of—

Amended 1981, 1990

1990 Pub. L. 101-508 Pub. L. 101–508, § 11801(a)(26), (c)(12)(D), redesignated par. (3) as (2) and struck out former par. (2) which related to use of percentage method for determining amount to add to reserve for bad debts.
1981 Pub. L. 97-34 Pub. L. 97–34 defined “allowable percentage” to mean 1.0 percent for taxable years beginning in 1982 and 0.6 percent for taxable years beginning after 1982, previously so applicable for taxable years beginning after 1981 and redefined “base year” by substituting the last taxable year beginning before 1976 for taxable years beginning after 1975 but before 1983, for the last taxable year beginning before 1976 for taxable years after 1975 but before 1982; and the last taxable year beginning before 1983 for taxable years beginning after 1982, for the last taxable year beginning before 1982 for taxable years beginning after 1981.

Cases: AmBase Corp. v. United States, 731 F.3d 109 (2d Cir. 2013)

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(A) the amount which bears the same ratio to loans outstanding at the close of the taxable year as (i) the total bad debts sustained during the taxable year and the 5 preceding taxable years (or, with the approval of the Secretary, a shorter period), adjusted for recoveries of bad debts during such period, bears to (ii) the sum of the loans outstanding at the close of such 6 or fewer taxable years, or

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(B) the lower of—

(i) the balance of the reserve at the close of the base year, or

(ii) if the amount of loans outstanding at the close of the taxable year is less than the amount of loans outstanding at the close of the base year, the amount which bears the same ratio to loans outstanding at the close of the taxable year as the balance of the reserve at the close of the base year bears to the amount of loans outstanding at the close of the base year.

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For purposes of this paragraph, the base year shall be the last taxable year before the most recent adoption of the experience method, except that for taxable years beginning after 1987 the base year shall be the last taxable year beginning before 1988.

(3) Regulations; definition of loan The Secretary shall define the term loan and prescribe such regulations as may be necessary to carry out the purposes of this section.

Amended 1976, 1990

1990 Pub. L. 101-508 Pub. L. 101–508, § 11801(c)(12)(D), (E), redesignated par. (4) as (3), substituted heading for one which read: “Regulations; definition of eligible loan, etc.”, and amended text generally. Prior to amendment, text read as follows: “The Secretary shall define the terms ‘loan’ and ‘eligible loan’ and prescribe such regulations as may be necessary to carry out the purposes of this section; except that the term ‘eligible loan’ shall not include—
“(A) a loan to a bank (as defined in section 581),
“(B) a loan to a domestic branch of a foreign corporation to which subsection (a)(2) applies,
“(C) a loan secured by a deposit (i) in the lending bank, or (ii) in an institution described in subparagraph (A) or (B) if the lending bank has control over withdrawal of such deposit,
“(D) a loan to or guaranteed by the United States, a possession or instrumentality thereof, or a State or a political subdivision thereof,
“(E) a loan evidenced by a security as defined in section 165(g)(2)(C),
“(F) a loan of Federal funds, and
“(G) commercial paper, including short-term promissory notes which may be purchased on the open market.” Former par. (3) redesignated (2).
1976 Pub. L. 94-455 Pub. L. 94–455 struck out “or his delegate” after “Secretary”.

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Amended 1986

1986 Pub. L. 99-514 Pub. L. 99–514, § 901(a)(2), added subsec. (c).

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(1) In general In the case of a large bank, this section shall not apply (and no deduction shall be allowed under any other provision of this subtitle for any addition to a reserve for bad debts).

(2) Large banks For purposes of this subsection, a bank is a large bank if, for the taxable year (or for any preceding taxable year beginning after December 31, 1986)—

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(A) the average adjusted bases of all assets of such bank exceeded $500,000,000, or

(B) such bank was a member of a parent-subsidiary controlled group and the average adjusted bases of all assets of such group exceeded $500,000,000.

(3) 4-year spread of adjustments

(A) In general Except as provided in paragraph (4), in the case of any bank which for its last taxable year before the disqualification year maintained a reserve for bad debts—

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(i) the provisions of this subsection shall be treated as a change in the method of accounting of such bank for the disqualification year,

(ii) such change shall be treated as having been made with the consent of the Secretary, and

(iii) the net amount of adjustments required by section 481(a) to be taken into account by the taxpayer shall be taken into account in each of the 4 taxable years beginning with the disqualification year with—

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(I) the amount taken into account for the 1st of such taxable years being the greater of 10 percent of such net amount or such higher percentage of such net amount as the taxpayer may elect, and

Amended 1988

1988 Pub. L. 100-647 Pub. L. 100–647, § 1009(a)(2)(B), substituted “such higher percentage of such net amount as the taxpayer may elect” for “such greater amount as the taxpayer may designate”.

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(II) the amount taken into account in each of the 3 succeeding taxable years being equal to the applicable fraction (determined in accordance with the following table for the taxable year involved) of the portion of such net amount not taken into account under subclause (I). The applicable If the case of the—fraction is— 1st succeeding year2⁄9 2nd succeeding year⅓ 3rd succeeding year4⁄9.

(B) Suspension of recapture for taxable year for which bank is financially troubled

(i) In general In the case of a bank which is a financially troubled bank for any taxable year—

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(I) no adjustment shall be taken into account under subparagraph (A) for such taxable year, and

(II) such taxable year shall be disregarded in determining whether any other taxable year is a taxable year for which an adjustment is required to be taken into account under subparagraph (A) or the amount of such adjustment.

(ii) Exception for elective recapture for 1st year Clause (i) shall not apply to the 1st taxable year referred to in subparagraph (A)(iii)(I) if the taxpayer elects a higher percentage in accordance with such subparagraph.

Amended 1988

1988 Pub. L. 100-647 Pub. L. 100–647, § 1009(a)(2)(C), substituted “elects a higher percentage” for “designates an amount”.

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(iii) Financially troubled bank For purposes of clause (i), the term “financially troubled bank” means any bank if, for the taxable year, the nonperforming loan percentage of such bank exceeds 75 percent.

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(iv) Nonperforming loan percentage For purposes of clause (iii), the term “nonperforming loan percentage” means the percentage determined by dividing—

(I) the sum of the outstanding balances of nonperforming loans of the bank as of the close of each quarter of the taxable year, by

(II) the sum of the amounts of equity of the bank as of the close of each such quarter.

In the case of a bank which is a member of a parent-subsidiary controlled group for the taxable year, the preceding sentence shall be applied with respect to such group.

(v) Other definitions For purposes of this subparagraph—

(I) Nonperforming loans The term “nonperforming loan” means any loan which is considered to be nonperforming by the primary Federal regulatory agency with respect to the bank.

(II) Equity The term “equity” means the equity of the bank as determined for Federal regulatory purposes.

(C) Coordination with estimated tax payments For purposes of applying section 6655(e)(2)(A)(i) with respect to any installment, the determination under subparagraph (B) of whether an adjustment is required to be taken into account under subparagraph (A) shall be made as of the last day prescribed for payment of such installment.

Amended 1987

1987 Pub. L. 100-203 Pub. L. 100–203 substituted “section 6655(e)(2)(A)(i)” for “section 6655(d)(3)”.

(4) Elective cut-off method If a bank makes an election under this paragraph for the disqualification year—

Amended 1988

1988 Pub. L. 100-647 Pub. L. 100–647, § 1009(a)(3), inserted at end “If the amount of the reserve referred to in subparagraph (B) as of the close of any taxable year exceeds the outstanding balance (as of such time) of the loans referred to in subparagraph (B), such excess shall be included in gross income for such taxable year.”

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(A) the provisions of this subsection shall not be treated as a change in the method of accounting of the taxpayer for purposes of section 481,

(B) the taxpayer shall continue to maintain its reserve for loans held by the bank as of the 1st day of the disqualification year and charge against such reserve any losses resulting from loans held by the bank as of such 1st day, and

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(C) no deduction shall be allowed under this section (or any other provision of this subtitle) for any addition to such reserve for the disqualification year or any subsequent taxable year.

If the amount of the reserve referred to in subparagraph (B) as of the close of any taxable year exceeds the outstanding balance (as of such time) of the loans referred to in subparagraph (B), such excess shall be included in gross income for such taxable year.

(5) Definitions For purposes of this subsection—

(A) Parent-subsidiary controlled group The term “parent-subsidiary controlled group” means any controlled group of corporations described in section 1563(a)(1). In determining the average adjusted bases of assets held by such a group, interests held by one member of such group in another member of such group shall be disregarded.

(B) Disqualification year The term “disqualification year” means, with respect to any bank, the 1st taxable year beginning after December 31, 1986, for which such bank was a large bank if such bank maintained a reserve for bad debts for the preceding taxable year.

Textual readingALL OF= a disqualification year

“the 1st taxable year beginning after December 31, 1986, for which such bank was a large bank”

“such bank maintained a reserve for bad debts for the preceding taxable year”

(C) Election made by each member In the case of a parent-subsidiary controlled group, any election under this section shall be made separately by each member of such group.

Amended 1988

1988 Pub. L. 100-647 Pub. L. 100–647, § 1009(a)(2)(A), added subpar. (C).