Bad debt tax deduction method proposed for financial institutions

ARTICLE | February 12, 2024

Authored by RSM US LLP

Executive summary

Are you in finance or tax management at a bank or insurance company? Would you like to simplify your tax accounting for credit losses? Doing so is optional. Read about the opportunity provided under recently proposed tax regulations.

Opportunity for credit loss deductions

Many banks, insurance companies and other financial companies now have an opportunity to simplify their tax accounting and deduct their book debt charge-offs on their tax returns. This opportunity is available for tax years ending on or after Dec. 28, 2023 under recently released proposed regulations.

Basing the tax charge-off amounts on the financial statement amounts can provide a tax computation that is simplified and has greater certainty. It may also provide acceleration of bad debt deductions. As a trade-off, applying this method can lessen tax-specific flexibility and judgment.

Who is eligible?

Not every financial company is eligible to apply credit loss book-tax accounting conformity under the proposed regulations.

Banks, bank holding companies, savings and loans, federal home loan banks, and farm credit institutions generally are eligible. However, credit unions and U.S. branches of foreign banks are not.

Regulated insurance companies are eligible; other insurance companies are not. Generally, a regulated insurance company is defined as a corporation:

1. Organized in the United States;
2. Subject to tax as an insurance company under the U.S. Tax Code;
3. Licensed, authorized or regulated by one or more States to sell insurance, reinsurance or annuity contracts to unrelated persons; and
4. Engaged in an insurance business.

Subsidiaries of eligible banks, insurance companies (and other companies descried above) may be eligible as well.

Which financial accounting standards could apply for tax?

The proposed regulations authorize all eligible taxpayers to apply generally accepted accounting principles (GAAP). The currently effective GAAP standard is commonly known as the current expected credit losses (CECL). CECL became effective for some companies for fiscal years beginning after Dec. 15, 2019, and became generally effective for all companies for years beginning after Dec. 15, 2022.

For insurance companies that do not produce GAAP financial statements, financial statements prepared under Statements of Statutory Accounting Principles (SSAP) standards would apply.

For a company applying the proposed regulations, a credit loss that meets the GAAP standard would be conclusively presumed correct for federal income tax purposes. Also, for insurance companies that do not produce GAAP financial statements, the credit losses recorded under SSAP principles would be presumed correct.

Would this rule apply to all debt instruments?

The proposed regulations would apply to debt instruments governed by section 166 of the Tax Code. They would not apply to certain corporate debt and government debt – debt meeting the definition of a “security” in section 165(g)(2)(C).

What about recoveries on previously written-off debt?

The proposed regulations do not require or permit book-tax conformity for recoveries on previously written-off debt. Companies conforming to financial accounting for charge-offs would still need to apply tax standards to their recoveries.

Conclusion

Applying the book-tax conformity provided in the proposed regulations can provide simplicity and greater certainty of tax computation. It may also provide acceleration of bad debt deductions. It is anticipated that many taxpayers would like to apply this recently-authorized tax accounting method. The IRS is expected to issue a Revenue Procedure providing details for this tax accounting method change.