Rev. Rul. 70-124

The Internal Revenue Service has been asked to clarify item 8 of Revenue Ruling 66-26, C.B. 1966-1, 41, which provides guidelines for computing annual reserve additions for bad debts by banks for taxable years ending after December 31, 1964.

Item 8 of Revenue Ruling 66-26 provides, in pertinent part, that the order in which the factors that make up the annual reserve addition should be claimed is: 1. net bad debts charged to the reserve; 2. an amount equal to one-tenth of the reserve deficiency; and, 3. an amount attributable to any increase in outstanding loans. A bank is not required to take as a tax deduction its maximum permissible annual reserve addition for each taxable year, and unused portions of the above factors may be used in a subsequent year.

The specific question raised is whether the portion of net bad debts charged to bad debt reserve in a taxable year which is in excess of the applicable limitations contained in section 4 or 6 of Revenue Ruling 65-92, C.B. 1965-1, 112, may be deducted in a subsequent taxable year.

Revenue Ruling 65-92 sets forth a revised method for computing annual additions to reserves for bad debts by banks for taxable years ending after December 31, 1964. Sections 4, 5, and 6 of Revenue Ruling 65-92 provide respectively the computations where reserves are less than the uniform ratio, where reserves exceed the uniform ratio, and the manner of computing the maximum annual reserve addition.

In those situations where the net bad debts charged to the reserve during a taxable year exceed the maximum permissible reserve addition for such year, computed pursuant to Revenue Ruling 65-92, the excess may be used in computing the reserve addition in a subsequent taxable year. Such excess is part of the "unused portions" referred to in item 8 of Revenue Ruling 66-26. In those situations where the net bad debts for a taxable year are less than the maximum permissible reserve addition for such year, the net bad debts for such year are deductible in full. However, if the bank, in either situation, takes a deduction for a taxable year in an amount which is less than the net bad debts for such year then the difference between the amount taken and the net bad debts comprises, in part, the "unused portions" referred to in item 8 of Revenue Ruling 66-26 and is available to the bank to be used in a subsequent year, subject to the limitations set forth in section 4 or 6 of Revenue Ruling 65-92, whichever is applicable.

The above conclusions also apply to the net bad debts charged to the reserve of a bank that computes its additions under section 5 of Revenue Ruling 65-92, subject to the limitations therein set forth in sections 4, 5, or 6.

Revenue Ruling 66-26, C.B. 1966-1, 41, is clarified.