Rev. Rul. 65-92

SECTION 1. PURPOSE.

The purpose of this Revenue Ruling is to provide a uniform percentage for computing annual additions to reserves for bad debts by banks in order to minimize the large differences in permissible reserves now existing amount banks under prior rulings.

SEC. 2. BACKGROUND.

Section 166(a) of the Internal Revenue Code of 1954 allows a deduction for a debt which became worthless during the taxable year and, under certain circumstances, for a debt which is recoverable only in part and is charged off within the taxable year. Section 166(c) of the Code provides that, in lieu of any deduction under section 166(a) of the Code, there shall be allowed (in the discretion of the Secretary or his delegate) a deduction for a reasonable addition to a reserve for had debts.

Mimeograph 6209, C.B. 1947-2, 26, authorized, in the case of banks, a special method for computing an annual addition to the reserve for bad debts. Under this method, a bank's bad debt reserve ceiling was computed by reference to a moving average experience factor for determining the ratio of losses to loans on the basis of 20 years of experience, including the taxable year. For any portion of such 20-year period during which a bank was not in existence, the bank was authorized to use the average experience of other similar banks with respect to the same type of loans.

Revenue Ruling 54-148, C.B. 1954-1, 60, supplemented Mimeograph 6209 and authorized a bank to use an average experience factor based on any 20 consecutive years of experience after 1927.

The Internal Revenue Service has reexamined the above rulings in the light of the experience developed thereunder. The rulings have resulted in large variances in reserves among banks and in reserve ceilings not related to the probability of bad debts on outstanding loans.

The Service has therefore approved a revised special method for use by banks which is designed to minimize the existing large variances in permissible reserves. This method, which is set forth in sections 3 through 6 of this Revenue Ruling and which utilizes a uniform ratio of 2.4 percent of outstanding loans, has been approved by the Service in view of the reserve levels previously established by banks, and the special circumstances applicable to the banking industry. This method will not be used by the Service as a precedent for determining reasonable additions to reserves for bad debts by taxpayers other than banks.

SEC. 3. UNIFORM RESERVE RATIO.

In lieu of reserve computations made through the use of a loss experience factor determined on an individual basis as provided in section 7 of this Revenue Ruling, a bank will be allowed deductions for additions to its reserve for bad debts until the reserve equals 2.4 percent of loans outstanding at the close of the taxable year, subject to the exceptions and limitations prescribed in sections 4, 5, and 6 of this Revenue Ruling.

SEC. 4. RESERVE LESS THAN UNIFORM RATIO.

If the dollar balance of a bank's reserve, as of the close of its taxable year immediately preceding the year of the change, is less than 2.4 percent of loans outstanding at such time, the amount of the difference (referred to herein as the deficiency in the reserve) may be included in the bank's annual addition to the reserve in an amount not exceeding one-tenth of the deficiency in the reserve, commencing with the year of the change. Such amount need not be added in any specific taxable year but not more than one-tenth of the deficiency will be permitted in any one year. A bank computing its annual reserve addition under this section will also be pernitted to include in such addition an amount equal to net bad debts charged to the reserve during the year. Further, it will be permitted to include in such addition 2.4 percent of the increase in its loans outstanding at the end of the taxable year over loans outstanding at the end of the year preceding the year of change, to the extent that a reserve addition with respect to such increase has not been taken in a prior year. The sum of the foregoing amounts, however, may not exceed an amount sufficient to increase the reserve to 2.4 percent of outstanding loans at the end of the taxable year. Thus, if a decrease in a bank's year-end outstanding loans has resulted in a reserve ratio in excess of 2.4 percent, no addition to the reserve would be permitted for that year. If a bank changes to the reserve method of accounting, it shall be treated, for purposes of this section, as having a reserve of zero for the taxable year immediately preceding the year of the change.

SEC. 5. RESERVE EXCEEDING UNIFORM RATIO.

If the dollar balance of a bank's reserve, as of the close of its taxable year ending in 1964, exceeds 2.4 percent of loans outstanding at such time, the addition to the reserve in any taxable year shall not increase the reserve above the greater of (i) such dollar balance, or (ii) 2.4 percent of loans outstanding at the close of the taxable year. Thus, a bank which has reserves exceeding 2.4 percent of outstanding loans may maintain the dollar balance of its reserve by making additions to its reserve equal to the net amount of bad debts charged to the reserve during the year. Notwithstanding the preceding rules of this section, 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 taxable year ending in 1964, the addition to the reserve shall not increase the reserve at the close of the taxable year to a percentage of outstanding loans which is larger than the percentage which the reserve bore to outstanding loans at the close of the taxable year ending in 1964.

SEC. 6. MAXIMUM ANNUAL RESERVE ADDITION.

Notwithstanding the provisions of section 4 and 5 of this ruling, the addition to the reserve that a bank will be permitted in a taxable year though the use of the uniform reserve ratio shall not exceed an amount equal to 0.8 percent of loans outstanding at the end of the taxable year, or an amount sufficient to bring the reserve to 0.8 percent of loans outstanding at the end of the taxable year, whichever amount is greater.

SEC. 7. PROBABLE EXPERIENCE METHOD.

In lieu of reserve computations made through the use of the uniform reserve ratio under sections 3 through 6 of this Revenue Ruling, a bank may compute its annual reserve additions under the method provided in this section. If a bank so computes its addition, it must establish, to the satisfaction of the District Director of Internal Revenue, that the amount computed is necessary in order to absorb the bad debts probably arising on loans outstanding at the close of the taxable year. In such event, the reasonableness of the proposed addition for the taxable year shall be determined under the provisions of section 166(c) of the Code in light of the facts existing at the close of such year. Thus, the reasonableness of the addition shall depend upon the total amount of the existing reserve and current business conditions, the nature of the bank's loans, the bank's past experience, and other factors, which may reasonably be expected to have a significant effect on the collection of the loans outstanding at the close of the taxable year. The reasonableness of the addition shall not, however, be based upon mere speculation, possibility, or contingency. For purposes of this section, the addition to the reserve for any taxable year will be regarded as reasonable if it does not increase the balance of the reserve (as of the close of such year) above an amount equal to the total amount of loans outstanding at the close of such year multiplied by the `moving average experience percentage' for such year. In determining the moving average experience percentage, reference shall be made to the bad debt experience of the bank with respect to its loans for a 6-year period comprising the taxable year and the 5 preceding taxable years. The moving average percentage shall be computed as the ratio which the total amount of net bade debts sustained on loans during such 6-year period bears to the sum of the total amounts of loans outstanding at the close of each taxable year in such period.

If the bank has not been in existence for the full 6-year period, then, for the portion of such period during which it was not in existence, the taxpayer may use the average bad debt experience of comparable banks with respect to comparable loans.

SEC. 8. DEFINITIONS OF TERMS.

.01 The term `banks' as used herein means banks or trust companies incorporated and doing business under the laws of the United States (including laws relating to the District of Columbia), of any State, or of any Territory, a substantial part of the business of which consists of receiving deposits and making loans and discounts. Such term does not include a mutual savings bank not having capital stock represented by shares, a domestic building and loan association as defined in section 7701(a)(19) of the Code, or a cooperative bank as defined in section 7701(a)(32) of the Code.

.02 The term `loans' as used in sections 3 through 6 of this ruling does not include Government insured or guaranteed loans to the extent so insured or guaranteed.

.03 The term `the year of change' means the first taxable year ending after December 31, 1964, or, in the case of a bank changing from the specific charge-off method to the reserve method in a later year, the year in which the change is made.

SEC. 9. BANKS ON SPECIFIC CHARGE-OFF METHOD.

Where a bank on the specific charge-off method of accounting for bad debts desires to change to the reserve method, application to make such a change shall be made in the manner prescribed by section 3 of Revenue Procedure 64-51, C.B. 1964-2, 1003, but the amount of the reserve at the end of the year of change and subsequent years shall be determined in accordance with the provisions of this Revenue Ruling.

SEC. 10. EFFECTIVE DATE.

The provisions of this Revenue Ruling are applicable for taxable years ending after December 31, 1964.

SEC. 11. EFFECT ON OTHER DOCUMENTS.

Mimeograph 6209, C.B. 1947-2, 26, and Revenue Ruling 54-148, C.B. 1954-1, 60, are hereby superseded. Section 4.02 of Revenue Procedure 64-51, C.B. 1964-2, 1003 (relating to change in accounting method), and Revenue Ruling 57-210, C.B. 1957-1, 94, Revenue Ruling 58-259, C.B. 1958-1, 116, Revenue Ruling 57-509, C.B. 1957-2, 145, Revenue Ruling 63-122, C.B. 1963-2, 98, and G.C.M. 25605, C.B. 1948-1, 38 (relating to the term `loans'), are hereby modified to remove therefrom the references to Mimeograph 6209 and Revenue Ruling 54-148, and substitute in place thereof reference to this Revenue Ruling for taxable years ending after December 31, 1964.

¹ Also released as Technical Information Release 707, dated Mar. 15, 1965.