Section 166(a)(2) of the Internal Revenue Code of 1986, as amended, permits a corporation to take an income tax deduction for partially worthless debts up to the amount of the debt charged-off by the corporation as uncollectible on its books and records, provided that the Internal Revenue Service (“IRS”) is satisfied that the debt is recoverable only in part.1 Section 1.166-2 of the Treasury Regulations provides a conclusive presumption of partial worthlessness for debts charged-off by a regulated corporation if the charge-off: (A) either (i) is ordered by a federal authority or a state authority that applies standards equivalent to those of the federal authority, or (ii) is made in accordance with established policies of such authorities, and upon such authorities’ first audit of the corporation subsequent to the charge-off, such authorities confirm in writing that the charge-off would have been subject to such specific orders if the audit had been made on the date of the charge-off; and (B) the amount so charged-off is claimed as a deduction by the corporation at the time of filing the return for the taxable year in which the charge-off occurs.2 The conclusive presumption regulations are intended to ensure taxpayers are treated fairly and consistently when dealing with the IRS and another branch of the federal government with respect to worthless or partially worthless debt.3
Banks have long taken advantage of the conclusive presumption regulations when using Section 166(a)(2) to deduct debts that national bank examiners, under the authority of the Comptroller of the Currency, required to be charged-off.4 Historically, it has been unclear whether insurance companies, regulated by state authorities, were entitled to use the conclusive presumption. Proponents argued that because state insurance regulators impose charge-off standards similar to federal bank regulators and possess similar authority to compel insurance companies to charge-off worthless debts, the conclusive presumption should apply to insurance companies. The IRS accepted a similar argument in holding that the conclusive presumption applies to loans classified as losses by Federal Deposit Insurance Corporation (“FDIC”) bank examiners based on the IRS’s determination that the national bank examiners and examiners from the FDIC follow similar guidelines and procedures in classifying bank loans and have similar authority to compel banks to charge-off worthless debt.5
State law requires insurance companies to file annual statements that comply with the accounting principles of the National Association of Insurance Commissioners (“NAIC”)6. In September 2009, the NAIC revised its Statement of Statutory Accounting Principles 43R (SSAP 43R). The revised SSAP 43R requires insurers to charge-off certain partially worthle ss debts and sets standards and procedures for charge-offs. In July 2012, the Commissioner of the Large Business & International (“LB&I”) Division of the IRS released a directive that LB&I examiners should not challenge the Section 166(a)(2) partial worthlessness deductions of insurance companies if the amount of the deduction is equal to the credit-related impairment charge-offs made by the company under SSAP 43R and the other requirements of the directive are met.7 The LB&I Commissioner explained that independently determining partial worthlessness for Section 166(a)(2) deductions imposes a significant burden on both insurance companies and the IRS. The directive does not mention the conclusive presumption regulations and thus, does not indicate whether the conclusive presumption applies to insurance companies.
In May 2013, the IRS issued a notice (“Notice”) that it is reevaluating the conclusive presumption regulations generally and requesting public comment.8 The Notice explains that the conclusive presumption provides administrative convenience; however, the policy behind the presumption requires regulators to follow similar standards to identify debts to be charged-off as tax administrators use to permit a deduction for a bad debt. Given significant changes to the regulatory standards for charge-offs used by banks, the IRS questions whether the conclusive presumption continues to be appropriate.
The Notice further remarks that the Treasury Department and the IRS have received questions about which taxpayers may qualify as “other corporations” for purposes of the conclusive presumption regulations, particularly with respect to insurance companies and government-sponsored enterprises. The Notice requests public comments on a number of issues, including which corporations are regulated by a federal or state entity that reviews and makes determinations about worthlessness of debt assets in a manner consistent with the tax standards for worthlessness under Section 166, and which of these entities should be covered by the revised conclusive presumption rules. Thus, the Notice provides the opportunity to provide comments to the IRS regarding the revision and application of the revised conclusive presumption rules with respect to insurance companies. Comments must be submitted by October 8, 2013.
IRS Circular 230 Disclosure:
This article was not intended or written by the author to be used and it cannot be used by any taxpayer for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code. A taxpayer should seek advice based on the taxpayer’s particular circumstances from an independent tax advisor.
126 U.S.C. § 166(a)(2).
2Treas. Reg. § 1.166-2(d).
3Rev. Rul. 80-180, 1980-2 C.B. 66.
4Rev. Rul. 66-335, 1966-2 C.B. 58.
5Rev. Rul. 79-214, 1979-2 C.B. 90.
6LB&I Directive, LB&I-4-0712-009 (July 30, 2012); e.g., Ga. Code Ann. § 33-3-21.3.
7LB&I Directive, LB&I-4-0712-009 (July 30, 2012).
8I.R.S. Notice 13-35, 2013-24 I.R.B. 1240.
Anthony R. Boggs is a Partner in the firm's Tax Practice and a CPA. He has over twenty years of tax experience, particularly related to federal transaction-based tax advice and planning. Mr. Boggs received his bachelor's degree from Missouri State University, his law degree from the University of Denver and his LL.M. in taxation from New York University.
Edgar B. Callaway has just begun his third year at the University of Georgia School of Law, where he is ranked in the top 20% of his class and is an editor of the Georgia Journal of International & Comparative Law. Edger received his bachelor's degree, cum laude, from Vanderbilt University. Last summer, he served as a judicial intern for The Honorable Clay D. Land in the District Court for the Middle District of Georgia.
