SECTION 11. BANK — Internal Revenue Bulletin 1998-51

BAD DEBTS (§ 585)

.01 Changing from the § 585 reserve method to the § 166 specific charge-off method.

(1) Description of change and scope.

11.01 of this APPENDIX solely because of the deemed liquidation of the bank arising from a QSSS election.

(i) a large bank as defined in § 585(c)(2); or

(ii) any bank within the scope of Rev. Proc. 97–18, 1997–1 C.B. 642, which applies to banks making this change in method of accounting in 1997 to become eligible to elect S corporation status for 1997. A bank is not outside the scope of Rev. Proc. 97–18 solely because it is a qualified subchapter S subsidiary. In that event, the S corporation (the parent) should follow the application procedures required by Rev. Proc. 97–18 on behalf of the bank.

(2) Section 481(a) adjustment. Generally, the amount of the § 481(a) adjustment for a change in method of accounting under section 11.01 of this APPENDIX is the amount of the bank’s reserve for bad debts as of the close of the taxable year immediately before the year of change. However, the amount of the § 481(a) adjustment does not include the amount of a bank’s pre-1988 reserves (as described in § 593(g)(2)(A)(ii), without taking into account § 593(g)(2)(B)) if the bank changed in a prior year from the § 593 reserve method to the § 585 reserve method and § 593(g) applied to that change. The deemed liquidation of a bank occurring solely because its parent makes a QSSS election does not accelerate the § 481(a) adjustment. In accordance with section 5.04(3)(c) of this revenue procedure, a bank that ceases to be a bank under § 581 must accelerate its

481(a) adjustment. (3) Change from § 585 required when electing S corporation status. A bank electing S corporation status (or a bank for which a QSSS election is filed) cannot use the § 585 reserve method. The filing by a bank of a Form 2553 (Election by a Small Business Corporation) or the filing by a bank’s parent of a QSSS election with respect to the bank will constitute an agreement by the bank to change its method of accounting for bad debts from the § 585 reserve method to the § 166 specific charge-off method effective as of the taxable year for which the S corporation election or QSSS election is

(a) Applicability. This change applies to a taxpayer that wants to change to the principal-reduction method of accounting described in section 5 of Rev. Proc. 97–39, 1997–2 C.B. 485. The principal-reduction method of accounting is an aggregate method of accounting for de minimis OID (discount) on certain loans originated by the taxpayer.

(b) Scope limitations inapplicable. A taxpayer that wants to make this change is not subject to the scope limitations in section 4.02 of this revenue procedure. However, if the taxpayer is under examination, before an appeals office, or before a federal court, the taxpayer must provide a copy of the application to the examining agent(s), appeals officer, or counsel for the government, as appropriate, at the same time that it files the copy of the application with the national office. The application must contain the name(s) and telephone number(s) of the examining agent(s), appeals officer, or counsel for the government, as appropriate.

(c) Description. The principal-reduction method of accounting is a permissible method for use by taxpayers to account for discount on one or more categories of loans described in section 4.02 or 4.03 of Rev. Proc. 97–39. If the principal-reduction method is used to account for any loans in a category of loans, the method must be used for the entire category of loans. The principal-reduction method applies only to loans described in section 3 of Rev. Proc. 97–39.

(a) Applicability. This change applies to a bank (as defined in § 581, including a bank for which a qualified subchapter S subsidiary (QSSS) election is filed) that wants to change its method of accounting for bad debts from the § 585 reserve method to the § 166 specific charge-off method.

(b) Certain scope limitations inap- plicable. A bank that changed from the § 593 reserve method under § 593(g) to the § 585 reserve method will not be prohibited under section 4.02(6) of this revenue procedure from changing its method of accounting for bad debts under section 11.01 of this APPENDIX solely because of the § 593(g) change. A bank for which a QSSS election is filed will not be prohibited under section 4.02(7) of this revenue procedure from changing its method of accounting for bad debts under section

(2) Manner of making the change.

(a) This change is made using a cut-off method and applies only to loans described in section 3 of Rev. Proc. 97–39 that were acquired on or after the first day of the year of change. See section 2.06 of this revenue procedure.

1998–51 I.R.B. 43 December 21, 1998

books and records sufficient to satisfy the district director that old and new loans have been adequately segregated.

(3) Additional requirements. On a statement attached to the application, the taxpayer must:

(a) identify the categories of loans to which the new method will apply; and

(b) describe any “additional categories” permitted under section 4.03 of Rev. Proc. 97-39.

(4) No audit protection. A taxpayer does not receive audit protection under section 7 of this revenue procedure in connection with this change.

.02 Pool of debt instruments.

(1) Description of change and scope .

(ii) Section 1004 of the Taxpayer Relief Act of 1997, which is effective for taxable years beginning after August 5, 1997, extended the rules in § 1272(a)(6) to any pool of debt instruments the yield on which may be affected by reason of prepayments. In particular, § 1272(a)(6) now applies to a pool of credit card receivables subject to a grace period provision (under which, for example, a credit card issuer does not charge interest for a billing cycle if the credit card obligor pays off its account balance by a specified date, even though the balance is not due on that date). See H.R. Conf. Rep. No. 220, 105th Cong., 1st Sess. 522 (1997). (A credit card receivable subject to a grace period provision has OID because none of the stated interest on the receivable is qualified stated interest under § 1.1273–1(c)).

(iii) The holder of a pool of credit card receivables subject to a grace period provision must accrue OID on the pool based on a reasonable assumption regarding the timing of the payments by the obligors of the receivables in the pool. Under §1272(a)(6), it is not reasonable for a holder to assume that all of the obligors will pay their balances by the specified grace period date and, based on this assumption, defer the inclusion of OID until the end of the grace period. If the payments in the pool occur soon after year end and before the holder files its tax return for the taxable year that includes such year end, the holder may accrue OID based on its actual experience rather than based upon a reasonable assumption. If the holder does not accrue OID based on its actual experience, the holder must make an adjustment to its income for the following taxable year to account for any difference between its accrual based on a reasonable assumption and its actual experience.

ply with the filing requirement in section 6.02(2)(a) of this revenue procedure or with the following filing requirement. The taxpayer must complete and file an application in duplicate. The original application must be attached to the taxpayer’s timely filed amended federal income tax return for the taxpayer’s first taxable year beginning after August 5, 1997. This amended return must be filed no later than April 30, 1999. A copy of the application must be filed with the national office (see section 6.02(6) of this revenue procedure for the address) no later than when the taxpayer’s amended return is filed.