Reserves for losses on loans of banks

# (a) Reserve for bad debts

(1) In general Except as provided in subsection (c), a bank shall be allowed a deduction for a reasonable addition to a reserve for bad debts. Such deduction shall be in lieu of any deduction under section 166(a). (2) Bank For purposes of this section— (A) In general The term "bank" means any bank (as defined in section 581). (B) Banking business of United States branch of foreign corporation The term "bank" also includes any corporation to which subparagraph (A) would apply except for the fact that it is a foreign corporation. In the case of any such foreign corporation, this section shall apply only with respect to loans outstanding the interest on which is effectively connected with the conduct of a banking business within the United States.

# (b) Addition to reserves for bad debts

(1) General rule For purposes of subsection (a), the reasonable addition to the reserve for bad debts of any financial institution to which this section applies shall be an amount determined by the taxpayer which shall not exceed the addition to the reserve for losses on loans determined under the experience method as provided in paragraph (2).

(2) Experience method The amount determined under this paragraph for a taxable year shall be the amount necessary to increase the balance of the reserve for losses on loans (at the close of the taxable year) to the greater of— (A) the amount which bears the same ratio to loans outstanding at the close of the taxable year as (i) the total bad debts sustained during the taxable year and the 5 preceding taxable years (or, with the approval of the Secretary, a shorter period), adjusted for recoveries of bad debts during such period, bears to (ii) the sum of the loans outstanding at the close of such 6 or fewer taxable years, or (B) the lower of— (i) the balance of the reserve at the close of the base year, or (ii) 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 base year, the amount which bears the same ratio to loans outstanding at the close of the taxable year as the balance of the reserve at the close of the base year bears to the amount of loans outstanding at the close of the base year. For purposes of this paragraph, the base year shall be the last taxable year before the most recent adoption of the experience method, except that for taxable years beginning after 1987 the base year shall be the last taxable year beginning before 1988.

(3) Regulations; definition of loan The Secretary shall define the term loan and prescribe such regulations as may be necessary to carry out the purposes of this section.

# (c) Section not to apply to large banks

(1) In general In the case of a large bank, this section shall not apply (and no deduction shall be allowed under any other provision of this subtitle for any addition to a reserve for bad debts).

(2) Large banks For purposes of this subsection, a bank is a large bank if, for the taxable year (or for any preceding taxable year beginning after December 31, 1986)— (A) the average adjusted bases of all assets of such bank exceeded $500,000,000, or (B) such bank was a member of a parent-subsidiary controlled group and the average adjusted bases of all assets of such group exceeded $500,000,000.

(3) 4-year spread of adjustments (A) In general Except as provided in paragraph (4), in the case of any bank which for its last taxable year before the disqualification year maintained a reserve for bad debts— (i) the provisions of this subsection shall be treated as a change in the method of accounting of such bank for the disqualification year, (ii) such change shall be treated as having been made with the consent of the Secretary, and (iii) the net amount of adjustments required by section 481(a) to be taken into account by the taxpayer shall be taken into account in each of the 4 taxable years beginning with the disqualification year with— (I) the amount taken into account for the 1st of such taxable years being the greater of 10 percent of such net amount or such higher percentage of such net amount as the taxpayer may elect, and (II) the amount taken into account in each of the 3 succeeding taxable years being equal to the applicable fraction (determined in accordance with the following table for the taxable year involved) of the portion of such net amount not taken into account under subclause (I). The applicable If the case of the— fraction is— 1st succeeding year 2/9 2nd succeeding year 1/3 3rd succeeding year 4/9. (B) Suspension of recapture for taxable year for which bank is financially troubled (i) In general In the case of a bank which is a financially troubled bank for any taxable year— (I) no adjustment shall be taken into account under subparagraph (A) for such taxable year, and (II) such taxable year shall be disregarded in determining whether any other taxable year is a taxable year for which an adjustment is required to be taken into account under subparagraph (A) or the amount of such adjustment. (ii) Exception for elective recapture for 1st year Clause (i) shall not apply to the 1st taxable year referred to in subparagraph (A)(iii)(I) if the taxpayer elects a higher percentage in accordance with such subparagraph. (iii) Financially troubled bank For purposes of clause (i), the term "financially troubled bank" means any bank if, for the taxable year, the nonperforming loan percentage of such bank exceeds 75 percent. (iv) Nonperforming loan percentage For purposes of clause (iii), the term "nonperforming loan percentage" means the percentage determined by dividing— (I) the sum of the outstanding balances of nonperforming loans of the bank as of the close of each quarter of the taxable year, by (II) the sum of the amounts of equity of the bank as of the close of each such quarter. In the case of a bank which is a member of a parent-subsidiary controlled group for the taxable year, the preceding sentence shall be applied with respect to such group. (v) Other definitions For purposes of this subparagraph— (I) Nonperforming loans The term "nonperforming loan" means any loan which is considered to be nonperforming by the primary Federal regulatory agency with respect to the bank. (II) Equity The term "equity" means the equity of the bank as determined for Federal regulatory purposes. (C) Coordination with estimated tax payments For purposes of applying section 6655(e)(2)(A)(i) with respect to any installment, the determination under subparagraph (B) of whether an adjustment is required to be taken into account under subparagraph (A) shall be made as of the last day prescribed for payment of such installment.

(4) Elective cut-off method If a bank makes an election under this paragraph for the disqualification year— (A) the provisions of this subsection shall not be treated as a change in the method of accounting of the taxpayer for purposes of section 481, (B) the taxpayer shall continue to maintain its reserve for loans held by the bank as of the 1st day of the disqualification year and charge against such reserve any losses resulting from loans held by the bank as of such 1st day, and (C) no deduction shall be allowed under this section (or any other provision of this subtitle) for any addition to such reserve for the disqualification year or any subsequent taxable year. If the amount of the reserve referred to in subparagraph (B) as of the close of any taxable year exceeds the outstanding balance (as of such time) of the loans referred to in subparagraph (B), such excess shall be included in gross income for such taxable year.

(5) Definitions For purposes of this subsection— (A) Parent-subsidiary controlled group The term "parent-subsidiary controlled group" means any controlled group of corporations described in section 1563(a)(1). In determining the average adjusted bases of assets held by such a group, interests held by one member of such group in another member of such group shall be disregarded. (B) Disqualification year The term "disqualification year" means, with respect to any bank, the 1st taxable year beginning after December 31, 1986, for which such bank was a large bank if such bank maintained a reserve for bad debts for the preceding taxable year. (C) Election made by each member In the case of a parent-subsidiary controlled group, any election under this section shall be made separately by each member of such group.