§ 593. Reserves for losses on loans
(a)
Reserve for bad debts
(1)
In general
Except as provided in paragraph (2), in the case of—
(2)
Organization must meet 60-percent asset test of section
7701
(a)(19)
This section shall apply to an association or bank referred to in paragraph (1) only if it meets the requirements of section
7701
(a)(19)(C).
(b)
Addition to reserves for bad debts
(1)
In general
For purposes of subsection (a), the reasonable addition for the taxable year to the reserve for bad debts of any taxpayer described in subsection (a) shall be an amount equal to the sum of—
(A)
the amount determined to be a reasonable addition to the reserve for losses on nonqualifying loans, computed in the same manner as is provided with respect to additions to the reserves for losses on loans of banks under section
585
(b)(2), plus
(B)
the amount determined by the taxpayer to be a reasonable addition to the reserve for losses on qualifying real property loans, but such amount shall not exceed the amount determined under paragraph (2) or (3), whichever is the larger, but the amount determined under this subparagraph shall in no case be greater than the larger of—
(ii)
the amount which, when added to the amount determined under subparagraph (A), equals the amount by which 12 percent of the total deposits or withdrawable accounts of depositors of the taxpayer at the close of such year exceeds the sum of its surplus, undivided profits, and reserves at the beginning of such year (taking into account any portion thereof attributable to the period before the first taxable year beginning after December 31, 1951).
(2)
Percentage of taxable income method
(A)
In general
Subject to subparagraphs (B) and (C), the amount determined under this paragraph for the taxable year shall be an amount equal to 8 percent of the taxable income for such year.
(B)
Reduction for amounts referred to in paragraph (1)(A)
The amount determined under subparagraph (A) shall be reduced (but not below 0) by the amount determined under paragraph (1)(A).
(C)
Overall limitation on paragraph
The amount determined under this paragraph shall not exceed the amount necessary to increase the balance at the close of the taxable year of the reserve for losses on qualifying real property loans to 6 percent of such loans outstanding at such time.
(D)
Computation of taxable income
For purposes of this paragraph, taxable income shall be computed—
(iii)
by excluding from gross income an amount equal to the net gain for the taxable year arising from the sale or exchange of stock of a corporation or of obligations the interest on which is excludable from gross income under section
103,
(iv)
by excluding from gross income dividends with respect to which a deduction is allowable by part VIII of subchapter B, reduced by an amount equal to 8 percent of the dividends received deduction (determined without regard to section
596) [1] for the taxable year, and
(c)
Treatment of reserve for bad debts
(1)
Establishment of reserves
Each taxpayer described in subsection (a) which uses the reserve method of accounting for bad debts shall establish and maintain a reserve for losses on qualifying real property loans, a reserve for losses on nonqualifying loans, and a supplemental reserve for losses on loans. For purposes of this title, such reserves shall be treated as reserves for bad debts, but no deduction shall be allowed for any addition to the supplemental reserve for losses on loans.
(2)
Certain pre-1963 reserves
Notwithstanding the second sentence of paragraph (1), any amount allocated pursuant to paragraph (5) (as in effect immediately before the enactment of the Tax Reform Act of 1976) during a taxable year beginning before January 1, 1977, to the reserve for losses on qualifying real property loans out of the surplus, undivided profits, and bad debt reserves (determined as of December 31, 1962) attributable to the period before the first taxable year beginning after December 31, 1951, shall not be treated as a reserve for bad debts for any purpose other than determining the amount referred to in subsection (b)(1)(B), and for such purpose such amount shall be treated as remaining in such reserve.
(3)
Charging of bad debts to reserves
Any debt becoming worthless or partially worthless in respect of a qualifying real property loan shall be charged to the reserve for losses on such loans, and any debt becoming worthless or partially worthless in respect of a nonqualifying loan shall be charged to the reserve for losses on nonqualifying loans; except that any such debt may, at the election of the taxpayer, be charged in whole or in part to the supplemental reserve for losses on loans.
(d)
Loans defined
For purposes of this section—
(1)
Qualifying real property loans
The term “qualifying real property loan” means any loan secured by an interest in improved real property or secured by an interest in real property which is to be improved out of the proceeds of the loan, but such term does not include—
(B)
any loan, whether or not evidenced by a security (as defined in section
165
(g)(2)(C)), the primary obligor on which is—
(D)
any loan which, within a 60-day period beginning in one taxable year of the creditor and ending in its next taxable year, is made or acquired and then repaid or disposed of, unless the transactions by which such loan was made or acquired and then repaid or disposed of are established to be for bona fide business purposes. For purposes of subparagraph (B)(iii), the term “affiliated group” has the meaning assigned to such term by section
1504
(a); except that (i) the phrase “more than 50 percent” shall be substituted for the phrase “at least 80 percent” each place it appears in section
1504
(a), and (ii) all corporations shall be treated as includible corporations (without any exclusion under section
1504
(b)).
(2)
Nonqualifying loans
The term “nonqualifying loan” means any loan which is not a qualifying real property loan.
(4)
Treatment of interests in REMIC’s
A regular or residual interest in a REMIC shall be treated as a qualifying real property loan; except that, if less than 95 percent of the assets of such REMIC are qualifying real property loans (determined as if the taxpayer held the assets of the REMIC), such interest shall be so treated only in the proportion which the assets of such REMIC consist of such loans. For purposes of determining whether any interest in a REMIC qualifies under the preceding sentence, any interest in another REMIC held by such REMIC shall be treated as a qualifying real property loan under principles similar to the principles of the preceding sentence, except that if such REMIC’s are part of a tiered structure, they shall be treated as 1 REMIC for purposes of this paragraph.
(e)
Distributions to shareholders
(1)
In general
For purposes of this chapter, any distribution of property (as defined in section
317
(a)) by a taxpayer having a balance described in subsection (g)(2)(A)(ii) to a shareholder with respect to its stock, if such distribution is not allowable as a deduction under section
591, shall be treated as made—
(A)
first out of its earnings and profits accumulated in taxable years beginning after December 31, 1951, (and, in the case of an S corporation, the accumulated adjustments account, as defined in section
1368
(e)(1)) to the extent thereof,
(B)
then out of the balance taken into account under subsection (g)(2)(A)(ii) (properly adjusted for amounts charged against such reserves for taxable years beginning after December 31, 1987),
This paragraph shall apply in the case of any distribution in redemption of stock or in partial or complete liquidation of a taxpayer having a balance described in subsection (g)(2)(A)(ii), except that any such distribution shall be treated as made first out of the amount referred to in subparagraph (B), second out of the amount referred to in subparagraph (C), third out of the amount referred to in subparagraph (A), and then out of such other accounts as may be proper. This paragraph shall not apply to any transaction to which section
381 applies, or to any distribution to the Federal Savings and Loan Insurance Corporation (or any successor thereof) or the Federal Deposit Insurance Corporation in redemption of an interest in a taxpayer having a balance described in subsection (g)(2)(A)(ii), if such interest was originally received by any such entity in exchange for assistance provided under a provision of law referred to in section
597
(c). This paragraph shall not apply to any distribution of all of the stock of a bank (as defined in section
581) to another corporation if, immediately after the distribution, such bank and such other corporation are members of the same affiliated group (as defined in section
1504) and the provisions of section 5(e) of the Federal Deposit Insurance Act (as in effect on December 31, 1995) or similar provisions are in effect.
(2)
Amounts charged to reserve accounts and included in gross income
If any distribution is treated under paragraph (1) as having been made out of the reserves described in subparagraphs (B) and (C) of such paragraph, the amount charged against such reserve shall be the amount which, when reduced by the amount of tax imposed under this chapter and attributable to the inclusion of such amount in gross income, is equal to the amount of such distribution; and the amount so charged against such reserve shall be included in gross income of the taxpayer.
(f)
Termination of reserve method
Subsections (a), (b), (c), and (d) shall not apply to any taxable year beginning after December 31, 1995.
(g)
6-year spread of adjustments
(1)
In general
In the case of any taxpayer who is required by reason of subsection (f) to change its method of computing reserves for bad debts—
(B)
such change shall be treated as initiated by the taxpayer and as having been made with the consent of the Secretary, and
(2)
Applicable excess reserves
(A)
In general
For purposes of paragraph (1), the term “applicable excess reserves” means the excess (if any) of—
(i)
the balance of the reserves described in subsection (c)(1) (other than the supplemental reserve) as of the close of the taxpayer’s last taxable year beginning before January 1, 1996, over
(ii)
the lesser of—
(I)
the balance of such reserves as of the close of the taxpayer’s last taxable year beginning before January 1, 1988, or
(II)
the balance of the reserves described in subclause (I), reduced in the same manner as under section
585
(b)(2)(B)(ii) on the basis of the taxable years described in clause (i) and this clause.
(B)
Special rule for thrifts which become small banks
In the case of a bank (as defined in section
581) which was not a large bank (as defined in section
585
(c)(2)) for its first taxable year beginning after December 31, 1995—
(i)
the balance taken into account under subparagraph (A)(ii) shall not be less than the amount which would be the balance of such reserves as of the close of its last taxable year beginning before such date if the additions to such reserves for all taxable years had been determined under section
585
(b)(2)(A), and
(ii)
the opening balance of the reserve for bad debts as of the beginning of such first taxable year shall be the balance taken into account under subparagraph (A)(ii) (determined after the application of clause (i) of this subparagraph).
The preceding sentence shall not apply for purposes of paragraphs (5) and (6) or subsection (e)(1).
(3)
Recapture of pre-1988 reserves where taxpayer ceases to be bank
If, during any taxable year beginning after December 31, 1995, a taxpayer to which paragraph (1) applied is not a bank (as defined in section
581), paragraph (1) shall apply to the reserves described in paragraph (2)(A)(ii) and the supplemental reserve; except that such reserves shall be taken into account ratably over the 6-taxable year period beginning with such taxable year.
(4)
Suspension of recapture if residential loan requirement met
(A)
In general
In the case of a bank which meets the residential loan requirement of subparagraph (B) for the first taxable year beginning after December 31, 1995, or for the following taxable year—
(B)
Residential loan requirement
A taxpayer meets the residential loan requirement of this subparagraph for any taxable year if the principal amount of the residential loans made by the taxpayer during such year is not less than the base amount for such year.
(C)
Residential loan
For purposes of this paragraph, the term “residential loan” means any loan described in clause (v) of section
7701
(a)(19)(C) but only if such loan is incurred in acquiring, constructing, or improving the property described in such clause.
(D)
Base amount
For purposes of subparagraph (B), the base amount is the average of the principal amounts of the residential loans made by the taxpayer during the 6 most recent taxable years beginning on or before December 31, 1995. At the election of the taxpayer who made such loans during each of such 6 taxable years, the preceding sentence shall be applied without regard to the taxable year in which such principal amount was the highest and the taxable year in such principal amount was the lowest. Such an election may be made only for the first taxable year beginning after such date, and, if made for such taxable year, shall apply to the succeeding taxable year unless revoked with the consent of the Secretary.
(5)
Continued application of fresh start under section
585 transitional rules
In the case of a taxpayer to which paragraph (1) applied and which was not a large bank (as defined in section
585
(c)(2)) for its first taxable year beginning after December 31, 1995:
(A)
In general
For purposes of determining the net amount of adjustments referred to in section
585
(c)(3)(A)(iii), there shall be taken into account only the excess (if any) of the reserve for bad debts as of the close of the last taxable year before the disqualification year over the balance taken into account by such taxpayer under paragraph (2)(A)(ii) of this subsection.
(7)
Conversions to credit unions
In the case of a taxpayer to which paragraph (1) applied which becomes a credit union described in section
501
(c) and exempt from taxation under section
501
(a)—
(A)
any amount required to be included in the gross income of the credit union by reason of this subsection shall be treated as derived from an unrelated trade or business (as defined in section
513), and
[1] See References in Text note below.