[Congressional Record Volume 141, Number 161 (Wednesday, October 18, 1995)]
[Extensions of Remarks]
[Pages E1971-E1972]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]




          H.R. 2494, THRIFT CHARTER CONVERSION TAX ACT OF 1995

                                 ______


                            HON. BILL ARCHER

                                of texas

                    in the house of representatives

                       Wednesday, October 18, 1995

  Mr. ARCHER. Mr. Speaker, today, I am introducing the Thrift Charter 
Conversion Tax Act of 1995, with James A. Leach, the chairman of the 
Banking and Financial Services Committee, and Marge Roukema, the 
chairwoman of the Financial Institutions and Consumer Credit 
Subcommittee, as original cosponsors. The three of us have worked 
together to identify and address potential tax consequences raised by 
the Banking Committee's proposal to require thrifts to convert their 
charters into bank charters. This bill is a product of our efforts.
  Requiring thrifts to convert to banks raises several banking, tax, 
housing, and accounting policy issues. It is not easy to reconcile 
these sometimes competing policies. Nonetheless, it is clear that the 
thrift charter conversion proposal must contain transitional tax relief 
cushioning the blow to thrifts required to convert to banks. This bill 
is intended to modify the tax laws to permit the conversion of thrifts 
to banks, consistent with the policies behind the thrift charter 
conversion proposal, and in a manner that is fair to the thrifts and 
consistent with our deficit reduction goals.
  The following is a technical explanation of the provisions of the 
bill.

 Technical Explanation of the Thrift Charter Conversion Tax Act of 1995

       1. Repeal ``percentage of taxable income'' method for the 
     calculation of bad debt deductions by thrift institutions.


                       Present Law and Background

 Tax treatment of bad debt deductions of savings institutions--reserve 
       methods of accounting for bad debts of thrift institutions

       A taxpayer engaged in a trade or business may deduct the 
     amount of any debt that becomes wholly or partially worthless 
     during the year (the ``specific charge-off'' method). Certain 
     thrift institutions (building and loan associations, mutual 
     savings banks, or cooperative banks) are allowed deductions 
     for bad debts under rules more favorable than those granted 
     to other taxpayers (and more favorable than the rules 
     applicable to other financial institutions). Qualified thrift 
     institutions are eligible to compute deductions for bad debts 
     using either the specific charge-off method or the reserve 
     method of section 593. To qualify for this reserve method, a 
     thrift institution must meet an asset test, requiring that 60 
     percent of its assets consist of ``qualifying assets'' 
     (generally cash, government obligations, and loans secured by 
     residential real property). This percentage must be computed 
     at the close of the taxable year, or at the option of the 
     taxpayer, as the annual average of monthly, quarterly, or 
     semiannual computations of similar percentages.
       If a thrift institution uses the reserve method of 
     accounting for bad debts, it must establish and maintain a 
     reserve for bad debts, charge actual losses against the 
     reserve, and is allowed a deduction for annual additions to 
     restore the reserve to its proper balance. Under section 593, 
     a thrift institution may elect, each year, to calculate its 
     annual addition to its bad debt reserve under either (1) the 
     ``percentage of taxable income'' method applicable only to 
     thrift institutions, or (2) the ``experience'' method also 
     used by small banks.
       Under the percentage of taxable income method, a thrift 
     institution generally may claim as a deduction an addition to 
     its bad debt reserve for an amount equal to 8 percent of its 
     taxable income (determined without regard to this deduction 
     and with additional adjustments). Under the experience 
     method, a thrift institution generally is allowed a deduction 
     for an addition to its bad debt reserve equal to the greater 
     of: (1) an amount based on its actual average experience for 
     losses in the current and five preceding taxable years, or 
     (2) an amount necessary to restore the reserve to its balance 
     as of the close of the base year. For taxable years beginning 
     before 1988, the ``base year'' was the last taxable year 
     before the most recent adoption of the experience method 
     (i.e., generally, the last year the taxpayer was on the 
     percentage of taxable income method). Pursuant to a provision 
     contained in the Tax Reform Act of 1986, for taxable years 
     beginning after 1987, the base year is the last taxable year 
     beginning before 1988. The base year amount is reduced to the 
     extent that the taxpayer's loan portfolio decreases. 
     Computing bad debts under a ``base year'' concept allows a 
     thrift institution to claim a deduction for bad debts for an 
     amount at least equal to the institution's actual losses that 
     were incurred during the taxable year.

                  Bad debt methods of commercial banks

       A small commercial bank (i.e., one with an adjusted basis 
     of assets of $500 million or less) only may use the 
     experience method or the specific charge-off method for 
     purposes of computing its deduction for bad debts. A large 
     commercial bank must use the specific charge-off method. If a 
     small bank becomes a large bank, it must recapture its 
     existing bad debt reserve (i.e., include the amount of the 
     reserve in income) through one of two methods. Under the 4-
     year recapture method, the bank generally includes 10 percent 
     of the reserve in income in the first taxable year, 20 
     percent in the second year, 30 percent in the third year, and 
     40 percent in the fourth year. Alternatively, a bank may 
     elect the cut-off method. Under the cut-off method, the bank 
     neither restores its bad debt reserve to income nor may it 
     deduct actual losses relating to loans held by the bank as of 
     the date of the required change in the method of accounting. 
     Rather, the amount of such losses are charged against and 
     reduce the existing bad debt reserve; any losses in excess of 
     the reserve are deductible.
     
[[Page E 1972]]


         Recapture of bad debt reserves by thrift institutions

       If a thrift institution become, a commercial bank, or if 
     the institution fails to satisfy the 60-percent qualified 
     asset test, the institution is required to change its method 
     of accounting for bad debts and, under proposed Treasury 
     regulations, is required to recapture its bad debt 
     reserve.\1\ The percentage of taxable income portion of the 
     reserve generally is included in income ratably over a 6-
     taxable year period. The experience method portion of the 
     reserve is not restored to income if the former thrift 
     institution qualified as a small bank. If the former thrift 
     institution is treated as a large bank, the experience method 
     portion of the reserve is restored to income either ratably 
     over a 6-taxable year period, or under the 4-year recapture 
     method described above.
     \1\ The requirement of the proposed regulations that a thrift 
     institution recapture its bad debt reserves upon a change in 
     the method of its accounting for bad debts is based on Nash 
     v. U.S., 398 U.S. 1 (1970), where the U.S. Supreme Court held 
     that a taxpayer essentially was required to recapture its bad 
     debt reserve when the related accounts receivable were 
     transferred by the taxpayer.
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       In addition, a thrift institution may be subject to a form 
     of reserve recapture even if the institution continues to 
     qualify for the percentage of taxable income method. 
     Specifically, if a thirft institution distributes to its 
     shareholders an amount in excess of its post-1951 earnings 
     and profits, such excess will be deemed to be distributed 
     from the institution's bad debt reserve and must be restored 
     to income (sec. 593(e)).

 Financial accounting treatment of tax reserves of bad debts of thrift 
                              institutions

       In general, for financial accounting purposes, a 
     corporation must record a deferred tax liability with respect 
     to items that are deductible for tax purposes in a period 
     earlier than they are expensed for book purposes. The 
     deferred tax liability signifies that, although a 
     corporation may be reducing its current tax expense 
     because of the accelerated tax deduction, the corporation 
     will become liable for tax in a future period when the 
     related item is expensed for book purposes (i.e., when the 
     timing item ``reverses''). Under the applicable accounting 
     standard (Accounting Principles Board Opinion 23), 
     deferred tax liabilities generally were not required for 
     pre-1988 tax deductions attributable to the bad debt 
     reserve method of thrift institutions because the 
     potential reversal of the bad debt reserve was indefinite 
     (i.e., generally, a reversal would only occur by operation 
     of sec. 593(e), a condition within the control of a thrift 
     institution). However, the establishment of 1987 as a base 
     year by the Tax Reform Act of 1986 increased the 
     likelihood of bad debt reserve reversals with respect to 
     post-1987 additions to the reserve and it is understood 
     that thrift institutions generally have recorded deferred 
     tax liabilities for these additions.

            Treatment of thrift institutions under H.R. 2491

       H.R. 2491 (the ``Thrift Charter Conversion Act of 1995'') 
     will require thrift institutions to forego their Federal 
     thrift charters and become either State-chartered thrift 
     institutions or Federally-chartered banks. If a thrift 
     institution becomes a bank, the institution will be subject 
     to recapture of all or a portion of its bad debt reserve 
     under proposed Treasury regulations. It is understood that 
     such recapture will require the institution to immediately 
     record, for financial accounting purposes, a current or 
     deferred tax liability for the amount of recapture taxes for 
     which liabilities previously had not been recorded 
     (generally, with respect to the pre-1988 reserves) regardless 
     of when such recapture taxes are actually paid to the 
     Treasury. It is further understood that the recording of this 
     liability generally will decrease the regulatory capital of 
     the new bank.


                        description of proposal

       The proposal would repeal the section 593 reserve method of 
     accounting for bad debts by thrift institutions, effective 
     for taxable years beginning after 1995. Under the proposal, 
     thrift institutions that qualify as small banks would be 
     allowed to utilize the experience method applicable to such 
     institutions, while thrift institutions that are treated as 
     large banks would be required to use the specific charge-off 
     method. Thus, the percentage of taxable income method of 
     accounting for bad debts would no longer be available for any 
     institution.
       A thrift institution required to change its method of 
     computing reserves for bad debts would treat such change as a 
     change in a method of accounting, initiated by the taxpayer, 
     and having been made with the consent of the Secretary of the 
     Treasury. Any section 481(a) adjustment required to be taken 
     into account with respect to such change generally would be 
     taken into account ratably over a 6-taxable year period, 
     beginning with the first taxable year beginning after 1995. 
     For purposes of determining the section 481(a) adjustment of 
     a taxpayer, the balance of the reserve for bad debts with 
     respect to the taxpayer's base year (generally, the balance 
     of the reserve as of the close of the last taxable year 
     beginning before January 1, 1988, adjusted for decreases in 
     the taxpayer's loan portfolio) would not be taken into 
     account. However, the balance of these pre-1988 reserves 
     would continue to be subject to the provisions of present-
     law section 593(e) (requiring recapture in the case of 
     certain excess distributions to shareholders).
       Thus, under the proposal, subject to the special rule 
     described below, a thrift institution that would be treated 
     as a large bank generally would be required to recapture its 
     post-1987 additions to its bad debt reserve, whether such 
     additions are made pursuant to the percentage of taxable 
     income method or the experience method. In addition, subject 
     to the special rule described below, a thrift institution 
     that would qualify as a small bank generally only would be 
     required to recapture its post-1987 additions to its bad debt 
     reserve that were attributable to the use of the percentage 
     of taxable income method during such period. If such small 
     bank would later become a large bank, any amount required to 
     be recaptured under present law would be reduced by the 
     amount of the pre-1988 reserve.
       Under a special rule, if the taxpayer meets a ``residential 
     loan requirement'' for any taxable year, the amount of the 
     section 481(a) adjustment otherwise required to be restored 
     to income would be suspended. A taxpayer would meet the 
     residential loan requirement if for any taxable year, the 
     principal amount of residential loans made by the taxpayer 
     during the year is not less than the average of the principal 
     amount of such loans during the six most recent testing 
     years. A ``testing year'' means (1) each taxable year ending 
     on or after December 31, 1990, and before January 1, 1996, 
     and (2) each taxable year ending after December 31, 1995, for 
     which the taxpayer met the residential loan would be a loan 
     described in section 7701(a)(19)(C)(v) (generally, loans 
     secured by residential real and church property and mobile 
     homes). The determination of whether a member of controlled 
     group of corporations meet the residential loan requirement 
     would be made on a controlled group basis. A special rule 
     would provide that a taxpayer that calculates its estimated 
     tax installments on an annualized basis would determine 
     whether it meets the residential loan requirement with 
     respect to each such installment. Treasury regulations are 
     expected to provide rules for the application of the 
     residential loan requirement rules in the case of mergers, 
     acquisitions, and other reorganizations of thrift and other 
     institutions.


                             effective date

       The proposal would be effective for taxable years beginning 
     after December 31, 1995.
       2. Treatment of payments made to the SAIF fund pursuant to 
     H.R. 2491.


                       present law and background

       In general, a taxpayer is allowed to deduct ordinary and 
     necessary expenses paid or incurred in carrying on a trade 
     business during the taxable year (sec. 162). However, amounts 
     that give rise to a permanent improvement or betterment must 
     be capitalized rather than deducted currently (sec. 263). 
     Whether an expenditure is deductible under section 162 or 
     must be capitalized under section 263 is often a matter of 
     dispute between the IRS and taxpayers and has been the 
     subject of significant litigation. Most recently, in INDOPCO 
     v. Commissioner, 503 U.S. 79 (1992), the U.S. Supreme Court 
     held that expenditures that give rise to a future benefit 
     must be capitalized. The INDOPCO decision overruled a prior 
     U.S. Supreme Court decision that has been interpreted to hold 
     that an expenditure must give rise to an identifiable asset 
     before it is capitalized (Lincoln Savings v. Comm., 403 U.S. 
     345 (1971), relating to additional premiums paid by a thrift 
     institution to the Federal Savings and Loan Insurance 
     Corporation). The scope of the INDOPCO decision is uncertain.
       H.R. 2491 would require thrift institutions to pay a 
     special assessment to the Saving Association Insurance Fund 
     (``SAIF''). The due date of the payment would be the first 
     business day of January 1996. The SAIF generally is the 
     insurance fund for deposits in thrift institutions. Effective 
     January 1, 1998, the SAIF would be merged with the Bank 
     Insurance Fund (``BIF'') (the insurance fund for deposits in 
     banks). Thrift institutions and banks also are required to 
     pay annual premiums to the SAIF and BIF, respectively, based 
     on the amount of their insured deposits. Currently, the 
     premium rate for the SAIF deposits is substantially higher 
     than the premium rate for BIF deposits. After the merger of 
     the SAIF and BIF in 1998, under H.R. 2491, thrift 
     institutions and banks would be subject to the same lower 
     deposit insurance rates generally applicable to banks.


                        description of proposal

       The proposal would provide that the special assessment paid 
     to the SAIF as required by H.R. 2491 would be deductible when 
     paid.


                             effective date

       The proposal would be effective upon enactment.

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