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Tax Alert: Book-Tax Conformity on Bad Debts and the Express Determination Letter

November 25, 2013

Attention: All Clients

As we have recommended in the past, we strongly suggest that at the onset of every regulatory examination by your Primary Federal Regulator you request them to issue an Express Determination Letter (EDL). The EDL allows you to automatically apply to the IRS for Book-Tax Conformity on Bad Debts Expenses. This affects a couple key items on your tax return.

First, it insures that for your federal income tax return you may deduct as a Bad Debt Expense the actual amount of Net Charge-Offs taken on your books for the year. While most of you may already receive a bad debt deduction for this amount, using the Conformity Method for taxes insures that.

Secondly, and more importantly at this point in time, is that the EDL allows you to also have Book-Tax Conformity on Nonaccrual Loan Interest. The IRS position has been that you must pay tax on the amount of interest that would have been accrued on your non-performing loans, even though you have not recognized that interest income on your books. Adopting the Conformity Method makes that go away. This can result in significant tax savings to some institutions, depending on their levels of nonaccrual loans.

Requesting the EDL must be done at the beginning of the exam, and it needs to be done at every federal exam. Once you receive the letter, it may be utilized in the first tax year after it is obtained. In other words, if you obtain an EDL in March 2014, the first tax return that you may use the Conformity Method is for the year of 2015. So, it is important to request and obtain the EDL as soon as possible. Also, just because you may not have many nonaccrual loans now, by the year the you may utilize the EDL that situation may have changed, so it is a good idea to get the EDL regardless of your current status.

Once you have a letter, please forward a copy to us so that we can place it in your file. In the rare instance where using the EDL and electing the Conformity Method are not beneficial to your institution, we simply will not elect conformity. Just because you get the EDL it doesn’t force you to use it. But, not having it absolutely eliminates your chances to benefit from the Conformity Method. So, please request the Express Determination Letter at all of your federal examinations.