IRS Changes to Bad Debt: The Allowance Charge-off Method

By Mikayla Roy September 11, 2024

In December of 2023, the IRS issued a Notice of Proposed Rulemaking (REG-121010-17) that sets forth additional guidance on bad debt deductions for financial institutions. Then, in June of 2024 the IRS issued Revenue Procedure 2024-30 to modify automatic Revenue Procedure 2024-23 related to the December 2023 Notice of Proposed Rulemaking. The new guidance allows regulated financial companies or group members (excluding banks using the Section 585 reserve method) to change their accounting methods to the Allowance Charge-off Method. The Allowance Charge-off Method (as defined in the December 2023 notice of proposed rulemaking) can be implemented using the automatic method change procedures of Rev. Proc. 2015-13. 

The proposed rules issued in December 2023 provide a method to determine when a debt instrument is worthless, partially or entirely, for purposes of bad debt deductions. Under the Allowance Charge-off Method, a taxpayer may claim a deduction to the extent a debt is charged-off from the Allowance for Credit Losses (ACL) under the company’s GAAP (generally accepted accounting principles) financial statement or if applicable, the statements of statutory accounting principles (SSAP). These rules essentially align the timing of charge-offs for tax and book purposes. The rules are similar to the old directive for bad debt deductions we discussed in a previous article.  The rationale behind allowing charge-offs to align with GAAP financials for tax deduction purposes relates to the strict regulatory requirements of GAAP and SSAP, which should ease the burden for both the IRS and the taxpayer when trying to determine when a debt is deemed worthless and deductible. 

The election to use the Allowance Charge-off method is a change in accounting method, and therefore a Form 3115 is required to implement the change. Fortunately, it is an automatic change under Rev. Proc 2024-30 and therefore will not require a filing fee.  

BNN Commentary: Without this change in accounting method, the taxpayer likely will continue to use the specific charge-off method and could give rise to the IRS arguing that a charge-off should occur in a different time frame than for GAAP (usually later). However, the inverse is also possible, where one might be arguing that a charge-off occurred earlier for tax purposes.

Rev. Proc. 2024-30 is applicable to tax years ending on or after December 28, 2023, using a cut-off method.  This means that taxpayers with calendar year-ends could take advantage of this change on their 2023 tax returns. All charge-offs must be treated under the taxpayer’s former method of accounting if they occur prior to the year of change, and any amount previously deducted under the former method of accounting may not be deducted under the new method. 

The Allowance Charge-off Method could be a welcome change to taxpayers. This new method may allow bad debt deductions to be less of a concern during an IRS audit and could simplify the accounting for bad debts for tax purposes.

Implementing the Allowance Charge-off Method likely will be appealing and beneficial to many, but it may not be useful or even available to everyone. For example, U.S. branches of foreign banks may not adopt the proposed method. Rev. Proc. 2024-30 could also cause compliance issues with the use of multiple tax methods. Since this procedure is applicable only to regulated financial groups, it seems to exclude partnerships, real estate investment trusts, and other groups that very commonly are used as subsidiaries for financial institutions. More clarity is needed there.  Additionally, some banks already may have made a conformity election for their bad debts, which often provides favorable treatment for nonaccrual interest. This new allowance charge-off method likely would require removal of the conformity election and could risk the favorable treatment of nonaccrual interest. Therefore, those with a conformity election in place may choose to forgo the Allowance Charge-off Method. 

Careful thought and consideration should be done before making this accounting method change. While it could be beneficial for many, your own situation should be discussed with your tax advisor before making the change. 

For more information or a discussion on how this may impact your bank, please contact your BNN tax advisor at 800.244.7444.