[Code of Federal Regulations]
[Title 26, Volume 7]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.585-5]

[Page 327-331]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.585-5  Denial of bad debt reserves for large banks.

    (a) General rule. For taxable years beginning after December 31, 
1986, a large bank (as defined in paragraph (b) of this section) may not 
deduct any amount under section 585 or any other section for an addition 
to a reserve for bad debts. However, for these years, except as provided 
in Sec. 1.585-7, a large bank may deduct amounts allowed under section 
166(a) for specific debts that become worthless in whole or in part. Any 
large bank that maintained a reserve for bad debts under section 585 for 
the taxable year immediately preceding its disqualification year (as 
defined in paragraph (d)(1) of this section) must follow the rules 
prescribed by Sec. 1.585-6 or Sec. 1.585-7 for changing from the 
reserve method of accounting for bad debts that is allowed by section 
585, to the specific charge-off method of accounting for bad debts, in 
its disqualification year. However, except as may be provided otherwise 
in regulations prescribed under section 593, the rules prescribed by 
Sec. Sec. 1.585-6 and 1.585-7 do not apply to a large bank that 
maintained a reserve for bad debts under section 593 for the taxable 
year immediately preceding its disqualification year.
    (b) Large bank--(1) General definition. For purposes of this 
section, a large bank is any institution described in Sec. 1.585-
1(b)(1) (i) or (ii) if, for the taxable year (or for any preceding 
taxable year beginning after December 31, 1986)--
    (i) The average total assets of the institution (determined under 
paragraph (c) of this section) exceed $500,000,000; or
    ii) The institution is a member of a parent-subsidiary controlled 
group (as defined in paragraph (d)(2) of this section) and the average 
total assets of the group exceed $500,000,000.
    (2) Large bank resulting from transfer by large bank--(i) In 
general. If a corporation acquires the assets of a large bank (as 
defined in this paragraph (b)) in an acquisition to which paragraph 
(b)(2) (ii), (iii) or (iv) of this section applies, the acquiring 
corporation (the acquiror) is treated as a large bank for any taxable 
year ending after the date

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of the acquisition in which it is an institution described in Sec. 
1.585-1(b)(1) (i) or (ii).
    (ii) Transfer of significant portion of assets where control is 
retained. This paragraph (b)(2)(ii) applies to any direct or indirect 
acquisition of a significant portion of a large bank's assets if, after 
the acquisition, the transferor large bank owns more than 50 percent (by 
vote or value) of the outstanding stock of the acquiror. For this 
purpose, stock of an acquiror is considered owned by a transferor bank 
if the stock is owned by any member of a parent-subsidiary controlled 
group (as defined in paragraph (d)(2) of this section) of which the bank 
is a member, by any related party within the meaning of section 267(b) 
or 707(b), or by any person that received the stock in a transaction to 
which section 355 applies.
    (iii) Transfer to which section 381 applies. This paragraph 
(b)(2)(iii) applies to any acquisition to which section 381(a) applies 
if, immediately after the acquisition, the acquiror's principal method 
of accounting for bad debts (determined under Sec. 1.381(c)(4)-1(c)(2)) 
with respect to its banking business is the specific charge-off method. 
In applying Sec. 1.381(c)(4)-1(c)(2) for this purpose, the following 
rules apply: A transferor large bank is considered to use the specific 
charge-off method for all of its loans immediately before the 
acquisition; an acquiror is considered to use a reserve method for all 
of its loans immediately before the acquisition; and all banking 
businesses of the acquiror immediately after the acquisition are treated 
as one integrated business. See Sec. Sec. 1.585-6(c)(3) and 1.585-
7(d)(2) for rules on the treatment of assets acquired from large banks 
in section 381(a) transactions.
    (iv) Transfer of substantially all assets to related party. This 
paragraph (b)(2)(iv) applies to any direct or indirect acquisition of 
substantially all of a large bank's assets if the transferor large bank 
and the acquiror are related parties before or after the acquisition and 
a principal purpose of the acquisition is to avoid treating the acquired 
assets as those of a large bank. A transferor bank and an acquiror are 
considered to be related parties for this purpose if they are members of 
the same parent-subsidiary controlled group (as defined in paragraph 
(d)(2) of this section) or related parties within the meaning of section 
267(b) or 707(b).
    (3) Examples. The following examples illustrate the principles of 
this paragraph (b):

    Example 1. Bank M, a calendar year taxpayer, is an institution 
described in Sec. 1.585-1(b)(1)(i). For its taxable year beginning on 
January 1, 1987, M has average total assets of $600 million. Since M's 
average total assets for 1987 exceed $500 million, M is a large bank for 
that year. Pursuant to Sec. 1.585-5(d)(1), 1987 is M's disqualification 
year. If M maintained a bad debt reserve under section 585 for its 
immediately preceding taxable year (1986), M must change in 1987 to the 
specific charge-off method of accounting for bad debts, in accordance 
with Sec. 1.585-6 or Sec. 1.585-7.
    Example 2. Assume the same facts as in Example 1. Also assume that 
in 1988 M disposes of a portion of its assets and, as a result, M's 
average total assets for taxable year 1988 fall to $400 million. M 
remains a large bank for taxable year 1988 and succeeding taxable years, 
since its average total assets for a preceding taxable year (1987) 
beginning after December 31, 1986, exceeded $500 million.
    Example 3. Bank P, a calendar year taxpayer, is an institution 
described in Sec. 1.585-1(b)(1)(i). P has average total assets of $300 
million for its taxable year beginning on January 1, 1988. For the same 
year, P is a member of a parent-subsidiary controlled group (within the 
meaning of Sec. 1.585-5(d)(2)) that has average total assets of $800 
million. In February 1989, the group sells its stock in P to several 
individual investors. P is a large bank for taxable year 1988 because it 
is a member of a group described in Sec. 1.585-5(b)(1)(ii) for that 
year. P also is a large bank for taxable year 1989 and succeeding 
taxable years because it was a member of a group described in Sec. 
1.585-5(b)(1)(ii) for a preceding taxable year (1988) beginning after 
December 31, 1986.
    Example 4. Assume the same facts as in Example 3, except that P's 
stock is purchased by a corporation that is not a large bank under Sec. 
1.585-5(b). Also assume that the purchasing corporation elects under 
section 338 to treat the stock purchase as an asset acquisition. Under 
section 338, P is considered to have sold all of its assets on the 
purchase date and is treated as a new corporation that purchased these 
assets on the next day. Since P is treated as a new corporation, its 
prior membership in a group described in Sec. 1.585-5(b)(1)(ii) does 
not cause it to be treated as a large bank for taxable years ending 
after the date of its sale by the group. However, P may be treated as a 
large bank because of new membership in such a group or pursuant to 
Sec. 1.585-5(b)(1)(i) or (b)(2).

[[Page 329]]

    Example 5. Bank Q is a large bank, within the meaning of Sec. 
1.585-5(b)(1), for its taxable year beginning on January 1, 1988, and 
hence for all later years. On March 1, 1989, Q transfers $200 million of 
its $600 million of assets to Bank R, a newly created subsidiary, in a 
transaction to which section 351 applies; these assets are R's only 
assets. On the same day, Q then spins off R in a transaction to which 
section 355 applies. After these transactions, the shareholders of Q own 
more than 50 percent of R's outstanding stock. Although R's average 
total assets do not exceed $500 million, R becomes a large bank on March 
1, 1989, pursuant to Sec. 1.585-5(b)(2)(ii). These transactions do not 
affect Q's status as a large bank.
    Example 6. Bank S is a large bank, within the meaning of Sec. 
1.585-5(b)(1)(ii), for its taxable year beginning on January 1, 1987. As 
a result, S changes to the specific charge-off method of accounting for 
bad debts in that year. Bank T, which is not a large bank under Sec. 
1.585-5(b), uses the reserve method of accounting for bad debts. On June 
30, 1988, T acquires substantially all of S's assets in a transaction to 
which section 381(a) applies. Immediately before the acquisition, S's 
banking business has total assets of $200 million, and T's has total 
assets of $250 million. To determine whether T is a large bank under 
Sec. 1.585-5(b)(2)(iii) for taxable years ending after the acquisition, 
it is necessary to determine T's principal method of accounting for bad 
debts with respect to its banking business immediately after the 
acquisition. This determination requires an application of Sec. 
1.381(c)(4)-1(c)(2). For this purpose, T's original and acquired banking 
businesses are treated as an integrated business. Applying Sec. 
1.381(c)(4)-1(c)(2), it is determined that the business's principal 
method of accounting for bad debts immediately after the acquisition is 
the reserve method. Hence, the acquisition does not cause T to become a 
large bank under Sec. 1.585-5(b)(2)(iii).

    (c) Average total assets--(1) In general. For purposes of paragraph 
(b)(1) of this section, and except as otherwise provided in paragraph 
(c)(3)(ii) of this section, the average total assets of an institution 
or group for any taxable year are determined by--
    (i) Computing, for each report date (as defined in paragraph (c)(2) 
of this section) within the taxable year, the amount of total assets (as 
defined in paragraph (c)(3) of this section) held by the institution or 
group as of the close of business on the report date;
    (ii) Adding these amounts; and
    (iii) Dividing the sum of these amounts by the number of report 
dates within the taxable year.
    (2) Report date--(i) Institutions--(A) In general. A report date for 
an institution generally is the last day of the regular period for which 
the institution must report to its primary Federal regulatory agency. 
However, an institution that is required to report to its primary 
Federal regulatory agency more frequently than quarterly may choose the 
last day of the calendar quarter as its report date, and an institution 
that is required to report to its primary Federal regulatory agency less 
frequently than quarterly must choose the last day of the calendar 
quarter as its report date. If an institution does not have a Federal 
regulatory agency, its primary State regulatory agency is considered its 
primary Federal regulatory agency for purposes of this paragraph 
(c)(2)(i)(A). In the case of a short taxable year that does not 
otherwise include a report date, the first or last day of the taxable 
year is the institution's report date for the year.
    (B) Alternative report date. In lieu of the report date prescribed 
by paragraph (c)(2)(i)(A) of this section, for any taxable year an 
institution may choose as its report date the last day of any regular 
interval in the taxable year that is more frequent than quarterly (such 
as bi-monthly, monthly, weekly, or daily).
    (ii) Groups. If all members of a parent-subsidiary controlled group 
have the same taxable year, a report date for the group is the report 
date, determined under paragraph (c)(2)(i) of this section, for any one 
member of the group that is an institution described in Sec. 1.585-
1(b)(1) (i) or (ii). The same report date must be used in applying 
paragraph (b)(1)(ii) of this section to all members of the group for a 
taxable year. If all members of a parent-subsidiary controlled group do 
not have the same taxable year, a report date for the group must be 
determined under similar principles.
    (iii) Member of group for only part of taxable year. If an 
institution is a member of a parent-subsidiary controlled group for only 
part of a taxable year, paragraph (b)(1)(ii) of this section is applied 
to the institution for that year on the basis of the group's average 
total assets for the portion of the year that the institution is a 
member of the

[[Page 330]]

group. Thus, only the group's report dates (as determined under 
paragraph (c)(2)(ii) of this section) that are included in that portion 
of the year are taken into account in determining the group's average 
total assets for purposes of applying paragraph (b)(1)(ii) of this 
section to the institution. If no report date of the group is included 
in that portion of the year, the first or last day of that portion of 
the year must be treated as the group's report date for purposes of this 
paragraph (c)(2)(iii).
    (3) Total assets--(i) All corporations. The amount of total assets 
held by an institution or group is the amount of cash, plus the sum of 
the adjusted bases of all other assets, held by the institution or 
group. For this purpose, the adjusted basis of an asset generally is its 
basis for Federal income tax purposes, determined under sections 1012, 
1016 and other applicable sections of the Internal Revenue Code. In 
determining the amount of total assets held by a group, any asset of a 
member of the group that is an interest in another member of the group 
is not to be counted.
    (ii) Foreign corporations. In determining the amount of total assets 
held by a foreign corporation, all of the corporation's assets are taken 
into account, including those that are not effectively connected with 
the conduct of a banking business within the United States. In the case 
of a foreign corporation that is not engaged in a trade or business in 
the United States, the adjusted basis of an asset must be determined 
substantially in accordance with United States tax principles as 
provided in regulations under section 964. In the case of a foreign 
corporation that is engaged in a trade or business in the United States, 
the amount of its average total assets for a taxable year (within the 
meaning of paragraph (c)(1) of this section) is the amount of the 
corporation's average worldwide assets used for purposes of computing 
the interest expense deduction allowable under section 882 and Sec. 
1.882-5 for the taxable year.
    (4) Estimated adjusted tax bases--(i) In general. The amount of the 
adjusted Federal income tax bases (tax bases) of assets held on a report 
date may be estimated, for purposes of applying paragraph (c)(3) of this 
section. This estimate must be based on the adjusted bases of the assets 
on that date as determined by reference to the asset holder's books and 
records maintained for financial reporting purposes (book bases). The 
estimate must reflect any change in the ratio between the asset holder's 
tax and book bases of assets that occurs during the taxable year, and 
the estimate must assume that this change occurs ratably. If an 
institution or group member estimates the tax bases of assets held on 
any report date during a taxable year, it must do so for all assets 
(other than cash) held on that report date, and it must do so for all 
other report dates during the year. However, the tax bases of assets may 
not be estimated for any report date that is the first or last day of 
the taxable year or that is determined under paragraph (c)(2)(i)(B) of 
this section.
    (ii) Formulas. The estimated amount of the tax bases of assets held 
on any report date during a taxable year is based on the following 
variables: The total book bases of the assets on the report date (B); 
the asset holder's tax/book ratio as of the close of the preceding 
taxable year (R); and the result (whether positive or negative) obtained 
when R is subtracted from the asset holder's tax/book ratio as of the 
close of the current taxable year (Y). For purposes of determining R and 
Y, an asset holder's tax/book ratio is the ratio of the total tax bases 
of all of the holder's assets (other than cash), to the total book bases 
of those assets. If an asset holder's taxable year is the calendar year 
and its report date is the last day of the calendar quarter, its 
estimated tax bases of assets held on the first three report dates of 
the year are determined under the following formulas:

1st Report Date=Bx(R+\1/4\Y)
2nd Report Date=Bx(R+\1/2\Y)

3rd Report Date=Bx(R+\3/4\Y)

    (5) Examples. The following examples illustrate the principles of 
this paragraph (c):

    Example 1. Bank U is a fiscal year taxpayer, and its fiscal year 
ends on January 31. U reports to its primary Federal regulatory

[[Page 331]]

agency as of the last day of the calendar quarter. U does not choose 
under Sec. 1.585-5(c)(2)(i)(B) a report date more frequent than 
quarterly. Thus, U's report dates under Sec. 1.585-5(c)(2)(i)(A) are 
March 31, June 30, September 30, and December 31. For its taxable year 
beginning on February 1, 1987, U has total assets (within the meaning of 
Sec. 1.585-5(c)(3)) of $480 million on March 31, $490 million on June 
30, $510 million on September 30, and $540 million on December 31. Thus, 
pursuant to Sec. 1.585-5(c)(1), U's average total assets for its 
taxable year beginning on February 1, 1987, are $505 million.
    Example 2. Bank W is a calendar year taxpayer, and its report date 
(within the meaning of Sec. 1.585-5(c)(2)(i)(A)) is the last day of the 
calendar quarter. Pursuant to Sec. 1.585-5(c)(4), W chooses to estimate 
the tax bases of its assets for 1990. Therefore, W must estimate the tax 
bases of all of its assets (other than cash) for its first three report 
dates in 1990. Since W's fourth report date (December 31) is the last 
day of its taxable year, the tax bases of its assets may not be 
estimated for this date. The adjusted tax bases ofall of W's assets 
(other than cash) are $450z on December 31, 1989, and $480z on December 
31, 1990. The book bases of those assets are $500z on December 31, 1989; 
$520z on March 31, 1990; $540z on June 30, 1990; $560z on September 30, 
1990; and $600z on December 31, 1990. Applying the formulas provided in 
Sec. 1.585-5(c)(4)(ii), W's tax/book ratio as of the close of 1989 (R), 
is 0.9 (450z/500z). W's tax/book ratio as of the close of 1990 is 0.8 
(480z/600z). Thus, Y is -0.1. The estimated adjusted tax bases of all of 
W's assets (other than cash) on the first three report dates of 1990 are 
as follows:
[GRAPHIC] [TIFF OMITTED] TC14NO91.160

    (d) Definitions. The following definitions apply for purposes of 
this section and Sec. Sec. 1.585-6, 1.585-7 and 1.585-8:
    (1) Disqualification year. A bank's disqualification year is its 
first taxable year beginning after December 31, 1986, for which the bank 
is a large bank within the meaning of paragraph (b) of this section.
    (2) Parent-subsidiary controlled group. A parent-subsidiary 
controlled group includes all of the members of a controlled group of 
corporations described in section 1563(a)(1). The members of such a 
group are determined without regard to whether any member is an excluded 
member described in section 1563(b)(2), a foreign entity, or a 
commercial bank.
    (3) Example. The following example illustrates the principles of 
this paragraph (d):

    Example. Bank X is a large bank within the meaning of Sec. 1.585-
5(b)(1)(i). Bank Y is not a large bank under Sec. 1.585-5(b), and it 
maintains a bad debt reserve under section 585. In 1988, X purchases all 
of the stock of Y. If the acquisition causes Y to become a member of a 
parent-subsidiary controlled group described in Sec. 1.585-5(b)(1)(ii), 
Y is a large bank beginning in its first taxable year that ends after 
the date of the acquisition. Pursuant to Sec. 1.585-5(d)(1), this year 
is Y's disqualification year. Y must change in this year to the specific 
charge-off method of accounting for bad debts, in accordance with Sec. 
1.585-6 or Sec. 1.585-7.

[T.D. 8513, 58 FR 68757, Dec. 29, 1993; 59 FR 15502, Apr. 1, 1994]