Banks and insurers are urging the U.S. Internal Revenue Service to give them a break when it comes to dealing with write downs of bad debt, particularly mortgage-backed securities that have little or no value.
At issue is when a financial institution can count a written-off debt as a tax loss. Currently, accounting rules stipulate the point at which a debt must be discounted for bookkeeping purposes, while IRS rules on timing aren’t as clear.
The lack of agreement has led to longer and more expensive regulatory examinations, the Consortium of Insurance Industry Associations says. The group this month urged the IRS to “reduce uncertainty” for the industry by permitting companies to take a tax deduction for structured securities when they’re written off as losses. Bank groups say it boils down to the tax agency following the lead of industry regulators.
“Banks aren’t trying to game the system,” Fran Mordi, tax counsel for the American Bankers Association, said last week. “If a loan is bad, it’s bad. IRS wants us to re-prove that it’s bad. If the loan is bad on the books, take it for tax today.”
Much of the uncollectible debt stemming from the financial crisis that peaked from late 2008 to early 2009 involved real estate, where loans went sour by the thousands. Insurers and banks that held mortgage-backed securities faced billions of dollars in losses. The IRS began considering a change in its rules after modifications in bank regulatory standards.
Banks and other businesses regulated by state or federal authorities were allowed to apply a “conclusive presumption of worthlessness” to bad debts in the early 1990s, letting them use the same standards in writing down bad debts for both book and tax purposes, Marc Levy, global banking and capital markets tax leader at Ernst & Young, said in May. Changes in accounting rules and banking regulations have led to situations where it wasn’t clear how to apply the IRS methods, Levy said.
Last year, the IRS negotiated a partial resolution with the insurance industry on how to treat securities judged partly or completely worthless, in terms of accounting and regulatory rules. By then, the issue had become the single largest audit concern for many insurers, according to the consortium. The banking industry is negotiating for a similar IRS directive.
Both industries have been in separate talks with the IRS over this often-contentious issue for years.
The agency may also lay out a more permanent solution to guide financial companies on when they can count such write downs as deductions. Recently, the IRS sought comments on whether it should change the current standards for presuming debts to be worthless.
Insurers have urged the IRS to conform to the rules governing the accounting treatment of the debts, according to Pete Bautz, vice president for taxes and retirement security for the American Council of Life Insurers in Washington. He said that would keep taxpayers from having to prove a debt couldn’t be collected as an accounting matter and again for tax purposes.
Under the current practice, taking a tax deduction hinges on whether companies can obtain specific written orders from state regulators verifying that a debt had to be written down for accounting purposes, Bautz said. “Those letters are difficult to get,” he said.
Insurers have asked the IRS to apply on a broader scale the same approach it agreed to in last year’s partial resolution. In the 2012 directive, the agency offered a safe-harbor provision allowing companies to have the tax treatment of their debts mimic the accounting handling in some cases, if the obligations had to be written down because of adverse financial conditions.
Insurers have also urged the tax agency to let companies self-certify losses, subject to “robust third-party review” by independent auditors or state insurance examiners, instead of requiring written confirmation from state regulators.
The industry is seeking two other changes in the way the IRS treats bad debts. The agency should let taxpayers take a deduction in the year the obligation becomes partly worthless, as long as there has been a related book charge-off in the current or a previous year, according to the consortium.
The other change sought by insurers would deal with situations where the adjusted tax basis of an asset exceeds its book basis. In this case, a partial bad-debt deduction should be measured by the higher adjusted tax basis, the letter said. The IRS should clarify that the deduction is the amount equal to the book basis after the charge-off, the consortium said.
Banks are hoping to get industry-specific guidance from the IRS by late November or early December, even as the agency considers how to handle a broader range of related issues. That sort of directive may take much longer to devise.
“We’re hoping to get the directive as soon as possible,” said the ABA’s Mordi. “A lot of banks are currently under examination.”
Yet bankers hope the IRS will offer a broader directive that one just dealing with mortgage-backed securities or other types of real-estate lending and investment, Mordi said.
“We don’t want to limit it to any particular types of loans,” she said. “That becomes very complicated for banks.”
The insurance industry consortium’s letter was signed by representatives of organizations including the American Council of Life Insurers, the Property Casualty Insurers Association of America and the Reinsurance Association of America. The letter from the ABA was also signed by a representative of the Clearing House Association LLP, which counts JPMorgan Chase & Co. (JPM), Citigroup Inc. (C) and Wells Fargo & Co. (WFC) among its members.
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