TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
Under longstanding regulations of the Internal Revenue
Service (IRS) (i.e., section 1.166-2(d)(1) of the Income Tax
Regulations), a commercial bank can obtain conclusive support of
loan charge-offs declared for tax purposes by obtaining written
confirmation from its primary federal regulator that such charge-offs would have been required for regulatory purposes. Since
1973, the Federal Reserve has been willing to provide a state
member bank with such a "confirmation letter," upon the bank's
request and in appropriate circumstances. This procedure, which
remains in effect, was set forth in SR-225, dated September 7,
1973.
Earlier this year, the IRS amended its regulations to
provide that, as an alternative to a confirmation letter from a
bank's federal regulator, it will accept an "express
determination letter" relating to the consistency of the bank's
loan loss classification standards with regulatory standards (see
section 1.166-2(d)(3) of the Income Tax Regulations). Express determination letters also provide state member banks conclusive support for their charge-offs declared for federal income tax purposes. Federal Reserve Board staff, working in conjunction with representatives of the other federal banking agencies and the IRS, has determined that the Federal Reserve should, upon request and in appropriate circumstances, provide state member banks with express determination letters in addition to
continuing to provide confirmation letters.
Examiner guidance for issuing express determination
letters and confirmation letters are included in Attachment 1,
along with a copy of the September 7, 1973 SR letter. This
guidance should be provided to each officer, examiner, and other
professional involved in the supervision of state member banks at
your Reserve Bank and should also be sent immediately to each
state member bank in your District along with the cover letter
included in Attachment 2.
Under longstanding regulations of the Internal Revenue
Any questions on this guidance should be directed to
Gerald Edwards, at (202) 452-2741, or Charles Holm, at (202) 452-3502.
Director
ATTACHMENTS TRANMITTED ELECTRONICALLY BELOW
EXAMINER GUIDANCE ON REVIEWING
A commercial bank can obtain conclusive support for the
loan charge-offs it declares for federal income tax purposes by
obtaining, from its primary federal regulator, either (1) a
"confirmation letter" indicating that the bank's charge-offs
would have been required for regulatory purposes, or (2) an
"express determination letter" certifying that the bank's loan
loss classification standards are consistent with regulatory
requirements. These letters are authorized by the Internal
Revenue Service (IRS) in section 1.166-2(d) of the Income Tax
Regulations. The Federal Reserve has determined that it will
provide a state member bank, upon its request and in appropriate
circumstances, either of the above letters. Examiner guidance on
issuing these letters is set forth below.
Under the IRS regulations relating to express
determination letters, a commercial bank may elect to conform its
tax treatment of bad debts with its regulatory reporting.
Institutions making this election and meeting the IRS's
requirements will automatically be allowed to declare charge-offs
for federal income tax purposes in the same year it takes charge-offs for regulatory purposes.
To be eligible, a bank must file a conformity election
with its federal tax return. The regulations also require the
bank's primary federal supervisory agency to determine expressly
that the bank maintains and applies classification standards for
loan charge-offs that are consistent with regulatory
requirements. To continue using the new method, the bank must
request a new letter at each subsequent examination that covers
the loan review process. According to the IRS regulations,
express determination letters may be issued to support charge-offs of commercial banks, but not bank holding companies and non-bank subsidiaries of the bank or holding company.
Procedures
The bank is responsible for requesting an express
determination letter. The request should be made immediately
prior to or at the start of an examination to the examiner-in-charge.
The examiner-in-charge will issue the letter only at
the completion of an examination that covers the bank's loan
review process and only when the examiner concludes that its
issuance is appropriate. The letter will be signed and dated by
the examiner-in-charge and provided to the bank for its files.
The letter is not part of the examination report, but a copy of
it should be maintained in the examination work papers and
supported by adequate documentation. Federal Reserve standards
for loan charge-offs and classification standards are set forth
in Section 211 (Installment Loans), Section 214 (Credit Card
Plans), and in Section 217 (Classification of Credits) of the
Commercial Bank Examination Manual, as well as in supplementary
policy guidance. The letter will be issued only if:
The letter should not be issued if any of the following occur:
Revoking the Election
The bank's election of the new method is to be revoked
automatically if the examiner does not issue an express
determination letter at the end of an examination covering the
loan review process. The Federal Reserve is not required to
rescind any previously issued determination letters.
Failure by the bank to obtain a determination letter
generally revokes the bank's election for the current year.
However, it generally does not invalidate a bank's election for
prior year(s). Failure to obtain a determination letter places
the burden of proof on the bank to support its loan charge-offs
for tax purposes. In certain instances, the bank may qualify for
a letter confirming the appropriateness of its charge-offs (as
discussed in the next major section below).
Language for Express Determination Letters
TO WHOM IT MAY CONCERN:
In connection with the most recent examination of [NAME
OF BANK], by the Federal Reserve Bank of [DISTRICT] as of
[EXAMINATION DATE], we reviewed the institution's loan review
process as it relates to loan charge-offs. Based on our review,
we concluded that the bank, as of that date, maintained and
applied loan loss classification standards that were consistent
with regulatory standards regarding loan charge-offs.
This statement is made on the basis of a review that
was conducted in accordance with our normal examination
procedures and criteria, including sampling of loans in
accordance with those procedures and criteria. It does not in
any way limit or preclude any formal or informal supervisory
action (including enforcement actions) by this supervisory
authority relating to the institution's loan review process or
the level at which it maintains its allowance for loan and lease
losses.
The longstanding Federal Reserve policies and
procedures for confirming charge-offs are set forth in the
attached letter dated September 7, 1973 sent to the officer in
charge of examinations at each Federal Reserve Bank (excluding
attachments which reiterated the guidance included in the
letter). These policies and procedures remain in effect.
Confirmation letters generally will be provided only for a bank
and its subsidiaries.
To assist the examiner in issuing confirmation letters,
it will be necessary for the bank to provide the examiner a list
of charge-offs, including the name of the borrower, the amount
charged off, the date charged off, the unpaid balance, and the
length of time each loan was delinquent when charged off.
Furthermore, the bank should maintain complete records supporting
the charge-offs, including financial statements, other supporting
documents, and the reasons for making the charge-offs. Examiners
should furnish the confirmation letter to the bank along with the
bank's list of charge-offs (adjusted as necessary based on the
examiner's review) based on a review of charged-off loans that
are significant in amount in relation to the size of the bank
and, for other loans, a review of the charge-off policies of the
bank for such loans and a review of an adequate sample of the
loan charge-offs.
Language for Confirmation Letters
TO WHOM IT MAY CONCERN:
In connection with the safety and soundness examination
of [NAME OF BANK] by the Federal Reserve System as of
[EXAMINATION DATE], we reviewed the institution's loan charge-offs. Based on our review, had the institution been examined as
of the dates of the charge-offs on the attached list, the loans
would have been required to be charged-off on those dates.
This statement is made on the basis of a review of the
institution's loan charge-offs, including sampling of loan
charge-offs in accordance with our policies and procedures. This
statement does not attest to the adequacy or sufficiency of the
institution's charge-offs. Furthermore, it does not in any way
limit or preclude any formal or informal supervisory actions
(including enforcement actions) by this supervisory agency
relating to the institution's loan review process or the level at
which it maintains its allowance for loan and lease losses.
[TO THE CHIEF EXECUTIVE OFFICER OF EACH
Under longstanding regulations of the Internal Revenue
Service (IRS) (i.e., section 1.166-2(d)(1) of the Income Tax
Regulations), a commercial bank can support its loan charge-offs
by obtaining written confirmation from its primary federal
regulator that such charge-offs would have been required for
regulatory purposes. In particular, such confirmations indicate
that loans charged off by the bank between examinations would
have been ordered by an examiner had the bank been under
examination at the time of the charge-off. Since September 1973,
the Federal Reserve has assisted state member banks by issuing,
upon request and in appropriate circumstances, "confirmation
letters" that are acceptable to the IRS.
Recently, the IRS added section 1.166-2(d)(3) to the
Income Tax Regulations in order to provide commercial banks with
an alternative approach to support bad debt deductions.1 Under
this approach, a bank, as an alternative to obtaining written
confirmation of its charge-offs, can obtain from its primary
federal regulator an "express determination letter" certifying
that the bank's loss classification standards for loan charge-offs are consistent with regulatory requirements.
After due consideration, and in cooperation with the U.S. Department of the Treasury and the other federal bank and
thrift supervisory agencies, the Federal Reserve has determined
that it will provide a state member bank, upon its request and in
appropriate circumstances, either of the above letters. The
Federal Reserve's guidance to examiners on these letters is
attached and sets forth the procedures and circumstances in which
the Federal Reserve will issue them.
Attachment
Footnotes 1. The new IRS regulation was published in the Federal Register on February 24, 1992, and an amendment to the regulation was published on October 2, 1992. Return to text |
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