The Reagan Tax Plan and Financial Institutions

American Banker, June 3, 1985 | Go to article overview

The Reagan Tax Plan and Financial Institutions


President Reagan's proposal to reform the income tax system includes extensive plans to revamp rules for financial institutions. The text below is the administration's outline and rationale for legislation affecting commercial banks and thrift institutions, including credit unions. The administration seeks to accomplish what it sees as a fairer levy on all financial institutions in regard to deductions of bad debts, deductions for interest on tax-exempt bonds, exemptions for credit unions, and the reorganizations rules for financially troubled thrifts. CHAPTER 10 REFORM TAXATION OF FINANCIAL INSTITUTIONS Part A. Commercial Banks And Thrift Institutions

This part discusses proposals to conform special rules relating to the taxation of banks and thrift institutions to the general rules for the taxation of corporate income. The special bad debt reserve deduction for banks and thrift institutions would be repealed. Interest allocable to tax-exempt obligations held by banks, savings and loans, and certain other thrift institutions would be nondeductible. The tax exemption of credit unions would be repealed in the case of large credit unions. Finally, special rules concerning reorganizations of certain thrift institutions and net operating losses of depository institutions would be repealed. Repeal Special Rules For Depository Institution Bad Debt Deductions General Explanation Chapter 10.01

Current Law

In general, taxpayers may deduct bad debts in the year in which they become wholly or partially and deduct a reasonable addition to the reserve each year. Although subject to this general rule, commercial banks and thrift institutions are also permitted to deduct additions to reserves for bad debts using methods unrelated to their actual loan loss experience. These methods for computing additions to reserves for tax purposes bear no relationship to regulatory requirements for bad debt reserves or to the present value of the expected future loan losses.

Commercial banks may utilize either the percentage method or a modified version of the experience method for determining their bad debt deductions. The percentage method allows a current deduction for additions to reserves sufficient to maintain a tax reserve of up to 0.6% of eligible loans outstanding. The experience method for banks generally is based on average loan losses over the most recent six-year period. Banks need not be consistent in their choice of method from one taxable year to another. The provision permitting use of the percentage method is scheduled to expire at the end of 1987, at which time all commerical banks must use the experience method.

Thrift institutions may use modified versions of the percentage method or experience method available to banks. Alternatively, thrift institutions, if they hold sufficient amounts of their assets in certain eligible investments (primarily residential mortgages), may elect the percentage of taxable income method for purposes of establishing their bad debt reserves for qualifying real property loans. Savings and loan associations and stock savings banks must hold at least 82% of their total assets in eligible investments to receive the maximum deduction, which is equal to 40% of taxable income (computed with certain modifications). A lower percentage of taxable income is deductible if less than 82% of total assets constitute eligible investments. Mutual savings banks must hold at least 72% of their total assets in eligible investments to receive the maximum deduction, which is also subject to reduction if the percentage of eligible investments is less than 72%.

Loans which become wholly or partially worthless during a taxable year are charged against the reserve. This carge reduces the reserve and, under the percentage of eligible loans or experience methods, increases the amount that must be added to the reserve to restore it to an appropriate level. …

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