Tax News and Developments January 2024
On 28 December 2023, the Treasury and the IRS released a notice of proposed rulemaking related to the determination of whether a debt instrument is worthless for US federal income tax purposes under Code section 166 (the “Proposed Regulations“). The Proposed Regulations would revise the standards under Treas. Reg. § 1.166-2 used to decide when debt instruments held by regulated financial companies or members of a regulated financial group are considered conclusively worthless.
Key takeaways from the Proposed Regulations include proposed amendments to Treas. Reg. § 1.166-2(d), the definition of “charge-off,” “regulated financial company,” and “regulated financial group,” a summary of current US GAAP and SSAPs methods, and information on the effective dates of the final regulations.
The final regulations would apply to charge-offs of presumed worthless debt made by a regulated company or member of a regulated financial group that occur in taxable years ending on or after the date the Treasury and the IRS publish their decision adopting the Proposed Regulations as final regulations. Taxpayers can also choose to apply the final regulations to financial statements in taxable years ending on or after the date the final regulations are published in the Federal Register and before Treasury and the IRS publish their decision adopting the Proposed Regulations as final regulations.
The Proposed Regulations are designed to modernize the Conclusive Presumption Regulations for regulated financial companies and members of regulated financial groups. These revisions will incorporate US Generally Accepted Accounting Principles (US GAAP) and Current Statements of Statutory Accounting Principles (SSAPs) into the federal tax standards for determining the worthlessness of debt under section 166.
For entities that apply US GAAP, a charge-off is an accounting entry that reduces the carrying value of debt when the debt is determined to be wholly or partially worthless. For regulated financial companies using SSAPs, a charge-off is an accounting entry that reduces the debt’s carrying value and results in a realized loss or a charge to the statement of operations on the regulated insurance company’s annual statement.
The Proposed Regulations define regulated financial companies to include state and federally-regulated banks and insurance companies. However, they do not include credit unions or US branches of foreign banks in this definition. Additionally, the Proposed Regulations do not include insurance companies that do not regularly issue insurance, reinsurance, or annuity contracts to unrelated persons in their definition of a regulated insurance company.
The Treasury and the IRS have requested comments on whether the Proposed Regulations should be modified to include credit unions, US branches of foreign banks, or insurance companies that only issue contracts to related persons into the definition of regulated financial companies.
Overall, the Proposed Regulations aim to align US federal tax standards with US GAAP and SSAPs, thereby reducing burdensome and outdated regulations for regulated financial companies and members of regulated financial groups. The Treasury and the IRS believe that these entities are subject to regulatory and accounting standards for charge-offs that are similar enough to the federal tax standards for determining worthlessness under section 166.