Category: Deductions & Credits
Subject: Losses
Title: Depositor Losses from Failed Bank
IRC Sections: 165(l)
Filename: 1241.html
Date Produced: 06/95 Copyright 1998, The Tax Resource Group. All rights reserved. Telephone
800-578-3498. Internet: www.taxresourcegroup.com Background
Taxpayer (TP) is a corporation and a depositor in a failed bank. When the
bank closed, TP's balance exceeded the amount of insurance coverage provided
by the FDIC. Accordingly, TP suffered a loss to the extent of the uninsured
portion of the deposit, some $68,000. Issue
What is the tax treatment of this loss? Answer
The loss is treated as a business bad debt loss. Discussion
Given the banking debacle that occurred in this country during the depression
in the 1930's, the tax treatment of deposits in failed financial institutions
is very well settled. Numerous courts have held that a debtor-creditor relationship
exists between a depositor and a bank. Accordingly, when a bank is unable
to repay a depositor, the depositor suffers a bad debt loss. See, for example,
Crystal Motor Lodge, Inc. v. Commissioner, 36 TCM 464 (1977); Kentucky
Rock Asphalt Co. v. Helburn [40-1 USTC ¶9185], 108 F. 2d 779, 781 (6th
Cir. 1940); Swastika Oil & Gas Co. v. Commissioner [Dec. 10,848], 40
B. T. A. 798, 801-802 (1939), aff'd [41-2 USTC ¶9727], 123 F. 2d 382
(6th Cir. 1941), cert. denied 317 U. S. 639 (1942); Eastern New Jersey Power
Co. v. Commissioner [Dec. 10,050], 37 B. T. A. 1037, 1039 (1938); Est. of
Grant v. Commissioner [Dec. 9898], 36 B. T. A. 1233, 1242 (1937); and Rev.
Rul. 71-577, 1971-2 C. B. 129. Of course, in order to claim a bad debt deduction, it is necessary to
follow all the rules under Section 166 regarding establishing the timing
of worthlessness and the character of the loan as between business and nonbusiness.
As you pointed out, Section 165(l) provides various rules applicable to
individual taxpayers intended to provide more favorable treatment to individual
depositors of failed financial institutions. Without this special rule,
such taxpayers would only be able to take a nonbusiness bad debt deduction
which produces a short-term capital loss. Since TP is a corporation engaged in a trade or business, there is a
presumption that any bad debt is a business bad debt. The facts of this
case only serve to underscore and strengthen that presumption. Accordingly,
it seems clear that TP's $68,000 should be treated as a business bad debt
in the year the deposit became worthless. You also raised the issue of California treatment of this item. I see
no reason to think the California treatment differs from the federal treatment. |
