Must a large bank recapture part of its New York bad debt reserve under Article 32 when current-year loans or the experience ratio fall below base-year levels?

Plain-English summary

KPMG LLP asked whether a bank taxed under Article 32 must recapture part of its New York State bad debt reserve when computing entire net income, in a year when its current-year loans outstanding fall below base-year loans or its current-year experience ratio falls below the base-year ratio. The bank is a "large" bank under IRC section 585(c), so federally it cannot use the reserve method and must use the specific charge-off method (IRC section 166(a)); for New York it computes its bad-debt deduction under section 1453(i).

The Department held there is no recapture:

• Section 1453(i) gives a subtraction modification (a deduction) that lets the bank build up its New York reserve. In a year when current-year loans drop below base-year loans, or the current-year experience ratio drops below the base-year ratio, the bank simply gets no section 1453(i) deduction for that year.
• There is no provision in section 1453 to recapture an amount previously deducted under section 1453(i). So even though the existing reserve exceeds what the current numbers would support, the bank is not required to recapture any prior deduction or to reduce the reserve.

What this means for you

A bad year means no deduction -- not a clawback

For a large bank using New York's section 1453(i) reserve mechanism, a year of shrinking loans or a falling experience ratio means it cannot take a section 1453(i) deduction that year. But there is no recapture of deductions it took in better years.

The reserve does not have to be drawn down

Even where the New York reserve ($56M / $46.8M in the examples) exceeds the currently allowable reserve (Method 2), Article 32 has no mechanism forcing the bank to reduce the reserve back down. The statute only governs additions, not clawbacks.

Federal "large bank" status sets the starting point

Because the bank is a section 585(c) large bank using the specific charge-off method federally, its New York deduction runs through section 1453(b)(11) (add-back of the IRC 166 deduction) and section 1453(i) (the New York reserve subtraction). The absence of a recapture rule is what drives the result.

Common questions

Q: Must a bank recapture its New York bad debt reserve when its loans shrink?
A: No. Section 1453 contains no recapture provision for amounts previously deducted under section 1453(i).

Q: What happens in a year when loans or the experience ratio fall below base year?
A: The bank gets no section 1453(i) deduction for that year -- but nothing is added back to income.

Q: Does the existing reserve have to be reduced to the currently allowable amount?
A: No. There is no mechanism in Article 32 requiring the reserve to be drawn down.

Citations and references

Statutes, regulations, and authorities:
- Tax Law section 1453(a) (banking corporation entire net income)
- Tax Law section 1453(b)(11) (add modification for IRC 166 deduction)
- Tax Law section 1453(i) (New York bad debt reserve subtraction for large banks)
- Internal Revenue Code section 585(c) (large bank; reserve method disallowed)
- Internal Revenue Code section 166(a) (specific charge-off method)
- KPMG LLP, TSB-A-01(13)C (Jan. 10, 2001)

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/corporation_ao_2001.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/corporation/a01_13c.pdf

Original ruling text

New York State Department of Taxation and Finance

Office of Tax Policy Analysis
Technical Services Division

TSB-A-01(13)C
Corporation Tax
January 10, 2001

STATE OF NEW YORK
COMMISSIONER OF TAXATION AND FINANCE
ADVISORY OPINION

PETITION NO. C000919A

On September 19, 2000, a Petition for Advisory Opinion was received from KPMG LLP,
345 Park Avenue, 38th Floor, New York, New York 10154.
The issue raised by Petitioner, KPMG LLP, is whether a bank is required to recapture a
portion of its New York State bad debt reserve when computing entire net income, under Article 32
of the Tax Law, when the amount of current year loans outstanding has decreased below the amount
of base year loans outstanding or when the current year experience ratio has decreased below the
base year ratio.
Petitioner submits the following facts as the basis for this Advisory Opinion.
The taxpayer, Bank, is a banking corporation subject to Article 32 of the Tax Law. Pursuant
to section 585(c) of the Internal Revenue Code (“IRC”), Bank is a “large” bank that is not permitted
to use the reserve method in computing its federal bad debt deduction. Instead, Bank must use the
specific charge-off method under section 166(a) of the IRC.
Petitioner states that in computing entire net income under section 1453 of the Tax Law,
Bank is required to apply the provisions of section 1453(i) in computing its bad debt deduction. In
general terms, this deduction will be the greater of the following two amounts:
Method 1: The amount necessary to increase the balance of the New York
State bad debt reserve for losses on loans (computed as of the close of the current
taxable year) to the amount which results from multiplying current year loans
outstanding by the current year’s experience ratio (i.e., the ratio of (a) the sum of bad
debts adjusted for recoveries sustained during the current taxable year and the five
preceding years to (b) the sum of loans outstanding at the close of such six taxable
years); or
Method 2: The amount necessary to increase the balance of the New York
State reserve for losses on loans (calculated as of the close of the taxable year) to the
lesser of (a) the balance of the bad debt reserve at the close of the taxpayer’s base
year, or (b) if the amount of loans outstanding at the close of the taxable year is less
than the amount of loans outstanding at the close of the base year, the amount which
results from multiplying the current year loans outstanding by the ratio of (1) base
year reserves to (2) base year loans outstanding.

-2TSB-A-01(13)C
Corporation Tax
January 10, 2001

During Bank’s fiscal 2000 taxable year, its current year balance of outstanding loans
decreased to a level less than Bank’s base year loans outstanding. The decrease in Bank’s loans
resulted from the maturation of existing loans coupled with retrenchment strategies and
redeployment of capital. Additionally, Bank’s fiscal 2000 experience ratio dropped below the base
year experience ratio. The decrease in the experience ratio resulted from a large charge-off that
occurred in 1994 which is no longer a part of the six year moving average.
Bank’s reserve for bad debts calculated under the six year moving average provided by
section 1453(i) of the Tax Law has not decreased in correspondence to the reduction of the loan
balance. For discussion purposes, Petitioner assumes the following amounts:
Base Year
Fiscal 1988

Preceding Year
Fiscal 1999

Current Year
Fiscal 2000

Outstanding Loans

$6 billion

$7 billion

$5 billion

Experience Ratio

.5000%

.8000%

.3000%

$30 million

$56 million

$15 million

Tentative Allowable Reserve
(Method 1)
Allowable Reserve Using Base
Year Ratio (Method 2)

$25 million

Under the facts set forth above, Petitioner states that Bank’s current year balance of loans
outstanding has decreased below its base year amount of loans outstanding. In addition, the current
year experience ratio (the six year moving average of bad debt losses sustained to total loans
outstanding) has declined below the ratio existing during Bank’s base year. However, the New York
reserve has not decreased in correspondence to the reduction of the loan balance. As a result, using
the hypothetical numbers set forth above, Bank has an allowable fiscal 2000 reserve of $25 million
(under Method 2). This is $31 million less than the beginning reserve balance of $56 million and
$5 million less than the base year reserve balance of $30 million.
Discussion
Section 1453(a) of the Tax Law provides that entire net income means total net income from
all sources which shall be the same as the entire taxable income (but not alternative minimum
taxable income) which the taxpayer is required to report to the United States Treasury Department
subject to the modifications and adjustments provided in section 1453 of the Tax Law.

-3TSB-A-01(13)C
Corporation Tax
January 10, 2001

Section 1453(b)(11) of the Tax Law provides an add modification for a taxpayer subject to
the provisions of section 585(c) of the IRC for the amount allowed as a deduction pursuant to section
166 of the IRC. Section 1453(i) of the Tax Law provides a subtraction modification for a taxpayer
subject to the provisions of section 585(c) of the IRC that is not subject to section 1453(h) of the Tax
Law, whereby the taxpayer may deduct an amount equal to or less than the amount determined
pursuant to section 1453(i) of the Tax Law. In this case, Bank is not allowed a deduction under
section 1453(i) of the Tax Law, to increase its New York State reserve for losses on loans, for a
taxable year during which the amount of Bank’s current year loans outstanding has decreased below
the amount of base year loans outstanding or the current year experience ratio has decreased below
the base year ratio.
There is no provision in section 1453 of the Tax Law to recapture an amount previously
allowed as a deduction under section 1453(i) of the Tax Law. Accordingly, for any taxable year that
the amount of Bank’s current year loans outstanding has decreased below the amount of base year
loans outstanding or the current year experience ratio has decreased below the base year ratio, no
recapture of a previous deduction allowed pursuant to section 1453(i) of the Tax Law is required to
reduce the balance of the New York State bad debt reserve for losses on loans.

DATED: January 10, 2001

NOTE:

/s/
Jonathan Pessen
Tax Regulations Specialist III
Technical Services Division

The opinions expressed in Advisory Opinions are
limited to the facts set forth therein.