Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 58-10

1958-1 C.B. 246

Sec. 593

IRS Headnote

A deduction for an addition to a reserve for bad debts made by a mutual savings bank, or other institution of the type referred to in section 593 of the Internal Revenue Code of 1954, in its Federal income tax return for its fiscal year ended June 30, 1955, which deduction equaled its taxable income for that year before such deduction, may not be eliminated by a net operating loss carryback from a subsequent year in order that the amount previously credited to a bad debt reserve may be transferred tax-free to the institution's surplus account.

Full Text

Rev. Rul. 58-10

Advice has been requested whether a deduction for an addition to a reserve for bad debts made by a mutual savings bank in its income tax return for its fiscal year ended June 30, 1955, which deduction equaled its taxable income for that year before such deduction, may be eliminated by a net operating loss carryback from taxpayer's fiscal year ended June 30, 1956, in order that the amount previously credited to the bad debt reserve may be transferred tax-free to the bank's surplus account.

The instant mutual savings bank had a small net operating loss for its first taxable fiscal year, the year ended June 30, 1954, which it carried over and deducted as a net operating loss deduction in its income tax return for the fiscal year ended June 30, 1955. The resulting taxable income for that year, approximately 23 x dollars, was deducted in its entirety as an addition to its reserve for bad debts, under section 593 of the Internal Revenue Code of 1954. Thus, its income tax return for that year disclosed a taxable income of zero. For the fiscal year ended June 30, 1956, taxpayer sustained a net operating loss of 24 x dollars. In carrying back the fiscal year 1956 net operating loss to fiscal year 1955, taxpayer desires to apply the carryback to reduce the taxable income for fiscal year 1955 computed before the deduction for the addition to its bad debt reserve, so that it may transfer the amount previously credited to the bad debt reserve to its surplus account free of tax.

With respect to the mutual savings banks, domestic building and loan associations, and cooperative banks, referred to therein, section 593 of the Code provides, in part, as follows:

* * * the reasonable addition to a reserve for bad debts for any taxable year shall in no case be less than the amount determined by the taxpayer as the reasonable addition for such year; except that the amount determined by the taxpayer under this sentence shall not be greater than the lesser of-

(1) the amount of its taxable income for the taxable year computed without regard to this section, or

(2) the amount by which 12 percent of the total deposits or withdrawable amounts of its depositors at the close of such year exceeds the sum of its surplus, undivided profits, and reserves at the beginning of the taxable year.

Section 1.593-1(b) of Income Tax Regulations further provides that `the amount of its taxable income for the taxable year,' computed without regard to section 593, is also to be computed without regard to any section of the Code providing for a deduction the amount of which is dependent upon the amount of taxable income (such as section 170 of the Code, relating to charitable, etc., contributions or gifts). While the effect of the foregoing sections of the Code and the regulations is to limit the amount of the deduction for an addition to a reserve for bad debts which the Commissioner of Internal Revenue may disallow, section 1.593-2 of the regulations authorizes the Commissioner to allow larger deductions for additions to a reserve for bad debts where circumstances in certain cases so warrant.

Before a taxpayer can carry back a net operating loss to a year in which it took its entire taxable income as a deduction under section 593 of the Code, it is necessary that taxable income first be created in that year by a reduction of the deduction taken as an addition to the reserve for bad debts. In the instant case, the taxpayer determined that its entire taxable income for the fiscal year 1955 was a reasonable addition to its reserve for bad debts. If the addition to the reserve was reasonable at that time, it does not become unreasonable because of subsequently occurring events such as a net operating loss in a subsequent year.

Accordingly, it is held that a deduction for an addition to a reserve for bad debts made by a mutual savings bank, or other institution of the type referred to in section 593 of the Code, in its Federal income tax return for its fiscal year ended June 30, 1955, which deduction equaled its taxable income for that year before such deduction, may not be eliminated by a net operating loss carryback from a subsequent year in order that the amount previously credited to the bad debt reserve may be transferred tax-free to the institution's surplus account.