8664. What accounting methods are available for a taxpayer to use in accounting for bad debts?Alexis Longrcline202014-07-07T22:48:00Z2014-07-07T22:48:00Z25172953Hewlett-Packard2463464148664. What accounting methods are available for a taxpayer to use in accounting for bad debts?Because the Tax Reform Act of 1986 repealed the reserve method of accounting for most taxpayers,.P.L. 99-514, §805(a). all taxpayers, except for certain financial institutions, must use the specific charge-off method in accounting for bad debts. Financial institutions may still be permitted to use the reserve method in accounting for bad debts. Under the specific charge-off method, the taxpayer deducts amounts that were charged off on its books during the tax year in question. To “charge-off” an item, a taxpayer can use any method that shows the intent to remove the debt as an asset..Rubinkam v Commissioner, 118 F.2d 148 (1941). The taxpayer must be the creditor both at the time that the worthlessness was determined and at the time the debt was charged-off.Wachovia Bank & Trust Co. v United States, 288 F.2d 750 (1961). (to allow otherwise would permit the taxpayer to claim a deduction for a loss that he did not own). A debt that is “significantly modified” is deemed charged off..Treas. Regs. §§1.166- 3(3) and 1.1001-3 (definition of significantly modified debt). A modification means any alteration of a lender’s or borrower’s legal rights or obligations, whether the alteration is evidenced by an express agreement (oral or written), conduct of the parties, or otherwise. A modification includes any total or partial deletion or addition to such rights or obligations, but excludes an alteration that occurs by operation of the terms of a debt instrument (i.e., the annual resetting of an interest rate). Treasury Regulation Section 1.1001-3(e)-(f) provides rules for determining when a modification is significant..Treas. Reg. §1.1001-3(c). The taxpayer must file a statement of facts substantiating the deduction along with the tax return containing the claim for the bad debt deduction..Treas. Reg. §1.166- 1(b). Financial institutions are also entitled to use the reserve method to account for losses resulting from bad debts. Instead of deducting specific bad debts from gross income, a financial institution can choose to deduct a reasonable amount as a reserve for bad debts. An account must be maintained for the bad debt reserves..Treas. Reg. §1.166- 4. The reasonableness of the amount claimed is a question of fact. Factors that are often considered in making the reasonableness determination include the type of business involved and the amount of the bad debt. Treas. Reg. §1.166- 4(b). What is reasonable in one business can vary from that which is reasonable for another business or in a different geographical area. In using the reserve method, the taxpayer must file a statement of facts in support of the claim for the bad debt deduction. The statement must contain the following information:(1)the amount of charge sales or other business transactions for the year and the percentage of the reserve from these sales; (2)the total amount of the business’ notes and accounts receivable at both the beginning and at the end of the tax year; (3)the amount of debts that has become wholly or partially worthless and the amounts charged against the reserve account; and (4)how the additional amount to the reserve account was determined..Treas. Reg. §1.166- 4(c). Special rules apply to certain banks claiming bad debt deductions..Treas. Reg. §1.166- 4(d), See Treas. Regs. §§1.585-1 through 1.585-3.If a claim for a bad debt deduction is disallowed during one tax year, but subsequently the debt actually does become worthless, the taxpayer has seven years to file a claim for refund for the year that the debt actually became worthless..IRC Sec. 6511(d)(1). This extension applies both to losses claimed under the specific charge-off method and under the reserve method.Smith Elec. Co. v. United States, 461 F.2d 790 (1972).. This extended period does not apply to partially worthless debt (see Q 8665)..Treas. Reg. §301.6511(d)-1(c).