LB&I instructs on insurance companies' partial worthlessness deductions under sec. 166(a) (2).

• Author: Garlock, David C.
• Position: IRS Large Business and International Division

The IRS issued a Large Business & International (LB&I) Industry Director Directive (IDD) (LBW-4-0712-009) addressing partial worthlessness deductions under Sec. 166(02) taken by insurance companies for eligible loans. The directive instructs LBW examiners to not challenge an insurance company's partial worthlessness deduction under Sec. 166(a)(2) if the amount deducted matches the amount of credit-related impairment charged off by the insurance company under National Association of Insurance Commissioners (NAIC) Statement of Statutory Accounting Principles (SSAP) 43R for eligible loans as reported on the company's annual statement.

While the IDD is applicable only if the insurance company meets certain requirements, it directs field examiners not to challenge the company's partial bad debt deductions for any open year. Although not stated explicitly, this audit protection extends even to years prior to the year of adoption of the terms of the IDD.

Background

Sec. 166(a)(2) indicates that when satisfied that a debt is recoverable only in part, the IRS may allow a partial deduction on the debt, in an amount not in excess of the part charged off within the tax year.

State law typically requires insurance companies to file annual statements with insurance regulatory authorities using accounting principles set out in the NAIC's Accounting Practices and Procedures Manual. SSAP 43R establishes accounting rules that taxpayers must follow if their loan-backed or other structured securities are impaired and subject to charge-off for all reporting periods ending on or after Sept. 30, 2009.

The issue of an insurance company's ability to use the presumptive conclusion of worthlessness under Regs. Sec. 1.1662(d) or how it should otherwise deal with partial worthlessness deductions was submitted to the IRS's Industry Issue Resolution Program (IIR) and was accepted in 2011. It would appear that this IDD is a response to the accepted IIR request.

Requirements Under the IDD

If an insurance company complies with the IDD, LB&I examiners should not challenge an insurance company's partial worthlessness deduction for eligible debt.

First-year adjustment: For the first tax year in which the insurance company applies the IDD (the adjustment year), the company's Sec. 166(a)(2) deduction will generally be equal to the company's SSAP 43R credit-related impairment charge-offs for the same items, except that the company increases or reduces its deduction by a positive...