rp-08-18.pdf

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Part III

Administrative, Procedural, and Miscellaneous

26 CFR 1.1361: Special Rule for Bank Required to Change from the Reserve Method
of Accounting on Becoming an S Corporation
(Also: Sections 166, 446, 481(a), 581, and 585)

Rev. Proc. 2008-18

SECTION 1. PURPOSE
This revenue procedure explains how a bank that changes from the reserve
method of accounting for bad debts under § 585 of the Internal Revenue Code for its
first taxable year for which an election under § 1362(a) is in effect may elect under
§ 1361(g) to take into account the resulting § 481(a) adjustment in determining taxable
income for the immediately preceding taxable year.
SECTION 2. BACKGROUND
.01 Section 1361(a) provides that the term “S corporation” means, with respect
to any taxable year, a small business corporation for which an election under § 1362(a)
is in effect for such year. Section 1361(b) provides that any corporation that is a
financial institution which uses the reserve method of accounting for bad debts

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described in § 585 is not eligible to be an S corporation.
.02 If a financial institution changes from the § 585 reserve method of
accounting for bad debts to the § 166 specific charge-off method, the amount of the
§ 481(a) adjustment for the change generally is the amount of the institution’s reserve
for bad debts as of the close of the taxable year immediately before the year of change.
This positive adjustment is generally taken into account over four taxable years
beginning in the year of change.
.03 Rev. Proc. 2002-9, 2002-1 C.B. 327, (as modified and amplified by Rev.
Proc. 2002-19, 2002-1 C.B. 696, as amplified, clarified and modified by Rev. Proc.
2002-54, 2002-2 C.B. 432, and as modified and clarified by Announcement 2002-17,
2002-1 C.B. 561) provides procedures by which a taxpayer may obtain the automatic
consent of the Commissioner of Internal Revenue under § 446 for a change in method
of accounting described in the APPENDIX of Rev. Proc. 2002-9. Section 11.01 of that
APPENDIX provides rules for a bank changing its method of accounting for bad debts
from the § 585 reserve method of accounting to the § 166 specific charge-off method of
accounting. A taxpayer complying with all of the applicable provisions of Rev. Proc.
2002-9 has obtained the consent of the Commissioner to change its method of
accounting.
.04 Section 8233(a) of the Small Business and Work Opportunity Act of 2007
(Public Law 110-28) added § 1361(g) to the Code. Section 1361(g) provides that, in the
case of a bank which changes from the reserve method of accounting for bad debts
described in § 585 for its first taxable year for which an election under § 1362(a) is in
effect, the bank may elect to take into account any adjustments under § 481 by reason

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of such change for the taxable year immediately preceding such first taxable year.
Section 1361(g) applies to taxable years beginning after December 31, 2006.
SECTION 3. SCOPE
.01 In general
. Section 11.01 of the APPENDIX of Rev. Proc. 2002-9 provides
rules for a bank (as defined in § 581, including a bank for which a qualified subchapter
S subsidiary (QSub) election is filed) that wants to change its method of accounting for
bad debts from the § 585 reserve method to the § 166 specific charge-off method.
Section 11.01 specifically references the requirement that a bank must change its
method of accounting for bad debts from the § 585 reserve method in order to be
eligible to elect subchapter S status.
.02 Election for § 481(a) adjustment
. Section 4.01 of this revenue procedure
describes the process by which a bank may elect under § 1361(g) to take into account
the § 481(a) adjustment resulting from a change in method of accounting for bad debts
in determining taxable income for the taxable year immediately preceding the year of
change.
SECTION 4. APPLICATION
.01 Requirements for election to include § 481(a) adjustment in taxable year
immediately preceding the year of change. For a taxable year beginning after
December 31, 2006, a bank that changes its method of accounting for bad debts, under
section 11.01 of the APPENDIX to Rev. Proc. 2002-9, from the § 585 reserve method to
the § 166 specific charge-off method for the first taxable year for which the S
corporation election is effective (year of change) may elect to take into account the
amount of the resulting § 481(a) adjustment in determining taxable income for the

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taxable year immediately preceding the year of change. To make this election, a bank
must (1) file an original and copy of Form 3115 under section 6.02(3) of Rev. Proc.
2002-9 for the year of change, (2) file an additional copy of the Form 3115 with its
original (or amended) federal income tax return for the taxable year immediately
preceding the year of change filed no later than the date the original Form 3115 is
properly filed under section 6.02(3) of Rev. Proc. 2002-9, and (3) include the amount of
the § 481(a) adjustment in gross income for the taxable year immediately preceding the
year of change. The original (and each copy of) Form 3115 must state at the top of the
document, “Section 1361(g) Election Filed Pursuant to Rev. Proc. 2008-18.”
.02 Example. X, a calendar year taxpayer, is a bank as defined in § 581 and is
not a large bank as defined in § 585(c)(2). For taxable years before 2007, X accounted
for its bad debts under the § 585 reserve method. By March 15, 2007, X properly filed a
Form 2553 electing to be an S corporation effective January 1, 2007. Pursuant to
section 11.01(3) of the APPENDIX to Rev. Proc. 2002-9, the filing of the Form 2553
constituted an agreement by X to change from the § 585 reserve method to the § 166
specific charge-off method in 2007 in accordance with all of the applicable provisions of
Rev. Proc. 2002-9. Thus, for example, X must file a Form 3115 for this change in
duplicate, in accordance with section 6.02(3) of Rev. Proc. 2002-9, by attaching the
original Form 3115 to X’s timely filed (including extensions) original federal income tax
return for 2007 and filing a copy of the Form 3115 with the national office. The amount
of X’s § 481(a) adjustment for the change is the amount of X’s bad debt reserve as of
the close of December 31, 2006. X wishes to elect under § 1361(g) to include the
§ 481(a) adjustment in income in the tax year ending December 31, 2006, the taxable

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year immediately preceding the year of change. To make this election, X must (1) file
an original and copy of Form 3115 under section 6.02(3) of Rev. Proc. 2002-9 for 2007,
(2) file an additional copy of the Form 3115 with its original (or amended) federal income
tax return for 2006 filed no later than the date the original Form 3115 is properly filed
under section 6.02(3) of Rev. Proc. 2002-9, and (3) include the amount of its § 481(a)
adjustment in gross income in its return for 2006. The original (and each copy of) Form
3115 must state at the top of the document, “Section 1361(g) Election Filed Pursuant to
Rev. Proc. 2008-18.”
SECTION 5. SPECIAL RULE FOR CERTAIN 2006 TAXABLE YEARS.
A special rule is provided for a bank that, prior to the issuance of this revenue
procedure, changed its method of accounting for bad debts from the § 585 reserve
method to the § 166 specific charge-off method under section 11.01 of the APPENDIX
of Rev. Proc. 2002-9 for a year of change beginning after December 31, 2005, and
ending before December 31, 2007 (“2006 taxable year”). This special rule only applies
if the bank elected to be an S corporation for its first taxable year beginning after
December 31, 2006. Under this special rule, the bank may elect to take the entire
§ 481(a) adjustment into account in determining taxable income for the 2006 taxable
year by attaching a copy of its original Form 3115 with the following language written on
the top of the document, "Special Election under Section 5 of Rev. Proc. 2008-18," to an
amended return for the 2006 taxable year that reflects the entire § 481(a) adjustment. A
copy of the original Form 3115 with the required language written at the top should also
be provided to the National Office (see section 6.02(6) of Rev. Proc. 2002-9 for the
address). This special rule only applies to an election made under this section 5 on an

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amended return for the 2006 taxable year filed on or before September 15, 2008.
SECTION 6. EFFECTIVE DATE
This revenue procedure is effective for taxable years beginning after December
31, 2006, except as provided in Section 5 of this revenue procedure.
SECTION 7. EFFECT ON OTHER DOCUMENTS

This revenue procedure modifies Rev. Proc. 2002-9 by adding section 4.01(1) of
this revenue procedure to section 11.01 of the APPENDIX of Rev. Proc. 2002-9. See
section 11.01 of the APPENDIX of Rev. Proc. 2002-9 for the specific rules relating to a
change in accounting method from the § 585 reserve method of accounting for bad
debts to the § 166 specific charge-off method of accounting.
SECTION 8. DRAFTING INFORMATION
The principal author of this revenue procedure is Laura C. Fields of the Office of
Associate Chief Counsel (Passthroughs and Special Industries). For further information
regarding this revenue procedure contact Laura C. Fields at (202) 622-3050 (not a toll
free call).