(a) Allowance of deduction. A taxpayer who has established the reserve method of treating bad debts and has maintained proper reserve accounts for bad debts or who, in accordance with paragraph (b) of § 1.166-1, adopts the reserve method of treating bad debts may deduct from gross income a reasonable addition to a reserve for bad debts in lieu of deducting specific bad debt items. This paragraph applies both to bad debts owed to the taxpayer and to bad debts arising out of section 166(f)(1)(A) guaranteed debt obligations. If a reserve is maintained for bad debts arising out of section 166(f)(1)(A) guaranteed debt obligations, then a separate reserve must also be maintained for all other debt obligations of the taxpayer in the same trade or business, if any. A taxpayer may not maintain a reserve for bad debts arising out of section 166(f)(1)(A) guaranteed debt obligations if with respect to direct debt obligations in the same trade or business the taxpayer takes deductions when the debts become worthless in whole or in part rather than maintaining a reserve for such obligations. See § 1.166-10 for rules concerning section 166(f)(1)(A) guaranteed debt obligations.
(b) Reasonableness of addition to reserve—(1) Relevant factors. What constitutes a reasonable addition to a reserve for bad debts shall be determined in the light of the facts existing at the close of the taxable year of the proposed addition. The reasonableness of the addition will vary as between classes of business and with conditions of business prosperity. It will depend primarily upon the total amount of debts outstanding as of the close of the taxable year, including those arising currently as well as those arising in prior taxable years, and the total amount of the existing reserve.
(2) Correction of errors in prior estimates. In the event that subsequent realizations upon outstanding debts prove to be more or less than estimated at the time of the creation of the existing reserve, the amount of the excess or inadequacy in the existing reserve shall be reflected in the determination of the reasonable addition necessary in the current taxable year.
(c) Statement required. A taxpayer using the reserve method shall file with his return a statement showing—
(1) The volume of his charge sales or other business transactions for the taxable year and the percentage of the reserve to such amount;
(2) The total amount of notes and accounts receivable at the beginning and close of the taxable year;
(3) The amount of the debts which have become wholly or partially worthless and have been charged against the reserve account; and
(4) The computation of the addition to the reserve for bad debts.
(d) Special rules applicable to financial institutions. For special rules for the addition to the bad debt reserves of certain banks, see §§ 1.585-1 through 1.585-3.
[T.D. 6500, 25 FR 11402, Nov. 26, 1960, as amended by T.D. 6728, 29 FR 5855, May 5, 1964; T.D. 7444, 41 FR 53481, Dec. 7, 1976; T.D. 8071, 51 FR 2479, Jan. 17, 1986; T.D. 9849, 84 FR 9233, Mar. 14, 2019]
Notes of Decisions
James A. Messer Co. v. Comm'r, 57 T.C. 848 (Tax Ct. 1972).
· cites it 8× “The reserve was replenished by annual additions thereto. Such additions are deductible if they are "reasonable" within the meaning of section 166(c) , and section 1.”
Handelman v. Comm'r, 36 T.C. 560 (Tax Ct. 1961).
· cites it 8× “They contend that the reasonableness is confirmed by the fact that the sales price of the notes and contracts took into account an allowance of 5 percent of face value for uncollectible accounts, and that the purchaser did later suffer loss in the collection of the notes and…”
Bird Mgmt., Inc. v. Comm'r, 48 T.C. 586 (Tax Ct. 1967).
· cites it 6× “Held , the Commissioner properly disallowed a deduction for an addition to T's bad debt reserve in the year of sale of its business assets, including all of its accounts receivable, since it had no accounts receivable at the close of the tax year, the time as of which the…”
Thor Power Tool Co. v. Comm'r, 64 T.C. 154 (Tax Ct. 1975).
· cites it 4× “10 *201 Section 166(c) gives the Commissioner the discretion to adjust the reserve for bad debts. To prevail, petitioner must show that the Commissioner abused such discretion.”
Valmont Indus., Inc. v. Comm'r, 73 T.C. 1059 (Tax Ct. 1980).
· cites it 2× “What constitutes a reasonable addition to a reserve for bad debts shall be determined in the light of the facts existing at the close of the taxable year of the proposed addition.”
Georgia Fed. Bank, F.S.B. v. Comm'r, 98 T.C. 105 (Tax Ct. 1992).
· cites it 2× “Courts have recognized that section 593 simply provides a method *32 for calculating an addition to bad debt reserves, a deduction for which was provided by section 166(c).”
Roanoke Vending Exch., Inc. v. Comm'r, 40 T.C. 735 (Tax Ct. 1963).
· cites it 2× “What constitutes a reasonable addition to a reserve for bad debts shall be determined in the light of the facts existing at the close of the taxable year of the proposed addition.”
Brooks v. Comm'r, 63 T.C. 1 (Tax Ct. 1974).
· cites it 6× “The determination must be made in the light of all relevant facts, including the nature of the business, past experience of the taxpayer, conditions of business prosperity, the total amount of debts outstanding at the close of the taxable year, and the total amount of the…”
Westchester Dev. Co. v. Comm'r, 63 T.C. 198 (Tax Ct. 1974).
· cites it 2× “, provides: (b) Reasonableness of addition to reserve -- (1) Relevant factors -- What constitutes a reasonable addition to a reserve for bad debts shall be determined in the light of the facts existing at the close of the taxable year of the proposed addition .”
Jostens, Inc. v. Comm'r, 58 T.C.M. 933 (Tax Ct. 1989).
· cites it 2× “" The addition to the reserve for bad debts depends on the "amount of debts that have become wholly or partially worthless * * *." Sec. 1.166-4(c)(3), Income Tax Regs.”
J. E. Hawes Corp. v. Comm'r, 44 T.C. 705 (Tax Ct. 1965).
· cites it 2× “And the general rule is well established that any balance in a reserve for bad debts existing when the reserve becomes no longer necessary must be included in taxable income, since the amount of such balance represents amounts which have been previously deducted.”
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