Deduction of FSLIC reserves: in CEBA's wake.

The Internal Revenue Service, in letter ruling 9252002, cleared up an arcane but persistent timing issue that has plagued savings and loans for several years: the deductibility of payments to a "secondary reserve" maintained by the Federal Savings and Loan Insurance Corporation (FSLIC).

The IRS ruled S&Ls were entitled to take a tax deduction for amounts paid into the reserve in May 1987--the time the reserve was extinguished.

First, some background: FSLIC institutions had been required to pay regular insurance premiums and, for a time, additional amounts that were treated as assets and recorded in a secondary reserve account. These amounts could be used to satisfy regular premium obligations and were available for FSLIC losses.

In 1987, in response to a General Accounting Office audit of its solvency, the FSLIC assessed a special premium against some member institutions by extinguishing the secondary reserve.

As a result of this action, there was no possibility the funds in the reserve would be returned. However, the Competitive Equality Bank Act of 1987 (CEBA), enacted later that same year, permitted an offset against future premium obligations based on the balance in the secondary reserve before extinguishment.

Because the reserve was thus recoverable, the IRS was asked to rule on whether the extinguished reserve balance was deductible.

The IRS said amounts paid into the reserve were deductible under revenue ruling 66-49 when used to pay regular premiums or losses or when the possibility of the funds' return was otherwise precluded. Here, the FSLIC extinguished the reserve through its special assessment. It thus eliminated any possibility the funds would be returned. So, on extinguishment--but before CEBA was taken into consideration--the reserve amounts became deductible.

The IRS concluded CEBA did not bar deductions because the FSLIC's extinguishment action had been made in response to the GAO audit and not in anticipation of relief provided by the act. Moreover, at the time it took the action, no one could have known whether any relief would be forthcoming.

Observation: Accordingly, deductions were proper for the year that included May 1987. This was when the "all events" test was met (under which a deduction can be taken when all events have occurred establishing the fact of a liability, and the liability's amount can be determined with reasonable accuracy), since it was the time the FSLIC conclusively exercised its authority to extinguish the reserve.