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Bank depositors thrown for a loss?

As has happened with many businesses, banks and other financial institutions are feeling the effects of today's economic climate. Some of these institutions have gone under, leaving depositors in the lurch.

When financial institutions fail, depositors often find themselves in a difficult situation, especially if their deposits are not federally insured. Before 1986, individuals who had incurred losses on deposits in financial institutions could take the loss as a bad debt only in the year the loss was sustained; in addition, unless the loss was incurred in the taxpayer's trade or business, it generally was considered a short-term capital loss.

In 1986, Congress recognized that losses on deposits in financial institutions were different from other debts owed to taxpayers. Because in most cases funds are deposited with the expectation they can be withdrawn on demand, these losses are more properly akin to casualty losses. The Tax Reform Act of 1986 added a provision that would allow individuals to treat losses on deposits in insolvent or bankrupt financial institutions as casualty losses in the year in which the amount of the loss could reasonably be estimated. This provision was further amended by the Technical and Miscellaneous Revenue Act of 1988 to allow taxpayers the choice of electing ordinary loss or casualty loss treatment for such lost deposits.

ELIGIBILITY REQUIREMENTS

To take advantage of these elections, a taxpayer may not be a 1% (or more) owner of the financial institution, an officer or related to any such owner or officer. The loss must have been suffered in a commercial bank, thrift institution, credit union or similar financial institution chartered and supervised under federal or state law. Qualifying deposits include any deposit, withdrawable account or repurchasable share.

An important restriction is that no part of the taxpayer's deposits in the financial institution be federally insured. Practically speaking, this requirement will be met only when none of the institution's deposits are federally insured.

TREATMENT OF LOSSES

Capital loss. If a short-term capital loss is taken, the taxpayer is allowed a $3,000 annual deduction, with a carryforward of any excess amount.

Casualty loss. Casualty losses may be deducted only if they exceed $100. In addition, only net losses that exceed 10% of the individual's adjusted gross income qualify, and they must be taken as an itemized deduction. Also, no carryforward of this loss would be allowed.

Ordinary loss. Ordinary loss treatment is limited to $20,000 ($10,000 if married and filing separately) in aggregate losses on deposits in the same institution for one particular year.

Note: An election of treatment for losses in one financial institution does not affect the treatment of losses from other financial institutions. However, an election does preclude a taxpayer from claiming the same loss as a bad debt.

Because these elections apply to amounts that are "reasonably estimated," they may apply to years prior to the final determination year. However, the taxpayer's failure to claim a loss in the year the loss first can be reasonably estimated will not preclude him or her from claiming such loss in a later tax year prior to the final determination year.

MAKING AN ELECTION

To make the election, the taxpayer must claim the loss as either casualty or ordinary on the income tax return for the year in which a reasonable estimate of the loss can be made (reduced by any proceeds reasonably expected under state law). The election should include information requested in applicable forms and instructions (for example, Form 4684, Casualties and Thefts). If the pertinent form and its instructions contain no guidance on this election for a specific situation, the taxpayer should include the name of the financial institution, the language "insolvent financial institution election" and the calculation of the reasonably estimated loss claimed.

Note: These elections, which may be revoked only with the Internal Revenue Service's consent, may be made on amended returns, if no election had been made and the period for filing a claim for refund or credit has not yet expired.

For a discussion of this and other recent developments, see the Tax Clinic department, edited by Alan M. Witt, in the October 1991 issue of The Tax Adviser.
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Article Details
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Author:Fiore, Nicholas J.
Publication:Journal of Accountancy
Date:Oct 1, 1991
Words:695
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