Rev. Rul. 79-228

ISSUE

Will a financial institution be granted permission to use the "actuarial method" of accounting to determine the amount of interest on installment loans to be included in gross income for federal income tax purposes?

FACTS

M is engaged in the general commercial banking business, computes its taxable income under an accrual method of accounting and uses a calendar year accounting period. In the course of its banking business, M makes installment loans to its customers. The interest element of each loan is either discounted from or added on to the loan principal.

In reporting its income for federal income tax purposes, M has consistently used a method of accounting under which it included in gross income the entire amount of the interest on an installment loan in the year in which the loan was made. M determined that this method of reporting interest does not clearly reflect income within the meaning of section 446(b) of the Internal Revenue Code of 1954. M timely filed Form 3115 (Application for Change in Accounting Method) requesting the consent of the Commissioner of Internal Revenue to change its method of accounting for interest on installment loans from its present method described above to a method of reporting interest as installment payments are due or received computed on the actuarial method. The actuarial method is a method described in Regulation Z, 12 CFR 226 (1969) of the Consumer Credit Protection Act, Pub. L. 90-321; 82 Stat. 146, et seq. (Truth in Lending Act), for allocating payments made on a debt between the amount financed and the amount of the finance charge (interest) pursuant to which a payment is applied first to the accumulated interest and then to the unpaid amount financed. M will also make a similar change in its financial accounting method.

LAW AND ANALYSIS

Section 1.446-1(c)(2)(ii) of the Income Tax Regulations provides, in part, that the Commissioner may authorize a taxpayer to adopt or change to a permissible method of accounting although the method is not specifically described in the pertinent regulations if, in the opinion of the Commissioner, income is clearly reflected by the use of such method.

In Rev. Rul. 72-100, 1972-1 C.B. 122, as clarified by Rev. Rul. 74-607, 1974-2 C.B. 149, the Service discusses the Rule of 78's method of computing interest on installment loans and implicitly recognizes it as a method that clearly reflects income.

The actuarial method and the Rule of 78's method are both predicated on the theory that interest earned on a loan should decline over the loan period in proportion to diminution of the unpaid principal balance. Moreover, the results achieved through application of these methods to like loan arrangements are comparable.

HOLDING

The actuarial method qualifies as a permissible method of accounting within the meaning of section 446 of the Code and M will be permitted to change its method of accounting for interest on installment loans to the actuarial method.