Rev. Rul. 80-361

When may a creditor-taxpayer suspend the accrual of interest income on a loan that becomes uncollectible during the taxable year?

FACTS

M, a domestic corporation, is a calendar year taxpayer that uses the accrual method of accounting. M made a secured loan to A in 1975. During 1975 and through the major part of 1976, A's financial condition was such that the interest on the loan obligation to M was collectible. During the latter part of 1976, however, due to sudden and severe financial reverses, A became insolvent, and, as a consequence, the debt became uncollectible. Short thereafter, A defaulted on the loan. The security was sufficient to satisfy only the principal amount of the indebtedness.

APPLICABLE LAW AND ANALYSIS

Section 1.451-1(a) of the Income Tax Regulations provides that under an accrual method of accounting, income is includible in gross income when all events have occurred that fix the right to receive such income and the amount thereof can be determined with reasonable accuracy.

Rev. Rul. 72-100, 1972-1 C.B. 122, as clarified by Rev. Rul. 74-607, 1974-2 C.B. 149, states that the right to receive interest income becomes fixed ratably over the period of the loan so long as all events have accrued to fix the right to receive income and the amount thereof can be fixed with reasonable accuracy.

A fixed right to a determinable amount does not require accrual, however, if the income item is uncollectible when the right to receive the item arises. Jones Lumber Co. v. Commissioner, 404 F.2d 764 (6th Cir. 1968).

When an income item is properly accrued and subsequently becomes uncollectible, a taxpayer's remedy is by way of deduction rather than through elimination of the accrual. Moreover, this rule is applicable even when the item is accrued and becomes uncollectible during the same taxable year. Spring City Foundry Co. v. Commissioner, 292 U.S. 182 (1934), Ct.D. 829, XIII-1 C.B. 28 (1934). Also Atlantic Coast Line Railroad Co. v. Commissioner, 31 B.T.A. 730, 751 (1934), acq., XIV-2 C.B. (1935).

HOLDINGS

The interest, the right to which became fixed during that part of 1976 prior to A's insolvency, accrued as such right arose and therefore must be included in the gross income of M for that year. To the extent that the accrued interest subsequently became uncollectible because of A's insolvency, M is entitled to treat the accrued interest as a bad debt pursuant to section 166 of the Code, provided the requirements of that section are satisfied.

The interest, the right to which became fixed during that part of 1976 after A's insolvency, did not properly accrue, since the interest was uncollectible at the time such right arose, Therefore, such interest need not be included in the gross income of M for 1976.