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TITLE 26-INTERNAL REVENUE CODE SECTION REFERRED TO IN OTHER SECTIONS This section is referred to in sections 58, 170, 171, 581, 851 of this title. § 585. Reserves for losses on loans of banks (a) Institutions to which section applies This section shall apply to the following fi- nancial institutions: (1) any bank (as defined in section 581) other than an organization to which section 593 applies, and (2) any corporation to which paragraph (1) would apply except for the fact that it Is a foreign corporation, and in the case of any such foreign corporation this section shall apply only with respect to loans outstanding the interest on which is effectively connected with the conduct of a banking business within the United States. (b) Addition to reserves for bad debts (1) General rule For purposes of section 166(c), the reason- able addition to the reserve for bad debts of any financial institution to which this section applies shall be an amount determined by the taxpayer which shall not exceed the greater of- (A) for taxable years beginning before 1988 the addition to the reserve for losses on loans determined under the percentagie method as provided in paragraph (2), or (B) the addition to the reserve for losses on loans determined under the experience method as provided in paragraph (3). (2) Percentage method The amount determined under this para- graph for a taxable year shall be the amount necessary to increase the balance of the re- serve for losses on loans (at the close of the taxable year) to the allowable percentage of eligible loans outstanding at such time, except that- (A) If the reserve for losses on loans at the close of the base year is less than the al- lowable percentage of eligible loans out- standing at such time, the amount deter- mined under this paragraph with respect to the difference shall not exceed one-fifth of such difference. (B) If the reserve for losses on loans at the close of the base year is not less than the allowable percentage of eligible loans outstanding at such time, the amount deter- mined under this paragraph shall be the amount necessary to increase the balance of the reserve at the close of the taxable year to (I) the allowable percentage of eligible loans outstanding at such time, or (iti) the balance of the reserve at the close of the base yesr, whichever is greater, but if the amount of eligible loans outstanding at the close of the taxable year is less than the amount of such loans outstanding at the close of the base year, the amount deter- mined under clause (ii) shall be the amount necessary to increase the balance of the re- serve at the close of the taxable year to the amount which bears the same ratio to eligi- ble loans outstanding at the close of the taxable year as the balance of the reserve at the close of the base year bears to the amount of eligible loans outstanding at the close of the base year. For purposes of this paragraph, the term "al- lowable percentage" means 1.8 percent for taxable years beginning before 1976; 1.2 per- cent for taxable years beginning after 1975 but before 1982; and 0.6 percent for taxable years beginning after 1981. The amount de- termined under this paragraph shall not exceed 0.6 percent of eligible loans outstand- ing at the close of the taxable year or an amount sufficient to increase the reserve for losses on loans to 0.6 percent of eligible loans outstanding at the close of the taxable year, whichever is greater. For purposes of this paragraph, the term "base year" means: for taxable years beginning before 1976, the last taxable year beginning on or before July 11, 1969, for taxable years beginning after 1975 but before 1982, the last taxable year begin- ning before 1976, and for taxable years begin- ning after 1981, the last taxable year begin- ning before 1982; except that for purposes of subparagraph (A) such term means the last taxable year before the most recent adoption of the percentage method, if later. (3) Experience method The amount determined under this para- graph for a taxable year shall be the amount necessary to increase the balance of the re- serve for losses on loans (at the close of the taxable year) to the greater of- (A) the amount which bears the same ratio to loans outstanding at the close of the taxable year as (I) the total bad debts sustained during the taxable year and the 5 preceding taxable years (or, with the ap- proval of the Secretary, a shorter period), adjusted for recoveries of bad debts during such period, bears to (it) the sum of the loans outstanding at the close of such 6 or fewer taxable years, or (B) the lower of- (i) the balance of the reserve at the close of the base year, or (it) if the amount of loans outstanding at the close of the taxable year is less than the amount of loans outstanding at the close of the base year, the amount which bears the same ratio to loans out- standing at the close of the taxable year as the balance of the reserve at the close of the base year bears to the amount of loans outstanding at the close of the base year. For purposes of this paragraph, the base year shall be the last taxable year before the most recent adoption of the experience method, except that for taxable years beginning after 1987 the base year shall be the last taxable year beginning before 1988. (4) Regulations; definition of eligible loan, etc. The Secretary shall define the terms "loan" and "eligible loan" and prescribe such regula- tions as may be necessary to carry out the purposes of this section; except that the term "eligible loan" shall not include- (A) a loan to a bank (as defined In section 581), Page 433 § 585