The FDIC’s Process for Writing Off Assets
March 2005
Report No. 05-014
AUDIT REPORT
Background and Purpose of Audit
The FDIC’s Division of Resolutions and Receiverships (DRR) is responsible for resolving failed FDIC-insured depository
institutions promptly, efficiently, and responsively in order to maintain public confidence in the nation’s financial system.
Once the resolution has occurred, the FDIC is appointed as receiver to wind up the closed institution’s affairs including its
liquidation and the disposition of assets. Until assets are sold (dispositioned), DRR performs required asset servicing in
order to maintain the assets’ values. When reasonable attempts to sell or recover assets have been unsuccessful and additional
expenditure of FDIC resources is unjustified, the FDIC may write off the assets.
In processing write-off transactions, the FDIC is required to report a canceled debt of $600 or more on Form 1099-C,
Cancellation of Debt, to the Internal Revenue Service (IRS).
Our audit scope included 435 write-off cases, valued at $292 million. We reviewed a sample of 24 write-off cases valued
at about $95 million.
The audit objective was to determine whether DRR’s decisions for writing off assets from failed financial insured depository
institutions were properly justified and adequately supported.
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Results of Audit
The FDIC has established a sound internal control process and procedures for writing off receivership assets in
conformity with DRR delegations of authority. For the 24 write-off cases we sampled, the decisions to write off
receivership assets from failed depository institutions were justified and adequately supported.
We also found, however, eight write-off cases totaling $31 million in debt for which DRR had not issued Forms 1099-C
in compliance with FDIC and IRS policies and directives. As a result, the government may have been deprived of significant
tax revenue.
Recommendations and Management Response
We recommended that DRR improve procedures related to reporting discharges of debt, issue Forms 1099-C for the write-off
cases identified in the report, and review all write-off cases for 2003 and 2004 to ascertain whether reporting of additional
discharges of debt is warranted. DRR concurred with two of our recommendations and partially concurred with the third
recommendation. Regarding the partial concurrence, DRR agreed to issue Forms 1099-C for the seven write-off cases that
involved loans to foreign debtors and loans discharged in corporate bankruptcies. DRR did not agree to issue the forms for
the remaining case because the taxable event occurred before bank failure, and DRR stated that it is not its policy to issue
a Form 1099-C in this circumstance. Notwithstanding, DRR has requested an FDIC Legal Division opinion regarding the
appropriateness of that policy. We consider management’s planned actions responsive to the recommendations.
Asset Write-Offs Requiring the Issuance of Form 1099-C |
Nature of Write-Off |
Number of Cases |
Value Of Cases |
Loans to Foreign Debtors |
4 |
$16,894,282 |
Loans Discharged in Corporate Bankruptcies |
3 |
13,346,240 |
Loans Previously Written Off by a Failed Institution |
1 |
418,026 |
Totals |
8 |
$30,658,548 |
Source: OIG review of DRR asset case files.
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DATE: |
March 31, 2005 |
MEMORANDUM TO: |
Mitchell L. Glassman, Director |
|
Division of Resolutions and Receiverships |
FROM: |
Russell A. Rau [Electronically produced version; original signed by Russell A. Rau] |
|
Assistant Inspector General for Audits |
SUBJECT: |
The FDIC’s Process for Writing Off Assets |
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Report No. 05-014 |
This report represents the results of the Federal Deposit Insurance Corporation (FDIC) Office of Inspector General’s (OIG)
audit of the FDIC’s process for writing off assets from failed insured financial depository institutions. A full or partial
write-off of a receivership[ 1 ] asset occurs when the amount of the asset is removed from the books of record because the value of
the legal obligation of the debtor has been declared a loss. The write-off process is described in detail in the Background
section of this report.
The objective of the audit was to determine whether decisions to write off assets from failed insured depository institutions
were properly justified and adequately supported. The scope of our audit included B-25 delegation of authority[ 2 ]
write-off cases from January 1, 2003 through September 30, 2004. According to the Division of Resolutions and Receiverships (DRR),
435 B-25 write-off cases had a book value of about $292 million for the period covered in our audit. Additional details on our
objective, scope, and methodology are presented in Appendix I.
BACKGROUND
The FDIC is charged with the resolution of failing FDIC-insured financial institutions. Once the resolution has occurred
and the FDIC is appointed receiver for the closed institution, DRR inventories and values any remaining assets and uses various
strategies to sell or recover assets. The disposition of certain assets can be lengthy. In the interim, DRR performs required
asset servicing (building maintenance, processing of loan payments, etc.) in order to maintain the assets’ values until they are
sold.
DRR Account Officers are responsible for managing the disposition of the assets. When reasonable attempts to sell or recover
assets have been unsuccessful and the DRR Account Officer believes that additional expenditure of FDIC resources are unjustified,
the Account Officer may request that the assets be written off. According to the FDIC, the full or partial write off of an asset
occurs when the FDIC removes the amount of the asset from the books of record because the value of the legal obligation of the
debtor has been declared a loss.
According to DRR’s Asset Disposition Manual, the Account Officer begins the write-off process with the preparation of a case
memorandum. The case memorandum should be a persuasive written document used to request and obtain authority to act with respect
to an asset. The delegations of authority determine the level for which a case is written. The cases have a two-fold purpose:
(1) to seek authority from the proper individual or committee and (2) to create a permanent record, in the form of an asset file,
of the FDIC’s actions taken to conform to its fiduciary responsibilities. The asset file must contain adequate documentation to
demonstrate that a reasonable attempt to recover the asset has been made. Once the write-off request is processed, the write-off
information is maintained in the FDIC’s National Processing System (NPS), which DRR uses to account for loans and related financial
transactions required from failed depository institutions.
Internal Revenue Service (IRS) regulations regarding reporting discharges of indebtedness are contained in 26 U.S.C. 6050P,
Information Reporting for Discharges of Indebtedness by Certain Federal Agencies. FDIC guidance regarding reporting discharges of
indebtedness is primarily contained in two documents. FDIC Circular 5400.1, Reporting for Discharge of Indebtedness (IRS Forms 1099),
dated May 1, 2001, contains guidance for the Account Officers on the events requiring the reporting of the discharges of
indebtedness. The circular states that a Form 1099-C must be filed with the IRS for each debtor for whom a debt of $600 or more is
canceled. DRR’s Field Financial Office (FFO) Accounting Manual provides instructions for handling write-off transactions. The FDIC’s
failure to issue a Form 1099-C, when appropriate to do so, subjects the FDIC to potential IRS penalties and theoretically deprives
the government of potential tax revenue.
RESULTS OF AUDIT
The FDIC has established a sound internal control process and procedures for writing off receivership assets managed by DRR
Account Officers in conformity with DRR delegations of authority. For the 24 write-off cases we sampled, the decisions to write
off receivership assets from failed depository institutions were properly justified and adequately supported. Accordingly, DRR
has reasonable assurance that established processes and procedures were implemented as designed. However, we identified eight
write-off cases involving about $31 million in debt for which DRR had not issued Forms 1099-C in compliance with FDIC and IRS
policies and directives. As a result, the government may have been deprived of significant tax revenue.[ 3 ]
IRS Requirements for Filing Form 1099-C
The FDIC must file Form 1099-C for each debtor for whom the FDIC has canceled a debt of $600 or more when an identifiable event
has occurred. IRS regulations define an identifiable event as:
- a discharge of indebtedness under Title 11 of the U.S. Code (bankruptcy);
- a cancellation or extinguishment of indebtedness that renders a debt unenforceable in a receivership, foreclosure, or similar proceeding in federal or state court;
- a cancellation or extinguishment of indebtedness upon the expiration of a statute of limitations for collection of an indebtedness;
- a cancellation of indebtedness pursuant to an election of foreclosure remedies by a creditor that statutorily extinguishes or bars the creditor's right to pursue collection;
- a cancellation of indebtedness that renders a debt unenforceable pursuant to a probate or similar proceeding;
- a discharge of indebtedness pursuant to an agreement between an applicable entity and a debtor to discharge indebtedness at less than full consideration; or
- the expiration of the non-payment testing period as described in the regulation.
Receivership Assets Written Off but Not Reported by DRR
The write-off cases for which DRR did not issue the required Forms 1099-C for discharges of debt fell into several categories
as shown in the table below. Generally, the forms were not issued because the Account Officers involved were not fully aware of
the reporting requirements associated with these rather atypical write-offs. A summary of the circumstances surrounding each
category of write-off follows. Additional details regarding the specific write-off cases were provided separately to DRR for its
use in resolving our finding.
Asset Write-Offs Requiring the Issuance of Form 1099-C |
Nature of Write-Off |
Number of Cases |
Value Of Cases |
Loans to Foreign Debtors |
4 |
$16,894,282 |
Loans Discharged in Corporate Bankruptcies |
3 |
13,346,240 |
Loans Previously Written Off by a Failed Institution |
1 |
418,026 |
Totals |
8 |
$30,658,548 |
Source: OIG review of DRR asset case files.
Loans to Foreign Debtors: DRR did not file Forms 1099-C for four write-off cases
totaling $16,894,282 in loans to foreign debtors. For example, DRR wrote off an $8.7 million loan to a foreign
debtor but did not issue the appropriate Form 1099-C. The DRR Account Officer responsible for this asset stated
that he was unaware of the requirement to issue Form 1099-C to a debtor with a foreign address. However, DRR’s
failure to issue the form is contrary to IRS regulations. Further, FDIC Circular 5400.1 states, “It is not the
responsibility of the FDIC to determine what is taxable income, only to report the discharge, regardless of circumstances.”
In addition, DRR’s Accounting Manual provides an example of when reporting discharges of debt to the
IRS is not required, which is misleading and incorrect. Specifically, the example describes a foreign customer
with a foreign address which is not in conformity with the IRS regulations. The regulations state that if a foreign
entity has income from any U.S. source, the entity must file a U.S. tax return. Therefore, DRR should have filed
Forms 1099-C for the four cases.
Loans Discharged in Corporate Bankruptcies: DRR did not file Forms 1099-C for three write-off
cases totaling $13,346,240 in loans discharged as part of corporate bankruptcies. For example, a corporation was granted
bankruptcy protection, which included a debt of about $4.8 million owed to an FDIC receivership. The DRR Account Officer
determined that repayment was unlikely and recommended writing off the debt. However, according to FDIC Circular 5400.1,
a corporate bankruptcy is an event requiring issuance of Form 1099-C.
For two other bankruptcy cases totaling $8.5 million, a DRR official agreed that Forms 1099-C should have been issued
and intends to issue them after collection activity on related loans has concluded.
Loans Previously Written Off by a Failed Institution: DRR did not file Forms 1099-C for over
100 loans valued at $418,026 that had been charged off by a bank prior to failure but had not been reported to the IRS.
When the FDIC took control of the bank, the FDIC recorded the loans in the receivership records as a
“control total”[ 4 ] for accountability purposes.
The DRR Account Officer recommended that the control total be written off the receivership records. However, when doing so,
DRR did not issue Forms 1099-C for the individual discharged debts. According to DRR, the forms were not issued because the
loan files were in poor shape, and DRR did not want to risk issuing incorrect forms. However, because the legitimacy of the
discharged amount of debt is a matter to be resolved between the debtor and the IRS, this is not a valid reason for failing
to report the discharges of debt.
CONCLUSION AND RECOMMENDATIONS
The decisions to write off receivership assets that we reviewed were properly justified and adequately supported.
However, the Corporation should take steps to ensure that the government is not deprived of significant tax revenue
resulting from cases we identified and that similar cases are properly reported in the future.
We recommend that the Director, DRR:
- Revise FDIC Circular 5400.1, Reporting for Discharge of Indebtedness (IRS Forms 1099), and the
supporting manuals to better conform with IRS regulations requiring the issuance of Forms 1099-C.
- Issue Forms 1099-C for those write-off cases identified in the report and provided to DRR that had not been
reported to the IRS.
- Review all write-offs for 2003 and 2004, and issue Forms 1099-C, if appropriate.
CORPORATION COMMENTS AND OIG EVALUATION
On March 10, 2005, the Director, DRR, provided a written response to a draft of this report. The response is
presented in its entirety in Appendix II of this report. The Director concurred with recommendations 1 and 3 and
partially concurred with recommendation 2. A summary of the Director’s responses and our analysis follows. See
Appendix III for additional details on the status of the recommendations.
The Corporation’s planned actions addressed recommendations 1 and 3. Regarding the 11 write-off cases discussed
in a draft of this report and in management’s comments related to recommendation 2, DRR agreed to issue Forms 1099-C
for the seven cases, totaling $30,240,522, that involved loans to foreign debtors ($16,894,282) and loans discharged
in corporate bankruptcies ($13,346,240). For the three cases (totaling $20,967,928) that were discussed in the draft
of this report and related to various non-loan assets, DRR provided additional information supporting its position
that Forms 1099-C were not necessary under the circumstances. We revised the report accordingly. Finally, DRR did
not agree to issue Forms 1099-C for the remaining case totaling $418,026. Specifically, the taxable event for that
case occurred before bank failure, and DRR indicated that its policy is not to issue a Form 1099-C in that circumstance.
Nevertheless, DRR has requested an opinion from the FDIC’s Legal Division regarding the appropriateness of that policy.
Taking into consideration that Forms 1099-C are not necessary for the three non-loan asset write-offs, we maintain
that the forms should be issued for the eight write-off cases totaling $30,658,548. We consider management’s planned
actions responsive to the recommendations, which are resolved but will remain undispositioned and open until we have
determined that agreed-to corrective actions have been completed and are effective.
APPENDIX I
OBJECTIVE, SCOPE, AND METHODOLOGY
The audit objective was to determine whether DRR’s decisions for writing off assets from failed financial insured
depository institutions were properly justified and adequately supported. The audit focused on determining compliance
with, and the adequacy of, existing policies and procedures and identifying opportunities for minimizing losses to the
insurance funds through the recovery of collateral or retention of the right to pursue the debtor for future satisfaction
of the debt. The scope of our audit included 435 B-25 write-off cases ($292 million book value) from January 1, 2003
through September 30, 2004.
To test DRR’s asset write-off procedures, we reviewed documentation supporting write-off decisions for a sample of
24 asset write-offs ($95 million book value) representing about 33 percent of the $292 million in write-offs for the
audit period. Specifically, we determined whether write-off decisions were: approved by officials with the appropriate
delegation of authority, adequately supported by corroborating evidence in DRR’s Credit Notation System (CNS) and asset
files, and reported to the IRS through issuance of Forms 1099-C.
Computer-processed data was not significant to our findings, conclusions, and recommendations; therefore, we were not
required to perform assessments of computer-processed data. We used computer-processed data as background information in
generating a universe of write-off cases from which to select our sample.
To gain an understanding of internal controls, we reviewed the following documents:
- Federal Deposit Insurance Act;
- DRR’s Strategic Plans for 2003 and 2004;
- DRR’s Asset Disposition Manual;
- the FDIC’s delegation of authority resolutions;
- DRR Circular 1160.1, DRR Senior Management Oversight Committee;
- FDIC Circular 5400.1, Reporting for Discharge of Indebtedness (IRS Form 1099);
- the FDIC’s Business Events Documentation Guide;
- minutes of Senior Management Oversight Committee meetings; and
- IRS Bulletins on Information Reporting Under Section 6050P for Discharge of Indebtedness, Instructions
for Forms 1099-A and 1099-C, and General Instructions on Use of Form 1120-F to Report Foreign Corporate
Income, Gains, Losses, Deductions, and Credits.
Also, we interviewed officials from DRR’s Asset Management Branch, Financial Reporting Group, and Internal Review Group,
which are located in Dallas, Texas.
In addition, we reviewed work performed by DRR’s Internal Review group. This included quarterly reviews of all actions
taken under delegated authority, including asset write-offs, and a DRR Internal Review report dealing specifically with B-25
write-off cases. We reviewed DRR Internal Review’s working papers and considered its efforts in designing our audit approach.
We performed our work at the FDIC office in Dallas, Texas, from August 2004 through January 2005. We conducted the audit
in accordance with generally accepted government auditing standards.
APPENDIX II
[ D ]
[ D ]
[ D ]
[ D ]
[ D ]
[ D ]
APPENDIX III
MANAGEMENT RESPONSES TO THE RECOMMENDATIONS
This table presents the management response that has been made on the recommendations in our report and the status of
the recommendations as of the date of report issuance. The table also reflects information obtained in discussions with
management regarding its response.
a Resolved – |
(1) Management concurs with the recommendation, and the planned corrective action is consistent with the recommendation. |
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(2) Management does not concur with the recommendation, but planned alternative action is acceptable to the OIG. |
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(3) Management agrees to the OIG monetary benefits, or a different amount, or no ($0) amount. Monetary benefits are considered resolved as long as management provides an amount. |
b Dispositioned – The agreed-upon corrective action must be implemented, determined to be effective, and the actual amounts of monetary benefits achieved through implementation identified. The OIG is responsible for determining whether the documentation provided by management is adequate to disposition the recommendation.
c Once the OIG dispositions the recommendation, it can then be closed.