Section 166(a) of the Internal Revenue Code provides that "any debt which becomes totally worthless during the taxable year shall be allowed as a deduction." However, in the case of a guarantor of another party's debt, a special set of rules applies to determine when that guarantor is entitled to a "bad debt" deduction (once the guarantor has fulfilled his obligation to the creditor).Sec. 1.166-1 Bad debts.(a) Allowance for deduction. Section 166 provides that in computing taxable income under section 63, a deduction shall be allowed in respect of bad debts owed to the taxpayer. For this purpose, bad debts shall, subject to the provisions of section 166 and the regulations made thereunder, be taken into account either as: (1) a deduction in respect of debts which become worthless in whole or in part ; or as(2) A deduction for a reasonable addition to a reserve for bad debts. The following case study is very useful: ISSUES1. What steps are required to record or remember the assignment of a loan (or part of the loan) as a loss-making asset for purposes of the compliance method of accounting for worthless bad debts?2. Does the conclusive presumption of uselessness under the compliance method apply to loans incorrectly classified as loss-making assets? FACTSABC is a bank (as defined in Section 1.166-2(d)(4)(i) of the Income Tax Regulations) and is subject to supervision by Federal authorities. ABC has elected under Section 1.166-2(d)(3) to use the compliance method of accounting to determine when debts owed to ABC become worthless bad debts. Pursuant to a resolution adopted by the ABC Board of Directors, ABC officers and employees are authorized to charge off loans (or portions of loans) only when write-off is required under loss classification standards on loans issued by the banking supervisory authority. Thus, when ABC officers and employees cancel a loan for regulatory purposes, they take no additional steps to record or remember whether, in their opinion, the cancellation is required by the loan loss standards that have been issued by the ABC supervisory authority. Loan loss standards require ABC to impute lost assets. Lossy assets are loans (or parts of loans) deemed unrecoverable and of such low value that their retention as bankable assets is not justified. In the case of a consumer loan or credit card debt, whether or not there is specific adverse information about the borrower, ABC is required to debit the asset when its delinquency exceeds certain established thresholds..