IRS issues IDD on contractual allowance issues in the health care industry.

• Author: Rohrs, Jane
• Position: Industry director directive

The Service has issued an industry director directive (IDD) (LMSB-04-0807-056) on contractual allowance issues in the health care industry. The IDD provides direction to the field on the efficient use of examination resources relating to the audit of contractual allowances. Specifically, the IDD provides a uniform format and approach for examiners to evaluate potential compliance risk related to contractual allowance issues, outlines the established issue management and oversight process, and introduces an initial set of audit guidelines.

Background

Health care providers primarily derive revenue from providing medical goods and services to patients. The providers generally issue multiple bills for the same services to the patient and third-party payers. Third-party payers include private insurance companies and government payers, such as Medicare and Medicaid.

Providers have standard charges for each specific good sold or service rendered. The standard charge amount is initially recorded as an account receivable on the financial books when the service is rendered or the good is sold. However, providers typically have contractual agreements with most third-party payers regarding the amount that the payer will reimburse for specific goods and services. The discount amount usually differs in contracts between a provider and different payers, and it often differs between different plans offered by the same payer.

A contractual allowance is not a bad debt because the provider was never entitled to collect the difference under the terms of the relevant contract. A provider's book contractual allowance represents the difference between the amount recorded on its books as a receivable at the time of the initial billing and the estimated net realizable value (NRV) of gross receipts reported for book purposes under generally accepted accounting principles (GAAP).The NRV is not an acceptable method of determining income for tax purposes.

On an income tax return, properly determined contractual allowances would offset gross receipts. The return may report either a net amount of receipts reduced for contractual allowances or total billed amounts with an offsetting reduction for contractual allowances. The reduction will often appear in returns and allowances.

When the provider issues a bill, it has, at a minimum, the following information:

* The identity of the patient and any known third party that may ultimately bear responsibility for some or all of...