Method changes within the nonaccrual experience method.

• Author: Rempalski, Kristy L.

A nonaccrual experience (NAE) method of accounting, as described in Sec. 448(d) (5), allows certain service providers to except from accrual the portion of revenue they have determined will not be collected, based on their own experience and through the use of formulas allowed under this section and the regulations. A taxpayer is eligible to use an NAE method of accounting if the taxpayer uses an accrual method of accounting with respect to amounts received for the performance of services by the taxpayer, and:

* The services are in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting (Sec. 448(d)(2)(A) and Temp. Regs. Sec. 1.448-1T(e)(4)); or

* The taxpayer has no more than $5 million annual gross receipts for all prior tax years (Sec. 448(c) and Temp. Regs. Sec. 1.448-IT(f)(2)).

A taxpayer, however, may not use an NAE method with respect to receivables for which interest is required to be paid or there is any other penalty for failure to timely pay the amount (Sec. 448(d)(5)(B)) or for amounts of receivables earned through a nonservice source, such as the sale of goods (Regs. Sec. 1.448-2(c)(1)(ii)(A)). In addition, amounts not billed or contractually not collectible should not be included in accounts receivable for the NAE calculation (Regs. Sec. 1.448-2(c)(1)(i)).

Methods and Sub-Methods

There are multiple methods and submethods within the NAE realm. A taxpayer may adopt or request the IRS's consent to change to a formula that clearly reflects the taxpayer's experience (Sec. 448(d)(5)(C)). This item focuses on the nuances surrounding the adoption of or change to the safe-harbor NAE methods described in Regs. Sec. 1.448-2(f). The intricacies of the respective methods, while fascinating, are beyond the scope of this item.

The regulations provide four safe-harbor methods of calculating the uncollectible portion of ending accounts receivable as a reduction in income as well as allowing the taxpayer to develop its own safe-harbor method (the fifth method or alternative method) that must be tested against the other four safe harbors. The four safe-harbor methods are presumed to clearly reflect income while the taxpayer must specifically demonstrate the clear reflection of income to use the alternative method. Each safe harbor and the alternative calculation is a method of accounting, so a change to a different safe-harbor method or to the alternative method is subject to the provisions of Secs. 446 and 481.

Applicable period: The safe-harbor methods use data obtained from the taxpayer's historical experience and require the selection of an "applicable period," which is the number of tax years from which the data are gathered. The taxpayer may...