52430 Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 

Amprolium in 

Grams per Ton Indications for Use Limitations Sponsor 

(i) 113.5 to 11, 

350; to provide 5 milligrams (mg) 

per kilogram 

of body 

weight per 

day. Calves: As an aid in the 

prevention of coccidiosis 

caused by Eimeria bovis and 

E. zurnii.

Top-dress on or mix in the daily ration. Feed for 21 days during periods of 

exposure or when experience indicates that coccidiosis is likely to be a 

hazard; as sole source of amprolium. Withdraw 24 hours before slaughter. 

A withdrawal period has not been established for this product in 

preruminating calves. Do not use in calves to be processed for veal.

050604 

(ii) 113.5 to 11, 

350; to provide 10 mg 

per kilogram 

of body 

weight per 

day. Calves: As an aid in the 

treatment of coccidiosis 

caused by Eimeria bovis and 

E. zurnii.

Top-dress on or mix in the daily ration. Feed for 5 days; as sole source of 

amprolium. Withdraw 24 hours before slaughter. A withdrawal period has 

not been established for this product in preruminating calves. Do not use 

in calves to be processed for veal. For a satisfactory diagnosis, a 

microscopic examination of the feces should be done by a veterinarian or 

diagnostic laboratory before treatment; when treating outbreaks, the drug 

should be administered promptly after diagnosis is determined.

050604 

* * * * * 

Dated: August 22, 2006. 

Steven D. Vaughn, 

Office of New Animal Drug Evaluation, Center 

for Veterinary Medicine. 

[FR Doc. E6–14673 Filed 9–5–06; 8:45 am] 

BILLING CODE 4160–01–S 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Parts 1 and 602 

[TD 9285] 

RIN 1545–BB43 

Nonaccrual-Experience Method of 

Accounting Under Section 448(d)(5) 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final regulations. 

SUMMARY: This document contains final 

regulations relating to the use of a 

nonaccrual-experience method of 

accounting by taxpayers using an 

accrual method of accounting and 

performing services. The final 

regulations reflect amendments under 

the Job Creation and Worker Assistance 

Act of 2002. The final regulations affect 

qualifying taxpayers that want to adopt, 

change to, or change a nonaccrualexperience method of accounting under 

section 448(d)(5) of the Internal 

Revenue Code (Code). 

DATES: Effective Date: These regulations 

are effective September 6, 2006. 

Applicability Date: These regulations 

are applicable for taxable years ending 

on or after August 31, 2006. 

Comment Date: Written comments 

must be received by January 4, 2007. 

These regulations require that a 

taxpayer’s nonaccrual-experience 

method must be self-tested against the 

taxpayer’s actual experience to 

determine whether the nonaccrualexperience method clearly reflects the 

taxpayer’s experience. The 

determination of actual experience is 

reserved in these regulations. Comments 

are requested concerning how to 

determine actual experience for 

purposes of timely performing selftesting. Send submissions to: 

CC:PA:LPD:PR (REG–141402–02), 

Internal Revenue Service, POB 7604, 

Ben Franklin Station, Washington, DC 

20044. Taxpayers also may submit 

comments electronically to the IRS 

internet site at http://www.irs.gov/regs. 

FOR FURTHER INFORMATION CONTACT: 

Concerning the regulations, W. Thomas 

McElroy, Jr., (202) 622–4970; 

concerning submission of comments, 

Kelly Banks, (202) 622–0392 (not tollfree numbers). 

SUPPLEMENTARY INFORMATION: 

Paperwork Reduction Act 

The collection of information 

contained in these final regulations has 

been reviewed and approved by the 

Office of Management and Budget in 

accordance with the Paperwork 

Reduction Act of 1995 (44 U.S.C. 

3507(d)) under control number 1545–

1855. 

The collection of information in these 

final regulations is in § 1.448–2(d)(8) 

and (e)(5). This information is required 

to enable the IRS to verify that a 

taxpayer is reporting the correct amount 

of income or gain or claiming the correct 

amount of losses, deductions, or credits 

from the taxpayer’s use of the 

nonaccrual-experience method of 

accounting. The collection of 

information is required to obtain a 

benefit. 

An agency may not conduct or 

sponsor, and a person is not required to 

respond to, a collection of information 

unless the collection of information 

displays a valid control number. 

The estimated annual burden per 

respondent is 3 hours. 

Comments concerning the accuracy of 

this burden estimate and suggestions for 

reducing this burden should be sent to 

the Internal Revenue Service, Attn: IRS 

Reports Clearance Officer, 

SE:W:CAR:MP:T:T:SP, Washington, DC 

20224, and to the Office of Management 

and Budget, Attn: Desk Officer for the 

Department of the Treasury, Office of 

Information and Regulatory Affairs, 

Washington, DC 20503. 

Books and records relating to a 

collection of information must be 

retained as long as their contents may 

become material in the administration 

of any internal revenue law. Generally, 

tax returns and tax return information 


jlentini on PROD1PC65 with RULES
Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 52431 

are confidential, as required by 26 

U.S.C. 6103. 

Background 

This document contains amendments 

to the Income Tax Regulations (26 CFR 

part 1) under section 448(d)(5). Section 

448(d)(5) was enacted by section 801 of 

the Tax Reform Act of 1986 (Pub. L. 99–

514, 100 Stat. 2085) and was amended 

by section 403 of the Job Creation and 

Worker Assistance Act of 2002 (Pub. L. 

107–147, 116 Stat. 21) (JCWA), effective 

for taxable years ending after March 9, 

2002. On September 4, 2003, the IRS 

and Treasury Department published in 

the Federal Register (68 FR 52543) 

proposed amendments to the 

regulations under section 448(d) by 

cross-reference to temporary regulations 

(REG–141402–02) and temporary 

regulations (68 FR 52496) (TD 9090) 

(collectively, the 2003 regulations) 

relating to the limitation on the use of 

the nonaccrual-experience method of 

accounting under section 448(d)(5). A 

public hearing was held on December 

10, 2003. Written and electronic 

comments responding to the proposed 

regulations were received. After 

consideration of all of the comments, 

the proposed regulations are adopted as 

revised by this Treasury decision, and 

the corresponding temporary 

regulations are removed. The revisions 

are discussed below. 

Explanation of Provisions and 

Revisions and Summary of Comments 

1. Overview 

These final regulations generally 

follow the rules in the 2003 regulations. 

The final regulations include the four 

safe harbor nonaccrual-experience 

methods provided in the 2003 

regulations, but those methods have 

been modified to provide more 

flexibility. Unlike the 2003 regulations, 

the final regulations do not require as a 

general rule that a taxpayer’s 

nonaccrual-experience method be tested 

against one of the safe harbor 

nonaccrual-experience methods. 

Instead, the final regulations adopt, with 

modifications, the general rule from the 

2003 regulations as a fifth safe harbor. 

The final regulations also adopt a new 

general rule that requires a taxpayer’s 

nonaccrual-experience method be tested 

against actual experience unless the 

taxpayer has adopted one of the five safe 

harbor methods. These final regulations 

apply to taxable years ending on or after 

August 31, 2006. 

Certain portions of the 2003 

regulations have been removed or 

incorporated into other paragraphs of 

the final regulations. Section 1.448–

2T(d) regarding certain receivables for 

which the nonaccrual-experience 

method is not allowed has been 

combined with § 1.448–2(c) in the final 

regulations. Special rules in various 

parts of the 2003 regulations such as 

§ 1.448–2T(e)(2)(ii) and (iii), 1.448–

2T(e)(3)(iii), 1.448–2T(e)(4)(ii) and (iii), 

and 1.448–2T(e)(5)(ii) and (iii), have 

been combined with the special rules in 

§ 1.448–2T(e)(7) and are now in § 1.448–

2(b), (c), and (d) of the final regulations. 

Most of § 1.448–2T(g), (h), and (j) of the 

2003 regulations relating to methods of 

accounting and audit protection have 

been removed. The IRS and Treasury 

Department intend to issue 

administrative guidance that will 

contain procedures for certain changes 

in a nonaccrual-experience method of 

accounting. The general rule that a 

nonaccrual-experience method is a 

method of accounting to which sections 

446 and 481 apply has been moved to 

§ 1.448–2(b). 

Other portions of the 2003 regulations 

have been moved to a new definitions 

and special rules paragraph in § 1.448–

2(c) of the final regulations. Section 

1.448–2T(d) regarding accounts 

receivable is included in a definition of 

accounts receivable in § 1.448–2(c)(1) of 

the final regulations. Other terms in the 

definitions paragraph include 

applicable period, bad debts, chargeoffs, determination date, recoveries, and 

uncollectible amount. The final 

regulations incorporate these 

definitions, as appropriate, throughout. 

For example, in the 2003 regulations the 

four safe harbor methods include bad 

debts in the numerator; however, safe 

harbor 2 did not refer to bad debts, but 

instead described them as ‘‘accounts 

receivable actually determined to be 

uncollectible and charged off * * *’’

These descriptions should not be 

interpreted differently. Therefore, the 

final regulations use the defined term 

bad debts in each numerator. Finally, 

the examples are changed to conform to 

other changes within the final 

regulations. 

2. Self-Testing Requirement 

The 2003 regulations provide that a 

taxpayer may use any nonaccrualexperience method of accounting, 

provided the taxpayer’s method meets 

the self-test requirements. The selftesting in the 2003 regulations requires 

a taxpayer to compare its proposed 

nonaccrual-experience method with one 

of the four safe harbor methods to 

determine whether the taxpayer’s 

proposed method clearly reflects 

experience. Self-testing is required in 

the first taxable year to determine 

whether the proposed method is 

allowed (first-year self-testing 

requirement) and, if allowed, self-testing 

is required every three taxable years 

thereafter (three-year self-testing 

requirement). The final regulations 

provide, as a general rule, that a 

taxpayer may use any nonaccrualexperience method of accounting that 

clearly reflects the taxpayer’s 

experience. The final regulations 

provide that taxpayers must self-test 

against the taxpayer’s actual experience 

to determine whether a method clearly 

reflects the taxpayer’s experience unless 

the taxpayer has adopted one of the five 

safe harbor methods. The final 

regulations reserve on the definition of 

actual experience. 

a. Appropriateness of Self-Testing 

Requirement 

Many commentators suggested that 

taxpayers should not be required to 

incur additional expenses to develop a 

separate system for performing the selftest, noting that it would be burdensome 

and impractical for the majority of 

taxpayers using an alternative 

nonaccrual-experience method to 

conduct the self-test due to the 

limitations of their existing automated 

recordkeeping systems. One 

commentator suggested that the self-test 

was outside the scope of the JCWA and 

legislative intent. These commentators 

all recommended that the final 

regulations omit the self-testing 

requirement. 

The JCWA provides that ‘‘[a] taxpayer 

may adopt, or * * * change to, a 

computation or formula that clearly 

reflects the taxpayer’s experience,’’ and 

that ‘‘[a] request [to change] shall be 

approved if such computation or 

formula clearly reflects the taxpayer’s 

experience.’’ Public Law 107–147, 

section 403(a). Taxpayers and the IRS 

must be able to determine whether a 

nonaccrual-experience method clearly 

reflects the taxpayer’s experience. The 

Secretary has broad authority to 

determine whether a method of 

accounting clearly reflects the 

taxpayer’s income. A self-testing 

requirement is consistent with the 

statute, because it is the manner by 

which taxpayers and the IRS determine 

whether a nonaccrual-experience 

method clearly reflects the taxpayer’s 

experience, and thus, clearly reflects the 

taxpayer’s income. Taxpayers must be 

able to show that a nonaccrualexperience method clearly reflects 

experience prior to adopting or 

changing to the method. The 

requirement to self-test provides an 

objective standard for making the 

determination. Therefore, the final 

regulations do not adopt the 


jlentini on PROD1PC65 with RULES
52432 Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 

recommendation to omit a self-testing 

requirement and retain the rule that a 

taxpayer must maintain books and 

records sufficient to prove that the 

taxpayer’s nonaccrual-experience 

method clearly reflects its experience 

for the taxable year of the exclusion. 

b. Standard for Comparison 

Commentators stated that the selftesting requirements do not allow 

taxpayers the opportunity to 

demonstrate that a proposed method 

clearly reflects their experience, because 

under the 2003 regulations all methods 

must be compared to one of the safe 

harbors. The commentators stated that 

none of the safe harbors reflect actual 

experience, because all of the safe 

harbors are moving averages rather than 

a comparison of the estimated 

uncollectible amount for a taxable year 

under the taxpayer’s nonaccrualexperience method to the actual 

collection experience of that taxable 

year’s accounts receivable. Thus, the 

commentators stated, the safe harbors 

may or may not reflect actual experience 

as well as the proposed method. 

The final regulations modify the selftesting requirements in response to 

these comments and eliminate the 

requirement in the 2003 regulations that 

a taxpayer’s nonaccrual-experience 

method must be tested against one of 

the four safe harbor methods. The final 

regulations require that the taxpayer’s 

nonaccrual-experience method must be 

tested against the taxpayer’s actual 

experience, unless the taxpayer is using 

one of the safe harbor nonaccrualexperience methods, which are deemed 

to clearly reflect experience. 

For taxpayers and the IRS to 

implement and administer the 

nonaccrual-experience method, the 

determination of actual experience is 

necessary. Although commentators 

stated that taxpayers should be allowed 

to use hindsight and that actual 

experience would require the use of 

data reflecting the portion of the subject 

accounts receivable that remain 

uncollectible, the commentators did not 

elaborate regarding what ‘‘remain 

uncollectible’’ means, nor did the 

commentators set the date at which 

accounts receivable ‘‘remain 

uncollectible.’’ The determination and 

proof of actual experience generally is a 

simple matter for taxpayers whose 

collection process with respect to the 

subject receivables is complete by the 

time the Federal income tax return is 

filed. The collection cycle for some 

taxpayers, however, may routinely span 

several taxable years. The commentators 

did not elaborate how such a factual 

determination could be made prior to 

filing the Federal income tax return for 

the applicable taxable year (or 

alternatively, prior to filing the method 

change request for the applicable 

taxable year) in cases in which a 

taxpayer’s collection cycle for the 

receivables goes beyond the date for the 

filing of the return (or method change). 

For taxpayers with a longer collection 

process, the determination of the final 

actual experience is not possible by the 

time the Federal income tax return is 

filed, and may continue to be 

incomplete upon examination by the 

IRS, if the taxpayer’s collection process 

with respect to receivables is still in 

process. Additionally, it is possible that 

accounts receivable written off in one 

taxable year may be recovered several 

taxable years later, even for taxpayers 

whose average collection cycle is short. 

Therefore, the final regulations reserve 

the determination of actual experience. 

The IRS and Treasury Department 

anticipate providing future guidance 

that may change or restrict the rules for 

self-testing and may address the 

determination of actual experience. In 

the meantime, taxpayers may request 

advance consent to use a method other 

than a safe harbor method, but in the 

request taxpayers must establish to the 

satisfaction of the Commissioner how 

the determination of actual experience 

is made. Comments are requested 

concerning how to determine actual 

experience. Specifically, the IRS and 

Treasury Department seek comments on 

how the use of hindsight data can be 

made administrable. For example, how 

will the IRS National Office have the 

necessary data furnished with the 

application for change in method of 

accounting, and how will the taxpayer 

be able to timely perform the selftesting? In particular, should one, fixed 

determination date be used as a cut-off 

for all information included in the 

determination of actual experience? 

What facts and circumstances, known 

by the filing deadline for a change in 

method of accounting and the filing 

deadline for an original Federal income 

tax return, can a taxpayer and the IRS 

rely on to determine the taxpayer’s 

actual experience for purposes of the 

first-year self-testing requirements for 

the application for change in method of 

accounting and for purposes of the 

three-year self-testing requirements for 

the filing of the Federal income tax 

return? For a taxpayer that is applying 

to adopt or change to a nonaccrualexperience method of accounting, 

should the taxpayer be allowed to rely 

on the results under the proposed 

method for the current taxable year 

compared to actual experience for old 

taxable years rather than a comparison 

of the results under the proposed 

method for the current taxable year 

compared to actual experience for the 

current taxable year at the time of filing, 

provided the taxpayer can demonstrate 

that there is not a change in the type of 

a substantial portion of the outstanding 

accounts receivable such that the risk of 

loss is substantially decreased? What 

standards should apply to a taxpayer 

who has had a change in the type of a 

substantial portion of the outstanding 

accounts receivable? If a taxpayer’s 

business has changed in a manner that 

impacts a substantial portion of its 

outstanding accounts receivable, the 

taxpayer’s historical data for its 

receivables could lose much of their 

relevance in determining the taxpayer’s 

current nonaccrual experience. 

c. Safe Harbor Comparison Method 

The final regulations retain a 

modified version of the self-test from 

the 2003 regulations, which required the 

comparison of a taxpayer’s method 

against one of the safe harbors. The safe 

harbor comparison method in the final 

regulations is used in conjunction with 

the fifth safe harbor nonaccrualexperience method, which allows a 

taxpayer to use any nonaccrualexperience method provided the 

method meets the safe harbor 

comparison method of self-testing. The 

safe harbor comparison method 

provided in the final regulations allows 

a taxpayer to compare the taxpayer’s 

method against any of the safe harbors 

1 through 4 during any self-testing 

period, rather than requiring the safe 

harbor chosen for comparison to be 

treated as a method of accounting. 

Because any of the safe harbors 1 

through 4 are deemed to clearly reflect 

experience, a taxpayer should be able to 

compare its method against any of the 

safe harbors 1 through 4 to determine 

whether its method clearly reflects 

experience. The IRS and Treasury 

Department anticipate that the 

procedures for changes in method of 

accounting to use the new safe harbor 

nonaccrual-experience method will be 

provided in administrative guidance, 

and that these changes will be made 

with automatic consent. 

d. Methods That Do Not Clearly Reflect 

Experience 

The 2003 regulations provide, as part 

of the three-year self-test requirement, 

that if the taxpayer’s cumulative 

alternative nonaccrual-experience 

amount excluded from income during 

the test period exceeds the taxpayer’s 

cumulative safe harbor nonaccrualexperience amount, the taxpayer must 


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Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 52433 

recapture the excess into income in the 

third taxable year of the three-year selftest. The IRS and Treasury Department 

intended this recapture provision to 

allow minor variances or fluctuations 

produced by the taxpayer’s nonaccrualexperience method without prohibiting 

continued use of the method. However, 

when the taxpayer’s nonaccrualexperience method produces results that 

are more than minor variations or 

fluctuations from the three-year self-test 

amounts, the method does not clearly 

reflect the taxpayer’s experience. The 

recapture provision addresses situations 

in which the taxpayer’s nonaccrualexperience method generally clearly 

reflects experience, but the taxpayer has 

an anomalous taxable year in which the 

method does not clearly reflect 

experience. However, methods may 

consistently provide large distortions 

from the taxpayer’s actual experience in 

future taxable years despite meeting the 

requirements of the first-year self-test. 

Consequently, the final regulations 

include a limit in the three-year selftesting provisions that, if exceeded, 

deems the taxpayer’s nonaccrualexperience method to not clearly reflect 

the taxpayer’s experience. Because the 

taxpayer must recapture the difference 

between the uncollectible amount under 

the taxpayer’s nonaccrual-experience 

method and the taxpayer’s actual 

experience, a change from the taxpayer’s 

nonaccrual-experience method to a 

permissible method in the subsequent 

taxable year does not require a section 

481(a) adjustment and is made on a cutoff basis. 

Additionally, to provide transparency, 

the IRS and Treasury Department intend 

to provide in future guidance 

descriptions of methods and 

characteristics of methods combined 

with specific taxpayer circumstances 

that do not clearly reflect experience. 

e. Other 

Commentators suggested that the selftest was not administrable in the context 

of consolidated groups. The IRS and 

Treasury Department believe that the 

final regulations do not impose more 

burden than any other method of 

accounting in the context of a 

consolidated group. Generally, methods 

of accounting, including the nonaccrualexperience method with its self-testing 

requirement, are adopted and applied 

separately by each entity within the 

consolidated group (or to separate trades 

or businesses within an entity), not at 

the consolidated group level. 

3. Safe Harbor Methods 

The 2003 regulations have four safe 

harbors: Safe harbor 1 (the six-year 

moving average method), safe harbor 2 

(the actual experience method), safe 

harbor 3 (the modified Black Motor 

method), and safe harbor 4 (the 

modified moving average method). 

Comments were received regarding safe 

harbors 1, 2, and 4. No comments were 

received regarding safe harbor 3. 

a. General Issues 

Commentators questioned the need to 

impose different time periods for 

different safe harbor methods. For 

example, in the 2003 regulations, safe 

harbors 1, 3 and 4 are based on a sixyear period (the current taxable year and 

the five immediately preceding taxable 

years), whereas safe harbor 2 is based on 

a three year period (the current taxable 

year and the two immediately preceding 

taxable years). These commentators 

recommended that, for consistency, the 

safe harbor methods should permit 

taxpayers to compute the uncollectible 

amounts using a period consisting of the 

current taxable year and no fewer than 

the two immediately preceding taxable 

years and no more than the five 

immediately preceding taxable years. 

Providing options among the safe 

harbors, including those with different 

time periods, is consistent with 

legislative intent to provide taxpayers 

‘‘with alternative computations or 

formulas that taxpayers may rely upon.’’

Different taxpayers may choose different 

methods with different time periods 

based on their individual circumstances 

and experience. The final regulations 

allow taxpayers flexibility to choose a 

period of at least three taxable years, but 

not more than six taxable years 

(applicable period), for purposes of the 

computations in each of the safe 

harbors. The taxable years included in 

the applicable period must be the most 

recent (which may or may not include 

the current taxable year, as applicable) 

and must be consecutive. 

Additionally, commentators stated 

that including the current taxable year 

in computations can cause difficulties 

when preparing computations for 

estimated taxes. Therefore, the final 

regulations allow taxpayers flexibility 

with regard to whether the current 

taxable year is included in the 

applicable period. The choice of which 

taxable years and how many are 

included in the applicable period is part 

of the taxpayer’s method of accounting 

under a safe harbor, and can be changed 

only with the consent of the 

Commissioner. Taxpayers making such 

a change may not have all the historical 

data necessary to compute a section 

481(a) adjustment. Therefore, the final 

regulations provide that the change is 

done on a cut-off basis rather than with 

a section 481(a) adjustment. 

Finally, some commentators reiterated 

their earlier suggestion that the Black 

Motor formula should be permitted as 

an additional safe harbor method. The 

IRS and Treasury Department continue 

to conclude that the Black Motor 

formula should not be provided as an 

additional safe harbor method because 

the formula overstates the uncollectible 

amount in many circumstances. The 

final regulations add a fifth safe harbor, 

which, as discussed above, allows 

taxpayers to use any alternative 

nonaccrual-experience method provided 

the method meets the requirements of 

the safe harbor comparison method 

under the self-testing requirements. The 

IRS and Treasury Department may 

provide additional safe harbors through 

future published guidance. In addition, 

if a taxpayer does not wish to rely on 

one of the safe harbors, the final 

regulations provide that a taxpayer may 

use any other alternative nonaccrualexperience method provided the 

method clearly reflects its experience 

and the taxpayer requests and receives 

consent from the Commissioner to use 

such method. 

Commentators requested that the 

regulations specifically include a 

statement that unintentional or 

immaterial variances will not cause a 

taxpayer to be changed to the specific 

charge-off method. As discussed in the 

preamble to the 2003 regulations, the 

IRS and Treasury Department do not 

contemplate that a taxpayer be changed 

to the specific charge-off method due to 

unintentional or immaterial variances, 

especially if a taxpayer is disadvantaged 

by the variances. Such a rule is 

unnecessary, particularly with the 

flexibility added to each of the safe 

harbors 

b. Safe Harbor 1—Revenue-Based 

Moving Average Method 

Safe harbor 1 in the 2003 regulations 

was referred to as the six-year moving 

average method. It is renamed the 

revenue-based moving average method 

in the final regulations to reflect the 

flexibility to choose between three to six 

taxable years for the applicable period. 

The final regulations provide that the 

revenue-based moving average 

percentage of safe harbor 1 (the ratio of 

net write-offs for the applicable period 

over accounts receivable earned over the 

same applicable period) is multiplied by 

a taxpayer’s accounts receivable balance 

at the end of the taxable year to 

determine the taxpayer’s nonaccrualexperience amount. 

A commentator suggested that a safe 

harbor method should be added that 


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52434 Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 

would modify safe harbor 1 to multiply 

the revenue-based moving average 

percentage by a taxpayer’s total billings 

(accounts receivable earned during the 

taxable year in lieu of its accounts 

receivable balance at the end of the 

taxable year). The commentator 

suggested that this new safe harbor 

would provide symmetry between the 

denominator of the revenue-based 

moving average percentage and the 

amount against which the revenuebased moving average percentage is 

multiplied. 

The final regulations do not adopt this 

recommendation. The IRS and Treasury 

Department previously analyzed the 

effects of multiplying the revenue-based 

moving average percentage by the total 

billings during the taxable year and 

determined that this computation 

overstates that portion of the taxpayer’s 

year-end accounts receivable balance 

that will not be collected. The existing 

formula is the method provided in 

former § 1.448–2T(e)(2), as contained in 

TD 8194, 53 FR 12513 (1988). Although 

the denominator and multiplicand are 

not symmetrical, the method accurately 

reflects the year-end receivables that 

will not be collected for taxpayers with 

a short collection cycle. 

c. Safe Harbor 2—Actual Experience 

Method 

Under safe harbor 2 of the 2003 

regulations, the taxpayer’s adjusted 

nonaccrual-experience amount is 

determined by tracking the receivables 

in the taxpayer’s accounts receivable 

balance at the beginning of the current 

taxable year to determine the dollar 

amount of the accounts receivable 

actually determined to be uncollectible 

and charged off and not recovered or 

determined to be collectible by the 

determination date. The determination 

date is the date selected by the taxpayer 

for the taxable year for purposes of safe 

harbor 2, and may not be later than the 

earlier of the due date, including 

extensions, for filing the taxpayer’s 

Federal income tax return for that 

taxable year or the date on which the 

taxpayer timely files the return for that 

taxable year. Under Option A of safe 

harbor 2, the computation is repeated 

for the taxpayer’s accounts receivable 

balance at the beginning of each of the 

two immediately preceding taxable 

years. Under Option B of safe harbor 2, 

taxpayers that do not have the 

information necessary to compute a 

three-year moving average in the first 

taxable year the method is used are 

allowed to transition into the method 

year-by-year. The total of the amounts 

determined to be uncollectible is 

divided by the total beginning accounts 

receivable balance for those taxable 

years used in the computation to 

determine the taxpayer’s three-year 

(Option A), or up to three-year (Option 

B), moving average percentage. This 

percentage is then multiplied by the 

taxpayer’s current year-end accounts 

receivable balance to arrive at the 

taxpayer’s actual nonaccrual-experience 

amount. The taxpayer’s actual 

nonaccrual-experience amount is then 

multiplied by 1.05 to determine the 

taxpayer’s adjusted nonaccrualexperience amount. 

As discussed above, the final 

regulations allow flexibility in the 

applicable period used in safe harbor 2. 

Additionally, because the final 

regulations provide definitions of terms 

used throughout the regulations for 

consistency, the terms used to describe 

the safe harbor 2 formula were changed 

to conform to the definitions in the final 

regulations. Although the description of 

the method may look as though it has 

changed substantially, the safe harbor 2 

method is not intended to operate 

differently than the 2003 regulations, 

other than the flexibility in the 

applicable period and, as discussed 

below, the flexibility in the 

determination dates and in tracing 

recoveries. 

Some commentators requested 

clarification as to whether safe harbor 2 

is based on a computation that takes 

into account all known information 

arising both before and after the 

determination date. The commentators 

suggested that the 2003 regulations may 

be interpreted as taking into account 

only all known information arising on 

or before determination dates for 

previous taxable years involved in the 

computation. 

The computation in safe harbor 2, 

Option A, in the final regulations, 

contemplates consideration of all 

known information arising on or before 

the determination date for the current 

taxable year, including beginning 

accounts receivable balances, chargeoffs and recoveries, with respect to all 

taxable years included in the 

computation. For example, if an account 

receivable of a calendar year taxpayer 

exists on January 1, 2006, and is charged 

off as a bad debt on December 15, 2007, 

the bad debt should be included in the 

computation in the taxable year it is 

charged off and every subsequent 

taxable year for as long as the 2006 

beginning of the year accounts 

receivable balance is part of the 

computation under this method. 

Consequently, the final regulations 

clarify that all known information 

arising on or before the determination 

date for the current taxable year, with 

respect to the taxable years included in 

the computation, should be considered. 

In the 2003 regulations, Option B 

allows a taxpayer to transition into the 

actual experience safe harbor method. 

The final regulations allow a new 

taxpayer with no beginning accounts 

receivable to transition under either 

Option A or Option B (see § 1.448–

2(d)(4) of the final regulations). Option 

B in the final regulations differs from 

Option A in that it allows a taxpayer to 

use multiple determination dates (one 

for each taxable year of the applicable 

period) instead of one determination 

date. Therefore, under Option B in the 

final regulations, a taxpayer has a choice 

of the applicable period, three to six 

taxable years, and the taxpayer uses 

separate determination dates for each 

taxable year in the applicable period. 

That is, a taxpayer must use bad debts 

sustained by the separate determination 

date of each taxable year during the 

applicable period rather than bad debts 

sustained by the determination date of 

the current taxable year. The 

determination date used for each taxable 

year must be the determination date 

originally used for each taxable year at 

the time the uncollectible amount for 

that taxable year was computed. For 

example, if an account receivable of a 

calendar year taxpayer exists on January 

1, 2006, and is charged off as a bad debt 

on December 15, 2007, and the 

determination date for the 2006 taxable 

year is September 1, 2007, the bad debt 

would never be included in the 

computation because it is charged off 

after the 2006 taxable year 

determination date. This method was 

requested by commentators to reduce 

the burden of having to update the total 

bad debts for a particular taxable year 

with every future computation that 

included that taxable year. 

Other commentators requested 

clarification as to whether the 

determination date used in safe harbor 

2 may shift from year to year. These 

commentators recommended that the 

final regulations confirm that a taxpayer 

may use a different determination date 

each taxable year, and that a change of 

determination date is not a change in 

method of accounting. Safe harbor 2 

contemplates that a taxpayer may file its 

Federal income tax return at different 

times from year to year, and that the 

choice of a determination date used in 

the computation is not a method of 

accounting. However, once a 

determination date is selected and used 

for a particular taxable year, it may not 

be changed for that taxable year. 

Therefore, the final regulations clarify 

that the determination date may be 

different from year to year, and that a 


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Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 52435 

change in the determination date is not 

a change in method of accounting. 

Under Option B of safe harbor 2, the 

2003 regulations provide that a newly 

formed taxpayer that chooses Option B 

and does not have any accounts 

receivable upon formation will not be 

able to exclude any portion of its yearend accounts receivable from income for 

its first taxable year because the 

taxpayer does not have any accounts 

receivable on the first day of the taxable 

year that can be tracked. Some 

commentators recommended that the 

final regulations either permit newly 

formed taxpayers using Option B to 

exclude a portion of their year-end 

accounts receivable balance, or in the 

alternative, clarify the rules for adopting 

this safe harbor in the taxpayer’s first 

taxable year in order to eliminate the 

administrative burden of filing Form 

3115, ‘‘Application for Change in 

Accounting Method,’’ in the succeeding 

taxable year. The final regulations retain 

this special rule in § 1.448–(d)(4) for 

both safe harbor 2 and safe harbor 4, 

because the methods require a 

beginning accounts receivable balance 

to compute the uncollectible amount. 

Use of another method in the first 

taxable year may not clearly reflect 

experience. The final regulations clarify 

that the taxpayer must begin creating its 

moving average in its second taxable 

year by tracking the accounts receivable 

as of the first day of its second taxable 

year. The use of one of the safe harbor 

nonaccrual-experience methods of 

accounting described in paragraph (f)(2), 

(f)(4), or (f)(5), if applicable, of the final 

regulations in a taxpayer’s second 

taxable year in this situation is not a 

change in method of accounting. 

Although the taxpayer must maintain 

the books and records necessary to 

perform the computations under the 

adopted safe harbor nonaccrualexperience method, the taxpayer is not 

required to affirmatively elect the 

method on its Federal income tax return 

for its first taxable year. 

Commentators requested that safe 

harbor 2 be modified to permit 

taxpayers to use any reasonable method 

to determine recoveries. In response to 

commentators’ concerns about whether 

taxpayers could use assumptions 

regarding recoveries rather than 

specifically trace, the preamble to the 

2003 regulations stated that the IRS and 

Treasury Department do not intend that 

a taxpayer be changed to the specific 

charge-off method due to unintentional 

and/or immaterial variances, especially 

if the taxpayer is disadvantaged by such 

variances. Some commentators believe 

that despite the preamble, the 2003 

regulations may require taxpayers to 

specifically trace 100% of recoveries. 

The IRS and Treasury Department did 

not intend to prevent taxpayers from 

using a method that allocates 100% of 

recoveries to current taxable year bad 

debts. Commentators also have stated 

that although some recoveries may be 

traceable, some recoveries may not be 

traceable due to lump sum recoveries 

from third parties. 

The final regulations provide that a 

taxpayer specifically should trace 

recoveries if the taxpayer is able to do 

so without undue burden. However, the 

IRS and Treasury Department believe if 

the taxpayer is unable specifically to 

trace all recoveries without undue 

burden, the taxpayer should be able to 

use any reasonable method in 

determining the amount of recoveries to 

be traced to each taxable year’s bad 

debts. Therefore, the final regulations 

allow taxpayers to use a reasonable 

allocation method. A method will be 

considered reasonable if there is a cause 

and effect relationship between the 

allocation base or ratio and the 

recoveries. The final regulations also 

provide that a taxpayer may trace only 

recoveries that are traceable and allocate 

the remaining, untraceable, recoveries to 

charge-offs of amounts in the relevant 

beginning accounts receivable balances. 

Methods that include, for example, 

receivables for which the nonaccrualexperience method is not allowed to be 

used (see § 1.448–2(c)(1)(ii)) generally 

will not be considered reasonable. 

d. Safe Harbor 3—Modified Black Motor 

Method 

Safe harbor 3 is a variation of the 

formula addressed in Black Motor Co. v. 

Commissioner, 41 B.T.A. 300 (1940), 

aff’d, 125 F.2d 977 (6th Cir. 1942). No 

comments were received regarding safe 

harbor 3. The final regulations adopt the 

method in the 2003 regulations, with 

minor revisions made to the terms used 

in the formulas to conform the terms 

used throughout the regulations. 

e. Safe Harbor 4—Modified Moving 

Average Method 

The 2003 regulations provide that, for 

purposes of safe harbor 4, a taxpayer 

may determine the uncollectible amount 

by multiplying its accounts receivable 

balance at the end of the current taxable 

year by the ratio of total bad debts 

charged off for the current taxable year 

and the five preceding taxable years 

other than the credit charges (accounts 

receivable) that were charged off in the 

same taxable year they were generated, 

adjusted for recoveries of charge-offs 

during that period, to the sum of 

accounts receivable at the end of the 

current taxable year and the five 

preceding taxable years. 

Some commentators argued that, by 

eliminating credit charges that were 

written off in the same taxable year they 

were generated, the effect of this 

computation for a taxpayer’s first 

taxable year is to eliminate the intended 

benefit of section 448(d)(5). These 

commentators recommended that the 

final regulations permit newly formed 

taxpayers using safe harbor 4 to exclude 

a portion of their year-end accounts 

receivable balance, or in the alternative, 

clarify the rules on adopting this safe 

harbor method in the taxpayer’s first 

taxable year in order to eliminate the 

administrative burden of filing Form 

3115 in the succeeding taxable year. 

This safe harbor method, like safe 

harbor 3, is a variation of the formula 

addressed in Black Motor Co. v. 

Commissioner. Safe harbor 4, by 

eliminating credit charges that were 

written off in the same taxable year they 

were generated, and thereby reducing 

the amount computed under the 

traditional Black Motor formula, 

remedies known shortcomings generally 

associated with the Black Motor 

formula, and as such, more accurately 

reflects a taxpayer’s nonaccrualexperience. Therefore, the final 

regulations retain this rule. 

Another commentator pointed out 

that there is a mismatching in the 

comparison of write-offs to accounts 

receivable in the formula used in safe 

harbor 4 because it compares the total 

accounts written off in a taxable year 

after the year of sale to the ending 

balances in accounts receivable for the 

six-year period. For example, the sum of 

the write-offs in each taxable year for 

the preceding taxable years’ charges for 

services in year 7 is for services 

rendered in years 1 through 6, but the 

ending balances in accounts receivable 

are from years 2 through 7. This 

commentator opined that, if charges for 

services and accounts receivable are 

increasing, the ratio of write-offs from 

prior balances relative to current 

receivables would be understated and 

therefore the uncollectible amount 

would be understated. The commentator 

suggested that the sum of the write-offs 

in each taxable year for the preceding 

taxable years’ charges for services 

should be divided by the sum of the 

beginning accounts receivable for the 

current and five preceding taxable years. 

The final regulations adopt this 

recommendation and, for purposes of 

safe harbor 4, the denominator is 

changed to reflect the beginning of the 

taxable year accounts receivable 

balances in lieu of accounts receivable 

balances at the end of the taxable year. 


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52436 Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 

4. Special Rules 

a. Acquisitions and Dispositions 

A commentator recommended that 

the final regulations clarify that newly 

formed or acquired taxpayers in a 

section 351(a) or 721(a) nontaxable 

transaction are allowed to use 

predecessor data to compute their 

uncollectible amount under the 

nonaccrual-experience method. The 

final regulations adopt this comment 

and provide special rules for 

acquisitions and dispositions. 

Taxpayers that acquire a major portion 

of a trade or business or a unit of a trade 

or business (for example, a hospital) 

should include the data from the 

predecessor in the computations to 

avoid potentially skewing the 

computations for the remainder of the 

applicable period. Additionally, 

taxpayers that dispose of a major 

portion of a trade or business or a unit 

of a trade or business should not use the 

data related to the disposed trade or 

business in the computations. For 

purposes of the nonaccrual-experience 

methods of accounting, a new, qualified 

taxpayer that acquires property in any 

transaction to which section 381(a) does 

not apply must adopt a nonaccrualexperience method on the basis of its 

own experience. However, to the extent 

predecessor information is available, the 

data must be used in the newly-adopted 

nonaccrual-experience method. 

b. Reportable Transactions 

Some commentators recommended 

that the book-tax difference that may 

result from the use of the nonaccrualexperience method not be taken into 

account in determining whether a 

transaction is a reportable transaction 

for purposes of the disclosure rules 

under § 1.6011–4(b)(6). As a result of 

Notice 2006–6 (2006–5 I.R.B. 385), 

book-tax differences no longer create 

reportable transactions under § 1.6011–

4(b)(6). Therefore, it is not necessary to 

adopt this recommendation. 

c. Short Taxable Years 

As discussed, the 2003 regulations 

generally provide procedures for 

taxpayers that have fewer than the 

requisite number of taxable years to 

adopt or change to a safe harbor 

nonaccrual-experience method. Some 

commentators requested rules on how 

taxpayers may compute their 

nonaccrual-experience amount in the 

case of a short taxable year. 

Commentators opined that for certain 

safe harbors, such as safe harbors 2, 3 

and 4, inaccurate income exclusion can 

arise because a short taxable year will 

have a disproportionate effect on the 

numerator and denominator of the 

computations. For example, a taxpayer 

that has a relatively stable balance of 

accounts receivable but a short period, 

such as three months, may generate only 

one-fourth of the normal write-offs. 

These commentators recommended that 

the final regulations provide that, if a 

taxpayer experiences a short taxable 

year, the net write-offs for the short 

period should be annualized in order to 

prevent distortion of the safe harbor 

computation. Alternatively, these 

commentators suggested that taxpayers 

should be allowed to include data from 

the previous twelve months in the safe 

harbor computation. For example, for a 

calendar year taxpayer who experiences 

a short period ending March 31st, the 

taxpayer would use data from the 

twelve months prior to the period 

ending on March 31st to compute its 

nonaccrual-experience amount. 

The final regulations provide that 

taxpayers must make appropriate 

adjustments for short taxable years for 

nonaccrual-experience methods that are 

based on a comparison of accounts 

receivable balance to total bad debts. 

The IRS and Treasury Department 

intend to issue administrative guidance 

on appropriate adjustments. 

d. Periodic Systems 

As with the 2003 regulations, the final 

regulations provide, in § 1.448–2(d)(2), 

that a taxpayer applies its nonaccrualexperience method with respect to each 

specific account receivable eligible for 

the method. The preamble to the 2003 

regulations states that a taxpayer may 

continue to use the periodic system 

described in Notice 88–51 (1988–1 C.B. 

535) in conjunction with any 

permissible nonaccrual-experience 

method used by the taxpayer. The use 

of a periodic method remains 

permissible under § 1.448–2(d)(2) of the 

final regulations. 

5. Effective Date 

These final regulations are applicable 

to taxable years ending on or after 

August 31, 2006. A commentator 

recommended that the final regulations 

be applied retroactively to allow 

taxpayers to settle any open taxable year 

in which the nonaccrual-experience 

method is an issue under consideration 

in examination, in Appeals, or before 

the U.S. Tax Court by using one of the 

safe harbor methods, and thus, avoid 

continued disagreements between the 

government and taxpayers. The final 

regulations do not adopt this 

recommendation. However, the 

Commissioner may settle an earlier 

taxable year on the basis of a safe harbor 

method that clearly reflects the 

taxpayer’s experience. 

6. Procedures for Adoption or Change in 

Method of Accounting 

The 2003 regulations include specific 

rules for filing an application to change 

to a nonaccrual-experience method of 

accounting. The final regulations omit 

these rules, which will be provided in 

administrative guidance. The guidance 

will include automatic consent 

procedures for filing an application to 

change to one of the safe harbor 

nonaccrual-experience methods of 

accounting. 

To adopt or change to a method other 

than one of the safe harbor nonaccrualexperience methods of accounting, a 

taxpayer must request advance consent 

under the current procedures for 

obtaining the consent of the 

Commissioner of Internal Revenue to 

change a method of accounting for 

Federal income tax purposes (see, for 

example, Rev. Proc. 97–27 (1997–1 C.B. 

680) (as modified and amplified by Rev. 

Proc. 2002–19 (2002–1 C.B. 696), as 

amplified and clarified by Rev. Proc. 

2002–54 (2002–2 C.B. 432)). In the 

interest of sound tax administration, a 

new taxpayer must request advance 

consent to adopt a method other than 

one of the safe harbor nonaccrualexperience methods to ensure that the 

method clearly reflects income and 

experience. 

Special Analyses 

It has been determined that this 

Treasury decision is not a significant 

regulatory action as defined in 

Executive Order 12866. Therefore, a 

regulatory assessment is not required. It 

also has been determined that section 

553(b) and (d) of the Administrative 

Procedure Act (5 U.S.C. chapter 5) does 

not apply to these regulations. It is 

hereby certified that the collection of 

information contained in these 

regulations will not have a significant 

regulatory impact on a substantial 

number of small entities. This 

certification is based upon the fact that 

the estimated burden associated with 

the information collection averages 

three hours per respondent. Moreover, 

for taxpayers that are eligible to use 

these regulations and that follow these 

regulations, any burden due to the 

collection of information in these 

regulations will be outweighed by the 

benefit received by accruing less income 

than would otherwise be required. 

Accordingly, a regulatory flexibility 

analysis is not required. Pursuant to 

section 7805(f) of the Internal Revenue 

Code, the proposed regulations 

preceding these regulations were 


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Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 52437 

submitted to the Chief Counsel for 

Advocacy of the Small Business 

Administration for comment on their 

impact on small business. 

Drafting Information 

The principal author of these 

regulations is W. Thomas McElroy, Jr. of 

the Office of Associate Chief Counsel 

(Income Tax and Accounting). However, 

other personnel from the IRS and 

Treasury Department participated in 

their development. 

List of Subjects 

26 CFR Part 1 

Income taxes, Reporting and 

recordkeeping requirements. 

26 CFR Part 602 

Reporting and recordkeeping 

requirements. 

Adoption of Amendments to the 

Regulations 

■ Accordingly, 26 CFR parts 1 and 602 

are amended as follows: 

PART 1—INCOME TAXES 

■ Paragraph 1. The authority citation 

for part 1 continues to read, in part, as 

follows: 

Authority: 26 U.S.C. 7805 * * * 

■ Par. 2. Section 1.448–2 is added to 

read as follows: 

§ 1.448–2 Nonaccrual of certain amounts 

by service providers. 

(a) In general. This section applies to 

taxpayers qualified to use a nonaccrualexperience method of accounting 

provided for in section 448(d)(5) with 

respect to amounts to be received for the 

performance of services. A taxpayer that 

satisfies the requirements of this section 

is not required to accrue any portion of 

amounts to be received from the 

performance of services that, on the 

basis of the taxpayer’s experience, and 

to the extent determined under the 

computation or formula used by the 

taxpayer and allowed under this 

section, will not be collected. Except as 

otherwise provided in this section, a 

taxpayer is qualified to use a 

nonaccrual-experience method of 

accounting if the taxpayer uses an 

accrual method of accounting with 

respect to amounts to be received for the 

performance of services by the taxpayer 

and either—

(1) The services are in fields referred 

to in section 448(d)(2)(A) and described 

in § 1.448–1T(e)(4) (health, law, 

engineering, architecture, accounting, 

actuarial science, performing arts, or 

consulting); or 

(2) The taxpayer meets the $5 million 

annual gross receipts test of section 

448(c) and § 1.448–1T(f)(2) for all prior 

taxable years. 

(b) Application of method and 

treatment as method of accounting. The 

rules of section 448(d)(5) and the 

regulations are applied separately to 

each taxpayer. For purposes of section 

448(d)(5), the term taxpayer has the 

same meaning as the term person 

defined in section 7701(a)(1) (rather 

than the meaning of the term defined in 

section 7701(a)(14)). The nonaccrual of 

amounts to be received for the 

performance of services is a method of 

accounting (a nonaccrual-experience 

method). A change to a nonaccrualexperience method, from one 

nonaccrual-experience method to 

another nonaccrual-experience method, 

or to a periodic system (for example, see 

Notice 88–51 (1988–1 C.B. 535) and 

§ 601.601(d)(2)(ii)(b) of this chapter), is 

a change in method of accounting to 

which the provisions of sections 446 

and 481 and the regulations apply. See 

also paragraphs (c)(2)(i), (c)(5), (d)(4), 

and (e)(3)(i) of this section. Except as 

provided in other published guidance, a 

taxpayer who wishes to adopt or change 

to any nonaccrual-experience method 

other than one of the safe harbor 

methods described in paragraph (f) of 

this section must request and receive 

advance consent from the Commissioner 

in accordance with the applicable 

administrative procedures issued under 

§ 1.446–1(e)(3)(ii) for obtaining the 

Commissioner’s consent. 

(c) Definitions and special rules—(1) 

Accounts receivable—(i) In general. 

Accounts receivable include only 

amounts that are earned by a taxpayer 

and otherwise recognized in income 

through the performance of services by 

the taxpayer. For purposes of 

determining a taxpayer’s nonaccrualexperience under any method provided 

in this section, amounts described in 

paragraph (c)(1)(ii) of this section are 

not taken into account. Except as 

otherwise provided, for purposes of this 

section, accounts receivable do not 

include amounts that are not billed 

(such as for charitable or pro bono 

services) or amounts contractually not 

collectible (such as amounts in excess of 

a fee schedule agreed to by contract). 

See paragraph (g) Examples 1 and 2 of 

this section for examples of this rule. 

(ii) Method not available for certain 

receivables—(A) Amounts not earned 

and recognized through the 

performance of services. A nonaccrualexperience method of accounting may 

not be used with respect to amounts that 

are not earned by a taxpayer and 

otherwise recognized in income through 

the performance of services by the 

taxpayer. For example, a nonaccrualexperience method may not be used 

with respect to amounts owed to the 

taxpayer by reason of the taxpayer’s 

activities with respect to lending 

money, selling goods, or acquiring 

accounts receivable or other rights to 

receive payment from other persons 

(including persons related to the 

taxpayer) regardless of whether those 

persons earned the amounts through the 

provision of services. However, see 

paragraph (d)(3) of this section for 

special rules regarding acquisitions of a 

trade or business or a unit of a trade or 

business. 

(B) If interest or penalty charged on 

amounts due. A nonaccrual-experience 

method of accounting may not be used 

with respect to amounts due for which 

interest is required to be paid or for 

which there is any penalty for failure to 

timely pay any amounts due. For this 

purpose, a taxpayer will be treated as 

charging interest or penalties for late 

payment if the contract or agreement 

expressly provides for the charging of 

interest or penalties for late payment, 

regardless of the practice of the parties. 

If the contract or agreement does not 

expressly provide for the charging of 

interest or penalties for late payment, 

the determination of whether the 

taxpayer charges interest or penalties for 

late payment will be made based on all 

of the facts and circumstances of the 

transaction, and not merely on the 

characterization by the parties or the 

treatment of the transaction under state 

or local law. However, the offering of a 

discount for early payment of an 

amount due will not be regarded as the 

charging of interest or penalties for late 

payment under this section, if—

(1) The full amount due is otherwise 

accrued as gross income by the taxpayer 

at the time the services are provided; 

and 

(2) The discount for early payment is 

treated as an adjustment to gross income 

in the year of payment, if payment is 

received within the time required for 

allowance of the discount. See 

paragraph (g) Example 3 of this section 

for an example of this rule. 

(2) Applicable period—(i) In general. 

The applicable period is the number of 

taxable years on which the taxpayer 

bases its nonaccrual-experience method. 

A change in the number of taxable years 

included in the applicable period is a 

change in method of accounting to 

which the procedures of section 446 

apply. A change in the inclusion or 

exclusion of the current taxable year in 

the applicable period is a change in 

method of accounting to which the 

procedures of section 446 apply. A 


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52438 Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 

change in the number of taxable years 

included in the applicable period or the 

inclusion or exclusion of the current 

taxable year in the applicable period is 

made on a cut-off basis. 

(ii) Applicable period for safe harbors. 

For purposes of the safe harbors under 

paragraph (f) of this section the 

applicable period may consist of at least 

three but not more than six of the 

immediately preceding consecutive 

taxable years. Alternatively, the 

applicable period may consist of the 

current taxable year and at least two but 

not more than five of the immediately 

preceding consecutive taxable years. A 

period shorter than six taxable years is 

permissible only if the period contains 

the most recent preceding taxable years 

and all of the taxable years in the 

applicable period are consecutive. 

(3) Bad debts. Bad debts are accounts 

receivable determined to be 

uncollectible and charged off. 

(4) Charge-offs. Amounts charged off 

include only those amounts that would 

otherwise be allowable under section 

166(a). 

(5) Determination date. The 

determination date in safe harbor 2 

provided in paragraph (f)(2) of this 

section is used as a cut-off date for 

determining all known data to be taken 

into account in the computation of the 

taxable year’s uncollectible amount. The 

determination date may not be later 

than the earlier of the due date, 

including extensions, for filing the 

taxpayer’s Federal income tax return for 

that taxable year or the date on which 

the taxpayer timely files the return for 

that taxable year. The determination 

date may be different in each taxable 

year. However, once a determination 

date is selected and used for a particular 

taxable year, it may not be changed for 

that taxable year. The choice of a 

determination date is not a method of 

accounting. 

(6) Recoveries. Recoveries are 

amounts previously excluded from 

income under a nonaccrual-experience 

method or charged off that the taxpayer 

recovers. 

(7) Uncollectible amount. The 

uncollectible amount is the portion of 

any account receivable amount due that, 

under the taxpayer’s nonaccrualexperience method, will be not 

collected. 

(d) Use of experience to estimate 

uncollectible amounts—(1) In general. 

In determining the portion of any 

amount due that, on the basis of 

experience, will not be collected, a 

taxpayer may use any nonaccrualexperience method that clearly reflects 

the taxpayer’s nonaccrual-experience. 

The determination of whether a 

nonaccrual-experience method clearly 

reflects the taxpayer’s nonaccrualexperience is made in accordance with 

the rules under paragraph (e) of this 

section. Alternatively, the taxpayer may 

use any one of the five safe harbor 

nonaccrual-experience methods of 

accounting provided in paragraphs (f)(1) 

through (f)(5) of this section, which are 

presumed to clearly reflect a taxpayer’s 

nonaccrual-experience. 

(2) Application to specific accounts 

receivable. The nonaccrual-experience 

method is applied with respect to each 

account receivable of the taxpayer that 

is eligible for this method. With respect 

to a particular account receivable, the 

taxpayer determines, in the manner 

prescribed in paragraphs (d)(1) or (f)(1) 

through (f)(5) of this section (whichever 

applies), the uncollectible amount. The 

determination is required to be made 

only once with respect to each account 

receivable, regardless of the term of the 

receivable. The uncollectible amount is 

not recognized as gross income. Thus, 

the amount recognized as gross income 

is the amount that would otherwise be 

recognized as gross income with respect 

to the account receivable, less the 

uncollectible amount. A taxpayer that 

excludes an amount from income during 

a taxable year as a result of the 

taxpayer’s use of a nonaccrualexperience method may not deduct in 

any subsequent taxable year the amount 

excluded from income. Thus, the 

taxpayer may not deduct the excluded 

amount in a subsequent taxable year in 

which the taxpayer actually determines 

that the amount is uncollectible and 

charges it off. If a taxpayer using a 

nonaccrual-experience method 

determines that an amount that was not 

excluded from income is uncollectible 

and should be charged off (for example, 

a calendar-year taxpayer determines on 

November 1st that an account receivable 

that was originated on May 1st of the 

same taxable year is uncollectible and 

should be charged off), the taxpayer may 

deduct the amount charged off when it 

is charged off, but must include any 

subsequent recoveries in income. The 

reasonableness of a taxpayer’s 

determination that amounts are 

uncollectible and should be charged off 

may be considered on examination. See 

paragraph (g) Example 12 of this section 

for an example of this rule. 

(3) Acquisitions and dispositions—(i) 

Acquisitions. If a taxpayer acquires the 

major portion of a trade or business of 

another person (predecessor) or the 

major portion of a separate unit of a 

trade or business of a predecessor, then, 

for purposes of applying this section for 

any taxable year ending on or after the 

acquisition, the experience from 

preceding taxable years of the 

predecessor attributable to the portion 

of the trade or business acquired, if 

available, must be used in determining 

the taxpayer’s experience. 

(ii) Dispositions. If a taxpayer 

disposes of a major portion of a trade or 

business or the major portion of a 

separate unit of a trade or business, and 

the taxpayer furnished the acquiring 

person the information necessary for the 

computations required by this section, 

then, for purposes of applying this 

section for any taxable year ending on 

or after the disposition, the experience 

from preceding taxable years 

attributable to the portion of the trade or 

business disposed may not be used in 

determining the taxpayer’s experience. 

(iii) Meaning of terms. For the 

meaning of the terms acquisition, 

separate unit, and major portion, see 

paragraph (b) of § 1.52–2. The term 

acquisition includes an incorporation or 

a liquidation. 

(4) New taxpayers. The rules of this 

paragraph (d)(4) apply to any newly 

formed taxpayer to which the rules of 

paragraph (d)(3)(i) of this section do not 

apply. Any newly formed taxpayer that 

wants to use a safe harbor nonaccrualexperience method of accounting 

described in paragraph (f)(1), (f)(2), 

(f)(3), (f)(4), or (f)(5) of this section 

applies the methods by using the 

experience of the actual number of 

taxable years available in the applicable 

period. A newly formed taxpayer that 

wants to use one of the safe harbor 

nonaccrual-experience methods of 

accounting described in paragraph (f)(2), 

(f)(4), or (f)(5) of this section in its first 

taxable year and does not have any 

accounts receivable upon formation may 

not exclude any portion of its year-end 

accounts receivable from income for its 

first taxable year. The taxpayer must 

begin creating its moving average in its 

second taxable year by tracking the 

accounts receivable as of the first day of 

its second taxable year. The use of one 

of the safe harbor nonaccrual-experience 

methods of accounting described in 

paragraph (f)(2), (f)(4), or (f)(5) of this 

section in a taxpayer’s second taxable 

year in this situation is not a change in 

method of accounting. Although the 

taxpayer must maintain the books and 

records necessary to perform the 

computations under the adopted safe 

harbor nonaccrual-experience method, 

the taxpayer is not required to 

affirmatively elect the method on its 

Federal income tax return for its first 

taxable year. 

(5) Recoveries. Regardless of the 

nonaccrual-experience method of 

accounting used by a taxpayer under 

this section, the taxpayer must take 


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Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 52439 

recoveries into account. If, in a 

subsequent taxable year, a taxpayer 

recovers an amount previously excluded 

from income under a nonaccrualexperience method or charged off, the 

taxpayer must include the recovered 

amount in income in that subsequent 

taxable year. See paragraph (g) Example 

13 of this section for an example of this 

rule. 

(6) Request to exclude taxable years 

from applicable period. A period shorter 

than the applicable period generally is 

permissible only if the period consists 

of consecutive taxable years and there is 

a change in the type of a substantial 

portion of the outstanding accounts 

receivable such that the risk of loss is 

substantially increased. A decline in the 

general economic conditions in the area, 

which substantially increases the risk of 

loss, is a relevant factor in determining 

whether a shorter period is appropriate. 

However, approval to use a shorter 

period will not be granted unless the 

taxpayer supplies evidence that the 

accounts receivable outstanding at the 

close of the taxable years for the shorter 

period requested are more comparable 

in nature and risk to accounts receivable 

outstanding at the close of the current 

taxable year. A substantial increase in a 

taxpayer’s bad debt experience is not, by 

itself, sufficient to justify the use of a 

shorter period. If approval is granted to 

use a shorter period, the experience for 

the excluded taxable years may not be 

used for any subsequent taxable year. A 

request for approval to exclude the 

experience of a prior taxable year must 

be made in accordance with the 

applicable procedures for requesting a 

letter ruling and must include a 

statement of the reasons the experience 

should be excluded. A request will not 

be considered unless it is sent to the 

Commissioner at least 30 days before 

the close of the first taxable year for 

which the approval is requested. 

(7) Short taxable years. A taxpayer 

with a short taxable year that uses a 

nonaccrual-experience method that 

compares accounts receivable balance to 

total bad debts during the taxable year 

should make appropriate adjustments. 

(8) Recordkeeping requirements—(i) A 

taxpayer using a nonaccrual-experience 

method of accounting must keep 

sufficient books and records to establish 

the amount of any exclusion from gross 

income under section 448(d)(5) for the 

taxable year, including books and 

records demonstrating—

(A) The nature of the taxpayer’s 

nonaccrual-experience method; 

(B) Whether, for any particular taxable 

year, the taxpayer qualifies to use its 

nonaccrual-experience method 

(including the self-testing requirements 

of paragraph (e) of this section (if 

applicable)); 

(C) The taxpayer’s determination that 

amounts are uncollectible; 

(D) The proper amount that is 

excludable under the taxpayer’s 

nonaccrual-experience method; and 

(E) The taxpayer’s determination date 

under paragraph (c)(5) of this section (if 

applicable). 

(ii) If a taxpayer does not maintain 

records of the data that are sufficient to 

establish the amount of any exclusion 

from gross income under section 

448(d)(5) for the taxable year, the 

Internal Revenue Service may change 

the taxpayer’s method of accounting on 

examination. See § 1.6001–1 for rules 

regarding records. 

(e) Requirements for nonaccrual 

method to clearly reflect experience—(1) 

In general. A nonaccrual-experience 

method clearly reflects the taxpayer’s 

experience if the taxpayer’s nonaccrualexperience method meets the self-test 

requirements described in this 

paragraph (e). If a taxpayer is using one 

of the safe harbor nonaccrual-experience 

methods described in paragraphs (f)(1) 

through (f)(4) of this section, its method 

is deemed to clearly reflect its 

experience and is not subject to the selftesting requirements in paragraphs (e)(2) 

and (e)(3) of this section. 

(2) Requirement to self-test—(i) In 

general. A taxpayer using, or desiring to 

use, a nonaccrual-experience method 

must self-test its nonaccrual-experience 

method for its first taxable year for 

which the taxpayer uses, or desires to 

use, that nonaccrual-experience method 

(first-year self-test) and every three 

taxable years thereafter (three-year selftest). Each self-test must be performed 

by comparing the uncollectible amount 

(under the taxpayer’s nonaccrualexperience method) with the taxpayer’s 

actual experience. A taxpayer using the 

safe harbor under paragraph (f)(5) of this 

section must self-test using the safe 

harbor comparison method in paragraph 

(e)(3) of this section. 

(ii) First-year self-test. The first-year 

self-test must be performed by 

comparing the uncollectible amount 

with the taxpayer’s actual experience for 

its first taxable year for which the 

taxpayer uses, or desires to use, that 

nonaccrual-experience method. If the 

uncollectible amount for the first-year 

self-test is less than or equal to the 

taxpayer’s actual experience for its first 

taxable year for which the taxpayer 

uses, or desires to use, that nonaccrualexperience method, the taxpayer’s 

nonaccrual-experience method is 

treated as clearly reflecting its 

experience for the first taxable year. If, 

as a result of the first-year self-test, the 

uncollectible amount for the test period 

is greater than the taxpayer’s actual 

experience, then—

(A) The taxpayer’s nonaccrualexperience method is treated as not 

clearly reflecting its experience; 

(B) The taxpayer is not permitted to 

use that nonaccrual-experience method 

in that taxable year; and 

(C) The taxpayer must change to (or 

adopt) for that taxable year either—

(1) Another nonaccrual-experience 

method that clearly reflects experience, 

that is, a nonaccrual-experience method 

that meets the first-year self-test 

requirement; or 

(2) A safe harbor nonaccrualexperience method described in 

paragraphs (f)(1) through (f)(5) of this 

section. 

(iii) Three-year self-test—(A) In 

general. The three-year self-test must be 

performed by comparing the sum of the 

uncollectible amounts for the current 

taxable year and prior two taxable years 

(cumulative uncollectible amount) with 

the sum of the taxpayer’s actual 

experience for the current taxable year 

and prior two taxable years (cumulative 

actual experience amount). 

(B) Recapture. If the cumulative 

uncollectible amount for the test period 

is greater than the cumulative actual 

experience amount for the test period, 

the taxpayer’s uncollectible amount is 

limited to the cumulative actual 

experience amount for the test period. 

Any excess of the taxpayer’s cumulative 

uncollectible amount over the 

taxpayer’s cumulative actual 

nonaccrual-experience amount 

excluded from income during the test 

period must be recaptured into income 

in the third taxable year of the threeyear self-test period. 

(C) Determination of whether method 

is permissible or impermissible. If the 

cumulative uncollectible amount is less 

than 110 percent of the cumulative 

actual experience amount, the 

taxpayer’s nonaccrual-experience 

method is treated as a permissible 

method and the taxpayer may continue 

to use its alternative nonaccrualexperience method, subject to the threeyear self-test requirement of this 

paragraph (e)(2)(iii). If the cumulative 

uncollectible amount is greater than or 

equal to 110 percent of the cumulative 

actual experience amount, the 

taxpayer’s nonaccrual-experience 

method is treated as impermissible in 

the taxable year subsequent to the threeyear self-test year and does not clearly 

reflect its experience. The taxpayer must 

change to another nonaccrualexperience method that clearly reflects 

experience, including, for example, one 

of the safe harbor nonaccrual-experience 


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52440 Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 

methods described in paragraphs (f)(1) 

through (f)(5) of this section, for the 

subsequent taxable year. A change in 

method of accounting from an 

impermissible method under this 

paragraph (e)(2)(iii)(C) to a permissible 

method in the taxable year subsequent 

to the three-year self-test year is made 

on a cut-off basis. 

(iv) Determination of taxpayer’s 

actual experience. [Reserved.] 

(3) Safe harbor comparison method—

(i) In general. A taxpayer using, or 

desiring to use, a nonaccrual-experience 

method under the safe harbor in 

paragraph (f)(5) of this section must selftest its nonaccrual-experience method 

for its first taxable year for which the 

taxpayer uses, or desires to use, that 

nonaccrual-experience method (firstyear self-test) and every three taxable 

years thereafter (three-year self-test). A 

nonaccrual-experience method under 

the safe harbor in paragraph (f)(5) of this 

section is deemed to clearly reflect 

experience provided all the 

requirements of the safe harbor 

comparison method of this paragraph 

(e)(3) are met. Each self-test must be 

performed by comparing the 

uncollectible amount (under the 

taxpayer’s nonaccrual-experience 

method) with the uncollectible amount 

that would have resulted from use of 

one of the safe harbor methods 

described in paragraph (f)(1), (f)(2), 

(f)(3), or (f)(4) of this section. A change 

from a nonaccrual-experience method 

that uses the safe harbor comparison 

method for self-testing to a nonaccrualexperience method that does not use the 

safe harbor comparison method for selftesting, and vice versa, is a change in 

method of accounting to which the 

provisions of sections 446 and 481 and 

the regulations apply. A change solely 

to use or discontinue use of the safe 

harbor comparison method for purposes 

of determining whether the nonaccrualexperience method clearly reflects 

experience must be made on a cut-off 

basis and without audit protection. 

(ii) Requirements to use safe harbor 

comparison method—(A) First-year selftest. The first-year self-test must be 

performed by comparing the 

uncollectible amount with the 

uncollectible amount determined under 

any of the safe harbor methods 

described in paragraph (f)(1), (f)(2), 

(f)(3), or (f)(4) of this section (safe harbor 

uncollectible amount) for its first 

taxable year for which the taxpayer 

uses, or desires to use, that nonaccrualexperience method. If the uncollectible 

amount for the first-year self-test is less 

than or equal to the safe harbor 

uncollectible amount, then the 

taxpayer’s nonaccrual-experience 

method is treated as clearly reflecting its 

experience for the first taxable year. If, 

as a result of the first-year self-test, the 

uncollectible amount for the test period 

is greater than the safe harbor 

uncollectible amount, then—

(1) The taxpayer’s nonaccrualexperience method is treated as not 

clearly reflecting its experience; 

(2) The taxpayer is not permitted to 

use that nonaccrual-experience method 

in that taxable year; and 

(3) The taxpayer must change to (or 

adopt) for that taxable year either—

(i) Another nonaccrual-experience 

method that clearly reflects experience, 

that is, a nonaccrual-experience method 

that meets the first-year self-test 

requirement; or 

(ii) A safe harbor nonaccrualexperience method described in 

paragraphs (f)(1) through (f)(5) of this 

section. 

(B) Three-year self-test. The three-year 

self-test must be performed by 

comparing the sum of the uncollectible 

amounts for the current taxable year and 

prior two taxable years (cumulative 

uncollectible amount) with the sum of 

the uncollectible amount determined 

under any of the safe harbor methods 

described in paragraph (f)(1), (f)(2), 

(f)(3), or (f)(4) of this section for the 

current taxable year and prior two 

taxable years (cumulative safe harbor 

uncollectible amounts). If the 

cumulative uncollectible amount for the 

three-year self-test is less than or equal 

to the cumulative safe harbor 

uncollectible amount for the test period, 

then the taxpayer’s nonaccrualexperience method is treated as clearly 

reflecting its experience for the test 

period and the taxpayer may continue to 

use that nonaccrual-experience method, 

subject to a requirement to self-test 

again after three taxable years. If the 

cumulative uncollectible amount for the 

test period is greater than the 

cumulative safe harbor uncollectible 

amount for the test period, the 

taxpayer’s uncollectible amount is 

limited to the cumulative safe harbor 

uncollectible amount for the test period. 

Any excess of the taxpayer’s cumulative 

uncollectible amount over the 

taxpayer’s cumulative safe harbor 

uncollectible amount excluded from 

income during the test period must be 

recaptured into income in the third 

taxable year of the three-year self-test 

period. If the cumulative uncollectible 

amount is less than 110 percent of the 

cumulative safe harbor uncollectible 

amount, the taxpayer’s nonaccrualexperience method is treated as a 

permissible method and the taxpayer 

may continue to use its alternative 

nonaccrual-experience method, subject 

to the three-year self-test requirement of 

this paragraph (e)(3)(ii)(B). If the 

cumulative uncollectible amount is 

greater than or equal to 110 percent of 

the cumulative safe harbor uncollectible 

amount, the taxpayer’s nonaccrualexperience method is treated as 

impermissible in the taxable year 

subsequent to the three-year self-test 

year and does not clearly reflect its 

experience. The taxpayer must change 

to another nonaccrual-experience 

method that clearly reflects experience, 

including, for example, one of the safe 

harbor nonaccrual-experience methods 

described in paragraphs (f)(1) through 

(f)(5) of this section, for the subsequent 

taxable year. A change in method of 

accounting from an impermissible 

method under this paragraph 

(e)(3)(ii)(B) to a permissible method in 

the taxable year subsequent to the threeyear self-test year is made on a cut-off 

basis. 

(4) Methods that do not clearly reflect 

experience. [Reserved.] 

(5) Contemporaneous documentation. 

For purposes of this paragraph (e), 

including the safe harbor comparison 

method of paragraph (e)(3) of this 

section, a taxpayer must document in its 

books and records, in the taxable year 

any first-year or three-year self-test is 

performed, the method used to conduct 

the self-test, including appropriate 

documentation and computations that 

resulted in the determination that the 

taxpayer’s nonaccrual-experience 

method clearly reflected the taxpayer’s 

nonaccrual-experience for the 

applicable test period. 

(f) Safe harbors—(1) Safe harbor 1: 

revenue-based moving average method. 

A taxpayer may use a nonaccrualexperience method under which the 

taxpayer determines the uncollectible 

amount by multiplying its accounts 

receivable balance at the end of the 

current taxable year by a percentage 

(revenue-based moving average 

percentage). The revenue-based moving 

average percentage is computed by 

dividing the total bad debts sustained, 

adjusted by recoveries received, 

throughout the applicable period by the 

total revenue resulting in accounts 

receivable earned throughout the 

applicable period. See paragraph (g) 

Example 4 of this section for an example 

of this method. Thus, the uncollectible 

amount under the revenue-based 

moving average method is computed: 


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Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 52441 

Bad debts sustained, adjusted by recoveries received,

during the applicable period

Total revenue resulting in accounts receivable during the

applicable period

×

Accounts receivable at

end of current taxable

year

(2) Safe harbor 2: actual experience 

method—(i) Option A: single 

determination date. A taxpayer may use 

a nonaccrual-experience method under 

which the taxpayer determines the 

uncollectible amount by multiplying its 

accounts receivable balance at the end 

of the current taxable year by a 

percentage (moving average nonaccrualexperience percentage) and then 

increasing the resulting amount by 5 

percent. See paragraph (g) Example 5 of 

this section for an example of safe 

harbor 2 in general, and paragraph (g) 

Example 6 of this section for an example 

of the single determination date option 

of safe harbor 2. The taxpayer’s moving 

average nonaccrual-experience 

percentage is computed by dividing the 

total bad debts sustained, adjusted by 

recoveries that are allocable to the bad 

debts, by the determination date of the 

current taxable year related to the 

taxpayer’s accounts receivable balance 

at the beginning of each taxable year 

during the applicable period by the sum 

of the accounts receivable at the 

beginning of each taxable year during 

the applicable period. Thus, the 

uncollectible amount under Option A of 

the actual experience method is 

computed: 

Bad debts sustained, adjusted by recoveries received that are allocable to

 the bad debts, by the determination date of the current taxable year related

 to the taxpayer’s accounts receivable balance at the beginning of each taxable

 year during the applicable period

Sum of accounts receivable at the beginning of each

taxable year during the applicable period

 of cu ×

Accounts

receivable at end

rrent taxable 

year

× 1.05

(ii) Option B: multiple determination 

dates. Alternatively, in computing its 

bad debts related to the taxpayer’s 

accounts receivable balance at the 

beginning of each taxable year during 

the applicable period, a taxpayer may 

use the original determination date for 

each taxable year during the applicable 

period. That is, the taxpayer may use 

bad debts sustained, adjusted by 

recoveries received that are allocable to 

the bad debts, by the determination date 

of each taxable year during the 

applicable period rather than the 

determination date of the current 

taxable year. See paragraph (g) Example 

7 of this section for an example of the 

multiple determination date option of 

safe harbor 2. Thus, the uncollectible 

amount under Option B of the actual 

experience method is computed: 

Sum of, for each taxable year during the applicable period, bad debts sustained,

 adjusted by recoveries received that are allocable to the bad debts, by

 that taxable year’s determination date and related to the taxpayer’s

 accounts receivable balance at the beginning of the taxable year

 of accounts receivable at the beginning of each 

taxa

Sum

ble year during the applicable period

×

Accounts

receivable at end

 of current taxable

year

× 1.05

(iii) Tracing of recoveries—(A) In 

general. Bad debts related to the 

taxpayer’s accounts receivable balance 

at the beginning of each taxable year 

during the applicable period must be 

adjusted by the portion, if any, of 

recoveries received that are properly 

allocable to the bad debts. 

(B) Specific tracing. If a taxpayer, 

without undue burden, can trace all 

recoveries to their corresponding 

charge-offs, the taxpayer must 

specifically trace all recoveries. 

(C) Recoveries cannot be traced 

without undue burden. If a taxpayer has 

any recoveries that cannot, without 

undue burden, be traced to 

corresponding charge-offs, the taxpayer 

may allocate those or all recoveries 

between charge-offs of amounts in the 

relevant beginning accounts receivable 

balances and other charge-offs using an 

allocation method that is reasonable 

under all of the facts and circumstances. 

(1) Reasonable allocations. An 

allocation method is reasonable if there 

is a cause and effect relationship 

between the allocation base or ratio and 

the recoveries. A taxpayer may elect to 

trace recoveries that are traceable and 

allocate all untraceable recoveries to 

charge-offs of amounts in the relevant 

beginning accounts receivable balances. 

Such an allocation method will be 

deemed to be reasonable under all the 

facts and circumstances. 

(2) Allocations that are not 

reasonable. Allocation methods that 

generally will not be considered 

reasonable include, for example, 

methods in which there is not a cause 

and effect relationship between the 

allocation base or ratio and methods in 

which receivables for which the 

nonaccrual-experience method is not 

allowed to be used are included in the 

allocation. See paragraph (c)(1)(ii) of 

this section for examples of receivables 

for which the nonaccrual-experience 

method is not allowed. 

(3) Safe harbor 3: modified Black 

Motor method. A taxpayer may use a 

nonaccrual-experience method under 

which the taxpayer determines the 

uncollectible amount by multiplying its 

accounts receivable balance at the end 

of the current taxable year by a 

percentage (modified Black Motor 

moving average percentage) and then 

reducing the resulting amount by the 

bad debts written off during the current 

taxable year relating to accounts 

receivable generated during the current 

taxable year. The modified Black Motor 

moving average percentage is computed 

by dividing the total bad debts 

sustained, adjusted by recoveries 

received, during the applicable period 


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52442 Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 

by the sum of accounts receivable at the 

end of each taxable year during the 

applicable period. See paragraph (g) 

Example 8 of this section for an example 

of this method. Thus, the uncollectible 

amount under the modified Black Motor 

method is computed: 

Bad debts sustained, adjusted

by recoveries received, during

the applicable period

Sum of accounts receivable at

the end of each taxable year

during the applicable period

 ×

Accounts

receivable

Bad

 at

end of current 

taxable year

 debts w

−

ritten off during the 

current taxable year relating to

accounts receivable generated

during the current taxable year

(4) Safe harbor 4: modified moving 

average method. A taxpayer may use a 

nonaccrual-experience method under 

which the taxpayer determines the 

uncollectible amount by multiplying its 

accounts receivable balance at the end 

of the current taxable year by a 

percentage (modified moving average 

percentage). The modified moving 

average percentage is computed by 

dividing the total bad debts sustained, 

adjusted by recoveries received, during 

the applicable period other than bad 

debts that were written off in the same 

taxable year the related accounts 

receivable were generated by the sum of 

accounts receivable at the beginning of 

each taxable year during the applicable 

period. See paragraph (g) Example 9 of 

this section for an example of this 

method. Thus, the uncollectible amount 

under the modified moving average 

method is computed: 

(Bad debts sustained, adjusted by recoveries

received, during the applicable period − debts written off in same t Bad axable year 

accounts receivable generated)

Sum of accounts receivable at the beginning of

each taxable year during the applicable period

 receivable at end

of curr × Accountsent taxable year

(5) Safe harbor 5: alternative 

nonaccrual-experience method. A 

taxpayer may use an alternative 

nonaccrual-experience method that 

clearly reflects the taxpayer’s actual 

nonaccrual-experience, provided the 

taxpayer’s alternative nonaccrualexperience method meets the self-test 

requirements described in paragraph 

(e)(3) of this section. 

(g) Examples. The following examples 

illustrate the provisions of this section. 

In each example, the taxpayer uses a 

calendar year for Federal income tax 

purposes and an accrual method of 

accounting, does not require the 

payment of interest or penalties with 

respect to past due accounts receivable 

(except in the case of Example 3) and, 

in the case of Examples 5 through 7, 

selects an appropriate determination 

date for each taxable year. The examples 

are as follows: 

Example 1 Contractual allowance or 

adjustment. B, a healthcare provider, 

performs a medical procedure on individual 

C, who has health insurance coverage with 

IC, an insurance company. B bills IC and C 

for $5,000, B’s standard charge for this 

medical procedure. However, B has a 

contract with IC that obligates B to accept 

$3,500 as full payment for the medical 

procedure if the procedure is provided to a 

patient insured by IC. Under the contract, 

only $3,500 of the $5,000 billed by B is 

legally collectible from IC and C. The 

remaining $1,500 represents a contractual 

allowance or contractual adjustment. Under 

paragraph (c)(1)(i) of this section, the 

remaining $1,500 is not a contractually 

collectible amount for purposes of this 

section and B may not use a nonaccrualexperience method with respect to this 

portion of the receivable. 

Example 2. Charitable or pro bono services. 

D, a law firm, agrees to represent individual 

E in a legal matter and to provide services to 

E on a pro bono basis. D normally charges 

$500 for these services. Because D provides 

its services to E pro bono, D’s services are 

never billed or intended to result in revenue. 

Thus, under paragraph (c)(1)(i) of this 

section, the $500 is not a collectible amount 

for purposes of this section and D may not 

use a nonaccrual-experience method with 

respect to this portion of the receivable. 

Example 3. Charging interest and/or 

penalties. Z has two billing methods for the 

amounts to be received from Z’s provision of 

services described in paragraph (a)(1) of this 

section. Under one method, for amounts that 

are more than 90 days past due, Z charges 

interest at a market rate until the amounts 

(together with interest) are paid. Under the 

other billing method, Z charges no interest 

for amounts past due. Under paragraph 

(c)(1)(ii) of this section, A may not use a 

nonaccrual-experience method of accounting 

with respect to any of the amounts billed 

under the method that charges interest on 

amounts that are more than 90 days past due. 

Z may, however, use the nonaccrualexperience method with respect to the 

amounts billed under the method that does 

not charge interest for amounts past due. 

Example 4. Safe harbor 1: Revenue-based 

moving average method. (i) F uses the 

revenue-based moving average method 

described in paragraph (f)(1) of this section 

with an applicable period of six taxable 

years. F’s total accounts receivable and bad 

debt experience for the 2006 taxable year and 

the five immediately preceding consecutive 

taxable years are as follows: 

Taxable 

year 

Total accounts 

receivable 

earned during 

the taxable 

year 

Bad debts 

adjusted for 

recoveries 

2001 .......... $40,000 $5,700 

2002 .......... 40,000 7,200 

2003 .......... 40,000 11,000 

2004 .......... 60,000 10,200 

2005 .......... 70,000 14,000 

2006 .......... 80,000 16,800 

Total ...... 330,000 64,900 

(ii) F’s revenue-based moving average 

percentage is 19.67% ($64,900/$330,000). If 

$49,300 of accounts receivable remains 

outstanding as of the close of that taxable 

year (2006), F’s uncollectible amount using 

the revenue-based moving average safe 

harbor method is computed by multiplying 

$49,300 by the revenue-based moving 

average percentage of 19.67%, or $9,697. 

Thus, F may exclude $9,697 from gross 

income for 2006. 

Example 5. Safe harbor 2: Actual 

experience method. (i) G is eligible to use a 

nonaccrual-experience method and wishes to 

adopt the actual experience method of 

paragraph (f)(2) of this section. G elects to use 

a three-year applicable period consisting of 

the current and two immediately preceding 

consecutive taxable years. G determines that 


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Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 52443 

its actual accounts receivable collection 

experience is as follows: 

Taxable 

year 

Total A/R 

balance at beginning of taxable year 

Bad debts, 

adjusted for 

recoveries, related to A/R 

balance at beginning of taxable year 

2006 .......... $1,000,000 $35,000 

2007 .......... 760,000 75,000 

2008 .......... 1,975,000 65,000 

Total ...... 3,735,000 175,000 

(ii) G’s ending A/R Balance on December 

31, 2008, is $880,000. In 2008, G computes 

its uncollectible amount by using a three-year 

moving average under paragraph (f)(2) of this 

section. G’s moving average nonaccrualexperience percentage is 4.7%, determined 

by dividing the sum of the amount of G’s 

accounts receivable outstanding on January 1 

of 2006, 2007, and 2008, that were 

determined to be bad debts (adjusted for 

recoveries allocable to the bad debts) on or 

before the corresponding determination 

date(s), by the sum of the amount of G’s 

accounts receivable outstanding on January 1 

of 2006, 2007, and 2008 ($175,000/ 

$3,735,000 or 4.7%). G’s uncollectible 

amount for 2008 is determined by 

multiplying this percentage by the balance of 

G’s accounts receivable on December 31, 

2008 ($880,000 x 4.7% = $41,360), and 

increasing this amount by 105% ($41,360 × 

105% = $43,428). G may exclude $43,428 

from gross income for 2008. 

Example 6. Safe harbor 2: Single 

determination date (Option A). H is eligible 

to use a nonaccrual-experience method and 

wishes to adopt the actual experience 

method of paragraph (f)(2) of this section. H 

elects to use a six-year applicable period 

consisting of the current and five 

immediately preceding taxable years. H also 

elects to use a single determination date in 

accordance with paragraph (f)(2)(i) of this 

section. H selects December 31, its taxable 

year-end, as its determination date. Since H 

is using a single determination date from the 

current taxable year, its determination date 

for the 2001–2006 applicable period is 

December 31, 2006. H has a $800 charge-off 

in 2003 of an account receivable in the 2003 

beginning accounts receivable balance. In 

2005, H has a recovery of $100 which is 

traceable, without undue burden, to the $800 

charge-off in 2003. Since the $100 recovery 

occurred prior to H’s December 31, 2006, 

determination date, it reduces the amount of 

H’s bad debts in the numerator of the formula 

for purposes of determining H’s moving 

average nonaccrual-experience percentage. In 

addition, H must include the $100 recovery 

in income in 2005 (see paragraph (d)(5) of 

this section regarding recoveries). 

Example 7. Safe harbor 2: Multiple 

determination dates (Option B). The facts are 

the same as in Example 6, except H elects to 

use multiple determination dates in 

accordance with paragraph (f)(2)(ii) of this 

section. Consequently, H’s determination 

date is December 31, 2001, for its 

calculations of the portion of the numerator 

relating to the 2001 taxable year, December 

31, 2002, for its calculations of the portion 

of the numerator relating to the 2002 taxable 

year, and so on through the final taxable year 

(2006), which has a determination date of 

December 31, 2006. Since the $100 recovery 

did not occur until after December 31, 2003 

(the determination date for the 2003 taxable 

year), it does not reduce the amount of H’s 

bad debts in the numerator of the formula for 

purposes of determining H’s moving average 

nonaccrual-experience percentage. However, 

H still must include the $100 recovery in 

income in 2005 (see paragraph (d)(5) of this 

section regarding recoveries). 

Example 8. Safe harbor 3: Modified Black 

Motor method. (i) J uses the modified Black 

Motor method described in paragraph (f)(3) 

of this section and a six-year applicable 

period. J’s total accounts receivable and bad 

debt experience for the 2006 taxable year and 

the five immediately preceding consecutive 

taxable years are as follows: 

Taxable 

year 

Accounts 

receivable at 

end of taxable 

year 

Bad debts 

(adjusted for 

recoveries) 

2001 .......... $130,000 $9,100 

2002 .......... 140,000 7,000 

2003 .......... 140,000 14,000 

2004 .......... 160,000 14,400 

2005 .......... 170,000 20,400 

2006 .......... 180,000 10,800 

Total ...... 920,000 75,700 

(ii) J’s modified Black Motor moving 

average percentage is 8.228% ($75,700/ 

$920,000). If the accounts receivable 

generated and written off during the current 

taxable year are $3,600, J’s uncollectible 

amount is $11,210, computed by multiplying 

J’s accounts receivable on December 31, 2006 

($180,000) by the modified Black Motor 

moving average percentage of 8.228% and 

reducing the resulting amount by $3,600 (J’s 

accounts receivable generated and written off 

during the 2006 taxable year). J may exclude 

$11,210 from gross income for 2006. 

Example 9. Safe harbor 4: Modified moving 

average method. (i) The facts are the same as 

in Example 8, except that the balances 

represent accounts receivable at the 

beginning of the taxable year, and J uses the 

modified moving average method described 

in paragraph (f)(4) of this section and a sixyear applicable period. Furthermore, the 

accounts receivable that were written off in 

the same taxable year they were generated, 

adjusted for recoveries of bad debts during 

the period are as follows: 

Taxable year 

Accounts 

receivable 

written off in 

same taxable 

year as generated 

(adjusted for 

recoveries) 

2001 ...................................... $3,033 

2002 ...................................... 2,333 

2003 ...................................... 4,667 

2004 ...................................... 4,800 

Taxable year 

Accounts 

receivable 

written off in 

same taxable 

year as generated 

(adjusted for 

recoveries) 

2005 ...................................... 6,800 

2006 ...................................... 3,600 

Total .................................. 25,233 

(ii) J’s modified moving average percentage 

is 5.486% (($75,700¥$25,233)/$920,000). J’s 

uncollectible amount is $9,875, computed by 

multiplying J’s accounts receivable on 

December 31, 2006 ($180,000) by the 

modified moving average percentage of 

5.486%. J may exclude $9,875 from gross 

income for 2006. 

Example 10. First-year self-test. Beginning 

in 2006, K is eligible to use a nonaccrualexperience method and wants to adopt an 

alternative nonaccrual-experience method 

under paragraph (f)(5) of this section, and 

consequently is subject to the safe harbor 

comparison method of self-testing under 

paragraph (e)(3) of this section. K elects to 

self-test against safe harbor 1 for purposes of 

conducting its first-year self-test. K’s 

uncollectible amount for 2006 is $22,000. K’s 

safe harbor uncollectible amount under safe 

harbor 1 is $21,000. Because K’s 

uncollectible amount for 2006 ($22,000) is 

greater than the safe harbor uncollectible 

amount ($21,000), K’s alternative nonaccrualexperience method is treated as not clearly 

reflecting its nonaccrual experience for 2006. 

Accordingly, K must adopt either another 

nonaccrual-experience method that clearly 

reflects experience (subject to the self-testing 

requirements of paragraph (e)(2)(ii) of this 

section, or a safe harbor nonaccrualexperience method described in paragraph 

(f)(1) (revenue-based moving average), (f)(2) 

(actual experience method), (f)(3) (modified 

Black Motor method), (f)(4) (modified moving 

average method) of this section, or another 

alternative nonaccrual-experience method 

under paragraph (f)(5) of this section that 

meets the self-testing requirements of 

paragraph (e)(3) of this section. 

Example 11. Three-year self-test. The facts 

are the same as in Example 10, except that 

K’s safe harbor uncollectible amount under 

safe harbor 1 for 2006 is also $22,000. 

Consequently, K meets the first-year self-test 

requirement and may use its alternative 

nonaccrual-experience method. 

Subsequently, K’s cumulative uncollectible 

amount for 2007 through 2009 is $300,000. 

K’s safe harbor uncollectible amount for 2007 

through 2009 under its chosen safe harbor 

method for self-testing (safe harbor 1) is 

$295,000. Because K’s cumulative 

uncollectible amount for the three-year test 

period (taxable years 2007 through 2009) is 

greater than its safe harbor uncollectible 

amount for the three-year test period 

($295,000), under paragraph (e)(3)(ii)(B) of 

this section, the $5,000 excess of K’s 

cumulative uncollectible amount over K’s 

safe harbor uncollectible amount for the 

three-year test period must be recaptured into 

income in 2009 in accordance with 


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52444 Federal Register / Vol. 71, No. 172 / Wednesday, September 6, 2006 / Rules and Regulations 

paragraph (e)(3)(ii)(B) of this section. Since 

K’s cumulative uncollectible amount for the 

three-year test period ($300,000) is less than 

110% of its safe harbor uncollectible amount 

($295,000 × 110% = $324,500), under 

paragraph (e)(3)(ii)(B) of this section, K may 

continue to use its alternative nonaccrualexperience method, subject to the three-year 

self-test requirement. 

Example 12. Subsequent worthlessness of 

year-end receivable. The facts are the same as 

in Example 4, except that one of the accounts 

receivable outstanding at the end of 2002 was 

for $8,000, and in 2003, under section 166, 

the entire amount of this receivable becomes 

wholly worthless. Because F does not accrue 

as income $1,573 of this account receivable 

($8,000 × .1967) under the nonaccrualexperience method in 2002, under paragraph 

(d)(2) of this section F may not deduct this 

portion of the account receivable as a bad 

debt deduction under section 166 in 2003. F 

may deduct the remaining balance of the 

receivable in 2003 as a bad debt deduction 

under section 166 ($8,000¥$1,574 = $6,426). 

Example 13. Subsequent collection of yearend receivable. The facts are the same as in 

Example 4. In 2007, F collects in full an 

account receivable of $1,700 that was 

outstanding at the end of 2006. Under 

paragraph (d)(5) of this section, F must 

recognize additional gross income in 2007 

equal to the portion of this receivable that F 

excluded from gross income in the prior 

taxable year ($1,700 × .1967 = $334). That 

amount ($334) is a recovery under paragraph 

(d)(5) of this section. 

(h) Effective date. This section is 

applicable for taxable years ending on or 

after August 31, 2006. 

§ 1.448–2T [Removed] 

■ Par. 3. Section 1.448–2T is removed. 

PART 602—OMB CONTROL NUMBERS 

UNDER THE PAPERWORK 

REDUCTION ACT 

■ Par. 4. The authority citation for part 

602 continues to read as follows: 

Authority: 26 U.S.C. 7805. 

■ Par. 5. In § 602.101, paragraph (b) is 

amended by adding an entry in 

numerical order to the table to read as 

follows: 

§ 602.101 OMB Control numbers. 

* * * * * 

(b) * * * 

CFR part or section where 

identified and described 

Current OMB 

control No. 

* * * * * 

1.448–2 ................................. 1545–1855 

* * * * * 

Steven T. Miller, 

Acting Deputy Commissioner for Services and 

Enforcement. 

Approved: August 30, 2006. 

Eric Solomon, 

Acting Deputy Assistant Secretary of the 

Treasury (Tax Policy). 

[FR Doc. 06–7446 Filed 8–31–06; 1:53 pm] 

BILLING CODE 4830–01–P 

DEPARTMENT OF THE TREASURY 

Internal Revenue Service 

26 CFR Part 301 

[TD 9284] 

RIN 1545–BC72 

Collection After Assessment 

AGENCY: Internal Revenue Service (IRS), 

Treasury. 

ACTION: Final regulations. 

SUMMARY: This document contains final 

regulations relating to the collection of 

tax liabilities after assessment. The 

regulations reflect changes to the law 

made by the Internal Revenue Service 

Restructuring and Reform Act of 1998. 

These regulations affect persons 

determining how long the Internal 

Revenue Service has to collect taxes that 

have been properly assessed. 

DATES: Effective Date: These regulations 

are September 6, 2006. 

FOR FURTHER INFORMATION CONTACT: 

Debra A. Kohn, (202) 622–7985 (not a 

toll-free number). 

SUPPLEMENTARY INFORMATION: 

Background 

This document contains amendments 

to the Procedure and Administration 

Regulations (26 CFR part 301) under 

section 6502 of the Internal Revenue 

Code (Code). The regulations reflect the 

amendment of the Code by section 3461 

of the Internal Revenue Service 

Restructuring and Reform Act of 1998 

(RRA 1998), Public Law 105–206 (112 

Stat. 685, 764). 

On March 4, 2005, a notice of 

proposed rulemaking (REG–148701–03) 

relating to collection after assessment 

was published in the Federal Register 

(70 FR 10572). No public hearing was 

requested or held. Written and 

electronic comments responding to the 

notice of proposed rulemaking were 

received. After consideration of all the 

comments, the proposed regulations are 

adopted as amended by this Treasury 

decision. The revisions are discussed in 

this preamble. 

Collection of Tax Liabilities After 

Assessment Under Section 6502 

Pursuant to section 6502 of the Code, 

the IRS generally has 10 years from the 

date of assessment to collect a timely 

assessed tax liability. Prior to January 1, 

2000, the effective date of section 3461 

of RRA 1998, section 6502 permitted the 

IRS to enter into agreements with the 

taxpayer to extend the period of 

limitations on collection at any time 

prior to the expiration of the period 

provided in section 6502. Prior to the 

enactment of RRA 1998, the IRS used 

these collection extension agreements, 

or waivers, in various circumstances to 

protect its ability to collect a tax liability 

beyond the original 10-year period of 

limitations on collection. For example, 

the IRS historically conditioned 

consideration of an offer in compromise 

upon the execution of a collection 

extension agreement or waiver. 

In addition, the Code contains several 

provisions that operate to toll the period 

of limitations on collection upon the 

occurrence of certain events. For 

example, section 6331(k) operates in 

part to suspend the period of limitations 

on collection for the period of time 

during which an offer in compromise is 

pending, for 30 days after rejection, and 

while a timely filed appeal is pending. 

Similarly, section 6503(h) operates to 

suspend the period of limitations on 

collection for the period of time during 

which the IRS is prohibited from 

collecting a tax due to a bankruptcy 

proceeding, and for 6 months thereafter. 

These statutory suspension provisions 

toll the period of limitations on 

collection even if the period of 

limitations on collection previously has 

been extended pursuant to an executed 

collection extension agreement. See 

Klingshirn v. United States (In re 

Klingshirn), 147 F.3d 526 (6th Cir. 

1998). 

Section 3461 of RRA 1998 amended 

section 6502 of the Code to limit the 

ability of the IRS to enter into 

agreements extending the period of 

limitations on collection. Section 3461 

of RRA 1998 also included an off-Code 

provision governing the continued effect 

of collection extension agreements 

executed on or before December 31, 

1999. 

Summary of Comments and 

Explanation of Provisions 

The final regulations incorporate the 

amendments made by section 3461 of 

RRA 1998. The regulations provide that 

the IRS may enter into an agreement to 

extend the period of limitations on 

collection if an extension agreement is 

executed: (1) At the time an installment 


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