The question may be corny but the answer is very important especially if you are an accrual basis taxpayer and in the business of providing health services. Why should you have to wait until specific receivables become worthless or otherwise uncollectible to take a deduction when experience allows you to determine with reasonable accuracy the portion of receivables that will not be collected? Federal Regulation §1.448-2 addresses the issue of the collectability of receivables in its discussion of the nonaccrual-experience method of accounting. The regulation states in part the following:"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" (emphasis added).
The specific requirements that must be met in order for a taxpayer to qualify to use the nonaccrual-experience method of accounting are as follows:
• The taxpayer must use an accrual method of accounting with respect to the amounts to be received for the performance of services; AND
• The services provided must be in certain specified fields, i.e. health, law, engineering, accounting, actuarial science, performing arts, or consulting OR the taxpayer meets the $5 million annual gross receipts test for all prior taxable years.
For purposes of using the nonaccrual-experience method of accounting, accounts receivable do not include amounts that are not billed and/or amounts that contractually are not collectible. Regulation §1.448-2 illustrates this point via the following example:
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 nonaccrual-experience method with respect to this portion of the receivable.
Another key point to keep in mind relates to recoveries. A taxpayer using the nonaccrual-experience method of accounting must take recoveries into account. If an amount excluded from income in one tax year is recovered in a subsequent tax year then the recovered amount must be included in income in the tax year during which the recovery occurred.