[Federal Register Volume 68, Number 171 (Thursday, September 4, 2003)]
[Rules and Regulations]
[Pages 52496-52508]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-22458]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

[TD 9090]
RIN 1545-BC31


Limitation on Use of the Nonaccrual-Experience Method of 
Accounting Under Section 448(d)(5)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Temporary regulations.

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SUMMARY: This document revises temporary income tax regulations to 
provide guidance regarding the use of a nonaccrual-experience method of 
accounting by taxpayers using an accrual method of accounting and 
performing services. The revisions reflect changes to section 448(d)(5) 
of the Internal Revenue Code by the Job Creation and Worker Assistance 
Act of 2002. The revised temporary regulations will affect taxpayers 
that no longer qualify to use a nonaccrual-experience method of 
accounting, and qualifying taxpayers that wish to adopt or change a 
nonaccrual-experience method of accounting. The text of these temporary 
regulations also serves as the text of the proposed regulations set 
forth in the Proposed Rules section of this issue of the Federal 
Register.

Effective Date:
    These regulations are effective September 4, 2003.
    Applicability Date: These regulations are applicable for taxable 
years ending after March 9, 2002.

FOR FURTHER INFORMATION CONTACT: Terrance McWhorter, (202) 622-4970 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    These regulations are being issued without prior notice and public 
procedure pursuant to the Administrative Procedure Act (5 U.S.C. 553). 
For this reason, the collection of information contained in these 
regulations has been reviewed and, pending receipt and evaluation of 
public comments, approved by the Office of Management and Budget under 
control number 1545-1855. Responses to this collection of information 
are mandatory.
    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.
    For further information concerning this collection of information, 
and where to submit comments on the collection of information and the 
accuracy of the estimated burden, and suggestions for reducing this 
burden, please refer to the preamble to the cross-referencing notice of 
proposed rulemaking published in the Proposed Rules section of this 
issue of the Federal Register.
    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 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 added to the 
Code by section 801 of the Tax Reform Act of 1986 (Public Law 99-514, 
100 Stat. 2085) and was amended by section 403 of the Job Creation and 
Worker Assistance Act of 2002 (Public Law 107-147, 116 Stat. 21) (the 
2002 Act), effective for taxable years ending after March 9, 2002. 
These regulations pertain to the nonaccrual of certain amounts by 
taxpayers using an accrual method of accounting and performing 
services.

Explanation of Provisions

Background

    Prior to being amended by the 2002 Act, pursuant to section 
448(d)(5) taxpayers using an accrual method of accounting and 
performing services were not required to accrue any portion of their 
service-related income that, on the basis of their experience, would 
not be collected. Temporary regulations under section 448(d)(5) (former 
temporary regulations) provided rules for the nonaccrual of certain 
amounts by service providers, including the use of experience to 
estimate uncollectible amounts and the mechanics of the nonaccrual-
experience method.
    Section 448(d)(5) was amended by section 403 of the 2002 Act, 
effective for taxable years ending after March 9, 2002. Section 
448(d)(5) now provides that a nonaccrual-experience method is available 
only for taxpayers using an accrual method who either provide services 
in fields described in section 448(d)(2)(A) (i.e., health, law, 
engineering, architecture, accounting, actuarial science, performing 
arts, or consulting), or that meet the $5 million annual gross receipts 
test of section 448(c) for all prior taxable years.
    The legislative history of the 2002 Act states that Congress 
believed that for many qualified service providers the formula 
contained in the former temporary regulations under section 448(d)(5) 
may not clearly reflect the amount of income that, based on experience, 
will not be collected. See H.R. Rep. No. 107-251. Congress noted that 
service providers were particularly disadvantaged by the formula 
contained in the former temporary regulations if significant time 
elapsed between the time the services were rendered and the time a 
final determination was made that the account would not be collected. 
Additionally, Congress noted that taxpayers qualified to use the 
nonaccrual-experience method of accounting should not be subject to a 
formula that required the payment of taxes on receivables that would 
not be collected.
    The amendments to section 448(d)(5) made by the 2002 Act require 
the Secretary to promulgate regulations. Specifically, the Secretary is 
required to prescribe regulations to permit a taxpayer to use 
computations or formulas that, based on experience, accurately reflect 
the amount of income that will not be collected. Section 448(d)(5), as 
amended, also permits a taxpayer to adopt, or request consent of the 
Secretary to change to, a computation or formula that clearly reflects 
the taxpayer's experience. Section 448(d)(5) further requires the 
Secretary to approve a request to change to a computation or formula 
that clearly reflects the taxpayer's experience. Lastly, the 
legislative history to the 2002 Act states that Congress anticipated 
that the Secretary would consider providing

[[Page 52497]]

safe harbors in such regulations that may be relied upon by taxpayers.
    In accordance with the amendments to section 448(d)(5) in the 2002 
Act, the IRS issued Notice 2003-12 (2003-6 I.R.B. 422) to provide 
interim guidance under section 448(d)(5), as amended, pending the 
issuance of new regulations. The interim guidance provided by Notice 
2003-12 included: (1) For taxpayers that no longer qualified to use a 
nonaccrual-experience method, procedures to change their method of 
accounting; (2) for taxpayers that qualified to use a nonaccrual-
experience method, two safe harbor nonaccrual-experience methods that 
were presumed to clearly reflect the taxpayer's nonaccrual-experience; 
(3) for taxpayers that qualified to use a nonaccrual-experience method 
but wished to compute their nonaccrual-experience using a formula other 
than the two safe harbors provided, the requirements necessary to use 
an alternative formula to compute their nonaccrual-experience; and (4) 
for taxpayers that wished to change to a different nonaccrual-
experience method, the procedures necessary to obtain automatic consent 
of the Commissioner to change to one of the safe harbor nonaccrual-
experience methods or to an alternative nonaccrual-experience method 
that clearly reflected their experience.
    The guidance provided in Notice 2003-12 has, for the most part, 
been incorporated as part of these temporary regulations. However, 
certain provisions in the Notice have been modified to address certain 
concerns raised by the commentators.

Charging of Interest

    Section 448(d)(5) and the former temporary regulations provide that 
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 
(other than, in certain circumstances, discounts offered for early 
payment of an amount due). One commentator suggested that a taxpayer 
should not be precluded from using a nonaccrual-experience method of 
accounting if the taxpayer's agreement contains a provision stating 
that interest is required to be paid but the taxpayer rarely enforces 
the provision. The IRS and Treasury Department continue to believe that 
if a taxpayer's agreement requires interest to be paid, or provides for 
any penalty for failure to timely pay any amounts due, such taxpayer is 
precluded from using the nonaccrual-experience method of accounting, 
regardless of whether the taxpayer actually imposes such interest or 
penalty.

Safe Harbor Methods

    The temporary regulations include the two safe harbor nonaccrual-
experience methods that were included in Notice 2003-12. The first safe 
harbor method (safe harbor 1) is the method provided in former Temp. 
Reg. Sec.  1.448-2T(e)(2). The second safe harbor method (safe harbor 
2) is the actual experience method that may be computed using a three-
year moving average beginning in the first taxable year this safe 
harbor method is used or, for taxpayers that do not have the 
information necessary to compute a three-year moving average in the 
first taxable year this method is used, the option of creating a three-
year moving average beginning with the first taxable year that the 
taxpayer uses this safe harbor method. A newly formed taxpayer choosing 
the option of creating a three-year moving average that does not have 
any accounts receivable upon formation will not be able to exclude any 
portion of its year-end 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 to track. Thus, a newly formed 
taxpayer that does not have any accounts receivable upon formation must 
begin creating its three-year moving average in its second taxable 
year.
    Commentators requested that the IRS and Treasury Department 
consider other suggested alternative safe harbor methods for inclusion 
in the temporary regulations. The IRS and Treasury Department analyzed 
alternative methods and, based on this analysis, have determined that 
two other formulas will clearly reflect a taxpayer's nonaccrual-
experience. As a result, the temporary regulations provide two 
additional safe harbor nonaccrual-experience methods that may be relied 
on by taxpayers as clearly reflecting their nonaccrual-experience.
    The third safe harbor 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). The nonaccrual-experience 
amount is computed by first determining the ratio of total bad debts 
charged off (adjusted for recoveries) for the current taxable year and 
the five preceding taxable years as compared to the total accounts 
receivable at the end of the current taxable year and the five 
preceding taxable years. This ratio is applied against the accounts 
receivable balance at the end of the current taxable year, and the 
resulting amount is then reduced by the credit charges (accounts 
receivable) generated and written off during the current taxable year, 
which results in the nonaccrual-experience amount for the current 
taxable year.
    The fourth safe harbor method (safe harbor 4) is computed by first 
determining the ratio of total bad debts charged off (adjusted for 
recoveries) 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 as compared to 
the total accounts receivable at the end of the current taxable year 
and the five preceding taxable years. This ratio is then applied 
against the accounts receivable balance at the end of the current 
taxable year, which results in the nonaccrual-experience amount for the 
current taxable year.
    Commentators suggested that the IRS and Treasury Department permit 
the formula addressed in Black Motor (``Black Motor formula'') as an 
additional safe harbor formula in the temporary regulations. The IRS 
and Treasury Department have analyzed the Black Motor formula and have 
determined that the formula should not be provided as an additional 
safe harbor formula because the formula only produces an accurate 
reflection of a taxpayer's experience in limited circumstances. The IRS 
and Treasury Department believe that safe harbors 3 and 4 (discussed 
above), which are modifications of the Black Motor formula, remedy many 
of the shortcomings of the Black Motor formula and, as a result, safe 
harbors 3 and 4 have been included in the temporary regulations as 
additional safe harbor formulas.
    The IRS and Treasury Department request comments on these safe-
harbor nonaccrual-experience methods and suggestions on any additional 
safe harbor methods that will clearly reflect a taxpayer's experience. 
Specifically, the IRS and Treasury Department request comments on any 
additional modification to the Black Motor formula that will result in 
an accurate reflection of a taxpayer's experience.

Self-Testing of Any Alternative Method

    Notice 2003-12 also allowed a taxpayer to use any alternative 
nonaccrual-experience method that clearly reflected the taxpayer's 
actual nonaccrual-experience, provided the taxpayer's alternative 
nonaccrual-experience method was ``self-tested'' in the first taxable 
year ending after March 9, 2002, in which the taxpayer uses the 
alternative nonaccrual-experience

[[Page 52498]]

method and every three taxable years thereafter. The Notice provided 
that if the taxpayer's total alternative nonaccrual-experience amount 
for the test period was less than or equal to the total adjusted 
nonaccrual-experience amount (actual nonaccrual-experience amount 
multiplied by 105%) for the test period, then the taxpayer's 
alternative nonaccrual-experience method would be treated as clearly 
reflecting its nonaccrual-experience for the test period and the 
taxpayer would be permitted to continue using the alternative 
nonaccrual-experience method, subject to self-testing again in three 
taxable years. However, if the taxpayer's total alternative nonaccrual-
experience amount for the test period was greater than the total 
adjusted nonaccrual-experience amount for the test period, the Notice 
stated that the taxpayer's alternative nonaccrual-experience method 
would be treated as not clearly reflecting its nonaccrual-experience 
for the test period and the taxpayer was required to change its 
nonaccrual-experience method of accounting to a method that would 
clearly reflect its nonaccrual experience.
    Some commentators suggested that the self-testing requirement in 
Notice 2003-12 should not be included in the regulations. They 
suggested that the self-testing requirement is inconsistent with the 
language and purpose of the amendments made by the 2002 Act. The 
commentators also suggested that it would be burdensome and impractical 
for many taxpayers using an alternative nonaccrual-experience method to 
conduct the self-test due to the limitations of their existing 
automated record keeping systems. Finally, one commentator suggested 
that if a taxpayer's alternative nonaccrual-experience method fails the 
self-testing requirements, then the temporary regulations should limit 
the taxpayer's exclusion under section 448(d)(5) to the taxpayer's 
adjusted nonaccrual-experience amount, rather than require the taxpayer 
to change its method of accounting.
    The IRS and Treasury Department believe that the self-testing 
requirement is consistent with the 2002 Act, which 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, Sec.  403(a). 
The IRS and Treasury Department believe that self-testing is necessary 
for taxpayers that do not use one of the four safe harbor methods 
provided to ensure that the statutory requirement that the taxpayer's 
formula or computation accurately reflect the taxpayer's nonaccrual 
experience is met. Therefore, the temporary regulations continue to 
permit a taxpayer to use any alternative nonaccrual-experience method, 
provided such method meets the self-testing requirements described in 
the temporary regulations. The IRS and Treasury Department welcome 
comments from taxpayers and practitioners specifically addressing the 
limitations of their record keeping systems that affect conducting 
self-testing, and ways in which the burden on taxpayers of self-testing 
might be reduced without compromising the statute's requirement that 
the taxpayer's method clearly reflect the taxpayer's experience.
    Under the temporary regulations, taxpayers using (or desiring to 
use) an alternative nonaccrual-experience method must self-test the 
method in the first taxable year ending after March 9, 2002, that the 
taxpayer uses, or desires to use, the method (first-year self-test), 
and every three taxable years thereafter (three-year self-test). When 
conducting the first-year self-test, a taxpayer is permitted to test 
its alternative nonaccrual-experience method against any of the four 
safe harbor methods. If a taxpayer is permitted to use its alternative 
nonaccrual-experience method as a result of satisfying the first year 
self-test, the temporary regulations require the taxpayer to include 
contemporaneous documentation in its books and records stating which 
safe harbor method was used during the self-test that permitted the 
taxpayer to use its alternative nonaccrual-experience method. When 
conducting any three-year self-test, the taxpayer must self-test its 
alternative nonaccrual-experience method against the same safe harbor 
method used during the immediately preceding self-test. The temporary 
regulations also provide rules for taxpayers that want to change the 
safe harbor method used to test their alternative nonaccrual-experience 
method.
    For purposes of the first-year self-test, if the alternative 
nonaccrual-experience amount for the first-year self-test is less than 
or equal to the nonaccrual-experience amount computed under the safe 
harbor formula selected by the taxpayer for the first-year self-test, 
then the taxpayer's alternative nonaccrual-experience method will be 
treated as clearly reflecting its nonaccrual-experience for the test 
period and the taxpayer may continue to use that alternative 
nonaccrual-experience method, subject to a requirement to self-test 
again after three taxable years. If the alternative nonaccrual-
experience amount is greater than the nonaccrual-experience amount of 
the safe harbor method selected by the taxpayer for its self-test 
method, then the taxpayer's alternative nonaccrual-experience method 
will be treated as not clearly reflecting its nonaccrual-experience for 
such taxable year and the taxpayer will not be permitted to use that 
alternative nonaccrual-experience method for such taxable year. The 
taxpayer is permitted, however, to adopt (or change to) a safe harbor 
nonaccrual-experience method provided in the regulations or another 
alternative nonaccrual-experience method, subject to the first-year 
self-test requirement.
    For purposes of the three-year self-test requirement, if the 
cumulative alternative nonaccrual-experience amount for the test period 
is less than or equal to the cumulative nonaccrual-experience amount 
(computed by using for each taxable year of the test period the safe 
harbor formula used, and contemporaneously documented, during the 
immediately preceding self-test) (cumulative safe harbor nonaccrual-
experience amount), then the taxpayer's alternative nonaccrual-
experience method will be treated as clearly reflecting its nonaccrual 
experience for the test period and the taxpayer may continue to use 
that alternative nonaccrual-experience method, subject to a requirement 
to self-test again in three taxable years. If the cumulative 
alternative nonaccrual-experience amount for the test period is greater 
than the cumulative safe harbor nonaccrual-experience amount, then the 
taxpayer's alternative nonaccrual-experience amount will be limited to 
the cumulative safe harbor nonaccrual-experience amount for the test 
period. Any excess of the taxpayer's cumulative alternative nonaccrual-
experience amount excluded from income during the test period over the 
taxpayer's cumulative safe harbor nonaccrual-experience amount must be 
recaptured into income in the third taxable year of the three-year 
self-test. The taxpayer may continue to use its alternative nonaccrual-
experience method, subject to the three-year self-test requirement.
    The IRS and Treasury Department request comments on the first-year 
self-test, three-year self-test, and recapture provisions of the 
temporary regulations.

Special Rules

    Notice 2003-12 provided that a taxpayer that did not maintain 
records of the data necessary to determine its actual nonaccrual-
experience would be subject to being changed by the IRS on

[[Page 52499]]

examination to the specific charge-off method. One commentator noted 
that a taxpayer should not be changed by the IRS to the specific 
charge-off method merely because of unintentional and/or immaterial 
variances between the methods permitted under these regulations and the 
taxpayers' computations, which are often due to factors beyond the 
taxpayer's control. Among the factors noted were inherent delays 
between the time services were rendered and when actual billing occurs 
(which may affect the determination of the year-end balance of accounts 
receivable, especially when services are provided at the end of one 
taxable year and the billing occurs a few days later in the subsequent 
taxable year), and constraints of the taxpayer's computer systems that 
limit the taxpayer's ability to maintain the data necessary for a 
nonaccrual-experience method. For example, a taxpayer may be unable to 
determine whether a particular recovery relates to an account 
receivable on hand at the beginning of the taxable year. The 
commentator noted that a taxpayer may therefore choose to treat all 
recoveries as relating to an account receivable on hand at the 
beginning of the taxable year, which under safe harbor 2, reduces the 
nonaccrual-experience amount that the taxpayer would be entitled to if 
the taxpayer precisely allocated its recoveries. Because these factors 
generally will result in a taxpayer claiming less than the proper 
nonaccrual-experience amount the taxpayer would otherwise be entitled 
to, the commentator requested that the IRS not change a taxpayer to the 
specific charge-off method due to variances similar to those noted 
above.
    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 a taxpayer is disadvantaged by such 
variances. As a result, the temporary regulations require only that a 
taxpayer maintain records that are sufficient to establish the amount 
of any exclusion from gross income under section 448(d)(5) for the 
taxable year. This rule is consistent and in accordance with Sec.  
1.6001-1(a) (rules regarding records). However, the IRS maintains the 
right to change a taxpayer to the specific charge-off method if such 
taxpayer fails to maintain sufficient records to establish the amount 
of any claimed exclusion from gross income under section 448(d)(5) for 
the taxable year. The IRS and Treasury Department request comments on 
this record keeping standard.

Periodic Systems

    Notice 88-51, 1988-1 C.B. 535, provides guidance on the use of a 
periodic system of applying the nonaccrual-experience method provided 
in former Temp. Reg. Sec.  1.448-2T(e)(2). The periodic system entails 
establishing an account based on the aggregate amount of accounts 
receivable that: (1) Are eligible for the nonaccrual-experience method; 
and (2) the taxpayer estimates will not be collected. The account is 
adjusted each year to reflect the taxpayer's estimate (using its 
nonaccrual-experience method) of the aggregate amount of the accounts 
receivable outstanding at year-end that will not be collected. A 
corresponding adjustment is then made to gross income.
    The IRS and Treasury Department intend to update Notice 88-51 to 
provide for the use of a periodic system by taxpayers using any 
nonaccrual-experience method. Pending the issuance of this guidance, a 
taxpayer may use the periodic system described in Notice 88-51 in 
conjunction with any permissible nonaccrual-experience method used by 
the taxpayer.

Accounting Method Change Procedures

    A change from a nonaccrual-experience method by a taxpayer no 
longer qualified to use such a method, a change to a nonaccrual-
experience method, a change from one nonaccrual-experience method to 
another nonaccrual-experience method, or a change from using one safe 
harbor method for self-testing to another safe harbor method, is a 
change in method of accounting to which the provisions of sections 446 
and 481, and the regulations thereunder, apply. The temporary 
regulations provide, in most instances, automatic consent for these 
changes. Taxpayers making these changes should follow the procedures of 
Rev. Proc. 2002-9. Additionally, the temporary regulations provide 
automatic consent procedures for taxpayers changing to a nonaccrual-
experience method to also request to change to a periodic system.

Additional Issues to be Addressed in Final Regulations

    The IRS and Treasury Department intend to address additional issues 
in future guidance that are not addressed in these temporary 
regulations. Specifically, the IRS and Treasury Department request 
comments on the effect on the computation of a taxpayer's nonaccrual-
experience as a result of a short taxable year, and an acquisition or 
disposition of an entity during a taxable year, including the 
acquisition or disposition of an entity disregarded for federal income 
tax purposes. The IRS and Treasury Department also request comments on 
whether the computation under the Actual Experience Method should be 
based on the prior three taxable years or, as currently provided, the 
current taxable year and the two immediately preceding taxable years.

Effect on Other Documents

    The following publication is obsolete as of September 4, 2003:
    Notice 2003-12 (2003-6 I.R.B. 422).
    The following publication is modified to include in section 5.06 of 
the Appendix as of September 4, 2003, only the changes in method of 
accounting provided in Sec.  1.448-2T(g)(2)(ii), (g)(3)(i) and (h):
    Rev. Proc. 2002-9 (2002-1 C.B. 327).

Special Analyses

    It has been determined that these temporary regulations are 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) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. For application 
of the Regulatory Flexibility Act, please refer to the cross-reference 
notice of proposed rulemaking published elsewhere in this issue of the 
Federal Register. Pursuant to section 7805(f) of the Internal Revenue 
Code, these regulations will be submitted to the Chief Counsel for 
Advocacy of the Small Business Administration for comment on their 
impact.

Drafting Information

    The principal author of these regulations is Terrance McWhorter 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.

Amendments to the Regulations

0
Accordingly, 26 CFR parts 1 and 602 are amended as follows:

[[Page 52500]]

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

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

0
Par. 2. Section 1.448-2T is revised as follows:


Sec.  1.448-2T  Nonaccrual of certain amounts by service providers 
(temporary).

    (a) In general. This section applies to taxpayers qualified to use 
a nonaccrual-experience method of accounting provided for in section 
448(d)(5) with respect to amounts to be received for the performance of 
services. 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 as described in Sec.  1.448-1T(e)(4) (i.e., 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 Sec.  1.448-1T(f)(2) for all prior taxable years.
    (b) Nonaccrual-experience method; treatment as method of 
accounting. Any taxpayer who 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 such person'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. This nonaccrual of amounts to be received for the 
performance of services shall be treated as a method of accounting 
under the Code (a nonaccrual-experience method).
    (c) Method not available if interest 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, the 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 such discount. See paragraph (f) Example 
1 of this section for an example of this rule.
    (d) Method not available for certain receivables--(1) Amounts 
earned and recognized through the performance of services. A 
nonaccrual-experience method of accounting may be used only with 
respect to amounts earned by the taxpayer and otherwise recognized in 
income (an account receivable) through the performance of services by 
such taxpayer. For example, a nonaccrual-experience 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 such amounts through the provision of 
services.
    (2) Special rule. Except as otherwise provided, for purposes of 
this section, accounts receivable do not include amounts that are not 
billed (e.g., for charitable or pro bono services) or amounts 
contractually not collectible (e.g., amounts in excess of a fee 
schedule agreed to by contract). See paragraph (f) Examples 2 and 3 of 
this section for examples of this rule.
    (e) Use of experience to estimate uncollectible amounts--(1) In 
general. In determining the portion of any amount due which, on the 
basis of experience, will not be collected, the taxpayer may use one of 
four safe harbor nonaccrual-experience methods of accounting provided 
in paragraphs (e)(2) through (e)(5) of this section. Alternatively, the 
taxpayer may use any other nonaccrual-experience method (``alternative 
nonaccrual-experience method'') that clearly reflects the taxpayer's 
nonaccrual-experience, subject to the requirements of paragraph (e)(6) 
of this section. The safe harbor nonaccrual-experience methods provided 
in paragraphs (e)(2) through (e)(5) of this section will be presumed to 
clearly reflect a taxpayer's nonaccrual-experience. For purposes of 
determining a taxpayer's nonaccrual-experience under any method 
provided in this paragraph (e), accounts receivable described in 
paragraphs (c) and (d) of this section are not taken into account. See 
paragraph (g) of this section for procedures to obtain automatic 
consent to change to one of the safe harbor nonaccrual experience 
methods or to an alternative nonaccrual-experience method.
    (2) Safe harbor 1: Six-year moving average method--(i) General 
rule. A taxpayer may use a nonaccrual experience method under which the 
taxpayer determines the uncollectible amount (six-year moving average 
amount) by multiplying its accounts receivable balance at the end of 
the current year by a percentage (six-year moving average percentage). 
The six-year moving average percentage is computed by dividing--
    (A) The total bad debts (with respect to accounts receivable) 
sustained throughout the period consisting of the taxable year and the 
five preceding taxable years (or, with the approval of the 
Commissioner, a shorter period), adjusted for recoveries of bad debts 
during such period; by
    (B) The sum of the accounts receivable earned throughout the entire 
six (or fewer) taxable year period (i.e., the total amount of sales 
resulting in accounts receivable). See paragraph (f) Example 4 of this 
section for an example of this method.
    (ii) Period of less than six taxable years. A period shorter than 
six taxable years generally will be appropriate only if the short 
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 specific evidence that the accounts receivable outstanding at 
the close of the taxable years for the shorter period requested are not 
comparable in nature and risk to accounts receivable outstanding at the 
close of the six taxable years. 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

[[Page 52501]]

shorter period, the experience for the excluded taxable years shall not 
be used for any subsequent year. A request for approval to exclude the 
experience of a prior taxable year shall be made in accordance with the 
applicable procedures for requesting a letter ruling and shall include 
a statement of the reasons such 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 such 
approval is requested.
    (iii) Special rule for new taxpayers. In the case of any current 
taxable year that is preceded by less than 5 taxable years, paragraph 
(e)(2)(i) of this section shall be applied by using the experience of 
the current year and the actual number of preceding taxable years.
    (3) Safe harbor 2: Actual experience method--(i) Option A: Three-
year moving average. A taxpayer may use a nonaccrual-experience method 
under which the taxpayer determines the uncollectible amount (actual 
nonaccrual-experience amount) by multiplying its year-end accounts 
receivable balance by a percentage (three-year moving average 
nonaccrual-experience percentage) reflecting its actual nonaccrual 
experience with respect to its accounts receivable balance at the 
beginning of the current taxable year and the two immediately preceding 
taxable years. Under this safe harbor method, a taxpayer is allowed to 
increase its actual nonaccrual-experience amount by 5 percent (adjusted 
nonaccrual-experience amount). The taxpayer's three-year moving average 
nonaccrual-experience percentage, actual nonaccrual-experience amount, 
and adjusted nonaccrual-experience amount are determined according to 
the following steps:
    (A) STEP 1. Track 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 date selected by the taxpayer 
(determination date) for the taxable year. 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 such return for 
that taxable year.
    (B) STEP 2. Repeat STEP 1 for the taxpayer's accounts receivable 
balance at the beginning of each of the two immediately preceding 
taxable years.
    (C) STEP 3. To determine the taxpayer's three-year moving average 
nonaccrual-experience percentage, divide the sum of the net 
uncollectible amounts from STEP 1 and STEP 2 by the sum of the accounts 
receivable balance at the beginning of the current taxable year and the 
accounts receivable balance at the beginning of each of the two 
preceding taxable years.
    (D) STEP 4. Multiply the percentage computed in STEP 3 by the 
taxpayer's accounts receivable balance at the end of the current 
taxable year. The product is the taxpayer's actual nonaccrual-
experience amount for the current taxable year.
    (E) STEP 5. To determine the taxpayer's adjusted nonaccrual-
experience amount, multiply the actual nonaccrual-experience amount 
from STEP 4 by 1.05. See paragraph (f) Example 5 of this section for an 
example of this method.
    (ii) Option B: Up to three-year moving average. Alternatively, 
except as provided in paragraph (e)(3)(iii) of this section, in 
computing its adjusted nonaccrual-experience amount described in 
paragraph (e)(3)(i) of this section, a taxpayer may use: its current 
year nonaccrual-experience percentage for the first taxable year this 
method is used; a two-year moving average nonaccrual-experience 
percentage for the second taxable year this method is used; and a 
three-year moving average nonaccrual-experience percentage for the 
third, and each succeeding, taxable year this method is used. See 
paragraph (f) Examples 6, 7, and 8 of this section for examples of this 
method.
    (iii) Special rule for new taxpayers. Any newly formed taxpayer 
that wants to use the safe harbor nonaccrual-experience method of 
accounting described in paragraph (e)(3)(ii) of this section in its 
first taxable year and does not have any accounts receivable upon 
formation will not be able to exclude any portion of its year-end 
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 to track. Therefore, the taxpayer must begin creating its 
three-year moving average in its second taxable year by tracking the 
accounts receivables as of the first day of its second taxable year.
    (4) Safe harbor 3: Modified Black Motor method--(i) In general. A 
taxpayer may use a nonaccrual-experience method under which the 
taxpayer determines the uncollectible amount (modified Black Motor 
amount) by multiplying its accounts receivable balance at the end of 
the current taxable year by a percentage (Black Motor moving average 
percentage), and then reducing the resulting amount by the credit 
charges (accounts receivable) generated and written off during the 
current taxable year. The Black Motor moving average percentage is 
computed by dividing--
    (A) The total bad debts sustained in the current taxable year and 
the five preceding taxable years (or, with the approval of the 
Commissioner, a shorter period), adjusted for recoveries of bad debts 
during such period; by
    (B) The sum of accounts receivable at the end of the current 
taxable year and the five preceding (or fewer) taxable years. See 
paragraph (f) Example 10 of this section for an example of this method.
    (ii) Period of less than six taxable years. The rules of paragraph 
(e)(2)(ii) of this section (regarding periods of less than six taxable 
years) shall apply to taxpayers using the Modified Black Motor method.
    (iii) Special rules for new taxpayers. In the case of any current 
taxable year that is preceded by less than 5 taxable years, paragraph 
(e)(4)(i) of this section shall be applied by using the experience of 
the current taxable year and the actual number of preceding taxable 
years.
    (5) Safe harbor 4: Modified six-year moving average method--(i) In 
general. A taxpayer may use a nonaccrual-experience method under which 
the taxpayer determines the uncollectible amount (modified six-year 
moving average amount) by multiplying its accounts receivable balance 
at the end of the current year by a percentage (modified six-year 
moving average percentage). The modified six-year moving average 
percentage is computed by dividing--
    (A) The total bad debts sustained in the current taxable year and 
the five preceding taxable years (or, with the approval of the 
Commissioner, a shorter period) other than the credit charges (accounts 
receivable) that were written off in the same taxable year they were 
generated, adjusted for recoveries of bad debts during such period; by
    (B) The sum of accounts receivable at the end of the current 
taxable year and the five preceding (or fewer) taxable years. See 
paragraph (f) Example 11 of this section for an example of this method.
    (ii) Period of less than six taxable years. The rules of paragraph 
(e)(2)(ii) of this section (regarding periods of less than six taxable 
years) shall apply to taxpayers using the Modified six-year moving 
average method.
    (iii) Special rules for new taxpayers. In the case of any current 
taxable year

[[Page 52502]]

that is preceded by less than 5 taxable years, paragraph (e)(5)(i) of 
this section shall be applied by using the experience of the current 
taxable year and the actual number of preceding taxable years.
    (6) Alternative nonaccrual-experience method--(i) In general. A 
taxpayer may use any alternative nonaccrual-experience method that 
clearly reflects the taxpayer's actual nonaccrual-experience, provided 
the taxpayer's alternative nonaccrual-experience method meets the self-
test requirements described in this paragraph (e)(6).
    (ii) Self-testing. A taxpayer using, or desiring to use, an 
alternative nonaccrual-experience method must ``self-test'' its 
alternative nonaccrual-experience method for its first taxable year 
ending after March 9, 2002, for which the taxpayer uses, or desires to 
use, that alternative nonaccrual-experience method (first-year self-
test), and every three taxable years thereafter (three-year self-test). 
Each self-test shall be performed by comparing the nonaccrual-
experience amount under the taxpayer's alternative nonaccrual-
experience method (alternative nonaccrual-experience amount) with the 
nonaccrual-experience amount that would have resulted from use of one 
safe harbor method described in paragraph (e)(2), (e)(3), (e)(4), or 
(e)(5) of this section selected by the taxpayer for use in conducting 
the self test (safe harbor comparison method), for the test period.
    (iii) Selection of safe harbor comparison method--(A) First-year 
self-test. For purposes of conducting the first-year self-test required 
under paragraph (e)(6)(ii) of this section, a taxpayer may self-test 
its alternative nonaccrual-experience method against any safe harbor 
method provided in paragraphs (e)(2) through (e)(5) of this section. 
See paragraph (f) Example 12 of this section for an example of this 
rule.
    (B) Three-year self-test. For purposes of conducting any three-year 
self-test required under paragraph (e)(6)(ii) of this section, the 
taxpayer must self-test its alternative nonaccrual-experience method 
against the same safe harbor comparison method used for the immediately 
preceding self-test. For purposes of the three-year self-test, the 
cumulative nonaccrual-experience amount for the safe harbor comparison 
method is computed by using, for each taxable year of the test period, 
the same safe harbor comparison method used during the immediately 
preceding self test (cumulative safe harbor nonaccrual-experience 
amount). See paragraph (f) Example 13 of this section for an example of 
this rule.
    (C) Change of safe harbor comparison method. (1) A taxpayer that 
wants to change the safe harbor comparison method it uses for purposes 
of the self-testing requirement of paragraph (e)(6)(ii) of this section 
may do so only for the first taxable year following any three-year 
self-test period and in accordance with this paragraph (e)(6)(iii)(C). 
A change in the taxpayer's safe harbor comparison method is a change in 
method of accounting to which the procedures of sections 446 and 481, 
and the regulations thereunder, apply.
    (2) For the taxable year a taxpayer wishes to change its safe 
harbor comparison method, the taxpayer must self-test its alternative 
nonaccrual-experience method against any safe harbor method provided in 
paragraphs (e)(2) through (e)(5) of this section other than the safe 
harbor comparison method currently used by the taxpayer and such self-
test shall be conducted as if such self-test was a first-year self-
test.
    (3) If the self-test described in paragraph (e)(6)(iii)(C)(2) of 
this section results in the taxpayer's alternative nonaccrual-
experience method clearly reflecting the taxpayer's nonaccrual-
experience as determined under paragraph (e)(6)(iv) of this section, 
then the taxpayer may change its safe harbor comparison method in 
accordance with the procedures under paragraph (g)(3) of this section. 
Such change shall be made on a cut-off basis and without audit 
protection.
    (4) If the self-test described in paragraph (e)(6)(iii)(C)(2) of 
this section results in the taxpayer's alternative nonaccrual-
experience method not clearly reflecting the taxpayer's nonaccrual-
experience as determined under paragraph (e)(6)(vi)(A) of this section, 
then the taxpayer cannot use the safe harbor comparison method selected 
and must either--
    (i) Continue using its current safe harbor comparison method; or
    (ii) Select another safe harbor comparison method, subject to the 
requirements of paragraphs (e)(6)(iii)(C)(2) and (3) of this section.
    (5) If a taxpayer meets the requirements of this paragraph 
(e)(6)(iii)(C) to change its safe harbor comparison method, the new 
safe harbor comparison method is not used for purposes of conducting 
the three-year self-test required by paragraph (e)(6)(ii) of this 
section for the taxable year immediately preceding the taxable year the 
taxpayer is permitted to change its safe harbor comparison method. The 
taxpayer's former safe harbor comparison method is used for purposes of 
conducting such three-year self-test and for purposes of determining 
any recapture amount under paragraph (e)(6)(vi)(B) of this section.
    (iv) Treated as clearly reflecting nonaccrual-experience. If the 
alternative nonaccrual-experience amount for the first-year self-test 
(or the cumulative nonaccrual-experience amount for the three-year 
self-test, as applicable) is less than or equal to the nonaccrual-
experience amount determined under paragraph (e)(6)(iii)(A) of this 
section (first-year self-test) or the cumulative safe harbor 
nonaccrual-experience amount determined under paragraph (e)(6)(iii)(B) 
of this section (three-year self-test), as applicable, of this section 
for the test period, then--
    (A) The taxpayer's alternative nonaccrual-experience method will be 
treated as clearly reflecting its nonaccrual-experience for the test 
period; and
    (B) The taxpayer may continue to use that alternative nonaccrual-
experience method, subject to a requirement to self-test again after 
three taxable years.
    (v) Contemporaneous documentation. For purposes of paragraph (e)(6) 
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 safe harbor comparison method used to conduct the self-test, 
including appropriate documentation and computations that resulted in 
the determination that the taxpayer's alternative nonaccrual-experience 
method clearly reflected the taxpayer's nonaccrual-experience for the 
applicable test period.
    (vi) Special rules for alternative nonaccrual-experience method. 
(A) First-year self-test. If, as a result of the first-year self-test 
requirement of paragraph (e)(6)(ii) of this section, the alternative 
nonaccrual-experience amount for the test period is greater than the 
safe harbor nonaccrual-experience amount for the test period, then--
    (1) The taxpayer's alternative nonaccrual-experience method will be 
treated as not clearly reflecting its nonaccrual-experience;
    (2) The taxpayer will not be permitted to use that alternative 
nonaccrual-experience method in such taxable year; and
    (3) The taxpayer must change to (or adopt) for such taxable year 
either--
    (i) A safe harbor nonaccrual-experience method described in 
paragraphs (e)(2) through (e)(5) of this section; or
    (ii) Another alternative nonaccrual-experience method, subject to 
the first-year self-test requirement of paragraph (e)(6)(ii) of this 
section. See paragraph

[[Page 52503]]

(f) Example 14 of this section for an example of this rule.
    (B) Three-year self-test. If, as a result of the three-year self-
test requirement of paragraph (e)(6)(ii) of this section, the 
cumulative alternative nonaccrual-experience amount for the test period 
is greater than the cumulative safe harbor nonaccrual-experience amount 
for the test period, the taxpayer's alternative nonaccrual-experience 
amount will be limited to the cumulative safe harbor nonaccrual-
experience amount for the test period. Any excess of the taxpayer's 
cumulative alternative nonaccrual-experience amount over the taxpayer's 
cumulative safe harbor nonaccrual-experience amount excluded from 
income during the test period must be recaptured into income in 
accordance with paragraph (e)(6)(vii) of this section. The taxpayer may 
continue to use its alternative nonaccrual-experience method, subject 
to the three-year self-test requirement in paragraph (e)(6)(ii) of this 
section. See paragraph (f) Example 15 of this section for an example of 
this rule.
    (vii) Recapture--(1) In general. Any amount required to be 
recaptured pursuant to paragraph (e)(6)(vi)(B) of this section must be 
included in income in the third taxable year of the three-year self-
test period. See paragraph (f) Example 15 of this section for an 
example of this rule.
    (7) Special rules--(i) Application to specific accounts receivable. 
The nonaccrual-experience method shall be applied with respect to each 
account receivable of the taxpayer that is eligible for such method. 
With respect to a particular account receivable, the taxpayer will 
determine, in the manner prescribed in paragraphs (e)(2) through (e)(6) 
of this section (whichever applies), the amount of such account 
receivable that is not expected to be collected. Such determination 
shall be made only once with respect to each account receivable, 
regardless of the term of such receivable. The estimated uncollectible 
amount shall not be recognized as gross income. Thus, the amount 
recognized as gross income shall be the amount that would otherwise be 
recognized as gross income with respect to the account receivable, less 
the amount which is not expected to be collected. A taxpayer that 
excludes an amount from income during a taxable year as a result of the 
taxpayer's use of a nonaccrual-experience method cannot deduct in any 
subsequent taxable year the amount excluded from income. Thus, the 
taxpayer cannot 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 (e.g., a calendar-
year taxpayer determines on November 1st that an account receivable 
that was originated on May 1st of the same 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 determinations that amounts 
are uncollectible and should be charged off may be considered on 
examination. See paragraph (f) Example 16 of this section for an 
example of this rule.
    (ii) Charge-off. For purposes of this section, amounts charged-off 
shall include only those amounts that would otherwise be allowable 
under section 166(a).
    (iii) Recoveries. Regardless of the nonaccrual-experience method of 
accounting used by a taxpayer under this section, the taxpayer must 
take into account recoveries of amounts previously charged off. If, in 
a subsequent taxable year, a taxpayer recovers an amount previously 
excluded from income under a nonaccrual-experience method or charged 
off, the taxpayer must include the recovered amount in income in that 
subsequent taxable year. See paragraph (f) Example 17 of this section 
for an example of this rule.
    (iv) Application of nonaccrual-experience method. The rules of 
section 448(d)(5) and the regulations thereunder shall be 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 ``taxpayer'' 
defined in section 7701(a)(14)).
    (v) Record keeping requirements. (A) A taxpayer using a nonaccrual-
experience method shall keep such books and records as are sufficient 
to establish the amount of any exclusion from gross income under 
section 448(d)(5) for the taxable year, including books and records 
demonstrating--
    (1) The nature of the taxpayer's nonaccrual-experience method;
    (2) Whether, for any particular taxable year, the taxpayer 
qualifies to use its nonaccrual-experience method (including the self-
testing requirements of paragraph (e)(6)(ii) of this section (if 
applicable));
    (3) The taxpayer's determination that amounts are uncollectible; 
and
    (4) The proper amount that is excludable under the taxpayer's 
nonaccrual-experience method.
    (B) A taxpayer that 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 may be subject to being 
changed by the IRS on examination to the specific charge-off method. 
See Sec.  1.6001-1 for rules regarding records.
    (f) 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 and, in the case of Examples 5 through 8 and 12 
through 15, selects an appropriate determination date for each taxable 
year.

    Example 1. Charging interest and/or penalties. A has two billing 
methods for the amounts to be received from A'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, A charges 
interest at a market rate until such amounts (together with 
interest) are paid. Under the other billing method, A charges no 
interest for amounts past due. Pursuant to paragraph (c) 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. A 
may, however, use the nonaccrual-experience method with respect to 
the amounts billed under the method that does not charge interest 
for amounts past due.
    Example 2. 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. Thus, pursuant to paragraph (d)(2) 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 accounts receivable.
    Example 3. 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 performed its services to E pro bono, D's 
services were never billed or intended to result in revenue. Thus, 
pursuant to paragraph (d)(2) of this section, the $500 forgone legal 
fee is not a

[[Page 52504]]

collectible amount for purposes of this section and D may not use a 
nonaccrual-experience method with respect to this portion of the 
accounts receivable.
    Example 4. Safe harbor 1: Six-year moving average method. (i) F 
uses the six-year moving average method described in paragraph 
(e)(2) of this section. F's total accounts receivable and bad debt 
experience for the current taxable year (2002) and the five 
preceding taxable years are as follows:

------------------------------------------------------------------------
                                                              Bad debts
                                                   Total       adjusted
                 Taxable year                     accounts       for
                                                 receivable   recoveries
------------------------------------------------------------------------
1997..........................................      $30,000       $5,700
1998..........................................       40,000        7,200
1999..........................................       40,000       11,000
2000..........................................       60,000       10,200
2001..........................................       70,000       14,000
2002..........................................       80,000       16,800
                                               --------------
    Total.....................................     $330,000      $64,900
------------------------------------------------------------------------

    (ii) Thus, F's six-year moving average percentage is 19.67% 
($64,900/$330,000). Assume that $49,300 of the total $80,000 of 
accounts receivable earned throughout the taxable year 2002 is 
outstanding as of the close of that taxable year. F's nonaccrual-
experience amount using the six-year moving average safe harbor 
method is computed by multiplying $49,300 by the six-year moving 
average percentage of .1967, or $9,697. Thus, F may exclude $9,697 
from gross income for 2002.
    Example 5. Safe harbor 2: Actual experience method (Option A). 
(i) G is eligible to use a nonaccrual-experience method and wishes 
to adopt the actual experience method of paragraph (e)(3)(i) of this 
section. G has the data necessary to track the uncollectible amounts 
in its beginning-of-year accounts receivable for the current taxable 
year and the two immediately preceding taxable years. G determines 
that its actual accounts receivable collection experience is as 
follows:

------------------------------------------------------------------------
                                                           Beginning A/R
                                                               amount
                                               Total A/R    charged off
                                               balance at        by
                Taxable year                   beginning   determination
                                                of year         date
                                                           (adjusted for
                                                            recoveries)
------------------------------------------------------------------------
2000........................................   $1,000,000       $35,000
2001........................................      760,000        75,000
2002........................................    1,975,000        65,000
                                             --------------
    Total...................................   $3,735,000      $175,000
------------------------------------------------------------------------

    (ii) G's ending A/R Balance on 12/31/2002 is $880,000. In 2002, 
G chooses to compute its nonaccrual-experience amount by using the 
three-year moving average under Option A of paragraph (e)(3)(i) of 
this section. Thus, G's three-year moving average nonaccrual-
experience percentage is 4.7%, determined by dividing the sum of the 
amount of G's receivables in its account on January 1st of 2000, 
2001, and 2002, that were determined to be uncollectible and charged 
off (adjusted for recoveries) on or before the corresponding 
determination dates, by the sum of the balances of G's accounts 
receivable account on January 1st of 2000, 2001, and 2002 (i.e., 
$175,000/$3,735,000 or 4.7%). Thus, G's actual nonaccrual-experience 
amount for 2002 is determined by multiplying this percentage by the 
balance of G's accounts receivable account on December 31, 2002 
(i.e., $880,000 x 4.7% = $41,360). G is permitted to exclude from 
gross income in 2002 an amount equal to 105% of G's actual 
nonaccrual-experience amount, or $43,428 ($41,360 x 105%). This is 
G's adjusted nonaccrual-experience amount for 2002.
    Example 6. Safe harbor 2: Actual experience method (Option B). 
The facts are the same as Example 5, except that G has not 
maintained the data necessary to use Option A of paragraph (e)(3)(i) 
of this section. G determines that, of its 2002 beginning-of-year 
receivables of $1,975,000, $65,000 were determined to be 
uncollectible and charged off (adjusted for recoveries) on or before 
September 15, 2003, the date G timely files its federal income tax 
return for 2002 (the determination date). G chooses to use Option B 
of paragraph (e)(3)(ii) of this section to compute its adjusted 
nonaccrual-experience amount for 2002. G's current year nonaccrual-
experience percentage is 3.3%, determined by dividing the amount of 
G's receivables in its account on January 1, 2002, that were charged 
off as uncollectible (adjusted for recoveries) on or before the 
determination date, by the balance of G's accounts receivable 
account on January 1, 2002 (i.e., $65,000/$1,975,000 or 3.3%). Thus, 
G's actual nonaccrual-experience amount for 2002 is determined by 
multiplying this percentage by the balance of G's accounts 
receivable account on December 31, 2002 (i.e., $880,000 x 3.3% = 
$29,040). G is permitted to exclude from gross income in 2002 an 
amount equal to 105% of G's actual nonaccrual-experience amount, or 
$30,492 ($29,040 x 105%). This is G's adjusted nonaccrual-experience 
amount for 2002.
    Example 7.  (i) The facts are the same as Example 6. G 
determines that its accounts receivable collection experience for 
2003 is as follows:

------------------------------------------------------------------------
                                                           Beginning A/R
                                                               amount
                                               Total A/R    charged off
                                               balance at        by
                Taxable year                   beginning   determination
                                                of year         date
                                                           (adjusted for
                                                            recoveries)
------------------------------------------------------------------------
2002........................................   $1,975,000       $65,000
2003........................................      880,000        95,000
                                             --------------
    Total...................................   $2,855,000      $160,000
------------------------------------------------------------------------

    (ii) G's ending A/R Balance on 12/31/2003 is $2,115,000. In 
2003, G must compute its nonaccrual-experience amount using an 
average of its actual nonaccrual-experience for 2002 and 2003 (in 
accordance with Option B of paragraph (e)(3)(ii) of this section). 
Thus, G's two-year moving average nonaccrual-experience percentage 
is 5.6%, determined by dividing the sum of the amount of G's 
receivables in its accounts on January 1st of 2002 and 2003, that 
were determined to be uncollectible and charged off (adjusted for 
recoveries) on or before the corresponding determination dates, by 
the sum of the balances of G's accounts receivable account on 
January 1st of 2002 and 2003 (i.e., $160,000/$2,855,000 or 5.6%). 
Thus, G's actual nonaccrual-experience amount for 2003 is determined 
by multiplying this percentage by the balance of G's accounts 
receivable account on December 31, 2003 (i.e., $2,115,000 x 5.6% = 
$118,440). G is permitted to exclude from gross income in 2003 an 
amount equal to 105% of G's actual nonaccrual-experience amount, or 
$124,362 ($118,440 x 105%). This is G's adjusted nonaccrual-
experience amount for 2003.
    Example 8. (i) The facts are the same as Example 7. G determines 
that its accounts receivable collection experience for 2004 is as 
follows:

------------------------------------------------------------------------
                                                           Beginning A/R
                                                               amount
                                               Total A/R    charged off
                                               balance at        by
                Taxable year                   beginning   determination
                                                of year         date
                                                           (adjusted for
                                                            recoveries)
------------------------------------------------------------------------
2002........................................   $1,975,000       $65,000
2003........................................      880,000        95,000
2004........................................    2,115,000       105,000
                                             --------------
    Total...................................   $4,970,000      $265,000
------------------------------------------------------------------------

    (ii) G's ending A/R Balance on 12/31/2004 is $1,600,000. In 
2004, G must compute its nonaccrual-experience amount using an 
average of its actual nonaccrual-experience for 2002, 2003, and 2004 
(in accordance with Option B of paragraph (e)(3)(ii) of this 
section). Thus, G's actual three-year moving average nonaccrual-
experience percentage is 5.3%, determined by dividing the sum of the 
amount of G's receivables in its account on January 1st of 2002, 
2003, and 2004, that were determined to be uncollectible and charged 
off (adjusted for recoveries) on or before the corresponding 
determination dates, by the sum of the balances of G's accounts 
receivable account on January 1st of 2002, 2003, and 2004 (i.e., 
$265,000/$4,970,000 or 5.3%). Thus, G's actual nonaccrual-experience 
amount for 2004 is determined by multiplying this percentage by the 
balance of G's accounts receivable account on December 31, 2004 
(i.e., $1,600,000 x 5.3% = $84,800). G is permitted to exclude from 
gross income in 2004 an amount equal to 105% of G's actual 
nonaccrual-experience amount, or $89,040 ($84,800 x 105%). This is 
G's adjusted nonaccrual-experience amount for 2004. Thereafter, G 
must continue to use a three-year moving average to compute its 
actual nonaccrual-experience, or obtain approval of the Commissioner 
to change its nonaccrual-experience method of accounting.
    Example 9.  H has not tracked its 2002 beginning-of-year 
accounts receivable. Therefore, H may not use the actual experience 
method described in paragraph (e)(3) of this section for 2002. H may 
use this method for 2003 if H tracks its 2003 beginning-of-year 
receivables, and

[[Page 52505]]

otherwisecomplies with the requirements of this section.
    Example 10. Safe harbor 3: Modified Black Motor method. (i) J 
uses the modified Black Motor method described in paragraph (e)(4) 
of this section. J's total accounts receivable and bad debt 
experience for the current taxable year (2002) and the five 
preceding taxable years are as follows:

------------------------------------------------------------------------
                                                  Accounts
                                                 receivable   Bad debts
                 Taxable year                    at end of    (adjusted
                                                  taxable        for
                                                    year     recoveries)
------------------------------------------------------------------------
1997..........................................     $130,000       $9,100
1998..........................................      140,000        7,000
1999..........................................      140,000       14,000
2000..........................................      160,000       14,400
2001..........................................      170,000       20,400
2002..........................................      180,000       10,800
                                               --------------
    Total.....................................     $920,000      $75,700
------------------------------------------------------------------------

    (ii) Thus, J's Black Motor moving average percentage is 8.228% 
($75,700/$920,000). Assume that the credit charges (accounts 
receivable) generated and written off during the current taxable 
year were $3,600. J's modified Black Motor amount is $11,210, 
computed by multiplying J's accounts receivable at December 31, 2002 
($180,000) by the Black Motor moving average percentage of .08228 
and reducing the resulting amount by $3,600 (J's credit charges 
(accounts receivable) generated and written off during the 2002 
taxable year). Thus, J may exclude $11,210 from gross income for 
2002.
    Example 11.  Safe harbor 4: Modified six-year moving average 
method. (i) The facts are the same as Example 10, except that J uses 
the modified six-year moving average method described in paragraph 
(e)(5) of this section. Assume further that the credit charges 
(accounts receivable) that were written off in the same taxable year 
they were generated, adjusted for recoveries of bad debts during 
such period are as follows:

------------------------------------------------------------------------
                                                                Credit
                                                               charges
                                                             written off
                                                               in same
                                                               taxable
                        Taxable Year                           year as
                                                              generated
                                                              (adjusted
                                                                 for
                                                             recoveries)
------------------------------------------------------------------------
1997.......................................................       $3,033
1998.......................................................        2,333
1999.......................................................        4,667
2000.......................................................        4,800
2001.......................................................        6,800
2002.......................................................        3,600
                                                            ------------
    Total..................................................      $25,233
------------------------------------------------------------------------

    (ii) Thus, J's modified six-year moving average percentage is 
5.486% (($75,700--$25,233)/$920,000). J's modified six-year moving 
average amount is $9,875, computed by multiplying J's accounts 
receivable at December 31, 2002 ($180,000) by the modified six-year 
moving average percentage of .05486. Thus, J may exclude $9,875 from 
gross income for 2002.
    Example 12.  Selection of a safe harbor method. (i) Beginning in 
2002, K is eligible to use a nonaccrual-experience method and wishes 
to adopt an alternative nonaccrual-experience method similar to the 
method described in Black Motor Co. v. Comm'r, 41 B.T.A. 300 (1940), 
aff'd, 125 F.2d 977 (6th Cir. 1942). Pursuant to paragraph 
(e)(6)(ii) of this section, K must self-test its alternative 
nonaccrual-experience method for the first taxable year it is used 
(2002), and every three taxable years thereafter for which K uses 
its alternative nonaccrual-experience method. Pursuant to paragraph 
(e)(6)(iii) of this section, K selects safe harbor 2 (actual 
experience method) for purposes of conducting its first year self-
test. Thus, beginning in 2002, K must begin tracking its beginning-
of-year accounts receivable and computing its actual nonaccrual-
experience as provided in paragraph (e)(3) of this section. However, 
because K lacks the data to use Option A (three-year moving average) 
under paragraph (e)(3)(i) of this section, K selects Option B (up to 
three-year moving average) under paragraph (e)(3)(ii) of this 
section. K's actual nonaccrual-experience amount and alternative 
nonaccrual-experience amount for 2002 are set forth below:

----------------------------------------------------------------------------------------------------------------
                                                                                      Beginning A/R
                                                                                          amount
                                                                          Total A/R    charged off   Alternative
                                                                          balance at        by       nonaccrual-
                              Taxable year                                beginning   determination   experience
                                                                           of year         date         amount
                                                                                      (adjusted for
                                                                                       recoveries)
----------------------------------------------------------------------------------------------------------------
2002...................................................................     $350,000       $14,000       $20,700
----------------------------------------------------------------------------------------------------------------

    (ii) K's ending A/R Balance on 12/31/2002 is $500,000. K's 
actual nonaccrual-experience percentage is 4%, determined by 
dividing the amount of K's receivables in its account on January 1, 
2002, that were charged off as uncollectible (adjusted for 
recoveries) on or before the determination date, by the balance of 
K's accounts receivable account on January 1, 2002 (i.e., $14,000/
$350,000 or 4%). Thus, K's actual nonaccrual-experience amount for 
2002 is determined by multiplying this percentage by the balance of 
K's accounts receivable account on December 31, 2002 (i.e., $500,000 
x 4% = $20,000). Because K's alternative nonaccrual-experience 
amount for 2002 ($20,700) is not greater than 105% of its actual 
nonaccrual-experience amount for 2002 (i.e., $20,000 x 1.05 = 
$21,000), pursuant to paragraph (e)(6)(iv) of this section, K's 
alternative nonaccrual-experience method will be treated as clearly 
reflecting its nonaccrual-experience for the test period 2002. 
Pursuant to paragraph (e)(6)(iv)(B) of this section, K may continue 
to use its alternative nonaccrual-experience method. Additionally, 
pursuant to paragraph (e)(6)(iv)(B) of this section, K is required 
to self-test its alternative nonaccrual-experience method again in 
2006, for taxable years 2003 through 2005 and, pursuant to paragraph 
(e)(6)(iii)(B) of this section, K must self-test its alternative 
nonaccrual-experience method against the actual experience method 
when conducting its three year self-test in 2006.
    Example 13. (i) The facts are the same as Example 12. K's 
alternative nonaccrual-experience amounts for taxable years 2003-
2005 are as follows:

----------------------------------------------------------------------------------------------------------------
                                                                         Beginning A/R
                                                                             amount
                                                             Total A/R    charged off      Actual    Alternative
                                                             balance at        by       nonaccrual-  nonaccrual-
                       Taxable Year                          beginning   determination   experience   experience
                                                              of year         date         amount       amount
                                                                         (adjusted for
                                                                          recoveries)
----------------------------------------------------------------------------------------------------------------
2003......................................................     $440,000       $30,000       $42,329      $43,050
2004......................................................      760,000        65,000       138,183      140,200
2005......................................................    1,965,000        65,000       101,106      110,550
                                                           --------------
    Total.................................................   $3,165,000      $160,000      $281,618     $293,800
----------------------------------------------------------------------------------------------------------------


[[Page 52506]]

    (ii) Assume that K's ending A/R balance on 12/31/05 is $2,000,000. 
Because K's cumulative alternative nonaccrual-experience amount for the 
test period ($293,800) is not greater than K's cumulative adjusted 
nonaccrual-experience amount (cumulative actual nonaccrual-experience 
amount x 105%) for the same period ($281,618 x 1.05 = $295,699), 
pursuant to paragraph (e)(6)(iv) of this section K's alternative 
nonaccrual-experience method will be treated as clearly reflecting its 
nonaccrual-experience for the test period. Pursuant to paragraph 
(e)(6)(iv)(B) of this section, K may continue to use its alternative 
nonaccrual-experience method. Additionally, pursuant to paragraph 
(e)(6)(iv)(B) of this section, K is required to self-test its 
alternative nonaccrual-experience method again in 2009, for taxable 
years 2006 through 2008 and, pursuant to paragraph (e)(6)(iii)(B) of 
this section, K must self-test its alternative nonaccrual-experience 
method against the actual experience method when conducting its three 
year self-test in 2009.
    Example 14. The facts are the same as Example 12, except that 
K's alternative nonaccrual-experience amount for 2002 is $22,000. 
Because K's alternative nonaccrual-experience amount for 2002 
($22,000) is greater than 105% of its actual nonaccrual-experience 
amount for 2002 (i.e., $20,000 x 1.05 = $21,000), pursuant to 
paragraph (e)(6)(vi)(A) of this section, K's alternative nonaccrual-
experience method will be treated as not clearly reflecting its 
nonaccrual experience for 2002. Accordingly, K must either adopt a 
safe harbor nonaccrual-experience method described in paragraphs 
(e)(2) (six-year moving average method), (e)(3) (actual experience 
method), (e)(4) (modified Black Motor method), or (e)(5) (modified 
six-year moving average method) of this section, or an alternative 
nonaccrual-experience method under paragraph (e)(6) of this section 
(subject to the self-testing requirements of paragraph (e)(6)(ii) of 
this section).
    Example 15. The facts are the same as Example 13, except that 
K's cumulative alternative nonaccrual-experience amount for 2003-
2005 is $300,000. Because K's cumulative alternative nonaccrual-
experience amount for the three year test period (taxable years 
2003-2005) is greater than its cumulative adjusted nonaccrual-
experience amount for the three year test period ($295,699), 
pursuant to paragraph (e)(6)(vi)(B) of this section the $4,301 
excess of K's cumulative alternative nonaccrual-experience amount 
over K's cumulative adjusted nonaccrual-experience amount for the 
three year test period must be recaptured into income in 2005 in 
accordance with paragraph (e)(6)(vii) of this section. K may 
continue to use its alternative nonaccrual-experience method, 
subject to the three-year self-test requirement in paragraph 
(e)(6)(ii) of this section.
    Example 16. Subsequent worthlessness of year-end receivable. The 
facts are the same as Example 4. Assume that one of the accounts 
receivable outstanding at the end of 2002 was for $8,000, and that 
in 2003, under section 166, the entire amount of this receivable 
becomes wholly worthless. Because F did not accrue as income $1,573 
of this account receivable ($8,000 x .1967) under the nonaccrual-
experience method in 2002, pursuant to paragraph (e)(7)(i) 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 17. Subsequent collection of year-end receivable. The 
facts are the same as in Example 4. Assume that an account 
receivable of $1,700 outstanding at the end of 2002 was collected in 
full by F in 2003. Pursuant to paragraph (e)(7)(iii) of this 
section, F must recognize additional gross income in 2003 equal to 
the portion of this receivable that F excluded from gross income in 
the prior year ($1,700 x .1967 = $334).

    (g) Changes to a nonaccrual-experience method of accounting--(1) In 
general. A change to a nonaccrual-experience method is a change in 
method of accounting to which the provisions of sections 446 and 481, 
and the regulations thereunder, apply.
    (2) Taxpayers no longer qualified under section 448 to use a 
nonaccrual-experience method--(i) First taxable year ending after March 
9, 2002. For a taxpayer who no longer qualifies under section 
448(d)(5), as amended, to use a nonaccrual-experience method, consent 
is hereby granted to change from the nonaccrual-experience method to 
the specific charge-off method for its first taxable year ending after 
March 9, 2002. Such change shall be made in accordance with the 
provisions of this paragraph (g)(2). Pursuant to the consent granted by 
this paragraph (g)(2), a taxpayer described in this paragraph (g)(2) 
that is using a nonaccrual experience method must change such method of 
accounting to the specific charge-off method for its first taxable year 
ending after March 9, 2002. The net amount of the required section 
481(a) adjustment is to be taken into account over a period of 4 
taxable years (or, if less, the number of taxable years that the 
taxpayer has used the nonaccrual-experience method). The taxpayer 
should attach Form 3115 to its income tax return for the year of 
change, and write ``Change from the Nonaccrual-Experience Method under 
Sec.  1.448-2T(g)'' at the top of the form. However, such a taxpayer is 
not required to file a Form 3115 with the national office, or pay any 
associated user fee.
    (ii) For taxable years subsequent to first taxable year ending 
after March 9, 2002. Taxpayers who no longer qualify under section 
448(d)(5), as amended, to use a nonaccrual-experience method in a 
taxable year subsequent to the first taxable year ending after March 9, 
2002, must follow the administrative procedures issued under Sec.  
1.446-1(e)(3)(ii) for obtaining the Commissioner's automatic consent to 
a change in accounting method. (For further guidance, for example, see 
Rev. Proc. 2002-9, 2002-1 C.B. 327, and Sec.  601.601(d)(2)(ii)(b) of 
this chapter.)
    (3) Taxpayers permitted to use a nonaccrual-experience method--(i) 
In general. Except as provided in paragraphs (g)(3)(ii) (regarding 
scope limitations) and (g)(4) (regarding certain concurrent changes) of 
this section, a taxpayer that wants to change to a nonaccrual-
experience method provided in this section, change from one nonaccrual-
experience method to another nonaccrual-experience method provided in 
this section, and/or change to a periodic system (for further guidance, 
for example, see Notice 88-51, 1988-1 C.B. 535, and Sec.  
601.601(d)(2)(ii)(b) of this chapter), must follow the administrative 
procedures issued under Sec.  1.446-1(e)(3)(ii) for obtaining the 
Commissioner's automatic consent to a change in accounting method (for 
further guidance, for example, see Rev. Proc. 2002-9, 2002-1 C.B. 327, 
and Sec.  601.601(d)(2)(ii)(b) of this chapter).
    (ii) Scope limitations. Any limitations on obtaining the automatic 
consent of the Commissioner do not apply to a taxpayer that wants to 
change to a nonaccrual-experience method of accounting provided in this 
section, and/or change to a periodic system (for further guidance, for 
example, see Notice 88-51, 1988-1 C.B. 535, and Sec.  
601.601(d)(2)(ii)(b) of this chapter), for either its first or second 
taxable year ending after March 9, 2002, provided the taxpayer's 
nonaccrual-experience method of accounting is not an issue under 
consideration for taxable years under examination at the time the Form 
3115 is filed with the national office. A taxpayer's nonaccrual-
experience method of accounting is an issue under consideration for the 
taxable years under examination if the taxpayer receives written 
notification (for example, by examination plan, information document 
request (IDR), or notification of proposed adjustments or income tax 
examination changes) from the examining agent(s) specifically citing 
the treatment of the nonaccrual-experience method of accounting as an 
issue under consideration.
    (iii) Form 3115 must be completed. When filing the Form 3115, the 
taxpayer

[[Page 52507]]

must complete all applicable parts of the form and write ``Automatic 
Change to Nonaccrual-Experience Method'' at the top of the form.
    (4) Certain concurrent changes--(i) Taxpayers concurrently changing 
to an accrual method of accounting--(A) Automatic consent. Taxpayers 
that want to change to a nonaccrual-experience method of accounting for 
the same taxable year for which they are required to change to an 
accrual method of accounting under section 448 and the regulations 
thereunder may concurrently change their method of accounting to a 
nonaccrual-experience method (with or without also changing to a 
periodic system (for further guidance, for example, see Notice 88-51, 
1988-1 C.B. 535, and Sec.  601.601(d)(2)(ii)(b) of this chapter)), 
under this paragraph (g)(4)(i) with automatic consent of the 
Commissioner if they otherwise qualify under this section to use a 
nonaccrual-experience method of accounting. Taxpayers changing to a 
nonaccrual-experience method under this paragraph (g)(4)(i) must comply 
with the provisions of Sec.  1.448-1(h)(2). Moreover, such taxpayers 
must type or legibly print the following statement at the top of page 1 
of Form 3115, ``Automatic Change to Nonaccrual-Experience Method and 
Overall Accrual Method.'' The consent of the Commissioner to change to 
a nonaccrual experience method is granted to taxpayers changing to such 
method under this paragraph (g)(4)(i).
    (B) Section 481(a) adjustment. In the case of a taxpayer changing 
to a nonaccrual-experience method under this paragraph (g)(4)(i), the 
section 481(a) adjustment resulting from the change to a nonaccrual-
experience method of accounting will be combined or netted with the net 
section 481(a) adjustment resulting from the change under Sec.  1.448-
1(h)(2), and the resulting net section 481(a) adjustment will be taken 
into account over the section 481(a) adjustment period as determined 
under the applicable administrative procedures issued under Sec.  
1.446-1(e)(3)(ii) for obtaining the Commissioner's consent to a change 
in accounting method.
    (ii) Taxpayers concurrently changing to a permissible special 
method--(A) Prior consent. A taxpayer required to change to an accrual 
method of accounting under section 448 and the regulations thereunder 
that, as part of such change, also wants to change to a nonaccrual 
experience method of accounting and a permissible special method of 
accounting under Sec.  1.448-1(h)(3), may concurrently change its 
method of accounting to a nonaccrual-experience method of accounting 
(with or without also changing to a periodic system (for further 
guidance, for example, see Notice 88-51, 1988-1 C.B. 535, and Sec.  
601.601(d)(2)(ii)(b) of this chapter)), under this paragraph (g)(4)(ii) 
with the prior consent of the Commissioner if the taxpayer otherwise 
qualifies under this section to use a nonaccrual-experience method of 
accounting. Taxpayers changing to a nonaccrual-experience method under 
this paragraph (g)(4)(ii) must comply with the provisions of Sec.  
1.448-1(h)(3). Moreover, such taxpayers must type or legibly print the 
following statement at the top of page 1 of Form 3115, ``Change to 
Nonaccrual-Experience Method and Special Method of Accounting--Section 
448.''
    (B) Section 481(a) adjustment. The section 481(a) adjustment 
resulting from a change in method of accounting described under this 
paragraph (g)(4)(ii) must be taken into account in accordance with the 
rules provided in paragraph (g)(4)(i)(B) of this section.
    (h) Transition rules--(1) In general. If a taxpayer adopted or 
changed to a nonaccrual-experience method of accounting in accordance 
with the provisions of Notice 2003-12 for any taxable year ending after 
March 9, 2002, and, on or before October 20, 2003, and for such taxable 
year the taxpayer would like to change to a different nonaccrual-
experience method of accounting as provided in paragraphs (e)(2) 
through (e)(6) of this section, and/or change to a periodic system (for 
further guidance, for example, see Notice 88-51, 1988-1 C.B. 535, and 
Sec.  601.601(d)(2)(ii)(b) of this chapter), the taxpayer must follow 
the administrative procedures issued under Sec.  1.446-1(e)(3)(ii) for 
obtaining the Commissioner's automatic consent to a change in 
accounting method (for further guidance, for example, see Rev. Proc. 
2002-9, 2002-1 C.B. 327, and Sec.  601.601(d)(2)(ii)(b) of this 
chapter) and must file the original Form 3115 either--
    (i) With an amended federal income tax return (or a qualified 
amended return under Rev. Proc. 94-69, 1994-2 C.B. 804, if applicable; 
hereinafter, referred to in this section as a ``qualified amended 
return'') on or before December 31, 2003, for the taxpayer's first 
taxable year ending after March 9, 2002, and any affected subsequent 
taxable year, and include the statement ``Filed Pursuant to Sec.  
1.448-2T(h)(1)(i)'' at the top of any amended federal income tax return 
(or qualified amended return);
    (ii) With the taxpayer's timely filed federal income tax return for 
the second taxable year ending after March 9, 2002, if this return has 
not been filed on or before September 4, 2003; or
    (iii) If the taxpayer's federal income tax return for the second 
taxable year ending after March 9, 2002, was filed on or before 
September 4, 2003, with an amended federal income tax return (or a 
qualified amended return) on or before December 31, 2003, for the 
second taxable year ending after March 9, 2002, and include the 
statement ``Filed Pursuant to Sec.  1.448-2T(h)(1)(iii)'' at the top of 
the amended federal income tax return (or qualified amended return).
    (2) Pending Form 3115. If a taxpayer filed a Form 3115 under the 
applicable administrative procedures with the national office to make a 
change in its method of accounting under section 448(d)(5), as amended, 
for a year of change for which this regulation is effective and the 
application or ruling request is pending with the national office on 
September 4, 2003, the taxpayer must notify the national office in 
writing prior to November 3, 2003, if the taxpayer wants to withdraw 
its Form 3115 under such administrative procedures. If the taxpayer 
notifies the national office within the time provided in this paragraph 
(h)(2), the taxpayer's Form 3115, and any user fee that was submitted 
with the Form 3115, will be returned to the taxpayer. A taxpayer whose 
Form 3115 is returned under this paragraph (h)(2) may file a new Form 
3115 under the provisions prescribed in paragraphs (g) and (h) of this 
section. If the taxpayer does not notify the national office within the 
time provided in this paragraph (h)(2), the national office will 
continue to process the taxpayer's Form 3115 in accordance with the 
administrative procedures under which it was originally filed.
    (i) [Reserved]
    (j) Audit protection. If a taxpayer uses one of the nonaccrual-
experience methods of accounting described in paragraphs (e)(3) (actual 
experience method), (e) (4) (modified Black Motor method), or (e)(5) 
(modified six-year moving average method) of this section to determine 
its amount excluded from gross income under section 448(d)(5), as 
amended, the taxpayer's use of that method will not be raised as an 
issue by the IRS in a taxable year that ends before September 4, 2003. 
If the taxpayer uses one of the nonaccrual-experience methods of 
accounting described in paragraphs (e)(3), (e)(4), or (e)(5) of this 
section, and its use of such method is an issue under consideration in 
examination (as defined in paragraph (g)(3)(ii) of this section), in 
appeals, or before the U.S. Tax Court in a taxable year that ends 
before September 4, 2003,

[[Page 52508]]

that issue will not be further pursued by the IRS.
    (k) Effective date. This section is applicable for taxable years 
ending after March 9, 2002. The applicability of this section expires 
on or before September 5, 2006.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

0
Par. 3. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

0
Par. 4. In Sec.  602.101, paragraph (b) is amended by adding an entry 
in numerical order to the table to read as follows:


Sec.  602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                            Current OMB
   CFR part or section where identified and described       control No.
------------------------------------------------------------------------
 
                                * * * * *
1.448-2T................................................       1545-1855
 
                                * * * * *
------------------------------------------------------------------------


Judith B. Tomaso,
Acting Deputy Commissioner for Services and Enforcement.
    Approved: August 28, 2003.
Gregory Jenner,
Deputy Assistant Secretary of the Treasury.
[FR Doc. 03-22458 Filed 9-3-03; 8:45 am]
BILLING CODE 4830-01-P