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Two important changes affect the "nonaccrual experience" (NAE) method of section 448(d)(5). The Job Creation and Worker Assistance Act of 2002(1) narrowed the classes of tax-payers who can use the NAE method, and Notice 2003-12, 2003-6 IRB 422, provided new methods of computing the NAE deduction.
BACKGROUND
Before TRA '86 eliminated the bad debt reserve for most businesses,2 Section 166(c) permitted any accrual-method tax-payer to create such a reserve. The bad debt reserve appeared on the balance sheet, reducing accounts receivable to equal the estimated amount that would be collected. A deduction was permitted for a reasonable addition to reserve account. The bad debt reserve assisted in the "clear reflection of income" goal by matching costs with collectible revenues.
Simultaneously with the elimination of bad debt reserve accounting, Congress required C corporations to use the accrual method.3 There are exceptions to the accrual requirement for qualified personal services corporations and small corporations (those with average annual gross receipts of less than $5 million) and partnerships not required to use inventory accounting.4
In what at first appears to be a concession (but does in fact have some theoretical underpinning, as will be discussed below), Congress created a new provision, Section 448(d)(5), whereby service providers were not required to accrue "such amount which (on the basis of such persons experience) will not be collected."
Not accruing the income under the NAE method and the former method of accruing the gross income but anticipating a bad debt deduction yield the same taxable income under the following condition: The same approach is used to calculate the reserve for bad debts and to compute the amount that will not be collected. Thus, it would seem that Congress could have taken a more direct approach: discontinue the zreserve for bad debts for all taxpayers except service providers.
The fact that the latter route was not taken suggests the scope of the NAE method is broader than a bad debt reserve-that is, the NAE method applies to receivables that will not be collected because of contract terms and subsequent events, as well as uncollectibility because of the financial circumstances of the debtor (discussed further, below). Thus, the section 448(d)(5) exclusion is broader than the section 166(c) bad debt reserve.
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