Hospital Corporation Disputes Change in Accounting, Insists Regs Are Invalid

HCA's primary business is the ownership, operation, and management of hospitals, and its income is derived entirely from the performance of services. The hospitals typically have significant accounts receivable outstanding over long periods and, therefore, often experience delays in collecting and determining when receivables should be written off as uncollectible. Prior to the Tax Reform Act of 1986 (TRA '86), HCA used either a full accrual method of accounting or a hybrid method. However after TRA '86, Congress required certain service providers, including HCA, to use a full accrual method of accounting. At the same time, Congress in section 448(d)(5) provided that such service providers shall not be required to accrue any portion of their receivables that their experience indicated they would not collect. This method of accounting for amounts estimated to be uncollectible is referred to as the "nonaccrual-experience method."

In 1987, the Treasury promulgated proposed and temporary regs prescribing a mandatory formula for determining amounts that would not be collected, and which therefore did not have to be accrued. In 1988, the Treasury issued revised proposed and temporary regs adopting a new formula. HCA timely elected to use the nonaccrual- experience method in its returns for 1987-1988, but instead of using the revised formula, which did not accurately reflect its experience, it used the original formula to determine its experience regarding uncollectible amounts. The IRS issued a deficiency determination, asserting that HCA had to determine its experience under the revised formula as set forth in temp. reg. section 1.448-2T(e)(2). The Tax Court agreed that HCA was required to use the revised formula.

HCA argues that the government does not attempt to defend the results of the revised formula, although it directly conflicts with the plain meaning of section 448(d)(5). The corporation also insists that the legislative history of section 448(d)(5) does not support the government's position and that the temporary reg is not entitled to judicial deference. HCA further contends that there is no support for the government's attempt to impose a cessation of business limitation on the 10-year spread provided by section 448(d)(7)(C)(ii).

I. INTRODUCTION.

[1] This appeal involves the application of two sections of the Internal Revenue Code ("I.R.C.").

[2] The first, I.R.C. section 448(d)(5), ¹ provides that a taxpayer "SHALL NOT BE REQUIRED to accrue any portion" of amounts to be received for the performance of services that, based on experience, it will not collect. However, the Commissioner, through an interpretative regulation, takes the position that he CAN REQUIRE the Taxpayers to accrue 80% or more of amounts that, based upon their experience, they will not collect.

[3] The second, I.R.C. section 448(d)(7)(C)(ii), provides that the period for taking into account the required section 481(a) adjustment resulting from a change from the cash to an accrual method "in the case of a hospital, SHALL BE 10 YEARS." However, the Commissioner, again through an interpretative regulation, takes the position that he can require the Taxpayers to take into account their section 481(a) adjustment ENTIRELY IN ONE YEAR, upon the sale of some, but not all, of their hospital assets.

[4] As explained in detail in the Taxpayers' initial brief ("T. Br."), the Commissioner's interpretations cannot be upheld because they directly conflict with the statutory language. The Commissioner's brief ("C. Br.") fails to demonstrate how his positions can be reconciled with the statutory language. Instead, the Commissioner argues that this Court must defer to his interpretations of the statutes and that the level of deference this Court must show in essence requires it to rubber-stamp his positions.

[5] Under any deference standard, the Commissioner's positions are indefensible. As has been made clear by every decision considering the deference issue, and even more clear by a recent decision of the Supreme Court, the deference to be given an agency interpretation is not absolute. Where, as here, the Commissioner's interpretations conflict with the statutory provisions they interpret, and are otherwise unreasonable and unpersuasive, they cannot be followed.

II. NONACCRUAL-EXPERIENCE METHOD ISSUE.

[6] In their initial brief, the Taxpayers noted that the formula (the "Revised Formula") in revised proposed and temporary Treas. Reg. section 1.448-2T (the "Revised Temporary Regulation") produces a result for the Taxpayers that is inconsistent with their experience, in direct conflict with the clear language of I.R.C. section 448(d)(5), and unreasonable. The Taxpayers also explained that, because the formula they used clearly and accurately reflected their income, the Commissioner could not change them to a method that did not. The Commissioner's brief does not adequately respond to any of these points.

A. THE COMMISSIONER MISSTATES THE TAXPAYERS' POSITION.

[7] The Commissioner's brief begins by erroneously suggesting that the Taxpayers contend that I.R.C. section 448(d)(5) REQUIRES the use of the formula first approved in Black Motor Co. v. Commissioner, 41 B.T.A. 300 (1940), aff'd on another issue, 125 F.2d 977 (6th Cir. 1942) (the "Black Motor formula"), to determine the portion of a taxpayer's year-end accounts receivable that will not be collected. (C. Br. pp. 9, 15, 30, 31) Despite the Commissioner's suggestion to the contrary, the Taxpayers have NEVER contended, and are not now contending, that the statute requires the use of any one formula. The Taxpayers recognize that it is unlikely that any one formula would accurately reflect every taxpayer's collection experience as required by I.R.C. section 448(d)(5). Although the Black Motor formula was originally developed by the Commissioner, approved by the Supreme Court and the Tax Court, and widely used, as the Commissioner's brief recognizes (C. Br. p. 23), it was always understood that the formula was not mandatory and could be modified to prevent an unreasonable result. See Thor Power Tool Co. v. Commissioner, 439 U.S. 522 (1979); Rev. Rul. 76-362, 1976-2 C.B. 45.

[8] Likewise, in the present case, the Revised Formula produces an unreasonable result for the Taxpayers -- and, indeed, for most taxpayers. The Taxpayers here do not argue that I.R.C. section 448(d)(5) requires the use of the formula (the "Original Formula") in the original Treas. Reg. section 1.448-2T (the "Original Temporary Regulation"). ² Rather, the Taxpayers argue that the language of I.R.C. section 448(d)(5) prohibits the Commissioner's application of a regulation mandating the use of a formula that produces egregious results totally contrary to the Taxpayers' actual experience. In contrast, the Original Formula produces a result that clearly reflects the Taxpayers' income and is consistent with the statute. Accordingly, the Taxpayers' use of the Original Formula was appropriate.

B. THE COMMISSIONER DOES NOT ATTEMPT TO DEFEND THE RESULTS OF

[10] Instead of attempting to justify these results, the Commissioner's brief attacks the general accuracy of the Original Formula, ³ citing, among other things, the 1988 comments of Thomas Evans, Associate Tax Legislative Counsel, and an article by W. Eugene Seago. (C. Br. pp. 27-28, 43) What the Commissioner fails to acknowledge is that neither of the sources he cites supports the Revised Formula. As the Taxpayers noted in their initial brief, the comments of Mr. Evans suggested that the Treasury was well aware of the flaws in the Revised Formula. (T. Br. pp. 17-18) While the Original Formula may have produced, in Mr. Evans' words, "bizarre" results for taxpayers in the utility industry, the Revised Formula produces "bizarre" results for most, if not all, other service providers.

[11] The Commissioner argues, without providing any support, that the Revised Formula "corrected a bias that existed in the original formula" (C. Br. p. 34), but, in reality, it merely substituted one bias for another. He replaced a formula that did not work for a small number of taxpayers with one that does not work for most other taxpayers. In fact, although the Commissioner relies on Mr. Seago's article, he evidently missed its conclusion, which makes this very point:

[T]he action taken by the Service [in promulgating the Revised

[12] The Commissioner makes no attempt to defend the Revised Formula because he cannot. As the Taxpayers have explained, the Revised Formula is internally inconsistent. (T. Br. pp. 20-23) Logically, it can rarely, if ever, produce a result that is an accurate estimate of the portion of year-end receivables that will not be collected. The Revised Formula compares average net bad debt write-offs to average TOTAL ANNUAL CHARGES and then applies that percentage to current YEAR-END RECEIVABLES -- an apples-to-oranges comparison.

[13] Despite the fact that the Revised Formula is logically flawed, the Commissioner insists that it is consistent with the language of I.R.C. section 448(d)(5) because the statute does not contain a prescribed formula for determining experience. (C. Br. p. 21) However, it is not what the statute does not contain, but what it does contain that is of primary importance. The statute plainly states that taxpayers "SHALL NOT BE REQUIRED to accrue any portion" of amounts "which (on the basis of experience) will not be collected."

[14] The statute certainly permits the Commissioner to challenge any exclusion from income that is not based on a taxpayer's experience or that exceeds the amount that such experience indicates is proper. However, it does not permit the Commissioner to REQUIRE INCLUSION in income of amounts that a taxpayer's experience indicates will not be collected. The Commissioner's argument is that neither accuracy nor the Taxpayers' experience matters. Rather, what matters is that his mandated formula be used whether or not it clearly or accurately reflects the Taxpayers' experience. This simply cannot be a correct interpretation of the statute.

[15] The Taxpayers' use of the Original Formula accurately reflected their experience and clearly reflected their income. The Commissioner makes no attempt to argue otherwise. The plain language of the statute requires that the Taxpayers' calculations be respected.

C. THE STATUTE'S LEGISLATIVE HISTORY DOES NOT SUPPORT THE

[17] At first glance, the legislative history to the Tax Reform Act of 1986 (the "1986 Act") appears to describe two different possible formulas for determining a taxpayer's experience. In one paragraph, the following description is given:

The amount of billings that, on the basis of experience,

[18] However, in the very next paragraph, an example is given that conflicts with the preceding narrative language it purports to illustrate:

For example, assume that an accrual-basis taxpayer has

[19] Obviously, the drafters did not intend for the example to conflict with the narrative it illustrates. Yet, they changed the amount to which the ratio was to be applied from total billings to year-end receivables -- as in the Black Motor formula. The drafters apparently believed that the narrative described the Black Motor formula, and they intended the example to do the same. This is confirmed elsewhere in the same legislative history. In the 1986 Act, Congress also repealed the bad debt reserve method that had previously been available for all accrual method taxpayers. In describing the "Present Law" that would be repealed, the House Report explains:

The most widely used formula for determining the appropriate bad

[20] This language describes the application to year-end receivables of a ratio of net bad debts to total receivables. Of course, this was a mistake, because the Black Motor formula actually used a ratio of net bad debts to year-end receivables -- not to total receivables. The same mistake was made in the example described above, upon which the Commissioner relies as support for his mandated formula. Taken together, this clearly suggests that the drafters of the example thought they were describing the Black Motor formula.

[21] Initially, the Treasury also read the legislative history as describing the Black Motor formula. In the preamble to the Original Temporary Regulation, the Treasury relied on the language from the House Report and then analogized it to the experience method prescribed for use by banks under Treas. Reg. section 1.585- 2(c)(1), which is the Black Motor formula. In the preamble, the Treasury quoted the legislative history previously described and stated that:

BASED ON THIS LANGUAGE, the regulations adopt a six-year

[22] The Commissioner now attempts to rely only upon the example, ignoring the narrative description of the formula, the fact that the formula in the example is the same as the description of the Black Motor formula in the same legislative history, and the Treasury's original interpretation of the legislative history. The Tax Court may have been correct in its determination that the legislative history here is confusing. See 107 T.C. 116, 133. What is clear, however, is that the legislative history does not support the Commissioner's argument that Congress, through the enactment of I.R.C. section 448(d)(5), intended to MANDATE any one approach to determine a taxpayer's experience, much less the flawed Revised Formula. Indeed, it is hard to believe that requiring the use of a single fixed formula for all taxpayers could ever be consistent with the statute's requirement that a taxpayer's experience be used to determine its uncollectible amounts. However, even if such a formula were possible, it clearly is not the Revised Formula.

[23] The House Ways and Means Committee report (the "Committee Report") to the Economic Security and Recovery Act of 2001 ("ESRA"), passed by the House of Representatives on October 24, 2001, makes this very clear. Under ESRA, the Treasury is instructed to permit eligible taxpayers to use any "computations or formulas which, based on experience, accurately reflect the amount of income that will not be collected by such person." H.R. 3090, 107th Cong., 1st Sess. (2001), reprinted in 201 DTR (BNA) at S-15 (Oct. 19, 2001 Text Supp.). The Committee Report explains this instruction as follows:

[T]he Committee believes that the formula contained in

[24] Thus, the legislative history to both ESRA and the 1986 Act refute the Commissioner's arguments here. The ESRA Committee Report underlines the flaw in the Revised Formula, while the earlier House Report appears to describe the Black Motor formula, does not endorse a single mandatory formula, and nowhere suggests that, in direct contravention of the statute, a taxpayer can be required to accrue amounts that its experience demonstrates will not be collected.

D. THE COMMISSIONER'S INSISTENCE THAT THIS COURT MUST DEFER TO

1. THE REVISED TEMPORARY REGULATION IS NOT ENTITLED TO JUDICIAL

[27] As explained above, the Commissioner's brief does not defend the reasonableness of the result obtained by the Revised Formula in this case or otherwise defend the logically flawed formula. In contrast, the Taxpayers' initial brief explains in detail why the Revised Formula is flawed and supports the reasonableness of the result obtained by the Taxpayers' use of the Original Formula. (T. Br. pp. 18-24, 31-33)

[28] Given that the Taxpayers' actual experience was that 20% or more of its receivables would not be collected, the 4% exclusion percentage provided by the Revised Formula is both arbitrary and unreasonable. The Commissioner justifies the Revised Formula on the ground that the Original Formula resulted in exclusions of ten times the amounts required for utilities. (C. Br. p. 28) What he falls to acknowledge, however, is that the Revised Formula results in the exclusion of 20% or less of the amount required to be excluded in the case of the Taxpayers. If this result is not unreasonable, it is hard to fathom what would be. If an 80% error were deemed "reasonable," it would render the second prong of the Chevron analysis a nullity. Accordingly, the Commissioner's interpretation of I.R.C. section 448(d)(5) is entitled to no deference.

2. ALTHOUGH ANY APPROPRIATE DEFERENCE ANALYSIS SHOULD NOT AFFECT

[30] Citing a number of pre-Mead cases, the Commissioner argues that the holding in Mead has little application in the tax area and does not govern the appropriate level of deference to be given Treasury regulations. (C. Br. pp. 35-39) However, it is clear that Mead applies to ALL agency guidance regarding statutes. As Mead broadly states: "We granted certiorari, 530 U.S. 1202 (2000), in order to consider the limits of Chevron deference owed to administrative practice in applying a statute." 121 S. Ct. at 2171. See also Household Int'l Tax Reduction Investment Plan v. Matz, 121 S. Ct. 2545 (June 25, 2001) (reversing and remanding a Seventh Circuit tax case which gave Chevron deference to an IRS interpretation "for further consideration in light of United States v. Mead Corp"), on remand to 88 A.F.T.R.2d 2001-5805 (7th Cir. Sept. 7, 2001) (declining under the Skidmore standard to give deference to IRS's interpretation).

[31] There is no real question as to the applicability of Mead, and the Commissioner seems to recognize this, given his focus on the Skidmore standard in his brief. The Commissioner's brief does not attempt to argue that Congress delegated to the Treasury the authority here "to make rules carrying the force of law" or that the Revised Temporary Regulation "was promulgated in the exercise of [any such] authority," both of which showings are required in order for Chevron deference to apply. Mead, 121 S. Ct. at 2171.

[32] Respondent cites numerous pre-Mead cases to support his assertion that interpretative regulations promulgated under I.R.C. section 7805(a) may be entitled to deference under Chevron. But see United States v. Vogel Fertilizer Co., 455 U.S. 16, 24 (1982) (holding that a regulation promulgated under I.R.C. section 7805(a) is entitled to "less deference than a regulation issued under a specific grant of authority"); Nalle v. Commissioner, 997 F.2d 1134, 1138 (5th Cir. 1993) (holding that a regulation promulgated under I.R.C. section 7805(a) is not entitled to Chevron deference). However, none of the cases cited by the Commissioner examines whether Congress intended the Treasury to legislate when promulgating rules under I.R.C. section 7805(a). To the contrary, those courts, as did the Tax Court in the proceedings below (107 T.C. at 129), presumed that such intent existed merely because of a perceived statutory ambiguity. However, Mead makes clear that such intent is not to be presumed; rather, courts must determine in each instance whether Congress intended the agency to speak with the force and effect of law when promulgating a particular pronouncement. 121 S. Ct. at 2171- 72 & n.11.

[33] Congress specifically gives the Treasury the authority to prescribe legislative regulations when it so desires (see, e.g., I.R.C. section 448(d)(8)). Where, as in I.R.C. section 448(d)(5), Congress refrains from giving such authority, the Treasury's authority is limited to promulgating interpretative regulations under I.R.C. section 7805(a). The Commissioner agrees that the Revised Temporary Regulation was such an interpretative regulation. See 53 Fed. Reg. 12534, 12534 (1988) (concluding that the promulgation of the Revised Temporary Regulation did not have to comply with the Administrative Procedure Act (the "APA") because it was interpretative").

[34] Such interpretative regulations are not subject to the notice-and-comment requirements of the APA, 5 U.S.C. section 553(b), and, thus, were never intended to have the force and effect of law. See, e.g., Shalala v. Guernsey Mem. Hosp., 514 U.S. 87, 99 (1995) ("Interpretative rules do not require notice and comment, although . . . they also do not have the force and effect of law . . . ."); Chrysler Corp. v. Brown, 441 U.S. 281, 315 (1979) (holding that "an interpretative regulation" does not carry the force and effect of law because it is "not the product of procedures which Congress prescribed as necessary prerequisites to giving a regulation the binding effect of law"). See also Senate Judiciary Committee Print, June 1945, Report on Administrative Procedure Act, reprinted in Administrative Procedure Act Legislative History, 79th Cong. 1944-46, at 18 (1946) ("Another reason [for the exception to the notice-and- comment requirement], which might be added, is that 'interpretative' rules -- as merely interpretations of statutory provisions -- are subject to plenary judicial review, whereas 'substantive' rules involve a maximum of administrative discretion.").

[35] The lack of notice-and-comment procedures here likewise indicates that the Revised Temporary Regulation does not carry the force and effect of law. Unlike final regulations, which reflect the comments of affected taxpayers, temporary regulations do not have the benefit of such insight. That is why, in 1988, Congress required the sunsetting of all new temporary regulations after three years. I.R.C. section 7805(e).

[36] In Mead, the Supreme Court noted that the "overwhelming number of [its] cases applying Chevron deference have reviewed the fruits of notice-and-comment rulemaking or formal adjudication." 121 S. Ct. at 2173. To support this point, the Supreme Court cited twenty-seven cases where it had given Chevron deference to an agency pronouncement only after formal adjudication or notice-and-comment procedures, including Atlantic Mutual Ins. Co. v. Commissioner, 523 U.S. 382, 389 (1998), a case on which the Commissioner relies. (C. Br. pp. 31, 35) See also American Express Co. v. United States, 262 F.3d 1376, 1382 (Fed. Cir. 2001) (stating that IRS position "not reflected in a regulation adopted after notice and comment . . . probably would not be entitled to Chevron deference"); Mearkle v. Commissioner, 838 F.2d 880, 883 (6th Cir. 1988) (holding that proposed Treasury regulations are not entitled to the deference afforded final regulations because proposed regulations do not undergo notice-and-comment procedures).

[37] The Revised Temporary Regulation was promulgated without the benefit of notice-and-comment procedures, notwithstanding the Commissioner's contention that "all taxpayers have been given notice of the revised formula and the opportunity to be heard" after it became effective. (C. Br. p. 43) As the Taxpayers have noted, and as this Court has recognized, a post-effective comment period is no substitute for allowing taxpayers to comment prior to the effective date. (T. Br. p. 29) Moreover, even thirteen years later, the Revised Temporary Regulation remains unaltered in temporary and proposed form, and no action has been taken on the post-effective comments. See Kikalos v. Commissioner, 190 F.3d 791, 796 (7th Cir. 1999) (sua sponte questioning whether a proposed and temporary Treasury regulation adopted without the benefit of notice-and-comment rulemaking and not made final in the ensuing twelve years would be entitled to Chevron deference).

[38] Respondent also argues that the Revised Temporary Regulation should be afforded Chevron deference merely because it is a "formal interpretation" of a statute -- apparently because the regulation was published and was promulgated by a "central board or office." (C. Br. pp. 36-37, 40) In Mead, however, the Supreme Court rejected this argument, holding that an administrative pronouncement is not entitled to Chevron deference merely because it is "official" or "authoritative." 121 S. Ct. at 2177 n.19.

3. UNDER THE SKIDMORE STANDARD, THE REVISED TEMPORARY REGULATION

a. DEGREE OF CARE.

[40] Because it was issued as a proposed and temporary regulation without the benefit of comments, the Revised Temporary Regulation was promulgated without the degree of care that surrounds the issuance of a final regulation. See, e.g., Commodity Futures Trading Comm'n v. Schor, 478 U.S. 833, 845 (1986) ("It goes without saying that a proposed regulation does not represent an agency's considered interpretation of its statute and that an agency is entitled to consider alternative interpretations before settling on the view it considers most sound."). It also was issued with some haste, only ten months after the Original Temporary Regulation (most likely to avoid the sunset rule of I.R.C. section 7805(e), which requires that all temporary regulations issued after November 11, 1988 expire within three years after issuance). Finally, it has remained as a proposed and temporary regulation for thirteen years even though the Treasury has acknowledged its flaws. (T Br. pp. 16- 18) This is hardly a high degree of care. Rather, it suggests a conscious decision by Treasury not to take further action to make changes to the regulation that such care would require.

b. CONSISTENCY.

[41] The Commissioner argues that the Revised Temporary Regulation is entitled to deference because he has consistently applied the Revised Formula to all taxpayers that qualify for the nonaccrual-experience method. (C. Br. p. 41) However, the question is not whether the Commissioner has consistently applied the flawed formula after it was promulgated, but whether the interpretation itself was one consistently maintained. Clearly, it was not. See Skidmore, 323 U.S. at 140 (focuses the inquiry on an interpretation's "consistency with earlier and later pronouncements"); INS v. Cardoza- Fonseca, 480 U.S. 421, 446 n.30 (1987) ("An agency interpretation of a relevant provision which conflicts with the agency's earlier interpretation is 'entitled to considerably less deference' than a consistently held agency view." (citation omitted)).

[42] Treasury initially published a nonaccrual-experience formula following the Black Motor formula (which was developed by the Commissioner and for nearly fifty years had been accepted by both the IRS and the courts) and then reversed course when confronted with the fact that this permitted utilities too great an exclusion. The only consistency shown here has been the Treasury's consistent disregard of the problems that its Revised Formula created for other taxpayers and its consistent failure to rectify these problems, despite including this project on the IRS business plan for eight years.

c. FORMALITY.

[43] The Revised Temporary Regulation was issued without notice-and-comment procedures, comments were not received until after it was issued, and there is a general recognition that it is flawed. The Revised Temporary Regulation also remains in temporary and proposed form after thirteen years, without any changes to reflect taxpayer comments or any explanation of why such comments did not warrant modification. Clearly, the Commissioner and the Treasury have not followed procedures in this case warranting much deference.

d. RELATIVE EXPERTNESS.

[44] Nowhere in the preamble to the Revised Temporary Regulation is there any discussion of how the Revised Formula can reasonably reflect taxpayer experience. Nor, for that matter, has the Commissioner attempted to defend the accuracy of the Revised Formula's determination of the Taxpayers' experience in his brief. Yet the statute requires the use of a taxpayer's experience to determine the amount to be excluded. The Commissioner and Treasury may have great expertise, but they have failed to use it properly in this particular case.

e. PERSUASIVENESS.

[45] In describing the persuasiveness of the Revised Temporary Regulation, the Commissioner's brief fails to address the fact that the Revised Formula is logically inconsistent and produces bizarre results for most taxpayers. The Commissioner relies upon an example in the legislative history in spite of the fact that the example uses the same language used to describe the Black Motor formula in the same legislative history.

[46] The Revised Temporary Regulation is logically flawed, creates unreasonable results at odds with the statute, and thus cannot be deemed persuasive. Accordingly, it is not entitled to deference under the Skidmore standard.

E. THE COMMISSIONER'S BRIEF DOES NOT ANSWER THE TAXPAYERS'

[48] The Commissioner may have misunderstood the Taxpayers' argument here. The Taxpayers do not argue, as suggested by the Commissioner (C. Br. p. 46), that they cannot be changed from a method that complies with generally accepted accounting principles ("GAAP") to a method developed by the Commissioner. The Taxpayers' argument has nothing to do with GAAP. The Taxpayers believe that they cannot be changed from a method that clearly reflects their income; nor may they be changed to a method that does not clearly reflect their income. See Dayton Hudson Corp. v. Commissioner, 153 F.3d 660, 664 (8th Cir. 1998). The Commissioner does not respond to this argument.

[49] In particular, the Commissioner's citation of Thor Power is misguided. The taxpayer in Thor Power argued: (1) that its use of a GAAP method required a finding of clear reflection and (2) that it should not have to use the Black Motor formula to determine its bad debt reserve addition. The Court held that GAAP is not determinative of clear reflection (a point not at issue in the present case) and upheld the use of the Black Motor formula. In neither instance did the taxpayer argue that the method being asserted by the Commissioner failed to reflect clearly its income, as the Taxpayers do here. Thus, the Commissioner is simply wrong to suggest that this issue was addressed in Thor Power.

III. TEN-YEAR SPREAD ISSUE.

[51] Nevertheless, the Commissioner asserts that "there is every reason to infer" that Congress desired the cessation-of- business rule, as set forth in Treas. Reg. section 1.448- 1T(g)(3)(iii) (the "Cessation Regulation"), to be applied to the 10- year spread that Congress required in I.R.C. section 448(d)(7)(C)(ii). (C. Br. p. 56) Of course, when a statute is plain, there is no room for any such inference. See, e.g., Carter v. United States, 530 U.S. 255, 271 (2000) ("In analyzing a statute, we begin by examining the text, not by 'psychoanalyzing those who enacted it.'" (citations omitted)). Moreover, there simply is no support in the legislative history for any such inference.

[52] In fact, the legislative history to I.R.C. section 448 is directly to the contrary. The cessation-of-business rule was one of several timing conditions that had been imposed by the Commissioner when granting permission to spread adjustments required by I.R.C. section 481(a). See Rev. Proc. 84-74, 1984-2 C.B. 736 sections 5.06- 5.09. Three such conditions were incorporated into the regulation at issue. Treas. Reg. section 1.448-1(g)(2)(1)(A) (limiting spread period to number of years method used, cf. Rev. Proc. 84-74 section 5.06(e)); Treas. Reg. section 1.448-1(g)(3)(i) (the "one-third rule," cf. Rev. Proc. 84-74 section 5.08); Treas. Reg. section 1.448- 1(g)(3)(iii) (the cessation-of-business rule, cf Rev. Proc. 84-74 section 5.09). As explained below, while the legislative history supports the imposition of such limitations on taxpayers operating businesses other than hospitals, whose spread period "SHALL NOT EXCEED 4 years," it supports no such limitations on the spread period for taxpayers operating hospitals, whose spread period "SHALL BE 10 years."

[53] The Conference Report explains: "The conferees intend that the timing of the section 481 adjustment OTHER THAN FOR A HOSPITAL will be determined under the provisions of Revenue Procedure 84-74, 1984-2 C.B. 736." H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. (1986), at II-289, reprinted in 1986-3 C.B. Vol. 4, at 289 (emphasis added). The only thing that can be inferred from this language is that Congress did NOT intend for the provisions of Rev. Proc. 84-74 to apply to the 10-year spread provided to taxpayers operating hospitals.

[54] The Commissioner agrees that the first two limitations described above do not apply to the 10-year spread afforded taxpayers operating hospitals. (C. Br. pp. 50-51) However, he suggests that the legislative history does not speak to the cessation-of-business limitation because it is not, in his words, a "general timing rule" set forth in section 5.06 of Rev. Proc. 84-74. (C. Br. p. 50) What the Commissioner ignores is that nothing in the legislative history singles out section 5.06 of Rev. Proc. 84-74. Instead, the House Report precludes the imposition on hospitals of the timing rules governing section 481(a) adjustments, and there can be no question that a provision accelerating recognition of a section 481(a) adjustment is a timing rule. Indeed, the Commissioner's own regulation describes both the one-third rule (which shortens the spread period if one-third of accounts receivable are collected quickly) and the cessation-of-business rule as "special timing rules." Treas. Reg. section 1.448-1(g)(3).

B. THE COMMISSIONER'S POLICY ARGUMENT IS BOTH IRRELEVANT AND

[56] Even so, the Commissioner's suggestion that the Cessation Regulation is necessary to prevent the omission of income by the Taxpayers is simply wrong. He makes the same mistake as the Tax Court in this case -- suggesting that without the Cessation Regulation, the Taxpayers could somehow avoid the tax on the section 481(a) adjustment.

[57] The Taxpayers agree with the Commissioner's statement that "[i]f the taxpayer ceases to exist, it would make no sense to allow the taxpayer to liquidate without paying the full section 481 adjustment." (C. Br. p. 56) However, as the Taxpayers' initial brief notes (T. Br. pp. 49-50), general principles of tax law would not allow any such avoidance. ⁶ The Commissioner responds to this argument by stating: "These cases do not purport to apply to the circumstances that might result here, where the corporations have not and might not ever liquidate." (C. Br. p. 57) That is precisely the point. If the Taxpayers continue in business, they will report and pay tax on the section 481(a) adjustment (over ten years) as required by I.R.C. section 448(d)(7)(C)(ii). ⁷ There will be no omission of income.

[58] The Commissioner also suggests that because ten years is a long period of time, the Taxpayers might lose the "wherewithal" to pay the tax on the section 481(a) adjustment that must be reported over that period. (C. Br. p. 56) This could happen regardless of whether a taxpayer sells any of its hospitals, and Congress nevertheless chose to provide for a 10-year spread period. Ironically, one of the very reasons for a spread period is to assure that taxpayers have the wherewithal to pay. There also is no reason to believe that the Taxpayers, who have remained the largest company in the hospital business, are any more likely to fall as a result of selling some of their hospitals than if they had not done so. ⁸

[59] Finally, even if there were some increased chance of bankruptcy, an argument based upon a hypothetical bankruptcy is no reason to impose a limitation that is contrary both to the statute and to its legislative history. See, e.g., United States v. Hughes Props., Inc., 476 U.S. 593 (1986) (holding that a taxpayer could accrue deductions for expenses that it had a fixed obligation to pay despite the Service's argument that it was possible that the taxpayer could go out of business or into bankruptcy and not ever actually make payment because such a possibility exists for every business).

[60] Thus, the Commissioner's policy argument is both irrelevant (given that the policy choices here were made by Congress) and incorrect. As such, it offers no support for upholding the validity of the Cessation Regulation.

CONCLUSION

[61] For the reasons set forth in the Taxpayers' initial brief and above, it is respectfully requested that the Court reverse the decision of the Tax Court below on these issues.

This 25th day of October 2001.

N. Jerold Cohen

[62] Appellants hereby certify that this reply brief complies with the type-volume limitation set out in Fed. R. App. P. 32(a)(7)(B)(i). The brief contains 6,959 words from the Statement of Jurisdiction through the Conclusion.

October 25, 2001 Date

[signed]

[63] This is to certify that a copy of the foregoing Proof Reply Brief of Appellants Hospital Corporation of America & Subsidiaries was served on Thomas J. Sawyer, Attorney, Appellate Section, United States Department of Justice, by mailing the same to him on October 26, 2001, in a postage paid wrapper addressed to him at P.O. Box 502, Washington, D.C. 20044.

This ___ day of October 2001.

² The Original Formula was based upon the Black Motor formula.

³ As discussed above, the Taxpayers have not suggested that the Original Formula produces a reasonable result in all circumstances, only that it produced a reasonable result for them in their circumstances (a point that the Commissioner makes absolutely no attempt to rebut).

⁴ Chevron U.S.A., Inc. v. Natural Resources Defense Council, 467 U.S. 837 (1984).

⁵ Skidmore v. Swift & Co., 323 U.S. 134 (1947).

⁶ In fact, section 5.09 of Rev. Proc. 84-74 did not explicitly cover situations in which a taxpayer terminated its existence, but instead dealt only with the cessation of particular trades or businesses by a taxpayer. General principles of tax law required acceleration if a taxpayer ceased to exist, not Rev. Proc. 84-74.

⁷ We also note that the Taxpayers could not distribute all of their assets but technically stay in existence in an effort to avoid the tax on the section 481(a) adjustment, because such would be deemed a de facto liquidation. See, e.g., Treas. Reg. section 1.332- 2(c); Rev. Rul. 61-191, 1961-2 C.B. 251 ("The principle of de facto dissolution is well established in the law . . . .").

⁸ We note that the Commissioner's brief states that the Taxpayers sold hospitals "but they remained engaged in other businesses." (C. Br. p. 17) As was stipulated, however, the Taxpayers continued in the HOSPITAL business, owning and operating other hospitals. (T. Br. p. 8)