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DOJ Argues Change in Accounting for Hospital Corp. Was Proper

NOV. 16, 2001

Hospital Corp. of America, et al. v. Commissioner

DATED NOV. 16, 2001
DOCUMENT ATTRIBUTES
  • Case Name
    HOSPITAL CORPORATION OF AMERICA & SUBSIDIARIES, Petitioner-Appellant v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee
  • Court
    United States Court of Appeals for the Sixth Circuit
  • Docket
    No. 01-1810
  • Institutional Authors
    Justice Department
  • Cross-Reference
    For text of Hospital Corp.'s opening appellate brief, see Doc 2001-

    22637 (96 original pages) [PDF] or 2001 TNT 175-69 Database 'Tax Notes Today 2001', View '(Number'.

    For text of Hospital Corp.'s reply brief, see Doc 2001-27872 (37

    original pages) [PDF] or 2001 TNT 228-24 Database 'Tax Notes Today 2001', View '(Number'.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    accounting methods, cash, limits
    accounting methods
  • Industry Groups
    Health care
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2001-29479 (71 original pages)
  • Tax Analysts Electronic Citation
    2001 TNT 241-23

Hospital Corp. of America, et al. v. Commissioner

 

=============== SUMMARY ===============

 

In a brief for the Sixth Circuit, the DOJ has argued that the Tax Court correctly required Hospital Corp. of America (HCA) to change its method of accounting to comport with revised temporary and proposed regs.

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.

The Justice Department argues that the Tax Court correctly held that the revised formula set forth in reg. section 1.448-2T to estimate uncollectible accounts receivable is valid as a reasonable construction of section 448(d)(5). The DOJ further maintains that the court correctly held that the 100 hospitals sold in 1987 that thus ceased operating were required to recognize that year the balances of the section 481 adjustments occasioned by those hospitals' change in accounting method. The Justice Department asserts that the court properly rejected HCA's argument that because they continued to operate other hospitals, they were entitled to spread the section 481 adjustments attributable to the businesses of the hospitals sold over 10 years, even though they were no longer operating those businesses.

 

=============== FULL TEXT ===============

 

IN THE UNITED STATES COURT OF APPEALS

 

FOR THE SIXTH CIRCUIT

 

 

ON APPEAL FROM THE DECISION OF THE

 

 

UNITED STATES TAX COURT

 

 

FINAL BRIEF FOR THE APPELLEE

 

 

EILEEN J. O'CONNOR

 

Assistant Attorney General

 

TERESA E. McLAUGHLIN

 

(202) 514-4342

 

THOMAS J. SAWYER

 

(202) 514-8129

 

Attorneys

 

Tax Division

 

Department of Justice

 

Post Office Box 502

 

Washington, D. C. 20044

 

 

TABLE OF CONTENTS

 

 

Statement in support of oral argument

 

Jurisdictional statement

 

Statement of the issues

 

Statement of the case

 

Statement of facts:

 

 

A. Introduction

 

 

B. The method for determining a taxpayer's "nonaccrual

 

experience" under § 448(d)(5)

 

 

C. The timing of the § 481 adjustment relating to the

 

hospital sold to HealthTrust

 

 

Standard of review

 

Summary of argument

 

Argument:

 

 

I The Tax Court correctly held that the revised formula set forth

 

in Treas. Reg. § 1.448-2T to estimate uncollectible accounts

 

receivables is valid as a reasonable construction of §

 

448(d)(5)

 

 

A. Introduction

 

 

B. The Tax Court correctly held that taxpayers were required to

 

use the amended formula set forth in the revised Temporary

 

Regulation

 

 

1. The "plain meaning" of § 448(d)(5) does not

 

require the Commissioner to permit taxpayers to use the

 

Black Motor formula

 

 

2. The formula set forth in the Temporary Treasury regulation

 

is a reasonable interpretation of the statute that finds

 

direct support in the relevant legislative history

 

 

a. Contrary to taxpayers' contention, the Supreme Court's

 

decision in Mead does not alter the

 

Chevron deference due the Temporary Regulation

 

 

b. In any event, the Temporary Regulations are entitled to

 

deference under Mead

 

 

i. Degree of care

 

 

ii. Consistency

 

 

iii. Formality

 

 

iv. Relative expertness

 

 

v. Persuasiveness of agency's opinion

 

 

3. The Commissioner acts well within his authority to require

 

a taxpayer to follow a regulation that reasonably

 

implements the intent of Congress

 

 

II The Tax Court correctly held that the taxpayers that ceased

 

operating the hospitals sold to HealthTrust in 1987 were

 

required to recognize that year the balances of the § 481

 

adjustments occasioned by those hospitals' change in accounting

 

method

 

 

A. Introduction

 

 

B. The Tax Court correctly applied the cessation of business

 

provision to taxpayers

 

 

1. Section 448(d)(7) contains a latent ambiguity, in that it

 

fails to address the timing of the § 481 adjustment if

 

the taxpayer ceases to operate the business to which that

 

adjustment relates

 

 

2. The regulation reasonably implements the intent of Congress

 

 

Conclusion

 

Certificate of compliance with type volume limitation

 

Appellee's designation of joint appendix

 

Addendum

 

 

TABLE OF AUTHORITIES

 

 

CASES:

 

 

Atlantic Mutual Ins. Co. v. Commissioner, 523 U.S. 382 (1998)

 

Beecham v. United States, 511 U.S. 368 (1994)

 

Black Motor Co. v. Commissioner, 41 B.T.A. 300 (1940),

 

aff'd on another issue, 125 F.2d 977 (6th Cir. 1942)

 

Boston Sand Co. v. United States, 278 U.S. 41 (1928)

 

Burlington Northern R.R. v. Oklahoma Tax Commission,

 

481 U.S. 454 (1987)

 

Cabell v. Markham, 148 F.2d 737 (2d Cir.), aff'd, 326

 

U.S. 404 (1945)

 

CenTRA, Inc. v. United States, 953 F.2d 1051 (6th Cir. 1992)

 

Chevron, U.S.A., Inc. v. Natural Resources Defense

 

Council, Inc., 467 U.S. 837, reh'g denied, 468

 

U.S. 1227 (1984)

 

Cloward Instrument Corp. v. Commissioner, 52 T.C.M. (CCH) 34

 

(1986), aff'd without published opinion,

 

842 F.2d 1294 (9th Cir. 1988)

 

Commissioner v. South Tex. Lumber Co., 333 U.S. 496 (1948)

 

Cottage Savings Assn. v. Commissioner, 449 U.S. 554 (1991)

 

E. Norman Peterson Marital Trust v. Commissioner, 78 F.3d 797

 

(2d Cir. 1996)

 

Goodwin's Estate v. Commissioner, 201 F.2d 576 (6th Cir.

 

1953)

 

Helvering v. Stockholdm Enskilda Bank, 293 U.S. 84 (1934)

 

John Hancock Mutual Ins. Co. v. Harris Trust & Savings

 

Bank, 510 U.S. 86 (1993)

 

Johnson City Medical Center v. United States, 999 F.2d 973

 

(6th Cir. 1993)

 

Miller v. United States, 65 F.3d 687 (8th Cir. 1995)

 

National Muffler Dealers Ass'n v. United States, 440 U.S. 472

 

(1979)

 

Nichols v. United States, 260 F.3d 637, 641 (6th Cir. 2000)

 

Ohio Periodical Distributors, Inc. v. Commissioner, 105

 

F.3d 322 (6th Cir. 1997)

 

Peoples Federal Savings and Loan Assn. v. Commissioner,

 

948 F.2d 289 (6th Cir. 1992)

 

Redlark v. Commissioner, 141 F.3d 936 (9th Cir. 1998)

 

Rowan Cos. v. United States, 452 U.S. 247 (1981)

 

Rust v. Sullivan, 500 U.S. 173 (1991)

 

Skidmore v. Swift & Co., 323 U.S. 134 (1944)

 

Thor Power Tool Co. v. Commissioner, 439 U.S. 522 (1979)

 

Train v. Colorado Public Interest Research Group, 426 U.S. 1

 

(1976)

 

United States v. American Trucking Association,

 

Inc., 310 U.S. 534 (1940)

 

United States v. Cleveland Indians Baseball Co., 121 S. Ct.

 

1433 (2001)

 

United States v. Correll, 389 U.S. 299 (1967)

 

United States v. Mead Corp., 121 S. Ct. 2164 (2001)

 

Wuebker v. United States, 205 F.3d 897 (6th Cir. 2000)

 

 

STATUTES:

 

 

H.R. 3838, 99th Cong., 1st Sess., § 902 (1985)

 

 

Internal Revenue Code (26 U.S.C.):

 

§ 166(a)

 

§ 166(c)

 

§§ 301-385

 

§ 446

 

§ 448

 

§ 448(d)(5)

 

§ 448(d)(7)

 

§ 461

 

§ 481

 

§ 6212

 

§ 6213

 

§ 7442

 

§ 7482

 

§ 7483

 

§ 7801

 

§ 7805

 

 

Tax Reform Act of 1986, Pub. L. No. 99-14, 100 Stat. 2085:

 

§ 801

 

§ 805

 

 

MISCELLANEOUS:

 

 

David A. Brennen, Treasury Regulations and Judicial

 

Deference in the Post- Chevron Era,

 

13 Ga. St. U.L. Rev. 387 (1997)

 

Federal Rules of Appellate Procedure, Rule 13

 

 

H.R. Conf. Rep. No. 99-841, reprinted in, 1986-3 C.B.

 

(vol. 4) 1

 

H.R. Rep. No. 99-426, reprinted in, 1986-3 C.B. (vol. 2) 1

 

8 Mertens Law of Fed. Income Tax § 30.98 (2001)

 

Michael Moriarty, "Accountants and Treasury Debate Nonaccrual

 

Experience Method," 88 Tax Notes 242 (1988)

 

Notice 88-51, 1988-1 C.B. 535

 

"Practitioners Say Proposed Ratio for Bad Debts Does Not Reflect

 

Experience," Daily Tax Rep. (BNA) No. 232 at G-3 (Dec. 2,

 

1988)

 

 

Revenue Procedures:

 

84-74, 1984-2 C.B. 736

 

97-27, 1997-1 C.B. 680

 

 

Revenue Rulings:

 

76-362, 1976-2 C.B. 45

 

80-39, 1980-1 C.B. 112

 

 

Michael I. Saltzman, IRS Practice and Procedure (2d ed. 1991):

 

¶ 3.01

 

¶ 3.02

 

 

W. Eugene Seago, "The Tax Court's First Experience with the Non-

 

Accrual-Experience Method," 86 J. Tax'n 284 (1997)

 

S. Rep. No. 99-113, reprinted in, 1986-3 C.B. (vol. 3) 1

 

 

Treasury Decisions:

 

 

T.D. 8143, 1987-2 C.B. 121

 

T.D. 8194, 1988-1 C.B. 186

 

T.D. 8514, 1994-1 C.B. 141

 

 

Treas. Order 111-2, 1981-1 C.B. 698

 

 

Treasury Regulations (26 C.F.R.):

 

§ 1.446-1(c)

 

§ 1.446-1(e)

 

§ 1.448-1T(g)

 

§ 1.448-1(g)

 

§ 1.448-2T(a)

 

§ 1.448-2T(b)

 

§ 1.448-2T(e)

 

§ 1.451-1(a)

 

 

Jules I. Whitman, John W. Gilbert & Peter J. Picotte, II,

 

The Black Motor Bad Debt

 

Formula: Why It Doesn't Work and How to Adjust It,

 

35 J. Tax. 366 (1971)

 

 

STATEMENT IN SUPPORT OF ORAL ARGUMENT

[1] Because both issues presented are questions of first impression that have substantial administrative importance, oral argument would be highly desirable.

JURISDICTIONAL STATEMENT

[2] On September 13, 1991, the Commissioner mailed a notice of deficiency pursuant to § 6212 of the Internal Revenue Code of 1986 (26 U.S.C.) (I.R.C.) to Hospital Corporation of America and Subsidiaries (taxpayers), determining deficiencies in their federal income taxes for the years 1987 and 1988 of $294,571,908 and $25,317,840, respectively. (R. 1, Ex. A (Notice of deficiency), Apx. 70.)1 On December 9, 1991, taxpayers filed a timely petition (R. 1, Apx. 9-69) in the United States Tax Court contesting the deficiencies. See I.R.C. § 6213(a). The Tax Court had jurisdiction over the petition under §§ 6213(a) and 7442.

[3] On March 9, 2001, the Tax Court entered a final decision (R. 109, Apx. 348), determining deficiencies of $76,588,579 for 1987 and $7,621,170 for 1988. On June 7, 2001, taxpayers filed a notice of appeal (R. 110, Apx. 349), which was timely under § 7483 and Fed. R. App. P. 13(a). This Court's jurisdiction rests upon § 7482(a)(1).

STATEMENT OF THE ISSUES

[4] 1. Under § 448(d)(5), a taxpayer need not accrue income from services rendered that, based on experience, will not be collected. Temp. Treas. Reg. § 1.448-2T(e)(2)(i) (26 C.F.R.) calls for calculating the uncollectible amount by multiplying receivables by a fraction, the numerator being total uncollectible receivables, less recoveries, during the current and five preceding years, and the denominator being the sum of accounts receivable earned (i. e., total sales) during the same six-year period, whereas taxpayers maintain that the denominator instead should be the sum of the yearend balances of the accounts receivable for the six years. The issue presented is whether the Tax Court correctly upheld the Temporary Regulation's formula as valid.

[5] 2. Certain of taxpayers' hospitals that changed their method of accounting from a hybrid, part-cash method to the accrual method in 1987 were sold later that year. To prevent the distortion in income that might otherwise result from a change in method of accounting, § 481(a)(2) generally requires an adjustment to prevent the duplication or omission of any deduction or item of gross income, such as the inclusion in income of uncollected receivables that had not been reportable under the cash method. Under § 448(d)(7)(C), the period for taking the § 481 adjustment into account "shall not exceed 4 years," but "in the case of a hospital, shall be 10 years." The issue in presented is whether the Tax Court correctly upheld as valid Treas. Reg. § 1.448- 1(g)(3)(iii) 's provision that if the taxpayer ceases to operate the hospital prior to the expiration of the spread period, it must then take any remaining balance of the § 481 adjustment into account.

STATEMENT OF THE CASE

[6] Taxpayers brought this proceeding in the Tax Court, contesting the Commissioner's determination of deficiencies for the years 1987 and 1988. This case was consolidated (R. 6, Order) for purposes of trial, briefing and opinion with other cases concerning deficiencies for several other taxable years. Certain issues were settled (R. 83, Stip.), while others were tried (R. 39, 50-55, 58, 66-68, Transcripts). The Tax Court (Judge Thomas B. Wells) issued several opinions. Although decisions were entered at the same time in all consolidated cases, taxpayers have appealed only the decision relating to the years 1987 and 1988 (R. 109; Apx. 348), while the Commissioner took no cross-appeals. Only two issues remain in dispute on appeal. Taxpayers challenge the formula set forth in Temp. Treas. Reg. § 1.448-2T(e)(3)(2)(i) for computing the uncollectible amount of billings, which the Tax Court upheld in an opinion reported at 107 T. C. 116 (1996). (R. 88, Apx. 301-347.) Taxpayers also attack the validity of Treas. Reg. § 1.448-1(g)(3)(iii) 's requirement, upheld by the Tax Court at 107 T. C. 73 (1996) (R. 87, Apx. 267-300), that any unrecognized portion of the § 481 adjustment must be taken into account in the year of cessation of a business.2

STATEMENT OF FACTS

A. Introduction

[7] Hospital Corporation of America (HCA) is a for-profit corporation that owns, operates and manages hospitals. (R. 44, Stip. ¶¶ 2-3; Apx. 352.) At the end of 1986, HCA owned and operated 243 hospitals. (Id., ¶ 108; Apx. 401.) Its corporate structure contained 134 separate corporations, many of which were used to run a single hospital, while some operated clusters of hospitals located within a single state. (Ibid.)

[8] Taxpayers used an accrual method of accounting for financial and other business purposes. (R. 44, Stip., ¶¶ 82- 84; Apx. 386.) For tax purposes, however, prior to 1987, 228 of the hospitals used a "hybrid" method of accounting that combined the cash and accrual methods.3 (Id., ¶¶ 104-108; Apx. 400-402.) Under the hybrid method, income and expenses relating to purchases and sales of medical supplies were reported on the accrual method, while income and related expenses from all other sources (including the provision of medical services) were reported on the cash method. (R. 84, Opinion at 53.) Some of taxpayers' hospitals, however, used the accrual method of accounting even before 1987, establishing reserves for bad debts in respect of accounts receivable under § 166(c) in lieu of the bad debt deduction authorized by § 166(a).

[9] In 1987, however, several changes made by the Tax Reform Act of 1986, Pub. L. No. 99-514, 100 Stat. 2085 (the 1986 Act), took effect, giving rise to the disputes here in issue. First, § 448, enacted by § 801(a) of the 1986 Act, 100 Stat. at 2345, prohibited "C corporations," see Subchapter C, §§ 301-385, such as taxpayers, from using the cash (including the hybrid) method of accounting and required them to use the accrual method instead. (R. 44, Stip., ¶ 137; Apx. 418.) At the same time, § 166(c) 's bad debt reserve deduction was repealed by § 805 of the 1986 Act, 100 Stat. at 2361-2362. In the case of income from the provision of services, however, unless interest or some other penalty for failure to make timely payment is charged, § 448(d)(5) makes an exception to the requirement of accrual for "any portion of such amounts which (on the basis of experience) will not be collected." The parties disagree over the correct formula for calculating this amount. See Part B and Argument I, infra.

[10] The required switch from the hybrid to accrual method of accounting also occasioned adjustments under § 481, over the period set by § 448(d)(7)(C), to prevent the duplication or omission of items of income or expense. Whether this period ends at all events upon cessation of the business, even in the case of a hospital, is disputed here. See Part C and Argument II, infra.

B. The method for determining a taxpayer's

 

"nonaccrual experience" under § 448(d)(5)

 

 

[11] In Temporary Regulations promulgated pursuant to § 448 on June 16, 1987, see T.D. 8143, 1987-2 C.B. 121, the Treasury initially adopted a formula for calculating the uncollectible amount of a receivable by multiplying the yearend receivables by a fraction, the numerator of which was total bad debts with respect to accounts receivable sustained during the current tax year and five preceding tax years (net recoveries), and the denominator of which was the sum of the accounts receivable at yearend for the same six-year period. Temp. Treas. Reg. § 1.448-2T(e)(2)(i), 62 Fed. Reg. 22775. This formula, first described in Black Motor Co. v. Commissioner, 41 B.T.A. 300 (1940), aff'd on another issue, 125 F.2d 977 (6th Cir. 1942), had been used by certain of taxpayers before 1987 in computing their bad debt reserves under former § 166(c).

[12] On April 15, 1988, some 10 months after promulgating the Black Motor formula, the Treasury amended the Temporary Regulation. T.D. 8194, 1988-1 C.B. 186, 187. The Treasury had become aware that the Black Motor formula was creating "bizarre" results for some taxpayers who write off large amounts of uncollectibles within the taxable year, such as a utility whose resulting bad-debt figure was ten times greater than the previous year's. See Remarks of Thomas Evans, Associate Tax Legislative Counsel, Department of the Treasury, quoted in "Practitioners Say Proposed Ratio for Bad Debts Does Not Reflect Experience," Daily Tax Rep. (BNA) No. 232 at G-3 (Dec. 2, 1988). In addition, questions had been received from taxpayers regarding the proper denominator of the fraction. T.D. 8194, supra, 1988-1 C.B. at 186, Addendum, infra at 73. The formula for determining the uncollectible amount was amended to provide that the denominator of the fraction by which a receivable is to be multiplied is the sum of accounts receivable earned (i.e., total sales) during the six year period, rather than the sum of the yearend balances of the accounts receivable.4

[13] Taxpayers timely elected the so-called "nonaccrual experience" method authorized by § 448(d)(5) and computed the amounts excludable from income under that method for the years in suit by using the "periodic system" described in Notice 88- 51, supra, except that they computed the uncollectible portion of the accounts receivable using the Black Motor formula set forth in the original Temporary Regulation, rather than the amended formula that superseded it. (R. 44, Stip., ¶ 163; Apx. 427.)

[14] Upon audit, the Commissioner determined that, by using the Black Motor formula in lieu of the amended formula, taxpayers had overstated the amount of excludable receivables. Taxpayers challenged the resulting deficiencies in the Tax Court. They argued that the amended Temporary Regulation is invalid because it is an unreasonable interpretation of the unambiguous language of § 448(d)(5), which in their view requires the use of the Black Motor formula. The Commissioner contended that § 448(d)(5) was indeed ambiguous because it did not specify how "experience" is to be determined and that the amended formula is a valid interpretation of the statute.

[15] The Tax Court upheld the amended Temporary Regulation. (R. 88, Opinion; Apx. 301-47.) First, the court noted that the statutory phrase "on the basis of experience" does not itself provide "a clear mechanism for determining how a taxpayer's bad debt experience will be utilized." (Id. at 23; Apx. 323.) The court noted taxpayer's reliance upon Congress's use of the term "experience method" in § 585(b)(2) (relating to banks' reserves for losses on loans) when it meant to apply the Black Motor formula, but the court considered it more likely that it would have referred to "the experience method" or the Black Motor formula if this had been its intention, rather than simply using the word "experience." (Id. at 25- 26; Apx. 325-36.)

[16] Having found § 448(d)(5) to be ambiguous, the court noted that the pertinent House Report (H.R. Rep. No. 99-426, 99th Cong., 2d Sess. at 608 (1986), Addendum, infra) first set forth a formula that called for using total sales in the multiplicand and also in the denominator of the fraction, but expressed the formula somewhat differently in an illustrative example, which referred to receivables outstanding at year end as being the multiplicand (but the total sales factor in the denominator of the fraction remained unchanged). (R. 88, Opinion at 27; Apx. 327.) "Because the report contains conflicting language, we do not think it clearly describes the formula" (id.), and the report, in the court's view, indicated merely that Congress intended the uncollectible amount to be determined in a manner "similar, but not identical, to the Black Motor formula" (id. at 28; Apx. 328).

[17] The court concluded that, "[i]n the absence of a clear indication of congressional intent on the precise question in issue," the only question remaining was whether the amended formula was "a permissible construction of the statute." (Id. at 28; Apx. 328). The court noted that the only difference between the two formulas was that denominator of the fraction contained the sum of yearend receivables in the original formula, but the sum of all accounts receivable earned in the amended formula. (Id. at 30-31; Apx. 330-31.) Because the sum of accounts receivable was contained in one of the two multiplicands mentioned in the House Report, the Secretary's choice of it was a permissible construction of the statute. (Id. at 36-37; Apx. 336-37.) The amended Temporary Regulation was therefore valid. (Id. at 38; Apx. 338.)

C. The timing of the § 481 adjustment relating to the

 

hospital sold to HealthTrust

 

 

[18] On September 1, 1987, HCAII, a subsidiary of HCA, sold all of the stock of certain other HCA subsidiaries that owned 104 hospitals and other facilities to HealthTrust, Inc. for consideration of more than $2 billion. (R. 44, Stip., ¶¶ 155, 182; Apx. 423, 436.) In some instances, where HealthTrust did not want to purchase all hospitals held by a subsidiary, the subsidiary (the "new parent") created its own "new" subsidiary and transferred to it the assets (including accounts receivable) and liabilities of the hospital(s) HealthTrust did wish to acquire. (Id., ¶¶ 157, 161; Apx. 424, 426.) HealthTrust then purchased the stock of the new subsidiary from HCAII, which had exchanged its stock for that of the new subsidiary with the new parent.5 (Id., ¶ 157; Apx. 424.)

[19] It is undisputed that, although the accounts receivable were transferred to the new subsidiaries together with the hospitals HealthTrust acquired, the new parent, which remained HCA's subsidiary, remained responsible to report the § 481 adjustment relating to the income from services billed but unpaid before the change in accounting method. (Id., ¶ 161; Apx. ___.) On the consolidated returns for the years 1987 and 1988, the new parents reported one-tenth of the § 481 adjustment respecting those hospitals' businesses, on the theory that they were entitled under § 448(d)(7)(C) to spread the § 481 adjustment for the hospitals sold to HealthTrust over 10 years, notwithstanding that they no longer operated those businesses. (Id., ¶ 160, Apx. 426.)

[20] Upon audit, the Commissioner, relying on Temp. Treas. Reg. § 1.448-1T(g)(3)(iii), see T.D. 8143, supra, 1987-2 C.B. at 130,6 determined that taxpayers were required to take into account the entire § 481 adjustment relating to the hospitals sold to HealthTrust because they had ceased to operate those businesses. Taxpayer contested resulting deficiencies in the Tax Court, contending that Treas. Reg. § 1.448-1(g)(3)(iii) is invalid because the plain language of § 448(d)(7)(C) allows taxpayers operating hospitals to spread the § 481 adjustment over 10 years. (R. 87, Opinion at 15; Apx. 281.)

[21] The Tax Court held that the regulation is valid and that taxpayers consequently were required to report in 1987 the entire § 481 adjustment relating to those hospitals they had ceased to operate. (R. 87, Opinion; Apx. 267-300). It rejected taxpayers' contention that the regulation is invalid because it conflicts with plain language of § 448(c)(7)(ii) allowing a 10-year spread. The Tax Court agreed with taxpayers that § 448(d)(7)(C)(ii) generally permits a taxpayer operating a hospital to spread a § 481 adjustment over a 10-year period, but it stated that "we do not agree[ ] * * * that the wording of the statute requires the conclusion that under no circumstances may the 10-year spread period for hospitals be shortened." (Id. at 18; Apx. 284.) The court cautioned against reading the phrase "shall be 10 years" in isolation, reasoning that taxpayers' analysis "basically ignores the other words in the statute and the statute and purpose of the statutory provision as a whole." (Id. at 19, Apx. 285.) In the court's view (id. at 20, Apx. 286 (emphasis in original)):

Congress' choice of the words 'in the case of a hospital' rather

 

than the phrase 'in the case of hospitals' renders section

 

448(d)(7)(C)(ii) ambiguous inasmuch as it is silent as to the

 

question of whether, where a taxpayer is engaged in the business

 

of operating hospitals, the tax benefit of spreading over

 

10 years a section 481(a) adjustment required to conform a

 

hospital's method of accounting to section 448(a) belongs

 

to the hospital to which the adjustment is attributable

 

or to the taxpayer that owns that hospital. Neither the statute

 

nor the legislative history addresses that precise question.

 

 

Nor did the statute or legislative history give any indication "that Congress gave any consideration to the treatment of the section 481(a) adjustment where a hospital ceases to engage in the trade or business giving rise to that section 481(a) adjustment * * * ." (Id., emphasis in original.) Because the statute "has left gaps creating ambiguity as to its precise meaning" (id.), the court held that the Commissioner's interpretation must be let stand if it is reasonable. The court went on to conclude that the regulation's requirement of accounting for any remaining § 481 adjustment in the event of a cessation of the business constituted a reasonable interpretation of the statutory scheme because it "is in harmony with the purposes of both sections 448 and 481 and is not inconsistent with the statutory scheme as a whole." (Id. at 26; Apx. 292).

STANDARD OF REVIEW

[22] Whether a Treasury Regulation is valid presents a question of law reviewed de novo. Nichols v. United States, 260 F.3d 637, 641 (6th Cir. 2000).

SUMMARY OF ARGUMENT

[23] 1. Under § 448(d)(5), which took effect in 1987, a taxpayer need not accrue income with respect to services rendered as to "any portion of such amounts which (on the basis of experience) will not be collected." Within months of enactment, the Secretary issued a Temporary Treasury Regulation that required a taxpayer to use a single formula to estimate the uncollectible amount. The formula adopted was the so-called Black Motor formula that had been used to estimate bad debt reserves under former § 166(c), which calls for multiplying the receivable by a fraction, the numerator being total uncollectible receivables (less recoveries) during the current and five preceding years, and the denominator being the sum of the yearend balances of the accounts receivable for the six years. Ten months later, however, because the Black Motor formula resulted in inordinately large deductions to taxpayers (such as public utilities) that write off large portions of receivables before year's end, and in answer to questions from taxpayers regarding whether the proper denominator was total sales or yearend receivable balances, the Treasury reconsidered the formula. It amended the Temporary Regulation by substituting in the denominator of the fraction, in place of the sum of the yearend balances of accounts receivable, total sales for the six-year period.

[24] The Tax Court correctly held that the plain language of § 448(d)(7) did not require the Commissioner to allow taxpayers to use the Black Motor formula. Indeed, nothing in the statute itself points to any particular formula. The Tax Court also correctly held that the amended formula is a reasonable interpretation of the statute. As the Tax Court noted, it is apparent from the legislative history that Congress preferred the use of a single formula, and the revised formula chosen by the Secretary finds direct support in the legislative history. The Secretary did not err by adopting that formula. Taxpayers argue that the amended formula is flawed and that the Black Motor formula is a better choice. But nowhere in the legislative history is the Black Motor formula mentioned, and that formula had previously been subject to criticism because it suffered from obvious flaws. As the Tax Court correctly held, the choice among reasonable alternatives for implementing a tax statute belongs to the Secretary, and the courts should ordinarily defer to the Secretary's choice. Indeed, given the direct support found in the legislative history for the Secretary's decision, it cannot be said that the Secretary's choice was unreasonable.

[25] 2. Section 448 required those of taxpayers not already using an overall accrual method of accounting to change to that method in 1987. Under § 448(d)(7)(A) and (B), the change in method is to be treated as one initiated by the taxpayer to which the Commissioner consents. To prevent the distortion in income that might otherwise result from a change in method of accounting, § 481(a)(2) generally requires an adjustment to prevent the duplication or omission of any deduction or item of gross income, such as the inclusion in income of uncollected receivables that had not been reportable under the cash method. Under § 448(d)(7)(C), the period for taking into account the § 481 adjustment "shall not exceed 4 years," but "in the case of a hospital, shall be 10 years."

[26] In keeping with longstanding pronouncements requiring taxpayers, as a condition of the Commissioner's consent to a change in accounting method, to accelerate any remaining § 481 adjustment upon ceasing the business to which that adjustment relates, Treas. Reg. § 1.448-1(g)(3)(iii) provides that if, prior to the expiration of the period for taking the § 481 adjustment into account, a taxpayer ceases to engage in the business in question, it must then take any remaining balance of the § 481 adjustment into account. A distortion in income would otherwise result.

[27] In 1987, certain of taxpayer's subsidiaries sold hospitals they had operated, but they remained engaged in other businesses. Rather than take the sold hospitals' § 481 adjustments into account that year, taxpayers sought to use the 10-year spread. They challenged the regulation's requirement that any remaining § 481 adjustment be recognized in the year of cessation of a business, as applied to taxpayers that operate hospitals.

[28] The Tax Court correctly upheld the regulation. Focusing on the language of the statute as a whole in light of its objectives, the court correctly held that § 448(d)(7)(C) 's plain language did not compel a reading allowing taxpayers to report only one-tenth of the adjustment in 1987 for those hospitals that they ceased to operate. Although the statute gives "a hospital" ten years in which to report the § 481 adjustment, it does not address the situation where the taxpayer stops operating the hospital to which the § 481 adjustment relates. The Secretary's regulation reasonably fills the gap left open by the statute. And, as the Tax Court noted, by preventing the omission and distortion of income, the regulation is in harmony with the Congressional intent behind §§ 448(d)(7) and 481 and the entire statutory scheme.

[29] The decision of the Tax Court is correct and should be affirmed.

ARGUMENT

 

 

I

 

 

THE TAX COURT CORRECTLY HELD THAT THE REVISED FORMULA SET FORTH

 

IN TREAS. REG. § 1.448-2T TO ESTIMATE UNCOLLECTIBLE ACCOUNTS

 

RECEIVABLES IS VALID AS A REASONABLE CONSTRUCTION OF §

 

448(d)(5)

 

 

A. Introduction

 

 

[30] Prior to 1987, in lieu of the bad debt deduction authorized by § 166(a), accrual-basis taxpayers were allowed to create a reserve account for bad debts that were anticipated. I.R.C. § 166(c) (1985). A reserve for bad debts "was essentially an estimate of future losses that could reasonably be expected to result from debts outstanding at the close of the taxable year." 8 Mertens Law of Fed. Income Tax § 30.98 (2001) (emphasis added). Reasonable additions that a taxpayer made to the reserve account during the taxable year were deductible under § 166(c).

[31] The reserve method for computing the bad debt deduction was repealed by § 805(a) of the Tax Reform Act of 1986 (the 1986 Act), Pub. L. No. 99-514, 100 Stat. 2085, 2361. Congress believed that it was inappropriate to allow a deduction to taxpayers for a loss that occurs in the future, which was "inconsistent with the treatment of other deductions under the all events test." H.R. Rep. No. 99-426, 99th Cong., 1st Sess. 577 (1985); S. Rep. No. 99- 313, 99th Cong., 2d Sess. 155 (1986).

[32] At the same time that Congress repealed the reserve method for computing the bad debt deduction (and also required more taxpayers to shift to the accrual method of accounting under § 448(a)), it created a new mechanism by which some accrual-based taxpayers could account for bad debts attributable to services rendered before those debts became worthless, known as the "nonaccrual-experience method" of accounting. Section 448(d)(5) provides:

Special Rule for Services. -- In the case of any person

 

using an accrual method of accounting with respect to amounts to

 

be received for the performance of services by such person, such

 

person shall not be required to accrue any portion of such

 

amounts which (on the basis of experience) will not be

 

collected. This paragraph shall not apply to any amount if

 

interest is required to be paid on such amount or there is any

 

penalty for failure to timely pay such amount.

 

 

As is apparent, § 448(d)(5) does not provide a deduction for debts that become worthless to an accrual-based taxpayer that has already recognized income from the transaction giving rise to the receivable. Instead, it excludes from income a portion of an account receivable that would otherwise be included in income under the all events test.

[33] The nonaccrual-experience method provided by § 448(d)(5) is considered a method of accounting, and a taxpayer must elect to use it. Temp. Treas. Reg. § 1.448-2T(b). The nonaccrual experience method is not available to all taxpayers. Rather, only taxpayers that provide services and do not charge interest or a penalty for late payment may take advantage of § 448(d)(5), and even then, such a taxpayer may only use the method with respect to its service-related accounts receivables. See H.R. Rep. No. 99-426 at 608, Addendum, infra at 20. As a result, taxpayers in nonservice businesses, such as manufacturers or wholesalers, are not eligible to benefit from this exclusion. They must accrue income from their billings and await the worthlessness of a debt before deducting it under § 166(a). It is therefore clear that by creating § 448(d)(5), Congress was giving a special tax benefit to service providers and that it expressed "little concern for what the elimination of the bad debt reserve would do to other taxpayers." W. Eugene Seago, "The Tax Court's First Experience with the Non- Accrual-Experience Method," 86 J. Tax'n 284 (1997).

[34] Section 448(d)(5) provides that the exclusion from income be computed "on the basis of experience" of a particular taxpayer, but, apart from referencing the taxpayer's experience, it does not provide any guidelines on how to compute the exclusion. Guidance is found, however, in the legislative history. In the House Report, Congress described that the exclusion should be based on a formula comprised of a multiplicand and an experience ratio. The multiplicand was described as "the total amount billed" and the experience ratio was described as the amount determined to be uncollectible over the last five years divided by the total amount billed over the last five years. H.R. Rep. 99-426 at 608, Addendum, infra at 21. This formula can be illustrated as follows:

            Legislative history formula (first paragraph)

 

 

                                       Total amount billed

 

                         Total        over 5 previous

 

                         amount       years that was not

 

                         billed in    collected

 

Uncollectible amount =   tax year  X  ______________________

 

                         for each     Total amount billed

 

                         receivable   during 5 years

 

 

[35] But, as noted by the Tax Court, the example that followed in the next paragraph of the House Report was different. It described the same experience ratio as used in the previous paragraph, but it used a different multiplicand. Instead of using the multiplicand of the total amount billed in the current tax year, it described the multiplicand as the receivable existing "at [the] close of the taxable year." Id. In other words, the formula applied in the second paragraph is illustrated as follows:

           Legislative history formula (second paragraph)

 

 

                                          Total amount billed

 

                         receivable      over 5 previous

 

                         outstanding     years that was not

 

                         at close of     collected

 

Uncollectible amount =   taxable year X  ____________________

 

                                          Total amount billed

 

                                          during 5 years

 

 

[36] Eight months after the Tax Reform Act of 1986 was signed into law, the Secretary issued a temporary Treasury regulation interpreting the new provisions contained in § 448. T.D. 8143, 1987-2 C.B. 121 (June 16, 1987) (containing newly proposed Temporary Treasury Regulations §§ 1.448-1T & -2T). The Temporary Regulation was intended to apply "to any person using an accrual method of accounting" (Temp. Treas. Reg. § 1.448-2T(a)), and, for those taxpayers that adopted the nonaccrual experience method (Temp. Treas. Reg. § 1.448-2T(b)), the regulation prescribed a six-year moving average formula. The regulation provided that "[n]o other method or formula may be used by a taxpayer in determining the uncollectible amounts under this section." Temp. Treas. Reg. § 1.448-2T(e)(1).

[37] The original formula adopted by the Temporary Regulation was as follows:

     Original formula in temp. regulation (Black Motor formula)

 

 

                                           Total bad debts sustained

 

                                           in current and past 5

 

Uncollectible       Acct.                  years

 

amount          =   rec. at         x      __________________________

 

                    year end

 

                                           Sum of acct. rec. at close

 

                                           of current and past 5

 

                                           years

 

 

[38] The formula was the same as the one the Commissioner had developed to estimate bad debts under § 166(c), and that formula was approved by the Tax Court in 1940. Black Motor Co., Inc. v. Commissioner, 41 B. T. A. 300, aff'd on other grounds, 125 F.2d 955 (6th Cir. 1942). Taxpayers that used a reserve account had followed a simple formula to determine the bad debt deduction: Bad debt deduction = Ending Reserve Requirement + Actual Bad Debts (less recoveries) -Beginning Reserve. While the formula for computing the actual deduction was quite simple, it was necessary that a taxpayer compute his Ending Reserve Requirement (i. e., an estimate of future losses). Under the Black Motor formula, a taxpayer generally used a six-year history to compute its reserve requirement. For example, assume a taxpayer had an average account receivable balance at the end of each year of $1 million, and also assume that over that same time, taxpayer annually wrote off an average of $125,000 in bad debts. The taxpayer would have an experience factor of 12.5 percent ($125,000/$1,000,000). If the taxpayer had a current year-end account receivable balance of $1.25 million, it would have an ending reserve requirement of $156,250 ($ 1.25 M x 12.5%). Taxpayer's deduction for a reasonable addition to the bad debt reserve would then be computed by using this ending reserve requirement in the above formula.

[39] The Black Motor formula was not without some controversy. See Jules I. Whitman, John W. Gilbert & Peter J. Picotte, II, The Black Motor Bad Debt Formula: Why It Doesn't Work and How to Adjust It, 35 J. Tax. 366 (1971) (noting that the formula accurately predicts a taxpayer's bad debts as long as they are charged off after 12 months, but that the formula loses its accuracy when debts are charged off much sooner or much later) (cited by the Supreme Court in Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 550 n. 33 (1979)).

[40] Notwithstanding some criticism of the Black Motor formula, the Supreme Court approved its use in Thor Power Tool Co. v. Commissioner, supra. In that case, the company's new management undertook a stringent review of its accounts receivables and determined that it should write off specific percentages of its account receivables based on their age. The Commissioner disallowed the deduction as excessive and instead used the Black Motor formula. The Court noted that the taxpayer bore a "heavy burden" to "show not only that his own computation is reasonable but also that the Commissioner's computation is unreasonable and arbitrary." 439 U.S. at 548. The Court acknowledged that the Black Motor formula could be faulted "because of its retrospectivity," in that a taxpayer's most recent experience is not given greater weight than experience from several years prior, but that the faults of the Black Motor formula "fall[] short of rendering the formula arbitrary." Id. at 549. At all events, "the formula possesses the not inconsiderable advantage of enhancing certainty and predictability in an area peculiarly susceptible of taxpayer abuse." Ibid.

[41] The Thor Power Tool Court went on to note that the Commissioner had issued a formal ruling, Revenue Ruling 76-362, 1976- 2 C.B. 45, that adopted the Black Motor formula as a general rule, but allowed either the taxpayer or the Commissioner to depart from the formula "in light of facts existing at the close of the taxable year." The Court held that the taxpayer in the case before it failed to meet its difficult burden to show that the Commissioner's determination was unreasonable, and it specifically disagreed with that taxpayer's application of a "mechanical" formula that essentially reflected an aging of its accounts receivable. 439 U.S. at 550 n. 33. The Court noted that "[m]anagement's pessimism may not have been unreasonable, but the Commissioner had the discretion to take a more sanguine view." Ibid.

[42] Although the formula used to determine the uncollectible amount was the same as used previously under § 166(c), the method adopted in the original Temporary Regulation is referred to as the specific receivable method because there is no reserve account. Rather, the uncollectible amount was determined for each account receivable.7

[43] The Secretary explained his decision to issue a regulation that contained only one formula in the preamble of the Treasury Decision containing the Temporary Regulation. The Secretary noted that the House Report had contained a reference to a formula, and that "[t]he regulations provide that the six-year moving average method is the exclusive means for determining the uncollectible portion of accounts receivable under the nonaccrual-experience method. Thus other methods of estimating uncollectible amounts which were available under section 166 are not available under the nonaccrual-experience method." T.D. 8143, 1987-2 C.B. 122. The Secretary reprinted the written formula contained in the legislative history, and indicated that, "[b]ased on this language, the regulations adopt a six-year moving average method similar to the experience method under § 1.585-2(c)(1)."

[44] It is important to note that the legislative history of § 448(d)(5) was NOT describing the Black Motor formula, as the experience ratio used in that formula did not have a denominator of the total amount billed during the previous five years, but only the total of the accounts receivables outstanding at the close of the previous five years. H.R. Rep. No. 99-426 at 608, Addendum, infra at 69. The Black Motor formula used a six-year moving average comprised of the current year and the previous five years.

[45] The Secretary quickly recognized a flaw in the original formula adopted by the temporary regulation. It became apparent that some taxpayers were excluding from their income exorbitantly large amounts of their accounts receivables. This problem arose because the original formula is premised on the assumption that accounts receivables are written off after one year. See W. Seago, 86 J. Tax. at 286 (" Where the time required to determine the uncollectibiity of an account approximates one year, the Black Motor formula will yield the correct reserve balance."). If a taxpayer writes off receivables much faster than that, he will obtain an unwarranted benefit. Id. at 285 (" utility companies were obtaining bizarre results -- reserves of ten times the amounts required -- from applying the Black Motor formula").

[46] Ten months after the Secretary issued the original Temporary Regulation, he issued another Treasury Decision amending the formula. The Secretary noted that he had received questions from taxpayers expressing confusion over whether the denominator of the fraction was determined on the basis of total sales or year-end balances of accounts receivable. T.D. 8194, 1988-1 C.B. at 186, Addendum, infra, at 73. Accordingly, the Secretary amended the Temporary Regulation, changing the formula to reflect that the denominator in the formula should be the total accounts receivables of all services billed, and not just those outstanding at the close of the year. Therefore, the revised formula is the formula used in the example to the House Report (see page 28, supra), although the formula uses current year data along with the five-year history.

B. The Tax Court correctly held that taxpayers were

 

required to use the amended formula set forth in the

 

revised Temporary Regulation

 

 

[47] In the present case, taxpayers timely adopted the nonaccrual experience method of accounting, and they filed a statement indicating that they would follow the periodic system to compute the amount that should be excluded from income as provided in Notice 88-51. But contrary to Notice 88-51, taxpayers did not compute their excluded income based on the revised formula. There is no dispute that if they are required to follow the formula set forth in the regulation, then the Tax Court's decision as it relates to this issue should be affirmed. Taxpayers challenge the revised formula set forth in the Temporary Treasury regulation on three grounds: (1) that the formula is inconsistent with the plain meaning of the statute, (2) that the Temporary Regulation is invalid, and (3) that even if it is valid, that the Commissioner lacks authority to implement that regulation if taxpayers' method correctly reflected their income. None of their contentions has merit.

1. The "plain meaning" of § 448(d)(5)

 

does not require the Commissioner to permit

 

taxpayers to use the Black Motor formula

 

 

[48] The Tax Court correctly held § 448(d)(5) was ambiguous in that it did not specify how the exclusion from income should be computed. The proper starting point, as the Tax Court noted (R. 88 at 20-21; Apx. 320-21), is the statutory language. United States v. American Trucking Association, Inc., 310 U.S. 534, 542-43 (1940); Helvering v. Stockholdm Enskilda Bank, 293 U.S. 84, 93-94 (1934).

[49] Section 448(d)(5) provides that a taxpayer shall not be required to accrue income that "on the basis of experience" will not be collected. The Tax Court correctly held (R. 88 at 23; Apx. 323) that the "statute on its face . . . provides no formula for calculating the amount," and that the ordinary definition of the word "experience" is "[a]n event or series of events participated in" or "[t]he totality of such events in the past of an individual or group." The Tax Court was correct, therefore, in concluding that the statute was ambiguous. It is obvious that a taxpayer's actual past experience should be considered in reaching the exclusion amount, but it is not clear exactly what experience should be considered.

[50] Taxpayers argue (Br. 20-25) that the formula adopted by the Secretary is inconsistent with the statute, and they appear to alter the argument they made to the Tax Court. The Tax Court had rejected (R. 88 at 23-24; Apx. 324-24) taxpayers' argument that the phrase "on the basis of experience" meant the experience method as set forth in the Black Motor formula, pointing out other statutes where Congress plainly adopted a specific formula. Taxpayers do not resurrect that argument, but instead contend generally that the formula set forth in the regulation reaches a result that is contrary to the statute. But this argument is more appropriately viewed as a challenge to the regulation, because, as the Tax Court correctly held, the statute itself is ambiguous.8

2. The formula set forth in the Temporary Treasury

 

regulation is a reasonable interpretation of the

 

statute that finds direct support in the relevant

 

legislative history

 

 

[51] Courts have historically deferred to Treasury regulations when interpreting a taxing statute, and the standards applicable to determining the validity of a Treasury regulation are well established. The regulation must be upheld if it "implement[s] the congressional mandate in some reasonable manner." Rowan Cos. v. United States, 452 U.S. 247, 252 (1981) (internal quotation marks and citations omitted); Atlantic Mutual Ins. Co. v. Commissioner, 523 U.S. 382, 389 (1998); Cottage Savings Assn. v. Commissioner, 449 U.S. 554, 560-561 (1991). A reviewing court is not free to set aside a regulation merely because it would have implemented the statute in a different manner. Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 842-43 & n. 11, reh'g denied, 468 U.S. 1227 (1984) (" The court need not conclude that the agency construction was the only one it permissibly could have adopted to uphold the construction, or even the reading the court would have reached if the question initially had arisen in a judicial proceeding."); see Ohio Periodical Distributors, Inc. v. Commissioner, 105 F.3d 322, 324-326 (6th Cir. 1997) (applying Chevron to interpretive Treasury Regulation); Peoples Federal Savings and Loan Assn. v. Commissioner, 948 F.2d 289, 299- 300 (6th Cir. 1992)(same); cf. Nichols, 260 F.3d at 644 (applying Chevron standard to uphold "legislative" consolidated return regulation). Indeed, "[t]he choice among reasonable interpretations is for the Commissioner, not the courts." National Muffler Dealers Ass'n v. United States, 440 U.S. 472, 488 (1979). In determining the intent of Congress, when the statute itself is not clear, it is appropriate to consider the legislative history to ascertain congressional intent. Burlington Northern R. R. v. Oklahoma Tax Commission, 481 U.S. 454, 461 (1987); American Trucking Association, 310 U.S. at 543-44.

[52] This case involves the validity of a temporary Treasury regulation. Temporary regulations are to be accorded the same deference as final regulations. E.g., E. Norman Peterson Marital Trust v. Commissioner, 78 F.3d 797, 798 (2d Cir. 1996) (" Until the passage of final regulations, temporary regulations are entitled to the same weight we accord to final regulations"); Redlark v. Commissioner, 141 F.3d 936, 939-940 (9th Cir. 1998)(assessing validity of Treas. Reg. § 1.163-9T by reference to standard generally applicable to final regulations); Miller v. United States, 65 F.3d 687, 689 (8th Cir. 1995) (same).

[53] The Secretary's determination in the Temporary Regulation that a single formula should be used to determine a taxpayer's experience for determining the uncollectible amount of his receivables, and the actual parameters for the formula, is a reasonable interpretation of § 448(d)(5). Indeed, the formula adopted by the Secretary is the same formula used in an example in the legislative history. Taxpayers are wrong, moreover, to suggest (Br. 23-24) that the Supreme Court's decision in Thor Power Tool -- approving of the Secretary's position under § 166(c) that the Black Motor formula was not the exclusive formula for determining the bad debt deduction -- requires the Secretary to allow for more than one formula under § 448(d)(5). Nothing in the statute or legislative history behind § 448(d)(5) indicates that Congress intended to apply the law as developed under § 166(c). Indeed, had Congress intended to do so, it could have easily accomplished that task. Congress did not amend § 166(c) in 1986, but completely repealed it.

[54] Taxpayers contend that the amended formula is biased, but they gloss over the fact that the amended formula actually corrected a bias that existed in the original formula. As taxpayers point out (Br. 14), taxpayers such as utilities that wrote off bad debts very quickly received a benefit over taxpayers -- with the same gross income and the same bad debt experience -- that took much longer to write off their debts. By changing the denominator in the formula to reflect the sum of 6 years of total sales, instead of the sum of 6 years of year-end receivables, the Secretary eliminated that bias. This result is achieved because the new equation eliminates the variable of accounts receivable outstanding at the end of the year, which would differ among those taxpayers that collected their receivables at different paces, and replaces it with a gross sales figure.

[55] Taxpayers also gloss over the fact that the revised formula adopts one of the methods used in the legislative history, while their own approach (the Black Motor formula) is not found in either the statute or the legislative history. To be sure, the Secretary initially adopted the Black Motor formula before reconsidering his position. But he did so quickly -- even before HCA filed its 1987 tax return.

a. Contrary to taxpayers' contention, the Supreme

 

Court's decision in Meaddoes

 

not alter the Chevron deference

 

due the Temporary Regulation

 

 

[56] Taxpayers contend that the Supreme Court's recent decision in United States v. Mead Corp., 121 S. Ct. 2164 (2001), has effectively undercut the decisions that accord significant weight to Temporary Treasury Regulations. But Mead, which was not a tax case, does not stand for that proposition. Indeed, in Mead, the Court cited its decision in Atlantic Mutual, upholding an interpretive Treasury Regulation, as an instance of rulemaking that it had accorded Chevron deference, although in that decision it had not explicitly alluded to the Chevron standard. If Mead has any application in the tax area, it is only to require that some less formal decisions of the Internal Revenue Service, such as revenue rulings and procedures, be given greater deference by the courts than some courts had been giving them.9 Even before Chevron was handed down, the courts deferred to a Treasury Regulation as long as it "implement[ed] the congressional mandate in some reasonable manner." See United States v. Correll, 389 U.S. 299, 307 (1967); see Goodwin's Estate v. Commissioner, 201 F.2d 576, 581 (6th Cir. 1953) (" Treasury Regulations are ordinarily valid unless unreasonable or inconsistent with the statute"). Temporary Regulations are no less entitled to Chevron deference than permanent ones. To be sure, Temporary Regulations are generally adopted without the benefit of comments from the public, but only because the need for immediate guidance renders it is [sic] impracticable to await such comment. See T.D. 8143, 1987-2 C.B. at 186.

[57] Section 7805(a) directs the Secretary to "prescribe all needful rules and regulations for the enforcement" of the Code. Treasury regulations, temporary Treasury regulations, Revenue Rulings, and formal IRS Notices are among the formal documents issued by the National Office of the Internal Revenue Service. See Michael I. Saltzman, IRS Practice and Procedure ¶ 3.01 (2d ed. 1991) (table listing IRS statements ranging from regulations, which are the "most reliable statements of position" to communications that are clearly intended to be informal and nonbinding).

[58] The Supreme Court has long held that the Secretary's formal interpretations of statutes and regulations administered by the IRS are entitled to significant deference from the courts. In United States v. Correll, 389 U.S. 299 (1967), a grocery salesman in Tennessee attempted to deduct his breakfast and lunch expenses on his income tax return. Taxpayers are permitted to deduct their "traveling expenses (including amounts expended for meals and lodging) while away from home" on business. I.R.C. § 162(a)(2) (1958) (which had re-enacted a previous version of that statute). The Secretary of the Treasury had not issued any regulation on point, but the Commissioner had first interpreted the deductibility of these types of traveling expenses in a 1940 revenue ruling, I. T. 3395, 1940-2 C.B. 64, in what was known as the "overnight" or "sleep or rest" rule. 389 U.S. at 302 n.10, 306. As noted by the Court, "the Commissioner has consistently construed travel 'away from home' to exclude all trips requiring neither sleep nor rest, regardless of how many cities a given trip may have touched." Id. at 302-03 (footnotes omitted).

[59] The courts of appeals were divided over the interpretation of § 162(a)(2), and the Sixth and Eighth Circuits had declined to follow the Commissioner's established interpretation. The Correll Court held that the Commissioner's interpretation was not contrary to the statute, and that, because Congress re-enacted the statute after 1940, the Commissioner's interpretation should be deemed to have received congressional approval. Id. at 305. The Court went on to note, in an oft-quoted passage, that the Commissioner's "sleep or rest rule" as set forth in his revenue ruling must be sustained because it "implement[ ed] the congressional mandate in some reasonable manner" (id. at 306-07 (footnotes omitted)):

Alternatives to the Commissioner's sleep or rest rule are

 

of course available. Improvements might be imagined. But we do

 

not sit as a committee of revision to perfect the administration

 

of the tax laws. Congress has delegated to the Commissioner, not

 

to the courts, the task of prescribing "all needful rules

 

and regulations for the enforcement" of the Internal Revenue

 

Code. 26 U.S.C. § 7805(a). In this area of limitless factual

 

variations "it is the province of Congress and the

 

Commissioner, not the courts, to make the appropriate

 

adjustments." Commissioner v. Stidger, 386 U.S. 287,

 

296. The rule of the judiciary in cases of this sort begins and

 

ends with assuring that the Commissioner's regulations fall

 

within his authority to implement the congressional mandate in

 

some reasonable manner. Because the rule challenged here has not

 

been shown deficient on that score, the Court of Appeals should

 

have sustained its validity.

 

 

See also United States v. Cleveland Indians Baseball Co., 121 S. Ct. 1433, 1444-45 (2001).

[60] The question recently addressed by the Supreme Court in Mead was whether Customs Service rulings are entitled to judicial deference. The Customs Service issues ruling letters at any of its 46 port-of-entry offices, id. at 2169, and it issues 10,000 to 15,000 rulings each year. Id. at 2174. It had issued a ruling letter that directly addressed the issue presented to the lower courts in Mead, involving the tariff classification for imported "day planners." Under the ruling, the day planners were subject to tariff. The Federal Circuit ruled in favor of the importer in Mead, however, holding that the courts owed no deference to that tariff classification ruling.

[61] The Supreme Court vacated the Federal Circuit's decision. The Court, citing Skidmore v. Swift & Co., 323 U.S. 134 (1944), noted that "[t]he fair measure of deference to an agency administering its own statute has been understood to vary with circumstances, and courts have looked to the degree of the agency's care, its consistency, formality, and relative expertness, and to the persuasiveness of the agency's position." Mead, 121 S. Ct. at 2171. The Court declined to give so-called Chevron deference -- where the agency interpretation is binding in court unless arbitrary or capricious or manifestly contrary to the statute -- to the Customs Service ruling. Nevertheless, the Court held that the Federal Circuit erred in giving the ruling no deference at all. The Court directed the Federal Circuit, on remand, to afford the deference prescribed under Skidmore v. Swift & Co. to the Customs Service ruling. 121 S. Ct. at 2175-76.

b. In any event, the Temporary Regulations are

 

entitled to deference under Mead

 

 

[62] Mead does not speak directly to guidance issued by the Treasury with respect to tax matters, but it is apparent that even if the so-called Skidmore factors are applied, Temporary Regulations are entitled to deference under Correll and Mead.

i. Degree of care

[63] Treasury regulations and temporary regulations approved by the Secretary under the express authority provided by 26 U.S.C. § 7805(a) are a paradigmatic example of a formal rule, issued by a "central board or office" in the format prescribed by Congress, to which deference is due. See Mead, 121 S. Ct. at 2176; Correll, 389 U.S. at 307. These regulations are written and reviewed at the highest level of the IRS and the Department of the Treasury.10 Treasury Decisions, Treasury Regulations, Temporary Regulations, and Revenue Rulings are all officially published in the Internal Revenue Bulletin and Cumulative Bulletin (and Treasury Decisions containing temporary and permanent regulations are also published in the Federal Register), and they are expressly adopted to serve as binding precedent.

[64] Unlike the unpublished Customs Service rulings at issue in Mead, where 10,000 to 15,000 were issued each year from 46 different offices, the Internal Revenue Service in 1999 issued only 59 Treasury Decisions and 58 Revenue Rulings, all of which were published. All Treasury Decisions and Revenue Rulings are issued by the IRS National Office in Washington, D.C. It is therefore manifest that Treasury Decisions containing temporary regulations are issued with great care.

ii. Consistency

[65] Treasury Decisions containing temporary regulations, moreover, are published to guide taxpayers and to promote the uniform application of the tax laws by IRS personnel, and they are intended to be binding on taxpayers and the Commissioner. There is no question in this case that the IRS has consistently applied the revised formula to all taxpayers that qualify for the nonaccrual method. To be sure, the Secretary revised the original formula, but he did so quickly, and the application of the amended formula has been consistent. As the Tax Court observed (R. 88 at 31; Apx. 331), the Secretary was entitled to alter his interpretation of the statute on further reflection. Rust v. Sullivan, 500 U.S. 173, 186 (1991); Chevron, 467 U.S. at 862; Peoples Federal Savings & Loan, 948 F.2d at 302.

iii. Formality

[66] A leading commentator has described the detailed and thoughtful procedure followed by the Secretary in issuing his regulations. See Saltzman, IRS Practice and Procedure at ¶ 3.02[2] (describing process followed by the Secretary in promulgating a regulation). As reflected in Mr. Saltzman's treatise, the procedure followed by the Secretary is a formal procedure that ensures adequate review at the highest levels of the Internal Revenue Service and the Treasury Department.

[67] It is true that while Temporary Regulations and permanent regulations generally follow the same process, there is one difference. Temporary Regulations are issued and become effective before notice and comment, because it is impracticable to await notice and comment before giving immediate guidance, while permanent regulations generally are not issued until after the notice and comment period has passed. (See T.D. 8194, 1987-2 C.B. at 186-187 (" A general notice of proposed rulemaking is not required by 5 U.S.C. 553 for temporary regulations.").) But as noted by Saltzman, "[t]he Treasury has frequently issues temporary regulations for immediate guidance where substantial legislation has been enacted." IRS Practice and Procedure at ¶ 3.02[3].

[68] Taxpayers appear to argue (Br. 28-29) that all Temporary Regulations, and indeed, all other agency guidance that is issued without the notice-and-comment provisions of the Administrative Procedure Act, 5 U.S.C. § 553(b)(3)(A) (which do not apply to interpretative regulations), are no longer entitled to judicial deference. But, as the Supreme Court noted in Mead, that does not foreclose the application of substantial deference to such rulings: "[T]he want of that procedure here does not decide the case, for we have sometimes found reasons for Chevron deference even when no such administrative formality was required and none was afforded." 121 S. Ct. at 2173.

[69] But in this case all taxpayers have been given notice of the revised formula and the opportunity to be heard. A hearing was held on December 1, 1988. See, e. g., Michael Moriarty, "Accountants and Treasury Debate Nonaccrual Experience Method," 88 Tax Notes 242 (1988) (describing the hearing). In that debate, Thomas Evans, the Treasury's Associate Tax Legislative Counsel, noted that "the legislative history clearly does not embrace the Black Motor formula," but instead that "the proposed regulations closely follow an example of the statutes application provided in the House Report." Id. In fact, Stephen Gertzman, who was among the attorneys who represented taxpayers below (but who has not entered an appearance on appeal) attended the hearing and argued that taxpayers should be allowed to depart from the single formula. Id. Evans disagreed and noted that while the revised formula is not perfect, "its 'net result will be fair' and will be an improvement over allowing the taxpayer to 'pick and choose' among nonaccrual ratio methods." Id. As a result, taxpayers in general, as well as taxpayers here in particular, have been given ample opportunity to comment on the Secretary's position.

[70] To demonstrate the error in taxpayers' argument that the only administrative pronouncements that are entitled to deference are those issued after the opportunity for notice and comment, this court need look no further than the Supreme Court's decision in Correll. The agency interpretation at issue in that case was a revenue ruling that was not issued with notice and comment (before or after its issuance). Yet the court treated the Commissioner's ruling as authoritative. Since the Supreme Court has cited Correll with approval in a tax case as recently as last term (at the same time it was considering Mead), it would be inappropriate to read Mead, which was not a tax case, as overruling Correll.

iv. Relative expertness

[71] The Internal Revenue Code has been described as "the most technical and complex of all federal statutory schemes." David A. Brennen, Treasury Regulations and Judicial Deference in the Post- Chevron Era, 13 Ga. St. U. L. Rev. 387, 388 (1997). Congress has delegated to the Treasury the authority to administer and enforce the Internal Revenue Code. I.R.C. § 7801(a). In recognition of the specialized nature of the Department of Treasury, Congress has authorized the Secretary to "prescribe all needful rules and regulations" to interpret and enforce the Internal Revenue Code. I.R.C. § 7805. There is simply no question as to the specialized knowledge possessed by Treasury employees, which satisfies any "relative expertness" requirement of Mead.

[72] Taxpayers suggest (Br. 26-27) that the regulation is entitled to less deference because it is an interpretive regulation (issued under the Secretary's general authority under § 7805) rather than a legislative regulation (where the substantive statute itself directs the Secretary to issue further guidance). But historically, the Supreme Court has given great deference to interpretive regulations, see Commissioner v. South Tex. Lumber Co., 333 U.S. 496, 501 (1948), and will apply them noting that "the choice among reasonable interpretations is for the Commissioner, not the courts," National Muffler Dealers Ass'n, 440 U.S. at 488. Nothing in Mead can be read to overrule this earlier authority.

v. Persuasiveness of agency's opinion

[73] A review of the preamble to the amended Temporary Regulations, T.D. 8194, 1988-1 C.B. at 122, Addendum, infra at 73, and Notice 88-51, 1988-a C.B. 736, 742-44, Addendum, infra, at 75, which gives guidance on the periodic system, together with press reports of the debate that occurred at the public hearing, makes it clear that Treasury and the IRS have explained the rationale for their decisions. As described in the preamble, the Secretary made the change after receiving questions from taxpayers and after reflecting further on the Congressional statements contained in the House Report.

[74] Taxpayers also argue that the Secretary is obligated to demonstrate that his formula must accurately predict each taxpayer's uncollectible receivables, but this approach is misguided. It is the Secretary's job to attempt to implement the statute as intended by Congress. The formula applied by the Secretary, taken directly from the House Report, cannot be said to be contrary to congressional intent.

3. The Commissioner acts well within his authority to

 

require a taxpayer to follow a regulation that

 

reasonably implements the intent of Congress

 

 

[75] Taxpayers argue (Br. 33-37) that the Commissioner cannot be permitted to require them to change from one approved method of accounting to another, if taxpayers' method of accounting clearly reflects their income. We do not quarrel with that general proposition, but it has no bearing here, where regulations provide the sole method of accounting for an item. The Supreme Court in Thor Power Tool rejected essentially the same argument that taxpayers are making here, in refusing to allow the taxpayer to jettison the method developed by the Commissioner in favor of one that comported with generally accepted accounting principles. 439 U.S. at 548-549.

II

 

 

THE TAX COURT CORRECTLY HELD THAT THE TAXPAYERS THAT CEASED

 

OPERATING THE HOSPITALS SOLD TO HEALTHTRUST IN 1987 WERE

 

REQUIRED TO RECOGNIZE THAT YEAR THE BALANCES OF THE § 481

 

ADJUSTMENTS OCCASIONED BY THOSE HOSPITALS' CHANGE IN ACCOUNTING

 

METHOD

 

 

A. Introduction

[76] Section 448, which took effect in 1987, required those of taxpayers using the hybrid, part-cash method of accounting to switch to the accrual method. This change in accounting occasioned a § 481 adjustment because those taxpayers had deferred income under that hybrid method of accounting that would have been recognized under the accrual method. Since they had reported income from services on the cash basis, no income had been recognized in 1986 respecting a patient treated that year who did not pay until 1987. But since the accrual method calls for recognizing income when the services are performed, the income did not accrue in 1987. By requiring this income that would otherwise be omitted to be taken into account, § 481 ensures that the item does not escape taxation.

[77] Section 448(d)(7), which contains special rules regarding the § 481 adjustment to be made in a case where the taxpayer was required to change its method of accounting, states as follows:

(7) Coordination with section 481. -- In the case of

 

any taxpayer required by this section to change its method of

 

accounting for any taxable year --

 

 

(A) such change shall be treated as initiated by the

 

taxpayer,

 

 

(B) such change shall be treated as made with the

 

consent of the Secretary, and

 

 

(C) the period for taking into account the adjustments

 

under section 481 by reason of such change --

 

 

(i) except as provided in clause

 

 

(ii), shall not exceed 4 years, and

 

 

(ii) in the case of a hospital, shall be 10

 

years.

 

 

[78] As originally reported by the House Committee on Ways and Means on December 7, 1985, the provision in the bill that culminated in § 448(d)(7)(C) provided that "the period for taking into account the adjustment under section 481 by reason of such change shall not exceed 5 years (10 years in the case of a hospital described in section 144(b)(3))." H.R. 3838, 99th Cong., 1st Sess., § 902 (1985). The House Report stated in part that, "[ i] n the case of the business of operating a hospital, the transitional rules will apply with the section 481 adjustment amount to be included in income over a period not to exceed ten taxable years, rather than five." H.R. Rep. No. 99-426, 99th Cong., 1st Sess. 609 (1985).

[79] The House Report further stated, regarding the timing of the § 481 adjustment, that "[ i] t is expected that the concepts of Revenue Procedure 84-74, 1984-2 C.B. 736, generally will apply to determine the actual timing of recognition of income or expense as a result of the adjustment.[]" H.R. Rep. No. 99-426 at 608-609 (footnote omitted). The Senate Report contained this same language. S. Rep. No. 99-313, 99th Cong., 2d Sess. 119 (1986). The Conference Report states in pertinent part that "In the case of a hospital, the adjustment shall be taken into account ratably over a 10-year period" (H.R. Conf. Rep. No. 99-841, 99th Cong., 2d Sess. II-288 (1986)) and that it was intended 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." Id. at II-289.

[80] Revenue Procedure 84-74, 1984-2 C.B. 736, outlined the procedures under Treas. Reg. § 1.446-1(e) for obtaining the Commissioner's consent to a change of accounting method,11 including rules regarding the timing of a § 481 adjustment. It provided that, in general, "the total net adjustment is to be taken into account ratably over the number of tax years (not to exceed 6) the taxpayer has used the method of accounting that is being changed." Id. at § 5.06(1)(e), 1984-2 C.B. at 742-43, Addendum, infra. Therefore, if a taxpayer used the cash method for three years, and then switched to the accrual method, the § 481 adjustment was required to be taken into account over three years. The Revenue Procedure further provided, however, that if the taxpayer stopped operating the business to which the § 481 adjustment related, the remaining § 481 adjustment was to be immediately accelerated. Id., § 5.09, 1984-2 C.B. at 744, Addendum, infra.12 In other words, the Revenue Procedure set forth general timing rules in § 5.06, but overrode those rules in § 5.09 by requiring acceleration of the § 481 adjustment if the taxpayer ceased to operate the business to which the adjustment related. For this point, the Revenue Procedure cited Revenue Ruling 80-39, 1980-1 C.B. 112, 113, which noted that if a taxpayer were to continue to spread the § 481(a) adjustment relating to a trade or business in which it no longer engaged, a distortion in its income would result.

[81] Against this backdrop, the Secretary issued a temporary regulation on June 16, 1987 (T.D. 8143, 1987-2 C.B. 121), which was adopted in final form, with slight modifications, in 1994 (T.D. 8514, 1994-1 C.B. 141). Treas. Reg. § 1.448-1(g)(2) provides, in relevant part as follows:

(2) Timing rules for section 481(a) adjustment -- (i) In

 

general. Except as otherwise provided in paragraph (g)(2)(ii)

 

and (g)(3) of this section, a taxpayer required by this section

 

to change from the cash method must take the section 481(a)

 

adjustment into account ratably (beginning with the year of

 

change) over the shorter of --

 

 

(A) The number of taxable years the taxpayer used the

 

cash method, or

 

 

(B) 4 taxable years.

 

 

(ii) Hospital timing rules -- (A) In general. In

 

the case of a hospital that is required by this

 

section to change from the cash method, the section

 

481(a) adjustment shall be taken into account ratably

 

(beginning with the year of change) over 10 years.

 

 

. . .

 

 

[82] It is clear under the foregoing provision that a hospital is treated more favorably than any other business with respect to whether the spread period can be reduced. For example, if a business other than a hospital is in operation for only three years prior to 1987, it may spread the § 481 adjustment only over three years. Treas. Reg. § 1.448-1(g)(2)(i)(A). But a hospital, even if in existence for only three years prior to 1987, may still spread the § 481 adjustment over ten years. Treas. Reg. § 1.448- 1(g)(2)(ii). Similarly, Treas. Reg. § 1.448-1(g)( 3)(i) applies a so-called "one-third" rule relating to taxpayers that have quickly recovered their accounts receivables, and it shortens the § 481 spread period because of those quick recoveries. But that provision of the regulation specifically provides that it "shall not apply to any hospital." The regulation manifestly recognizes, as a general rule, that the spread period for hospitals should not be shortened.

[83] Although the regulation does not apply to a hospital those rules that shorten the spread period for other taxpayers when the business to which the § 481 adjustment relates is still ongoing, it does include hospitals within the cessation of business rule also adopted therein. Treas. Reg. § 448-1(g)(3)(iii) provides in pertinent part as follows:

(3) Special timing rules for section 481(a) adjustment --

 

. . .

 

 

. . .

 

 

(iii) Cessation of trade or business. If a taxpayer

 

ceases to engage in the trade or business to which the

 

section 481(a) adjustment relates, or if the taxpayer

 

operating the trade or business terminates existence, and

 

such cessation or termination occurs prior to the

 

expiration of the adjustment period described in paragraph

 

(g)(2)(i) or (ii) of this section, the taxpayer must take

 

into account, in the taxable year of such cessation or

 

termination, the balance of the adjustment not previously

 

taken into account in computing taxable income. . . .

 

 

B. The Tax Court correctly applied the cessation of

 

business provision to taxpayers

 

 

[84] In this case, HCA sold more than 100 of its hospitals in 1987. The timing of the § 481 adjustment is in dispute only in instances relating to the businesses of the hospitals that were transferred by some of taxpayers to new subsidiaries, the stock of which was immediately distributed to HCAII and sold to HealthTrust. Taxpayers argued that, by reason of the fact that they continued to operate other hospitals, they were entitled to spread the § 481 adjustments attributable to the businesses of the hospitals sold over 10 years, even though they were no longer operating those businesses. They challenge the validity of the cessation-of-business rule provided in Treas. Reg. § 1.448-1(g)(3)(iii) as being contrary to the plain language of § 448(d)(7)(C). As we shall show, however, the Tax Court correctly upheld the regulation as valid.

1. Section 448(d)(7) contains a latent

 

ambiguity, in that it fails to address the

 

timing of the § 481 adjustment if the

 

taxpayer ceases to operate the business to

 

which that adjustment relates

 

 

[85] Citing § 448(d)(7)(C)'s provision that the period for taking a § 481 adjustment into account "in the case of a hospital, shall be 10 years," whereas in the case of other businesses, the spread "shall not exceed 4 years," taxpayers argue that the cessation of business provision of Treas. Reg. § 1.448-1(g)(3)(iii) is invalid, as applied to a § 481 adjustment arising from a hospital. They contend that the regulation is contrary to the statute's plain language. The Tax Court correctly rejected taxpayers' contention, noting that it did "not agree[] . . . that the wording of the statute requires the conclusion that under no circumstances may the 10-year spread for hospitals be shortened." (R. 87 at 18; Apx. 284.) Indeed, it is only by reading the phrase "shall be 10 years" in isolation that taxpayers' conclusion is necessarily reached, and such a shortsighted reading would violate settled principles of statutory construction. The court must "examine first the language of the governing statute, guided not by a single sentence or member of a sentence, but looking to the provisions of the whole law, and to its object and policy." John Hancock Mutual Ins. Co. v. Harris Trust & Savings Bank, 510 U.S. 86, 94 (1993) (internal quotations and citations omitted); see Beecham v. United States, 511 U.S. 368, 372 (1994) (" the plain meaning that we seek to discern is the plain meaning of the whole statute, not of isolated sentences").13

[86] As the Tax Court correctly observed (R. 87 at 20; Apx. 286), the statute is ambiguous in that "section 448(d)(7)(C) gives no indication that Congress gave any consideration to the treatment of the section 481(a) adjustment where a hospital ceases to engage in the trade or business giving rise to that section 481(a) adjustment or where the hospital terminates existence prior to the end of the spread period." As discerned by the Tax Court, Congress used the word "taxpayer" twice in § 448(d)(7), but it chose to use the word "hospital," and not taxpayer, when it provided the ten-year period. And as the Tax Court further noted (id.), Congress did not address the situation where the taxpayer engages in the business of operating hospitals, plural; it created a 10-year spread "in the case of a hospital," singular, generating (and leaving unaddressed) the critical question whether the tax benefit of the spead belongs to the hospital to which the § 481 adjustment relates or to the taxpayer that owns that hospital. Taxpayers attempt to downplay this significant difference in word choice by contending (Br. 46-47) that Congress must have meant to refer to the taxpayer that owns a hospital, "because a hospital does not pay taxes." But the language of the statute is not so clear. Congress could just as well have meant, and probably did mean, to allow only a hospital that continues to operate to spread the adjustment over ten years.

[87] When the phrase taxpayers rely upon is construed in light of the statute as a whole, including its purposes, the fallacy of their proposed construction becomes apparent. The court's task was to read § 448(d)(7)(C) in a manner so as to "fullfil the congressional objective of coordinating section 448(a) and section 481(a) in a reasonable manner." (R. 87 at 30; Apx. 296.) As noted by the Tax Court (id. at 31, Apx. 297), "a cessation-of-business provision appears to have been included customarily as a condition to consent to a spread of a section 481(a) adjustment whenever the Commissioner issued a change in accounting method ruling." E.g., Rev. Rul. 80-39, supra. Given that Congress expressly chose to structure the change in accounting method as one initiated by the taxpayer to which the Commissioner consented, see § 448(d)(7)(A), (B), there is every reason to infer that it wished to trigger the concepts attendant to such changes, including the cessation-of- business rule, a salutary rule that prevents the distortion of income.

[88] As the Tax Court further noted, if taxpayers' interpretation is correct, a substantial risk is created that the § 481 adjustment might go unpaid. If the taxpayer ceases to exist, it would make no sense to allow the taxpayer to liquidate without paying the full § 481 adjustment. And even if the taxpayer continues to exist, but no longer receives any income from the operation of the hospital, that taxpayer will depend on revenue unrelated to the hospital to pay the § 481 adjustment. Whether such revenue will exist in ten years will of course be unknown during the first year. In this case, there is no indication that HCA's other operations will not be able to fund the § 481 adjustment of the hospitals that it sold to HealthTrust. But it does not require much imagination to envision any number of circumstances where a taxpayer might not retain the wherewithal to pay tax on the adjustment over ten years, resulting in a loss of revenue.

[89] In fact, taxpayers recognize that their reading of § 448(d)(7) might lead to that situation where the § 481 adjustment would not be paid, and they agree that this result would be untenable. They nevertheless suggest (Br. 49) that this result could be avoided by application of the "general principle[] of tax law" that "income is to be taxed to whomever earns it," and that, if the Commissioner anticipated being placed in the situation where a taxpayer would not pay the tax, he could assess a tax liability and rely on the courts to sustain the tax under that general principle.14 The cases taxpayers cite, however, do not involve § 481 adjustments relating to a particular business that has ceased to operate, but unreported income that has not been reported by a corporation that is liquidating. These cases do not purport to apply to the circumstances that might result here, where the corporations have not and might not ever liquidate.

2. The regulation reasonably implements the intent of

 

Congress

 

 

[90] The Tax Court correctly held that the regulation reasonably implemented the intent of Congress, and this Court should defer to the Secretary's decision. The regulation appropriately recognizes that a hospital is to be given a special benefit in § 448(d)(7) that is not available to other taxpayers. Indeed, as long as the taxpayer is still operating the hospital to which the § 481 adjustment relates, the ten-year period cannot be shortened.

[91] In this case, as the Tax Court observed (R. 87 at 20; Apx. 286), neither the statute nor the legislative history directly addressed the situation where the hospital ceases to engage in the trade or business or terminates its existence prior to the spread period, and the statute "left gaps creating ambiguity as to its precise meaning." (Id.) Analyzing the purpose of the § 481 adjustment and the spread period allowed by § 448(d)(7), the court aptly concluded (id. at 25-26) that "in the absence of a cessation-of-business acceleration provision, a taxpayer could contravene the general intent of section 481(a), which is to prevent the omission or duplication of an item of income or expense as a result of a change in the method of accounting, by merely restructuring its business."

[92] Although taxpayers correctly note (Br. 53) that the Conference Report stated that "[t]he 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," and that that Revenue Procedure contained the cessation of business rule, the conferees' statement may fairly be reconciled with the regulation's adoption of a cessation-of-business provision. H.R. Conf. Rep. 99-841 at II-289. As noted above, the Revenue Procedure contained general timing rules in § 5.06, but the cessation-of-business rule was contained in § 5.09. It is reasonable to infer that the conferees were referring to the Revenue Procedure's general timing rules, rather than also to its cessation- of-business provision. For example, the conferees made it clear that they intended the matter to be one of "timing" and not avoidance. Id. at II-289. The Tax Court therefore was correct (R. 87 at 30; Apx. 296) in refusing to "read the cryptic passage in the conference report as a clear expression of congressional intent to restrict the Commissioner's authority to compel acceleration" in the situation where the hospital to which the § 481 adjustment relates ceases doing business. The Secretary's adoption of a regulation restricting the circumstances in which the ten-year spread period may not be shortened to those other than the cessation of the business to which the § 481 adjustment relates may be harmonized with the sentence in the Conference Report, if both are read in light of the accounting provisions' general goal of preventing the omission and distortion of income.

CONCLUSION

[93] For the foregoing reasons, the decision of the Tax Court should be affirmed.

EILEEN J. O'CONNOR

 

Assistant Attorney

 

General

 

TERESA E. McLAUGHLIN

 

(202) 514-4342

 

THOMAS J. SAWYER

 

(202) 514-8129

 

Attorneys

 

Tax Division

 

Department of Justice

 

Post Office Box 502

 

Washington, D.C. 20044

 

 

NOVEMBER 2001

CERTIFICATE OF COMPLIANCE WITH TYPE VOLUME LIMITATION

[94] I certify that this brief complies with the type volume limitation set forth in Rule 32(a)(7)(C) of the Federal Rules of Appellate Procedure. The brief contains 13,602 words.

THOMAS J. SAWYER

 

Attorney

 

 

CERTIFICATE OF SERVICE

[95] It is hereby certified that service of this brief has been made on counsel for the appellant by mailing two copies thereof on this 16th day of November, 2001, in an envelope, properly addressed as follows:

N. Jerold Cohen, Esquire

 

Walter H. Wingfield, Esquire

 

Teresa W. Roseborough, Esquire

 

Amanda B. Scott, Esquire

 

Matthew J. Gries, Esquire

 

Thomas A. Cullinan, Esquire

 

Sutherland Asbill & Brennan LLP

 

999 Peachtree Street, N. E.

 

Suite 2300

 

Atlanta, Georgia 30309-3996

 

 

THOMAS J. SAWYER

 

Attorney

 

 

APPELLEE'S DESIGNATION OF JOINT APPENDIX

[96] The appellee designates no additional items in the record to be included in the joint appendix.

ADDENDUM

 

 

1. H.R. Rep. No. 99-426, reprinted in, 1986-3 C.B. (vol. 3) 604-609

 

(excerpts relating to nonaccrual experience and 10-year spread

 

issues)

 

 

2. Treas. Dec. 8143, 1987-2 C.B. 121, 122 (excerpts from preamble

 

relating to original formula for nonaccrual experience)

 

 

3. Treas. Dec. 8194, 1988-1 C.B. 186 (excerpts from preamble related

 

to revised formula for nonaccrual experience)

 

 

4. Notice 88-51, 1988-1 C.B. 535 (regarding periodic method for

 

nonaccrual experience method)

 

 

5. Rev. Proc. 84-74, 1984-2 C.B. 736, 742-44 (excerpts relating to

 

timing of section 481 adjustment)

 

FOOTNOTES

 

 

1 "R." references are to the documents comprising the original record on appeal, as numbered by the Clerk of the Tax Court. "Apx." references are to the deferred appendix.

2 The Tax Court's opinions on issues no longer in dispute are reported at 67 T.C.M. (CCH) 2369 (1994) (R. 19) (motion to compel production); 71 T.C.M. (CCH) 2319 (1996) (R. 84) (permissibility of use of hybrid method of accounting for years before 1987); 72 T.C.M. (CCH) 1581 (1996) (R. 89) (amount realized on sale of subsidiaries' stock); 109 T. C. 21 (1999) (R. 90) (depreciation); 74 T.C.M. (CCH) 1020 (1997) (R. 91) (captive insurance).

3 Under the cash receipts and disbursements method of accounting, see I.R.C. § 446(c)(1); Treas. Reg. § 1.446- 1(c)(1)(i) (26 C.F.R.), a taxpayer generally includes an item in income in the year when it is actually or constructively received, Treas. Reg. § 1.451-1(a), and deducts an expense in the year paid, Treas. Reg. § 1.461-1(a)(1). Under the accrual method, see I.R.C. § 446(c)(2); Treas. Reg. § 1.446-1(c)(1)(ii), income is generally recognized in the year in which all the events have occurred that fix the taxpayer's right to receive the income and the amount thereof can be determined with reasonable accuracy, Treas. Reg. § 1.451-1(a), while expenses are deductible in the year in which all the events have occurred that establish the fact of liability, the amount of the liability can be determined with reasonable accuracy and economic performance has occurred, see Treas. Reg. § 1.461-1(a)(2); I.R.C. § 461(h).

4 Although both the original and amended formulas applied the fraction to each receivable, in order to relieve taxpayers of the administrative burden of tracking such items individually, the Commissioner established the so-called "periodic system," a method "somewhat similar to a reserve method" that establishes an account for the aggregate amount of accounts receivable that will not be collected, rather than separately considering each receivable. Notice 88-51, 1988-1 C.B. 535, 536, Addendum, infra. At yearend, the account is adjusted to reflect the amount that it is estimated will not be collected on outstanding accounts receivable, and income is increased to reflect any decrease in the reserve balance or decreased to reflect any increase therein. Id.

5 In some instances, HCA sold the stock of corporations that operated only one hospital to HealthTrust. (R. 44, Stip. ¶¶ 155, 161.) There is no dispute as to the timing of the § 481 adjustment in those cases.

6 A final regulation, Treas. Reg. § 1.448- 1(g)(3)(iii), adopted in 1993 by T.D. 8514, 1994-1 C.B. 141, and made applicable to post-1986 taxable years, contains essentially the same provision as was found in the Temporary Regulation. As the Tax Court noted, taxpayer does not dispute that the final regulation applies here. (R.87, Opinion at 28 N.13; Apx. 294)

7 The Temporary Regulation did not create a method similar to the reserve account used in former § 166(c), but the Secretary did acknowledge that the House Report gave authority to him to adopt a "periodic system" to compute the uncollectible portion of accounts receivables. The Secretary "specifically invite[ d] comments on the operation of a periodic system of applying the non-accrual-experience method, and the manner in which a taxpayer using that system would account for wholly or partially worthless debts." T.D. 8143, 1987-2 C.B. at 122, Addendum, infra at 72. At approximately the same time that the Secretary revised the Temporary Regulation (as we discuss infra), the Secretary also implemented a periodic system to be used at the taxpayer's election (as it was by taxpayers here) under the nonaccrual-experience method. See Notice 88-51, 1988-1 C.B. 535, Addendum, infra at 75-77. The periodic system implemented by Notice 88- 51 is similar to the reserve method used under former § 166(c). Instead of applying the experience factor to each account receivable arising during the year, as is the case under the separate- receivables method, a taxpayer establishes an account representing all amounts that it estimates will not be collected (regardless of when the receivable was created). See p. 9 n. 4, supra. Notice 88-51 provided that the experience factor provided in the formula in the revised Temporary Regulation was to be followed in the periodic system.

8 Taxpayers rely on the proposition that, in hindsight, their approach worked better than the Secretary's in this particular case. But § 448(d)(5) necessarily requires the parties to estimate future debts that will become uncollectible, and not keep a tax year open until an amount can be determined with certainty based on subsequent events.

9 This Court already accords some deference under Chevron to Revenue Rulings. E. g., Wuebker v. United States, 205 F.3d 897, 903 (6th Cir. 2000); Johnson City Medical Center v. United States, 999 F.2d 973, 976 (6th Cir. 1993); CenTRA, Inc. v. United States, 953 F.2d 1051, 1056 (6th Cir. 1992).

10See Treas. Order 111-2, 1981-1 C.B. 698, 699 (" final determination of the Treasury Department's position" on Treasury regulations and published Revenue Rulings has been delegated by the Secretary to the Assistant Secretary (Tax Policy)).

11 Recall that, under § 448(d)(7)(A) and (B), the change in accounting method, although required by § 448(a), was to be treated as having been initiated by the taxpayer and consented to by the Commissioner.

12 Revenue Procedure 84-74 has now been superseded by Revenue Procedure 97-27, 1997-1 C.B. 680, which maintains the cessation of business rule.

13 Even the ascertainment of a meaning apparent on the face of a statute need not end the inquiry. Train v. Colorado Public Interest Research Group, 426 U.S. 1, 10 (1976); United States v. American Trucking Ass'n, Inc., 310 U.S. 534, 544 (1940). The plain meaning rule, after all, is "an axiom of experience rather than a rule of law, and does not preclude consideration of persuasive evidence if it exists." Boston Sand Co. v. United States, 278 U.S. 41, 48 (1928) (Holmes, J.); see Cabell v. Markham, 148 F.2d 737, 739 (2d Cir.) (L. Hand, J.), aff'd, 326 U.S. 404 (1945).

14 Taxpayers cite Cloward Instrument Corp. v. Commissioner, 52 T.C.M. (CCH) 34 (1986), aff'd without published opinion, 842 F.2d 1294 (9th Cir. 1988) (Br. 49), for that proposition. But it is apparent that the assignment of income principle was an important factor before the Tax Court in that case.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Case Name
    HOSPITAL CORPORATION OF AMERICA & SUBSIDIARIES, Petitioner-Appellant v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee
  • Court
    United States Court of Appeals for the Sixth Circuit
  • Docket
    No. 01-1810
  • Institutional Authors
    Justice Department
  • Cross-Reference
    For text of Hospital Corp.'s opening appellate brief, see Doc 2001-

    22637 (96 original pages) [PDF] or 2001 TNT 175-69 Database 'Tax Notes Today 2001', View '(Number'.

    For text of Hospital Corp.'s reply brief, see Doc 2001-27872 (37

    original pages) [PDF] or 2001 TNT 228-24 Database 'Tax Notes Today 2001', View '(Number'.
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    accounting methods, cash, limits
    accounting methods
  • Industry Groups
    Health care
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2001-29479 (71 original pages)
  • Tax Analysts Electronic Citation
    2001 TNT 241-23
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