Hosp. Corp. of America & Subsidiaries v. Comm'r of Internal Revenue

Decision Date17 September 1996
Docket Number13074–91,6351–92.,28588–91,Nos. 10663–91,s. 10663–91
Citation107 T.C. 116,107 T.C. No. 8
PartiesHOSPITAL CORPORATION OF AMERICA AND SUBSIDIARIES, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

N. Jerold Cohen, Randolph W. Thrower, J.D. Fleming, Jr., Walter H. Wingfield, Stephen F. Gertzman, Reginald J. Clark, Amanda B. Scott, Walter T. Henderson, Jr., William H. Bradley, and John W. Bonds, Jr., Atlanta, GA, for petitioners in docket No. 10663–91. N. Jerold Cohen, Randolph W. Thrower, J.D. Fleming, Jr., Walter H. Wingfield, Stephen F. Gertzman, Reginald J. Clark, Amanda B. Scott, Walter T. Henderson, Jr., William H. Bradley, John W. Bonds, Jr., and Daniel R. McKeithen, Atlanta, GA, for petitioners in docket No. 13074–91.

N. Jerold Cohen, Walter H. Wingfield, Stephen F. Gertzman, Amanda B. Scott, Reginald J. Clark, Randolph W. Thrower, Walter T. Henderson, Jr., and John W. Bonds, Jr., Atlanta, GA, for petitioners in docket No. 28588–91.N. Jerold Cohen, Reginald J. Clark, Randolph W. Thrower, Walter T. Henderson, Jr., and John W. Bonds, Jr., Atlanta, GA, for petitioners in docket No. 6351–92.Robert J. Shilliday, Jr., Dunwoody, GA, Vallie C. Brooks, Nashville, TN, and William B. McCarthy, for respondent.

Ps own, operate, and manage hospitals and related businesses. For taxable year ended 1987 and following years, certain Ps elected to use the nonaccrual-experience method provided pursuant to sec. 448(d)(5), I.R.C. On audit, R determined that those Ps could not use the nonaccrual-experience method to compute taxable income for either 1987 or 1988 because Ps sold medical supplies and because they could not determine the portion of their income attributable solely to the performance of services, or, alternatively, that if Ps are entitled to use the nonaccrual-experience method, they must use the formula set forth in amended sec. 1.448–2T(e), Temporary Income Tax Regs., 53 Fed.Reg. 12513 (Apr. 15, 1988), as applied to the portion of the hospitals' income that R determined is attributable to the performance of services. Ps claim that all of the hospitals' income is attributable to the performance of services and, therefore, they may use the nonaccrual-experience method for all of their income, the amended temporary regulations are invalid, and Ps may use the formula originally set forth in sec. 1.448–2T(e), Temporary Income Tax Regs., 52 Fed.Reg. 22775 (June 16, 1987).

Held: Amended sec. 1.448–2T(e), Temporary Income Tax Regs., 53 Fed.Reg. 12513 (Apr. 15, 1988), is a permissible construction of sec. 448(d)(5), I.R.C., and, therefore, the amount to be excluded from income for 1987 and 1988 pursuant to sec. 448(d)(5), I.R.C., must be calculated as required by the amended temporary regulations.

Held, further: Medical supplies are a necessary and vital part of furnishing medical services to Ps' patients and, therefore, income attributable to medical supplies constitutes income earned from the performance of services for purposes of sec. 448(d)(5), I.R.C.

WELLS, Judge.

These cases were consolidated for purposes of trial, briefing, and opinion and will hereinafter be referred to as the instant case.1 Respondent determined deficiencies in petitioners' consolidated corporate Federal income tax as shown below.

+---------------------+
                ¦¦TYE ¦Deficiency     ¦
                ++----+---------------¦
                ¦¦1978¦$2,187,079.00  ¦
                ++----+---------------¦
                ¦¦1980¦388,006.58     ¦
                ++----+---------------¦
                ¦¦1981¦94,605,958.92  ¦
                ++----+---------------¦
                ¦¦1982¦29,691,505.11  ¦
                ++----+---------------¦
                ¦¦1983¦43,738,703.50  ¦
                ++----+---------------¦
                ¦¦1984¦53,831,713.90  ¦
                ++----+---------------¦
                ¦¦1985¦85,613,533.00  ¦
                ++----+---------------¦
                ¦¦1986¦69,331,412.00  ¦
                ++----+---------------¦
                ¦¦1987¦294,571,908.00 ¦
                ++----+---------------¦
                ¦¦1988¦25,317,840.00  ¦
                +---------------------+
                

Respondent also determined that the provision for increased interest pursuant to section 6621(c) applied. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.

The issue to be decided in the instant opinion is what amount, if any, petitioners may exclude from income for taxable years ended 1987 and 1988 pursuant to the nonaccrual-experience method.

FINDINGS OF FACT

Some of the facts have been stipulated for trial pursuant to Rule 91. We incorporate those stipulated facts herein by reference and find them as facts herein.

During the years in issue, petitioners were members of an affiliated group of corporations whose common parent was Hospital Corporation of America (HCA). 2 HCA maintained its principal offices in Nashville, Tennessee, on the date the petitions were filed. For each of the years involved in the instant case, HCA and its domestic subsidiaries filed a consolidated Federal corporate income tax return (consolidated return) on Form 1120 with the Director of the Internal Revenue Service Center at Memphis, Tennessee.

Petitioners' primary business is the ownership, operation, and management of hospitals. A detailed description of petitioners' hospital operations is set forth in Hospital Corp. of America v. Commissioner, T.C.Memo. 1996–105, most of which will not be reiterated here. Our findings of fact contained in that Memorandum Opinion are incorporated herein.

For taxable years ended before January 1, 1987, some petitioner hospitals used the Black Motor formula 3 to determine the portion of their yearend accounts receivable that was unlikely to be collected. Those hospitals established reserves for bad debts (bad debt reserves) and, based on the Black Motor determinations, for years ended prior to 1987 they deducted additions to the bad debt reserves as ordinary business expenses in accordance with section 166(c).4 In audits of petitioners' Federal income tax returns for years ended prior to 1987, respondent did not contend that the Black Motor formula employed by those petitioners incorrectly reflected the hospitals' bad debt experience. In some instances, respondent's agents required petitioners not using the Black Motor formula to employ that formula to compute their bad debt reserves. In accordance with the repeal of section 166(c), effective for the year ended 1987, petitioners could use only the specific charge-off method to deduct bad debts. Tax Reform Act of 1986, Pub.L. 99–514, sec. 805, 100 Stat. 2361–2362.

With the consolidated return for taxable year ended 1987, petitioners timely filed an application on Form 3115, Application for Change In Accounting Method, to elect the so-called nonaccrual-experience method 5 for taxable year ended 1987. Petitioners elected to use the periodic system 6 of the nonaccrual-experience method to estimate on a hospital-by-hospital basis the portion of their income they would not collect (sometimes hereinafter referred to as the Uncollectible Amount), except that petitioners computed the Uncollectible Amount by using the formula (Original Formula) 7 set forth in section 1.448–2T(e)(2)(i), Temporary Income Tax Regs., 52 Fed.Reg. 22775 (June 16, 1987) (Original Temporary Regulations), rather than the formula (Amended Formula) set forth in amended section 1.448–2T(e)(2), Temporary Income Tax Regs., 53 Fed.Reg. 12513–12514 (Apr. 15, 1988) (Amended Temporary Regulations). Hereinafter, we sometimes will refer to the method petitioners used to compute the Uncollectible Amount for years ended 1987 and 1988 as the modified periodic system.

For taxable years ended 1987 and 1988, petitioners reduced (or increased) income of each hospital by the sum of (1) net writeoffs of bad debts (i.e., total bad debts written off during the year less any recoveries) and (2) the annual increase or decrease in the aggregate Uncollectible Amount (i.e., the aggregate amount that petitioners estimated would not be collected on accounts receivable outstanding at yearend) computed on the basis of the modified periodic system. Respondent agrees that petitioners' reductions for net writeoffs of bad debts were proper but does not agree with petitioners' computation of the aggregate Uncollectible Amount.

For each petitioner qualified to use the nonaccrual-experience method, petitioners computed the amount of the negative section 481(a) adjustment relating to the change to that method to be equal to the Uncollectible Amount as of December 31, 1986, as calculated under the modified periodic system. 8 In the case of those petitioners that had employed an overall accrual method of accounting for taxable years ended prior to January 1, 1987, each petitioner's negative section 481(a) adjustment relating to the change to the nonaccrual-experience method for taxable years ended 1987 and 1988 equaled the amount of the net positive section 481(a) adjustment relating to the repeal of the reserve method of accounting for those years.

In the case of those petitioners that had employed the hybrid method of accounting for taxable years ended prior to January 1, 1987, to the extent that the Uncollectible Amount was attributable to the use of the cash method for taxable years ended prior to January 1, 1987, each qualified petitioner reduced taxable income for each of the years ended 1987 and 1988 by one-tenth of the portion of accounts receivable estimated to be uncollectible as of December 31, 1986, using the modified periodic system. To the extent that the Uncollectible Amount was attributable to the use of an accrual method for taxable years ended prior to January 1, 1987, the Uncollectible Amount was equal to the net positive section 481(a) adjustment relating to the repeal of the reserve method of accounting for bad debts. As calculated by petitioners, for taxable years ended 1987 and 1988 the negative section 481(a) adjustment relating to the election of the nonaccrual-experience method was equal to the positive section 481(a) adjustment relating to the repeal of the reserve method of...

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    ...Hosp. Corp. of Am. & Subs. v. Commissioner, 348 F.3d 136, 144 (6th Cir.2003), affg. 107 T.C. 73, 1996 WL 518053 (1996) and 107 T.C. 116, 1996 WL 525231 (1996). We put it here because the Seventh Circuit will be reviewing our decision in this case. 6. The majority seeks to make much of diffe......
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    ...103-104 (D.C. Cir. 2003); Hosp. Corp. of Am. & Subs. v. Commissioner, 348 F.3d 136, 144 (6th Cir. 2003), affg. 107 T.C. 73 (1996) and 107 T.C. 116 (1996). We put it here because the Seventh Circuit will be reviewing our decision in this 6. The majority seeks to make much of differing deadli......
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1 books & journal articles
  • IRS guidance on the nonaccrual experience method of accounting.
    • United States
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    ...formula often understated many taxpayers' actual bad-debt experience. This problem was illustrated in Hospital Corp. of America (HCA), 107 TC 116 (1996), in which the taxpayer used a method known as the "Black Motor" formula (after Black Motor Co., 125 F2d 977 (6th Cir. 1942)), to compute i......

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