35 T.C. 236 (1960), 72227, St. Luke's Hosp., Inc. v. C. I. R.

Docket Nº:72227.
Citation:35 T.C. 236
Opinion Judge:TRAIN, Judge:
Attorney:William T. Hancock, Esq., and George Richardson, Jr., Esq., for the petitioner. C. Ralph Musgrove, Esq., for the respondent.
Judge Panel:MURDOCK, J., dissenting: TURNER, KERN, RAUM, PIERCE, ATKINS, and SCOTT, JJ., agree with this dissent.
Case Date:November 09, 1960
Court:United States Tax Court

Page 236

35 T.C. 236 (1960)




No. 72227.

United States Tax Court

November 9, 1960

1. For the years prior to the calendar year 1953, petitioner, owner and operator of a hospital, had kept its books and filed its returns on an accrual basis. Because of the nature of petitioner's business, it had many bad debts, and as its business expanded it became more and more burdensome to determine what account receivable were uncollectible. For this and other reasons petitioner requested permission of respondent to change its method of reporting income to the cash receipts and disbursements method for 1953 and subsequent years, which permission was granted, the terms and conditions of the change being agreed upon. Petitioner prepared its returns and reported its income on the cash basis for 1953, 1954, and 1955. Held: Petitioner is entitled to report its income on the cash basis for 1953, 1954, and 1955. The consent to the change was valid, never revoked, and while petitioner retained, basically, an accrual method in keeping its books and records, cash basis income could be readily ascertained therefrom.

2. The third condition of the consent required that items of income previously accrued and returned as income, should be excluded from income, ‘ irrespective of when such items are collected.’ Petitioner excluded its accounts receivable balance as of December 31, 1952, in its entirety from 1953 income. Held: The condition provided only for the exclusion of such items from income as they were received and taken into income on the cash basis. Years in which the accounts receivable balance was collected determined.

Page 237

William T. Hancock, Esq., and George Richardson, Jr., Esq., for the petitioner.

C. Ralph Musgrove, Esq., for the respondent.

TRAIN, Judge:

Respondent determined deficiencies in the petitioner's income taxes for the calendar years 1952, 1953, 1954, and 1955, in the respective amounts of $13,064.76, $75,334.69, $37,233.46, and $7,740.02. With respect to several items upon which minor portions of the deficiencies were based, the parties have reached agreement, to which effect will be given under Rule 50. The main issue is whether petitioner, having requested and received permission from respondent to change from an accrual to the cash receipts and disbursements method of reporting income for 1953 and subsequent years, properly reported income on the cash basis for those years, when it continued to employ primarily an accrual method of accounting in keeping its books and records. If not, it must be determined whether petitioner is entitled to bad debt deductions for these same years based on its bad debt experience in and method of reporting for the years immediately preceding 1953, and whether recoveries during the year 1953 on bad debts, charged off in taxable years for which an excess profits tax was not imposed, should be excluded from excess profits net income for that year.


Some of the facts have been stipulated and are hereby found as stipulated.

The petitioner, St. Luke's Hospital, Inc., is a corporation organized under the laws of the State of West Virginia on March 21, 1921, and has its principal office and place of business at Bluefield, West Virginia. Its income tax returns for the years here involved were duly

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filed with the district director of internal revenue for the district of West Virginia at Parkersburg.

For its taxable year ended December 31, 1952, and for prior calendar years, petitioner kept its books and prepared and filed its income tax returns on an accrual method.

Petitioner owns and operates a hospital in Bluefield. Its business is the customary hospital service business. It is not a merchandising business, and petitioner has no merchandise inventories which would require the use of an accrual method in keeping its books or reporting its income. Its income is derived from providing hospital and professional care to the sick.

Petitioner provides service and care for many patients who are indigent or otherwise unable to pay for such services. In many instances, people are admitted to petitioner's hospital under emergency circumstances and petitioner has no opportunity to ascertain or know anything about their ability to pay. Further, unforeseeably prolonged treatments due to complications, recurring illness, or other illness in the same family often result in the incurring of bills beyond the means of patients. There are no publicly supported institutions in petitioner's community where care is provided for indigent patients, and public funds supplied by the appropriate State agency are frequently inadequate to cover the full cost of the services which petitioner provides to patients who cannot pay therefor. As a result, petitioner is unable to control credits as an ordinary business does.

The collection of accounts was a serious problem in petitioner's business. Bad debts were very large. In charging off accounts receivable as uncollectible, in years prior to 1953, petitioner charged off those accounts that were approaching the statute of limitations, those that were in large amounts and upon which only token payments were being made, those accounts on which petitioner's experience had been uniformly bad, as for example, when it knew the family and that it would never collect on the account, and also those accounts where a patient would come in and incur an additional bill. An approximate doubling of hospital capacity by the year 1951 through increasing the number of beds so increased the number of patient accounts that the matter of determining what accounts should be charged off became more and more burdensome.

During the 6 years immediately preceding the year 1953 petitioner's gross operating income after refunds, allowances, and discounts, as shown on its books, was as follows:

1947 $396,337.16

1948 501,540,59

1949 540,484.25

1950 544,773.15

1951 674,240.85

1952 826,167.39

Page 239 During the 6 years immediately preceding the year 1953, petitioner charged off on its books as bad debts the following amounts:

1947 $47,393.11

1948 97,713.48

1949 118,982.79

1950 92,912.09

1951 89,208.67

1952 162,886.33

Such chargeoffs represent an average of 17.485 per cent of the gross operating income of those years. In light of petitioner's poor experience in collecting accounts, its difficulties in determining when to charge off such accounts, coupled with the inability of petitioner in many instances to control the granting of credit, together with the fact that petitioner was, under its accrual method of reporting income, paying taxes currently on accounts receivable on which it was not collecting in the current year, and might never collect at all, petitioner's president, its board of directors, and the certified public accountant who supervised its accounting operations concluded that the cash basis of reporting income would more truly reflect petitioner's income. The accountant suggested that petitioner request permission from respondent to change from its accrual method to the cash basis of reporting income. Accordingly, petitioner requested such permission by letter dated March 16, 1953, in which it was stated: Re: Change in Accounting Method Dear Sir: (Petitioner) * * * has maintained its accounts on the accrual basis and has used such basis in the preparation of its U.S. income tax returns. It is believed that the cash receipts and disbursements method of accounting will more clearly reflect the annual income of the corporation and accordingly we request permission to change from the accrual method to the cash receipts and disbursements method for the calendar year 1953 beginning January 1, 1953. We here set forth our reason for desiring this change. For the last several years the volume of business handled by the hospital has grown rapidly * * * . This growth should continue * * * . Experience points out that the loss as bad debts has been approximately 15% of the original charges to patients. Further, with this experience, it has currently proven very cumbersome and time consuming to periodically review many hundreds of accounts for the purpose of eliminating those receivables which probably will not be collected. The volume of annual bad debts is apparent * * * . Also, the corporation has in operation an approved profit sharing plan * * *, and under this plan the profits for distribution are computed on the basis of cash receipts and disbursements, after provision for income taxes on this basis. Thus, it is quite apparent that complete accounting on the cash basis would simplify the work of our business office and more clearly reflect the annual income of the corporation. Attached hereto is a statement specifying the classes of items differently treated under the two methods and specifying all amounts which would be duplicated or entirely omitted as a result of the proposed change. Page 240 Accordingly, we respectfully request permission to change to the cash receipts and disbursements method of accounting beginning with the year 1953. The attached statement in its entirety was as follows:


Following we set forth the significant items which will require special treatment in carrying out the proposed change in accounting method:

1. Accounts receivables at December 31, 1952 as set forth on the books of the company aggregated...

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