What is the non-cumulative experience (NAE) method?
The Non-Accumulated Experience (NAE) method is an accounting procedure allowed by the Internal Revenue Code (IRC) for handling bad debts.
This method can only be applied to bad debts for services performed in the fields of accounting, actuarial science, architecture, consulting, engineering, healthcare, law, or the performing arts. The business in question must also have average annual gross income for the preceding three fiscal years of less than $ 5 million. More information can be found in IRS Publication 535: Business Expenses.
- The Non-Accumulated Experience Method (NAE) is an accounting standard that accounts for bad or delinquent debts.
- With this method, companies do not have to accumulate income that, based on past experience, is not expected to be collected.
- Instead, bad debts that are likely to go uncollected can be written off.
Understanding the non-cumulative experience method
A business incurs bad debt when it cannot collect the money owed to it. Bad debts that cannot be claimed on the company’s tax return using the unearned experience method can be claimed using the specific write-off method, which is more common. According to NAE, the company can estimate the level of debt that will end up as bad debt based on its own past experiences with customers and suppliers.
A non-cumulative experience accounting method, as described in SEC rule 448 (d) (5), allows certain service providers to exclude from accrual the portion of income that they have determined will not be charged, based on in your own experience and by using formulas allowed under this section and the regulations. These service providers must belong to the following categories in the fields of:
- actuarial science,
- law, or
- performing Arts.
According to the rule, a taxpayer is eligible to use an NAE accounting method if the taxpayer uses an accrual accounting method with respect to the amounts received for the provision of services by the taxpayer, is in one of the sectors of services listed above, and earned less than $ 5 million in gross income in any of the last three tax years.
The reconciliation principle requires that expenses correspond to related income in the same accounting period in which the income transaction occurs. To comply with GAAP tax rules, bad debt expenses must be estimated using the allocation method in the same period in which the sale occurs.
Use of the non-cumulative experience method
There are several ways to use NAE. For example, a taxpayer may request the consent of the IRS to change to a formula that clearly reflects the taxpayer’s experience. This article focuses on the nuances surrounding the adoption or switch to Safe Harbor NAE methods. Safe harbor refers to an accounting method that avoids legal or tax regulations or one that allows for a simpler method of determining a tax consequence than the methods described by the precise language of the tax code.
In September 2011, the IRS published a revised rule that allowed a safe harbor method for taxpayers who account for income using the NAE method to calculate bad income by applying a factor of 95% to their allowance for doubtful accounts as determined through the applicable financial statements of the taxpayer. .