Chapter 11 - Tax-Accounting Methods
Updates
Drugs of Medical Service Provider Found Not to be Merchandise: (page 347) Osteopathic Medical Oncology and Hematology P.C. v. Comm'r., 113 T.C. No. 26 (1999) involved a medical clinic that specialized in chemotherapy and hematology treatments. Chemotherapy drugs are pharmaceuticals that may only be prescribed by a doctor and sold by a
licensed pharmacist. OM is not a licensed pharmacist that thus, did not
(and could not) sell the drugs, but used them only in providing services
to patients. OM typically only had a two-week supply of the chemotherapy
drugs on hand. OM used the cash method for financial and tax purposes
and expensed the drugs as purchased. The IRS argued that the drugs were
merchandise and that OM was required to account for their purchase and
sale using the accrual method. The Service proposed to change OM from
the cash to the hybrid method of accounting.
Interesting comments from the majority in finding that the drugs were
supplies rather than merchandise include:
- OM was prohibited from selling the drugs and this unique factor
must be considered in determining whether inventory rules apply.
- OM "is not a merchandiser" and only provides the drugs to patients
as an integral and inseparable part of its services.
- "'Merchandise' denotes commodities or goods that are bought and
sold in business." OM's situation is not like a grocery store selling
drugs to customers for self-administration. OM is "not peddling
products."
- The high cost of the drugs is not relevant. The drugs are not on
display and do not play a central role in the sale of OM's services.
Also, neither the type or "magnificence" of the drugs plays a part in
whether patients decide to purchase OM's services.
- The inclusion of the drugs on patient bills was mostly due to
insurance rules that OM is subject to.
- The fact that the drugs represent about 26% of OM's gross receipts
is not relevant once it is determined that the items are not
merchandise. The percentage measure goes to determine whether
merchandise is an income-producing factor, not whether it is
merchandise.
A dissenting judge noted that health care providers do sell goods. While
a physician may recommend the drug, the patients make the decision
whether or not to receive the drugs. "Moreover, if those patients decide
to receive chemotherapy drugs, they want the drugs and nothing in the
record (or in common sense) leads me to believe that the drugs are
necessarily subordinate to the physician's services."
Legislative Proposal to Simplify Tax Accounting for Small Businesses: (page 346) H.R. 2273 (106th Congress) would allow small businesses to use the cash method of accounting even if they have inventory. A small business is one with average annual gross receipts over the prior three year period of $5 million or less.
Recent ruling clarifies timing of
income for photo-processing work by accrual method
taxpayer: (page 349) Technical Advice Memorandum
(TAM) 9823003 involved Taxpayer, an accrual method
operator of several retail stores, most of which provide
film processing services for customers. Customers drop
off their film and the store has it processed and
returned to the store to be picked up by the customer.
Customers are under no obligation to purchase their
photos if they are not completely satisfied. If photos
are not picked up after a certain period of time, they
are discarded and the customer is not obligated to pay
for the processing costs. Taxpayer only reported revenue
from film processing when customers purchased their
photos. Upon examination by the IRS, the revenue agent
took the position that revenue should be reported when
the prints are delivered to the store for customer
pick-up, rather than when they are actually purchased by
the customer. The revenue agent argued that Taxpayer had
a fixed right to receive income at the time the prints
are delivered to the store because at that time,
Taxpayer's required performance had occurred - that is,
the film had been developed. The IRS National Office
disagreed with the revenue agent and ruled that the film
processing revenue was not includible in income until
customers actually purchased their photos. "[F]or
accrual method taxpayers, it is the right to receive an
amount and not the actual receipt that determines the
inclusion of the amount in gross income. ... In the case
of a taxpayer selling goods, the taxpayer's inventory is
reduced and a claim of th e purchase price arises at the
time the sale is made. ... Until a sale occurs, the
required performance has not occurred to fix a taxpayer's
right to receive income under the first part of the
all-events test under section 1.451-1(a). Therefore, a
taxpayer selling goods generally accrues income from the
sale of goods at the time of the sale."
Legislative Proposal to Clarify
Whether Doctors Have Inventory: (page 346) H.R.
4132 (105th Congress), the Accounting Fairness for
Physicians and Dentists Act of 1998, would change the
Internal Revenue Code to provide that physicians and
dentists are not required to use the accrual method of
accounting. This change would eliminate the need to
determine if certain doctors, such as orthodontists and
allergy doctors, have inventory held for sale to
customers.
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Last updated on February 24, 2000.
Tax Aspects of Business Transactions: A First Course, by
Annette Nellen
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