Medical Practice Scores Victory in Inventory Correct Accounting Method Case

July 27, 2015

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In a noteworthy victory for medical practices with significant drugs and supplies on hand, the U.S. Tax Court recently held that chemotherapy drugs that a professional medical corporation administered to its patients were not ‘merchandise’ under Treas. Reg. ß 1.471-1 and the taxpayer could therefore account for such drugs on a cash basis. Osteopathic Medical Oncology and Hematology PC. v. Commissioner, 113 TC. No. 26; No. 11551-98 (Nov. 22, 1999)

The taxpayer in the case, a professional service corporation, was a hematology/oncology practice specializing in the treatment of cancer. This included treatment protocols utilizing chemotherapy, which require the use of drugs and other pharmaceuticals as part of the treatment plan. The practice used the cash method of accounting to expense the cost of the drugs when they were acquired. The IRS on examination determined that the drugs were ‘merchandise’ (i.e., inventory) under Treas. Reg. ß 1.471-1, and that the practice therefore was required to use the accrual method of accounting to report all related revenues and drug purchases.

The Tax Court rejected the IRS’ characterization of the drugs as inventory, ruling that the intrinsic nature of the practice was as a service provider. The court found that the practice’s use of the chemotherapy drugs was secondary to the delivery of its services, and that the practice used the drugs as an indispensable and inseparable part of the rendering of its services. The court accordingly concluded that the chemotherapy and other drugs were not ‘merchandise’ under Treas. Reg. ß 1.471-1, and that the practice had properly used the cash method of accounting to expense the cost of the drugs it purchased.


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