Academic journal article Journal of Accountancy

Taxpayers Win Round in Cash Method Battle

Academic journal article Journal of Accountancy

Taxpayers Win Round in Cash Method Battle

Article excerpt

In the past, the IRS prevented taxpayers who maintained inventories from using the cash method of accounting for federal income tax purposes. Instead, Treasury regulations section 1.446-1 (c)(2)(i) forced taxpayers to use the accrual method to account for purchases and sales.

Under section 1.471-1, the use of inventories is required "in every case in which the production, purchase, or sale of merchandise is an income-producing factor." The determination of whether "merchandise" is an income-producing factor has long been a source of controversy between taxpayers and the IRS.

The IRS had successfully argued that it had the authority to require taxpayers to use the accrual method even when they were predominantly service providers and did not maintain inventories per se. For example, in Commissioner v. Thompson Electric, Inc. (TC Memo 1995-292), the IRS contended an electrical contractor had inventories and was, therefore, required to use the accrual method of accounting. This argument prevailed, even though Thompson Electric

* Did not offer its supplies for sale to the public.

* Did not separately itemize supplies on its invoices.

* Did not separately charge for its services.

* Did not usually permit the customers to select the materials to be used in connection with the provision of services.

Traditionally, taxpayers, such as physicians, who engaged strictly in the provision of services, were not affected by these rules because none of their revenue was attributable to merchandising activities.

In Osteopathic Medical Oncology and Hematology, PC v. Commissioner (113 TC no. 26), a divided Tax Court determined when supplies or goods would be considered "merchandise." The case involved a professional services corporation that provided oncology services and administered chemotherapy treatment to patients (see "Cash Accounting Okay for Drugs" JofA, Mar. …

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