Physician practices and proper accounting methods.

• Author: Koppel, Michael D.

Rev. Proc.2000-22 and the Tax Court's decision in Osteopathic Medical Oncology and Hematology, P.C., 113 TC 376 (1999), provide a clearer understanding in advising physician practices on adopting correct accounting methods. Rev. Proc. 2000-22 permits most taxpayers with $1 million or less in average annual gross receipts to elect out of the requirement to account for inventories or use the accrual method of accounting for purchases and sales of merchandise. (For a discussion, see Hesse, "Rev. Proc. 2000-22 Allows Certain Taxpayers to Use Cash Method" p. 870, this issue.) In Osteopathic Medical Oncology and Hematology, P.C., the Tax Court found that drugs administered by a medical practice as an indispensable part of its services were hot "merchandise" under Regs. Sec. 1.471-1. The result was that the practice correctly maintained its books and records on the cash method for tax purposes.

Cash vs. Accrual Accounting Methods

The obvious advantage of a medical practice electing the cash method is deferral of income until revenue is collected. Taxpayers generally elect this accounting method on a timely filed initial return. Only the IRS can grant permission for a taxpayer to change from the accrual to the cash method. The Service almost never gives permission to change to the cash method, because it views the accrual method as a better means of accurately matching income and expenses.

Sec. 448 limits which entities may use the cash method. C corporations, partnerships with C corporations as partners, tax shelters or unrelated trade or business activities of tax-exempt organizations generally cannot use the cash method; see Sec. 448 and Temp. Regs. Sec. 1.448-1T. Conversely, sole proprietorships, partnerships with no C corporation partners and S corporations are allowed to use the cash method. Occasionally, the IRS grants exceptions to C corporations (provided the average annual gross receipts are less than $5 million), qualified personal service corporations (as defined under Sec. 448(d)(2)) and farming businesses.

The Service may deny the use of the cash method, if it "does not clearly reflect income" (Sec. 446(b)). One example of a "clear reflection of income" is an entity deemed to have an inventory. In an attempt to match income with expenses, the IRS would mandate a change to the accrual method.

Denial of Cash Method when Inventory Is Present

Inventories/accrual method requirement. Sec. 471 and Regs. Sec. 1.471-1 provide that inventories...