Tax issues: Drug inventory, hybrid vehicles, new tax law

Practice Pointers. By Cathy B. Goldsticker, AMNews contributor. June 18, 2007.

PRACTICE POINTERS

Answers to questions about the business side of your practice

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Question: Our practice keeps various drugs on hand for patient injections. At times, if we are concerned about future vendor availability, we may maintain significant quantities, even though it strains our bank account. We are on the cash basis accounting method and deduct the drug costs as paid. Is that OK with the Internal Revenue Service?

Answer: The IRS would prefer that you inventory the drugs on hand and be on the accrual method of accounting. In fact, the IRS has tried to make its point in the tax courts by saying that the accrual method of accounting more clearly reflects income for medical practices with large drug purchases, and these items should be "inventoried" or deducted when used, as opposed to when purchased.

The good news is that the tax courts did not agree with the IRS and believe the cash basis of accounting does clearly reflect income. The courts view the drugs as supplies supporting a medical service and not inventory being purchased for resale. Therefore, the drug purchases can be deducted as paid.

To clarify its position, in 2002, the IRS issued a revenue procedure for medical practices and other businesses that report gross receipts less than $10 million. The revenue procedure provides the guidance that the cash basis of accounting will be acceptable unconditionally, and drugs, if viewed secondary to the medical service being provided, can be deducted when purchased.

However, if your practice has receipts in excess of the threshold amount, then there is formal authority from the IRS to support the use of the accrual basis of accounting, but hopefully the prior successful case law will be supportive of your situation.