Court Opinion

ID: 4473139
Source: CourtListenerOpinion
Date Created: 2020-01-14 19:35:08.018776+00
Date Added: 2024-06-11T14:53:50.228401
License: Public Domain

Halpern, J., dissenting: I. Introduction Respondent determined a deficiency in petitioner’s 1995 Federal income tax liability. That deficiency resulted from respondent’s rejection of the cash receipts and disbursements method of accounting (the cash method) used by petitioner to compute taxable income and his recomputation of petitioner’s 1995 taxable income under a hybrid method of accounting. Under that method (the hybrid method), petitioner was required to use an accrual method to account for purchases and sales of merchandise. Respondent recomputed petitioner’s taxable income pursuant to his authority to require a taxpayer to use a method of accounting that clearly reflects income, if the method used by the taxpayer does not clearly reflect income. See sec. 446(b). Whether a particular method of accounting clearly reflects income is a question of fact, and the issue must be decided on a case-by-case basis. See, e.g., Hamilton Indus., Inc. v. Commissioner, 97 T.C. 120, 128-129 (1991). Generally, where respondent has determined that a taxpayer’s method of accounting does not clearly reflect income, the taxpayer must demonstrate either that his method of accounting clearly reflects income or that respondent’s method does not clearly reflect income. See Asphalt Prods. Co. v. Commissioner, 796 F.2d 843, 847 (6th Cir. 1986), affg. in part and revg. in part T.C. Memo. 1984-208. Petitioner has demonstrated neither that the cash method clearly reflected its income nor that the hybrid method does not. Petitioner has demonstrated to the majority’s satisfaction, however, that its business is a service business. The majority holds: “Service income, by definition, does not include income from the sale of goods.” Majority op. p. 391. Therefore, reasons the majority, petitioner is not engaged in the sale of merchandise (a word that the majority equates with the word “goods”). Id. Since petitioner is not engaged in the sale of merchandise, the majority concludes that respondent may not require petitioner to use “an inventory method of accounting”. Majority op. p. 382; see sec. 1.471-1, Income Tax Regs. Finally, limiting its consideration to the incompatibility of the cash method with an inventory method of accounting, see sec. 1.446-l(c)(2)(i), Income Tax Regs., the majority finds that respondent abused his discretion in requiring petitioner to use the hybrid method and that petitioner may continue to report all of its income and expenses under the cash method. I dissent from the conclusion that petitioner is not engaged in the sale of merchandise. I also wish to caution against undue reliance on the majority’s conclusion that respondent abused his discretion in requiring petitioner to use the hybrid method. As will be explained, by his answer to the petition, respondent has limited the issues before the Court. II. Facts The majority has set forth many of the facts stipulated by the parties, and, for the most part, I shall not repeat those facts. The following facts relate to petitioner’s return, respondent’s determination of a deficiency, and the pleadings in this case. On its Form 1120, U.S. Corporation Income Tax Return, for 1995, petitioner reported gross receipts of $2,938,726, no amount of cost of goods sold, and a gross profit equal to its gross receipts. Among other items, petitioner deducted $772,522 for “medical supplies” (chemotherapy drugs), $600,328 for compensation paid to its three physician-shareholder-officers (officer compensation), and other salaries and wages of $630,381. Petitioner’s deduction for chemotherapy drugs equaled 26 percent of its reported gross receipts and gross profits and 129 percent of its officer compensation. For 1995, under the hybrid method, respondent disallowed the deduction for chemotherapy drugs claimed by petitioner and required petitioner to recompute its gross profit by subtracting from gross receipts (determined under an accrual method) the cost of the chemotherapy drugs “conveyed” (sold) by petitioner during that year. The net adjustment to petitioner’s 1995 taxable income (the net adjustment) was an increase of $180,344, resulting from (1) an increase of $148,557 in gross receipts to reflect accounts receivable with respect to chemotherapy drugs and (2) an increase in closing inventory for the actual cost, $31,887, of such drugs on hand at the end of 1995. In respondent’s notice of deficiency in tax (the notice), respondent explains the net adjustment as follows: It is determined that since the cash basis of accounting does not clearly reflect income as required by the Internal Revenue Code section 446(b), the Government is changing the taxpayer’s method of accounting from the overall cash receipts and disbursements method of accounting to a hybrid method by which purchases and sales of merchandise are accounted for on the accrual method of accounting, with maintenance of inventories. In the petition, petitioner avers, among other things, that it is a qualified personal service corporation within the meaning of section 448(d)(2), "thus allowing it the use of the cash method of accounting.” See sec. 448(a) and (b). In the answer, respondent denies petitioner’s averment that it is allowed to use the cash method and “[ajlleges that the petitioner is required to maintain inventories and, therefore, is required to use the accrual method for the purchase and sale of inventories.” III. Pertinent Provisions of the Code and Regulations Gross income is defined in section 61(a), which includes, as an item of gross income, “[g]ross income derived from business”. Sec. 61(a)(2). In pertinent part, section 1.61-3(a), Income Tax Regs., provides: “In a manufacturing, merchandising, or mining business, ‘gross income’ means the total sales, less the cost of goods sold, plus any income from investments and from incidental or outside operations or sources.” The regulations thus recognize that a necessary step in the calculation of the gross income from sales (at least in a manufacturing, merchandising, or mining business) is a determination of the cost of goods sold. That recognition implies the use of inventories, to determine the cost of goods sold.1 Section 1.162-1(a), Income Tax Regs., confirms the role that inventories play in the determination of gross income from sales: “The cost of goods purchased for resale, with proper adjustment for opening and closing inventories, is deducted from gross sales in computing gross income.” Section 446(a) provides the general rule for methods of accounting: “Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.” In pertinent part, section 446(b) provides: “[I]f the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary, does clearly reflect income.” Section 471(a) is specific with respect to the use of inventories: SEC. 471(a). General Rule. — Whenever in the opinion of the Secretary the use of inventories is necessary in order clearly to determine the income of any taxpayer, inventories shall be taken by such taxpayer on such basis as the Secretary may prescribe as conforming as nearly as may be to the best accounting practice in the trade or business and as most clearly reflecting the income. The Secretary has exercised the discretion conferred upon him by Congress in section 471 by requiring, pursuant to regulations, that, “[i]n order to reflect taxable income correctly, inventories at the beginning and end of each taxable year are necessary in every case in which the production, purchase, or sale of merchandise is an income-producing factor.” Sec. 1.471—1, Income Tax Regs. The determination that a taxpayer must maintain inventories has two important consequences for the computation of the taxpayer’s taxable income. First, to the extent that costs incurred by the taxpayer are reflected in items of inventory that, at the end of the taxpayer’s taxable year, remain unsold, such costs will not contribute to the cost of goods sold for that year and, thus, will result in a correspondingly higher gross income from sales for the year.2 Second, if a taxpayer is required to use inventories, then, to reflect its income clearly, it must use an accrual method of accounting with respect to purchases and sales of inventory items. See sec. 1.446-1(c)(2)(i), Income Tax Regs.3 The rationale behind this accrual requirement is explained in Knight-Ridder Newspapers, Inc. v. United States, 743 F.2d 781, 789 (11th Cir. 1984) (“According to accounting wisdom, the income realized from the sale of merchandise is most clearly measured by matching the cost of that merchandise with the revenue derived from its sale.”). Even if a taxpayer need not maintain inventories, the recovery of costs associated with the production of income may not be governed by the taxpayer’s method of accounting. That treatment is well known with respect to the recovery of certain capital expenditures by way of the deduction for depreciation. See sec. 167(a); sec. 1.446-1(a)(4)(ii), Income Tax Regs. (“Expenditures made during the year shall be properly classified as between capital and expense.”). More pertinent to our case is section 1.162-3, Income Tax Regs., which addresses the cost of materials and supplies (without distinction, supplies) that do not constitute inventory. Unless the purchase of such supplies constitutes a capital expenditure, section 1.162-3, Income Tax Regs., provides: Taxpayers carrying materials and supplies on hand should include in expenses the charges for materials and supplies only in the amount that they are actually consumed and used in operation during the taxable year for which the return is made, provided that the costs of such materials and supplies have not been deducted in determining the net income or loss or taxable income for any previous year. If a taxpayer carries incidental materials or supplies on hand, for which no record of consumption is kept or of which physical inventories at the beginning and end of the year are not taken, it will be permissible for the taxpayer to include in his expenses and to deduct from gross income the total cost of such supplies and materials as were purchased during the taxable year for which the return is made, provided the taxable income is clearly reflected by this method. Section 1.162-3, Income Tax Regs., provides for the deferred expense treatment of nonincidental supplies without regard to the taxpayer’s overall method of accounting. IV. Discussion A. Purchases and Sales of Inventory 1. Respondent’s Pleading Petitioner expended $772,522 for chemotherapy drugs during 1995 and treated that expenditure as an expenditure for incidental supplies. That was plain error under section 1.162-3, Income Tax Regs. See concurring opinion of Judge Beghe p. 394. Respondent treated the expenditure as if it constituted the cost of goods purchased for resale. On the facts of this case, in terms of accounting for the cost of the chemotherapy drugs, it makes no difference whether the $772,522 expended for chemotherapy drugs is treated as the cost of goods held for resale or as a deferred expense.4  The only issue open to debate is whether respondent can compel petitioner to account for amounts billed to Medicare (and to patients) under an accrual method. Although section 1.446-1(c)(2)(ii), Income Tax Regs., leaves no doubt that the Secretary can so compel petitioner if purchases and sales of inventory are involved, nothing in section 446(b) prohibits the Secretary from so compelling petitioner if purchases and sales of inventory are not involved. Section 446(c) specifically permits a taxpayer to compute taxable income under the cash method; nevertheless, that permission is made subject to the Secretary’s section 446(b) authority to reject the taxpayer’s method of accounting. See sec. 446(c). By the pleadings, however, the parties have limited what petitioner must prove to stay on the cash method. Above, in section II, I have set forth both respondent’s explanation of the net adjustment and his allegation, in response to petitioner’s averment that it is entitled to use the cash method, that “petitioner is required to maintain inventories and, therefore, is required to use the accrual method for the purchase and sale of inventories.” (Emphasis added.) Correctly, the majority thinks that a fair reading of the issue for trial in this case, as framed by the pleadings, is whether petitioner is required to maintain inventories. I agree with the limited scope of the majority’s inquiry, in this case. I do not agree, however, that petitioner need not use inventories. 2. Inventories Are Required As set forth above in section III, regulations provide: (1) Inventories are necessary in every case in which the sale of merchandise is an income-producing factor, and (2) with limited exceptions, in any case in which it is necessary to use an inventory, an accrual method must be used with regard to purchase and sales. See secs. 1.446-1(c)(2), 1.471—1, Income Tax Regs. Thus, generally, if the purchase and sale of merchandise is an income-producing factor, an accrual method must be used with regard to such purchases and sales. The nominal focus of the majority’s inquiry is whether the chemotherapy drugs are merchandise: “We focus our inquiry on whether the chemotherapy drugs were supplies deductible under section 162, or merchandise that must be inventoried under section 471.” Majority op. p. 381. The majority states: “Respondent’s characterization of the chemotherapy drugs as merchandise offends the natural and ordinary meaning of the term ‘merchandise’.” Id. p. 386. The majority concedes, however: “Although pharmaceuticals could reasonably be construed to be merchandise in some contexts, * * * it does not necessarily follow that pharmaceuticals are merchandise in all contexts.” Id. p. 386 The majority reaches the conclusion that the chemotherapy drugs are not merchandise on the basis that petitioner “is not a merchandiser”, id. p. 384, its business “is inherently a service business”, id. p. 385, or “[sjimply put, petitioner is not peddling products.” Id. p. 386. The majority’s conclusions seem to be informed by its view: “A medical practice such as petitioner’s is inherently a service business, and the drugs administered in the practice are subordinate to the provision of the medical services.” Id. p. 385. 3. Conclusion of Law The majority’s conclusion that the chemotherapy drugs are not merchandise is not a finding of fact. The majority’s conclusion that the chemotherapy drugs are not merchandise appears to rely on a number of propositions that, when taken together, amount to a rule of law (i.e., a rule of general application). The majority’s view that a medical practice such as petitioner’s is inherently a service business is dependent on a number of factors (some of which are conclusory): “the uniqueness of the industry in which petitioner operates”, the fact that petitioner’s business is a “quintessential service business”, the “inseparable connection” of the chemotherapy drugs to the performance of services, and, finally “[s]ervice income, by definition, does not include income from the sale of goods”. From those factors, the majority composes the following rule of law: Doctors (medical and osteopathic) are not in trade. The dictionary gives as one definition of trade: “the business of buying and selling commodities; commerce.” The American Heritage Dictionary of the English Language 1897 (3d ed. 1992). The majority believes that doctors are not in trade because they are members of a learned profession, whose stock in trade is knowledge, not goods or merchandise. See majority op. p. 385. The majority relies on Abbott Labs. v. Portland Retail Druggists Association, Inc., 425 U.S. 1 (1976), to support its conviction that doctors are not in trade (i.e., are not merchants). Abbott Labs., however, is an antitrust case, in which the Supreme Court addressed purchases by nonprofit hospitals of pharmaceutical products at favored prices from the manufacturers of those products. The issue was the proper construction of the phrase “purchases of their supplies for their own use,” as it appears in 52 Stat. 446, 15 U.S.C. sec. 13c (1994) (referred to by the Supreme Court as the “Nonprofit Institutions Act”). The precise question was whether the nonprofit hospitals’ purchases in question were exempt from the proscription of the Robinson-Patman Antidiscrimi-nation Act, ch. 592, 49 Stat. 1526 (1936), 15 U.S.C. secs. 13, 13a, 13b, and 21a (1994), because they were for the hospitals’ own use, within the meaning of the Nonprofit Institutions Act. Abbott Labs. v. Portland Retail Druggists Association, Inc., supra at 4. The majority states: “The exemption generally applies where the nonprofit institution is purchasing the drugs for its ‘own use’ as opposed to sale to patients.” Majority op. p. 385 (emphasis added). Apparently, since, in Abbott Labs., the Supreme Court found that at least some of the drugs in question were purchased by the hospitals for their own use (within the meaning of 15 U.S.C. sec. 13c), the majority concludes that those drugs were not purchased for resale (which, I assume, leads to the conclusion that doctors, like the hospitals, are not merchants). The majority mischaracterizes a provision of the Nonprofit Institutions Act, 15 U.S.C. sec. 13c (1994). That provision provides as follows: “Nothing in the * * * Robinson-Patman Antidiscrimi-nation Act, shall apply to purchases of their supplies for their own use by schools, colleges, universities, public libraries, churches, hospitals, and charitable institutions not operated for profit.” The provision does not establish a dichotomy between use and sale, as suggested by the majority.5 See, e.g., De Modena v. Kaiser Found. Health Plan, Inc., 743 F.2d 1388, 1393 (9th Cir. 1983) (referring to Abbott Labs. v. Portland Retail Druggists Association, Inc., 425 U.S. 1 (1976), and holding: “[Djrugs purchased by an HMO * * * for resale to its members are purchased for the HMO’s ‘own use’ within the meaning of the Nonprofit Institutions Act and thus qualify for protection under the Act.”). Abbott Labs, is no support for the proposition that, as a matter of law, petitioner is not selling merchandise. The majority also cites St. Luke’s Hosp., Inc. v. Commissioner, 35 T.C. 236, 238 (1960), for the proposition that petitioner is not selling merchandise when it administers chemotherapy drugs. The principal issue in St. Luke’s Hosp., Inc. was whether the taxpayer, having requested and received permission from the Commissioner to change from an accrual method to the cash method of accounting for 1953 and thereafter, properly reported income on the cash method when it continued to employ primarily an accrual method in keeping its books and records. We concluded that it did properly report income on the cash method since, notwithstanding the taxpayer’s retention of an accrual method, its cash-basis income could readily be ascertained from its books and records. Our findings of fact included the following: Petitioner owns and operates a hospital in Bluefield. Its business is the customary hospital service business. It is not a merchandising business, and petitioner has no merchandise inventories which would require the use of an accrual method in keeping its books or reporting its income. Its income is derived from providing hospital and professional care to the sick. [/&] Those are not statements of law but findings of fact. The findings that the Bluefield hospital is in the customary service business of hospitals and has no merchandise is not necessarily applicable to petitioner. Petitioner is not a hospital but runs a chemotherapy clinic, where chemotherapy drugs constitute both a significant cost and a substantial source of revenue. There is no finding as to how significant drugs and similar items were to the overall cost of treatment at the Bluefield hospital. In St. Luke’s Hospital, Inc. v. Commissioner, supra, which dealt with medicine as it was practiced over more than 40 years ago, the Commissioner did not even suggest that inventories were required.6 It is no authority for any conclusion of law. Nor can the majority rely on any rule of law that service providers need never use inventories: “We have previously examined service transactions in a variety of industries to determine whether the transactions in substance involved solely the sale of a service, or whether the transactions involved the sale of both a service and merchandise.” Majority op. p. 383. Finally, the majority’s reliance on Hospital Corp. of Am. v. Commissioner, 107 T.C. 116 (1996), to support its proposition that petitioner’s income is attributable solely to services and not to some combination of services and merchandise is puzzling. In Hospital Corp. of Am., we did indeed find that, for purposes of section 448(d)(5), the use of medical supplies is part of the medical services furnished patients by the hospitals in question. See id. at 144. In the same breath, however, we found “the cost of those supplies is an incidental cost of the health care services provided by the hospitals.” Id. Given that finding, the fact that Hospital Corp. of Am. involves a different section of the statute, and our specific reservation in Hospital Corp. of Am. that we were not deciding the question of whether the furnishing of medical supplies by the hospitals as a part of the rendering of services to their patients could be considered to be a sale of inventory, I do not consider that case as persuasive with respect to the issue before us today. The majority cannot escape an examination of the particular facts of this case in light of the relevant provisions of law. 4. Finding of Fact We find the instant setting distinguishable from the setting of those cases in which we have held that goods utilized by a service provider were merchandise for purposes of the inventory rules. We give significance to the uniqueness of the industry in which petitioner operates in relation to the other service industries we have addressed on this issue and bear in mind the recent case of Hospital Corp. of Am. v. Commissioner, 107 T.C. 116, 143-145 (1996).* * * [Majority op. p. 384.] What facts distinguish this case from those cases in which we have held that goods utilized by a service provider were merchandise for purposes of section 1.471-1, Income Tax Regs.? I agree with the majority’s observations that medicine is unique, and that it is inherently a service business. So what? Contrary to the majority’s impression, health care providers do sell goods. See, e.g., De Modena v. Kaiser Found. Health Plan, Inc., supra (drugs purchased by an HMO for resale to its members are purchased for the hmo’s own use). The relevant distinction is between supplies, for which inventories need not be taken, and merchandise held for sale (merchandise), for which inventories must be taken. Compare section 1.162-3, Income Tax Regs., with section 1.471-1, Income Tax Regs. I agree with the majority when it states: “The statute and the regulations do not define the word ‘merchandise’ or ‘inventory’, nor do they clearly distinguish between ‘inventory’ and ‘materials and supplies’ that are not actually consumed and remain on hand.” Majority op. p. 382. As previously discussed, supra section IV.A. 1, it was plain error for petitioner to treat the expenditure for the chemotherapy drugs as an expenditure for incidental supplies, and, in terms of properly accounting for that expenditure, it makes no difference whether the expenditure is treated as being for merchandise or for supplies. The relevant difference is with respect to the application of section 1.446-1(c)(2)(i), Income Tax Regs., which, with an exception not here relevant, and taking into account section 1.471-1, Income Tax Regs., requires an accrual method with regard to purchases and sales of merchandise. The majority agrees that the distinction between supplies and merchandise does not turn on the nature of the underlying commodity: “pharmaceuticals could reasonably be construed to be merchandise in some contexts”. Majority op. p. 386. In Wilkinson-Beane, Inc. v. Commissioner, 420 F.2d 352, 354 (1st Cir. 1970), affg. T.C. Memo. 1969-79, the Court of Appeals for the First Circuit determined that the meaning of the term “merchandise”, as used in section 1.471-1, Income Tax Regs., “must be gathered from the context and the subject.” The context and the subject are the explicit requirement that a taxpayer’s method of accounting clearly reflect income. See sec. 446(b). Income realized from the sale of merchandise is most clearly measured by matching the cost of that merchandise with the revenue derived from its sale. Knight-Ridder Newspapers, Inc. v. United States, 743 F.2d at 789. Given the lack of any clearly pertinent distinction between the term “supplies” and the term “merchandise”, where the facts raise some question (as they do here), we should inquire which classification results in a clearer reflection of the taxpayer’s income. The majority describes as seminal the opinion of the Court of Appeals for the First Circuit in Wilkinson-Beane, Inc. v. Commissioner, supra. The taxpayer in Wilkinson-Beane, Inc. was an undertaking establishment, which argued the primacy of the services that it provided to its customers. The Court of Appeals affirmed the finding of the Tax Court that the taxpayer was selling merchandise. The Court of Appeals stated: We fully recognize that petitioner was in the business or providing valuable services. But we think it would be anomalous to hold that a taxpayer in a service business can have no merchandise even though he derives a substantial portion of his income from the regular purchase and sale of tangible personal property. We certainly have no basis for so restricting the application of the word ‘merchandise’. * * * Since the caskets play a central role in the ‘sale’ of taxpayer’s service, to use its term, we see no error in the determination that the caskets were merchandise. [Id. at 355.] The Court of Appeals’ inquiry into the centrality of the property to the sale and the substantiality of the income attributable to the property has been followed in subsequent cases. For example, in J.P. Sheahan Associates, Inc. v. Commissioner, T.C. Memo. 1992-239, we determined whether roofing materials constituted merchandise, and we looked to whether the materials were shown separately on the customer’s bill, they represented a substantial amount of the total bill, and they were marked up. In Thompson Elec., Inc. v. Commissioner, T.C. Memo. 1995-292, which involved an electrical contractor, we said: “If the cost of material a taxpayer uses to provide a service is substantial compared to its receipts, the material is a substantial income-producing factor even if the taxpayer does not mark up the prices charged to its customers for the material.” What I distill from the Wilkinson-Beane, Inc. line of cases is that, where the question is whether a provider of services is using supplies or selling merchandise, the answer turns on whether the commodity in question is a substantial and identifiable source of revenue. If so, and if the merchandise is an income-producing factor, than such merchandise must be inventoried and an accrual method is appropriate (and may be required) to match costs and revenue. On the facts before us, I would require inventories because petitioner is selling merchandise that is an income-producing factor. The majority’s finding that the chemotherapy drugs are subordinate to the services rendered ignores the substantiality and centrality of the income attributable to the chemotherapy drugs and involves conclusions that have no basis in the record. The only facts stipulated with respect to the medical aspects of petitioner’s business are set forth in the margin.7 Petitioner is a corporation, operating clinics and employing physicians, nurses, nursing assistants, laboratory technicians, administrative personnel, and office workers. The parties have not stipulated how individuals came to be petitioner’s patients. Given petitioner’s apparent specialization, it is likely that patients were referred for chemotherapy drug treatment. Nothing in the record establishes the majority’s findings that “patients played no role in determining the type or amount of drugs used on them”, majority op. p. 387, or that patients must “agree to petitioner’s overall chemotherapy service, and, when they do agree to this service, they have no say in the type or quantity of chemotherapy drugs which petitioner uses in their care.” Majority op. p. 385. Nor does anything in the record establish: “Usually, they [patients] are not even aware of the type or quantity of chemotherapy drugs used on them as part of their treatment.” Id. Contrary to the inference in the majority’s opinion, petitioner’s physician-employees do not choose or decide that a patient shall receive chemotherapy drugs. Common experience tells us that, although petitioner’s physician-employees may recommend such treatment, the patients are the ones who must make the decision 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. I cannot agree with the majority’s conclusion that, with respect to petitioner’s business, the provision of chemotherapy drugs was subordinate to the provision of medical services. B. Clear Reflection of Income If a taxpayer’s method of accounting does not clearly reflect income, section 446(b) accords the Secretary the authority to require the taxpayer to compute taxable income under such method as, in the opinion of the Secretary, does clearly reflect income. We have interpreted respondent’s position in this case as requiring petitioner to use an accrual method (the hybrid method) only because purchases and sales of inventory were involved. Having concluded that petitioner did not purchase and sell inventory, the majority has determined that respondent abused his discretion in requiring petitioner to use the hybrid method. Taxpayers should not read too much into that determination. As stated, although section 1.446-l(c)(2)(ii), Income Tax Regs., leaves no doubt thát respondent can so compel petitioner if purchases and sales of inventory are involved, nothing in section 446(b) prohibits the Secretary from so compelling petitioner if purchases and sales of inventory are not involved. Moreover, although section 446(c) specifically permits a taxpayer to compute taxable income under the cash method, that permission is made subject to the Secretary’s section 446(b) authority to reject the taxpayer’s method of accounting. See sec. 446(c). The legislative endorsement of the cash method undoubtedly means that wages and salaries can be reported on the cash method. The taxpayer in this case, however, is not a wage earner. Petitioner is a corporation, with three physician-shareholder-employees, three other physician-employees, numerous other employees, and, for 1995, just shy of $3 million in receipts. For that year, it paid officer compensation of $600,328 and other salaries and wages of $630,381, for a total of just over $1.2 million. If the value of the services provided by all six physicians employed by petitioner is measured by their compensation, then that value is somewhere in the neighborhood of $1 million (given that there were numerous employees other than physician employees). Petitioner, thus, had receipts of about $2 million attributable to something other than the negotiated value (to the corporation) of physician’s services, including chemotherapy drugs costing $772,522. Petitioner’s receivables at the end of 1995 were $148,557. I know of no rule of law that forecloses an inquiry into whether, to reflect clearly petitioner’s income, the receivables attributable to the chemotherapy drugs used during the year should not be reported on an accrual method, as would be the case under the hybrid method. Recently, in Oakcross Vineyards, Ltd. v. Commissioner, T.C. Memo. 1996-433, affd. 142 F.3d 444 (9th Cir. 1998), we sustained the Commissioner’s determinations that (1) the cash method did not clearly reflect a farmer’s receipts from the sale of grapes and (2) an accrual method was required. We surveyed many of the cases dealing with a challenge by the Commissioner to the cash method, including cases involving the Commissioner’s rejection of the cash method for reporting receipts. Among the cases we surveyed were the following: American Fletcher Corp. v. United States, 832 F.2d 436 (7th Cir. 1987) (credit card charge account service required to change from cash method to an accrual method); Applied Communications, Inc. v. Commissioner, T.C. Memo. 1989-469 (concerning sales of computer software by the developer of the software and taking into account that “cash method of accounting is not appropriate for petitioner because it generates substantial amounts of receivables or deferrals of revenue as evidenced by the difference between its software income for tax and financial purposes”); Silberman v. Commissioner, T.C. Memo. 1983-782 (cash receipts and disbursements method of accounting could not be used by a movie production partnership because the predicted delay between expenditures and receipts created a mismatching of funds and a distortion of income), affd. without published opinions sub nom. Appeal of David Whin, Inc., Appeal of Giordano, Appeal of Malanka, Stamato v. Commissioner, 770 F.2d 1068, 1069, 1072, 1075 (3d Cir. 1985). In Oakcross Vineyards, Ltd., we also pointed out that the question of whether a taxpayer’s method of accounting materially distorts or clearly reflects income is one of fact and is to be resolved on a case-by-case basis. As previously stated, where the Commissioner has determined that a taxpayer’s method of accounting does not clearly reflect income, the taxpayer must demonstrate either that his method of accounting clearly reflects income or that the Commissioner’s method does not clearly reflect income. Respondent’s explanation of the net adjustment in the notice is broader than the ground he relies on in the answer. That narrowing of his ground in the answer may not have been intended. Taxpayers similarly situated to petitioner should be prepared to demonstrate that the cash method clearly reflects their income or that the hybrid method does not.8  V. Conclusion For the foregoing reasons, I dissent from the majority’s opinion. Cohen, Whalen, and Chiechi, JJ., agree with this dissent.   The determination of cost of goods sold and gross income from sales for a manufacturer involves the use of inventories pursuant to the basic accounting equation described below: Beginning inventory. $XXX Purchases of inventory. XXX Production costs incurred. XXX Total cost of goods available for sale . XXX Less: Ending inventory . XXX Cost of goods sold. XXX Gross receipts from sales. XXX Less: Cost of goods sold. XXX Gross income from sales (sec. 61). XXX It can be seen from the foregoing equation that the amount of a taxpayer’s ending inventory and cost of goods sold both have a very direct effect on the amount of the taxpayer’s gross income from sales; however, those effects are exerted in opposite directions. All other things being constant, as a taxpayer’s ending inventory increases in amount, its cost of goods sold decreases, and its gross income from sales increases. In contrast, as a taxpayer’s ending inventory decreases in amount, its cost of goods sold increases, and its gross income from sales decreases. The foregoing equation and comment appear in Schneider, Federal Income Taxation of Inventories, sec. 1.01, at 1:4-1:5 (1999).    But cf. sec. 1.471-4, Income Tax Regs. (“Inventories at cost or market, whichever is lower.”).    The taking of inventories does not of itself represent a separate and distinct method of accounting. As Professor Chirelstein states: “Rather, it is a component of the over-all accounting procedure whose essential purpose is to establish the cost of goods sold as a step towards determination of the taxpayer’s gross income from business operations.” Chirelstein, Federal Income Taxation, A Law Student’s Guide to the Leading Cases and Concepts, par. 12.03, at 269 (8th ed. rev. 1999).    The notice of deficiency shows a zero sec. 481 adjustment.    In Abbott Labs. v. Portland Retail Druggists Association, Inc., 425 U.S. 1 (1976), each of the hospitals in question operated a pharmacy, which was a separate department of the hospital, and whose operations produced revenue in excess of cost. The pharmacies dispensed the pharmaceutical products in question. The Supreme Court used the terms “sales” and “dispensations” with reference to those products, and without any clear distinction between the two terms. The Supreme Court categorized the following dispensations as for the hospitals’ “own use”: 1. To the inpatient, or to the emergency facility patient, upon his discharge and for his personal use away from the premises. 2. To the outpatient for personal use away from the premises. 3. To the hospital’s physicians, employees, or students, for their personal use or for the use of their dependents. Clearly the third category, if not all three, constitutes sales of merchandise by the pharmacies, notwithstanding that such merchandise was acquired for the hospitals’ own use. Nothing in the opinion indicates that the pharmacies failed to inventory their pharmaceuticals.    In Abbott Labs. v. Portland Retail Druggists Association, Inc., supra at 11, decided in 1976, the Supreme Court stated with respect to nonprofit hospitals: “we recognize * * * that the concept of the nonprofit hospital and its appropriate and necessary activity has vastly changed and developed since the enactment of the Nonprofit Institutions Act in 1938.” Needless to say, much more has changed in the last 23 years.    When an individual first becomes a patient of petitioner, one of petitioner’s physicians examines the patient in order to determine the proper chemotherapy treatment for that patient. When a patient has been evaluated and a chemotherapy regime has been prescribed, the patient begins regular, periodic treatments. Petitioner’s physicians prescribed the chemotherapy regime but, with rare exception, did not actually administer the chemotherapy drugs to patients during taxable years 1995 to present. Chemotherapy drugs were administered by oncology nurses during taxable year 1995. Prior to the initiation of each course of chemotherapy, the patients were seen and evaluated by the attending physician. The patients were not examined at the time of every chemotherapy administration pursuant to the standard practice of medical oncology. Once a patient has begun a chemotherapy regime, that patient will see one of petitioner’s physicians approximately every 4 to 6 weeks, between treatments. While a physician must be available to respond to emergencies, a physician is not required to be in every room with a patient while chemotherapy treatment is being administered.    Taxpayers may have difficulty in proving that a method of accounting such as the hybrid method does not clearly reflect income. In Hospital Corp. of Am. v. Commissioner, T.C. Memo. 1996-105, we concluded that certain hospitals’ use of a hybrid method of accounting that reported on an accrual method revenue allocable to charges for supplies and pharmaceuticals clearly reflected the hospitals’ income.