Category: Accounting Periods & Methods
Subject: Cash Method of Accounting
Title: Maker of Orthotic Devices
IRC Sections: 446
Filename: 1113.html
Date Produced: 3/97

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Taxpayer (TP) makes orthotic devices, artificial limbs and supports.

IRS, citing Regs. Section 1.446-1(a)(4)(i) and Revenue Ruling 73-485, contends that TP must use the accrual method of accounting because production, purchase, or sale of merchandise of any kind is an income-producing factor." For this purpose, merchandise includes all finished or partly finished goods and, in the case of raw materials and supplies . . . those which have been acquired for sale or which will physically become a part of merchandise intended for sale," including containers. Reg. Sec. 1.471-1. Also, in any case in which inventories are required, it is necessary to use the accrual method of accounting for purchases and sales. Reg. Sec. 1.446-1(c)(2)(i).

There is a very extensive line of cases and rulings in the mixed-services area: activities that involve both a product and a service. I have included the following summaries to give you a feel for the area.

Wilkinson-Beane, Inc. v. Comr., 420 F.2d 352, 355-57 (1st Cir. 1970)
An undertaker was required to maintain an inventory of caskets, even though the caskets could not be purchased separately and the taxpayer's practice was to charge one lump sum for the complete funeral service. The court noted that the cost of the caskets amounted to 15% of gross receipts, and held that the caskets were merchandise and an income-producing factor within the meaning of the regulation.

Fred H. McGrath & Son, Inc., v. U.S., 549 F. Supp. 491 (S.D.N.Y. 1982)
Undertaker's caskets, facts similar to Wilkinson-Beane

Surtronics, Inc. v. Comr., 50 T.C.M. 99 (1985).
Electroplater required to keep inventories of the metals it used in its processes. The taxpayer did not even own the items being plated. The cost of the actual metal was only about 5% of the taxpayer's overall charge and was not separately stated. The taxpayer had no inventory of finished goods. In this case that taxpayer did not make any profit on the materials

Rev. Rul. 74-279, 1974-1 C.B. 110
Taxpayer was an optometrist providing eyeglasses and frames. Taxpayer charged a single sales price for glasses, frames, and "the various services provided, such as grinding to prescription, etc.

Rev. Rul. 73-485, 1973-2 C.B. 150
Taxpayer provided artificial limbs and orthopedic braces to handicapped charging one un-itemized price for the prosthetic devices, instruction in their use, and custom fitting.

TAM 8744005
Taxpayer provided maintenance services for building lighting fixtures at a flat fee which included replacement of light bulbs as necessary.

TAM 9527003
Taxpayer was a partnership selling electricity. Electricity held to be property even though under state law the sale of electricity is a service.

Knight-Ridder Newspapers v. U.S., 743 F.2d 781 (11th Cir. 1984)
Newspaper required to maintain inventories of paper and ink.

Fame Tool & Mfg. Co. v. Comr., 334 F. Supp. 23 (S.D. Ohio 1971)
Custom tool and die maker had to use inventories for work in process although it maintained no finished goods inventories.

Middlebrooks v. Comr., 34 T.C.M. 1187 (1975)
Advance printing costs for trade magazine inventoriable although when magazines were printed taxpayer immediately sold them to a distributor).

J.P. Sheahan Associates v. Comr., 63 TCM 2842
Taxpayer was a roofing contractor. He had building materials delivered to the job site earmarked for use on that particular job. The taxpayer actually took title to the materials.

Asphalt Products Co., Inc., CA-6, 86-2 USTC ¶9556, 796 F2d 843. Rev'd on another issue, SCt, 87-1 USTC ¶9341, 107 SCt 2275.
Taxpayer was in the asphalt paving business. Due to weather conditions in the area in which the taxpayer operated, no paving activities took place during the winter months. The end of the tax year fell during these months. Accordingly, the taxpayer had little or no inventory on hand at the end of any given year.

Thompson Electric, Inc., 69 TCM 3045, Dec. 50,727(M), TC Memo. 1995-292.
Taxpayer was an electrical contractor. The cost of materials ranged from 37% to 44% of gross receipts. The facts that the contractor did not display supplies to its customers or the public, did not itemize its supplies on bids or invoices, did not sell materials separately from its services, and did not generally allow customers to select materials did not change the outcome of the case.

Epic Metals Corporation, 48 TCM 357, Dec. 41,297(M), TC Memo. 1984-322
Taxpayer was required to maintain inventories and to change to the accrual method of accounting. Taxpayer momentarily had bare legal title to the goods it sold although the goods never came into the taxpayer's possession.

I find nothing in current matter or in the 4 tax acts passed in late 96 that would positively affect the outcome of your case. Further, I do not see a way to distinguish your client's facts from those of the many other mixed-services cases.