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

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.

Consult your tax adviser for additional information because this is a tax area that receives attention from the IRS.

Question: What are the tax benefits for purchasing a business vehicle that is considered a "hybrid vehicle?"

Answer: If you have purchased a vehicle after 2005 that has been determined to be adequately energy efficient, it may be eligible for federal tax credits.

The eligibility depends on when the vehicle is purchased, what type of fuel it uses, what type of vehicle it is, and how many vehicles have been sold at the time you make your purchase. The allowable credit is for qualified fuel-cell motor vehicles, advanced lean-burn technology motor vehicles, qualified hybrid motor vehicles and qualified alternative fuel motor vehicles.

The full amount of tax credit is available until the vehicle manufacturer sells its 60,000th qualifying vehicle. After the quarter in which the 60,000th vehicle is sold, the tax credit is reduced to 50% of the original amount, then later becomes 25% of the original credit amount, and then later no tax credit whatsoever.

Ford and Mercury have not reached the 60,000 vehicle sales mark, so the full credit of $1,950-$3,000 is still available. Nissan and GM's hybrid vehicles' full tax credits are also still available.

Lexus and Toyota's hybrid vehicle sales have reached the sales mark, but reduced tax credits are still available.

Other vehicle manufacturers have eligible tax credit hybrid models, so check on the availability before making your purchase.

The vehicle does not have to be a qualifying business vehicle. Personal use is acceptable for the tax credit, but the vehicle must be new.

Question: Are there any provisions in the recently signed tax legislation that will affect my practice or my personal income taxes?

Answer: President Bush on May 25 signed into law the Small Business and Work Opportunity Tax Act of 2007. The tax law was part of the Iraq war funding legislation and includes many business and individual tax provisions.

There are revenue enhancers for the IRS as well as savings for taxpayers within the tax act, with various effective dates depending on the provision. It is important to quickly become familiar with the tax law changes because some of the provisions are effective immediately.

Included in the changes that might apply to you:

• The accelerated annual tax write-off of furniture and equipment increases to $125,000 and is phased-out if $500,000 or more of purchases are made during the year.
• Many tax benefits for hurricane survivors have been extended.
• If spouses operate a business together, they may elect to not file a partnership income tax return.
• Penalties for bad checks written to the IRS have increased, and penalties for erroneous refund claims have been installed. Interest and penalty charges have been extended.
• The "kiddie tax" penalty now applies to students from ages 18 to 24, if claimed as dependents by their parents. The kiddie tax means the child's money is taxed at the parents' rate if unearned income exceeds $1,700. That makes shifting investments to children -- even for their own college funds -- less attractive.
• Many changes to the work opportunity tax credit were enacted.