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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 “[a]lleges 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
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