                        T.C. Memo. 2000-130



                      UNITED STATES TAX COURT



         MID-DEL THERAPEUTIC CENTER, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

           D. RICHARD ISHMAEL, M.D., PC, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 9060-97, 9270-97.            Filed April 11, 2000.



     Bruce A. Moates and LeRoy D. Boyer, for petitioners.

     Elizabeth Downs, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     MARVEL, Judge:   Respondent determined a deficiency of

$211,979 in petitioner D. Richard Ishmael, M.D., PC's 1995

Federal income tax, and a deficiency of $140,025 in petitioner

Mid-Del Therapeutic Center, Inc.'s Federal income tax for the

taxable year ended April 30, 1995.   Both petitioners petitioned
                                - 2 -

the Court to redetermine the respective deficiencies.    These

cases were consolidated for purposes of trial, briefing, and

opinion because they involve common questions of law and fact.

     The deficiencies result from respondent's determination,

pursuant to section 446(b),1 that petitioners must use an accrual

method of accounting to report their taxable income.    The

ultimate issue to be decided is whether respondent abused his

authority under section 446(b) by requiring petitioners to change

from the cash receipts and disbursements method of accounting

(the cash method) to the accrual method.   In order to decide that

issue, we must examine the related question of whether

chemotherapy drugs and related medications (the drugs),

administered by petitioners to patients during the course of

medical treatments, are merchandise which must be inventoried.

We hold that the drugs in question are not merchandise and that

respondent abused his discretion under section 446(b) by

requiring petitioners to change from the cash method to the

accrual method of accounting.




     1
      All section references are to the Internal Revenue Code in
effect for the taxable years in issue, and all Rule references
are to the Tax Court Rules of Practice and Procedure. For
convenience, all monetary amounts have been rounded to the
nearest dollar.
                                - 3 -



                           FINDINGS OF FACT

     Some of the relevant facts have been stipulated and are so

found.   The stipulation of facts is incorporated herein by this

reference.

     Petitioner Mid-Del Therapeutic Center, Inc. (Mid-Del), and

petitioner D. Richard Ishmael, M.D., PC (PC), are Oklahoma

corporations,2 each of which operates a chemotherapy clinic in

the Oklahoma City metropolitan area (collectively, the clinics).

On the dates the petitions in these consolidated cases were

filed, the principal place of business of Mid-Del was in Midwest

City, Oklahoma, and the principal place of business of PC was in

Oklahoma City, Oklahoma.    Dr. D. Richard Ishmael, an oncologist,

owns 100 percent of the stock of both Mid-Del and PC.   PC is Dr.

Ishmael's personal service corporation, and Mid-Del is a

subchapter C corporation, owned and managed by Dr. Ishmael.

The Clinics in General

     Petitioners' clinics have provided outpatient chemotherapy

treatment to Dr. Ishmael's patients since 1988.   Prior to 1988,

Dr. Ishmael administered chemotherapy treatments to patients in

hospitals on an inpatient basis.    By 1988, various drugs had been

developed to mitigate the severe nausea associated with



     2
      Mid-Del was incorporated in 1991, and PC was incorporated
in 1982.
                                 - 4 -

chemotherapy.    These drugs enabled patients to receive

chemotherapy treatments on an outpatient basis.    When Medicare

decided not to pay for inpatient chemotherapy under most

circumstances, that decision effectively forced chemotherapy out

of hospitals and into outpatient clinics.

     During the period in issue, PC employed a staff of employees

consisting of nurses, nursing assistants, laboratory technicians,

physician assistants, administrative clerks, pharmacists,

pharmacy technicians, and office maintenance workers.      Mid-Del

had no employees, but instead used contract nursing services

leased through the Cancer Care Network and paid a common

paymaster for doctors’ services and other labor costs.      PC

provided administrative services, including bookkeeping and

billing, for both clinics.    Mid-Del paid PC an annual fee for

these administrative services.

Treatment of Patients

     Many local doctors referred patients to the clinics for

treatment of cancer, lupus, AIDS, and some types of arthritis.

Dr. Ishmael scheduled 2 days a week to see patients at each of

the clinics.    As a general rule, he saw patients at the PC clinic

on Mondays and Wednesdays and at the Mid-Del clinic on Tuesdays

and Thursdays.    The clinics' hours were Monday through Friday,

from 8 a.m. to 5 or 6 p.m.    Chemotherapy treatments were

administered at both clinics 5 days a week.
                               - 5 -

     On a patient's first visit, Dr. Ishmael examined the patient

in order to determine the proper chemotherapy treatment (if any)

for that patient.   When Dr. Ishmael prescribed a chemotherapy

treatment, his order for the patient's individualized

chemotherapy treatment was recorded in the patient's file, which

was maintained at the clinic where that patient received

treatment.   Once a patient was evaluated and a chemotherapy

regimen had been prescribed, the patient began regular, periodic

treatments, which could continue for several months or years.

Dr. Ishmael wrote prescriptions for any drugs a patient needed

that were not administered by the clinics.

     Once a patient began a chemotherapy regimen, that patient

would see Dr. Ishmael approximately every 4 to 6 weeks for

reevaluation.   However, patients generally did not see Dr.

Ishmael each time they came to the clinic for treatment.    While a

doctor had to be available in the office to respond to medical

emergencies during working hours, one was not required to be

present in the treatment room while a chemotherapy treatment was

being administered.   When Dr. Ishmael was not available,

arrangements with other physicians ensured the availability of a

physician in the event of an emergency.

     Prior to every chemotherapy treatment, a patient had blood

tests, which were performed at the clinics upon the patient's

arrival.   A nurse drew the blood to be tested, and a lab
                               - 6 -

technician performed the tests at the in-office lab.    Blood tests

were performed in order to insure that the patient was not too

ill to receive the chemotherapy treatment.    If a patient's blood

count indicated that the patient was too ill for the prescribed

treatment, a nurse would contact Dr. Ishmael, who then might

prescribe a reduced dosage.   When the test results indicated a

patient could receive his chemotherapy safely, the pharmacist was

notified to prepare the appropriate chemotherapy treatment for

the patient, as previously prescribed by Dr. Ishmael.    Mid-Del

sent its orders for preparation of chemotherapy treatments to the

pharmacist at the PC clinic by fax machine and received the

prepared treatments from the PC pharmacist via courier service.

     Registered nurses administered the chemotherapy treatments

and provided extensive counseling and education to patients

regarding their treatments.   The nurses spent a large amount of

time counseling patients because of the profound psychological

effects of chemotherapy treatments.    Administration of a

chemotherapy treatment to a patient generally took 2 to 8 hours.

A few patients were equipped with an apparatus which slowly

administered their treatment over a period of days.    Other

patients received drugs that required the nurse to sit with the

patient throughout the treatment and closely monitor the

administration of the drug and the reaction of the patient.    Dr.
                               - 7 -

Ishmael frequently adjusted a patient's chemotherapy treatment in

accordance with the patient's response to the treatment.

The Chemotherapy Drugs and Ancillary Medications Used in
Treatments

     After a chemotherapy drug has been tested and scientifically

proven effective to treat a particular condition, it is approved

for use by the Food and Drug Administration.   Once a drug is

approved, it can be used to treat conditions other than those for

which it is approved because chemotherapy drugs may be effective

against multiple forms of cancer.    For example, a drug approved

for use against ovarian cancer might be used to treat lung

cancer, even though its use to treat lung cancer is not an

approved use.   Petitioners were not reimbursed by Medicare for

their use of approved drugs if the condition for which the drug

was administered was not an approved use, on the grounds that

such treatments were experimental.

     Dr. Ishmael treated some of his patients with drugs that

were not approved for a particular condition when he believed the

drug would help those patients, even though he knew that Medicare

or nongovernmental health insurance carriers (private insurers)

would not pay for costs associated with experimental treatments.

Although petitioners bore the cost of these treatments, Dr.

Ishmael authorized the treatments when he felt that they were
                               - 8 -

appropriate because his overriding concern was the welfare of his

patients.3

     Dr. Ishmael, petitioners’ staff, and petitioners’ patients

viewed the chemotherapy treatments, and the drugs used in those

treatments, as medical services, not as the purchase and sale of

drugs.

The Pharmacy

     PC maintained an onsite pharmacy, where chemotherapy drugs

purchased by both PC and Mid-Del were stored and where a

pharmacist employed by PC mixed and prepared chemotherapy

treatments; i.e., mixtures of chemotherapy drugs in prescribed

amounts, for both clinics.   Chemotherapy drugs purchased by Mid-

Del were accounted for separately and held in a separate area

from chemotherapy drugs purchased by PC.   Mid-Del paid PC a

monthly fee for PC's provision of pharmacy services to Mid-Del.

     Petitioners used approximately 85 different chemotherapy

drugs to treat patients.   Generally, petitioners attempted to

keep a 2-week supply of each drug on hand, although some

chemotherapy drugs were ordered on an as-needed basis.

Petitioners sometimes stocked up on a newly approved chemotherapy



     3
      For example, Dr. Ishmael prescribed an experimental drug,
Taxotere, for a patient dying of lung cancer. The patient had
been doing very poorly and was getting ready to enter a hospice
program, but Dr. Ishmael persuaded her family to allow him to
provide the treatment. Treatment continued despite a cost to the
clinic of $10,000 per week. The treatment was successful.
                                - 9 -

drug if they had a patient population that would benefit from

that drug.

      PC's computer system kept a constantly updated record of

each clinic's stock of chemotherapy drugs and ancillary

pharmaceuticals.    Drug orders were placed automatically and

electronically by computer when the onhand quantity of a

particular drug dropped to a predetermined minimum balance.

Petitioners’ software only tracked drugs.

     The shelf lives for chemotherapy drugs varied from about 6

months to 1 year in an unmixed state.    A mixed or prepared

chemotherapy treatment generally had to be used within 3 to 24

hours.

Billing and Reimbursement

     Each time a patient visited a clinic for treatment, a nurse

completed a charge sheet.    The charge sheet was then used to bill

the patient or the party primarily responsible for payment.     The

charge sheet indicated the patient's diagnosis and the amounts of

chemotherapy drugs administered, as well as any other medications

or procedures used in treating the patient on that day.    After

the patient's treatment for that day was complete, the charge

sheet was forwarded to the billing department at PC to determine

the amount to be charged or billed.

     Most clinic patients had Medicare or private insurance

coverage.    For such patients, petitioners filed for payment
                               - 10 -

directly with Medicare or the insurance company.4   Thus, most

bills were submitted to Medicare or private insurers.

     In accordance with Medicare regulations and private

insurers’ requirements, the submitted bills reflected the

specific drugs, and amounts thereof, administered to each

patient.    Each compensable service and drug provided in the

course of chemotherapy treatment was assigned a specific code for

billing purposes.    The billing code for a particular chemotherapy

drug was referred to as its "J-code", which corresponded to a

specific drug and a specific amount of that drug.    A

miscellaneous J-code was used for drugs that had not been

assigned a specific J-code.

     Petitioners' charges for chemotherapy drugs were based on

the drugs' average wholesale price (AWP), which was determined by

reference to the "Red Book", a publication that PC received

annually.   To determine the amount charged for each drug, the

billing department multiplied the AWP by a certain multiple,

which varied depending upon whether the bill was being submitted

to a private insurer or Medicare.    On the other hand, although

AWP was the starting point used to calculate the charges made for



     4
      Only "Medicare providers" may bill Medicare directly.
Prior to 1995, petitioners were not "Medicare providers" and,
therefore, billed the patients directly. The patients then
submitted their bills to Medicare for reimbursement. In 1995,
petitioners were “Medicare providers” and billed Medicare
directly for medical services provided to covered patients.
                              - 11 -

chemotherapy drugs for both Medicare and private insurers, the

reimbursement policies of the private insurers changed

frequently, affecting the amount that petitioners actually

collected and the predictability of the billing and collection

process.

     Petitioners' bills also included charges for Dr. Ishmael's

professional services,5 administration of the chemotherapy

treatments, other supplies, miscellaneous medications, and

laboratory items.

     Determinations regarding reimbursement of charges were made

by Medicare and private insurers on an item-by-item basis.

Medicare and the insurance companies took similar positions

regarding some items.   For example, neither Medicare nor the

insurance companies paid for unapproved chemotherapy treatments.

Thus, petitioners were reimbursed for chemotherapy drugs used

during chemotherapy treatments only if the drug administered to

the patient had been approved for that specific therapeutic

purpose.

     The reimbursement policies of Medicare and the private

insurers with respect to other items differed.   For example, the

extra cost incurred by petitioners for a staff pharmacist to mix

the chemotherapy treatments was not specifically reimbursed by


     5
      Mid-Del did not bill patients or insurers for Dr. Ishmael’s
professional services. Instead, PC billed patients and insurers
for all of the doctor’s services, wherever provided.
                              - 12 -

Medicare.   Medicare did not reimburse petitioners for nondrug

supplies used in administering treatments.    Some private

insurers, however, did cover these charges.

     With respect to chemotherapy drugs, petitioners' claims for

reimbursement included only charges for chemotherapy drugs

prepared from petitioners' own supply and administered by

petitioners’ nursing staff to the patient.

      When petitioners received a payment from Medicare or an

insurance company, they also received an "Explanation of

Benefits" (EOB), which detailed amounts allowed and disallowed as

to each specific charge and amounts due (copay amounts) from

secondary insurance or the patient as to each specific charge.

Petitioners routinely wrote off disallowed charges as they

received EOB’s from the insurance companies.    Petitioners wrote

off the disallowed charges because agreements with the insurance

companies prevented petitioners from seeking payment for those

charges from the patients directly.    Copay amounts were not

written off as long as the patient continued to receive

treatments, even if the patient was indigent or full payment was

not otherwise expected.   Petitioners kept daily, monthly, and

annual summaries of charges, reimbursements, and writeoffs.

     When PC's billing office determined from an EOB that an

allowable charge had been disallowed, a corrected bill or

explanation was submitted, and the writeoff of the disallowed
                               - 13 -

amount would be delayed until a revised EOB was received.    A

substantial percentage of the claims filed by petitioners with

Medicare and other insurance companies was rejected the first

time and had to be resubmitted.

     Some patients who did not have any medical insurance

coverage or who could not afford their copayments were treated at

the clinics.   Dr. Ishmael expected these patients to pay whatever

they could afford.    The business office usually tried to work out

some sort of payment schedule, even if the payment would only

cover a small portion of the cost of treatment.   No attempt was

made to charge only what a patient could afford or to write down

an account in expectation of what ultimately might be collected.

Eventually, if an account showed no activity for an extended

period of time because a patient had died, left the area, or

other circumstances indicated that the account was wholly

worthless, petitioners wrote off the entire account.

     Neither petitioner had signs in its clinics that indicated

payments should be arranged before services were rendered.

Petitioners never charged interest or finance charges on patient

accounts.    At least in part because of the patients' medical

conditions, petitioners did not use aggressive collection

practices.
                                             - 14 -



Accounting Issues–Background

           It is a customary and accepted practice in the health care

industry for health care practitioners to use the cash method of

accounting.          PC used the cash method of accounting for both

income tax purposes and for bookkeeping purposes and consistently

reported the drugs used in patient treatments as supplies and not

as inventory.               With the exception of its Federal income tax

return for 1993, Mid-Del used the cash method of accounting for

income tax purposes and consistently reported the drugs used in

patient treatments as supplies and not as inventory.                             Mid-Del

used the accrual method of accounting for bookkeeping purposes.

           PC reported the following gross receipts, direct costs

associated with patient treatments, and gross profit for the

taxable years ending April 30, 1993, 1994, and 1995, using the

cash method of accounting:


     TYE        Gross          Other costs    Gross       Medical supplies and    Medical
                receipts1                     profit      drugs included in       supplies and
                                                          other costs             drugs as a
                                                                                  percentage of
                                                                                  gross receipts


    04/30/93   $1,519,988       $425,554     $1,094,434        $183,136              12

    04/30/94    2,106,670        454,982      1,651,688         367,793              17

    04/30/95    2,100,440        513,006      1,587,434         451,976              22


1
    Net of returns and allowances.
                                              - 15 -

           Mid-Del reported the following gross receipts, direct costs

associated with patient treatments, and gross profit for 1993,

1994, and 1995, using the cash method of accounting:

     TYE          Gross        Other costs     Gross      Medical supplies and   Medical supplies
                  receipts1                    profit     drugs included in      and drugs as a
                                                          other costs            percentage of
                                                                                 gross receipts


    1993
    amended2      $1,849,403    $643,959     $1,205,444         unknown            unknown

    1994           2,469,928     806,510      1,663,418         $806,510             33

    1995           1,780,767     721,944      1,058,823          721,994             41


1
    Net of returns and allowances, for 1994 and 1995.
2
  Mid-Del originally reported its income for 1993 using an accrual method of
accounting. During an audit of its 1993 Federal income tax return, Mid-Del submitted
an amended return reporting its income and expenses for 1993 using the cash method of
accounting. The audit was closed by agreement using the figures reflected on the
amended return.


           The combined average annual gross receipts of both

petitioners for the 3 years ending with the taxable years in

issue was less than 5 million dollars.

               For accounting purposes, Mid-Del and PC each valued their

chemotherapy drugs and miscellaneous medications at actual cost.

As of taxable years ending April 30, 1994, and April 30, 1995,

PC's drugs on hand were valued at $44,593 and $42,143,

respectively.              As of December 31, 1994, 1995, and 1996, Mid-Del's

drugs on hand were valued at $37,273, $60,382, and $67,634,

respectively.

           Neither petitioner made any attempt to manipulate income or

expenses by deferring income or paying unnecessary expenses at

the end of the taxable year.
                              - 16 -

The Notices of Deficiency

     Following an audit, respondent issued notices of deficiency

to each of the petitioners in which respondent determined that

they must use the accrual method.   The notices of deficiency

described respondent’s determination as follows: “It is

determined the accrual method of accounting more clearly reflects

income than your current ‘Cash Basis’ method of accounting.”

                              OPINION

     Section 446(b) vests the Commissioner with broad discretion

in determining whether a particular method of accounting clearly

reflects income.   See Knight-Ridder Newspapers, Inc. v. United

States, 743 F.2d 781, 788 (11th Cir. 1984); Ansley-Sheppard-

Burgess Co. v. Commissioner, 104 T.C. 367, 370 (1995); RLC Indus.

Co. v. Commissioner, 98 T.C. 457, 491 (1992), affd. 58 F.3d 413

(9th Cir. 1995).   The Commissioner's determination is entitled to

more than the usual presumption of correctness.   See Ansley-

Sheppard-Burgess Co. v. Commissioner, supra; RLC Indus. Co. v.

Commissioner, supra.   Accordingly, the Commissioner's

interpretation of the "clear-reflection standard [of section

446(b)] 'should not be interfered with unless clearly unlawful.'"

Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 532 (1979)

(quoting Lucas v. American Code Co., 280 U.S. 445, 449 (1930)).

The taxpayer bears "a 'heavy burden of * * * [proof],'" and the

Commissioner's determination "is not to be set aside unless shown
                               - 17 -

to be 'plainly arbitrary.'"    Id. at 532-533 (quoting Lucas v.

Kansas City Structural Steel Co., 281 U.S. 264, 271 (1930)).

The Commissioner's determination that a taxpayer's method of

accounting does not clearly reflect its income is given great

deference by this Court, but the Commissioner may not require a

taxpayer to change from an accounting method which clearly

reflects income to an alternate method of accounting merely

because the Commissioner considers the alternate method to more

clearly reflect the taxpayer's income.    See Ansley-Sheppard-

Burgess Co. v. Commissioner, supra at 371.

     The issue of whether the taxpayer's method of accounting

clearly reflects income is a question of fact to be determined on

a case-by-case basis.    See id.   In reviewing the Commissioner's

determination that the taxpayer's method of accounting does not

clearly reflect income, the function of the Court is to determine

whether there is an adequate basis in law for the Commissioner's

conclusion.   See RCA Corp. v. United States, 664 F.2d 881, 886

(2d Cir. 1981).    Consequently, to prevail, a taxpayer must prove

that the Commissioner's determination was arbitrary, capricious

or without sound basis in fact or law.    See Knight-Ridder

Newspapers, Inc. v. United States, supra; Ansley-Sheppard-Burgess

Co. v. Commissioner, supra.

     Sec. 471(a) provides:

     SEC. 471.    GENERAL RULE FOR INVENTORIES.

          (a) General Rule.--Whenever in the opinion of the
     Secretary the use of inventories is necessary in order
                                - 18 -

     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.

By regulation, the Secretary has determined that inventories are

necessary in every case in which the production, purchase, or

sale of merchandise is an income-producing factor in the

taxpayer's business.     See sec. 1.471-1, Income Tax Regs.   Unless

otherwise authorized by the Commissioner, a taxpayer who is

required to maintain inventories must use an accrual method of

accounting with regard to purchases and sales of inventory.     See

Asphalt Prods. Co. v. Commissioner, 796 F.2d 843, 849 (6th Cir.

1986), affg. in part and revg. in part Akers v. Commissioner,

T.C. Memo. 1984-208, revd. on another issue 482 U.S. 117 (1987);

sec. 1.446-1(c)(2)(i), Income Tax Regs.

     Respondent argues that the drugs at issue in this case are

merchandise, the purchase and sale of which are income-producing

factors in petitioners’ businesses, and, therefore, petitioners

are required to use the accrual method of accounting to report

their taxable income.6    Petitioners take exception to respondent's

characterization of the drugs, countering that the drugs are

supplies used in the course of treating patients, with the result



     6
      Respondent does not argue in this case that Mid-Del failed
to satisfy the book consistency requirement. See sec. 446(a).
Respondent’s arguments are directed solely to whether Mid-Del had
inventories within the meaning of sec. 471.
                              - 19 -

that, under their view, the regulations requiring use of the

accrual method are inapplicable.    We agree with petitioners that

their drugs are not merchandise.

     The term "merchandise" as used in section 1.471-1, Income

Tax Regs., encompasses goods purchased in condition for sale,

goods awaiting sale, articles of commerce held for sale, and all

classes of commodities held for sale.    See Wilkinson-Beane, Inc.

v. Commissioner, 420 F.2d 352, 354-355 (1st Cir. 1970), affg.

T.C. Memo. 1969-79.   Thus, items are merchandise if held for

sale.   See id.

     We recently held in a Court-reviewed opinion that

chemotherapy and other drugs, when used in the course of treating

patients, are not held for sale and, therefore, are not

merchandise.   See Osteopathic Med. Oncology & Hematology, P.C. v.

Commissioner, 113 T.C. 376 (1999).     In Osteopathic Med. Oncology

& Hematology, P.C., our holding was premised on our conclusion

that the chemotherapy drugs and ancillary medications were both

inseparable from the medical services provided to patients by the

taxpayer and subordinate to the medical services provided.    See

id. at 384-385.

     As in Osteopathic Med. Oncology & Hematology, P.C., the

furnishing of drugs and other medical supplies in this case is

inseparable from and subordinate to the medical services provided

by petitioners to their patients.    See id.   Patients come to the

clinics to receive medical treatment from Dr. Ishmael, not to
                              - 20 -

purchase drugs per se.   The drugs are administered to patients

during the course of their treatment.    At no point during the

treatment process does a patient acquire title to the drugs or

exercise control over them.   A patient does not direct how or

when the drugs are administered, nor can a patient simply

purchase the drugs for self-treatment.    Upon completion of each

treatment, there is nothing left for a patient to acquire, sell,

or otherwise exert ownership rights over.    Although there are

some factual differences between this case and Osteopathic Med.

Oncology & Hematology, P.C., the key operational facts for

purposes of our determination of whether petitioners’

chemotherapy drugs constitute merchandise are virtually

identical.   We hold that this case is controlled by Osteopathic

Med. Oncology & Hematology, P.C. and that, therefore, for

purposes of section 1.471-1, Income Tax Regs., petitioners’

chemotherapy drugs are not merchandise.

     Respondent's determinations in the notices of deficiency

regarding petitioners’ use of the accrual method do not state

that the determinations were premised on respondent’s conclusion

that the chemotherapy drugs are merchandise.7   On brief, however,


     7
      Other than respondent’s argument that the drugs used by
petitioners are inventory requiring use of the accrual method,
respondent has not posited any reason why petitioners' use of the
cash method does not clearly reflect income. In fact,
respondent’s determination in the notices of deficiency in this
case, read literally, is only that the accrual method “more
clearly reflects income than your current ‘Cash Basis’ method of
accounting.” Implicit in respondent’s determination as phrased
                                                    (continued...)
                                  - 21 -

respondent’s argument as to why petitioners are required to use

the accrual method is based solely on his position that the drugs

used by petitioners are merchandise that must be inventoried.

Respondent does not dispute that petitioners’ use of the cash

method clearly reflects income to the extent that the drugs are

not merchandise.       Because we hold that petitioners' drugs are not

merchandise, it follows that petitioners are neither required to

maintain inventories with respect to their drugs by section

1.471-1, Income Tax Regs., nor required to use an accrual method

by section 1.446-1(c)(2)(i), Income Tax Regs.       See Osteopathic

Med. Oncology & Hematology, P.C. v. Commissioner, supra at 391-

392.

           We hold, therefore, that respondent abused his discretion

in requiring petitioners to change from the cash method of

accounting to an accrual method.




       7
      (...continued)
is the recognition that petitioners’ cash method of accounting
does reflect their income clearly, albeit not as clearly as the
accrual method. Although the language used in respondent’s
notices of deficiency may be nothing more than a verbal foot-
fault, or an ill-phrased attempt to summarize the requirements of
sec. 471(a), respondent has offered no evidence to explain why
the determinations were phrased as stated in the notices.
Although the Commissioner’s determination that a taxpayer’s
method of accounting does not clearly reflect its income is
entitled to great deference, the Commissioner may not require a
taxpayer to change from a method of accounting that clearly
reflects income to another method of accounting because the
Commissioner determines that the alternate method will reflect
the taxpayer’s income more clearly. See Ansley-Sheppard-Burgess
Co. v. Commissioner, 104 T.C. 367, 371 (1995).
                                - 22 -

         In light of our holding, we find it unnecessary to address

petitioners' additional assignments of error.8    We have carefully

considered all remaining arguments made by respondent for a

result contrary to that expressed herein, and to the extent not

discussed above, we find them to be irrelevant or without merit.

     To reflect the foregoing,



                                           Decisions will be entered

                                      for petitioners.




     8
      On brief, petitioners made several additional arguments in
support of their contention that respondent abused his
discretion. Petitioners argued that the cash method clearly
reflected their income, irrespective of whether inventories were
required by sec. 1.471-1, Income Tax Regs.; that an audit of Mid-
Del’s 1993 Form 1120 resulted in an authorization for Mid-Del
(and PC, by implication) to use the cash method; that sec. 448
permitted petitioners' continued use of the cash method, also
irrespective of whether merchandise inventories were required;
and finally, that computational errors were made in the sec. 481
adjustment.
