Schulde v. Commissioner
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Schulde v. Commissioner, 372 U.S. 128, 19631, was the last in a trilogy of United States Supreme Court cases discussing the Federal income tax treatment of prepayments in an accrual method accounting system. The Court ruled for the Commissioner of Internal Revenue, following the reasoning in the cases of American Automobile Association and Automobile Club of Michigan. The Court ruled that in accrual method accounting, prepayments are includible in gross income (i.e., are taxable) in the year received if they are not paid for services to be rendered on a specific date.
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[edit] Facts
Taxpayers operated a ballroom dance studio under a contract with Arthur Murray, Inc. The studio offered two basic contracts: a cash plan requiring the student to pay the entire down payment at the time the contract was executed, with the balance in installments, and a deferred payment plan where the student only paid a portion of the down payment, and with the remainder to be paid as designated in negotiable note signed at the time of the contract. The contract structure of the studio stated that (1)the student would pay tuition, (2) the student must pay tuition, (3) no refunds, (4) the contract was non-cancelable. The contracts further stated the number of lessons to be provided, but did not provide for the date of lessons.
[edit] Question
"Was it proper for the Commissioner, exercising his discretion under Section 446(b) to reject the studio's accounting system as not clearly reflecting income and to include as income in a particular year advance payments by way of cash, negotiable notes and contract installments falling due but remaining unpaid during the year?"
[edit] Decision
The court relied upon the decisions in American Automobile Ass'n v. United States, 367 U.S. 687, and Automobile Club of Michigan v. Commissioner, 353 U.S. 180, in which the court rejected the taxpayer's accounting method because, the advance payments related to services to be performed without mentioning a specific date. Likewise, in the instant case, the court found the taxpayer's accounting did not take into account a specific date for performance of the services. Finally the court found that the studio took bonuses paid from contract sales in the year of sales despite the income being deducted to later years. Thus, followed the precedent of American Automobile and Automobile Club of Michigan and ruled for the commissioner.
[edit] Other considerations
The High Court later held in a decision concerning the deposits paid by electricity rate payers and held that those amounts unlike Schlude were not includible into income for the utility taxpayer. The reason in the opinion was that the rate payers have the legal right to get the deposit back. As a result of being required to include cash received as current revenue without allowing a corresponding expense deduction for the increase in liability, this decision accelerates the tax timing of recognition of income. However, this rule does not harm inurance companies because they may set up tax reserves as liabilities which give rise to current tax deductions.
[edit] See also
[edit] External links
Text of the Case: http://supreme.justia.com/us/372/128/case.html
[edit] References
Samuel A. Donaldson, Federal Income Taxation of Individuals 49-52 (2005).
