Cohen v. Commissioner

Edward L. Cohen, Petitioner, v. Commissioner of Internal Revenue, Respondent Cohen v. Commissioner Docket No. 36400 United States Tax Court 21 T.C. 855; 1954 U.S. Tax Ct. LEXIS 275; March 8, 1954, Promulgated *275 Decision will be entered under Rule 50. Accounting -- Accrual -- Interest -- Payment Doubtful. -- A taxpayer regularly using an accrual method of accounting may deduct accrued interest even though not in good financial condition. Arthur R. Silsdorf, Esq., for the petitioner. Charles M. Greenspan, Esq., for the respondent. Murdock, Judge. MURDOCK *855 The Commissioner determined deficiencies in the income tax of the petitioner for 1944 and 1945 of $ 1,176.80 and $ 1,373.31. The issue for decision is whether the Commissioner erred in disallowing deductions in each year for accrued interest. FINDINGS OF FACT. The petitioner filed his individual income tax returns for the taxable years with the collector of internal revenue for the second district of New York. The petitioner is a stockbroker who has been a member of the New York Stock Exchange since 1924. He formed a partnership with Ira Streusand in 1937 and since then the partnership has operated under the name of Edward L. Cohen and Company. He was actively engaged in the brokerage business during 1944 and 1945. An accrual method of accounting has been employed at all times material hereto in keeping the petitioner's*276 books and in filing his income tax returns. His returns have been filed in accordance with the method of bookkeeping employed and that method clearly reflects his annual income. The petitioner owed interest on indebtedness during each of the taxable years. $ 4,241.32 of interest accrued on that indebtedness during 1944 and $ 4,131.48 accrued on that indebtedness in 1945. Interest on the indebtedness totaling those amounts was accrued on the books *856 of the petitioner and was deducted on the petitioner's returns for those years. Most of the debts which the petitioner owed were incurred from 1930 to 1935 and substantial amounts of the principal had been paid on some of them prior to 1944. He borrowed some money and made some repayments during the taxable years. He paid some interest during the taxable years but most of that which accrued was not paid during those years. The liabilities of the petitioner exceeded his assets during 1944 and 1945. The Commissioner, in determining the deficiencies, disallowed deductions for interest of $ 4,241.32 for 1944 and $ 4,131.48 for 1945 with the explanation that: (a) It is held that you are not on the accrual method and that the use*277 of such method does not reflect your true income. It is further held that you have failed to establish the existence of any legal obligation to pay interest, and the amount of such interest if a legal obligation did exist. Accordingly, the amounts claimed by you as interest deductions in your returns for the years 1944 and 1945 have been disallowed. All facts stipulated by the parties are incorporated herein by this reference. OPINION. The evidence shows that the books of the petitioner were regularly kept on an accrual method of accounting at all times material hereto and that the use of that method clearly reflects his annual income. The evidence also shows that the amount of the interest accrued on his books for the taxable years was a legal obligation. The determination of the Commissioner was erroneous insofar as it disallowed the deductions claimed for interest on the returns. The Commissioner had no right under the law to disregard the accrual method of bookkeeping employed by the petitioner and to determine the deficiencies on a cash basis. The petitioner had a right to use an accrual method of accounting, he actually used that method in keeping his books, that method*278 clearly reflects his income, and his returns were filed on an accrual basis in accordance with his books. The Commissioner argues that the petitioner's method of accounting and reporting did not clearly reflect his income because the petitioner was not in a sound financial condition and it was unlikely that he would ever be able to pay some of the interest which was accrued on his books. The stipulated facts show that the petitioner was not in the best financial condition but he continued to conduct his business. Small portions of the accrued interest were actually paid and *857 payments of principal were also made, in the taxable years. There may have been doubt as to the ultimate ability of the petitioner to pay the accrued interest in full, but there was no certainty that he would be unable to do so. The rule which emerges from the decisions of this Court is that deductions for accrued interest are proper where it can not be "categorically said at the time these deductions were claimed that the interest would not be paid, even though the course of conduct of the parties indicated that the likelihood of payment of any part of the disallowed portion was extremely doubtful." *279 D. J. Jorden, 11 T. C. 914, 925. Butler Consolidated Coal Co., 6 T. C. 183; Panhandle Refining Co., 45 B. T. A. 651; Hummel-Ross Fibre Corporation, 40 B. T. A. 821, where deductions for accrued interest were allowed despite the inability of the debtor to meet its obligations as they matured. See also I. T. 3635, 1944 C. B. 101; Keebey's, Inc. v. Paschal, 188 F. 2d 113. Cf. Helvering v. Russian Finance & Construction Corp., 77 F. 2d 324, 327; Spring City Foundry Co. v. Commissioner, 292 U.S. 182. The facts in this case bring it well within the rule stated above and distinguish it from Zimmerman Steel Co., 45 B. T. A. 1041, revd. 130 F. 2d 1011; Florence Pearlman, 4 T. C. 34, affirmed on other grounds 153 F. 2d 560; Millar Brainard, 7 T. C. 1180, in which the United States Court of Appeals*280 for the Seventh Circuit, pursuant to a stipulation of the parties, ordered the Tax Court to vacate its decision and enter one of no deficiency. The petitioner is entitled to the deductions claimed. Decision will be entered under Rule 50.