Daily Record Co. v. Commissioner

DAILY RECORD CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Daily Record Co. v. Commissioner Docket No. 12058. United States Board of Tax Appeals 13 B.T.A. 458; 1928 BTA LEXIS 3244; September 21, 1928, Promulgated *3244 The petitioner made its income and profits-tax returns for 1921 and prior years on a cash receipts and disbursements basis. It made no material change in its bookkeeping in 1921. Held, that a return on the cash receipts and disbursements basis reflected its true net income for 1921. Theodore B. Benson, Esq., and Edgar T. Wagner, Esq., for the petitioner. Bruce A. Low, Esq., and George Herr, Esq., for the respondent. SMITH *458 The Commissioner has determined a deficiency in income and profits tax for the calendar year 1921 in the amount of $11,173.67. The points in issue are whether there should be added to the income reported by the petitioner for 1921, $34,428.43 representing accounts receivable at the beginning of the year, and whether deductions should be increased by $8,723.48 for bad debts determined to be worthless during the year. FINDINGS OF FACT. The petitioner is a Maryland corporation with its principal office and place of business in Baltimore. It was incorporated on April 7, 1890, and has continuously since such date been engaged in the business of publishing a record of court proceedings, real estate transfers, *3245 and items of interest to the legal profession under the name of "The *459 Daily Record." In addition to The Daily Record, the petitioner did job printing. Such businesses were engaged in during the year 1921. Its income is derived principally from advertising, job printing and subscriptions. For the year 1921 and for all prior years the petitioner prepared and filed its income and profits-tax returns on a cash receipts and disbursements basis. Its return for 1922 was filed on the accrual basis and in that return it stated, "Prior returns based on actual cash receipts and disbursements. April, 1921, system of accounts was installed placing books on accrual basis." From the date of its organization and through the year 1921, the business engaged in by the petitioner has been for the most part on the basis of credit. Following the receipt of an order for the publication of an advertisement, and when the first publication is inserted the practice of the petitioner has consistently been to "book" the charge and to render a bill to the attorney who ordered the insertion. It was necessary to extend credit to executors of estates and attorneys in divorce cases as payment*3246 was not made until ordered by the court, which frequently required more than a year. The petitioner has at all times maintained a customers' ledger in which accounts are maintained under the names of attorneys ordering publications for their clients. On the left-hand side of this ledger the charge for each publication is entered, and, on the right-hand side, payments rendered as received on the line opposite the charge. Sometimes the charge was not settled for many years. The account was left open unless or until it had been determined to be worthless, in which event it would be marked "M.O.," meaning marked off. The customers' ledger has been continuously maintained and credit entries have at all times been made thereon by the petitioner. This ledger was not in any manner changed in 1921. It has at all times been the practice of the petitioner to render bills to the attorney ordering the publication and to look to the attorney for payment only in the event the attorney collects from his client. The petitioner has never sued an attorney to collect a charge made against him. There has never been any change in this practice since the beginning of the business. It has been*3247 the practice of the petitioner at all times to charge up the bad accounts by marking "M.O." The petitioner's cash books show that no change in the accounting system has been made by any entries in such books. The petitioner has never at any time bought or sold merchandise. The only inventory carried at any time consisted of supplies. *460 The petitioner paid its bills promptly and on or before the tenth of the following month, and never at any time had bills or accounts payable on its books. In April, 1921, the petitioner opened a general ledger in which accounts were set up with certain capital assets. In an accounts receivable account were shown the balances of the customers' accounts on given dates and also reserve accounts for income taxes and for commissions expected to be paid in connection with the collection of accounts receivable, and $34,428.43 was entered in this books as accounts receivable at January 1, 1921. The accounts receivable at December 31, 1921, after charging off $8,723.48 as uncollectible, amounted to $36,102.27. No changes were made in the method of doing business or in the practice of charging attorneys at the time of booking of advertisements, *3248 nor were any changes made in entries in other books. The income-tax return filed by the petitioner for 1920, on a cash receipts and disbursements basis, showed collections amounting to $96,204.68 and disbursements, including $1,727.57 for exhaustion, wear and tear of equipment, of $70,839.79. Included in the income was $250 in dividends. After the exclusion of this amount from gross income, the resulting net income liable to tax is shown to have been $24,844.89. Upon audit of the petitioner's books of account and return for 1921, the Commissioner determined that its books of account were kept on the accrual basis and that there should be added to the gross income reported for 1921 the amount of $34,428.43, which represented accounts receivable at December 31, 1920, and that there should be deducted from total gross income for 1921, $8,723.48 for bad debts determined to be worthless and charged off during the taxable year. OPINION. SMITH: Section 232 of the Revenue Act of 1921 states: That in the case of a corporation subject to the tax imposed by section 230 the term "net income" means the gross income as defined in section 233 less the deductions allowed by section*3249 234, and the net income shall be computed on the same basis as is provided in subdivision (b) of section 212 * * * Section 212(b) provides: The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made upon such basis and in such manner as in the opinion of the Commissioner does clearly reflect the income. * * * The *461 petitioner made its returns of net income for 1921 and prior years, upon the cash receipts and disbursements basis. It included in income all revenue cash received and deducted therefrom cash disbursements including a reasonable amount for exhaustion, wear and tear of property. Its returns were consistently made upon this basis. Prior to 1921 it had no general ledger. In that year it opened a general ledger with certain accounts therein. It opened an account for "customers' accounts" to which were transferred the balances*3250 of the accounts shown in the customers' ledger. It also opened accounts with capital assets upon which depreciation was claimed, and sundry other controlling accounts. This general ledger, however, had no "Profit and Loss" account and no account which shows the true gains of the taxable year. It had a "surplus" account but an inspection of that account shows that it in no wise reflected the gains of the year either upon a cash receipts and disbursements basis or upon the accrual basis. The respondent held, however, that the keeping of the general ledger operated to place the petitioner's books of account upon the accrual basis and, inasmuch as the general ledger showed accounts receivable at December 31, 1920, in the amount of $34,428.43 which had never been taken into income, that this amount should be included in the gross income of 1921. Consistent with this theory, he also allowed the deduction from gross income of 1921 of $8,723.48, representing accounts which the petitioner had determined to be worthless in 1921 and which it had charged off as bad accounts on its customers' ledger. The net result of this change was to increase the net income reported by the petitioner in*3251 the amount of $24,844.89 by $25,704.95. The respondent apparently recognized the distortion of income by this proceeding and therefore determined the tax liability of the petitioner for 1921 under the provisions of section 328. In this proceeding the petitioner makes two contentions: First, that it did not change its method of accounting from the basis of cash to that of accrual in 1921, and, second, that if it did so change its method of accounting the accounts receivable on its books at December 31, 1921, and representing accruals in 1920 and prior years, should not be included in income for the calendar year 1921. It is well settled that the income of the petitioner is to be determined by actual facts as to which the books of account are only evidential. ; . The gist of these decisions is that in order to be income amounts must have been received or accrued and that this is a question of fact not to be determined by any error in bookkeeping made either during the taxable year or in prior years. The essence of the contention of the respondent*3252 in this proceeding is that on December 31, 1920, the petitioner had on its books of *462 account $34,428.43 of accounts receivable which had never been included in income in returns for prior years and that if the petitioner is not required to take this amount up as income in 1921, the amount will escape tax altogether; for when the accounts are collected they will not be reflected in gross income upon an accrual basis, since they will not accrue in the year in which collected. By this very argument the Commissioner admits the nonaccrual of the accounts in 1921. It is the contention, however, that where a taxpayer changes from cash basis to an accrual basis he must take up in the income of the year of change uncollected items of income which have accrued in prior years but which have not been returned as income in prior years. In support of this contention the respondent relies upon the decision of the Board in . It is not, however, necessary for us to consider this angle of the argument. We are convinced from an examination of the evidence of record that there was no material change made by the petitioner in the keeping of*3253 its accounts during the year 1921. No argument is made and we think no argument can be made that the net income shown by the return filed for 1921 on the cash receipts and disbursements basis reflects the true net income of petitioner for 1921. The business of the petitioner was such that the accrual method of accounting is not necessary to reflect its correct income. The difference between receipts and disbursements accurately reflects that income. The petitioner had been in business for a great many years. For aught we can determine the accounts receivable for many years prior to 1921 were as great as they were at December 31, 1920. There is no evidence of a change made by the petitioner in its bookkeeping to minimize its taxes. Counsel for the petitioner suggests that if its returns are to be put on an accrual basis for 1921, all that it should be required to include in income for 1921, over the amount which it has reported on a cash receipts and disbursements basis, is the amount of the increase in accounts receivable at the beginning and close of 1921. This would reflect the income on an accrual basis and all that the Commissioner could contend would be an accrual in 1921, *3254 if returns for years prior to 1921 had been made on the accrual basis. Upon the facts before us we are of the opinion that the cash receipts and disbursements basis is the proper basis for a return of this petitioner for 1921. Its books of account clearly reflect the flow of cash. The true gain of the petitioner appears to have been substantially $24,844.89, the amount shown upon its original return. The Board can not countenance the distortion of this income by adding thereto approximately $25,000 of accounts receivable at December 31, 1920. The accruals at 1920 and prior years could not have accrued in 1921, except in a bookkeeping sense. *463 It not appearing from the record whether any part of the deficiency found by the respondent is clearly due, Judgment will be entered under Rule 50.