Yost Auto Co. v. Commissioner

YOST AUTO COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Yost Auto Co. v. Commissioner Docket No. 43815. United States Board of Tax Appeals 26 B.T.A. 685; 1932 BTA LEXIS 1272; July 20, 1932, Promulgated *1272 A reserve which is set up in the taxable year to cover a future liability is not deductible in determining net income for that year where it appears that the claimed deduction represents an estimate of the amount which petitioner may have to pay at some time during the following year and no definite liability has been incurred in the taxable year. William J. Ostheimer,1 B.T.A. 18, followed. P. R. Strout, C.P.A., for the petitioner. P. A. Bayer, Esq., for the respondent. MATTHEWS *685 This proceeding involves a deficiency in income tax for the calendar year 1927 in the sum of $459, and arises upon the disallowance by the respondent of a reserve of $1,400 set up by the petitioner in *686 that year for tire expense and claimed as a deduction from gross income. FINDINGS OF FACT. The petitioner is a corporation, with its office and principal place of business at Edmonds, Washington. During the taxable year the petitioner owned and operated an automobile stage system between Seattle and Edmonds, Washington, and way points. The petitioner kept its books on the accrual basis. It followed the uniform classification*1273 of accounts for auto transportation companies prescribed by the State Department of Public Works. Under this classification the petitioner maintained an account for tires, "E-6." The Public Works classification under this head states: "Charge to this account the cost of tires and tubes at the time they are placed on the cars, whether in actual service or as spares. * * * Credit to this account any revenues derived from the sale of used tires or tubes and any amounts received as adjustments on tires or tubes." The petitioner bought no new tires for its stage buses in 1927, but hired tires from the Firestone Tire & Rubber Company under a contract by which the Firestone Company furnished to petitioner the "Operating Company," tires at an agreed rate per bus mile, title remaining in the Firestone Company. The seventh paragraph of this contract reads as follows: Operating Company agrees upon the termination by full performance and expiration of this contract at its election either to (1) purchase such casings and tubes on buses, in Operating Company's garages and those being used in the service of the fleet on the basis of Firestone Company's Service Dealer's Prices less an amount*1274 for mileage service rendered or (2) to continue for a period of one hundred twenty days thereafter to use all such casings and tubes enumerated in option (1) at the rate hereinabove provided, and at the expiration of such one hundred twenty days to purchase the tires then on hand on the basis as set out in option (1) herein. The term of the contract ran from November 1, 1926, to May 1, 1928. At the end of 1927 petitioner had seven buses equipped with hired tires. These buses were equipped with tires when bought by petitioner and the tires were included in the cost. When tires were purchased petitioner charged them to expense. The tires on the seven buses which were replaced by the hired tires were put in stock and used by petitioner on other buses. During 1927 the petitioner paid (including a payment made on January 9, 1928) the Firestone Company $2,886.44 for tire mileage in accordance with the contract. In addition petitioner set up for 1927 a reserve of $1,400 in its "E-6, Tires" account, tires for seven buses, covering the amount estimated as necessary to purchase these *687 tires from the Firestone Company on the termination of the contract, May 1, 1928. This*1275 reserve was disallowed by the respondent as a deduction from gross income for 1927. OPINION. MATTHEWS: The petitioner in this case is protesting the disallowance by the respondent of a deduction from gross income for 1927 in the sum of $1,400. This amount is entered on its books under its account for tires as "reserve for seven buses" and in his report to the stockholders for the year 1927 the general manager of the petitioner corporation explains this entry as follows: During the year, most of the tires on our stage equipment were used up and replaced with contract tires of the Firestone Tire & Rubber Company. For the purpose of replacing these buses with our own rubber at such future time as this may become necessary, a reserve fund for this purpose was set up to the amount of $1,400.00 and charged to tire operation expenses. After including this item in our cost of tires for the year, the tires cost us 1.27 cents per mile, as compared with 1.33 per mile for the previous year. We have found that the petitioner did not purchase any tires during the year 1927 and the items aggregating $2,886.44 which were charged to the account for tires in 1927, in addition to the reserve*1276 fund of $1,400, represented payments made to the Firestone Tire & Rubber Company under a contract whereby the Firestone Company furnished tires to the petitioner at an agreed rate per bus mile. This contract was to run to May 1, 1928, and it was provided that the petitioner might continue to use the hired tires at the rate specified for an additional period of 120 days before purchasing them in accordance with the terms of the contract, which are more fully set out in our findings. Seven buses were equipped with hired tires in 1927. The general manager of the petitioner corporation testified that the reserve for tires in the sum of $1,400 represented an estimate of the amount petitioner would have to pay the Firestone Company for the hired tires at the expiration of the contract. The statute provides that expenses paid or incurred during the taxable year shall be allowed as deductions in computing net income. Under the accrual system of bookkeeping items of expense may be accrued where they represent obligations or expenses definitely incurred, but liabilities or expenses will be considered to have accrued only when all the events have occurred from which liability or expense*1277 can be determined and become fixed. , affirming . In , a lessee of chattels sought to take as a deduction amounts set aside as a reserve in anticipation of liability under the terms of the lease to replace the leased property. It was held that only the amounts actually expended or for *688 which liability had actually been incurred during the taxable year may be deducted. See also ; ; ; . Even if we concede that, under the circumstances of the instant case, business prudence may have justified the petitioner's setting up in 1927 of a reserve for tires, it is clear that no liability in praesenti was incurred in the taxable year. It appears that a liability to purchase tires in some amount would be incurred at some time in the future, but reference to the provisions of the contract, which*1278 expired on May 1, 1928, but might be continued at the petitioner's option on the same basis for 120 days thereafter, shows how indefinite, on the evidence presented, is the obligation of the petitioner to make any payment under the contract at its termination. We conclude that the reserve for tires is not deductible in determining net income for 1927. Judgment will be entered for the respondent.