Opinion
Docket No. 33796 33797.
1954-03-24
HARRY M. LEVIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.FREDA H. LEVIN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Benjamin F. Kivnik, Esq., for the petitioners. Edward Pesin, Esq., for the respondent.
Benjamin F. Kivnik, Esq., for the petitioners. Edward Pesin, Esq., for the respondent.
The partnership of which petitioners were members executed a contract in December 1946 for advertising which required services for that and subsequent years. In the taxable year 1946 and full amount of the contract price was accrued and claimed as an expense deduction. Held, only that portion representing services rendered in 1946 was accruable as an expense incurred in that period.
In these consolidated proceedings respondent determined deficiencies in income tax for the taxable year 1946 as follows:
+-------------------------+ ¦Harry M. Levin ¦$3,106.49¦ +---------------+---------¦ ¦Freda H. Levin ¦1,284.01 ¦ +-------------------------+
The single issue presented is whether the respondent erred in disallowing to petitioners, associated in a partnership keeping its books and reporting its income on the calendar year, accrual basis of accounting, a business deduction for the taxable year 1946 for the full amount of a contract of advertising entered into in that year, but calling for services in subsequent years as well.
Part of the facts are stipulated and are found accordingly.
FINDINGS OF FACT.
Petitioners Harry M. Levin and Freda H. Levin are husband and wife, residing in Philadelphia, Pennsylvania. For the taxable year 1946 they filed their individual returns with the collector of internal revenue for the first district of Pennsylvania, at Philadelphia.
During the calendar year 1946 petitioners were associated as partners, trading as Golden Brand Food Products Company, hereinafter referred to as the partnership, in the business of manufacturing, producing, and selling food products. The partnership at all times maintained its records and filing its income tax returns on a calendar year, accrual basis of accounting.
On December 12, 1946, the partnership, through its advertising agent, Seberhagen, Inc., entered into a written contract of advertising with National Transitads, Inc. The contract provided for the bulkhead display of cards advertising the partnership's product, Cream-Wipt Salad Dressing, in the combined subway and elevated systems of the Philadelphia Transportation Company, for a period of 2 years commencing December 5, 1946, at a rate of $733 per month. The contract was terminable by the partnership only at the end of 6, 12, or 18 months, upon 30 days' written notice to National Transitads, Inc. If the contract was terminated at the end of 6 months the applicable short rate, which was greater than the contract rate, would apply.
The contract provided further that all of the representations and agreements by the parties were contained therein and no representation or promise not set forth therein would offset the obligations of the parties thereunder.
On December 17, 1946, Seberhagen, Inc., the advertising agency for the partnership, submitted at the latter's request, an invoice for advertising services for the period from December 5, 1946, to December 4, 1947, at the rate of $733 per month, totaling $8,796 for the 12 months. The partnership thereafter accrued on its books as an advertising expense for the taxable year ended December 31, 1946, the entire amount of $8,796 contained in the invoice.
The partnership made payments on the invoice of December 17, 1946, as follows:
+-----------------------+ ¦Date ¦Amount ¦ +--------------+--------¦ ¦Feb. 10, 1947 ¦$2,199 ¦ +--------------+--------¦ ¦Mar. 31, 1947 ¦2,199 ¦ +--------------+--------¦ ¦July 29, 1947 ¦2,199 ¦ +--------------+--------¦ ¦Nov. 3, 1947 ¦1,466 ¦ +--------------+--------¦ ¦Dec. 1, 1947 ¦733 ¦ +--------------+--------¦ ¦Total ¦$8,796 ¦ +-----------------------+
In May 1948 the partnership was advised by National Transitads, Inc., that an increase in advertising rates would be imposed upon it at the end of the year. Petitioner Harry M. Levin, for the partnership, objected on the grounds that it was understood the partnership had a contract for a period of 5 years rather than for 2 years from December 5, 1946. Following such objection, National Transitads, Inc., in May 1948, executed with the partnership an advertising contract dated as of December 12, 1946, canceling the contract previously executed on that date.
The contract executed in May 1948 was identical with the contract executed December 12, 1946, except for the following differences: The period was to extend for 5 years from December 5, 1946, rather than 2 years, and the contract was not terminable by the partnership before the expiration of 1 year from that date, or at the end of yearly periods thereafter.
In determining the deficiencies against the respective partners the respondent increased the distributive share of petitioner Harry M. Levin in the net income of the partnership by the amount of $4,359.99, and the net income of petitioner Freda H. Levin by the amount of $2,179.99.
OPINION.
LEMIRE, Judge:
The question presented is whether the respondent erred in disallowing to petitioners, associated in a partnership keeping its books and reporting its income on the calendar year, accrual basis of accounting, a business deduction for the full amount of a contract of advertising entered into in that year, but calling for services in subsequent years as well.
On December 17, 1946, Seberhagen, Inc., the advertising agent for petitioners' partnership, Golden Brand Food Products Company, mailed to the partnership, at the latter's request, an invoice covering advertising expense for the period from December 5, 1946, to December 4, 1947. The partnership accrued the entire amount of $8,796 on its books as an advertising expense for the taxable year ended December 31, 1946, and deducted the amount on the partnership income tax return filed for that year.
The petitioners argue that the total amount of $8,796 shown on the invoice was properly accruable by their partnership in the taxable year 1946 as its liability for that year was incurred upon the execution of the contract under which the right of cancellation existed only at the end of each year. We deem it unnecessary to determine whether the substitute contract for 5 years or the original contract for 2 years is controlling, since the right to accrue would be the same under either contract.
A taxpayer on the accrual method of accounting is not entitled to a deduction of an amount representing business expenses unless all of the events have occurred which establish a definite liability to pay and also fix the amount of such liability. Where the liability is uncertain because of the existence of a contingency the item is not accruable. Dixie Pine Co. v. Commissioner, 320 U.S. 516; American National Co. v. United States, 274 U.S. 99; and United States v. Anderson, 269 U.S. 422.
The respondent has disallowed the amount in excess of that portion applicable to the month of December 1946 on the ground that the petitioners were only contingently liable for the advertising services to be performed in a subsequent year and the allowance of the total amount involved here would not clearly reflect the partnership income for the taxable year 1946.
In our opinion the petitioners' contention cannot be sustained. Under the contract of December 1946 the petitioners incurred no liability but merely agreed to become liable to pay in the event the future services called for were performed. The measure of such an 999 obligation is not the contract price which the petitioners here seek to deduct but a contingent response in damages for its breach. Hallack & Howard Lumber Co., 18 B.T.A. 954. That contingency not having arisen, such a liability was never incurred. In the case at bar, as in the last cited case
We think no liability was incurred by the petitioner under its contract with Allen until, at the time in 1921 contemplated by the parties when making the contract, Allen commenced his performance. In other words, the agreement made in 1920 did not then incur a liability but was simply an agreement under which a liability would be incurred in the future. * * *
Cases dealing with the creation of reserves anticipating liabilities yet to be incurred are not without analogy. In such cases it has been well established that the accrual method of accounting does not permit the anticipation in the taxable year of future expenses in other years prior to the rendition of the services fixing the liability for which the payment is to be made. See Spencer, White & Prentis v. Commissioner, 144 F.2d 45, certiorari denied 323 U.S. 780; Amalgamated Housing Corporation, 37 B.T.A. 817, affirmed per curiam 108 F.2d 1010; and Atlas Mixed Mortar Co., 23 B.T.A. 245.
The respondent properly increased the gross income of the partnership by the amount of advertising expenses improperly accrued for the year 1946 and, accordingly, the gross income of each petitioner was properly increased by the respective distributive share of the partnership income as adjusted. The precise adjustment is not disclosed by the record.
Decision will be entered under Rule 50.