Schlude v. Commissioner of Internal Revenue

RESPONDENT: Commissioner of Internal Revenue
LOCATION: Beaumont Mills

DECIDED BY: Warren Court (1962-1965)
LOWER COURT: United States Court of Appeals for the Eighth Circuit

CITATION: 372 US 128 (1963)
ARGUED: Dec 10, 1962
DECIDED: Feb 18, 1963

Facts of the case


Media for Schlude v. Commissioner of Internal Revenue

Audio Transcription for Oral Argument - December 10, 1962 in Schlude v. Commissioner of Internal Revenue

Earl Warren:

Number 80, Mark E. Schlude, et al., Petitioners, versus Commissioner of Internal Revenue.

Mr. Bauersfeld.

Carl F. Bauersfeld:

May it please the Court.

This is an income tax case.

The issue is whether the accrual method of accounting be continue to be used for income tax purposes where advance receipts are involved.

By the accrual method of accounting is meant the taxpayer's recognition of income when earned by performance whether before or after payment and the deduction of expenses as incurred whether before or after actual payment.

The facts necessary to understand the issue here present may be very briefly stated.

The taxpayer is -- of partner in a partnership that gave them instruction services under a contract for students.

The students made down payment and agreed to pay the balance of the contract price in installments.

The service contract is given rise to the tax controversy here where those as to which the student -- the taxpayer's performance extended beyond the taxable period in which the contracts were entered into.

Certified public accounting firm designed to partnerships bookkeeping system on the accrual basis accurately to match partnerships revenue derived from services rendered in each tax year with the costs of rendering services in such year.

And I will explain the exact detail of the accounting system shortly in the course of my argument.

The respondent initially required the partnership to include as income the entire face amount of each contract in the tax year in which it was entered into.

The respondent has now retreated from that position in this Court, but his confession does not, in any way, change or alter the basic issue.

The respondent now says that the entire face amount of each contract need not be taken into consideration or into income at the time that is signed but he still contends that all advance receipts actually received by a partnership for future instruction must be reported as income no later than the year in which the receipt -- receipt is obtained and that all other amounts under the contracts are to be reportable in the tax year when the students were obligated to make payments.

The respondent relying on the American Automobile Associate versus the United States in 367, U.S. urges that any accrual accounting system for deferring recognition of advance receipts must be rejected as violating tax accounting principles.

Here, we differ very greatly with the respondent.

If that case is read as we believe is proper then it is clear that the prior decisions of this Court in relevant tax statute authorized an accrual-basis taxpayer to be taxed on advanced receipts only in the year in which they are earned.

On the other hand, if the respondent is correct as to the meaning of the A.A.A. case, accrual-basis taxpayers will be required to use the cash method of accounting when that -- whenever they are paid advance receipts by their customers.

Now, incidentally by advance receipts, I mean any payments received before being earned by performance either by rendering services or providing goods as the case may be.

The American Automobile Association, we believe, did not reject the use of the accrual principle as such for reporting advance receipts of income in the tax year in which they are earned.

It did reject the application of that principle because of defects in bringing together the specific -- the costs of earning them with the receipts in that particular case.

We contend that in A. A. A., the Court ruled only that the Commissioner of Internal Revenue was incurred to disregard the method of accrual accounting for advance receipt used by the taxpayer there because the method did not precisely match the portion of the costs of performing services or the association's individual members in the tax year with the proper portion of advance dues paid by each member.

The association's accrual accounting procedures required only that dues be recorded as income for tax purposes on a month-by-month basis ratably over the membership period.

Without regard to the actual costs of services rendered of the members for performance require, the Court found that the accounting system used by the association did not accurately and precisely matched revenues with related costs because the system would base on statistical computations and calculations and averages reflecting the overall costs of rendering services to all its members on a (Inaudible) -- accrual basis.

The association I emphasized was unable to show that the method of deferral used for any relationship to the services yet to be performed or that the services to be performed would be equal for each member.

For this reason, we believe, the case stands only for the proposition that the accrual method of accounting they're use was so imprecise that the Commissioner's decision to set it aside was not arbitrary.

Now, by contrast here --

Which case are you talking about?

The Michigan case or the --