Source: https://supreme.justia.com/cases/federal/us/280/445/
Timestamp: 2019-04-25 09:49:13+00:00

Document:
Justia › US Law › US Case Law › US Supreme Court › Volume 280 › Lucas v. American Code Co.
Lucas v. American Code Co.
of a judgment which it suffered in 1922 and paid in 1923. The judgment was founded on a breach of contract committed by the taxpayer in 1919, in discharging a sales manager who, by the terms of the contract, was to be employed for eighteen years more and be compensated by commissions on sales. Though denying and contesting its liability, the taxpayer had set up on its books in 1919 a reserve equal to the commissions for that year, and had increased it in 1920 on the same basis, and, after the rendition of the judgment, it had adjusted the reserve to the amount of the recovery.
1. Since the general requirement of the statute that losses be deducted in the year in which they are sustained calls for a practical, and not a legal, test, and since the direction, § 212(b), that net income be computed according to the method of accounting regularly employed by the taxpayer is expressly limited to case where the Commissioner believes that the accounts clearly reflect the net income, the administrative interpretation and practice in these regards should not be disturbed by the courts unless clearly unlawful. P. 280 U. S. 449.
2. Since it could not be said that the loss actually paid by the taxpayer in 1923 was, as a matter of law or undeniable fact, sustained in the year 1919, and since the taxpayer did not in that year accrue an estimated amount of the loss on its books, rejection of the deduction for that year should be sustained. Pp. 280 U. S. 450-452.
3. Mere reserves to cover contingent liabilities are not allowable as deductions. P. 280 U. S. 452.
Certiorari, 279 U.S. 832, to review a judgment of the circuit court of appeals reversing a decision of the Board of Tax Appeals, 10 B.T.A. 476, which sustained the Commissioner in rejecting a claim for a refund and in asserting a deficiency.
When the income tax return for 1919, of the American Code Company, Inc., was being audited in 1925, the company filed with the Commissioner of Internal Revenue a claim for a refund based upon its failure to deduct from its 1919 gross income the amount for which judgment was recovered against it in 1922, on a contested liability for a breach of contract in 1919. The Commissioner of Internal Revenue rejected the claim and asserted a deficiency. His ruling was sustained by the Board of Tax Appeals. 10 B.T.A. 476. Its decision was reversed by the United States Circuit Court of Appeals for the Second Circuit. 30 F.2d 222, 224. We granted a writ of certiorari. 279 U.S. 832.
the amount of such commissions, $14,764.79. At the close of 1920, the amount in this reserve was increased by $32,994.09, computed on the same basis. In 1922, after a jury trial, judgment for $21,019.19 was entered in the trial court, and, on appeal by the company, was affirmed by the Appellate Division. The company then prosecuted a further appeal to the Court of Appeals. In 1923, the judgment was affirmed by that court and paid by the company. The judgment having been rendered by the trial court early in 1922 before the books were closed for 1921, the reserve set up was adjusted as of the close of 1921 to the amount of the recovery, $21,019.19. That sum is claimed as the deduction for 1919.
The company kept its books and made its income tax returns on the accrual basis. The Revenue Act of 1918, Act of February 24, 1919, c. 18, § 234(a), (4), 40 Stat. 1057, 1077, 1078, provides that, in computing net income, "losses sustained during the taxable year and not compensated for by insurance or otherwise" shall be allowed as deductions. Section 212(b) provides that the net income shall be computed "in accordance with the method of accounting regularly employed in keeping the books of such taxpayer," unless the method employed does not clearly reflect the net income. And Article 111 of Regulations No. 45 (1920 ed.) of the Bureau of Internal Revenue provides that a "person making returns on an accrual basis has the right to deduct all authorized allowances, whether paid in cash or set up as a liability. . . ."
The company's argument, sustained by the court of appeals, is that, since the breach of the contract occurred in 1919, all the facts which gave rise to the liability were fixed in that year; that damages must be assessed as of the date of the breach; that the loss therefore occurred in that year, and that it is immaterial that the amount of the damages was not determined or paid until later.
"a taxpayer first ascertains the amount of a loss sustained during a prior taxable year which has not been deducted from gross income, he may render an amended return for such preceding taxable year, including such amount of loss in the deductions from gross income, and may file a claim for refund of the excess tax paid by reason of the failure to deduct such loss in the original return."
Generally speaking, the income tax law is concerned only with realized losses, as with realized gains. Weiss v. Wiener, 279 U. S. 333, 279 U. S. 335. Exception is made, however, in the case of losses which are so reasonably certain in fact and ascertainable in amount as to justify their deduction, in certain circumstances, before they are absolutely realized. As respects losses occasioned by the taxpayer's breach of contract, no definite legal test is provided by the statute for the determination of the year in which the loss is to be deducted. The general requirement that losses be deducted in the year in which they are sustained calls for a practical, not a legal, test. And the direction that net income be computed according to the method of accounting regularly employed by the taxpayer is expressly limited to cases where the Commissioner believes that the accounts clearly reflect the net income. Much latitude for discretion is thus given to the administrative board charged with the duty of enforcing the act. Its interpretation of the statute and the practice adopted by it should not be interfered with unless clearly unlawful.
"Any amount paid pursuant to a judgment or otherwise on account of damages for personal injuries, patent infringement or otherwise, is deductible from gross income when the claim is put in judgment or paid. . . ."
been payable in that year if Farquhar had remained in the company's employ. That the company did not intend the reserve to be an accrual of the total estimated loss is clearly indicated by the fact that, in 1920, it charged to the reserve, to cover the commissions which would have been payable in 1920, an additional amount, more than double that charged in 1919.
The prudent businessman often sets up reserves to cover contingent liabilities. But they are not allowable as deductions. [Footnote 3] The reserve set up by the company was of that character. It cannot be said that the loss actually paid by the company in 1923 was, as a matter of law or of undeniable fact, sustained in 1919. Nor did the company so regard it. The case at bar is unlike United States v. Anderson, 269 U. S. 422. There, the liability for the munitions tax at a fixed rate on the business done in 1916 had confessedly accrued in that year, and was a charge on the business of that year, although the exact amount due may not have been then ascertainable and the tax was not payable until 1917. It is also unlike American National Co. v. United States, 274 U. S. 99. There, the bonus contract provided definitely for the payment of a fixed amount. It was debitum in praesenti, solvendum in futuro. The case at bar is in principle more like Lewellyn v. Electric Reduction Co., 275 U. S. 243.
Appeal of Producers Fuel Co., 1 B.T.A. 202; Appeal of Brighton Mills, 1 B.T.A. 392; Appeal of New Process Cork Co., 3 B.T.A. 1339; Appeal of Bump Confectionery Co., 4 B.T.A. 50; Appeal Hamler Coal Co., 4 B.T.A. 947; Empire Printing & Box Co. v. Commissioner, 5 B.T.A. 203; Appeal of Nice Ball Bearing Co., 5 B.T.A. 484, 495; Raleigh Smokeless Fuel Co. v. Commissioner, 6 B.T.A. 381; Farmers National Bank v. Commissioner, 6 B.T.A. 1036; Jewell v. Commissioner, 6 B.T.A. 1040; Lynchburg Colliery Co. v. Commissioner, 7 B.T.A. 282; Hidalgo Steel Co. v. Commissioner, 8 B.T.A. 76; Fraser Brick Co. v. Commissioner, 10 B.T.A. 1252, 1258; Safe Guard Check Writer Corp. v. Commissioner, 10 B.T.A. 1262; Ledbetter Manufacturing Co. v. Commissioner, 12 B.T.A. 145; J. G. Curtis Leather Co. v. Commissioner, 13 B.T.A. 1259, 1265. Compare Appeal of Lane Construction Corporation, 4 B.T.A. 1133; Celluloid Co. v. Commissioner, 9 B.T.A. 989, 1005; Graham-Bumgarner Co. v. Commissioner, 11 B.T.A. 603, 605; Lehigh & Hudson River Ry. Co. v. Commissioner, 13 B.T.A. 1154, 1164.
Thus, in Appeal of Producers Fuel Co., note 1 supra, there were two contracts for the purchase, respectively, of 15,700 and 20,000 tons of coal in equal monthly installments between May, 1920, and March, 1921, and between May, 1920, and May 1921. Both contracts were broken in December, 1920, and offers of settlement were immediately made. Reserves of $7,500 and $30,000 were set up in 1920. The claims were settled in January, 1921, for $5,500 and $29,792.40. Similar situations were involved in Raleigh Smokeless Fuel Co. v. Commissioner and Fraser Brick Co. v. Commissioner, ibid.
Compare Appeal of Uvalde Co., 1 B.T.A. 932; Appeal of M. C. Stockbridge, 2 B.T.A. 327; Appeal of Northwestern Bakers Supply Co., 2 B.T.A. 834; Appeal of Richmond Light & R. Co., 4 B.T.A. 91; Alston v. Commissioner, 4 B.T.A. 1159; Davis Co. v. Commissioner, 6 B.T.A. 281, 283; Fibre Yarn Co. v. Commissioner, 10 B.T.A. 479, 480; Kaufmann, Department Stores, Inc. v. Commissioner, 11 B.T.A. 949.

References: v. 
 v. 
 § 212
 § 234
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v.