Case Name: Robert G. Frame, Petitioner, v. Commissioner of Internal Revenue, Respondent
Court: United States Tax Court
Jurisdiction: United States
Decision Date: 1951-03-08
Citations: 16 T.C. 600
Docket Number: Docket No. 24180
Parties: Robert G. Frame, Petitioner, v. Commissioner of Internal Revenue, Respondent.
Judges: Raum, agrees with this dissent.
Reporter: Reports of the Tax Court of the United States
Volume: 16
Pages: 600–607

Head Matter:
Robert G. Frame, Petitioner, v. Commissioner of Internal Revenue, Respondent.
Docket No. 24180.
Promulgated March 8, 1951.
R. J. Cleary, Esq., for the petitioner.
Albert J. C Connor, Esq., for the respondent.

Opinion:
OPINION.
Disney, Judge:
This case involves income tax for the calendar year 1945. Deficiency was determined in the amount of $44,215.22. Only a part thereof is involved here. The only question presented is whether the Commissioner erred in adding to petitioner's net income $53,890.28 because of the addition to income of petitioner's debit balance of accounts receivable on his books at the beginning of the taxable year. The problem is whether the Commissioner, in connection with requiring petitioner, who had made no change in his method of accounting, to change from the cash to the accrual method in reporting income on his tax returns, properly made the above addition to petitioner's net income for 1945, from accounts receivable at the end of 1944. The petitioner agrees that income should be increased by $19,828.79, which is (except for minor adjustments as to which there appears no disagreement) the difference between $67,315.25 ("1945 income per books (accrual basis)" according to respondent's computation before addition of accounts receivable as of January 1,1945) less $48,626.55, the amount reported by petitioner for 1945. Thus, in effect, the petitioner does not object to being placed on an accrual basis for 1945, but objects to having included in his income for that year the amount of accounts- receivable at the end of the previous year.
All facts are stipulated and we find them to be as stipulated. It is not considered necessary to set forth such facts here except as follows: The petitioner at all times filed his returns, for 1945 and previous years, on the cash basis; but he had kept the books of a sole proprietorship, engaged in the electrical installation business, on the accrual basis. He made no change in the accounting method or ac counting period during tbe years 1942 to 1945, inclusive, and did not request permission of the Commissioner to make any change. The Commissioner added $53,390.28 to petitioner's income for the taxable year. The deficiency notice explains the addition to income as follows:
(b) It is determined that tbe net profit resulting from the operation of your business during tbe taxable year, is understated in the amount of $53,390.28.
The first report of an internal revenue agent in 1947, on petitioner's return for 1945, made minor changes (as to rental income and an error in addition) resulting in an overassessment of $725.64, which was paid. No change was made by the agent's report in the income reported from the sole proprietorship. Another internal revenue agent's report in-1949 notified petitioner of the addition of the $53,-390.28 to income, explaining it:
To adjust income from business from the cash basis as reported to the accrual method. See Section 41, Reg. 111. Also to take into consideration, the items of accounts receivable, accounts payable, and accrued expense as of the beginning of the year, which are not reflected in the return for the prior year.
The petitioner relies upon Estate of Samuel Mnookin, 12 T. C. 744, which in turn relied upon Greene Motor Co., 5 T. C. 314. The respondent makes no attempt to distinguish either case and states his position as follows:
Respondent's position in this proceeding is that the accounts receivable accrued on the books of account in the taxable years 1942 through 1944, but not reported in petitioner's returns for those years, constituted a part of petitioner's gross income for the taxable year 1945. Respondent's position and argument on this same question were submitted to this Court in Estate of Samuel Mnookin, (1949) 12 T. C. 744 (N. A. 1949-2 C. B. 4, on appeal to Eighth Circuit). It is-believed that no useful purpose would be served by arguing this question again, in the present brief, other than to state, for purposes of the record, that respondent does not agree with the decision of the Tax Court in the Mnookin case, and that, in our view, respondent should prevail in the present proceeding on the authority of Z. W. Koby, (1950) 14 T. C. [1103] (No. 123); Schuman Carriage Company, Ltd., (1941) 43 B. T. A. 880; Hardy, Inc. v. Commissioner, (C. A. 2, 1936 ) 82 F. (2d) 249; and Carter v. Commissioner, (C. A. 6, 1949) 173 F. (2d) 29.
Since the filing of the briefs of both parties, the Mnookin case has been affirmed, Commissioner v. Mnookin's Estate, 184 Fed. (2d) 89. In the Koby case, supra, we stated that the Greene Motor Co. and MnooMn cases were readily distinguishable, pointing out that they involved "the propriety of increasing the income of one year by an amount erroneously excluded from income in a prior year." We find that the respondent is in agreement that the petitioner's method of accounting for the business of the sole proprietorship, on the accrual basis, clearly reflected income, for, as above seen, the respondent states that his position and argument on this same question were submitted in the MnooMn case, and the United States Court of Appeals, Eighth Circuit, in affirming, pointed out that it was in that case conceded that the method of accounting regularly employed by the taxpayer clearly reflected his income; and the respondent not only does not here contend otherwise but upon brief, in stating the question, says that the "petitioner's books of account have consistently used the accrual method of accounting."
The Mnookin case, in the United States Court of Appeals, distinguishes all of the cases, above listed, relied upon by the respondent except the Koby case (now on appeal), on the ground that in the Mnookin case "the taxpayer's books were at all times kept on the proper basis and no changes in his method of accounting ever occurred or were required and says:
In this case there is no suggestion of fraud on the part of Mnookin. All that the evidence shows is mistake in the interpretation of the income tax law. In the years prior to 1942 Mnookin's books were kept on the accrual basis. As so kept they correctly reflected his income for those years. The Commissioner having failed to assert the Government's claims for deficiencies for the years prior to 1942 may not circumvent the statute Of limitations barring the Government's claims simply because otherwise the income of Mnookin for years prior to 1942 will escape taxation. Ross v. Commissioner, supra; Countway v. Commissioner, 1 Cir., 127 F. 2d 69, 76. The discretion which the Commissioner has under section 41 of the Code to make such computations as will clearly reflect income does not empower him to add to the taxpayer's gross income for a given year an item which rightfully belongs to an earlier year. The mistaken omission from income of an amount properly includible does not nullify the statute of limitations on assessment and collection of income taxes. Clifton Manufacturing Co. v. Commissioner, 4 Cir., 137 F. 2d 290, 293, 150 A. L. R. 749.
The parallel between this case and the Mnookin case is remarkable. In both the books of a sole proprietorship were kept on an accrual basis, and in both income was reported in whole or in part on a cash basis. In both cases the Commissioner added to reported income of the taxable year the amount of accounts receivable at the end of the previous year. In the Mnookin case the amount of accounts receivable :added to income by the Commissioner was approximately $103,000, while here it was about $53,000. The income reported in the Mnoohim, case, on the cash basis, for the previous year, was about $74,000. Thus, it appears that a considerable portion was not reported in accord with the accrual system under which the proprietorship books were kept. Here the entire income was reported on the cash basis. . That is the only difference from the Mnookin case.
The Koby case is, as it states, "readily distinguishable" from the Greene Motor Co. and Mnookin cases, and therefore from this one, The petitioner in that matter had kept his books for a long time on a task basis and at first reported on a cash basis for 1943, the taxable fear, and 1942, involved because of the forgiveness feature of the £urra»t Tax Payment Act of 1943. He then filed amended returns on an accrual basis for those years (also for 1944 and 1945). The Commissioner approved the amended returns on the ground that the accrual method was proper, but made adjustments of about $525 by adding to income the net between accounts receivable and accounts payable at the beginning of the year, and by adding about $39,000, the opening inventory, saying that it represented a double deduction as it had been included in cost of merchandise purchased in former years. The petitioner agreed that for 1942, and many years prior thereto, he should have reported on an accrual basis. Thus, it is seen that that case involved not merely inclusion in income of one year of an amount erroneously not included in an earlier year, though the books were properly kept for the earlier year, but a eomplete change of accounting away from a basis not only admittedly wrong, but a change from which was, in effect if not in words, asked for by the filing of amended returns on the accrued, proper basis. Since the other cases cited by respondent have already been distinguished by us and the United States Court of Appeals in the Mnookin case, and, except the Carver case, by us in Greene Motor, supra, we point out only that they all, except Carver, involved change from an improper system of keeping the books of the business. In the Schuman case the books were kept and the returns were made on a hybrid base not reflecting income. The basis was accrual except interest income and the Commissioner placed the interest on the accrual basis. No accounts receivable were involved. Quoting Hygienic Products Co., 37 B. T. A. 202, affd., 111 Fed. (2d) 330, as to hybrid system of accounting, the Board upheld the Commissioner. The Hardy case involved change of books by the Commissioner from the cash to an accrual basis in accordance with changes in bookkeeping, lending themselves to the accrual method, made on August 1 of 1925, the taxable year, and petitioner's request, filed before audit of the return for 1925, for permission to change to the accrual method for 1926. The court said:
* » * with both the petitioner and the commissioner in agreement that in 1926 the accrual method was a proper one and like conditions to be taken for granted to have prevailed in the business for the last half of 1925 at least, the determination of the commissioner that the accrual basis was necessary for 1925 in order clearly to reflect the petitioner's income during that period will 'not be disturbed.
In the Carver case books were kept on the accrual basis, and the returns, to the extent of using opening and closing paper inventories in computation of cost of goods sold, had for several years, including the taxable year, been made on an accrual basis, otherwise on the cash basis. Thus, it appears that the returns were on a hybrid basis, and, in part, consistent with the books, and consistent with the change made by the Commissioner in putting the return for the taxable year on the accrual basis. The hybrid returns did not clearly reflect income -either in the taxable year or the prior year. We held that the petitioner had not shown error.
Here the petitioner is not averse to the change to the accrual basis, with resultant addition to income of the difference between respondent's figures for 1945 income per books on' the accrual basis, before addition of accounts receivable from the previous year or years, but contends only that such accounts receivable from previous years do not belong to 1945 and may not be thrown into income of the taxable year. We think that this case is governed by the principle set forth in the Mnookin case, as above recited. The accounts receivable here involved, as of the end of the year 1944 were not income in 1945, the taxable year, either upon the cash basis or the accrual basis, and on an annual tax basis should not be included in income of that year. Burnet v. Sanford & Brooks, 282 U. S. 359; United States v. Anderson, 269 U. S. 422. Nothing in this record indicates, and it is not contended, that the accounts receivable were not proper subjects of accrual in the earlier year, or years. That the petitioner did not so accrue them then is no reason to accrue them in 1945. In Clifton Mfg. Co., supra, that was the situation, and the court said:
It is pointed out that considerable discretion is lodged in the Commissioner by § 41 of the Revenue Act of 1936, 49 Stat. 1648, 26 U. S. C. A. Int. Rev. Code, § 41, to make such a computation as will clearly reflect the taxpayer's income, if the taxpayer's method of accounting does not do so. See, Lucas v. American Code Co., 280 U. S. 445, 449; 50 S. Ct. 202, 74 L. Ed. 538, 67 A. L. R. 1010. But, it can hardly be said that this authority empowers the Commissioner to add to the taxpayer's gross income for a given year an item which rightfully belongs to an earlier year under the recognized system of accrual accounting. We are merely brought back to the original inquiry whether the item in controversy was accruable prior to the tax year 1937.
In Security Flour Mills Co. v. Commissioner, 321 U. S. 281, it was said:
In short, the petitioner's position is that the Commissioner and the Board of Tax Appeals are authorized and required to make exceptions to the general rule of accounting by annual periods wherever, upon analysis of any transaction, it is found that it would be unjust or unfair not to isolate the transaction and treat it on the basis of the long term result. We think the position is not maintainable.
* we think it was not intended to upset the well understood and consistently applied doctrine that cash receipts or matured accounts due on the one hand, and cash payments or accrued definite obligations on the other, should not be taken out of the annual accounting system and, for the benefit of the Government or the taxpayer, treated on a basis which is neither a cash basis nor .an accrual basis, because so to do would, in a given instance, work a supposedly more equitable result to the Government or to the taxpayer.
We hold that the Commissioner erred in adding petitioner's debit balance of accounts receivable at the beginning of the year 1945 to petitioner's income for that year.
Reviewed by the Court.
Decision will be entered v/nder Rule 50.