Brown v. Helvering

• Decision Date: 15 January 1934
• Docket Number: No. 187,187
• Citation: 54 S.Ct. 356,291 U.S. 193,78 L.Ed. 725
• Parties: BROWN v. HELVERING, Commissioner of Internal Revenue
• Court: U.S. Supreme Court

291 U.S. 193

54 S.Ct. 356

78 L.Ed. 725

BROWN

v HELVERING, Commissioner of Internal Revenue.

No. 187.

Argued Dec. 13, 14, 1933.

Decided Jan. 15, 1934.

Messrs. Arthur B. Dunne and Peter F. Dunne, both of San Francisco, Cal., for petitioner.

The Attorney General, and Mr. J. Crawford Biggs, Sol. Gen., of Washington, D.C., for respondent.

Mr. Justice BRANDEIS delivered the opinion of the Court.

An unincorporated concern known as Edward Brown & Sons, of San Francisco, has since 1896 acted as Pacific Coast General Agent for fire insurance companies. ¹ In 1923, Arthur M. Brown conducted the concern alone. In 1925 and 1926, he and his son Arthur M. Brown, Jr., conducted it as partners. The general agent receives as compensation from its principals, among other things, a so-called 'overriding commission' on the net premiums derived from business written through the local agents. The question for decision is, how the income of the petitioner, Arthur M. Brown, derived from overriding commissions during the years 1923, 1925, and 1926 should be calculated for purposes of the federal income tax. The Commissioner of Internal Revenue held that, in determining income, the gross overriding commissions on business written during the year should not be subjected to any deduction on account of cancellations expected to occur in later years. The taxpayer contends that either the gross overriding commissions should be subjected to such a deduction of that parts of the gross overriding commissions should be allocated as earnings of future years.

The term 'net premium' as used in providing for overriding commissions means the gross premium on the business written less the return premium and the net cost of any reinsurance. Fire insurance policies are written for periods of one, three, or five years, with the right of cancellation by either party at stipulated rates of premium return. Premiums being payable in advance (subject to the 60-day grace period), a return premium is paid to the policyholder in case of cancellation; and the general agent, who receives the premium, pays the return premium. The company writing a policy frequently reinsures in another company a part of its contingent liability; and the general agent, who makes the payments for reinsurance, receives, in case of cancellation, a return of a proportionate part of the cost of the canceled reinsurance. The general agent makes to each principal remittances on monthly balances, crediting itself, among other things, with the overriding commissions on premiums receivable, with the return premiums paid and with the net amount paid for reinsurance; and charging itself, among other things, with a proportionate part of any overriding commissions previously credited in respect of any business which has been canceled during the month. Thus, whenever there is a cancellation and a return or credit of a portion of the premium and of the cost of any reinsurance, the general agent returns to the company or charges itself with a corresponding portion of the overriding commission.

Prior to 1923, overriding commissions on new business were accounted income of the year in which the business was written; and refunds of overriding commission on account of cancellations were accounted expenses of the year of cancellation. The books of the general agent have at all times been kept on the accrual basis. Although no change was made in the method of accounting between the general agent and its principals, there was set up on the books of the concern at the close of 1923, for the first time, a liability account entitled 'Return Commission.' In it was recorded an estimate of the liability expected to arise out of the general agent's obligations to refund to the companies a proportionate part of the overriding commission received because of cancellations which it was expected would occur in future years. The estimate was based on the experience of the preceding five years. Thus, on the books, the year's income from overriding commissions was reduced by the amount of refunds which, it was estimated, would have to be made in future years. This changed method of accounting has been followed ever since; and the difference in the method of calculating the general agent's income has been reflected in the returns made by Brown of his taxable income.

The ratio of cancellations to premiums receivable having been 22.38 per cent. for the five years ending in 1923, the gross income from overriding commissions on business written in 1923, amounting to $236,693.31, was subjected on the books to a deduction of $52,971.96; and this amount was credited to the 'Return Commission' account. Similarly, at the close of each of the years 1924, 1925, and 1926, the credit balance in the 'Return Commission' account was adjusted so that it bore the same relation to the overriding commissions on business written during the year as the total fire insurance premiums canceled in the preceding five-year period bore to the gross premiums on business written during those years. The ratio of cancellations for the five years ending in 1925 having been 21.55 per cent., and the total overriding commissions $244,597.88, a deduction of $3,292.98 was made, representing the net addition to the 'Return Commission' account in 1925. The ratio of cancellations to premiums for the five-year period ending in 1926 having been 21.13 per cent., and the total overriding commissions $258,677.57, a deduction was made of $1,947.77 representing the net addition to the 'Return Commission' account in 1926.²

In making his federal income tax return for the years 1923, 1925, and 1926, Brown claimed as deductions the benefit of the credits so made to the 'Return Commission' account. The Commissioner of Internal Revenue disallowed these deductions; and accordingly assessed to Brown for 1923 a deficiency of $17,923.03; for 1925 a deficiency of $1,520.19; and for 1926 a deficiency of $944.30.³ The Commission's determinations were sustained by the Board of Tax Appeals, 22 B.T.A. 678; and its order was affirmed by the Circuit Court of Appeals. 63 F.(2d) 66. Certiorari was granted by this Court (290 U.S. 607, 54 S.Ct. 61, 78 L.Ed. —-) because of alleged conflict with the decision of the Circuit Court of Appeals for the Fourth Circuit in Virginia-Lincoln Furniture Corp. v. Commissioner of Internal Revenue, 56 F.(2d) 1028, and other cases.

First. The Commissioner properly disallowed the deduction on account of the credits to the 'Return Com- mission' account. Under the Revenue Acts, taxable income is computed for annual periods. If the accounts are kept on the accrual basis, the income is to be accounted for in the year in which it is realized, even if not then actually received; and the deductions are to be taken in the year in which the deductible items are incurred. What is taxable as income is provided by the Revenue Act of 1921, c. 136, 42 Stat. 227, 237, 239.⁴ Section 212(a) declares: 'That in the case of an individual the term 'net income' means the gross income as defined in section 213, less the deductions allowed by section 214.' Section 214(a) declares: 'That in computing net income there shall be allowed as deductions: 1. All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.' The only relevant deductions allowable by law are those provided for in section 214; and the burden rests upon the taxpayer to show that he was entitled to the deduction claimed. Reinecke v. Spalding, 280 U.S. 227, 232, 50 S.Ct. 96, 74 L.Ed. 385.

The overriding commissions were gross income of the year in which they were receivable. As to each such commission there arose the obligation—a contingent liability—to return a proportionate part in case of cancellation. But the mere fact that some portion of it might have to be refunded in some future year in the event of cancellation or reinsurance did not affect its quality as income. Compare American National Co. v. United States, 274 U.S. 99, 47 S.Ct. 520 71 L.Ed. 946. When received, the general agent's right to it was absolute. It was under no restriction, contractual or otherwise, as to its disposition, use, or enjoyment. Compare North American Oil Consolidated v. Burnet, 286 U.S 417, 424, 52 S.Ct. 613, 76 L.Ed. 1197.⁵ The refunds during the tax year of those portions of the overriding commissions which represented cancellations during the tax year had, prior to the tax return for 1923, always been claimed as deductions; and they were apparently allowed as 'necessary expenses paid or incurred during the taxable year.' The right to such deductions is not now questioned. Those which the taxpayer claims now are of a very different character. They are obviously not 'expenses paid during the taxable year.' They are bookkeeping changes representing credits to a reserve account.

These charges on account of credits to the 'Return Commission' reserve account are claimed as deductions on the ground that they are expenses 'incurred,' 'during the taxable year.' It is true that, where a liability has 'accrued during the taxable year,' it may be treated as an expense incurred; and hence as the basis for a deduction, although payment is not presently due, United States v. Anderson, 269 U.S. 422, 440, 441, 46 S.Ct. 131, 70 L.Ed. 347; American National Co. v. United States, 274 U.S. 99, 47 S.Ct. 520, 71 L.Ed. 946; Aluminum Castings Co. v. Routzahn, 282 U.S. 92, 51 S.Ct. 11, 75 L.Ed. 234, and although the amount of the liability has not been definitely ascertained. United States v. Anderson, supra.⁶ Compare Continental Tie & Lumber Co. v. United States, 286 U.S. 290, 296, 52 S.Ct. 529, 76 L.Ed. 1111. But no liability accrues during the taxable year on account of cancellations which it is expected may occur in future years, since the events necessary to create the liability do not occur during the taxable year. Except as otherwise specifically provided by statute, a...