Schlude v. Comm'r of Internal Revenue, Docket Nos. 62109

• Decision Date: 28 September 1959
• Docket Number: Docket Nos. 62109,69591-69593.
• Citation: 32 T.C. 1271
• Parties: MARK E. SCHLUDE AND MARZALIE SCHLUDE, ET AL.,1 PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
• Court: U.S. Tax Court

32 T.C. 1271

MARK E. SCHLUDE AND MARZALIE SCHLUDE, ET AL.,1 PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 62109

69591-69593.

Tax Court of the United States.

Filed September 28, 1959.

Carl F. Bauersfeld, Esq., and Einar Viren, Esq., for the petitioners.

William E. McCormick, Esq., for the respondent.

The Studio, a partnership operating Arthur Murray Dance Studio, entered into contracts with students whereby it agreed to furnish dancing lessons and the student agreed to pay therefor. The student would make a downpayment and pay the balance in installments, sometimes giving a note therefor. The Studio, an accrual basis partnership, returned as gross income the pro rata amount of the contract price based on the number of lessons taught during the year. Usually, by the end of the year, the balance of the contract price or some portion thereof had been paid by the student. The Commissioner determined that the entire contract price had to be returned as gross income in the year the contract was entered into on the ground that it had been received or accrued. Held, for the Commissioner. The entire contract price accrued at the time the contract was entered into since the Studio had a right to receive a fixed and determinable amount.

The respondent determined deficiencies in income tax as follows:

+-----------------------------------------------------------------+
                ¦Docket No.¦Petitioner                          ¦Year  ¦Deficiency¦
                +----------+------------------------------------+------+----------¦
                ¦62109     ¦Mark E. Schlude and Marzalie Schlude¦1950  ¦$15,819.14¦
                +----------+------------------------------------+------+----------¦
                ¦69591     ¦Mark E. Schlude                     ¦1952  ¦9,264.69  ¦
                +----------+------------------------------------+------+----------¦
                ¦69592     ¦Marzalie Schlude                    ¦1952  ¦8,971.55  ¦
                +----------+------------------------------------+------+----------¦
                ¦          ¦                                    ¦( 1953¦83,395.82 ¦
                +----------+------------------------------------+------+----------¦
                ¦69593     ¦Mark E. Schlude and Marzalie Schlude¦( 1954¦11,544.32 ¦
                +-----------------------------------------------------------------+
                

Respondent on brief concedes that the proceeding for 1950 (Docket No. 62109) is barred by the statute of limitations. Therefore, findings of fact as to the partnership fiscal year 1950 will in the main be omitted. No deficiency for the fiscal year 1951 was determined.

In the remaining proceedings the deficiencies are based on a number of adjustments, only one of which (for each year) is in issue. The adjustment in issue relates to the income of a partnership known as Arthur Murray Dance Studio in which the petitioners were equal partners. This adjustment was the adding to the income of the partnership the yearly increases in an account entitled ‘Deferred Income’ on the ground that such amounts represented taxable income.

For the fiscal year 1950, the respondent, in his deficiency notice, explained this adjustment as follows:

EXPLANATION OF PARTNERSHIP ADJUSTMENTS.

1— Income is increased by the amount of prepaid income received during the fiscal year. Income is also increased by the amount of the accounts receivable and notes receivable that are attributable to the fiscal year.

The prepaid income was restricted as to use. It clearly represented income to the partnership in the year it is received.

As for the accounts and notes receivable, these are income to an accrual basis taxpayer for the period in which they arise. * * *

All the similar adjustments for the taxable years, in this respect, are the same as above except as to amounts.

FINDINGS OF FACT.

Some of the facts have been stipulated; they are incorporated herein by this reference.

Petitioners Mark E. and Marzalie Schlude, husband and wife, are residents of Omaha, Nebraska, and filed their returns on the cash basis for the years involved with the now district director of internal revenue for the district of Nebraska.

On June 18, 1946, the petitioners formed a partnership known as Arthur Murray Dance Studio, hereinafter sometimes referred to as the Studio, in which they were equal partners, for the purpose of conducting dance studios in territories authorized by various franchise agreements received from Arthur Murray, Inc., New York, New York.

The franchise agreements required the partnership to pay Arthur Murray, Inc., a royalty of 10 per cent of the gross receipts of such dancing school or schools. In addition, the agreements required the partnership to pay Arthur Murray, Inc., 5 per cent of its gross receipts to be held in escrow by Arthur Murray, Inc., and to protect and indemnify Arthur Murray, Inc., from any and all claims that may be made against it as a result of granting the franchise to the partnership. The payments to the escrow fund were to continue until the partnership had deposited the total sum of $20,000 with Arthur Murray, Inc. Thereafter, no further payments were to be made to the fund unless the fund was depleted by payments therefrom, in which case payments were to be continued or resumed until the fund amounted to the sum of $20,000. These amounts were required to be paid weekly. The franchise agreement gave Arthur Murray, Inc., control and supervisory powers over many phases of the conduct of the business of the Studio. It also required the Studio to honor the unused portion of paid courses of lessons of students enrolled in any other studio licensed by Arthur Murray, Inc., by giving lessons to such students. Arthur Murray, Inc., also required other studios to do the same. The sum of $1.50 per hour was to be paid by the studio holding the contract to the studio giving the lesson.

Pursuant to the franchise agreements, the partnership operated studios for the teaching of private ballroom dancing to individual students. The location of the various studios being operated by the partnership and the date of their formation is as follows:

+---------------------------------------------+
                ¦Location                 ¦Date of formation  ¦
                +-------------------------+-------------------¦
                ¦Omaha, Nebraska          ¦June 18, 1946      ¦
                +-------------------------+-------------------¦
                ¦Lincoln, Nebraska        ¦Sept. 20, 1948     ¦
                +-------------------------+-------------------¦
                ¦Sioux City, Iowa         ¦Oct. 1, 1949       ¦
                +-------------------------+-------------------¦
                ¦Sioux Falls, South Dakota¦June 1, 1952       ¦
                +-------------------------+-------------------¦
                ¦Grand Island, Nebraska   ¦Oct. 3, 1953       ¦
                +---------------------------------------------+
                

When a student engaged the Studio to teach dancing lessons, the student and the Studio executed one of the six forms of written contracts entitled as follows:

(a) Enrollment Agreement And Contract With Student For Instruction.

(b) Extension Agreement And Contract With Student For Instruction.

(c) Renewal Agreement And Contract With Student For Instruction.

(d) Deferred Payment Enrollment Agreement And Contract With Student For Instruction.

(e) Deferred Payment Extension Agreement And Contract With Student For Instruction.

(f) Deferred Payment Renewal Agreement And Contract With Student For Instruction.

There are basically two types of contracts entered into between the partnership and students, i.e., the cash plan contracts (contracts (a), (b), and (c)), and the deferred payment plan contracts (contracts (d), (e), and (f)). Each plan has three categories. The first sale of a dance course represents an original sales contract (contracts (a) and (d)). After the student has contracted for an original course, he has the privilege prior to the fifth hour of instruction on the original course of enlarging that course at a lesser rate by entering into an ‘extension’ agreement course (contracts (b) and (e)). A renewal course (contracts (c) and (f)) is one sold to a student after his completion of the original and extension courses.

Under contracts (a), (b), and (c) a portion of the contract price was paid in cash at the time of signing the agreement and the balance was to be paid in deferred installments. Under contracts (d), (e), and (f) a portion of the downpayment was paid in cash at the time of contracting. The balance of the downpayment was to be paid in installments and the remaining balance of the contract price was to be paid in the manner set forth in a negotiable note which accompanied the contract.

All of the contracts provided that (1) the student should pay tuition for lessons in a certain amount, (2) the student should not be relieved of his obligation to pay the tuition agreed upon in the contract, (3) no refunds would be made, and (4) the contract is noncancellable. The contracts provided for a specific number of hours of lessons ranging from 5 hours to 2,000 and 1,200 hours. Some of the contracts were for lifetime courses which, in addition to 1,200 specified hours, the student is entitled to 2 hours of lessons per month plus 2 parties a year for life. Under many of the contracts the lessons extended beyond the fiscal year in which the contract was entered into. Most of the lessons which extended beyond the fiscal year in which the contract was entered into were taught in the fiscal year immediately succeeding the year in which the contract was entered into. At the time of contracting, the student and the Studio did not agree upon a schedule for performance of the lessons upon fixed dates. The dates for instruction were arranged from time to time as lessons were given.

Notes accompanying deferred payment contracts received by the Studio were negotiated with a local bank. At the time a student's note was negotiated with the bank, the bank would deduct its interest charges and give approximately 50 per cent of the balance of the note to the partnership and set up a reserve account for the other 50 per cent of the note which the partnership could not use until after the note was paid...