American Automobile Association v. United States, No. 288

• Court: United States Supreme Court
• Writing for the Court: CLARK
• Citation: 367 U.S. 687,6 L.Ed.2d 1109,81 S.Ct. 1727
• Parties: AMERICAN AUTOMOBILE ASSOCIATION, Petitioner, v. UNITED STATES
• Docket Number: No. 288
• Decision Date: 19 June 1961

367 U.S. 687 81 S.Ct. 1727 6 L.Ed.2d 1109 AMERICAN AUTOMOBILE ASSOCIATION, Petitioner,

v.

UNITED STATES.

No. 288. Argued April 17, 1961. Decided June 19, 1961. Rehearing Denied Oct. 9, 1961.

See 82 S.Ct. 24.

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Mr. Fleming Bomar, Washington, D.C., for petitioner.

Mr. Louis F. Oberdorfer, Washington, D.C., for respondent.

Mr. Justice CLARK delivered the opinion of the Court.

In this suit for refund o federal income taxes the petitioner, American Automobile Association, seeks determination of its tax liability for the years 1952 and 1953. Returns filed for its taxable calendar years were prepared on the basis of the same accrual method of accounting as was used in keeping its books. The Association reported as gross income only that portion of the total prepaid annual membership dues, actually received or collected in the calendar year, which ratably corresponded with the number of membership months covered by those dues and occurring within the same taxable calendar year. The balance was reserved for ratable monthly accrual over the remaining membership period in the following calendar year as deferred or unearned income reflecting an estimated future service expense to members. The Commissioner contends that petitioner should have reported in its gross income for each year the entire amount of membership dues actually received in the taxable calendar year without regard to expected future service expense in the subsequent year. The sole point at issue, therefore, is in what year the prepaid dues are taxable as income.

In auditing the Association's returns for the years 1952 through 1954, the Commissioner, in the exercise of his discretion under § 41 of the Internal Revenue Code of 1939,¹

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determined not to accept the taxpayer's accounting system. As a result, adjustments were made for those years principally by adding to gross income for each taxable year the amount of prepaid dues which the Association had received but not recognized as income, and subtracting from gross income amounts recognized in the year although actually received in the prior year. A net operating loss claimed for 1954 and corresponding carryback deductions were greatly reduced, and tax deficiencies were assessed for 1952 and 1953. Petitioner paid the deficiencies and its timely claim for refund was denied. Suit to recover was instituted in the Court of Claims, but the court sustained the Commissioner, 181 F.Supp. 255. Recognizing a conflict between the decision below and that in Bressner Radio, Inc., v. Commissioner, 2 Cir., 267 F.2d 520, we granted certiorari. 364 U.S. 813, 81 S.Ct. 69, 5 L.Ed. 45. We have concluded that for tax purposes the dues must be included as income in the calendar year of their actual receipt.

The Association is a national automobile club organized as a nonstock membership corporation with its principal office in Washington, D.C. It provides a variety of services² to the members of affiliated local automobile clubs and those of ten clubs which taxpayer itself directly

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operates as divisions, but such services are rendered solely upon a member's demand. Its income is derived primarily from dues paid one year in advance by members of the clubs. Memberships may commence or be renewed in any month of the year. For many years, the association has employed an accrual method of accounting and the calendar year as its taxable year. It is admitted that for its purposes the method used is in accord with generally accepted commercial accounting principles The membership dues, as received, were deposited in the Association's bank accounts without restriction as to their use for any of its corporate purposes. However, for the Association's own accounting purposes, the dues were treated in its books as income received ratably³ over the 12-month membership period. The portions thereof ratably attributb le to membership months occurring beyond the year of receipt, i.e., in a second calendar year, were reflected in the Association's books at the close of the first year as unearned or deferred income. Certain operating expenses were chargeable as prepaid membership cost and deducted ratably over the same periods of time as those over which dues were recognized as income.

The Court of Claims bottomed its opinion on Automobile Club of Michigan v. Commissioner, 1957, 353 U.S. 180, 77 S.Ct. 707, 1 L.Ed.2d 746, finding that 'the method of treatment of prepaid automobile club membership dues employed (by

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the Association here was,) * * * for Federal income tax purposes, 'purely artificial." 181 F.Supp. 255, 258. It accepted that case as 'a rejection by the Supreme Court of the accounting method advanced by plaintiff in the case at bar.' Ibid. The Association does not deny that its accounting system is substantially identical to that used by the petitioner in Michigan. It maintains, however, that Michigan does not control this case because of a difference in proof, i.e., that in this case the record contains expert accounting testimony indicating that the system used was in accord with generally accepted accounting principles; that its proof of cost of member service was detailed; and that the correlation between that cost and the period of time over which the dues were credited as income was shown and justified by proof of experience. The holding of Michigan, however, that the system of accounting was 'purely artificial' was based upon the finding that 'substantially all services are performed only upon a member's demand and the taxpayer's performance was not related to fixed dates after the tax year.' 353 U.S. 180, 189, note 20, 77 S.Ct. 713. That is also true here.⁴ As the Association's own accounting expert testified:

'You are dealing with a group or pool. Any pooling or risk situation, particular members may in a particular year require very little of a specific service that is rendered to certain other members. I wouldn't know that the experience on that would be, but I would think it would be rather irregular between individual members. * * * I am buying the

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availability of services, the protection * * *. Frankly, the irregularity of the actual furnishing of the maps and helping you out when you run out of gasoline and so on, I frankly don't think that has a blessed thing to do with the over-all accounting.'

It may be true that to the accountant the actual incidence of cost in serving an individual member in exchange for his individual dues is inconsequential, or, from the viewpoint of commercial accounting, unessential to determination and disclosure of th overall financial condition of the Association. That 'irregularity,' however, is highly relevant to the clarity of an accounting system which defers receipt, as earned income, of dues to a taxable period in which no, some, or all the services paid for by those dues may or may not be rendered. The Code exacts its revenue from the individual member's dues which, no one disputes, constitute income. When their receipt as earned income is recognized ratably over two calendar years, without regard to correspondingly fixed individual expense or performance justification, but consistently with overall experience, their accounting doubtless presents a rather accurate image of the total financial structure, but fails to respect the criteria of annual tax accounting and may be rejected by the Commissioner.

The Association further contends that the findings of the court below support its position. We think not. The Court of Claims' only finding as to the accounting system itself is as follows:

'22. The method of accounting employed by plaintiff during the years in issue has been used regularly by plaintiff since 1931 and is in accord with generally accepted commercial accounting principles and practices and was, prior to the adverse determination by the Commissioner of the Internal Revenue, customarily and generally employed in the motor club field.'

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This is only to say that in performing the function of business accounting the method employed by the Association 'is in accord with generally accepted commercial accounting principles and practices.' It is not to hold that for income tax purposes it so clearly reflects income as to be binding on the Treasury.⁵ Likewise, other findings merely reflecting statistical computations of average monthly cost per member on a group or pool basis are without determinate significance to our decision that the federal revenue cannot, without legislative consent and over objection of the Commissioner, be made to depend upon average experience in rendering performance and turning a profit. Indeed, such tabulations themselves demonstrate the inadequacy from an income tax standpoint of the pro rata method of allocating each year's membership dues in equal monthly installments not in fact related to the expenses incurred. Not only did individually incurred expenses actually vary from month to month, but even the average expense varied—recognition of income nonetheless remaining ratably constant. Although the findings below seem to indicate that it would produce substantially the same result as that of the system of ratable monthly recognition actually employed, we consider similarly unsatisfactory, from an income tax standpoint, allocation of monthly dues to gross monthly income to the extent of actual service expenditures for the same month computed on a group or pool basis. In addition, the Association's election in 1954 to change its monthly recognition formula⁶ to one which treats one-half of the dues as income in the year of receipt

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and the other half as income received in the subsequent year, without regard to month of payment, only more clearly indicates the artificiality of its method, at least so far as controlling tax purposes are concerned. Moreover, the Association realized that the findings of the Court of Claims were not alone...