Geyer, Cornell & Newell, Inc. v. Comm'r of Internal Revenue

• Decision Date: 23 January 1946
• Docket Number: Docket Nos. 1019,1187,1186,1188.,1185
• Citation: 6 T.C. 96
• Court: U.S. Tax Court
• Parties: GEYER, CORNELL & NEWELL, INC., PETITIONER, ET AL.,1 v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

6 T.C. 96

GEYER, CORNELL & NEWELL, INC., PETITIONER, ET AL.,1

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Docket Nos. 1019

1185

1186

1187

1188.

Tax Court of the United States.

Promulgated January 23, 1946.

1. INCOME— BAD DEBT RESERVE— RESTORING UNNEEDED BALANCE TO INCOME.— A balance in a reserve for bad debts, built up by additions which offset taxable income, is properly to be restored to income of the year in which the need for maintaining the reserve ceases, a year prior to the year here in question.

2. EXCESS PROFITS— ABNORMAL INCOME— ATTRIBUTABLE TO OTHER YEARS.—Regardless of whether certain income formed a class within the meaning of section 721(a)(1), I.R.C., and even though it represented net abnormal income, held, that no part of it was attributable to other years. Sec. 721(b). Richard F. Barrett, Esq., for the petitioners.

Harold D. Thomas, Esq., for the respondent.

The Commissioner determined the following deficiencies for the calendar year 1940:

+-----------------------------------------------------------------------------+
                ¦                        ¦         ¦          ¦Declared  ¦            ¦       ¦
                +------------------------+---------+----------+----------+------------+-------¦
                ¦                        ¦Docket   ¦Income tax¦value     ¦Excess      ¦Penalty¦
                ¦                        ¦No.      ¦          ¦excess    ¦profits     ¦       ¦
                +------------------------+---------+----------+----------+------------+-------¦
                ¦                        ¦         ¦          ¦profits   ¦tax         ¦       ¦
                ¦                        ¦         ¦          ¦tax       ¦            ¦       ¦
                +------------------------+---------+----------+----------+------------+-------¦
                ¦Geyer, Cornell & Newell,¦1019     ¦$11,933.00¦          ¦$37,586.62  ¦       ¦
                ¦Inc                     ¦         ¦          ¦          ¦            ¦       ¦
                +------------------------+---------+----------+----------+------------+-------¦
                ¦The Geyer Co            ¦1188     ¦12,229.72 ¦$2,619.18 ¦927.75      ¦$231.94¦
                +-----------------------------------------------------------------------------+
                

He also determined that Mary A. Geyer (Docket No. 1185), Mercedes G. Geyer (Docket No. 1186), and Bertram B. Geyer (Docket No. 1187), were liable as transferees of the Geyer Co. (hereinafter referred to as Geyer) for amounts due from it. The liability of these three petitioners for any amounts due from Geyer has been stipulated. Both corporations assign as error the action of the Commissioner in adding to income $48,942.88 representing a reserve for bad debts. Geyer, Cornell & Newell, Inc. (hereinafter referred to as G.C.N.) also contends that it received a ‘class‘ of income from advertising Nash automobiles, this income was abnormal, and a part was attributable to other years under section 721 of the Internal Revenue Code. These are the only questions presented for decision. The petitioners also contest the penalty, but, since the Commissioner does not list it among the questions presented, we assume that he concedes error to the extent of the penalty.

FINDINGS OF FACT.

Geyer is an Ohio corporation, organized in 1912. It conducted an advertising agency business until June 30, 1935. G.C.N. is a New York corporation, organized in 1926. It has conducted an advertising agency business from the date of its incorporation until the present time. Geyer or its stockholders owned all of the outstanding voting stock of G.C.N. Both corporations have kept their books and filed their tax returns for calendar years upon an accrual method of accounting.

Geyer filed its return for the calendar year 1940 with the collector of internal revenue for the first district of Ohio. G.C.N. filed its return for 1940 with the collector of internal revenue for the third district of New York.

Geyer sold its business to G.C.N. for cash on July 1, 1935, but retained some assets including securities, cash, notes, and accounts receivable. Geyer did not operate as an advertising agency after July 1, 1935.

Geyer contracted with publishers for advertising space in advance of the date of publication. Amounts involved were large and the space was not transferable. Payment for this advertising was due from Geyer on a fixed date. Geyer sent a bill to its client, which bill was due prior to the date upon which Geyer had to pay the publisher. The bill which Geyer sent to its client was for an amount equal to the gross charge of the publisher for the advertising space. Geyer, however, paid the publisher a lesser amount after deducting a discount of 15 percent, and this discount represented Geyer's profit. Delinquency or default occurred on the part of a few clients. G.C.N. used the same method.

Geyer adopted a reserve method of treating bad debts of clients on its books and its income tax returns. Additions to this reserve were claimed as deductions on its income tax returns for years prior to 1934. These additions represented a small percentage of sales to or of amounts due from clients. They bore no relation to other receivables, if any. Deductions of additions to the reserve were allowed by the Commissioner. They offset income otherwise taxable. The reserve amounted to $49,093.52 at the close of 1933. No further additions to the reserve were made and deducted thereafter. Accounts then due from clients amounted to $52,819.75. Small amounts were charged to the reserve up to the end of June 1935, at which time the balance paid by the close of 1935 except for an amount in the amount of $61.58. This latter account was closed on December 19, 1938, by the receipt of $11.49 in cash, cancellation of a claim of a publisher in the amount of $31.33, and a charge against the reserve of the balance of $18.76. This reduced the balance in the account to $48,942.88 at which it remained until December 1940, when Geyer transferred all of its assets to G.C.N. and dissolved.

G.C.N., after acquiring all of the advertising agency business on July 1, 1935, had insufficient assets to provide the necessary credit with publishers and Geyer therefore guaranteed its accounts payable to publishers. Geyer also on at least two occasions advanced money to G.C.N.

Representatives of the Bureau of Internal Revenue were acquainted at all times material hereto with the true situation in regard to the various accounts of Geyer and its guarantee of certain accounts payable of G.C.N. Representatives of Geyer, in discussions with agents of the Bureau of Internal Revenue up to 1940, stated that Geyer needed the reserve of about $48,000 because it might be compelled to make payments on its guarantee of the obligations of G.C.N. to publishers.

Geyer and G.C.N. entered into an agreement on December 18, 1940, whereby Geyer agreed to transfer all of its assets to G.C.N. in exchange for 400 shares of the voting common stock of G.C.N. and the assumption by G.C.N. of all of the liabilities of Geyer. One of the purposes of this agreement was to provide G.C.N. with sufficient capital of its own to carry on its business. This agreement was carried out and, pursuant to the plan, Geyer immediately distributed the 400 shares of G.C.N. stock pro rata to its stockholders in complete liquidation and in redemption of their shares of Geyer stock. Geyer was dissolved on December 23, 1940. Among the assets of Geyer at the time of the above transfer was an account receivable due from G.C.N. in the amount of $152,024.84. G.C.N., after the transfer, charged this amount to its account payable to Geyer, closing that account. The amount of the balance in Geyer's reserve account for bad debt due from clients, $48,932.88, was entered on the books of G.C.N. at the date of the transfer and has remained there without change material hereto. G.C.N. was not permitted to use, and did not use, a reserve method for bad debts, but used the direct charge-off method. The closing balances of G.C.N.'S accounts receivable from clients for the years 1935 through 1940 ranged from about $57,000 to $264,000. Geyer never had to make good on its guarantee of the accounts of G.C.N. to publishers.

The Commissioner, in determining the deficiencies, included the amount of $48,942.88 in the income of Geyer, upon the ground that the need for the reserve ceased in 1940, and also included it in the income of G.C.N. upon the ground that it was realized in the extinguishment of G.C.N.'S debt to Geyer.

G.C.N., like most advertising agencies, accepted only one client for each type of product to be advertised. It had about 15 clients during 1940. Nash-Kelvinator Corporation (hereafter called Nash), was one of its principal clients in 1940. It has furnished advertising for Kelvinator refrigerators since 1935 and for Nash automobiles since 1937. It keeps a separate account for each client and, in the case of Nash and another client, a separate account for each of the two products advertised. Advertising different products for different clients requires the use of different skills and experience to solve the different problems presented. Specialists in advertising a particular product or group of products are employed. A group doing certain parts of the work on Nash automobile advertising was separate from groups doing similar special work on other products. G.C.N. had never advertised automobiles before it obtained the Nash automobile account and it had to bring in some new employees experienced in advertising automobiles.

Nash employed a fiscal year ending September 30, and shortly after that date brought out the new model automobiles for the next year. For example, the 1941 models were brought out in the fall of 1940. The advertising work for each new model was performed during a twelve-month period beginning on April 1 preceding the date on which the new model appeared. Income from advertising this model was realized in the twelve months beginning in October, about the time that the new model appeared.

The following table shows the income and expense of the Nash automobile...