James M. Pierce Corporation v. CIR

• Decision Date: 28 February 1964
• Docket Number: No. 17265.,17265.
• Citation: 326 F.2d 67
• Parties: JAMES M. PIERCE CORPORATION, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Eighth Circuit

326 F.2d 67 (1964)

JAMES M. PIERCE CORPORATION, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 17265.

United States Court of Appeals Eighth Circuit.

January 8, 1964.

Rehearing Denied February 28, 1964.

Kent Emery, Des Moines, Iowa, made argument for petitioner and filed brief with James F. Swift, Des Moines, Iowa.

Harry Marselli, Atty., Dept. of Justice, Washington, D. C., made argument for respondent and filed brief with Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, Harry Baum and Earl J. Silbert, Attys., Dept. of Justice, Washington, D. C.

Before VAN OOSTERHOUT and BLACKMUN, Circuit Judges, and YOUNG, District Judge.

BLACKMUN, Circuit Judge.

The Tax Court has upheld the Commissioner's determination of a deficiency in the federal income tax of James M. Pierce Corporation for its fiscal year ended June 30, 1957. Judge Mulroney's decision, not reviewed by the full court, is reported at 38 T.C. 643. The taxpayer has petitioned for review.

The initial issue before us concerns the includability in gross income of the amount of prepaid magazine subscriptions unexpired in the taxable year during which the publication was sold and the subscription liability was assumed by the purchaser.

The Commissioner originally determined deficiencies in tax for each of the taxpayer's fiscal years 1954 to 1957, inclusive. These were attributable, almost in their entirety, to claimed surtax for improper accumulation of surplus, under § 102(a) of the Internal Revenue Code of 1939 for fiscal 1954, and to claimed accumulated earnings tax, under § 531 of the 1954 Code for the other taxable years. Only in an amendment to his answer did the Commissioner propose a further and additional deficiency for fiscal 1957 attributable to the unexpired subscriptions.

The Tax Court decided the accumulation issue in favor of the taxpayer. No cross petition for review has been filed by the Commissioner. Consequently the accumulation issue and taxes for fiscal 1954 to 1956, inclusive, are not before us. Helvering v. Pfeiffer, 302 U.S. 247, 250-251, 58 S.Ct. 159, 82 L.Ed. 231 (1937). The court, however, decided the subscription issue in favor of the Commissioner and held that there was a deficiency in the taxpayer's fiscal 1957 income tax in the amount of $222,788.96. It is this result which is under attack here.

The taxpayer is an Iowa corporation organized in 1902 for the purpose of taking over an existing publishing business established by its founder. It published in Des Moines a farm newspaper called The Iowa Homestead. It sold subscriptions to this paper for fixed terms beyond one year with advance payment made by the subscriber.

In September 1929 the taxpayer sold, under contract, its real estate, machinery and equipment and all assets relating to its job printing business and to the newspaper to the Wallace Publishing Company, publisher of another farm newspaper called Wallaces' Farmer. This purchaser combined the two papers into one and published it under the name of Wallaces' Farmer and Iowa Homestead.

Wallace, both before and after the purchase, had a business practice of selling a perpetual subscription. The subscription could be redeemed by the subscriber, his heirs, or assigns, at any time after one year for nine-tenths of the purchase price. Upon the sale of a perpetual subscription Wallace allocated on its books one-tenth of the price to earned income for the then current taxable year and nine-tenths to a perpetual subscription reserve account. If the subscription was redeemed, that reserve, of course, was debited accordingly.

In 1931 Wallace became delinquent under its purchase contract with the taxpayer. Foreclosure proceedings were instituted. A receiver was appointed. Finally, in December 1935, the taxpayer, at a sheriff's sale, purchased all Wallace's property used in the operation of its business. The taxpayer bid in the property for $1,013,000 and assumed Wallace's liabilities including those for unexpired subscriptions. It then continued the publication of the combined newspaper. The taxpayer, however, sold no perpetual subscriptions.

The taxpayer filed its income tax returns on the accrual method of accounting. Since 1919 it had reported as income only an aliquot part of its prepaid subscriptions in each year and carried the balance in an unearned subscription reserve account. This was a method employed by many publishers. It found official sanction in I.T. 3369, 1940-1 C.B. 46, for accrual basis publishers, such as the taxpayer, who had consistently followed the practice over a period of years. This reporting method, however, was denied to new publishers and others.

In June 1957 the taxpayer's shareholders, in contemplation of the provisions of § 337 of the 1954 Code, adopted a plan of complete liquidation. This plan complied with Iowa law. Under Iowa Code, § 491.56, I.C.A. the taxpayer continues appropriately to act for the purpose of winding up its affairs. On June 27 the shareholders approved an offer of The Prairie Farmer Publishing Company, an Illinois corporation, to purchase the business. By the sale agreement, effective June 28, Prairie paid the taxpayer $1,406,789 in cash and also assumed "* * * the obligation of Pierce to publish `Wallaces' Farmer and Iowa Homestead' and to carry out in accordance with their terms all subscription contracts in force as of the date of closing for the unexpired period of the subscriptions". On June 28, the balance in the taxpayer's reserve for unearned subscriptions was $396,019.31, and that in its reserve for perpetual subscriptions, taken over entirely from Wallace, was $40,340.25. These totaled $436,359.56. This figure was taken into account as an adjustment in the amount of the cash paid by Prairie.

The taxpayer did not report any part of its unearned and perpetual subscription reserves, theretofore untaxed, as income for fiscal 1957. These are the amounts which the Commissioner determined were includable.

The issue therefore is the proper income tax handling of these reserves. The Tax Court held, pp. 655-657 of 38 T.C., that they were includable in their entirety in fiscal 1957. It reasoned that when Prairie assumed these liabilities the taxpayer realized income accordingly; that the need for holding the unearned subscriptions in a reserve account then no longer existed; that the taxpayer was released from its liability to its subscribers; that this was the appropriate time to restore the prepayments to income; and that if this were not done the amounts would escape tax altogether. It drew an analogy to the bad debt reserve cases and it found support in the 1958-enacted § 455 of the 1954 Code. It summarily dismissed, p. 658, as having no merit, taxpayer's secondary argument that it had paid Prairie to assume the liabilities under the subscription contracts and hence was entitled to a deduction for that payment.

We agree with the Tax Court's holding that, technically, the reserves were includable in gross income and taxable for fiscal 1957. We disagree, however, with its dismissal of the taxpayer's secondary argument. We hold, instead, that, under the facts of this case, the inclusion is in effect nullified by an offsetting deduction equal to the amount by which the gross sale price to Prairie was reduced by Prairie's assumption of the subscription liabilities, and that this is so whether there is a "payment" by the passing of dollars back and forth or whether only the net cash amount is transferred.

1. The income aspect. Perhaps it is now settled that, for taxable years ending prior to 1958, a taxpayer-publisher's receipt of cash subscriptions prepaid for more than one year normally would constitute taxable income for the year of receipt despite the taxpayer's being on the accrual system. Schlude v. Commissioner, 372 U.S. 128, 132-135, 83 S.Ct. 601, 9 L.Ed.2d 633 (1963); American Auto. Ass'n v. United States, 367 U.S. 687, 81 S.Ct. 1727, 6 L.Ed.2d 1109 (1961); Popular Library, Inc., 39 T.C. 1092, 1098 (1963). See Automobile Club v. Commissioner, 353 U.S. 180, 188-190, 77 S.Ct. 707, 1 L.Ed.2d 746 (1957). Cf. Beacon Publishing Co. v. Commissioner, 218 F.2d 697 (10 Cir.1955), and the Supreme Court's refusal, footnote 20, p. 189 of 353 U.S., pp. 712, 713 of 77 S.Ct., 1 L.Ed.2d 746, to pass upon the correctness of that decision.

But, and in any event, this result did not ensue for Pierce because of the sanction by I.T. 3369, supra, of the taxpayer's long continued contrary practice.

It would therefore seem logically to follow that, when the reasons for the establishment of the reserves and their tax deferral cease to exist, the taxability which had been deferred should forthwith mature. We so hold and do so with the following observations:

(a) Both reserves were set up by the taxpayer as a matter of realistic accounting recognition of the taxpayer's obligations and liabilities. It made sense taxwise, too, to defer the inclusion of prepaid subscriptions in income until the obligations with attendant expenses were being fulfilled. As has been noted, the tax authorities went along with this. It makes equal sense, however, that, when the taxpayer's obligations and liabilities terminate, the continuance of the reserves and of the tax deferral should also cease. This took place in fiscal 1957, the year of the sale to Prairie and its assumption of the subscription obligations. All this is practical accounting and practical tax treatment. It is not a matter of the receipt of income through Prairie's assumption of liabilities; it is a matter of income inclusion by the rightful cessation of income deferral.

(b) We find precedent in the bad debt cases. Where additions to a reserve for bad debts have been effected, with deductions from gross income, and then the need for the reserve ceases, the amount of the reserve at that time is includable in gross income. West Seattle National Bank of Seattle, 33 T.C. 341, 343-44 (1959), aff'd 288 F.2d 47...