Nash v. United States
| Decision Date | 18 May 1970 |
| Docket Number | No. 678,678 |
| Citation | 90 S.Ct. 1550,26 L.Ed.2d 1,398 U.S. 1 |
| Parties | James G. NASH et al., Petitioners, v. UNITED STATES |
| Court | U.S. Supreme Court |
Harold I. Apolinsky, Birmingham, Ala., for petitioners.
Matthew J. Zinn, office Sol. Gen., Washington, D.C., for respondent.
Petitioners were partners operating eight finance offices in Alabama. The partnership reported its income on the accrual method of accounting and instead of deducting bad debts within the taxable year as permitted by § 166(a) of the Internal Revenue Code of 1954 it used the reserve method of accounting as permitted by § 166(c). Under the reserve method of accounting a taxpayer includes in his income the full face amount of a receivable on its creation and adjusts at the end of each taxable year the reserve account so that it equals that portion of current accounts receivable that is estimated to become worthless in subsequent years. Any additions necessary to increase the reserve are currently deductible. When an account receivable becomes worthless during the year, the reserve account is decreased and no additional bad debt deduction is allowed. As of May 31, 1960, the partnership books showed accounts receivable of $486,853.69 and a reserve for bad debts of $73,028.05.
On June 1, 1960, petitioners formed eight new corporation and transferred the assets of the eight partner- ship offices, including the accounts receivable, to the corporations in exchange for shares of the corporations—a transfer that concededly provided no gain or loss under § 351 of the Code.
The Commissioner determined that the partnership should have included in income the amount of the bad debt reserve ($73,028.05) applicable to the accounts receivable that had been transferred. Tax deficiencies were computed; and petitioners, having paid them, brought this suit for refunds. The District Court allowed recovery and the Court of Appeals reversed, 414 F.2d 627. We granted the petition for certiorari to resolve the conflict between the Fifth and the Ninth Circuits1 on this question of law. 396 U.S. 1000, 90 S.Ct. 556, 24 L.Ed.2d 492. We share the view of the Ninth Circuit and reverse the present judgment.
There is no provision of the Code that deals precisely with this question. But the Commissioner's basic premise2 rests on the so-called tax benefit rule, viz., that a recovery of an item that has produced an income tax benefit in a prior year is to be added to income in the year of recovery.3 The Commissioner argues that that rule, applicable here, means that unused amounts in a bad debt reserve must be restored to income when the reserve is found to be no longer necessary, as it was here, when the partnership's 'need' for the reserve ended with the termination of its business. Congress could make the end of 'need' synonymous with 'recovery' in the meaning of the tax benefit rule and make the rule read: '(A) bad debt reserve that has produced an income tax benefit in a prior year is to be added to income in the year when it was recovered or when its need is ended.' The semantics would then be honored by the Commissioner's ruling. But we do not feel free to state the tax benefit rule in those terms in the present context. We deal with § 351(a) of the Code which provides:
'No gain or loss shall be recognized if property is transferred to a corporation by one or more persons solely in exchange for stock or securities in such corporation and immediately after the exchange such person or persons are in control * * * of the corporation.'
All that petitioners received from the corporations were securities equal in value to the net worth of the accounts transferred, that is the face value less the amount of the reserve for bad debts. If, as conceded, there is no 'gain' or 'loss' recognized as a result of the transaction, it seems anomalous to treat the bad debt reserve as 'income' to the transferor.4
Deduction of the reserve from the face amount of the receivables transferred conforms to the reality of the transaction, as the risk of noncollection was on the transferee. Since the reserve for purposes of this case was deemed to...
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...of income when the event occurs in the later year.24 Our approach today is consistent with our decision in Nash v. United States, 398 U.S. 1, 90 S.Ct. 1550, 26 L.Ed.2d 1 (1970). There, we rejected the Government's argument that the tax benefit rule required a taxpayer who incorporated a par......
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