U.S. Supreme Court American Automobile Ass'n v. United
States, 367
U.S. 687 (1961) American Automobile Association v.
United States No. 288 Argued April 17, 1961 Decided June 19, 1961 367
U.S. 687 CERTIORARI TO THE COURT OF
CLAIMS Syllabus Petitioner keeps its books and makes its income tax returns on a
calendar year accrual basis. For the years 1952 and 1953, it
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 occurring during the same
taxable year. The balance was reserved for ratable monthly accrual
over the remaining membership periods in the following calendar
year, as deferred or unearned income reflecting the estimated
expense of service to its members. In the exercise of his
discretion under § 41 of the Internal Revenue Code of 1939, the
Commissioner determined not to accept petitioner's accounting
system, and assessed deficiencies resulting mainly from
petitioner's failure to include in its gross income for each year
the total amount of dues received during that year. Held: the Commissioner's action is sustained. Pp. 367 U. S.
688 -698.

															(a) The accounting method used by petitioner may present an
accurate image of the total financial structure, but it fails to
respect the criteria of annual tax accounting, and it may be
rejected by the Commissioner. Pp. 367 U. S.
690 -692.

															(b) A different conclusion is not required by the finding of the
Court of Claims that petitioner's method of accounting had been
used regularly by it since 1931, and was in accord with generally
accepted commercial accounting principles and practices. Pp. 367 U. S.
692 -694.

															(c) The conclusion here reached is confirmed by the facts that
Congress introduced into the Internal Revenue Code of 1954
provisions which specifically permitted essentially the same
practice as that employed by petitioner; it repealed those
provisions retroactively one year later; and, in 1958, it rejected
a proposed amendment which would have specifically permitted this
practice with respect to prepaid automobile association membership
dues. Pp. 367 U. S.
694 -698.

															___ Ct. Cl. ___, 181 F. Supp. 255, affirmed. Page 367 U. S. 688 MR. JUSTICE CLARK delivered the opinion of the Court.

															In this suit for refund of 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, [ Footnote 1 ] Page 367 U. S. 689 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, 267 F.2d 520, we
granted certiorari. 364 U.S. 813. 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 services [ Footnote 2 ] to the members of affiliated
local automobile clubs and those of ten clubs which taxpayer itself
directly Page 367 U. S. 690 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 ratably [ Footnote 3 ] over the 12-month membership
period. The portions thereof ratably attributable 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, 353 U. S. 180 (1957), finding that

															"the method of treatment of prepaid automobile club membership
dues employed [by Page 367 U. S. 691 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. 353 U.S.
180, 353 U. S. 189 ,
note 20. That is also true here. [ Footnote 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 Page 367 U. S. 692 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 the
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. " Page 367 U. S. 693 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. [ Footnote 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 formula [ Footnote 6 ] to one which treats one-half of the dues as
income in the year of receipt Page 367 U. S. 694 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 sufficient for its
purposes. In its petition for rehearing below, petitioner
specifically asked that they be amended and enlarged, especially as
to No. 22 set out above. Rehearing and amendment were denied.

															Whether or not the Court's judgment in Michigan controls our disposition of this case, there are other
considerations requiring our affirmance. They concern the action of
the Congress with respect to its own positive and express statutory
authorization of employment of such sound commercial accounting
practices in reporting taxable income. In 1954, the Congress found
dissatisfaction in the fact that,

															"as a result of court decisions and rulings, there have
developed many divergencies between the computation of income for
tax purposes and income for business purposes as computed under
generally accepted accounting principles. The areas of difference
are confined almost entirely to questions of when certain types of
revenue and expenses should be taken into account in arriving at
net income."

															House Ways and Means Committee Report, H.R.Rep.No.1337, 83d
Cong., 2d Sess. 48. As a result, it introduced into the Internal
Revenue Code of 1954 § 452 and § 462, [ Footnote 7 ] which specifically permitted essentially the
same practice as was employed by the Association here. [ Footnote 8 ] Only one year later,
however, Page 367 U. S. 695 in June 1955, the Congress repealed these sections
retroactively. It appears that, in this action, Congress first
overruled the long administrative practice of the Commissioner and
holdings of the courts in disallowing such deferral of income for
tax purposes, and then, within a year, reversed its own action.
This repeal, we believe, confirms our view that the method used by
the Association could be rejected by the Commissioner. While the
claim is made that Congress did not "intend to disturb prior law as
it affected permissible accrual accounting provisions for tax
purposes," H.R.Rep. No. 293, 84th Cong., 1st Sess. 4-5, the cold
fact is that it repealed the only law incontestably permitting the
practice upon which the Association depends. To say that, as to
taxpayers using such systems, Congress was merely declaring
existing law when it adopted § 452 in 1954, and that it was merely
restoring unaffected the same prior law when it repealed the new
section in 1955 for good reason, is a contradiction in itself,
"varnishing nonsense with the charm of sound." Instead of
constituting a merely duplicative creation, the fact is that § 452
for the first time specifically declared petitioner's system of
accounting to be acceptable for income tax purposes, and overruled
the longstanding position of the Commissioner and courts to the
contrary. And the repeal of the section the following year, upon
insistence by the Treasury that the proposed endorsement of such
tax accounting would have a disastrous impact on the Government's
revenue, was just as clearly a mandate from the Congress that
petitioner's system was not acceptable for tax purposes. To
interpret its careful consideration of the problem otherwise is
to Page 367 U. S. 696 accuse the Congress of engaging in sciamachy. We are further
confirmed in this view by consideration of the even more recent
action of the Congress in 1958, subsequent to the decision in Michigan, supra. In that year, § 455 [ Footnote 9 ] was added to the Internal Revenue Code
of 1954. It permits publishers to defer receipt as income of
prepaid subscriptions of newspapers, magazines and periodicals. An
effort was made in the Senate to add a provision in § 455 which
would extend its coverage to prepaid automobile club membership
dues. [ Footnote 10 ] However,
in conference, the House Conferees refused to accept this
amendment. Senator Byrd explained the rejection of the amendment to
the Senate (104 Cong.Rec., Part 14, p. 17744):

															"It was the position of the House conferees that this matter of
prepaid dues and fees received by nonprofit service organizations
was a part of the entire subject dealing with the treatment of
prepaid income, and that such subject should be left for study of
this entire problem. . . . [ Footnote 11 ]"

															It appears, therefore, that, pending its own further study,
Congress has given publishers but denied automobile Page 367 U. S. 697 clubs the very relief that the Association seeks in this
Court.

															To recapitulate, it appears that Congress has long been aware of
the problem this case presents. In 1954, it enacted § 452 and §
462, but quickly repealed them. Since that time, Congress has
authorized the desired accounting only in the instance of prepaid
subscription income, which, as was pointed out in Michigan, is ratably earned by performance on "publication
dates after the tax year." 353
U. S. 353 U.S. 180, 353 U. S. 189 ,
note 20. It has refused to enlarge § 455 to include prepaid
membership dues. At the very least, this background indicates
congressional recognition of the complications inherent in the
problem and its seriousness to the general revenue. We must leave
to the Congress the fashioning of a rule which, in any event, must
have wide ramifications. The Committees of the Congress have
standing committees expertly grounded in tax problems, with
jurisdiction covering the whole field of taxation and facilities
for studying considerations of policy as between the various
taxpayers and the necessities of the general revenues. The validity
of the long established policy of the Court in deferring, where
possible, to congressional procedures in the tax field is clearly
indicated in this case. [ Footnote 12 ] Finding only that, in light of Page 367 U. S. 698 existing provisions not specifically authorizing it, the
exercise of the Commissioner's discretion in rejecting the
Association's accounting system was not unsound, we need not
anticipate what will be the product of further "study of this
entire problem." Affirmed. [ Footnote 1 ]

															A taxpayer's

															"net income shall be computed . . . in accordance with the
method of accounting regularly employed in keeping the books . . .
but . . . if the method employed does not clearly reflect the
income, the computation shall be made in accordance with such
method as in the opinion of the Commissioner does clearly reflect
the income. . . ."

															53 Stat. 24, 26 U.S.C. (1952 ed.) § 41. See also the
similar provision in the Internal Revenue Code of 1954, 26 U.S.C.
(1958 ed.) § 446.

															[ Footnote 2 ]

															These generally include furnishing road maps, routing, tour
books, etc.; emergency road service through contracts with local
garages; bail bond protection; personal automobile accident
insurance and theft protection; and, in some of its divisions,
motor license procurement, brake and headlight adjustment service,
notarial duties and advice in the prosecution of small claims.

															[ Footnote 3 ]

															In 1952 and 1953, dues collected in any month were accounted as
income to the extent of one-twenty-fourth for that month (on the
assumption that the mean date of receipt was the middle of the
month), one-twelfth for each of the next eleven months, and again
one-twenty-fourth in the anniversary month. In 1954, however,
guided by its own statistical average experience, the Association
changed its system so as to more simply reach almost the same
result by charging to year of receipt, without regard to month of
receipt, one-half of the entire dues payment, and deferring the
balance to the following year.

															[ Footnote 4 ] Beacon Publishing Co. v. Commissioner, 218 F.2d 697,
and Schuessler v. Commissioner, 230 F.2d 722, may be
distinguished from the present case on the same grounds which made
them distinguishable in Automobile Club of Michigan v.
Commissioner, 353 U. S. 180 , 353 U. S. 189 ,
note 20.

															[ Footnote 5 ]

															The Hearing Commissioner of the Court of Claims had specifically
found as fact that petitioner's "method of accounting . . . clearly
reflected its net income for such years." The court, however, did
not adopt that finding.

															[ Footnote 6 ] See note 2 supra. [ Footnote 7 ]

															26 U.S.C. (1952 ed., Supp. II) §§ 452, 462, repealed, 69 Stat.
134 (1955).

															[ Footnote 8 ]

															The Senate Report included this language:

															"Under the 1939 Code, regardless of the method of accounting . .
. , amounts are includible in gross income by the recipient not
later than the time of receipt if they are subject to free and
unrestricted use by the taxpayer even though the payments are for
goods or services to be provided by the taxpayer at a future
time."

															S.Rep. No. 1622, 83d Cong., 2d Sess. 301.

															[ Footnote 9 ]

															26 U.S.C. (1958 ed.) § 455.

															[ Footnote 10 ]

															An unsuccessful attempt to induce congressional action on this
problem was made last year, see H.R. 11266, 86th Cong., 2d
Sess., which passed the House August 24, 1960, 106 Cong.Rec. 17482,
but failed to draw any action by the Senate before adjournment. An
identical bill is currently pending, see H.R. 929, 87th
Cong., 1st Sess., and H.R.Rep. No. 381, accompanying the bill and
recommending its passage. Under that measure, the taxpayer's
liability to its members " shall be deemed to exist ratably over the period . . . that such services are required to be
rendered, or . . . privileges . . . made available." (Emphasis
added.)

															[ Footnote 11 ]

															The Eighty-fourth Congress started the study of "legislation
dealing with prepaid income and reserves for estimated expenses. .
. ." S.Rep. No. 372, 84th Cong., 1st Sess. 6.

															[ Footnote 12 ]

															In 1955, it was estimated that transitional loss of revenue
under § 452 and § 462, repealed that year, would total in excess of
a billion dollars. H.R.Rep. No. 293, 84th Cong., 1st Sess. 3. That
this impact on the revenue continues to be an important factor in
congressional consideration of the problem is indicated by the
observation of the House Committee on Ways and Means that a
"transitional rule" is necessary "to minimize the initial revenue
impact" of the measure currently pending. H.R.Rep. No. 381, 87th
Cong., 1st Sess. 4. That the system used by petitioner here is,
perhaps, presently not uncommon may be indicated by the fact that,
during this Term alone, several cases involving similar systems
have reached this Court.

															MR. JUSTICE STEWART, whom MR. JUSTICE DOUGLAS, MR. JUSTICE
HARLAN and MR. JUSTICE WHITTAKER join, dissenting.

															In Automobile Club of Michigan, the Court pointed out
that the method of accounting employed by the taxpayer was "purely
artificial" so far as the record there showed. 353 U.S. at 353 U. S. 189 .
Here, by contrast, the petitioner proved, and the Court of Claims
found, that the method of accounting employed by the petitioner
during the years in issue was in accord with generally accepted
commercial accounting principles and practice, was customarily
employed by similar taxpayers, and, in the opinion of qualified
experts in the accounting field, clearly reflected the petitioner's
net income. I do not understand that the Court today questions
either that proof or those findings. [ Footnote 2/1 ]

															The Court thus holds that the Commissioner is authorized to
disregard and override a method of reporting income under which
prepaid dues are deferred in direct Page 367 U. S. 699 relation to the taxpayer's costs under its membership contracts.
The effect of the Court's decision is to allow the Commissioner to
prevent an accrual basis taxpayer from making returns in accordance
with the accepted and clearly valid accounting practice of
excluding from gross income amounts received as advances until the
right to such amounts is earned by rendition of the services for
which the advances were made. To permit the Commissioner to do
this, I think, is to ignore the clear statutory command that a
taxpayer must be allowed to make his returns in accord with his
regularly employed method of accounting so long as that method
clearly reflects his income. [ Footnote
2/2 ] The result, I am afraid, will be to engender far-reaching
confusion and injustice in the administration of the Internal
Revenue Laws. [ Footnote 2/3 ] I The Commissioner's basic argument against the deferred reporting
of prepayments has traditionally been that such a method conflicts
with a series of decisions of this Court Page 367 U. S. 700 which establish the so-called "claim of right doctrine."
[ Footnote 2/4 ] In this case, the
Government abandoned that argument, with good reason. As four
Circuits have correctly held, the claim of right doctrine furnishes
no support for the Government's position. Bressner Radio, Inc.
v. Commissioner, 267 F.2d 520, 524, 525-528; Schlude v.
Commissioner, 283 F.2d 234; Schuessler v.
Commissioner, 230 F.2d 722, 725; Beacon Publishing Co. v.
Commissioner, 218 F.2d 697, 699-701. [ Footnote 2/5 ] A claim of right without "restriction on
use" may be the crucial factor in determining that particular funds
are includable in gross income. See North American Oil
Consolidated . Burnet, 286 U. S. 417 ; United States v. Lewis, 340 U. S. 590 ; Healy v. Commissioner, 345 U. S. 278 . But
it hardly follows that all such funds must necessarily be reported
by an accrual basis taxpayer as income in the year of receipt,
whether or not then earned. Page 367 U. S. 701 The Government shifted its argument in this case to the
contention that the "annual accounting requirement" demands
that

															"[n]either income nor deduction items may be accelerated or
postponed from one taxable year to another in order to reflect the
long-term economic result of a particular transaction or group of
transactions."

															The Government finds a basis for this argument in such cases as Security Flour Mills Co. v. Commissioner, 321 U.
S. 281 ; Brown v. Helvering, 291 U.
S. 193 ; Burnet v. Sanford & Brooks Co., 282 U. S. 359 ; Guaranty Trust Co. v. Commissioner, 303 U.
S. 493 ; and Heiner v. Mellon, 304 U.
S. 271 .

															The Court today does not base its decision on this theory,
presumably because the Court believes, as I do, that the theory is
not valid. Putting to one side the point that many of the cases
relied on involved cash basis taxpayers, [ Footnote 2/6 ] these decisions no more pertain to
deferred reporting of totally unearned receipts than do the claim
of right decisions. These cases, like the claim of right cases,
start from the premise that the income in question Page 367 U. S. 702 has been fully earned. [ Footnote
2/7 ] The underlying premise of the annual accounting
requirement is that otherwise reportable income derived from a
transaction cannot be excluded from gross income in order to let
the taxpayer wait to see in a later year how the over-all
transaction turns out. [ Footnote
2/8 ] That is not the issue in this case. The question here is
whether any reportable income has been derived from a transaction
when payments are received in advance of performance.

															Although wisely rejecting the claim of right and annual
accounting arguments, the Court decides this case upon grounds
which seem to me equally invalid. I can find nothing in Automobile Club of Michigan which controls disposition of
this case. And the legislative history upon which the Court
alternatively relies seems to me upon examination to be singularly
unconvincing.

															In Michigan, there was no offer of proof to show the
rate at which the taxpayer fulfilled its obligations under its
membership contracts. The deferred reporting of prepaid dues was,
therefore, rejected in that case simply because there was no
showing of a correlation between the amounts deferred and the costs
incurred by the taxpayer in carrying Page 367 U. S. 703 out its obligations to its members. Until today, that case has
been recognized as one that simply held that, in the absence of
proof that the proration used by the taxpayer reasonably matched
actual expenses with the earning of related revenue, the
Commissioner was justified in rejecting the taxpayer's proration. I
am hardly alone in thinking that Michigan was decided upon
the very premise that a realistic deferral of income based upon
proof of average costs of service during identifiable periods would
be entirely permissible. See Bressner Radio, Inc. v.
Commissioner, 267 F.2d 520, 526-529. [ Footnote 2/9 ] Such proof was concededly adduced in this
case.

															As to the enactment and repeal of § 452 and § 462, upon which
the Court places so much reliance, there are at the outset obvious
difficulties in relying on what happened in 1954 and 1955 to
ascertain the meaning of § 41 of the 1939 Code. See Fogarty v.
United States, 340 U. S. 8 , 340 U. S. 13 -14; Gemsco, Inc. v. Walling, 324 U. S. 244 , 324 U. S. 265 ; Cammarano v. United States, 358 U.
S. 498 , 358 U. S. 510 .
But, these problems aside, I think that the enactment and
subsequent repeal of § 452 and § 462 give no indication of
Congressional approval of the position taken by the Commissioner in
this case. If anything, the legislative action leads to the
contrary impression.

															The statutory provisions in question were passed as part of a
general revision of the internal revenue laws in 1954. Section 452
permitted an accrual basis taxpayer to defer the inclusion of
advances in gross income until they were earned. [ Footnote 2/10 ] Most significantly, a taxpayer
could shift to Page 367 U. S. 704 this method without the consent of the Commissioner. Section
462, which permitted the deduction of anticipated expenses, was not
aimed specifically at the problem of reporting advances. [ Footnote 2/11 ] The function of the
provisions was to bring

															"[t]ax accounting . . . more nearly in line with accepted
business accounting by allowing prepaid income to be taxed as it is
earned, rather than as it is received, and by allowing reserves to
be established for known future expenses. [ Footnote 2/12 ]"

															In seeking to accomplish this objective, Congress recognized
that, as a result of "court decisions and rulings," the claim of
right approach had been used to require reporting for the year of
receipt all payments "subject to free and unrestricted use . . .
even though the payments are for goods or services to be provided
by the taxpayer at a future time." H.R.Rep. No. 1337, 83d Cong., 2d
Sess. Page 367 U. S. 705 48, A159. [ Footnote 2/13 ]
Congressional awareness of administrative and judicial
misapplication of the claim of right doctrine clearly did not imply
approval of it. For, by 1954, "[i]t was long recognized that the
difficulty lay not with the statute, but with administrative and
court interpretation." [ Footnote
2/14 ] And while the Committee reports contain no express
rejection of the Commissioner's interpretation of the 1939 statute,
the language used in explaining the need for a change certainly
indicates disapproval. [ Footnote
2/15 ]

															Although § 452 and § 462 were short-lived, the shape of the
decisional law with respect to § 41 of the 1939 Code changed
considerably during the interval between the passage and repeal of
the new sections. In Beacon Publishing Co. v.
Commissioner, 218 F.2d 697, 699, the Tenth Circuit rejected
the Commissioner's reliance on the claim of right rationale and
found that the deferment of Page 367 U. S. 706 advances in accord with accrual principles did "clearly reflect
. . . income" under § 41. At about the same time, a Ninth Circuit
decision permitted income received from the sale of goods to be
offset by a deduction for the future expense of shipping the goods. Pacific Grape Products Co. v. Commissioner, 219 F.2d
862.

															When Congress repealed § 452 and § 462, the record shows that it
was fully aware of these decisions. Congress recognized that the
rationale of these cases would produce a complete reversal of the
previous administrative position with respect to the reporting of
unearned receipts under § 41 and its counterpart under the 1954
Code, § 446. Congressional intent with respect to this possibility
was entirely clear -- the trend of judicial decisions should be
allowed to run its course without any inference of disapproval
being drawn from the repeal of § 452 and § 462. This intent was
evidenced in the assurances which the House Ways and Means
Committee demanded and received from the Secretary of the Treasury,
who had sought the repeal of the two sections. In a letter to the
Chairman of the Committee, the Secretary stated:

															"My dear Mr. Chairman: This letter will confirm the statements
made to you today by Treasury representatives."

															" * * * *" "Furthermore, the Treasury Department will not consider the
repeal of section 452 as any indication of congressional intent as
to the proper treatment for prepaid subscriptions and other
items of prepaid income, either under prior law or under other
provisions of the 1954 code. In other words, the repeal of
section 452 will not be considered by the Department as either the
acceptance or the rejection by Congress of the decision in Beacon Publishing Co. v. Commissioner Page 367 U. S. 707 (218 F.2d 697, C.A. 10, 1955) or any other judicial
decisions."

															"It is my understanding that the foregoing is consistent
with the desire of your committee, with which I agree, that
the repeal of sections 452 and 462 should operate simply to
reestablish the principles of law which would have been applicable
if sections 452 and 462 had never been enacted."

															H.R.Rep. No. 293, 84th Cong., 1st Sess. 5. (Emphasis supplied.)
The same viewpoint was expressed in the Senate Report, which
stated:

															"Another aspect of the uncertainty with respect to subscription
income if section 452 is repealed arises from a recent circuit
court decision in Beacon Publishing Company v.
Commissioner (C.C.A.10th, January 3, 1955). The court in this
case held that the deferral of prepaid subscription income was in
fact proper under the accrual method of accounting. The Secretary
of the Treasury, in the letter previously referred to, which he
sent to the chairman of the House Committee on Ways and Means,
indicated that the repeal of section 452 would not be taken as an
indication by the Treasury Department of congressional intent as to
the proper treatment of prepaid subscription income under prior law
or under other provisions of the 1954 code. He also indicated that
the repeal of section 452 will not be considered by the Department
as either acceptance or rejection by Congress of the decision in Beacon Publishing Company v. Commissioner, or in any other
judicial decisions. . . ."

															"Uncertainty will also exist in other areas with the repeal of
these two provisions. In Pacific Grape Products (C.C.A.9th, February 10, 1955), for example, the circuit court held
that certain freight and Page 367 U. S. 708 shipping expenses incurred after the end of the year could be
accrued for tax purposes as of the end of the year. An extension of
the principles laid down in this case might well lead the courts in
the future to permit the accrual of most estimated expenses which
would be covered by section 462 even though this section is
repealed."

															S.Rep. No. 372, 84th Cong., 1st Sess. 5-6. [ Footnote 2/16 ]

															To my mind, this legislative history shows that Congress made
every effort to dissuade the courts from doing exactly what the
Court is doing in this case -- drawing from the repeal of § 452 an
inference of Congressional disapproval of deferred reporting of
advances. [ Footnote 2/17 ] But
even if the legislative history on this point were hazy, the same
conclusion would have to be reached upon examination of
Congressional purpose in repealing § 452 and § 462. Cf. United
States v. Benedict, 338 U. S. 692 , 338 U. S. 696 .
For the fact of the matter is, contrary to the impression left by
the Court's opinion, that the reasons for rejecting § 452 and § 462
were entirely consistent with accepting the deferred reporting of
receipts in a case like this. Sections 452 and 462 were repealed
solely because of a prospective loss of revenue during the first
year in which taxpayers would take advantage of the new sections.
[ Footnote 2/18 ] Insofar as the
reporting of advances was concerned, that Page 367 U. S. 709 loss of revenue would have occurred solely as a consequence of
taxpayers' changing their method of reporting, without the
necessity of securing the Commissioner's consent, to that
authorized under § 452 and § 462. [ Footnote 2/19 ] The taxpayer who shifted his basis for
reporting advances would have been allowed what was commonly termed
a "double deduction" during the transitional year. [ Footnote 2/20 ] Under § 462, deductions
could be taken in the year of change for expenses attributable to
advances taxed in prior years under a claim of right theory, as
well as for reserves for future expenditures attributable to
advances received and reported during that year. Similarly, under §
452, prepayments received during the year of transition would be
excluded from gross income, while current expenditures attributable
to past income would still be deductible. [ Footnote 2/21 ]

															The Congressional purpose in repealing § 452 and § 462 --
maintenance of the revenues -- does not, however, require
disapproval of sound accounting principles in cases of taxpayers
who, like the petitioner, have customarily and regularly used a
sound accrual accounting method in reporting advance payments. No
transition Page 367 U. S. 710 is involved, and no "double deduction" is possible. Moreover,
taxpayers formerly reporting advances as income in the year of
receipt can now shift to a true accrual system of reporting only
with the approval of the Commissioner. See Treas.Reg. 111,
§ 29.41-2 (1943); Treas.Reg. 118, § 39.41-2(c) (1953); Int.Rev.Code
of 1954, § 446(e). [ Footnote
2/22 ] Before giving his approval, the Commissioner can be
expected to insist upon adjustments in the taxpayer's transition
year to forestall any revenue loss which would otherwise result
from the change in accounting method. See Kahuku Plantation Co.
v. Commissioner, 132 F.2d 671, 674; 2 Mertens, Law of Federal
Income Taxation, §§ 12.21, 12.21a. Cf. Brown v. Helvering, 291 U. S. 193 , 291 U. S.
204 .

															In short, even if the legislative history of the repeal of § 452
and § 462 did not clearly indicate, as it does, that the repeal of
those sections should have no bearing upon judicial determination
of whether the deferred reporting of advances "clearly reflects
income," the purpose of the Congress which repealed those
provisions would lead to the same conclusion. It need hardly be
added that the subsequent legislative activity cited by the Court
in no way alters this conclusion. Contrary to the Court's
suggestion, the "relief that the Association seeks in this Court"
is far short of what was sought in 1958 in urging that the coverage
of § 455 be extended to prepaid automobile club membership dues. As
enacted, § 455 was not limited in application to publishers
previously reporting prepaid subscriptions on a deferral basis. See I.T. 3369, 1940-1 Cum.Bull. 46. It applied to all
publishers using the accrual method, and permitted a change Page 367 U. S. 711 to deferred reporting of subscriptions for the year 1958 without consent of the Commissioner. 26 U.S.C. §
455(c)(3)(B). II I think the Government's position in this case is at odds with
the statutes, [ Footnote 2/23 ]
regulations [ Footnote 2/24 ] and
court decision, [ Footnote
2/25 ] Page 367 U. S. 712 which, since 1916, have recognized that realistic accrual
accounting does "clearly reflect income." If I am correct, the law
did not give the Commissioner any "discretion . . . not to accept
the taxpayer's accounting system."

															The basic concept of including advances in gross income only as
they are earned is but an aspect of accrual accounting principles
which have consistently received judicial approval. We have, for
example, often recognized that deductions for business expenses
must be reported as soon as the obligation to pay becomes
"certain." See, e.g., United States v. Anderson, 269 U. S. 422 ; American National Co. v. United States, 274 U. S.
99 ; Niles Bement Pond Co. v. United States, 281 U. S. 357 , 281 U. S. 360 ; United States v. Olympic Radio & Television, 349 U. S. 232 , 349 U. S. 236 .
This may be before or after cash payment is made, [ Footnote 2/26 ] or even before it is due. [ Footnote 2/27 ] The controlling factor is
not the flow of cash, but the "economic and bookkeeping" principles
with which § 41 is concerned. United States v. Anderson,
supra, at 269 U. S. 441 . See also American National Co. v. United States, supra. These principles are at the foundation of the so-called "all
events" test for determining the accrual of deductions. See
United States v. Anderson, supra, at 269 U. S. 441 ;
[ Footnote 2/28 ] United
States v. Consolidated Page 367 U. S. 713 Edison Co., 366 U. S. 380 , 366 U. S.
384 -386. The same principles are applicable to the
accrual of income. See Continental Tie & Lumber Co. v.
United States, 286 U. S. 290 . As
has been correctly noted, "[i]t is a necessary corollary of this economic and bookkeeping' proposition" upon which Anderson rested that receipts are not reportable in income
until "substantially 'all the events' have occurred, both as to the
cost and time of performance, which must occur in order to
discharge the liability to perform which was given by [the
taxpayer] in return for the receipt." Bressner Radio, Inc. v. Commissioner, 267 F.2d 520,
524. See also United States v. Anderson, supra, at 269 U. S. 440 ; Beacon Publishing Co. v. Commissioner, 218 F.2d 697, 699.
Indeed, "accrual" of income has been commonly defined in terms of
"earnings" from the sale of goods or the performance of services. See, e.g., Spring City Foundry Co. v. Commissioner, 292 U. S. 182 , 292 U. S.
184 -185; Stanley and Kilcullen, The Federal Income Tax
(3d ed. 1955), 190. [ Footnote
2/29 ] In rejecting Page 367 U. S. 714 petitioner's method of allocating prepaid advances, the Court, I
think, disregards these basic principles.

															The net effect of compelling the petitioner to include all dues
in gross income in the year received is to force the petitioner to
utilize a hybrid accounting method -- a cash basis for dues and an
accrual basis for all other items. Schlude v.
Commissioner, 283 F.2d 234, 239. Cf. Commissioner v. South
Texas Lumber Co., 333 U. S. 496 , 333 U. S. 501 .
For taxpayers generally, the enforcement of such a hybrid
accounting method may result in a gross distortion of actual
income, particularly in the first and last years of doing business.
On the return for the first year in which advances are received, a
taxpayer will have to report an unrealistically high net income,
since he will have to include unearned receipts, without any
offsetting deductions for the future cost of earning those
receipts. On subsequent tax returns, each year's unearned
prepayments will be partially offset by the deduction of current
expenses attributable to prepayments taxed in prior years. Even
then, however, if the taxpayer is forbidden to correlate earnings
with related expenditures, the result will be a distortion of
normal fluctuations in the taxpayer's net income. For example, in a
year when there are low current expenditures because of fewer
advances received in the preceding year, the result may be an
inflated adjusted gross income for the current year. Finally,
should the taxpayer decide to go out of business upon fulfillment
of the contractual obligations already undertaken, in the final
year, there will be no advances to report and many costs
attributable to advances received in prior years. The result will
be a grossly unrealistic reportable not loss.

															The Court suggests that the application of sound accrual
principles cannot be accepted here because deferment is based on an
estimated rate of earnings, and because this estimate, in turn, is
based on average, not Page 367 U. S. 715 individual, costs. It is true, of course, that the petitioner
cannot know what service an individual member will require, or when
he will demand it. Accordingly, in determining the portion of its
outstanding contractual obligations which have been discharged
during a particular period (and hence the portion of receipts
earned during that period), the petitioner can only compare the
total expenditures for that period against estimated average
expenditures for the same number of members over a full contract
term. But this use of estimates and averages is in no way
inconsistent with long accepted accounting practices in reflecting
and reporting income.

															As the Government has pointed out in past litigation,

															"many business concerns . . . keep accounts on an accrual basis
and have to estimate for the tax year the amount to be received on
transactions undoubtedly allocable to such year." Continental Tie & Lumber Co. v. United States, 286 U. S. 290 , 286 U. S.
295 -296. Similarly, the deduction of future expenditures
which have already accrued often requires estimates like those
involved here. See, e.g., Harrold v. Commissioner, 192
F.2d 1002; Schuessler v. Commissioner, 230 F.2d 722; Denise Coal Co. v. Commissioner, 271 F.2d 930, 934-937; Hilinski v. Commissioner, 237 F.2d 703. Finally, it is to
be noted that the regulations under both the 1939 and 1954 Codes
permit various methods of reporting income which require the use of
estimates. [ Footnote 2/30 ] In the
absence of any showing that the estimates used here were faulty, I
think the law did not Page 367 U. S. 716 permit the Commissioner to forbid the use of standard accrual
methods simply upon the ground that estimates were necessary to
determine what the rate of deferral should be.

															Similarly, it is not relevant that the petitioner "defers
receipt . . . 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 fact of the matter is that what the petitioner has an
obligation to provide, i.e., the constant readiness of
services if needed, will with certainty be provided during the
period to which deferment has been made. Averages are frequently
utilized in tax reporting. In computing the value of work in
process, in distributing overhead to product cost, and in various
other areas, the use of averages has long been accepted. See,
e.g., Rookwood Pottery Co. v. Commissioner, 6 Cir., 45 F.2d
43; Eatonville Lumber Co. v. Commissioner, 10 B.T.A. 232.
The use of an "average cost" is particularly appropriate here,
where the dues are earned by making services continuously
available. The cost of doing so must necessarily be based on
composite figures.

															For these reasons, I think that the petitioner's original
returns clearly reflected its income, that the Commissioner was
therefore without authority under the law to override the
petitioner's accounting method, and that the judgment should be
reversed.

															[ Footnote 2/1 ]

															The Court does not, for example, challenge Finding No. 26 of the
Court of Claims:

															"Had the plaintiff recognized, assigned and transferred to its
gross income account its monthly receipts of dues collected in
advance in the proportion to its cost of servicing all of its
members each month, instead of ratably over the membership period
of 12 months, the proportion of advance dues which would have been
recognized and assigned to gross income during the years in issue
herein would have been substantially the same as the gross income
from dues as determined and reported by the plaintiff under the
method of accounting actually employed."

															[ Footnote 2/2 ]

															Int.Rev.Code of 1939, § 41, 53 Stat. 24. Int.Rev.Code of 1954, §
446, 26 U.S.C. § 446.

															[ Footnote 2/3 ]

															The scope of the problem is well illustrated by the reported
cases. See, e.g., South Dade Farms v. Commissioner, 138
F.2d 818 (rent received in advance); Clay Sewer Pipe Ass'n v.
Commissioner, 139 F.2d 130 (subscriptions for promotion
campaign to be consummated in years subsequent to receipt); Beacon Publishing Co. v. Commissioner, 218 F.2d 697
(advance newspaper subscription payments); Bressner Radio, Inc.
v. Commissioner, 267 F.2d 520 (advance payments in a
television servicing contract); Schlude v. Commissioner, 283 F.2d 234 (fees for dancing lessons paid in advance); Moritz
v. Commissioner, 21 T.C. 622 ("customers' deposits" on
undeveloped photographs); South Tacoma Motor Co. v.
Commissioner, 3 T.C. 411 (proceeds from sale of coupons
entitling bearer to garage services in later years); Your
Health Club, Inc. v. Commissioner, 4 T.C. 385 (advance
payments for use of gym and other facilities); Northern
Illinois College of Optometry v. Commissioner, 2 CCH Tax
Ct.Mem. 664 (tuition paid in advance).

															[ Footnote 2/4 ]

															Almost all of the decisions sustaining the Commissioner's
disallowance of deferred reporting of advances by accrual basis
taxpayers have relied on the claim of right doctrine. See,
e.g., Andrews v. Commissioner, 23 T.C. 1026, 1032-1033; South Dade Farms v. Commissioner, 138 F.2d 818 ( but
compare Schuessler v. Commissioner, 230 F.2d 722); Clay
Sewer Pipe Ass'n v. Commissioner, 139 F.2d 130; Automobile
Club of Michigan v. Commissioner, 230 F.2d 585, 591, affirmed on other grounds, 353 U. S. 353 U.S.
180. The Tax Court has carried the claim of right doctrine to the
point where it was found applicable to advance fees which were due
but not yet paid. Your Health Club, Inc. v. Commissioner, 4 T.C. 385.

															[ Footnote 2/5 ]

															The rejection of the applicability of the claim of right
doctrine in these cases has been enthusiastically approved by legal
commentators. See, e.g., Gelfand, The "Claim of Right"
Doctrine, 33 Taxes 726; Wolder, Deduction of Reserves for Future
Expenses and Deferring of Prepaid Income, 34 Taxes 524; Note, 59
Col.L.Rev. 942, 946. But cf. Freeman, Tax Accrual
Accounting for Contested Items, 56 Mich.L.Rev. 727, 730-732,
747.

															[ Footnote 2/6 ] See, e.g., Guaranty Trust Co. v. Commissioner, 303 U. S. 493 ; Burnet v. Sanford & Brooks Co., 282 U.
S. 359 . In the latter case, the Court took special
notice of the fact that the taxpayer had not "attempted to avail
itself" of the accrual system under which "expenses of a
transaction incurred in one year might be offset by the amounts
actually received from it in another." 282 U.S. at 282 U. S. 366 .
In Security Mills Flour Co. v. Commissioner, 321 U.
S. 281 , the taxpayer was attempting to use what the
Court described as "a divided and inconsistent method of accounting
not properly to be denominated either a cash or an accrual system."
321 U.S. at 321 U. S. 287 .
In Brown v. Helvering, 291 U. S. 193 , the
taxpayer was on an accrual basis generally, but its assertion of a
right to defer reporting "overriding commissions" constituted a
change in accounting procedures as to the acceptance of which the
Commissioner was said to have "wide discretion." 291 U.S. at 291 U. S. 204 . See the discussion in Bressner Radio, Inc. v.
Commissioner, 267 F.2d 520, 525-526.

															[ Footnote 2/7 ]

															With the possible exception of contingent related expenditures,
which cannot not be accurately measured. See Brown v.
Helvering, 291 U. S. 193 , 291 U. S.
200 -201.

															[ Footnote 2/8 ]

															This becomes entirely clear upon examination of the cases upon
which the Government relies. For example, in Heiner v.
Mellon, 304 U. S. 271 ,
members of partnerships which had been formed to liquidate two
corporations attempted to defer reporting income earned during the
year until it could be determined in a subsequent year whether the
partnerships' over-all liquidation enterprise had been profitable.
The Court held that such a postponement was barred by the annual
accounting principle. In Security Flour Mills Co. v.
Commissioner, 321 U. S. 281 , the
taxpayer attempted to reopen a prior year's return so as to deduct
amounts which it had subsequently paid but of receipts earned in
that year. Again, the Court relied on the annual accounting
principle in denying the taxpayer's claim.

															[ Footnote 2/9 ] See also Hoffman, Accounting Treatment Counts in
Determining Net Taxable Income, 35 Taxes 918, 921; Behren, Prepaid
Income-Accounting Concepts and The Tax Law, 15 Tax L.Rev. 343,
359-360; Note, 67 Yale L.J. 1425, 1439-1440.

															[ Footnote 2/10 ]

															There were certain restrictions upon the period over which the
advances could be deferred, but these are not relevant for our
purposes here. See Proposed Treas.Reg. § 1.452, 20
Fed.Reg. 515; Wolder, Deduction of Reserves for Future Expenses and
Deferring of Prepaid Income, 34 Taxes 524; Bierman and Helstein,
Accounting for Prepaid Income and Estimated Expenses under the
Internal Revenue Code of 1954, 10 Tax L.Rev. 83, 93-96. Section 452
specifically envisage the deferral of club dues. See H.R.Rep. No. 1337, 83d Cong., 2d Sess. 48.

															[ Footnote 2/11 ] See, e.g., S.Rep. No. 372, 84th Cong., 1st Sess. 2.
Section 462 provided that,

															"In computing taxable income for the taxable year, there shall
be taken into account (in the discretion of the secretary or his
delegate) a reasonable addition to each reserve for estimated
expenses. . . ."

															§ 462(a), 68A Stat. 158. "Estimated expense" was defined as a
deduction

															"(A) part or all of which would . . . be required to be taken
into account for a subsequent taxable year; (B) which is
attributable to the income of the taxable year or prior taxable
years for which an election under this section is in effect; and
(C) which the Secretary or his delegate is satisfied can be
estimated with reasonable accuracy."

															§ 462(d)(1), 68A Stat. 158. See Bierman and Helstein,
Accounting for Prepaid Income and Estimated Expenses under the
Internal Revenue Code of 1954. 10 Tax L.Rev. 83, 103-113.

															[ Footnote 2/12 ]

															S.Rep. No. 372, 84th Cong., 1st Sess. 3 (quoting from the tax
recommendation in the Presidential budget message of 1954).

															[ Footnote 2/13 ]

															There were some exceptions to the rigid application of this rule
which had been recognized. See I.T. 3369, 1940-1 Cum.Bull.
46 (permitting deferred reporting of subscriptions for publishers
who had consistently followed that practice); I.T. 2080, III-2
Cum.Bull. 48 (1924) (permitting deferment of receipts from sales of
tickets for tourist cruises), but compare National Airlines,
Inc. v. Commissioner, 9 T.C. 159. See also Veenstra &
DeHaan Coal Co. v. Commissioner, 11 T.C. 964; Summit Coal
Co. v. Commissioner, 18 B.T.A. 983.

															[ Footnote 2/14 ]

															Freeman, Tax Accrual Accounting for Contested Items, 56
Mich.L.Rev. 727, 729, n. 9. See Bierman and Helstein,
Accounting for Prepaid Income and Estimated Expenses under the
Internal Revenue Code of 1954, 10 Tax L.Rev. 83, 84.

															[ Footnote 2/15 ]

															"Present law provides that the net income of a taxpayer shall be
computed in accordance with the method of accounting regularly
employed by the taxpayer if such method clearly reflects the income
and the regulations state that approved standard methods of
accounting will ordinarily be regarded as clearly reflecting
taxable income. Nevertheless, as a result of court decisions and
rulings, there have developed many divergencies between the
computation of income for tax purposes and income for business
purposes as computed under generally accepted accounting
principles. . . ."

															H.R.Rep. No. 1337, 83d Cong., 2d Sess. 48.

															[ Footnote 2/16 ] See also H.R.Rep. No. 293, 84th Cong., 1st Sess.
4-5.

															[ Footnote 2/17 ]

															It is to be noted that no such inference was relied upon in the Michigan case, although the same arguments with respect to
§§ 452 and 462 were pressed upon the Court by the Government. See Brief for Respondent, pp. 62-65, Automobile Club
of Michigan v. Commissioner, 353 U. S. 180 .

															[ Footnote 2/18 ] See H.R.Rep. No. 293, 84th Cong., 1st Sess. 2-5; S.Rep.
No. 372, 84th Cong., 1st Sess. 4-5; Hearings Before the Senate
Finance Committee on H.R. 4725, 84th Cong., 1st Sess. 6. The
prospective loss was more than ten times the original estimate of
47 million. Ibid. See Note, 67 Yale L.J. 1425,
1432, n. 25.

															[ Footnote 2/19 ]

															There was also a problem of expanded use of reserves for
estimated expenditures under § 462 for items like vacation pay
which were not related to the reporting of advances. See Hearings Before the Senate Finance Committee on H.R. 4725, 84th
Cong., 1st Sess. 5, 9; Sporrer, The Past and Future of Deferring
Income and Reserving for Expenses, 34 Taxes 45, 55-56; Griswold,
Federal Taxation (5th ed. 1960), 497-498.

															[ Footnote 2/20 ] See S.Rep. No. 372, 84th Cong., 1st Sess. 4; Hearings
Before the Senate Finance Committee on H.R. 4725, 84th Cong., 1st
Sess. at 7, 8, 10; Dakin, The Change from Cash to Accrual
Accounting for Federal Income Tax Purposes -- Pyramided Income,
Double Deductions and Double Talk, 51 Nw.U.L.Rev. 515, 50 -538;
Griswold, Federal Taxation (5th ed. 1960), 497-498; Note, 67 Yale
L.J. 1425, 1430.

															[ Footnote 2/21 ]

															Only one-tenth of the estimated loss during the transitional
year was attributable to § 452. See Hearings Before the
Senate Finance Committee on H.R. 4725, 84th Cong., 1st Sess.
21.

															[ Footnote 2/22 ] See also Treas.Reg. § 1.446-1(e)(2) (1957); Brown
v. Helvering, 291 U. S. 193 , 291 U. S.
204 -205; Advertisers Exchange, Inc. v.
Commissioner, 25 T.C. 1086; 2 Mertens, Law of Federal Income
Taxation, §§ 12.19-12.20.

															[ Footnote 2/23 ]

															The Revenue Act of 1913, 38 Stat. 114, provided only for a
strict cash receipts and disbursements method of accounting. See e.g., § IIB, 38 Stat. 167. In the 1916 Act, the
sections dealing with permissible methods of computing income were
revised to provide that:

															"A corporation . . . keeping accounts upon any basis other than
that of actual receipts and disbursements, unless such other basis
does not clearly reflect its income, may, subject to regulations
made by the Commissioner of Internal Revenue, with the approval of
the Secretary of the Treasury, make its return upon the basis upon
which its accounts are kept, . . ."

															§ 13(d), 39 Stat. 771. See also § 8(g), 39 Stat. 763
(identical provision with respect to returns filed by
individuals).

															These sections were designed specifically to permit accrual
accounting. See H.R.Rep. No. 922, 64th Cong., 1st Sess. 4; United States v. Anderson, 269 U.
S. 422 , 269 U. S.
439 -441. In the Revenue Act of 1918, the necessity of
obtaining special permission to use the accrual method was omitted, see § 212(b), 40 Stat. 1064-1065, and the provision
permitting the use of accrual accounting remained substantially the
same for the next thirty-six years. See Int.Rev.Code of
1939, § 41, 53 Stat. 24; Reubel v. Commissioner, 1 B.T.A.
676, 677-678. In 1954, the pertinent provision was again changed,
with specific mention of the "accrual method." See Int.Rev.Code of 1954, § 446, 26 U.S.C. § 446. See
generally May, Accounting and the Accountant in the
Administration of Income Taxation, 47 Col.L.Rev. 377, 380-382.

															[ Footnote 2/24 ] See, e.g., T.D. 2433, 19 Treas.Dec. 5 (1917);
Treas.Reg. 45, Art. 23, Art. 111 (1920); Treas.Reg. 118, § 39.41
(1953); Treas.Reg. § 1.446-1 (1957).

															[ Footnote 2/25 ] See, e.g., United States v. Anderson, 269 U.
S. 422 ; Niles Bement Pond Co. v. United States, 281 U. S. 357 ; Aluminum Castings Co. v. Routzahn, 282 U. S.
92 ; Spring City Foundry Co. v. Commissioner, 292 U. S. 182 , 292 U. S.
184 -185; see also Weed & Brothers v. United
States, 38 F.2d 935, 938-940, 69 Ct.Cl. 246, 251-257.

															[ Footnote 2/26 ] Compare, e.g., Aluminum Castings Co. v. Routzahn, 282 U. S. 92 (deduction taken in year prior to cash disbursement) with
Shelby Salesbook Co. v. United States, 104 F. Supp. 237
(deduction taken in later year).

															[ Footnote 2/27 ] United States v. Anderson, 269 U.
S. 422 ; American National Co. v. United States, 274 U. S. 99 ; Aluminum Castings Co. v. Routzahn, 282 U. S.
92 .

															[ Footnote 2/28 ]

															The Court there held that an accrual taxpayer should have
deducted a tax expense in 1916 so that it properly could have been
offset against the profits from sales in 1916, upon which the tax
was levied. The Court rejected the contention that the tax could
not accrue in 1916 because it was not due until 1917. It
stated:

															"In a technical legal sense, it may be argued that a tax does
not accrue until it has been assessed and becomes due; but it is
also true that, in advance of the assessment of a tax, all the
events may occur which fix the amount of the tax and determine the
liability of the taxpayer to pay it. In this respect, for purposes
of accounting and of ascertaining true income for a given
accounting period, the munitions tax here in question did not stand
on any different footing than other accrued expenses appearing on
appellee's books. In the economic and bookkeeping sense with which
the statute and Treasury decision were concerned, the taxes had
accrued. It should be noted that § 13(d) makes no use of the words
'accrue' or 'accrual,' but merely provides for a return upon the
basis upon which the taxpayer's accounts are kept, if it reflects
income -- which is precisely the return insisted upon by the
government."

															269 U.S. at 269 U. S.
441 .

															[ Footnote 2/29 ]

															The authors there state:

															"In the ordinary case, accrual precedes actual receipt, since
there is an accrual when there is a right to receive. But, in some
cases, items are received before they are earned, and then the
receipt precedes the accrual." See also Continental Tie & Lumber Co. v. United
States, 286 U. S. 290 ; Georgia School Book Depository, Inc. v. Commissioner, 1
T.C. 463; 1961 C.C.H.Tax Reporter § 2820.025 ("On the accrual
basis, income is reported when earned"); Freeman, Tax Accrual
Accounting for Contested Items, 56 Mich.L.Rev. 727, 728.

															[ Footnote 2/30 ] See, e.g., Treas.Reg. 111, § 29.42-4 (1943), Treas.Reg.
118, § 39.42-4 (1953), and Treas.Reg. § 1.451-3 (1957) (providing
for the percentage of completion method of reporting income on
long-term contracts); Treas.Reg. 111, § 29.42-5 (1943), Treas.Reg.
118, § 39.42-5 (1953), and Treas.Reg. § 1.451-4 (1957) (providing
for the deduction for redemption of trading stamps based upon "The
rate, in percentage, which the stamps redeemed in each year bear to
the total stamps issued in such year"). See generally Brown
& Williamson Tobacco Corp. v. Commissioner, 16 T.C.
432.


U.S. Supreme Court United States v. Gilmore, 372 U.S.
39 (1963) United States v.
Gilmore No. 21 Argued March 27-28,
1962 Restored to the calendar for
reargument April 2, 1962 Reargued December 5-6,
1962 Decided February 18,
1963 372 U.S.
39 CERTIORARI TO THE UNITED STATES
COURT OF CLAIMS Syllabus Respondent sued for refund of part of the income taxes paid by
him for the years 1953 and 1954, on the ground that legal expenses
incurred by him in defending divorce litigation with his former
wife were deductible under § 23(a)(2) of the Internal Revenue Code
of 1939, as amended, which allots as deductions from gross income
"ordinary and necessary expenses . . . incurred . . . for the
conservation . . . of property held for the production of income."
His gross income was derived almost entirely from his salary as
president of three corporations which were franchised automobile
dealers and from dividends from his controlling stock in such
corporations. His wife had sued for divorce, alimony, and an
alleged community property interest in such stock, and he alleged
that, had he not succeeded in defeating these claims, he might have
lost his stock, his corporate positions, and the dealer franchises,
from which nearly all of his income was derived. Held: none of respondent's expenditures in resisting
these claims is deductible under § 23(a)(2). Pp. 372 U. S.
40 -52.

															(a) The origin and character of the claim with respect to which
an expense was incurred, rather than its potential consequences
upon the fortunes of the taxpayer, is the controlling basic test of
whether the expense was "business" or "personal," and hence whether
or not it is deductible under § 23(a)(2). Pp. 372 U. S.
44 -51.

															(b) The wife's claims stemmed entirely from the marital
relationship, and not, under any tenable view of things, from
income-producing activity. Therefore, none of respondent's
expenditures in resisting these claims can be deemed "business"
expenses deductible under § 23(a)(2). Pp. 372 U. S.
51 -52.

															___ Ct. Cl. ___, 290 F.2d 942, reversed and case remanded. Page 372 U. S. 40 MR. JUSTICE HARLAN delivered the opinion of the Court.

															In 1955, the California Supreme Court confirmed the award to the
respondent taxpayer of a decree of absolute divorce, without
alimony, against his wife Dixie Gilmore. [ Footnote 1 ] Gilmore v. Gilmore, 45 Cal. 2d
142 , 287 P.2d 769. The case before us involves the
deductibility for federal income tax purposes of that part of the
husband's legal expense incurred in such proceedings as is
attributable to his successful resistance of his wife's claims to
certain of his assets asserted by her to be community property
under California law. [ Footnote
2 ] The claim to such deduction, which has been upheld by the
Court of Claims, 290 F.2d 942, is founded on § 23(a)(2) of the
Internal Revenue Code of 1939, 26 U.S.C. (1952 ed.) § 23(a)(2),
which allows as deductions from gross income

															". . . ordinary and necessary expenses . . . incurred during the
taxable year [ Footnote 3 ] . . .
for the . . . conservation . . . of property held for the
production of income."

															Because of a conflict of views among the Court of Claims, the
Courts of Appeals, and the Tax Court regarding the Page 372 U. S. 41 proper application of this provision, [ Footnote 4 ] and the continuing importance of the
question in the administration of the federal income tax laws, we
granted certiorari on the Government's petition. 368 U.S. 816. The
case was first argued at the last Term and set for reargument at
this one. 369 U.S. 835.

															At the time of the divorce proceedings, instituted by the wife
but in which the husband also cross-claimed for divorce,
respondent's property consisted primarily of controlling stock
interests in three corporations, each of which was a franchised
General Motors automobile dealer. [ Footnote 5 ] As president and principal managing officer of
the three corporations, he received salaries from them aggregating
about $66,800 annually, and in recent years his total annual
dividends had averaged about $83,000. His total annual income
derived from the corporations was thus approximately $150,000. His
income from other sources was negligible. [ Footnote 6 ]

															As found by the Court of Claims, the husband's overriding
concern in the divorce litigation was to protect these assets
against the claims of his wife. Those claims had two aspects:
first, that the earnings accumulated and retained by these three
corporations during the Gilmores' marriage (representing an
aggregate increase in corporate net worth of some $600,000) were
the product of respondent's personal services, and not the result
of accretion in capital values, thus rendering respondent's
stockholdings in the enterprises pro tanto community
property Page 372 U. S. 42 under California law; [ Footnote
7 ] second, that, to the extent that such stockholdings were
community property, the wife, allegedly the innocent party in the
divorce proceeding, was entitled under California law to more than
a one-half interest in such property. [ Footnote 8 ]

															The respondent wished to defeat those claims for two important
reasons. First, the loss of his controlling stock interests,
particularly in the event of their transfer in substantial part to
his hostile wife, might well cost him the loss of his corporate
positions, his principal means of livelihood. Second, there was
also danger that if he were found guilty of his wife's sensational
and reputation-damaging charges of marital infidelity, General
Motors Corporation might find it expedient to exercise its right to
cancel these dealer franchises.

															The end result of this bitterly fought divorce case was a
complete victory for the husband. He, not the wife, was granted a
divorce on his cross-claim; the wife's community property claims
were denied in their entirety; and she was held entitled to no
alimony. 45 Cal. 2d
142 , 287 P.2d 769.

															Respondent's legal expenses in connection with this litigation
amounted to $32,537.15 in 1953 and $8,074.21 in 1954 -- a total of
$40,611.36 for the two taxable years in question. The Commissioner
of Internal Revenue found all of these expenditures "personal" or
"family" expenses, and, as such, none of them deductible. 26 U.S.C.
(1952 ed.) Page 372 U. S. 43 § 24(a)(1). [ Footnote 9 ] In
the ensuing refund suit, however, the Court of Claims held that 80%
of such expense (some $32,500) was attributable to respondent's
defense against his wife's community property claims respecting his
stockholdings, and hence deductible under § 23(a)(2) of the 1939
Code as an expense "incurred . . . for the . . . conservation . . .
of property held for the production of income." In so holding the
Court of Claims stated:

															"Of course, it is true that, in every divorce case, a certain
amount of the legal expenses are incurred for the purpose of
obtaining the divorce and a certain amount are incurred in an
effort to conserve the estate, and are not necessarily deductible
under section 23(a)(2), but when the facts of a particular case
clearly indicate (as here) that the property around which the
controversy evolves is held for the production of income, and,
without this property, the litigant might be denied not only the
property itself but the means of earning a livelihood, then it must
come under the provisions of section 23(a)(2). . . . The only
question then is the allocation of the expenses to this phase of
the proceedings. [ Footnote
10 ]"

															290 F.2d at 947.

															The Government does not question the amount or formula for the
expense allocation made by the Court of Claims. Its sole contention
here is that the court below misconceived the test governing §
23(a)(2) deductions, in that the deductibility of these expenses
turns, so it is argued, not upon the consequences to respondent of
a Page 372 U. S. 44 failure to defeat his wife's community property claims, but upon
the origin and nature of the claims themselves. So viewing Dixie
Gilmore's claims, whether relating to the existence or division of
community property, it is contended that the expense of resisting
them must be deemed nondeductible "personal" or "family" expense
under § 24(a)(1), not deductible expense under § 23(a)(2). For
reasons given hereafter we think the Government's position is
sound, and that it must be sustained. I For income tax purposes, Congress has seen fit to regard an
individual as having two personalities:

															"one is [as] a seeker after profit who can deduct the expenses
incurred in that search; the other is [as] a creature satisfying
his needs as a human and those of his family but who cannot deduct
such consumption and related expenditures. [ Footnote 11 ]"

															The Government regards § 23(a)(2) as embodying a category of the
expenses embraced in the first of these roles.

															Initially, it may be observed that the wording of § 23(a)(2)
more readily fits the Government's view of the provision than that
of the Court of Claims. For, in context, "conservation of property"
seems to refer to operations performed with respect to the property
itself, such as safeguarding or upkeep, rather than to a taxpayer's
retention of ownership in it. [ Footnote 12 ] But more illuminating than the mere language
of § 23(a)(2) is the history of the provision.

															Prior to 1942, § 23 allowed deductions only for expenses
incurred "in carrying on any trade or business," the deduction
presently authorized by § 23(a)(1). In Higgins v.
Commissioner, 312 U. S. 212 ,
this Court gave that provision Page 372 U. S. 45 a narrow construction, holding that the activities of an
individual in supervising his own securities investments did not
constitute the "carrying on of trade or business," and hence that
expenses incurred in connection with such activities were not tax
deductible. Similar results were reached in United States v.
Pyne, 313 U. S. 127 , and City Bank Farmers Trust Co. v. Helvering, 313 U.
S. 121 . The Revenue Act of 1942 (56 Stat. 798, § 121),
by adding what is now § 23(a)(2), sought to remedy the inequity
inherent in the disallowance of expense deductions in respect of
such profit-seeking activities, the income from which was
nonetheless taxable. [ Footnote
13 ]

															As noted in McDonald v. Commissioner, 323 U. S.
57 , 323 U. S. 62 ,
the purpose of the 1942 amendment was merely to enlarge "the
category of incomes with reference to which expenses were
deductible." And committee reports make clear that deductions under
the new section were subject to the same limitations and
restrictions that are applicable to those allowable under §
23(a)(1). [ Footnote 14 ]
Further, this Court has said that § 23(a)(2) "is comparable and in pari materia with § 23(a)(1)," providing for a class of
deductions "coextensive with the business deductions allowed by §
23(a)(1), except for" the requirement that the income-producing
activity qualify as a trade or business. Trust of Bingham v.
Commissioner, 325 U. S. 365 , 325 U. S.
373 -374 .

															A basic restriction upon the availability of a § 23(a)(1)
deduction is that the expense item involved must be one that has a
business origin. That restriction not only Page 372 U. S. 46 inheres in the language of § 23(a)(1) itself, confining such
deductions to "expenses . . . incurred . . . in carrying on any
trade or business," but also follows from § 24(a)(1), expressly
rendering nondeductible "in any case . . . [p]ersonal, living, or
family expenses." See note
9 supra. In light of what has already been said with
respect to the advent and thrust of § 23(a)(2), it is clear that
the "[p]ersonal . . . or family expenses" restriction of § 24(a)(1)
must impose the same limitation upon the reach of § 23(a)(2) -- in
other words, that the only kind of expenses deductible under §
23(a)(2) are those that relate to a "business," that is,
profit-seeking, purpose. The pivotal issue in this case then
becomes: was this part of respondent's litigation costs a
"business," rather than a "personal" or "family," expense?

															The answer to this question has already been indicated in prior
cases. In Lykes v. United States, 343 U.
S. 118 , the Court rejected the contention that legal
expenses incurred in contesting the assessment of a gift tax
liability were deductible. The taxpayer argued that, if he had been
required to pay the original deficiency, he would have been forced
to liquidate his stockholdings, which were his main source of
income, and that his legal expenses were therefore incurred in the
"conservation" of income-producing property, and hence deductible
under § 23(a)(2). The Court first noted that the "deductibility [of
the expenses] turns wholly upon the nature of the activities to
which they relate" (343 U.S. at 343 U. S.
123 ), and then stated:

															"Legal expenses do not become deductible merely because they are
paid for services which relieve a taxpayer of liability. That
argument would carry us too far. It would mean that the expense of
defending almost any claim would be deductible by a taxpayer on the
ground that such defense was made to help him keep clear of liens
whatever income-producing Page 372 U. S. 47 property he might have. For example, it suggests that the
expense of defending an action based upon personal injuries caused
by a taxpayer's negligence while driving an automobile for pleasure
should be deductible. Section 23(a)(2) never has been so
interpreted by us. . . ."

															"While the threatened deficiency assessment . . . added urgency
to petitioner's resistance of it, neither its size nor its urgency
determined its character. It related to the tax payable on
petitioner's gifts. . . . The expense of contesting the amount of
the deficiency was thus at all times attributable to the gifts, as
such, and accordingly was not deductible."

															"If, as suggested, the relative size of each claim, in
proportion to the income-producing resources of a defendant, were
to be a touchstone of the deductibility of the expense of resisting
the claim, substantial uncertainty and inequity would inhere in the
rule. . . . It is not a ground for [deduction] that the claim, if
justified, will consume income-producing property of the
defendant."

															343 U.S. at 343 U. S.
125 -126.

															In Kornhauser v. United States, 276 U.
S. 145 , this Court considered the deductibility of legal
expenses incurred by a taxpayer in defending against a claim by a
former business partner that fees paid to the taxpayer were for
services rendered during the existence of the partnership. In
holding that these expenses were deductible even though the
taxpayer was no longer a partner at the time of suit, the Court
formulated the rule that,

															"where a suit or action against a taxpayer is directly connected
with, or . . . proximately resulted from, his business, the expense
incurred is a business expense. . . ."

															276 U.S. at 276 U. S. 153 .
Similarly, in a case involving an expense incurred in satisfying an
obligation (though not a litigation expense), it was said that "it
is the origin of the Page 372 U. S. 48 liability out of which the expense accrues" or "the kind of
transaction out of which the obligation arose . . . which [is]
crucial and controlling." Deputy v. du Pont, 308 U.
S. 488 , 308 U. S. 494 , 308 U. S.
496 .

															The principle we derive from these cases is that the
characterization, as "business" or "personal," of the litigation
costs of resisting a claim depends on whether or not the claim
arises in connection with the taxpayer's profit-seeking activities.
It does not depend on the consequences that might result to a
taxpayer's income-producing property from a failure to defeat the
claim, for, as Lykes teaches, that "would carry us too
far," [ Footnote 15 ] and
would not be compatible with the basic lines of expense
deductibility drawn by Congress. [ Footnote 16 ] Moreover, such a rule would lead to
capricious results. If two taxpayers are each sued for an
automobile accident while driving for pleasure, deductibility of
their litigation costs would turn on the mere circumstance of the
character of the assets each happened to possess, that is, whether
the judgments against them stood to be satisfied out of income- or
nonincome-producing property. We should be slow to attribute to
Congress a purpose producing such unequal treatment among
taxpayers, resting on no rational foundation. Page 372 U. S. 49 Confirmation of these conclusions is found in the incongruities
that would follow from acceptance of the Court of Claims' reasoning
in this case. Had this respondent taxpayer conducted his automobile
dealer business as a sole proprietorship, rather than in corporate
form, and claimed a deduction under § 23(a)(1), [ Footnote 17 ] the potential impact of his
wife's claims would have been no different than in the present
situation. Yet it cannot well be supposed that § 23(a)(1) would
have afforded him a deduction, since his expenditures, made in
connection with a marital litigation, could hardly be deemed
"expenses . . . incurred . . . in carrying on any trade or
business." Thus, under the Court of Claims' view, expenses may be
even less deductible if the taxpayer is carrying on a trade or
business instead of some other income-producing activity. But it
was manifestly Congress' purpose with respect to deductibility to
place all income-producing activities on an equal footing. And it
would surely be a surprising result were it now to turn out that a
change designed to achieve equality of treatment in fact had served
only to reverse the inequality of treatment.

															For these reasons, we resolve the conflict among the lower
courts on the question before us ( note 4 supra ) in favor of the view that the
origin and character of the claim with respect to which an expense
was incurred, rather than its potential consequences upon the
fortunes of the taxpayer, is the controlling basic test of whether
the expense was "business" or "personal," and hence whether it is
deductible or not under § 23(a)(2). We find the reasoning
underlying the cases taking the "consequences" view
unpersuasive. Baer v. Commissioner, 196 F.2d 646, upon which the
Court of Claims relied in the present case, is the leading Page 372 U. S. 50 authority on that side of the question. [ Footnote 18 ] There, the Court of Appeals for the
Eighth Circuit allowed a § 23(a)(2) expense deduction to a taxpayer
husband with respect to attorney's fees paid in a divorce
proceeding in connection with an alimony settlement which had the
effect of preserving intact for the husband his controlling stock
interest in a corporation, his principal source of livelihood. The
court reasoned that, since the evidence showed that the taxpayer
was relatively unconcerned about the divorce itself,

															"[t]he controversy did not go to the question of . . . [his]
liability [for alimony] [ Footnote 19 ] but to the manner in which [that liability]
might be met . . . without greatly disturbing his financial
structure;"

															therefore, the legal services were "for the purpose of
conserving and maintaining" his income-producing property. 196 F.2d
at 649-650, 651.

															It is difficult to perceive any significant difference between
the "question of liability" and "the manner" of its discharge, for,
in both instances, the husband's purpose is to avoid losing
valuable property. Indeed, most of the cases which have followed Baer have placed little reliance on that distinction, and
have tended to confine the deduction to situations where the wife's
alimony claims, if successful, might have completely destroyed the
husband's Page 372 U. S. 51 capacity to earn a living. [ Footnote 20 ] Such may be the situation where loss of
control of a particular corporation is threatened, in contrast to
instances where the impact of a wife's support claims is only upon
diversified holdings of income-producing securities. [ Footnote 21 ] But that rationale too
is unsatisfactory. For diversified security holdings are no less
"property held for the production of income" than a large block of
stock in a single company. And, as was pointed out in Lykes,
supra, at 343 U. S. 126 ,
if the relative impact of a claim on the income-producing resources
of a taxpayer were to determine deductibility, substantial
"uncertainty and inequity would inhere in the rule."

															We turn then to the determinative question in this case: did the
wife's claims respecting respondent's stockholdings arise in
connection with his profit-seeking activities? II In classifying respondent's legal expenses, the court below did
not distinguish between those relating to the claims of the wife
with respect to the existence of community property and those
involving the division of any such property. Supra, p. 372 U. S. 41 -42.
Nor is such a breakdown necessary for a disposition of the present
case. It is enough to say that in both aspects the wife's claims
stemmed entirely from the marital relationship, and not, under any
tenable view of things, from income-producing activity. This is
obviously so as regards the claim to more than an equal division of
any community property Page 372 U. S. 52 found to exist. For any such right depended entirely on the
wife's making good her charges of marital infidelity on the part of
the husband. The same conclusion is no less true respecting the
claim relating to the existence of community property. For no such
property could have existed but for the marriage relationship.
[ Footnote 22 ] Thus, none of
respondent's expenditures in resisting these claims can be deemed
"business" expenses, and they are therefore not deductible under §
23(a)(2).

															In view of this conclusion, it is unnecessary to consider the
further question suggested by the Government: whether that portion
of respondent's payments attributable to litigating the issue of
the existence of community property was a capital expenditure or a
personal expense. In neither event would these payments be
deductible from gross income.

															The judgment of the Court of Claims is reversed, and the case is
remanded to that court for further proceedings consistent with this
opinion. It is so ordered. MR. JUSTICE BLACK and MR. JUSTICE DOUGLAS believe that the Court
reverses this case because of an unjustifiably narrow
interpretation of the 1942 amendment to § 23 of the Internal
Revenue Code, and would accordingly affirm the judgment of the
Court of Claims.

															[ Footnote 1 ]

															Despite the divorce, Dixie Gilmore is referred to throughout
this opinion as the "wife."

															[ Footnote 2 ]

															Although the second Mrs. Gilmore, having been a party to one of
the tax returns involved in this case, is also a respondent here,
Mr. Gilmore will be referred to herein as the sole respondent.

															[ Footnote 3 ]

															The taxable years in question are 1953 and 1954. The year 1954
is governed by the 1954 Code. Since the relevant provisions, §§ 212
and 262, are substantially identical with those of the 1939 Code,
for the sake of clarity, we shall refer only to the 1939 Code.

															[ Footnote 4 ] Compare Lewis v. Commissioner, 253 F.2d 821 (C.A.2d
Cir.), and Douglas v. Commissioner, 33 T.C. 349, with
Gilmore v. United States, 290 F.2d 942 (Ct.Cl.) -- the present
case -- and Baer v. Commissioner, 196 F.2d 646 (C.A.8th
Cir.).

															[ Footnote 5 ]

															He owned 100% of the outstanding stock of Don Gilmore-San
Francisco, 73 1/3% of the outstanding stock of Don Gilmore-Hayward,
and 60% of the outstanding stock of Don Gilmore-Riverside.

															[ Footnote 6 ]

															$1,024.90 in 1953, and $516.60 in 1954.

															[ Footnote 7 ] See Pereira v. Pereira, 156 Cal. 1, 103 P. 488; Lenninger v. Lenninger, 167 Cal. 297, 139 P. 679; Huber v. Huber, 27 Cal. 2d
784 , 167 P.2d 708.

															[ Footnote 8 ]

															Under California law, a party granted a divorce on grounds of
extreme cruelty or adultery may, in the court's discretion, be
awarded up to all of the community property of the marriage.
Cal.Civ.Code, § 146. See Barham v. Barham, 33 Cal. 2d
416 , 202 P.2d 289; Wilson v. Wilson, 159 Cal. App.
2d 330 , 323 P.2d 1017. Such grounds for divorce were alleged by
each of these spouses against the other.

															[ Footnote 9 ]

															Section 24(a)(1) provides: "In computing net income no deduction
shall in any case be allowed in respect of -- (1) Personal, living,
or family expenses. . . ."

															[ Footnote 10 ]

															Several other issues involving deficiency assessments for the
years 1953, 1954, and 1955 were decided by the Court of Claims, but
they are not before this Court.

															[ Footnote 11 ]

															Surrey and Warren, Cases on Federal Income Taxation, 272
(1960).

															[ Footnote 12 ] See 4 Mertens, Law of Federal Income Taxation (rev. ed.
1960), § 25 A. 09 at 19-20.

															[ Footnote 13 ] See H.R.Rep. No. 2333, 77th Cong., 2d Sess. 46.

															[ Footnote 14 ]

															H.R.Rep. No. 2333, 77th Cong., 2d Sess. 75:

															"A deduction under this section is subject, except for the
requirement of being incurred in connection with a trade or
business, to all the restrictions and limitations that apply in the
case of the deduction under section 23(a)(1)(A) of an expense paid
or incurred in carrying on any trade or business." See also S.Rep. No. 1631, 77th Cong., 2d Sess. 88.

															[ Footnote 15 ]

															The Treasury Regulations have long provided:

															"An expense (not otherwise deductible) paid or incurred by an
individual in determining or contesting a liability asserted
against him does not become deductible by reason of the fact that
property held by him for the production of income may be required
to be used or sold for the purpose of satisfying such
liability."

															Treas.Reg. (1954 Code) § 1.212-1(m); see Treas.Reg. 118
(1939 Code) § 39.23(a)-15(k).

															[ Footnote 16 ]

															Expenses of contesting tax liabilities are now deductible under
§ 212(3) of the 1954 Code. This provision merely represents a
policy judgment as to a particular class of expenditures otherwise
nondeductible, like extraordinary medical expenses, and does not
cast any doubt on the basic tax structure set up by Congress.

															[ Footnote 17 ]

															We find no indication that Congress intended § 23(a)(2) to
include such expenses.

															[ Footnote 18 ]

															Besides the present case see to the same effect, e.g.,
Patrick v. United States, 288 F.2d 292 (C.A.4th Cir.), No. 22, reversed today, post, p. 372 U. S. 53 ; Owens v. Commissioner, 273 F.2d 251 (C.A.5th Cir.); Bowers v. Commissioner, 243 F.2d 904 (C.A.6th Cir.); McMurtry v. United States, 132 F. Supp. 114.

															[ Footnote 19 ]

															Expenses incurred in divorce litigation have generally been held
to be nondeductible. See, e.g., Richardson v.
Commissioner, 234 F.2d 248 (C.A.4th Cir.); Smith's Estate
v. Commissioner, 208 F.2d 349 (C.A.3d Cir.); Joyce v.
Commissioner, 3 B.T.A. 393. See also Treas.Reg. (1954
Code) § 1.262-1(b)(7):

															"Generally, attorney's fees and other costs paid in connection
with a divorce, separation, or decree for support are not
deductible by either the husband or the wife."

															[ Footnote 20 ] See, e.g., the present case, 290 F.2d at 947; Tressler v. Commissioner, 228 F.2d 356, 361 (C.A.9th
Cir.); Howard v. Commissioner, 202 F.2d 28, 30 (C.A.9th
Cir.).

															[ Footnote 21 ] Compare with the present case Davis v. United States, 287 F.2d 168, 152 Ct.Cl. 805, reversed in part on other
grounds, 370 U. S. 65 , in
which the Court of Claims held to be nondeductible the legal
expenses of resisting the wife's threat to stock not essential to
protect the husband's employment.

															[ Footnote 22 ]

															The respondent's attempted analogy of a marital "partnership" to
the business partnership involved in the Kornhauser case, supra, is, of course, unavailing. The marriage
relationship can hardly be deemed an income-producing activity.