
    AMERICAN AUTOMOBILE ASSOCIATION v. THE UNITED STATES
    [No. 311-58.
    Decided March 2, 1960.
    Plaintiff’s motion for rehearing overruled May 4, 1960] 
    
    
      
      Mr. Fleming Bomar for the plaintiff. Messrs. Joseph E. McAndrews and Ivins, Phillips & Barker were on the brief.
    
      Mr. Jerry M. Hamovit, with whom was Mr. Assistant Attorney General Charles K. Bice, for the defendant. Messrs. James P. Garland and Lyle M. Turner were on the brief.
    
      
      Affirmed by the Supreme Court, 367 U.S. 687.
    
   Jones, Chief Judge,

delivered the opinion of the court:

The plaintiff, a motor club, seeks to recover Federal income taxes and assessed interest paid for the calendar years 1952 and 1953. The issue to be decided here involves the tax treatment to be accorded the prepaid income of an accrual basis taxpayer. The problem arises because club membership dues are paid to the taxpayer for 12 months in advance.

Plaintiff is a national organization which renders services to affiliated local automobile clubs and their members and performs services of a public nature in fields relating to motoring and travel. In addition to its activities as a national organization, the plaintiff operates directly, as divisions, ten local automobile clubs. A substantial portion of the annual gross income of plaintiff is derived from dues, prepaid for one year in advance, received from members of the automobile clubs operated as divisions of the plaintiff.

Plaintiff provides services for the members of the local divisions over the 12-month period following payment of dues. These services, although not completely uniform, generally included the following: (a) A travel service which included trip planning, tour books, accommodation directories, maps and recommended routes; (b) emergency road service which consisted of towing, changing tires, replacing batteries and other minor repairs; the road service was provided by plaintiff through contracts made with garages and service stations in the areas served by its divisions; (c) bail bond protection up to $5,000 through contracts made by the plaintiff with bondsmen; (d) personal automobile accident insurance; (e) a theft reward offered by the plaintiff for information leading to the arrest and conviction of any person stealing a member’s car; (f) in addition, the plaintiff, in one or more of its divisions, provided other personal services for members which included procuring motor licenses, notarial services, brake and headlight adjustments, and advice on how to prepare and file papers in small claims courts.

The prepaid dues collected from members of its divisions were deposited in plaintiff’s bank accounts with no restrictions as to their use for any of its corporate purposes. However, the dues upon collection were reflected in a liability account designated “Deferred Eevenue — Membership Dues.” Thereafter, a pro rata part of the dues was removed from the liability account and reflected in an “income” account. Dues collected from members who joined in the month of January were recognized as income in January only to the extent of 1/24 (a half of 1/12) of such collections, on the assumption that the average or mean date of the January collections would be the middle of the month. Thereafter, 1/12 of the dues collected in January was taken out of the liability account and credited to income in each of the following 11 months (i.e., February through December). The remaining 1/24 of the dues collected in January was kept as a liability in the “Deferred Eevenue— Membership Dues” account on December 31, but was subsequently recognized as income for January of the following year.

Dues collected in each of the other months of the calendar year were treated in the same manner. That is, 1/24 of each month’s collections was recognized as income in the first month of membership, 1/12 of the amount paid was recognized as income in each of the following eleven months, and the remaining 1/24 was allocated to income in the month when membership expired. Commencing in 1954, the plaintiff, in order to simplify internal accounting detail, changed its procedure in the monthly accounting for dues by assigning 50 percent of the dues to income for the current year and allocating the other 50 percent as a liability which matured as income in the following tax year.

In preparing its income tax returns for the years in suit, plaintiff, an accrual basis taxpayer, excluded from the income received in each year that portion of membership dues which remained in the liability account (“Deferred Revenue — Membership Dues”) at the end of the taxable year. It thus treated dues as income ratably over the 12-month period of membership, whether or not such period extended beyond the close of its taxable year.

Expenses which plaintiff considered to fall within the category of prepaid membership costs, e.g., salesmen’s commissions and the cost of accident insurance covering the period of a membership, even though paid by plaintiff, were not deducted entirely in the taxable year paid or incurred, but instead were deducted ratably over the same periods of time that dues were recognized as income.

The income reported by plaintiff in its tax return for the calendar year 1953 attributable to dues received from members of its divisions was $3,337,813.44, representing $1,562,-042.23 of prepaid dues collected in 1952 but not recognized as income until 1953, plus $1,775,771.21 of dues collected in 1953 and recognized as income in that year.

For 1954, dues reported by plaintiff as income for purposes of the Federal income tax totaled $3,794,672.20, representing $1,755,407.46 of advance dues collected in 1953 but not recognized as income until 1954, plus $2,039,264.74 of dues collected in 1954 and recognized as income in that year.

Plaintiff claimed that as a result of a 1954 net operating loss in the amount of $289,967.67, it was entitled to a net operating loss carryback deduction in 1952 in the amount of $154,411.11, and a net operating loss carryback deduction in 1953 in the amount of $135,556.56. Upon examination of the plaintiff’s Federal income tax returns for the calendar years 1952, 1953, and 1954, the Commissioner of Internal Eevenue disallowed plaintiff’s deferral of income from one year to another, for years subsequent to 1953, thereby increasing plaintiff’s 1954 net operating income from $353,-279.09 to $481,557.59 and reducing plaintiff’s 1954 net operating loss from $289,967.67 to $14,412.49. The net effect of the Commissioner’s determination was to reduce plaintiff’s net operating loss carryback deduction to $14,412.49 in 1952 and to eliminate entirely any net operating loss carryback deduction in 1953.

The issue to be decided by this court is whether the Commissioner of Internal Eevenue correctly determined that plaintiff’s method of accounting — with respect to dues received from members of its divisions — does not clearly reflect plaintiff’s income within the meaning of § 41 of the Internal Eevenue Code of 1939 and § 446 of the Internal Eevenue Code of 1954. Section 41 required that “the 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 . ...”

The Commissioner of Internal Eevenue disallowed the deferral of income from one year to another on the ground that prepaid dues received under a “claim of right,” without restriction as to their disposition, represents income in the year of receipt and should be taxed in that year regardless of the method of accounting employed by the taxpayer. This position is based on the claim of right doctrine enunciated by the Supreme Court in North American Oil Co. v. Burnet, 286 U.S. 417, 424 (1932). It is of course fairly obvious that, once it is determined that prepaid income is required to be included in income in the year of receipt under the claim of right doctrine, it would necessarily follow that any other method of reporting would not “clearly reflect the income.”

The opposite view, advanced by the plaintiff — that the claim of right doctrine does not relate to the question whether items that admittedly belong to the taxpayer may be attributed to a taxable year other than that of receipt in accordance with principles of accrual accounting — has been succinctly presented by Mr. Justice Harlan, dissenting in Automobile Club of Michigan v. Commissioner, 353 U.S. 180, 191-192 (1957).

However, we do not find it necessary to resolve this issue, since we agree with the Government’s contention that the method of treatment of prepaid automobile club membership dues employed by the plaintiff was dealt with by the Supreme Court in Automobile Club of Michigan v. Commissioner, 353 U.S. 180, rehearing denied, 353 U.S. 989 (1957), and was held to be, at least for Federal income tax purposes, “purely artificial.” In the Automobile Club of Michigan case prepaid membership dues were credited upon receipt to an account carried as a liability and designated “Unearned Membership Dues.” “During the first month of membership and each of the following eleven months one-twelfth of the amount paid . . . [was] credited to an accownt designated Membership Income.'1 This method of accounting was followed by petitioner [a motor club] from 1934. The income from such dues reported by petitioner in each of its tax returns for 1943 through 1947 was the amount credited in the year to the ‘Membership Income’ account.” 353 U.S. at 188. (Emphasis supplied.)

The Commissioner of Internal Revenue had determined that this method of accounting — which is essentially the same method used by the plaintiff in the case at bar — did not clearly reflect income. The Supreme Court, in affirming the action of the Commissioner, stated (353 U.S. at 189-190) :

The petitioner does not deny that it has the unrestricted use of the dues income in the year of receipt, but contends that its accrual method of accounting clearly reflects its income and that the Commissioner is therefore bound to accept its method of reporting membership dues. We do not agree. * * * The fro rata allocation of the membership dues in monthly amounts is purely artificial and bears no relation to the services which petitioner may in fact be called upon to render for the member. Section 41 vests the Commissioner with discretion to determine whether the petitioner’s method of accounting clearly reflects income. We cannot say, in the circumstances here, that the discretionary action of the Commissioner, sustained by both the Tax Court and the Court of Appeals, exceeded permissible limits. See Brown v. Helvering, 291 U.S. 193, 204-205. [Emphasis supplied.]

Although it would appear that Automobile Club of Michigan does not expressly rule out deferral of income, we are constrained to interpret this language as a rejection by the Supreme Court of the accounting method advanced by plaintiff in the case at bar.

We are influenced in our decision by the language used by the Court to distinguish on their facts Beacon Publishing Co. v. Commissioner, 218 F. 2d 697 (10th Cir. 1955) (deferral of prepaid magazine subscription income) and Schuessler v. Commissioner, 230 F. 2d 722 (5th Cir. 1956) (reserves set up to meet future costs) :

In Beacon, performance of the subscription, in most instances, was, in part, necessarily deferred until the publication dates after the tax year. In Schuessler, performance of the service agreement required the taxpayer to furnish services at specified times in years sub-quent to the tax year. In this case [as in the case at bar], 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. We express no opinion upon the correctness of the decisions in Beacon or Bchuessler.

But regardless of the underlying basis for the Court’s rejection of “the pro rata allocation of the membership dues in monthly amounts” as “purely artificial,” we feel constrained by the decision in Automobile Club of Michigan to reject that same method of accounting for tax purposes in the case at bar.

The plaintiff is therefore not entitled to recover and its petition will be dismissed.

It is so ordered.

Littleton, Judge {Bet.); Laramoke, Judge, and Madden, Judge, concur.

Whitaker, Judge,

concurring:

From the enactment of the Corporation Excise Tax Act of 1909 and the first income tax act in 1913, it has been universally supposed that in order to “clearly reflect income” the taxpayers’ accounting method must treat as gross income amounts received or accrued in the taxable year, with certain exceptions specified in the Code. The income under consideration here was received in plaintiff’s taxable year. Plaintiff’s method of accounting treats a portion of that income as not having been received in the taxable year and, thus, does not clearly reflect its income, unless it comes within the statutory exceptions. Those exceptions are, for example, reserves for depreciation, obsolescence, and depletion, and, in the case of insurance companies prepaid premium reserves. The statute does not allow the deduction of reserves to anticipate expenses of meeting the demands of plaintiff’s membership. What plaintiff, in effect, seeks to do is to deduct such a reserve from the income it received within the taxable year.

I also concur in the majority opinion.

FINDINGS OF FACT

The court, having considered the evidence, the report of Trial Commissioner Marion T. Bennett, and the briefs and argument of counsel, makes findings of fact as follows:

1. Plaintiff is a corporation with its principal office at 1712 G Street, Northwest, Washington, I).C. Plaintiff was incorporated in the year 1910 under the laws of the State of Connecticut and was organized and is operated as a non-stock, membership corporation.

2. Plaintiff is a national organization which renders services to affiliated local automobile clubs and their members and performs services of a public nature in fields relating to motoring and travel.

3. In addition to the activities described in paragraph two above, plaintiff operates directly, as divisions, the following local automobile clubs:

District of Columbia Division of AAA
(Metropolitan area, Washington, D. C.)
Louisiana Division oí AAA (entire state)
Massachusetts Division of AAA (part of state)
New Hampshire Division of AAA (entire state)
New Mexico Division of AAA (entire state)
North Florida Division of AAA 1 / , , , x South Florida Division of AAA j (Part of state>
Texas Division of AAA (part of state)
Wisconsin Division of AAA (entire state)
Wyoming Division of AAA (entire state)

4. A substantial portion of the annual gross income of plaintiff is derived from dues, prepaid for one year in advance, received from members of the automobile clubs described in paragraph three and operated as divisions of plaintiff. Plaintiff provides services for such members over the 12-month period following payment of dues. The services provided by plaintiff for the members of its divisions during the years in issue, although tending to be parallel, were not completely uniform and included the following: (a) A complete travel service which included trip planning, tour books, accommodation directories, maps and recommended routes, (b) Emergency road service which consisted of towing, changing tires, replacing batteries and other minor repairs. The road service was provided by plaintiff through contracts made with garages and service stations in the areas served by its divisions, (c) Bail bond protection up to $5,000 through contracts made by the plaintiff with bondsmen, (d) Personal automobile accident insurance which included hospitalization, personal injury and death benefits on a sliding scale in the event of a motoring accident. The plaintiff contracted for the insurance on a group basis and paid the premiums on the group policies, (e) A theft reward offered by the plaintiff for information leading to the arrest and conviction of any person stealing a member’s car. In addition, the plaintiff, in one or more of its divisions, provided other personal services for members which included procuring motor licenses, notarial services, brake and headlight adjustments, and advice on how to prepare and file papers in small claims courts.

5. In order to make available and provide for the members of its divisions the services which plaintiff provides, plaintiff during the years in issue owned or rented offices in 39 to 41 different geographical locations and had on its divisions’ payroll 495 employees in December 1953 and 603 employees in December 1954.

6. Plaintiff, commencing with the calendar year 1943, has been required to file Federal income tax returns and to pay Federal income taxes on its net income. Its Federal income tax returns are filed with the District Director of Internal Revenue, Baltimore, Maryland. The plaintiff’s taxable year is the calendar year.

7. Plaintiff employs the accrual method of accounting in keeping its books and records and in filing its Federal income tax returns.

8. Plaintiff, within the time prescribed by law, filed Federal income tax returns with the District Director of Internal Revenue, Baltimore, Maryland, for the calendar years 1952,1953 and 1954. The 1952 return reported a net income of $152,975.51, the 1953 return reported a net income of $352,125.84, and the 1954 return reported a net operating loss in the amount of $290,186.04.

9. Upon examination of plaintiff’s Federal income tax returns for the calendar years 1952, 1953 and 1954, the Commissioner of Internal Revenue made several minor adjustments which, are not in issue in this proceeding, the net effect of which was to increase plaintiff’s 1952 net income to $154,411.11, to increase plaintiff’s 1953 net income to $353,-279.09, and to reduce plaintiff’s 1954 net operating loss to $289,967.67.

10. Plaintiff claimed that as a result of its 1954 net operating loss in the amount of $289,967.67, it was entitled to a net operating loss carryback deduction in 1952 in the amount of $154,411.11, and a net operating loss carryback deduction in 1953 in the amount of $135,556.56.

11. Upon examination of plaintiff’s Federal income tax returns for the calendar years 1952,1953 and 1954, the Commissioner of Internal Revenue also determined not to recognize the method of accounting employed by plaintiff in computing its income derived from prepaid dues collected from members of its divisions during the calendar years 1953 and 1954, which is the issue in this proceeding. The net effect of such determination was to increase plaintiff’s 1953 net income from $353,279.09 to $481,557.59 and to reduce plaintiff’s 1954 net operating loss from $289,967.67 to $14,412.49, with the further result that the Commissioner reduced plaintiff’s net operating loss carryback deduction from $154,411.11 to $14,412.49 in 1952 and eliminated entirely any net operating loss carryback deduction in 1953.

12. The Commissioner of Internal Revenue determined the increase of plaintiff’s income for 1953 by $128,278.50 and the reduction of plaintiff’s loss for 1954 by $275,555.15 was in the following manner:

1953 Adjustments 1951 Adjustments
Reserve for unearned and deferred income Dec. 31 of current year_ $1, 756, 485. 46 $2, 039,264.43
Less reserve for unearned and deferred income Dec. 31 of prior year_ 1, 562, 042.23 1, 756, 485.46
Difference - 194, 443. 23 282, 778.97
Less
Prepaid commissions:
Dec. 31 of current year-398, 482. 36 405, 706.15
Dec. 31 of prior year— 332,317. 63 398, 482.36
195S 1964 Adjustments Adjustments Difference_ $66,164. 73 $7, 223. 79
Net additional income determined for the current year_ 128, 278. 50 275, 555.18

All of the foregoing items are reflected in the plaintiff’s balance sheets as of December 31 for the years involved, which were filed with its income tax returns for 1953 and 1954. The liabilities contain the account unearned and deferred income, and the assets contain the account prepaid commissions, but the latter account is not involved in the items labeled prepaid commissions in the above tabulation. The deduction items employed by the Commissioner of the Internal Eevenue Service represent plaintiff’s asset account for prepaid membership costs. The plaintiff’s assets for 1954 do not reflect any amount for prepaid membership costs, but its liabilities for unearned and deferred income reflect the approximate net difference between $2,039,264.43 and $405,706.15 in its 1954 balance sheet.

13. As a result of the adjustments described heretofore, the Commissioner of Internal Eevenue on May 15, 1956, asserted an income tax deficiency against plaintiff in the amount of $58,083.58 for the calendar year 1952, and in the amount of $137,907.48 for the calendar year 1953. These deficiencies in tax, plus interest of $2,019.37 for the year 1952 and $10,789.77 for the year 1953, were paid by plaintiff on May 25,1956, and May 28,1956.

14. On May 10, 1958, plaintiff filed timely claims for refund for each of the years in suit, which claims for refund-raised the issues upon which plaintiff now seeks recovery in this action. On July 1, 1958, the Commissioner of Internal Eevenue notified plaintiff by registered letter that its claims for refund had been denied.

15. Plaintiff, a nonstock, membership corporation, obtained substantially all of the funds necessary to carry on the operation of its divisions by dues from its members, paid for one year in advance.

16. Under the method of accounting employed by plaintiff during the years in issue, prepaid dues collected from members of its divisions were not regarded entirely as income for accounting purposes in the calendar year of receipt, but instead prepaid dues were recognized and treated as income ratably over the 12-month membership period whether or not such period extended beyond the close of plaintiff’s taxable year.

As of December 31 of each taxable year, the proportion of dues collected within the year which was applicable under plaintiff’s system of accounting to memberships extending beyond the close of the taxable year was considered and recorded as a liability of plaintiff and was reflected on plaintiff’s balance sheet with its tax return as a liability.

Expenses which plaintiff considered to fall within the category of prepaid membership costs, e.g., salesmen’s commissions, and the cost of accident insurance covering the period of a membership, even though paid by plaintiff, were not deducted entirely in the taxable year paid or incurred, but instead were deducted ratably over the same periods of time that dues were recognized as income.

17. During the calendar years 1953 and 1954, plaintiff recorded on its books and records, by months, the following amounts of prepaid dues collected from members of its divisions:

loss 195
January_ $257, 698. 02 $290,764.23
February— 236, 610. 67 284, 319.95
March_ 282,430. 08 351, 697.47
April_ 296, 647. 02 329, 066. 99
May_ 328,191. 75 382, 385.38
June_ 378, 716. 30 451,260. 81
July-386,150. 87 435, 832. 93
August_ 336, 269.66 395, 009.70
September-. 275, 235. 54 260, 950. 54
October_ 268,661.48 309, 543.51
November_ 219,278. 02 279,144.44
December_ 265, 289.26 308, 553.22
3, 531,178. 67 '4, 078, 529.17

This money was deposited in plaintiff’s bank accounts with no restrictions as to its use for any of its corporate purposes.

Section 4 of the bylaws of the American Automobile Association specifically provided for the use of funds and reads as follows:

section 4. {Use of Fwnds) This corporation shall use its funds only to accomplish the objects and purposes specified in Section 3, and no part of said funds shall inure, or be distributed, to the members of this corporation. On dissolution the funds of the corporation shall be distributed to one or more regularly organized charitable organizations to be selected by the Board of Directors.

18. Under the accounting system employed by the plaintiff from 1931 through 1953 prepaid dues collected from members who joined in the month of January were recognized as income in January to the extent of 1/24 of such collections, on the assumption that the average or mean date would be the middle of the month. Thereafter, 1/12 of prepaid collections for January was transferred or allocated to income for each of the following 11 months, and 1/24 of January collections remained a liability on December 31 and was transferred and recognized as income for January of the following year.

Prepaid dues for each month of the calendar year were treated in the same manner, that is, 1/24 of such collections was transferred and recognized as income in the current month when collections were made, 1/12 of such collections during the following 11 months and 1/24 thereof in the last month when membership expired. The monthly collections of prepaid dues during a calendar year which were recognized and transferred to income during the current year and the portion thereof remaining in the liability account at the end of the year, which was entitled deferred revenue MEMBERSHIP DUES, UNEARNED AND DEFERRED INCOME Or SOUie similar title, appear in the following tabulation:

Portion Remaining in the Liability Account Dec. Portion Treated as SI and Treated as Income lor the Income the Pol-Current Year lowing Year
January_ 23/24 1/24
February_ 21/24 3/24
March_ 19/24 5/24
April_ 17/24 7/24
May_ 15/24 9/24
June_ 13/24 11/24
July_ 11/24 13/24
August _ 9/24 15/24
September_ 7/24 17/24
October_ 5/24 19/24
November _ 3/24 21/24
December_ 1/24 23/24

The allocation of prepaid dues each month f acilitated the preparation of monthly statements of income and expenses. Had monthly collections been equal for each month during a year, the amount recognized as income during the current year and the amount remaining as a liability at the end of the year would have been equal under the foregoing apportionments.

19. Under the method of accounting employed by plaintiff, the proportion existing between dues collected from members of its divisions within a calendar year, which dues were recognized as income during such year, and the proportion of such dues regarded as a liability at the end of such year was as follows for the calendar years 1949 through 1954:

Portion Remaining in the Liability Account Deo. Portion Recognized as SI and Treated as Income During the Income the Fol~ Tear Collected lowing Tear
1949_ 49.9% 50.1%
1950_ 50.0% 50.0%
1951_ 50.2% 49.8%
1952_ 50.6% 49.4%
1953_ 50.3% 49.7%
1954_ 50.0% 50.0%

20. Commencing in 1954, in order to simplify much internal detail, the plaintiff changed its procedure in the monthly accounting for prepaid dues by the assignment of 50 percent to income for the current year and 50 percent as a liability which matured as income for the following year.

Plaintiff also adjusted certain inconsistencies in its prepaid expense account in 1954. Some division managers were paid a straight salary, whereas others were paid a nominal salary plus incentive commissions based upon the number of members within the division. These incentive commissions had been previously charged to the prepaid expense account and prorated over membership periods, whereas such incentive pay was actually a part of the manager’s compensation. It was treated as current expense in 1954 and thereafter. Also, guaranteed commissions to new salesmen for a certain limited period had been included with commissions earned on subscriptions obtained, as prepaid expense, and beginning in 1954 such unearned guaranteed payments were charged to current expenses.

The plaintiff continued the apportionment of prepaid dues collected and prepaid expenses for commissions and insurance oyer the period of membership as it had done previously. The basic method of accounting employed by plaintiff in 1954 was consistent with that employed by plaintiff in 1953 and prior years.

21. The income reported by plaintiff in its tax return for the calendar year 1953 attributable to dues received from members of its divisions was $3,337,813.44, representing $1,562,042.23 of prepaid dues collected in 1952 but not recognized as income until 1953, plus $1,775,771.21 of dues collected in 1953 and recognized as income in that year.

For 1954, dues reported by plaintiff as income for purposes of the Federal income tax totaled $3,794,672.20, representing $1,755,407.46 of advance dues collected in 1953 but not recognized as income until 1954, plus $2,039,264.74 of dues collected in 1954 and recognized as income in that year.

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.

The Internal Revenue Service did not question the method of accounting employed by plaintiff in computing its net income until the calendar year 1954, at which time deficiencies were proposed for the calendar years 1950, 1951 and 1952, but plaintiff was not required to pay those deficiencies by reason of a compromise settlement.

23. The determination of additional income by the Commissioner of the Internal Revenue Service for the taxable

years involved herein was made by including as income the advance payment of dues covering membership benefit periods in the following year and excluding those payments received in the prior year that covered membership benefit periods in the current year.

By taking into income for the current year the amount which plaintiff treated as a liability for servicing membership periods in the following year, the amount of such receipts would be reflected in the plaintiff’s surplus account at the end of the current year. The plaintiff’s balance sheet as of December 31, 1953, filed with its tax returns for 1953 and 1954 reflecting the items involved, is compared with the balance sheet which would result from the adjustments by the Commissioner of the Internal Revenue Service in the following table:

Balance Sheet on December SI, 1953 (5) Reflecting the Adjustments by (o) Reported by the Commissioner Plaintiff of IRS
Assets:
Cash _ $1, 941, 723. 88 $1, 941,723. 88
Prepaid membership cost-398,482. 36
Prepaid commissions_ 177, 079. 51 177, 079. 51
All other accounts, net_ 2, 834, 525.72 2, 834, 525. 72
Total assets_ 5,351, 811. 47 4,953,329.11
Liabilities :
Unearned and deferred income_ 1,756, 485. 46
All other liabilities_ 1,063,462. 99 1, 063,462. 99
Total liabilities-2, 819, 948.45 1,063,462.99
Surplus 2, 531, 863. 02 3,889, S66.12

24. The defendant contends that the sole issue is whether the Commissioner of Internal Revenue erred in refusing to allow plaintiff to defer a portion of income actually received, without any restriction as to its use, from the year in which it was received to the following year when services might have to be performed under the membership contracts.

The plaintiff’s gross income from dues was measured by collections for the period memberships were in effect during the current year. This included pro rata amounts of prepaid dues collected in the prior year covering membership periods that extended into the current year, but excluded prepaid dues collected in the current year for membership periods that extended into the following year. The membership service costs and other operating expenses paid or incurred during the current year were then deducted from such gross income for its determination of net income.

25. Restrictions on the use of funds represented by prepaid dues were not required or intended by the plaintiff’s members. On the contrary, the receipt of prepaid dues from members constituted the principal source of plaintiff’s operating funds as heretofore found. Funds from other sources, such as sales of publications, materials and supplies, advertising, etc., were normally received only after the costs and expenses were incurred in producing such revenues.

There is no evidence that membership contracts, or certificates issued by plaintiff to its members, provided any restriction in the use of funds received by plaintiff for dues paid in advance. Plaintiff’s financial responsibility is not questioned.

26. The plaintiff prepared and submitted tabulations of the aggregate costs incurred by all of its divisions in servicing all members thereof for each month of each year from 1948 through 1954. These tabulations were received as plaintiff’s exhibits 2 through 7, inclusive.

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.

27. The proportions of prepaid dues transferred and assigned to gross income by the plaintiff on a pro rata monthly time basis are compared with the proportion of assignments under the average monthly cost bases for servicing memberships in the following table:

1953 Average Average Plaintiffs Monthly Monthly Pro Rata Costs for Costs Over Method as Current Prior 5-Year Reported Year Period
Apportioned to Gross Income during current year_ 50.3% 49.8% 50.4%
Deferred to the Following Tear (reported as a liability at the end of the current year)_ 49. 7% 50.2% 49. 6%
195^
Apportioned to Gross Income during the current year-50.0% 48.8% 51.0%
Deferred to the following year (reported as a liability at the end of the current year)_ 50. 0% 51. 2% 49. 0%

28. The recognition, assignment and transfer of dues collected in advance to gross income on the basis of actual costs of servicing members is feasible under the accrual method of accounting, particularly in testing the results of prorating such collections on a time basis. It is not as practicable as the assignment of prepaid dues on a pro rata monthly basis because the current costs incurred must first be determined. The employment of a prior year’s monthly costs or a composite of monthly costs for five prior years might not be as accurate as the method actually employed by plaintiff because of a constant increase in membership reflected over the years or by abnormal costs of servicing members during one or more of such prior years.

When members paid their annual membership dues they became entitled to membership services over a period of 12 months, notwithstanding any variations in costs to the plaintiff in furnishing the services that might be required.

29. The plaintiff’s membership for all divisions reflects a constant increase from month to month during 1953 and 1954. The minimum number of memberships in effect in 1953 was 220,435 in January and the maximum was 246,856 in December of that year. The minimum number of memberships in effect in 1954 was 249,805 in January and the maximum was 295,889 in December of that year. The average cost to plaintiff of servicing a member during the calendar year 1953 was $14.50 and the average cost for 1954 was $14.72.

30. The plaintiff’s costs for servicing members were substantially in proportion to membership from year to year with reasonable constancy from month to month. The plaintiff’s actual costs of servicing all members from 1948 to 1954 are set out in the following tabulation:

1948_ $1, 587,794. 87
1949_. 1, 698,144.27
1950- 2, 012,466.23
1951- 2, 614,396. 96
1952- 3,109, 068.21
1953- 3, 377, 389. 91
1954- 3,991, 068.00

31. The actual average monthly cost per membership in effect during 1953 and 1954 and the percentage of the total annual cost per member is reported in the following tabulation, with the percentage of the total monthly costs to the total costs for the preceding five-year period:

The foregoing tabulation reflects the actual average cost to plaintiff in each month of the years involved for each member whose membership continued iu effect. The difference between the costs incurred for servicing memberships that continued from the prior year and the membership fees collected in the prior year, but treated by plaintiff as a liability of the plaintiff at the end of the year and transferred to gross income in the current year, would, under plaintiff’s system of accounting, represent the net income in the current year applicable to such memberships.

CONCLUSION OE LAW

Upon the foregoing findings of fact, which are made a part of the judgment herein, the court concludes as a matter of law that plaintiff is not entitled to recover, and its petition is therefore dismissed. 
      
       Plaintiff’s taxable year was the calendar year.
     
      
       To the same effect, § 446, Int. Rev. Code of 1954, provides that: “Taxable Income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.” However, “If the method used does not clearly reflect income, the computation of taxable Income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.”
     
      
       “[The claim of right] doctrine, it seems to me, comes into play only in determining whether the treatment of an item of income should be influenced by the fact that the right to receive or beep it is in dispute; it does not relate to the entirely different question whether items that admittedly belong to the taxpayer may be attributed to a taxable year other than that of receipt in accordance with principles of accrual accounting.” (Automobile Club of Michigan v. Commissioner, 353 U.S. 180, 191-192 (dissenting opinion) (1957).)
     
      
       See Automobile Club of Michigan v. Commissioner, 353 U.S. at 192-193 (dissenting opinion)'.
     
      
      
         Automobile Club of Michigan v. Commissioner, 353 U.S. at 189, fn. 20. (Emphasis supplied.)
     
      
       Cf. Bressner Radio, Inc. v. Commissioner, 267 E. 2d 520, 528-529 (2d Cir. 1959) ; Automobile Club of Southern California v. United States, Civil No. 1169-58, S. D. Cal., January 22, 1960.
     
      
       Defendant offered no testimony. Plaintiff’s testimony consisted of that of its staff auditors supplemented by outstanding certified public accountants testifying as experts who were, also, either familiar with plaintiff’s problem or had some direct association with it and whose Qualifications were not challenged. They were: Dr. Wm. A. Patón, for 44 years a professor of accounting and economics at the university of Michigan and an author and consultant on accounting. George D. Baker, Washington, D.C., resident partner of Ernst and Ernst, Certified Public Accountants. Herbert T. McAuly, a general and managing partner of Ernst and Ernst. 8. Alexander Bell, partner in Peat, Marwick, Mitchell & Co., largest firm of Certified Public Accountants in the world.
     