Schlude v. Commissioner

372 U.S. 128 (1963)

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Nature of the Case

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Facts

Schlude (P), husband and wife, formed a partnership to operate ballroom dancing studios pursuant to an Arthur Murray, Inc., franchise agreement. Lessons were offered under either of two basic contracts. The cash plan contract required the student to pay the entire down payment in cash at the time the contract was executed with the balance due in installments thereafter. The deferred contract required only a portion of the down payment to be paid in cash. The remainder of the down payment was due in stated installments, and the balance of the contract price was to be paid as designated in a negotiable note signed at the time the contract was executed. The contracts designated the period during which the lessons had to be taken, there was no schedule of specific dates, which were arranged from time to time as lessons were given. P reported income for tax purposes on an accrual system of accounting. When a contract was entered into, a 'deferred income' account was credited for the total contract price. At the close of each fiscal period, the student record cards were analyzed, and the total number of taught hours was multiplied by the designated rate per hour of each contract. The resulting sum was deducted from the deferred income account and reported as earned income on the financial statements and the income tax return. If there was no activity on the account for longer than a year, an entry would be made canceling the untaught portion of the contract, removing that amount from the deferred income account, and recognizing gain to the extent that the deferred income exceeded the balance due on the contract, i. e., the amounts received in advance. Three certified public accountants testified that in their opinion the accounting system employed truly reflected net income in accordance with commercial accrual accounting standards. D included in gross income for the years in question not only advance payments received in cash but the full face amounts of notes and contracts executed during the respective years. The Tax Court agreed and the Court of Appeals reversed. The Supreme Court ruled on AAA v. United States 367 U.S. 911. The Supreme Court granted certiorari and reversed and remanded. On remand both the Court of Appeals ruled the method did not clearly reflect income. The Supreme Court granted certiorari. The United States in the Supreme Court has retreated somewhat and does not now claim that gross income of future payments which were not evidenced by a note and which were neither due by the terms of the contract nor matured by performance of the related services were includable.