RJ Channels, Inc. v. Commissioner
2018 T.C. Memo. 27
Tax Ct.2018Background
- RJ Channels, Inc. (RJC) and Channels & Channels, Inc. (C&C) are accrual-basis C corporations providing tax-return preparation services; Ronald J. Channels owned RJC and co-owned C&C. Cases consolidated in Tax Court; respondent issued notices of deficiency for the years at issue.
- RJC received large client payments: $150,000 (Betzler) and $65,000 (Wyatt) during the year ending 5/31/2012, and $153,600 (Betzler) during the year ending 5/31/2013; RJC represented it would repay fees if it could not obtain a favorable result (conditions subsequent). Funds were deposited with no restrictions and were used by RJC; none were returned.
- RJC paid modest amounts of certain clients’ legal/professional fees and taxes in 2012; those sums (and sums paid by Mr. Channels personally) were later reimbursed by clients at unspecified times.
- RJC claimed a $325,000 deduction in 2013 as a contingent liability for a lawsuit (Bogard) filed against others (Channels & Barth, LLP and Mr. Channels), to which RJC was not a party.
- C&C paid small client obligations in 2012 (and its officer reimbursed some), and claimed those amounts as deductions on its 2012 return; respondent disallowed most “Other deductions” for both corporations and asserted accuracy-related penalties (sec. 6662(a)).
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| When must RJC include the large client fees in income? (timing on accrual method) | Fees were effectively prepaid and not taxable on receipt; income may be deferred to later year. | Under accrual "all events" test and claim-of-right doctrine, fees received without restriction are includible in year of receipt. | Fees are includible in gross income in the year of receipt: $215,000 in TYE 5/31/2012 and $153,600 in TYE 5/31/2013. |
| Are client expenses paid by RJC in 2012 deductible under IRC §162? | Payments were business expenses and thus deductible. | Payments of another taxpayer’s obligations generally are not ordinary and necessary business expenses; plaintiff failed to substantiate. | Disallowed: RJC did not meet its burden to show the payments were deductible business expenses. |
| Is RJC entitled to deduct $325,000 in 2013 as a contingent liability for the Bogard lawsuit? | Contingent liability deduction justified (relied partly on non-tax rules). | No liability established as to RJC; accrual requirements (all events, determinable amount, economic performance) are unmet. | Disallowed: RJC failed to prove liability, amount determinable, or economic performance; deduction denied. |
| Are C&C’s 2012 client-obligation and miscellaneous deductions deductible under §162? | C&C asserted deductions for client obligations and various business expenses. | Respondent contends the payments were obligations of clients (not ordinary business expenses) and plaintiff failed to substantiate amounts. | Disallowed: C&C failed to carry its burden to substantiate and to show the payments were deductible business expenses; penalty applies if deficiency determined. |
Key Cases Cited
- Schlude v. Commissioner, 372 U.S. 128 (discusses accrual-basis taxpayer treatment of advance payments)
- Spring City Foundry Co. v. Commissioner, 292 U.S. 182 (fixing right to income under accrual method)
- North American Oil Consolidated v. Burnet, 286 U.S. 417 (claim-of-right doctrine: receipt without restriction taxable in year of receipt)
- Commissioner v. Indianapolis Power & Light Co., 493 U.S. 203 (distinguishing whether payments are income at all vs. timing on accrual method)
- Charles Schwab Corp. & Subs. v. Commissioner, 107 T.C. 282 (distinguishing conditions precedent vs. conditions subsequent under all-events test)
- Interstate Transit Lines v. Commissioner, 319 U.S. 590 (payments of another’s obligations ordinarily not deductible)
- Deputy v. DuPont, 308 U.S. 488 (same principle regarding non-deductibility of obligations of others)