KAHLER v. COMMISSIONER OF INTERNAL REVENUE

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Docket Number

Docket No. 27517.

Attorney(S)

Walter R. Brown, Esq., for the petitioner. Thomas A. Steele, Jr., Esq., for the respondent.

Judges

MURDOCK, J., concurring:

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Smart Summary

Factual and Procedural Background

Petitioner Charles F. Kahler, a cash basis taxpayer, received a commission check dated December 31, 1946, after banking hours, for services rendered in 1946. Petitioner reported these commissions as income in 1947, while the respondent (Commissioner of Internal Revenue) determined the commissions were taxable income in 1946, resulting in a deficiency determination of $2,073.30 for 1946. Petitioner contested this determination. The key procedural posture is that the Tax Court was asked to decide the correct taxable year for the commission income recognition.

Legal Issues Presented

Whether a cash basis taxpayer realizes income in the taxable year when a commission check is delivered after banking hours on the last day of the year.
Whether receipt of a check dated and delivered on December 31, but cashed in the following year, constitutes income in the year of delivery or the year of cashing.

Arguments of the Parties

Petitioner's Arguments

Receipt of a check does not constitute income in the year of receipt unless the check is received sufficiently before year-end to be converted into cash in that year.
Petitioner relied on precedents where checks delivered late in the year but not cashed until the following year were not considered income in the year of delivery due to restrictions or timing.
Petitioner attached a letter explaining that commission checks were normally received the following year and contended the check should be reported in 1947, not 1946.

Respondent's Arguments

The commissions were income in 1946 because the check was delivered to petitioner in 1946, despite being after banking hours.
The respondent cited regulations and case law supporting inclusion of income in the year received, regardless of when the check was cashed.
The respondent's position was that delivery of the check constituted realization of income under the cash basis method.

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
L. M. Fischer, 14 T.C. 792 (1950)	Check delivery subject to substantial restriction delays income realization to year cashing occurs.	Distinguished because in the instant case no restriction existed on the check delivered December 31, 1946.
Urban A. Lavery, 5 T.C. 1283 (1945), aff'd 158 F.2d 859 (C.A. 7, 1946)	Check delivery constitutes income in the year of delivery.	Supported the court’s conclusion that delivery on December 30 constitutes income in that year.
Harvey H. Ostenberg, 17 B.T.A. 738 (1929)	Check delivery on December 31 constitutes income for that year.	Reinforced that income is realized upon delivery even if check cannot be cashed until next year.
Estelle Broussard, 16 T.C. 23 (1951)	Payment by check relates back to delivery date if check is honored upon presentation.	Analogous to instant case supporting income realization at delivery.
Estate of Modie J. Spiegel, 12 T.C. 524 (1949)	Payment by check is conditional until honored; date of payment relates back to delivery if check is honored.	Applied to support that delivery of check is income realization absent dishonor or restriction.

Court's Reasoning and Analysis

The court focused on the question of when income is realized under the cash basis method for tax purposes. It considered statutory provisions requiring income to be included in the year it is received, unless accounting methods clearly reflect income in another period. The court distinguished the Fischer case, where the check delivery was subject to a restriction, from the present case, where no such restriction existed. It found that the cases of Lavery and Ostenberg, where income was realized upon delivery of the check even if late in the year, were controlling.

The court referenced Treasury Regulations mandating income inclusion in the year received and noted that payment by check is a conditional payment that relates back to the date of delivery if the check is honored. The court rejected the petitioner’s argument that inability to cash the check within the taxable year delayed income realization. It concluded that the petitioner realized income upon receipt of the check on December 31, 1946, despite it being after banking hours and cashed in 1947.

Holding and Implications

Holding: The petitioner realized income in 1946 upon receipt of the commission check dated and delivered December 31, 1946.

Implications: The decision affirms that under the cash basis accounting method, income is realized upon actual receipt of a check, regardless of whether the check is received after banking hours or cashed in the subsequent year, absent any restrictions on the check. This ruling clarifies that the timing of cashing is immaterial if delivery occurred within the taxable year. No new precedent was created beyond confirming existing principles, and the decision results in the deficiency determination being upheld against petitioner.

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CHARLES F. KAHLER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

The respondent determined a deficiency in income tax for the year 1946 in the amount of $2,073.30. The petitioner has conceded the correctness of some of the adjustments made in determining the deficiency. The sole issue is whether petitioner realized income in 1946 when his employer paid him for commissions earned during that year by a check dated December 31, 1946, and delivered it to him after banking hours.

Some of the facts were stipulated.

FINDINGS OF FACT.

The stipulated facts are so found, and are incorporated herein.

Petitioner, an individual, residing in Grinnell, Iowa, filed his cash basis Federal income tax return for the calendar year 1946 with the collector of internal revenue at Des Moines, Iowa.

For all times material herein, petitioner was employed by a seed company from which he received a base salary and commissions for his services. Sometime after 5 p. m. on December 31, 1946, petitioner received a check drawn by his employer dated December 31, 1946, in the amount of $4,332.97. This commission check was cashed by petitioner at the drawee bank on January 2, 1947. The total amount of commissions earned by petitioner during 1946 amounted to $5,410.39 from which amount there was subtracted Federal withholding tax plus another small adjustment resulting in the net amount for which the check was made out.

Petitioner reported such commissions as income for 1947. Petitioner's employer (on the accrual basis) deducted the commissions paid petitioner on December 31, 1946, in its 1946 tax return; and included within the taxes withheld on wages and commissions paid its employees during 1946, the amount withheld from such commission check.

To his tax return for 1946, petitioner attached the following letter:

FEBRUARY 1, 1947.

State Tax Commission, Income Tax Division, Des Moines Building, Des Moines 7, Iowa.

GENTLEMEN:

In re: Charles F. Kahler, 1803 Eighth Avenue, Grinnell, Iowa; Social Security Number 478-07-6573; 1946 Income Tax Return.

In addition to the income shown on the above named taxpayer's income tax return for 1946, we wish to call your attention to the fact that the Sumner Seed Company reports payment to him for the calendar year 1946, the sum of $6,549.87, less withholding tax in the sum of $1,022.89. Of the above amounts, he actually received as weekly wages from the Sumner Seed Company during 1946 totaling $1,139.48. The balance of $5,410.39 was not received by him until the evening of December 31, 1946, after banking hours. Naturally, it was impossible to cash this check for $5,410.39 until in 1947, and it is his contention that this check should not be reported in his 1946 return, but will be shown on his 1947 return, both state and federal.

In view of the fact that this income of $5,410.39 will not be shown until he prepares his 1947 return and in view of the fact that he will not claim the withholding tax on this income until he makes his 1947 return, he is asking both the State of Iowa and the Collector of Internal Revenue to make an immediate audit on his returns.

He will greatly appreciate your giving this matter your very early attention.

Very truly yours,

(Signed) Charles P. Vogel CHARLES P. VOGEL.

(Signed) C. F. Kahler

CPV/S

Petitioner did not expect to receive his 1946 commission check during 1946, since generally commission checks for any year were received sometime during the following year. His commissions for 1945 were received in January 1946, and reported in his Federal income tax return for 1946.

The respondent determined that the commissions in the amount of $5,410.39 were taxable income to petitioner in the calendar year 1946, and not in 1947.

OPINION.

RICE, Judge:

The sole issue is when did the petitioner realize the income represented by the commission check delivered December 31, 1946. Was it in 1946, as determined by respondent, or in 1947, as claimed by petitioner? This, in turn, is based on the question whether the receipt of a check by a cash basis taxpayer after banking hours on the last day of the taxable period constitutes a realization of income.

Applicable provisions of the statute are set forth in the margin.

SEC. 22. GROSS INCOME.
(a) GENERAL DEFINITION. — "Gross income" includes gains, profits, and income derived from salaries, wages, or compensation for personal service * * *
SEC. 41. GENERAL RULE.
The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or 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. * * *
SEC. 42. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED.
(a) GENERAL RULE. — The amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under section 41, any such amounts are to be properly accounted for as of a different period. * * *

In his brief, petitioner argues that "the mere receipt of a check does not give rise to income within the taxable year of receipt unless the check is received in sufficient time before the end of the taxable year so the check may be converted into cash within the taxable year." In support of such result, petitioner relies upon L. M. Fischer, 14 T.C. 792 (1950); Urban A. Lavery, 5 T.C. 1283 (1945), affd. (C. A. 7, 1946) 158 F.2d 859; and Harvey H. Ostenberg, 17 B. T. A. 738 (1929).

In the Fischer case, we held that a check delivered to the taxpayer on December 31, 1942, which was not deposited until 1943, was not income in 1942 but in 1943, since the check was subject to a substantial restriction. At the time of delivery of such check, there was an oral agreement made between the drawer and the taxpayer that the latter would hold the check for a few days before he cashed it since the drawer was short of money in the bank. Such a situation is completely distinguishable from that in the instant case.

The Lavery and Ostenberg cases both decided that checks delivered to the taxpayers were income in the year of delivery. In the Lavery case delivery was on December 30, and in the Ostenberg case delivery was on December 31. Petitioner relies on the dicta appearing in these cases to the effect that the result might have been different had the petitioner in either case been able to show that he could not have cashed the check in the year drawn. We fail to see where there should be any difference in result just because it might be impossible to cash a check in the year in which drawn, where delivery actually took place in such year. Respondent's regulations provide that all items of gross income shall be included in the taxable year in which received by the taxpayer, and that where services are paid for other than by money, the amount to be included as income is the fair market value of the thing taken in payment.

Treasury Regulations 111, sec. 29.22 (a)-3, and sec. 29.41-2.

Analogous cases to the instant case are those which were concerned with the proper year in which deductions might be taken where a check was drawn and delivered in one year and cashed in a subsequent year. Under the negotiable instruments law, payment by check is a conditional payment subject to the condition that it will be honored upon presentation; and once such presentation is made and the check is honored, the date of payment relates back to the time of delivery. See Estelle Broussard, 16 T.C. 23 (1951); Estate of Modie J. Spiegel, 12 T.C. 524 (1949); and cases cited therein. In the Spiegel case we said, at page 529:

It would seem to us unfortunate for the Tax Court to fail to recognize what has so frequently been suggested, that as a practical matter, in everyday personal and commercial usage, the transfer of funds by check is an accepted procedure. The parties almost without exception think and deal in terms of payment except in the unusual circumstance, not involved here, that the check is dishonored upon presentation, or that it was delivered in the first place subject to some condition or infirmity which intervenes between delivery and presentation.

Under such circumstances, we feel that it is immaterial that delivery of a check is made too late in the taxable year for the check to be cashed in that year. The petitioner realized income upon receipt of the commission check on December 31, 1946.

Reviewed by the Court.

Decision will be entered for the respondent.

MURDOCK, J., concurring:

I agree with the result reached that is regarded as payment and income unless it is subject to some restriction but feel that the petitioner's case is weaker in some respects than the majority opinion might indicate. A finding is made that the check in question was received by the petitioner "sometime after 5 p. m. on December 31, 1946." There is also evidence that he could not have obtained cash for the check at the drawee bank but he could have deposited the check in that bank, later on December 31, 1946. There was another bank in the town and the evidence does not show whether or not he could have cashed the check in that bank after regular banking hours. Furthermore he might have made some other use of the check during 1946. For example, he might have cashed it at some place other than at a bank or he might have used it to discharge some obligation, within the year 1946.

HARRON, J., agrees with this concurring opinion.