Brooks v. Commissioner

Louis M. Brooks, Petitioner, v. Commissioner of Internal Revenue, Respondent

Brooks v. Commissioner

Docket No. 5872

United States Tax Court

6 T.C. 504; 1946 U.S. Tax Ct. LEXIS 261;

March 18, 1946, Promulgated

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Decision will be entered for the respondent.

Income -- Periods for Reporting -- Use of Fiscal Year Only Where Books Are Kept. -- The requirement in section 41, that if a taxpayer does not keep books he must use the calendar year basis, is not satisfied by the keeping of informal records on a file in combination with some summary sheets incorporated in a binder marked "Ledger."

A. E. James, Esq., for the petitioner.

Carl A. Stutsman, Jr., Esq., for the respondent.

Murdock, Judge.

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MURDOCK

The Commissioner determined a deficiency of $ 644.91 in the petitioner's income tax for the calendar year 1940, and a deficiency of $ 5,899.09 in his income tax for the calendar year 1941. The petitioner filed returns for a period of ten months beginning January 1 and ending October 31, 1940, and for the twelve months ending October 31, 1941. The only issue is whether the Commissioner erred in determining the deficiencies on the basis of calendar years.

FINDINGS OF FACT.

The petitioner is an individual. His returns for years prior to 1940 were filed for calendar years.

He applied, in September 1940, for permission to change his taxable year from a calendar year to a fiscal year ending October 31. The Commissioner in that same month wrote a letter granting permission "to change the basis of computing his income and filing income tax returns from the calendar year to the fiscal year ending October 31, effective October 31, 1940 * * *." This permission was "conditioned upon the maintenance of books of account or other competent records accurately reflecting his income from all business and other sources on the basis of the full fiscal year ending October 31."

The petitioner filed income tax returns for ten months ending October 31, 1940, and for twelve months ending October 31, 1941. The latter return was filed with the collector of internal revenue for the district of Connecticut. His returns were filed on the basis of cash receipts and disbursements.

The Commissioner, in determining the deficiencies, computed the petitioner's income for the calendar year 1940 and for the calendar year 1941, and explained that that was required by section 41 of the Internal Revenue Code, since the petitioner did not keep books. He made a number of adjustments, none of which are in controversy.

The petitioner, upon receiving a dividend, wrote a notation on a piece of paper showing the date and amount of the dividend. He made this notation usually either on the envelope in which the dividend had been mailed to him, or upon some paper enclosed with the dividend, showing the name of the payor company. He then placed this paper on a file which he kept. If he received a check for interest or some other item with a statement attached, he placed the statement on the file. He also placed upon the file brokerage receipts for bond coupons which he turned over to the broker. If he sold any security during the year, he placed on the file the broker's memorandum showing the details of the sale, and attached to that memorandum another broker's memorandum showing the details of the purchase of the stock. He also placed upon the file pencil memoranda to show expenditures for repairs to property which he rented to others. The petitioner received checks for oil royalties with a statement attached. He placed those statements on the file. If he made a contribution of any kind, he placed a receipt, or some notation of the contribution, showing the date, the amount and the recipient, on the file. He placed on the file receipts for taxes paid. He placed the above items and some others on the file in chronological order without separating them into any classifications.

The petitioner had followed the above method of keeping a record of certain of his items of income and deduction for a number of years prior to 1940. He maintained such a file for the period of ten months ending October 31, 1940, and another for the twelve months ending October 31, 1941. It had been his custom, in filing his income tax returns for the calendar years prior to 1940, to add separately the dividends, interest, oil royalties, and other items of income, as well as contributions, taxes, and other deductions, to make a statement showing those totals and to send that statement to an accountant in another city who then made up his return.

He made no change in the above method in 1940 and 1941 except to change files on October 31 and except that at some time after October 31, 1940, he sent his file of income and deductions for the ten months ending on that date to the accountant above mentioned, and at some time after October 31, 1941, he sent his file for the twelve months preceding that date to the same accountant. The accountant sorted the papers on the file into groups. That is, he put all the notations referring to dividends together, and all the notations referring to interest together, etc. He numbered some of the papers. He then made some entries on loose leaf pages which he incorporated in a binder entitled "Louis M. Brooks Ledger." He also prepared the petitioner's income tax returns.

One of the pages for the ten-month period ending October 31, 1940, is entitled "Income from Dividends Received." On that page are listed the names of a dozen or more companies. Opposite each name there is a reference by a number to one of the pieces of paper on the file, followed by the amount of each dividend received, and in the right hand column the total amounts received during the year from that source is shown. The right hand column is added, and below the entries a red line has been drawn across the page. The total of the dividends was reported on the income tax return.

Another page is entitled "Income from interest from Banks & Mortgages." It is, in so far as material hereto, as follows:

1940	10 Mo. Meyer Lapuk	12.50
	Norma C. Burgess	25.00
		37.50
1940-41	Meyer Lapuk	25.00
	Norma C. Burgess	37.50
		62.50

Another page is entitled "Income from Interest on Bonds." It is, in so far as material hereto, as follows:

			1940	United Light & Power	162.50
				N. Y. C. 4 1/2 2013	90.
				Balt. & O	18.
					270.50
			1940-
			1941	Bald. Loco	60.00
1941	Int. on Pur. Items			B. & O	297.63
	Bald. Loco	11.00		L. I. Ltg	60.00
	L. Is. Rwy	24.50		NYC	90.00
	Chi. Terre H	21.88		U. S. Power Lt. (Sold)	147.14
	Chi. Terre H	6.94		Chi. T. H	50.00
	Net Interest	802.95		United L & Pwr	162.50
		867.27			867.27

It does not appear that any current record was kept in the file of the debit items shown above.

Another page is entitled "Income from Interest on Governments," and under the figures 1940 and 1941, the words "None Taxable" have been entered.

Another page is entitled "Income from Share of M. S. Brooks Sons." That was a partnership of which the petitioner was a member. A single entry for each period shows the petitioner's distributable share of the income of that partnership for its accounting period ending within the year taken from the information return of the partnership prepared by this same accountant. The partnership used a fiscal year accounting period ending October 31 of each year.

Another page is entitled "Income from Rents & Royalties." On the left-hand half of the page for 1940 it shows an amount for depreciation, an amount for repairs, an amount for depletion, and an amount representing the net income for the year, and a balancing total, while on the right-hand half for 1940 it shows an item of rent and two items of royalty, and the total of the three items which balances the left-hand column. The account is then ruled off. The account for the next period shows similar entries.

Another page is entitled "Income from Profit or Loss on Sales of assets." It shows on the left-hand half of the page the cost of any asset sold during the year, and on the right-hand half of the page the amount realized from the sale. The difference is shown as gain or loss. It also gives the number of shares and the name of the security sold.

Contributions and taxes are listed and totaled on separate pages.

Another page is entitled "Expense of Miscellaneous Losses and Business Expense." It shows, for the two periods here in controversy, counsel fees, and for the latter period safe-deposit box rent, brokers' commissions, and an accounting fee.

All of the above accounts were ruled off to separate each period ending on October 31. Not all are supported by notations in the file kept by the petitioner. References are not shown for all of the entries for the ten-month period ending December 31, 1940.

It does not appear that the petitioner ever saw or referred to this so-called ledger or that any use was ever made of it except as the accountant may have used it in making up the petitioner's income tax return for each period. It does not contain any capital accounts or any other accounts for the periods here in controversy except those mentioned above. The entries on the pages in the book were made by an accountant at the latter's office.

The petitioner maintained a file during the twelve-month period ending October 31, 1941. It was similar in all material respects to the one above described. The petitioner placed the sheets on this file in chronological order and the accountant rearranged them after October 31, 1941, under various titles such as dividends, interest, etc. The accountant made sheets for this period similar to those described above. The column for reference on the so-called ledger sheets for the twelve-month period ending October 31, 1941, is blank except in the case of dividends.

OPINION.

Section 41 of the Internal Revenue Code provides in part that if a taxpayer "does not keep books, the net income shall be computed on the basis of the calendar year." The Commissioner, by his letter granting permission to this petitioner to file returns for fiscal years ending October 31 upon condition that he maintain books of account "or other competent records accurately reflecting his income" from all sources, could not waive or modify the statutory requirement. Max H. Stryker, 36 B. T. A. 326. The parties recognize this. They differ only on the question of whether or not the petitioner kept books within the meaning of section 41. The petitioner contends that the file and the ledger constitute books kept by him.

The use of the calendar year for making returns antedates the use of fiscal year periods. Congress, as subsequent acts were passed, permitted more and more classes of taxpayers to use the fiscal year, but always upon certain conditions, one of which was the keeping of books. The reason, necessity, or justification for this requirement of keeping books may not be too obvious, but the requirement clearly appears in the law and must be given effect.

The statement of an all-inclusive definition of the words "keep books" as used in section 41 may be difficult. Bookkeeping is usually understood as the recording of business transactions in books of account. Walton Accounting -- Charles H. Langer, 1929. Funk & Wagnals New Standard Dictionary, 1935 edition, defines bookkeeping as "The art, method, or practise of recording business transactions distinctly and systematically in blank books provided for the purpose, so as to show the goods and moneys received, disposed of, and on hand, the credits given, and the assets, liabilities, and general status of the business, person, or house." We have heretofore held that informal records such as check stubs, rent receipts, and dividend statements are not books within the requirement of section 41. Max H. Stryker, supra. The slips of paper which the petitioner kept on a file were merely informal records and the complete file did not constitute a book within the meaning of section 41.

The petitioner did not keep a book showing any assets such as stocks, mortgages, or real estate owned by him. When he received a dividend, he did not make any entry in a book to show the receipt of that dividend. Instead, he merely cut off the front of the envelope or used a slip of paper accompanying the dividend check on which to make a notation of the receipt of the dividend. When he received a check for mortgage interest with a statement attached, he did not make any entry of the receipt of the interest in a book, but merely tore off the statement and stuck it in his file. He owned and rented some real estate. He did not maintain any account in a book or elsewhere showing the cost and date of acquisition of the property or the value of the depreciable improvements on the property such as would be necessary for the computation of depreciation. He maintained no account of any kind relating to depreciation on his rented real property. He computed depreciation, in some way not shown by the record, in an amount exactly equaling the rent from his rented property. Repairs to rented property are not adequately recorded in the file. If he bought a security, he retained the statement furnished him by the broker. This was not retained in the file to which reference has been made, but in another not offered in evidence. Then, in the year in which a security was sold, he attached the purchase memorandum to the sales memorandum and put the two of them in the file. Such records furnished by the broker do not constitute books of account of the petitioner when retained by him in a file.

Much information which the Commissioner, if he attempted an audit, would no doubt want to have in order to verify the correctness of the petitioner's returns could not be obtained from the file. For example, he would have no way of determining from the file the amount of depreciation to which the petitioner might be entitled. Without knowing how many shares of stock the petitioner held and for what period of the year he held them, the Commissioner would not be able to tell whether or not the dividends were correctly reported. These and other difficulties would be present just the same if a calendar year were used. Nevertheless, placing the pieces of paper on the file from day to day was not keeping books within the meaning of section 41 so as to justify the use of a period other than the calendar year for reporting income.

The so-called ledger which the petitioner's accountant prepared from the file does not justify the petitioner's use of a fiscal period ending on October 31. A ledger is not a book of original entry. One of its purposes is to classify and summarize entries found in a book of original entry. A bookkeeping system usually includes a ledger, but, in and of itself, a ledger does not constitute keeping of books within the meaning of section 41. One of the pages showed the petitioner's distributive share of the net income of a partnership of which he was a member, whereas the file contained no reference to that item, but otherwise these pages did not make up any of the deficiencies of the file itself. The only purpose back of the preparation of the so-called ledger sheets, so far as this record shows, was to do something to comply with the condition upon which the Commissioner granted permission to change to a fiscal period. It does not appear that the ledger was ever used for any purpose. The evidence rather indicates that the petitioner never had possession of it or paid any attention to it and that it was at all times in the possession of the accountant. This accountant was not regularly employed by the petitioner, but simply assisted him in tax matters. The petitioner did not keep books as required by section 41 and, therefore, did not have a right under the statute to report his income on the basis of a fiscal year ending October 31.

Decision will be entered for the respondent.