Burnet v. Sanford & Brooks Co.
51 S. Ct. 150, 282 U.S. 359, 1931 U.S. LEXIS 7 (1931)
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Rule of Law:
Income must be computed and taxed on the basis of a fixed annual accounting period. Money received in one taxable year constitutes income for that year, even if it represents reimbursement for losses incurred and deducted in prior years on the same transaction.
Facts:
- From 1913 to 1915, Sanford & Brooks Co. performed a dredging contract for the United States government.
- During the performance of the contract, the company's expenses exceeded the payments it received by $176,271.88.
- In its income tax returns for the years 1913-1916, Sanford & Brooks Co. deducted these expenses as they were paid, resulting in reported net losses for most of those years.
- In 1915, the company abandoned work on the contract.
- Subsequently, the company's predecessor sued the United States for breach of warranty regarding the nature of the material to be dredged.
- In 1920, the company received a judgment of $192,577.59 from the government.
- This payment was designated as compensation for the costs of the work, including the $176,271.88 by which its expenses had previously exceeded receipts.
- Sanford & Brooks Co. did not include the $176,271.88 portion of the payment as gross income in its 1920 tax return.
Procedural Posture:
- The Commissioner of Internal Revenue made a deficiency assessment against Sanford & Brooks Co. for its 1920 income and profits taxes.
- Sanford & Brooks Co. appealed the assessment to the Board of Tax Appeals (the court of first instance).
- The Board of Tax Appeals sustained the Commissioner's action.
- Sanford & Brooks Co., as appellant, appealed the Board's decision to the U.S. Court of Appeals for the Fourth Circuit.
- The Court of Appeals reversed the Board of Tax Appeals' order, ruling in favor of Sanford & Brooks Co.
- Burnet, the Commissioner of Internal Revenue, as petitioner, was granted a writ of certiorari by the U.S. Supreme Court to review the judgment of the Court of Appeals.
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Issue:
Does a payment received in one year as compensation for expenses incurred on a contract in prior years constitute taxable income for the year of receipt, even if the overall transaction resulted in no net profit for the taxpayer?
Opinions:
Majority - Justice Stone
Yes. A payment received as compensation for previously incurred expenses is taxable as gross income in the year of receipt under the annual accounting principle. The U.S. tax system is based on fixed, annual accounting periods, not on the net outcome of transactions that may span multiple years. The money received in 1920 was derived from the company's business operations and falls within the statutory definition of gross income. The fact that the company suffered net losses in earlier years, which it deducted at the time, does not change the character of the 1920 receipt as income for that taxable period. The Sixteenth Amendment does not require Congress to adopt a transactional system of accounting; it permits a system based on annual returns to ensure a regular and ascertainable flow of revenue. The taxpayer did not avail itself of available accounting methods for long-term contracts that might have matched income and expenses in a different manner, and therefore must report the income in the year it was received.
Analysis:
This landmark decision firmly establishes the annual accounting principle as a fundamental tenet of United States tax law. It rejects a 'transactional' approach, where the tax consequences of a multi-year endeavor are determined only upon its completion. The ruling solidifies that each tax year stands on its own, providing certainty for the government's revenue collection and for taxpayers' reporting obligations. While this principle can create harsh results by taxing receipts that merely offset prior losses, it prompted Congress to later enact legislative remedies, such as net operating loss (NOL) carryback and carryforward provisions, to mitigate these effects.
