TAX RESEARCH MEMORANDUM ASSIGNMENT 1 One of your clients is an incorporated funeral home, Peaceful Pastures Funeral Home, Inc. (?Peaceful?). Peaceful, an accrual basis taxpayer, provides a full line of funeral services and sells goods related to those services. Over the last few years, however, the cost of these goods and services have risen dramatically. As a result, more of Peaceful?s customers have had difficulties paying their bills or have selected goods and services that cost less, sharply impacting Peaceful's bottom line. As a result, Peaceful has attempted to design an approach that allows customers to prepay for their funeral goods and services. Under this program, the customer pays in advance for the goods and services that will be provided at the time of their death, often at a significant discount. Under the terms of the contract, the payments are refundable at the contract purchaser's request any time until the goods and services are provided to them. Given that it is an accrual basis taxpayer, Peaceful has included these payments and income for the year the funeral service is provided. This year, the IRS sent Peaceful an audit notice. It contends that the amount prepaid under Peaceful?s program constitutes prepaid income that must be included in Peaceful?s income (and therefore subject to tax) in the year in which it is received. Peaceful has come to you for advice. Is the IRS correct? COMPOSE A TAX FILE MEMORANDUM CONCERNING THIS ISSUE USING THESE FACTS AND THE RESEARCH MATERIALS PROVIDED TO YOU IN THE NEXT FEW PAGES (30 POINTS).

TAX RESEARCH MEMORANDUM ASSIGNMENT 1 One of your clients is an incorporated funeral home, Peaceful Pastures Funeral Home, Inc. (\"Peaceful\"). Peaceful, an accrual basis taxpayer, provides a full line of funeral services and sells goods related to those services. Over the last few years, however, the cost of these goods and services have risen dramatically. As a result, more of Peaceful's customers have had difficulties paying their bills or have selected goods and services that cost less, sharply impacting Peaceful's bottom line. As a result, Peaceful has attempted to design an approach that allows customers to prepay for their funeral goods and services. Under this program, the customer pays in advance for the goods and services that will be provided at the time of their death, often at a significant discount. Under the terms of the contract, the payments are refundable at the contract purchaser's request any time until the goods and services are provided to them. Given that it is an accrual basis taxpayer, Peaceful has included these payments and income for the year the funeral service is provided. This year, the IRS sent Peaceful an audit notice. It contends that the amount prepaid under Peaceful's program constitutes prepaid income that must be included in Peaceful's income (and therefore subject to tax) in the year in which it is received. Peaceful has come to you for advice. Is the IRS correct? COMPOSE A TAX FILE MEMORANDUM CONCERNING THIS ISSUE USING THESE FACTS AND THE RESEARCH MATERIALS PROVIDED TO YOU IN THE NEXT FEW PAGES (30 POINTS). Checkpoint Contents Federal Library Federal Source Materials Federal Tax Decisions American Federal Tax ReportsAmerican Federal Tax Reports (Prior Years) 1990AFTR 2d Vol. 65 65 AFTR 2d 90407 (888 F.2d 208) 65 AFTR 2d 90301 (19 Cl Ct 1)COMM. v. INDIANAPOLIS POWER & LIGHT CO., 65 AFTR 2d 90394 (110 S.Ct.589), Code Sec(s) 451; 61, (S Ct), 01/09/1990 American Federal Tax Reports COMM. v. INDIANAPOLIS POWER & LIGHT CO., Cite as 65 AFTR 2d 90394 (110 S.Ct.589), 01/09/1990 , Code Sec(s) 61 COMMISSIONER of Internal Revenue, PETITIONER v. INDIANAPOLIS POWER & LIGHT COMPANY, RESPONDENT Case Information: Code Sec(s): 61 Court Name: U.S. Supreme Court, Docket No.: No. 881319, Date Decided: 01/09/1990 Prior History: Court of Appeals, 62 AFTR 2d 885708 ( TC 964 (No.52), affirmed. Tax Year(s): Years 1974, 1975, 1976, 1977. Dispositio n: Decision for Taxpayer. Cites: 65 AFTR 2d 90394, 493 US 203, 110 S Ct 589, 107 L Ed 2d 591, 901 USTC P 50007. 857 F.2d 1162), aff'g HEADNOTE 1. TIME FOR REPORTING INCOMEPrepaid incomereceipt for future services or sale of personal property. Customer deposits required by public utility to insure customer creditworthiness and bill payment weren't advance payments for electricity and weren't taxable income to utility on receipt. Utility didn't have requisite "complete dominion" over payments at time they were made, the crucial point for determining taxable income. 11th Circuit's holding in City Gas Co. of Fla. v. Comm., 50 AFTR 2d 825959 ( 689 F2d 943), not followed. Utility's right to keep deposits depended on events outside its controlcustomer's purchase of electricity, decision to have deposit applied to 88 future bills, or default. Utility's dominion over fund was far less complete than is ordinarily case in advancepayment situation. Closest analogy is lease deposits. Reference(s): PH Fed 2d 4515.191(90); 615.003(10). Code Sec. 61 ; Code Sec. 451 . OPINION On Writ of Certiorari to the United States Court of Appeals for the Seventh Circuit. Syllabus Respondent Indianapolis Power and Light Co. (IPL), a regulated Indiana utility and an accrualbasis taxpayer, requires customers having suspect credit to make deposits with it to assure prompt payment of future electric bills. Prior to termination of service, customers who satisfy a credit test can obtain a refund of their deposits or can choose to have the amount applied against future bills. Although the deposits are at all times subject to the company's unfettered use and control, IPL does not treat them as income at the time of receipt but carries them on its books as current liabilities. Upon audit of IPL's returns for the tax years at issue, petitioner Commissioner of Internal Revenue asserted deficiencies, claiming that the deposits are advance payments for electricity and therefore are taxable to IPL in the year of receipt. The Tax Court ruled in favor of IPL on its petition for redetermination, holding that the deposits' principal purpose is to serve as security rather than a prepayment of income. The Court of Appeals affirmed. Held: The customer deposits are not advance payments for electricity and therefore do not constitute taxable income to IPL upon receipt. Although IPL derives some economic benefit from the deposits, it does not have the requisite "complete dominion" over them at the time they are made, the crucial point for determining taxable income. IPL has an obligation to repay the deposits upon termination of service or satisfaction of the credit test. Moreover, a customer submitting a deposit makes no commitment to purchase any electricity at all. Thus, while deposits eventually may be used to pay for electricity by virtue of customer default or choice, IPL's right to retain them at the time they are made is contingent upon events outside its control. This construction is consistent with the Tax Court's longstanding treatment of sums deposited to secure a tenant's performance of a lease agreement, perhaps the closet analogy to the present situation. 857 F.2d 1162 [ 62 AFTR2d 885708], affirmed. BLACKMUN, J., delivered the opinion for a unanimous Court. Opinion Justice BLACKMUN delivered the opinion of the Court. Respondent Indianapolis Power & Light Company (IPL) requires certain customers to make deposits with it to assure payment of future bills for electric service. Petitioner Commissioner of Internal Revenue contends that these deposits are advance payments for electricity and therefore constitute taxable income to IPL upon receipt. IPL contends otherwise. I IPL is a regulated Indiana corporation that generates and sells electricity in Indianapolis and its environs. It keeps its books on the accrual and calendar year basis. [pg. 90395] During the years 1974 through 1977, approximately 5% of IPL's residential and commercial customers were required to make deposits "to insure prompt payment," as the customers' receipts stated, of future utility bills. These customers were selected because their credit was suspect. Prior to March 10, 1976, the deposit requirement was imposed on a casebycase basis. IPL relied on a credit test but employed no fixed formula. The amount of the required deposit ordinarily was twice the customer's estimated monthly bill. IPL paid 3% interest on a deposit held for six months or more. A customer could obtain a refund of the deposit prior to termination of service by requesting a review and demonstrating acceptable credit. The refund usually was made in cash or by check, but the customer could choose to have the amount applied against future bills. In March 1976, IPL amended its rules governing the deposit program. See Title 170, Ind. Admin. Code 4115 (1988). Under the amended rules, the residential customers from whom deposits were required were selected on the basis of a fixed formula. The interest rate was raised to 6% but was payable only on deposits held for 12 months or more. A deposit was refunded when the customer made timely payments for either nine consecutive months, or for 10 out of 12 consecutive months so long as the two delinquent months were not themselves consecutive. A customer could obtain a refund prior to that time by satisfying the credit test. As under the previous rules, the refund would be made in cash or by check, or, at the customer's option, applied against future bills. Any deposit unclaimed after seven years was to escheat to the State. See Ind. Code 3291 1 6(a) (1988) IPL did not treat these deposits as income at the time of receipt. Rather, as required by state administrative regulations, the deposits were carried on its books as current liabilities. Under its accounting system, IPL recognized income when it mailed a monthly bill. If the deposit was used to offset a customer's bill, the utility made the necessary accounting adjustments. Customer deposits were not physically segregated in any way from the company's general funds. They were commingled with other receipts and at all times were subject to IPL's unfettered use and control. It is undisputed that IPL's treatment of the deposits was consistent with accepted accounting practice and applicable state regulations. Upon audit of respondent's returns for the calendar years 1974 through 1977, the Commissioner asserted deficiencies. Although other items initially were in dispute, the parties were able to reach agreement on every issue except that of the proper treatment of customer deposits for the years 1975, 1976, and 1977. The Commissioner took the position that the deposits were advance payments for electricity and therefore were taxable to IPL in the year of receipt. He contended that the increase or decrease in customer deposits outstanding at the end of each year represented an increase or decrease in IPL's income for the 2 year. IPL disagreed and filed a petition in the United States Tax Court for redetermination of the asserted deficiencies. In a reviewed decision, with one judge not participating, a unanimous Tax Court ruled in favor of IPL. 88 T.C. 964 (1987). The court followed the approach it had adopted in City Gas Co. of Florida v. Commissioner of Internal Revenue, 74 T.C. 386 (1980), rev'd, 689 F.2d 943 [ 50 AFTR2d 825959] (CA 11 1982). It found it necessary to "continue to examine all of the circumstances," 88 T.C., at 976, and relied on several factors in concluding that the deposits in question were properly excluded from gross income. It noted, among other things, that only 5% of IPL's customers were required to make deposits; that the customer rather than the utility controlled the ultimate disposition of a deposit; and that IPL consistently treated the deposits as belonging to the customers, both by listing them as current liabilities for accounting purposes and by paying interest. Id., at 976978. The United States Court of Appeals for the Seventh Circuit affirmed the Tax Court's decision. 857 F.2d 1162 [ 62 AFTR2d 885708] (1988). The court stated that "the proper approach to determining the appropriate tax treatment of a customer deposit is to look at the primary purpose of the deposit based on all the facts and circumstances...." Id., at 1167. [pg. 90396] The court appeared to place primary reliance, however, on IPL's obligation to pay interest on the deposits. It asserted that " as the interest rate paid on a deposit to secure income begins to approximate the return that the recipient would be expected to make from 'the use' of the deposit amount, the deposit begins to serve purposes that comport more squarely with a security deposit." Id., at 1169. Noting that IPL had paid interest on the customer deposits throughout the period in question, the court upheld, as not clearly erroneous, the Tax Court's determination that the principal purpose of these deposits was to serve as security rather than as prepayment of income. Id., at 1170. Because the Seventh Circuit was in specific disagreement with the Eleventh Circuit's ruling in City Gas Co. of Florida, supra, we granted certiorari to resolve the conflict. U.S. (1989). II We begin with the common ground. IPL acknowledges that these customer deposits are taxable as income upon receipt if they constituteadvance payments 3 for electricity to be supplied. The Commissioner, on his part, concedes that customer deposits that secure the performance of nonincomeproducing covenantssuch as a utility customer's obligation to ensure that meters will not be damagedare not taxable income. And it is settled that receipt of a loan is not income to the borrower. See Commissioner v. Tufts, 461 U.S. 300, 307 [ 51 AFTR2d 831132] (1983) ("Because of [the repayment] obligation, the loan proceeds do not qualify as income to the taxpayer"); James v. United States, (accepted definition of 366 U.S. 213, 219 [ 7 AFTR2d 1361] (1961) gross income "excludes loans"); Commissioner v. Wilcox, 327 U.S. 404, 408 [ 34 AFTR 811] (1946). IPL, stressing its obligation to refund the deposits with interest, asserts that the payments are similar to loans. The Commissioner, however, contends that a deposit which serves to secure the payment of future income is properly analogized to an advance payment for goods or services. See Rev. Rul. 72 519, 19722 Cum. Bull. 32, 33 ("[W] hen the purpose of the deposit is to guarantee the customer's payment of amounts owed to the creditor, such a deposit is treated as an advance payment, but when the purpose of the deposit is to secure a property interest of the taxpayer the deposit is regarded as a true security deposit"). In economic terms, to be sure, the distinction between a loan and an advance payment is one of degree rather than of kind. A commercial loan, like an advance payment, confers an economic benefit on the recipient: a business presumably does not borrow money unless it believes that the income it can earn from its use of the borrowed funds will be greater than its interest obligation. See Illinois Power Co. v. Commissioner of Internal Revenue, 792 F.2d 683, 690 [ 58 AFTR2d 865122] (CA7 1986). Even though receipt of the money is subject to a duty to repay, the borrower must regard itself as better off after the loan than it was before. The economic benefit of a loan, however, consists entirely of the opportunity to earn income on the use of the money prior to the time the loan must be repaid. And in that context our system is content to tax these earnings as they are realized. The recipient of an advance payment, in contrast, gains both immediate use of the money (with the chance to realize earnings thereon) and the opportunity to make a profit by providing goods or services at a cost lower than the amount of the payment. The question, therefore, cannot be resolved simply by noting that respondent 4 derives some economic benefit from receipt of these deposits. Rather, the issue turns upon the nature of the rights and obligations that IPL assumed when the deposits were made. In determining what sort of economic benefits qualify as income, this Court has invoked various formulations. It has referred, for example, to "undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion." Commissioner v. Glenshaw Glass Co., [pg. 90397] 348 U.S. 426, 431 [ 47 AFTR 162] (1955). It also has stated: "When a taxpayer acquires earnings, lawfully or unlawfully, without the consensual recognition, express or implied, of an obligation to repay and without restriction as to their disposition, 'he has received income....' " James v. United States, 366 U.S., at 219, quoting North American Oil Consolidated v. Burnet, 286 U.S. 417, 424 [ 11 AFTR 16] (1932). IPL hardly enjoyed "complete dominion" over the customer deposits entrusted to it. Rather, these deposits were acquired subject to an express "obligation to repay," either at the time service was terminated or at the time a customer established good credit. So long as the customer fulfills his legal obligation to make timely payments, his deposit ultimately is to be refunded, and both the timing and method of that refund are largely within the control of the customer. The Commissioner stresses the fact that these deposits were not placed in escrow or segregated from IPL's other funds, and that IPL therefore enjoyed unrestricted use of the money. That circumstance, however, cannot be dispositive. After all, the same might be said of a commercial loan; yet the Commissioner does not suggest that a loan is taxable upon receipt simply because the borrower is free to use the funds in whatever fashion he chooses until the time of repayment. In determining whether a taxpayer enjoys "complete dominion" over a given sum, the crucial point is not whether his use of the funds is unconstrained during some interim period. The key is whether the taxpayer has some guarantee that he will be allowed to keep the money. IPL's receipt of these deposits was accompanied by no such guarantee. Nor is it especially significant that these deposits could be expected to generate income greater than the modest interest IPL was required to pay. Again, the same could be said of a commercial loan, since, as has been noted, a business is unlikely to borrow unless it believes that it can realize benefits that exceed the cost of servicing the debt. A bank could hardly operate profitably if its earnings on deposits did not surpass its interest obligations; but the deposits themselves are 5 not treated as income. Any income that the utility may earn through use of the deposit money of course is taxable, but the prospect that income will be generated provides no ground for taxing the principal. The Commissioner's advance payment analogy seems to us to rest upon a misconception of the value of an advance payment to its recipient. An advance payment, like the deposits at issue here, concededly protects the seller against the risk that it would be unable to collect money owed it after it has furnished goods or services. But an advance payment does much more: it protects against the risk that the purchaser will back out of the deal before the seller performs. From the moment an advance payment is made, the seller is assured that, so long as it fulfills its contractual obligation, the money is its to keep. Here, in contrast, a customer submitting a deposit made no commitment to purchase a 6 specified quantity of electricity, or indeed to purchase any electricity at all. IPL's right to keep the money depends upon the customer's purchase of electricity, and upon his later decision to have the deposit applied to future bills, not merely upon the utility's adherence to its contractual duties. Under these circumstances, IPL's dominion over the fund is far less complete than is ordinarily the case in an advancepayment situation. The Commissioner emphasizes that these deposits frequently will be used to pay for electricity, either because the customer defaults on his obligation or because the customer, having established credit, chooses to apply the deposit to future bills rather than to accept a refund. When this occurs, the Commissioner argues, the transaction, from a cashflow standpoint, is equivalent to an advance payment. In his view this economic equivalence mandates identical tax treatment. Whether these payments constitute income when received, however, depends upon the parties' rights and obligations at the time the payments are made. The problem with petitioner's argument perhaps can best be understood if we imagine a loan between parties involved in an ongoing commercial relationship. At the time the loan falls due, the lender may decide to apply the money owed him to the purchase of goods or services rather than to accept repayment in cash. But this decision does not mean that the loan, when made, was an advance payment after all. The lender in effect has taken repayment of his money (as was his contractual right) and has chosen to use the proceeds for the purchase of goods or services from the borrower. Although, for the sake of convenience, the parties may combine the two steps, that decision does not blind us to the fact that in 8 substance two transactions are involved. It is this element of choice that distinguishes an advance payment from a loan. Whether these customer deposits are the economic equivalents of advance payments, and therefore taxable upon receipt, must be determined by examining the relationship between the parties at the time of the deposit. The individual who makes an advance payment retains no right to insist upon the return of the funds; so long as the recipient fulfills the terms of the bargain, the money is its to keep. The customer who submits a deposit to the utility, like the lender in the previous hypothetical, retains the right to insist upon repayment in cash; he may choose to apply the money to the purchase of electricity, but he assumes no obligation to do so, and the utility therefore acquires no unfettered "dominion" over the money at the time of receipt. When the Commissioner examines privately structured transactions, the true understanding of the parties, of course, may not be apparent. It may be that a transfer of funds, though nominally a loan, may conceal an unstated agreement that the money is to be applied to the purchase of goods or services. We need not, and do not, attempt to devise a test for addressing those situations where the nature of the parties' bargain is legitimately in dispute. This particular respondent, however, conducts its business in a heavily regulated environment; its rights and obligations visavis its customers are largely determined by law and regulation rather than by private negotiation. That the utility's customers, when they qualify for refunds of deposits, frequently choose to apply those refunds to future bills rather than taking repayment in cash does not mean that any customer has made an unspoken commitment to do so. Our decision is also consistent with the Tax Court's longstanding treatment of lease depositsperhaps the closest analogy to the present situation. The Tax Court traditionally has distinguished between a sum designated as a prepayment of rentwhich is taxable upon receiptand a sum deposited to secure the tenant's performance of a lease agreement. See, e.g., J. & E. Enterprises, Inc. v. 9 Commissioner, 26 TCM 944 [ 67,191 PH Memo TC](1967). In fact, the customer deposits at issue here are less plausibly regarded as income than lease deposits would be. The [pg. 90399] typical lease deposit secures the tenant's fulfillment of a contractual obligation to pay a specified rent throughout the term of the lease. The utility customer, however, makes no commitment to purchase any services at all at the time he tenders the deposit. We recognize that IPL derives an economic benefit from these deposits. But a taxpayer does not realize taxable income from every event that improves his economic condition. A customer who makes this deposit reflects no commitment to purchase services, and IPL's right to retain the money is contingent upon events outside its control. We hold that such dominion as IPL has over these customer deposits is insufficient for the deposits to qualify as taxable income at the time they are made. The judgment of the Court of Appeals is affirmed. It is so ordered. 1 2 The parties' stipulation sets forth the balance in IPL's customerdeposit account on December 31 of each of the years 1954, 1974, 1975, 1976, and 1977. In his notice of deficiency, the Commissioner concluded that IPL was required to include in income for 1975 the increase in the account between December 31, 1954, and December 31, 1975. For 1976 and 1977, IPL was allowed to reflect in income the respective decreases in the account during those years.3 This Court has held that an accrualbasis taxpayer is required to treat advance payments as income in the year of receipt. See Schlude v. Commissioner, 372 U.S. 128 [ 11 AFTR2d 751] (1963); American Automobile Assn. v. United States, 367 U.S. 687 [ 7 AFTR2d 1618] (1961); Automobile Club of Michigan v. Commissioner, 353 U.S. 180 [ 50 AFTR 1967] (1957). These cases concerned payments nonrefundable fees for servicesthat indisputably constituted income; the issue waswhen that income was taxable. Here, in contrast, the issue is whether these deposits, as such, are income at all.4 See Illinois Power Co., 792 F.2d, at 690. See also Burke & Friel, Recent Developments in the Income Taxation of Individuals, TaxFree Security: Reflections on Indianapolis Power & Light, 12 Rev. of Taxation of Individuals 157, 174 (1988) (arguing that economicbenefit approach is superior in theory, but acknowledging that "an economicbenefit test has not been adopted, and it is unlikely that such an approach will be pursued by the Service or the courts"). 5 Cf. Rev. Rul. 71189, 19711 Cum. Bull. 32 (inactive deposits are not income until bank asserts dominion over the accounts). See also FidelityPhiladelphia Trust Co. v. Commissioner, 23 T.C. 527 (1954). 6 A customer, for example, might terminate service the day after making the deposit. Also, IPL's dominion over a deposit remains incomplete even after the customer begins buying electricity. As has been noted, the deposit typically is set at twice the customer's estimated monthly bill. So long as the customer pays his bills in a timely fashion, the money he owes the utility (for electricity used but not yet paid for) almost always will be less than the amount of the deposit. If this were not the case, the deposit would provide inadequate protection. Thus, throughout the period the deposit is held, at least a portion is likely to be money that IPL has no real assurance of ever retaining. 7 The Commissioner is unwilling, however, to pursue this line of reasoning to the limit of its logic. He concedes that these deposits would not be taxable if they were placed in escrow, Tr. of Oral Arg. 4; but from a cashflow standpoint it does not make much difference whether the money is placed in escrow or commingled with the utility's other funds. In either case, the utility receives the money and allocates it to subsequent purchases of electricity if the customer defaults or chooses to apply his refund to a future bill. 8 The Commissioner contends that a customer's decision to take his refund while making a separate payment for services, rather than applying the deposit to his bill, would amount to nothing more than an economically meaningless "exchange of checks." But in our view During the years 1974 through 1977, the total amount that escheated to the State was less than $9,325. Stipulation of Facts 25. the "exchange of checks," while less convenient, more accurately reflects the economic substance of the transactions. 9 In J. & E. Enterprises the Tax Court stated: "If a sum is received by a lessor at the beginning of a lease, is subject to his unfettered control, and is to be applied as rent for a subsequent period during the term of the lease, such sum is income in the year of receipt even though in certain circumstances a refund thereof may be required.... If, on the other hand, a sum is deposited to secure the lessee's performance under a lease, and is to be returned at the expiration thereof, it is not taxable income even though the fund is deposited with the lessor instead of in escrow and the lessor has temporary use of the money.... In this situation the acknowledged liability of the lessor to account for the deposited sum on the lessee's performance of the lease covenants prevents the sum from being taxable in the year of receipt." 26 TCM, at 945946. In Rev. Rul. 72519, 19722 Cum. Bull. 32, the Commissioner relied in part on J. & E. Enterprises as authority for the proposition that deposits intended to secure incomeproducing covenants are advance payments taxable as income upon receipt, while deposits intended to secure nonincomeproducing covenants are not. Id., at 33. In our view, neither J. & E. Enterprises nor the other cases cited in the Revenue Ruling support that distinction. See Hirsch Improvement Co. v. Commissioner of Internal Revenue, 143 F.2d 912 [ 32 AFTR 1104] (CA2), cert. denied, 323 U.S. 750 (1944); Mantell v. Commissioner, 17 T.C. 1143 (1952); Gilken Corp. v. Commissioner, 10 T.C. 445 (1948), aff'd, 176 F.2d 141 [ 38 AFTR 265] (CA6 1949). These cases all distinguish between advance payments and security deposits, not between deposits that do and do not secure incomeproducing covenants. 2010 Thomson Reuters/RIA. All rights reserved. Checkpoint Contents Federal Library Federal Source Materials Federal Tax Decisions Tax Court Memorandum DecisionsTax Court & Board of Tax Appeals Memorandum Decisions (Prior Years) 2003TC Memo 2003348 TC Memo 2003309 Perry Funeral Home, Inc., TC Memo 2003340, Code Sec(s). 451; 6662; 7491, 12/16/2003 Tax Court & Board of Tax Appeals Memorandum Decisions Perry Funeral Home, Inc. v. Commissioner, TC Memo 2003340 , Code Sec (s) 451. PERRY FUNERAL HOME, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent. Case Information: HEADNOTE 1. Time for reporting incomeaccrual methodrefundable deposit vs. advance paymentspreneed funeral contracts. Accrualmethod funeral home corp. properly reported monies received for Massachusetts regulated pre need funeral service contracts in year services were actually rendered, rather than in payment year as IRS contended: following Supreme Court precedent, payments were refundable deposits, not advance payments, where contracts contained openended cancellation and refund rights that left taxpayer without complete dominion and control over funds. Notably, under contracts' plain language and pursuant to Massachusetts regs], customers controlled whether or when refund would be made; and fact that cancellation/refund rights were rarely exercised was irrelevant. Reference(s): 4515.191(22) Code Sec. 451 2. Accuracyrelated penaltiesburden of proof and production substantial authorityreliance on return preparer. Accuracyrelated penalties for negligence and/or substantial understatement were upheld to extent applicable after Rule 155 computations against funeral home corp. with respect to conceded items: IRS met its burden of production as to subject items through presumptively correct deficiency notice and taxpayer's concessions; taxpayer showed no substantial authority for or adequate disclosure of those items; and alleged reliance on return preparer wasn't excuse absent proof that preparer was given all necessary information as to subject items. Reference(s): 66,625.01(20) ; 74,915.03(3) Code Sec. 6662 ; Code Sec. 7491 Syllabus Official Tax Court Syllabus P is a funeral home organized and operating in Massachusetts. During the years in issue, P entered into preneed funeral contracts and received payments in advance of death for goods and services to be provided later at the contract beneficiary's death. These payments were refundable at the contract purchaser's request, pursuant to State law, at any time until the goods and services were furnished. P, an accrual basis taxpayer, included these payments in income not in the year of receipt but in the year in which the goods and services were provided. Code Sec(s): 451 Docket: Dkt. No. 1472202. Date Issued: 12/16/2003. Judge: Opinion by Wherry, J. Tax Year(s): Years 1996, 1997. Disposi tion: Decision for Taxpayer in part and for Commissioner in part. Held: Payments received by P under its preneed funeral contracts are includable in gross income only upon the provision of the subject goods and services. Held, further, P is liable for the sec. 6662, I.R.C., accuracyrelated penalty with respect to items conceded by P, apart from the preneed accounting issue. Counsel Edward DeFranceschi, David Klemm, and Jason Bell, for petitioner. Louise R. Forbes, for respondent.WHERRY, Judge MEMORANDUM FINDINGS OF FACT AND OPINION Respondent determined the following deficiencies and penalty with respect to petitioner's Federal income taxes for the calendar years 1996 and 1997: Year Deficiency . 1996 $1,044,037 . 1997 1,817 Penalty I.R.C. Sec. 6662 $106,877.80 After concessions by the parties, the principal issues for decision are: [pg. 1968] (1) Whether payments received by petitioner under preneed funeral contracts are includable in gross income during the year of receipt or during the year in which the goods and services are provided by petitioner; and (2) whether petitioner is liable for the section 6662 1 accuracyrelated penalty. FINDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulations of the parties, with accompanying exhibits, are incorporated herein by this reference. Petitioner is a funeral home located at all relevant times in New Bedford, Massachusetts. Petitioner began operations in 1963 as a partnership and was incorporated under the laws of the Commonwealth of Massachusetts on September 19, 1967. Brothers Thomas Perry and William Perry each own a 50 percent interest in petitioner and are funeral directors licensed by the Commonwealth of Massachusetts. Petitioner's Operations Prior to and during the years in issue, petitioner entered into preneed funeral contracts. Under these arrangements, the contract purchaser selected, on a prospective basis, the goods and services to be provided by petitioner at the contract beneficiary's death. Petitioner would designate the selected items and applicable charges on a written form. If the resultant balance was then paid in advance of death, either in a lump sum or in installments, petitioner agreed to honor the contract at death as written, without additional cost to the purchaser or family. If the resultant balance was to be paid through the proceeds of an insurance policy or was left unfunded, the amount due would be recalculated in accordance with the prices in effect at the time of death. The written form used by petitioner for these purposes was not specific to prearranged funerals and contained no express provisions regarding the use or refundability of amounts received thereunder. A handwritten notation that the contract was irrevocable was added to certain of the forms, allegedly for reasons related to Medicaid eligibility. Regardless of such language, however, it was petitioner's practice to indicate to purchasers that they had the right to cancel at 2 any time and would receive their money back. The experience of petitioner has been that only a very small percentage of preneed contracts are in fact canceled. The record indicates that during the period from approximately 1997 through the time of trial in 2003, six contracts 3 were canceled. The amounts paid thereon were refunded, and on certain occasions the refunds also included an interest component based on \"kind of a guess\" about prevailing rates. During the years in issue, petitioner maintained a business checking account and the following investments: A Putnam Investments mutual fund account, a Merrill Lynch ready asset account, Fleet Financial shares, Massachusetts Savings Investments certificates of deposit, a BayBank money market account, a BayBrokerage account (for 1996 only), and a BayBank escrow account. Moneys received pursuant to preneed contracts were placed by petitioner in one of the investment vehicles. Upon petitioner's provision of goods and services at the death of a preneed contract beneficiary, an amount equal to the purchase price of the contract was transferred from the investment accounts to petitioner's checking account. The BayBank escrow account is a compilation of accounts, opened before 1996, each in the name of an individual contract beneficiary. Petitioner's accountant advised establishment of the escrow account in the early 1990s. This account was used for the deposit of preneed receipts for a period prior to the years in issue, until the resultant administrative burden caused petitioner to discontinue the practice. The balance of the BayBank escrow account as of January [pg. 1969] 1, 1996, was $106,579.16, and those funds are not at issue in this proceeding. The investments other than the Baybank escrow account are held solely in petitioner's name and list petitioner's tax identification number. Petitioner's Accounting and Tax Reporting Petitioner is an accrual basis taxpayer. For accounting purposes, petitioner records payments received pursuant to preneed contracts as liabilities under the designation prearranged funerals. Petitioner does not recognize as income payments recorded on its books and records as prearranged funerals until the tax year in which the goods and services are provided. Petitioner does recognize interest and dividend income earned on the investments, exclusive of the BayBank escrow account, into which the preneed funds are deposited. Petitioner filed Forms 1120, U.S. Corporation Income Tax Return, for 1996, 1997, and 1998 consistent with the foregoing approach. Attached to each return is a Schedule L, Balance Sheets per Books. These Schedules L reflect as \"Other investments\" the following balances in petitioner's investment vehicles, including the BayBank escrow account: Year 1996 1997 1998 As of Jan. 1 $2,270,655 2,431,946 2,515,217 As of Dec. 31 $2,431,946 2,515,217 2,503,934 Also on the Schedules L, petitioner included in \"Other current liabilities\" the following amounts for prearranged funerals: Year 1996 1997 1998 As of Jan. 1 $1,587,416 1,612,272 1,614,929 As of Dec. 31 $1,612,272 1,614,929 1,543,284 Respondent on June 26, 2002, issued to petitioner the statutory notice of deficiency underlying the present litigation. Therein, respondent determined, inter alia, that moneys received under preneed contracts are to be characterized as income to petitioner in the year of receipt. OPINIONI. Preliminary Matters A. Burden of Proof In general, the Commissioner's determinations are presumed correct, and the taxpayer bears the burden of proving otherwise. Rule 142(a). Section 7491, effective for court proceedings that arise in connection with examinations commencing after July 22, 1998, may operate, however, in specified circumstances to place the burden on the Commissioner. Internal Revenue Restructuring & Reform Act of 1998, Pub. L. 105206, sec. 3001(c), 112 Stat. 727. With respect to factual issues and subject to enumerated limitations, section 7491(a) may shift the burden of proof to the Commissioner in instances where the taxpayer has introduced credible evidence. Concerning penalties and additions to tax, section 7491(c) places the burden of production on the Commissioner.The record in this case is not explicit as to when the underlying 4 examination began. As regards the substantive accounting issues, however, the Court finds it unnecessary to decide whether the burden should be shifted under section 7491(a). Few facts concerning how petitioner conducted the preneed transactions are in dispute. Given this circumstance, the record is not evenly weighted and is more than sufficient to render a decision on the merits based upon a preponderance of the evidence. With respect to the penalty, because respondent on brief assumes that section 7491(c) is applicable, the Court will do likewise. B. Evidentiary Motion After the trial in this case, petitioner filed a motion for the Court to take judicial notice of the consent judgment rendered in Commonwealth v. DescheneCosta, C.A. [pg. 1970] No. C030647 (Mass. Super. Ct. June 4, 2003). The motion is made pursuant to rule 201 of the Federal Rules of Evidence, which provides in relevant part as follows: Rule 201. Judicial Notice of Adjudicative Facts (a) Scope of rule.This rule governs only judicial notice of adjudicative facts. (b) Kinds of facts.A judicially noticed fact must be one not subject to reasonable dispute in that it is either (1) generally known within the territorial jurisdiction of the trial court or (2) capable of accurate and ready determination by resort to sources whose accuracy cannot reasonably be questioned. This Court has previously noted that \"under rule 201, records of a particular court in one proceeding commonly are the subject of judicial notice by the same and other courts in other proceedings\