*2337 Held that net additions to petitioner's reserve for bad debts in 1924 and 1925 were proper deductions from its gross income in each of such years.
*762 The respondent has asserted deficiencies in income tax for the years 1924 and 1925, in the respective amounts of $577.99 and $547.66, *763 and has advised the petitioner of an overpayment for the year 1926 in the amount of $31.37. For its cause of action the petitioner alleges that the respondent has erroneously and improperly disallowed as a deduction an amount of $4,623.94 for 1924, and an amount of $4,612.79 for 1925, representing net increases in its reserve for bad debts for such years for the reason that permission had not been secured from the Commissioner to use the reserve method in accounting for bad debts as deductions from income.
FINDINGS OF FACT.
The petitioner is an Illinois corporation with its principal office at East St. Louis, where it is engaged in the manufacture and sale of ice cream at wholesale.
Prior to 1923 the petitioner had no regular system of corporation*2338 accounting and its books consisted only of a cash book, a customers' sales record, and a single entry ledger kept by an office girl. The results of its operations were crudely fashioned into reports by an outside bookkeeper, who devoted only a few days in each year to such work. This condition resulted from the fact that the petitioner began business in a very small way. The growth of its operations was not accompanied by a corresponding, efficient system of accounting. Prior to 1923 it had no means of accurately ascertaining the annual amounts of its profits or losses.
Early in 1923 petitioner employed an accountant, who installed a complete set of books on the accrual basis and thereafter, throughout that year and the taxable years, devoted all his time to his duties as bookkeeper for the petitioner. In the year 1923 such bookkeeper set up a reserve for bad debts on the books of the petitioner in the amount of $1,500 and in the income-tax return rendered for such year deducted the amount of $902.07 from gross income as a reserve for bad debts as of December 31. This amount represented the amount of $1,500 originally set up in that year, less reductions resulting from the*2339 collection of accounts regarded as worthless at the time the original entry was made.
The petitioner's income-tax return for 1923 and its accounts for such year were examined by the respondent and, after some adjustments, accepted by both parties, and the tax shown to be due thereon was paid. As finally adjusted petitioner's return for 1923 included a deduction of $902.07, representing net addition to reserve for bad debts for such year.
The petitioner's total sales for the years 1924 and 1925 amounted to $358,762.69 and $423,324.49, respectively. At the close of 1924 its books disclosed accounts receivable and bills receivable in the *764 respective amounts of $16,304.03 and $16,440.24 and for the year 1925 of $13,188.50 and $23,893.60. For each of such years it added $6,000 to its reserve for bad debts and credited such reserve with certain collections previously regarded as worthless. In its income-tax returns for the taxable years it deducted the amounts of $4,623.95 and $4,212.79 as net additions to its reserve for bad debts for such respective years. In his audit of such returns the Commissioner disallowed the deductions so taken and added the amounts thereof*2340 to income in the respective years.
The petitioner's sales are made to a large number of small customers. Its custom is to require payment within 30 days. Accounts running over that period are regarded as doubtful. Customers who do not pay within 30 days are thereafter put on a cash basis. Customers conducting small confectionery or refreshment stands frequently fail and in nearly all such cases amounts due petitioner are uncollectible. At the close of each year the bookkeeper and an officer of the petitioner examine and consider each account before determining the amount to be added to the reserve for bad debts and the amount added is based upon the previous experience of the petitioner.
OPINION.
LANSDON: In this proceeding the Board must decide (1) whether the petitioner had the right to set up a reserve for bad debts in each of the taxable years, and (2) if so, were the charges thereto reasonable in amount? The respondent bases his determination on his finding that petitioner, having once elected to deduct bad debts ascertained to be worthless in the taxable year, may not thereafter change to the reserve method without furst asking and obtaining permission so to do.
*2341 The statutes governing here are of the Revenue Acts of 1921 and 1924, section 234(a)(5) of which provides:
That in computing the net income of a corporation subject to the tax imposed by section 230 there shall be allowed as deductions:
* * *
(5) Debts ascertained to be worthless and charged off within the taxable year (or in the discretion of the Commissioner, a reasonable addition to a reserve for bad debts); and when satisfied that a debt is recoverable only in part, the Commissioner may allow such debt to be charged off in part.
For the administration of the above provision the Commissioner has promulgated substantially identical articles 151 of Regulations 62 and 65 which, in part, are as follows:
Taxpayers were given an option for 1921 to select either of the methods mentioned for treating such debts. (See article 151, Regulations 62.) The method used in the return for 1921 must be used in returns for subsequent *765 years and for returns under the Revenue Act of 1926 unless permission is granted by the Commissioner to change to the other method. A taxpayer filing a first return of income may select either of the two methods subject to approval by the Commissioner*2342 upon examination of the return. If the method selected is approved, it must be followed in returns for subsequent years, except as permission may be granted by the Commissioner to change to another method. Application for permission to change the method of treating bad debts shall be made at least 30 days prior to the close of the taxable year for which the change is to be effective. (See also article 155.)
The sole purpose of the statutory provision and administrative regulations cited above is to assist in the ascertainment of true taxable income. For the same purpose the Revenue Acts of 1921 and 1924 also provide in section 212(b) as follows:
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.
*2343 The Commissioner accepted the petitioner's return for 1923 and computed and settled tax liability on the facts set forth therein, which included a deduction from gross income on account of a net addition to a reserve for bad debts. We think such acceptance was sufficient permission to this petitioner to make its subsequent returns on the reserve basis. ; ; ; .
The evidence shows that the reserve for bad debts set up by the petitioner in the taxable years amounted to 2 per cent and 1 1/2 per cent, respectively, of the gross sales of such years and that such amounts were reasonable and were based on its previous experience. We conclude, therefore, that the net additions to such reserves are proper deductions from the gross income of the petitioner in the respective taxable years.
Decision will be entered for the petitioner.