SCOTUS Reports

Tag: Section 107(b) IRC

  • Cozzens v. Commissioner, 19 T.C. 663 (1953): Tax Treatment of Author Royalties and the 80% Requirement

    19 T.C. 663 (1953)

    To qualify for income averaging under Section 107(b) of the Internal Revenue Code for income derived from artistic works, a taxpayer must receive at least 80% of the gross income from the work in the taxable year, and the doctrine of constructive receipt does not apply to royalties not subject to the author’s unrestricted right of demand.

    Summary

    James Gould Cozzens, an author, sought to utilize Section 107(b) of the Internal Revenue Code to reduce his 1942 tax liability related to royalties from his book, “The Just and the Unjust.” He argued that he constructively received over 80% of the book’s income in 1942. The Tax Court disagreed, finding that he did not actually or constructively receive the required 80% because the publishing contract did not guarantee such payment, and he had no unrestricted right to demand additional royalties beyond what was actually paid. Therefore, he could not average his income over multiple years for tax purposes.

    Facts

    Cozzens spent several years researching and writing “The Just and the Unjust,” completing it in April 1942 and publishing it in July 1942. His contract with Harcourt, Brace and Company, Inc., dated March 24, 1942, provided for a $1,000 advance and royalty payments to be settled semi-annually. Cozzens’s wife, acting as his agent, requested advance royalty payments to meet the 80% threshold for favorable tax treatment under Section 107(b). While the publisher was willing to make advancements from accrued sales proceeds, no firm agreement was reached. Cozzens actually received $31,700 in royalties in 1942. Total royalties through 1943 were $40,944.28. The IRS determined a deficiency, arguing Cozzens did not meet the 80% requirement in 1942.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in Cozzens’s 1943 income tax. Cozzens petitioned the Tax Court, contesting the deficiency. The Tax Court addressed whether Cozzens was entitled to the benefits of Section 107(b) of the Internal Revenue Code.

    Issue(s)

    1. Whether Cozzens received at least 80% of the gross income from “The Just and the Unjust” in 1942, thus qualifying for income averaging under Section 107(b) of the Internal Revenue Code.

    2. Whether Cozzens constructively received additional royalty income in 1942, even though it was not actually paid, based on the publisher’s willingness to make advance payments.

    Holding

    1. No, because Cozzens did not actually receive 80% of the gross income from the book in 1942, as required by Section 107(b).

    2. No, because the doctrine of constructive receipt did not apply, as Cozzens lacked an unrestricted right to demand the additional royalties in 1942.

    Court’s Reasoning

    The court reasoned that Section 107(b) explicitly requires the taxpayer to receive at least 80% of the gross income from the artistic work in the taxable year. Since Cozzens only received $31,700 in 1942, while 80% of the total income through 1943 was $32,755.42, he failed to meet this threshold. Regarding constructive receipt, the court emphasized that income must be credited to the taxpayer’s account without restriction or set aside for their use under their unrestricted control. The court found that the contract gave Cozzens no right to royalties in excess of the initial advance, and it was neither abrogated nor amended. The publisher’s willingness to make advances was a “purely gratuitous arrangement,” not an obligation, and Cozzens “could not have demanded them as a matter of right.” The court cited Avery v. Commissioner, 292 U.S. 210, emphasizing that a mere willingness to pay is insufficient; the taxpayer must have the unqualified right to demand the funds.

    Practical Implications

    This case clarifies the strict requirements for utilizing Section 107(b) (and similar income averaging provisions). Authors and other creators must ensure they actually receive at least 80% of the income from their work in a single tax year to qualify. The case underscores that a mere offer or willingness to pay additional amounts is insufficient to trigger constructive receipt; the taxpayer must have an unqualified, legal right to demand those funds. Tax planning is critical for authors who anticipate significant royalty income, as simply arranging for a publisher’s willingness to advance payments is not enough to secure favorable tax treatment. Later cases would cite Cozzens for the principal that to apply the doctrine of constructive receipt, income must be credited to the taxpayer’s account or set aside for their use without restriction.

  • Barber v. Commissioner, 19 T.C. 600 (1952): Income Averaging for Inventors Who Manufacture and Sell

    19 T.C. 600 (1952)

    Income derived from the manufacture and sale of a patented item is not eligible for income averaging under Section 107(b) of the Internal Revenue Code unless the taxpayer can demonstrate that a specific portion of the income is directly attributable to the patent itself, rather than simply to manufacturing and sales operations.

    Summary

    Alfred Barber, an inventor, sought to use Section 107(b) of the Internal Revenue Code to spread income he received in 1945 from the manufacture and sale of voltmeters over a 36-month period, arguing that the income was derived from his patented invention. The Tax Court denied his claim, holding that the income was primarily attributable to his manufacturing and selling activities in 1945, not to the underlying patent. Barber failed to prove that any portion of the voltmeter sales price represented a royalty or was otherwise specifically linked to the value of his patent. The court emphasized that Section 107(b) is intended to provide relief when income is generated by work performed over an extended period, not by ongoing business operations.

    Facts

    Alfred Barber invented a voltmeter between 1930 and 1935 and obtained a patent in 1936. He assigned the patent to Premier Crystal Laboratories, Inc., which never manufactured or sold the voltmeters. In 1943, Premier Crystal Laboratories reassigned the patent rights back to Barber. Barber then began manufacturing and selling voltmeters himself. In 1945, Barber’s gross income from voltmeter sales was $40,304.86, representing over 80% of his gross income from voltmeter sales for 1945 and the preceding and following years. Barber expanded his facilities and staff to support voltmeter production. He calculated his income tax liability for 1945 by treating the income from voltmeter sales under Section 107 of the Internal Revenue Code, which allows income from inventions developed over 36 months to be spread out over that period for tax purposes.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in petitioners’ income tax for 1945. The Commissioner argued that Section 107 was inapplicable to Barber’s income from the manufacture and sale of voltmeters. Barber petitioned the Tax Court for a redetermination of the deficiency.

    Issue(s)

    Whether the income Alfred Barber received from the manufacture and sale of voltmeters in 1945 qualifies for income averaging under Section 107(b) of the Internal Revenue Code, given that the income was derived from manufacturing and selling activities rather than directly from the patent itself.

    Holding

    No, because Barber failed to demonstrate that any specific portion of the income he received was attributable to the patent itself, as opposed to the manufacturing and selling operations he conducted in 1945.

    Court’s Reasoning

    The court reasoned that Section 107(b) is intended to provide tax relief when a taxpayer receives a large amount of income in one year that is attributable to work performed over a number of years. While the invention of the voltmeter took place over several years, the income at issue was generated by manufacturing and selling activities in 1945. The court distinguished between royalty income derived directly from a patent (which would be eligible for Section 107(b) treatment) and income derived from the business of manufacturing and selling a patented product. The court stated, “Of course, if it could be shown that some portion of the 1945 income from the manufacture and sale of the voltmeters was allocable to the patent, then there would be a basis for the application of section 107, but only to that extent.” Because Barber did not prove that any portion of his income was attributable to the patent, the court held that Section 107(b) was inapplicable. The court noted that Barber bore the burden of proving that some portion of his income was allocable to the patent and he failed to meet this burden.

    Practical Implications

    This case clarifies that Section 107(b) of the Internal Revenue Code is not a general tax break for inventors who manufacture and sell their inventions. To qualify for income averaging, inventors must demonstrate a direct link between the patent and the income received. This case highlights the importance of proper accounting practices to allocate income between manufacturing/sales and patent royalties. Attorneys advising inventors should counsel them to maintain records that clearly distinguish between income derived from the patent itself and income derived from manufacturing and selling activities. Later cases have cited Barber to emphasize the requirement of demonstrating a clear nexus between the income and the qualifying activity (invention, artistic creation, etc.) for income averaging purposes.

  • Richardson v. Commissioner, 14 T.C. 547 (1950): Tax Treatment of Income from Literary Works Created Over Long Periods

    14 T.C. 547 (1950)

    Section 107(b) of the Internal Revenue Code allows authors who spend more than 36 months creating a literary work to spread the income received from that work over a longer period for tax purposes, even if preliminary work or lost drafts contribute to the final product.

    Summary

    Iliff David Richardson, author of “American Guerrilla in the Philippines,” sought to utilize Section 107(b) of the Internal Revenue Code to reduce his tax burden by spreading income from his book over a 36-month period. The Commissioner argued that Richardson did not meet the 36-month requirement. The Tax Court ruled in favor of Richardson, holding that his work on the book, including lost drafts and preliminary notes, extended over more than 36 months, thus entitling him to the tax benefits.

    Facts

    Richardson, a U.S. Navy serviceman, began making notes for a book based on his war experiences no later than November 1, 1941. He lost these notes, and subsequent rewritten drafts, due to enemy action and a shipwreck. Despite these setbacks, he continued to gather information and rewrite his manuscript. In November 1944, he partnered with Ira Wolfert to finalize the manuscript, which was published as “American Guerrilla in the Philippines” in April 1945. Richardson received significant income from the book and related rights in 1945 and 1946.

    Procedural History

    The Commissioner of Internal Revenue determined a deficiency in Richardson’s 1945 income tax, arguing that he was not entitled to the benefits of Section 107(b) of the Internal Revenue Code. Richardson petitioned the Tax Court for a redetermination of the deficiency.

    Issue(s)

    Whether Richardson’s work on the book “American Guerrilla in the Philippines” extended over a period of more than 36 months, thus qualifying him for the tax benefits provided by Section 107(b) of the Internal Revenue Code.

    Holding

    Yes, because Richardson’s work on the book, including the creation and recreation of lost notes and manuscripts, began no later than November 1, 1941, and continued until at least January 15, 1945, exceeding the 36-month requirement.

    Court’s Reasoning

    The Tax Court rejected the Commissioner’s argument that only the time Richardson spent as a guerrilla should be considered. The court reasoned that the entire process of creating the book, including the initial note-taking, the loss and rewriting of drafts, and the final collaboration with Wolfert, should be considered part of the writing process. The court emphasized Richardson’s persistence and determination in pursuing his goal of writing a book based on his war experiences. The court stated, “There is nothing unusual in the fact that, in the final form of the book ‘American Guerrilla in the Philippines,’ petitioner omitted much material he had collected and perpetuated in the form of notes and manuscript concurrently made with the happening of the several events. The preparation of any ‘literary composition’ is usually a process of writing and rewriting, cutting here and adding there.” The court concluded that the preliminary work and lost drafts were inextricably interwoven with the final product and should be included in calculating the 36-month period.

    Practical Implications

    This case clarifies that the 36-month period for income averaging under Section 107(b) (and its successors) includes all work contributing to a literary composition, not just the final drafting stages. Authors can include time spent on research, preliminary drafts, and even work that was ultimately discarded in the final version. This broad interpretation benefits authors by allowing them to spread income over a longer period, reducing their tax liability. The ruling emphasizes a holistic view of the creative process, acknowledging that discarded work and preliminary efforts are integral to the final product. Later cases applying this ruling would likely focus on documenting the timeline and scope of the author’s work, including evidence of preliminary research, drafts, and revisions to demonstrate that the 36-month requirement has been met.