## Facts

- RCA sold consumer products and, at purchase, offered prepaid service contracts lasting 3 to 24 months, paid by a single lump-sum fee and providing service on demand during the term.
- RCA used an accrual-based deferral method: it reported part of each fee immediately (selling/processing costs plus profit) and placed the remainder in a deferred-income account.
- RCA then recognized deferred amounts monthly over the contract term using statistical projections of service-call timing based on experience (including seasonality and expected workloads).
- After auditing RCA’s 1958 and 1959 returns, the Commissioner determined the deferral method did not clearly reflect income under I.R.C. § 446(b) and required RCA to include the full prepaid fees in income when received.
- RCA paid the assessed tax and sued for a refund in the Southern District of New York.
- Following a bench trial, the district court found RCA’s method matched revenues and related expenses with reasonable precision, held the Commissioner abused his discretion, and awarded a refund (about $5.96 million plus interest).
- The United States appealed.

## Issues

1. Whether the Commissioner abused his discretion under I.R.C. § 446(b) by rejecting RCA’s accrual deferral method for prepaid service-contract income and requiring inclusion upon receipt.
2. Whether a deferral method that depends on estimates of future customer service demands can, as a matter of law, clearly reflect income for tax purposes.
3. Whether any statutes, regulations, or administrative guidance limited the Commissioner’s § 446(b) discretion for the years at issue.

## Decision

- The Second Circuit reversed the district court.
- The court held the Commissioner did not abuse his discretion in rejecting RCA’s deferral method and requiring full inclusion of prepaid fees upon receipt.
- The case was remanded for proceedings consistent with denying the claimed refund.

## Legal Principles

- Under I.R.C. § 446(b), if a taxpayer’s accounting method does not clearly reflect income, the Commissioner may compute taxable income under a method that, in the Commissioner’s opinion, clearly reflects income.
- The Commissioner has broad discretion under § 446(b); the taxpayer bears the burden to show the Commissioner’s determination was plainly arbitrary or an abuse of discretion.
- Conformity with business accounting or GAAP does not control federal income tax accounting; “clear reflection of income” is a tax standard shaped by statutory and administrative policy.
- The Commissioner may reject deferral of advance payments where deferral depends on predicting future customer behavior (such as timing of service calls), because such predictions create timing uncertainty for government revenue.
- Courts may not substitute their preferred accounting method for the Commissioner’s; the proper inquiry is whether the Commissioner’s choice was unreasonable or unlawful.
- General administrative pronouncements or later guidance do not, without clear applicability, compel acceptance of a taxpayer’s method or eliminate the Commissioner’s discretion for prior tax years.

## Conclusion

The Second Circuit held that the IRS acted within its § 446(b) discretion in requiring RCA to recognize prepaid service-contract fees as income when received, even though RCA’s deferral approach attempted to match revenues and expenses through statistical estimates of future service demand.


RCA Corp. v. United States, 664 F.2d 881 (2d Cir. 1981)