## Facts

- An accrual-method taxpayer operated a gas furnace business.
- In 1946, he sold 665 furnaces, each accompanied by a written promise to turn the furnace on and off annually for five years.
- The expected cost of the service was supported by evidence that each service call cost about $2.
- The taxpayer charged $20–$25 more per furnace than competitors, attributing the premium to the included service guarantee.
- For 1946, the taxpayer accrued and deducted a $13,300 reserve, calculated as the estimated cost of performing the five-year service obligations for the 1946 sales.
- The Commissioner disallowed the deduction; the Tax Court sustained the disallowance.
- The taxpayer petitioned the Fifth Circuit for review.

## Issues

1. Whether an accrual-basis taxpayer may deduct, in the year of sale, a reserve representing the reasonably estimated cost of future services required by a legally enforceable multi-year service guarantee created by those sales.
2. Whether disallowing such an accrual would prevent the taxpayer’s method of accounting from clearly reflecting income for the taxable year.

## Decision

- The Fifth Circuit reversed the Tax Court.
- The court held the taxpayer could deduct the $13,300 reserve in 1946.
- The court found the service guarantee created a definite, fixed legal liability when the furnaces were sold in 1946.
- The reserve amount was supported by evidence and was not treated as speculative.
- Allowing the accrual better reflected annual income by matching the price premium received in 1946 with the associated service obligation.

## Legal Principles

- Under accrual accounting for federal income tax, an expense may be accrued and deducted when the taxpayer incurs a fixed legal liability in the taxable year, even if performance and payment occur in later years.
- Labeling an item a “reserve” does not bar deduction if it represents a substantiated estimate of a present legal obligation.
- The governing statutory inquiry is whether the taxpayer’s accounting treatment clearly reflects income on an annual basis; methods that materially distort annual income may be rejected.
- Where current sales revenue includes consideration for future services required by contract, accrual of the related service costs in the year the obligation arises may be permitted to reflect income accurately.

## Conclusion

The Fifth Circuit held that the taxpayer’s 1946 furnace sales created an enforceable, fixed service-guarantee liability, and because the reserve was reasonably supported and improved annual income matching, the taxpayer could deduct the accrued $13,300 reserve in 1946.


Schuessler v. Commissioner, 230 F.2d 722 (5th Cir. 1956)