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The use of a subjective measure of value is contrary to the usual way of valuing either services or property, and would make the administration of the tax laws in this area depend upon a knowledge by the Commissioner of the state of mind of the individual taxpayer. The sound administration of tax law requires that there be as nearly objective a measure of the value of services that can be included in income as possible, and the only objective measure is fair market value.
David Rooney, Richard Plotkin, and Grafton Willey were partners in Rooney, Plotkin & Willey (the partnership), a certified public accounting firm located in Newport, Rhode Island. The partnership reported its income on a calendar year basis. The books and records of the partnership were maintained by the use of the accrual method. However, adjustments were made at year’s end to convert the records to the cash method for federal income tax purposes. The partners made it a practice to patronize the business establishments of many of their clients because they believed it to be good for business. At times, the partners paid for the goods and services received from a client through a practice known as "cross-accounting." On such occasions, they reduced the client's debt to the partnership by an amount equal to the price normally charged for such goods and services by the client to its retails customers. The partnership then recognized that amount as gross receipts. In 1981, four of the partnership's clients became delinquent in paying for services rendered that year. The partnership attempted to collect the unpaid balances by making demands for payment and threatening to institute collection proceedings. After such efforts proved unsuccessful, the partnership allowed petitioners David A. and Jeanne R. Rooney, husband and wife; petitioners Richard A. and Patricia D. Plotkin, husband and wife, and petitioner Grafton H. Willey, IV, to receive goods and services from such clients in 1981. The partnership used its cross-accounting procedure to credit the clients for these goods and services. The partners became dissatisfied with the cross-accounting arrangement with these four clients. They determined that some of the goods received were overpriced and that some of the services were not satisfactorily performed and that therefore the value to them of the goods and services was less than the normal retail prices charged by such clients. The partners agreed that they patronized the clients only because they were in danger of going out of business and that the only way to reduce the amount owed to the partnership was to cross-account. Consequently, the partners "discounted" the retail prices of the goods and services received by them from the four clients and reduced the partnership's gross receipts account by the amount of the discount. The four clients were never informed that the partnership made such adjustments. The Commissioner, determining the fair market value of the goods and services received by the petitioners to be equal to the prices normally charged by the clients to their retail customers, issued separate notices of deficiency to the Rooneys, to the Plotkins, and to Mr. Willey. The petitioners challenged the Commissioner's determination of the fair market value of such goods and services.
In computing its income, may an accounting partnership discount the retail prices of goods and services received in exchange for accounting services by considering the partners' subjective determination of value?
The court held that under the standard enunciated in Koons v. United States, 315 F.2d at 545, the petitioners may not adjust the acknowledged retail price of the goods and services received merely because they decided among themselves that such goods and services were overpriced. The court was not persuaded by the petitioners' claims that they were compelled by circumstances to patronize these clients and that they were therefore "forced" to accept prices for the goods and services higher than they would have otherwise paid. The court noted that the petitioners themselves made the decision to accept compensation in a form other than cash. Moreover, although the petitioners claimed that they would not have willingly paid the retail prices for the goods and services received from the four clients, those prices were accepted by other customers of those clients and thus represented the prices established in the marketplace. Thus, the court concluded that the fair market value of the goods and services received by the petitioners was the prices charged by the partnership's clients to their retail customers.