American Automobile Association v. United States Case Brief Summary | Law Case Explained

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American Automobile Association v. United States | 367 U.S. 687 (1961)

If a taxpayer is paid for services that it won’t provide until the next year, is the prepaid money considered income in the year it’s received or the year the services are provided? The United States Supreme Court explored this question in American Automobile Association versus United States.

The American Automobile Association, or AAA, provided on-demand automobile services to its members. Members would prepay for a 12-month membership that started in the month purchased.

AAA used an accrual method for its accounting and for paying income taxes, which meant the money it received was treated as income only after triple A actually earned the money.

Specifically, AAA prorated its membership payments, treating 1/12th as income for each of the 12 months. The monthly income from all members was pooled and offset against the expense of providing whatever services any member had requested that month. Because memberships frequently spanned two calendar years, some membership money was treated as taxable income in the calendar year after AAA received it. This accrual method was consistent with generally accepted accounting principles.

The commissioner of the Internal Revenue Service determined that AAA’s method didn’t clearly reflect its actual income and that a full membership payment was income in the year received. Under the commissioner’s method, AAA owed more income tax.

AAA sued the commissioner to have the extra tax refunded. The U.S. Court of Claims dismissed the lawsuit, finding that for prepaid services, the entire payment is taxable income in the year it’s paid. However, the Second Circuit had held that for prepaid services, the prepayment may be considered taxable income on a prorated basis. The United States Supreme Court granted cert to resolve the split.

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