Miele v. Commissioner

Fierro and Miele (the law firm) (plaintiffs) were law partners. The law firm followed the cash method of accounting when it filed its partnership income-tax returns. In keeping with the Pennsylvania Code of Professional Responsibility, the law firm kept all client advances segregated in a firm trust account. When a case was concluded, the attorneys would transfer the earned portion of any client funds from the trust account to the general partnership account and refund any unearned funds to the client. For tax purposes, the law firm would record prepaid legal fees as income when it transferred the funds to the general partnership account, which it did only about four times per year for reasons of administrative convenience. Thus, some funds that were earned and available in one tax year would not be included in income until the following tax year. Specifically, at the end of 1972, there was $68,199 in the trust account, $35,623.75 of which had been earned in 1972 but was not transferred to the general partnership account and not recorded as income until 1973. The commissioner of internal revenue (defendant) increased the law firm’s 1972 gross income to include amounts received in the trust account that year. The law firm petitioned for review, arguing that client advances are not taxable income until the funds are actually received via transfer in the general partnership account. The commissioner argued that client advances are taxable income when initially received by the firm, regardless of whether they are ultimately earned and transferred to the general partnership account.