Bent v. Commissioner ( 1930 )

H. STANLEY BENT, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Bent v. Commissioner

Docket No. 18458.

United States Board of Tax Appeals

19 B.T.A. 181; 1930 BTA LEXIS 2464;

February 28, 1930, Promulgated

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1. The method of accounting of a partnership engaged in construction projects, some of which were not completed within a year, was to set up a separate account for each project. The charges of each project, representing costs and expenses, and the credits, representing periodical compensation, were carried in the project account. The project account was not closed until the project was completed and accepted, and then gain or loss on the project was transferred to profit and loss of the business. Profit or loss was not computed annually. Tax returns had consistently been made on the so-called term contract basis. Held, the method used correctly reflected income, returns in accordance therewith were proper, and partner had no right to have taxable income from uncompleted projects computed on an annual accrual basis.

2. The fact that taxpayer correctly enters his current transactions in primary accounts and that net income could be calculated therefrom each year is not sufficient to establish that he is entitled, contrary to his regular practice, to have his income for a single year from uncompleted projects computed upon an annual accrual basis.

Julius V. Patrosso, Esq., and W. H. Teasley, C.P.A., for the petitioner.

J. E. Mather, Esq., for the respondent.

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STERNHAGEN

The Commissioner determined a deficiency in income tax for 1920 of $12.73. Petitioner attacks this because respondent has (1) disallowed a part of the net loss alleged to have been sustained for 1919, (2) disallowed expense items totaling $3,115.67 as deductions in computing the partnership net income for 1922 and allocating such expenses to 1920 and 1921 in the amounts of $1,102.40 and $2,013.27, respectively, and (3) determined the partnership net income for 1920 by a long-term contract method of accounting instead of the annual accrual method.

FINDINGS OF FACT.

Petitioner, a citizen and resident of the State of California, was during 1920 a member of the firm of Bent Brothers, a partnership composed of himself and Arthur S. Bent. The partnership is engaged in the construction, under contracts, of dams, reservoirs, canals and similar projects. Frequently such projects are not completed within the same taxable year in which the work is begun.

The method of accounting regularly employed in keeping the partnership's books, from the inception of the business in 1920 until the partnership was succeeded by a corporation in 1923, was as follows: A separate account was kept in the partnership books for each project undertaken. At the end of the month this account was charged with the cost, whether paid or not, of all labor, materials and direct expenses incurred during the month and chargeable to the project. At the close of the year the account was charged with its proportion of the indirect expenses, or overhead, of the business incurred during the year, whether paid or not. The overhead was distributed over the several projects upon which work had been performed during the year in the same proportions that the total costs of each project incurred during the year bore to the total costs of all projects incurred during the year. If the contract provided for payment upon completion of the project, the customer's account was charged and the separate account of the project was credited, when all work was completed and accepted. If payment was to be made as the work progressed, upon the basis of monthly estimates by the customer's engineer of work completed during the month and the amount of payment due therefor, the customer's account was charged, and the separate account of the project was credited, as such estimates were received, with the amount of payment shown to be due by the estimate. If the contract provided that a percentage of the amount due on each estimate was to be withheld pending completion and acceptance of the project, the separate account of the project was credited only with the payment due and the amount of the holdback was credited to "Retention Account." No accounting was made for any gain or loss on any project until the work was completed and accepted. Until that time, the debit balance in a project account was considered an investment and carried on the books as an asset. When work was completed and the project accepted, the project account was closed by transferring the balance representing gain or loss to profit and loss account.

The net income reported by the partnership in all returns filed for Federal income-tax purposes was computed in accordance with the method of accounting employed in keeping the books.

During 1920 the partnership was engaged on four projects which were not completed in the same taxable year in which work was begun. Devil's Gate Dam was commenced in 1919 and completed in 1920; work on Huntington Park Reservoir began in 1920 and was completed in 1921; work on Rodeo Drain started in 1920 and was completed in 1921; and work on San Dimas Dam began in 1920 and was completed in 1922.

Devil's Gate Dam was constructed under contract with the Los Angeles County Flood Control District. This contract provided that compensation should be paid to the partnership upon the basis of monthly estimates of materials furnished and work completed at the following rates:

Item 1, for 3,000 cubic yards dry earth excavation at the unit
price of $1.80 per cubic yard, total amount	$ 5,400.00
Item 2, for 2,000 cubic yards wet earth excavation at the unit
price of $1.80 per cubic yard, total amount	3,600.00
Item 3, for 3,000 cubic yards dry solid rock excavation at the
unit price of $3.85 per cubic yard, total amount	11,550.00
Item 4, for 3,000 cubic yards wet solid rock excavation at the
unit price of $3.85 per cubic yard, total amount	11,550.00
Item 5, for 28,350 cubic yards concrete which may have large stones
embedded, at the unit price of $2.55 per cubic yard, total amount	72,292.50
Item 6, for 4,000 cubic yards plain concrete at the unit price of
$2.55 per cubic yard, total amount	10,200.00
Item 7, for 1,000 cubic yards re-enforced concrete at the unit
price of $11.60 per cubic yard, total amount	11,600.00
Item 8, for 620 lineal feet precast hand rail, lamp posts, etc.,
at the unit price of $7.50 per lineal foot, total amount	4,650.00
Item 9, for 620 lineal feet of 2" fibre conduit with No. 6 copper
wire pulled into conduit and lamp posts set in place at the unit
price of $1.00 per lineal foot, total amount	620.00
Item 10, for 300 lineal feet of concrete lined tunnel at the unit
price of $71.00 per foot, total amount	21,300.00
Item 11, for 10,000 pounds steel re-enforcement at the unit price
of $.06 per pound, total amount	600.00
Item 12, for 6,300 square feet road surfacing at the unit price of
$.15 per square foot, total amount	945.00
Item 13, for 3,000 lineal feet 2 1/2" drilled grout holes at the
unit price of $5.00 per lineal foot, total amount	15,000.00
Item 14, for the work of placing 1,000 sacks cement in grouting at
the unit price of $.60 per sack, total amount	600.00
Item 15, for extra work, the amount specified in Section 19 of the
general conditions and definitions.
Total amount of this bid is	169,907.50

Compensation shown to be due by the monthly estimates of the chief engineer of the Flood Control District were usually paid by the 10th of the following month.

In accordance with the method of accounting employed in keeping the books, the partnership included in the return for 1920 the entire compensation received for and all of the costs and expenses incident to the construction of Devil's Gate Dam which was completed in that year, but did not include the income or expenses relating to the three other projects commenced but not completed in that year. It was the partnership's custom to report income from each job when it was completed.

OPINION.

STERNHAGEN: The respondent determined a deficiency for 1920 and overassessments for 1919, 1921, and 1922. Ad to the latter, the Board is without jurisdiction, , and numerous later decisions; Roberts Manual, Part I, p. 540.

The item as to alleged net loss of 1919 has apparently been abandoned, as there is neither evidence nor argument in respect of it.

The petitioner assigns and respondent concedes an error in shifting a deduction of $1,102.40 for expense from 1922 to 1920. The facts do not appear, so we must accept the mutual concession and require that the net income of 1920 be increased by this amount.

The principal contention of the petitioner is that the partnership income should be computed each year on an annual accrual basis. This is predicated upon the view, looking at Revenue Act of 1918, section 212, that this is in accordance with the method of accounting regularly employed and that such method clearly reflected its income. The respondent, in determining the deficiency, has adhered to the method of computation adopted by the partnership in its tax returns and consistently used for many years, including 1920, namely, the so-called long-term contract method. By this method, net income from each contract has regularly been computed in the year of its completion. The petitioner, notwithstanding its practice since 1913 of filing returns on the long-term contract basis and its use of that basis in the return for 1920, now seeks to overthrow this deficiency by having this method set aside and the annual method substituted. The argument by which this is attempted to be supported is that its accounts have been kept that way, and this is sought to be demonstrated by showing that the accounts at the end of each year contain data disclosing gross income accrued and deductions incurred.

It is true that monthly estimates and receipts of each project were accounted for monthly, and its costs and expenses were entered as incurred. They were entered, however, not in general accounts, but in specific contract accounts, and were not carried into the earnings of the business until the project was completed. Meanwhile, costs of labor and material, and expenses, direct and indirect, so charged in the project account were treated as investment in the project and carried as an asset on the books; and compensation so accrued monthly and credited in the project account was treated "as a reduction of cash investment in the project." Not until the completion of the project were these carried into profit and loss to determine gain or loss in the business.

This in our opinion shows that the partnership's and the petitioner's returns were properly made on the long-term contract basis, that this was in accordance with the accounting method regularly employed, and respondent was fully justified in adopting this method in auditing the return. See . The fact that some of the contracts were performed within a year and some took longer, creates no inconsistency in the method and does not detract from a clear reflection of income. It is not controlling that the primary accounts were currently kept so as to permit net earnings to be calculated at the end of each year. This is merely saying that all financial items were honestly recorded when they occurred, which is a postulate of any system of accounts. The method of accounting is not determinable alone from this, but is reflected rather by the system in which these primary entries were carried forward to ascertain periodical gains or losses. When, as here, the specific project accounts have been withheld from profit and loss until the completion of the project and this in disregard of any intervening annual period, it can not be said that the taxpayer's accounting method is one of the annual accrual of net income.

Furthermore, since the deficiency has been determined by this method and petitioner has not established what in fact was the income resulting from the method he suggests, with the consequent tax liability, the deficiency could not be set aside on the record in any event.

Judgment will be entered under Rule 50.