Ellis v. Commissioner

JAMES C. ELLIS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

DRURY SMEATHERS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Ellis v. Commissioner

Docket Nos. 20254, 20255.

United States Board of Tax Appeals

16 B.T.A. 1225; 1929 BTA LEXIS 2428;

June 28, 1929, Promulgated

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The long-term contract basis of reporting income of the petitioners herein held to properly reflect income. Held, further, that petitioners, having elected to file returns on that basis, may not change to a different basis.

Harry A. Fellows, Esq., and A. E. James, Esq., for the petitioners.

T. M. Mather, Esq., for the respondent.

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MARQUETTE

In these cases, which were duly consolidated for hearing and decision, the respondent has asserted deficiencies in income tax for the calendar year 1921 as follows:

James C. Ellis	$2,225.33
Drury Smeathers	1,115.13

He also determined that for the year 1920 there are overassessments as to James C. Ellis and Drury Smeathers in the amounts of $655.89 and $93.52, respectively.

The petitioners allege that their tax liability for both the years 1920 and 1921 is in controversy.

FINDINGS OF FACT.

The petitioners are individuals residing at Owensboro, Ky. During the years 1920 and 1921 they were members of the partnership of Spurrier, Ellis and Smeathers, which consisted of themselves and J. W. Spurrier.

In the year 1920 the partnership of Spurrier, Ellis and Smeathers, entered into a contract with the State of Kentucky, for the grading and draining of a section of a certain highway. The work was begun in 1920 and was completed in 1921. The entire amount received by the partnership under the contract was $157,898.80 and the expenditures made thereunder were $106,462.37, leaving a net profit of $51,436.43, of which the petitioners were each entitled to one-third. Of said net profits $22,302.44 were attributable to the year 1920 and $29,133.99 to the year 1921.

On March 14, 1921, the partnership filed a return for the year 1920, on the face of which the statement was made that:

This partnership was organized in June 1920 and in July following it entered into a contract for the construction of an improved highway and began to construct such highway in July 1920 and did not complete said road by December 31st 1920, but later completed said road in 1921. This partnership had no other business or income in 1920 than the building of said road and it elects to make return of income as to said road on the basis of completed work.

The partnership filed a return of income for the year 1921 on May 15, 1922, in which it allocated the income from said contract to the years 1920 and 1921, and reported the amount of $26,181.18 as income for 1921. On May 15, 1922, the partnership also filed an amended return for 1920, in which it reported the amount of $22,302.45 as income from said contract for 1920.

The petitioner, Ellis, filed an income-tax return for 1920, but did not report any amount as income from said partnership of Spurrier, Ellis and Smeathers.

The petitioners filed returns of income for the year 1921 and each of them reported as his distributive share of the partnership income for that year the amount of $8,727.06. On March 15, 1923, the petitioner, Ellis, filed an amended return for 1920 and reported as his distributive share of the partnership income for that year the amount of $7,434.15.

The respondent, upon audit of the returns of the petitioners, has determined that the entire profit from said road contract is income to the partnership for the year 1921, and that each of the petitioners should be taxed on his distributive share thereof, and that there are deficiencies and overassessments as above set forth.

OPINION.

MARGUETTE: There is no dispute between the parties as to the facts of the cases at bar. They agree that the partnership of which the petitioners were members made a profit of $51,436.43 on its road contract, and that each of the petitioners received one-third of that profit. The petitioners contend that the profit should be allocated to the years 1920 and 1921 in proportion to receipts and expenditures in each of those years, and that they should return their distributive shares accordingly. The respondent urges that the partnership and the members thereof elected to make their returns on the basis of a completed contract, and, having so elected, they are bound thereby, and in support of his position he cites article 36 of Regulations 45. The parties have agreed that if the contention of the petitioners is well taken, $22,302.44 of the profit from the contract should be allocated to 1920, and $29,133.99 to 1921.

It is clear from the record that the partnership in its original return for 1920 elected to stand squarely on the completed contract basis, and, none of the partners having returned any amount as income from the partnership in 1920, it may be assumed that they also elected to report the profit from the contract on that basis. Such a course was authorized by article 36 of Regulations 45, which provides that:

ART. 36. Long-term contracts. - Persons engaged in contracting operations, who have uncompleted contracts, in some cases perhaps running for periods of several years, will be allowed to prepare their returns so that the gross income will be arrived at on the basis of completed work; that is, on jobs which have been finally completed any and all moneys received in payment will be returned as income for the year in which the work was completed. If the gross income is arrived at by this method, the deduction from such gross income should include and be limited to the expenditures made on account of such completed contracts. Or the percentage of profit from the contract may be estimated on the basis of percentage of expenditures, in which case the income to be returned each year during the performance of the contract will be computed upon the basis of the expenses incurred on such contract during the year; that is to say, if one-half of the estimated expenses necessary to the full performance of the contract are incurred during one year, one-half of the gross contract price should be returned as income for that year. Upon the completion of a contract, if it is found that as a result of such estimate or apportionment the income of any year or years has been overstated or understated, the taxpayer must file amended returns for such year or years. See section 212 of the statute, and articles 22-24.

But the petitioners say that the article just quoted is invalid, since it permits a taxpayer to report on a basis that does not fairly reflect his income, and that, therefore, an election made under authority of the article is not binding. We can not agree with that argument. It is true that returning income on the completed contract basis may result in a larger income in a given year than would be reported for the same year were the profit spread over the entire term in which the contract was performed. But it seems to us that the former method of returning the profit from a long-term contract is no more likely to result in distortion of income than the latter method. For example, a contract covering a period of two years may show a profit at the end of the first year based on receipts and expenditures at that time, whereas the contract when completed may result in a loss. The completed contract basis will always reflect the gain or loss from the contract as a whole, while the other method may result in a gain being reported in one year when the contract terminates in a loss, or a loss being reported when a gain finally is realized. The regulation in question is designed to reflect income from long-term contracts, and we are unable to perceive that it is inconsistent with or is not authorized by law. .

It seems to us that the petitioners, having elected to report on the basis of a completed contract, should not now be heard to complain because the respondent refuses to permit them to change to another basis. There is little, if any, difference between the situation here and that of a husband and wife electing to file joint or separate returns. In those cases we have held that where the election has been made it is binding. ; ; ; ; ; .

Judgment will be entered for the respondent.