Frontier Custom Builders, Inc. v. Commissioner

Case: 14-60518 Document: 00513195062 Page: 1 Date Filed: 09/16/2015
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 14-60518 United States Court of Appeals
Fifth Circuit
FILED
FRONTIER CUSTOM BUILDERS, INCORPORATED, September 16, 2015
Lyle W. Cayce
Petitioner – Appellant, Clerk
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent – Appellee.
Appeal from a Decision of the
United States Tax Court
Docket No. 2678-10
Before CLEMENT, PRADO, and ELROD, Circuit Judges.
PER CURIAM:*
This case arises from a tax dispute between Frontier Custom Builders,
Inc. (Frontier) and the Commissioner of Internal Revenue over certain
deductions that Frontier claimed for the 2005 tax year. The deductions were
mostly comprised of employee salaries and year-end bonuses, including
$1,318,000 in total compensation paid to the company’s founder, President,
and CEO, Wayne Bopp. The Commissioner audited Frontier and determined
* Pursuant to 5th Cir. R. 47.5, the court has determined that this opinion should not
be published and is not precedent except under the limited circumstances set forth in 5th Cir.
R. 47.5.4.
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that most of the salaries at issue should have been capitalized, instead of
deducted, under the applicable tax rules, codified at 26 U.S.C. § 263A and
Treasury Regulation § 1.263A.
Under these rules, producers of real property must capitalize, rather
than deduct, all of their production costs. 1 Because Frontier designs, builds
(through contractors), and sells custom homes and improvements on real
property, it is subject to these rules. According to the rules, capitalizable
production costs include both “direct costs” of production and “indirect costs”
of production. The term “indirect costs” includes “service costs,” only some of
which must be capitalized. Service costs are costs identified with a particular
service department or function within a business and are broken down into
three subcategories: (1) capitalizable service costs; (2) deductible service costs;
and (3) mixed service costs. Treas. Reg. § 1.263A-1(e)(4). Capitalizable service
costs are those service costs that “directly benefit or are incurred by reason of
the performance of the [taxpayer’s] production . . . activities.” Id.
§ 1.263A-1(e)(4)(ii)(A). Mixed service costs are only partially allocable to
production and, to properly account for the proportion benefitting production
1 Under section 263A of the Internal Revenue Code, taxpayers who “produce” real or
tangible property must capitalize all costs that are allocable to property production activities
(“production costs”). Capitalizable production costs may not be deducted from taxable
income. Production costs generally include both direct costs and “those indirect costs . . . part
or all of which are allocable to” property production. 26 U.S.C. § 263A(a)(2). The Secretary
of the Treasury has promulgated Uniform Capitalization Rules, pursuant to 26 U.S.C.
§ 263A(i), that further define direct and indirect costs, list several examples of each, and
provide a method for calculating the total amount of production costs (those direct and
indirect costs allocable to production). See Treas. Reg. § 1.263A-1.
To “produce” means to “construct, build, install, manufacture, develop, or improve.”
26 U.S.C. § 263A(g)(1). Moreover, “real property includes land, unsevered natural products
of land, buildings, inherently permanent structures, and improvements, as well as walls,
partitions, doors, wiring, plumbing, central air-conditioning and heating systems, pipes and
ducts, elevators and escalators, and other similar property.” Real Estate Professional’s Tax
Guide § 6:32.
2
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activities, must be capitalized pursuant to a “reasonable allocation method.”
Id. § 1.263A-1(g)(4) (providing the “direct reallocation method” and the “step-
allocation method” as two example methods); § 1.263A-1(h) (providing a
“simplified service cost method”).
Applying these tax rules, the Commissioner determined that most of
Frontier’s deducted amounts in 2005, and in particular, Bopp’s compensation,
were capitalizable service costs. The Commissioner sent a notice of deficiency
to Frontier in the amount of $653,272. Frontier filed a petition with the Tax
Court seeking redetermination of the alleged deficiency.
The Tax Court denied Frontier’s request for relief, noting that it was
required to uphold the Commissioner’s calculation method unless that method
was “clearly unlawful”—a clear abuse of discretion. Frontier Custom Builders,
Inc. v. Comm’r, 106 T.C.M. 393, 2013 WL 5446690, at *6 (2013) (citing
Thor Power Tool Co. v. Comm’r, 439 U.S. 522 (1979)). The Tax Court
determined that “Frontier ha[d] made no showing that respondent abused his
discretion in choosing the simplified production and simplified service cost
methods of accounting.” Id. at *7. In the Tax Court’s view, Frontier failed to
present evidence sufficient to prove that most of Bopp’s time was spent on
deductible services. Frontier had stipulated before trial that it could not
“produce contemporaneous time records to show how many hours [ ]Bopp spent
on his various activities.” Id. at *9. The only evidence Frontier offered was
Bopp’s testimony, which the Tax Court determined to be “self-serving
testimony that is uncorroborated by persuasive evidence.” Id. (citing Tokarski
v. Comm’r, 87 T.C. 74, 77 (1986) (holding that a court is not required to accept
such testimony)). The Tax Court explained that because Frontier failed to
show “that no substantial portion of [Bopp’s] time was spent on production-
3
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related activities,” it would defer to the Commissioner’s calculation method, 2
which included all of Bopp’s compensation as a mixed service cost. 3 Id. The
Tax Court adopted and entered a final deficiency calculation of $365,899.
Frontier appealed to the Fifth Circuit.
In challenging the deficiency, Frontier argues that it is exempt from the
requirements in § 263A because its primary business during 2005 was sales
and marketing, not production-related services. Relatedly, Frontier argues
that any production-related costs incurred by its subcontractors are not
2 Frontier argued before the Tax Court and on appeal that the Commissioner changed
his calculation method after trial, having submitted his original calculation in a stipulated
exhibit used at trial and a new calculation in his post-trial brief. Frontier asserted that doing
so introduced a “new matter” that required transferring the burden of proof to the
Commissioner. However, the Tax Court noted that the change in method had no prejudicial
effect on Frontier, and while “akin to a new matter,” did not actually introduce a new matter.
Frontier Custom Builders, Inc. v. Comm’r, 106 T.C.M. 393, 2013 WL 5446690, at *7
(2013). Both the pre- and post-trial calculation methods presumed that Bopp’s compensation
was capitalizable and relied on the same underlying financial data, but differed in
determining the exact proportion that should be capitalized instead of deducted. The Tax
Court determined that the post-trial calculation “[did] not alter the original deficiency or
require the presentation of different evidence,” and, because Frontier relied entirely on its
broad argument that none of Bopp’s compensation was capitalizable, the change did not
prejudice “Frontier’s case-in-chief because Frontier made no idiosyncratic argument based
on respondent’s stipulated, pretrial calculation.” Id. (citing Shea v. Comm’r, 112 T.C. 183,
191 (1999) (holding that new theories that merely clarify or develop an original calculation
are not new matters)). When pressed at oral argument, Frontier could not articulate to us
how the change in calculation had any prejudicial effect on the trial. Thus, we find no error
in the Tax Court’s analysis.
3 The Tax Court also rejected Frontier’s argument that Bopp’s testimony was
sufficient to support the inference that he spent only 10% or less of his time on production-
related activities, triggering the right to a 100% deduction under the de minimis rule. See
Treas. Reg. § 1.263A-1(g)(4)(ii) (“[I]f 90 percent or more of a mixed service department’s costs
are deductible service costs, a taxpayer” need not allocate any of those costs to production or
capitalize those costs.). Because Bopp could not “substantiate the time he spent on each of
his other activities,” the Tax Court declined to apply the de minimis exception. Frontier,
2013 WL 5446690, at *9.
4
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attributable to Frontier for purposes of § 263A. 4 In addition, Frontier contends
that even if it is subject to § 263A, Bopp’s compensation should not be
capitalized because his work “relat[ed] to overall management, overall
company policy, general financial accounting, strategic business planning, and
marketing, selling, or advertising.”
Like the Tax Court, we review the Commissioner’s determination of
taxable income for abuse of discretion. See St. James Sugar Coop., Inc. v.
United States, 643 F.2d 1219, 1222–23 (5th Cir. Unit A May 1981) (“[N]o
method of accounting may be used that in the opinion of the Commissioner of
Internal Revenue does not clearly reflect income. The Commissioner has been
given broad discretion in determining what methods satisfy this standard.”)
(footnote omitted) (citing Thor Power Tool, 439 U.S. at 532; Comm’r v. Hansen,
360 U.S. 446, 467 (1959); Lucas v. Am. Code Co., 280 U.S. 445, 449 (1930)).
Determinations in a notice of deficiency are presumptively correct. United
States v. Janis, 428 U.S. 433, 440–41 (1976). “The taxpayer bears ‘a heavy
burden of proof’ to show that the Commissioner abused his discretion, and the
Commissioner’s determination ‘is not to be set aside unless shown to be plainly
arbitrary.’” Capitol Fed. Sav. & Loan Ass’n & Subsidiary v. Comm’r, 96 T.C.
204, 210 (1991) (quoting Thor Power Tool, 439 U.S. at 532–33). Any findings
of fact are reviewed for clear error. BMC Software, Inc. v. Comm’r, 780 F.3d
669, 674 (5th Cir. 2015).
Having reviewed the briefs and record in this case, as well as the Tax
Court’s thorough opinion, we determine that the findings of fact are not clearly
erroneous and that the Commissioner’s calculation method does not represent
4This argument fails. “The taxpayer shall be treated as producing any property
produced for the taxpayer under a contract with the taxpayer . . . .” 26 U.S.C. § 263A(g)(2)
(emphasis added) (counting only costs actually incurred by the taxpayer under such contract).
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an abuse of discretion. 5 Although many of Bopp’s hours were spent managing
the company, the record reflects that a substantial portion of Bopp’s activities
directly benefitted, or were incurred by reason of, production. Some of his
activities included: designing homes that were later produced; creating the
processes and procedures for building homes; selecting developers and
reviewing subcontractors; resolving issues that arose at worksites during
production; selecting and installing the home design software; meeting weekly
with project managers to stay apprised of production timelines; and evaluating
project managers’ productivity reports. These activities are sufficient to
support the Commissioner’s capitalization of Bopp’s compensation.
We AFFIRM.
5 The Tax Court also did not err in determining that Frontier’s mitigation claim was
premature. To qualify for mitigation, a taxpayer must prove that certain statutory
requirements have been satisfied, including that there has been a final “determination.” 26
U.S.C. § 1313(a); Cocchiara v. United States, 779 F.2d 1108, 1112 (5th Cir. 1986) (holding
that the taxpayer has the burden of proof); United States v. Rachal, 312 F.2d 376, 383 (5th
Cir. 1962) (holding that the facts of each case must fit “into the concrete, detailed
requirements set out in the statute”). Frontier failed to show that the “determination” has
become “final” within the meaning of 26 U.S.C. §§ 1313(a)(1) and 7481—at the time Frontier
appealed, the time in which to file a notice of appeal had not expired, and the Tax Court’s
decision was not yet affirmed, reversed, or modified by a court of appeals.
6