Trinity Industries, Inc. and Subsidiaries v. Commissioner

132 T.C. No. 2UNITED STATES TAX COURT
TRINITY INDUSTRIES, INC. AND SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 12395-06. Filed January 28, 2009.
Company T, a member of P’s affiliated group,
contracted to build barges for two established
customers; pursuant to an interim financing
arrangement, part of the purchase price was deferred
until 18 months after the delivery of each barge. The
two customers later claimed damages from alleged
defects in barges that they had previously purchased
from T under earlier contracts; they withheld deferred
payments due under the later contract, asserting common
law rights to offset the deferred payments against
their claimed damages under the earlier contracts. In
reporting the affiliated group’s 2002 consolidated
income, P accrued only the payments actually received
in 2002 and excluded the deferred payments. Held, the
full contract price of the barges delivered in 2002
must be accrued that year; accrual is not postponed by
the purchasers’ assertion of rights to withhold
deferred payments under common law claims of offset.
Held, further, amounts due to T and withheld by the
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obligors pursuant to common law claims of offset are
not deductible in 2002 pursuant to sec. 461(f), I.R.C.
Michael L. Cook, Jeffry M. Blair, and William C. Brooks, for
petitioner.
George E. Gasper and Garrett D. Gregory, for respondent.
THORNTON, Judge: Trinity Industries, Inc. (petitioner), is
the common parent of an affiliated group of corporations making a
consolidated return of income (the affiliated group).1 By notice
of deficiency, respondent determined a $5,900,808 deficiency for
petitioner’s taxable year ending March 31, 1999.2 All but one of
the adjustments that gave rise to that deficiency have been
settled. The only remaining issue involves accrual of income
earned by petitioner’s wholly owned subsidiary, Trinity Marine
Products, Inc. (Trinity), for the taxable year ending December
31, 2002.
More particularly, in 2002 Trinity contracted to build
barges for two established customers. Part of the purchase price
1
The parties use the term “petitioner” to refer principally
to Trinity Industries, Inc., although they sometimes seem to use
the term also to refer, without distinction, to its affiliated
group of corporations or its wholly owned subsidiary, Trinity
Marine Products, Inc. For simplicity and convenience, we have
generally adhered to the terminology used in the parties’
stipulations and arguments.
2
In September 2001, petitioner changed its yearend from
Mar. 31 to Dec. 31.
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was deferred until 18 months after the delivery of each barge.
The two customers later claimed damages allegedly caused by
defects in barges that they had previously purchased from Trinity
under earlier contracts. They sought to offset their unpaid
deferred obligations under the later contract against claimed
damages arising under the earlier contracts.
For the taxable year ending December 31, 2002, Trinity was
included in petitioner’s consolidated U.S. corporate income tax
return. Petitioner, an accrual basis taxpayer, included in the
affiliated group’s 2002 consolidated income payments received for
barges that Trinity delivered in 2002 but excluded the deferred
payments. In the notice of deficiency, respondent determined
that petitioner’s failure to accrue the deferred payments in 2002
resulted in an understatement of the affiliated group’s 2002
consolidated income which contributed to an overstatement of the
2002 consolidated net operating loss that petitioner had carried
back to the 1999 consolidated return. The issues for decision
are: (1) Whether petitioner properly excluded the withheld
payments from its 2002 income; and (2) if petitioner was required
to accrue the withheld payments in 2002, whether it may deduct
the withheld payments in 2002 pursuant to section 461(f).3
3
Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the year at issue, and Rule
references are to the Tax Court Rules of Practice and Procedure.
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FINDINGS OF FACT
The parties have stipulated some facts, which we find
accordingly, except as otherwise noted. When it petitioned the
Court, petitioner’s principal place of business was in Texas.
Petitioner is a diversified industrial company engaged in
the manufacture, marketing, and leasing of various products.
Trinity manufactures inland barges, primarily for commercial
marine transportation companies.
The First Contracts With Flowers and Florida Marine
In the late 1990s Trinity entered into a series of contracts
to build barges for J. Russell Flowers, Inc. (Flowers), and,
separately, for Florida Marine Transporters, Inc. (Florida
Marine) (hereinafter we sometimes refer to these contracts
collectively as the first contracts). Payment under these
contracts was generally due upon delivery of each barge.4
Trinity delivered the barges to Flowers and Florida Marine on
various dates between September 1997 and March 2000. Petitioner
4
The parties have stipulated that a portion of the purchase
price of the barges delivered to J. Russell Flowers, Inc.
(Flowers), under the first contracts was deferred for 18 months
as part of an interim financing arrangement. The stipulated
contract which is in evidence provides, however, that the
$265,000 contract price for each barge delivered to Flowers was
due within 10 days of the invoice date; an invoice was to be
issued upon installation of the covers for each vessel. Because
the stipulation is clearly contrary to the facts established by
the stipulated contract, we shall disregard the stipulation. See
Cal-Maine Foods, Inc. v. Commissioner, 93 T.C. 181, 195 (1989).
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accrued and reported the sales income in the taxable year in
which Trinity delivered the barges.
The Second Contract With Flowers and Florida Marine
On May 22, 2000, after the delivery and acceptance of the
barges that were the subject of the first contracts, Trinity
entered into another contract (the second contract) with Flowers
and Florida Marine. Under the second contract, Trinity, as
builder, agreed to deliver certain barges to Flowers, as
purchaser; Flowers had the right to assign its contractual rights
to Florida Marine (which was also a signatory to the contract)
with respect to a specified number of the barges.
The contract price was generally $1,290,000 for each barge,
with $1 million to be paid upon completion and acceptance of each
barge. The contract provided for “interim financing” of the
$290,000 balance, which the purchaser was to pay to Trinity, with
interest, within 18 months of delivery of each barge.5 Pursuant
to the second contract, Trinity built numerous barges and
delivered them to either Flowers or Florida Marine at various
times between April 2001 and September 2002.
5
A contract addendum dated Mar. 19, 2001, provided that
Trinity would provide two additional barges for $841,000 each,
with $651,000 payable upon completion and acceptance of each
barge and payment of the $190,000 balance deferred for 18 months
pursuant to an “interim financing” provision. Another contract
addendum dated May 16, 2002, provided for an additional six
barges for $1,353,000 each, with payment due in full upon
delivery of each barge.
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Problems With Barges Sold Under the First Contracts
After the execution of the second contract, problems
developed with the barges that Trinity had sold to Flowers and
Florida Marine under the first contracts. Flowers and Florida
Marine complained that the coatings on the barges were defective
and caused the barges to rust. Trinity denied any liability
concerning this alleged defect.
The Florida Marine Litigation
On May 15, 2002, Florida Marine filed a petition for an
unspecified amount of damages in the 22d Judicial Court, St.
Tammany Parish, Louisiana, against petitioner, Trinity, a coating
manufacturer, a coating distributor, and three insurance
companies (the Trinity defendants). On March 20, 2003, Florida
Marine filed a motion for leave to file a second supplemental and
amending petition for damages, requesting declaratory judgment
that it was entitled to offset unpaid deferred obligations under
the second contract against Florida Marine’s claim for damages
with respect to barges purchased under the first contracts.
In its memorandum in support of the aforementioned motion,
filed concurrently with the motion, Florida Marine stated that it
“does not dispute that certain amounts are due Trinity” pursuant
to the second contract but indicated that Florida Marine and
Trinity disagreed as to when the deferred payments were due. The
memorandum stated that Florida Marine had placed in escrow the
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amounts that Trinity had claimed were past due. The memorandum
indicated that the declaratory judgment action would enable the
court to declare the rights of Flowers Marine to a “set off
and/or credit for amounts, if any, owed by Florida Marine and to
Trinity * * * under the * * * [second contract] against such
amounts as Trinity * * * may be indebted to Florida Marine * * *
under claims which are the subject of the principal action.”
In their opposition to Florida Marine’s motion the Trinity
defendants argued that Florida Marine’s motion should be denied
because, among other reasons, applicable Louisiana law would not
permit Florida Marine’s obligations under the second contract to
be offset against its claim for damages with respect to barges
purchased under the first contracts, which were “contingent,
uncertain, and contested”.6
The Flowers Litigation
On October 7, 2002, Flowers filed a complaint in the U.S.
District Court for the Northern District of Mississippi,
Greeneville Division, against petitioner, Trinity, a coating
manufacturer, and a coating distributor. In its complaint
Flowers sought an order of rescission whereby Trinity would be
required to repurchase from Flowers 56 barges sold under the
6
The record does not reveal the disposition of Florida
Marine’s motion for leave to file a second supplemental and
amending petition for damages.
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first contracts for $13,977,578 less an “offset credit” of
$8,020,000 for deferred principal payments that it owed Trinity
under the second contract. Alternatively, the complaint sought
actual damages of not less than $8,400,000 plus punitive damages
of $100 million. The complaint also sought a declaratory
judgment that Flowers was entitled to exercise its “common law
right of offset” with respect to “$8,020,000 it owes to Trinity”
as deferred installment payments on barge sales under the second
contract, plus accrued interest. The complaint stated that
Flowers would “set aside the amounts of the deferred payments in
a segregated investment account as each installment and the
interest accruals become due. It will then hold said segregated
account as collateral security for and as an offset against any
amounts that may be due * * * [Flowers] from Trinity as a result
of the allegations contained in this Complaint.”
Attached as an exhibit to Flowers’s complaint was a letter
from Flowers dated October 7, 2002, to Trinity whereby Flowers
proposed rescinding the first contracts with respect to the 56
allegedly defective barges. The letter stated that if Trinity
declined this tender offer, Flowers would “protect itself by
exercising its common law right of offset with respect to
$8,020,000 in deferred installment payments” that it owed Trinity
under the second contract. The letter stated that as each of the
installments came due, Flowers would deposit the principal and
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accrued interest in a segregated investment account to be “held
as an offset against and as collateral security for” damages
alleged in the complaint. Alternatively, the letter stated that
if Trinity accepted the tender offer, the offset and segregated
account would be “reversed” and that Flowers would then pay the
deferred installments as they came due.7
On October 9, 2003, Trinity filed a motion for partial
summary judgment, arguing that Flowers’s claim for setoff was
improper because, among other reasons, Flowers’s “highly
contested” claim for unliquidated damages was not currently due
and payable, and Trinity would “never owe” Flowers damages in
regards to the barges sold under the first contracts. By order
dated March 18, 2004, the District Court denied Trinity’s motion
for summary judgment.
Withholding of Deferred Payments
During 2002, 2003, and 2004 deferred payments fell due from
Flowers and Florida Marine with respect to barges that Trinity
had delivered to them under the second contract in 2001 and 2002.
Because the deferred payments were due 18 months after delivery,
however, deferred payments for barges delivered in 2002 fell due
7
The letter further stated that the aforementioned
complaint had been filed in the U.S. District Court for the
Northern District of Mississippi, Greeneville Division, but that
service on the defendants had been deferred 30 days to give
Trinity an opportunity to respond to Flowers’ tender offer.
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only during 2003 and 2004. The parties have stipulated that
Flowers withheld total payments of $8,020,000, of which
$2,320,000 was attributable to barges delivered in 2002.8 The
parties have also stipulated that Florida Marine withheld
additional total payments of $2,836,060, of which $2,200,000 was
attributable to barges delivered in 2002.9
Settlement Agreement With Florida Marine
On March 12, 2004, Trinity and Florida Marine entered into a
settlement agreement. In compromise of the disputed claims,
Trinity agreed to credit Florida Marine with the $2,200,000 of
unpaid deferred obligations as to which Florida Marine had
asserted a right of offset. Florida Marine agreed to pay Trinity
8
The $2,320,000, which apparently does not include accrued
interest, represents eight deferred payments of $290,000 each,
with the earliest falling due on Aug. 18, 2003, and the latest on
Mar. 13, 2004. The remaining $5,700,000 of deferred payments
relates to barges delivered in 2001 pursuant to the second
contract. The record does not reveal the exact dates on which
these last-mentioned deferred payments fell due or more
particularly what portion of these withheld payments might have
fallen due in 2002.
9
The $2,200,000, which apparently does not include accrued
interest, represents 11 deferred payments of $200,000 each, with
the earliest falling due on Sept. 1, 2003, and the latest on Feb.
8, 2004. The record does not reveal why these deferred payment
amounts differ from the $290,000 deferred payments specified
under the second contract. The remaining $636,060 of deferred
payments relates to barges delivered in 2001 pursuant to the
second contract. The record does not reveal the exact dates on
which these last-mentioned deferred payments fell due or more
particularly what portion of these withheld payments might have
fallen due in 2002.
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the remaining $617,400 balance over 12 months.10 Trinity further
agreed to repair specified barges sold to Florida Marine under
the first contracts.
Settlement Agreement With Flowers
On April 28, 2005, Trinity and Flowers entered into a
settlement agreement. Trinity agreed to repurchase certain
barges sold to Flowers under the first contracts and to pay
Flowers $5,764,000 in damages. Flowers agreed to pay Trinity the
$8,020,000 it withheld under the second contract. The settlement
agreement specified that this amount was to be offset by the
agreed-upon damages, resulting in a payment from Flowers to
Trinity of $2,256,000.
Income Tax Reporting
Petitioner used the accrual method of accounting for all
relevant periods. With respect to barges delivered under the
second contract in 2001, petitioner accrued the full amount of
the sales, including deferred payments, and reported these
amounts as income in 2001.11 With respect to barges delivered
under the second contract in 2002, however, petitioner reported
10
The record does not reveal why the $2,817,400 balance due
reflected in the settlement agreement differs from the $2,836,060
that the parties have stipulated Florida Marine withheld from
Trinity.
11
Petitioner subsequently made an informal claim with the
IRS to reduce its 2001 income, which the IRS denied. This claim
is not at issue in this case.
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as income only the amounts received during 2002; it excluded the
$4,520,000 of deferred payments as to which Florida Marine and
Flowers asserted rights of offset.
Notice of Deficiency
In the notice of deficiency respondent determined that
failure to accrue the deferred payments for the barges delivered
in 2002 under the second contract resulted in a $4,520,000
understatement of the affiliated group’s 2002 consolidated income
and a corresponding overstatement of the 2002 consolidated net
operating loss carryback claimed on petitioner’s consolidated
return for the taxable year ending March 31, 1999.
OPINION
1. Accrual Method of Accounting
The primary issue is whether petitioner, as an accrual basis
taxpayer, was required to accrue in 2002 deferred payments for
barges that Trinity delivered under the second contract in 2002,
with respect to which the obligors claimed rights of offset for
damages allegedly arising with respect to barges that they had
previously purchased under the first contracts.
Under the accrual method of accounting, income is generally
recognized when all the events have occurred that fix the right
to receive the income, and the amount of the income can be
determined with reasonable accuracy. Secs. 1.446-1(c)(1)(ii)(A),
1.451-1(a), Income Tax Regs. Consequently, “An accrual basis
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taxpayer * * * must report income in the taxable year in which
the last event occurs which unconditionally fixes the right to
receive the income and there is a reasonable expectancy that the
right will be converted to money.” Schlumberger Technology Co.
v. United States, 195 F.3d 216, 219 (5th Cir. 1999); see Charles
Schwab Corp. & Includable Subs. v. Commissioner, 107 T.C. 282,
292 (1996), affd. 161 F.3d 1231 (9th Cir. 1998).
Trinity’s delivery of each barge to Flowers or Florida
Marine unconditionally fixed its right to receive the full
contract price under the second contract. Absent the offset
claims by Flowers and Florida Marine, there would appear to be no
dispute that petitioner was required to accrue the full contract
price of each barge, including deferred payments, in the year of
delivery. Indeed, that is the way petitioner reported its
consolidated income with respect to barges delivered under the
second contract in 2001, before Flowers and Florida Marine
asserted their offset claims.
For barges delivered under the second contract in 2002, on
the other hand, petitioner accrued only the payments received
upon delivery and excluded the deferred payments.12 Petitioner
12
In the amended answer, filed after trial upon the
granting of respondent’s motion to conform pleadings to proof
pursuant to Rule 41(b), respondent asserts that petitioner
improperly changed its accounting method with respect to barges
delivered in 2002 pursuant to the second contract. Petitioner
(continued...)
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contends that it was not required to accrue these deferred
payments in 2002 because of Florida Marine’s and Flowers’ claims
of rights to offset the deferred payments under the second
contract against damages allegedly arising under the first
contracts. Petitioner relies upon a line of cases which stands
generally for the proposition that in certain circumstances an
accrual basis taxpayer need not accrue unpaid income if the
obligor disputes the validity of the claim. See, e.g., N. Am.
Oil Consol. v. Burnet, 286 U.S. 417 (1932); Gar Wood Indus., Inc.
v. United States, 437 F.2d 558 (6th Cir. 1971); Cold Metal
Process Co. v. Commissioner, 17 T.C. 916 (1951), affd. per order
53-1 USTC par. 9135 (6th Cir. 1952); Jamaica Water Supply Co. v.
Commissioner, 42 B.T.A. 359 (1940), affd. 125 F.2d 512 (2d Cir.
1942); Ryan v. Commissioner, T.C. Memo. 1988-12, affd. sub nom.
Lamm v. Commissioner, 873 F.2d 194 (8th Cir. 1989); Breeze Corps.
v. United States, 127 Ct. Cl. 261, 117 F. Supp. 404 (1954).
For instance, in Gar Wood Indus., Inc. v. United States,
supra, upon which petitioner places particular reliance, the
taxpayer manufactured equipment for the U.S. Army Corps of
12
(...continued)
replies that it did not change its method of accounting in 2002
because the dispute with the purchasers represented a change in
underlying facts within the meaning of sec. 1.446-1(e)(2)(ii)(b),
Income Tax Regs. Because we conclude that petitioner was
required to accrue the disputed income in 2002, it is unnecessary
to decide this issue.
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Engineers (Corps). The contracts contained “price
redetermination” clauses, which authorized renegotiation of the
contracts after partial performance. Id. at 559. When certain
of the contracts were nearing completion, the Corps, anticipating
a price redetermination, unilaterally began withholding amounts
otherwise due to the taxpayer under the contracts. The pricing
dispute was resolved 2 years later. The court held that the
taxpayer was not required to accrue the withheld amounts in the
year the withholding occurred because the taxpayer “never had a
fixed right to the full contract price” and the Corps’ refusal to
honor the contract price negated whatever right the taxpayer
otherwise had to receive the withheld amounts. Id. at 561.
Similarly, all the other cases upon which petitioner relies
involve situations in which obligors disputed the fact or amount
of their liability with respect to the item to be accrued.
By contrast, insofar as the record shows, neither Flowers
nor Florida Marine ever disputed the fact or amount of its
obligation to Trinity under the second contract. To the
contrary, their filings in the commercial litigation expressly
acknowledged their obligations to Trinity under the second
contract and indicated that they were setting the withheld
amounts aside in “escrow” or as “collateral security” to offset
whatever damages Trinity might ultimately be determined to owe
them with respect to their claims under the first contracts.
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In Commissioner v. Hansen, 360 U.S. 446 (1959), the Supreme
Court considered a somewhat analogous situation in which buyers
withheld a portion of the sales price to satisfy potential claims
against the taxpayer seller. More particularly, in Hansen auto
dealers entered into a financing arrangement whereby they sold
customers’ installment notes to finance companies, which withheld
a portion of the purchase price as security to cover possible
losses on the notes. The Supreme Court held that the auto
dealers were required to accrue the withheld amounts as income
when the notes were sold. The Court rejected the dealers’
argument that accrual was excused by their present inability to
compel the finance companies to pay them the reserved amounts.
“[T]he question is not whether the taxpayers can presently
recover their reserves, for * * * it is the time of acquisition
of the fixed right to receive the reserves and not the time of
their actual receipt that determines whether or not the reserves
have accrued and are taxable.” Id. at 464.
The Court noted that although the reserves were subject to
being offset by the dealers’ contingent liabilities to the
finance company, “only the obligations * * * arising from those
liabilities may be offset against a like amount in the dealer’s
reserve account.” Id. at 465. Consequently, the Court reasoned,
any use of the reserves in paying those obligations would amount
to the dealers’ receiving something of value. The Court stated:
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“In any realistic view we think that the dealer has ‘received’
his reserve account whether it is applied, as he authorized, to
the payment of his obligations to the finance company, or is paid
to him in cash.” Id. at 466. The Court concluded that the
dealers must contemporaneously accrue the withheld amounts, even
if those funds were not available for paying the resulting tax
liability, stating: “it is a normal result of the accrual basis
of accounting and reporting that taxes frequently must be paid on
accrued funds before receipt of the cash with which to pay them”.
Id. at 466-467; see also Stendig v. United States, 843 F.2d 163(4th Cir. 1988) (requiring the taxpayer to accrue rents received
from its apartment complex, including a portion that was
deposited into reserve accounts to secure the maintenance and
operation of the complex); Clark v. Woodward Constr. Co., 179
F.2d 176 (10th Cir. 1950) (requiring the taxpayer to accrue
income from highway construction contracts when the State
accepted the work, notwithstanding a contractual provision which
permitted the State, after accepting the work, to withhold 15
percent of the contract price pending publication of statutory
notice to any claimants against the taxpayer).
The instant case presents a stronger argument, we believe,
for requiring accrual of income than Commissioner v. Hansen,
supra, or the other cases just cited. Unlike these other cases,
the instant case does not involve any question as to whether the
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right to receive income was vitiated by a contractual provision
for withholding a portion of the sales price. Rather, as
previously discussed, under the second contract petitioner had a
fixed and absolute right to the deferred payments as soon as each
barge was delivered. Pursuant to the claims of offset asserted
by Flowers and Florida Marine, the withheld payments were to be
applied only in satisfaction of Trinity’s or petitioner’s alleged
obligations to them arising under the first contracts.
Petitioner effectively received the withheld amounts when,
pursuant to the settlement agreement, they were applied in
compromise of Flowers’ and Florida Marine’s claims. In the final
analysis, then, the offset claims affected only the timing of
petitioner’s receipt of income under the second contract and not
its right to receive the income.
Petitioner’s contentions might be broadly construed as
turning upon doubts as to the collectibility of Flowers’ and
Florida Marine’s debts for the deferred payments. Petitioner
does not contend that it is entitled to a bad debt deduction with
respect to these debts and has offered no proof that the debts
were wholly or partially worthless so as to meet the requirements
under section 166 for claiming a bad debt deduction.
Nevertheless, petitioner seems to suggest broadly that, apart
from any question about deductions, doubts about the
collectibility of the debts justify postponing the accrual of the
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income. In Spring City Foundry Co. v. Commissioner, 292 U.S.
182, 184 (1934), the Supreme Court squarely rejected such a
contention as having “no merit”. The Court stated:
Keeping accounts and making returns on the accrual
basis, as distinguished from the cash basis, import
that it is the right to receive and not the actual
receipt that determines the inclusion of the amount in
gross income. When the right to receive an amount
becomes fixed, the right accrues. * * *
* * * If such accounts receivable become uncollectible,
in whole or part, the question is one of the deduction
which may be taken according to the applicable statute.
* * * That is the question here. It is not altered by
the fact that the claim of loss relates to an item of
gross income which had accrued in the same year. [Id.
at 184-185.]
Pursuant to these principles, an accrual basis taxpayer
generally must accrue income once the all-events test is
satisfied, even though payment may be postponed until a
subsequent year. Harmont Plaza, Inc. v. Commissioner, 64 T.C.
632, 648, 649 (1975), affd. 549 F.2d 414 (6th Cir. 1977); Georgia
School-Book Depository, Inc. v. Commissioner, 1 T.C. 463, 468
(1943). As a limited exception to this rule, accrual may not be
required if the income was of doubtful collectibility or it was
reasonably certain that it would not be collected as of the time
the taxpayer’s right to receive the income arose. Harmont Plaza,
Inc. v. Commissioner, supra at 649-650; Atl. Coast Line R.R. v.
Commissioner, 31 B.T.A. 730, 751 (1934), affd. 81 F.2d 309 (4th
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Cir. 1936).13 The income-accrual exception is narrowly applied
so not to “be allowed to swallow up the fundamental rule upon
which it is engrafted” requiring accrual. Georgia School-Book
Depository, Inc. v. Commissioner, supra at 469. The exception
has typically been applied where the debtor is “insolvent or in
fact bankrupt.” Harmont Plaza, Inc. v. Commissioner, supra at
650.
Petitioner does not contend and the evidence does not show
that Flowers or Florida Marine was insolvent or bankrupt or that
the collectibility of their debts was otherwise called into
question by their respective financial conditions. In any event,
Flowers and Florida Marine asserted their claims of offset only
after the barges were delivered under the second contract and
petitioner’s right to the income had become fixed. In fact,
insofar as the record shows, Florida Marine did not assert its
13
Under this exception, “the fact that the obligation later
became worthless in part, even though within the same taxable
year is * * * immaterial”. Atl. Coast Line R.R. v. Commissioner,
31 B.T.A. 730, 751 (1934), affd. 81 F.2d 309 (4th Cir. 1936). At
first blush there may appear to be some tension between this
statement and a statement in a Memorandum Opinion of this Court
that the income-accrual exception may apply “when, in the same
year that a taxpayer’s right to income arises, collection and
receipt of the income become sufficiently doubtful or when it
becomes reasonably certain that the income will not be
collected.” Elec. Controls & Serv. Co. v. Commissioner, T.C.
Memo. 1996-486. In that case, however, the Court held that
nonaccrual of certain contract payments was permitted in part
because of the contingent nature of the taxpayer’s right to
receive the payments. By contrast, petitioner’s right to receive
the deferred payments under the second contract was unconditional
and fixed upon delivery of the barges.
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offset claims until March 2003, after the close of the taxable
year in which petitioner’s right to the income under the second
contract had arisen. In these circumstances, postponing accrual
of the income is not justified.
In conclusion, in 2002 petitioner was required to accrue the
deferred payments due on the barges delivered that year under the
second contract.
2. Deductibility of Withheld Payments Under Section 461(f)
Alternatively, petitioner claims that pursuant to section
461(f) it is entitled to deduct $4,520,000 in 2002 on the ground
that it “transferred” this amount to Flowers and Florida Marine
in satisfaction of their disputed claims for damages with respect
to allegedly defective barges that Trinity delivered under the
first contracts.
An accrual basis taxpayer generally may take a liability
into account only in the taxable year in which all events have
occurred to allow the fact and amount of the liability to be
determined with reasonable accuracy and economic performance has
occurred with respect to the liability. Sec. 1.461-1(a)(2),
Income Tax Regs. If a liability is contingent on the outcome of
a contested lawsuit, then it generally may not be taken into
account until the dispute is resolved. See Willamette Indus.,
Inc. v. Commissioner, 92 T.C. 1116, 1121 (1989), affd. 149 F.3d
1057 (9th Cir. 1998). Section 461(f) provides a limited
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exception to this general rule by permitting a taxpayer to deduct
a contested liability, provided the taxpayer has transferred
assets in the same tax year to satisfy the claimed liability.
Section 461(f) provides in relevant part:
SEC. 461(f). Contested Liabilities. -If-
(1) the taxpayer contests an asserted liability,
(2) the taxpayer transfers money or other property
to provide for the satisfaction of the asserted
liability,
(3) the contest with respect to the asserted
liability exists after the time of the transfer, and
(4) but for the fact that the asserted liability
is contested, a deduction would be allowed for the
taxable year of the transfer * * * (or for an earlier
taxable year) * * *
then the deduction shall be allowed for the taxable
year of the transfer. * * *
The burden of proof is on petitioner to show that it satisfies
all four requirements of section 461(f). See Rule 142; Davies v.
Commissioner, 101 T.C. 282, 286 (1993).
The parties disagree primarily as to whether petitioner
meets the second requirement listed above that there be a
transfer of money or other property in satisfaction of the
asserted liability. Petitioner contends that it transferred
property to Flowers and Florida Marine “when Flowers and Florida
Marine withheld payment under the Second Contract as an offset
against their alleged damages”. The record shows, however, that
the $4,520,000 of deferred payments as to which petitioner claims
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a deduction came due under the second contract in 2003 and 2004.
Flowers and Florida Marine cannot meaningfully be said to have
withheld the deferred payments before they came due. At most,
Flowers and Florida Marine threatened in 2002 to withhold the
deferred payments, although as previously discussed the record
does not establish that Florida Marine even asserted its offset
claim before 2003.
Section 461(f) allows a deduction only for “the taxable year
of the transfer.” Consequently, even if we were to agree with
petitioner that the withheld payments represented transfers of
funds to Flowers or Florida Marine, we would conclude that the
transfers occurred in 2003 and 2004, so that petitioner would not
be entitled to the claimed deduction under section 461(f).14
More fundamentally, we disagree with petitioner’s contention
that the withholding of the deferred payments by Flowers and
Florida Marine represented a transfer by petitioner within the
meaning of section 461(f). The regulations require that the
taxpayer transfer “money or other property beyond his control
14
The record does not clearly establish what amount, if
any, of deferred payments Flowers or Florida Marine might have
withheld in 2002 with respect to barges delivered in 2001.
Consequently, if we were to construe petitioner’s claim, contrary
to petitioner’s own articulation of it, as encompassing amounts
withheld by Flowers or Florida Marine in 2002 with respect to
barges delivered in 2001, we would conclude that petitioner’s
claim must fail by virtue of its failure to carry its burden to
prove the amount of payments withheld in 2002.
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* * *. * * * In order for money or other property to be beyond
the control of a taxpayer, the taxpayer must relinquish all
authority over such money or other property.” Sec. 1.461-
2(c)(1), Income Tax Regs. As a necessary corollary, and as
common sense dictates, before a taxpayer may transfer money or
other property beyond its control or authority, it first must
have the money or other property within its control or authority.
Obviously, the deferred payments were not in petitioner’s
control or authority, at least not so long as Flowers and Florida
Marine withheld them. By withholding the deferred payments,
Flowers and Florida Marine merely perpetuated their own control
over these funds. Although, as previously discussed, Trinity
possessed contractual rights to the withheld payments sufficient
to require accrual of the income, neither Trinity nor petitioner
relinquished those rights, at least not in 2002, but instead
vigorously disputed the claimed rights of offset.
In contending that the withheld payments constituted a
transfer within the meaning of section 461(f), petitioner relies
upon Chernin v. United States, 149 F.3d 805 (8th Cir. 1998).
Petitioner’s reliance is misplaced. In Chernin, the court held
that a transfer was accomplished within the meaning of section
461(f) by a court-issued writ of garnishment that forced the
taxpayer to transfer funds owed to him as compensation. The
court reasoned that the writ of garnishment “shifted actual
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control over the funds from the taxpayer to the garnishees”. Id.
at 810. By contrast, in 2002 there was no court-issued writ or
other order of any competent legal authority to force Trinity to
transfer funds owed to it.
In sum, we conclude and hold that in 2002 petitioner did not
transfer money or other property in satisfaction of Flowers’ and
Florida Marine’s asserted liabilities and consequently is
entitled to no deduction pursuant to section 461(f).
To reflect the foregoing and the parties’ stipulation of
settled issues,
Decision will be entered
under Rule 155.