Court Opinion

ID: 4482999
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:15:50.090003+00
Date Added: 2024-06-11T14:54:02.524023
License: Public Domain

OPINION Sterrett, Judge: The respondent determined deficiencies in petitioner’s Federal income taxes for the fiscal years ended September 30, 1958, September 30, 1959, September 30, 1960, and September 30, 1961. The only issue in controversy is whether respondent is entitled to adjust petitioner’s Federal income tax liability for those years pursuant to sections 1311 through 1314. Some of the facts have been stipulated and are so found. The stipulation of facts, together with the exhibits attached thereto, are incorporated herein by this reference. B. C. Cook & Sons, Inc. (hereinafter petitioner), is a Florida corporation, with its principal office in Haines City, Fla. Its corporate income tax returns for its fiscal years ended September 30, 1958, September 30, 1959, September 30, 1960, and September 30, 1961, were filed with the District Director of Internal Revenue for the District of Florida. At all times pertinent hereto, petitioner was engaged in the business of acquiring citrus fruit for distribution to processing plants. During its fiscal year ended September 30, 1965, petitioner discovered that an employee had embezzled substantial sums of money over a period of years extending at least from 1958 through 1965. Petitioner had hired the employee as a bookkeeper at the time the corporation was organized in November 1956. He was authorized, among other things, to write checks, to place them before a corporate officer for signature, and to record expenditures in the corporate books of account. In this capacity he prepared checks to pay for fruit purchases. Commencing at least with a check dated January 20,1958, and continuing at least through January 11, 1965, the employee caused checks to be drawn on petitioner’s bank account to J. C. Jackson, a fictitious name used by the employee. The employee deposited the checks in a local bank to an account styled J. C. Jackson, which was in reality owned by him, and he ultimately received the proceeds of the checks. The checks to J. C. Jackson were reflected on petitioner’s books as payments for fruit purchases. In fact, no fruit was ever purchased from J. C. Jackson or the employee and none was at any time physically included in petitioner’s inventory. On its income tax returns for the fiscal years ended September 30,1958, through September 30, 1965, petitioner reflected fruit purchases, in computing its costs of goods sold and/or cost of operations, as follows: Fiscal year Amount Fiscal year Amount 1958 _ $5,921,077 1962 _ $8,489,741 1959 _ 12,680,523 1963 _ 6,892,574 1960 _ 8,774,972 1964 _ 14,556,888 1961 _ 12,120,781 1965 _ 9,783,091 The checks to J. C. Jackson were included in these amounts, with the exception of the 1965 fiscal year on which return petitioner claimed the entire embezzlement loss as a deduction under section 165,1.R.C. 1954.1  As a result of including the checks to J. C. Jackson in its cost of goods sold and/or in its cost of operations, petitioner’s gross income for each taxable year involved was understated by the amount of the checks drawn in each of such years, and its taxable income was similarly understated in each of such years. The amounts known to have been embezzled in each of petitioner’s fiscal years 1958 through 1965 are as follows: Fiscal year Amount Fiscal year Amount 1958 _ $49,750.00 1962 _ $103,250.00 1959 _ 107,150.00 1963 _ 100,087.50 1960 _ 111,750.00 1964 _ 165,625.00 1961 _ 132,750.00 1965 _ 101,850.00 $872,212.50 Additional amounts may or may not have been embezzled from petitioner. Of the total amount of $872,212.50 known to have been embezzled, petitioner recovered from the employee the amount of $254,595.98 during its 1965 fiscal year. On its income tax return filed for the fiscal year 1965, petitioner claimed as a deduction an embezzlement loss in the amount of $605,116.52, computed as follows: Fiscal year Amount of loss 1968_ $37,250.00 1959_ 107,150.00 1960_ 111,750.00 1961_ 132,750.00 1962_ 103,250.00 1963_ 100,087.50 1964— 165,625.00 1965— 101,850,00 Total_ 859,712.50 Less recovery 254,595.98 Loss claimed. 605,116.52 The amount of loss so claimed corresponds with the amount of the aforementione'd checks except for the fiscal year 1958. For that year the checks totaled $49,750 rather than the amount of $37,250 as set out on petitioner’s return filed for its 1965 fiscal year. This is a difference of $12,500 and is represented by check number 1515 in that amount issued on March 3, 1958, to J. C. Jackson. The embezzlement loss for the 1965 fiscal year was not added to petitioner’s cost of goods sold in that year but rather was claimed as a deduction under section 165. The return filed by petitioner for its 1965 fiscal year reflected a net operating loss in the amount of $383,923.65. Of this amount, $17,567 was deducted as a net operating loss carryback to its 1962 fiscal year; $118,490 was deducted as a net operating loss carryback to its 1963 fiscal year; and $247,867 was deducted as a net operating loss carryback to its 1964 fiscal year. In a prior statutory notice of deficiency issued to petitioner on November 6, 1970, with respect to the fiscal years ended September 30, 1962, to September 30, 1965, inclusive, respondent determined that the deduction of $605,116.52, claimed as an embezzlement loss on petitioner’s return filed for its 1965 fiscal year was not allowable to the extent of $388,900. The amount disallowed by respondent was attributable to embezzlements in the following fiscal years and in the following amounts: Fiscal year Amount Fiscal year Amount 1958_ $37,250 1960_$111,750 1959_ 107,150 1961_ 132,750 $388,900 These are the years and amounts involved in the instant proceeding. At the time respondent issued his prior statutory notice of deficiency, he was barred by section 6501 from assessing and collecting additional income taxes for petitioner’s fiscal years 1958 through 1961, except insofar as sections 1311 through 1315 might have been applicable. On January 28, 1971, petitioner filed a timely petition with this Court seeking a redetermination of respondent’s determination. The petition and proceeding were assigned docket No. 692-71. The opinion of this Court in that matter was filed on December 29, 1972, and is reported at 59 T.C. 516 (1972). The decision therein, allowing the deduction for the embezzlement loss, was entered on February 2,1973; the appeal period expired on May 3, 1973, and no appeal was taken from such decision. Thus, that decision became final on May 3,1973. The final decision entered by this Court in B. C. Cook & Sons, Inc., 59 T.C. 516 (1972), represents a “determination” within the meaning of section 1313(a)(1). Respondent’s statutory notice determining the deficiencies in income taxes against petitioner for the fiscal years ended September 30,1958, through September 30, 1961, which are involved here, was sent to petitioner by certified mail on November 15, 1973, which date was prior to the expiration of the 1-year period of limitations set forth in section 1314(b). If sections 1311 through 1315 are applicable to permit assessment and collection of the deficiencies in income taxes for the fiscal years 1958 through 1961, the deficiencies as determined by respondent in his statutory notice dated November 15,1973, are computed correctly in accordance with section 1314(a), based on the known embezzlements set forth above. On February 11, 1974, petitioner filed a petition with this Court seeking a redetermination of respondent’s determination with respect to its fiscal years 1958 through 1961, inclusive. On September 10, 1974, respondent filed a Motion for Summary Judgment pursuant to Rule 121, Tax Court Rules of Practice and Procedure. On October 18,1974, petitioner filed a response to respondent’s Motion for Summary Judgment opposing the granting of said motion and requesting that a hearing be set. The hearing was held on December 2,1974. The facts may be briefly summarized. From 1958 through 1965 one of petitioner’s employees embezzled from it substantial sums of money by writing checks for fictitious fruit purchases. Petitioner’s cost of goods sold was correspondingly overstated,. and its gross income and taxable income were correspondingly understated for each of the fiscal years herein involved. In 1965 the scheme was discovered and petitioner claimed the embezzlement losses as a deduction under section 165(a) and (e). Our earlier decision in B. C. Cook & Sons, Inc., 59 T.C. 516 (1972), allowed the deduction. On November 15, 1973, respondent mailed his statutory notice of deficiency for the fiscal years 1958, 1959,1960, and 1961. On that date he was barred from assessing and collecting any additional taxes by section 6501, except as may be provided by sections 1311 through 1314. Section 1311(a) provides: (a) General Rule. — If a determination (as defined in section 1313) is described in one or more of the paragraphs of section 1312 and, on the date of the determination, correction of the effect of the error referred to in the applicable paragraph of section 1312 is prevented by the operation of any law or rule of law, * * * then the effect of the error shall be corrected by an adjustment made in the amount and in the manner specified in section 1314. Section 1311(b) sets forth conditions necessary for an adjustment. Subparagraph (1) permits an adjustment only if the party who was successful in the “determination” maintained a position inconsistent with the erroneous treatment which position was adopted in the “determination.” The parties agree that our prior decision in B. C. Cook & Sons, Inc., supra, is a “determination” on the date of which correction of the overstatements in cost of goods sold in 1958, 1959, 1960, and 1961 was barred by section 6501. The controverted points are (1) whether the facts presented fall within any of the circumstances described in section 1312, and (2) whether petitioner has maintained an inconsistent position. Our resolution of the former makes it unnecessary to decide the latter issue. Respondent’s position is that section 1312(2) encompasses the factual setting before us.2 He argues that the legislative history demonstrates that Congress intended the words, “double allowance of a deduction or credit” in section 1312(2) to include any position taken by a taxpayer which would result in a double reduction of tax. He urges that a broad interpretation is necessary to effectuate the purpose of the mitigation provisions. Respondent relies heavily on the following statement appearing in the report of the Senate Finance Committee, S. Rept. No. 1567,75th Cong., 3d Sess. (1938), 1939-1 (Part 2) C.B. 779,815: The legislation here proposed is based upon the following principles: [[Image here]] (2) Subject to the foregoing principles, disputes as to the year in which income or deductions belong, or as to the person who should have the tax burden of income or the tax benefit of deductions, should never result in a double tax or a double reduction of tax, or an inequitable avoidance of tax.[3] He interprets this to mean that the mitigation provisions are designed to encompass any situation involving a double tax benefit. We do not agree. The statement does not even purport to deal with the concrete circumstances covered by sections 1311 through 1314. It is only one of the general principles upon which those sections are based. The following statement from the conference report, H. Rept. No. 2330, 75th Cong., 3d Sess. (1938), 1939-1 (Part 2) C.B. 817, 835, belies respondent’s interpretation: This amendment provides for mitigation of some of the inequities under the income-tax laws caused by the statute of limitation and other provisions which now prevent equitable adjustment of various income-tax hardships. * * * The Senate amendment was drawn to discourage this practice in specified types of cases by authorizing corrective adjustment.[4] [Emphasis supplied.] A reading of the two statements together convinces us that Congress intended to preclude the possibility of a double tax benefit only in the specific circumstances set forth in section 1312. It is with this in mind that we construe the statute. We conclude that the instant facts are not within the scope of section 1312(2). Concededly, our “determination” in B. C. Cook & Sons, Inc., supra, allowed a deduction for petitioner’s 1965 taxable year. It is not, however, a deduction “which was erroneously allowed to the taxpayer for another taxable year.” In the fiscal years involved, petitioner erroneously overstated its cost of goods sold and consequently understated its gross income and taxable income. It is true that the same result would have obtained had petitioner erroneously claimed an itemized deduction for cost of goods sold. However, there is a crucial distinction between the treatment of either basis or cost of goods sold and deductible expenses. Both basis and cost of goods sold are offsets employed in the computation of gross income, section 1001(a); sec. 1.61-3(a), Income Tax Regs. Itemized deductions, on the other hand, are subtracted from gross income in arriving at taxable income. In Estate of Walter E. Dorn, 54 T.C. 1651 (1970), this Court recognized the importance of this fundamental distinction. In interpreting the meaning of the word “deduction” in section 642(g) we stated: Respondent contends here, as he did in Bray, that there is no distinction in operation and effect between an offset and deduction warranting the variant treatment given them in Bray. Both the offset and statutory deduction serve to reduce the gain realized or increase losses sustained. Thus, respondent argues, the policy underlying section 642(g), which is the denial of a double advantage from deductions available with respect to both income and estate taxes, is equally applicable to offsets and deductions. * * * While the offset and deduction bear the similarity suggested by respondent, they differ markedly in character and tax treatment. As pointed out in Bray, selling expenses are fundamentally capital expenditures akin to those which are added to the cost of property. As such they are not deductible but may be utilized only as a reduction of the sales proceeds. * * * Furthermore, offsets, as in the case of basis, are taken into consideration in arriving at gross income. Gross income with respect to dealings in property is defined as the “gain” from such dealings. Sec. 61(a)(3). The term “gain,” in turn, is described as the amount realized upon sale of the property less its adjusted basis. Selling expenses, whether viewed as a reduction of the amount realized or an addition to basis, reduce the amount of gain and hence the gross income resulting from the transaction. Statutory deductions, on the other hand, do not affect gross income but are subtracted therefrom in determining taxable income. Respondent, in seeking to include offsets within the term “deduction” in section 642(g), ignores the fundamental distinctions outlined above. Such distinctions are not mere matters of form. Failure to take account of basis or offset in determining gross income would, for reasons indicated above, result in the taxation of gross receipts rather than gross income, contrary to the express purpose and statutory scheme of the Code. Moreover, the nontaxability of selling expenses in the present situation results from the absence of statutory provisions requiring their inclusion in gross income rather than from the deductibility of such expenses as in the case of true deductions. Congress, in its enactment of section 642(g), evidenced an intent to deny “deductions,” often referred to as matters of legislative grace, rather than offsets which cannot be so classified. * * * [Fn. refs, omitted. Estate of Walter E. Dorn, 54 T.C. 1651, 1654, 1655 (1970).] This distinction was also recognized by the Ninth Circuit Court of Appeals in Curtis Gallery & Library, Inc. v. United States, 388 F. 2d 358 (9th Cir. 1967). In holding therein that an overstatement of gross income was not the equivalent of a deduction within the meaning of section 1312 the court stated at page 361: During the proceedings in the trial court, the government suggested that paragraph (4) might apply, and the trial court accepted the suggestion. Before us, both the government and the taxpayers say that the paragraph does not apply. They are right. Paragraph (4) reads: “(4) Double disallowance of a deduction or credit. — The determination disallows a deduction or credit which should have been allowed to, but was not allowed to, the taxpayer for another taxable year, or to a related taxpayer.” Here, the Commissioner did disallow the taxpayers’ claimed deduction for 1956. But, as applied to the earlier years, there is not here involved either a deduction or a credit that should have been allowed in any of those years. Throughout the code, deductions are referred to as amounts paid or incurred by the taxpayer that may be subtracted from gross income in order to arrive at taxable income. See, e. g., sections 161-182, 211-217. The Commissioner did not disallow any deductions in prior years. He merely accepted the taxpayers’ own overstatement of their income. A correction of that error would not have been the allowance of a deduction. * * * See also Estate of Viola E. Bray, 46 T.C. 577 (1966); J. T. Bridges, 64 T.C. 968 (1975). The mitigation provisions are extremely complex and are written with great precision. “Deduction” appears several times in section 1312, but nowhere is it used in connection with errors relating to gross income. Rather, the terms “inclusion,” “exclusion,” and “omission,” are used to describe such errors. We also note that the language of section 1312(2) parallels the language of section 161 which reads: “In computing taxable income under section 63(a), there shall be allowed as deductions the items specified in this part.” (Emphasis supplied.) Where a phrase is used in different parts of the same statute it will be presumed to have the same meaning throughout. Atlantic Cleaners & Dryers, Inc. v. United States, 286 U.S. 427 (1932); Commissioner v. Ridgway’s Estate, 291 F. 2d 257, 259 (3d Cir. 1961). It is apparent that Congress used the word “deduction” as a term of art. This proves to us that Congress intended “deduction” in section 1312(2) to include deductions from gross income in arriving at taxable income and only that. In James Bremen, 20 T.C. 495 (1953), this Court was presented a similar situation in sections 1311 through 1315 context. The taxpayer had purchased bonds in 1944 which he sold in 1945. He claimed a deduction in 1944 for amortizable bond premium, made a downward adjustment in basis, and reported a corresponding increase in gain on the sale of the bonds in 1945. The respondent reversed these steps, determined a deficiency for 1944, and granted a refund for 1945. The taxpayer accepted the refund, which was premised on the increased 1945 basis, and successfully contested the 1944 deficiency in this Court. The respondent then determined a deficiency for 1945, the assessment and collection of which were barred, except for section 3801, I.R.C. 1939. He argued for the applicability of section 3801(b)(2), I.R.C. 1939, which is substantially identical to section 1312(2). We held that, “the amount of the deduction was a factor in adjusting the basis of the bonds for the purpose of determining the taxable gain on their sale in 1945, but that is a different matter from claiming ‘a deduction’ in 1945.” James Brennen, supra at 500.5 See also Harry Landau, 21 T.C. 414 (1953). In Max Schulman, 21 T.C. 403 (1953), the facts were identical to those involved in James Brennen, supra. Respondent made the argument that section 3801(b)(3), I.R.C. 1939, was applicable.6 In further explication of our position we said: Respondent, in invoking subsection (b)(3), argues that a deduction from gross income is equivalent to an exclusion from gross income for the purposes of subsection (b)(3). The respondent cites no authority in support of this novel contention, and, in our opinion, it is without merit. [Max Schulman, 21 T.C. 403, 407(1953).] These cases give recognition to the statutory scheme of the Code and the fundamental differences therein between the tax treatment of either basis or cost of goods sold and itemized deductions. The precise terminology of section 1312 makes clear that Congress is cognizant of this distinction. This awareness is further demonstrated by sections 6501(e)(l)(A)(i)7 and 1382(a).8 Had Congress intended section 1312(2) to include reductions in arriving at gross income it would have so indicated in clear, unambiguous terms. Absent such a statement, we are convinced that the word “deduction” in section 1312(2) refers only to deductions subtracted from gross income in arriving at taxable income. It may be fairly said that petitioner has not turned the appropriate square corner with its Government. It has availed itself of a situation which slips between the statutory cracks to gain án unwarranted tax advantage. Nonetheless, it is entitled to our unprejudiced interpretation of the law in issue. An appropriate order will be issued denying respondent’s Motion for Summary Judgment and petitioner is invited to submit such a motion on its own behalf. Reviewed by the Court. Featherston, J., did not participate in the consideration or disposition of this case.   All statutory references are to the Internal Revenue Code of 1954, as amended, unless otherwise indicated.    SEC. 1312. CIRCUMSTANCES OF ADJUSTMENT. The circumstances under which the adjustment provided in section 1311 is authorized are as follows: [[Image here]] (2) Double allowance of a deduction or credit — The determination allows a deduction or credit which was erroneously allowed to the taxpayer for another taxable year * * *    This is the Senate report accompanying sec. 820 of the Revenue Act of 1938, 52 Stat. 581, which contained the first mitigation provisions. The language of sec. 820(b)(2) of that Act is substantially identical to that of sec. 1312(2).    This is the conference report accompanying sec. 820 of the Revenue Act of 1938, 52 Stat. 581.    Congress has implicitly expressed approval of our decision in James Brennen, 20 T.C. 495 (1953). Subsequent to that decision several substantive changes were made expanding the circumstances encompassed by sec. 1312. No change was made, however, expanding the scope of sec. 1312(2) to reach the facts of that case.   SEC. 3801. MITIGATION OF EFFECT OF LIMITATION AND OTHER PROVISIONS IN INCOME TAX CASES. (b) Circumstances of Adjustment. — When a determination under the income tax laws— * * * (3) Requires the exclusion from gross income of an item with respect to which tax was paid and which was erroneously excluded or omitted from the gross income of the taxpayer for another taxable year or from the gross income of a related taxpayer; or * * *    SEC. 6501(e). Substantial Omission of Items — Except as otherwise provided in subsection (c)— (1) Income taxes. — In the case of any tax imposed by subtitle A— (A) General rule. — If the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 percent of the amount of gross income stated in the return, the tax may be assessed, or a proceeding in court for the collection of such tax may be begun without assessment, at any time within 6 years after the return was filed. For purposes of this subparagraph— (i) In the case of a trade or business, the term “gross income” means the total of the amounts received or accrued from the sale of goods or services (if such amounts are required to be shown on the return) prior to diminution by the cost of such sales or services; * * *    SEC. 1382. TAXABLE INCOME OF COOPERATIVES. (a) Gross Income. — Except as provided in subsection (b), the gross income of any organization to which this part applies shall be determined without any adjustment (as a reduction in gross receipts, an increase in cost of goods sold, or otherwise) by reason of any allocation or distribution to a patron out of the net earnings of such organization or by reason of any amount paid to a patron as a per-unit allocation (as defined in section 1388(f)).