Court Opinion

ID: 4624202
Source: CourtListenerOpinion
Date Created: 2020-11-21 02:54:39.873131+00
Date Added: 2024-06-11T07:56:29.297838
License: Public Domain

RUSSELL G. FINN AND MARGARET A. FINN, EXECUTRIX OF THE ESTATE OF JOHN FINN, DECEASED, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.Finn v. CommissionerDocket No. 9309.United States Board of Tax Appeals22 B.T.A. 799; 1931 BTA LEXIS 2064; March 18, 1931, Promulgated *2064 John P. O'Hara, Esq., for the petitioners.  Arthur Carnduff, Esq., for the respondent.  VAN FOSSAN *799  The petitioners seek a redetermination of the deficiencies and overassessments in income taxes determined by the respondent for 1920 and 1921.  In the case of Russell G. Finn the respondent determined a deficiency of $6,175.32 for 1920 and an overassessment of $830.93 for 1921.  In the case of John Finn the respondent determined a deficiency of $6,175.32 for 1920 and an overassessment of $318.49 for the year 1921.  By proper order Margaret A. Finn, Executrix of the Estate of John Finn, was substituted for the petitioner, John Finn, deceased.  The question raised by the pleadings is the amount of net income derived by the partnership, of which the petitioners were members, from two certain long-term contracts.  Evidence was presented by the petitioners at the hearing as to a further issue relating to the disallowance of an alleged bad debt of $13,200, due from the city of Detroit.  This issue was not raised in the pleadings, and as it is disregarded and not considered in the brief filed in petitioners' behalf, we assume that it has been abandoned. *2065  In any event, the Board is without jurisdiction to consider issues not properly raised in the pleadings.  See , and cases therein cited. FINDINGS OF FACT.  During 1920 John Finn and his son, Russell G. Finn, were equal partners in the firm of John Finn and Son.  The partnership was engaged in a general contracting business in the city of Detroit, Mich.  From the inception of the business and until 1920, it was the accounting practice of the partnership not to recognize or make a formal accounting on its books for the gain or loss on a particular contract job until the job was completed.  Upon the completion of each job the difference between the total costs incurred and the total compensation received, representing gain or loss, was transferred to profit and loss account.  In 1920 the partnership was engaged in construction work on about twelve contract jobs.  As to all but two of these jobs, the compensation provided by contract was a fixed amount or lump sum.  The partnership's accounting for the receipts and expenditures of *800  all but the two excepted jobs was consistent with its prior accounting practice; that is*2066  to say, the gain or loss on each job, with two exceptions, was accounted for only when the job was completed.  The two exceptions are the job known as the Municipal Tuberculosis Sanitarium at Northville, Mich., constructed under contract with the city of Detroit, and hereinafter referred to as the Northville job and the job known as the Oakland Hills Country Club buildings, hereinafter referred to as the Oakland Hills job.  The contract for the Northville job contains the following provisions relating to compensation: ARTICLE 3.  The owner agrees to pay the Contractor for the services which the Contractor agrees to perform under this contract, a fee equal to seven percent of the total cost of the work which, with said total cost, shall be due and payable in seven day installments as nearly as possible in compliance with city practice, as evidenced by approved statements of the Contractor.  The Contractor guarantees that the cost of the work, including his fee, shall not exceed One Million Four Hundred Sixty Thousand, Eight Hundred Dollars ($1,460,800.00) exclusive of fixed allowances.  In the event of the cost of the complete work exceeding the Contractor's guaranteed estimate, *2067  there shall be deducted from the Contractor's fee an amount equal to 15% of such excess.  * * * ARTICLE 11.  In the event of a deduction for overrun of the guaranteed estimate of One Million Four Hundred Sixty Thousand Eight Hundred Dollars (1,460,800.00) the regular rate of percentage (7%) shall be added to the gross cost of construction, then 15% of the amount of the net overrun shall be deducted for the overrun, plus the Contractor's fee.  The contract for the Oakland Hills job contains the following provisions relating to compensation: ARTICLE 2.  The Owner agrees to pay the Contractor for the services which the Contractor agrees to perform under this contract, a fee equal of 10% of the total gross cost of the work which will said total gross cost, shall be due and payable upon the request of the Contractor, as evidenced by approved statements of the Contractor.  The Contractor guarantees that the cost of the work, including his fee, shall not exceed the sum of TWO HUNDRED SEVENTY FIVE THOUSAND DOLLARS ($275,000.00).  In the event of the cost of the completed work exceeding the Contractor's guaranteed estimate, there shall be deducted from the Contractor's fee an amount*2068  equal to 25% of such excess.  In the event of a deduction for over-run, the deduction shall be made as follows: To the total gross cost of the work the Contractor shall add an amount equal to 10% of such gross cost.  Then from the actual gross cost of the work (exclusive of the fee) then shall be deducted the amount of the guaranteed estimate ($275,000.00).  The remainder of this subtraction shall constitute the over-run.  25% of this over-run shall be deducted from the Contractor's fee.  It will thus be established that the Contractor shall receive as compensation for the execution of the above mentioned building, the total gross cost of the work plus a fee of 10%, less 25% of the over-run as computed by the above method.  *801  The contracts for the Northville and Oakland Hills jobs were the first of their kind entered into by the partnership.  Under all prior contracts, the partnership received a fixed price or lump sum, as compensation, while these two contracts provided for compensation upon the basis of total cost plus a fee representing stated percentages of total cost, less, in each case, a higher percentage of the excess over the guaranteed maximum total cost.  It*2069  was the desire of the partners that the accounting for the gains or losses on these two jobs should conform with their accounting practice as to all other jobs, that is to say, that no gain or loss on either of these two jobs be recognized or accounted for until the job was completed, and instructions to that effect were given to the bookkeeper.  During 1920, the partnership received fees for work completed on the Northville and Oakland Hills jobs, in the amounts of $75,537.06 and $28,047.13, respectively.  These fees were credited on the books to a new account denominated "Gross Profits from Contracts." At the close of the year it was believed by the partners that the total cost of each of these jobs would exceed the gauranteed maximum cost in the contract.  Based upon known costs incurred to date and estimated costs to complete both jobs, it was estimated that the total amount which would be deducted from the total fees under the two contracts would be not less than $75,000 and perhaps more than $90,000.  Accordingly, there was set up on the books a "Reserve for Overrun" of $90,000 to take care of the estimated deductions.  Based upon the proportion of expenses for labor and*2070  materials incurred to date to the estimated total expenses necessary for full performance of the contracts, the Northville job was approximately 90 per cent completed and the Oakland Hills job was 78.82 per cent completed, at December 31, 1920.  The Northville and Oakland Hills jobs were completed in 1921.  In each case the total cost of construction, including contractor's fee, exceeded the guaranteed maximum cost in the contract.  The amounts charged back to the partnership as deductions from the fees computed according to the contracts on account of exceeding the guaranteed maximum costs, were $26,200.05 in the case of the Northville job, and $29,188.14 in the case of the Oakland Hills job.  The partnership filed a return for 1920 on Form 1965.  It was the intent and purpose of the partnership, in making the return, to compute the income from the Northville and Oakland Hills jobs on the completed-contract basis, in conformity with the method employed in computing the income from all other contract jobs.  It included in gross income total fees received for the Northville and Oakland Hills jobs, amounting to $103,584.19, less $90,000 set aside *802  to the "Reserve for Overrun, *2071  " or a net amount of $13,584.19.  The total gross income reported from all contract operations, including the Northville and Oakland Hills jobs, amounted to $86,501.97.  The net income shown by the return was $49,362.49.  Russell G. Finn and John Finn filed returns for 1920, in which each reported a distributive share in the net income of the partnership of $24,681.24.  In 1924 the books of the partnership were examined by a revenue agent, and in a report bearing date of June 5, 1924, covering the tax liability of John Finn for 1920, the agent, without stating his reasons therefor, increased the distributive share of that individual in the partnership net income from $24,681.24, shown in his return, to $81,007.13.  In a supplemental report bearing date of August 11, 1925, the same agent, without stating his reasons therefor, reduced the said John Finn's distributive share in the partnership net income from $81,007.13, shown in his first report, to $49,977.20 and recommended the assessment of an additional tax of $6,175.32, the amount of the deficiency determined in the deficiency notice to that individual.  In the case of Russell G. Finn, the respondent also determined a deficiency*2072  of $6,175.32, without setting forth the basis therefor in the deficiency notice.  It was stipulated at the hearing "that the gross income for 1920 as reported by the petitioner on his income tax return is correct and was accepted by the Government; and the deficiency is based solely on the disallowance of the item of $90,000 reserve." OPINION.  VAN FOSSAN: The respondent having determined an overassessment for 1921 in the case of both petitioners, the Board is without jurisdiction to determine any issue raised for that year.  . Accordingly, the petition, so far as it relates to 1921, is dismissed.  The petitioners contend that in computing the income of the partnership from the Northville and Oakland Hills jobs, the full amount of $90,000 set aside as a "Reserve for Overrun" should be allowed as an offset against the fees received on those jobs; or, in the alternative, that the income of the partnership from the Northville and Oakland Hills jobs should be redetermined on the completed contract basis, in accordance with article 36 of Regulations 45.  The respondent contends that a portion of the reserve represents a contingent*2073  liability which can not properly be taken into consideration in computing the income of the partnership.  The respondent makes no defense to the petitioners' alternative contention.  We omit consideration of the first contention advanced by the petitioners to consider the alternative one, because we believe that *803  in the latter lies the proper solution of the issue.  An individual taxpayer who is a member of a partnership must return as income his distributive share in the partnership net income, section 218(a), Revenue Act of 1918; and the partnership net income must be determined in accordance with the method of accounting regularly employed in keeping the partnership books.  Sections 218(d) and 212, Revenue Act of 1918; . The respondent's regulations permit the computation of income from long-term contracts upon the completed-contract basis.  Article 26.  Regulations 45.  The completed-contract basis of computing income clearly reflects the income from long-term contracts.  *2074 ; ; and ; and when the taxpayer's books are regularly kept upon the completed-contract basis, income must be computed on the same basis, for the purposes of the income tax.  ; and Except for the Northville and Oakland Hills jobs, the accounting for all contract operations of the partnership was made on the completed-contract basis.  It was not the intention of the partners that the accounting for the Northville and Oakland Hills jobs should differ, in any respect, from the method followed as to all other jobs; on the contrary, it was their wish, expressly communicated to the bookkeeper, that the accounting for the gains or losses on these two jobs should conform with the accounting practice as to all other jobs.  Technically, it did not so conform, because there was an accounting made for the fees, as gains, prior to the completion of the contracts; but the reason for this, according to the bookkeeper's testimony, was his lack of experience and*2075  of knowledge of what was required in the way of book entries, considering the peculiar compensation provisions of the two contracts.  He had never before made an accounting for operations carried on under contracts which contained similar provisions as to guaranteed maximum costs and reduced fees in the event such guaranteed costs were exceeded.  He believed, when he set up the "Reserve for Overrun" of $90,000 to take care of the estimated deductions which would be made from the fees provided in the two contracts on account of exceeding the guaranteed costs, that the accounting for those jobs conformed with the method otherwise used in keeping the books.  In that he was mistaken.  But his error, due to inexperience, can not alter the accounting method otherwise regularly employed in keeping the partnership books.  The partnership having kept its books upon the completed-contract basis, the statute requires that its net income shall be computed upon the same basis.  On this basis, gains and losses derived from long-term *804  contracts are to be included in income only when the jobs are completed.  Since the Northville and Oakland Hills jobs were not completed until 1921, any*2076  gains in respect of those jobs should be eliminated from the income for 1920.  Obviously, it follows that any portion of the "Reserve for Overrun" which has been allowed by the respondent, either as a deduction or as an offset against income for 1920, should be eliminated from the computation of net income.  Judgment will be entered under Rule 50.