Opinion
Docket No. 105040.
1943-01-26
W. F. TRIMBLE AND SONS COMPANY, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Walter W. McVay, Esq., for the petitioner. Charles Oliphant, Esq., for the respondent.
1. The petitioner, engaged in long term contracts, kept its books and prepared its Federal income tax returns upon a basis of billing clients, in most cases, in accordance with engineers' determinations of percentage of work completed, and deducting therefrom expenses actually incurred. Compensating adjustments were made in the year of completion of contract. Held, that petitioner's method clearly reflected income and that the statute of limitation had run, as to one taxable year, upon the assessment made.
2. Held that petitioner has not shown error in computation of depreciation. Walter W. McVay, Esq., for the petitioner. Charles Oliphant, Esq., for the respondent.
This proceeding involves income tax for the calendar years 1935 and 1936, respondent having determined deficiencies in the sums of $2,747.16 and $1,060.29 for the two years respectively. The issues presented are whether the petitioner reported its gross profits on long term contracts so as to reflect clearly its net income arising thereunder for the years in question; whether petitioner claimed excessive depreciation allowances; and whether assessment of the deficiency asserted for the year 1935 is barred by the statute of limitations.
FINDINGS OF FACT.
During the taxable years in question petitioner, a corporation organized under the laws of the State of Pennsylvania, was a general contractor engaged in the construction business. Its Federal income tax returns for the years 1935 and 1936 were filed with the collector of internal revenue for the twenty-third district of Pennsylvania, at Pittsburgh.
When a long term contract was obtained, it was petitioner's practice to set up a separate account for that contract. Expenses or charges incurred in connection with such contract were entered in the account relating to that contract under the heading ‘cost.‘ Bills sent out to the customer were entered in the same account under the heading ‘billings.‘ Overhead expenses, such as office salaries, were separately considered as expenses, and claimed as business expenses in the returns.
At the close of each of the taxable years there existed unbilled charges against customers which were allocable, under petitioner's accounting practice, to the year so closed. This was due to a lag of from a few days to not more than thirty days between the time of the inception of such charges and the time when the bills were made up and mailed. Book entries of such delayed billings, however, were made for the year in which the charges arose, without regard to time of billing.
In computing its gross profit on a long term contract, petitioner deducted the sum of all entries under the heading ‘cost‘ from the sum of all entries under the heading ‘billings,‘ as of the last day of the calendar year. The difference between the sum of all accounts showing profit and all accounts showing loss was returned as net profit or loss, as the case might be, on long term construction contracts.
The petitioner adopted this accounting method in 1920 and has prepared its income tax returns in accordance therewith, consistently, since that time.
The amount of petitioner's billings against a particular customer depended upon the terms of the contract. On large contracts billings were made, in most cases, in accordance with engineers' determinations of percentage of work completed; in the case of other contracts, different systems, not described by either party, were followed. The figures used were not always obtained from the engineers. In no case did architects' or engineers' certificates showing the percentage of completion during the taxable year of the entire work to be performed accompany the petitioner's income tax returns.
Accounts in petitioner's books in which cost and/or billings entries were made for the years 1935 and 1936, and the amounts of the entries for all years in which these accounts were carried, are shown in the following table, together with a summary showing the totals of all cost and billings entries, and the ultimate excess of the one over the other with respect to each account herein involved:
+-----------------------------------------------------------------------------+ ¦SUMMARY ¦ +-----------------------------------------------------------------------------¦ ¦ ¦1933 ¦1934 ¦ +-------------------------------+---------------------+-----------------------¦ ¦ ¦Cost ¦Billings ¦Cost ¦Billings ¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦Heinz Memorial Chapel ¦$76,477.10¦$68,383.03¦$371,501.97¦$378,533.05¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦Pittsburgh Joint Stock Yds. Co ¦ ¦ ¦21,387.49 ¦21,094.73 ¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦Allegheny County Home—Woodbine ¦ ¦ ¦ ¦ ¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦Fort Pitt Bedding Co. boiler ¦ ¦ ¦30,522.72 ¦35,000.00 ¦ ¦room r* ¦ ¦ ¦ ¦ ¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦Fort Pitt Bedding Co. ¦ ¦ ¦ ¦ ¦ ¦(addition) ¦ ¦ ¦ ¦ ¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦Foster Memorial Bldg ¦ ¦ ¦ ¦ ¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦Farmers Bank Bldg. alterations ¦ ¦ ¦ ¦ ¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦Steel City Elec. Co ¦ ¦ ¦ ¦ ¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦Jones & Laughlin Steel res. lab¦ ¦ ¦ ¦ ¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦Pennsylvania Railroad banana ¦ ¦ ¦ ¦ ¦ ¦warehouse ¦ ¦ ¦ ¦ ¦ +-------------------------------+----------+----------+-----------+-----------¦ ¦United Engineering & Fdry. Co. ¦ ¦ ¦ ¦ ¦ ¦(fire wall) ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
1935 1936 Cost Billings Cost Billings Heinz Memorial Chapel $74,493.81 $79,705.06 $12,367.47 $13,128.76 Pittsburgh Joint Stock Yds. Co 14,697.45 15,578.04 196,916.25 204,359.60 Allegheny County Home—Woodbine 873,421.70 860,475.82 467,296.75 513,186.37 Fort Pitt Bedding Co. boiler room Fort Pitt Bedding Co. (addition) 73,161.12 77,100.00 Foster Memorial Bldg 256,140.36 248,534.75 133,695.60 118,954.65 Farmers Bank Bldg. alterations 213,993.47 210,024.34 Steel City Elec. Co 21,210.84 25,262.87 Jones & Laughlin Steel res. lab 24,654.26 26,537.20 Pennsylvania Railroad banana 883.33 warehouse United Engineering & Fdry. Co. 6,486.79 9,280.00 (fire wall)
1937 1938 Cost Billings Cost Billings Heinz Memorial Chapel $2,425.35 $3,001.57 $6,136.44 Pittsburgh Joint Stock Yds. Co 205,112.69 $232,736.19 98.61 1,801.45 Allegheny County Home—Woodbine 1,367.64 1,935.09 Fort Pitt Bedding Co. boiler room Fort Pitt Bedding Co. (addition) Foster Memorial Bldg 24,886.91 46,202.60 1.73 Farmers Bank Bldg. alterations 8,883.31 29,176.10 Steel City Elec. Co 2,798.81 1,401.42 Jones & Laughlin Steel res. lab 11,500.86 8,320.17 Pennsylvania Railroad banana 8,075.88 10,806.94 warehouse United Engineering & Fdry. Co. (fire 186.53 wall)
+-----------------------------------------------------------------------------+ ¦ ¦Summary ¦ +------------------------------------+----------------------------------------¦ ¦ ¦Cost ¦Billings ¦Profit or ¦ ¦ ¦ ¦ ¦loss ¦ +------------------------------------+--------------+------------+------------¦ ¦Heinz Memorial Chapel ¦ ¦$540,267.27 ¦$545,886.34 ¦$5,619.07 ¦ +------------------------------------+-+------------+------------+------------¦ ¦Pittsburgh Joint Stock Yds. Co ¦ ¦438,212.49 ¦475,570.01 ¦37,357.52 ¦ +------------------------------------+-+------------+------------+------------¦ ¦Allegheny County Home—Woodbine ¦ ¦1,342,086.09¦1,375,598.28¦33,511.19 ¦ +------------------------------------+-+------------+------------+------------¦ ¦Fort Pitt Bedding Co. boiler room ¦)¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ +------------------------------------+-+------------+------------+------------¦ ¦ ¦)¦103,683.84 ¦112,100.00 ¦8,416.16 ¦ +------------------------------------+-+------------+------------+------------¦ ¦Fort Pitt Bedding Co. (addition) ¦)¦ ¦ ¦ ¦ +------------------------------------+-+------------+------------+------------¦ ¦Foster Memorial Bldg ¦ ¦414,724.60 ¦413,692.00 ¦(1,032.60) ¦ +------------------------------------+-+------------+------------+------------¦ ¦Farmers Bank Bldg. alterations ¦ ¦222,876.78 ¦239,200.44 ¦16,323.66 ¦ +------------------------------------+-+------------+------------+------------¦ ¦Steel City Elec. Co ¦ ¦24,009.65 ¦26,664.29 ¦2,654.64 ¦ +------------------------------------+-+------------+------------+------------¦ ¦Jones & Laughlin Steel res. lab ¦ ¦36,155.12 ¦34,857.37 ¦(1,297.75) ¦ +------------------------------------+-+------------+------------+------------¦ ¦Pennsylvania Railroad banana ¦ ¦8,959.21 ¦10,806.94 ¦1,847.73 ¦ ¦warehouse ¦ ¦ ¦ ¦ ¦ +------------------------------------+-+------------+------------+------------¦ ¦United Engineering & Fdry. Co. (fire¦ ¦6,673.32 ¦9,280.00 ¦2,606.68 ¦ ¦wall) ¦ ¦ ¦ ¦ ¦ +-----------------------------------------------------------------------------+
The petitioner's return for 1935, as to contracts not completed in the taxable year, reflected a loss sustained in the amount of $10,520.77, being the excess of the total of its 1935 cost entries over total billings entries, as set out in the foregoing table. The petitioner's return for 1936, as to contracts not completed in that taxable year, reflected a profit of $43,229.03, the excess of the total of 1936 billings entries over total cost entries.
The respondent determined that petitioner's method of reporting profit or loss on long term contracts was the percentage of completion method, but that petitioner did not report the correct percentages of completion in the taxable years, nor correctly allocate the percentages of all expenditures under the several contracts to the taxable years. He further determined that gross profit or loss on any contract for a particular year should be that percentage of the total ultimate profit or loss which the amount of cost incurred in that year bears to total cost incurred in respect of the whole contract. The following tables reflect profit or loss on each long term contract as reported by petitioner and respondent's adjustments thereto:
+--------------------------------------------------------------+ ¦1935 ¦ +--------------------------------------------------------------¦ ¦ ¦Reported ¦Adjusted ¦ +----------------------------+----------------+----------------¦ ¦Fort Pitt Bedding Co ¦Profit¦$3,938.88¦Profit¦$5,941.81¦ +----------------------------+------+---------+------+---------¦ ¦Allegheny County Home ¦Loss ¦12,945.88¦Profit¦21,815.79¦ +----------------------------+------+---------+------+---------¦ ¦Foster Memorial ¦Loss ¦7,605.61 ¦Loss ¦638.15 ¦ +----------------------------+------+---------+------+---------¦ ¦Heinz Memorial Chapel ¦Profit¦5,211.25 ¦Profit¦775.43 ¦ +----------------------------+------+---------+------+---------¦ ¦Pittsburgh Joint Stock Yards¦Profit¦880.59 ¦Profit¦1,291.35 ¦ +----------------------------+------+---------+------+---------¦ ¦Reported net loss ¦ ¦10,520.77¦ ¦ ¦ +-----------------------------------+---------+------+---------¦ ¦Net profit as adjusted ¦ ¦ ¦29,186.23¦ +-----------------------------------+---------+------+---------¦ ¦Increase in net profit ¦ ¦ ¦39,707.00¦ +-----------------------------------+---------+------+---------¦ ¦ ¦ ¦ ¦ ¦ ¦ +--------------------------------------------------------------+
1936 Reported Adjusted Allegheny County Home Profit $45,889.62 Profit $11,661.89 Farmers Deposit National Bank Loss 3,969.13 Profit 15,670.71 Foster Memorial Loss 14,740.95 Loss 332.50 Heinz Memorial Chapel Profit 761.29 Profit 129.24 Pittsburgh Joint Stock Yards Profit 7,443.35 Profit 17,167.28 Steel City Electric Co Profit 4,052.03 Profit 2,344.05 Pennsylvania R. R. Banana Warehouse Loss 883.33 Loss none United Engineering & Foundry Co Profit 2,793.21 Profit 2,606.68 Jones & Laughlin Steel Corp Profit 1,882.94 Loss 885.07 Reported net profit 43,229.03 Net profit adjusted 48,362.28 Increase in net profit 5,133.25
Respondent determined that the book loss of $883.33 for 1936 on the Pennsylvania Railroad account, resulting from a cost entry in that amount, should be eliminated and the entry transferred to 1937, because the contract was started late in December 1936; and that the 1937 cost entry of $186.53 in the United Engineering & Foundry Co. account should be allocated to 1936, thereby increasing the 1936 cost entry in that amount, for the reason that the contract was started and practically completed in 1936. In computing the ultimate profit on Pittsburgh Joint Stock Yards Co. contract he employed the figure of $19,061.46 as cost incurred in 1934, rather than $21,387.49, the amount of the 1934 cost entry on petitioner's books; he also excluded both cost and billings entries appearing on petitioner's books in 1938, and therefore allocated to each of the taxable years a percentage of a determined ultimate profit of $37,980.71, rather than the ultimate profit of $37,357.52 reflected by the books. All contracts here involved were completed in 1937 except Heinz Memorial Chapel and Pittsburgh Joint Stock Yards, which were completed in 1938. In 1937 the gross income was, on the Commissioner's theory, overstated to offset the insufficient profits or losses taken into the years 1935 and 1936.
The Allegheny contract was closed in 1937 at a profit of $33,511.19. The Foster Memorial contract was closed in 1937 at a loss of $1,032.60. The Allegheny contract was about two-thirds completed in 1935 and the Foster Memorial contract was over 60 percent completed in that year. The Farmers Deposit National Bank contract was 96 percent completed in 1936, and was closed at a profit of $16,323.66. The Pittsburgh Stock Yards contract was about 45 percent completed in 1936. The Heinz Memorial Chapel contract was completed in 1938 at a total profit of $5,619.07.
In its return for the taxable year 1935 the petitioner claimed the sum of $880.31, and for the taxable year 1936 the sum of $1,715.67, as deductions for depreciation on its automotive and construction equipment. It used the general rate of 33 1/3 percent in computing its depreciation on these assets. The respondent has determined that total depreciation allowable for 1935 is $306.48, and for 1936 is $1,252.81, and has adjusted petitioner's reported net income for the two years accordingly.
The petitioner had purchased a boom for a steam shovel in 1932 for $1,980.75; had attached it to a shovel purchased in 1929; and had discontinued use of that equipment in 1937.
The respondent determined that 25 percent was the allowable rate of depreciation on petitioner's automotive equipment, with the exception of one International truck, as to which he determined that 20 percent was the proper rate; and that 16 2/3 percent was the rate properly applicable to physical equipment used in construction work, with the exception of the steam shovel boom purchased in 1932, with respect to the undepreciated balance of which he determined that the rate of 25 percent should apply.
The petitioner's income tax return for the taxable year 1935 was filed on March 16, 1936. It reported under the heading ‘Gross Income‘ a ‘total income‘ of $94,256.77. Item 6 under the heading ‘Gross Income‘ is labeled ‘Gross Profit where inventories are not an income-determining factor (Building Account).‘ The petitioner reported that item as $68,347.75. The respondent determined that that item should be increased by $39,707; and that petitioner's net income for the year in question, after making certain other adjustments not here in issue, should be increased by $35,545.87. Notice of the determination of deficiency for both of the years here in question was given to the petitioner by respondent by letter dated July 9, 1940. Petition was filed with this Court on October 1, 1940.
OPINION.
DINSEY, Judge:
Three questions here are presented: Has the statute of limitations run as to assessment for the year 1935? Did the respondent err in denying the depreciation claimed by the petitioner? Did he err in adding to the petitioner's income on the ground that the petitioner's system of computing income from long term contracts did not clearly reflect income?
KERN, J., concurs only in the result.
Both petitioner on its books and Commissioner in the deficiency notice treat the two Fort Pitt Bedding Co. contracts as one, uncompleted in 1934.
SEC. 275. PERIOD OF LIMITATION UPON ASSESSMENT AND COLLECTION.Except as provided in section 276—(a) GENERAL RULE.— The amount of income taxes imposed by this title shall be assessed within three years after the return was filed, and no proceeding in court without assessment for the collection of such taxes shall be begun after the expiration of such period.
(c) OMISSION FROM GROSS INCOME.— If the taxpayer omits from gross income an amount properly includible therein which is in excess of 25 per centum 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 5 years after the return was filed.
SEC. 41. GENERAL RULE.The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer's annual accounting period is other than a fiscal year as defined in section 48 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year. (For use of inventories, see section 22(c).)