Opinion
No. 42120.
May 31, 1938.
Eugene Meacham, of Washington, D.C., for plaintiff.
J.H. Sheppard, of Washington, D.C., and James W. Morris, Asst. Atty. Gen. (Robert N. Anderson and Fred K. Dyar, both of Washington D.C., on the brief), for the United States.
Before BOOTH, Chief Justice, and GREEN, LITTLETON, WILLIAMS, and WHALEY, Judges.
Action by the Hegeman-Harris Company, Inc., against the United States to recover an alleged overpayment of income taxes for 1928 and 1929.
Petition dismissed.
Plaintiff seeks to recover an alleged overpayment of income tax for 1928 and 1929 in the net amount for the two years of $2,147.12. The petition alleged overpayments of $61,396.28 for 1928 and $37,375.08 for 1929, totaling $98,771.36.
Plaintiff was engaged in building construction as a general contractor and for the most part its income was derived from long-term contracts on construction projects not completed within the taxable year in which the work was begun. It kept its books on the accrual basis and employed the percentage-of-completion method of accounting in keeping its books and making its income tax returns prior to and during 1928 and 1929. It contends in this proceeding that its returns filed for 1928 and 1929 on the percentage-of-completion basis and that that method of keeping its books did not properly reflect its income; that its profits from long-term construction contracts were not reported in accordance with Treasury Regs. 74, and that no election as to the method of reporting income was made by the taxpayer; that the taxable income for the years in question should now be determined on the completed-contract basis.
Special Findings of Fact.
1. Plaintiff is a New York corporation with its principal office in New York City and with branch offices in Chicago, Illinois, Boston, Massachusetts, and other cities. From its organization in 1917 to and including the periods involved in this suit, it was engaged in building construction work as a general contractor. Frequently its construction projects were not completed in the taxable year in which the work was begun.
2. Plaintiff kept its books and prepared and filed its income tax returns on the accrual basis, and employed the percentage-of-completion method of accounting and reported its income in accordance with that method. That basis was followed not only for the taxable years 1928 and 1929, but also had been consistently followed for many years prior thereto.
In keeping its books on the accrual basis, it maintained its accounts with respect to its construction contracts on the basis of what is termed "percentage of completion," recognized and authorized by Art. 332, Treasury Regs. 74, by which method profits or losses on its various contracts were estimated each year and accrued on its books. On that basis the estimated profit or loss on a contract which was not completed within a given year was arrived at by charging to that account all items of material and direct labor (whether paid for or not) applicable to that contract up to the end of the year in which the profit or loss was being determined, and by crediting to the account, up to the same date, requisitions for payment to the contractor (whether received or not) in accordance with the terms of the contract under which the work was being carried on, the difference between those charges and credits constituting the estimated profit or loss which plaintiff accrued on its books and reported as taxable income or loss in its returns. Since the foregoing method resulted in the determination of profits or losses on given dates which often differed from the correct profits or losses as shown by the final determination upon completion of the contract or contracts, compensating adjustments were made when the exact amount of profits or losses was determined for each contract upon its completion.
In determining the foregoing estimated profits or losses, the plaintiff did not include overhead expense in computing such profits or losses upon the percentage-of-completion basis, but such overhead expenses were treated as separate items, both on its books of account and as deductions from gross income in its income tax returns. The same treatment was accorded these items in the computation on the completed-contract basis hereinafter referred to.
3. Plaintiff filed its return for 1928 on the basis that its books were kept as set out in finding 2, and reported therein a tax of $66,734.93, which was paid as follows: April 15, 1929, $16,683.76; June 14, 1929, $16,683.73; September 16, 1929, $16,683.73, and December 13, 1929, $16,683.71.
It filed its return for 1929 on the same basis as for 1928, and reported therein a tax of $68,536.86, which it paid as follows: $17,134.22 on March 16, June 13, and September 13, 1930, and $17,134.20 on December 13, 1930.
4. January 23, 1931, plaintiff filed claims for refund for 1928 and 1929 in the respective amounts of $61,396.28 and $37,375.08, and assigned the following grounds therefor: "Basis of computation of original gross income from jobs was in error. Revised gross income figures based on the Completed Contract Method attached."
October 21, 1931, the Commissioner advised plaintiff in part as follows:
"Reference is made to protest filed on August 22, 1931, * * * against the proposed rejection of your claims for the refund of $61,396.28 and $37,375.08 for the calendar years 1928 and 1929 as set forth in Bureau letters dated May 25, 1931, and August 12, 1931, respectively.
"As you were previously advised, since your company elected to file your return on the long term contract basis, a change to the completed contract basis may not be made during the taxable year [Ellis v. Com'r, 16 B.T.A. 1225]. No evidence has been submitted to show that the amount of profit reported in your returns on the long term contract basis was materially erroneous. The rejection of the claims will officially appear on a schedule to be approved by the Commissioner."
The claims were rejected on a schedule signed by the Commissioner April 15, 1932.
5. The return for 1928, in which income from long-term contracts was computed on the basis of percentage of completion, showed a total net income of $556,124.39. When changed to show income from long-term contracts on the completed-contract basis, the net income for 1928 would be $682,751.56 and the tax computed thereon would be $81,930.19 instead of $66,734.93, as shown in the original return, in which the income from long-term contracts was computed on the percentage-of-completion basis.
The return for 1929 in which income from long-term contracts was computed on the basis of percentage of completion showed a total net income of $623,062.40. When changed to show income from long-term contracts on the completed-contract basis, the net income for 1929 would be $465,404.32 and the tax computed thereon would be $51,194.48 instead of $68,536.86, as shown on the original return, in which the income from long-term contracts was computed on the percentage-of-completion basis.
The record in this case shows that the overpayment sought to be recovered is based on the claimed right to change the method or basis on which the taxes for 1928 and 1929 were returned and paid, and finally determined by the Commissioner, from the percentage-of-completion method of computing income from long-term contracts to the completed-contract method. This, we think, the plaintiff may not do. Plaintiff kept its books and filed its return on the accrual basis which has been consistently followed. In keeping its books on this basis plaintiff used in connection with its construction contracts the percentage-of-completion method of accounting by which profits or losses on various contracts were estimated each year and accrued on its books. This method of accounting was recognized and authorized by section 1102(a) of the Revenue Act of 1926, 44 Stat. 9, 112, 26 U.S.C.A. § 1345; section 41 of the Revenue Act of 1928, 45 Stat. 791, and Art. 334 of Treasury Regs. 74 made pursuant to sections 1101 and 1102(a) of the Revenue Act of 1926, 26 U.S.C.A. §§ 1350, 1345. The revenue acts in force during the taxable years, and prior thereto, provided that net income be computed upon the basis of the taxpayer's annual accounting period in accordance with the method of accounting regularly employed by it in keeping its books, but that if the method employed did not clearly reflect the income the computation should be made in accordance with such method as, in the opinion of the Commissioner, would clearly reflect the income. The statutes further provided that every person liable to tax should keep such records, render under oath such statements, make such returns, and comply with such rules and regulations, as the Commissioner, with the approval of the Secretary, might from time to time prescribe and that the Commissioner should prescribe and publish all needful rules and regulations for the enforcement of the statutes. Art. 334, Regs. 74, in effect during the taxable years, provided with reference to the method of accounting and making returns of income under long-term contracts as follows:
"Art. 334. Long-term contracts. — Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used herein the term `long-term contracts' means building, installation, or construction contracts covering a period in excess of one year. Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon the following bases:
"(a) Gross income derived from such contracts may be reported upon the basis of percentage of completion. In such case there should accompany the return certificates of architects or engineers showing the percentage of completion during the taxable year of the entire work to be performed under the contract. There should be deducted from such gross income all expenditures made during the taxable year on account of the contract, account being taken of the material and supplies on hand at the beginning and end of the taxable period for use in connection with the work under the contract but not yet so applied. If, upon completion of a contract, it is found that the taxable net income arising thereunder has not been clearly reflected for any year or years, the Commissioner may permit or require an amended return.
"(b) Gross income may be reported in the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of completion.
"Where a taxpayer has filed his return in accordance with the method of accounting regularly employed by him in keeping his books and such method clearly reflects the income, he will not be required to change to either of the methods above set forth. If a taxpayer desires to change his method of accounting in accordance with paragraphs (a) and (b) of this article, a statement showing the composition of all items appearing upon his balance sheet and used in connection with the method of accounting formerly employed by him, should accompany his return."
Under the percentage-of-completion method of accounting employed by plaintiff with reference to construction contracts, the estimated profit or loss on a contract not completed within a given year was determined by charging to the account all items of material and labor applicable to the contract to the end of the year and crediting to the account requisitions to the contractor for payments in accordance with the terms of the contract; the difference between the charges and credits constituted the profit or loss which plaintiff accrued on its books and carried into his tax returns. This method was recognized and authorized by subdivision (a) of Art. 334, Regs. 74. Where the profits or losses under the foregoing method differed from the correct profits and losses determined on the completion of a contract, compensating adjustments were made upon completion of the work. Plaintiff did not include overhead expense in estimating its profits and losses but treated that as separate items, both on its books and as deductions from gross income on its tax returns. The regulations hereinabove quoted authorize the use of the percentage-of-completion basis or the completed-contract basis of accounting for income, and the concluding sentence of subdivision (a) of Art. 334 states that "If, upon completion of a contract, it is found that the taxable net income arising thereunder has not been clearly reflected for any year or years, the Commissioner may permit or require an amended return."
The record in this case does not disclose that plaintiff endeavored to file an amended return for any year pursuant to the provisions of the regulations in order to make adjustment or to correct any error in the determination of its income on the percentage-of-completion basis of accounting employed. The record does show, however, and we have found as a fact that plaintiff made compensating adjustments on its books when the exact amount of profit or loss had been determined for each contract upon completion. In these circumstances the plaintiff, having elected to make its returns and pay its tax upon the percentage-of-completion basis with reference to long-term contracts, is bound by such election and may not later change to a completed-contract basis. The taxing statutes require no more than the method of accounting employed by the taxpayer clearly reflect the income under that method. The provision in the statutes to the effect that if the method of accounting employed does not clearly reflect the income, the computation of income shall be made in accordance with such method as, in the opinion of the Commissioner, does reflect the income, does not authorize a taxpayer to select one or two years from a long period of its business operations and change the method of accounting consistently employed for a long period of time and seek a refund, because, for such year or years, it would have paid less tax if it had kept its books and made its returns on some other basis of accounting. This taxpayer employed a recognized and authorized method of accounting. The Commissioner of Internal Revenue held that this method clearly reflected the income and this record does not establish that the Commissioner's decision was erroneous. The manner of selecting the method of accounting to be used and followed is left to the sound discretion of the taxpayer, the only restriction being that such method must be one that clearly reflects income. See Art. 322, Regs. 74. The record in this case does not establish and plaintiff does not contend that the percentage-of-completion basis of accounting did not clearly reflect its income on that basis. Its only complaint is that by employing the percentage-of-completion method it paid more tax for 1928 and 1929 than it would have been required to pay had it employed the completed-contract method of accounting in reporting its income for tax purposes. For 1928 on the completed-contract basis, plaintiff's tax would have been $15,195.20 greater than the amount shown by its books returned and paid, and for 1929 its tax on the completed-contract basis would have been $17,342.38 less than that paid on the percentage-of-completion basis. The net result on the completed-contract basis for both years would have been an overassessment of only $2,147.20. A change for certain years in any recognized method of accounting is likely to show an additional tax or an overassessment, but this fails to establish that the method of accounting employed does not properly reflect the income for the purpose of taxation. The Commissioner's regulations with reference to the methods of accounting to be employed in determining income for tax purposes under long-term contracts were authorized by law and are reasonable. They therefore have force in effect of law. The employment of the percentage-of-completion method of accounting and the accrual of profits from long-term contracts in the year in which earned does not offend any provisions of the taxing statutes. Where the statute permits an election as to the basis on which income may be returned for taxation, the taxpayer is bound by the basis selected. Pacific National Co. v. Welch, 304 U.S. 191, 58 S.Ct. 857, 82 L.Ed. ___, decided May 2, 1938; United States v. Kaplan, 304 U.S. 195, 58 S.Ct. 859, 82 L.Ed. ___, decided May 2, 1938; Le Bolt Co. v. United States, 67 Ct.Cl. 422, 423. The decisions uniformly hold that where a taxpayer had elected to file returns on either one of two bases prescribed by the Commissioner relating to long-term contracts, such taxpayer is bound to such election and may not later change the basis of reporting income. Ellis v. Commissioner, 16 B.T.A. 1225; Bent v. Commissioner, 19 B.T.A. 181, affirmed 9 Cir., 56 F.2d 99; Fort Pitt Bridge Works v. Commissioner, 24 B.T.A. 626, approved on this point 3 Cir., 92 F.2d 825; Ross B. Hammond, Inc., v. Commissioner, 36 B.T.A. 497; Allhands v. Crooks, D.C.W.D.Mo., 15 A.F.T.R. 633; Paul and Mertens' Vol. 1, Law Federal Income Taxation, pp. 599-600, section 11.108.
Plaintiff is not entitled to recover and the petition is dismissed. It is so ordered.