Opinion
Docket No. 80737.
1961-11-27
LOYD L. PARKER AND HATTIE B. PARKER, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
James R. Cornish, Esq., for the petitioners. George Voss, Esq., for the respondent.
James R. Cornish, Esq., for the petitioners. George Voss, Esq., for the respondent.
In 1954 and 1955 petitioners engaged in the purchase and sale of real estate equities and in the purchase and sale of automobiles. They kept their books and records as to such transactions on a hybrid system of accounting. The Commissioner, in his determination of the deficiencies, placed the transactions in automobiles on an accrual basis of accounting, instead of a hybrid system. He made no change in petitioners' hybrid system of accounting as to transactions in real estate equities. Petitioners contend that the Commissioner having initiated the change in petitioners' accounting system for automobiles should go all the way and change petitioners' method of accounting as to real estate transactions from a hybrid system to an accrual system. The Parker Motor Company and the Parker Realty Company were two separate businesses. Held, the Commissioner's computation of income from automobile transactions on an accrual basis is sustained. Held, further, the Commissioner did not err in failing to compute the income of the Parker Realty Company in his determination of the deficiencies on an accrual basis.
The Commissioner has determined deficiencies, overassessment, and additions to tax under sections 294(d)(1)(A) and 294(d)(2), I.R.C. 1939, in petitioners' income tax as follows:
+----------------------------------------------------------+ ¦ ¦ ¦ ¦Additions to tax ¦ +----+----------+--------------+---------------------------¦ ¦Year¦Deficiency¦Overassessment¦Sec. ¦Sec. 294(d)(2)¦ +----+----------+--------------+------------+--------------¦ ¦ ¦ ¦ ¦294(d)(1)(A)¦ ¦ +----+----------+--------------+------------+--------------¦ ¦1954¦$7,121.24 ¦ ¦$727.72 ¦$472.03 ¦ +----+----------+--------------+------------+--------------¦ ¦1955¦7,726.33 ¦ ¦ ¦ ¦ +----+----------+--------------+------------+--------------¦ ¦1956¦ ¦$1,582.68 ¦ ¦ ¦ +----------------------------------------------------------+
The deficiency for 1954 is due mainly to one adjustment made by the Commissioner to the taxable income shown on the joint return. That adjustment is'(a) Business income $22,564.61,‘ and is explained in the deficiency notice as follows:
(a) It is determined that income from the sale of automobiles in the years 1954 and 1955, as computed on the accrual method under the provisions of Section 446(c)(2) of the Internal Revenue Code of 1954, was understated in amounts of $22,564.61 and $22,413.04, respectively.
The overassessment for 1956 is explained by the Commissioner in his deficiency notice as follows:
(b) It is also determined that income from the sale of automobiles in the year 1956, as computed on the accrual method under the provisions of Section 446(c) (2) of the Internal Revenue Code of 1954, was overstated in the amount of $6,129.34.
In their amended petition which was filed at the hearing petitioners contest the correctness of the foregoing adjustments which were made by the Commissioner in all 3 of the years, 1954, 1955, and 1956. The main point of petitioners' contest is that the Commissioner in computing the net income for all 3 taxable years, 1954, 1955, and 1956, placed petitioners' income from the sale of automobiles on an accrual basis, whereas he made no changes in petitioners' reporting of income from the sale of residential homes from an incorrect hybrid system of accounting. Petitioners contend that the Commissioner should also have placed the income from real estate equities on an accrual basis.
Petitioners' assignment of error (a) is as follows:
(a) The Commissioner of Internal Revenue erred in the method employed in changing Petitioners' method of accounting and reporting income in the following respects:
(i) The Commissioner erroneously determined that Petitioners' business of selling automobiles was a separate and distinct business apart from the business of buying and selling residential homes.
(ii) The Commissioner changed Petitioners' method of accounting and reporting income from the sale of automobiles but did not change Petitioners' method of accounting and reporting income from the sale of residential homes from an incorrect to a correct method so as to correctly and clearly reflect Petitioners' annual net income, whether the sale of automobiles and the sale of residential homes is determined to be one or two separate and distinct businesses.
It is manifest that we have no jurisdiction of the year 1956, an overassessment having been determined for that year and not any deficiency. See 9 Mertens, Law of Federal Income Taxation, sec. 50.12. Therefore, petitioners' appeal for 1956 will be dismissed for lack of jurisdiction.
FINDINGS OF FACT.
Many of the facts have been stipulated and the stipulation of facts, together with exhibits attached thereto, is incorporated herein by this reference.
Petitioners are husband and wife residing in Houston, Texas. Petitioners are engaged in buying and selling automobiles and buying and selling equities in real estate. They filed their Federal income tax returns on a community property basis in joint returns for the calendar years 1954 and 1955, the years here involved, with the director of internal revenue for the first district of Texas at Austin.
Parker Realty Company Transactions.
During the year 1947, petitioners began buying and selling equities in residential homes in the city of Houston, Texas, under the name Parker Realty Company. Petitioners have since inception of that company and are presently buying and selling equities in residential homes.
Petitioners purchased the fee title to residential homes for cash in all cases by general warranty deed subject to first lien mortgage on the property, if any.
Petitioners sold real estate equities by two methods: Namely, by contract for deed and by general warranty deed, promissory notes of purchaser secured by deed of trust on the property. On sales by contract for deed, the purchaser paid part cash and executed promissory note payable to petitioners for the balance of the purchase price, payable in monthly installments with interest thereon at the rate of 6 percent per annum. Contract for deed made provision for execution of general warranty deed conveying the property to purchaser upon payment of the promissory note in full; further, that purchaser assume the unpaid balance of any first lien mortgage on the property.
On sales by general warranty deed and promissory note secured by deed of trust, the purchaser paid part of the sales price in cash and executed promissory note payable to petitioners for the remaining balance, payable in monthly installments with interest thereon at the rate of 6 percent per annum and secured by deed of trust on the property. At the time of sale, petitioners conveyed the property to purchaser by general warranty deed. Purchaser assumed the unpaid balance on any first lien mortgage on the property.
For all calendar years since inception in 1947 to the present time, petitioners have maintained single-entry bookkeeping records for purchases and sales of real estate equities. During all the years since inception in 1947, petitioners maintained separate ledger sheets for expenses of conducting the business which were deducted in the calendar year paid. Petitioners maintained a separate ledger sheet for each real estate equity. All costs of the property were recorded as debits. All amounts received from the sale of the property, including cash downpayment, collections on notes, interest collected, and rents collected prior to sale and between sales, if the property was repossessed, were recorded as credits. In the year of final collection of all amounts owing from purchaser, petitioners reported on their joint income tax returns the difference between the cost of the property recorded as debits and the total amount collected from the property recorded as credits in income.
Petitioners reported income from the sale of real estate equities on a hybrid method of accounting. Under this method, petitioners reported income from the sale of real estate equities for the years 1954 and 1955 as follows:
+------------------+ ¦Year ¦Amount ¦ +------+-----------¦ ¦1954 ¦$14,439.77 ¦ +------+-----------¦ ¦1955 ¦12,625.01 ¦ +------------------+
Under petitioner's method of reporting income gain or loss from cash sales and gain or loss, interest, and rental income in calendar years prior to 1954, which had been collected in full was reported as income in years prior to 1954. Gain or loss, interest, and rental income on sales in calendar years prior to 1954 which had not been collected in full prior to January 1, 1954, were not reported in income in calendar years prior to 1954, but were reported in years subsequent to the calendar year 1953 in the year of final collection. Unreported income on sales in calendar years prior to January 1, 1954, which had not been closed out and collected in full and interest and rental income collected in years prior to 1954 by petitioners are summarized as follows:
+------------------------------------------------------+ ¦Year of sale¦Gain (loss)¦Rental income¦Interest income¦ +------------+-----------+-------------+---------------¦ ¦ ¦on sales ¦collected ¦collected ¦ +------------+-----------+-------------+---------------¦ ¦1948 ¦0 ¦$912.00 ¦0 ¦ +------------+-----------+-------------+---------------¦ ¦1949 ¦$3,535.88 ¦1,075.00 ¦$125.06 ¦ +------------+-----------+-------------+---------------¦ ¦1950 ¦3,359.57 ¦1,451.50 ¦397.03 ¦ +------------+-----------+-------------+---------------¦ ¦1951 ¦12,451.87 ¦1,378.00 ¦1,140.21 ¦ +------------+-----------+-------------+---------------¦ ¦1952 ¦24,873.13 ¦2,722.85 ¦2,757.96 ¦ +------------+-----------+-------------+---------------¦ ¦1953 ¦26,542.72 ¦2,159.50 ¦5,333.02 ¦ +------------+-----------+-------------+---------------¦ ¦Total ¦70,763.17 ¦9,698.85 ¦9,753.28 ¦ +------------------------------------------------------+
Petitioners' income from the sale of real estate equities computed on the accrual method of accounting for the years 1954 and 1955 is summarized as follows:
+-----------------------------------------------------+ ¦ ¦1954 ¦1955 ¦ +---------------------------------+---------+---------¦ ¦Gain (loss) on sale ¦$2,867.21¦($220.58)¦ +---------------------------------+---------+---------¦ ¦Interest income collected: ¦ ¦ ¦ +---------------------------------+---------+---------¦ ¦Notes acquired prior to 1954 ¦5,142.50 ¦3,372.38 ¦ +---------------------------------+---------+---------¦ ¦Notes acquired after Jan. 1, 1954¦222.49 ¦508.13 ¦ +---------------------------------+---------+---------¦ ¦Rental income collected ¦1,097.75 ¦583.74 ¦ +---------------------------------+---------+---------¦ ¦Total ¦9,329.95 ¦4,243.67 ¦ +---------------------------------+---------+---------¦ ¦Expenses ¦2,824.68 ¦2,193.69 ¦ +---------------------------------+---------+---------¦ ¦Net income ¦6,505.27 ¦2,049.98 ¦ +-----------------------------------------------------+
The respondent in his notice of deficiency did not change petitioners' method of reporting income from the sale of real estate equities.
Parker Motor Company Transactions.
In September 1953, petitioner Loyd L. Parker and Roy Walker formed a partnership for the purchase and sale of automobiles at retail. On April 19, 1954, petitioners purchased the interest of Roy Walker. The income of petitioners from this partnership was included in the income of petitioners' return for the year ended December 31, 1954. Since termination of the partnership, and until the end of 1958, petitioners purchased and sold automobiles at retail under the name of Parker Motor Company.
In operating the business of buying and selling real estate equities and automobiles, petitioners used the office in their house at 4606 Austin Street, and at 3505 Washington Street, Houston, Texas, for these activities. Petitioners' employees who were primarily employed for the sale of automobiles and maintaining the automobile lot were used occasionally in the real estate activities, such as cleaning up houses. Petitioners maintained bank accounts in the City National Bank and Almeda State Bank, Houston, Texas, under the names Loyd L. and Hattie B. Parker. Petitioners deposited receipts from the sale of automobiles and real estate equities in these accounts. Checks for purchases of automobiles and real estate equities were drawn on the City National Bank, Houston.
Petitioners purchased automobiles for cash. Petitioners resold automobiles for all cash or for a small cash downpayment and installment payments for the remaining balance. Purchaser executed Texas conditional sales contract providing for monthly installments without interest thereon. Petitioners transferred certificate of title to the purchaser with mortgage shown thereon. Petitioners retained possession of the certificate of title until full payment of all amounts owing at which time certificate of title was mailed to purchaser.
Petitioners did not maintain a general ledger for sale of automobiles; however, they maintained single-entry records. A separate ledger sheet was maintained for each of the following named accounts on which all amounts were recorded as debits:
(1) Cost of cars purchased.
(2) Cost of cars repossessed and repurchased.
(3) Parts and repairs.
(4) Title, tax, and license expense.
(5) Overhead (operating expenses).
(6) Salaries.
Petitioners maintained a separate ledger sheet for each of the following accounts, all amounts being recorded as credits:
(1) Miscellaneous receipts.
(2) Cash sales.
(3) Downpayments on automobiles sold.
(4) Amounts received on closed-out notes.
(5) Amounts received on current notes.
Petitioners reported income from the sale of automobiles on a hybrid method of accounting in the manner described below:
(1) Petitioners deducted all operating expenses in the year paid.
(2) Petitioners determined cost of automobiles sold on an accrual basis. Petitioners deducted ending inventory of automobiles on hand at the end of each year from the total of beginning inventory and purchases.
(3) Petitioners included in sales all amounts received in cash, consisting of cash sales, amounts collected as downpayments on automobiles sold, and amounts received on closed-out notes and current notes.
(4) Petitioners did not include in sales the amounts owing to petitioners on conditional sales contracts at the end of each year here involved.
(5) The amounts owing on conditional sales contracts at the end of each taxable year here involved were as follows:
+------------------+ ¦Year ¦Amount ¦ +------+-----------¦ ¦1954 ¦$25,967.75 ¦ +------+-----------¦ ¦1955 ¦51,552.02 ¦ +------------------+
Respondent increased the income of petitioners from the sale of automobiles as follows:
+-----------------------------------------------------------------------+ ¦Income reported by petitioners from sales of ¦1954 ¦1955 ¦ +-----------------------------------------------+-----------+-----------¦ ¦automobiles ¦($7,628.86)¦($3,582.99)¦ +-----------------------------------------------+-----------+-----------¦ ¦Increase of income from sales of automobiles by¦ ¦ ¦ +-----------------------------------------------+-----------+-----------¦ ¦respondent ¦22,564.61 ¦22,413.04 ¦ +-----------------------------------------------------------------------+
Except for minor adjustments, the net effect of the change of petitioners' method of reporting income from the sale of automobiles by the respondent was the inclusion in income of the uncollected amounts on conditional sales contracts at the end of each year here involved. In other words, respondent placed petitioners' income from the sale of automobiles in the taxable years on an accrual basis. Petitioners concede that their hybrid method of reporting income from the sale of real estate equities and automobiles does not clearly reflect petitioners' annual net income. Petitioners also concede that respondent's change of reporting income from the sale of automobiles to the accrual method clearly reflects part of petitioners' income but does not clearly reflect petitioners' overall annual net income from the sale of automobiles and real estate equities, in both of which activities they were engaged in the taxable years. Petitioners pray that their income from the sale of real estate equities be placed on an accrual basis in each of the taxable years in the computation of the deficiencies as was done in the computation of petitioners' net income from the sale of automobiles.
Petitioners' business under the name of Parker Realty Company operated as described in the Findings of Fact and the business operated under the name of Parker Motor Company in the manner described in the Findings of Fact were two separate businesses.
OPINION.
BLACK, Judge:
Respondent in his determination of the deficiencies has added to the taxable net income shown on the joint returns filed by petitioners for the years 1954 and 1955, $22,564.61 and $22,413.04, respectively, and has explained his adjustments as follows:
(a) It is determined that income from the sale of automobiles in the years 1954 and 1955, as computed on the accrual method under the provisions of Section 446(c)(2) of the Internal Revenue Code of 1954, was understated in amounts of $22,564.61 and $22,413.04, respectively.
Section 446 of the 1954 Code to which respondent refers is printed in the margin.
SEC. 446. GENERAL RULE FOR METHODS OF ACCOUNTING.(a) GENERAL RULE.— Taxable income shall be computed under the method of accounting on the basis of which the taxpayer regularly computes his income in keeping his books.(b) EXCEPTIONS.— If no method of accounting has been regularly used by the taxpayer, or if the method used does not clearly reflect income, the computation of taxable income shall be made under such method as, in the opinion of the Secretary or his delegate, does clearly reflect income.(c) PERMISSIBLE METHODS.— Subject to the provisions of subsections (a) and (b), a taxpayer may compute taxable income under any of the following methods of accounting—(1) the cash receipts and disbursements method;(2) an accrual method;(3) any other method permitted by this chapter; or(4) any combination of the foregoing methods permitted under regulations prescribed by the Secretary or his delegate.(d) TAXPAYER ENGAGED IN MORE THAN ONE BUSINESS.— A taxpayer engaged in more than one trade or business may, in computing taxable income, use a different method of accounting for each trade or business.(e) REQUIREMENT RESPECTING CHANGE OF ACCOUNTING METHOD.— Except as otherwise expressly provided in this chapter, a taxpayer who changes the method of accounting on the basis of which he regularly computes his income in keeping his books shall, before computing his taxable income, under the new method, secure the consent of the Secretary or his delegate.
Inasmuch as petitioners were, in fact, during the taxable years conducting two businesses, to wit, Parker Realty Company and Parker Motor Company, they could have, under the permission granted by section 446(d) of the Code quoted in the margin, used a different method of accounting for each trade or business. But they did not do so. The facts show that the methods of accounting used by the Parker Realty Company and the Parker Motor Company were essentially the same. The method of accounting used in both business activities was a hybrid system of accounting. The Commissioner initiated a change in petitioners' method of accounting for the Parker Motor Company. Both parties in their briefs discuss section 481, I.R.C. 1954. That part of section 481 which it seems to us is applicable to the instant case is printed in the margin,
and provides that, if the taxpayer initiates the change in method, adjustments are to be made to prevent duplication or omissions of income.
SEC. 481. ADJUSTMENTS REQUIRED BY CHANGES IN METHOD OF ACCOUNTING.(a) GENERAL RULE.—In computing the taxpayer's taxable income for any taxable year (referred to in this section as the ‘year of the change’)—(1) if such computation is under a method of accounting different from the method under which the taxpayer's taxable income for the preceding taxable year was computed, then(2) there shall be taken into account those adjustments which are determined to be necessary solely by reason of the change in order to prevent amounts from being duplicated or omitted, except there shall not be taken into account any adjustment in respect of any taxable year to which this section does not apply unless the adjustment is attributable to a change in the method of accounting initiated by the taxpayer.
It seems clear that in the instant case the petitioners did not initiate any change in accounting methods. In their brief they concede that neither the method used in Parker Realty transactions nor in Parker Motor transactions clearly reflected income. They concede that the methods of accounting used by them were a hybrid system which, under the applicable law and regulations, did not clearly reflect income. Therefore, they argue, that in view of the fact that the Commissioner in his deficiency notice initiated the change and placed all automobile transactions on an accrual basis, he should carry through with it and use the accrual system both as to the dealings in real estate equities and the dealings in automobiles. As we understand from the record, petitioners concede that to change them to an accrual system from the hybrid system will result in an increase in their income from the sale of automobiles, $22,564.61 in 1954 and $22,413.04 in 1955. But they also contend that to use an accrual system in their transactions in real estate equities for the same taxable years will result in much less income than was reported by them on their joint returns from the sale of real estate equities. They point out that there was reported in the joint return for 1954, $14,439.66, and in the joint return for 1944, $12,625.01 from the sale of real estate equities. There will be substantially less than the above figures under an accrual system. Petitioners contend that to use an accrual method on the sale of real estate equities instead of the hybrid system which was used in the returns will result in a net income of $6,505.27 for 1954 instead of the net income of $14,439.66 which was actually reported from this source, and that for 1955 there will be a net income of $2,049.98 from this source instead of the $12,625.01 which was actually reported on the joint return. Therefore, say petitioners, inasmuch as the Commissioner in his deficiency notice has placed the Parker Motor Company on an accrual basis, he should also place the Parker Realty Company on an accrual basis.
If petitioners' contention is correct that they were engaged in only one business and not two, then they would doubtless be correct in contending that the Commissioner could not place one branch of the business, to wit, the purchase and sale of automobiles, on an accrual basis and leave the other branch of the business, to wit, the purchase and sale of real estate equities, on the hybrid system of accounting. He would doubtless have to place both lines of business, if they are to be considered one business, on an accrual basis, having placed one of them on an accrual system. But in our findings of fact we have found, after a careful consideration of all the evidence, both oral and stipulated, that petitioner was, during the taxable years in question, operating two separate businesses, viz: (1) The purchase and sale of real estate equities under the name of Parker Realty Company, and (2) the purchase and sale of automobiles under the name of Parker Motor Company. It being true that petitioner was operating two separate businesses, we know of no law which would prevent the Commissioner from determining that the books and records of the purchase and sale of automobiles and the income tax returns based thereon did not reflect correctly petitioners' income from that business and from determining that the Parker Motor Company be placed on an accrual basis. This he has done. But he does not at the same time have to initiate a change in the method of accounting of petitioner's Parker Realty Company in the purchase and sale of real estate equities from the hybrid system of accounting, which was used to an accrual system of accounting. Of course, it is permissible for petitioner to make application to the Commissioner to make such a change but he has not done so. If he should make application for such a change and it should be granted, he would be the initiator of the change and some adjustments for prior years would doubtless have to be made under the applicable statute.
It is the contention of respondent that to hold in the instant case that the Commissioner has initiated a change in the accounting methods of Parker Realty Company would prevent some $89,000 of pre-1954 income from being taxed. In other words, if such change is initiated by petitioner adjustments for prior years to the taxable years here involved will have to be made totaling some $89,000. We, of course, do not here pass upon what changes would have to be made in the event petitioner initiates the change— he has not done so. What we hold is that the Commissioner in his deficiency notice did change petitioner from the hybrid system of accounting to an accrual system in petitioner's business of buying and selling automobiles.
We also hold that in his determination of the deficiencies the Commissioner has made no change in the method of accounting of the Parker Realty Company. If the petitioner is to make a change in the hybrid system of accounting used in the Parker Realty Company business to an accrual system, he will have to make application to the Commissioner to make such a change and if the Commissioner should grant the request, he will doubtless require that adjustments are to be made by petitioner for prior years to prevent duplications or omissions of income. We have no such question before us in the instant case. Therefore, we hold that the Commissioner did not err in failing to compute petitioners' income from Parker Realty Company transactions on an accrual basis.
At the trial concessions were made by both parties as to certain more or less minor items. These concessions will be given effect under Rule 50.
Decision will be entered for the years 1954 and 1955 under Rule 50, and, an order will be entered for the year 1956 dismissing the proceeding for lack of jurisdiction.