Opinion
Docket No. 29726.
1951-12-5
D. A. MACDONALD AND OMAH MACDONALD (HUSBAND AND WIFE), PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
James A. Taylor, Esq., for the petitioners. Newman A. Townsend, Jr., Esq., for the respondent.
STATUTE OF LIMITATIONS— CODE SECTION 3801.— The application of Internal Revenue Code section 3801 in deficiency cases is limited to the increase in tax which results from adjustment for specific items as to which an inconsistent position has been maintained. In the absence of a showing by the respondent of the tax effect on income for the years 1938 to 1940 of specific amounts for accrued items and inventory that were taken into consideration in a decision of this Court for the year 1942, section 3801 does not authorize the assessment of deficiencies for the earlier years after the normal period of assessment has expired even though the respondent's method of computation for the earlier years was similar to the method permitted for the year 1942. James A. Taylor, Esq., for the petitioners. Newman A. Townsend, Jr., Esq., for the respondent.
The respondent determined the following deficiencies in petitioners' income tax:
+-----------------------------+ ¦Calendar year ¦Deficiency ¦ +----------------+------------¦ ¦1938 ¦$1,167.09 ¦ +----------------+------------¦ ¦1939 ¦59.78 ¦ +----------------+------------¦ ¦1940 ¦686.49 ¦ +----------------+------------¦ ¦Total ¦1,913.36 ¦ +-----------------------------+
These deficiencies result from respondent's determination that the income of a retail furniture store owned by the petitioner, Omah MacDonald, for the years 1938 through 1940 should be computed on the accrual method of accounting with the use of inventories rather than on the cash basis. The petitioners contest the entire deficiencies contending that assessment for these years is barred by the 3-year statute of limitations. The respondent admits that the statute of limitations has tolled under section 275 of the Internal Revenue Code, and relies on section 3801 of the Code as his authority for determining these deficiencies.
The facts were stipulated and are so found. Those material to the controversy are set forth in our findings of fact.
FINDINGS OF FACT.
The petitioners, D. A. MacDonald and Omah MacDonald, are husband and and wife and reside at West Palm Beach, Florida. Their income tax returns for the calendar years 1938 through 1940 were filed with the collector of internal revenue for the district of Florida.
From May 2, 1938, through December 31, 1943, petitioner Omah MacDonald, was the owner and manager of a retail furniture store in West Palm Beach, Florida, known as Badcock's Economy Furniture Store (hereinafter sometimes referred to as Badcock).
For the years 1938 through 1941, the petitioners, who were husband and wife, filed joint income tax returns in which they reported Badcock's income on the cash receipts and disbursement basis. For the years 1942 and 1943, the petitioners filed separate individual income tax returns. In Omah MacDonald's returns for those years, Badcock's income was reported on the cash receipts and disbursements basis.
For the years 1938 to 1943, inclusive, the annual net income of Badcock was computed and reported by the petitioners on the cash receipts and disbursements basis from information recorded in daily cash books and monthly summary cash books. The daily cash books and the monthly summary cash books contained the entire record of cash transactions. Badcock at no time maintained a general ledger or any form of double entry books.
In addition to its daily cash and monthly summary cash books, Badcock maintained certain memoranda records which included memoranda record book of installment accounts receivable, contract memoranda records, inventory memoranda records, and monthly summaries of cash and installment records. Accounts payable were recorded in summaries in Badcock's inventory memoranda records and nowhere else.
Badcock's memoranda records reflect inventories, accounts receivable and accounts payable as follows:
+---------------------------------------------+ ¦Date ¦Inventory¦A/C Receivable¦A/C Payable¦ +--------+---------+--------------+-----------¦ ¦5-2-38 ¦$2,604.41¦$14,262.50 ¦$1,975.74 ¦ +--------+---------+--------------+-----------¦ ¦12-31-38¦2,983.62 ¦16,610.39 ¦1,500.59 ¦ +--------+---------+--------------+-----------¦ ¦12-31-39¦2,669.47 ¦16,786.57 ¦1,403.25 ¦ +--------+---------+--------------+-----------¦ ¦12-31-40¦3,056.37 ¦24,115.24 ¦2,734.96 ¦ +--------+---------+--------------+-----------¦ ¦12-31-41¦2,745.56 ¦16,632.32 ¦1,252.29 ¦ +--------+---------+--------------+-----------¦ ¦12-31-42¦4,379.97 ¦9,530.34 ¦752.59 ¦ +--------+---------+--------------+-----------¦ ¦12-31-43¦4,157.98 ¦12,980.20 ¦452.50 ¦ +---------------------------------------------+
On October 31, 1947, the respondent mailed a notice of deficiency to Omah MacDonald in which a deficiency in income tax of $7,483.69 for the the year 1943 was determined. Because of the provisions of the Current Tax Payment Act of 1943, the deficiency also covered her tax liability for the year 1942. In that notice of deficiency, the respondent determined that Badcock's income should be reported on the accrual basis with the use of inventories rather than on the cash receipts and disbursements basis employed by Omah MacDonald in her income tax returns.
Pursuant to his determination that Badcock's income should be reported on the accrual basis of accounting with the use of inventories, the respondent increased Badcock's income as reported for the year 1943 by adding thereto the amount by which the balance in Badcock's accounts receivable memorandum account as of December 31, 1943, exceeded the balance in that account as of December 31, 1942, (or January 1, 1943) and the amount by which the balance in its accounts payable memorandum account as of December 31, 1942, (or January 1, 1943) exceeded the balance in that account as of December 31, 1943. The respondent decreased Badcock's income as reported for 1943 by subtracting therefrom the amount by which Badcock's merchandise inventory as of December 31, 1942, (or January 1, 1943) exceeded its merchandise inventory as of December 31, 1943.
Pursuant to his determination that Badcock's income should be reported on the accrual basis with the use of inventories, the respondent increased Badcock's income as reported for the year 1942 by adding thereto the amount of Badcock's merchandise inventory and the balance in its accounts receivable memorandum account as of December 31, 1942. The respondent decreased Badcock's income as reported for the same year by subtracting therefrom the balance in its accounts payable memorandum account as of December 31, 1942. In computing Badcock's income for the year 1942, the respondent did not give effect to Badcock's merchandise inventory and the balance in its accounts receivable and accounts payable memorandum accounts as of December 31, 1941 (or January 1, 1942). The inventory and account balances determined by respondent were as follows:
+---------------------------------------------------+ ¦ ¦12/31/41¦12/31/42 ¦12/31/43 ¦ +---------------------+--------+---------+----------¦ ¦Accounts Receivable ¦None ¦$9,530.34¦$12,980.20¦ +---------------------+--------+---------+----------¦ ¦Accounts Payable ¦None ¦752.59 ¦452.50 ¦ +---------------------+--------+---------+----------¦ ¦Merchandise Inventory¦None ¦4,379.97 ¦4,157.98 ¦ +---------------------------------------------------+
Omah MacDonald filed a timely petitioner with the Tax Court for a redetermination of the deficiency. That petition was assigned Docket No. 16677. (That proceeding and the opinion and decision rendered therein will hereinafter be referred to as that of Omah MacDonald, Docket No. 16677.) The pleadings in that case contained no assignment of error or other reference with respect to the respondent's failure to give effect to Badcock's merchandise inventory and the balances in its accounts receivable and accounts payable memorandum accounts as of December 31, 1941, (or January 1, 1942) in his computation of Badcock's income for the year 1942 on the accrual basis.
In her pleadings in Docket No. 16677, Omah MacDonald assigned as error the respondent's adoption of the accrual method in computing Badcock's income and his refusal to adopt the cash receipts and disbursements method. Her resistance to the respondent's determination that Badcock's income should be computed on the accrual basis and her insistence that it was properly computed on the cash receipts and disbursements basis persisted throughout the hearing and on brief.
On brief in that case, Omah MacDonald pointed out that even if the Court should hold, contrary to her contentions, that Badcock's income for the years 1942 and 1943 should be reported on the accrual basis, the deficiency determined by the respondent was incorrect because the respondent erred in computing the amount of income that had accrued to Badcock during the year 1942. She pointed out that the respondent failed to give effect to Badcock's merchandise inventory and the balance in its accounts receivable and accounts payable memorandum accounts as of December 31, 1941, (or January 1, 1942) in computing the amount of income that had accrued to Badcock during the year 1942.
The respondent replied in his brief with the following remark:
In her brief the petitioner contends that the respondent's determination distorts Badcock's net income for 1942 because it does not give effect to the inventory and outstanding balance of unpaid installment accounts and unpaid invoices of January 1, 1942. If the Court should determine that the income of Badcock's Economy Furniture Store should be reported on the accrual basis but that, as contended by petitioner, effect should be given to the inventory and outstanding balance of unpaid installment accounts and unpaid invoices of January 1, 1942, it is submitted that there are adequate facts in the record upon which proper adjustments may be based in a recomputation under Rule 50.
On February 29, 1949, the Tax Court entered its Memorandum Findings of Fact and Opinion in the case of Omah MacDonald, Docket No. 16677, in in which it held that Badcock's income for the years 1942 and 1943 should be determined on the accrual basis with the use of inventories. The Court stated that the income for the taxable year 1942, as determined in respondent's notice of deficiency, should be adjusted properly to reflect Badcock's merchandise inventory and the balances in its accounts receivable and accounts payable memorandum accounts as of January 1, 1942. The Tax Court found that the inventory and the balances in these accounts as of January 1, 1942, were as follows:
+--------------------------------+ ¦Accounts receivable ¦$16,632.32¦ +---------------------+----------¦ ¦Merchandise inventory¦2,745.56 ¦ +---------------------+----------¦ ¦Accounts payable ¦1,252.29 ¦ +--------------------------------+
and stated that:
Petitioner contends that the respondent's failure to consider the inventory, the outstanding balance of unpaid installments and unpaid invoices as of January 1, 1942, results in a distortion of Badcock's net income for 1942. The respondent does not dispute this. Since it appears obvious that such is the result, effect will therefore be given to such balances in the computation to be made under Rule 50.
Thereafter, the respondent filed a proposed computation for entry of decision under Rule 50 which disclosed a deficiency, as redetermined in income tax of $622.98 for the year 1943. In the proposed computation under Rule 50, adjustments were made which gave proper effect to the merchandise inventory, accounts receivable and accounts payable of Badcock as of January 1, 1942, in the amounts set forth in the Court's Findings of Fact.
In the computation for entry of decision the respondent stated:
Explanation of Adjustment.
It has been conceded that the inventory and the unpaid installments or accounts receivable as at January 1, 1942 should be considered in determining the income under the accrual method of accounting since a closing inventory was used and the accounts receivable as of December 31, 1942 were included in the sales. Also that adjustment should be made for amounts owed for purchases as at December 31, 1941. These adjustments decrease the income by $18,125.59. * * *
The Tax Court entered a decision that there was a deficiency in income tax of $622.98 for the year 1943. That decision became final on August 11, 1949.
On July 18, 1950, the respondent mailed a notice of deficiency to the petitioners, D. A. MacDonald and Omah MacDonald, in which deficiencies in income tax for the calendar years 1938, 1939, and 1940 were determined and which is the basis of this proceeding. The deficiencies asserted in the notice of deficiency for the years 1938, 1939, and 1940 result from the respondent's determination that Badcock's income for those years should be computed on the accrual basis with the use of inventories, and that the merchandise inventories and the balances in the accounts receivable and accounts payable memorandum accounts at the beginning and end of each year should be used in computing Badcock's income for those years. The method used in reaching this determination substantially followed the method this Court directed be followed in computing the Badcock income for 1942.
In the notice of deficiency the respondent determined that the petitioner's net taxable income should be adjusted because of increases in the net income of Badcock as follows:
+--------------------------------------+ ¦ ¦ ¦ ¦Net income ¦ +----+----------+----------+-----------¦ ¦ ¦Net income¦Adjustment¦per return ¦ +----+----------+----------+-----------¦ ¦Year¦per return¦increase ¦as adjusted¦ +----+----------+----------+-----------¦ ¦1938¦$2,936.75 ¦$14,958.16¦$17,894.91 ¦ +----+----------+----------+-----------¦ ¦1939¦6,933.08 ¦1,130.71 ¦8,063.79 ¦ +----+----------+----------+-----------¦ ¦1940¦4,240.01 ¦7,374.02 ¦11,614.03 ¦ +--------------------------------------+
The petitioners have not executed waivers, as provided in section 276 (b) of the Internal Revenue Code, to extend the statutory period for assessment of income taxes for the taxable years 1938 through 1940.
OPINION.
ARUNDELL, Judge:
The respondent's determination of deficiencies in this proceeding was concededly made after the normal 3-year statute of limitations for assessment prescribed by Internal Revenue Code section 275(a) had run. The determination, as stated in the notice of deficiency, was made under the provisions of Code section 3801.
That section provides for an exception to the operation of the normal period of limitations for assessment by the Commissioner, or claim for refund by the taxpayer, when certain conditions exist. It does not obliterate the generally prescribed for either assessment (Code section 275(a) or refund, (Code section 322(b)). Basic in our tax system is a period prescribed by Congress upon which both the Government and the citizen may rely in the absence of exceptional circumstances which are recognized and provided for by statute. Speaking of statutes of limitation generally, the Supreme Court in Rothensies v. Electric Storage Battery Co., 329 U.S. 296, said:
This section, insofar as material at the point, provides for an additional period for determination of deficiencies under circumstances set forth therein. The notice of deficiency in this proceeding was timely under the extended period.
It probably would be all but intolerable, at least Congress has regarded it as ill-advised, to have an income tax system under which there never would come a day of final settlement and which required both the taxpayer and the Government to stand ready forever and a day to produce vouchers, prove events, establish values and recall details of all that goes into an income tax contest. Hence a statute of limitation is an almost indispensable element of fairness as well as of practical administration of an income tax policy.
The intent of Congress in enacting section 3801 was in harmony with the thought expressed in the above quotation. This is clearly shown by the report of the Senate Finance Committee with respect to proposals that became section 820 of the Revenue Act of 1938, which is now Code section 3801 (S. Rept. No. 1567, 75th Cong., 3d sess., (1938) p. 49, 1939-1 C.B.(Part 2) 815) as follows:
The legislation here proposed is based upon the following principles:
(1) To preserve unimpaired the essential function of the statute of limitations, corrective adjustments should (a) never modify the application of the statute except when the party or parties in whose favor it applies shall have justified such modification by active inconsistency, and (b) under no circumstances affect the tax save with respect to the influence of the particular items involved in the adjustment.
It is a rule long recognized that the party who invokes an exception to the basic statutory limitation period must plead it and assume the burden of proving all of the prerequisites to its application. Farmers Feed Co., 10 B.T.A. 1069; Bonwit Teller & Co., 10 B.T.A. 1300; White Eagle Oil & Refining Co., 19 B.T.A. 185. See 34 Am.Jur., Limitation of Actions, section 451. In this proceeding, the respondent recognizes his burden and has attempted to meet it.
One of the prerequisites to the application of the exception provided for in section 3801 is the maintenance by the taxpayer, in deficiency proceedings, of a position which is inconsistent with an erroneous exclusion, inclusion, omission, allowance or disallowance, and which the Commissioner attempts to correct at a date after the expiration of the basic period. Both parties argue the matter of whether there exists an inconsistency on the part of the petitioner Omah MacDonald (1) in calling attention in the 1942-1943 proceeding to the obvious need for adjusting the 1942 opening figures on account of receivables, payables, and inventory, and (2) her reporting the income of Badcock for 1938-1940 on the cash basis.
For reasons hereinafter stated, we think that we need not decide the question of inconsistency of position.
The other petitioner, D. A. MacDonald, was a ‘related taxpayer‘ under the definition in section 3801(a)(3).
If we assume, as contended by the respondent, that there was an inconsistent position on the part of Omah MacDonald as between the 1938-1940 period and the years 1942-1943, it is our opinion that the respondent still has not met his burden. Section 3801, throughout its several subsections, provides for an adjustment as to ‘an item‘ or ‘items‘ with respect to which a determination has been made. Following are some excerpts from section 3801 (emphasis added):
Subsection (a)(1)(C)— ‘(i) * * * items with respect to which the claim was allowed * * * (ii) * * * items with respect to which the claim was disallowed * * * .‘
Subsection (b)(1)— ‘ * * * the inclusion in gross income of an item * * * .‘
Subsection (b)(3)— ‘ * * * the exclusion from gross income of an item * * * .‘
See also the statement in the Finance Committee Report above quoted, that section 3801 is to be confined ‘to the influence of the particular items involved in the adjustment.‘
Subsection (d) provides for the ‘Ascertainment of Amount of Adjustment.‘ One of the steps prescribed is the ascertainment of ‘the increase or decrease in the tax previously determined which results solely from the correct exclusion, inclusion, allowance * * * of the item, inclusion, deduction, credit, gain, or loss, which was the subject of the error.‘ ‘The item‘ with respect to which a determination was made by our decision in the 1942-1943 proceeding (Docket No. 16677) was an adjustment of the 1942 opening figures of Badcock by a net amount of $18,125.59 which consisted of opening inventory ($2,745.56), accounts receivable ($16,632.32), less amounts owed on purchases, i.e., accounts payable ($1,252.29). In his determination of deficiencies in this proceeding the respondent does not attempt to trace back into the prior years the adjustment affected by our decision as to the year 1942. Instead, he has determined increases in income for the years 1838-1940 on the basis of the records of Badcock for each of those years and has computed a deficiency based on such increases. He has not determined ‘the increase * * * in the tax * * * which results solely from‘ the adjustment to 1942 opening figures on account of accruables and inventory at the beginning of that year, which was given effect in our decision for the 1942-1943 years. For all that we know, the 1942 adjustment may have resulted entirely from transactions that occurred in the year 1941, which is not involved in this proceeding. If so, then no part of the accruable items or inventory can properly be carried back to prior years and used to adjust income for such years.
As we read section 3801 and its legislative history, it permits the taxpayer or the Commissioner, as the case may be, to correct prior years' taxes after expiration of the normal limitation period based on specific items which have been erroneously treated due to an inconsistent position with respect to such items. Section 3801 does not purport to permit adjustments for prior years for items that are merely similar to those with respect to which a determination has been made for another year. This, in effect, is what the respondent seeks to do in this proceeding. Because the income of Badcock for 1942 was determined by taking into consideration receivables, payables, and inventories, the respondent takes the position that similar items should be taken into consideration for the earlier years.
Accordingly, we hold that the respondent has not met his burden in that he has not shown what portion, if any, of the increase in tax determined for the years 1938-1940 results from the adjustment for the specific accruals and inventory permitted for 1942 by our determination with respect to that year. It follows that section 3801 is not available to the respondent to extend the statutory period for assessment and that assessment is barred under the provisions of section 275 (a) of the Code.
Decision will be entered for the petitioners.