*49 Decision will be entered for the respondent.
Petitioner organized and controlled a corporation to own land and erect houses for sale thereon. To do the actual construction, he organized a limited partnership, of which he was the only general partner and in which his interest was 85 per cent. The corporation contracted with the partnership, by long-term contract, to construct houses for a specified remuneration per house. At the same time, petitioner was a substantial stockholder in a corporation engaged in housing construction under generally similar circumstances. Before the end of the partnership's first taxable year, but at a time when construction in both operations was nearing completion and a profit was indicated for the partnership project as against a loss on the other operation, petitioner caused a new corporation to be formed and for its common and preferred stock to acquire the stock of the corporation and the business and assets of the partnership, after which the partnership was dissolved. A return was thereafter filed for the partnership, in which none of the payments received by it under the contract and none of the expenses incurred by it in the performance*50 thereof were accounted for or reported, but which return was intended to indicate an election to report the contract profits on the completed contracts basis. The new corporation completed the work under the contract, and in its return for its first fiscal year reported the contract profits in toto. The respondent determined that such reporting of the contract profits did not clearly reflect the income of the partnership for the period of its operation, and on a ratable basis allocated a portion of the said profits to the partnership as its income for the taxable period covering its existence and operations. Held, that the respondent did not err in his determination of partnership income under the contract. Standard Paving Co. v. Commissioner, 190 F.2d 330">190 F. 2d 330, affirming 13 T.C. 425">13 T. C. 425.
*155 The respondent determined a deficiency in income tax against the petitioners for the calendar year 1948 in the amount of $ 76,517.63. The question for decision is whether the respondent erred in determining that $ 128,090.43 of the profit realized under a certain construction contract completed in the fiscal year ended August 31, 1949, was the income for the taxable period ended August 31, 1948, of a partnership of which Alden Charles Palmer was a partner. The disallowance of a claimed deduction for contributions has been conceded.
FINDINGS OF FACT.
The petitioners are husband and wife, and reside at 3255 Palmer Drive, Los Angeles, California. They filed a joint income tax return for the calendar year 1948 with the collector of internal revenue for the sixth district of California. They reported their income on a cash receipts *52 and disbursements basis.
From 1921 through the taxable year, Alden Charles Palmer, sometimes referred to as Palmer or petitioner, was variously engaged as construction superintendent, contractor, builder, and subdivider. On August 20, 1947, he caused Santa Anita Square, Inc., a California corporation, sometimes referred to as Santa Anita, to be incorporated. Santa Anita was organized for the purpose of acquiring and developing land through the construction of a housing project thereon, and to that end, it immediately acquired a tract of land, designated as Tract No. 13613, in Los Angeles County. The land was located at or near Temple City, 15 to 18 miles from Los Angeles, and in the vicinity of the Santa Anita Race Track.
*156 All of Santa Anita's stock was held by Palmer, members of his immediate family, and near relatives. Included were two sons, two brothers, a niece, and the husband of a niece of Palmer. Palmer was president, and Santa Anita was at all times under his control and direction. 1 Its address was that of Palmer's home.
*53 For the purpose of doing the actual work of constructing the houses, Palmer, on September 5, 1947, organized a limited partnership under the name of A. C. Palmer & Company, sometimes referred to as the partnership. Palmer was the only general partner, and had an 85 per cent interest therein. The limited partners were Van Dell, his construction superintendent, Cranford, a civil engineer, Green, the architect, and Curry, an attorney. Their respective interests were 6, 3, 2, and 4 per cent, and they contributed cash in units of $ 1,000 for each per cent of interest received. Van Dell, Cranford, and Green were employed by the partnership, receiving salaries of $ 850, $ 600, and $ 500 per month, respectively. Curry was Palmer's attorney.
Tract No. 13613 was divided into lots numbered 1 through 160, and pursuant to a resolution adopted by its board of directors on September 29, 1947, Santa Anita applied to the Bank of America National Trust & Savings Association, hereafter referred to as Bank of America, for 160 loans, each loan to be applied to the construction of a house on 1 of the 160 lots. Among the papers submitted in support of the 160 applications for loans were financial *54 statements of Santa Anita and of Palmer. Also submitted was a letter from A. C. Palmer & Company, the partnership, by Palmer as general partner, to the Bank of America, the Federal Housing Administration, and all concerned, which letter was to confirm that the partnership was to perform and complete the tract improvements and the erection of residences on the tract under a cost-plus contract with Santa Anita Square, Inc., "wherein the construction fee will be payable only at the completion of the project and out of loan funds then remaining and/or proceeds from sales." 2
Thereafter, on October 16, 1947, the Bank of America submitted 160 applications to the Federal Housing Administration, sometimes referred to as Federal Housing, for insurance on the mortgages to be given by Santa Anita to secure the 160 loans applied for, and under date of October 21, 1947, was notified*55 by Federal Housing that the financing as proposed did not qualify for mortgage insurance *157 for the reason that "[waiver] of contractor's construction fee until the tract is sold out constitutes secondary financing and therefore is contrary to the Administrative Rules and Regulations."
Under date of October 27, 1947, Santa Anita, in a letter signed by Palmer as president, requested the Bank of America to resubmit the applications to the Federal Housing Administration for firm commitments of mortgage insurance on the first 46 cases, lots 1 through 46, and for conditional commitments for the balance, lots 47 through 160, and that in making such renewal of applications, to "[eliminate] entirely the proposed agreement between mortgagor and the builder relative to delayed payment of builder's fee."
In keeping with that request, and by a letter also dated October 27, 1947, the Bank of America wrote the Federal Housing Administration for firm commitments on mortgage insurance for the first 46 applications and conditional commitments as to the rest.
Thereafter, and under date of October 29, 1947, Santa Anita and the partnership entered into a contract, whereby the partnership, referred*56 to therein as the contractor, was to build for Santa Anita 160 houses on the 160 lots in tract No. 13613. Under the contract the partnership was to furnish all of the materials and perform all of the work shown on the drawings and described in the specifications prepared by Green, architect for the owner. The remuneration to be received by the partnership was separately stated and in a fixed amount for each house. By the terms of the contract the project was "segregated into four parts or groups," and the construction work was to be "commenced and prosecuted in each of the several groups if, as and when" Santa Anita should direct. The first group included lots 1 through 46, and the contract prices for the work the partnership was to do in the building of the 46 houses in that group were in a total amount of $ 410,842. The second group consisted of lots 47 through 101, and the total price to be paid for the building of the houses on the lots in that group was $ 490,491. Group 3 consisted of lots 102 through 130, and the prices to be paid for the construction of the houses in that group were in the total amount of $ 259,314. The fourth group consisted of lots 131 through 160, *57 and the prices to be paid for the construction of the houses in that group were in the total amount of $ 267,737. The prices to be paid if all of the houses in the four groups were constructed were in a total amount of $ 1,428,384.
Work on each group was to be commenced by the partnership within 30 days after written notice from Santa Anita. The prices per house as stated in the contract were to be applicable only for the particular group, or groups, as to which the partnership should be authorized to commence work within 4 months from the date of the *158 contract, and where work on any group, or groups, was not authorized within that time, the prices, at the option of the partnership, were to be renegotiated to reflect any increased cost of labor or materials. And if Santa Anita should fail to agree to such renegotiated prices, the partnership could, at its option, terminate the agreement as to all or any of the groups for which authority to commence construction had not been given within 4 months of the date of the agreement.
Payments on account were to be made by Santa Anita on or about the tenth day of each month, the amount of the payment required being 100 per cent *58 of the contractor's cost of labor and materials incorporated in the work and all materials suitably stored at the site thereof up to the last of the preceding month, less the aggregate of previous payments. Final payment was due 35 days after the substantial completion of the work, and it was provided that upon written notice the work was ready for final inspection and acceptance, Santa Anita should make inspection promptly, and if the work was found to be acceptable, it was to issue promptly a final certificate that the work had been completed and had been accepted under the terms and conditions of the contract. Upon the issuance of such final certificate, the entire balance due the partnership was to be due and payable. At Santa Anita's option, however, final payment could be made in its preferred stock, at the par value thereof.
The contract also provided that:
If, prior to commencement of work upon any Group or Groups, it becomes necessary or advisable, to the satisfaction of the Owner, to abandon or to suspend for an indefinite period the work upon such Group or Groups, then the Owner, at its option, may terminate this Agreement as to such Group or Groups by written notice*59 to the Contractor, in which event the Owner shall be liable to the Contractor only to the extent of indemnifying the Contractor against actual damages resulting directly from such termination, but the Contractor shall not be entitled to prospective profits on work unperformed or materials unfurnished unless, and then only to the extent that, such materials have been specially fabricated for the work.
Provision was further made that Santa Anita, rather than its architect, was to supervise the work, and that wherever the word "Architect" appeared in the contract or in the general conditions attached thereto, the reference should be held to mean Santa Anita.
The houses were to be 2- and 3-bedroom homes, and there were 9 different floor plans. The prices Santa Anita was obligated by the contract to pay to the partnership for the construction of the houses ranged from a low of $ 8,620 to a high of $ 9,765 per house, with the prices on the great majority ranging between $ 8,620 and $ 9,000. According to plans, the houses when completed were to be sold at prices ranging from $ 11,700 to $ 14,550 per house.
*159 Under date of November 19, 1947, the Federal Housing Administration, using*60 its appropriate printed forms, advised the Bank of America that it was thereby issuing to it a conditional commitment for "insurance of the mortgage" covering its loan on each of lots 47 through 160. And under date of November 20, 1947, on similar duly executed forms, it further advised the bank that it was issuing thereby a firm commitment for "insurance of the mortgage" covering the loan the bank was making on each of lots 1 through 29 and lots 34 through 46 of the said tract.
Thereafter, and under date of December 1, 1947, the Bank of America and Santa Anita executed an instrument designated "Owner-Builder Agreement." The agreement recited that the Bank of America had agreed to make 46 loans to Santa Anita in a total amount of $ 358,600, and that Santa Anita, in consideration of these loans, agreed to construct or have constructed 46 single-family residences, 1 on each of the 46 lots; that the construction should commence not later than 30 days from the date of the agreement, and should be fully completed not later than July 1, 1948, and that the property should be free of liens and all bills for labor and materials paid on or before August 1, 1948. The agreement also provided*61 that the loans should be paid to Santa Anita in 5 amounts of 20 per cent each of the total loans, the first 20 per cent to be paid when the deeds of trust had been recorded and the final 20 per cent when the building had been completed. Attached to and made a part of the agreement was a schedule showing the amount of the loan against each of the 46 lots and the building to be constructed thereon.
At the instigation or requirement of the Bank of America, Santa Anita, on December 8, 1947, executed an instrument designated "Control Agreement" with Builders' Control Service, Inc., sometimes referred to as Builders' Control, a loan disbursement agency. The agreement recited that Santa Anita had secured loans in a total amount of $ 358,600 from the Bank of America, to be used in the construction of a residence and garage on each of lots 1 through 46, and that the total estimated cost of such construction was $ 436,762; that Santa Anita would assign to Builders' Control the proceeds of the said loans and would deposit a further sum of $ 45,000 and a bill of sale for prepaid materials in the amount of $ 70,421.75, which with the loan proceeds should make up the estimated cost of construction, *62 plus such additional reserve funds as may have been requested by Builders' Control or the lender; and that Builders' Control would apply the money received as promptly as reasonably possible to payment for labor, services, materials, and other items properly incurred as construction costs, and should have the sole option to make payments directly to the subcontractors, laborers, and suppliers. There *160 were further and other provisions giving in considerable detail the rights and powers of Builders' Control to supervise the payment of construction costs and to see that moneys received by it were properly applied. Santa Anita agreed to proceed with reasonable diligence in the commencement and completion of construction, and was to receive from Builders' Control any balance of the funds remaining after construction was completed and the costs were paid. Builders' Control was to receive a fee for its services equal to 1 1/2 per cent of the funds disbursed by it for construction.
Also under date of December 8, 1947, the partnership executed a waiver of any and all "lien rights" it then had or might acquire against lots 1 through 46, and expressly released Builders' Control from*63 any obligations to pay to it any sums for its services "as Superintendent, or otherwise."
The first foundations for houses in group 1, lots 1 through 46, were started during December 1947, and by the end of that month Santa Anita had started its campaign to sell the houses under construction and to be constructed.
As listed by Builders' Control, but with dates not shown, its first two disbursements under the control agreement were advances of $ 10,000 and $ 15,000 to the partnership, to be used as a revolving fund in connection with the construction work it was to do under its contract with Santa Anita. This was followed by a disbursement of $ 10,000 to the partnership, which disbursement was described as "Payroll Advance."
Beginning with December 22, 1947, and at varied intervals thereafter, the partnership would submit statements to Builders' Control covering its disbursements for materials in connection with the construction of the houses and would receive reimbursement therefor from Builders' Control. Also at varied intervals, Builders' Control, according to its statement of disbursements, would make a "Payroll Reimbursement" to the partnership.
Under date of March 1, 1948, *64 the Bank of America and Santa Anita executed a so-called owner-builder agreement, relating to lots 47 through 101. This agreement, in material respects, was similar to that executed under date of December 1, 1947, with reference to lots 1 through 46. The loans on lots 47 through 101 in total amount were shown as $ 437,500. Construction of the houses on the said lots was to commence not later than 30 days from the date of the instrument. They were to be completed not later than July 1, 1948, and by August 1, 1948, were to be free of all liens and all bills for labor and materials were to have been paid. The loan proceeds were to be paid 40 per cent upon the recording of the deeds of trust and 15 per cent each (1) when the floor joists were in place; (2) when the roof was *161 on and plumbing and electrical work was roughed in; (3) when "plastered inside and out," and finished lumber, sash, and doors were on the ground; and (4) when the houses were completed, and the work approved by the Federal Housing Administration.
Under date of March 4, 1948, a control agreement relating to lots 47 through 101 was executed by Santa Anita and Builders' Control, which agreement was in terms*65 similar to that which had been signed with reference to lots 1 through 46. In addition to the net loan proceeds, Santa Anita was to deposit with Builders' Control the further sum of $ 15,000 and a bill of sale for prepaid materials in the amount of $ 21,359.84. Under the same date the partnership executed a waiver of any "lien rights" it had or might acquire against the said lots, and released Builders' Control of any obligation to pay it for services "as Superintendent, or otherwise."
Previously, under date of March 1, 1948, Santa Anita had executed an assignment to Builders' Control of the first $ 25,000 of cash proceeds from the sale of lots 1 through 101 and the improvements thereon, less costs of sale, the said $ 25,000 to be disbursed by Builders' Control pursuant to the terms of the control agreement. It was further provided that upon satisfaction of the provisions of the control agreement the assignment should be null and void.
The first foundations for the houses in group 2, lots 47 through 101, were started during March 1948.
By letter dated March 19, 1948, Santa Anita authorized the partnership to furnish specified extras to the construction contract between them dated*66 October 29, 1947, at an added cost of $ 300 per house, making an aggregate added cost therefor of $ 48,000. In addition, the allowance for lighting fixtures was increased from $ 50 per house, as provided by the contract, to $ 75 per house, or an added aggregate increase of $ 4,000.
Under date of June 10, 1948, the Bank of America and Santa Anita executed a so-called owner-builder agreement relating to the remaining lots 102 through 160. The terms of the agreement were in pertinent respects similar to the terms of the agreement dated March 1, 1948, and covering lots 47 through 101. The loans to which the Bank of America was committed were $ 471,500 in total amount. Construction was to be commenced by July 10, 1948, namely, "not later than 30 days from the date" of the agreement, and was to be fully completed not later than September 4, 1948; and further, the property was to be free of all liens and all bills for labor and materials were to be paid on or before October 1, 1948.
A control agreement relating to lots 102 through 160 was executed by Santa Anita and Builders' Control under date of June 14, 1948, which agreement in pertinent respects was similar to the control *162 *67 agreements executed with reference to the other lots. In addition to the net loan proceeds, Santa Anita was to deposit with Builders' Control the further sum of $ 45,000. Concurrently, the partnership executed a comparable waiver of any "lien rights" it had or might acquire against the said lots and a release of Builders' Control of any obligation to pay it for services "as Superintendent, or otherwise."
By an instrument also dated June 14, 1948, Santa Anita assigned to Builders' Control all proceeds from the sale of lots 102 through 160 and the improvements thereon, less the costs of sale, the said proceeds to be disbursed by Builders' Control pursuant to the control agreement. It was further provided that upon satisfaction of all provisions of the control agreement the assignment should be null and void.
The foundations for the houses in group 3, lots 102 through 130, and in group 4, lots 131 through 160, were started in June 1948.
The Lovedahl Construction Company, an Oklahoma corporation, was incorporated November 5, 1947. Its stock as originally issued was as follows:
| Shares of | Shares of | |
| Shareholder | $ 100 common | $ 100 preferred |
| stock | stock | |
| Mr. and Mrs. L. R. Lovedahl | 10 | 26 |
| Alden Charles Palmer | 5 | 150 |
| A. C. Palmer, Jr | 1 | 24 |
| Richard J. Palmer, in trust | 1 | 9 |
| William B. Palmer, in trust | 1 | 9 |
| The Gustaveson Company | 1 | 48 |
*68 As originally planned, the Lovedahl Construction Company was to engage in housing construction in Oklahoma City. Due to an adverse zoning regulation, however, that plan never came to fruition, and when organized the Lovedahl Construction Company was to build housing projects in Stillwater, Oklahoma, the seat of Oklahoma A. & M. College. Control of operations was primarily in the hands of Lovedahl. The petitioner had to do more with the financing and served in an advisory or consulting capacity.
As in the case of the Santa Anita venture, the acquisition or ownership of the property itself was in a separate corporation, College Homes, Inc., organized for the purpose under the laws of Oklahoma. Except for "a little common stock" acquired by two other persons, the stock of College Homes, Inc., was owned by petitioner and by Lovedahl and his wife.
The Stillwater project was an apartment project, and was approved by the Federal Housing Administration to supply rental housing. In planning and for construction purposes the operation was divided into nine separate projects, each one to be financed and constructed *163 separately. By the summer of 1948, three of the projects were*69 under construction and the Lovedahl Construction Company was obligated to carry them to completion. At the time these three projects were "filed of record" the petitioners, Palmer and his wife, personally obligated themselves as "indemnitors" for College Homes, Inc., "to the tune of about $ 51,000."
Lovedahl, who was managing the operations of Lovedahl Construction Company, suffered a nervous breakdown, and petitioner found it necessary to take over. On July 24, 1948, he and his sons purchased the common and preferred stock of Lovedahl's and his wife's for cash, the petitioner acquiring 7 shares of the Lovedahls' 10 shares of common stock and all 26 shares of the preferred stock, the remaining shares of common stock being acquired 1 share by Alden Charles Palmer, Jr., 1 share, in trust, for Richard J. Palmer, and 1 share, in trust, for William Buddy Palmer. After the purchase of the Lovedahls' stock, the name of Lovedahl Construction Company was changed to A. C. Palmer Construction Company, sometimes referred to hereafter as Oklahoma Construction.
At or about the same time the construction company stock was acquired, petitioner also acquired the Lovedahl's stock in College Homes, *70 Inc., after which he owned all of the College Homes stock except the few shares of common stock outstanding with the two other persons "who were in the deal originally."
When petitioner acquired the above stock from the Lovedahls and took control of operations, the first project, consisting of 4 buildings containing 24 apartments, was probably 75 per cent complete. As to that project, the apparent result was that there was a loss, but the extent of the loss was not known. As to the next two projects, construction in some if not all instances had reached floor level. It was also apparent that if all nine projects were to be built, changes in construction designs would be necessary if they were to stay within the limits of cost commitments. The readily available labor supply was inadequate and it was necessary to pay premium wages for some key personnel and mechanics. Shelter had to be provided in some cases. Petitioner found it necessary in one instance to transport plasterers from Los Angeles to Stillwater "in order to proceed." And there were instances where subcontractors refused to stand by their original bids.
In organizing College Homes, Inc., petitioner and Lovedahl had*71 no intention that College Homes should enter into the business of owning and renting the said apartments upon their completion. Their intention and purpose was that College Homes would sell the projects as completed to Oklahoma A. & M. College, to be used by it as rental housing for students, members of its faculty, and possibly *164 other college personnel. There were conferences from time to time attended by petitioner, the Lovedahls, the president of the college, and possibly Federal Housing officials, at which it was petitioner's understanding that the college would acquire the projects "one by one on a self liquidating basis." There was no contract to purchase or agreement as to the terms of purchase or of the price to be paid, but petitioner was told by the president that "they would arrange negotiations to acquire the property," although it later appeared "they were going to negotiate or they were going to attempt to negotiate on their own basis."
From the building trade standpoint, the project at Stillwater was overdeveloped. The first project was completed early in November 1948, at which time College Homes, Inc., was able to rent only 8 of the 24 apartments. 3
*72 On some undisclosed date or dates, petitioner discussed income tax problems which might result from the Stillwater and Santa Anita projects with tax counsel. One matter which was discussed was whether a profit on the Santa Anita venture might be offset against a loss on the Oklahoma venture. Following or as the result of these discussions, petitioner approached the limited partners of the partnership, and on August 31, 1948, acquired their partnership interests for cash equal to the payments which had been made by the limited partners therefor. In acquiring these interests, the petitioner had prepared and made no accounting to the limited partners of the then financial condition of the partnership. He did complain of the condition of the projects at Stillwater and of the resulting effects it might have on his individual financial condition, and he may have told Green that he feared a possible loss in Oklahoma and if he went bankrupt he wouldn't want his other partners involved. Curry, one of the limited partners, had been advised that the partnership had "incurred expense and not income, with the result that as of that date it showed a loss." He knew that petitioner, "as the *73 general partner, had it wholly within his control to continue or discontinue the partnership." These factors had some bearing on his sale of his limited interest to petitioner, although the most "potent" factor in his mind "was the fact that it appeared that there might be a conflict" between his interest as a partner and his representation of petitioner as an attorney.
On the next day, September 1, 1948, A. C. Palmer & Company, a California corporation, sometimes referred to as Palmer & Company, was organized, whereupon the original stock of the corporation was issued as follows: 200 shares of common stock to petitioner, for the *165 assets of the partnership; 1,520 shares of preferred stock to petitioner, for his stock in Oklahoma Construction; 207 shares of preferred stock to Alden Charles Palmer, Jr., for his stock in Oklahoma Construction; 77 shares of preferred stock, in trust, for Richard J. Palmer, for stock in Oklahoma Construction similarly held in trust; 77 shares of preferred stock, in trust, for William Buddy Palmer, for stock in Oklahoma Construction similarly held in trust; and 414 shares of preferred stock to the Gustaveson Company, for its stock in Oklahoma Construction. *74 After the transfers, Oklahoma Construction was wholly owned by Palmer & Company.
By September 1, 1948, 80 of the houses in the Santa Anita project had been completed and notices of completion filed. This included all 46 houses comprising group 1. Deposits had been received on 127 houses. Sales escrows had been opened on 95 houses, and had been closed on 7. All of the remaining houses were under construction. There were none in respect of which the foundations had not been completed, and approved by Federal Housing, and on all construction had progressed to such point as to permit completion within 3 to 4 months.
A major objective, if not the major objective, in the organization of Palmer & Company and in its acquisition of the business of the partnership, including the construction contract with Santa Anita, and its acquisition of the outstanding stock of Oklahoma Construction was the offsetting, for income tax purposes, of the loss of Oklahoma Construction on the Stillwater projects against the profit on the Santa Anita project.
Construction of all homes in the Santa Anita project was substantially completed and the last notice of completion was filed on December 3, 1948. *75 The last notice of completion had been recorded in the public records of Los Angeles County by the end of 1948. The number of homes actually constructed was 159, instead of 160 as originally planned. During 1948 the 135th sales escrow on the Santa Anita project was closed, reflecting gross sales of $ 1,360,872. The last of the 159 houses was sold by Santa Anita in February 1951.
The six remaining projects which had been planned for Stillwater were never started. They were canceled on January 13, 1949.
On June 20, 1949, Santa Anita wrote Palmer & Company ordering and authorizing certain extras relating to bathrooms, halls, kitchens, and breakfast rooms for the entire tract and for complete change of models for units 3 and 4. For such extras, Palmer & Company was to receive $ 31,500, against which a credit of $ 9,045, for the omission of construction of a house on lot 130, was to be applied, leaving $ 22,455 as the net amount payable for the extras so ordered.
*166 Inclusive of the extras and revisions ordered under dates of March 19, 1948, and June 20, 1949, the total price Santa Anita was obligated to pay under its contract of October 29, 1947, for the construction of 159*76 houses which it built for Santa Anita was $ 1,502,839. The cost to the partnership and Palmer & Company in carrying out the contract and supplying the extras was $ 1,287,829.67, resulting in a gross profit of $ 215,009.33. The addition of insurance refunds and other discounts earned increased the profits to $ 223,813.86, while a loss on equipment used on the project in the amount of $ 1,050.12 brought the final gross profit under the contract, inclusive of the extras ordered, to $ 222,663.74. The total overhead, exclusive of officers' salaries, was $ 50,520.29, and after allowing for overhead in that amount, there was a net profit under the contract and in respect of the extras ordered of $ 172,143.45.
As of November 10, 1947, the petitioner had estimated that Santa Anita's gross sales from the 160 houses planned for the tract would amount to $ 1,988,650. Its actual gross sales from the sale of the 159 houses built were $ 1,924,760.
As shown by its books, the paid-in capital of Santa Anita as of September 25, 1947, was $ 30,000 for common stock and $ 130,000 for preferred stock. The amount shown as paid in for preferred stock was increased to $ 150,000 at October 3, 1947, and*77 to $ 190,000 at March 31, 1948. The amount shown as paid in for preferred stock was reduced by retirement of such stock to $ 175,000 at June 30, 1948; to $ 125,200 at July 31, 1948; to $ 85,000 at August 31, 1948; to $ 75,000 at January 31, 1949; to $ 25,000 at May 19, 1949; and to zero at May 31, 1949. The amount shown as paid in for common stock continued at $ 30,000 until August 1, 1950, when it was shown as reduced to $ 8,500, by retirement of such stock.
After the transfer of the partnership assets and business to Palmer & Company for its common stock, the first, and its only return, was prepared and filed for the partnership purporting to cover the partnership operations for the entire period of its existence, namely, the period from September 5, 1947, the date of organization, through August 31, 1948, the date of dissolution. In the return so filed the partnership did not account for or report any of the payments it had received on account under the Santa Anita contract during such period, and it did not claim as deductions on the return any of the expenses it had incurred during the period in its operations in performance of the contract and shown as such on the partnership*78 books. As so filed, the return was intended to indicate that the partnership had elected to account for and report the results of its operations under the Santa Anita contract by the so-called completed contracts method of reporting contract profits, thereby leaving Palmer & Company to report *167 the profits in toto for the year in which performance under the contract should be completed as to the houses in all four groups. The only item reported on the return as gross income was $ 2,178.79, described as cash discounts earned. A loss of $ 118.90 on the sale of a table saw was claimed, which with other deductions in a total amount of $ 19,649.32 disclosed a reported net loss of $ 17,589.43. The $ 19,649.32 was made up of varied amounts described as repairs, social security taxes, depreciation, insurance expenses, auto expenses, stationery and printing, professional fees, office expenses, telephone and telegram, utilities, licenses and permits, miscellaneous expenses, and blueprints, plans, etc. There was no disclosure on the return as to the operation to which the deduction items so claimed were related. The partnership balance sheet for August 31, 1948, as set out in the*79 return, reflected, among other items, an asset of $ 961,900.42, described as construction in process, $ 20,432.29 as reserve for depreciation, $ 92,899.79 as advances to joint venture, 4 cash of $ 18,867.90, and total assets of $ 1,096,471.34. The balancing amount under liabilities was shown as consisting of $ 2,713.66 as withholding taxes, $ 1,091,757.68 as notes and mortgages payable, and a net amount of $ 2,000 as partners' capital accounts.
For the fiscal year ended August 31, *80 1949, Palmer & Company, with its subsidiary corporation Oklahoma Construction, filed a consolidated return on November 14, 1949. In arriving at a reported net income of $ 1,601.59, it took into account the loss of $ 170,156.29 sustained by Oklahoma Construction and the total profits under the October 29, 1947, construction contract between Santa Anita and the partnership, which contract had been acquired by Palmer & Company on September 1, 1948, as a part of the assets of the partnership paid in by petitioner for 200 shares of Palmer & Company's common stock. In reporting the profits on the Santa Anita construction, it included the extras and revisions authorized by Santa Anita under dates of March 19, 1948, and June 20, 1949. To arrive at the net profit under the said contract, including such extras and revisions, it deducted the expenses and costs which had been incurred by the partnership on the Santa Anita project for the period ending August 31, 1948, as well as the expenses which it, Palmer & Company, had incurred from and after September 1, 1948.
In his determination of deficiency, the respondent allocated the profit realized under the construction contract with Santa Anita*81 in *168 part to the partnership for the period ended August 31, 1948, and the remainder to Palmer & Company for the period from and after September 1, 1948. In making this allocation, he first arrived at a total gross income of $ 222,663.74, which included the profits on the extras and revisions authorized by Santa Anita under dates of March 19, 1948, and June 20, 1949, which gross income was in the same amount as had been reported by Palmer & Company on its consolidated return for the fiscal year ended August 31, 1949. He next eliminated the profits realized by Palmer & Company on the extras it had been authorized to furnish under the authorization of June 20, 1949, and to which the partnership had never been a party, leaving a net profit, after such elimination, of $ 168,930.14. The total cost to the partnership and to Palmer & Company in carrying out the contract, exclusive of the extras ordered by the letter of June 20, 1949, was $ 1,268,587.98. Of those costs, he determined that $ 961,900.42 had been incurred and expended by the partnership up to and including August 31, 1948, with the remainder having been incurred by Palmer & Company from and after September 1, 1948. *82 He next allocated the $ 168,930.14, being the total net profit under the contract of October 29, 1947, including the revisions ordered under date of March 19, 1948, between the partnership and Palmer & Company on the basis of the ratios of the costs incurred by each, to arrive at $ 128,090.43 as the profit of the partnership for its fiscal period ended August 31, 1948.
OPINION.
The general rule for accounting for and reporting income as stated in section 42 (a) of the Internal Revenue Code of 1939, is that "[the] amount of all items of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under methods of accounting permitted under section 41, any such amounts are to be properly accounted for as of a different period." In section 41 so referred to, it is provided that "[the] net income shall be computed upon the basis of the taxpayer's annual accounting period * * * 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*83 with such method as in the opinion of the Commissioner does clearly reflect the income." Under these provisions other methods of accounting, including accrual accounting and the numerous variations thereof, as well as cash receipts and disbursements accounting, are recognized so long as in the opinion of the Commissioner the particular method employed clearly reflects the income.
*169 Pursuant to and under the above statutory provisions, the Commissioner has provided by regulation, section 29.42-4 of Regulations 111, 5*85 that taxpayers whose income is derived, in whole or in part, from long-term contracts may, as to such income, prepare their returns upon "either" of two stated bases. On one basis, commonly referred to as the percentage of completion basis, the gross income from such contracts is to be reported according to the percentage of completion during the taxable year of the entire work to be performed under the contract. By the other, commonly referred to as the completed contracts method, the gross income under the contract is to be reported in full "for the year in which the contract is finally completed and accepted." The right to report contract profits by the completed*84 contracts method is conditioned, however, on an election by the taxpayer "as a consistent practice so to treat such income," and there is the further proviso that "such method clearly reflects the net income." The term "long-term contracts" is defined by the regulation to mean building, installation, or construction contracts covering a period in excess of 1 year from the date of execution of the contract to the date on which the contract is finally completed and accepted. 6 Both of the above methods of accounting for and reporting long-term contract income are forms of accrual accounting and reporting. By the percentage of completion method, the indicated profit under the contract is accrued ratably according to the percentage of completion during the taxable year of the entire work under the contract, while by the completed contracts method, the entire profit accrues in the year *170 in which the contract is completed. On neither basis must there be actual payment or a right to require payment in the taxable year.
The partnership return filed for the period ended August 31, 1948, the entire period of the partnership's existence and operations, did not take into account or report any of the payments which had been received on account under the Santa Anita contract, or any part of the $ 961,900.42 covering the expenditures which had been incurred in its performance under the contract and carried as an asset item in that amount as construction in process. Although it was stated thereon that the return was prepared on a cash basis, it was not a cash basis return, but was a return prepared pursuant to the completed contracts method of reporting contract income, the purpose being that the profits under the Santa Anita contract be reported in toto as the income of Palmer & Company for the year all work under the contract should be completed. The evidence shows that all of the*86 houses were completed and notices of completion had been recorded by the end of December 1948, and Palmer & Company, which had been organized on September 1, 1948, and which as of that date had acquired the assets of the partnership and the stock of Oklahoma Construction in nontaxable transfers, prepared and filed a consolidated return with Oklahoma Construction for the fiscal year ended August 31, 1949, in which, by the completed contracts method, it did account for and report in full the profits under the Santa Anita contract and similarly claimed deductions for the losses sustained by Oklahoma Construction on the Stillwater projects.
Determining that such a reporting of the profits under the Santa Anita contract did not properly or clearly reflect the respective earnings of the partnership and Palmer & Company thereunder, the respondent has allocated the said profits between the partnership and Palmer & Company in such amounts as in his opinion did fairly reflect their respective earnings under the contract. In so doing, he determined that the partnership, for the fiscal period ended August 31, 1948, realized that portion of the total profits under the contract that its costs *87 in performing the contract through that date bore to the total costs, excluding from such allocation, however, both the costs and the profits under the supplemental authorization by Santa Anita to Palmer & Company, under date of June 20, 1949, which was after the date of the filing of formal acceptance by Santa Anita of the work under the contract, and in which the partnership never participated. The apparent effect of this determination was to shift the accounting for and reporting of the income under the contract from the completed contracts method to the percentage of completion method, the other method prescribed by the above regulation for reporting long-term contract income.
*171 It is well settled that a taxpayer may make changes in the conduct of his business and plan and execute his transactions in such manner as will, in respect of operations and transactions thereafter occurring, result in a minimum of tax under the law. On the other hand, it is equally well settled that income is taxable to the earner thereof, and this rule has been declared and applied in cases where contemporaneously with the earning or accrual of income, such income, by prior anticipatory assignment, *88 might belong to or be the property of another. See Lucas v. Earl, 281 U.S. 111">281 U.S. 111; Helvering v. Horst, 311 U.S. 112">311 U.S. 112; Helvering v. Eubank, 311 U.S. 122">311 U.S. 122; and Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579. The question here, however, is as to the earnings for a period prior to any transfer or assignment, whether anticipatory or fully executed, and is whether a contractor in the process of completing the work under a long-term contract may, by the transfer to another of his or its assets, including the contract, and by the filing of a return for the period ending with the transfer on the completed contracts basis, obviate or be relieved of any and all obligations ever to account for and report, for income tax purposes, the earnings properly attributable to the work done up to the time of the transfer.
That a substantial profit was earned on the Santa Anita contract and much the greater portion of the work done and the expenses incurred in the earning of those profits was done by and were those of the partnership, not Palmer & Company, are all established by the*89 evidence. At or prior to September 1, 1948, 80 of the 159 houses constructed under the contract had been completed and notices of completion had been filed. The remaining houses were in process of construction and in less than 4 months thereafter they likewise had been completed. The facts further show that the 80 houses which had been completed at or prior to September 1, 1948, included all 46 houses comprising group 1. The amount of the recompense to be paid by Santa Anita and to be received by the contractor was in a fixed amount for each individual house, and while we are not advised as to the date when all of the payments were finally made, it was on such contract price that Palmer & Company accounted for and reported the profits in the succeeding fiscal year, by the completed contracts method, and there is no claim that the total profits under the contract as so computed were not correct in amount. Also it would follow, we think, that upon completion of the 80 houses in question the costs of construction thereof had likewise become fixed and determined and the profit thereon was then determinable. Furthermore, by the terms of the contract, the construction of the houses*90 was to be by groups, and the obligations of the parties with respect to the houses in one group were not dependent upon the carrying *172 out of the contract with respect to the other groups. It would thus appear that whatever may have been the case with respect to those of the 80 completed houses which were in the groups not yet completed, the profits on the houses in group 1 had not only been earned in the period ended August 31, 1948, but, absent the long-term contract, would by an accrual method of accounting have constituted taxable income for such period. The facts further show that not only had a major portion of the physical construction on all of the houses been accomplished by the partnership prior to its termination, but that the costs incurred in the performance of its work under the contract amounted to $ 961,900.42 out of ultimate total costs for the entire contract of $ 1,268,587.98. And there is no showing that from a practical or common sense standpoint, or on the percentage of completion basis, the expenditures of the partnership in the course of its operations under the contract could not and did not reasonably reflect the earning of a comparable portion*91 of the total profit. See, in that connection, Jud Plumbing & Heating v. Commissioner, 153 F.2d 681">153 F. 2d 681, affirming 5 T.C. 127">5 T. C. 127.
Being a long-term contract, the partnership was privileged under the above regulation to account for and report the contract profits on the basis of the percentage of completion during the taxable period of the entire work to be performed under the contract, or, subject to specified conditions, by the completed contracts method. Prerequisite to the accounting for and reporting of such profits by the completed contracts method, however, the partnership must have elected as a "consistent" practice so to treat such income, and that method, when used, must "clearly reflect" the net income. Certainly, on the facts of this case, the partnership had not, and in the circumstances, could not have, established a consistent practice of treating long-term contract profits by the completed contracts method of accounting for and reporting its income. At the time of its termination it had not been in existence for quite a full year, and the Santa Anita contract then in process was, insofar as appears, its one*92 and only long-term contract, and when its one and only return was filed, indicating a purpose to account for and report the profits of the said contract by the completed contracts method, the partnership had already been dissolved, its business and assets had been transferred to another entity, and even the power to establish a consistent practice of reporting long-term contract income by the completed contracts method no longer existed. It was in these circumstances that the respondent, having first determined that the completed contracts method of reporting income did not clearly reflect the income of the partnership under the Santa Anita contract for the period of its existence and operations, which clear reflection of income was *173 likewise a prerequisite under the regulation to the use of the completed contracts method of reporting long-term contract income, determined that that portion of the total contract profits which the costs incurred by the partnership in its work under the contract bore to the total contract costs, represented the reportable income of the partnership for the period of its operations.
It is the contention of the petitioner, on brief, that the partnership, *93 by reason of unresolved contingencies at the time it was terminated, never received or realized any income under the contract on either a cash or accrual method of accounting, and such being the case, all of the contract profits were as a matter of fact and law the income of Palmer & Company in its fiscal year ended August 31, 1949, during which the work under the contract was completed, and since under the statute income must be accounted for and reported on an annual basis, the respondent may not, under the provisions of section 41, by allocation, require the partnership to report profits for its accounting period ended August 31, 1948, which it did not receive or realize during such period, but which were the income of Palmer & Company in its fiscal year ended August 31, 1949.
Whether under the law and regulations a taxpayer may or may not account for and report income from long-term contracts by the cash receipts and disbursements method or by an accrual method other than the methods authorized by the above regulation, is of no moment here, since the partnership here did neither. And to say that as a matter of law there is and can be no accrual of long-term contract income so*94 long as there are contingencies which, when resolved, might or could in some degree affect the amount of ultimate profits, would be to hold that the percentage of completion method of accounting for and reporting such income is unsound and without basis in the law. Such method of accounting for and reporting long-term contract income is based on the proposition that as a general rule such contracts move to completion substantially as anticipated and planned by the parties and that the work done in progress toward completion of the entire work reasonably and fairly reflects the earning of a ratable portion of the anticipated ultimate profit, and the accrual on an annual basis of the profits so indicated has long been accepted and established as a sound and proper method for recording and reporting long-term contract income. That is not to say, however, that a ratable accrual of the contract profits would still be required, if there were unresolved contingencies of such character as to render the ultimate collection thereof improbable and unlikely. Not only is there no showing of the existence of such an improbability, but to the contrary, the evidence supports the conclusion that*95 the profits as determined were collectible. For a case wherein variations *174 of the meaning of the word accrued were discussed and one question was as to the accrual of profits on work or business only partially performed as of the end of the taxable period, see Helvering v. Estate of Enright, 312 U.S. 636">312 U.S. 636, 642-645.
As supporting his determination, the respondent cites and relies on Standard Paving Co. v. Commissioner, 190 F. 2d 330, affirming 13 T. C. 425, and Jud Plumbing & Heating, Inc. v. Commissioner, supra. In Jud Plumbing, the taxpayer, a corporation, at a time when there had been substantial performance of certain contracts but not completion, dissolved and transferred its assets and business to its stockholders in liquidation. These stockholders took over the operation and completed the contracts and, as in the instant case, in returns filed for the year of completion, accounted for and reported the entire contract profits by the completed contracts method. In Standard Paving, under comparable conditions, the assets and business, *96 including the incompleted contracts, were transferred by the petitioner corporation to its parent company in a nontaxable reorganization or exchange. The unfinished contracts were thereafter completed by the parent company, which, as in Jud Plumbing and in the instant case, accounted for and reported the contract profits in toto by the completed contracts method for the succeeding taxable year. In those cases, as in the instant case, the Commissioner, relying on section 41 as his authority, determined that on such state of the facts the completed contracts method of accounting did not clearly reflect the income from the contracts involved, and determined the income of the original contractor for the period prior to the disposition of the contracts, by relating its performance of the contract to the entire work under the contract. In both Jud Plumbing and Standard Paving, the petitioner corporation had been in existence and conducting a long-term contracts business over a period of years prior to the taxable year in question, and for such prior years and as to contracts completed had established a consistent practice of reporting the profits from such contracts by the*97 completed contracts method approved by the above regulation. Even so, however, it was held that with respect to contracts in process of construction the original contracting corporation could not avoid the tax on the profits earned by its work in the performance of the contract by dissolving, as in the Jud Plumbing case, and transferring its assets, including the contracts, to its stockholders prior to completion; or, as in the Standard Paving case, by transferring its assets, including the contracts, to its parent company in a nontaxable exchange prior to completion, and that the Commissioner, under the statute, was justified in determining that as to the contracts in question the completed contracts method of accounting did not clearly reflect the income of the transferring corporations *175 and in allocating a ratable portion of the total contract profits to the original contracting corporations as the income earned prior to the said transfers.
It is thus apparent, we think, that in material respects the situation here is the same as in Jud Plumbing and Standard Paving, and that the rule pronounced in those cases is applicable and controlling here. We so *98 hold. See also Guy M. Shelley, 2 T.C. 62">2 T. C. 62.
In concluding and holding as above stated, we have not overlooked the contract provision which would have permitted Santa Anita to make the final payment under the contract in its preferred stock at the par value thereof. Although the contention is not otherwise developed, there is some suggestion, on brief, that by reason of that provision in the contract, a contrary decision to that pronounced is required. Suffice it to say that there is no showing of record that in the event of such election the stock, on any pertinent date, would have had a value less than par and that the portion or amount of the profits earned through the partnership's performance of the contract would have been in any amount other than that shown and determined herein.
Decision will be entered for the respondent.
Footnotes
1. The exact ownership and distribution of the stock of Santa Anita Square, Inc., is not shown of record, but it was Palmer's testimony that he had complete control and direction of the corporation from its "initial commencement." At another point in the testimony, and in identifying a certain activity as that of Santa Anita, he explained, "Frankly myself as president as [sic↩] Santa Anita Square."
2. We find nothing of record to indicate the amount of the fee or "plus" part of the amount to be paid for the work to be done under the agreement.↩
3. We find nothing of record to indicate that College Homes did or did not sell or otherwise dispose of the completed projects.↩
4. There is some indication of record that the partnership, in a joint venture with another of petitioner's corporations, A. C. Palmer Construction Company, a California corporation, was also engaged in the construction of streets, sidewalks, and other improvements in the Santa Anita project, but if so, there is nothing of record to indicate or show just how, when, or by whom the results of such joint operation were reported for income tax purposes. In any event, no such operation is in any way involved in or related to the question here.↩
5. Sec. 29.42-4. 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 in this section the term "long-term contracts" means building, installation, or construction contracts covering a period in excess of one year from the date of execution of the contract to the date on which the contract is finally completed and accepted. Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon either of 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.
(b) Gross income may be reported for 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.
A taxpayer may change his method of accounting to accord with paragraph (a) or (b) of this section only after permission is secured from the Commissioner as provided in section 29.41-2.↩
6. The above two methods have long been established and recognized as proper methods for accounting for and reporting income from long-term contracts. See article 121 of Regulations 33, promulgated under the Revenue Acts of 1916 and 1917.↩