*158 Decision will be entered for the respondent.
A corporation which reported income from long term construction contracts on the completed contract method of accounting was liquidated during the taxable year, prior to the completion of the contracts. In its returns for the last taxable period of its existence the corporation did not report any income with respect to the uncompleted contracts. The assets of the corporation, including the contracts, were transferred to the corporation's principal stockholder, who completed the contracts during the taxable year and reported all of the profits therefrom in his individual return. At the time of the liquidation of the corporation the contracts were in various stages of completion, ranging from 44 percent to 98 percent completed. Held, that the method of accounting used by the corporation in the last taxable period of its existence did not clearly reflect its income under section 41 of the Internal Revenue Code, and that the profits from the contracts are to be allocated between the corporation and the individual according to the method of computation used by respondent.
*127 The respondent has determined deficiencies in income tax, declared value excess profits tax, and excess profits tax against the petitioner, Jud Plumbing & Heating, Inc., transferor, and against the individual petitioners as transferees for the year 1941 in the amounts of $ 3,819.95, $ 3,939.75 and $ 12,603.92, respectively. The individual petitioners have stipulated that they are liable for the deficiencies in tax in the event that the petitioner corporation is held to be liable. The only issue is whether any taxable income accrued to the petitioner corporation from certain uncompleted*160 construction contracts which were in process of construction at the date the petitioner corporation was liquidated so as to be taxable to the petitioner corporation.
The proceedings were consolidated for hearing.
The petitioner corporation filed its returns for the taxable year with the collector for the first district of Texas.
Most of the facts have been stipulated.
*128 FINDINGS OF FACT.
We adopt the stipulation of facts filed by the parties and such stipulated facts are incorporated herein by reference. Only those stipulated facts essential to an understanding of the issue are set forth herein.
The petitioner, Jud Plumbing & Heating, Inc., hereinafter called the corporation, is a dissolved corporation acting by and through a majority of its board of directors as of the date of its dissolution. It was incorporated under the laws of the State of Texas on June 18, 1926, and was dissolved on September 5, 1941. As of August 31, 1941, all of the assets of the corporation were transferred to Ed. J. Jud, who was then its president and who owned substantially all of the capital stock. Ed. J. Jud also assumed all of the liabilities of the corporation and the business was continued*161 and operated by Ed. J. Jud, personally, without change and without interruption, except to the extent necessary under regulatory statutes of the State of Texas to change from a corporate form to a sole proprietorship.
From the year 1933 to the date of its dissolution the corporation followed the so-called "completed contract" or "job cost" method of accounting. Such method of accounting takes into gross income for tax purposes profits or losses on construction contracts when the jobs are completed. The corporation did not compute profits or take into account as gross income any amount in respect to or arising from uncompleted contracts at the date of its dissolution. The respondent included in gross income the amount of $ 32,854.06 which he computed as income which had accrued to petitioner corporation in respect of certain uncompleted contracts. The income from such contracts was taken into account in the individual community returns of Ed. J. Jud and Alice Gorrell Jud for the taxable year 1941.
The accounting method used by the corporation for all the taxable years from 1933 to the date of dissolution was as follows: When a contract was taken by it, a job cost account was opened*162 in its books. All costs incurred in the construction under the contract were charged to the job cost account. All progress estimates rendered the owners and the final estimates rendered were credited to the job cost account. When all of the costs incurred on the job had been entered and all of the progress estimates and the final estimate entered, the job account balance showed either a profit or a loss. The profit or a loss for each contract, thus determined, was taken into account and reported as gross income for tax purposes in the taxable year when the final balance was determined.
The corporation used for accounting purposes two accounting classifications for the plumbing and heating jobs taken by it, (1) repair work and (2) contract work. For the purpose of classification in its *129 accounting records, the "repair work" was defined as being all jobs, usually repairs, not taken on an agreed or fixed sum contract basis, such jobs ordinarily not exceeding a final contract or sales price of $ 100. The repair work consisted largely of plumbing repairs. For the performance of repair work, several repair trucks are owned and operated, these being equipped with an assortment*163 of plumbing supplies, consisting of pipe, pipe fittings, lead, faucets, and other small items, which, through experience, the management has determined are required to do the ordinary repair job. When customers order repair work the plumber goes to the job in the repair truck and makes the repair, and when the work is completed he reports the completion to the office. Such completion report shows the labor hours consumed and the supplies and parts used on the job. The office bills the job to the owner and makes entry of income direct in the profit and loss income accounts. All expenses of the repair work department, consisting of salaries, wages, truck expense, and other expenses, are charged direct to the profit and loss accounts each month when incurred. Contract work was defined as jobs taken on an agreed or fixed sum basis, usually covering new heating or plumbing systems and ordinarily exceeding a contract or sales price of $ 100.
The corporation followed the accounting procedure of crediting the job cost account and charging the promisee account receivable with each progress estimate. As a usual procedure, the promisees deduct a percentage, or sum commonly called "retainage," *164 and pay the progress estimate, less the "retainage." The retainage is paid by the promisee upon final completion and acceptance of the project. Estimates are usually prepared and presented promisee at or near the close of the month, so that at the close of any particular month estimates which have been credited to the job cost account may not have been paid, and, if paid, the payment made is less the "retainage."
The method of accounting so used by the corporation was one generally recognized and accepted as correct for firms engaged in the heating and plumbing contracting business or similar types of business. The corporation followed the same accounting procedure in determining its taxable gross income for the period from January 1 to August 31, 1941, that it followed for the year 1940 and for several years prior thereto. The respondent has not objected on any previous occasion to returns of the corporation which were prepared on the accounting method hereinbefore described.
Upon the dissolution of the corporation on August 31, 1941, its affairs were liquidated by the cancellation of its outstanding stock and its assets were transferred to Ed. J. Jud, who also assumed all debts*165 and liabilities of the corporation and assumed the performance of all uncompleted contracts entered into by it, he agreeing to complete the same and fulfill all obligations existing or which might *130 arise by reason of or on account of the same and to receive all proceeds accruing therefrom. At the time of dissolution the corporation had 22 uncompleted contracts in existence.
There were four uncompleted contracts at August 31, 1941, upon which the respondent computed and determined gross income. The job cost accounts in respect to such contracts, together with computation of profits as thus made by respondent, are as follows:
| Costs | Percent | Profit to | |||
| Name of job cost | incurred to | Total or | completed | Total | Aug. 31, |
| account | Aug. 31, | final cost | Aug. 31, | profit | 1941 |
| 1941 | 1941 | ||||
| Lincoln Courts | $ 68,334.97 | $ 69,785.15 | 97.70 | $ 13,861.55 | $ 13,573.23 |
| Victoria Courts | 97,968.03 | 154,765.95 | 63.30 | 22,304.61 | 14,118.82 |
| Temporary Buildings, | |||||
| Randolph Field, | |||||
| Texas | 10,736.02 | 18,219.63 | 58.93 | 8,344.37 | 4,917.34 |
| Fred Poage | 1,041.02 | 2,362.78 | 44.06 | 555.32 | 244.67 |
| Total | 32,854.06 |
The amount of $ 32,854.06 shown in the foregoing schedule*166 under the column captioned "Profit to Aug. 31, 1941" is the amount of gross income arrived at and used by respondent in computing the proposed deficiencies in taxes. The accounting method followed by respondent was to first undertake to determine the total costs incurred for each job account to August 31, 1941, by taking into consideration the items in each job account from the books kept by the corporation, then referring to the books kept by Ed. J. Jud, successor to the corporation, and finding the total or final cost of the job and the profits on the job when finally completed. The per centum of job costs at August 31, 1941, as thus arrived at, to the final job costs was then computed. The per centum thus computed was then multiplied by the final profit figure to determine the profit which had accrued to August 31, 1941. However, in arriving at costs to August 31, 1941, as to the Victoria Courts job, he allowed and deducted $ 23,739.27 as representing the materials on hand, but not in place on the job. The figures used correspond with the books, which allow for said deduction of $ 23,739.27.
The 18 uncompleted contracts other than the 4 heretofore mentioned involved various*167 sums, the final estimates ranging from $ 86 to $ 50,532, and at the time of the dissolution of the corporation expenditures in and for the performance of all had been made and progress estimates had been made in connection with 4 of these contracts. There was an ultimate profit as to 16 of these contracts and an ultimate loss in connection with 2 of the contracts.
With respect to the four contracts upon which respondent based his determination of deficiencies, the payments received by the corporation and those received by Ed. J. Jud were as follows: *131
| Aggregate | Aggregate | |
| payments received | payments received | |
| by corporation | by Ed. J. Jud | |
| to Aug. 31, 1941 | ||
| Lincoln Courts | $ 72,307.00 | $ 11,044.73 |
| Victoria Courts | 128,955.29 | 47,875.91 |
| Temporary Buildings, Randolph Field, | ||
| Texas | 26,573.52 | |
| Fred Poage | 1,000.00 | 1,917.10 |
The Lincoln Courts contract was a subcontract entered into between the corporation and H. B. Kilstofte, dated August 26, 1940, for the installation of plumbing and gas piping in buildings in a housing project. The subcontract work was completed about December 1, 1941. The project, including such subcontract work, was partially accepted November*168 26, 1941, and was finally accepted as of December 18, 1941. The final estimate on the subcontract was rendered in December 1941. The corporation bound itself to furnish all labor and materials and to fully construct and complete according to plans and specifications to the full satisfaction of the architect. Provision was made for additions to or deductions from the agreed work. Kilstofte agreed to pay 90 percent of all labor and material placed in position and for which the owner had paid Kilstofte, to be paid on or about the twentieth of the following month, except the last payment, which was to be paid within 30 days after the materials and labor installed by the subcontractor had been completed and approved by the achitect. It was further provided that no payments on account should operate as an approval of the work or material or any part thereof; also that Kilstofte would not hold up any payments because of faulty materials that might necessitate repair or replacement, but the corporation agreed to replace, repair, and remove any materials found faulty by the inspectors. The subcontractor was also charged with full responsibility for damages caused by his operations to*169 plaster, painting, mill work, or any other items damaged.
The Victoria Courts contract was a subcontract between the corporation and Robert E. McKee, dated September 30, 1940, calling for the installation of plumbing and gas fittings in buildings in a housing project. The work was completed in the month of December 1941, except for certain minor details, and final estimate was rendered as of December 31, 1941. The final acceptance was on or about January 29, 1942. Such contract provided for the furnishing of all labor, material, equipment, scaffolds, supplies, and services to complete the plumbing and gas fittings in strict accordance with plans and specifications and subject to the approval of the owner. Payments to subcontractor were to be those allowed the general contractor by the owner. The right was reserved to the contractor to require changes in and additions to the work contracted for. It was provided that the subcontractor should promptly amend and make good any defective *132 materials and workmanship to the entire approval and acceptance of the owner and architect. The subcontractor was required to secure his work and bear all loss or damage at any time prior*170 to final completion and acceptance, unless caused by negligence of the contractor.
There were two subcontracts as to Temporary Buildings, Randolph Field, Texas, carried in one account, which were between the corporation and J. E. Dickey, each dated July 30, 1941. They called for installation of plumbing, gas fittings, and heating in certain buildings at Randolph Field. Completion was had in the month of November 1941 and final estimate was rendered in that month. Final acceptance was had in November 1941. The corporation agreed to furnish all labor and material and to install the plumbing, gas fittings, and heating as per plans and specifications. Payments were to be made in accordance with Dickey's contract with the Government.
The Fred Poage contract was one covering work and materials for installing plumbing fixtures in a private dwelling. The contract was made about June 1941, and the work was completed and accepted in the month of December 1941.
The return of the corporation showed income reported on the accrual basis and gross sales of $ 172,003.95 for the taxable year.
The statement of adjustment in the notice of deficiency is as follows:
The primary requirement under*171 section 41 of the Internal Revenue Code is that the method of accounting employed must clearly reflect the income. If the method does not clearly reflect the income "the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income." In the opinion of the Commissioner such method as clearly reflects the income under the circumstances of your particular case for the taxable period in question requires the accrual of profits on uncompleted contracts at date of liquidation of the corporation.
OPINION.
The issue in this proceeding requires a determination of the correct method of accounting to be used by the corporation in computing its income for the last period of its existence. The corporation used two different methods of accounting, one for its repair work and the other for its contract work. Only the method used for the contract work is in controversy here.
The corporation had been in existence since 1926. For a number of years prior to the taxable year, it had computed its income from the contract work on the completed contract method of accounting, which takes into gross income, for tax purposes, the profits *172 or losses upon the completion of the contract. The corporation was formally dissolved on September 5, 1941, and all of its assets were transferred to petitioner, Ed. J. Jud, as of August 31, 1941. At that date the corporation had 22 uncompleted contracts in process of construction. *133 These contracts, which were in various stages of completion, were taken over by Jud, personally, and completed by him during the taxable year, and the income from the contracts was taken into account in the community returns of the individual petitioners. The corporation did not compute any profits from these uncompleted contracts at the date of its dissolution, nor did it take into account as taxable gross income any amount with respect to these contracts.
The respondent has determined the deficiencies upon the basis of the four largest contracts. He has ignored the other 18 contracts as being insignificant, although 16 resulted in an ultimate profit and 2 in an ultimate loss. The respondent has determined the profit on each of the 4 contracts to August 31, 1941, by computing the ratio of costs incurred to August 31, 1941, to the final costs on each contract and then applying that ratio *173 to the total profits on each contract.
The petitioners contend that the corporation had no taxable income from these contracts at the date of its dissolution because the contracts were not completed at that time, and its standard method of accounting took into account only profits or losses computed as of the date the contracts were completed. They argue that this method has been consistently used by the corporation and that respondent is without authority to compute income by a different method merely because the corporation was liquidated.
Under the respondent's regulations the corporation could elect to report gross income from contracts covering a period in excess of one year at the time the contracts were completed, provided that such method was consistently used and clearly reflected the net income. Regulations 103, sec. 19.42-4 (b). Two of the four contracts, namely, the Randolph Field contract and the Fred Poage contract, were completed in less than one year, and thus the regulations did not authorize the corporation to use the completed contract method of accounting for these contracts. However, petitioners contend that the corporation's consistent practice has been to*174 treat these contracts on the same basis as long term contracts, and since respondent, in the notice of deficiency, has used the same method of allocating income to these contracts as he did to the Lincoln Courts and Victoria Courts contracts, we think the same method of accounting should be used in computing the profits on all of the four contracts.
Section 41 of the Internal Revenue Code provides, in part, as follows:
The net income shall be computed upon the basis of the taxpayer's annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. * * *
*134 The method of accounting in connection with long term contracts authorized by the regulations clearly reflects income if it is consistently used and if the taxpayer continues in existence. However, if a corporation using that method is liquidated during the taxable*175 year and prior to the completion of the contracts, the completed contract method of accounting does not clearly reflect income for the final period of the corporation's existence. Therefore, under section 41 the respondent is authorized to recompute the corporation's income by the use of such method as will clearly reflect the income. The effect of the method used by the respondent in this proceeding is to reallocate the income from the contracts in proportion to the work done by the respective parties. The fundamental concept of taxation is that income is taxable to him who earns it and that concept, we think, is correctly applied by the respondent here. That the corporation earned the income which respondent has taxed to it seems apparent from the facts. For example, in the Lincoln Courts contract the final cost of the contract was $ 69,785.15. The costs incurred to August 31, 1941, and apparently expended by the corporation, were $ 68,334.97. Progress estimates of $ 82,524.46 had been rendered by the corporation to the customer and $ 72,307.97 had actually been received by the corporation to August 31, 1941. Thus, after August 31, 1941, Ed. J. Jud expended only $ 1,450.18*176 as additional costs, but he received payments of $ 11,044.73 and reported in his return for the taxable year the total profit of $ 13,861.55.
The completed contract method of accounting has a limited application. However, if it is used the taxpayer does not report income from a contract until such contract is completed, nor does he take any deductions with respect to the expenses incurred in the contract until completion, at which time he strikes a balance and reports either profit or loss. Although this method of accounting is sanctioned under certain conditions, the primary requisite is that it must correctly reflect income. The completed contract method is primarily an accrual method of accounting. In United States v. Anderson, 296 U.S. 422">296 U.S. 422, it was pointed out that the accrual system was incorporated into the law:
* * * to enable taxpayers to keep their books and make their returns according to scientific accounting principles, by charging against income earned during the taxable period the expenses incurred in and properly attributable to the process of earning income during that period; * * *
In this case if the corporation had remained *177 in existence the method of accounting used would have correctly reflected income. However, upon liquidation of the corporation prior to completion of the contracts, the income from the work done by the corporation is not reported if the completed contract method of accounting is followed. Thus, although the completed contract method of accounting is an *135 accrual system, its effect here, if petitioners' contentions were sustained, would be to subvert the fundamental concept of an accrual system of accounting.
It can not be said that the method of accounting used by respondent in computing the deficiencies is so unreasonable and arbitrary that it must be disregarded. Under the circumstances, it is probably the best method of determining the correct allocation of the profits from each contract. Cf. Reynolds v. Cooper, 64 Fed. (2d) 644; affd., 291 U.S. 192">291 U.S. 192; Rouss v. Bowers, 30 Fed. (2d) 628; certiorari denied, 279 U.S. 853">279 U.S. 853. At any rate, petitioners have not shown a better way to allocate the profits. Since respondent's determination is prima facie correct, *178 the burden of establishing a better method is upon the petitioners.
The petitioners rely upon Commissioner v. Montgomery, 144 Fed. (2d) 313, and Iowa Bridge Co. v. Commissioner, 39 Fed. (2d) 777. Those cases, however, are distinguishable upon their facts. In the Montgomery case, supra, the taxpayer correctly reported in his individual income tax return his proportionate share of the profits from a long term construction contract which was assigned to a corporation prior to completion. The issue in the Iowa Bridge Co. case, supra, did not involve the applicability of section 41 of the Internal Revenue Code and in that case the Government rested the entire issue upon the question of the validity of the assignments. In any event that decision was rendered before the Supreme Court decisions of Helvering v. Horst, 311 U.S. 112">311 U.S. 112, and Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579, which emphasize the principle that income is taxable to the person who earns it. This case more nearly resembles Guy M. Shelly, 2 T. C. 62,*179 where we held that income was properly taxable to the liquidated corporation even though the long term contract was not fully completed at the time of such liquidation.
Accordingly, respondent's determination is sustained.
Decision will be entered for the respondent.