*655 Where petitioner, engaged in the contracting business, kept his books upon the accrual basis, and in the year 1931, in conformity with his custom, set up on his books the cash received from the United States Government under contracts with it, and also set up the amounts of earned percentages retained by the Government pending completion of the contracts, the respondent, in determining the deficiencies, having determined that this was a proper method of reflecting the income of the petitioner, and there being no showing that such method does not clearly reflect the income, held, the respondent's determination should be approved irrespective of whether the contracts were long term contracts within the meaning of article 334 of Regulations 74.
*726 These are proceedings, duly consolidated for hearing, for the redetermination of deficiencies in income tax for the year 1931 in the amount of $2,995.23 as to each petitioner.
It is alleged in substance by each petitioner that the respondent erred in holding that the income from the business of Sam Orino*656 *727 was $150,291.25 instead of $122,954.75 as reported (a difference of $27,336.50) and including one-half of such increase in the income of each petitioner, such increase representing percentages retained by the Government until after the close of the taxable year, when certain road construction contracts were completed.
The respondent denies that such action by him was erroneous, but in his answer in each proceeding affirmatively alleges in the alternative that, if the contention of the petitioners is correct, then the income reported by the petitioners for the year 1931 should be increased by the amount of $9,238.05 representing the total amount retained in 1930 contracts which was received by the petitioners in 1931 and was not reported in their returns for 1931 or included in income by the respondent.
The respondent alleges that this amount of $9,238.05 should be divided, one-half to each petitioner.
FINDINGS OF FACT.
The petitioners are residents of Spokane, Washington.
The parties entered into a written stipulation which is in part as follows:
I.That the petitioner Sam Orino is a road contractor. That the petitioners San Orino and Rosa Orino are*657 husband and wife and each made a return covering his or her half of the community income for the year 1931. That the income of each was solely the result of community efforts.
II.That among other road contracts that petitioner Sam Orino was working on during the year 1931 were certain contracts entered into with the Bureau of Public Roads of the United States Department of Agriculture. That there were five of said contracts and they were known and designated as follows, and on December 31, 1931 were completed to the percentage listed after each contract:
| Bureau of Public Roads No. 13, H-3, 12, J-1 | 95% |
| Bureau of Public Roads No. 28-B | 90% |
| Bureau of Public Roads No. 8-J | 65% |
| Bureau of Public Roads No. 8-K | 60% |
| Bureau of Public Roads No. 7-D-1 | 70% |
That each contract above referred to is hereto attached and made a part hereof.
IV.That during the year 1931 the bookkeeper of the petitioner Sam Orino, following his custom of former years, set up in his books not only the amounts received in cash by Orino from the United States Government upon each of these *728 contracts but also set up the amount of the percentages retained by the Government*658 under Article 16 of the various contracts, which are attached hereto. That the total amount of said retained percentages amount to $41,029.93 on the above listed five contracts. That when the petitioners made up their income tax returns for 1931 they did not include these retained percentages as income. In determining the deficiencies from which the appeals are taken, the respondent has increased the net income reported by the petitioners by the amount of the retained percentages; namely, $41,029.93, and has reduced said income by the allowance of other deductions in the amount of $13,693.43, resulting in the net increase of the reported taxable income of the community in the amount of $27,336.50 as shown in the deficiency letters, copies of which are attached to the petitions.
V.The petitioners' books were kept on the accrual basis. The petitioners reported their income for federal income tax purposes on the percentage of completion of contract basis.
VI.On petitioners' books the full amount; namely, the amount received in cash from the Government plus the percentage retained by the Government, was treated as income.
VII.In making their income tax returns*659 for years prior to 1931, the petitioners had always in computing the profit on the percentages of completion of contract basis, included as the amounts received on said contracts, the cash received plus the percentage retained by the Government.
VIII.On December 31, 1930 there were being withheld retained percentages on incompleted contracts as of that date the total amount of $9,238.05.
IX.Said amount of $9,238.05 was paid to and received by the petitioners during the year 1931.
X.The petitioners did not include any part of said $9,238.05 in their income tax returns for the year 1931 and the respondent has not included any part of said last mentioned amount in the income on which the deficiencies are based.
, the five contracts referred to in the above stipulation, which were entered into in April, May, and June of 1931, are incorporated herein by reference. Each of such contracts contains article 16, portions of which are as follows:
Article 16. Payments to contractors. - (a) Unless otherwise provided in the specifications, partial payments will be made as the work progresses at the end of each calendar month, or as soon thereafter as practicable, *660 on estimates made and approved by the contracting officer. In preparing estimates the material delivered on the site and preparatory work done may be taken into consideration.
(b) In making such partial payments there shall be retained 10 per cent on the estimated amount until final completion and acceptance of all work *729 covered by the contract: Provided, however, That the contracting officer, at any time after 50 per cent of the work has been completed, if he finds that satisfactory progress is being made, may make any of the remaining partial payments in full: And provided further, That on completion and acceptance of each separate building, vessel, public work, or other division of the contract, on which the price is stated separately in the contract, payment may be made in full, including retained percentages thereon, less authorized deductions.
* * *
(d) Upon completion and acceptance of all work required hereunder, the amount due the contractor under this contract will be paid upon the presentation of a properly executed and duly certified voucher therefor, after the contractor shall have furnished the Government with a release, if required, of all*661 claims against the Government arising under and by virtue of this contract, other than such claims, if any, as may be specifically excepted by the contractor from the operation of the release in stated amounts to be set forth therein.
Contract No. 13, H-3, 12, J-1 provided that the work should be completed within 200 calendar days; contract No. 28-B provided that the work should be completed within 300 calendar days; contract No. 8-J provided that the work should be completed within 250 calendar days; contract No. 8-K provided that the work should be completed within 300 calendar days; and contract No. 7-D-1 provided that the work should be completed within 250 calendar days. Each contract contained provisions for the termination of the contract by the Government in the event that the work was not prosecuted so as to be completed within the specified time, and provided for payment of damages to the Government occasioned by delay.
The estimates turned in by engineers on the job monthly are never exactly correct. Such estimates vary to an appreciable or considerable extent. In the event that some of the work has to be re-done, it is done at the contractor's expense, and this*662 happens quite often. This reduces the contractor's profit. While petitioner Sam Orino was engaged in work under contract No. 28-B, the Forest Service claimed that a fire escaped from the right of way, owing to the negligence of Orino, and spread over a considerable area. The Forest Service claimed a loss of $7,691.32 for moneys expended in hiring crews to fight the fires. The Forest Service induced the Bureau of Public Roads to hold up Orino's deferred percentages and the final estimate on this work until this matter was adjusted. The matter was in controversy for about two years. It was finally settled in February 1934, by Orino's agreement to pay $1,000. Orino signed a waiver and was paid $1,000 less than the contract price.
OPINION.
MCMAHON: The question presented is whether the respondent erred in including in petitioners' taxable incomes the amount of the retained percentages under the contracts. The parties apparently are agreed *730 that whatever income is taxable to the petitioners is taxable equally to each as community income. The stipulated facts show that the petitioners reported their income from the contracts on the basis of the percentage of completion*663 of the contracts. Sections 41 and 42 of the Revenue Act of 1928, which deal with methods and periods of accounting, are set forth in the margin. 1
We find it unnecessary to decide, and specifically do not decide, the question of whether these contracts were long term contracts within the meaning of the applicable regulations, *664 article 334, Regulations 74. 2 Such regulations do not require a taxpayer to return income from long term contracts on either of the bases provided therein, but permit him to do so. If we were to assume in the instant proceedings that the contracts in question are long term contracts within the meaning of the regulations, the petitioners having elected to return income therefrom on the basis of percentage of completion of contracts and no change therefrom having been sought so far as the record shows, the result would be in accord with the determination of the respondent, since under this basis of returning income the full percentage is to be returned in any particular year even though actual payment of a balance due is not made until a later year. ; appeal dismissed in ; and . *731 3 If we were to assume that these contracts are not long term contracts within the meaning of the regulations, the result would still remain the same, as will be immediately pointed out.
*665 The stipulation shows that petitioners' books were kept on the accrual basis and that in 1931, following their custom of former years, the petitioners set up on their books the amounts retained by the Government as well as the amounts received in cash. Thus the "method of accounting regularly employed in keeping the books" was in accord with the method which the respondent determined was the proper method of returning the income. Section 41 of the Revenue Act of 1928 provides that the net income shall be computed in accordance with the method of accounting regularly employed in keeping the books of the taxpayer, unless, among other things, the method employed does not clearly reflect the income. Here the respondent has held that this method does clearly reflect income. His determination has the support of a presumption of correctness and the petitioners have the burden of proving it to be wrong. . The petitioners have not shown that this method does not substantially and clearly reflect their income.
The petitioners contend that it does not and point to the fact that it ultimately developed, in 1934, that they received*666 $1,000 less than the contract price under contract No. 28-B, due to a set-off of claims of the Government against them for a loss from a fire alleged to have been due to negligence of Sam Orino. However, this does not show that petitioners' system of returning income does not clearly reflect income for 1931, the only year before us. The set-off in 1934 of $1,000 against the amount due the petitioners for 1931 does not, for income tax purposes, affect the question of the amount of income accruable by the petitioners for 1931. That is a separate transaction for tax purposes. The petitioners, by relinquishing in 1934 their right to receive $1,000 of the contract price accrued by them for 1931, secured a release from liability on account of the fire alleged to have been due to the negligence of petitioner Sam Orino. The transaction was in effect the same as if petitioners had received the $1,000 in 1934 and then paid it out for the release, which was the consideration for the $1,000. Whether such amount might be deductible from gross income for the year 1934 when paid, or even for some other year, it is unnecessary for us to here decide. No claim is made that it is deductible in*667 the year before us.
Nor does the fact that work has to be re-done sometimes on contracts generally affect the question here presented. There is no *732 evidence to show that any of the work under any of the contracts in question herein had to be re-done. Furthermore, we may not indulge in a presumption that the petitioners did not do the work under the contracts according to specifications or that any of it had to be re-done.
We hold that the petitioner has not shown that the respondent erred in his determination of the tax liability of the petitioners for the year 1931.
In the view we have taken it becomes unnecessary to consider the alternative affirmative allegations of the respondent.
Decision will be entered for the respondent.
Footnotes
1. SEC. 41. GENERAL RULE.
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. * * *
SEC. 42. PERIOD IN WHICH ITEMS OF GROSS INCOME INCLUDED.
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. ↩
2. ART. 334. Long-term contracts. - Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used herein the term "long-term contracts" means building, installation, or construction contracts covering a period in excess of one year. Persons whose income is derived in whole or in part from such contracts may, as to such income, prepare their returns upon the following bases:
(a) Gross income derived from such contracts may be reported upon the basis of percentage of completion. * * * If, upon completion of a contract, it is found that the taxable net income arising thereunder has not been clearly reflected for any year or years, the Commissioner may permit or require an amended return.
(b) Gross income may be reported in the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such income, provided such method clearly reflects the net income. * * *
Where a taxpayer has filed his return in accordance with the method of accounting regularly employed by him in keeping his books and such method clearly reflects the income, he will not be required to change to either of the methods above set forth. * * *
[See ; ; but see also ↩
3. To similar effect is Allhands v. Crooks,↩ an unreported decision rendered December 27 1930, by the United States District Court for the Western District of Missouri.