*853 1. Upon the evidence, held that an amount of $19,170.73 constituted unreturned investment in a joint venture and hence was not deductible as a bad debt in the year 1927; that petitioner is entitled to deduct $11,834.23 of such amount as a loss sustained in the year 1927; and that petitioner is not entitled to deduct the remaining $7,336.50 as a bad debt or loss in the year 1928.
2. Held that an amount of $53,391.84 received by petitioner in the year 1927 as damages for loss of anticipated profits resulting from breach of a contract constitutes income to petitioner in that year.
3. Upon the evidence, held that the provisions of article 36 of Regulations 69 dealing with return of income under "long-term contract" do not apply to the instant proceeding, notwithstanding that petitioner returns his income upon a completed contract basis.
*1039 This is a proceeding for the redetermination of a deficiency in income taxes for the calendar year 1928 in the amount of $3,902.84. The petitioner*854 alleges error on the part of the respondent as follows:
(a) Failure to allow petitioner as a deduction the sum of $19,170.73 as a debt ascertained to be worthless and charged off during the calendar year 1928 pursuant to the authorization of Regulations 74, Article 191, in such cases made and provided; or
*1040 Failure to allow the petitioner $7,336.50 on account of a bad debt in the year 1928 and $11,834.23 as a loss in the year 1927 on construction contract on the completed contract basis, thereby making said $11,834.23 as part of a statutory net loss to be carried forward to the year 1928 together with statutory net loss set forth in (b) hereof.
(b) Failure to allow the petitioner $60,316.19 (which includes the amount of $11,834.23 mentioned in the foregoing paragraph) as a statutory net loss sustained in the year 1927 to be carried forward to the year 1928 as a deduction from income.
FINDINGS OF FACT.
The petitioner is an individual with principal office at St. Louis, Missouri. For many years the petitioner has been in the business of contracting for drainage, levee, canal, harbor, and dredging work. The contracts frequently extend over one or more years, *855 sometimes over two or three years. It has been the custom of the petitioner to set up the profits or losses on these long term contracts as of the year when the contract or work is completed. His income tax returns have been made on this basis.
On March 20, 1919, the petitioner entered into a contract with A. V. Wills & Sons, an Illinois corporation, creating a joint venture, petitioner's interest therein being 50 percent. Petitioner agreed to furnish half the funds and equipment and receive half the profits. The purpose of the venture was to carry out the work of constructing certain drainage ditches which A. V. Wills & Sons had contracted to do for the Cache River Drainage District under a prior agreement. The joint venture was operated under the name of Cache River Dredge Co. On November 22, 1928, in , the United States Circuit Court of Appeals for the Seventh Circuit held that this agreement did not create a partnership, but a joint enterprise.
The work on the Cache River Drainage District*856 job continued until sometime in 1924 when it was stopped on a suspension order from the Cache River Drainage District. The work at that time had been completed to within 150 to 200 feet of the terminus as specified in the contract. No work was performed by the Cache River Dredge Co. thereafter on this project. Under the contract the practice had been for the drainage district to make an estimate each month of the work which had been done and make payments monthly, less a retained percentage of from 10 to 20 percent, which was to be held by the drainage district until the completion of the job. All the completed work done by the joint venture was accepted by the drainage district, and an estimate thereof was made. However, this was not a final estimate and no final estimate was ever rendered. The retained *1041 percentage was never paid in full. The portion of the retained percentage which was never paid amounted to about $2,000. Demand therefor was made by A. V. Wills & Sons from 1924 on and later by petitioner on numerous occasions.
The Cache River Drainage District ordered the Cache River Dredge Co. to stop work because the district had no money to do the balance*857 of the work and asked the Cache River Dredge Co. to stand in readiness to do the balance of the work when money was obtained to complete it. The drainage district had some hope of getting money from an adjoining district which was in process of formation, but never did, and the district had to raise its own money. Litigation arose about the question of the district's issuing more bonds to raise money to complete the project and the Cache River Dredge Co. was asked to wait till the litigation was settled. This litigation was finally decided by the Supreme Court of Arkansas on May 23, 1927, in . The result was that the district was allowed to issue bonds and raise emough money to complete the work under the original plan. In the meantime, A. V. Wills & Sons was in 1926 adjudged bankrupt and had gone out of business. The Cache River Drainage District then advertised for bids upon the work remaining to be done to effect complete drainage. Petitioner was the successful bidder. Operating as the Sternberg Dredging Co., petitioner entered into a contract with the Cache River Drainage District*858 on June 30, 1927. During the period between the time the work ceased under the first contract and the time that the new contract was let, the dredges which had been used by the joint venture had been held at the place of operations with a skeleton crew. Shortly after petitioner had obtained the new contract, he purchased, at public sale, the dredges which had been used by the joint venture and completed the work with such dredges. The assets of the joint venture were advertised for sale July 6, 1927. The petitioner already had a half interest in such dredges.
An account headed "Cache River Dredge Company, Investment Account" in petitioner's ledger shows that from September 4, 1919, to March 3, 1924, the petitioner made payments to or for the Cache River Dredge Co. in the total amount of $52,585.97. These payments made to the Cache River Dredge Co. were for the purpose of financing the purchase of equipment needed on the job. The agreement between the petitioner and the Cache River Dredge Co. provided that the moneys paid to that company by petitioner should be repaid out of the receipts of the joint venture. He received from that company, over the period from December 23, 1919, to*859 January 25, 1924, amounts totaling $33,415.24, the debit balance of the account being $19,170.73. *1042 This account shows that an entry was made on December 31, 1928, in the amount of $19,170.73 to balance the account. This entry was for a "bad debt" in the amount of $19,170.73. This amount was charged off to profit and loss in the year 1928 and deduction was made by petitioner in his income tax return for 1928 of that amount as a bad debt. The respondent disallowed this claimed deduction.
The payments made by the Cache River Drainage District for the work done by the joint venture never went directly to the petitioner. Since A. V. Wills & Sons was the principal contractor, payments were made to that company, which in turn would then pay the Cache River Dredge Co. Payments were made by the district up to 1924, but not thereafter. A. V. Wills & Sons had not paid petitioner all of his share of the amounts received from the district. Petitioner filed a claim in the District Court of the United States for the Eastern District of Illinois against the trustee in bankruptcy of and for the estate of A. V. Wills & Sons, bankrupt, for $7,336.50, and sought its allowance as*860 a preferred debt. The matter was referred to a master, who found for this petitioner. The District Court approved the allowance of the claim, but denied to it any preference. Thereafter the petitioner appealed to the United States Circuit Court of Appeals for the Seventh Circuit. On November 22, 1928, that court affirmed the decision of the , supra ). In its opinion the court stated in part:
* * * Claimant's debt arose out of the advancement of moneys to a joint enterprise or attempted partnership consisting of two members - claimant and the bankrupt. The bankrupt withheld money belonging to the joint enterprise and upon the dissolution of such joint enterprise became indebted to claimant. But we find nothing in these facts that would justify us in giving this claim preference over the other debts of bankrupt.
In addition to the amounts paid to the Cache River Dredge Co. up to 1924, heretofore referred to, the petitioner made payments from 1924 to 1927 aggregating $2,227.25 for phone calls, office expense, telegrams, and salaries to watchmen. The amount realized from the sale, on July 16, 1927, of equipment of the joint venture*861 was $1,125, and this was credited in partial satisfaction of this account. The balance, $1,102.25, was charged off as a bad debt December 31, 1928. This amount was allowed by the respondent as a deduction.
In 1920 the petitioner, as an individual, entered into a contract with Drainage District No. 7 of Poinsett County, Arkansas, to do some work on "Improvement No. 64." The district made advance payments to petitioner for installation of equipment, as was customary, in the amounts of $9,000 and $6,118.88 on the respective date of December 31, 1920, and January 31, 1921, these amounts being carried in an open account on petitioner's books until 1927. The petitioner also *1043 had three or four other contracts with that district covering other improvements. After he had completed two or three of the others he reached Improvement No. 64. After he had started work on this improvement, the district wrote him a letter to stop work. However, the petitioner refused to stop and continued work for about three months. The district did not pay petitioner any estimates on Improvement No. 64. Each month he requested the district to pay him for the work done. The district refused*862 to pay and the petitioner finally declared the contract breached and entered suit against the district in the United States District Court for the Eastern District of Arkansas for the work done and the expected profit on the balance of the work. This suit was entered in June 1924, about two months after petitioner stopped work upon the improvement. On March 16, 1925, the court rendered judgment in favor of the petitioner in the sum of $109,332.66. Of this amount $35,963.25 was on account of work which petitioner had actually done and the rest of the judgment covered loss of anticipated profits. In 1925 the drainage district paid the petitioner on account of this judgment $36,000 in certificates of the district, which amount the petitioner returned as income in his income tax return for the year 1925. Thereafter, in 1925, Drainage District No. 7 of Poinsett County, Arkansas, appealed to the United States Circuit Court of Appeals for the Eighth Circuit, which reduced the judgment to $89,391.84, in its opinion filed October 7, 1926, in *863 Drainage District No. 7 of . The court, with petitioner's consent, by an opinion filed November 30, 1926, allowed Drainage District No. 7 a credit for the $15,118.88 which had been advanced to petitioner in Drainage District No. 7 of . The difference of $53,391.84 between the amount of the judgment rendered by the Circuit Court and the amount of $36,000 which had been paid by the district to the petitioner in certificates in 1925 was paid to the petitioner in the following manner: The district was credited with the $15,118.88 which it had advanced to petitioner, and it paid petitioner $272.96 in cash, and $38,000 in its certificates. These payments were made in 1927. The certificates were taken by petitioner at par value and were fully redeemed. This amount of $53,391.84 was included in the petitioner's income tax return for the year 1927. In the return the petitioner reduced such sum to $51,239.84 by deducting amounts purporting to represent attorney fees, collection fees, and discount upon sale of bonds. *864 In such return the petitioner claimed a net loss of $61.71. No part of the $53,391.84 was included in income in any return for any year prior to 1927.
*1044 OPINION.
MCMAHON: The first question presented is whether the petitioner is entitled to deduct, in the calendar year 1928, an amount of $19,170.73 as a debt ascertained to be worthless and charged off. Leo M. Geissal, who was office manager of the petitioner and had charge of petitioner's books and records, and the petitioner himself, each testified that this amount represented "advances" made to the Cache River Dredge Co., which was a joint venture composed of the petitioner as an individual and A. V. Wills & Sons, a corporation. It is not clear just what these witnesses meant by the word "advances." However, considering the evidence as a whole, we can not conclude that the amount constituted loans which would give rise to an indebtedness. The records of the petitioner show that this amount was the excess of the amounts paid by petitioner from September 4, 1919, to March 3, 1924, to or for the Cache River Dredge Co. over the amounts received by him from such company during the period from December 23, 1919, to*865 January 25, 1924. The account in the records of the petitioner in which this item appears is headed "Cache River Dredge Company, Investment Account," and the evidence shows that the payments were made to the company for the purpose of financing the purchase of equipment needed on the job. The evidence further shows that the agreement between the petitioner and the Cache River Dredge Co. provided that the moneys paid to that company by the petitioner should be repaid out of the receipts of the joint venture. It is also shown by the evidence that the agreement of joint venture provided that the petitioner and A. V. Wills & Sons should each furnish half the funds and equipment and receive half the profits. There is no evidence as to how much money or equipment was furnished by A. V. Wills & Sons and there is nothing to show that the amount paid in by the petitioner amounted to more than his share of the amount to be contributed. In short, there is no proof to show that any portion of the amount advanced by petitioner was on behalf of A. V. Wills & Sons, giving rise to a debt from A. V. Wills & Sons to the petitioner. Nor do we see how it can be reasoned under any circumstances that*866 there was a debt owing from the joint venture to the petitioner. Petitioner himself was one of the two parties to the joint venture upon an equal basis. We can not assume that the amounts paid were not for and on behalf of the petitioner in accordance with the agreement of the joint venture. It should be noted that this was not a partnership. The United States Circuit Court of Appeals for the Seventh Circuit so held in an action between this petitioner and the trustee in bankruptcy for the estate of ). It is our opinion that the amount of $19,170.73 did *1045 not constitute a debt owing to the petitioner but constituted the portion of his investment in the joint venture which had not been returned to him. It follows that the petitioner is not entitled to take the amount of $19,170.73 as a bad debt reduction in the year 1928.
The petitioner contends in the alternative that of the amount of $19,170.73, the amount of $11,834.23 should be allowed as a loss in the year 1927 and the amount of $7,336.50 should be allowed as a deduction for a bad debt in the year 1928. However, we see no logical reason for splitting up this amount*867 of $19,170.73 in the manner urged. In our opinion, as hereinabove emphasized, the amount of $19,170.73 represented the excess of the amounts invested by petitioner in the joint venture over and above the amounts which he received therefrom. A loss of this type is deductible in the year in which it is sustained. The real question here is as to the amount and year of the loss sustained, if any; and this depends upon the peculiar circumstances involved in this proceeding. .
It was in 1924 that the Cache River Drainage District directed the joint venture to cease operations and apparently at that time petitioner was "out of pocket" $19,170.73. However, it was not in that year that the loss was sustained, because there remained a reasonable possibility that the district would be able to raise funds for the original contract to be performed. The evidence shows that the court did permit the district to issue further bonds and thereby raise money. In other words, until it was definitely determined that there would be no completion of this enterprise by the joint venture it could not be reasonably determined whether petitioner*868 had sustained a loss upon the venture as a whole, which is the test. Nor can it be reasonably said that the fact that A. V. Wills & Sons went into bankruptcy in 1926 gave rise to a loss by the petitioner. In our view there still remained the possibility that the work might be continued. However, when in 1927 the district entered into a new contract, that with the petitioner individually, to construct a complete drainage system, it became a certainty that performance by or in behalf of the joint venture would not be continued and that the petitioner would not receive his half of the unpaid $2,000 representing the percentage retained by the drainage district until the completion of the job. In our opinion it was in 1927 that petitioner sustained his loss. However, we can not find that the full amount of his loss was $19,170.73. Petitioner still had pending in the courts a claim for $7,336.50 against A. V. Wills & Sons. If this amount were collected it would reduce his loss in the joint venture by that amount. See , and cases cited therein. We *1046 accordingly hold that in the*869 computation of the petitioner's net income for the year 1927, or as contended by the petitioner, his net loss for that year, the petitioner is entitled to deduct the amount of $11,834.23 as a loss.
The question next arises as to whether the petitioner is entitled to deduct the amount of $7,336.50 in the year 1928. In our opinion the petitioner, upon whom rests the burden of proof, has failed to adduce sufficient evidence that he sustained a loss in this amount in 1928. There is no proof whatever as to the amount of the assets or liabilities of the bankrupt, A. V. Wills & Sons. All we know is that the petitioner claimed this amount as a preferred claim before the District Court, the bankruptcy court; that the master in bankruptcy found for the petitioner; that the bankruptcy court approved the allowance of the claim but denied to it any preference; and that thereafter the United States Circuit Court of Appeals for the Seventh Circuit on November 22, 1928, affirmed the decision of the ). The petitioner apparently contends that if this claim had been held to be a preferred claim he would have received the full amount thereof. *870 However, there is no proof to show how much of the claim could have been or was paid out of the bankrupt's estate after the decision of the Circuit Court of Appeals holding that it was not a preferred claim. We are not at liberty to assume that the claim was either wholly or partly worthless. We accordingly hold that the amount of $7,336.50 is not deductible as a loss in the year 1928. For the same reasons the petitioner is not entitled to deduct this amount as a bad debt in the year 1928.
The petitioner also contends that he sustained a statutory not loss for the year 1927 in the amount of $60,316.19, which he is entitled to carry forward to the year 1928. In arriving at this amount of net loss the petitioner treated the amount of $11,834.23 referred to above as deductible in 1927. This, as pointed out above, was proper, and any net loss resulting from the allowance of this deduction in 1927 may be allowed as a deduction in computing the net income for the year 1928, in accordance with section 117(e) of the Revenue Act of 1928. 1 In arriving at such amount of net loss the petitioner also eliminated from income an amount of $53,391.84 which had been included by him in his*871 return for the year 1927. This amount represents the final amount paid to the petitioner as damages for breach of contract by Drainage District No. 7 of Poinsett County, Arkansas. Payment was effected by paying petitioner *1047 $272.96 in cash and $38,000 in certificates of the district, and by crediting the district with an amount which it had advanced to petitioner at a prior time. The certificates were taken by petitioner at par and were fully redeemed. This payment was made to the petitioner in 1927, pursuant to a judgment of the United States Circuit Court of Appeals for the Eighth Circuit rendered in that year (). We see no reason for holding that this whole amount was not income to the petitioner in 1927. Amounts received in settlement of an action for damages are income in the year in which received. ; and . We accordingly hold that the amount in question should not be excluded from income of the petitioner for the year 1927.
*872 Each of the parties refers us to section 212(b) of the Revenue Act of 1926 2 and article 36 of Regulations 69, promulgated under the Revenue Act of 1926, 3 as to each issue.
*873 In our opinion the provisions of article 36 have no application here. In the case of work done for the Cache River Drainage District the petitioner was not operating under the contract. The long term contract was held by A. V. Wills & Sons. Petitioner was operating under the agreement of joint venture with A. V. Wills & Sons. Furthermore, even if these were long term contracts, in neither case was the contract "finally completed and accepted" as required by this provision of the regulations. In the case of the work done for Drainage District No. 7 of Poinsett County, Arkansas, the income received by the petitioner was in reality damages for breach of contract. However, if it were considered income from a long term contract it was not income prior to 1927 for the reason that it was not until 1927 that it was "determined" as required by the regulations.
Decision will be entered under Rule 50.
Footnotes
1. (e) Net loss for 1926 or 1927.↩ - If for the taxable year 1926 or 1927 a taxpayer sustained a net loss within the provisions of the Revenue Act of 1926, the amount of such net loss shall be allowed as a deduction in computing net income for the two succeeding taxable years to the same extent and in the same manner as a net loss sustained for one taxable year is, under this Act, allowed as a deduction for the two succeeding taxable years.
2. (b) 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. * * * ↩
3. ART. 36. 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:
* * *
(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. * * * ↩