[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT FILED
________________________
U.S. COURT OF APPEALS
ELEVENTH CIRCUIT
No. 02-10716 MARCH 21, 2003
________________________ THOMAS K. KAHN
CLERK
Tax Court Docket Nos. 20220-98, 20221-98
ALAN G. BONE, KATHLEEN A. BONE,
JEFFREY M. GUERRERO, GENEDINE
R. GUERRERO,
Petitioners-Appellants,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
________________________
Appeal from a Decision of the
United States Tax Court
_________________________
(March 21, 2003)
Before ANDERSON and CARNES, Circuit Judges, and HAND*, District Judge.
ANDERSON, Circuit Judge:
*
Honorable William B. Hand, United States District Judge for the Southern District of
Alabama, sitting by designation.
Petitioners, Alan & Kathleen Bone and Jeffrey & Genedine Guerrero
(hereinafter "Taxpayers"), challenge the decision of the United States Tax Court
disallowing over $2 million in deductions taken in 1993 by their business, A.J.
Concrete Services, an S corporation ("AJCS").1 These deductions related to
expenses attributable to various long-term construction contracts that AJCS
transferred to four related C corporations in January 1993. The Tax Court
concluded that the deductions were impermissible because the expenses benefitted
the C corporations, not AJCS, once the contracts were transferred. Taxpayers
appeal that decision. We affirm.
I. BACKGROUND
AJCS is an S corporation that was incorporated in 1987. Jeffrey Guerrero
owns 51% of AJCS and Alan Bone owns the remaining 49%. AJCS was originally
in the construction business, with its principal focus on supplying construction
1
In an earlier case, we discussed the difference between a traditional corporation (a C
corporation) and an S corporation:
Simply speaking, under Subchapter C of the Internal Revenue Code, the income
of a C corporation is subject to corporate tax and any distributions it makes to its
shareholders will be subject to a second, individual tax. Under Subchapter S,
certain C corporations are permitted to elect to be S corporations. While the S
corporation determines taxable income at the corporate level, this corporate
income is passed through to the S shareholders and taxed to them at their
individual rates.
Coggin Auto. Corp. v. Commissioner, 292 F.3d 1326, 1327 n.3 (11th Cir. 2002) (internal
citations omitted).
2
forming services to contractors. AJCS was a calendar-year taxpayer (i.e., it
calculated its income and resulting tax based on revenues and expenses received
and paid during the calendar year), and it utilized the "completed contract method"
of accounting for tax purposes.2 For financial accounting purposes, however,
AJCS used the "percentage of completion" method, which reflects revenue and
expenses already received from and dedicated to ongoing contracts.
As of December 31, 1992, AJCS had $2,680,500 of recognized gross profit
related to 29 partially-completed construction contracts.3 On January 1, 1993, the
company transferred all of these contracts to four C corporations: A.J. Concrete
Forming of Georgia ("Georgia"); A.J. Concrete Forming Central, Inc. ("Central");
A.J. Concrete Forming East, Inc. ("East"); and A.J. Concrete Forming West, Inc.
2
"Under the completed contract method, the total income from a contract is recognized,
and the total costs of performance are deducted, in the taxable year in which the contract is
completed." Broadway v. Commissioner, 111 F.3d 593, 594 n.4 (8th Cir. 1997).
3
As of December 31, 1992, AJCS estimated that the overall value of the ongoing
contracts was $19,975,949, and that it would make an overall gross profit of $8,763,221. The
recognized gross profit figure discussed supra ($2,680,500) represented the difference between
contract revenues received ($6,733,848) and actual costs expended ($4,053,348) as of December
31, 1992.
3
("West") (hereinafter, collectively, the "C Corporations").4 There was a written
assignment contract, though that contract was never signed or dated by any of the
parties. Among other things, the contract provided that:
• Any and all of AJCS's ownership rights in the partially
completed contract would be transferred to the C Corporations
as of January 1, 1993.
• The C Corporations would complete the work on the contracts
and their compensation would be the unpaid balance on those
contracts.
• The C Corporations acknowledged that their costs might exceed
the revenues on the assigned contracts.
• AJCS was responsible for general and administrative costs as
well as any indirect costs associated with the assigned contracts.
The ostensible purpose of assigning the contracts was to allow AJCS to get out of
the construction forming business and into the business of providing management
services to the C Corporations in exchange for fees equal to approximately three
percent.
Because AJCS used the completed contract method for tax purposes, it was
4
The stock ownership in the four C Corporations was as follows: (1) Georgia was owned
47.5% by Guerrero, 47.5% by Jeff Klewein, and 5% by Jeff Hoylman; (2) Central was owned
47.5% by Jeff Klewein, 47.5% by Rick Klewein, and 5% by Dave Entinghe; (3) East was
owned 47.5% by Bone, 47.5% by Rick Klewein, and 5% by Robb Webb; and (4) West was
owned 47.5% by Bone, 47.5% by Jeff Klewein, and 5% by Ken Ritter. While Taxpayers owned
large shares in 3 of the 4 C Corporations, they did not own a majority interest in any of them.
4
not required to report the $2,680,500 in recognized gross profits until the period in
which the contracts were completed, or, as in this case, until the contracts were
transferred. Thus, on its return for the 1993 tax year, AJCS reported as gross
income the $2,680,500 in recognized gross profits from the transferred contracts.
AJCS also claimed deductions totaling $2,808,034 relating to the transferred
contracts, including $546,479 attributable to overhead allocated to 1992. The
result was that AJCS reported a net loss for the 1993 tax year of $236,300.
After conducting an audit of AJCS's 1993 return, the IRS determined that all
of the deductions, save for the overhead expenses allocated to 1992, should be
disallowed because the expenses were incurred in 1993, after the contracts were
transferred. Primarily because of the disallowance of those deductions, which
totaled $2,261,555, the IRS determined that AJCS had a taxable income of
$2,470,021 rather than a loss of $236,300. Because the tax liability of an S
corporation flows through to the individual taxpayers, the IRS issued a notice of
deficiency for the adjustments to the Taxpayers. The notices showed a tax
deficiency of $524,103 for the Bones and $545,324 for the Guerreros.
Taxpayers filed a petition in the United States Tax Court seeking a
redetermination of the alleged deficiencies. Prior to trial, the parties stipulated that
the partially-completed contracts were transferred to the C Corporations on January
5
1, 1993. At trial, AJCS's chief financial officer testified that the contracts were in
fact transferred to the C Corporations on that date, and that the C Corporations had
worked on and completed a number of the contracts in 1993, claiming income and
expenses associated with those projects. He also testified that $2,625,666 of the
$2,808,034 in reported expenses were associated with the transferred contracts.
After the conclusion of the trial, the Tax Court ruled in favor of the
Commissioner, holding that $2,261,555 of the expenses deducted by AJCS were
really expenses of the C Corporations because they were incurred after the
contracts were transferred. The court rejected the notion that AJCS was required
by the assignment contract to pay those expenses because that agreement was
neither signed nor dated. The court also noted that a company cannot, as a general
rule, deduct expenses incurred on behalf of another taxpayer, and that an exception
to that rule did not apply in this case. The court also found that the Taxpayers had
not adequately preserved the issue of whether their income was overstated and had
failed to present sufficient evidence to support their deduction for workers'
compensation insurance, a deduction the court indicated likely belonged to the C
Corporations. After the Tax Court denied Taxpayers' motion to reconsider its
decision, Taxpayers filed this appeal.
6
II. STANDARD OF REVIEW
We review the Tax Court's findings of fact for clear error, even where those
facts are based on stipulations entered into by the parties. See Florida Hosp. Trust
Fund v. Commissioner, 71 F.3d 808, 810 (11th Cir. 1996). We review the Tax
Court's legal conclusions de novo. Id. Whether a party earns income under I.R.C.
§ 61 is a question of fact reviewed under the clearly erroneous standard. See
Commissioner v. Duberstein, 363 U.S. 278, 291-92, 89 S.Ct. 1190, 1200 (1960)
(reviewing for clear error the determination of whether a transfer was a gift).
Likewise, whether an amount paid by a corporation is deductible as an "ordinary
and necessary business expense" of the corporation under I.R.C. § 162(a) is a
question of fact, see Commissioner v. Heininger, 320 U.S. 467, 475, 64 S.Ct. 249,
254 (1943), and we thus review such a finding for clear error. At the time the case
was tried, the Commissioner's determinations in his notices of deficiency were
entitled to a presumption of correctness, and Taxpayers bore the burden of proving,
by a preponderance of the evidence, that the Commissioner's determinations were
incorrect. Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 9 (1993).5
5
For audits beginning after July 2, 1998, the burden of proof was shifted to the
Commissioner under certain circumstances. See I.R.C. § 7491.
7
III. ANALYSIS
Our analysis here begins with the well-settled proposition that when a
taxpayer who is using the completed contract method for tax purposes disposes of a
contract prior to its completion, the taxpayer must recognize its allocated portion of
the contract revenue, and may deduct any corresponding portion of its expenses, as
of the time the contract was transferred. See Jud Plumbing & Heating, Inc. v.
Commissioner, 153 F.2d 681, 685 (5th Cir. 1946) (requiring dissolved corporation
to include as income progress payments on partially-completed contracts where
contracts were transferred to corporation's principal shareholder upon dissolution)6;
Dillard-Waltermire v. Campbell, 255 F.2d 433, 436 (5th Cir. 1958) (affirming
Commissioner's reallocation of income earned prior to the transfer of partially-
completed contract).7 The Tax Court found that AJCS transferred its interest in the
partially-completed contracts as of January 1, 1993. The company thus properly
6
In Bonner v. City of Prichard, 661 F.2d 1206, 1209 (11th Cir. 1981) (en banc), this Court
adopted as binding precedent all of the decisions of the former Fifth Circuit handed down prior to
the close of business on September 30, 1981.
7
See also J.M. Turner & Co. v. Commissioner, 247 F.2d 370, 373 (4th Cir. 1957) ("The
completed contracts method of reporting . . . is not a device by which income can be transferred
from one taxpayer to another. A change in the ownership of the contract during the course of
construction would normally result in an accrual for tax purposes of income to the transferor,
notwithstanding he had previously been reporting upon the completed contracts method.");
Standard Paving Co. v. Commissioner, 190 F.2d 330, 332-33 (9th Cir. 1951) (same).
8
declared as income AJCS's gross profits on the contracts prior to the date of
transfer, $2,680,500. As a general matter, though, Taxpayers would not have been
entitled to deduct expenses related to those contracts that were incurred after the
date on which the contracts were transferred to the C Corporations.
Notwithstanding these well-settled principles, Taxpayers argue that they are
entitled to relief. They first claim that the Tax Court erred when it determined that
the contracts were in fact transferred from AJCS to the C Corporations. The parties
stipulated prior to trial that "[o]n January 1, 1993, [AJCS] transferred its
incomplete contracts to [the] four "C" Corporations . . . ." At trial, Taxpayers
argued, among other things, that the expenses AJCS incurred in 1993 were
expenses that it was contractually required to undertake pursuant to the written
agreement assigning the partially-completed contracts to the C Corporations.8 The
Tax Court concluded that the agreement was invalid, citing the fact that it was
unsigned, undated, and "lacking in the usual earmarks of a contract that has been
negotiated at arm's length." Taxpayers insist that the stipulation was predicated on
the assignment's validity, and that if the assignment is said to be invalid, the
8
Even if the Tax Court had found the written agreement was valid, it would not have
helped Taxpayers. Under that agreement, Taxpayers were responsible only for "general and
administrative" and "indirect" costs associated with the assigned contracts. Taxpayers' problem
is that they failed to prove that the $2,261,555 they seek to deduct were general, administrative,
or indirect expenses.
9
stipulation should be deemed invalid as well. Without the stipulation, Taxpayers
argue that there is no evidence to support a finding that the contracts were in fact
transferred. And, if the contracts were not transferred, they argue that any expenses
incurred in relation to those contracts were properly claimed by AJCS.
We do not agree. The stipulation speaks for itself and makes no reference to
any assignment contract. Moreover, the fact that the particular assignment contract
was deemed invalid does not exclude the possibility that a transfer nonetheless
occurred. At oral argument, we specifically asked Taxpayers' counsel whether
AJCS received the remaining balance of the $19 million due on the contracts. She
conceded that the money due under the contracts was paid to the C Corporations,
not AJCS. The fact that the balance due on the contracts was paid to those
corporations indicates that a transfer indeed occurred, regardless of the validity of
the written, but unsigned, contract examined by the Tax Court. In light of that fact,
the stipulation between the parties, the testimony at trial, and the other conduct of
the parties, we agree with the Tax Court that AJCS transferred the partially-
completed contracts to the C Corporations on January 1, 1993. The Tax Court is
certainly not clearly erroneous in that regard.
Though Taxpayers recognize the general rule that a taxpayer can only deduct
expenses incurred prior to the date on which a partially-completed contract is
10
transferred, they insist an exception exists where a deduction is necessary to
"match" expenses with revenue. In other words, if the revenue received represents
a "prepayment" on work to be performed, Taxpayers insist that the costs associated
with performing that work, even if they are incurred after the date of transfer, are
allowable deductions.
Although we acknowledge that there is some authority for the proposition
asserted by the Taxpayers, we need not resolve that legal issue. We reject that
argument on the facts. First, it is not at all clear that this matching argument was
raised in the court below when Taxpayers were represented by different counsel.
Arguments not raised in the court below are usually not considered by this Court.
Depree v. Thomas, 946 F.2d 784, 793 (11th Cir. 1991). More important,
Taxpayers' counsel was unable to point to any evidence at oral argument
specifically linking the expenses incurred in 1993 to the revenue received in 1992.
Given the fact that only $6.7 million of the estimated $19.9 million in revenue on
the project had been received by AJCS as of December 31, 1992, it is not self-
evident that the expenses incurred in 1993 related to the $6.7 million already
received rather than the $13.2 million remaining due on the project. After a careful
review of the record, we are unaware of any evidence specifically linking the 1993
expenses to the $6.7 million received by AJCS prior to the transfer of the contracts.
11
Given the fact that Taxpayers bear the burden of proving their entitlement to the
deduction at issue, this evidentiary gap is fatal to their claim. 9
Taxpayers also argue that there is another exception permitting them to
deduct
expenses related to a partially-completed contract after the transfer date. In order
for a business expense to be deductible under I.R.C. § 162, the expense must be
"ordinary" and "necessary." Ellis Banking Corp. v. Commissioner, 688 F.2d 1376,
1378 (11th Cir. 1982). As a general rule, a payment by one taxpayer on behalf of
another is not an ordinary and necessary business expense. See Welch, 290 U.S. at
114-15, 54 S.Ct. at 9-10. See also Dietrick v. Commissioner, 881 F.2d 336, 338
(6th Cir. 1989) ("It has long been the general rule that a taxpayer may not deduct
expenses incurred on behalf of another taxpayer's business."). An exception
applies, though, where the expenses are incurred to "protect or promote" the
taxpayer's business. See Lohrke v. Commissioner, 48 T.C. 679, 684-85 (1967).
9
For similar reasons, we also reject Taxpayers' argument that the court below erred by not
finding that AJCS had overstated its income. This argument is merely the converse of the
matching argument, in that Taxpayers argue that if the contracts (and their related expenses)
belonged to the C Corporations, the $2,680,500 in gross income would rightfully belong to those
corporations, not AJCS, because that money represented a payment for services to be performed
at a later date. Like the matching argument, we cannot assume that the money received by AJCS
prior to the date of transfer represented a prepayment for services to be rendered without
evidence linking those specific monies to the expenses later incurred. Because Taxpayers have
failed to point to any such evidence, we have no basis for granting their requested relief.
12
In Lohrke, the court noted that the first step in identifying whether this
exception applies is to determine the taxpayer's motive for paying the obligations
of another taxpayer. The court indicated that if the taxpayer's payment on behalf of
another corporation is intended to serve as a capital investment of some kind, with
the hope that the taxpayer might later realize a return on his investment in the way
of increased profits in the other corporation, the exception does not apply. Id. at
688. On the other hand, the court recognized that if the payments are used to
directly promote or protect the taxpayer's own business, the exception would apply.
In reviewing the case before it, the court concluded that the taxpayer's payments
were not intended as a capital investment in another corporation but were instead
used to protect its own business. Consequently, the deductions were allowed. Id.
This Court reached a similar result in Lutz v. Commissioner, 282 F.2d 614 (5th Cir.
1960). That case involved a situation where one corporation payed the debts of
three corporations it controlled and attempted to claim those payments as
deductible business expenses. We concluded that the payments were necessary to
"protect and preserve" the controlling corporation's business. Specifically, we
noted that the payments were needed to protect the goodwill value of the
corporation's trademark and to ensure that it maintained its license with the
Department of Agriculture. Id. at 620-21. We thus held that the deduction should
13
have been allowed. Id. at 621.
As other courts have recognized, however, the "protect and promote"
exception is limited to those situations where "there [is] 'a clear proximate danger
to the taxpayer and . . . a payment made to protect an existing business from harm.'"
Dietrick, 881 F.2d at 339 (ellipses in original) (quoting Young & Rubicam, Inc. v.
United States, 187 Ct. Cl. 635, 410 F.2d 1233, 1243 (1969)). The court in Dietrick
emphasized that the burden is on the taxpayer to show "'a direct nexus between the
purpose of the payment and the taxpayer's business or income producing activities .
. . .'" Id. (quoting Lettie Page Whitehead Foundation, Inc. v. United States, 606
F.2d 534, 538 (5th Cir. 1979)). The court there affirmed the lower court's finding
that the "protect and promote" exception did not apply because the taxpayer was
attempting to establish a new business with his payments rather than furthering the
interest of his existing business. Id. at 640.
Taxpayers here argue that the "protect and promote" exception applies and
that the Tax Court clearly erred in its finding to the contrary. There are two parts to
their argument. First, they claim that the Tax Court erred by finding that AJCS had
no valid reason for agreeing to pay the costs of completing the contracts in light of
the fact that it was not to receive any of the proceeds from those contracts.
Taxpayers insist that the court's finding is inconsistent with its earlier finding that
14
AJCS had received $2,680,500 of recognized gross profits related to the contracts.
That profit, Taxpayers contend, was a prepayment on work to be performed, such
that it was necessary for the company to complete the work in order to justify the
income it received. Taxpayers appear to be rehashing their matching argument,
and as with that argument, their claim fails because they have failed to substantiate
their conclusory assertions with any evidence specifically linking the money
received prior to the date the contracts were transferred with the expenses incurred
in 1993.
Taxpayers also argue that the "protect and promote" exception applies in
light of the obligations they undertook to various builders in the transferred
contracts. Taxpayers insist that if those contracts were breached on account of the
C Corporations' failure to complete them, they would have been liable for damages,
and that as a result, their expenses in completing the contract were necessary to
protect their own business. The Tax Court rejected this argument, though, because
Taxpayers were unable to prove, to the court's satisfaction, that the C Corporations
lacked the financial ability to complete the contracts. Its finding was based in part
on the fact that the C Corporations actually loaned money to AJCS during the tax
year in question. In addition, the fact that the C Corporations stood to receive the
remaining $13.2 million due on the contracts suggests that the C Corporations had
15
the ability to complete the contracts. At the very least, we cannot say that the Tax
Court clearly erred when it found that these expenses were used to benefit the C
Corporations rather than AJCS.10
IV. CONCLUSION
Because we affirm the Tax Court's finding that the partially-completed
contracts were transferred to the C Corporations on January 1, 1993, AJCS was not,
under the applicable rules, entitled to claim as a deduction any expenses related to
those contracts incurred after the transfer date. Taxpayers have failed to show that
any exception to those rules applies here. Accordingly, the decision of the United
States Tax Court is hereby AFFIRMED.
10
For the same reason, we also reject Taxpayers' claim that they are entitled to a deduction
for workers' compensation insurance premiums. The question is not whether those expenses
were incurred; rather, the question is whether those expenses were incurred on behalf of AJCS,
or at the very least to "protect or promote" its business. Because Taxpayers failed to show that
the premiums were a necessary expenditure for AJCS's business, we cannot say that the Tax
Court clearly erred when it denied Taxpayers the benefit of a deduction.
16