RACMP Enters., Inc. v. Comm'r of Internal Revenue, 23954–97.

Decision Date30 March 2000
Docket NumberNo. 23954–97.,23954–97.
Citation114 T.C. No. 16,114 T.C. 211
PartiesRACMP ENTERPRISES, INC., Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
CourtU.S. Tax Court

OPINION TEXT STARTS HERE

Corporate taxpayer, a concrete contractor, petitioned for redetermination of deficiencies arising from disallowance of cash method of accounting. The Tax Court, Parr, J., held that: (1) taxpayer's contracts were to provide services, such that material was an indispensable and inseparable part of providing service; (2) material that required labor, and material, combined with other tangible personal property, lost its separate identity, such that taxpayer was not selling merchandise, as would require accrual method of accounting; and (3) IRS abused its discretion in determining that taxpayer had to use accrual method of accounting for income tax reporting.

Decision for taxpayer.

Marvel, J., dissented.

Gerber, J., dissented in written opinion, in which Cohen, Ruwe, Halpern, and Thornton, JJ., joined.

Halpern, J., dissented in written opinion, in which Cohen, Ruwe, Gerber, and Thornton, JJ., joined. Kevin P. Courtney, for petitioner.

Steven Walker, for respondent.

PARR, J.*

P is a construction contractor that enters into contracts to construct, place, and finish concrete foundations, driveways, and walkways for real property developers. P uses the cash method to recognize income and to expense the cost of concrete and other materials. R determined that the material P uses in providing service to its clients is “merchandise” under sec. 1.471–1, Income Tax Regs., and that P must report its income on the accrual method of accounting.

Held: P's contract to provide labor and material to a real property developer is a contract to provide service, and the material is an indispensable and inseparable part of the provision of that service. See Osteopathic Med. Oncology & Hematology, P.C. v. Commissioner, 113 T.C. 376, 384, (1999).

Held, further, material that is provided by a construction contractor according to the terms of a contract that requires the provision of labor and material, and which, when combined with other tangible personal property, loses its separate identity to become an integral and inseparable part of a building or other real property, is not merchandise within the meaning of sec. 1 .471–1, Income Tax Regs.

Held, further, under the facts of this case, R abused his discretion in determining that P must use the accrual method of accounting to report its income for Federal income tax purposes.

Respondent determined an $82,577 income tax deficiency for petitioner's tax year ended August 31, 1994, and a section 6662 1 accuracy-related penalty of $16,515.

The issues for determination are: (1) Whether the material provided by petitioner in accordance with its contract to construct and place concrete foundations, driveways, and walkways is merchandise within the meaning of section 1.471–1, Income Tax Regs. We hold it is not. (2) Whether respondent abused his discretion in determining that petitioner's use of the cash method of accounting did not clearly reflect its income. We hold he did. (3) Whether petitioner is liable for an accuracy-related penalty. Because of our disposition of the preceding issues, we need not address this issue.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulations of facts and the attached exhibits are incorporated herein by this reference. At the time the petition in this case was filed, petitioner was a California corporation with its principal place of business in Gilroy, California, where it had a small office and an equipment yard.

Petitioner is a licensed contractor in the State of California, holding a class C–8 license to construct, place, and finish concrete foundations and flatwork. The term “flatwork” means driveways and walkways.

Petitioner used concrete, sand, drain rock, and various hardware items (wire mesh, rebar, anchor bolts and rods, holddowns, P.A. straps, column bases, post bases, and drain piping), to perform its contracts.

The concrete, sand, rock, and hardware items were delivered to the construction site, not to petitioner's equipment yard or office. The invoices show that during the year at issue, the cost of sand was $6.50 per ton and drain rock $11.65 per ton. Occasionally, when the construction site became congested, petitioner would put some of the hardware items in the back of a truck, store the truck in its equipment yard overnight, and return it to the construction site the following day. Petitioner had a metal storage container similar to the type of containers used on cargo ships at its equipment yard that it used to store equipment and some hardware items.

The Construction CycleA. The Bid

During the year at issue, petitioner performed its construction activity in the following manner. Petitioner obtained a set of building plans from a developer and then visited the construction site to evaluate the soil, weather, and traffic conditions, and to ascertain the location of the materials suppliers. Petitioner calculated its bid price by summing its estimates of the cost of the labor and materials required to perform the work plus a margin for profit based upon the cost of the labor, the quantity of materials, and the complexity of the job.

The following is a typical bid worksheet prepared by petitioner:

Typical Bid Worksheet

+------------------------------+
                ¦Ready-mix concrete   ¦$547.80 ¦
                +---------------------+--------¦
                ¦Sand                 ¦225.00  ¦
                +---------------------+--------¦
                ¦Other materials      ¦69.44   ¦
                +---------------------+--------¦
                ¦Other materials      ¦7.70    ¦
                +---------------------+--------¦
                ¦Other materials      ¦4.80    ¦
                +---------------------+--------¦
                ¦Total                ¦854.74  ¦
                +---------------------+--------¦
                ¦Tax (8.5%)           ¦72.65   ¦
                +---------------------+--------¦
                ¦Total materials cost ¦927.39  ¦
                +---------------------+--------¦
                ¦                     ¦        ¦
                +---------------------+--------¦
                ¦Plus labor           ¦477.20  ¦
                +---------------------+--------¦
                ¦Equals               ¦1,404.59¦
                +---------------------+--------¦
                ¦                     ¦        ¦
                +---------------------+--------¦
                ¦Plus 15% profit      ¦210.69  ¦
                +---------------------+--------¦
                ¦Total                ¦1,615.28¦
                +------------------------------+
                

B. The Contract

If petitioner's bid was accepted by the developer, a written contract was executed to construct, place, and finish the required foundations and flatwork. The parties stipulated that a typical contract between petitioner and its clients provided the following:

In consideration of the mutual agreements contained herein, Contractor and Subcontractor [petitioner] agree as follows:

1. Work. The work to be performed hereunder shall include, and Subcontractor shall perform, all duties and services necessary or inherent to the type and trade classification of FOUNDATION & FLATWORK, the scope of which is more fully defined in Exhibit AScope of the Work, hereto (the “Work”). The Work shall include all work of such type and trade classification for the Project, and is to be performed in strict compliance with this Subcontract and the Contract Documents (as defined in Paragraph 9 hereof) and all addenda, amendments and changes thereto, whether or not stipulated in the Contract Documents, and shall include all work ordinarily and usually performed, and the supply of all facilities ordinarily and usually provided as part of the Work covered by this Subcontract or ordinarily and usually performed by a subcontractor doing work of such trade classification. Subcontractor, to the entire satisfaction and approval of Contractor (or its authorized representatives and/or assigns) and all governing agencies agrees to furnish sufficient labor, materials, tools, equipment and services and to properly perform the Work in a sound workmanlike and substantial manner. Subcontractor is employed by Contractor as an independent contractor to perform the work.

* * *

15. Materials and Workmanship; Inspection and Testing

(a) All materials used in the Work shall be furnished in ample quantities to facilitate the proper and expeditious execution of the Work and shall be new and of the most suitable grade of their respective kinds and purpose. At the request of the Contractor, Subcontractor shall furnish to Contractor for approval, full information and/or samples concerning the materials or articles which Subcontractor intends to incorporate in the Work. The materials actually used in the Work shall conform to the information or samples approved. Machinery, equipment, materials and articles installed or used without such approval shall be used by Subcontractor at the risk of subsequent rejection by Contractor.

(b) Except as otherwise provided herein, all material and workmanship, if not otherwise designated by the Contract Documents, shall be subject to inspection, examination and test by Contractor at any and all times during manufacture and/or construction and at any and all places when such manufacturing or construction are carried on. Contractor shall have the right to reject improper or defective material or workmanship or require correction without charge to Contractor. Subcontractor shall promptly segregate and remove rejected material from the Project Site. Nothing contained in this Paragraph 15 shall in any way restrict the rights of Contractor under any warranty by Subcontractor of material or workmanship.

16. Warranty; Customer Service

(a) Subcontractor warrants and represents to Owner and to Contractor that the workmanship of the Work, all materials and equipment furnished for the Work, and all other aspects regarding the Work to be performed under this Subcontract shall be in conformance with this Subcontract and the Contract Documents, be of finest quality, and be free from faults and defects of design, material and Workmanship for a period of two (2) years from (i) the date of the...

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  • Cuthbertson v. Comm'r
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    ...Sec. 446(b). The Commissioner's determination may be challenged only upon a showing of abuse of discretion. RACMP Enters. v. Commissioner, 114 T.C. 211, 218-219 (2000). Whether an abuse of discretion occurred depends upon whether the Commissioner's determination is without sound basis in fa......
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