8 T.C. 874 (1947), 4424, Harris Hardwood Co., Inc. v. C.I.R.
|Citation:||8 T.C. 874|
|Opinion Judge:||ARNOLD, Judge:|
|Party Name:||HARRIS HARDWOOD COMPANY, INC., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.|
|Attorney:||H. F. Hinderer, C.P.A., for the petitioner. Edward L. Potter, Esq., for the respondent.|
|Case Date:||April 24, 1947|
|Court:||United States Tax Court|
1. Petitioner expended $2,765.29 for grading and dirt fill in connection with 1940 flood damage and in erecting a levee to protect its plant from future floods. Held, no part of the expenditure is deductible as an ordinary and necessary business expense of 1941.
2. Held, petitioner has established its right to deduct a casualty loss in 1940 of $2,765.29.
3. Dividends under a group life insurance policy, issued in August 1934 and carried by petitioner for the benefit of its employees, were payable and received at the end of each policy year for the first nine years of the policy, except for the years 1935, 1936, 1939, 1942, and 1943. Held, the entire amount of the 1940 dividend is taxable for excess profits tax purposes in 1940 and petitioner is not entitled to apportion any part thereof to its 1939 taxable income; held, further, petitioner has failed to establish that any part thereof is attributable to prior or future years as required by section 721(b), I.R.C., and section 35.721-3, Regulations 112.
4. Certain deductions during the base period years for unemployment compensation payments, and dues and subscription expenses determined to be abnormal in amount and disallowed under section 711(b)(1)(J)(ii); interest deductions held not abnormal in amount.
Petitioner is entitled to an unused excess profits credit carryback from the year 1943.
Respondent determined deficiencies for the taxable years 1940 and 1941 as follows:
Nature of tax 1940 1941
Income tax $194.27 [*] $2,230.67
Declared value excess profits tax 58.69
Excess profits tax 1,148.80 9,907.92
The issues are (1) whether respondent erroneously treated as a capital expenditure the amount of $2,765.29 expended for grading and dirt full, which petitioner claims was an ordinary and necessary expense in 1941, or (2), in the alternative, whether 1940 income should be reduced by a casualty loss of equal amount from damages due to a flood; (3) whether respondent erroneously treated a group life insurance dividend in the amount of $1,483.56 as fully taxable for excess profits tax in 1940; (4) whether petitioner's base period net income should be adjusted under section 711(b)(1)(J)(ii) for abnormalities in (a) unemployment compensation taxes, (b) interest, and (c) dues and subscription expense; and (5) whether petitioner is entitled to an unused excess profits credit carry-back from the year 1943 of $22,271.21. Petitioner abandoned an allegation of error relating to group life insurance premiums. FINDINGS OF FACT. The petitioner is a Virginia corporation, organized in 1919. It is engaged in the business of manufacturing hardwood flooring, with its principal office in Roanoke, Virginia. Its income and excess profits tax returns were filed with the collector of internal revenue at Richmond, Virginia. The petitioner used the accrual method of accounting. The manufacturing plant operated by petitioner consists of approximately 15 acres located at Roanoke, Virginia. The equipment and properties have a cost basis in excess of $200,000. The improvements consist of an extensive lumber yard, 6 dry kilns, a 2-story planing mill, warehouse, and office building, trackage, roads, and flooring machinery and equipment. The petitioner normally carries 3,000,000 to 5,000,000 feet of lumber in the yard, plus extensive warehouse inventories of finished stock. The plant has a frontage of approximately 2,700 feet on the banks of the Roanoke River. On August 14, 1940, the Roanoke River flooded to a stage of 19 1/2 feet, compared with a normal stage of 3 feet at the company's plant. The flood put 8 feet of water into the dry kilns, more than 5 feet into the mill, and 4 feet into the boiler house. The flood currents washed Page 876 out roads and trackage, damaged kilns, buildings, and machinery, floated away stacks of lumber up to several thousand feet, and damaged inventories extensively. Petitioner had no flood insurance. Following the flood petitioner paid $2,765.29 for dirt and hauling costs. Of this amount approximately two-thirds was used to build a new river levee to prevent a repetition of the 1940 flood and the balance was used to replace washout damage to roads and trackage. The amount of $2,765.29 was charged on petitioner's books to 1940 expense and was taken as an expense deduction for income tax purposes in 1940. The inventory loss was absorbed into expense and is not in controversy. No other repair item is in controversy. Petitioner's 1940 and 1941 tax returns show deductions for repairs of $18,235.27 and $25,909.79, respectively. In determining petitioner's 1941 tax liability respondent made six adjustments to its net income. The first adjustment was designated ‘ (a) Capital expenditures $3,242.98.‘ This adjustment was explained as follows:
(a) Expenditures of this amount have been determined to be capital expenditures and not deductible from gross income. Section 19.24-2, Regulations 103.
Included in the disallowed expenditures is the amount of $2,765.29 expended in the construction of a levee to hold back flood water of the Roanoke River. The contention in your protest that this expenditures (sic) was a currently deductible expense and not a capital improvement has been denied. Damage inflicted by the flood which was not repaired included settled piers and sagging roof and floor in the warehouse, crumbled retainer walls in kilns, garage floor which had to be replaced where flood waters had washed fill out from under it, and cracked wall in boiler house. The above damage did not prevent operation of the plant. The amount of the unrepaired flood damage at the end of 1940 was estimated to be at least $5,000. No deduction was claimed in the 1940 return for loss sustained from the flood. In 1940 petitioner sustained a casualty loss of $2,765.29 as a result of the flood. During the taxable years and prior thereto petitioner carried a group life insurance policy, No. G-4628, with the Prudential Life Insurance Co. of America on the lives and for the benefit of its employees. This policy was issued on or about August 26, 1934. Petitioner paid all the premiums on the policy and was entitled to all dividends thereon in accordance with the following dividend provision of the policy:
Annually, during its continuance in force, the proportion of the divisible surplus accruing upon this policy shall be ascertained and apportioned by the Board of Directors and credited to this Policy at the end of the policy year as a dividend. Such dividend shall be (1) paid to the Employer in cash or (2) at the option of the Employer applied to the reduction of the premium then due, if any; or upon the written request of the Employer it may be (3) left to accumulate
to the credit of the Policy with interest compounded annually at the rate of 3 1/2% plus such additional interest as the Company may declare on such funds and withdrawable at any time.
The only dividends received by petitioner to and including the year 1943 were $115.55 in the policy year ended 1937; $756.81 in the policy year 1938; $1,483.56 in the policy year 1940; and $621.01 in the policy year 1941. No dividends were received in 1935, 1936, 1939, 1942, or 1943. The Federal Unemployment Compensation Act and the Virginia Unemployment Compensation Act became effective January 1, 1936. Without reflecting reductions in rates, due to state merit ratings, the Federal and the Virginia unemployment compensation rates were fixed at the following percentage rates applied to all compensation up to $3,000 per employee:
Year Virginia Federal Total
Percent Percent Percent
1936 0.9 0.1 1.0
1937 1.8 .2 2.0
1938 2.7 .3 3.0
1939 to date 2.0 .3 3.0
The unemployment compensation acts are administered by the several states, subject only to certain Federal restrictions and regulations. The Commonwealth of Virginia, in common with other states, established individual reserve accounts for each employer. Virginia followed a policy of charging against such reserves claims paid to unemployed persons who were former employees. Virginia established a merit-rating system granting lower rates to those employers whose reserves, by reason of steady employment and low labor turnover, reached certain standards. Petitioner qualified for the best merit rating in the first year that such rating applied. The ratings applied to petitioner during the years pertinent hereto were as follows:
Year Virginia Federal Total
Percent Percent Percent
1936 0.9 0.1 1.0
1937 1.8 .2 2.0
1938-1940, incl 2.7 .3 3.0
1941 1.0 .3 1.3
1942 1.0 .3 1.3
1943 1.0 .3 1.3
Petitioner's unemployment compensation payments were substantially reduced by the merit-rating reduction rates. This reduction of rates resulted from reserves built up during the base period years, favorable labor relations, and low labor turnover. The favorable labor relations and low labor turnover continued unchanged through 1940, 1941, and 1942. Page 878 During the base period years and the taxable years petitioner's volume of business, gauged by lumber footage consumed, was as follows:
1936 9,000,000 1940 10,
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