Agnellino v. CIR, 13655.

• Decision Date: 09 May 1962
• Docket Number: No. 13655.,13655.
• Citation: 302 F.2d 797
• Parties: Anthony AGNELLINO and Florence Agnellino, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Third Circuit

302 F.2d 797 (1962)

Anthony AGNELLINO and Florence Agnellino, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 13655.

United States Court of Appeals Third Circuit.

Argued December 18, 1961.

Decided May 9, 1962.

Benjamin Weiner, New Brunswick, N. J. (Mayo & Weiner, New Brunswick, N. J., on the brief), for petitioners.

Robert L. Waters, Washington, D. C. (Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson and Robert N. Anderson, Attys., Department of Justice, Washington, D. C., on the brief), for respondent.

Before McLAUGHLIN, KALODNER and HASTIE, Circuit Judges.

HASTIE, Circuit Judge.

The Tax Court has determined that there are deficiencies aggregating $54,532.45 in the joint income tax returns of petitioners, Anthony Agnellino and his wife Florence, for the five years from 1953 through 1957. To these deficiency assessments 50 per cent fraud penalties were added. On this appeal the taxpayers contest both the deficiency assessments and the fraud penalties.

During the taxable years Anthony Agnellino operated a motel and a drive-in restaurant in Eatontown, New Jersey. Starting in 1952 with 13 motel units, he increased the size of the motel to 27 units during the summer of 1953. In 1957, 6 more units were added. In 1958 Agnellino discontinued his own operation of the restaurant and leased it for a rental agreed not to be less than $5000. In 1959 he sold the entire operation for $175,000.

In calculating or reconstructing the income of this business for the taxable years the Tax Court used methods which the taxpayers say were improper. Unfortunately, this is a case in which it has not been possible to use the taxpayers' own records and books of account or their accounting methods as guides to official inquiry. The taxpayers have explained that their motel records for 1953, 1954 and 1955 were destroyed in a fire. Their accountant's "work papers", which they offered as a substitute, were admittedly made without any examination of the now missing records by the accountant. Motel records for 1956 and 1957 were incomplete. Moreover, they disclosed numerous mathematical inaccuracies. No record of restaurant receipts existed for 1953, 1954, 1955 and most of 1957, and records for 1956 and the remainder of 1957 were incomplete. Thus, to determine how much the business had earned during the taxable years, it was proper and indeed necessary to devise some substitute method for reconstructing income. True, Section 446(b) of the 1954 Internal Revenue Code as derived from Section 41 of the 1939 Code, 26 U. S.C. § 446(b) and § 41, requires that such substitute methods shall "in the opinion of the Secretary or his delegate * * * clearly reflect income." But this does not mean that the determination must or can be precise as is a computation based upon accurate detailed records maintained in the regular course of business. It is enough that in logic and in the light of normal business experience the method used provides a fair and rational measure of income. United States v. Johnson, 1943, 319 U.S. 503, 517-518, 63 S.Ct. 1233, 87 L.Ed. 1546; Shahadi v. Commissioner, 3d Cir., 266 F.2d 495, cert. denied, 1959, 361 U.S. 874, 80 S.Ct. 137, 4 L.Ed.2d 113; Bishoff v. Commissioner, 3d Cir. 1928, 27 F.2d 91.

Once the method itself is found acceptable the Tax Court's factual findings in the course of applying that method must be upheld unless they are found to be clearly erroneous. See Valetti v. Commissioner, 3d Cir. 1958, 260 F.2d 185; Conway v. United States, 1st Cir. 1960, 278 F.2d 710.

The parties have called the method used to determine motel income in this case the "sheet count" method because it was based upon the number of fresh sheets rented by the motel during each taxable year. Allowance was made for sheets used by persons other than paying guests. A special computation was made for long term guests. Otherwise, each two sheets were taken to represent one guest occupying a room for one day at a rate of $7.10, which the parties stipulated as the average rate for 1954 and all subsequent years. If there was any obvious error in this method, it lay in the failure to take into account those cases where two guests may have used but a single pair of sheets. But this discrepancy was obviously favorable to the taxpayers. We are satisfied that the sheet count method, as employed here, was a legally permissible way of determining minimum gross receipts of the motel. Compare Cohen v. Commissioner, 9th Cir. 1959, 266 F.2d 5.

A large part of the detailed fact finding involved in applying the sheet count method to the computation of motel income was based upon stipulations. The only substantial challenge to this detailed computation which requires discussion concerns the year 1953. The Tax Court's findings as to the number of sheets used in 1954 and subsequent years and its finding that $7.10 was the average daily room rate during those years were based on stipulations or testimony or both. But no evidence of the number of sheets used or rates charged in 1953 was introduced and no figures were stipulated for that year. The Tax Court stated that it was unable to determine how the agents of the Internal Revenue Service who handled this case arrived at an amount representing 1953 motel receipts.

In these circumstances, the Tax Court drew the inference that the average number of sheets used annually after 1953 was also a fair and reasonable approximation of the number of sheets used during 1953, provided that appropriate deductions should be made, as they were, for the smaller number of rooms in use during the first half of 1953. This inference necessarily involved the assumption that the rate of occupancy in 1953 was as high as the average occupancy rate thereafter. The record shows that, in conversations with agents who tried to reconstruct his income, Agnellino referred generally to the pattern of motel occupancy, stating that his motel was full during the busy season with occupancy falling off to 60 or 70 per cent during the off season. He suggested no significant variation in this pattern from year to year or in any particular year. Moreover, Agnellino's action in doubling the capacity of the motel in 1953 and again increasing its capacity in 1957 is some indication that this entire period was a time of high occupancy. It was, therefore, not unreasonable for the Tax Court to use the average sheet count for 1954 and subsequent years as fairly reflecting 1953 experience as well.

Similar considerations justified the use of the average room rate of $7.10, stipulated for 1954 and subsequent years, as a valid approximation for 1953. Here again, Agnellino discussed with the agents the rates charged for various rooms without specifying years, indicating a rather stable rate structure.

The basic datum in reconstructing restaurant gross receipts was the cost of food purchased for the establishment. From this were subtracted amounts agreed fairly to represent the cost of food consumed by the Agnellino family and the cost of food stolen. The cost of food consumed by employees was also deducted. The Tax Court then undertook to determine the percentage relation between the cost of food served to patrons and the gross restaurant receipts in such an enterprise as...