Bolling v. CIR

• Decision Date: 28 February 1966
• Docket Number: No. 17912.,17912.
• Parties: Glenn L. BOLLING and Ila L. Bolling, Mae L. Hausmann, Fairhills Company, B & H Homes, Inc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Eighth Circuit

357 F.2d 3 (1966)

Glenn L. BOLLING and Ila L. Bolling, Mae L. Hausmann, Fairhills Company, B & H Homes, Inc., Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 17912.

United States Court of Appeals Eighth Circuit.

February 28, 1966.

William H. Curtis, Kansas City, Mo., Roy C. Hormberg, Kansas City, Mo., for petitioners.

Crombie J. D. Garrett, Attorney, Tax Division, Department of Justice, Washington, D. C., Louis F. Oberdorfer, Asst. Atty. Gen., Tax Division, Dept. of Justice, Washington, D. C., Lee A. Jackson and Meyer Rothwacks, Attorneys, Tax Division, Dept. of Justice, Washington, D. C., for respondent.

Before VAN OOSTERHOUT, BLACKMUN and MEHAFFY, Circuit Judges.

BLACKMUN, Circuit Judge.

Glenn L. Bolling and Mae L. Hausmann were engaged in the business of constructing and selling homes in the Kansas City area. They conducted their business through two accrual basis partnerships, Bolling-Hausmann Builders and Bolling-Hausmann Development Company, and two wholly owned accrual basis corporations, Fairhills Company and B & H Homes, Inc. At issue here are asserted deficiencies in federal income tax for the individual taxpayers for the calendar years 1959 and 1960, for Fairhills for its fiscal years ended March 31 in each of the years 1958-60, inclusive, and for B & H for its fiscal year ended June 30, 1961. The cases were consolidated for trial in the Tax Court and come to us as a unit.¹

The Tax Court stated the issues as follows:

"(1) Whether accrual basis home builders and sellers acting as loan guarantors for customers must include in income in the year of sale portions of sales proceeds pledged as loan security to the lender, which lender thereby granted loans to the sellers\' customers in excess of the usual maximum amounts; and if so,

"(2) Whether petitioners are entitled to deductions for additions to bad debt reserves" under § 166 of the Internal Revenue Code of 1954.²

Judge Forrester, in an opinion not reviewed by the full court, answered the first question in the affirmative and the second in the negative and thus decided both issues against the taxpayers. T.C. Memo 1964-143.

There is no dispute as to the facts. The homes constructed and sold by the taxpayers were low or moderately priced dwellings. They were sold under contracts providing for a down payment as small as 5% of the sales price. This naturally entailed more than the usual risk for a lending agency. A plan, however, was evolved with Home Savings Association of Kansas City. Home's normal policy was to limit the amount of any home loan to a maximum of 80% of appraised value. By contracts with Builders, B & H and Fairhills, Home agreed to lend up to 95% of appraised value to customers of the taxpayers. The particular vendor-taxpayer agreed to pledge and assign to Home, as collateral, a share account of Home equal to the difference between 90% of Home's appraisal and the amount loaned.³ To this extent the amount loaned was deposited by Home in the share account rather than paid to the vendor. The purchaser did not become indebted to the vendor. Each of these contracts also provided that (a) "The collateral shall earn a dividend at the current rate and shall be payable to the Seller at the regular dividend paying periods"; (b) the vendor's share "shall be in one account for the entire group of loans" for that vendor; (c) subject to stated conditions and limitations, the collateral would be released to the vendor as loan principal was reduced; and (d) in the event of a foreclosure, Home was authorized to make up any deficiency from the share account. The taxpayers did not contemplate full release of the collateral share accounts for some years.

It is thus apparent that these agreements served to reduce Home's exposure beyond the specified ceiling, that the full purchase price was not received by the seller at the time of the sale, and that, for each vendor, Home's collateral was pooled and subject to use in the event of any foreclosure and deficiency.

In line with these agreements, amounts were credited by Home to share accounts for Builders, Fairhills and B & H during the tax years in issue. This led to the tax issues now before us.

On the income issue Judge Forrester held that his decision was controlled by Key Homes, Inc., 30 T.C. 109 (1958), aff'd 271 F.2d 280 (6 Cir. 1959), and that the taxpayers "have failed to sustain their burden of proving that the instant factual context presents additional contingencies of a magnitude sufficient to alter the rule of Key Homes, Inc." On the deduction issue, the court, after expressing doubt as to whether Builders and Fairhills had complied with formal requirements for bad debt reserves, held that, in any event, "guarantor situations are not within the purview of the bad debt reserve provision". He adhered to Wilkins Pontiac, 34 T.C. 1065 (1960), despite its reversal, 298 F.2d 893 (9 Cir. 1961), but expressed "sympathy with the views of the Ninth Circuit" and described the situation as an "unfair" and "unhappy" one.

A. The includability issue. For a reporting entity on the accrual basis the standard as to includability of an income item "is the right to receive and not the actual receipt * * *. When the right to receive an amount becomes fixed, the right accrues". Spring City Foundry Co. v. Commissioner, 292 U.S. 182, 184-185, 54 S.Ct. 644, 645, 78 L.Ed. 1200 (1934). The Court in that case made it clear that predicted uncollectibility, no matter how certain, does not affect a creditor's right to receive payment and, consequently, its obligation to accrue and include in gross income. This principle is accepted by both sides here but the taxpayers assert that it does not have application to the present facts.

Commissioner of Internal Revenue v. Hansen, 360 U.S. 446, 79 S.Ct. 1270, 3 L.Ed.2d 1360 (1959), although it concerns automobile dealers rather than home builders, is significant. Hansen resolved an existing conflict among lower court decisions (including one of our own, Glover v. Commissioner, 253 F.2d 735 (8 Cir. 1958)) as to the inclusion, for an accrual basis taxpayer, of amounts in automobile dealers' reserve accounts. The details of the several cases varied somewhat but, in general, the lender paid the dealer the face amount of a customer's note less a certain percentage which the lender credited to the dealer but withheld in a reserve account. The dealer indorsed the note with recourse or otherwise agreed to protect the lender against loss. The reserve was held as collateral to secure this obligation. Periodically, the lender released to the dealer any amount in the account which exceeded a stated percentage of outstanding loans. The dealers contended, as do the builders here, that the amounts so retained were subject to such contingent liabilities that it could not be known in the year of sale how much, if any, of the reserves would ever be received by them and that, therefore, they did not acquire a fixed right to receive the reserved amounts and these did not qualify as accrued income to them.

The Supreme Court held, pp. 464-466 of 360 U.S., 79 S.Ct. 1270, that (a) the fact the dealer could not presently compel the finance company to pay over the reserve did not negate the existence of a fixed right to receive the reserved amount, within the meaning of the language quoted from Spring City; (b) the existence of contingent liabilities on the part of the dealer to the finance company, to which the reserve was subject, did not deny the existence of a fixed right to receive, for any use of the reserve in payment of those obligations would amount to something received by the dealer; and (c) income therefore accrued when the amounts withheld were entered on the books of the finance companies as liabilities to the dealers.⁴

We perceive no distinction of substance between automobile dealers' reserves and those of home builders. The practical problem and the solution are the same in both situations. The lending institution provides funds to relieve the vendor of receivables and thus to keep the vendor in capital; the vendor acquiesces in the reserve; the lender protects itself by it. The account is there for the benefit of the seller and he possesses "the right to receive" it within the context of income tax accrual accounting.

Key Homes, Inc., supra, 30 T.C. 109 (1958), although decided by the Tax Court prior to Hansen, applied to real estate sales what is essentially the rationale of Hansen. Judge Mulroney there followed the early real estate case of E. J. Gallagher Realty Co., 4 B.T.A. 219, 222-223 (1926). To the same effect are Carl B. Holland, T.C. Memo 1963-108 (Judge Arundell), and Warren G. Morris, T.C. Memo 1963-139 (Judge Fay). The Sixth Circuit's per curiam affirmance of Key Homes, 271 F.2d 280, came after the Supreme Court's decision in Hansen and flatly relied on Hansen as authority governing the real estate situation. It is, thus, precedent for the Commissioner here. So, too, is American Community Builders, Inc. v. Commissioner, 301 F.2d 7, 9 and footnote 5 (7 Cir. 1962).

The taxpayers, however, would distinguish or lessen the authority of Hansen and Key Homes on a number of grounds:

1. They would rely on Barham v. United States, 256 F.2d 456 (4 Cir. 1958). That decision, however, predated Hansen. Further, the court there followed Johnson v. Commissioner, 233 F.2d 952 (4 Cir. 1956), and Texas Trailercoach, Inc. v. Commissioner, 251 F.2d 395 (5 Cir. 1958), both of which were classified by the Supreme Court as contrary to the result it reached in Hansen. See footnote 1 on p. 450 of 360 U.S., on p. 1273 of 79 S.Ct. One district court judge has rightly characterized Johnson v. Commissioner as "substantially eroded by the decision in Hansen". Noble Motor Co. v. United States, 231 F.Supp. 702, 704 (D.Md.1964). At this date, therefore, we are not persuaded by the authority of Barham.

2. They would distinguish Hansen on the ground that it concerned...