Bone v. C.I.R., No. 02-10716.

• Decision Date: 21 March 2003
• Docket Number: No. 02-10716.
• Citation: 324 F.3d 1289
• Parties: Alan G. BONE, Kathleen A. Bone, Jeffrey M. Guerrero, Genedine R. Guerrero, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Eleventh Circuit

324 F.3d 1289

Alan G. BONE, Kathleen A. Bone, Jeffrey M. Guerrero, Genedine R. Guerrero, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 02-10716.

United States Court of Appeals, Eleventh Circuit.

March 21, 2003.

Nancy O. Kuhn, Michael I. Sanders, Powell, Goldstein, Frazer & Murphy, LLP, Washington, DC, for Petitioners-Appellants.

Regina S. Moriarty, Thomas K. Sawyer, Washington, DC, for Respondent-Appellee.

Appeal from a Decision of the United States Tax Court.

Before ANDERSON and CARNES, Circuit Judges, and HAND^*, District Judge.

ANDERSON, Circuit Judge:

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 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. ("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 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 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.

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, 80 S.Ct. 1190, 1200, 4 L.Ed.2d 1218 (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, 88 L.Ed. 171 (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, 78 L.Ed. 212 (1933).⁵

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 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 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...