Clement v. United States, 131-75.
| Decision Date | 14 July 1978 |
| Docket Number | No. 131-75.,131-75. |
| Citation | 580 F.2d 422 |
| Parties | Robert E. and Jane Ann Harden CLEMENT v. The UNITED STATES. |
| Court | U.S. Claims Court |
Charles A. Pinney, Jr., El Centro, Cal., for plaintiff.
James L. Malone III, Washington, D.C., with whom was Asst. Atty. Gen. M. Carr Ferguson, for defendant. Theodore D. Peyser, Jr., Robert S. Watkins, and Michael J. Dennis, Washington D.C., of counsel.
Before DAVIS, KUNZIG and BENNETT, Judges.
This is an income tax refund suit in which the issue is whether the taxpayers, limited partners in a cattle-feeding partnership, were entitled under the law as it stood in 1968 to deduct the cost of cattle feed bought in one year and consumed in the following year, as an ordinary and necessary business expense in the year of purchase. The Commissioner of Internal Revenue disallowed the $33,959 sought to be deducted, the taxpayers paid the deficiency and claimed a refund of $14,170, and this action followed the denial of the claim.
Trial Judge Schwartz, who held for the taxpayers, passed on three issues: (1) whether the prepayment for the feed in the purchase year was made for a business purpose and not for tax avoidance;1 (2) whether allowance of the deduction for the feed in the purchase year would result in a material distortion of income; and (3) whether, even if there would be such a material distortion of income, the taxpayers were nevertheless entitled as farmers to deduct the feed-prepayment in the purchase year. The trial judge held, first, that the prepayment was made for a business purpose; this determination is accepted by the defendant and not challenged before the court. The second holding in the Trial Division was that the prepayment would in fact result in a material distortion of income; this ruling is now accepted and not attacked by the taxpayers before the court. The only ruling of the trial judge which is disputed before us is that, despite the material distortion of income, taxpayers were nevertheless entitled as farmers to deduct the prepayment in the year of purchase.2 On that ultimate question we differ from the trial judge.
In Part One of this opinion, infra we adopt and set forth those portions of the Trial Judge Schwartz's opinion which are accepted by both parties (see note 2, supra), i. e. the statement of the facts3 and of the issues, the decision on business purpose, and the determination that there would be material distortion of income if taxpayers were permitted to deduct the feed-prepayment in the purchase year.
In Part Two of the opinion, infra, we discuss the reasons why, in our view, the deduction is not allowable, given the now-unchallenged finding of material distortion of income.
The Facts. The plaintiffs together constituted one of 10 limited partners in a California partnership known as Vanderbilt Group No. 2.4 The partnership was organized under an agreement filed on December 1, 1968, to engage in the business of buying, feeding and selling cattle. The taxpayers contributed $35,000 to the partnership's initial capitalization of $321,000, entitling them to a 10.90342 percent share in the partnership profits and losses.
The partnership agreement provided that the single general partner should enter into a "Cattle Feeding Advisory and Services Agreement" with a Mr. R. C. Chapman, of Whittier, California, doing business as the Whittier Cattle Company. The agreement with Mr. Chapman, made in December 1968, vested him with management of the partnership's operations. He was authorized to propose cattle and feed investment programs, buy and sell both feed and cattle, locate feedyards for cattle and arrange the feeding, keep the partnership's accounts and manage its daily business.
Acting in his capacity as managing agent, Chapman on December 27, 1968 purchased $311,548 worth of cattle feed for the partnership in three lots:
The purchase price was paid and the check cleared before the end of the year. The grain purchased was in existence; the partnership obtained warehouse receipts for the entire amount. The purchase of grain was the partnership's only business transaction in 1968.
The partnership filed an information return for 1968, reporting a gross profit of zero, a deduction of $311,548 on account of the purchase of grain and thus a net loss of $311,548. The plaintiffs' 10.9 percent share of the loss was $33,959, the only loss in the adjusted gross income they reported in their cash basis joint return for 1968. The loss reduced their otherwise gross income from $76,009 to $42,051. The return showed the following gains and partnership loss:
Dividends $17,587
Interest 4,993
Rental property income 5,902
Trust Income 17,820
Operation of hobby shop 3,959
Sale/exchange of property 23,948
Miscellaneous (trustee fee) 1,800
Vanderbilt No. 2 loss (33,959)
Adjusted Gross Income $42,051
The adjusted gross income of $42,051 was reduced by deductions and exemptions to a taxable income of $26,865. As already noted, the Commissioner's disallowance of the loss of $33,959 is the basis of the present suit.
Chapman began to purchase cattle shortly after the beginning of the new year. It took about 2 weeks after the transaction for the cattle purchased to be delivered to the feedlot. While the dates of purchase are not clear on the record, cattle began arriving at the designated feedlots on or about January 15, 1969. The 4,268 head of cattle bought by the partnership arrived in 17 lots at the following dates between January and July 1969:
January 15, 1969 573 head
January 17, 1969 124
January 23, 1969 92
March 24, 1969 100
March 28, 1969 121
April 21, 1969 146
April 22, 1969 116
April 24, 1969 248
May 23, 1969 352
May 26, 1969 372
May 28, 1969 279
June 2, 1969 244
June 5, 1969 187
June 20, 1969 1,113
July 10, 1969 170
July 14, 1969 10
July 28, 1969 21
4,268 head
In the spring, Chapman exchanged the warehouse receipts for 44,000 of the 98,400 bushels of the partnership's corn in Omaha, for the same amount delivered to an Oakland, Iowa feedyard, on payment of a transportation differential. Thereafter, he sold back to his vendor, Cargill, the receipts for the remaining 54,400 bushels at Omaha for $1.2475 per bushel, less a storage charge of .0036 cents per bushel, and bought 55,000 bushels at Grand Island, Nebraska, for $1.22 per bushel.
The cattle owned by the partnership eventually consumed an amount of feed roughly equal to the amounts first purchased in the prior December, plus additional feed bought in 1969 at a cost of $59,429. Some small amounts of milo and corn were apparently left over and sold to feedyards, and the proceeds were reported as income. The partnership's gross profit on the sale of the feed cattle in 1969 was $271,936. Its information return in that year showed a gross profit in that amount, expenses of $130,340 and a net profit of $141,596, of which the plaintiffs' 10.9 percent share was $15,439.
Despite a profit from Vanderbilt No. 2 of $15,439, the taxpayer-plaintiffs' adjusted gross income was reduced by substantial losses from other investments to $4,423, as follows:
Dividends $9,937
Interest 3,018
Rental property income 3,976
Trust income 19,670
Trustee fee 1,800
Operation of hobby shop 817
Sale/exchange of property 15,880
An unrelated business loss (17,779)
Oil well investment expenses (48,333)
Vanderbilt No. 2 income 15,439
Adjusted Gross Income $4,423
Deductions and exemptions reduced taxable income to zero, actually a loss.
In 1970 the partnership in its information return reported a gross profit of $104,379 from the sale of cattle and feed, expenses of $46,424, including $29,875 for grain, and a net profit of $57,955, of which profit the plaintiffs' share was $6,345.
In 1970 the plaintiffs' adjusted gross income was $10,338, reflecting the profit of $6,345 from Vanderbilt No. 2 and further substantial losses in an oil well venture, as follows:
Dividends 2,614
Interest 3,206
Rental property income 4,517
Trust income 19,810
Trustee fee 1,800
Operation of hobby shop 1,917
Sale/exchange of property (1,000)
Partnership income (other than Vanderbilt No. 2) 615
Loss from oil well investment (29,485)
Vanderbilt No. 2 income 6,345
Adjusted Gross Income $10,338
Deductions and exemptions again, as in 1969, reduced the taxable income to zero, actually a deficit of $518.
The Issues. The issues requiring decision involve the application to the facts of the...
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