Daley v. United States

• Decision Date: 18 April 1957
• Docket Number: No. 15181.,15181.
• Citation: 243 F.2d 466
• Parties: John P. DALEY, Minerva B. Daley, Morris Daley, Zelma B. Daley, William Radtke, Clara Radtke, and Homer Bosse, Trustee of the Estates of Morris K. Daley, Alice M. Daley, Susan R. Daley, James D. Daley, Kathryn F. Daley, and Peter D. Daley, Appellants, v. UNITED STATES of America, Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

243 F.2d 466 (1957)

John P. DALEY, Minerva B. Daley, Morris Daley, Zelma B. Daley, William Radtke, Clara Radtke, and Homer Bosse, Trustee of the Estates of Morris K. Daley, Alice M. Daley, Susan R. Daley, James D. Daley, Kathryn F. Daley, and Peter D. Daley, Appellants, v. UNITED STATES of America, Appellee.

No. 15181.

United States Court of Appeals Ninth Circuit.

April 18, 1957.

Orrick, Dahlquist, Herrington & Sutcliffe, William D. McKee, Eric Sutcliffe, San Francisco, Cal., for appellants.

Charles K. Rice, Asst. Atty. Gen., Lee A. Jackson, Sheldon I. Fink, Grant W. Wiprud, Washington, D. C., Lloyd H. Burke, U. S. Atty., Lynn Gillard, Asst. U. S. Atty., San Francisco, Cal., for appellee.

Before ORR, FEE, and CHAMBERS, Circuit Judges.

ORR, Circuit Judge.

In July, 1942, Daley Brothers, Ltd., were awarded a contract by the United States of America to construct a relocation center in Delta, Utah. Daley Brothers, Ltd., consisted of John P. Daley, Morris Daley, and Homer Bosse, Trustee of six trusts formerly created for the benefit of the Daley children. Daley Brothers, Ltd., formed a joint venture, hereafter the Venture, with William Radtke, to undertake performance of the contract. Appellants here are John Daley, Morris Daley, Bosse, and Radtke, together with their respective spouses.

The contract was to be completed on or before September 6, 1942. Several agreements supplemental to the original contract were entered into which extended the completion date to February 16, 1943, at which time the work done under the contract was accepted as finished and satisfactory by the Government.

The original contract price was $2,834,212.51; supplemental agreements increased the price to $3,653,259.12. Progress payments were made beginning with the construction period ending August 26, 1942.¹ By the end of 1942 nine progress payments had been made, amounting to $3,180,536.97, about 90% of the total contract price.

The Venture showed gross receipts of $3,655,672.28 upon its partnership return of income for 1942, indicating that the total contract price had been accrued on the books. The Venture's return indicated the partners' shares as going to Daley Brothers and William Radtke. On the fourth page of said return, the following appeared: "4. Check whether this return was prepared on the cash or accrual x basis." The Venture filed no return of income for 1943.

John P. Daley, Morris Daley, William Radtke, together with their spouses, and Homer Bosse as trustee, filed individual income tax returns for 1942 based on the 1942 Venture return.

In 1947 the Venture filed an amended partnership income tax return for 1942 and an amended return for 1943. The amended returns were accompanied by refund claims by the distributees of the Venture's net income. The Venture's amended 1942 return reported no gross receipts, profit, or loss from the Delta contract, but showed "advances" of $3,180,536.97. This was the sum of actual net progress payments received by the Venture as of December 31, 1942. The Venture's amended 1943 return showed gross receipts of $3,620,546.28, indicating the Delta contract was reported as being finished.

The identical refund claims of the taxpayers stated their claims should be allowed for the following reasons:

"The change in the amended partnership income tax returns is for the reason that erroneous returns were filed for the years 1942 and 1943. The amended returns are consistent with the accounting procedure which was followed by Daley Brothers prior to 1942. The amended returns are to correct the Delta, Utah, contract which was completed on September 15, 1943, and erroneously included in income for the year 1942. The claim reflects the correct tax liability in accordance with sec. 6 of the current tax payment act of 1943, Public No. 68 — 78th Congress. Included in the correction is the amount of renegotiation refund which was erroneously deducted from income in the 1942 return. It is respectfully requested that refund in the amount set forth in the claim and as also shown on the amended individual income tax return for 1943 be refunded."

Subsequent amended refund claims by John and Morris Daley in 1951 concerned a revision of income to the trusts created for their children, and stated almost verbatim the basis for refund in the original claims.

Each claim for refund was denied by the Commissioner of Internal Revenue.

The trial court found that the Venture was bound by its intentionally reporting 1942 income from the Delta contract on the accrual basis of accounting, and rejected the taxpayers' contention that the 1942 Venture return was on the completed contract basis of accounting, mistakenly applied.

The trial court did find, however, that under the accrual system, some of the Delta contract income did not in fact accrue until 1943, and therefore was improperly reported as 1942 income; but denied recovery of overpayment because the taxpayers failed to include the improper accrual in the refund claims as a ground for relief.

The main issues for solution are: (1) Whether the trial court's finding that the Venture elected to report 1942 income from the Delta contract on the accrual basis of accounting is supported by substantial evidence and therefore not clearly erroneous; (2) In the event we determine that the trial court's finding that the Venture elected to report on the accrual basis should be affirmed, then are the taxpayers entitled to recover the improper 1942 accruals in this action; and (3) Whether the accrual basis of accounting does not clearly reflect income from the Delta contract, so that the taxpayers are not bound by its election, and could amend to the completed contract basis of accounting for 1942 and 1943.

The District Court found:

"The reporting by Daley Brothers Delta War Venture of all of the receipts from the War Department Contract as income on the 1942 return was not the result of a mistaken belief on the part of anyone that the contract was completed in 1942. At the time the return was filed the plaintiffs and their accountant knew the contract was not completed until 1943. All of the income from the contract was intentionally reported as accruing during the year 1942 although a portion of the income from that contract did, in fact, accrue in 1943."

and concluded:

"That Daley Brothers Delta War Venture elected to report the income from the War Department contract for the year 1942 on the accrual basis of accounting."

The trial court further found (1) that the contract was not in fact completed as of December 31, 1942, and that this fact was obvious to everyone concerned; it discredited the testimony of the Venture's accountant to the effect that he prepared the return in the belief that the Delta contract had been completed in 1942; (2) that John P. Daley, the manager of the Venture, reported to the Army Engineers that the basis used in reporting revenue from the contract for income tax purposes was the accrual method, and not the completed contract method; and (3) that on the fourth page of the Venture's 1942 income tax return, the "accrual" box is marked for the accounting method employed in preparing the return.

We first examine the evidence upon which the trial court based its finding that the Venture intentionally elected to report income from the Delta contract on the accrual basis.

Appellants submit that the fact that all parties knew the contract was not completed on December 31, 1942, bears no relation to the question of whether the accrual method was used, and therefore cannot be said to support the finding that the completed contract basis was not used. Appellants urge that the fundamental feature of the completed contract method is the closing out of all of the receipts and expenses of a contract in one accounting period so as to reflect the net income from the contract; and that the Venture followed this method, but mistakenly used December 31, 1942, as the end of the period.

To evaluate properly appellants' contentions we must examine the concepts of the completed contract accounting method. In doing so, we keep in mind that the Venture had been organized for the sole purpose of executing the Delta contract, and therefore there are no considerations of multi-contract construction accounting involved.²

The crux of the completed contract method is the adjustment of the normal annual accounting period to coincide with the term of the construction contract, so that the total cost and the total revenue of the single contract are matched in a single accounting period. The annual accounting concept is rejected in favor of a period (necessarily longer than a year) equalling the time needed to complete fully the particular project.

American Institute of Accountants, Accounting Research Bulletin No. 45 reads:

"* * * 9. The completed-contract method recognizes income only when the contract is completed, or substantially so. Accordingly, costs of contracts in process and current billings are accumulated but there are no interim charges or credits to income other than provision for losses. * * *"

U. S. Treas. Reg. 111, § 29.42-4(b) (1943) provided:

"Gross income may be reported for the taxable year in which the contract is finally completed and accepted if the taxpayer elects as a consistent practice so to treat such income, provided such method clearly reflects the net income. If this method is adopted there should be deducted from gross income all expenditures during the life of the contract which are properly allocated thereto, taking into consideration any material and supplies charged to the work under the contract but remaining on hand at the time of completion."

Of course, a prime defect in the method is the lack of a periodic reflection of income; many years may pass until net income is determined, depending on the length of the project. See Herwitz, Accounting for Long-Term Construction Contracts: A Lawyer's Approach, 70 Harv.L.Rev. 449, 458...