Harrold v. Commissioner of Internal Revenue

• Decision Date: 07 December 1951
• Docket Number: No. 6286,6287.,6286
• Citation: 192 F.2d 1002
• Parties: HARROLD v. COMMISSIONER OF INTERNAL REVENUE. CROMLING v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Fourth Circuit

192 F.2d 1002 (1951)

HARROLD v. COMMISSIONER OF INTERNAL REVENUE.

CROMLING v. COMMISSIONER OF INTERNAL REVENUE.

Nos. 6286, 6287.

United States Court of Appeals Fourth Circuit.

Argued October 4, 1951.

Decided December 7, 1951.

Harry Friedman, Washington, D. C., for petitioner.

Louise Foster, Special Asst. to the Atty. Gen. (Theron Lamar Caudle, Asst. Atty. Gen., and A. F. Prescott, Special Asst. to the Atty. Gen., on brief), for respondent.

Before PARKER, SOPER and DOBIE, Circuit Judges.

SOPER, Circuit Judge.

These are petitions to review orders of the Tax Court involving income tax for the year 1945, upholding the Commissioner of Internal Revenue's disallowance of a deduction of $25,210.18, and asserting a deficiency against taxpayer Harrold in the amount of $12,935.95 and taxpayer Cromling in the amount of $11,458.04.

During the taxable year and prior thereto, the taxpayers were partners doing business under the firm name of Cromling & Harrold and were engaged in the mining of bituminous coal from leased lands by the strip mining method. This is a process whereby the soil or overburden is removed so that the coal can be mined with shovels. The partnership kept its books and filed its federal income tax returns on the accrual basis.

In 1945 the partnership removed coal by the strip mining method from 31.09 acres of land in West Virginia held by it under five leases and contracts which required it to conduct the mining operations in conformity with the laws of West Virginia and of the United States, and to restore and replace the surface in compliance with provisions of pertinent laws of West Virginia. Before starting mining operations on the leased lands, the partnership obtained strip mining permits as required by the laws of West Virginia, and posted penal bonds with the state to insure faithful performance of its statutory obligation to refill the lands. The contractual and statutory obligation on the partnership to "backfill" required it to put the soil back the way both the state and the lessor farmers wanted it. It was necessary to fertilize and replant the land with grass, shrubs or clover before the Department of Mines of West Virginia would release the bonds.

At the end of 1945 the tract of 31.09 acres had been completely stripped and the coal had been removed; and the obligation of the partners to refill had become fixed and definite. Paul Harrold, one of the partners, had been actively engaged in strip mining and back-filling lands in West Virginia for sixteen years. Based on this experience the firm estimated in 1945 that the cost of the refill in this instance would amount to $1,000 per acre; but since the firm was using its equipment in stripping operations elsewhere it postponed the refilling until 1946, and in accord with sound accounting practice set up a reserve on its books for the accrued expense involved in the sum of $31,090 and deducted the same as an expense of the business in its federal income tax for 1945.

The process of back-filling was commenced in the spring of 1946, when the weather became favorable, and was completed during 1946 at a cost of $25,210.18 or $5,879.82 less than estimated and accrued. Accordingly the partnership reduced the 1945 accrual on its books, and, on January 6, 1947, filed an amended partnership return for the taxable year 1945, reducing the estimated deduction to the actual cost of back-filling the land.

The Tax Court, conceding that it was the practice of prudent business men to set up reserves to cover contingent liabilities, nevertheless held that deduction from income in 1945 could not be allowed because the liability which it represented was not fixed and certain, but was based merely on an estimate of the future cost of the work. In support of this conclusion it pointed out that the cardinal rule in the federal income tax system is that net income must be computed and taxed on an annual basis so as to provide revenue to the government at regular intervals; and hence neither income nor deduction may be accelerated or postponed from one taxable year to another in order to reflect the ultimate result of a business transaction; and this principle must be observed, even though the allocation of an indefinite obligation to the taxable year in a given instance would seemingly work a more equitable result to the government or the taxpayer. Burnet v. Sanford & Brooks Co., 282 U.S. 359, 363, 51 S.Ct. 150, 75 L.Ed. 383; Brown v. Helvering, 291 U.S. 193, 54 S.Ct. 356, 78 L. Ed. 725.

Accordingly it is established that deductions may be taken on an accrual basis only in the year in which the taxpayer's liability to pay has become fixed and certain; and in some decisions, notably Security Flour Mills Co. v. Com'r, 321 U.S. 281, 286-287, 64 S.Ct. 596, 88 L.Ed. 725, and Dixie Pine Products Co. v. Com'r, 320 U.S. 516, 519, 64 S.Ct. 364, 88 L.Ed. 420 it has been said that unless the amount as well as the fact of liability has become final and definite in the year in which the accrual is claimed, the deduction must be allowed only in the year in which the payment actually takes place. It is true that in these cases the court was concerned with the existence rather than the amount of the liability; but in other decisions uncertainty of the amount alone has been held enough to bar the accrual of the expense in the year in which the liability therefor has become established. Thus in Spencer, White & Prentis v. Com'r, 2 Cir., 144 F.2d 45, a contractor, under an obligation to restore certain structures in the streets of New York which had been disturbed or destroyed in the construction of a subway, was not allowed to accrue the estimated cost of restoration in a tax year prior to the doing of the work; and in Capital Warehouse Co. v. Com'r, 8 Cir., 171 F.2d 395, a warehouseman, who collected from customers upon the receipt of goods for storage, a charge for the removal of the goods subsequently to take place, was not allowed to accrue in advance the cost of the removal operation based on the experience of other warehousemen, that 60 per cent of the cost should be allocated to the expense of handling out and 40 per cent. to the expense of handling in, owing to the fact that merchandise usually came into the warehouses in carload lots and left in less than carload lots. The experience of the taxpayer, however, differed in that in its case the merchandise was shipped out in carload lots.

There is no material distinction between Spencer, White & Prentis v. Com'r, supra, and the pending case unless it be that in the former an approximate estimate of the cost of the work of restoration, considering the number and unusual character of the items involved, could not be easily arrived at before the work was undertaken. In any event, we think that the ability to make an approximate estimate should be the determining factor in each case, rather than the literal application of the formula that an asset or a liability may not be accrued in any taxable year prior to its liquidation, unless both the existence and the amount thereof is fixed and certain.

As to the need for the existence of a definite asset or liability to justify an accrual in the taxable year, there can be no doubt as many decisions attest; Lucas v. American Code Co., 280 U.S. 445, 50 S.Ct. 202, 74 L.Ed. 538; Burnet v. Sanford & Brooks Co., 282 U.S. 359, 51 S.Ct. 150, 75 L.Ed. 383; but it has not been deemed essential that the amount of an accrued liability shall have been definitely ascertained to justify deduction from income in the taxable year. Confessedly, it is enough if the facts from which the amount can be calculated had then occurred and are later ascertained, or as Judge Learned...