Jones v. CIR

• Decision Date: 19 July 1962
• Docket Number: No. 18764.,18764.
• Citation: 306 F.2d 292
• Parties: A. Raymond JONES and Mary Lou Jones, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. DRILLING ACCESSORY AND MANUFACTURING CO., Inc., Respondent.
• Court: U.S. Court of Appeals — Fifth Circuit

306 F.2d 292 (1962)

A. Raymond JONES and Mary Lou Jones, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. DRILLING ACCESSORY AND MANUFACTURING CO., Inc., Respondent.

No. 18764.

United States Court of Appeals Fifth Circuit.

July 19, 1962.

Wentworth T. Durant, Ronald M. Mankoff, Dallas, Tex., for petitioners.

Abbott M. Sellers, Acting Asst. Atty. Gen., Lee A. Jackson and Melva M. Graney, Attys., Dept. of Justice, Hart H. Spiegel, Chief Counsel, I.R.S., Claude R. Marshall, Special Atty., I.R.S., Burt J. Abrams, Atty., Dept. of Justice, Washington, D. C., for respondent.

Before JONES, BROWN and GEWIN, Circuit Judges.

GEWIN, Circuit Judge.

These consolidated cases¹ relate to the income tax liability of A. Raymond Jones (and his wife, Mary Lou)² for the years 1951 and 1953³; and the liability of Drilling Accessory & Manufacturing Company, Inc.,⁴ (referred to as Drilling) resulting from a deficiency asserted by the Commissioner of Internal Revenue for the taxable year May 1, 1953 to January 31, 1954. Jones (sometimes referred to as taxpayers) filed petition for review in Case No. 75149; and the Commissioner seeks review in Case No. 75196 only to protect the revenue in the event the individual taxpayers, Jones, are held not to be taxable on the net proceeds of a judgment of the United States Court of Claims. The memorandum findings of fact and opinion relate to both cases. Separate decisions were rendered and both were entered on the same date.

The problems to be resolved by this Court, broadly speaking, relate to an alleged anticipatory assignment of income; cash and accrual methods of accounting; the determination of whether certain income should be taxed as ordinary income or should be treated as long term capital gains; and other incidental problems relating to the foregoing. The solution of certain of the problems will extinguish others that arose in the Tax Court. We will try to summarize such facts as seem to be necessary to our decision and then discuss questions of law involved.

In 1943, the taxpayer, A. Raymond Jones, subcontracted from the general contractor, W. C. Shepherd, a portion of the construction work on a United States Army Corps of Engineers project known as the Cumberland Oil Field Protective Levee. Jones was engaged in the earth moving business as a sole proprietor at that time.

The Corps of Engineers changed the specifications on the project and the conditions of the job proved to be different from those represented to Jones. For these reasons Jones suffered a loss on his subcontract for the years 1943 and 1944 in excess of $350,000.00. During the course of the job, a Mr. A. J. Rife, a surety on Jones' bond, loaned him $450,000.00 to finance the completion of the subcontract. In 1944 and 1945, Jones sold and leased his equipment and from the proceeds repaid part of his debt to Rife. After part satisfaction of the debt, the balance, a sum of $265,958.13 was cancelled by Rife.

In 1944, the prime contractor, Shepherd, submitted a claim to the government for $1,235,833.65 additional compensation on the Cumberland project, part of which claim related to services performed by Jones as subcontractor. Under the applicable Federal law, Jones had no direct recourse against the government, and could recover only through Shepherd or Shepherd's surety.

During 1952, Jones ceased operating as a sole proprietor and transferred all of the assets of his business, except any rights he might have to additional compensation from the Cumberland project, to two corporations one of which was Drilling Accessory and Manufacturing Co., Inc. The stock of Drilling was owned by Jones and several key employees, Jones owning 67% of the stock.

On January 26, 1953 a Notice of Deficiency was sent to the taxpayers asserting a deficiency against them of $301,171.48 for taxes due in 1948, 1949 and 1950, years in which Jones had been in business as a sole proprietor and for which no tax returns had been filed. On February 3, 1953, Jones entered into a contract with Drilling whereby he assigned, sold, setover, transferred and conveyed all of his right, title or interest in and to the claim, or interest in the claim versus the United States (pending in the name of W. C. Shepherd), for reimbursement of losses sustained or for work and labor performed by Jones pursuant to his subcontract on the above mentioned construction project. According to the assignment contract, Drilling agreed to pay Jones the sum of $10,000.00 and all of taxpayers' income tax liability for the years 1948, 1949 and 1950 including interest, penalties and expenses incurred in the defense of such tax liability. The claim versus the United States arose in 1944 upon completion of the project. The claim was denied after repeated appeals and negotiations extending over a period of almost five years. Suit was then commenced in the U. S. Court of Claims on May 9, 1949, in the name of the prime contractor, Shepherd. Both Shepherd and Jones were interested in the prosecution of the claim.

The contract of assignment between Jones and Drilling is rather full and complete. It contains recitals to the effect that attorneys in Dallas, Texas, and Washington, D. C. had been employed on a contingency basis to prosecute the claim against the Government; that Jones had expended considerable time, effort and money in the prosecution of the claim and was desirous of shifting any further expense in connection therewith. Drilling agreed to sustain and pay for any further additional expense in connection with the claim. The contract was approved at a special meeting of the Board of Directors of Drilling. According to the minutes which were introduced in evidence, there was considerable discussion by the Directors as to the desirability of entering into the contract; the uncertainties involved in the claim versus the United States; and the tax liability asserted against the individual taxpayers for the years 1948, 1949 and 1950. The Directors further concluded that should a profit be realized from the transaction ultimately, the same was not to become available to pay dividends but was to be retained as working capital. The Secretary-Treasurer of Drilling was directed to pay Jones the $10,000.00 consideration provided in the contract; or if Jones so elected, to execute a note of the corporation payable to Jones for said sum to be dated February 3, 1953, payable on demand with interest at the rate of 5%. Although Jones was a majority stockholder, there were four members of the Board of Directors, Jones being one, and no family relationship between the members of the Board is indicated.

Finally, in July of 1953 the Court of Claims ruled on the suit which Shepherd had commenced against the United States in 1949. The Court ruled that Shepherd was entitled to 37% of the additional compensation he had claimed for the Cumberland Project. Shepherd v. United States, 113 F.Supp. 648, 125 Ct. Cl. 724. That decision became a final one on October 11, 1953; labeling $339,677.68 of the total recovery as relating to work performed by Jones. The necessary expenses and fees totaling $79,741.61 attributable to Jones were deducted and in April of 1954, a check for $259,936.07 was sent to Jones and he immediately endorsed and delivered it to Drilling pursuant to the assignment contract of the prior year.

Taxpayers filed a petition in the Tax Court in April 1953 to review the 1948, 1949 and 1950 deficiencies assessed against them, but at the time conceded that they were indebted for certain tax deficiencies and interest. At all times relevant to this case, no payment has been made on the tax deficiencies either by Jones or Drilling.

At the inception of his business, taxpayer kept his books and reported his income on the cash receipts and disbursement basis. There were no income tax returns filed by taxpayer for the years 1948, 1949 and 1950, but the tax due was determined on the cash basis. The Tax Court found taxpayer to be on the cash basis for those years.⁵ In the instant case, the Tax Court found that in 1951 taxpayer's books reflected certain accounts receivable and payable, notes payable, and accrued payroll taxes. The amounts in connection with a certain Government project (Randall Field) were not accrued but later reported on a cash basis. Jones also kept his books and reported income on the cash basis for the years 1953 through 1958. Taxpayers never requested or received permission of the Commissioner as required by the applicable regulation to change his accounting method either in 1951 or in 1953.⁶ The Tax Court ultimately found that taxpayers kept their books on the accrual basis in 1951.

The Commissioner determined deficiencies in income tax and additions to tax for substantial underestimation and failure to file declarations of estimated tax against taxpayers for the calendar years 1951 and 1953, and against Drilling for the period ending January 31, 1954, and the taxable year ending January 31, 1956. The decisions are dated July 29, 1960.

The Tax Court found that taxpayers had elected to change from the cash to the accrual method of reporting income in 1951 which change was impliedly consented to by the Commissioner. However, an amount which the Commissioner had determined to be due in 1951 was held not to accrue until 1952 and hence taxable in the latter year. Neither party seeks review of the latter holding.

The Tax Court next found that since taxpayers failed to obtain the Commissioner's express consent to leave the accrual method of reporting income pursuant to the claimed voluntary change by taxpayers to such method in 1951 plus implied consent of the Commissioner, they were required to accrue, in 1953, the amount of $259,936.07 realized from the judgment. It held that Jones' assignment to Drilling was an anticipatory assignment of income, and accordingly held the amount to be taxable as ordinary income...