Rankin v. Commissioner
| Decision Date | 31 July 1996 |
| Docket Number | Docket No. 26270-93. |
| Citation | 72 T.C.M. 289 |
| Parties | James M. Rankin and Shirley Rankin v. Commissioner. |
| Court | U.S. Tax Court |
David M. Kirsch, San Jose, Calif., for the petitioners. Thomas G. Schleier and Elaine Sierra, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined the following deficiency in, and additions to, petitioners' 1988 Federal income tax:
Additions to Tax
---------------------------------
Deficiency Sec. 6651(a)(1) Sec. 6653(a)(1)
$155,255 $38,485 $7,856
Unless otherwise indicated, all section references are to the Internal Revenue Code as in effect for the year in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
After concessions, the principal issue we must decide centers around whether a change in the practice of offsetting, against the gross receipts of petitioner James M. Rankin's (petitioner) bail bond business, payments made into certain accounts maintained for him as part of that business is a change in a method of accounting. If the change in the practice is a change in a method of accounting, then respondent may, pursuant to section 481(a), make an adjustment increasing petitioners' income in connection with the change.
Some of the facts have been stipulated for trial pursuant to Rule 91 and are incorporated herein by reference. We find as facts herein the facts stipulated by the parties.
At the time of filing the petition in the instant case, petitioners resided in Union City, California. Petitioner Shirley Rankin is a petitioner solely by reason of having filed joint returns with petitioner. Petitioner maintained his books and filed his Federal income tax returns using the cash receipts and disbursements method of accounting.
Petitioner is licensed as a bail bond agent by the California Department of Insurance and, since 1968, has been engaged in the bail bond business in that State. During 1988, petitioner operated his bail bond business at five different locations in California: Redwood City, San Jose, Oakland, Hayward, and Vallejo. On petitioners' 1988 Federal income tax return, petitioner reported income from his bail bond business on four Schedules C.
From the beginning of his bail bond business, petitioner's primary surety company has been Associated Bond & Insurance Agency (Associated), and, during 1988, petitioner executed bail bonds as an agent of Associated. The terms of petitioner's agency for the period from October 1, 1981, through the time of trial are set out in a written agreement with Associated (agreement). In prior years, petitioner had a similar agreement with Associated.
A bail bond is a performance bond requiring the appearance of a criminal defendant at judicial proceedings. The principal on the bond is the defendant; the obligee is California, which requires the defendant's appearance; and the surety is the insurance company writing the bond, which guarantees performance. As a bail bond agent, petitioner is permitted to solicit, negotiate, and execute bail bonds on behalf of a surety company (an insurance company) with which he is affiliated and which he represents when he executes a bond. Petitioner functions as the agent of the surety company, executing bonds, collecting premiums, and attempting to assure performance of the bonds on behalf of the surety.
When petitioner writes a bond, he collects 10 percent of the face amount of the bond from a defendant as his earned premium. Pursuant to the agreement, petitioner: (1) Pays 13 percent of the premium collected to Associated, the surety, as a bond cost; (2) pays an additional 10 percent of the premium collected, or 1 percent of the face amount of the bond, to an indemnity fund known as a "Build Up Fund" (BUF); and (3) keeps the remainder of the premium.1
The surety company that issues a bond is principally liable to California for assuring a defendant's court appearance. In the event a defendant fails to appear, the surety company has to pay a late surrender fee or forfeiture to California. If a defendant is not brought to court within 180 days of a failure to appear, the court issues a summary judgment in the amount of the bond, resulting in a loss on the bond. The agreement, however, shifts ultimate liability for expenses and forfeitures on each bond from Associated to petitioner, who is personally liable for the amount of the loss. In the agreement, petitioner agrees to bring a defendant to court as required by the bond, or, if he fails, to indemnify the surety for any expenses incurred, including a forfeiture. If petitioner brings the defendant to court within the required time, the bond is exonerated and there is no loss. A loss occurs only when petitioner is unable to bring the defendant to court. Petitioner's liability for expenses associated with a bond forfeiture does not arise prior to his obligation to indemnify Associated.2
As security for petitioner's promise to indemnify Associated, the agreement requires petitioner to contribute to a BUF account, and amounts paid into the BUF accounts are derived from bond premiums collected. Associated established and maintained BUF accounts for petitioner with the Bank of America and functioned as trustee for petitioner with respect to the BUF accounts. The BUF accounts are required as a necessary condition of petitioner's doing business as a bail bondsman. In accordance with the agreement, the funds in the BUF accounts were accumulated in proportion to the volume of outstanding bonds executed by petitioner on behalf of Associated. Accrued interest, which belonged to petitioner, was accumulated in the accounts. Although Associated is not required to give petitioner notice of any draw on the BUF accounts, petitioner typically received quarterly or semiannual reports and periodically inquired about the status of his accounts.
Only Associated, and not petitioner or California, had the right to withdraw funds from the BUF accounts maintained for petitioner. Although Associated had the right to draw on the BUF accounts, those funds could be used only to satisfy petitioner's obligation to indemnify it, and so its control of the funds' disposition was very restricted. When Associated became liable for a bond forfeiture, it could, but was not required to, draw from a BUF account to pay its obligation to California. Pursuant to the agreement, Associated could forgo indemnity from the BUF account. When a loss occurred, Associated would customarily ask petitioner whether he wanted it to be paid from one of the BUF accounts or from other sources. If petitioner elected to pay the loss from other sources, the BUF account would not be drawn upon, and petitioner would reimburse the surety directly. Historically, petitioner has had a very low rate of payments for forfeitures made from his BUF accounts. During 1988, Associated drew only the amount of $4,633.35 from the BUF accounts maintained for petitioner to satisfy any of petitioner's liabilities pursuant to the agreement. Petitioner paid all of his other expenses associated with bond forfeitures in 1988 from sources other than the BUF accounts.
Petitioner does not have access to his BUF accounts until the agreement is terminated and all outstanding bonds and all other liabilities petitioner may have to Associated are satisfied. Either petitioner or Associated may terminate the agreement, with or without cause, subject to certain notice requirements. Upon termination of the agreement and satisfaction of all liabilities secured by the BUF accounts, the balance in the BUF accounts is required to be released to petitioner.
On his tax returns since 1968, petitioner offset his gross receipts by the amount contributed to his BUF accounts as a portion of cost of goods sold. However, the parties have stipulated that the offsets claimed by petitioner for payments to the BUF accounts are not properly claimable in any taxable period. Rather, if a forfeiture occurs and Associated is paid out of a BUF account, the amount so paid is properly deductible in the year payment is made. Petitioner reported most, but not all, of the interest accumulated on his BUF accounts on his Federal income tax returns for the taxable years 1968 through 1988.
Pursuant to the practice used by petitioner for accounting for his BUF accounts from 1968 through 1988, petitioner did not claim as deductions on petitioners' tax returns forfeitures or summary judgments paid from the BUF accounts maintained for him. Rather, the deductions claimed for forfeitures or summary judgments represented only those amounts paid from other sources. Pursuant to that practice, petitioner did not intend to report as income the balances remaining in the accounts upon termination of the agreement and satisfaction of all liabilities secured by them.
As of January 1, 1988, Associated maintained seven separate BUF accounts for petitioner. As of that date, the surety's ledgers for petitioner's BUF accounts reflected the following balances:
Account Balance
Rankin-Johnson ................... $20,075.58
Rankin-Vallejo ................... 10,986.80
James M. Rankin (Ann) ............ 71,420.02
James M. Rankin-Hayward .......... 5,360.87
James M. Rankin #2 ............... 92,180.28
Rankin-Carter .................... 10,294.23
Rankin-Williams .................. 1,803.70
The opening balance of petitioner's BUF accounts as of that date shown in the surety's ledgers was $212,122 (rounded). The amount of accumulated interest on the BUF accounts as of January 1, 1988, shown in the surety's ledgers was $65,623 (rounded). For purposes of calculating the adjustment of petitioners' income to be made pursuant to section 481(a), the opening balance of the BUF accounts as of January 1, 1988, is considered to be $146,499 (rounded), which does not include the amount of...
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