Souther Mail Transport, Inc. v. Commissioner
| Decision Date | 30 April 1992 |
| Docket Number | Docket No. 40953-84. |
| Citation | 63 T.C.M. 2893 |
| Parties | Southeastern Mail Transport, Inc. v. Commissioner. |
| Court | U.S. Tax Court |
Jones E. Davis, 620 Matterhorn Rd., Jacksonville, Fla., for the petitioner. Francis C. Mucciolo, for the respondent.
Memorandum Findings of Fact and Opinion
Respondent determined a deficiency in petitioner's Federal corporate income tax in the amount of $328,549 for its fiscal year ended June 30, 1981.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the taxable year in question, and all Rule references are to the Tax Court Rules of Practice and Procedure.
After a concession,1 the issues for decision are:
(1) Whether petitioner regularly used the cash or the accrual method of accounting, and whether respondent is entitled to recompute petitioner's income using the cash method of accounting;
(2) Whether petitioner's gross income for the taxable year properly includes $369,831.38 compensation the United States Postal Service withheld from petitioner at the direction of the Department of Labor, and whether petitioner may deduct this same amount;
(3) Whether petitioner is entitled to reduce its gross income by $1,483,103.24, the amount of a loan petitioner allegedly received from one of its suppliers;
(4) Whether petitioner is entitled to deduct certain expenses it incurred but did not pay during the taxable year;
(5) Whether petitioner has substantiated and is entitled to deduct certain miscellaneous expenses it allegedly incurred and paid during the taxable year;
(6) Whether petitioner is entitled under section 165 to deduct $330,513.05 for losses allegedly sustained on the repossession of its tractors;
(7) Whether petitioner is entitled under section 166 to deduct $1,785,064.74 in alleged bad debts owing to petitioner from the owner-operators;
(8) Whether petitioner is entitled under section 165 to deduct $639,811.81 in losses from judgments petitioner's creditors allegedly obtained against petitioner.2
Some of the facts have been stipulated and are so found. The stipulation of facts, supplemental stipulation of facts, second supplemental stipulation of facts, and the exhibits attached thereto are incorporated herein by this reference.
Petitioner, Southeastern Mail Transport, Inc., had its principal office in Jacksonville, Florida, at the time it filed its petition. From July of 1977, through June 30, 1981, Tony E. Davis (Davis) served as petitioner's president and chairman of the board and owned 100 percent of petitioner's outstanding stock.
Petitioner engaged in the business of transporting mail under contracts with the United States Postal Service (Postal Service). A single mail contract covers a run between two cities. Davis was a sole proprietor when he started in the mail-transport business and had only one contract transporting mail from Jacksonville, Florida, to Lakeman, Florida. Davis operated under this one contract from 1970 until late 1975 when another contractor subcontracted two additional smaller runs to him. In 1977 Davis incorporated petitioner and obtained the remainder of petitioner's Postal Service contracts through the competitive bidding process. During the taxable year in issue petitioner operated under 17 contracts of varying distances between a total of 18 different cities.
In 1981 petitioner was experiencing cash flow problems, and Davis decided to engage a consultant to try to remedy the situation. Petitioner engaged the services of Lewis C. Lawhorn (Lawhorn). Prior to that engagement, Lawhorn had already been serving as the trustee over a payroll account for paying co-drivers, as will be discussed below. As a condition to providing his services as a consultant, Lawhorn asked for and received full control over petitioner, including sole signatory authority over petitioner's various checking accounts. Lawhorn consulted for petitioner for 2 or 3 months during 1981 and prior to May 1981.
Early in May of 1981, petitioner entered into a contract to sell all of its assets to Federal Postal Carriers, Inc. (FPC), a Florida corporation owned and operated by James R. Georges, Jr. (Georges). The contract's closing date was contingent upon the occurrence of certain conditions, including the Postal Service's agreeing to have petitioner's contracts assigned to the purchaser. In order to ensure against petitioner's financial decline during the period before closing, FPC insisted that petitioner enter into an agreement giving Corporate Management Consultant Services, Inc. (CMCS), another Florida corporation owned and operated by Georges, full control over petitioner's operations. CMCS began operating petitioner's business sometime during the period May 1, 1981, through May 5, 1981, and continued to do so until June 25, 1981.
On June 25, 1981, the United States Department of Labor, Wage and Hour Division, requested the Postal Service to withhold funds owing to petitioner. The Postal Service paid petitioner every 28 days, for all services rendered up to the preceding Friday. The Department of Labor (DOL) took this withholding action to redress wage and hour violations petitioner had committed. Pursuant to DOL's request, the Postal Service withheld from petitioner $369,831.38, the remaining amount of funds due petitioner for services it had performed under its contracts. Petitioner ceased operations on Friday, June 26, 1981, and never operated again.3 Thereafter, the Postal Service took bids from third parties on petitioner's mail-hauling contracts. After the loss of its contracts petitioner had no means to repay its debts or to conduct any business activities.
During 1981, before petitioner prepared its Federal income tax return for its taxable year ended June 30, 1981, the Federal Bureau of Investigation (FBI) seized petitioner's records. As a result of the FBI's investigation, the United States indicted Davis on mail fraud charges. Davis pled guilty in return for a reduced sentence.
At the time of the FBI's seizure of the records, petitioner's records (bank statements, cancelled checks, invoices, etc.) were in "total disorder". No journals and ledgers had yet been prepared for the year. Petitioner did not maintain any contemporaneous books during the taxable year in issue (July 1, 1980 to June 30, 1981) and began the task of creating accounting journals and ledgers for that year after the release of its records in 1987. The record in this case does not explain why petitioner failed to keep contemporaneous accounting books during its fiscal year ended June 30, 1981.
For petitioner's taxable years ended June 30, 1978, June 30, 1979, and June 30, 1980, Reo M. Hood (Hood), a certified public accountant with over 15 years' experience, audited petitioner's books and prepared its financial statements and Federal corporate income tax returns. In calculating income for each of these years, Hood began with income received during the taxable year, subtracted the figure for the prior year's accounts receivable, and then added the figure for the current year's accounts receivable. In calculating expenses for each of these years, Hood began with expenses paid during the taxable year, subtracted the figure for the prior year's accounts payable, and then added the figure for the current year's accounts payable. Hood prepared petitioner's financial statements and Federal income tax returns pursuant to the accrual method of accounting during those years.
As noted above, petitioner did not maintain any contemporaneous accounting books and ledgers during the taxable year in issue. Moreover, petitioner's Federal corporate income tax return for the fiscal year ended June 30, 1981, was filed in 1983, approximately two years after the close of the taxable year, and was prepared without the benefit of petitioner's records, which were still in the custody of the FBI at that time. The gross receipts figure reflected on this return and the expenses were not the product of the accrual method of accounting. Hood prepared that return, but he merely wrote down figures supplied to him by Davis and his father (Jones E. Davis).
After the FBI released petitioner's records in 1987, Hood began the task of creating journals and ledgers for petitioner's fiscal year ended June 30, 1981. At that time in 1987 Hood also prepared a statement of income and expenses for petitioner's 1981 taxable year. Hood generally followed the accrual method of accounting in preparing this statement.4 Hood derived the income figure — $10,797,602.49 — primarily from bank deposits.5
Petitioner first came to DOL's attention in 1978. Over the next few years petitioner would come under DOL's scrutiny for alleged wage and hour violations at least twice. On June 25, 1981, DOL's Wage and Hour Division requested the Postal Service to withhold funds owing to petitioner. DOL took this action to redress petitioner's violation of the minimum wage provisions of the Service Contract Act of 1956. Pursuant to DOL's request, the Postal Service withheld from petitioner $369,831.38, the remaining amount of funds due petitioner for services it had performed under its contracts. At that time DOL was claiming over $1,000,000 for petitioner's alleged violations.
On July 28, 1987, the administrative law judge presiding over the Matter of United States Department of Labor v. Tony E. Davis, et al., Case No: 83-SCA-16, concluded that petitioner had violated the Service Contract Act of 1956 and certain regulations thereunder and owed the $369,831.38 as back wages to its employees. Accordingly, the administrative law judge ordered the Postal Service to...
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