Sternberg v. COMMISSIONER OF INTERNAL REVENUE
| Decision Date | 26 July 1935 |
| Docket Number | Docket No. 55758. |
| Citation | 32 BTA 1039 |
| Parties | HERMAN J. STERNBERG, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Board of Tax Appeals |
David Baron, Esq., for the petitioner.
Bernard D. Daniels, Esq., C. A. Ray, Esq., and T. M. Mather, Esq., for the respondent.
This is a proceeding for the redetermination of a deficiency in income taxes for the calendar year 1928 in the amount of $3,902.84. The petitioner alleges error on the part of the respondent as follows:
(a) Failure to allow petitioner as a deduction the sum of $19,170.73 as a debt ascertained to be worthless and charged off during the calendar year 1928 pursuant to the authorization of Regulations 74, Article 191, in such cases made and provided; or Failure to allow the petitioner $7,336.50 on account of a bad debt in the year 1928 and $11,834.23 as a loss in the year 1927 on construction contract on the completed contract basis, thereby making said $11,834.23 as part of a statutory net loss to be carried forward to the year 1928 together with statutory net loss set forth in (b) hereof.
(b) Failure to allow the petitioner $60,316.19 (which includes the amount of $11,834.23 mentioned in the foregoing paragraph) as a statutory net loss sustained in the year 1927 to be carried forward to the year 1928 as a deduction from income.
FINDINGS OF FACT.
The petitioner is an individual with principal office at St. Louis, Missouri. For many years the petitioner has been in the business of contracting for drainage, levee, canal, harbor, and dredging work. The contracts frequently extend over one or more years, sometimes over two or three years. It has been the custom of the petitioner to set up the profits or losses on these long term contracts as of the year when the contract or work is completed. His income tax returns have been made on this basis.
On March 20, 1919, the petitioner entered into a contract with A. V. Wills & Sons, an Illinois corporation, creating a joint venture, petitioner's interest therein being 50 percent. Petitioner agreed to furnish half the funds and equipment and receive half the profits. The purpose of the venture was to carry out the work of constructing certain drainage ditches which A. V. Wills & Sons had contracted to do for the Cache River Drainage District under a prior agreement. The joint venture was operated under the name of Cache River Dredge Co. On November 22, 1928, in Herman J. Sternberg v. Thomas J. Canavan, Trustee in Bankruptcy of and for the Estate of A. V. Wills & Sons, Contractors, A Corporation, Bankrupt, 29 Fed. (2d) 235, the United States Circuit Court of Appeals for the Seventh Circuit held that this agreement did not create a partnership, but a joint enterprise.
The work on the Cache River Drainage District job continued until sometime in 1924 when it was stopped on a suspension order from the Cache River Drainage District. The work at that time had been completed to within 150 to 200 feet of the terminus as specified in the contract. No work was performed by the Cache River Dredge Co. thereafter on this project. Under the contract the practice had been for the drainage district to make an estimate each month of the work which had been done and make payments monthly, less a retained percentage of from 10 to 20 percent, which was to be held by the drainage district until the completion of the job. All the completed work done by the joint venture was accepted by the drainage district, and an estimate thereof was made. However, this was not a final estimate and no final estimate was ever rendered. The retained percentage was never paid in full. The portion of the retained percentage which was never paid amounted to about $2,000. Demand therefor was made by A. V. Wills & Sons from 1924 on and later by petitioner on numerous occasions.
The Cache River Drainage District ordered the Cache River Dredge Co. to stop work because the district had no money to do the balance of the work and asked the Cache River Dredge Co. to stand in readiness to do the balance of the work when money was obtained to complete it. The drainage district had some hope of getting money from an adjoining district which was in process of formation, but never did, and the district had to raise its own money. Litigation arose about the question of the district's issuing more bonds to raise money to complete the project and the Cache River Dredge Co. was asked to wait till the litigation was settled. This litigation was finally decided by the Supreme Court of Arkansas on May 23, 1927, in Lesser Goldman Cotton Co. v. Cache River Drainage District, 294 S. W. 711. The result was that the district was allowed to issue bonds and raise enough money to complete the work under the original plan. In the meantime, A. V. Wills & Sons was in 1926 adjudged bankrupt and had gone out of business. The Cache River Drainage District then advertised for bids upon the work remaining to be done to effect complete drainage. Petitioner was the successful bidder. Operating as the Sternberg Dredging Co., petitioner entered into a contract with the Cache River Drainage District on June 30, 1927. During the period between the time the work ceased under the first contract and the time that the new contract was let, the dredges which had been used by the joint venture had been held at the place of operations with a skeleton crew. Shortly after petitioner had obtained the new contract, he purchased, at public sale, the dredges which had been used by the joint venture and completed the work with such dredges. The assets of the joint venture were advertised for sale July 6, 1927. The petitioner already had a half interest in such dredges.
An account headed "Cache River Dredge Company, Investment Account" in petitioner's ledger shows that from September 4, 1919, to March 3, 1924, the petitioner made payments to or for the Cache River Dredge Co. in the total amount of $52,585.97. These payments made to the Cache River Dredge Co. were for the purpose of financing the purchase of equipment needed on the job. The agreement between the petitioner and the Cache River Dredge Co. provided that the moneys paid to that company by petitioner should be repaid out of the receipts of the joint venture. He received from that company, over the period from December 23, 1919, to January 25, 1924, amounts totaling $33,415.24, the debit balance of the account being $19,170.73. This account shows that an entry was made on December 31, 1928, in the amount of $19,170.73 to balance the account. This entry was for a "bad debt" in the amount of $19,170.73. This amount was charged off to profit and loss in the year 1928 and deduction was made by petitioner in his income tax return for 1928 of that amount as a bad debt. The respondent disallowed this claimed deduction.
The payments made by the Cache River Drainage District for the work done by the joint venture never went directly to the petitioner. Since A. V. Wills & Sons was the principal contractor, payments were made to that company, which in turn would then pay the Cache River Dredge Co. Payments were made by the district up to 1924, but not thereafter. A. V. Wills & Sons had not paid petitioner all of his share of the amounts received from the district. Petitioner filed a claim in the District Court of the United States for the Eastern District of Illinois against the trustee in bankruptcy of and for the estate of A. V. Wills & Sons, bankrupt, for $7,336.50, and sought its allowance as a preferred debt. The matter was referred to a master, who found for this petitioner. The District Court approved the allowance of the claim, but denied to it any preference. Thereafter the petitioner appealed to the United States Circuit Court of Appeals for the Seventh Circuit. On November 22, 1928, that court affirmed the decision of the District Court (29 Fed. (2d) 235, supra). In its opinion the court stated in part:
* * * Claimant's debt arose out of the advancement of moneys to a joint enterprise or attempted partnership consisting of two members — claimant and the bankrupt. The bankrupt withheld money belonging to the joint enterprise and upon the dissolution of such joint enterprise became indebted to claimant. But we find nothing in these facts that would justify us in giving this claim preference over the other debts of bankrupt.
In addition to the amounts paid to the Cache River Dredge Co. up to 1924, heretofore referred to, the petitioner made payments from 1924 to 1927 aggregating $2,227.25 for phone calls, office expense, telegrams, and salaries to watchmen. The amount realized from the sale, on July 16, 1927, of equipment of the joint venture was $1,125, and this was credited in partial satisfaction of this account. The balance, $1,102.25, was charged off as a bad debt December 31, 1928. This amount was allowed by the respondent as a deduction.
In 1920 the petitioner, as an individual, entered into a contract with Drainage District No. 7 of Poinsett County, Arkansas, to do some work on "Improvement No. 64." The district made advance payments to petitioner for installation of equipment, as was customary, in the amounts of $9,000 and $6,118.88 on the respective date of December 31, 1920, and January 31, 1921, these amounts being carried in an open account on petitioner's books until 1927. The petitioner also had three or four other contracts with that district covering other improvements. After he had completed two or three of the others he reached Improvement No. 64. After he had started work on this improvement, the district wrote him a letter to stop work. However, the petitioner refused to stop and continued work for about three months. The district did not pay petitioner any estimates on Improvement No. 64. Each month he requested the district to pay him for the work done. The district refused to pay and the petitioner finally declared the contract breached and entered suit against the district...
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