Wood v. Commissioner of Internal Revenue, 16090.

• Decision Date: 13 August 1957
• Docket Number: No. 16090.,16090.
• Citation: 245 F.2d 888
• Parties: Nona B. WOOD, Owen A. Wood, Owen A. Wood and Nona B. Wood, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Owen A. WOOD and Nona B. Wood, Respondent.
• Court: U.S. Court of Appeals — Fifth Circuit

245 F.2d 888 (1957)

Nona B. WOOD, Owen A. Wood, Owen A. Wood and Nona B. Wood, Petitioners, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

COMMISSIONER OF INTERNAL REVENUE, Petitioner, v. Owen A. WOOD and Nona B. Wood, Respondent.

No. 16090.

United States Court of Appeals Fifth Circuit.

June 28, 1957.

As Modified on Petition for Rehearing August 13, 1957.

COPYRIGHT MATERIAL OMITTED

Wright Matthews, Dallas, Tex., Douglas W. McGregor, Houston, Tex., McGregor & Sewell, Houston, Tex., of counsel, for petitioner.

Meyer Rothwacks, A. F. Prescott, Lee A. Jackson, Attys., Dept. of Justice, John M. Morawski, Sp. Atty., Washington, D. C., Charles K. Rice, Asst. Atty. Gen., John Potts Barnes, Chief Counsel, Int. Rev. Serv., Washington, D. C., for respondent.

Before HUTCHESON, Chief Judge, and TUTTLE and JONES, Circuit Judges.

JONES, Circuit Judge.

This is a Federal income tax case. The taxpayers, Owen A. Wood and Nona B. Wood, are husband and wife and are residents of Texas. The tax years involved are 1945 through 1949. The taxpayers filed separate returns reporting community income for the years 1945 through 1947, and joint returns for 1948 and 1949. The taxpayers made land purchases in the western part of Florida of 5240 acres in 1943, 17,755 acres in 1944, 3437 acres in 1945, and 220 acres in 1946, a total of 26,652 acres. They undertook to make sales by mail solicitation. Purchase order forms were sent to prospective customers. The 1944 purchase order form provided that if the purchaser was not fully pleased with the tract selected for him by Wood he could exchange it for any unsold farm of the same size. One of the forms used in 1945 stated that Wood agreed promptly to send the purchaser a plat showing the location of the tract and if the purchaser was not satisfied with the tract as shown on the plat, he would promptly advise Wood who would refund the payment. Another 1945 purchase order form provided that if the purchaser was not pleased with his farm when he made an inspection of it he might select any unsold farm and purchase it at its then price, applying upon it the payments previously made. A form letter used in replying to inquiries made in response to advertisements urged the sending of a purchase order and a first payment with a visit to the site "just as soon as you can". In this letter it was said that the purchaser, if not satisfied with the farm selected for him by Wood, could select other property and receive credit for the prior payments, or if the purchaser did not wish another tract the purchase contract could be cancelled and the amount paid would be refunded. The 1946 form of purchase order recited that if the purchaser, upon receipt of plats showing the location of the farm selected for him, was not pleased with its location, he could return the plats within five days and get back all money paid by him. Where contracts were defaulted or were cancelled by agreements, refunds were sometimes made, but in other instances the amounts received were retained by the taxpayers. Until final payment on a contract had been made, the taxpayers retained possession of the lot and paid the property taxes on it.

The taxpayers, in their income tax returns, reported their profit on their land sale transactions in a manner referred to as a completed contract basis. Using this basis the taxpayers did not include any of the payments received on a land sale installment contract until the year in which the final payment was made and the deed delivered. When the final payment was made, all the profit from the sale was included in the tax return as gross income. The taxpayers deducted as business expense substantial amounts paid by them for the construction and maintenance of roads in the development. The Commissioner of Internal Revenue disagreed with the taxpayers' method of computing their tax and determined that the profits on land sales represented taxable income during the years received. The Commissioner concluded that the cost of building and maintaining roads was a capital outlay to be added to the cost of the unsold lots. Deficiency and negligence penalty assessments were made for the years 1945 through 1949. The taxpayers petitioned the Tax Court for a redetermination of the taxes as assessed by the Commissioner. The proceedings were consolidated in the Tax Court. It decided that the Commissioner's method of computing income was not shown to be arbitrary or an unreasonable abuse of discretion; the taxpayers' gross income for 1945 and 1946 was more than twenty-five per cent. greater than reported and hence, under Section 275(c) of the Internal Revenue Code of 1939, 26 U.S.C.A. I.R.C.1939, § 275(c), the notices of deficiencies for those years were not barred by the three-year statute of limitations, 26 U.S. C.A. I.R.C.1939, § 275(a); that the road costs should be capitalized; that no justification for imposing penalties was shown; and that there were tax deficiencies for 1945, 1946 and 1947, of $12,950.40, $35,971.07, and $2,041.86. The Tax Court, applying the method of computation used by the Commissioner, found overpayments of income tax of $5,435.10 for 1948 and $225.00 for 1949. The taxpayers have petitioned for a review of the Tax Court's decision as to the years 1945, 1946 and 1947, and the Commissioner has filed a Petition for Review of the decision as to the 1948 and 1949 taxes as a protection in the event it is held that the taxpayers' method of computing income was correct.

The Internal Revenue Code makes the following provisions:

"The net income shall be computed upon the basis of the taxpayer\'s annual accounting period (fiscal year or calendar year, as the case may be) in accordance with the method of accounting regularly employed in keeping the books of such taxpayer; but if no such method of accounting has been so employed, or if the method employed does not clearly reflect the income, the computation shall be made in accordance with such method as in the opinion of the Commissioner does clearly reflect the income. If the taxpayer\'s annual accounting period is other than a fiscal year as defined in section 48 or if the taxpayer has no annual accounting period or does not keep books, the net income shall be computed on the basis of the calendar year." 26 U.S. C.A. I.R.C.1939, § 41.

Supplementing the Code provision are the following regulations:

"Net income must be computed with respect to a fixed period. Usually that period is 12 months and is known as the taxable year. * * * The time as of which any item of gross income or any deduction is to be accounted for must be determined in the light of the fundamental rule that the computation shall be made in such a manner as clearly reflects the taxpayer\'s income. If the method of accounting regularly employed by him in keeping his books clearly reflects his income, it is to be followed with respect to the time as of which items of gross income and deductions are to be accounted for. (See sections 29.42-1 to 29.42-3, inclusive). If the taxpayer does not regularly employ a method of accounting which clearly reflects his income, the computation shall be made in such manner as in the opinion of the Commissioner clearly reflects it." Reg. 111, § 29.41-1.

"Approved standard methods of accounting will ordinarily be regarded as clearly reflecting income. * * * All items of gross income shall be included in the gross income for the taxable year in which they are received by the taxpayer, and deductions taken accordingly, unless in order clearly to reflect income such amounts are to be properly accounted for as of a different period. * * *" Reg. 111, § 29.41-2.

"Income from long-term contracts is taxable for the period in which the income is determined, such determination depending upon the nature and terms of the particular contract. As used in this section the term `long-term contracts\' means building, installation, or construction contracts covering a period in excess of one year from the date of execution of the contract to the date on which the contract is finally completed and accepted. * * *" Reg. 111, § 29.42-4.

The taxpayers urge that each lot purchaser had at all times prior to the final payment upon his installment contract an unqualified right to cancel his contract and receive a refund of all payments made. The Tax Court found no legal obligation binding the taxpayers to make refunds. It held that the installment payments were received without restriction and the taxpayers' right to use them was absolute. These findings were not erroneous. Commissioner of Internal Revenue v. Union Pacific Railroad Co., 2 Cir., 1936, 86 F.2d 637; Commons v. Commissioner, 20 T.C. 900. See Burnet v. Sanford & Brooks Co., 282 U.S. 359, 51 S.Ct. 150, 75 L.Ed. 383; North American Oil Consolidated v. Burnet, 286 U.S. 417, 52 S.Ct. 613, 76 L.Ed. 1197; Healy v. Commissioner, 345 U.S. 278, 73 S.Ct. 671, 97 L.Ed. 1007.

The provisions of Reg. 111, § 29.42-4 do not apply to the type of transactions here involved. The contracts of the taxpayers for the sale of real estate are in no sense building, installation or construction contracts such as are within the terms of the quoted regulation.

The method used by the taxpayers during the tax years under review had been used by the taxpayers during prior years without criticism or objection by the Commissioner. This is urged by the taxpayers as tantamount to approval by the Commissioner and that the accounting procedures followed for a period should not be changed. The Commissioner cannot be obligated to continue an erroneous method or, by acquiescence, waive for future years the discretionary power which the Congress has granted. Brown v. Helvering, 291 U.S. 193, 54 S.Ct. 356, 78 L.Ed. 725.

The statutory provision, § 41, supra, giving to the Commissioner the authority to make computations by such method as in his opinion clearly reflects income is a grant of wide discretion, and his action may be challenged...