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Clark v. Commissioner of Internal Revenue

decided: March 13, 1958.


Author: Mclaughlin

Before MARIS, McLAUGHLIN and HASTIE, Circuit Judges.

McLAUGHLIN, Circuit Judge.

This is an appeal from the Tax Court's ascertainment of deficiencies totaling $23,547.07 in petitioner's income taxes for the years 1947 through 1950 and from the assertion of penalties of $1,070 for 1947 under § 293(b), I.R.C.1939, 26 U.S.C. § 293(b),*fn1 and of $2,246.92 under §§ 294(d) (1) (A) and (d) (2), I.R.C. 1939, 26 U.S.C. § 294(d) (1) (A), (d) (2).*fn2

During the critical period petitioner was the owner of four farms in Lancaster County, Pennsylvania; two of these he operated himself and the other two were rented on an equal shares arrangement. He also engaged in wholesaling potatoes, a business which prospered and which required most of his time. His financial records are available only from August, 1949 on, those prior to that time having been destroyed under what the Tax Court justifiably found were innocent circumstances. Bank records were in existence, however, and since petitioner transacted virtually all of his business through his checking account, reliance on the bank records by both parties is well placed.

Several questions are presented, the one most fundamental to the case being whether the Commissioner could and did properly resort to the net worth method for asserting the deficiencies. § 41, I.R.C.1939, 26 U.S.C. § 41 states:

"The net income shall be computed * * * 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. * * *"

Since no records were available for the period from January 1, 1947 until August 9, 1949 the Commissioner was clearly entitled to resort to the net worth method to determine petitioner's income during that interval. Hooper v. United States, 10 Cir., 1954, 216 F.2d 684. For the remainder of the time in question there were records, but it is equally clear that the government may resort to the net worth method for testing their accuracy. Davis v. C.I.R., 7 Cir., 1956, 239 F.2d 187; Jacobs v. United States, 1954, 126 F.Supp. 154, 131 Ct.Cl. 1. If glaring discrepancies are found, as in this instance, the net worth computation may be used as prima facie evidence of the actual amounts of income.Holland v. United States, 1954, 348 U.S. 121, 75 S. Ct. 127, 99 L. Ed. 150; Kite v. C.I.R., 5 Cir., 1955, 217 F.2d 585; United States v. Ridley, D.C.Ga. 1954, 120 F.Supp. 530. In the absence of serious challenge to the Commissioner's use of the net worth system of computation his determination is presumptively correct. Rubino v. C.I.R., 6 Cir., 1955, 226 F.2d 291. See Helvering v. Taylor, 1935, 293 U.S. 507, 515, 55 S. Ct. 287, 79 L. Ed. 623. Having decided that net worth can be applied, we come to the questions raised by petitioner concerning the correctness of the mechanics employed in so doing.

As a formula the net worth method might be stated: increase in net worth plus non-deductible disbursements minus non-taxable receipts equals taxable net income. "Increase in net worth" depends, of course, upon careful measurement of net worth at the beginning and at the end of the year. Though the initial determination of net worth - here petitioner's net worth as of January 1, 1947 - must be fixed carefully, it does not have to be done to a mathematical certainty. Gariepy v. United States, 6 Cir., 1951, 189 F.2d 459; United States v. Glazer, D.C.E.D.Mo.1952, 14 F.R.D. 86.

Petitioner complains that the Commissioner's treatment of checks drawn and presumably delivered but still outstanding at the end of the tax year was incorrect. Petitioner asserts that his bank balance should have been reduced by the aggregate amount of such outstanding checks, thereby decreasing the figure for net worth at the end of each taxable year. The Commissioner counters that the bank balance was not so reduced because the petitioner had been on a cash basis rather than an accrual basis for the years in question, and to have reduced the bank balance for checks outstanding would be a distortion of the income figures under that plan.

Most of the outstanding checks in each year represented disbursements for business expenses, and were deductible. For a taxpayer on a cash basis, as petitioner was, the year in which a business expense can be deducted turns on when it was paid. The question is whether the expenses were paid if the checks were still outstanding. As a general proposition delivery of a check will establish the same right to a deduction as would delivery of cash. It does not matter that the check was not cashed or deposited or the drawer's account charged until the following year. The check is regarded as payment on a condition subsequent, and if the condition of honor on presentment is met the payment is regarded as absolute from the time the check was delivered.C.I.R. v. Bradley, 6 Cir., 1932, 56 F.2d 728, affirming 1930, 19 B.T.A. 49; Field, 15 T.C.M. 631 (1956). And see Broussard, 1951, 16 T.C. 23; Estate of Spiegel, 1949, 12 T.C. 524.Where the check is given with the understanding then or later that it will not be cashed in the current tax year, a cash basis taxpayer is not allowed a deduction. Eagleton v. C.I.R., 8 Cir., 1938, 97 F.2d 62; Fischer, 1950, 14 T.C. 792.It has been held that the date of mailing the check to a charity was the date of payment for the cash-basis drawer. Witt's Estate v. Fahs, (D.C.Fla.1956), 160 F.Supp. 521. Consequently it would seem that the petitioner might have deducted the amounts of the outstanding checks representing payments for business expenses, absent any evidence that there was an understanding with each payee the checks would not be cashed until a new tax year had begun. Since that is so it would appear that the cash-basis taxpayer subjected to a net worth computation of his tax liability would be entitled to have his year-end bank balance reduced by the amount of all outstanding checks. The presumption conforming with experience would be that outstanding checks have been delivered; the burden of proof would then be on the government to show that they had not been delivered. Those checks representing non-deductible disbursements would also have their tax effect in the earlier year, being added into the non-deductible expenditures element of the determination of taxable income.

The Tax Court in its opinion did not allow the amounts of the checks outstanding to reduce the bank balance at year's end because it found that all of them except insignificant amounts were for the acquisition of assets which it assumed were still on hand at the end of the tax year. Hence the change in net worth would not be affected by an accounting formality crediting one asset and debiting another, leaving the total unchanged. This reasoning is acceptable as to the checks representing purchases of livestock for reasons to be later set out, but it has no support in the evidence with reference to potatoes and feed. The feed may already have been consumed, the potatoes sold and payment received, in which case petitioner's increase in net worth and consequent tax liability would be overstated.

What petitioner's eventual tax liability will be is for the Tax Court to say after a redetermination of the figure for "Cash on hand" represented by bank balances at the end of each year. The checks outstanding at the end of the years 1946 through 1950 will be given effect in the year they were delivered in such a redetermination.

Another item in the annual computation of net worth which petitioner asserts is represented by erroneous figures is livestock on hand. It seems to be agreed that the Commissioner's figures for 1947, 1948 and 1949 are correct, leaving those for 1946 and 1950 in dispute. Petitioner told the investigating agents and testified before the Tax Court that it was his practice to buy cattle in the fall, to keep them over the winter, and to sell them in the spring. There is no way of ascertaining the identity of animals sold or in fact how many were bought and sold or remained on hand at any one time. The Commissioner therefore deemed it reasonable to take the total of disbursements for livestock made between October 1 and December 31 each year as representing the value of livestock bought each fall and on hand the beginning of each succeeding tax year. Petitioner claims this is arbitrary. He suggests a figure of some $16,000 rather than the $12,000 figure of the Commissioner for December 31, 1946 and $11,443 rather than $12,592 for December 31, 1950. Petitioner complains that according to the evidence some cattle purchases were made for cash and that some of the bank records showed purchases before October 1st. There is insufficient foundation in the record as to sales of cattle and as to the amounts of cash disbursements for livestock and the years in which they were made to warrant replacing the Commissioner's figures with petitioner's. It is for this reason that outstanding checks at year's end which represent purchases of livestock need not be subtracted from the year-end bank balances; the amounts would simply require transfer to another category of assets. We assume that the Commissioner in his original determination did not include in livestock inventory any animals purchased by checks still outstanding at year's end, as that would have had the effect of twice including their value. The judgment of the Tax Court with respect to its treatment of livestock will be affirmed.

It is further claimed that the Commissioner erred in not allowing some $3,000 in his initial calculation for the end of 1946 for trucks. The Tax Court was justified in sustaining the Commissioner's figure by finding that the trucks then on hand had already been fully ...

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