Opinion
Docket Nos. 35555 35556.
1954-04-30
D. E. ALEXANDER, PETITIONER v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.D. E. ALEXANDER AND LUCILLE D. ALEXANDER, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Theodore R. Meyer, Esq. , and Robert H. Schnacke, Esq. , for the petitioners. Leonard Allen Marcussen, Esq. , for the respondent.
1. Petitioner was engaged in the cattle business as a ‘cattle feeder’; he purchased calves and yearlings which he fed for 9 to 18 months and be then sold as beef cattle. He regularly kept his books and reported his income on a cash basis. Under his method of accounting, he consistently charged off and deducted as an operating expense, the cost of cattle in the year of purchase. He did not defer deduction of the cost of cattle until the year of sale. Held, that although the petitioner is on a cash basis, he is required, nevertheless, by Regulations 111, section 29.22(a)–7 to defer deduction of the cost of cattle until the year of sale.
2. Petitioner sold cattle in 1945 and 1946 which were purchased prior to 1945, and the cost thereof deducted by the petitioner in the year of purchase. In determining deficiencies for 1945 and 1946, respondent did not include in cost of sales the cost of cattle sold in those years but purchased prior to 1945. Held, petitioner is entitled to include in cost of sales for 1945 and 1946, the cost of cattle which were purchased prior to 1945 and sold in 1945 and 1946, even though the cost thereof had been deducted by petitioner in determining income of a prior year. Theodore R. Meyer, Esq., and Robert H. Schnacke, Esq., for the petitioners. Leonard Allen Marcussen, Esq., for the respondent.
The Commissioner determined deficiencies in income tax for the years 1945–1948, as follows:
+-----------------------------------------------------------+ ¦Docket No.¦Name ¦Year¦Amount ¦ +----------+------------------------------+----+------------¦ ¦35555 ¦D. E. Alexander ¦1945¦$112,355.02 ¦ +----------+------------------------------+----+------------¦ ¦ ¦ ¦1946¦29,944.20 ¦ +----------+------------------------------+----+------------¦ ¦35556 ¦D. E. and Lucille D. Alexander¦1947¦34,732.69 ¦ +----------+------------------------------+----+------------¦ ¦ ¦ ¦1945¦1 40,271.70¦ +-----------------------------------------------------------+
1 The deficiency for 1945 was increased by the Commissioner from $26,348.20 to $10,271.70 in his amended answer which was filed at the hearing.
Income for the taxable years of the cattle business of D. E. Alexander was reported on a cash basis. The accounting records for the business were consistently kept on a cash basis, and under this method of accounting petitioner consistently charged off and deducted as an operating expense the cost of livestock, which he purchased for resale, in the year of purchase. The Commissioner has determined that deduction of the purchase cost of livestock, properly, is to be deferred until the year of sale.
The chief question is whether the respondent erred in disallowing deduction for the cost of livestock which was purchased in each of the taxable years, where the livestock was not sold in the year of purchase, so as to require petitioner to defer deduction of the cost thereof until the year of sale.
If the respondent's determination is sustained under the chief issue, it will be necessary to decide whether petitioner is entitled to deduct, in each of the years 1945 and 1946, the cost of certain livestock which was sold in those years but which was purchased prior to 1945, and the cost thereof deducted by petitioner in the year of purchase.
The petitioners concede that other adjustments made by the respondent are proper.
FINDINGS OF FACT.
The facts which have been stipulated are found as facts. The stipulation and the attached exhibits are incorporated herein by this reference.
The petitioners, husband and wife, are residents of Napa, California. D. E. Alexander is referred to hereinafter as the petitioner because the issues presented relate solely to his business. Petitioner kept his books and prepared his tax returns on a cash basis. The petitioners filed separate returns for 1945 and 1946; joint returns were filed for 1947 and 1948. The returns were filed with the collector for the first district of California.
During the taxable years, the petitioner was engaged in the cattle business as a cattle feeder; that is to say, he purchased calves and yearlings which he fed until they reached marketable weight, at which time he sold them as beef cattle. Petitioner conducted his business as a sole proprietor.
The petitioner has been engaged in the cattle business for over 30 years. Prior to 19348 he maintained a breeding herd and bred the cattle which he sold. Beginning in 1934, he began to sell his breeding herd in order to change his business to that of a cattle feeder. By 1939, petitioner's business was confirmed, exclusively, to that of a cattle feeder.
During the taxable years, petitioner carried on his cattle business in California, Oregon, and Montana. He owned and operated a 3,600-acre ranch in Napa County, California, and a 2,500-acre ranch in Oregon. In addition, he grazed cattle on leased land. The petitioner purchased most of his cattle in Montana. The purchases were usually made in the fall of the year, and as many as several hundred head of cattle were purchased at one time. Calves were purchased at an average weight of 400 pounds, and yearlings were purchased at an average weight of 700 pounds; they were sold when they reached a marketable weight of about 1,100 pounds. The calves were fed for 15 to 18 months, and the yearlings for 9 or 10 months before they reached a marketable weight. Petitioner grazed his cattle in California in the winter, and in Oregon in the summer. He did not keep any cattle for more than 18 months.
Petitioner kept his books and reported his income on a straight cash receipts and disbursements basis. He has regularly followed that method of accounting since 1936. Petitioner did not keep an inventory of cattle and he did not use an inventory in determining his income. In accounting for and reporting his income, petitioner deducted from gross receipts in each year the cost of the cattle which he purchased in the same year; that is to say, the cost of cattle was deducted from gross receipts as an operating expense in the year in which the cattle were purchased, rather than from the proceeds of sale in the year in which the cattle were sold.
The following schedule shows the petitioner's gross receipts and net income (or loss) from his cattle business as reported in his income tax return for each of the years 1945 to 1948, inclusive. The schedule also shows the cost of the cattle purchased by the petitioner in each year and deducted from gross receipts in determining income:
+-----------------------------------------------------------------------------+ ¦Year¦Gross ¦Net income (or¦Cost of cattle purchased by petitioner and ¦ ¦ ¦receipts ¦loss) ¦deducted as an expense ¦ +----+----------+--------------+----------------------------------------------¦ ¦1945¦$209,879 ¦$44,453 ¦$125,030 ¦ +----+----------+--------------+----------------------------------------------¦ ¦1946¦215,294 ¦27,428 ¦101,127 ¦ +----+----------+--------------+----------------------------------------------¦ ¦1947¦249,565 ¦(73,569) ¦207,912 ¦ +----+----------+--------------+----------------------------------------------¦ ¦1948¦440,728 ¦(1,117) ¦305,661 ¦ +-----------------------------------------------------------------------------+ The parties have stipulated the following facts:
9. The following schedule shows the number of cattle on hand on January 1 of each year; the number purchased during the year; the number sold during the year; the number of casualties suffered in each year; and the number on hand at the end of the year for each of the years 1945 to 1949, inclusive:
+-------------------------------------------------+ ¦ ¦1945 ¦1946 ¦1947 ¦1948 ¦1949 ¦ +-------------------+-----+-----+-----+-----+-----¦ ¦On hand January 1 ¦1,683¦1,688¦1,636¦2,049¦2,010¦ +-------------------+-----+-----+-----+-----+-----¦ ¦Purchases ¦1,272¦978 ¦1,685¦1,772¦790 ¦ +-------------------+-----+-----+-----+-----+-----¦ ¦Totals ¦2,955¦2,666¦3,321¦3,821¦2,800¦ +-------------------+-----+-----+-----+-----+-----¦ ¦Sold ¦1,214¦988 ¦1,206¦1,737¦1,269¦ +-------------------+-----+-----+-----+-----+-----¦ ¦Missing and died ¦53 ¦42 ¦66 ¦74 ¦82 ¦ +-------------------+-----+-----+-----+-----+-----¦ ¦Total deductions ¦1,267¦1,030¦1,272¦1,811¦1,351¦ +-------------------+-----+-----+-----+-----+-----¦ ¦On hand December 31¦1,688¦1,636¦2,049¦2,010¦1,449¦ +-------------------------------------------------+
10. The following schedule shows an estimated breakown of the cattle on hand on December 31 of each year from 1944 to 1949, inclusive, as between cattle purchased in each of said years and those [cattle] purchased in the preceding year, and it is stipulated that the following schedule shall be accepted as accurate for purposes of these proceedings:
+-------------------------------------------------+ ¦ ¦1944 ¦1945 ¦1946 ¦1947 ¦1948 ¦1949 ¦ +-------------+-----+-----+-----+-----+-----+-----¦ ¦Current year ¦718 ¦1,265¦968 ¦1,181¦u,262¦732 ¦ +-------------+-----+-----+-----+-----+-----+-----¦ ¦Previous year¦965 ¦423 ¦668 ¦868 ¦748 ¦717 ¦ +-------------+-----+-----+-----+-----+-----+-----¦ ¦Totals ¦1,683¦1,688¦1,636¦i,049¦i,010¦1,449¦ +-------------------------------------------------+
11. The average cost per head of cattle purchased in each of the years 1943 to 1949, inclusive, was as follows:
+------------------+ ¦Fear¦Average cost ¦ +----+-------------¦ ¦1943¦$52.90 ¦ +----+-------------¦ ¦1944¦84.38 ¦ +----+-------------¦ ¦1945¦98.29 ¦ +----+-------------¦ ¦1946¦103.40 ¦ +----+-------------¦ ¦1947¦$123.39 ¦ +----+-------------¦ ¦1948¦172.49 ¦ +----+-------------¦ ¦1949¦131.68 ¦ +------------------+
12. The following schedule, assuming sales on a first-in, first-out basis, shows the total cost of cattle on hand on the dates indicated based upon the average unit costs set forth in paragraph 11 above and the breakdown of the cattle on hand on each of said dates as set forth in paragraph 10 above:
+----------------------------------------+ ¦Dec. 31, 1944¦$111,633.34¦ ¦ +-------------+-----------+--------------¦ ¦Dec. 31, 1945¦160,029.59 ¦ ¦ +-------------+-----------+--------------¦ ¦Dec. 31, 1946¦165,748.92 ¦ ¦ +-------------+-----------+--------------¦ ¦Dec. 31, 1947¦235,474.80 ¦ ¦ +-------------+-----------+--------------¦ ¦Dec. 31, 1948¦309,978.10 ¦1 $288,208.60¦ +-------------+-----------+--------------¦ ¦Dec. 31, 1949¦220,065.09 ¦1 207,696.84 ¦ +----------------------------------------+
1 With 1948 purchases valued at 155.24, representing market value of 1948 purchases at December 31, 1948.
The data set forth in paragraphs 9, 10, 11, and 12 of the stipulation filed herein is based on information contained in the petitioner's books and in the supporting records, including purchase invoice, bills of sales, and notebooks used by petitioner's cowhands. The petitioner and his accountant prepared and submitted the data during the course of the revenue agent's investigation, and it was used by the respondent in determining the deficiencies.
The respondent, in his notices of deficiencies, adjusted the amount of the deduction claimed by petitioner in each of the taxable years as cost of feeder cattle, so as to defer deduction of the purchase cost of the cattle until the year of sale. The respondent's notice of deficiency for the year 1947 contains the following explanation of the adjustments:
Income is increased by $74,725.87 through adjustment of deduction allowable for costs of cattle sold in 1947, computed as follows:
+-----------------------------------------------------------------------------+ ¦1685 head of cattle purchased in 1947 by D. E. ¦ ¦62,188.70 ¦ ¦Alexander and charged to expense ¦ ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦Less cattle sold, died, or missing during the year ¦ ¦62,188.70 ¦ ¦from 1947 purchases—504 head ¦ ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦Remaining cost of cattle purchased in 1947 transferred¦ ¦145,723.50¦ ¦to later years when sales were made ¦ ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦Less: Cost of cattle purchased in 1945 and sold in ¦$65,657.72 ¦ ¦ ¦1947–668 head ¦ ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦Cost of cattle purchased in 1946 and sold in 1947–100 ¦10,340.00 ¦ ¦ ¦head ¦ ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦ ¦ ¦$75,997.72¦ +------------------------------------------------------+-----------+----------¦ ¦Balance ¦ ¦69,725.87 ¦ +------------------------------------------------------+-----------+----------¦ ¦Add for correction of costs claimed in return: ¦ ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦Cost of 1947 purchases claimed in return ¦$212,912.29¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦Actual cost, as determined by audit, and as shown ¦207,912.29 ¦ ¦ ¦above ¦ ¦ ¦ +------------------------------------------------------+-----------+----------¦ ¦ ¦ ¦5,000.00 ¦ +------------------------------------------------------+-----------+----------¦ ¦Increase ¦ ¦$74,725.87¦ +-----------------------------------------------------------------------------+
Similar adjustments were made by the respondent for the years 1945, 1946, and 1948 with one exception. In determining the deficiency for each of the years 1945 and 1946, the respondent did not include in cost of sales the amounts of $75,940.60 and $35,692.74, respectively, which amounts represent the cost of cattle which were actually sold in those years but which were purchased prior to 1945, and the cost thereof deducted by the petitioner in the year of purchase.
In his notice of deficiency for 1948, the respondent erroneously determined that the cost of cattle sold in 1948, including cattle which were lost or which died in 1948, was $252,927.24. The correct cost of cattle sole in 1948, including cattle which were lost or which died in 1948, is $231,148.97. The respondent, by an amended answer filed at the hearing, has claimed an increased deficiency for 1948 based upon a correction of the error.
OPINION.
HARRON, Judge:
The chief question is whether the petition, who is on a cash basis, is entitled to deduct the cost of feeder cattle in the year of purchase, as he contends, or whether the deduction of such cost must be deferred until the year in which the cattle are sold, as respondent determined.
The respondent contends that the petitioner's practice of deducting the cost of cattle as an operating expense in the year of purchase without regard to when the cattle are sold distorts income. He argues that although the petitioner is on a cash basis, petitioner is required, nevertheless, by section 29.22(a)–7 of Regulations 111,