William T. Lord and Yvetta Lord, Appellants, v. United States of America, Appellee.george A. Lord and Cora M. Lord, Appellants, v. United States of America, Appellee.richard H. Lord and Elizabeth C. Lord, Appellants, v. United States of America, Appellee.p. S. Lord and Muriel T. Lord, Appellants, v. United States of America, Appellee, 296 F.2d 333 (9th Cir. 1962)

Hampson & Weiss, by Robert L. Weiss, Alfred A. Hampson and John C. McLean, Portland, Ore., for appellant.

Louis F. Oberdorfer, Asst. Atty. Gen., Lee A. Jackson, A. F. Prescott, Washington, D. C., and Thomas H. McPeters, Alexandria, Va., Attys., Dept. of Justice, Sidney I. Lezak, Acting U. S. Atty., and Edward J. Georgeff, Asst. U. S. Atty., Portland, Ore., for appellee.

Before MERRILL and KOELSCH, Circuit Judges, and BEEKS, District Judge.

BEEKS, District Judge.

This is a suit for tax refund by appellants, members of a partnership called P. S. Lord Associates (herein referred to as Associates), which in 1950 and 1951 had two long term subcontracts for mechanical engineering work in Alaska. The partners claim that due to errors in determining the percentage to which each contract was complete at the end of fiscal 1950, the partnership income was overstated and thus each member's income was overstated. In 1952, after both contracts had been completed, appellants filed amended tax returns for 1950 alleging the foregoing facts. The Government refused the refund and this action followed.¹  The lower court found for appellee (herein called the Government) from which this appeal is taken. Appellants have specified error in that (a) the District Court found the 1950 return clearly reflected income, (b) it adjudged the tax legally assessed and collected, and (c) the court having concluded that appellants' amended return for 1950 clearly reflected income, did not enter judgment as prayed for by appellants.

In reporting income for the fiscal year ending November 30, 1950, Associates used the percentage of completion method authorized by Treasury Regulation 111 (1939 Code) Sec. 26.42-4(a)²  and the percentage of completion reported therein was based upon the required engineer's certificate which accompanied the return. The percentage of completion recited in the certificate was measured by engineering estimates of physical progress determined primarily from visual inspection of the work in progress.

The amended return filed by appellants for fiscal 1950 likewise followed the percentage of completion method but the percentage of completion used therein was predicated on the ratio that the costs incurred bore to the total cost and no engineer's certificate accompanied the amended return.

Accordingly, it appears that while appellants prepared both returns on the percentage of completion method, different procedures were used in arriving at the percentage figure.

Both methods employed by appellants in determining percentage of completion clearly reflect income when properly applied, and, when so applied, are equally acceptable to the Commissioner.³ 

The conflict in this case revolves around the question of whether a taxpayer who uses the percentage of completion method of computing net income on long term contracts may, after computing the percentage of completion by one method, later change such percentage by use of a different method to show that less income was actually earned.

Appellants' major contention⁴  is that due to errors in computing the percentage of completion for fiscal 1950, their reported income was too large and they argue that the amended return merely constituted an adjustment within the percentage of completion method prescribed by the regulations.

We are unable to agree with such contention. The method used by Associates to prepare the original return for fiscal 1950 is an approved method and clearly reflects income. It is our view that appellants are bound by their election to report income in accordance with such method and may not retroactively change to another method to correct errors in the original return without securing the Commissioner's consent. An amended return purporting to correct errors in the original return must be calculated in accordance with the method initially used to compute income. The fallacy involved in appellants' contention is that such a procedure would allow a taxpayer to wait until the termination of a long term contract and then evaluate the method which would be most favorable to him over the long term. He could affirm the method originally employed or change to another method of computing the percentage of completion depending upon which would be to his financial advantage over the term of the contract. Such a course of conduct is repugnant to our system of taxation.

If Associates, or anyone, were allowed to report income in one manner and then freely change to some other manner, the resulting confusion would be exactly that which was to be alleviated by requiring permission to change accounting methods. An appropriate statement of the reasons for requiring such permission is found in Pacific National Co. v. Welch, 304 U.S. 191, 58 S. Ct. 857, 858, 82 L. Ed. 1282 (1938):

"Change from one method to the other, as petitioner seeks, would require recomputation and readjustment of tax liability for subsequent years and impose burdensome uncertainties upon the administration of the revenue laws. It would operate to enlarge the statutory period for filing returns (sec. 53(a)) to include the period allowed for recovering overpayments (sec. 322(b)). There is nothing to suggest that Congress intended to permit a taxpayer, after expiration of the time within which return is to be made, to have his tax liability computed and settled according to the other method."

Unquestionably, the law allows correction of a return when it can be shown that the return does not clearly reflect income. Also, it is obvious here that Associates could not correct visual estimates after the job was complete. However, the onus ought properly to be on the taxpayer to make sure that the method of estimating percentage of completion is used correctly as the job progresses. Pacific National Co. v. Welch, supra, provides a further appropriate comment:

"While petitioner's return may have been an inept application of the deferred payment method, there is nothing in it or the statement of claim for refund that gives any support to the idea that, if rightly applied, that method would not clearly reflect income."

Appellants having misapplied an acceptable method of calculating the 1950 return are nonetheless bound thereby. Consequently, the judgment of the District Court is affirmed.