Possession Is 100% of the Tax Law

The accrual of some disputed payments may garner a deduction. But a company has to have control of the deferred funds.

In a case dating back to a lawsuit filed in 2000, the Tax Court has ruled on the matter of accruing disputed payments involving barge-maker Trinity Industries, an accrual method taxpayer, and its customers J. Russell Flowers Inc. and Florida Marine Transporters Inc. (FMT). The case facts are as follows: in Trinity Industries and Subsidiaries v. Commissioner, 132 T.C. No. 2 (2009), Trinity Industries entered into a series of contracts to build barges for Flowers and FMT. Payment was due upon delivery of the flat-bottomed boats, and Trinity duly delivered the barges on various dates between September 1997 and March 2000.

Trinity accrued and reported the sales income in the year in which it delivered the barges. Then, on May 22, 2000, Trinity entered into a second contract with Flowers and FMT. The contract price in each case was $1.29 million for each barge, with $1 million to be paid upon completion and acceptance of each barge and the balance within 18 months of delivery.

After the execution of the second contract, serious problems developed with the barges that Trinity had sold to Flowers and FMT under the first contracts. Lawsuits and countersuits were filed. On March 12, 2004, Trinity and FMT entered into a settlement agreement in which Trinity agreed to credit FMT with the $2.2 million of unpaid deferred obligations to which FMT had asserted a “right of offset.” In other words, the deferred payments had been withheld by FMT.

As a result, FMT agreed to pay Trinity the remaining $617,000 balance over a period of 12 months. On April 28, 2005, Trinity and Flowers entered into their own settlement agreement: Trinity agreed to repurchase certain barges sold to Flowers under the first contracts and pay Flowers $5,764,000 in damages. Flowers, in turn, agreed to pay Trinity the $8,020,000 it withheld under the second contract.

With respect to barges delivered under the second contract in 2001, Trinity accrued the full amount of the sales — including deferred payments — and reported those amounts as income (for federal income-tax purposes) in 2001. However, with respect to barges delivered under the second contract in 2002, Trinity reported as income only the amount received during 2002. That means Trinity excluded the deferred payments to which Flowers and FMT asserted rights of offset. The government objected to this approach to reporting income and the Tax Court upheld the government’s objection.

WillensFinal“Before a taxpayer may transfer money ‘beyond its control,’ it must first have the money ‘within its control.’” — Robert Willens

All Events Test
The issue is whether Trinity, an accrual basis taxpayer, was required to accrue in 2002 deferred payments for barges it delivered under the second contract in 2002 — the payments Flowers and FMT (the obligors) claimed as rights of offset. Under the accrual method of accounting, income is recognized when “all the events” have occurred that fix the right to receive the income and the amount can be determined with “reasonable accuracy.”


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