                        T.C. Memo. 1996-486



                      UNITED STATES TAX COURT



     ELECTRIC CONTROLS AND SERVICE CO., INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 23672-93.                 Filed October 29, 1996.



     William S. Fishburne III and Sidney T. Philips, for

petitioner.

     Linda J. Wise, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     SWIFT, Judge:   Respondent determined a deficiency in

petitioner's 1989 corporate Federal income tax of $218,015 and an

addition to tax under section 6651(a)(1) of $66,778.
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     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for 1989, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

     After settlement, the primary issue for decision is the

proper accrual in petitioner's taxable year ending February 28,

1989, of amounts billed but not received under a long-term

construction contract.


                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

     Petitioner is an Alabama corporation with its principal

place of business in Birmingham, Alabama.   Petitioner is engaged

in the construction of industrial plants and buildings.

Petitioner's taxable year ends on February 28 of each year.

     In early 1987, Clinch River Corp. (Clinch River)

incorporated for the purposes of purchasing, renovating, and

operating a paper mill that it purchased later that year.    In

October of 1987, Clinch River hired petitioner to substantially

renovate the mill.   The mill had been built in the early 1900's

but had been closed in 1985 upon bankruptcy of the former owner

and operator of the mill.

     Under the long-term, cost-plus contract that was entered

into on October 23, 1987, between Clinch River and petitioner

(October 1987 contract), Clinch River was to reimburse petitioner

the costs of labor, materials, and subcontractor fees, and to pay
                                - 3 -

petitioner a fee of 15 percent in excess of labor and material

costs and subcontractor fees.   Clinch River had little startup

capital and was required to take out lines of credit to finance

the mill renovation.

     Under the October 1987 written contract, total payments due

petitioner for renovation of the mill were estimated at

$2,730,000, and completion of the renovation was estimated for

March 1, 1988.   Payments were to be made by Clinch River to

petitioner periodically as renovation of the mill progressed, and

final payment was to correspond with the completion of the

renovation.

     Not until July of 1988, however, did petitioner complete

renovation of the mill, and, by the time the renovation was

complete, total payments due petitioner from Clinch River under

the cost-plus contract had increased to $5,136,000.

     Because of the large increase in the costs of renovation

over the $2,730,000 that petitioner initially had estimated and

because of financial difficulties that Clinch River experienced

during renovation of the mill, Clinch River did not make timely

payments to petitioner, and both Clinch River and petitioner

recognized that Clinch River would have difficulty making the

full payment due petitioner for petitioner's renovation of the

mill.   By letter dated April 18, 1988, petitioner wrote Clinch

River and offered to make adjustments in the payments due

petitioner from Clinch River for renovation of the mill.
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     Between January and July of 1988, under the October 1987

contract, Clinch River made payments to petitioner totaling

$3,180,000, leaving a balance of $1,956,000 ($5,136,000 less

$3,180,000 equals $1,956,000) to be paid upon completion of the

mill renovation which balance, in July of 1988, was accrued as

income on petitioner's books and records.

     Upon completion of the renovation, the mill reopened, and

Clinch River began operating the mill 7 days a week.    Clinch

River, however, failed to pay the $1,956,000 balance due

petitioner under the October 1987 cost-plus contract.

     By letter dated July 11, 1988, Clinch River wrote petitioner

and acknowledged the $5,136,000 total bill for renovation of the

mill, but Clinch River also requested additional time to pay the

$1,956,000 balance due.   Specifically, Clinch River represented

that by October 30, 1988, it would make an additional payment of

$603,000 to be financed from additional loan proceeds.    Clinch

River made no representation as to when it would pay the amount

due in excess of $603,000.

     By letter dated October 25, 1988, Clinch River informed

petitioner that it would not be able to pay the $603,000 promised

by October 30, 1988.   Clinch River had no capital, operating

funds, or credit from which to make the payment.

     Due to Clinch River's financial condition, petitioner and

Clinch River renegotiated certain aspects of the cost-plus

contract relating to renovation of the mill and specifically
                              - 5 -

relating to payment of the $1,956,000 balance due petitioner.

Under a written agreement dated November 23, 1988 (November 1988

contract), Clinch River agreed, among other things, to pay

petitioner:


     (1) $400,000 by January 15, 1989;

     (2) beginning with the mill's first profitable quarter, $5
     per ton for each salable ton produced, for a period of up to
     24 months, up to a maximum total additional payment under
     this provision of $400,000; and

     (3) in each month of 1989 that is profitable for the mill,
     an additional $5 per ton for all tons produced in each
     month;

     (4) in the event Clinch River sells the mill and receives
     from the sale less than $12 million, an additional amount so
     that the total amount paid petitioner for renovation of the
     mill would equal $4.4 million. Alternatively, if a sale of
     the mill realizes for Clinch River more than $12 million, an
     additional amount so that the total amount paid petitioner
     for renovation of the mill would equal $4.5 million.


     Because of the above alteration of the October 1987

contract, on January 4, 1989, an adjustment reducing accrued

income by $724,975 was made on petitioner's management reports

with respect to its renovation of the mill to reflect that, as of

November 30, 1988, petitioner had the potential to receive a

total of only $4,411,025 from its work on the mill -- $5,136,000

(total contract amount as of completion of the renovation) less

$4,411,025 (approximate minimum that petitioner was scheduled to

receive, under the November 1988 contract, on sale of the mill)

equals $724,975.
                                 - 6 -

     On January 15, 1989, Clinch River failed to make the

$400,000 payment due petitioner on that date under the November

1988 contract.

     On February 2, 1989, petitioner and Clinch River

renegotiated in writing certain aspects of the November 1988

contract (February 1989 contract).       Under the February 1989

contract, in lieu of the $400,000 that was due petitioner on

January 15, 1989 (under the November 1988 contract), Clinch River

agreed to pay directly to various suppliers and subcontractors

$340,148 that was owed by petitioner to the suppliers and

subcontractors for their work on the mill renovation, and Clinch

River agreed to pay petitioner only the $59,852 balance of the

$400,000 that was scheduled to be paid on January 15, 1989

($400,000 less $340,148 equals $59,852).       Under the February 1989

contract, the two other provisions of the November 1988 contract

that made additional payments from Clinch River to petitioner

contingent upon Clinch River's profitability and production

remained in effect.   The provisions of the November 1988 contract

relating to a possible sale of the paper mill are not mentioned

in the February 1989 contract.

     From the time of initial startup of the mill in July of 1988

through the end of petitioner's 1989 taxable year, Clinch River's

financial statements reflected a total net operating loss of

$4,340,926 and no profit from operation of the mill.       Petitioner

received copies of Clinch River's monthly financial statements

from July of 1988 through the end of Clinch River’s fiscal year
                                  - 7 -

ending July 2, 1989.    Each of these monthly financial statements

reflected total liabilities in excess of total assets and a net

operating loss for Clinch River that increased significantly for

almost every month, as set forth below:


                         Total               Total      Net Operating
Month Ending             Assets           Liabilities   Loss (To Date)

July   31,   1988      $10,812,640        $12,231,286   $  (609,170)
Aug.   28,   1988       10,623,865         12,798,253    (1,309,637)
Sep.   25,   1988       10,745,749         13,978,696    (2,352,740)
Oct.   23,   1988       11,430,129         15,014,491    (2,651,004)
Nov.   20,   1988       10,468,891         14,703,381    (3,234,931)
Dec.   18,   1988       10,571,153         15,344,598    (3,704,189)
Jan.   15,   1989       10,518,158         15,573,595    (3,935,168)
Feb.   13,   1989       10,325,572         15,893,548    (4,340,926)
Mar.   12,   1989        9,200,617         15,190,987    (4,704,722)
Apr.    9,   1989        9,123,278         15,722,158    (5,206,418)
June    4,   1989        9,086,060         16,568,885    (5,938,446)
July    2,   1989        9,072,587         17,057,265    (6,372,108)


       In order to cover expenses associated with production, the

paper mill apparently had to produce and sell at least 170 tons

of paper per day.    As of January 25, 1989, the paper mill was

apparently producing only 150-170 tons of paper per day, dropping

to 123 tons per day as of April 9, 1989, and rising to 140 tons

per day as of July 30, 1989.

       In summary, with regard to payments due from Clinch River,

as of February 28, 1989, the close of petitioner's 1989 taxable

year, petitioner had not received from Clinch River the

$1,956,000 balance due under the original October 1987 contract,

the $400,000 due under the first provision of the November 1988

contract, nor the $59,852 due under the first provision of the
                               - 8 -

February 1989 contract.   The $340,148 that Clinch River owed

suppliers and subcontractors under the February 1989 contract was

never paid, and petitioner never received any payments under the

provisions of the November 1988 contract that were dependent on

the mill's profitability and production.

     By February 28, 1989, several priority deeds of trust had

been filed in Tennessee by other creditors against Clinch River

and perfected against the mill and other property of Clinch River

in the total amount of $4,469,999.

     On March 19, 1989, yearend closing adjustments were made on

petitioner's books and records with respect to petitioner's

taxable year ending February 28, 1989, reflecting a reduction in

the contract price for petitioner's renovation of the mill from

the original $5,136,000 to $4,500,000.   On petitioner's books and

records, petitioner recorded this adjustment as a debit (or

reduction) of $636,000 in accrued income and as a credit (or

decrease) of $636,000 in petitioner's accounts receivable with

respect to Clinch River ($5,136,000 less $4,500,000 (maximum

amount that petitioner would receive under the November 1988

contract on sale of the mill) equals $636,000).

     Petitioner also made a yearend closing adjustment on its

books and records with respect to petitioner's taxable year

ending February 28, 1989, to reflect the $340,148 that petitioner

would not receive because Clinch River had agreed to pay the

$340,148 directly to suppliers and subcontractors but that
                                 - 9 -

petitioner had previously accrued as income as part of the total

$5,136,000 contract price under the cost-plus contract with

Clinch River.   This adjustment was reflected as a further debit

(or reduction) of $340,148 in accrued income and as a credit (or

decrease) of $340,148 in petitioner's accounts receivable with

respect to Clinch River.

     Lastly, as a further yearend closing adjustment on its books

and records with regard to its contract with Clinch River,

petitioner "wrote-down" the original $5,136,000 contract price by

an additional $600,000 to reflect what petitioner perceived as

the unlikelihood of receiving any further payments under the

November 1988 and February 1989 contracts with Clinch River that

were dependent on profitability and production of the mill.    This

adjustment was reflected by a $600,000 debit (or increase) to a

bad debt expense account and by a $600,000 credit (or decrease)

to petitioner's accounts receivable with respect to Clinch River.

     On July 11, 1989, petitioner filed suit against Clinch River

in the Chancery Court for Roane County, Tennessee, seeking to

recover $1,956,000 (the balance due under the original October

1987 contract between Clinch River and petitioner) with respect

to its renovation of the paper mill.

     On April 9, 1990, Clinch River filed for chapter 11

bankruptcy in the U.S. Bankruptcy Court (Bankruptcy Court) for

the Southern District of Ohio.    As of the date of trial, Clinch

River was operating under a plan of reorganization that was
                              - 10 -

confirmed by the Bankruptcy Court on July 19, 1993.   As indicated

above, petitioner never received any additional payments from

Clinch River.

     Petitioner filed an untimely corporate Federal income tax

return for its taxable year ending February 28, 1989 (the 1989

return).   The 1989 return was originally due on May 15, 1989, but

petitioner on that date obtained a filing extension until

November 15, 1989.   Respondent, however, did not receive

petitioner's 1989 corporate Federal income tax return until

June 25, 1990.

     On the application for automatic extension of time to file

its 1989 return, petitioner reported a tentative tax liability of

$80,000, an estimated tax payment of $20,000, and an estimated

balance due of $60,000.   The $60,000 payment that was to

accompany petitioner's extension request was not received by

respondent until May 17, 1989.

     Consistent with the above yearend closing adjustments that

were made on petitioner's books and records with regard to

payments due from Clinch River, on petitioner’s 1989 corporate

Federal income tax return, petitioner accrued $4,159,8521 in

income, and petitioner claimed a $600,000 bad debt deduction with



1
     $5,136,000 (initially accrued on petitioner's books and
records) less $636,000 (for first contract price adjustment) less
$340,148 (for amount to be paid by Clinch River directly to
suppliers and subcontractors) equals $4,159,852.
                              - 11 -

respect to payments not received from Clinch River for

petitioner's renovation of the mill.

     On audit, respondent accepted petitioner's reductions of

$636,000 and $340,148 to the originally accrued total income of

$5,136,000 relating to petitioner's contract with Clinch River.

Respondent, however, issued a notice of deficiency disallowing

the claimed $600,000 bad debt deduction on the ground that

petitioner had not established that the balance of the debt still

owed to petitioner from Clinch River was wholly or partially

worthless.

     In the notice of deficiency, respondent also determined that

petitioner was liable for an addition to tax under section

6651(a)(1) for failure to timely file a 1989 corporate Federal

income tax return.   Because petitioner's $60,000 estimated tax

payment due with the May 15, 1989, extension request was not

received by respondent until 2 days after that date, this $60,000

payment was not included by respondent in the computation under

section 6651(b) of the amount of the delinquency addition to tax

under section 6651(a)(1).

     Petitioner now argues, in the alternative, that either the

$600,000 claimed bad debt deduction should be allowed or the 1989

yearend accrued income of $4,159,852 relating to the contract

with Clinch River should have been, and should now be, reduced by

an additional $600,000 because of the contingencies associated

with Clinch River's obligation to make further payments to
                                - 12 -

petitioner and because of substantial doubt, as of February 28,

1989, as to collectibility of any further payments from Clinch

River.     Petitioner also makes other alternative arguments.


                                OPINION

     Generally, under section 451(a) and the regulations

thereunder, an accrual basis taxpayer is required to accrue for

each year income where, during that year, all events have

occurred that fix the taxpayer's right to receive the income and

where the amount can be determined with reasonable accuracy.

Secs. 1.446-1(c)(1)(ii), 1.451-1(a), Income Tax Regs.    The time

when income accrues is largely a question of fact.     San Francisco

Stevedoring Co. v. Commissioner, 8 T.C. 222, 226 (1947).

         Income that satisfies the all-events test of the accrual

method of accounting is generally accruable even though later

events may postpone, even until a subsequent year, actual payment

and receipt of the amount fixed and due.     Harmont Plaza, Inc. v.

Commissioner, 64 T.C. 632, 648, 649 (1975), affd. 549 F.2d 414

(6th Cir. 1977); Georgia School-Book Depository, Inc. v.

Commissioner, 1 T.C. 463, 468 (1943).

     A limited exception to the above general rule regarding the

accrual of income may apply when, in the same year that a

taxpayer's right to income arises, collection and receipt of the

income become sufficiently doubtful or when it becomes reasonably

certain that the income will not be collected.     Clifton
                               - 13 -

Manufacturing Co. v. Commissioner, 137 F.2d 290, 292 (4th Cir.

1943), revg. on the facts 1 T.C. 71 (1942); Corn Exch. Bank v.

United States, 37 F.2d 34, 35 (2d Cir. 1930); Harmont Plaza, Inc.

v. Commissioner, supra at 649-650; Chicago & N.W. Ry. v.

Commissioner, 29 T.C. 989, 996 (1958); Georgia School-Book

Depository, Inc. v. Commissioner, supra at 468-469; Atlantic

Coast Line R.R. v. Commissioner, 31 B.T.A. 730, 749 (1934), affd.

81 F.2d 309 (4th Cir. 1936); Johnson v. Commissioner, T.C. Memo.

1982-517, affd. without published opinion 729 F.2d 1447 (3d Cir.

1984); Cappuccilli v. Commissioner, T.C. Memo. 1980-347, affd.

668 F.2d 138 (2d Cir. 1981).

     Mere financial difficulty of the debtor, however, or the

fact that a lapse of time is contemplated before payment is

possible will not be regarded as establishing the requisite

doubtful collectibility.   Harmont Plaza, Inc. v. Commissioner,

supra at 650; Commercial Solvents Corp. v. Commissioner, 42 T.C.

455, 470 (1964); Automobile Ins. Co. v. Commissioner, 72 F.2d

265, 267-268 (2d Cir. 1934).

     Accrual of income also may not be required if the right to

receive income is contingent upon the happening of a future

event.   See Guarantee Title & Trust Co. v. Commissioner, 313 F.2d

225, 227 (6th Cir. 1963), revg. on the facts T.C. Memo. 1961-122.

Where receipt of income is contingent on realization of profits

or net income by the payor, the income may be regarded as

contingent and nonaccrual in the current year may be justified.
                              - 14 -

Pierce Estates, Inc. v. Commissioner, 195 F.2d 475, 477 (3d Cir.

1952), revg. on the facts 16 T.C. 1020 (1951).

     Respondent cites Spring City Foundry Co. v. Commissioner,

292 U.S. 182 (1934), for the proposition that an absolute rule

exists that once an accrual method taxpayer has earned income,

the income must immediately be accrued, and subsequent events

occurring within the same year affecting collectibility of the

income can never justify nonaccrual of the income in that year.

Respondent’s interpretation of Spring City Foundry Co. v.

Commissioner, supra, is not followed by the above-cited case

authority, and we do not so interpret it herein.

     In the instant case, the record establishes that by

November 23, 1988 (the date of the November 1988 contract),

Clinch River's obligation to pay petitioner the $600,000 in issue

had become contingent and, by February 28, 1989, of very doubtful

collectibility.   The unprofitability of the mill, the low level

of production of the mill, and the serious financial condition

and apparent insolvency of Clinch River, make clear the strong

unlikelihood that petitioner would receive a payment under the

two contingent provisions of the November 1988 and the February

1989 contracts with Clinch River.   No realistic prospect of a

sale of the mill was evident, and, in light of the failure to

mention, in the February 1989 contract, the sale provisions of

the November 1988 contract, those provisions appear not to have

been included in the February 1989 contract.
                              - 15 -

     The doubtful collectibility of the $600,000 in dispute is

established by the contingent nature of petitioner's right to

receive any further payments and by Clinch River's serious

financial condition and history of delinquent payments under the

various contracts.

     These factors taken together constitute and are to be

regarded as more than mere obstacles postponing payment and

receipt of the $600,000 in dispute.    The combination of the

contingent nature of the payments that were due and the severe

financial condition of Clinch River created serious and

reasonable doubt as to whether petitioner would ever collect any

portion of the $600,000 in dispute and justify, in this case,

nonaccrual of this $600,000 in petitioner's 1989 taxable year.

     The fact that petitioner, in subsequent years, sued Clinch

River for recovery of the full balance due under the original

October 1987 contract does not alter our conclusion herein.     Such

legal action, in this case, must be regarded as merely protective

and perfunctory.   It did not alter or eliminate the price

reductions that had occurred and that respondent recognizes

herein, and it did not alter or eliminate the unlikelihood that

petitioner would receive any additional payment from Clinch

River.

     Because we hold for petitioner as to nonaccrual of the

$600,000 in dispute, we need not address petitioner's alternative
                               - 16 -

argument regarding the claimed $600,000 bad debt deduction and

other alternative arguments.

     With respect to the addition to tax under section 6651(a)(1)

for petitioner's failure to timely file its 1989 corporate

Federal income tax return and the computation of that addition to

tax, we hold for respondent.   Petitioner has offered no evidence

to establish reasonable cause for its failure to timely file its

1989 corporate Federal income tax return nor any evidence to

establish that the $60,000 estimated tax payment was made on

May 15, 1989, the due date of the estimated tax payment for

purposes of computing the amount of the addition to tax under

section 6651(a)(1).   We sustain respondent on these issues.


                                    Decision will be entered

                               under Rule 155.
