                       132 T.C. No. 2



                UNITED STATES TAX COURT



TRINITY INDUSTRIES, INC. AND SUBSIDIARIES, Petitioner v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 12395-06.                Filed January 28, 2009.



     Company T, a member of P’s affiliated group,
contracted to build barges for two established
customers; pursuant to an interim financing
arrangement, part of the purchase price was deferred
until 18 months after the delivery of each barge. The
two customers later claimed damages from alleged
defects in barges that they had previously purchased
from T under earlier contracts; they withheld deferred
payments due under the later contract, asserting common
law rights to offset the deferred payments against
their claimed damages under the earlier contracts. In
reporting the affiliated group’s 2002 consolidated
income, P accrued only the payments actually received
in 2002 and excluded the deferred payments. Held, the
full contract price of the barges delivered in 2002
must be accrued that year; accrual is not postponed by
the purchasers’ assertion of rights to withhold
deferred payments under common law claims of offset.
Held, further, amounts due to T and withheld by the
                                - 2 -

     obligors pursuant to common law claims of offset are
     not deductible in 2002 pursuant to sec. 461(f), I.R.C.



     Michael L. Cook, Jeffry M. Blair, and William C. Brooks, for

petitioner.

     George E. Gasper and Garrett D. Gregory, for respondent.



     THORNTON, Judge:    Trinity Industries, Inc. (petitioner), is

the common parent of an affiliated group of corporations making a

consolidated return of income (the affiliated group).1   By notice

of deficiency, respondent determined a $5,900,808 deficiency for

petitioner’s taxable year ending March 31, 1999.2   All but one of

the adjustments that gave rise to that deficiency have been

settled.    The only remaining issue involves accrual of income

earned by petitioner’s wholly owned subsidiary, Trinity Marine

Products, Inc. (Trinity), for the taxable year ending December

31, 2002.

     More particularly, in 2002 Trinity contracted to build

barges for two established customers.    Part of the purchase price


     1
       The parties use the term “petitioner” to refer principally
to Trinity Industries, Inc., although they sometimes seem to use
the term also to refer, without distinction, to its affiliated
group of corporations or its wholly owned subsidiary, Trinity
Marine Products, Inc. For simplicity and convenience, we have
generally adhered to the terminology used in the parties’
stipulations and arguments.
     2
       In September 2001, petitioner changed its yearend from
Mar. 31 to Dec. 31.
                                   - 3 -

was deferred until 18 months after the delivery of each barge.

The two customers later claimed damages allegedly caused by

defects in barges that they had previously purchased from Trinity

under earlier contracts.       They sought to offset their unpaid

deferred obligations under the later contract against claimed

damages arising under the earlier contracts.

       For the taxable year ending December 31, 2002, Trinity was

included in petitioner’s consolidated U.S. corporate income tax

return.       Petitioner, an accrual basis taxpayer, included in the

affiliated group’s 2002 consolidated income payments received for

barges that Trinity delivered in 2002 but excluded the deferred

payments.       In the notice of deficiency, respondent determined

that petitioner’s failure to accrue the deferred payments in 2002

resulted in an understatement of the affiliated group’s 2002

consolidated income which contributed to an overstatement of the

2002 consolidated net operating loss that petitioner had carried

back to the 1999 consolidated return.       The issues for decision

are:       (1) Whether petitioner properly excluded the withheld

payments from its 2002 income; and (2) if petitioner was required

to accrue the withheld payments in 2002, whether it may deduct

the withheld payments in 2002 pursuant to section 461(f).3




       3
       Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the year at issue, and Rule
references are to the Tax Court Rules of Practice and Procedure.
                              - 4 -

                        FINDINGS OF FACT

     The parties have stipulated some facts, which we find

accordingly, except as otherwise noted.    When it petitioned the

Court, petitioner’s principal place of business was in Texas.

     Petitioner is a diversified industrial company engaged in

the manufacture, marketing, and leasing of various products.

Trinity manufactures inland barges, primarily for commercial

marine transportation companies.

The First Contracts With Flowers and Florida Marine

     In the late 1990s Trinity entered into a series of contracts

to build barges for J. Russell Flowers, Inc. (Flowers), and,

separately, for Florida Marine Transporters, Inc. (Florida

Marine) (hereinafter we sometimes refer to these contracts

collectively as the first contracts).   Payment under these

contracts was generally due upon delivery of each barge.4

Trinity delivered the barges to Flowers and Florida Marine on

various dates between September 1997 and March 2000.   Petitioner




     4
       The parties have stipulated that a portion of the purchase
price of the barges delivered to J. Russell Flowers, Inc.
(Flowers), under the first contracts was deferred for 18 months
as part of an interim financing arrangement. The stipulated
contract which is in evidence provides, however, that the
$265,000 contract price for each barge delivered to Flowers was
due within 10 days of the invoice date; an invoice was to be
issued upon installation of the covers for each vessel. Because
the stipulation is clearly contrary to the facts established by
the stipulated contract, we shall disregard the stipulation. See
Cal-Maine Foods, Inc. v. Commissioner, 93 T.C. 181, 195 (1989).
                               - 5 -

accrued and reported the sales income in the taxable year in

which Trinity delivered the barges.

The Second Contract With Flowers and Florida Marine

     On May 22, 2000, after the delivery and acceptance of the

barges that were the subject of the first contracts, Trinity

entered into another contract (the second contract) with Flowers

and Florida Marine.   Under the second contract, Trinity, as

builder, agreed to deliver certain barges to Flowers, as

purchaser; Flowers had the right to assign its contractual rights

to Florida Marine (which was also a signatory to the contract)

with respect to a specified number of the barges.

     The contract price was generally $1,290,000 for each barge,

with $1 million to be paid upon completion and acceptance of each

barge.   The contract provided for “interim financing” of the

$290,000 balance, which the purchaser was to pay to Trinity, with

interest, within 18 months of delivery of each barge.5     Pursuant

to the second contract, Trinity built numerous barges and

delivered them to either Flowers or Florida Marine at various

times between April 2001 and September 2002.



     5
       A contract addendum dated Mar. 19, 2001, provided that
Trinity would provide two additional barges for $841,000 each,
with $651,000 payable upon completion and acceptance of each
barge and payment of the $190,000 balance deferred for 18 months
pursuant to an “interim financing” provision. Another contract
addendum dated May 16, 2002, provided for an additional six
barges for $1,353,000 each, with payment due in full upon
delivery of each barge.
                                 - 6 -

Problems With Barges Sold Under the First Contracts

     After the execution of the second contract, problems

developed with the barges that Trinity had sold to Flowers and

Florida Marine under the first contracts.     Flowers and Florida

Marine complained that the coatings on the barges were defective

and caused the barges to rust.    Trinity denied any liability

concerning this alleged defect.

The Florida Marine Litigation

     On May 15, 2002, Florida Marine filed a petition for an

unspecified amount of damages in the 22d Judicial Court, St.

Tammany Parish, Louisiana, against petitioner, Trinity, a coating

manufacturer, a coating distributor, and three insurance

companies (the Trinity defendants).      On March 20, 2003, Florida

Marine filed a motion for leave to file a second supplemental and

amending petition for damages, requesting declaratory judgment

that it was entitled to offset unpaid deferred obligations under

the second contract against Florida Marine’s claim for damages

with respect to barges purchased under the first contracts.

     In its memorandum in support of the aforementioned motion,

filed concurrently with the motion, Florida Marine stated that it

“does not dispute that certain amounts are due Trinity” pursuant

to the second contract but indicated that Florida Marine and

Trinity disagreed as to when the deferred payments were due.     The

memorandum stated that Florida Marine had placed in escrow the
                              - 7 -

amounts that Trinity had claimed were past due.   The memorandum

indicated that the declaratory judgment action would enable the

court to declare the rights of Flowers Marine to a “set off

and/or credit for amounts, if any, owed by Florida Marine and to

Trinity * * * under the * * * [second contract] against such

amounts as Trinity * * * may be indebted to Florida Marine * * *

under claims which are the subject of the principal action.”

     In their opposition to Florida Marine’s motion the Trinity

defendants argued that Florida Marine’s motion should be denied

because, among other reasons, applicable Louisiana law would not

permit Florida Marine’s obligations under the second contract to

be offset against its claim for damages with respect to barges

purchased under the first contracts, which were “contingent,

uncertain, and contested”.6

The Flowers Litigation

     On October 7, 2002, Flowers filed a complaint in the U.S.

District Court for the Northern District of Mississippi,

Greeneville Division, against petitioner, Trinity, a coating

manufacturer, and a coating distributor.   In its complaint

Flowers sought an order of rescission whereby Trinity would be

required to repurchase from Flowers 56 barges sold under the



     6
       The record does not reveal the disposition of Florida
Marine’s motion for leave to file a second supplemental and
amending petition for damages.
                                - 8 -

first contracts for $13,977,578 less an “offset credit” of

$8,020,000 for deferred principal payments that it owed Trinity

under the second contract.    Alternatively, the complaint sought

actual damages of not less than $8,400,000 plus punitive damages

of $100 million.   The complaint also sought a declaratory

judgment that Flowers was entitled to exercise its “common law

right of offset” with respect to “$8,020,000 it owes to Trinity”

as deferred installment payments on barge sales under the second

contract, plus accrued interest.   The complaint stated that

Flowers would “set aside the amounts of the deferred payments in

a segregated investment account as each installment and the

interest accruals become due.   It will then hold said segregated

account as collateral security for and as an offset against any

amounts that may be due * * * [Flowers] from Trinity as a result

of the allegations contained in this Complaint.”

     Attached as an exhibit to Flowers’s complaint was a letter

from Flowers dated October 7, 2002, to Trinity whereby Flowers

proposed rescinding the first contracts with respect to the 56

allegedly defective barges.   The letter stated that if Trinity

declined this tender offer, Flowers would “protect itself by

exercising its common law right of offset with respect to

$8,020,000 in deferred installment payments” that it owed Trinity

under the second contract.    The letter stated that as each of the

installments came due, Flowers would deposit the principal and
                               - 9 -

accrued interest in a segregated investment account to be “held

as an offset against and as collateral security for” damages

alleged in the complaint.   Alternatively, the letter stated that

if Trinity accepted the tender offer, the offset and segregated

account would be “reversed” and that Flowers would then pay the

deferred installments as they came due.7

     On October 9, 2003, Trinity filed a motion for partial

summary judgment, arguing that Flowers’s claim for setoff was

improper because, among other reasons, Flowers’s “highly

contested” claim for unliquidated damages was not currently due

and payable, and Trinity would “never owe” Flowers damages in

regards to the barges sold under the first contracts.   By order

dated March 18, 2004, the District Court denied Trinity’s motion

for summary judgment.

Withholding of Deferred Payments

     During 2002, 2003, and 2004 deferred payments fell due from

Flowers and Florida Marine with respect to barges that Trinity

had delivered to them under the second contract in 2001 and 2002.

Because the deferred payments were due 18 months after delivery,

however, deferred payments for barges delivered in 2002 fell due



     7
       The letter further stated that the aforementioned
complaint had been filed in the U.S. District Court for the
Northern District of Mississippi, Greeneville Division, but that
service on the defendants had been deferred 30 days to give
Trinity an opportunity to respond to Flowers’ tender offer.
                               - 10 -

only during 2003 and 2004.    The parties have stipulated that

Flowers withheld total payments of $8,020,000, of which

$2,320,000 was attributable to barges delivered in 2002.8    The

parties have also stipulated that Florida Marine withheld

additional total payments of $2,836,060, of which $2,200,000 was

attributable to barges delivered in 2002.9

Settlement Agreement With Florida Marine

     On March 12, 2004, Trinity and Florida Marine entered into a

settlement agreement.   In compromise of the disputed claims,

Trinity agreed to credit Florida Marine with the $2,200,000 of

unpaid deferred obligations as to which Florida Marine had

asserted a right of offset.    Florida Marine agreed to pay Trinity



     8
       The $2,320,000, which apparently does not include accrued
interest, represents eight deferred payments of $290,000 each,
with the earliest falling due on Aug. 18, 2003, and the latest on
Mar. 13, 2004. The remaining $5,700,000 of deferred payments
relates to barges delivered in 2001 pursuant to the second
contract. The record does not reveal the exact dates on which
these last-mentioned deferred payments fell due or more
particularly what portion of these withheld payments might have
fallen due in 2002.
     9
       The $2,200,000, which apparently does not include accrued
interest, represents 11 deferred payments of $200,000 each, with
the earliest falling due on Sept. 1, 2003, and the latest on Feb.
8, 2004. The record does not reveal why these deferred payment
amounts differ from the $290,000 deferred payments specified
under the second contract. The remaining $636,060 of deferred
payments relates to barges delivered in 2001 pursuant to the
second contract. The record does not reveal the exact dates on
which these last-mentioned deferred payments fell due or more
particularly what portion of these withheld payments might have
fallen due in 2002.
                                - 11 -

the remaining $617,400 balance over 12 months.10    Trinity further

agreed to repair specified barges sold to Florida Marine under

the first contracts.

Settlement Agreement With Flowers

          On April 28, 2005, Trinity and Flowers entered into a

settlement agreement.     Trinity agreed to repurchase certain

barges sold to Flowers under the first contracts and to pay

Flowers $5,764,000 in damages.     Flowers agreed to pay Trinity the

$8,020,000 it withheld under the second contract.     The settlement

agreement specified that this amount was to be offset by the

agreed-upon damages, resulting in a payment from Flowers to

Trinity of $2,256,000.

Income Tax Reporting

      Petitioner used the accrual method of accounting for all

relevant periods.     With respect to barges delivered under the

second contract in 2001, petitioner accrued the full amount of

the sales, including deferred payments, and reported these

amounts as income in 2001.11    With respect to barges delivered

under the second contract in 2002, however, petitioner reported


     10
       The record does not reveal why the $2,817,400 balance due
reflected in the settlement agreement differs from the $2,836,060
that the parties have stipulated Florida Marine withheld from
Trinity.
     11
       Petitioner subsequently made an informal claim with the
IRS to reduce its 2001 income, which the IRS denied. This claim
is not at issue in this case.
                               - 12 -

as income only the amounts received during 2002; it excluded the

$4,520,000 of deferred payments as to which Florida Marine and

Flowers asserted rights of offset.

Notice of Deficiency

     In the notice of deficiency respondent determined that

failure to accrue the deferred payments for the barges delivered

in 2002 under the second contract resulted in a $4,520,000

understatement of the affiliated group’s 2002 consolidated income

and a corresponding overstatement of the 2002 consolidated net

operating loss carryback claimed on petitioner’s    consolidated

return for the taxable year ending March 31, 1999.

                               OPINION

1.   Accrual Method of Accounting

     The primary issue is whether petitioner, as an accrual basis

taxpayer, was required to accrue in 2002 deferred payments for

barges that Trinity delivered under the second contract in 2002,

with respect to which the obligors claimed rights of offset for

damages allegedly arising with respect to barges that they had

previously purchased under the first contracts.

      Under the accrual method of accounting, income is generally

recognized when all the events have occurred that fix the right

to receive the income, and the amount of the income can be

determined with reasonable accuracy.     Secs. 1.446-1(c)(1)(ii)(A),

1.451-1(a), Income Tax Regs.   Consequently, “An accrual basis
                                - 13 -

taxpayer * * * must report income in the taxable year in which

the last event occurs which unconditionally fixes the right to

receive the income and there is a reasonable expectancy that the

right will be converted to money.”       Schlumberger Technology Co.

v. United States, 195 F.3d 216, 219 (5th Cir. 1999); see Charles

Schwab Corp. & Includable Subs. v. Commissioner, 107 T.C. 282,

292 (1996), affd. 161 F.3d 1231 (9th Cir. 1998).

     Trinity’s delivery of each barge to Flowers or Florida

Marine unconditionally fixed its right to receive the full

contract price under the second contract.      Absent the offset

claims by Flowers and Florida Marine, there would appear to be no

dispute that petitioner was required to accrue the full contract

price of each barge, including deferred payments, in the year of

delivery.   Indeed, that is the way petitioner reported its

consolidated income with respect to barges delivered under the

second contract in 2001, before Flowers and Florida Marine

asserted their offset claims.

     For barges delivered under the second contract in 2002, on

the other hand, petitioner accrued only the payments received

upon delivery and excluded the deferred payments.12      Petitioner


     12
       In the amended answer, filed after trial upon the
granting of respondent’s motion to conform pleadings to proof
pursuant to Rule 41(b), respondent asserts that petitioner
improperly changed its accounting method with respect to barges
delivered in 2002 pursuant to the second contract. Petitioner
                                                   (continued...)
                              - 14 -

contends that it was not required to accrue these deferred

payments in 2002 because of Florida Marine’s and Flowers’ claims

of rights to offset the deferred payments under the second

contract against damages allegedly arising under the first

contracts.   Petitioner relies upon a line of cases which stands

generally for the proposition that in certain circumstances an

accrual basis taxpayer need not accrue unpaid income if the

obligor disputes the validity of the claim.   See, e.g., N. Am.

Oil Consol. v. Burnet, 286 U.S. 417 (1932); Gar Wood Indus., Inc.

v. United States, 437 F.2d 558 (6th Cir. 1971); Cold Metal

Process Co. v. Commissioner, 17 T.C. 916 (1951), affd. per order

53-1 USTC par. 9135 (6th Cir. 1952); Jamaica Water Supply Co. v.

Commissioner, 42 B.T.A. 359 (1940), affd. 125 F.2d 512 (2d Cir.

1942); Ryan v. Commissioner, T.C. Memo. 1988-12, affd. sub nom.

Lamm v. Commissioner, 873 F.2d 194 (8th Cir. 1989); Breeze Corps.

v. United States, 127 Ct. Cl. 261, 117 F. Supp. 404 (1954).

     For instance, in Gar Wood Indus., Inc. v. United States,

supra, upon which petitioner places particular reliance, the

taxpayer manufactured equipment for the U.S. Army Corps of



     12
      (...continued)
replies that it did not change its method of accounting in 2002
because the dispute with the purchasers represented a change in
underlying facts within the meaning of sec. 1.446-1(e)(2)(ii)(b),
Income Tax Regs. Because we conclude that petitioner was
required to accrue the disputed income in 2002, it is unnecessary
to decide this issue.
                              - 15 -

Engineers (Corps).   The contracts contained “price

redetermination” clauses, which authorized renegotiation of the

contracts after partial performance.    Id. at 559.    When certain

of the contracts were nearing completion, the Corps, anticipating

a price redetermination, unilaterally began withholding amounts

otherwise due to the taxpayer under the contracts.      The pricing

dispute was resolved 2 years later.    The court held that the

taxpayer was not required to accrue the withheld amounts in the

year the withholding occurred because the taxpayer “never had a

fixed right to the full contract price” and the Corps’ refusal to

honor the contract price negated whatever right the taxpayer

otherwise had to receive the withheld amounts.     Id. at 561.

Similarly, all the other cases upon which petitioner relies

involve situations in which obligors disputed the fact or amount

of their liability with respect to the item to be accrued.

     By contrast, insofar as the record shows, neither Flowers

nor Florida Marine ever disputed the fact or amount of its

obligation to Trinity under the second contract.      To the

contrary, their filings in the commercial litigation expressly

acknowledged their obligations to Trinity under the second

contract and indicated that they were setting the withheld

amounts aside in “escrow” or as “collateral security” to offset

whatever damages Trinity might ultimately be determined to owe

them with respect to their claims under the first contracts.
                               - 16 -

     In Commissioner v. Hansen, 360 U.S. 446 (1959), the Supreme

Court considered a somewhat analogous situation in which buyers

withheld a portion of the sales price to satisfy potential claims

against the taxpayer seller.   More particularly, in Hansen auto

dealers entered into a financing arrangement whereby they sold

customers’ installment notes to finance companies, which withheld

a portion of the purchase price as security to cover possible

losses on the notes.   The Supreme Court held that the auto

dealers were required to accrue the withheld amounts as income

when the notes were sold.   The Court rejected the dealers’

argument that accrual was excused by their present inability to

compel the finance companies to pay them the reserved amounts.

“[T]he question is not whether the taxpayers can presently

recover their reserves, for * * * it is the time of acquisition

of the fixed right to receive the reserves and not the time of

their actual receipt that determines whether or not the reserves

have accrued and are taxable.”    Id. at 464.

     The Court noted that although the reserves were subject to

being offset by the dealers’ contingent liabilities to the

finance company, “only the obligations * * * arising from those

liabilities may be offset against a like amount in the dealer’s

reserve account.”   Id. at 465.   Consequently, the Court reasoned,

any use of the reserves in paying those obligations would amount

to the dealers’ receiving something of value.   The Court stated:
                                 - 17 -

“In any realistic view we think that the dealer has ‘received’

his reserve account whether it is applied, as he authorized, to

the payment of his obligations to the finance company, or is paid

to him in cash.”   Id. at 466.    The Court concluded that the

dealers must contemporaneously accrue the withheld amounts, even

if those funds were not available for paying the resulting tax

liability, stating:   “it is a normal result of the accrual basis

of accounting and reporting that taxes frequently must be paid on

accrued funds before receipt of the cash with which to pay them”.

Id. at 466-467; see also Stendig v. United States, 843 F.2d 163

(4th Cir. 1988) (requiring the taxpayer to accrue rents received

from its apartment complex, including a portion that was

deposited into reserve accounts to secure the maintenance and

operation of the complex); Clark v. Woodward Constr. Co., 179

F.2d 176 (10th Cir. 1950) (requiring the taxpayer to accrue

income from highway construction contracts when the State

accepted the work, notwithstanding a contractual provision which

permitted the State, after accepting the work, to withhold 15

percent of the contract price pending publication of statutory

notice to any claimants against the taxpayer).

     The instant case presents a stronger argument, we believe,

for requiring accrual of income than Commissioner v. Hansen,

supra, or the other cases just cited.     Unlike these other cases,

the instant case does not involve any question as to whether the
                              - 18 -

right to receive income was vitiated by a contractual provision

for withholding a portion of the sales price.   Rather, as

previously discussed, under the second contract petitioner had a

fixed and absolute right to the deferred payments as soon as each

barge was delivered.   Pursuant to the claims of offset asserted

by Flowers and Florida Marine, the withheld payments were to be

applied only in satisfaction of Trinity’s or petitioner’s alleged

obligations to them arising under the first contracts.

Petitioner effectively received the withheld amounts when,

pursuant to the settlement agreement, they were applied in

compromise of Flowers’ and Florida Marine’s claims.    In the final

analysis, then, the offset claims affected only the timing of

petitioner’s receipt of income under the second contract and not

its right to receive the income.

      Petitioner’s contentions might be broadly construed as

turning upon doubts as to the collectibility of Flowers’ and

Florida Marine’s debts for the deferred payments.   Petitioner

does not contend that it is entitled to a bad debt deduction with

respect to these debts and has offered no proof that the debts

were wholly or partially worthless so as to meet the requirements

under section 166 for claiming a bad debt deduction.

Nevertheless, petitioner seems to suggest broadly that, apart

from any question about deductions, doubts about the

collectibility of the debts justify postponing the accrual of the
                              - 19 -

income.   In Spring City Foundry Co. v. Commissioner, 292 U.S.

182, 184 (1934), the Supreme Court squarely rejected such a

contention as having “no merit”.   The Court stated:

     Keeping accounts and making returns on the accrual
     basis, as distinguished from the cash basis, import
     that it is the right to receive and not the actual
     receipt that determines the inclusion of the amount in
     gross income. When the right to receive an amount
     becomes fixed, the right accrues. * * *

     * * * If such accounts receivable become uncollectible,
     in whole or part, the question is one of the deduction
     which may be taken according to the applicable statute.
     * * * That is the question here. It is not altered by
     the fact that the claim of loss relates to an item of
     gross income which had accrued in the same year. [Id.
     at 184-185.]

     Pursuant to these principles, an accrual basis taxpayer

generally must accrue income once the all-events test is

satisfied, even though payment may be postponed until a

subsequent year.   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).   As a limited exception to this rule, accrual may not be

required if the income was of doubtful collectibility or it was

reasonably certain that it would not be collected as of the time

the taxpayer’s right to receive the income arose.      Harmont Plaza,

Inc. v. Commissioner, supra at 649-650; Atl. Coast Line R.R. v.

Commissioner, 31 B.T.A. 730, 751 (1934), affd. 81 F.2d 309 (4th
                               - 20 -

Cir. 1936).13   The income-accrual exception is narrowly applied

so not to “be allowed to swallow up the fundamental rule upon

which it is engrafted” requiring accrual.    Georgia School-Book

Depository, Inc. v. Commissioner, supra at 469.    The exception

has typically been applied where the debtor is “insolvent or in

fact bankrupt.”    Harmont Plaza, Inc. v. Commissioner, supra at

650.

       Petitioner does not contend and the evidence does not show

that Flowers or Florida Marine was insolvent or bankrupt or that

the collectibility of their debts was otherwise called into

question by their respective financial conditions.    In any event,

Flowers and Florida Marine asserted their claims of offset only

after the barges were delivered under the second contract and

petitioner’s right to the income had become fixed.    In fact,

insofar as the record shows, Florida Marine did not assert its


       13
       Under this exception, “the fact that the obligation later
became worthless in part, even though within the same taxable
year is * * * immaterial”. Atl. Coast Line R.R. v. Commissioner,
31 B.T.A. 730, 751 (1934), affd. 81 F.2d 309 (4th Cir. 1936). At
first blush there may appear to be some tension between this
statement and a statement in a Memorandum Opinion of this Court
that the income-accrual exception 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.” Elec. Controls & Serv. Co. v. Commissioner, T.C.
Memo. 1996-486. In that case, however, the Court held that
nonaccrual of certain contract payments was permitted in part
because of the contingent nature of the taxpayer’s right to
receive the payments. By contrast, petitioner’s right to receive
the deferred payments under the second contract was unconditional
and fixed upon delivery of the barges.
                               - 21 -

offset claims until March 2003, after the close of the taxable

year in which petitioner’s right to the income under the second

contract had arisen.    In these circumstances, postponing accrual

of the income is not justified.

     In conclusion, in 2002 petitioner was required to accrue the

deferred payments due on the barges delivered that year under the

second contract.

2.   Deductibility of Withheld Payments Under Section 461(f)

     Alternatively, petitioner claims that pursuant to section

461(f) it is entitled to deduct $4,520,000 in 2002 on the ground

that it “transferred” this amount to Flowers and Florida Marine

in satisfaction of their disputed claims for damages with respect

to allegedly defective barges that Trinity delivered under the

first contracts.

     An accrual basis taxpayer generally may take a liability

into account only in the taxable year in which all events have

occurred to allow the fact and amount of the liability to be

determined with reasonable accuracy and economic performance has

occurred with respect to the liability.    Sec. 1.461-1(a)(2),

Income Tax Regs.   If a liability is contingent on the outcome of

a contested lawsuit, then it generally may not be taken into

account until the dispute is resolved.    See Willamette Indus.,

Inc. v. Commissioner, 92 T.C. 1116, 1121 (1989), affd. 149 F.3d

1057 (9th Cir. 1998).    Section 461(f) provides a limited
                              - 22 -

exception to this general rule by permitting a taxpayer to deduct

a contested liability, provided the taxpayer has transferred

assets in the same tax year to satisfy the claimed liability.

Section 461(f) provides in relevant part:

          SEC. 461(f).   Contested Liabilities. -If-

               (1) the taxpayer contests an asserted liability,

               (2) the taxpayer transfers money or other property
          to provide for the satisfaction of the asserted
          liability,

               (3) the contest with respect to the asserted
          liability exists after the time of the transfer, and

               (4) but for the fact that the asserted liability
          is contested, a deduction would be allowed for the
          taxable year of the transfer * * * (or for an earlier
          taxable year) * * *

          then the deduction shall be allowed for the taxable
          year of the transfer. * * *

The burden of proof is on petitioner to show that it satisfies

all four requirements of section 461(f).    See Rule 142; Davies v.

Commissioner, 101 T.C. 282, 286 (1993).

     The parties disagree primarily as to whether petitioner

meets the second requirement listed above that there be a

transfer of money or other property in satisfaction of the

asserted liability.   Petitioner contends that it transferred

property to Flowers and Florida Marine “when Flowers and Florida

Marine withheld payment under the Second Contract as an offset

against their alleged damages”.   The record shows, however, that

the $4,520,000 of deferred payments as to which petitioner claims
                               - 23 -

a deduction came due under the second contract in 2003 and 2004.

Flowers and Florida Marine cannot meaningfully be said to have

withheld the deferred payments before they came due.    At most,

Flowers and Florida Marine threatened in 2002 to withhold the

deferred payments, although as previously discussed the record

does not establish that Florida Marine even asserted its offset

claim before 2003.

     Section 461(f) allows a deduction only for “the taxable year

of the transfer.”    Consequently, even if we were to agree with

petitioner that the withheld payments represented transfers of

funds to Flowers or Florida Marine, we would conclude that the

transfers occurred in 2003 and 2004, so that petitioner would not

be entitled to the claimed deduction under section 461(f).14

     More fundamentally, we disagree with petitioner’s contention

that the withholding of the deferred payments by Flowers and

Florida Marine represented a transfer by petitioner within the

meaning of section 461(f).    The regulations require that the

taxpayer transfer “money or other property beyond his control




     14
       The record does not clearly establish what amount, if
any, of deferred payments Flowers or Florida Marine might have
withheld in 2002 with respect to barges delivered in 2001.
Consequently, if we were to construe petitioner’s claim, contrary
to petitioner’s own articulation of it, as encompassing amounts
withheld by Flowers or Florida Marine in 2002 with respect to
barges delivered in 2001, we would conclude that petitioner’s
claim must fail by virtue of its failure to carry its burden to
prove the amount of payments withheld in 2002.
                              - 24 -

* * *. * * *   In order for money or other property to be beyond

the control of a taxpayer, the taxpayer must relinquish all

authority over such money or other property.”   Sec. 1.461-

2(c)(1), Income Tax Regs.   As a necessary corollary, and as

common sense dictates, before a taxpayer may transfer money or

other property beyond its control or authority, it first must

have the money or other property within its control or authority.

     Obviously, the deferred payments were not in petitioner’s

control or authority, at least not so long as Flowers and Florida

Marine withheld them.   By withholding the deferred payments,

Flowers and Florida Marine merely perpetuated their own control

over these funds.   Although, as previously discussed, Trinity

possessed contractual rights to the withheld payments sufficient

to require accrual of the income, neither Trinity nor petitioner

relinquished those rights, at least not in 2002, but instead

vigorously disputed the claimed rights of offset.

     In contending that the withheld payments constituted a

transfer within the meaning of section 461(f), petitioner relies

upon Chernin v. United States, 149 F.3d 805 (8th Cir. 1998).

Petitioner’s reliance is misplaced.    In Chernin, the court held

that a transfer was accomplished within the meaning of section

461(f) by a court-issued writ of garnishment that forced the

taxpayer to transfer funds owed to him as compensation.   The

court reasoned that the writ of garnishment “shifted actual
                              - 25 -

control over the funds from the taxpayer to the garnishees”.    Id.

at 810.   By contrast, in 2002 there was no court-issued writ or

other order of any competent legal authority to force Trinity to

transfer funds owed to it.

     In sum, we conclude and hold that in 2002 petitioner did not

transfer money or other property in satisfaction of Flowers’ and

Florida Marine’s asserted liabilities and consequently is

entitled to no deduction pursuant to section 461(f).

     To reflect the foregoing and the parties’ stipulation of

settled issues,


                                         Decision will be entered

                                    under Rule 155.
