22 T.C. 781 (1954)

A taxpayer may be entitled to relief under Internal Revenue Code §722 if they can demonstrate that their base period earnings were depressed due to temporary economic circumstances that were unusual for the taxpayer’s business and caused an inadequate standard of normal earnings, such as an extended drought.

Summary

Morrow-Thomas Hardware Company (Petitioner) sought relief from excess profits taxes, claiming their base period earnings were depressed due to drought and dust storms, unusual in their trade territory. The U.S. Tax Court determined that the Petitioner’s business was indeed affected by the drought. However, the court also determined that the Petitioner’s business and sales volume was higher than that of the previous 4 years. The court determined that the Petitioner was not entitled to the higher constructie average base period net income because of the inability to prove that its sales decreased or that its expenses increased because of the weather. The court ultimately granted the Petitioner relief and a constructie average base period net income by an amount that factored in lost sales due to the weather, which it estimated as $25,000.

Facts

Morrow-Thomas Hardware Company, a wholesale and retail hardware business in Amarillo, Texas, claimed relief from excess profits taxes, citing depressed earnings during its base period due to an extended drought and dust storms in the 1930s. The business’s operations, primarily serving the farming and ranching sectors, were negatively impacted by the weather conditions. The Commissioner of Internal Revenue denied the relief. The company’s base period covered the years 1936 through 1939. The company had a retail business and a wholesale business.

Procedural History

The taxpayer filed claims for relief and refund, which were denied by the Commissioner. The taxpayer then brought the case to the U.S. Tax Court.

Issue(s)

1. Whether the petitioner’s business was depressed during the base period due to temporary economic circumstances unusual to it within the meaning of § 722(b)(2) of the Internal Revenue Code?

2. Whether the petitioner’s average base period net income is an inadequate standard of normal earnings?

3. Whether the petitioner was entitled to a fair and just amount representing normal earnings to be used as a constructive average base period net income.

Holding

1. Yes, because the prolonged drought, crop failures, and dust storms created temporary economic circumstances unusual in the taxpayer’s trade territory.

2. Yes, because the drought and dust storms meant the petitioner’s average base period earnings were not an adequate measure of its normal earning potential.

3. Yes, because the court could estimate a fair and just amount of normal earnings for the taxpayer based on evidence presented to it.

Court’s Reasoning

The Tax Court applied § 722 of the Internal Revenue Code to determine whether the taxpayer was entitled to relief from excess profits taxes. The court examined the facts to determine if the taxpayer’s average base period net income was an inadequate standard of normal earnings. The court found that the drought and dust storms constituted unusual temporary economic circumstances. The court found the petitioner’s base period sales volumes to be higher than in any other four consecutive year period, which is why it was not entitled to the increased constructive average base period net income. In determining the amount of relief, the court looked at what sales the taxpayer lost and factored that lost sales into its calculations.

Practical Implications

This case is significant because it shows when a taxpayer may be entitled to excess profits tax relief under the I.R.C. § 722. Legal practitioners should be mindful of the following:

• The court’s willingness to consider the impact of unusual economic conditions on a taxpayer’s earnings.
• The importance of providing evidence to demonstrate the connection between the economic conditions and the business’s performance.
• The fact that the taxpayer has the burden of proof to establish the amount of a fair and just amount of income.