Tax Court addresses claim of offset against deferred payments.

• Author: Hanway, Kurt R.

In a Tax Court case published on January 28, 2009, Trinity Industries, Inc., 132 T.C. No. 2, the court required the taxpayer to accrue in income, in the year it is earned, the total contract price for the sale of barges--including amounts withheld by customers against deferred payments because of a commercial contract dispute. The taxpayer (Trinity) treated the withheld amounts as nonaccruable. In addition, the Tax Court denied Trinity's deduction of the withheld amount as a Sec. 461(f) contested liability because Trinity failed to transfer money for the satisfaction of the liability.

Facts

Trinity, an accrual-method taxpayer, entered into a series of contracts with two customers in the late 1990s to provide barges. Trinity generally recognized revenue upon the delivery date of the barges. In 2000, Trinity entered into a second contract with the customers to provide additional barges for a contract price of $1.29 million: $1 million was due upon acceptance of the barge and the remainder was due within 18 months of delivery. Trinity delivered the barges under the second contract in 2001 and 2002.

After execution of the second contract, the customers complained to Trinity that the coatings of the first barges were defective and caused the barges to rust. Trinity denied any liability. Starting in 2002, the customers filed lawsuits, including petitions to exercise their common law right of offset by deducting damages from the first contract barges against deferred amounts owed for the second contract barges. Trinity ultimately entered into settlement agreements with both customers.

For barges delivered in 2001, Trinity recognized as income the full amount of the sales, including the deferred payments. For barges delivered in 2002, Trinity recognized only the amounts received in 2002, excluding the deferred payments against which the two customers asserted rights of offset.

Issue

The primary issue was: Is Trinity, an accrual-method taxpayer, required to accrue in 2002 deferred payments for barges it delivered in 2002 under the second contract and for which the customers claimed rights of offset for damages arising from the barges previously purchased under the first contract? A secondary issue was: Could Trinity deduct in 2002 the payments withheld by the customers as Sec. 461(f) contested liabilities?

Analysis

The IRS contended that Trinity's delivery of the barges under the second contract unconditionally fixed its right to receive the full...