Rev. Rul. 69-314

Advice has been requested as to when amounts withheld from a builder of small boats, pending completion and acceptance of the contract, are to be included in income under an accrual method of accounting.

Under contracts entered into by the taxpayer and the United States Government, 10 percent of the amounts billed on each boat until 50 percent complete is retained by the Government. Thereafter, no further amounts are withheld so that the overall retainage applicable to each boat amounts to five percent. As each boat is delivered and accepted, 40 percent of the retainage applicable to such boat is payable to the taxpayer. The remaining 60 percent of the retainage is not payable to the taxpayer until all boats specified in the particular contract are delivered and accepted.

Section 1.451-1(a) of the Income Tax Regulations provides that under an accrual method of accounting, income is includible in gross income when all the events have occurred that fix the right to receive such income and the amount thereof can be determined with reasonable accuracy.

In Charles F. Dally v. Commissioner, 20 T.C. 894 (1953), acquiescence, C.B. 1954-1, 4, affirmed on another issue, 227 F. 2d 724 (1955), certiorari denied, 351 U.S. 908 (1956), the taxpayer, reporting income on the accrual method of accounting, contracted with the Government in 1942 to manufacture and deliver housing units. Performance of the contract was completed in 1943. As provided by the contract, payments were made on the basis of properly certified periodic estimates of completed units. In addition, the contract provided that 10 percent of each payment was to be retained until all construction work on all housing units was finished and finally accepted by the Government. Estimates submitted in 1942 showed that the contract was 86.7 percent completed in that year. Under these facts, the court held that the taxpayer did not have to accrue in 1942 an amount equal to 10 percent of the estimates submitted in that year because the right to this amount "did not and could not ripen" until 1943 when all of the taxpayers' work was finished and finally accepted by the Government. See also D. Allan Harmon v. United States, 205 F. 2d 919 (1953).

In the present case, all events that fix the taxpayer's right to receive 40 percent of the retainage applicable to each boat do not occur until each boat is accepted. Similarly, all events that fix the taxpayer's right to receive the remaining 60 percent of the retainage do not occur until final acceptance of all boats specified in the particular contract. Accordingly it is held that the taxpayer is not required to include in income 40 percent of the retainage applicable to each boat until final acceptance of such boat occurs, and he is not required to include in income the remaining 60 percent of the retainage until final acceptance of all boats specified in the particular contract occurs.

In order to change to the above method of treating the retainages under an accrual method of accounting, a taxpayer must, under section 1.446-1(e)(3) of the regulations, obtain the prior consent of the Commissioner of Internal Revenue by filing an application for change in accounting method on Form 3115, Application for Change in Accounting Method, within 90 days after the beginning of the taxable year in which the change is to be made.