Opinion
Docket No. 4288.
1945-09-19
ESTATE OF S. W. ANTHONY, DECEASED, GORDON MORRIS, LES M. HENDERSHOT, AND THE FIRST NATIONAL BANK AND TRUST COMPANY OF TULSA, CO-EXECUTORS, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
Roger S. Randolph, Esq., for the petitioners. Owen W. Swecker, Esq., for the respondent.
Roger S. Randolph, Esq., for the petitioners. Owen W. Swecker, Esq., for the respondent.
The decedent and X each owned an undivided interest in an oil lease. The purchaser of the oil impounded decedent's share of the proceeds after a lien was placed thereon by X because of a dispute with decedent resulting in litigation as to decedent's share of development and operating costs. In 1937 decedent gave his interest in the lease and in the impounded income to his brother. Held, the executors of decedent-donor, who was on the cash basis, received taxable income in 1940 when the litigation was terminated and the income released.
The Commissioner determined a deficiency in income tax for the year 1940 in the amount of $4,059.38. The question presented for our determination is whether petitioners are taxable on impounded oil income released in 1940 which decedent gave to his brother in 1937 after it was impounded.
FINDINGS OF FACT.
The facts are found as stipulated.
Petitioners are coexecutors of the estate of S. W. Anthony, deceased, having been so appointed by the County Court of Creek County, State of Oklahoma, on February 14, 1944. S. W. Anthony, the decedent, formerly a resident of Mounds, Oklahoma, died on January 17, 1944.
The decedent's books and records during the calendar years 1936 to 1940, inclusive, were kept on the cash basis and his income tax return for each of those years was filed on the cash basis with the collector of internal revenue for the district of Oklahoma.
On July 22, 1936, decedent acquired an oil and gas mining lease covering an undivided one-half interest in premises located in Creek County, Oklahoma. On August 19, 1936, Klingensmith Oil Co. (hereinafter referred to as Klingensmith) acquired an oil and gas mining lease covering the other undivided one-half interest in the premises. On September 6, 1936, without consulting with decedent or obtaining his consent, Klingensmith commenced the drilling of an oil well on the premises. The well was completed September 26, 1936, and was productive. It, therefore, was necessary to find a purchaser for the oil and gas produced therefrom. Klingensmith made arrangements for the Texas Co. to purchase the oil and gas, and decedent and Klingensmith signed a division order dated September 29, 1936, authorizing the Texas Co. to purchase all oil and gas produced from the premises. Thereafter, Klingensmith drilled four additional wells on the premises, the last one being completed on March 18, 1937. The Texas Co. purchased currently all oil and gas produced from the premises.
Klingensmith drilled all five wells without reaching an understanding with decedent as to what portion, if any, of the development equipment, and operating costs decedent was to pay. When the first well proved to be productive, Klingensmith claimed that decedent should pay one-half of all such costs and furnished decedent with an itemized statement of all costs applicable to the first well. Decedent refused to pay any part of such costs because in his opinion they were excessive. Klingensmith, therefore, in order to protect its claim, filed a lien with the Texas Co. This lien was filed on November 30, 1936, and before the Texas Co. had paid anything to decedent on account of its purchases of oil and gas from the premises. This lien covered decedent's entire interest in the premises. Accordingly, the Texas Co. impounded all moneys acquiring to the interest of decedent.
For the period beginning with initial production from the premises and ending on April 20, 1937, there was purchased by the Texas Co. $31,175.09 of oil and gas produced from decedent's interest in the premises. This entire amount was impounded by the Texas Co. by reason of the lien. Klingensmith claimed that during this period it had expended on decedent's behalf and that decedent owed it the following amounts:
+---------------------------+ ¦For development ¦$14,112.31¦ +----------------+----------¦ ¦For equipment ¦8,721.65 ¦ +----------------+----------¦ ¦For operating ¦4,108.48 ¦ +----------------+----------¦ ¦Total ¦26,942.44 ¦ +---------------------------+
Decedent denied that he owed any of these amounts.
On April 20, 1937, and prior to the time that anything had been paid to or received by him, decedent assigned by gift all of his interest in the premises to his brother, Frank A. Anthony of Nodaway County, Missouri. The assignment included all amounts impounded by the Texas Co. and it stated that:
* * * in consideration of One Dollar and other good and valuable considerations, the receipt of which is hereby acknowledged, the undersigned, the present owner of said lease and all rights thereunder or incident thereto, does hereby bargain, sell, transfer, assign and convey all right, title and interest of the original lessee and the present owner in and to said lease and rights thereunder, together with all personal property used or obtained in connection therewith, and together with all of the interest of the said S. W. Anthony in and to the oil produced from said lease-hold estate or the proceeds thereof, or the gas produced from said lease-hold estate, now in the hands of the Texas Company, a corporation, or which may be now or hereafter come into the hands or possession of any other corporation or person; subject however to any lawful claim of the Klingensmith Oil Company for and in connection with its operations on said lease-hold estate, to Frank A. Anthony, of Nodaway County, State of Missouri.
This gift was reported in the decedent's 1937 gift tax return at a net value of $46,396.33 and gift tax was paid thereon. The valuation was arrived at in the following manner:
+--------------------------------------------------------------+ ¦Actual value of oil and gas sales to April 20, 1937¦$31,175.09¦ +---------------------------------------------------+----------¦ ¦Estimated value thereafter ¦39,111.11 ¦ +---------------------------------------------------+----------¦ ¦Value of equipment ¦3,052.57 ¦ +---------------------------------------------------+----------¦ ¦Total ¦73,338.77 ¦ +---------------------------------------------------+----------¦ ¦Less claim of Klingensmith ¦26,942.44 ¦ +---------------------------------------------------+----------¦ ¦Net value ¦46,396.33 ¦ +--------------------------------------------------------------+
On December 18, 1938, and prior to the time that anything had been paid to or received by him by reason of the assignment dated April 20, 1937, Frank A. Anthony assigned by gift three-fourths of his interest in the premises. Klingensmith continued to operate the premises, but no agreement was reached between Klingensmith and Frank A. Anthony or his assignees with regard to the charges for development, equipment, and operating costs applicable to the one-half interest assigned by the decedent.
On September 21, 1939, Klingensmith filed a petition in the District Court of Creek County, Oklahoma, against decedent, Frank A. Anthony, Veva Lindsey, Ruby F. Anthony (and as trustee), and the Texas Co., as defendants. In this petition Klingensmith claimed that it had spent on behalf of the decedent and his assignees up to September 1, 1939, the sum of $39,283.08 (which included interest computed monthly on statements previously rendered), and asked judgment for this amount and asked the court to enter an order restraining the Texas Co. from paying the impounded funds to any of the defendants. On September 21, 1939, the court issued a temporary restraining order. On September 29, 1939, the decedent filed in the proceeding a disclaimer wherein he stated that he disclaimed any interest in and to the premises or to the proceeds therefrom in the hands of the Texas Co., and requested that the action be dismissed as to him. Upon motion of certain of the defendants, the case was removed to the United States District Court for the Northern District of Oklahoma under date of October 4, 1939. On October 10, 1939, the Texas Co. answered that it had been withholding payment of all proceeds applicable to decedent's interest by reason of the decedent's letter to it dated December 21, 1936, and that:
* * * in view of the written advice given this defendant by the defendant S. W. Anthony in said letter which was received by it at or about the time it received the said division order signed by said defendant S. W. Anthony, and in view of the institution and pendency of this action and of the allegations and prayer contained in plaintiff's petition, this defendant is unable to determine who is entitled thereto and will, therefore, hold the same until the further order of this Court.
On November 4, 1939, Klingensmith dismissed the action in so far as it applied to the decedent. On January 22, 1940, the remaining defendants answered and denied that $39,283.08 was the correct amount of one-half of the actual cost of developing, equipping, and operating the premises, claimed that this amount was excessive, and requested that the restraining order be set aside and that a special master be appointed to take an accounting between the parties. Subsequently the parties adjusted their differences and agreed that there was due to the plaintiff the sum of $32,500. Accordingly, judgment was entered on March 4, 1940, ordering that the Texas Co. pay this amount to Klingensmith out of the impounded funds held by it, and ordering that all remaining impounded funds be paid to Frank A. Anthony and his assigns. This was done by the Texas Co. in March 1940. Accordingly, in March 1940 Frank A. Anthony and his assigns received from the Texas Co. the $31,175.09 (less the applicable costs of development, equipment, and operation) which had been impounded for the period ending on April 20, 1937.
Respondent determined that the decedent was subject to income tax in 1940 on $8,822.81 from this source, computed as follows:
+-------------------------------------------------------------------------+ ¦Income received ¦$31,175.09¦ +--------------------------------------------------------------+----------¦ ¦Less operating and development expense withheld ¦14,010.46 ¦ +--------------------------------------------------------------+----------¦ ¦Balance ¦17,164.63 ¦ +--------------------------------------------------------------+----------¦ ¦Less depreciation ¦480.99 ¦ +--------------------------------------------------------------+----------¦ ¦ ¦16,683.64 ¦ +--------------------------------------------------------------+----------¦ ¦50% of net income from the property ¦8,341.82 ¦ +--------------------------------------------------------------+----------¦ ¦27 1/2% depletion ¦8,573.15 ¦ +--------------------------------------------------------------+----------¦ ¦Depletion allowable, sec. 114 (b) (3) of Internal Revenue Code¦8,341.82 ¦ +--------------------------------------------------------------+----------¦ ¦Taxable net income ¦8,822.81 ¦ +-------------------------------------------------------------------------+
OPINION.
HILL, Judge:
The petitioners ably epitomized the case as follows:
A and K each owned an undivided interest in an oil lease. During 1936 and 1937 all proceeds from the sale of A's oil were impounded by The Texas Company because of a dispute between A and K which resulted in litigation. On April 20, 1937, A irrevocably assigned his interest in the lease and in all impounded income to F. The impounded net income up to April 20, 1937, amounted to $8,822.81. In 1940 the $8,822.81 was released by The Texas Company and paid to F.
Question: Is the $8,822.81 taxable in 1940 to A, who is on the cash basis?.
Petitioners rely on Estate of H. H. Timken, 47 B.T.A. 494; affd., 141 Fed.(2d) 625, as controlling. That case is not in point. In 1931 the decedent there, H. H. Timken, and his two sisters loaned to their brother, W. R. Timken, $3,000,000 in cash and securities and took his promissory note therefor, due one year after date. W. R. Timken did not pay the note at maturity and defaulted on interest payments on and after April 30, 1932. Accrued and unpaid interest amounted to $476,539.87 as of January 1935. On January 24, 1935, the decedent and his sisters, by deed of gift, conveyed their interests in the loan to the Timken Foundation. In December 1936 a compromise settlement of the debt was made between the foundation and W. R. Timken. The Commissioner's contention was that the decedent's share of the accrued interest was taxable income to him in 1935, or else in 1936 and 1937, when the compromise settlement and payments were made. By a divided court, we held that the decedent did not realize taxable income to the extent that the accrued interest was paid, either in 1935, when the gift was made, or in 1936 and 1937, when the interest was paid. W. R. Timken was unable to pay the interest at any time prior to the assignment by decedent. If we consider the tree to be the capital asset which gives rise to the fruit, the tree had there produced no fruit at the time of the gift and was unable to do so. Here, on the other hand, with the oil lease or property considered as the tree, the fruit had been produced and ripened on the tree but was kept from decedent, the then owner of the tree, by an intervening force. The income had already arisen from the property prior to the assignment of both the property and the income. Decedent was the owner of the property when it produced the income. He was prevented from receiving the income only because an intervener, separate and apart from the income-producing property, namely, his creditor Klingensmith, had caused a lien to be placed on the property and the income therefrom in order to ensure the payment of the debt. The assignment of merely the oil lease by decedent would not carry with it the oil or its proceeds produced prior thereto and held for decedent by the Texas Co. as a stakeholder. 2 Thornton, Oil and Gas, 5th Ed., sec. 401. McGuire v. Wright, 18 W.Va. 507. The decedent was evidently aware of this when he specifically assigned his rights to the impounded income as well as his rights in the oil lease:
* * * the present owner of said lease * * * does hereby * * * assign and convey all right, title and interest of the original lessee and the present owner in and to said lease and rights thereunder, * * * together with all of the interest of the said S. W. Anthony in and to the oil produced from said lease-hold estate or the proceeds thereof, or the gas produced from the said lease-hold estate, now in the hands of theTexas Company, * * * (Emphasis supplied.)
The entire basis of our opinion in the Timken case was that the debtor was unable to pay the interest at the date of the gift. In other words, the tree itself was unable to produce the fruit. As we there said:
* * * If by some fortuitous circumstance the debtor becomes able to pay the interest in a later year and pays it, we think that it constitutes income of the donee and not of the donor. * * *
This is far different from the instant case, where the tree has seasonably produced the fruit and it is impounded pending the outcome of a dispute between the owner of the tree and his creditor. When the owner then gives the tree away along with the ripened fruit which is kept from his enjoyment only by a lien placed on it by his creditor, he must be said to have realized income when the lien is removed. The fruit was ‘as effectively gathered by the owner of the tree as if he had plucked the fruit himself.‘ Estate of Bertha May Holmes, 1 T.C. 508. This is fruit produced by the tree in a prior season and stored or impounded for the use of the owner of the tree, either directly or for his use indirectly, in satisfying the claim of his creditor.
Unlike the Timken case, the income here was produced and earned by the capital asset while the donor still owned it. The situation may be brought into better focus by considering a hypothetical case wherein the facts are the same except that the donor assigns the impounded earnings to X and the lease to Y. The earnings, having been produced and impounded prior to the gift, can not be attributed to the lease while in the hands of Y. The lease was intact when given to Y, but the fruit of earlier years had already been separated from it. Nor may the earnings be attributed to X, for he does not own the tree. The fruit was produced and earned while the donor owned the tree. As stated in 2 Mertens, Law of Federal Income Taxation (1942), Sec. 18.02, in discussing the rationale of Helvering v. Horst, 311 U.S. 112:
* * * It is true that the majority opinion gives lip-service to the distinction previously drawn in earlier cases between an assignment of income and one of corpus but it should be noted that the Court really emphasizes the distinction between income subsequently earned on property previously acquired by the assignee, such as rent from a lease or a crop raised on a farm after the leasehold or the farm had been given away, and the separate transfer of the right to interest or wages previously accrued or earned, the distinction being premised primarily on the ground that the dominant purpose of the revenue law is the taxation of income to those who earned or otherwise created the right to receive it or to enjoy the benefit of it when paid.
Reviewed by the Court.
Decision will be entered for respondent. SMITH, J., dissenting: It seems to me that it is a cardinal principle of the income tax law that a man making his returns on a cash basis is liable to income tax upon only the income which he receives during the taxable year. Where a man has given away property the donee is taxable upon income which he receives on the gift. In 1937 the petitioner gave to his brother all of his right, title, and interest in and to a certain oil lease, together with impounded royalties. If he received taxable income upon any part of the impounded royalties it seems to me he received that income in 1937— the year of the gift. If satisfaction from the making of the gift is to be treated as income, that satisfaction was realized by S. W. Anthony in 1937. He received nothing in 1940 either in the form of impounded royalties or in satisfaction for his gift. The amount received by the donee in 1940 is not logically the income of the donor. Would it be held that if the donor had died in 1938 and possibly the administration of the estate closed prior to 1940, that the estate derived taxable income in 1940 because it was in that year that the donee collected the impounded royalties? Such a doctrine seems to me to do violence to sound principles of taxation.
It should be noted that in the instant case it was not known in 1937 what the amount of the impounded royalties belonging to S. W. Anthony was. It was not an account settled. No one received income from the impounded royalties until the account was settled, and that was not until 1940.
Estate of Bertha May Holmes, 1 T.C. 508 (C.C.A., 2d Cir.); petition for review dismissed Jan. 25, 1945), is cited as authority for the conclusion reached in the majority opinion. There the owner of certain shares in a building and loan association gave the shares away, together with certain credited accumulated dividends thereon, to her son and daughter fifteen days prior to the maturity date of the shares. The accumulated income was received by the donees shortly after the date of the gift and all within the same taxable year. We held that the donor was taxable on so much of the dividends as had been credited to the shares prior to the time of the gift. In support of our decision we cited Helvering v. Horst, 311 U.S. 112. See also Helvering v. Eubank, 311 U.S. 122. In the last named case it was held that a person who had earned the right to receive renewal commissions was taxable upon those renewal commissions even though before the date of the receipt of them such person had made a gift of his right to receive them to his wife.
I do not think that Estate of Bertha May Holmes, supra, and Helvering v. Horst, supra, are authority for holding that a donor is taxable upon the income of a gift in a year subsequent to the year of the gift; for the satisfaction for the gift came in the year in which the gift was made. It seems to me also that it is a far cry from the situation presented here to that presented in Helvering v. Eubank, supra; for under section 22(a) of the Internal Revenue Code a man is taxable upon ‘gains, profits, and income derived from salaries, wages, or compensation for personal service, of whatever kind and in whatever form paid.‘
In my opinion the amount received by the donee in 1940 was income taxable to him; it was the fruit garnered by him. Since S. W. Anthony received no part of the impounded royalties in 1940 or any satisfaction in 1940 from the gift made by him in 1937, I think it is error to hold that he is taxable upon any part of the income received by the donee in 1940.