Opinion
Docket Nos. 23880 23881.
1951-03-26
FLOYD H. BROWN AND KATIE LOU D. BROWN, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.FLOYD H. BROWN, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
J. C. Smith, Esq. and C. L. Brooke, C.P.A., for the petitioners. Jackson L. Bailey, Esq., for the respondent.
J. C. Smith, Esq. and C. L. Brooke, C.P.A., for the petitioners. Jackson L. Bailey, Esq., for the respondent.
Petitioner Floyd H. Brown, a resident of Louisiana, filed a petition for divorce from Daisy E. Brown in June 1938. He obtained a decree of separation on July 2, 1938, and a decree of divorce on September 30, 1939. On July 8, 1938, the parties executed a settlement agreement.
1. Held, under the facts, payments of $500 monthly made by petitioner to Daisy E. Brown in 1943, 1945 and 1946, pursuant to the agreement, were consideration for the waiver of support rights by Daisy E. Brown and were deductible by petitioners under section 23(u), Internal Revenue Code. Thomas E. Hogg, 13 T.C. 361, followed.
2. Held, further, petitioner Floyd H. Brown was entitled to depletion in 1945 and 1946 on the $500 monthly assigned to Daisy E. Brown as security for the above payments from income of a certain oil lease interest owned by him. Regulations 111, section 29.23(m)-1.
In these consolidated proceedings respondent determined deficiencies in income tax in the following amounts:
+-----------------------------------------------------------------+ ¦Docket No.¦Petitioner ¦Year¦Deficiency¦ +----------+--------------------------------------+----+----------¦ ¦23880 ¦Floyd H. Brown and Kathie Lou D. Brown¦1943¦$365.55 ¦ +-----------------------------------------------------------------+
( 1945 1,743.05 23881 Floyd H. Brown ( 1946 3,240.67
The questions presented are:
(1) Are payments of $500 monthly made by petitioner Floyd H. Brown to Daisy E. Brown, his divorced wife, deductible in the taxable years by petitioners under section 23(u), Internal Revenue Code?
(2) Do respondent's assertion of deficiencies for the years 1943 through 1948 against Daisy E. Brown for failure to report the $500 monthly payments as income under section 22(k) of the Code, and respondent's collection of said deficiencies estop respondent from now contending that such payments are not deductible by petitioners under section 23(u) of the Code?
(3) If such payments are deductible by petitioner Floyd H. Brown in 1945 and 1946, is he entitled to depletion on the oil lease income securing the payments?
FINDINGS OF FACT.
Floyd H. Brown (hereinafter referred to as petitioner), and his wife, Katie Lou D. Brown, are residents of Carmi, Illinois. The income tax returns for the taxable years involved were filed with the collector of internal revenue for the eighth district of Illinois.
Petitioner is engaged in the business of drilling oil wells and has been so engaged for some 39 years.
Prior to July 6, 1938, petitioner and his former wife, Daisy E. Brown, were residents of the State of Louisiana, a community property state, and resided in Shreveport, Caddo Parish, Louisiana.
Sometime in June 1938, petitioner filed a petition for divorce from Daisy E. Brown in Caddo Parish, Louisiana. On July 2, 1938, judgment decreeing separation a mensa et thoro in favor of petitioner and against Daisy E. Brown was rendered in the First Judicial District Court, Caddo Parish, Louisiana, and on July 6, 1938, the judgment was signed and filed. On September 30, 1939, judgment decreeing divorce a vinculo matrimonii in favor of petitioner and against Daisy E. Brown was rendered, signed and filed in the above court.
On July 8, 1938, petitioner and Daisy E. Brown executed the following agreement:
STATE OF LOUISIANA:
PARISH OF CADDO:
WHEREAS, on July 2, 1938, judgment of separation from bed and board was rendered in favor of Floyd H. Brown and against Daisy Earp Brown in cause No. 74,639 on the docket of the First Judicial District Court, Caddo Parish, Louisiana, said judgment having been signed in open court on July 6, 1938, to which said judgment reference is here made; and,
WHEREAS, said parties desire to adjust their differences by mutual consent and partition and settle the community estate heretofore existing between them;
NOW, THEREFORE, in consideration of the premises, the said FLOYD H. BROWN and the said DAISY EARP BROWN do hereby stipulate and agree that said community estate shall be partitioned and settled upon the following terms, conditions and covenants, to-wit:
The said Floyd H. Brown does hereby agree and obligate himself:
(a) To pay to the said Daisy Earp Brown the sum of FIVE HUNDRED ($500.00) DOLLARS per month during the natural life of the said Daisy Earp Brown, and as security for the payment of said sum the said Floyd H. Brown does hereby GRANT, BARGAIN, SELL, ASSIGN, TRANSFER, CONVEY AND DELIVER unto the said Daisy Earp Brown, Five Hundred ($500.00) Dollars per month from proceeds accruing to the credit of the lease interest owned by him in the B. F. Hindman Lease, Rusk County, Texas, particularly described as follows, to-wit:
The effective date of this assignment shall be July 1, 1938, and shall continue thereafter from month to month during the natural life of said Daisy Earp Brown, provided that said assignment shall terminate and revest in said Floyd H. Brown five (5) years from July 1, 1938, or on June 30, 1943, in the event the said Floyd H. Brown has, on or before said date, delivered to said Daisy Earp Brown a term annuity policy of New York Life Insurance Company providing for the payment to said Daisy Earp Brown of the sum of Five Hundred ($500.00) Dollars per month beginning July 1, 1943, and continuing during her natural life.
Any pipe line company purchasing the oil, gas or other minerals produced from the hereinabove-described tract of land is hereby authorized and directed to pay to said Daisy Earp Brown said full sum of Five Hundred ($500.00) Dollars per month until it shall have been served with written notice that said assignment has been terminated, as herein provided:
(b) The said Floyd H. Brown does hereby GRANT, BARGAIN, SELL, TRANSFER, CONVEY AND DELIVER unto the said Daisy Earp Brown all of his right, title and interest in and to Municipal No. 961 Thoro Boulevard in the City of Shreveport, Caddo Parish, Louisiana, together with all contents therein, particularly described as follows, to-wit:
Lot Twenty-Four (24) and Lot Twenty-One (21) less the West 20 feet thereof, in Audubon Place Subdivision, City of Shreveport, Caddo Parish, Louisiana, together with all improvements thereon.
(c) The said Floyd H. Brown does hereby GRANT, BARGAIN, SELL, TRANSFER, CONVEY AND DELIVER unto the said Daisy Earp Brown all of his right, title and interest in and to the oil, gas and other minerals, subject to mineral lease, hereafter produced, saved and marketed from:
Southeast Quarter of Southeast Quarter (SE 1/4 of SE 1/4), Northwest Quarter of Southeast Quarter (NW 1/4 of SE 1/4), Southeast Quarter of Northeast Quarter (SE 1/4 of NE 1/4), and Northwest Quarter of Northeast Quarter (NW 1/4 or NE 1/4), Section Fifteen (15), Township Twenty-one (21), Range Ten (10), Webster Parish, Louisiana.
(d) The said Floyd H. Brown does hereby convey and deliver unto the said Daisy Earp Brown all of his right, title and interest in and to that certain Packard Sedan now in possession of the said Daisy Earp Brown.
(e) The said Floyd H. Brown furthermore assumes, obligates himself and agrees to promptly pay all community debts and does hereby agree to indemnify and save harmless the said Daisy Earp Brown from and against said debts.
In consideration of the above and foregoing provisions, Daisy Earp Brown does hereby:
(a) Waive and renounce any and all rights which she may now or hereafter have in and to all other community property, real, personal or mixed, acquired by either party hereto during the existence of their marriage, and does hereby GRANT, BARGAIN, SELL, TRANSFER, CONVEY AND DELIVER unto the said Floyd H. Brown all of her right, title and interest in and to said property. * * *
(b) The said Daisy Earp Brown furthermore waives and renounces any and all claims, demands or choses in action which she may now or hereafter have against the said Floyd H. Brown for maintenance, alimony or support, and all other choses in action which she may now or hereafter have against the said Floyd H. Brown.
WITNESS THE EXECUTION HEREOF On this 8th day of July A.D. 1938.
FLOYD H. BROWN. DAISY EARP BROWN.
Petitioner and Daisy E. Brown were represented by separate attorneys during the divorce proceedings. Their community property consisted in large part of drilling equipment with was not susceptible of division without considerable decrease in value. The following balance sheet, prepared in contemplation of the separation and showing the book net worth of the community property as of March 31, 1938, was furnished the attorneys:
+------------------------------------------------------+ ¦Statement of Assets and Liabilities as of March 31, ¦ ¦1938 ¦ +------------------------------------------------------¦ ¦ ¦ ¦ ¦ ¦ ¦ +------------------------------------------------------+
Assets Current: Cash in Banks $3,119.78 Accounts Receivable 11,980.94 Notes Receivable 9,118.53 Total Current Assets $24,219.25 Operating Leases: Hindman Lease, Well and Equipment Cost (Note A) 26,896.21 Less: Reserve for Depreciation $4,544.25 Reserve for Depletion of Lease Cost 16,256.61 20,800.86 $6,095.35 Hayner-Patton Lease, Well and Equipment Cost (Note A) 12,530.53 Less: Reserve for Depreciation 192.18 Reserve for Depletion 158.02 350.20 12,180.33 18,275.68 Investments in Other Oil Properties: Royalty Interests—Producing and Non-producing 7,822.39 Less: Depletion on Production Received in 1938 569.32 7,253.07 Non Operating Lease Interests 17,746.52 Partnership Interests 3,750.00 28,749.59 Stocks: F. H. Brown, Inc. (Note B) 52,008.57 Interstate Production Corporation (Note C) Insolvency 9,572.60 Sugar Creek Syndicate 2,939.78 Shreveport Base Ball Club 500.00 Shreveport Country Club 250.00 46,125.75 Other Assets: Cash Surrender Value of Life Insurance Policies 26,230.51 Residence—961 Thoro Boulevard 18,701.50 Camp and Improvements 3,654.59 Lots in San Diego, California 8,927.55 Motor Boat 332.90 Packard Automobile (Note D) 1,440.00 Pumping Equipment (Note E) 8,390.02 67,677.07 Total Assets $185,047.34
Liabilities F. H. Brown, Inc $32,316.96 Sundry Accounts and Taxes Payable 2,962.82 $35,279.78
Net worth Difference between total assets and total of liabilities plus reserves for depreciation and depletion $143,167.53 Reserve for Depletion on Hindman Lease (under various Revenue Acts) in access of cost of Hindman Lease (not including wells and equipment) (Note F) 6,600.03 Book Net Worth (Note G) $149,767.56
Note A— The amount shown as investment is the cost as reflected by books, after taking deduction for intangible drilling costs, which are considered to be an expense item under the various Revenue Acts, where the option to charge off these expenditures has been elected, which you have done in prior years.
The total depletion allowable has exceeded the cost of the Hindman Lease, so only the amount necessary to eliminate lease cost is shown here. The balance is reflected in ‘Net Worth.‘
Note B— This amount of $52,008.57 shows the book value of your stock in the F. H. Brown, Inc., as reflected by the books of that corporation. Your personal books reflect a cost of $78,799.59 for your investment in F. H. Brown, Inc.
The fixed assets reflected on the books of F. H. Brown, Inc., were at March 31, 1938:
+------------------------------------------------+ ¦Cost ¦$338,759.64¦ ¦ +------------------------+-----------+-----------¦ ¦Reserve for Depreciation¦115,773.52 ¦ ¦ +------------------------+-----------+-----------¦ ¦Net book value ¦ ¦$222,986.12¦ +------------------------------------------------+
F. H. Brown, Inc., had direct obligations of $273,478.48 on March 31, 1938, in addition to which it had a direct obligation to the First National Bank of Bartlesville, Oklahoma, in the amount of $202,659.00 for which it also has the same amount as being due from the Phillips Petroleum Company.
F. H. Brown, Inc., has an asset, which was considered at full value in arriving at book value of your stock, an account receivable from yourself in the amount of $32,316.96, the same amount shown as a liability for you.
Note C— Your Personal investment in Interstate Production Company is shown on your personal books to be $7,500.00. However, after giving effect to adjustments which will be reflected in the income tax return of this corporation, its balance sheet at March 31, 1938 showed that, in order to pay off its liabilities, all assets would have had to have been worth book cost, after which there would have been an insolvency of $9,610.74. Since you owned 502 of the 504 shares, your portion of that insolvency was $9,572.60. (See also Note G.)
Note D— The Packard Automobile is carried at a cost of $2,880.00. No depreciation has been taken on the books, on account of none having been allowable for income tax purposes. For the purpose of this statement, the cost has been cut in half, and the automobile is shown at $1,440.00. You stated that it is not worth that much as a trade in value.
Note E— This is pumping equipment which was purchased to be put on the Hayner-Patton lease. Since it is not in active use, no computation has been made for sustained depreciation up to March 31, 1938. Naturally, it does not have this cost value now.
Note F— This $6,600.03 is the excess of 27 1/2% depletion allowed by the various revenue acts over the total cost of the Hindman Lease. The balance of the well and equipment cost is returnable to you through depreciation. In other words, while a statement set up in the ordinary way of showing debits on one side and credits on the other would show a net worth of $143,167.53, when we come to make an analysis by putting the depreciation and depletion reserves against the assets which they reduce, it is found that the revenue acts have given you $6,600.03 non-taxable income, which is rightfully part of your net worth.
Note G— With the exception of those items noted above, the figures in this statement reflect your costs, as shown in your ledger. No attempt has been made to obtain valuations, and the only changes from book costs are in those cases where deductions have been taken, under the various revenue acts, for intangible costs, percentage depletion in excess of depletion on cost, etc., and those shown in Notes A to F.
Further reference is made to Note ‘C‘ above— Interstate Production Corporation. You understand, of course, that this statement is meant to reflect, as nearly as practicable, your net worth on a cost basis (with these few exceptions). The fact that the Interstate Production Corporation stock shows a book insolvency of $9,572.60, is not, in fact, a legal liability on your part, as this statement might be misunderstood to show, at first glance. Should the Interstate Production Corporation become insolvent, your loss would be only your investment, and you would not be called upon to make up any insolvency.
The community was liable on the obligations of F. H. Brown, Inc., since petitioner was endorser of all the company's paper. Petitioner has paid all of the debts owed by him and Daisy E. Brown at the time they were judicially separated. He has also paid her the sum of $500 per month as provided in the agreement. He recognizes that he is personally responsible to make her these payments for the balance of her life.
Petitioner and Daisy E. Brown resided together continuously until the time of the initial separation in 1938. During such years petitioner paid all personal living expenses of the parties and Daisy E. Brown received no specified allowance but received money as she desired it. The judgment of separation dated July 2, 1938, and the judgment of divorce dated September 30, 1939, make no reference to support or alimony.
Daisy E. Brown filed claims for refund for the taxable years 1943 and 1944 and stated under oath therein as follows:
* * * The taxpayer has received $6,000.00 during the year in payments of $500.00 a month from the proceeds of the operation of the Hindman Lease in the State of Texas.
Taxpayer is divorced from her husband, F. H. Brown. In the decree of divorcement the court acknowledged that the property which had been accumulated during the community of acquets and gains of F. H. Brown and Mrs. Daisy E. Brown belonged to them in the ratio of one half to each. The community property consisted to a large extent of assets in use in the husband's business and was not susceptible of division in kind. In lieu of the taxpayer's community interest in said property, the court awarded her judgment, giving her the home, the family car, certain royalty interest, and decreeing that her former husband shall pay her the sum of $500.00 per month during her natural life. In view of this taxpayer's life expectancy such payments of $500.00 a month will constitute the value of her full and entire community interest in and to all the community property acquired in the name of the husband during their marriage.
In view of the fact that the $500.00 is not alimony but is a return of property, this amount is believed by the taxpayer not to be income under the provisions of the Internal Revenue Code.
Daisy E. Brown did not in her income tax returns filed for the taxable years 1945 through 1948, inclusive, return as income the $6,000 a year received in payments of $500 a month from the proceeds of the operation of Hindman oil lease, stating as her reason for not doing so that such amounts were receipt of principal on settlement or disposal of community property because of divorce in 1938.
In each of his income tax returns filed for the years 1942 to 1946, inclusive, petitioner did not return as income the $6,000 received by Daisy E. Brown from the Hindman oil lease.
OPINION.
JOHNSON, Judge:
Petitioners claim that the payments of $500 monthly made as per agreement by petitioner Floyd H. Brown to his former wife, Daisy E. Brown, are deductible under section 23(u), Internal Revenue Code, which allows the deduction by the husband of amounts includible under section 22(k) in the gross income of the wife. Section 22(k) provides:
(k) ALIMONY, ETC., INCOME.— In the case of a wife who is divorced or legally separated from her husband under a decree of divorce or of separate maintenance, periodic payments * * * received subsequent to such decree in discharge of, * * * a legal obligation which, because of the marital or family relationship, is imposed upon or incurred by such husband under such decree or under a written instrument incident to such divorce or separation shall be includible in the gross income of such wife. * * *
Daisy E. Brown was ‘divorced * * * from her husband under a decree of divorce ‘ dated September 30, 1939. The payments here in controversy were ‘received subsequent to such decree in discharge of a legal obligation‘ which, the facts show and respondent does not dispute, was ‘incurred by such husband under * * * a written instrument incident to such divorce or separation.‘ See Thomas E. Hogg, 13 T.C. 361, and cases cited therein. The issue here is whether or not the legal obligation was incurred ‘because of the marital or family relationship.‘ Section 22(k).
Here the divorce decree made no provision for alimony. However, in Thomas E. Hogg, supra, on which petitioners rely, this Court held that where a husband's payments to a divorced wife pursuant to agreement are ‘in the nature of alimony‘ and ‘in lieu of alimony,‘ then the legal obligation was incurred because of the marital or family relationship and the payments are deductible under section 23(u).
Respondent's contention is that the payments were not made as alimony or support, or in lieu thereof, but solely in settlement of the community property rights of Daisy E. Brown. He cites Regulations 111, section 29.22(k)-1, which provides that section 22(k):
* * * does not apply to that part of any periodic payment attributable to that portion of any interest in property transferred in discharge of the husband's obligation under the decree or instrument incident thereto, which interest originally belonged to the wife * * * .
Therefore, respondent contends, the payments are includible, not in the gross income of Daisy E. Brown, but of petitioners, and are not deductible by petitioners under section 23(u).
Under the agreement Daisy E. Brown received $500 monthly, the residence in Shreveport with all the contents, certain mineral rights, and a Packard automobile, and petitioner assumed all the community debts. In consideration of the above, Daisy E. Brown renounced her interest in the community property and conveyed that interest to petitioner, and waived all claims to maintenance, alimony, or support she might have ‘now or hereafter‘ against petitioner. Thus it is clear that under the agreement Daisy E. Brown received a settlement both of her community property rights and of her support rights. But it is not clear from the agreement alone of which rights the $500 monthly payments were in settlement.
Respondent emphasizes the references in the agreement to the community property and the fact that the community property at the time of the separation had a book net worth of $149,767.56, (and he contends that its fair market value was in excess of that figure). Therefore he concludes that the agreement was solely for the settlement of the community property interest of Daisy E. Brown.
The balance sheet from which the above net worth figure was obtained carried the Shreveport residence at a cost of $18,701.50 and the Packard automobile at a value of $1,440. However, there is no indication on the balance sheet or elsewhere in the record as to the value of the mineral rights received by Daisy E. Brown under the agreement. But, even assuming that the value of the residence, automobile, and mineral rights received by her do not add up to the value of her interest in the community property, it does not follow that the monthly payments must have been in settlement of that interest. Under the agreement petitioner assumed all the community debts. The facts show that F. H. Brown, Inc., at the time of the agreement had direct obligations of $273,478.48. The community was liable on the obligations of F. H. Brown, Inc., since petitioner was endorser of all the corporations's paper. Petitioner testified that he paid community debts of ‘well over $200,000.00.‘.” In being freed of these debts Daisy E. Brown received something we can well surmise was of more practical value to her than a full half share in the community property, consisting largely of drilling equipment which it was not feasible to divide. Therefore we conclude that the transfer of the home and its contents, the Packard automobile, and the mineral rights, and the assumption of the community debts by petitioner, may properly be deemed the consideration for the transfer by Daisy E. Brown of her interest in the community property, and the $500 monthly payments the consideration for her waiver of support rights.
But respondent points out that ‘petitioner has not shown that under the law of Louisiana his divorced wife would have been granted alimony or support in any event.‘ However, it was not necessary for petitioner to show this. At the time the negotiations for the agreement were under way Daisy E. Brown was the wife of petitioner. As such, she of course had a present right to support, and petitioner had been discharging that right. It would be unrealistic to hold that she gave up this right to support without consideration and that, as respondent contends, everything she received under the agreement was in exchange for her share of the community property.
Moreover, the evidence indicates that the parties had support in mind when they agreed upon the payments. L. M. Moffitt, who, like petitioner, was in the oil business and lived in Shreveport in 1938, and who was called as a witness for petitioners, testified that he was a good friend of both petitioner and Daisy E. Brown from 1921 to the time of separation in 1938. He stated that both parties consulted him at various times concerning the separation. After failing to bring about a reconciliation, he then ‘took the viewpoint that after as long a married life as they had had * * * she was entitled to a sufficient payment through the remainder of her life so as to keep her comfortably situated, and a home in which to live, which was agreeable to both parties finally.‘
Thus, to reiterate, we conclude that Daisy E. Brown gave up her present right to support in exchange for a future contractual right to support in the form of monthly payments of $500. And, as we said in Thomas E. Hogg, supra, ‘the husband incurred this contractual obligation because of the marital relationship,‘ whether or not there was any provision under law which would require the payment of alimony. Accordingly, the payments in controversy were deductible by petitioners under section 23(u), and we so hold.
Our holding on this issue makes it unnecessary to consider petitioners' contention that respondent is estopped to question the deductibility of the payments.
Respondent's contention that petitioner Floyd H. Brown is not entitled to depletion on the income from the Hindman oil lease to the extent that the payments to Daisy E. Brown were made from this income is clearly untenable. The agreement shows that the lease interest was owned by petitioner, and that the assignment to Daisy E. Brown of $500 per month from the lease income was merely as security for the payments petitioner was to make under the agreement. As the owner of the lease interest, petitioner was entitled to depletion on the income therefrom. Regulations 111, section 29.23(m)-1.
Decisions will be entered for the petitioners.