Bruce v. United States

• Decision Date: 02 February 1966
• Docket Number: Civ. A. No. 65-H-30.
• Citation: 254 F. Supp. 816
• Parties: Homer L. BRUCE, Plaintiff, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of Texas

254 F. Supp. 816

Homer L. BRUCE, Plaintiff, v. UNITED STATES of America, Defendant.

Civ. A. No. 65-H-30.

United States District Court S. D. Texas, Houston Division.

February 2, 1966.

Homer L. Bruce, Houston, Tex., pro se.

Richard M. Roberts, Acting Asst. Atty., Myron C. Baum, Robert L. Waters, O. Jan Tyler, Attorneys, Tax Division, Department of Justice, Washington, D. C., Woodrow Seals, U. S. Atty., and John H. Baumgarten, Asst. U. S. Atty., Houston, Tex., for defendant.

INGRAHAM, District Judge.

On January 15, 1965, plaintiff, Homer L. Bruce, filed suit against the United States of America for the refund of income taxes paid under protest by plaintiff for the years 1961, 1962 and 1963. Stipulations of fact were filed by the parties and plaintiff introduced additional evidence at a trial held on November 22, 1965. The question is whether plaintiff need pay income taxes on funds received by him from the Trinity Petroleum Trust prior to the time the total payments exceed his basis in the Trust. This court holds that plaintiff must pay income taxes, subject only to the statutory depletion allowance.

The following facts are taken from the stipulations of fact filed by both parties. Trinity Petroleum Company, hereinafter "Company", owned various oil and gas royalties in five states. Company organized Trinity Petroleum, Inc., hereinafter "Inc.", and on October 1, 1951, conveyed all its royalties to Inc. in exchange for 95% of all income received by Inc. from these royalties. Profits received on the other 5% would go to Company as Inc.'s sole owner should dividends be paid.

This same day Trinity Petroleum Trust, hereinafter "Trust", issued its 192,500 shares of beneficial interest to Company. Company distributed these shares in Trust to Company's shareholders in return for their 192,500 shares of Company.

These transactions left the following situation: Inc. held all the royalties. 95% of Inc.'s royalty revenue went directly to Trust. Any dividends declared by Inc. on the other 5% of its revenues also went to Trust.

Internal Revenue has insisted upon the following treatment of these proceeds: (1) Inc. passes 95% of its royalty income to Trust without taxation consequence. From the 5% it retains, Inc. deducts taxes paid, expenses, and 27½% depletion to compute its taxable income. (2) Trust deducts from its total receipts from Inc. taxes paid, expenses, and 27½% depletion on the 95% of royalties to compute taxable income. Insofar as Trust pays out to its shareholders an amount greater than taxable income, it pays no taxes. (3) The holder of shares of beneficial interest in the trust divides his receipts into three categories. That portion corresponding to Inc.'s dividends to Trust is taxable as ordinary income, depletion already having been allowed Inc. The remainder corresponds to the 95% paid directly to Trust by Inc. The shareholder reports as ordinary income his portion of Trust's taxable income from the royalties. The remainder is not taxable and it corresponds roughly to the depletion allowance claimed by Trust.

Plaintiff and his wife held as community property 6,152 shares of beneficial interest in Trust. Upon the death of plaintiff's wife on October 14, 1959, plaintiff became the sole holder of these shares. They were valued at $37 per share for federal estate tax purposes, and under Section 1014 of the Internal Revenue Code, $37 per share is now plaintiff's basis for all 6,152 shares.

Plaintiff received payments from Trust in 1961, 1962 and 1963 roughly totaling his proportionate share of all Trust's income in these years. Plaintiff did not include any of these proceeds in his income tax returns as taxable income. Plaintiff was subsequently assessed deficiencies as outlined above: (1) income corresponding to Inc.'s dividends to Trust taxable in full; (2) income corresponding to Trust's other taxable income taxable in full; (3) additional amounts corresponding to Trust's allowance for depletion not taxable. Plaintiff paid these assessments and instituted the present suit for refund.

I.

Plaintiff's basic position relies upon the Supreme Court case of Burnet v. Logan, 283 U.S. 404, 51 S.Ct. 550, 75 L.Ed. 1143 (1931). The Supreme Court there held that when it is impossible to determine with fair certainty the fair market value of property held for the production of income, the owner may consider all returns to be returns of capital until he recoups his basis. After that, all sums received are ordinary income.

Plaintiff seeks to bring himself within this rule. He and his witnesses maintain that it is impossible to ascertain the value of the many royalties held by Inc., "many, many tracts in 36 fields in 6 different states." Because Inc. does not have the power to acquire new leases, plaintiff claims it impossible to establish that his basis will ever be realized via the depletion allowances he now enjoys. There is opinion testimony that he never will recover his basis. At the rate of depletion allowed in the years in question, it would take over thirty years of similar production for the allowance to total up to his basis. With no new leases, plaintiff claims future production will decline.

From these facts and opinions, plaintiff concludes that recovery of his basis is far less certain than it was in the Logan case. There the taxpayer held the right to receive a specified interest in 60¢ per ton to be paid upon the extraction of ore from a mine. The future payment price, 60¢, was certain, and there was only one mine, containing non-fugitive minerals. Yet the Supreme Court said:

"She properly demanded the return of her capital investment before assessment of any taxable profit based on conjecture." Burnet v. Logan, supra, 283 U.S. 413, 51 S.Ct. 552.

Plaintiff maintains that the "conjecture" necessary in the Logan case is only slight compared to that necessary to value Inc.'s royalties. Consequently, he should pay no tax until his full basis of $37 per share is realized.

II.

Plaintiff has failed to establish the requisite uncertainty necessary to bring him within the Logan rule. A central factor relied upon by the Supreme Court was that it could not foretell with anything like reasonable certainty that the taxpayer would recover her capital investment.

"Respondent might never recoup her capital investment from payments only conditionally promised." Burnet v. Logan, supra, 283 U.S. at 413, 51 S.Ct. at 552.

"Some valuation—speculative or otherwise—was necessary in order to close the estate. It may never yield as much, it may yield more." Burnet v. Logan, supra, at 413-414, 51 S.Ct. at 553.

The latter quotation was followed by an important analogy:

"If a sum equal to the value thus ascertained had been invested in an annuity contract, payments thereunder would have been free from income tax until the owner had recouped his capital investment." Burnet v. Logan, supra, at 414, 51 S.Ct. at 553.

Certainly the distinguishing point about an annuity contract is that one never knows if the holder will live long enough to recoup his capital investment. The prospect of receiving income or interest is most uncertain. (It is interesting to note that despite this uncertainty, the Code today requires certain annuity payments to be apportioned between return of capital and income according to actuarial statistics. See Section 72 of the Internal Revenue Code.)

The Court of Appeals for the Sixth Circuit recently stated the rule of Logan to be:

"Determination of the issue (whether income taxes are due before capital investment is recouped) turns on the question of whether the investment * * * is of such a speculative nature that the purchaser * * * cannot be reasonably certain of ever recovering his cost (citing Burnet v. Logan)." Darby Investment Corp. v. Commissioner of Internal Revenue, 315 F.2d 551, 552 (C.A.6th, 1963).

Plaintiff cites two federal cases illustrating applications of Logan. Both cases strongly reinforce the crucial role in Logan of the certainty of return of capital. In Helvering v. Drier, 79 F.2d 501 (C.A.4th, 1951), the taxpayer had been awarded damages plus interest, the annual payments of which were conditioned upon annual receipt by the United States of war debts from Germany. The court refused to consider any portion of payments made to be payments of interest (and thus taxable income) until plaintiff received the principal sum due.

"Hence it has been doubtful ever since the award of 1929 was made whether the taxpayer ever would receive payment thereof in full. Under these circumstances, we agree with the Board that the case is governed by the rule in Burnet v. Logan * *" Helvering v. Drier, supra, 79 F.2d at 503.

In the second case relied upon by plaintiff, Axe v. United States, 191 F.Supp. 671 (D.Kan.1961), the court applied the Logan rule because there was uncertainty as to whether any payment, capital or income, would ever be made.

In summary, Logan and subsequent cases clearly establish that before income taxes will be deferred until capital has been recouped, there must be uncertainty as to whether the taxpayer's basis will ever be recovered. Plaintiff's basis for his shares of beneficial interest in Trust is $37 per share. It is stipulated that plaintiff has received the following per share payments from Trust:

                    1960       $ 3.37
                    1961         3.755
                    1962         4.58
                    1963         4.97
                    1964         5.15
                

Payments for the five year period total $21.825 per share, well over one-half plaintiff's basis in the shares. The amount has increased each year. From these facts and the detailed information about the royalties presented to this court, this court holds that there is strong reasonable certainty that plaintiff will recoup his basis in the shares.

Plaintiff introduced evidence at the trial that he will never recoup his basis through the deductions presently allowed plaintiff. Plaintiff has at no time maintained that any uncertainty exists as to whether he...