58 T.C. 452 (1972), 5276-69, Jahn v. Commissioner of Internal Revenue

Docket Nº:5276-69.
Citation:58 T.C. 452
Opinion Judge:WITHEY, Judge:
Party Name:HAROLD E. JAHN AND MARY JAHN, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Attorney:Leonard J. Simasko, for the petitioners. Patrick R. McKenzie, for the respondent.
Case Date:June 12, 1972
Court:United States Tax Court
 
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Page 452

58 T.C. 452 (1972)

HAROLD E. JAHN AND MARY JAHN, PETITIONERS

v.

COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

No. 5276-69.

United States Tax Court

June 12, 1972

Page 453

Leonard J. Simasko, for the petitioners.

Patrick R. McKenzie, for the respondent.

Petitioners owned a farm in Michigan, and on January 2, 1964, entered into an ‘ agreement’ with two individuals, Neyer and Andres, with respect to such property whereby the latter agreed to drill oil and gas wells thereon at their sole risk and expense and to market the production therefrom. Petitioners retained the rights to five-eighths of all production to be realized from the property and Neyer and Andres were to receive three-eighths of the proceeds. On the same day that petitioners signed the ‘ agreement’ and in conjunction therewith, petitioners received $50,000 from Andres. Petitioners reported the $50,000 as the proceeds from the sale of a capital asset. In 1964, eminent domain proceedings were brought by Michigan Consolidated Gas Co. against the land in question whereby Consolidated took over the use of the property. During 1964 and 1965 Consolidated took gas from the property and impounded the money payable to petitioners. On May 6, 1966, a settlement was finalized whereby petitioners received $935,000 in settlement of their claims against Consolidated. Petitioners reported this entire amount as long-term capital gain in 1966. Held:

1. The $50,000 payment in dispute was an inducement in the form of a bonus or advance royalty for entering into an oil and gas lease under which the petitioners retained an economic interest in the oil and gas production and, therefore, was ordinary income to petitioners in 1964.

2. As part of the settlement with Consolidated, the petitioners received at least $159,718.95 as their share in production for the period from 1964 through July 6, 1965, and such sum was ordinary income to them in 1966.

WITHEY, Judge:

Respondent determined deficiencies against petitioners for the taxable years 1964 and 1966 in the amounts of $3,164.56 and $21,141.16, respectively.

The principal issues presented for our consideration are (1) whether a $50,000 payment was the proceeds of a sale of a three-eighths interest in all the minerals lying beneath petitioners' farm to Neyer and Andres or whether it represented a bonus or advance royalty under a lease, and (2) whether the petitioners received as part of a settlement in 1966 of their claims against Michigan Consolidated Gas Co. royalty payments amounting to $159,718.95.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found and incorporated herein by reference.

Petitioners Harold E. Jahn and Mary Jahn are husband and wife whose residence was in St. Clair, Mich., at the time the petition herein was filed.

The petitioners filed their income tax returns for the calendar years 1964 and 1966 with the district director of internal revenue, Detroit, Mich.

Petitioners owned real property in St. Clair County, Mich., and on January 2, 1964, entered into an agreement with John Neyer and Ray Andres with respect to such property whereby Neyer and Andres agreed to ‘ commence to drill on the permitted location * * * and shall proceed with all due diligence to drill such well to completion at their sole risk and expense.’

Neyer and Andres were to ‘ operate, or arrange for operation, of all wells on the premises covered hereby, and shall market the production therefrom at not less than going field prices.’

Petitioners retained the rights to five-eighths of all production realized from the property and Neyer and Andres were to receive three-eighths of the production.

Neyer and Andres were obliged to drill and complete all wells at their own risk and expense but petitioners were obliged to pay their five-eighths share of operating such wells after completion.

Neyer and Andres were obliged to carry workmen's compensation insurance as required by the laws of the State of Michigan and public

Page 454

liability and property damage insurance with respect to the premises covered by the agreement and they were to hold petitioners harmless from all claims, demands, and causes of action arising directly or indirectly out of their operations on the premises.

The agreement also stated that ‘ no mining partnership or joint undertaking shall be considered as created’ between petitioners and Neyer and Andres by reason of the latter's operations.

On the same day that petitioners signed the oil and gas drilling agreement and in conjunction therewith the petitioners received $50,000 from Andres.

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