Davis v. Comm'r of Internal Revenue
| Decision Date | 31 July 1980 |
| Docket Number | 6319-78.,Docket Nos. 6540-77 |
| Citation | 74 T.C. 881 |
| Parties | JOE C. DAVIS, ESTATE of RASCOE B. DAVIS, THIRD NATIONAL BANK, EXECUTOR, and DELTA C. DAVIS, PETITIONERS v. COMMISSIONER of INTERNAL REVENUE, RESPONDENTJOE C. DAVIS, PETITIONER v. COMMISSIONER of INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
1. P and others were partners in PS, a coal mining joint venture. PS acquired by lease the rights to mine coal from the properties of various landowner-lessors. PS then subleased these rights to a corporation, WC, which carried out the actual mining and paid royalties to PS.
PS paid yearly advanced minimum royalties to the landowners before coal was mined and earned royalties per ton as coal was mined. Earned royalties due the landowners were reduced by credits for earlier unearned advanced royalties paid.
PS and each of its partners reported all royalties received from WC, the mining corporation, as capital gain under secs. 631(c) and 1231, I.R.C. 1954. Held: PS and its partners may not deduct from ordinary income advanced minimum royalties and earned royalties paid to landowner-lessors. Under sec. 631(c), PS must instead subtract royalties paid from royalty income for purposes of sec. 1231.
2. When PS was organized, P contributed three leases to PS on which P (and his controlled corporation) had paid advanced minimum royalties. P (and his corporation) had taken ordinary deductions for these advanced royalties. PS specially allocated royalty income from WC to P to the extent PS received credits reducing earned royalties due the landowners for the advanced minimum royalties paid by P (and his corporation) on the contributed leases. Held: P's special allocation is not ordinary income under the tax benefit rule. There has been no “recovery” by either P or PS, and the special allocation to P of coal royalties paid to PS retains its character as capital gain under sec. 631(c) in the hands of P, secs. 702(b) and 704(a).
3. Held, P did not realize taxable income by reason of his gifts of appreciated securities to certain trusts where such gifts were conditioned upon the trustee's agreed payment of the resulting Federal and State gift taxes. Henry v. Commissioner, 69 T.C. 665 (1978), appeal filed (6th Cir., May 5, 1978), followed. William Waller, James T. O'Hare, and Elliott W. Jones, for the petitioners.
Robert B. Nadler, for the respondent.
Respondent determined the following deficiencies in petitioners' Federal income taxes:
+---------------------------------------------------------------+
¦Petitioner(s) ¦Docket No. ¦Year ¦Deficiency ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦ ¦ ¦
+------------------------------+------------+------+------------¦
¦Joe C. Davis ¦6540-77 ¦1967 ¦$2,562.55 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦1968 ¦39,926.07 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦1969 ¦43,827.58 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦1970 ¦28,660.40 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦1971 ¦33,501.26 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦ ¦ ¦
+------------------------------+------------+------+------------¦
¦Joe C. Davis ¦6319-78 ¦1972 ¦398,422.68 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦1973 ¦63,673.85 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦1974 ¦65,240.58 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦1975 ¦59,781.49 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦ ¦ ¦
+------------------------------+------------+------+------------¦
¦Estate of Rascoe B. Davis, ¦6540-77 ¦1967 ¦114.18 ¦
+------------------------------+------------+------+------------¦
¦deceased, Third National Bank,¦ ¦1968 ¦1,172.93 ¦
+------------------------------+------------+------+------------¦
¦executor, and Delta C. Davis ¦ ¦1969 ¦1,521.49 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦1970 ¦1,791.68 ¦
+------------------------------+------------+------+------------¦
¦ ¦ ¦1971 ¦2,027.86 ¦
+---------------------------------------------------------------+
These cases have been consolidated for purposes of trial, briefing, and opinion.
Because of concessions, the remaining issues presented are:
(1) Whether all or any part of advanced and earned royalties, paid on coal mining leases by petitioners' partnership with respect to coal disposed of by sublease under sections 631(c) and 1231,1 are (a) deductible from ordinary income under section 162 or (b) must be subtracted from coal royalty receipts with the net amount treated as either capital gain or ordinary loss under section 1231;
(2) Whether the tax benefit rule requires petitioner Joe Davis to treat as ordinary income rather than capital gain certain amounts of royalty income allocated to him by his partnership with respect to contributed coal mining leases on which he and his controlled corporation had previously taken ordinary deductions for advanced minimum royalties;
(3) Whether petitioner Joe Davis realized taxable income upon gifts of stock to trusts for the benefit of nephews and nieces where such gifts were conditioned upon the trustee's agreed payment of the resulting gift taxes.
All of the facts have been stipulated and are found accordingly.
Petitioner Joe Davis resided in Nashville, Tenn., at the times his petitions were filed herein. When their petition was filed in this case, Third National Bank, executor of the Estate of Rascoe Davis, had its principal place of business in Nashville, Tenn., and Delta C. Davis, Rascoe's widow, resided in Nashville, Tenn. Delta C. Davis is a party herein only because she filed joint returns with her husband Rascoe for the years in issue.
During each of the years in controversy, petitioner Joe Davis, his brother Rascoe Davis, now deceased, and five other individuals were partners in a joint venture initially called Davis Webster County Development, and later, Cumberland Land Co. (hereinafter Cumberland). Cumberland was organized under a joint venture agreement dated January 1, 1966. Joe Davis had a 667;8-percent interest in Cumberland's profits and losses; Rascoe Davis' interest was 43;8 percent.2 Cumberland and each of its partners were calendar year, cash basis taxpayers.
Cumberland was in the business of leasing coal mining rights from landowners in Kentucky and then subleasing those rights to a mining company called Webster County Coal Corp. (hereinafter Webster Coal). Between 1967 and 1971, the same individuals who were partners in Cumberland owned all of the stock of Webster Coal, with the exception that Joe Davis held some Webster Coal stock through his controlled corporation, Davis Coals, Inc. (hereinafter Davis Coals). On February 22, 1971, an unrelated corporation called Mapco, Inc., acquired Webster Coal by merger.
All of Cumberland's transactions were carried out in the following manner. Cumberland acquired by lease the rights to mine seams of No. 9 grade coal on or underlying the properties of various landowners. In every case but one, the consideration for the lease was the greater of an advanced yearly minimum amount, paid on acquisition, or earned royalties3 of 10 cents a ton for coal mined under the lease. The yearly minimum royalties were “advanced” in the sense that when coal was later mined, the earned royalties then due were reduced by credits for earlier unearned royalties paid.
Cumberland's leases were thereafter subleased to the mining operator, Webster Coal. Between 1966 and 1971, 11 subleases were executed in all, which for convenience will be referred to in the order in which they were executed. In some cases, leases were subleased to Webster Coal immediately after Cumberland acquired them.4 More frequently, however, a group of leases acquired over time was later subleased to Webster Coal as a unit. For example, the seventh sublease, dated March 30, 1970, transferred to Webster Coal Cumberland's rights under five separate leases acquired between April 1968 and April 1969. On the other hand, in the 10th sublease, dated November 1, 1970, Cumberland transferred to Webster Coal its rights under 19 leases acquired between August and October of that same year. Whatever the delay between lease and sublease, Cumberland subleased all of the coal mining rights it acquired and never mined coal itself.
Under each sublease, Cumberland was entitled to either earned royalties on the coal extracted or yearly advanced minimum royalties. Earned royalties were the greater of 30 cents per ton or 81;2 percent of the gross sales price. However, Webster Coal paid advanced minimum royalties at the end of each lease year if earned royalties were less than the specified minimum. Thus, although Cumberland's advanced minimum payments to landowners in a given year could exceed royalty income, for coal actually mined Cumberland was ensured a profit of at least 20 cents per ton. Profits on a particular sublease would be larger either if royalties due the landowner were reduced by credits for earlier advanced royalties or if Cumberland's royalty income was greater than 30 cents per ton, based on 81;2 percent of...
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