Donnell v. Comm'r of Internal Revenue (In re Estate of Donnell)
| Decision Date | 13 July 1967 |
| Docket Number | Docket Nos. 2752-65— 2754-65. |
| Citation | 48 T.C. 552 |
| Parties | ESTATE OF H. W. DONNELL, DECEASED, WILLIE HAYDEN DONNELL, EXECUTRIX, AND MRS. WILLIE HAYDEN DONNELL, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Harold D. Rogers and Paul W. Eggers, for the petitioners.
Harold L. Cook, for the respondent.
Held: 1. Petitioners are entitled to deduct as intangible drilling and development expenses certain amounts paid in 1959 and 1960 for drilling on four illegally deviated oil wells bottomed outside of property on which they had a working interest in a lease.
2. Petitioners are not entitled to depletion allowance deductions in 1961 and 1962 with respect to oil produced from four illegally deviated oil wells bottomed outside of property on which they had a working interest in a lease because they had no ‘economic interest’ in the oil in place. However, petitioners are entitled to depletion allowance deductions in 1961 of 53.48 percent of the gross income from the lease which was produced from seven nondeviated oil wells.
3. In substance, petitioners constructively received certain additional taxable income for 1961, 1962, and 1963 from an oil production payment made to another where they guaranteed the payout of the production payment. In the transactions of Jan. 11, 1961, petitioners acquired one property interest instead of two.
In these consolidated cases the respondent determined the following income tax deficiencies against the petitioners:
+----------------------------------------------------------------+
¦Petitioners ¦Docket ¦Year ¦Deficiency¦
+---------------------------------------+-------+-----+----------¦
¦ ¦No. ¦ ¦ ¦
+---------------------------------------+-------+-----+----------¦
¦ ¦ ¦(1959¦$8,298.48 ¦
+---------------------------------------+-------+-----+----------¦
¦H. W. Donnell and Willie Hayden Donnell¦2752-65¦(1960¦8,665.87 ¦
+---------------------------------------+-------+-----+----------¦
¦ ¦ ¦(1961¦10,805.78 ¦
+---------------------------------------+-------+-----+----------¦
¦H. W. Donnell ¦2753-65¦1963 ¦1,343.31 ¦
+---------------------------------------+-------+-----+----------¦
¦Willie Hayden Donnell ¦2754-65¦1963 ¦1,343.32 ¦
+----------------------------------------------------------------+
In docket No. 2752-65 the year 1962 in involved because of a net operating loss carryback to the year 1959. Petitioners filed separate community income tax returns for 1962 and 1963.
Three issues are presented for our decision. They are:
(1) Whether the petitioners are entitled to deduct as intangible drilling and development expenses the amounts of $15,334.05 in 1959 and $12,949.31 in 1960 for drilling on four illegally deviated oil wells bottomed outside of property on which they had a working interest in the Ephriam lease.
(2) Whether the petitioners are entitled to the depletion deductions claimed in 1961 and 1962 with respect to oil produced from four illegally deviated oil wells bottomed outside of property on which they had a working interest in the Ephriam lease.
(3) Whether the petitioners constructively received additional taxable income of $5,118.25, $8,523.04, and $6,668.15 in the years 1961, 1962, and 1963 from an oil production payment made to another in connection with the Fleming lease where the petitioners guaranteed the payout of the production payment.
The resolution of a fourth issue pertaining to a claimed net operating loss carryback from 1962 to 1959 will depend upon our decisions on the other three issues and can be given effect in the Rule 50 computation.
The facts have been stipulated by the parties. Their stipulation and the exhibits attached thereto are incorporated herein by this reference and are hereby adopted as our findings. To the extent pertinent they are set our below.
H. W. Donnell and Willie Hayden Donnell (hereinafter called petitioners) were husband and wife during the years 1959 through 1963 and, at the time the petitions were filed herein, their legal residence was Kilgore, Tex. H. W. Donnell died testate on August 16, 1966. In his will he named his wife, Willie Hayden Donnell, as independent executrix of his estate.
The petitioners filed joint Federal income tax returns for the years 1959, 1960, and 1961, and separate Federal income tax returns for the years 1962 and 1963 with the district director of internal revenue at Dallas, Tex. They used the cash receipt and disbursement method of accounting and reporting of income and expenses will respect to their oil and gas business.
Petitioners were engaged in the oil and gas business and other businesses during the years 1959 through 1963. Petitioners owned a portion of a leasehold working interest in many oil and gas leases. Most of the leases owned by the petitioners were owned in conjunction with other persons.
During the years 1959 through 1962 the petitioners owned an undivided 50 percent of the seven-eighths working interest in the George Ephriam lease located in Rusk County, Tex. This lease was operated by J. D. Laird.
During the period from 1958 through 1961 11 producing oil wells were drilled on the Ephriam lease as follows:
+-----------------------+
¦ ¦Number of ¦
+------+----------------¦
¦Year ¦wells drilled ¦
+------+----------------¦
¦1958 ¦1 ¦
+------+----------------¦
¦1959 ¦2 ¦
+------+----------------¦
¦1960 ¦4 ¦
+------+----------------¦
¦1961 ¦4 ¦
+-----------------------+
In 1959 the petitioners were billed by the operator of the Ephriam lease and paid the sum of $15,334.05 representing their share of the intangible drilling and development costs for wells 3 and 4 on the Ephriam lease.
In 1960 the petitioners were billed by the operator of the Ephriam lease and paid the sum of $12,949.31 representing their share of the intangible drilling and development costs for wells 2 and 4 on the Ephriam lease.
Petitioners elected on their first income tax return for which an election was required under section 612, I.R.C. 1954, to deduct as expenses all intangible drilling and development costs and such election continued through the years in controversy. In their Federal income tax returns for the years 1959 and 1960 the petitioners elected to deduct as expenses the costs of wells 3 and 4 in 1959, and the cost of wells 2 and 4 in 1960 on the Ephriam lease. Petitioners also deducted on their income tax returns for all years here in issue all intangible drilling and development costs as to faulty wells or dry holes.
In October 1962 the Railroad Commission of the State of Texas determined that 4 of the 11 wells, namely wells 1 through 4, on the Ephriam lease, were deviated to a greater degree than was permitted by the regulations of the railroad commission. As a result of such determination, these wells have been shut-in. Wells 1 through 4 on the Ephriam lease were drilled into and bottomed in producing oil sands which were outside the verticle extensions of the boundaries of the Ephriam leasehold property.
All of the 11 wells on the Ephriam oil and gas lease were drilled on that lease. None of such wells were surfaced off the Ephriam lease in which the petitioners owned an undivided 50 percent of the working interest. During the years 1959 through 1962 the petitioners had to look to the oil production from the Ephriam lease for the return of their investment in such lease. Petitioners also had an investment in equipment on wells 1 through 4 on the Ephriam lease.
For each of the years 1959 through 1962 the petitioners deducted all of the operating expenses (lifting costs and overhead expenses) incurred in operating the Ephriam lease together with depletion allowable with respect to the lease. None of these expenses were disallowed by respondent in the notices of deficiencies.
All of the oil and gas royalty interests and oil payments owned by other parties in the Ephriam lease were paid by General American Pipe Line Co. in the years here in issue out of the production of the wells on the Ephriam lease.
No claims were made against any owner of any royalty or working interest in the Ephriam lease as to the right to receive oil production from the 11 wells drilled on the lease prior to July 1962.
The oil allowables per oil well on the Ephriam lease, as set by the Railroad Commission of the State of Texas, for the period January 1, 1961, to August 1, 1964, are as follows:
+----------------------------------------------------------------------------------------------+
¦Well No.— ¦
+----------------------------------------------------------------------------------------------¦
¦ ¦1 ¦2 ¦3 ¦4 ¦5 ¦6 ¦7 ¦8 ¦9 ¦10 ¦11 ¦Total ¦
+---------+------+------+------+------+------+------+------+------+------+------+------+-------¦
¦1961 ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦ ¦
+---------+------+------+------+------+------+------+------+------+------+------+------+-------¦
¦January ¦$8.00 ¦$18.33¦$16.90¦$17.70¦$18.70¦$17.72¦$17.70¦ ¦ ¦ ¦ ¦$115.05¦
+---------+------+------+------+------+------+------+------+------+------+------+------+-------¦
¦February ¦8.00 ¦18.33 ¦16.90 ¦17.70 ¦18.70 ¦17.72 ¦17.70 ¦ ¦ ¦ ¦ ¦115.05 ¦
+---------+------+------+------+------+------+------+------+------+------+------+------+-------¦
¦March ¦8.00 ¦18.33 ¦16.90 ¦17.70 ¦18.70 ¦17.72 ¦17.70 ¦ ¦ ¦ ¦ ¦115.05 ¦
+---------+------+------+------+------+------+------+------+------+------+------+------+-------¦
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