Estate of Wilbur v. Comm'r of Internal Revenue

• Decision Date: 16 December 1964
• Docket Number: Docket No. 1086-63.
• Citation: 43 T.C. 322
• Parties: ESTATE OF RICHARD R. WILBUR, DOROTHY P. WILBUR AND UNITED CALIFORNIA BANK, COEXECUTORS, AND DOROTHY P. WILBUR, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
• Court: U.S. Tax Court

43 T.C. 322

ESTATE OF RICHARD R. WILBUR, DOROTHY P. WILBUR AND UNITED CALIFORNIA BANK, COEXECUTORS, AND DOROTHY P. WILBUR, PETITIONERS,

v.COMMISSIONER OF INTERNAL REVENUE, RESPONDENT

Docket No. 1086-63.

Tax Court of the United States.

Filed December 16, 1964.

Hart H. Spiegel, for the petitioners.

David R. Brennen, for the respondent.

Pursuant to regulations section 1.162-12 a farmer has an option either to deduct or to capitalize so-called cultural practices expenditures; and the Commissioner admits that the farmer may elect to deduct some while at the same time capitalizing other such expenditures.

1. Held, that taxpayer-farmer who in fact deducted certain cultural practices expenditures on his 1958-60 returns may not be required to capitalize them merely because in electing to capitalize other such expenditures in those years he erroneously thought he was capitalizing all such expenditures.

2. Held, taxpayer may not by amended returns or otherwise, have the benefit of expense deductions in respect of the cultural practices expenditures that he in fact capitalized on his returns for 1956, 1958, 1959, and 1960. In this connection, it is held that the applicable regulations are valid; that no mistake has been established as to the exercise of the option to capitalize the amount in question for 1956; and that the taxpayer was bound by his election to capitalize in 1956, 1958, 1959, and 1960.

OPINION

RAUM, Judge:

The Commissioner determined income tax deficiencies and additions thereto in the aggregate amount of $262,552.07 for the years 1954, 1955, 1956, 1959, and 1960. The parties have reached agreement as to all issues except those involving certain farming expenses referred to as ‘cultural practices expenditures.’ These remaining issues affect only the deficiences for the years 1956, 1959, and 1960, but the year 1958 appears to be involved also by reason of a possible carryover. The facts have been stipulated.

Richard R. Wilbur resided with his wife Dorothy during the tax years in Yuba City, Calif. She is involved herein only because they filed joint returns. He died in December 1961 and will sometimes hereinafter be referred to as the taxpayer. He was engaged in farming on a large scale in the Sacramento Valley, particularly in the production of peaches, prunes, almonds, and English walnuts, all of which are grown on trees.

A tree will not bear a crop of commercial value for at least several years after planting; thus, a peach tree will not produce a paying crop until the fourth year of its life, a prune tree until the sixth year, and an English walnut tree until the eighth year. After the initial capital expenses are incurred in planting the orchards, it is necessary to make large expenditures from time to time thereafter for irrigation, cultivation, pruning, fertilizing, spraying, and other care of the trees which have not yet reached the productive state. Such expenditures are referred to as cultural practices expenditures. They are apparently similar in character to maintenance expenses for like purposes after full production has been attained, and the parties have stipulated that ‘They were ordinarily paid in his (taxpayer's) farming business, and they were necessarily so paid.’

The Treasury has long recognized that although cultural practices expenditures are of the type that may normally be deducted as ordinary and necessary expenses, they also bear a similarity to capital outlays, and it has given farmers an option to treat them either way. This option is presently contained in Income Tax Regulations section 1.162-12 which provides: ‘Amounts expended in the development of farms, orchards, and ranches prior to the time when the productive state is reached may be regarded as investments of capital.’ Identical provisions in prior regulations have been in effect for some 45 years,¹ and a ruling issued as far back as 1923 has explicitly interpreted the regulations as meaning that ‘the taxpayer has the option of charging such amounts as expense or capitalizing them.’ I.T. 1610, II-1 C.B. 85.²

The dispute between the parties herein is whether certain cultural practices expenditures in the years 1956, 1958, 1959, and 1960 must be capitalized, in view of the manner in which such expenditures or portions thereof were treated on the returns for those years. We turn to the facts out of which the issues arise.

In each of the years 1953, 1954, and 1955, the taxpayer made substantial cultural practices expenditures, which he deducted in full as business expenses on his returns and which were allowed by the Commissioner. In 1956 the taxpayer made substantial cultural practices expenditures in respect of orchards planted in prior years as well as cultural practices expenditures in the amount of $19,575 in respect of orchards planted in 1956; he deducted as business expenses the amounts relating to the previously planted orchards, but included the $19,575 in the cost of planting the new orchards in 1956 which he capitalized.³ The Commissioner made no adjustment in the taxpayer's treatment of any of the cultural practices expenditures made in 1956. The taxpayer made substantial cultural practices expenditures in 1957 which he deducted in full as business expenses; the Commissioner did not disturb these deductions.

In the preparation of the 1958, 1959, and 1960 returns, the taxpayer and his accountants computed his cultural practices expenditures as $38,881.74, $66,003, and $64,300.50, respectively. When these returns were prepared, the accountants explained that no taxable income would appear thereon and, acting upon their advice, the taxpayer determined to capitalize these amounts so that he could recover them in subsequent years through depreciation. Accordingly, these amounts were in fact included among the capital expenditures reflected on the returns for each of the years, and depreciation deductions have been taken in respect thereof in subsequent years— all in accordance with the taxpayer's books. The taxpayer and his accountants thought that they were capitalizing expenditures to the maximum extent permitted by law in the 1958-60 returns. However, through oversight, they miscalculated the amounts of cultural practices expenditures during each of those years, which in fact were $81,653.50, $95,002.40, and $73,157.50, respectively.⁴ The differences of $42,771.76, $28,999.40, and $8,857 were included among the deductions for business expenses in the 1958, 1959, and 1960 returns, respectively.

In supporting the deficiencies determined for 1959 and 1960 the Commissioner takes the position that these additional amounts which had been deducted in the 1958-60 returns must be capitalized along with the amounts of cultural practices expenditures actually reflected as capital items on those returns. Petitioners, on the other hand, contend that the taxpayer had a right to deduct cultural practices expenditures and that to the extent that such deductions were actually taken on the returns they may not be disturbed. In addition, petitioners make the sweeping contention that all cultural practices expenditures are by their nature deductible business expenses and that the regulations giving taxpayers the option to treat such expenditures as capital outlays or deductions are invalid. Finally, they contend that even if the regulations are valid the taxpayer was entitled to deduct the cultural practices expenditures capitalized in the returns. In connection with that final contention they filed amended returns for 1958-60 on January 2, 1963, and an amended return for 1956 on March 12, 1963, claiming all cultural practices expenditures as deductions for such years, even those capitalized in the original returns. As to the deficiencies for 1959 and 1960, petitioners point to the fact that other adjustments required by the Commissioner result in taxable income for these years,⁵ and they argue that since the taxpayer thought he did not have any taxable income at the time he filed his original returns, he did not have a meaningful choice when he elected to capitalize cultural practices expenditures, with the consequence that he should not be bound by that election. As to 1956, they argue that the $19,575 cultural practices expenditures were mistakenly capitalized and should now be treated as business deductions.

We hold, first, that the Commissioner may not require the capitalization of those amounts actually deducted in the taxpayer's original returns for 1958-60; second, that the applicable regulations permitting the capitalization of cultural practices expenditures are valid; and, third, that the taxpayer was bound by the election to capitalize the amounts actually reflected as capitalized in the 1958-60 returns, as well as the amount capitalized in the 1956 return.

1. In the 1958-60 returns, cultural practices expenditures in the respective amounts of $42,771.76, $28,999.40, and $8,857 were in fact included among the deductions taken. The Commissioner does not dispute that such deductions were authorized under section 162(a) of the 1954 Code, which provides for a deduction of ‘all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.’ However, he does contend that the taxpayer elected to capitalize all cultural practices expenditures in the years 1958-60, that the adjustments giving rise to the 1959 and 1960 deficiencies in this respect simply correct the error made by the taxpayer in determining all of the cultural practices expenditures, and that such adjustments merely give full effect to the election made by the taxpayer.

We think that the Commissioner's position is based upon a misconception of the record. It is true that the taxpayer and his accountants believed that they were capitalizing expenditures to the full extent permitted by law when they capitalized cultural practices expenditures in the amounts of $38,881.74, $66,003, and...