Frazell v. United States

• Decision Date: 31 January 1963
• Docket Number: Civ. A. No. 8031.
• Parties: William D. FRAZELL and Martha T. Frazell v. The UNITED STATES of America.
• Court: U.S. District Court — Western District of Louisiana

213 F. Supp. 457

William D. FRAZELL and Martha T. Frazell v. The UNITED STATES of America.

Civ. A. No. 8031.

United States District Court W. D. Louisiana, Shreveport Division.

January 31, 1963.

W. Scott Wilkinson, Wilkinson, Lewis, Madison & Woods, Shreveport, La., for plaintiffs.

Edward L. Shaheen, U. S. Atty., Shreveport, La., for the Government.

BEN C. DAWKINS, Jr., Chief Judge.

This action is brought to recover income taxes assessed, and paid under protest, together with statutory interest, from the Government.¹

In substance, the complaint alleges that the Internal Revenue Service erroneously assessed and collected additional federal income taxes (and interest) from plaintiffs, William D. Frazell and his wife, for the year 1955, in the amounts of $32,084.90 from each plaintiff. Plaintiffs pray for judgment in these amounts plus interest against the United States.

Although the facts are relatively undisputed, the case having been submitted on the pleadings and evidence adduced without trial on the merits, the parties disagree over the legal consequences flowing therefrom. The facts are:

Frazell is a geologist by occupation, having been graduated with a Bachelor of Science degree in Geology from Southern Methodist University in 1934, and a Master of Arts degree in Geology from the University of Texas in 1935. Following graduation, he was employed by Union Producing Company as a geologist and continued in that position until 1949, when he became associated with W. C. Woolf and N. H. Wheless in a speculative oil venture, the legal nature of which is seriously disputed by the parties. The Government maintains that plaintiff was merely "employed" by Woolf and Wheless, while Frazell contends that he was a principal to a "joint venture" among the three. Both parties point to the written agreement setting forth the relationships among Woolf, Wheless and Frazell in support of their respective positions.²

The essence of the agreement was that Frazell would combine his technical skill and geological information with capital supplied one half by Woolf and one half by Wheless for the purchase and development of oil, gas and mineral leases in Texas and any other areas designated by Woolf and Wheless during the life of the contract. Frazell, upon discovering likely mineral producing acreage, was to secure contracts for the acquisition of leases or other mineral rights, and submit them to Woolf and Wheless for their approval, whereupon the interests would be acquired by Frazell, one half in the name of Wheless and one half in the name of Woolf.

Frazell's findings and recommendations would not obligate Wheless and/or Woolf and, upon either or both of the latter declining to acquire the interests, Frazell would be allowed to make other arrangements for his own acquisition or acquisition by a third party only with the written consent of Wheless and Woolf. Any interests acquired by Wheless and Woolf in which Frazell did not desire an interest would not relate to plaintiff's participation under the agreement.

Frazell agreed to a monthly salary or drawing account of $675.00, plus expenses, in return for his full-time efforts in discovering and securing potentially profitable mineral properties or interests for future development. Presumably to give Frazell added incentive, Woolf and Wheless provided for limited participation by him in the profits resulting from development of the leases which he secured. Frazell's interest would arise according to the agreement only after Wheless and Woolf had recovered their full costs and expenses on the properties. All property and leases acquired by Frazell were to be held under record ownership of Wheless and Woolf who, together, retained at least nominal control and management over the properties.

After recovery of expenses and costs by Wheless and Woolf, Frazell, upon written request, was to be assigned his specified interest in the properties and thereafter be entitled to the portion of production allocated to his interest. His interest was subject, however, to its proportionate share of future costs for developing, operating, producing, transporting and marketing the production from the properties, plus a "reasonable charge" for overhead costs and expenses. Any outstanding indebtedness against the properties would be charged pro rata against Frazell's share of production from the properties.

The agreement further provided that, should Wheless and Woolf dispose of the properties and, after recovering costs and expenses, realize a profit therefrom, Frazell would be entitled to his proportionate share therein. Prior to assignment of his interest in any property to him, Frazell was prohibited by the terms of the agreement from disposing of his rights arising under the agreement. After being assigned his interest, Frazell, prior to disposing of all or any part of his interest, was obligated to grant Woolf and Wheless what amounted to a "first option" on the purchase thereof.

His participation was limited to those leases and interests acquired through his efforts under the provisions of the agreement, which, upon thirty days' notice by any party, was subject to termination.

The combined efforts of Frazell, Wheless and Woolf under this agreement proved profitable. From February 9, 1951, through March 31, 1955, Wheless and Woolf advanced capital in the sum of $1,245,106.00 and recovered from oil and gas production on the properties the sum of $1,008,613.00, thus leaving an unrecovered balance in the sum of $236,493.00. In the period beginning January 1, 1955, and ending January 1, 1956, the properties produced an average net monthly income of $29,326.00. Because no further expenditures for development were required, Frazell, Wheless and Woolf expected the properties to be "paid out" by November 30, 1955.

The parties to this agreement decided, at this time, to organize a corporation for the purpose of continuing their mutually profitable association in oil and gas ventures. Accordingly, on March 21, 1955, Frazell, Wheless and Woolf organized the W. W. F. Oil Corporation under the laws of Delaware. All properties acquired through the efforts of Frazell under the agreement were transferred to the corporation and each party received shares of stock in the corporation proportionate to his respective interest in the properties. Wheless (N. H. Wheless Oil Company) received 21,750 shares. Woolf received 21,750 shares, and Frazell received 6,500 shares (13% of the aggregate 50,000 shares). In addition, Frazell was elected president of the W. W. F. Oil Corporation at an annual salary of $16,000. Woolf and Wheless were elected Vice Presidents.

In filing their federal income tax returns for the year 1955, plaintiffs treated their receipt of the 6,500 shares of stock in the W. W. F. Oil Corporation as a tax-free exchange of property for stock under Section 351(a) of the Internal Revenue Code of 1954.³

Subsequently, the District Director made an additional assessment against each plaintiff in the amount of $26,364.54 (additional federal income taxes for the period from January 1, 1955, through December 31, 1955,) and $5,720.36 (interest), or an aggregate demand for $32,084.90 against each plaintiff.

In the Director's "Explanation of Items Changed," he reasoned that, under the original agreement among Wheless, Woolf and Frazell, the interest possessed by Frazell was only a "contingent interest," of such a nature that the taxpayer would not be considered as "owning" an interest in the properties until the "payout" was accomplished. Therefore, he reasoned, when the properties were transferred to the W. W. F. Oil Corporation prior to "payout," the taxpayers were not in a position to exchange "property" for the 6,500 shares of no par value stock they received because their "contingent interest" amounted only to "* * * a promise to receive an interest in the properties, if and when, payout was accomplished." Section 351(a) of the Code allows for a tax-free exchange of property for stock but since the taxpayers did not "own" an interest in the properties, according to the Director's position, the taxpayers had no "property" within the meaning of that Section which they could transfer in exchange for the 6,500 shares of stock in the W. W. F. Oil Corporation. Accordingly, the stock thus received by taxpayers was treated, for tax purposes, as additional compensation for services rendered by Frazell in his capacity as a geologist, and taxed accordingly under the provisions of Section 61(a) (1) of the Internal Revenue Code of 1954. The Engineer Revenue Agent set the fair market value of the stock at $14.00 per share and the resulting value of the stock received by Frazell was set at $91,000.00. This amount was returned to income under Section 61(a) (1) for the year 1955.

The parties have jointly stipulated that the ultimate issue to be resolved is whether the Commissioner correctly included the $91,000.00 in Frazell's gross income for the taxable year 1955. They further agreed that, should judgment for plaintiffs in any amount be rendered, the Internal Revenue Service shall compute the resulting tax consequences subject to review by plaintiffs.

Plaintiffs' position is that Frazell, after working for Union Producing Company for fourteen years, decided to forego his fixed salary in order to embark on a joint venture with Wheless and Woolf, thereby combining his geological information and professional training with capital supplied by Wheless and Woolf. As noted above, from February 9, 1951, through March 31, 1955, Wheless and Woolf advanced capital in the sum of $1,245,106.00 but recovered from oil and gas production the sum of $1,008,613.00. During this same period, Frazell supplied to the venture a very valuable oil map which was his private property, as well as his professional information, knowledge and skill in furtherance of the joint efforts of the parties, and in addition to a growing...