Gmelin v. Commissioner
| Decision Date | 29 July 1988 |
| Docket Number | 3831-85.,Docket No. 3673-85 |
| Citation | 55 TCM (CCH) 1410,1988 TC Memo 338 |
| Parties | Lenz W. Gmelin and Ingeborg U. Gmelin v. Commissioner. |
| Court | U.S. Tax Court |
Donald A. Richards, 80 Main St., West Orange, N.J., for the petitioners. Caroline R. Ades, Edward G. Martoglio, and Frank Agostino for the respondent.
Memorandum Findings of Fact and Opinion
In a notice of deficiency dated November 30, 1984, respondent determined deficiencies in petitioners' Federal income tax for the years and in the amounts as follow:
Year Amount
1979 .................. $624,106
1980 .................. 725,024
Respondent's answers assert that the deficiencies constitute substantial underpayments attributable to tax-motivated transactions within the meaning of section 6621(c).2
The dispute in this case arises out of petitioners' investment in various coal mining limited partnerships. Respondent audited the partnerships but failed to issue a statutory notice within the statute of limitations for 1978, the year petitioners deducted losses in connection with these partnerships. Respondent thereafter issued a statutory notice with respect to the following 2 years, including in petitioners' income amounts taken as deductions in the earlier year. Petitioners challenge the validity of the later notice and respondent's determination that the amounts deducted in 1978 are includable in petitioners' income for the later years.
After concessions, the issues for decision are: (1) whether the 6-year statute of limitations set forth in section 6501(e)(1) is applicable to petitioners' 1979 tax year; (2) whether the November 30, 1984, statutory notice for petitioners' 1980 tax year is valid; (3) whether the November 30, 1984, notice of deficiency violates due process; (4) whether petitioners realized income in either 1979 or 1980 with respect to their 1978 investment in Brandywine Associates (Brandywine), Cherry Run Associates (Cherry Run), and Clear Fork Associates (Clear Fork); (5) whether petitioner Ingeborg U. Gmelin is an innocent spouse under section 6013(e); and (6) whether petitioners' deficiencies constitute substantial underpayments attributable to tax-motivated transactions within the meaning of section 6621(c).
Some of the facts have been stipulated and they are so found. Petitioners' residence at the time of the filing of these petitions was in Kinnelon, New Jersey. During the years in issue, petitioners were married and filed joint Federal income tax returns.
Brandywine, Cherry Run, and Clear Fork are three of a number of coal mining limited partnerships organized and promoted by Karl R. Huber (Huber, Jr.) and his father, Karl Huber (Huber). Huber, Jr., is a graduate of the Harvard Law School. He was admitted to the New Jersey Bar in 1965; he was suspended from the practice of law in New Jersey in 1979 and disbarred in 1986.
Brandywine, Cherry Run, and Clear Fork were organized in 1978 under the Uniform Limited Partnership Act of the State of New Jersey. At the time of organization, Huber, Jr., was the sole general partner of each partnership. The amended limited partnership agreements required Huber, Jr., to contribute $20,000, $25,000, and $9,000 to Brandywine, Cherry Run, and Clear Fork, respectively. Brandywine had 42 limited partners whose contributions totaled $600,000; Cherry Run had 34 limited partners who contributed a total of $750,000; and Clear Fork had 31 limited partners who contributed a total of $491,000.
In 1978 each of the three partnerships entered into the following agreements: (1) lease agreement with Boden Coal Company, a West Virginia corporation (Boden-WV); (2) mining agreement with Stallion Mining Corporation, a West Virginia corporation (Stallion); (3) coal sales or requirements contract with Boden Coal Company, a Delaware corporation (Boden-DEL); and (4) research and development agreement with Cognitech Research Laboratories, Ltd. (Cognitech), a limited partnership formed under the laws of New Jersey. Huber, Jr., drafted all of the agreements for each of the partnerships in issue.
The lease agreement between Brandywine and Boden-WV, which was executed on December 29, 1978, involved the coal rights to the Stockton-Lewiston (Lower Bench) seam underlying the Eril Price Tract, and an undivided 24-percent interest in all of the Coalburg seam underlying the Gillespie Tract in Boone County West Virginia. The lease agreement required Brandywine to pay a production royalty in addition to an advanced minimum royalty of $480,000 for the first year of the lease. Section 8 of the lease agreement, which is entitled "Additional Mining Rights and Obligations," includes the following subsection:
(b) Lessee Brandywine shall begin mining the leased property no later than September 1, 1980. It shall conduct its mining operations in strict compliance with all Federal and State mining laws and regulations and will save Lessor Boden-WV harmless for Lessee's failure so to do. Lessee shall be and is obligated diligently to mine and remove all coal that may be mineable and merchantable and that can be profitably removed by Lessee, it being agreed that in event any of said coal cannot be so profitably removed that the Lessee shall be relieved of the obligation of mining the same. The Lessor and Lessee or their engineers, at least as frequently as every six (6) months and more often if required by Lessor or Lessee, shall jointly determine whether Lessee has mined and removed all the mineable and merchantable coal from any given area or part of the leased premises.
On October 23, 1978, Clear Fork and Boden-WV executed a lease agreement similar to the agreement executed by Brandywine and Boden-WV. The amount of the advanced minimum royalty was $400,000. The lease agreement required Clear Fork to begin mining the leased property (all of the Coalburg seam underlying the Eril Price Tract in Boone County, West Virginia) no later than December 1, 1979.
In addition to the lease agreements with Boden-WV, each of the partnerships entered into a mining contract with Stallion. Stallion agreed to commence preparation and development of the property leased by Brandywine, Cherry Run, and Clear Fork on or before September 1, 1980, March 1, 1979, and December 1, 1979, respectively. However, Stallion filed for Chapter 11 bankruptcy in November 1979 and no mining was commenced with respect to the three partnerships in issue.
Each of the partnerships also executed a coal sales or requirements contract with Boden-DEL. Boden-DEL agreed to purchase from Brandywine 150,000 net tons of coal in 1979 and each calendar year thereafter. The net tons of coal to be purchased by Boden-DEL from Cherry Run and Clear Fork were 200,000 and 130,000, respectively.
Additionally, each of the partnerships entered into a Research and Development Agreement (RDA) with Cognitech, a limited partnership, organized for tax purposes. The research and development was to commence on the date of each agreement between Cognitech and the partnerships. Pursuant to the RDA between Brandywine and Cognitech, the latter agreed to develop and to manufacture or license a commercially feasible ultrasonically augmented chemical coal cleaning (desulfurization) process. The RDA required Brandywine to pay $2,000,000 to Cognitech on December 29, 1978, the date on which the agreement was executed. Of the $2,000,000 consideration to be paid by Brandywine to Cognitech, $1,860,000 was paid by Brandywine's promissory note. The note provided for the payment of no interest and payment of principal in monthly installments of $38,750 from November 1, 1980, to October 1, 1984.
Pursuant to the RDA between Cherry Run and Cognitech, the latter agreed to engage in the research and development of a commercially feasible, stable coal/oil Thixotrope. Cherry Run agreed to pay $2,500,000 to Cognitech on July 5, 1978, the date on which the agreement was executed. Of the $2,500,000 to be paid by Cherry Run, $2,300,000 was paid by Cherry Run's promissory note. The note provided for the payment of no interest and payment of principal in monthly amounts of $47,917 from April 1, 1979, to March 1, 1983.
The RDA between Clear Fork and Cognitech provided that Cognitech would engage in the development and manufacture or license of commercially feasible Thixogel fire and explosion quenching systems in the mine environment. Clear Fork agreed to pay $1,600,000 for the services and of that amount $1,500,000 was paid by Clear Fork's promissory note to Cognitech. The note provided for the payment of no interest and payment of principal in the monthly amounts of $31,250 from February 1, 1980, until January 1, 1984.
The notes payable to Cognitech that were executed in connection with the RDAs were to be paid from coal mining revenue. The notes provide that the "unpaid balance of the principal sum of this Note and interest hereon shall immediately become due and payable, at the election of the holder hereof" upon, inter alia, 6 months default in any payment. None of the partnerships paid the notes to Cognitech, and Cognitech did not institute an action to enforce the notes. The record does not indicate the amount of research, if any, that was conducted with respect to the projects that were the subject of the Cognitech RDAs.
Each of the notes payable to Cognitech included the following subordination and liability paragraphs:
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