57 T.C.M. (CCH) 910
J. ALFRED LEVERT II AND MARTHA F. LEVERT, Petitioners
COMMISSIONER OF INTERNAL REVENUE, Respondent
Nos. 533-85, 42103-85, 48623-86.
United States Tax Court
July 13, 1989
Gerald H. Litwin, for the petitioners.
Albert G. Kobylarz, for the respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined the following deficiencies and additions to tax against petitioners:
|| Additions to Tax Under Sections2
Respondent also determined that petitioners were liable for increased interest under section 6621(c) (formerly designated section 6621(d)) with respect to a portion of the 1981 underpayment and the entire 1982 underpayment. After concessions, the issues presented are (1) whether, and to what extent, petitioners incurred mining exploration expenditures that are currently deductible under section 617, (2) the proper year for deducting any such expenditures under the accrual method of accounting, and (3) whether petitioners are liable for the determined additions to tax and increased interest. FINDINGS OF FACT Some of the facts have been stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference. Petitioners are married and resided in New Orleans, Louisiana, when they filed their petitions. Petitioners have a significant background in the business of exploring for various mineral resources, including natural gas, oil, and metals. After graduating from Tulane University in 1966, petitioner J. Alfred Levert II (‘ Mr. Levert‘ ) was employed by a brokerage firm in New Orleans. As manager of the firm's commodities department, Mr. Levert worked on gold and silver transactions. After some ten years at the firm, Mr. Levert left to enter the ‘ minerals business.‘ He formed a partnership with Bill Broadnax for the purpose of oil and gas exploration. Since 1976, Mr. Levert has participated in numerous other partnerships engaged in mineral resources exploration. Mr. Levert and petitioner Martha F. Levert (‘ Mrs. Levert‘ ) own and operate roughly 30 mineral properties. Prior to 1980, petitioners made a major discovery of natural gas. In 1980, petitioners decided to diversify their interests by increasing their investment in liquid petroleum and ‘ hard minerals,‘ i.e., metals. In the spring of 1980, petitioners began negotiations with Mr. Lawrence T. Atkinson. Mr. Atkinson is the president of Combined Metals Reduction Company (‘ Combined Metals‘ ) and its subsidiaries. Combined Metals is a mining company engaged in exploration and processing. Combined Metals and its subsidiaries have facilities in Fish Lake Valley, Nevada, including an extensive library, laboratories, shops, warehouses, heavy equipment, and aircraft. Mr. Atkinson had acquired a controlling stock interest in Combined Metals in 1974. Mr. Levert had known Mr. Atkinson since that time, and the two men had participated in various business ventures together. In their negotiations with Mr. Atkinson, petitioners sought exploration services. Their goal was to acquire reserves of gold or silver and sell the reserves to a buyer capable of processing ore. During negotiations, petitioners attempted to obtain the maximum ‘ exploration area‘ for a predetermined contract price. Petitioners did not receive tax advice respecting any proposed transaction with Mr. Atkinson. On December 30, 1980, petitioners entered into an ‘ Exploration Agreement‘ (‘ the 1980 contract‘ ) with Dallas Mines Nevada, Inc. (‘ the contractor‘ ), which is a second-tier subsidiary of Combined Metals. Although Mrs. Levert alone signed the 1980 contract, petitioners considered themselves members of ‘ Inyo Exploration,‘ a joint venture, and Mrs. Levert signed the 1980 contract on behalf of Inyo Exploration. The 1980 contract required the contractor to perform various services within an exploration area consisting of portions of Inyo and San Bernardino Counties, California. The 1980 contract described all of the specified services as ‘ Exploration Services‘ and further classified the services into three groups, ‘ Phase 1 -- Overview of Exploration Area,‘ ‘ Phase 2 -- Appraisal of Selected Targets,‘ and ‘ Phase 3 -- Acquisition of Mineral Rights.‘ Phase 1 services included ‘ compilation of published studies, reports, geologic surveys and production records (if any) with respect to the Exploration Area, ‘ review of various aerial and satellite photographs, and some mapping. Phase 2 services included surface and underground mapping, and sampling. Phase 3 services included assisting petitioners in obtaining ‘ mineral rights‘ to those portions of the exploration area that demonstrated ‘ economic potential.‘ The 1980 contract imposed no deadline for the performance of the ‘ exploration services‘ but estimated that Phases 1 and 2 would be completed within 200 days. The 1980 contract required the contractor to notify petitioners after completing each of Phases 1 and 2. The 1980 contract also provided, ‘ Contractor shall not be required to proceed with the next following phase until Owner » petitioners shall have given Contractor a written 'Notice to Proceed’ .‘ Petitioners agreed to pay the contractor $243,750 for the specified services. Of the foregoing amount, petitioners agreed to pay $18,750 in cash, while the balance of the contract price was represented by a promissory note for $225,000, bearing 12 percent interest, and payable in installments of $18,750 due every four months beginning April 30, 1981. Roughly one year later, on December 8, 1981, petitioners entered into a second ‘ Exploration Agreement‘ (‘ the 1981 contract‘ ). The 1981 contract specified a different contractor, Dallas Mines, Inc., a subsidiary of Combined Metals. (Hereinafter, Dallas Mines Nevada, Inc., and Dallas Mines, Inc., will both be referred to as ‘ the contractor.‘ ) Mrs. Levert signed the 1981 contract on behalf of Inyo Exploration. The 1981 contract contained terms essentially identical to those in the 1980 contract. Some distinctions, however, merit mention. The 1981 contract involved a different exploration area, specifically, a portion of Esmeralda County, Nevada. The 1981 contract estimated that Phases 1 and 2 would be completed within 600 days. Like the 1980 contract, the 1981 contract required the contractor to advise petitioners of the completion of each of Phases 1 and 2. The 1981 contract, in language similar but not identical to that contained in the 1980 contract, further provided, ‘ Contractor shall not be required to proceed with the next following phase until owner shall have given contractor a written 'Notice to Proceed’ specifying the tasks for which Contractor will be additionally compensated.‘ Petitioners agreed to pay the contractor $160,000 for the specified services. Of the foregoing amount, petitioners agreed to pay $20,000 in cash, while the balance, $140,000, was represented by a promissory note calling for seven quarterly installments commencing on July 1, 1982, and bearing 12 percent interest. Petitioners also agreed to pay additional compensation to the contractor for certain services, including the staking of claims and the negotiation of leases and purchases of ‘ mineral lands.‘ After the contractor began performing its duties, petitioners visited a number of mining properties and the contractor's facilities in Nevada. Petitioners communicated with the contractor regularly, most frequently by telephone. The contractor completed performance of the 1980 and 1981 contracts to petitioners' satisfaction. While performing its duties, the contractor commercially exploited a number of ‘ mine dumps‘ on behalf of petitioners. Mine dumps are piles of waste created by exploratory digging. Rising metal prices and an extraction process known as ‘ cyanization‘ had increased the attractiveness of exploiting dumps. The contractor acquired 300 tons of dump ore on a claim named ‘ Beagle Sam‘ in exchange for exploration results. In a letter dated April 9, 1981, Mr. Atkinson told Mr. Levert that the ore most likely would produce ten ounces of silver per ton. In a letter dated December 14, 1982, Mr. Atkinson told Mr. Levert that petitioners could acquire an ore stockpile located on a claim named ‘ High Hopes‘ in exchange for ‘ road work‘ performed by the contractor. In a letter dated February 3, 1983, Mr. Atkinson told Mr. Levert about two dumps at a claim named ‘ Jeannette‘ and predicted ‘ some mining profit.‘ Mr. Atkinson also referred to dumps at claims named ‘ Wildhorse‘ and ‘ Nina.‘ In a letter dated March 24, 1983, Mr. Atkinson agreed to waive interest accruing after January 1, 1983, on the balance owed pursuant to the 1980 contract. According to the letter, interest would again begin to accrue upon the contractor's resumption of ore processing and the resulting recovery of metal by petitioners. The letter stated that petitioners owned one-half of 2,100 ounces of silver and 12 ounces of gold ‘ in solution‘ (undergoing processing). The letter also stated that the ‘ Jeannette ore‘ consisted of 220 tons, containing roughly 13 ounces of gold and 5,900 ounces of silver, and that the ore would be processed soon. The following table sets forth metal prices reported by the Wall Street Journal on various dates:
|| Gold (per ounce)
|| Silver (per ounce)
| February 4, 1980
| September 8, 1982
| March 24, 1983
In 1987, Mr. Atkinson...