Vest v. Comm'r of Internal Revenue
| Decision Date | 28 October 1971 |
| Docket Number | Docket No. 3726-69. |
| Parties | EARL VEST AND FAY VEST, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
William L. Kerr, for the petitioners.
Frederick B. Strothman, for the respondent.
1. All the stock of V corporation was exchanged for stock of S corporation. At the time, V's sole asset was a lease on oil and gas underlying a portion of petitioners' land. The lease had been acquired upon the organization of V from petitioners through a revocable trust of which petitioners were settlors and beneficiaries. Prior to the organization of V, petitioners and S had unsuccessfully attempted to arrange an exchange of the minerals for a ranch. Petitioners had V corporation organized for the purpose of developing the mineral interests and to correct or alleviate certain title problems in the interests. When V was organized, petitioners had no knowledge of a possible exchange of V stock for S stock. Held, V was organized for a business purpose, and was not a step in an integrated transaction to exchange a mineral interest for stock; thus the exchange of V stock for S stock was nontaxable within the meaning of sec. 354(a)(1) since a sec. 368(a)(1)(B), I.R.C. 1954, reorganization had taken place.
2. During 1966, S corporation paid petitioners amounts with respect to roads, flowlines, and well and tank battery locations on petitioners' land. The amounts were paid under the terms of an oil and gas lease which remained in effect as long as oil and gas continued to be produced. Held, the amounts received were in the nature of rent and taxable as ordinary income.
3. Petitioners, in 1965, paid a $20,000 fee to the trustee of their revocable trust, and claimed the entire amount as a deduction. Held, fee allocated among legal fees and trustee expenses, deductible under sec. 212, I.R.C. 1954, and expenses incurred for the benefit of V corporation which are capital in nature and nondeductible.
4. In 1965, 1966, and 1967, petitioners received certain payments under a water rights agreement with Shell. The payments were not made out of production from the deposit conveyed. Held, petitioners did not retain an economic interest in the water in place, the agreement constituted a sale, and amounts received under the agreement are taxable as capital gain.
Respondent determined the following deficiencies in petitioners' income taxes for the indicated years:
+--------------------+
¦Year ¦Deficiency ¦
+------+-------------¦
¦1965 ¦$762,913.92 ¦
+------+-------------¦
¦1966 ¦13,561.30 ¦
+------+-------------¦
¦1967 ¦3,863.48 ¦
+--------------------+
This case presents the Court with four questions for determination:
(1) Whether petitioner received certain shares of Standard Oil Co. of California as part of a tax-free corporate reorganization or as a lease bonus or advanced royalty on an oil and gas lease, in 1965.
(2) Whether $33,422 received by petitioners during 1966, from Standard of California with respect to roads, flowlines, well locations, and tank batteries located on petitioners' ranch is taxable as ordinary income or as capital gain received for the sale of a surface easement.
(3) Whether the amount of $20,000 paid in 1965 under a fee agreement with a trustee of a revocable trust established by petitioners constitutes an ordinary and necessary business expense.
(4) Whether an agreement between petitioners and Shell Oil Co. was a disposition of water rights and a perpetual easement such that payments made pursuant to the agreement in 1965, 1966, and 1967 constitute capital gain, or whether the agreement was instead a lease of water rights generating ordinary income.
Earl Vest (hereinafter referred to as Earl) and Fay Vest are husband and wife (hereinafter collectively referred to as petitioners). At the time of filing their petition herein they resided in Monahans, Tex. They filed their joint Federal income tax returns for the taxable years 1965, 1966, and 1967 with the district director of internal revenue, Dallas, Tex. Petitioners have one son named Sam Vest (hereinafter referred to as Sam). Sam and the petitioners will hereinafter be referred to collectively as the Vests.
Earl's attorney during the years in issue was William Monroe Kerr. William Monroe Kerr, along with his father, William L. Kerr, and his brother, Ted M. Kerr, was a partner in the law firm of Kerr, Fitz-Gerald and Kerr.
In 1936 Earl purchased 12,009 acres of land in Winkler and Ector Counties, Tex., known as the Cowden Ranch. The land continues to be known as the Cowden Ranch. At that time Earl acquired full rights to the surface of and certain less extensive interests in the minerals in and under the 12,009 acres.
The Cowdens, during their ownership, had conveyed to others a portion of the mineral interests in the land. Earl believed that by the 1936 conveyance he acquired, in addition to all of the surface, all of the executive, bonus, and rental rights in oil, gas, and other minerals (except an undivided one-sixteenth interest under 80 acres), and also undivided royalty interests, as follows:
+--------------------------------------------+
¦ ¦Number ¦
+---------------------------------+----------¦
¦Fractional interests of royalty ¦of acres ¦
+---------------------------------+----------¦
¦All ¦1,280 ¦
+---------------------------------+----------¦
¦11/64 ¦880 ¦
+---------------------------------+----------¦
¦23/64 ¦80 ¦
+---------------------------------+----------¦
¦43/64 ¦640 ¦
+---------------------------------+----------¦
¦15/16 ¦160 ¦
+---------------------------------+----------¦
¦27/64 ¦8,969 ¦
+---------------------------------+----------¦
¦ ¦12,000 ¦
+--------------------------------------------+
Over the years, Earl conducted cattle-ranching operations on the surface of the Cowden Ranch, and in the early years of his ownership gave oil and gas leases on portions of the ranch as opportunities presented themselves. Throughout his adult life Earl has engaged in the cattle business. During the 1950's Earl, Sam, and two others did some oil and gas exploration together, drilling in excess of 60 wells.
During all times relevant to this case, Chevron Oil Co., a California corporation authorized to do business in Texas, was a wholly owned subsidiary of Standard Oil of California, a Delaware corporation. Chevron sometimes operated in Texas under the name of Standard Oil of Texas. Chevron Oil Co., Standard Oil of California, and Standard Oil of Texas hereinafter will be collectively referred to as Standard. Standard, over a period of several years, had been trying to acquire from Earl oil and gas leases on parts of the Cowden Ranch.
On May 9, 1964, petitioners made a gift to their son Sam, individually, of an undivided one-third interest and to Sam, as trustee for his children, of an undivided two-thirds interest in all the mineral interests owned by petitioners in the north half of each of six sections on the west side of the Cowden Ranch, and in an additional quarter section of each of said sections. Earl retained a quarter section in each section with the idea of drilling it himself thereby to prove the acreage conveyed to Sam.
Sometime prior to July 1964, a representative of Standard negotiated with Earl for a lease in western 6,640 acres of the Cowden Ranch. Initially Earl was not interested in making a deal because he felt the consideration offered by Standard was too small.
On July 6, 1964, the Standard representative suggested to Earl that Standard might be willing to pay $1 million for mineral rights on the 6,640 acres. Earl indicated that he was interested in making a deal for that amount, provided the manner in which the transaction was consummated would not produce taxable income. It was Earl's opinion that he could exchange the mineral interest in the western 6,640 acres of the Cowden Ranch for the surface rights to another ranch without incurring taxes on the exchange. Earl suggested that Standard purchase a ranch worth $1 million to Earl's liking and then trade it for the mineral interests Standard desired. Additionally, it was requested that Standard pay to the Vests the usual one-eighth royalty subject to proportionate reduction as the Vest's interests might appear, plus an additional or bonus royalty not subject to reduction. As a result of the proposed deal, Standard was to receive a net 75-percent working interest in the oil and gas under the west end of the Cowden Ranch. Standard's representative was receptive to the proposal and, on July 9, 1964, reported it back to his company recommending approval. The recommendation proceeded through channels in Standard and was approved by the executive committee of that organization on July 16, 1964. Sometime thereafter Earl and Standard agreed that the proposed trade would be carried out on the basis outlined.
In anticipation of the trade with Standard, Earl and Sam Vest, on July 14, 1964, rearranged the manner in which the Vest family held its mineral interests in the Cowden Ranch. Consequently, in the 6,640 acres that Standard wanted, Sam, individually and as trustee for his children, became owner of a fractional undivided interest in oil, gas, and other minerals equal to the fractional undivided interest therein that the Vest family owned in oil and gas royalties, and Earl became owner of the remaining fractional undivided interest in the oil, gas, and other minerals subject to nonparticipating royalties which were outstanding when Earl acquired the Cowden Ranch. The rearrangement was undertaken so that Earl could convey to Standard in fee simple all his interest in oil and gas in the 6,640 acres in...
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