Weed v. Comm'r of Internal Revenue, DOCKET No. 46312.
| Decision Date | 22 September 1955 |
| Docket Number | DOCKET No. 46312. |
| Citation | 24 T.C. 1025 |
| Parties | W. F. WEED, INDIVIDUAL, AND ESTATE OF ELEANOR M. WEED, DECEASED, W. F. WEED, EXECUTOR, PETITIONERS, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Peter B. Wells, Esq., for the petitioners.
W. B. Riley, Esq., for the respondent.
Held, the gain resulting from W. F. Weed's sale and transfer of a sulphur payment carved out of his pooled royalty interests in sulphur produced from deposits in place, which interests Weed had owned for several years prior to the date of sale, was taxable as long-term capital gain on the installment basis and not as ordinary income.
The Commissioner has determined deficiencies in petitioner's income taxes as follows:
+----------------+
¦Year¦Deficiency ¦
+----+-----------¦
¦1948¦$4,136.79 ¦
+----+-----------¦
¦1949¦1,055.76 ¦
+----------------+
The deficiency for 1948 is due to the following adjustments:
+---------------------------------------------------+
¦(a) Disallowed as nontaxable capital gain¦$1,242.52¦
+-----------------------------------------+---------¦
¦(b) Income from sulphur royalty ¦12,551.00¦
+-----------------------------------------+---------¦
¦(c) Net loss not deductible in 1948 ¦2,372.01 ¦
+---------------------------------------------------+
Adjustments (b), which is the principal adjustments, is described in the deficiency notice as follows:
(b) As stated above the amount received for the assignment of a sulphur payment less 23% depletion is included in full in income. See item (d) for reduction of capital gain.
+-----------------------------+
¦Amount received ¦$16,300¦
+---------------------+-------¦
¦Less: Depletion, 23% ¦3,749 ¦
+---------------------+-------¦
¦Amount taxable ¦12,551 ¦
+-----------------------------+
The petition assigns error only as to adjustment (b) described above. The assignment of error is as follows:
I. The commissioner erred in disallowing long term capital gains treatment on the sale of sulphur in place in the ground.
The deficiency for 1949 is based principally upon an adjustment of the same kind and in the same amount as adjustment (b) for 1948, and the assignment of error is the same for 1949 as for 1948. There is also an adjustment for 1949 of $116.67 for disallowance of medical expenses but counsel stated at the hearing that that will be automatically taken care of when we decide the main adjustment in the case.
W. F. Weed, sometimes hereinafter referred to as petitioner, resides in Beaumont, Texas. Eleanor M. Weed was petitioner's wife during the tax years 1948 and 1939, and at all other times pertinent hereto. She died testate on August 3, 1952, whereupon, by order of the Probate Court of Jefferson County, Texas, petitioner was appointed independent executor of her estate. He has continued as such to the date of this hearing.
Petitioner and his wife filed joint income tax returns for 1948 and 1949 with the collector of internal revenue, Austin, Texas.
In 1945 and 1946, as principal stockholder, petitioner formed two companies Pre-Fab Building Supply Corporation, and Star Lumber Company, and also formed, as a wholly owned subsidiary of the latter, Planet Lumber Corporation. In 1947, these companies were in need of funds and were not sufficiently sound financially to have adequate credit. In addition, petitioner contemplated the organization of another corporation whose capital requirements would exceed $100,000. Such corporation was actually formed in May 1948, and petitioner did supply most of its capital.
Petitioner in 1947 believed that, in 1948 and the succeeding years, he would need all (or a large part) of the credit which was available to him personally at the banks or through similar sources to obtain funds for use in the carrying on of the aforementioned business enterprises. He therefore desired some assurance that he would have a definite source of funds (other than banks and similar sources) for payment of his individual Federal income taxes due in those later years.
On December 23, 1947, petitioner was the owner of a pooled over-riding royalty interest in sulphur produced by the Texas Gulf Sulphur Company from a tract of land referred to as Boling Dome, in Wharton County, Texas.1 Petitioner's royalty interest entitled him to receive $0.00966133 per long ton of sulphur produced from Boling Dome by the aforementioned company, irrespective of what the market price for such sulphur might be. Royalty payments were made by the company monthly, based on the previous month's production. Petitioner's $0.00966133 per long ton interest represented the aggregate of three pooled royalty interests, each in a lesser amount, received by petitioner (a) from his father by two inter vivos deeds dated September 1, 1933, and August 15, 1935, respectively, and (b) after his father's death, from the latter's estate by independent executor's deed dated August 1, 1945, Such interest was not held by petitioner primarily for sale to customers in the ordinary course of his trade or business.
In the summer or early fall of 1947, petitioner, Frank C. Taylor (a C.P.A. then retained as accountant for petitioner's personal affairs and who prepared petitioner's 1947 return), and Marion Munro (a C.P.A. then retained by two of petitioner's corporations and who subsequently prepared petitioner's individual joint returns for 1948 and 1949) discussed the problem of petitioner's business commitments and the need for providing some sure source of funds with which to pay petitioner's individual income taxes, especially those due in January 1948. It was suggested that petitioner might sell a portion of his Boling Dome royalty interest, and Munro expressed the opinion that such a transaction would have the advantage of being taxed to petitioner at capital gain rates. Munro indicated a probable willingness to purchase a portion of that royalty interest and negotiations followed.
Petitioner and Munro discussed the amount of money petitioner would probably need in later years to pay his taxes, the probable amount of sulphur still in place (which they estimated to be about 45 million tons), the anticipated annual rate of sulphur production, the annual royalty payments which would probably be received by a purchaser of petitioner's interest, the probable amount of time required for pay-outs from sulphur production of different sums of money, the discount factor (such as the interest Munro would have to pay on funds borrowed by him to purchase the royalty interest) which affected Munro's profit from the transaction, and the tax savings to petitioner.
It was finally agreed that the transaction would be based upon petitioner's anticipated requirements for funds to pay taxes for the succeeding 3 years, and upon a 4-year pay-out period from sulphur production to Munro. On this basis, it was determined that petitioner would assign to Munro a portion of his royalty interest on 6,000,000 long tons of sulphur, from which Munro would receive $50,000 within about 4 years, and that, in return, Munro would pay petitioner $46,500 about 4 years, and that, in return would pay petitioner $46,500 over a 3-year period. Munro advised petitioner that the latter's tax savings resulting from the transaction would be about $4,000 to $4,500 and Munro estimated that his own profit from the transaction (after allowance for the discount factor) would approach $2,000.
On December 24, 1947, petitioner executed a deed conveying to Munro 86.254514 per cent of his pooled royalty interest of $0.00966133 (i.e. $0.00833333) per long ton on 6,000,000 long tons of sulphur to be produced from Boling Dome. In consideration therefor Munro gave petitioner:
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¦Check dated Dec. 24, 1947 ¦$13,900¦
+---------------------------------------------------------------------+-------¦
¦Promissory note due Dec. 24, 1948 (with 6 per cent annual interest ¦16,300 ¦
¦ter after maturity) ¦ ¦
+---------------------------------------------------------------------+-------¦
¦Promissory note due Dec. 24, 1949 (with 6 per cent annual interest ¦16,300 ¦
¦ter after maturity) ¦ ¦
+---------------------------------------------------------------------+-------¦
¦ ¦$46,500¦
+-----------------------------------------------------------------------------+
Pertinent portions of the assignment follow:
I, W. F. WEED, in consideration of ($13,900 cash and the two $16,300 (notes) * * * do hereby SELL, TRANSFER AND ASSIGN, unto the said Marion F. Munro, * * * 86.254514% of $.00966133 per long ton pooled royalty on sulphur produced by Texas Gulf Sulphur Company at Boling Dome, Wharton County, Texas, from lands and premises described in said above named conveyances (to petitioner from his father and his father's estate), until six million (6,000,000) long tons of sulphur have been produced and accounted for to the said Marion F. Munro therefrom, which royalty so sold and here assigned and conveyed amounts to $.00833333 per long ton.
This assignment and the royalty transferred and assigned hereby on sulphur produced from Boling Dome, * * * shall continue to be effective until said Marion F. Munro shall have received said royalty on six million (6,000,000) long tons of sulphur and no longer. * * *
The following statement shows the payments made by Munro to petitioner, pursuant to the above conveyances, and the method of financing used by Munro:
+----------------------------------------------------------------+
¦ ¦ ¦Munro's loans from First Nation Bank, ¦
+--------------+----------+--------------------------------------¦
¦ ¦Munro's ¦Beaumont, Texas...To continue reading
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