Crews v. Commissioner , 30 B.T.A. 615 ( 1934 )

RALPH W. CREWS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

ROBERT E. CREWS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

AMY TRESNER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

MARY WILLIS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

CHARLES CREWS, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.

Crews v. Commissioner

Docket Nos. 66701-66703, 66718, 66766.

United States Board of Tax Appeals

30 B.T.A. 615; 1934 BTA LEXIS 1293;

May 2, 1934, Promulgated

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Gross income from an interest in oil and gas property, as a basis for depletion under section 114(b)(3) of the Revenue Act of 1928, is the gross amount for which production is sold.

Albert L. McRill, Esq., for the petitioners.

John H. Pigg, Esq., for the respondent.

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LANSDON

The respondent has determined deficiencies for the year 1930 in the respective amounts of $6,941.03, $7,029.79, $7,715.69, $7,267.71, and $7,531.38. The only issue involved is the amount of depletion allowance to which each petitioner is entitled in the taxable year. The parties read a stipulation into the record and agreed to the introduction of certain documents in evidence, and the petitioner adduced the oral testimony of several witnesses.

FINDINGS OF FACT.

The petitioners are five of the six children and are heirs at law of Thomas A. Crews and his wife, Lulu Crews, who died in 1909 and 1910, respectively. The six children, all minors, acquired 240 acres of land in Garfield County, Oklahoma, by inheritance from their parents. No actual division of the land was made to the minor children, each of whom was entitled to one sixth thereof, but in the year 1912 Laura E. Crews, an aunt of the heirs at law, was appointed guardian during their minority.

On February 21, 1916, the guardian executed an oil and gas lease covering the entire 240 acres to B. A. Garber. By various assignments such lease passed in turn to the Chanute Mining Co. on May 18, 1916, the Garfield Oil Co. on the same date, the Exchange Oil Co. on December 19, 1918, and finally to the Sinclair Oil Co. on January 9, 1922.

The lease executed and eventually assigned to the Sinclair Oil Co., as above set out, was the subject of extensive litigation, beginning in 1921. The basis of the litigation was that the operating company, which was also the operator of leases on all contiguous acreage, had violated the implied agreement to drill offset wells on the Crews land, and that the Crews heirs were being deprived of their proper share of income due under the reservation of royalty of one eighth provided in the lease. After several trials and resulting decisions in the courts of Oklahoma, the Sinclair Oil Co. and the heirs entered into a compromise agreement in 1930, under which the heirs received $355,000 in that year.

Pending the outcome of the litigation started in 1921, the Crews heirs entered upon the leased land, claiming that the property was not being developed in conformity with the express and implied terms of the lease, with the result that the oil therein was being drained out by offset wells on adjoining properties. They began operations in 1922 as the "Crews Estate Oil and Gas Producers", hereinafter called the Crews heirs. Notice was served on the purchasers of oil and gas that the Sinclair Oil Co. and its associates claimed the income of all production made by the Crews heirs.

In order to provide an outlet for their production, the Crews heirs entered into an escrow agreement with the Garber Refining Co. and the Farmers State Bank, both of Garber, Oklahoma, in which the Garber Refining Co. agreed to purchase the oil and gas produced by the heirs, provided the funds paid theretof rwere deposited in the "Crews Estate Oil and Gas Producers" escrow account in the Farmers State Bank pending final determination of the ownership thereof either by the courts or otherwise by a settlement between the parties out of court.

Under the escrow agreement the Crews heirs, upon making proper bond, were permitted to withdraw from the escrow account all necessary funds for the development, equipment, and operation of such wells as they might drill. The balance of the funds in escrow was to be invested in United States bonds and held by the Farmers State Bank for the benefit of the parties finally determined to be the owners of the account.

During the period of their operations and prior to October 20, 1930, the Crews heirs sold oil and gas produced from their property for the gross amount of $1,462,504.02. In the taxable year they received $355,000 from the Sinclair Oil Co. as their share of proceeds from sales of oil produced from their land by that concern. Their total receipts in the taxable year from sales of oil and gas produced from their property amounted to $1,817,504.02. They had additional income from other sources of $47,871.79, or a total gross income of $1,865,375.81.

For the purpose of computing the net income of the several petitioners for the year 1930, deductions from the gross income of the Crews heirs are allowable as follows: Production cost, $849,544.37; attorney fees, $163,000; expenses in connection with impounded funds, $10,000; loss from dissipation of escrow account, $514,000; or a total of $1,536,544.37. The net income after such deductions is $328,831.44, or $54,805.24 for each of the six heirs at law.

No accounting of the proceeds of the operations by the Crews heirs deposited in the escrow account has ever been made in any income tax return. While the litigation was in progress, the Commissioner investigated the question of Federal income tax liability with respect to such funds and agreed that full accounting for income tax liability should be made upon the release of the impounded funds. On October 18, 1930, a final settlement of all litigation between the Crews heirs and the Sinclair Oil Co. was effected by compromise, and on that date the Crews heirs were obliged to account for the entire receipts as income in 1930, under the terms of their agreement with the Commissioner.

Upon demand for payment of the balance of the escrow funds, it developed that the Farmers State Bank was insolvent and that the United States bonds in the amount of $514,000 could not be produced by the bank. No part of this amount has ever been received and the whole was a loss to the Crews heirs in 1930.

On October 15, 1930, George I. Taft, the managing director of the Farmers State Bank, was found by the roadside near Garber, suffering from wounds from which he died on the next day. The bank was closed on October 17 and 18, Friday and Saturday. On Monday, October 20, 1930, before the State Banking Department of Oklahoma would permit the bank to reopen, an indemnity contract was executed by the Crews heirs and B. A Garber, president of the bank, and certain associates, in which properties of various sorts were transferred to Ralph Crews and R. N. Williams as trustees to indemnify and secure the escrow account for such heirs. The value of the trusteed properties was represented by Garber to be in excess of $900,000. The Commissioner originally determined that this contract was without value, but at the hearing his counsel received permission to amend his answer to include affirmative allegation of a value thereof equal to the amount as represented by Garber. The trustees have received only about $1,000 under the contract and have spent more than $40,000 in the administration of the trust. The indemnity contract was worthless from the date of its execution.

In their respective income tax returns for 1930 the Crews heirs reported no income from receipt of the escrow funds in that year. Upon audit of the several returns the Commissioner determined that the net income of the heirs in 1930 was $359,343.70, or $59,890.62 for each of four of the six and $59,890.61 for each of the two others, and determined deficiencies accordingly. In his computation of the deficiencies he allowed no deduction for depletion.

OPINION.

LANSDON: The redetermination of the deficiencies in question requires us to ascertain (1) the gross income which the Crews heirs realized from their oil and gas property in 1930, as the basis for the depletion allowance now claimed; (2) the net income of each petitioner in 1930, computed without allowance for depletion; and (3) the net taxable income of each petitioner after the deduction of allowable depletion, if any.

On the facts it is clear that no accounting for tax purposes of any of the income here involved was possible prior to October 20, 1930. The rights of the Crews heirs to the proceeds of their own operations prior to that date and their share of the proceeds of operations of the Sinclair Oil Co. for the same period were being litigated in the courts and final settlement was made by compromise on that date. Under the terms of the settlement the heirs in the taxable year received $355,000 as their share of the proceeds from the operations of the Sinclair Oil Co. and became entitled to receive the balance in the escrow account. It was in that year that it first became possible to account for the income involved for Federal tax purposes. ; . Since there was no liability for tax until the date of the settlement which released the impounded funds, it follows of course, that all deductions in connection with the taxability of the income involved are allowable in the year of the release of the impounded funds. If the petitioners are entitled to any allowance for depletion, the deduction therefor must be made in 1930 and in conformity with statutory provisions then effective.

The petitioners claim an allowance for depletion in the taxable year as authorized by section 114(b)(3) of the Revenue Act of 1928. ^{*1301 oil and gas property of the Crews heirs in that year was $1,817,504.02, that upon that amount as the basis the heirs are entitled to a deduction of 27 1/2 percent for depletion not in excess of 50 percent of their net income, and that each of them is, therefore, entitled to one sixth of such allowance in computing his taxable income.}

There is no dispute over the amount of the production or the gross receipts realized from the sale thereof. The oil property of the Crews heirs was depleted by the removal of oil and gas that was sold for $1,817,504.02. This the respondent does not deny, but he has determined that the gross income from the property was not the amount for which the oil and gas was sold, but that amount reduced by the loss sustained by the petitioner through the failure of the escrow agent to pay over the balance of the impounded funds on demand in 1930. His position is that as the Crews heirs never received the amount lost through failure to recover from the escrow agent, such amount cannot be included in the computation of the gross income received from the property. In our opinion there is no merit in this contention. The Farmers State Bank received the proceeds of the sale of oil and gas produced from the property in question as the agent of the rightful owners. We are of the opinion that $1,817,504.02 is the correct basis for computing the depletion in question.

In computing allowable depletion under section 114(b)(3) of the Revenue Act of 1928 all the limitations specified therein must be observed. The maximum amount of depletion that may be allowed on the facts herein is $499,813, or $83,302.16 for each of the six heirs, but the amount allowable is limited to 50 percent of the taxpayer's net income, computed without regard to depletion. We have found that the net income of each of the petitioners in 1930 so computed was $54,805.24. It follows, therefore, that the deduction to which each is entitled is limited to 50 percent of such amount, or $27,402.62. The taxable income of each of the petitioners from the "Crews Estate Oil and Gas Producers" in 1930 was $27,402.62.

Decision will be entered under Rule 50.

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Footnotes

• 1. SEC. 114. (b) (3) PERCENTAGE DEPLETION FOR OIL AND GAS WELLS. - In the case of oil and gas wells the allowance for depletion shall be 27 1/2 per centum of the gross income from the property during the taxable year. Such allowance shall not exceed 50 per centum of the net income of the taxpayer (computed without allowance for depletion) from the property, except that in no case shall the depletion allowance be less than it would be if computed without reference to this paragraph. ↩