Filed: Jan. 12, 1998
Latest Update: Nov. 14, 2018
Summary: 110 T.C. No. 2 UNITED STATES TAX COURT ESTATE OF ALGERINE ALLEN SMITH, DECEASED, JAMES ALLEN SMITH, EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent* Docket Nos. 19200-94, 3976-95. Filed January 12, 1998. P (decedent's estate) settled and paid claims that were based in part on excessive royalties that had been paid to and reported by decedent in prior years. In our previous opinion in these cases, we held that P was entitled to an overpayment of income tax pursuant to applica
Summary: 110 T.C. No. 2 UNITED STATES TAX COURT ESTATE OF ALGERINE ALLEN SMITH, DECEASED, JAMES ALLEN SMITH, EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent* Docket Nos. 19200-94, 3976-95. Filed January 12, 1998. P (decedent's estate) settled and paid claims that were based in part on excessive royalties that had been paid to and reported by decedent in prior years. In our previous opinion in these cases, we held that P was entitled to an overpayment of income tax pursuant to applicat..
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110 T.C. No. 2
UNITED STATES TAX COURT
ESTATE OF ALGERINE ALLEN SMITH, DECEASED, JAMES ALLEN SMITH,
EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE,
Respondent*
Docket Nos. 19200-94, 3976-95. Filed January 12, 1998.
P (decedent's estate) settled and paid claims that
were based in part on excessive royalties that had been
paid to and reported by decedent in prior years. In
our previous opinion in these cases, we held that P was
entitled to an overpayment of income tax pursuant to
application of sec. 1341, I.R.C., and that such
overpayment was includable in the taxable estate.
Estate of Smith v. Commissioner, 108 T.C. 412 (1997).
The parties now disagree on the method of calculating
the overpayment. R also seeks to amend the answer in
order to decrease the credit for State death taxes that
was previously allowed in the estate tax notice of
deficiency.
Held: Relief under sec. 1341, I.R.C., is
restricted to the portion of P's settlement payments
that represents items of income that were previously
included in decedent's income.
*
This opinion supplements our opinion in Estate of Smith v.
Commissioner, 108 T.C. 412 (1997).
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Held, further, the amount of any overpayment that
results from the application of sec. 1341, I.R.C., is
not restricted to the amount computed under sec.
1341(b)(1), I.R.C.
Held, further, Rule 155(c), Tax Court Rules of
Practice and Procedure, prohibits a party from raising
new issues for purposes of making a computation
pursuant to Rule 155. R may not amend the answer.
Michael C. Riddle and Harold A. Chamberlain, for petitioner.
Carol Bingham McClure, for respondent.
SUPPLEMENTAL OPINION
RUWE, Judge: On June 4, 1997, we issued our opinion in
these consolidated cases. Estate of Smith v. Commissioner, 108
T.C. 412 (1997). Pursuant to that opinion, the parties filed
separate computations pursuant to Rule 155.1 These cases are
before the Court again because the parties cannot agree on the
proper method for computing the overpayment of income tax and the
deficiency in estate tax.2
The issues presented concern: (1) The proper method for
computing an income tax credit and resulting overpayment under
1
Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code in effect as of the
date of decedent's death.
2
As indicated in our previous opinion, we believed based on
representations of the parties in their posttrial briefs that the
parties were in agreement as to the computational aspects of
these cases.
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section 1341(a)(5) and (b),3 and (2) whether respondent may now
amend the answer to reduce the amount of the credit for State
death taxes that was determined in the notice of deficiency.
Respondent's Rule 155 computation uses the reduced credit in
computing the estate tax deficiency.
These cases were submitted fully stipulated. Neither party
alleges any factual dispute, and neither party argues that
additional evidence is necessary to resolve the computational
dispute. We shall summarize the relevant facts and our holdings
for each of the remaining computational issues.4
Section 1341 Credit
In 1970, decedent and her two aunts, Jessamine and Frankie
Allen, entered into oil and gas leases from which they derived
royalties during the years 1975 through 1980. Jessamine and
Frankie Allen died in 1979 and 1989, respectively, and decedent
served as the independent executrix of both their estates. Upon
Jessamine's death, decedent inherited a portion of Jessamine's
interest in the leased property. Upon Frankie's death, decedent
inherited all of Frankie's interest in the leased property,
including the remaining portion of Jessamine's interest which
Frankie had previously inherited.
3
The amount of the resulting overpayment will be
determinative of the amount of a corresponding asset for estate
tax purposes.
4
A more complete statement of facts is contained in our
previous opinion.
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In 1988, Exxon filed suit against certain owners of royalty
and mineral interests, including decedent and Frankie
individually and against decedent as executrix of the estate of
Jessamine. Exxon claimed that it had overpaid royalties during
the years 1975 through 1980. Exxon's base claims for overpaid
royalties were made against decedent and Frankie in the following
amounts:
Algerine Allen Smith $249,304
Frankie Allen 783,013
Total Damages Sought $1,032,317
Exxon's claim against decedent represented 24 percent of the
total damages sought against decedent and Frankie.5
Decedent died in 1990 after she had inherited Jessamine's
and Frankie's interests in the oil and gas properties. Thus, by
1992, Exxon's claims for excess royalties paid to Jessamine,
Frankie, and decedent were all being pursued against petitioner
(decedent's estate). In 1992, petitioner settled and paid the
above claims for $681,840.
On her 1975 through 1980 Federal income tax returns,
decedent reported gross royalties from the oil and gas leases in
question in the following amounts:
5
The record does not disclose how much of Exxon's stated
claims related to excess royalties received by Jessamine prior to
her death in 1979 or by Jessamine's estate after her death.
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Year Amount
1975 $58,512
1976 62,302
1977 45,061
1978 36,734
1979 36,846
1980 44,725
Total $284,180
On her returns for those years, decedent deducted an allowance
for depletion in an amount which was 22 percent of the gross
royalties reported.
Petitioner filed a Federal income tax return for the taxable
year 1992 on which it reported and paid a tax of $8,338. This
1992 tax was computed without taking a deduction for any portion
of the amount paid to Exxon in 1992.
Section 1341 provides relief to taxpayers who are forced to
repay an item previously reported as income under a claim of
right. Both parties agree that for purposes of section 1341,
petitioner and decedent should be treated as one and that
petitioner is entitled to section 1341 relief. Both parties also
agree that relief should be in the form of a credit computed
pursuant to section 1341(a)(5) and (b).
The pertinent provisions of section 1341 provide as follows:
SEC. 1341. COMPUTATION OF TAX WHERE TAXPAYER RESTORES
SUBSTANTIAL AMOUNT HELD UNDER CLAIM OF
RIGHT.
(a) General Rule.--If--
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(1) an item was included in gross income for a
prior taxable year (or years) because it appeared that
the taxpayer had an unrestricted right to such item;
(2) a deduction is allowable for the taxable year
because it was established after the close of such
prior taxable year (or years) that the taxpayer did not
have an unrestricted right to such item or to a portion
of such item; and
(3) the amount of such deduction exceeds $3,000,
then the tax imposed by this chapter for the taxable
year shall be the lesser of the following:
(4) the tax for the taxable year computed with
such deduction; or
(5) an amount equal to--
(A) the tax for the taxable year computed
without such deduction, minus
(B) the decrease in tax under this chapter
(or the corresponding provisions of prior revenue
laws) for the prior taxable year (or years) which
would result solely from the exclusion of such
item (or portion thereof) from gross income for
such prior taxable year (or years).
* * * * * * *
(b) Special Rules.--
(1) If the decrease in tax ascertained under
subsection (a)(5)(B) exceeds the tax imposed by this
chapter for the taxable year (computed without the
deduction) such excess shall be considered to be a
payment of tax on the last day prescribed by law for
the payment of tax for the taxable year, and shall be
refunded or credited in the same manner as if it were
an overpayment for such taxable year.
Petitioner argues that the entire 1992 payment of $681,840
was in satisfaction of a claim against decedent's estate and,
therefore, the entire amount is eligible to be used to reduce
royalty income previously reported by decedent for purposes of
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recomputing the amount of decedent's income tax for the years
1975 through 1980 pursuant to section 1341(a)(5). Respondent
argues that the section 1341(a)(5) adjustment is limited to the
portion of the $681,840 settlement that represents excess
royalties that were paid to and reported by decedent during the
years 1975 through 1980. We agree with respondent.
Neither party cites any case law to support their respective
positions. Nevertheless, the language of the statute indicates
that its relief is focused on a "taxpayer", who reported an
"item" in "gross income" for a "prior taxable year" where it is
established after the close of that taxable year "that the
taxpayer did not have an unrestricted right to such item". Sec.
1341(a). The computation contained in section 1341(a)(5) directs
the taxpayer to recompute the tax for the "prior taxable year (or
years) which would result solely from the exclusion of such item
(or portion thereof) from gross income for such prior taxable
year (or years)." From this, we believe it is clear that section
1341 relief is restricted to items of income previously received
and reported by a taxpayer who must repay those same items in a
subsequent year.
Kraft v. United States, 991 F.2d 292 (6th Cir. 1993),
supports this analysis. In Kraft, the taxpayer invoked section
1341 based upon amounts he was required to repay because of a
fraud perpetrated in prior years. The fraudulently obtained
funds had been deposited into a corporate account and reported as
corporate income. The taxpayer's benefit came in the form of
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salary from the corporation. Under these circumstances, the
court held section 1341 inapplicable because it was the
corporation, rather than the taxpayer, who had previously
reported the item being repaid. Kraft v. United States, supra at
299.6
It is undisputed that petitioner, as decedent's estate,
stands in the same position as decedent for purposes of applying
section 1341. Thus, in these cases, section 1341 relief is
restricted to that part of the $681,840 that represents the
royalties that decedent had personally received and reported for
the years 1975 through 1980. Decedent did not receive royalties
paid to Jessamine and Frankie during the years 1975 through 1980,
nor did she report or pay tax on those amounts. We hold that
only that portion of the $681,840 that represents repayment of
royalties previously received and reported by decedent can be
used to provide benefits to petitioner under section 1341.
6
As succinctly stated in Judge Nelson's concurring opinion:
For a taxpayer to take advantage of § 1341, he
must show, among other things, (1) that 'an item' was
included in a prior year's gross income because of an
apparent unrestricted right to the item, and (2) that
it was subsequently established that the taxpayer did
not have an unrestricted right to 'such item' or
portion thereof. 26 U.S.C. §§ 1341(a)(1) and (a)(2).
Both sections clearly speak of the same 'item.'
The 'item' included in the Krafts' gross income
for the prior year at issue here was not a fee received
from Blue Cross; it was, rather, a salary item received
by Dr. Kraft from his corporation. * * * [Kraft v.
United States, 991 F.2d 292, 300 (6th Cir. 1993).]
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There is nothing in the record to indicate how much of
Exxon's claim related to excess royalties paid to Jessamine or
her estate, and respondent does not factor this into respondent's
computation. Since it appears likely that some part of the claim
against decedent was attributable to royalties paid to Jessamine
or her estate, respondent's decision not to allocate any portion
of the settlement to Jessamine works in petitioner's favor.7
Respondent's computation uses Exxon's allocation of its claims as
between decedent and Frankie, which, as previously stated,
attributes to decedent 24 percent of the excess royalty claims
against decedent and Frankie. Under these circumstances, we find
that 24 percent is the most appropriate percentage for purposes
of determining the portion of the settlement that is available
for purposes of computing petitioner's section 1341 relief.
While we reject petitioner's argument that the entire
$681,840 is available to adjust decedent's previously reported
income, we also reject part of the computational method proposed
by respondent. Respondent's Rule 155 computation seems to assume
that decedent received royalties in excess of what she reported
for the years 1975 through 1980. This assumption is based on
unexplained allegations made by Exxon in its lawsuit. Relying on
Exxon's apparent claim that it paid more royalties to decedent
than she reported, respondent's computation reduces the portion
7
Respondent's counsel explained that there was no
information upon which to allocate any of Exxon's claims to
royalties paid to Jessamine or her estate.
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of the settlement that respondent attributes to decedent's
previously reported royalties. However, the parties have
stipulated that decedent reported all the royalties that she
received for the years 1975 through 1980. Under these
circumstances, the Rule 155 computation cannot be based on the
assumption that decedent received more royalty income during the
years 1975 through 1980 than she reported on her returns.8
Based upon the available information, we find that 24
percent of the $681,840 settlement, or $163,641, should be
attributed to excess royalties received and reported by decedent
during the years 1975 through 1980.9 This $163,641 should then
be allocated to each of the years 1975 through 1980 in proportion
to the amount of gross royalties that decedent reported during
each of these years. For purposes of making the computations
required by section 1341(a)(5), these respective amounts should
be reduced by the proportionate amount of depletion allowance
that decedent took on her 1975 through 1980 returns. The
resulting amounts should then be excluded from reported income
8
Respondent made no argument that this aspect of the
computation was an attempt to determine which portion of Exxon's
claims against decedent was attributable to Jessamine's
royalties. Indeed, respondent's counsel acknowledged that
Jessamine's royalties could not be identified and that
respondent's computations give petitioner the benefit of any
doubt on this point.
9
This allocation does not attribute any portion of the
$681,840 settlement to interest that Exxon claimed in addition to
its base claim for excess royalties. Respondent's proposed
computation made no allocation of the $681,840 settlement to
interest and presented no arguments regarding how such an
allocation should or could be made.
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for each year, and the resulting tax decrease should be computed
for each year. The total of these tax decreases for prior years
is the amount that is available as a credit for 1992 pursuant to
section 1341(a)(5)(B).
Both parties agree that petitioner will be entitled to an
overpayment as a result of applying section 1341(a)(5) and
(b)(1), but they disagree about whether section 1341(b)(1) sets
the limit on the amount of the overpayment.
For purposes of applying section 1341(b)(1) to these cases,
the "taxable year" is 1992. Section 1341(b)(1) provides in
pertinent part that "If the decrease in tax ascertained under
subsection (a)(5)(B) exceeds the tax imposed by this chapter for
the taxable year (computed without the deduction) such excess
shall be considered to be a payment of tax on the last day
prescribed by law for the payment of tax for the taxable year,
and shall be refunded or credited in the same manner as if it
were an overpayment for such taxable year." Respondent argues
that the amount of the overpayment for 1992 is limited to the
amount described in section 1341(b)(1). Petitioner disagrees.
Again, neither party cites any previous cases dealing with this
issue, and we have found none.
Section 1341 provides a method for determining the tax for a
year in which a taxpayer repays items that had been reported as
income in prior years under claim of right. Under section
1341(a)(5), the first step is to compute the tax for the taxable
year (1992) without regard to any deduction allowable pursuant to
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section 1341. Here that tax is $8,338, which petitioner
previously reported and paid. The second step is to determine
the amount of the decrease in tax for the prior years, which
would result solely from the exclusion of the previously
reported, but now repaid, items. Petitioner's 1992 income tax
liability is then determined by subtracting the decrease in tax
in prior years (1975 through 1980) from $8,338. We know that the
decrease in tax from prior years exceeds $8,338. Therefore, we
know that there will be no tax liability for 1992 even though
petitioner has paid $8,338. It follows that petitioner has
overpaid its tax liability for 1992 by at least $8,338.
Section 1341(b)(1) prescribes the method for dealing with
the amount by which the decrease in tax for prior years exceeds
the tax for 1992 as computed with no section 1341 deduction. It
provides that "such excess shall be considered to be a payment of
tax on the last day prescribed by law for the payment of tax for
the taxable year [1992], and shall be refunded or credited in the
same manner as if it were an overpayment for such taxable year."
Sec. 1341(b)(1). Respondent's position is that section
1341(b)(1) places a limit on the amount of any overpayment to
which petitioner is entitled.10 We disagree. Section 1341(b)(1)
10
In the Written Statement In Support of Respondent's Rule
155 Calculation, respondent states:
Section 1341(b)(1) provides in pertinent part that 'if
the decrease in tax ascertained under subsection
(a)(5)(B) exceeds the tax imposed for the taxable year
(continued...)
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simply allows the amount of tax decrease from prior years that is
not used up in computing the correct 1992 tax liability under
section 1341(a)(5) to also be "considered" to be an overpayment.
Nothing in section 1341(b)(1) limits the tax computation under
section 1341(a)(5) from independently producing an incremental
amount of the final overpayment.
Credit for State Death Taxes
On its estate tax return, petitioner claimed a credit for
State death taxes that it had paid in the amount of $23,917. In
the notice of deficiency for estate tax, respondent determined
that petitioner was entitled to a "Credit for state death taxes
substantiated" in the amount of $144,089 and allowed this amount
in computing the amount of the deficiency. In effect,
respondent's notice of deficiency reflected a determination that
petitioner had fully substantiated a right to the credit. The
$144,089 amount was apparently based upon the total amount of
State death taxes that petitioner would be liable for if
respondent's adjustments were upheld. As part of the Rule 155
(...continued)
(computed without the deduction) such excess shall be
considered to be a payment of tax on the last day
prescribed by law for the payment of tax for the
taxable year, and shall be refunded or credited in the
same manner as if it were an overpayment for such
taxable year.' (Emphasis added.) Thus, the amount of
the overpayment is not the entire amount computed
pursuant to section 1341(a)(5) as petitioner contends,
but only the excess of that amount over petitioner's
income tax liability for 1992 in the amount of
$8,338.00. * * *
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computation, respondent, for the first time, alleges that the
notice of deficiency was in error, and that $120,172 of the
credit allowed should have been reflected on a different line in
the notice of deficiency as "Additional credit for state death
taxes allowable, if substantiated." Had this been done, the
amount of the deficiency determined by respondent would have been
increased by $120,172.11
Respondent now wants to amend the answer to correct the
error and increase the deficiency. Apparently, assuming that
this will be permitted, respondent has included this adjustment
in the Rule 155 computation. The problem with respondent's
position is that Rule 155(c) precludes a party from raising a new
issue in a proceeding under Rule 155. The credit for State death
taxes was previously uncontested and has nothing to do with the
other computational issues. We, therefore, deny respondent's
motion for leave to amend answer. The Rule 155 computation
should not include any change to the credit for State death taxes
as determined in the notice of deficiency.
Appropriate orders will
be issued.
11
Respondent recognizes that the actual impact of
respondent's error will probably be far less than this since, as
a result of our prior opinion, petitioner's taxable estate will
be increased. To the extent petitioner is obligated to pay
additional State death taxes, it would be entitled to a
substantial amount of the credit already allowed. See sec. 2011.
