Opinion
Docket No. 21385.
1951-01-17
KURT H. DECOUSSER, PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT.
M. B. Decker, Esq., for the petitioner. Thomas V. Lefevre, Esq., for the respondent.
M. B. Decker, Esq., for the petitioner. Thomas V. Lefevre, Esq., for the respondent.
In 1938 petitioner entered into a partnership with B for the purpose of operating a gas field. The agreement was that they were equal partners in any profits. The details of how to finance drilling and concerning some small items of expense were not worked out as of the time of the signing of the agreement in 1938. A dispute developed between petitioner and his partner concerning financing the drilling, depletion expenses and management and other expenses. In 1943 petitioner filed a lawsuit against his partner for the purpose of getting his share of the profits. The bill of complaint also requested an accounting and dissolution of the partnership. This lawsuit was settled on April 16, 1944. The partnership had net income of $35,165.30, $31,479.61 and $4,328.97, in the years 1942, 1943, and 1944. Held, petitioner is taxable on his distributive share of the partnership profits in the amounts of $12,582.65, $15,739.80, and $2,164.48 in 1942, 1943, and 1944, respectively.
Respondent determined deficiencies in petitioner's income and victory tax for the year ended December 31, 1943, in the amount of $2,864.50, and in his income tax for the year ended December 31, 1944, in the amount of $654.43. The petitioner claims ‘overassessments‘ of $3,229.91 and $66.95 for 1943 and 1944, respectively. The year 1942 is also involved because of the forgiveness feature of the Current Tax Payment Act of 1943. The questions presented are:
(a) Was petitioner's distributive share of the income of the partnership of which he was a member, $12,582.65, $15,739.80, and $2,164.48 in 1942, 1943, and 1944, respectively, as respondent contends?
In the deficiency notice, petitioner's income from the partnership is determined as $12,750.61 in 1942, $15,921.64 in 1943, and $2,164.48 in 1944. Depletion was erroneously computed for 1942 and 1943 in this determination and respondent now contends that petitioner's corrected partnership income is $12,582.65 for 1942 and $15,739.80 for 1943. 1944 remains unchanged.
(b) In the event that petitioner's distributive share of the income of the partnership was uncertain and in controversy during 1942 and 1943, was petitioner taxable in 1944 upon the distributive share which he received in that year by virtue of a compromise agreement between him and his partner?
FINDINGS OF FACT.
During the years 1942, 1943, and 1944 petitioner resided in Lansing, Michigan. He filed his Federal tax returns for those years with the collector of internal revenue for the district of Michigan on April 15, 1943, March 10, 1944, and January 10, 1945, respectively. Petitioner is a mining and petroleum engineer and has been employed for the past 20 years by Socony-Vacuum Oil Co., Inc.
In 1937 petitioner secured leases for Socony-Vacuum on approximately 3,500 acres in Home Township, Montcalm County, Michigan, on which, early in 1938, Socony-Vacuum drilled a well known as No. 405-Chris Hansen No. 1. No oil was discovered in that well, but gas was.
Shortly after the drilling of that well, one Leslie T. Barber approached petitioner and suggested that they obtain the gas rights to the area from the various companies holding leases and develop them together on a partnership basis. On August 19, 1938, petitioner and Barber entered into a written partnership agreement as follows:
This confirms a mutual agreement between Kurt H. deCousser and Leslie T. Barber whereby they are to operate a gas field as equal partners (sic) in any profits that may be derived therefrom.
It is understood by each of the parties that the acreage being operated is farm out acreage and all carries an overriding royalty of 1/5, part of said acreage being owned by the Belvidere Oil Company which is controlled (sic) by Leslie T. Barber and this fact is mentioned that there can be no misunderstanding on the part of either party in this connection. Said gas field being located in Township 12 North, Range 6 West. It is now known at this time how the complete drilling program will be financed but at this time the money is being supplied under a contract whereby Leslie T. Barber is borrowing part of the funds and is using his own tools to drill the wells and is charging each well into a trustee account at $7,500.00 and it is also understood by the parties hereto that there are also some small items of expense incurred by said Leslie T. Barber that will have to be agreed on when some permanent plan of operation is adopted as accurate records of such expense has not been kept.
The purpose of this declaration is that Kurt H. deCousser and his heirs may be fully protected in the event of the death of said Leslie T. Barber.
Petitioner and Barber operated under that partnership agreement as partners or joint venturers through April 16, 1944.
The understanding between the partners under that agreement was that petitioner would give geological advice and prepare studies of the area as well as an estimate of the reserves. On the basis of such studies petitioner and Barber hoped to obtain a loan to help finance the drilling. It was agreed that Barber would drill the wells, receive $7,500 from the partnership for each well drilled, operate those wells, and keep the books of account. All leases were taken and all other matters were handled in Barber's name. They obtained a loan of $25,000, purchased No. 405-Chris Hansen No. 1 from Socony-Vacuum and drilled 11 additional wells. These wells were known as:
406-Neilsen-Hamilton & Towle
407-Mortensen-Sack
408-Snyder-Lavender-Roose
416-C. J. Mann
420-De Je
424-Matherson
426-Burt-Mann
429-Hackett-Sack
430-John Hansen
434-Sack-Peterson
438-Belvidere-Hackett
In the latter part of 1938 Barber demanded that petitioner raise $50,000 additional capital for the partnership. Petitioner informed Barber that he was unable to do so. However, he assisted Barber in an unsuccessful attempt to obtain a loan of $50,000. He also loaned Barber $200 out of his personal funds which the latter repaid. In the fall of 1938 petitioner got a lease known as the Weber lease located outside Home Township in Salem Township, Allegan County, Michigan. He assigned that lease to the partnership. Shortly before Christmas, 1938, a producing well was brought in nearby greatly enhancing the value of the Weber lease. Barber sold that lease for $5,000. Petitioner asked Barber for one-half the proceeds but the latter insisted that the money be left in the partnership to finance future drilling. In the course of the dispute Barber informed petitioner that as to future wells to be drilled, the partnership arrangement would not apply. It was agreed that petitioner would have the option of participating in future wells but in order to do so he must pay his proportionate share of the costs of drilling each. Subsequently petitioner obtained financing and participated in several wells on this basis. Such wells were not considered as a part of the partnership venture. Only the 12 wells listed above were part of the assets of the partnership business.
Barber drilled three non-producing wells in 1940. He demanded that a portion of the costs of drilling those wells be charged against the profits of the partnership venture on the ground that they served to outline the limits of the field. Petitioner agreed and this was done. Such expense had been written off prior to 1942.
In June 1941 petitioner received from Barber a financial statement prepared by the accountant for the partnership. This statement covered the partnership's operations up to April 30, 1941. The operations of the partnership resulted in a profit for the first time in 1941. After the close of that year Barber sent petitioner a statement showing the partnership income for 1941 to be $30,852.24, before depletion, and his distributive share, before depletion, to be one-half, or $15,426.12. Petitioner reported that amount as income from the partnership on his Federal tax return for 1941.
Early in 1943 petitioner requested and sometime shortly before April 15, 1943, received a report from Barber of the profits of the venture for 1942. Because of the lateness of this report petitioner had to request an extension of time for filing his return for 1942. That report showed partnership income for 1942 of $35,501.22, after depletion, and showed petitioner's distributive share to be one-half of the partnership profits or $17,750.61, less a management fee of $5,000, or a net of $12,750.61. Petitioner did not agree with the imposition of the management fee nor with certain expenses which Barber had deducted in arriving at the partnership income. However, because of the shortness of time, petitioner reported on his income tax return the net amount credited to him by Barber as his distributive share of the partnership profits for 1942 in the amount of $12,750.61.
That report from Barber also revised downward petitioner's distributive share of the partnership profits for 1941 by deducting from it a management fee of $3,333.33 and depletion of $4,793.07, thereby reducing his share from $15,426.12 to $7,299.72. Petitioner did not agree with those revisions.
As a result of the conflict between petitioner and Barber with respect to his 1941 and 1942 distributive share of the partnership profits, petitioner on October 18, 1943, filed suit against Barber and the Consumers Power Company, the purchaser of all the gas produced by the partnership wells. In that suit he claimed one-half of the profits of the venture as his distributive share and he prayed for an accounting, dissolution of the partnership, appointment of a receiver, and a temporary injunction against dissipation of partnership assets. He alleged that Barber's accounting for 1942 and his amended accounting for 1941 showed erroneous charges against partnership income of $800 and $1,200 for office overhead for 1941 and 1942, respectively, as well as erroneous charges for depletion of $16,430.31 and well maintenance of $2,664.83 for 1942. He also alleged that the management charges of $3,333.33 and $5,000 for 1941 and 1942, respectively, and depletion of $4,793.07 for 1941 were improper charges against his distributive share. Concerning the amount of income from the partnership activities, petitioner alleged as follows in his bill of complaint:
That this Plaintiff claims that according to Defendant's own statement he is entitled to a total of $15,426.12 as profits for the year 1941 and approximately $27,913.18 as profits for the year 1942, making a total of $43,114.70 of which sum there has only been paid $12,201.52, leaving a balance due of $30,813.18 together with the profits due this Plaintiff for the period of January 1st to July 31st of 1943 which are unknown.
Barber's answer denied the existence of a partnership and that the charges against income and petitioner's distributive share shown on the statement were improper and alleged affirmatively that petitioner had failed to live up to his partnership obligations and that petitioner had elected to dissolve the partnership on January 25, 1939, because of petitioner's refusal to permit his $2,500 share of the Weber lease proceeds to be used for future drilling.
Petitioner obtained a temporary injunction restricting Consumers Power Company from making payments to Barber for gas purchased from the partnership wells pending decision of the suit. During the course of the litigation the Consumers Power Company impounded the sum of $35,674.24 due to the partnership for gas purchased.
Petitioner did not report any income from the partnership on his return for 1943. In a letter attached to such return petitioner stated as follows:
Enclosed income tax report for 1943 is contingent upon the outcome of a lawsuit now in progress, which was started in October 1943. Since no one can forecast the outcome of a lawsuit, I made my 1943 tax report without reference to gas properties in which I own an interest in Home Twp. Montcalm County, Michigan.
Should I lose this suit my 1942 income tax report will have to be revised downward and a considerable refund will be due me. My attorneys feel that I have a most excellent case and should win, in which event I will have to revise my 1942 tax report upward somewhat and my 1943 tax report will be revised upward considerable.
Firmly believing that I will win the case I am leaving the $782.85 which I have overpaid as a credit against this increase. If you have any suggestions or know of a better way to handle this matter I will appreciate hearing from you. I have no report on the earnings of the properties for 1943 and feel indignant about the reported earnings of 1942. That is what the dispute is about.
On April 26, 1944, petitioner and Barber entered into a settlement agreement dissolving the partnership as of April 1, 1944, and dividing its assets. Petitioner received $17,026.23 in cash from the impounded funds and seven producing wells as follows:
+--------------------------------------+ ¦405-Hanson No. 1¦426-Burt-Mann ¦ +----------------+---------------------¦ ¦416-C. J. Mann ¦434-Sack-Peterson ¦ +----------------+---------------------¦ ¦420-De Je ¦438-Belvidere-Hackett¦ +----------------+---------------------¦ ¦424-Matherson ¦ ¦ +--------------------------------------+
Barber received $18,648.01 in cash from the impounded funds, one producing well, No. 407-Mortensen-Sack, and four non-producing wells: 406-Neilsen-Hamilton & Towle; 408-Snyder-Lavender-Roose; 429-Hackett-Sack, and 430-John Hansen.
The gas sales and profits of the Barber-deCousser partnership for the years 1942, 1943, and 1944 were as follows:
+------------------------------------------------------------------------------+ ¦ ¦1942 ¦1943 ¦1944 ¦Totals ¦ +---------------------------------+----------+----------+----------+-----------¦ ¦Gross gas runs ¦$61,077.21¦$66,118.04¦$18,169.07¦$145,364.32¦ +---------------------------------+----------+----------+----------+-----------¦ ¦Less severance tax ¦1,221.54 ¦1,322.36 ¦363.38 ¦2,907.28 ¦ +---------------------------------+----------+----------+----------+-----------¦ ¦Net gas runs ¦59,855.67 ¦64,795.68 ¦17,805.69 ¦142,457.04 ¦ +---------------------------------+----------+----------+----------+-----------¦ ¦Operating expenses ¦7,894.14 ¦15,133.61 ¦9,147.76 ¦32,175.51 ¦ +---------------------------------+----------+----------+----------+-----------¦ ¦Net profit of venture ¦51,961.53 ¦49,662.07 ¦8,657.93 ¦110,281.53 ¦ +---------------------------------+----------+----------+----------+-----------¦ ¦Depletion, 27 1/2 per cent of ¦16,796.23 ¦18,182.46 ¦ ¦ ¦ ¦gross ¦ ¦ ¦ ¦ ¦ +---------------------------------+----------+----------+----------+-----------¦ ¦Depletion 50 per cent net ¦ ¦ ¦4,328.97 ¦ ¦ +---------------------------------+----------+----------+----------+-----------¦ ¦Net taxable income ¦35,165.30 ¦31,479.61 ¦4,328.97 ¦ ¦ +------------------------------------------------------------------------------+
The sum of $12,000 was received by petitioner from the partnership prior to the settlement agreement of April 26, 1944, in the following installments:
+------------+ ¦1941¦$3,000 ¦ +----+-------¦ ¦1942¦6,000 ¦ +----+-------¦ ¦1943¦3,000 ¦ +------------+
After the settlement agreement petitioner claimed that his taxable income from the partnership, after depletion, was as follows:
+---------------+ ¦1942¦$4,376.64 ¦ +----+----------¦ ¦1943¦3,882.12 ¦ +----+----------¦ ¦1944¦533.86 ¦ +---------------+
Petitioner arrived at this result by adding $12,000 in cash actually distributed to him prior to 1944 to the $17,026.23 in cash distributed to him in April 1944 as part of his settlement dissolving the partnership after litigation and by subtracting from this total sum of $29,026.23, the sum of $15,426.12 reported by him as income from the partnership in 1941, and by calling this previously unreported distributed cash of $13,600.11 his total distributive share, before depletion, of the partnership income for 1942 to 1944, inclusive. He then determined that the $13,600.11 is 12.3321 per cent of the $110,281.53, the total partnership income, before depletion. He termed this his percentage of the partnership income and applied it to the partnership income, after depletion, for each year to ascertain his taxable distributive share for that year as set forth above.
The respondent determined that petitioner's taxable income from the partnership is one-half of the partnership income, after depletion, less $5,000, or $12,582.65 in 1942, $15,739.80 in 1943, and $2,164.48 in 1944.
OPINION.
HILL, Judge:
The primary question is whether the respondent correctly determined that petitioner's distributive share of the income of the partnership involved for the years 1942, 1943, and 1944 was in the amounts set forth above. The petitioner argues that the existence of a controversy between him and Barber during those years rendered the amount of his distributive share indefinite and impossible of ascertainment and that such amounts were not specifically established until the settlement agreement of April 26, 1944. With respect to his contention, petitioner states on brief as follows:
* * * They (petitioner and Barber) were to be equal partners in the profits but there was no definite understanding as to the amount Mr. Barber was to receive for management nor was there anything definite in respect to the capital contributions. * * *
He also states that:
* * * The agreement of August 10, 1928 was so vague and indefinite in respect to management and other fees to be paid to Mr. Barber, capital contributions and in many other respects, that it was impossible to determine the distributive share of the profits of Petitioner from said agreement, * * * .
Petitioner thus maintains that the amounts of the cash paid to him under the settlement agreement, together with cash previously distributed to him, should be related back to the years in question in accordance with the formula set forth in our findings. We do not agree with his contention.
With respect to taxation of members of a partnership, section 182 of Internal Revenue Code provides:
SEC. 182. TAX OF PARTNERS.
In computing the net income of each partner, he shall include, whether or not distribution is made to him
(c) His distributive share of the ordinary net income or the ordinary net loss of the partnership, computed as provided in section 183(b).
Hence, in accordance with the statute, each partner is taxable upon his distributive share of the partnership profits whether received by him or not. See Bourne v. Commissioner, 62 Fed.(2d) 648.
Final determination of the basic issue, then, turns upon the answer to the question— In what percentage, if any, of the net profits of the partnership in question did petitioner have a right to share during the years in question? There is no dispute as to the amounts of the partnership net income for each of the years before us. They were stipulated by the parties as set forth in our findings. We think, moreover, that there can be little doubt that petitioner had a right in accordance with the partnership agreement of August 10, 1938, to a 50 per cent share of the partnership profits at least in the years 1942 and 1943. It is true that there was certain vagueness concerning financing and ‘some small items of expense‘ in the agreement and that during the existence of the partnership petitioner and Barber had several disagreements from which arose certain alterations to the original agreement. So far as the facts show, however, none of these ever resulted in an amendment to the provision of the agreement that petitioner and Barber were to share in partnership profits on a 50-50 basis.
Those disputes are outlined in detail in our findings. It will be noted that there were several disagreements prior to 1942 which resulted in some modifications of the agreement. One change resulted from a dispute which arose late in 1938 or early 1939 concerning Barber's request of petitioner that the latter loan the partnership $50,000 for working capital. Petitioner could not do so. As a result of this it was agreed that petitioner would not participate in future wells unless he contributed to the cost of drilling them. Another modification came about in 1940 as a result of a dispute concerning sharing expenses of drilling three wells which proved to be dry holes. An agreement was reached concerning this and the expense of drilling those wells was completely absorbed prior to 1942.
The only dispute concerning partnership income and the partners' share thereof which affected petitioner's income for the years in question resulted from Barber's 1943 accounting to petitioner. In it Barber not only revised downward petitioner's income for 1941, but also made some adjustments for 1942. Barber's statement for 1942 showed a partnership profit of $35,501.22, after depletion, and also a deduction of $5,000 for management fees from petitioner's share of $17,750.61, which reduced his share to $12,750.61. Petitioner then brought suit on October 18, 1943, asking for his 50 per cent share of the partnership profits, and an accounting and dissolution of the partnership. In his bill of complaint, petitioner alleged that he was entitled to a total of $15,426.12 and $27,913.18 in profits for the years 1941 and 1942, respectively. Certainly those facts show that there was no agreement between the partners to change the provision that they were to share in partnership profits on an equal basis.
Moreover, with respect to 1942, respondent has not attempted to tax petitioner on an amount of petitioner's distributive share of profits of the partnership greater than the $12,750.61 which Barber, in his accounting, stated was petitioner's share; indeed, the respondent has determined that his income due to partnership activity in 1942 was $12,582.65, which is less than the amount Barber originally said that he was entitled to receive. The respondent determined this lower figure after readjusting the allowance for depletion. In short, the respondent in computing petitioner's profits for 1942 has reduced it by all the deductions in controversy. If petitioner's theory in the lawsuit against Barber was proper his distributive share was higher than the amount respondent determined. We believe that in the circumstances of this case and in the light of section 182 of the Code that respondent's determination with respect to 1942 is proper and we so hold.
As to 1943, there appearing to be no specific items in controversy and since as of the end of that year it appeared from all the facts then known that petitioner had a right to share in 50 per cent of the partnership profits, we hold that respondent's determination that his distributive share for that year was $15,739.80 also should be sustained.
Our conclusion in this respect is supported by, among others, First Mechanics Bank v. Commissioner, 91 Fed.(2d) 175. In that case the Court found that one Bird entered into a joint venture in 1916 with a Canadian company for the purpose of fulfilling certain contracts. Under the agreement Bird was to receive profits of 15 per cent from some contracts and 5 per cent from others. Deliveries under one of the contracts were completed in 1916. Under another, manufacture was completed in 1917, but while awaiting shipment the products were destroyed by fire or explosions at Kingsland, New Jersey.
In 1916 Bird wrote the Canadian company demanding an accounting for his profits and also threatened court action. Bird brought suit in 1919. The issue involved the contract completed and under which delivery had been made in 1916. Bird was entitled to some $312,000 as the result of this contract in 1916. However, he compromised with the Canadian company in 1928 after protracted litigation for $200,000. The taxpayer claimed he should have reported $312,000 in 1916, while the Commissioner argued that he was taxable on $200,000 in 1928. The Court said as follows with respect to the question:
In the present case the contracts were completed in 1916. The profits were realized by the joint venture at that time and there was nothing conditional or contingent about their receipt. They were earned and paid. Bird, therefore, was legally entitled to his share of the profits which was $312,723.46, and was taxable on that share although he did not actually receive it in that year. That he saw fit to compromise the amount due him for $200,000 in 1928 did not diminish his liability for taxes for 1916. Appeal of Fred Truempy, supra, (1 B.T.A. 349); Appeal of Robert A. Faesy, supra, (1 B.T.A. 350).
See also D. H. Byrd, 32 B.T.A. 568.
With respect to the year 1944, however, it may be argued that petitioner's ratio of his distributive share of the partnership profits was changed by virtue of the settlement agreement of April 16, 1944, between him and Barber. If that were true, it would follow that he would not have been entitled to 50 per cent of the partnership profits for 1944. We do not believe, however, that petitioner has shown that that ratio was changed by the settlement agreement. By it petitioner received $17,026.33 in cash and seven producing wells. But in his formula for determining his share of partnership profits petitioner considered only the cash distributed to him. He claims that the value of the wells was not includible in his taxable income for any of the years in question because distribution of assets upon dissolution of a partnership is not a taxable event, citing Annie Laurie Crawford, et. al., Executors, 39 B.T.A. 521, and Robert W. Wilmot, 44 B.T.A. 1155. We do not agree with his argument. Concerning the cases cited we said in James F. Curtis, 3 T.C. 648, 662:
* * * The Crawford and Wilmot decisions most assuredly do not suggest that partners may postpone the imposition of tax on partnership profits by the simple expedient of distributing such profits in the form of property other than cash. Hence, they do not assist petitioner in avoiding tax on his portion of the gains arising from the joint transactions.
Here the primary purpose of petitioner's lawsuit was to claim one-half of the profits of the venture between him and Barber. So far as the facts show the settlement determined that question. At lease it has not been shown that the wells distributed to petitioner on the settlement date were anything else than a distribution of part of his share of the profits for the years 1942, 1943, and 1944. It is thus apparent that petitioner should have included not only the amount of the cash in his computation of income for the years in question, but also any value of the wells distributed to him. And since petitioner has not proved the value of such wells, or that it was less than an amount, when added to the cash, equal to 50 per cent of the partnership profits for 1944, we can not say that the respondent's determination with respect to that year is erroneous. We therefore hold that respondent's determination was also proper as to 1944.
In the petition, petitioner states as follows concerning the settlement:* * * In May of 1944, your petitioner and the said Leslie T. Barber adjusted by agreement between themselves the distributive shares of the profits from said partnership venture * * * whereby petitioner accepted $17,026.33 of said impounded funds, and seven of the producing wells, and Leslie T. Barber accepted $18,648.01 of the impounded funds and five producing wells. * * *
In view of the above it is not necessary to discuss issue (2).
Decision will be entered under Rule 50.