Lead Opinion
In docket No. 19200-94, respondent determined an estate tax deficiency of $663,785 and an accuracy-related penalty under section 6662(a)
After concessions, the issues remaining for decision are: (1) Whether petitioner’s section 2053(a)(3) deduction for a claim against the estate is limited to the amount for which the claim was settled following decedent’s death; (2) if petitioner is entitled to a section 2053(a)(3) deduction for the entire amount claimed on the Federal estate tax return, whether petitioner realized discharge of indebtedness income pursuant
Background
This case was submitted fully stipulated pursuant to Rule 122. The stipulation of facts, supplemental stipulation of facts, and stipulation of settled issues are incorporated herein by this reference.
Algerine Allen Smith (decedent) died testate on November 16, 1990, in Texas. James Allen Smith, decedent’s son, is the executor of the estate. Mr. Smith resided in Larchmont, New York, at the time he filed the petition in this case.
On April 23, 1970, decedent, as lessor, entered into an oil, gas, and mineral lease with Humble Oil & Refining Co. (Humble). Pursuant to this lease agreement, decedent retained a royalty interest in oil and gas production obtained from an 80-acre tract of land in Wood County, Texas. On April 23, 1970, Jessamine and Frankie Allen, decedent’s aunts, also entered into oil and gas leases with Humble, pursuant to which they retained royalty interests from the oil and gas production obtained from certain tracts of land in Wood County. Humble was subsequently acquired by Exxon Corp. (Exxon).
Jessamine and Frankie Allen died in 1979 and 1989, respectively, and decedent served as the independent executrix of both estates. Upon Jessamine’s death, decedent inherited a portion of Jessamine’s interest in the leased property. Upon Frankie’s death, decedent inherited all Frankie’s interest in the leased property, as well as the remaining portion of Jessamine’s interest which Frankie had previously inherited.
Decedent’s, Frankie’s, and Jessamine’s interests in the Wood County property were part of a unit formation known as the Hawkins Field Unit (hfu). The Texas Railroad Commission, which regulates oil and gas operations in Texas, approved the HFU for unitization on November 26, 1974. In a unit agreement, effective January 2, 1975, interest owners in the area utilized oil and gas rights pertaining to the unitized formation. The unit agreement embraces interests of
During the early operation of the HFU, the Federal Government, acting initially through the Federal Energy Administration and later through the Department of Energy (doe), regulated the price of domestic crude oil through the application of two-tier price regulations under 10 C.F.R. secs. 212.73 and 212.74 (1975). Producers were required to sell “old” crude oil at the lower tier price and were allowed to sell “new” crude oil at a higher price.
In June 1978, the DOE filed suit against Exxon as operator of the HFU. The DOE contended that Exxon had misclassified crude oil produced from the HFU, which resulted in overcharges in violation of the doe’s petroleum price regulations. Exxon vigorously defended against the doe’s allegations. Nevertheless, on October 9, 1980, Exxon announced to the HFU interest owners that it would begin to withhold amounts owed to the interest owners under Exxon’s posted prices for the oil produced. In justification for tendering less than the amount due under Exxon’s classification of the oil, Exxon stated that it desired to create a fund for payment of any liability it might eventually have to the DOE. The amounts withheld represented the difference between the higher price charged by Exxon and the lower price the DOE contended was the maximum lawful selling price. Exxon withheld these amounts from October 1, 1980, to January 28, 1981, the date on which oil prices in the United States were decontrolled.
In response, certain HFU royalty interest owners filed suit against Exxon in October 1980 in the U.S. District Court for the District of Texas (Tyler Division), arguing that Exxon was required to pay them the full amount of their royalty. Jarvis Christian College v. Exxon Corp., docket No. TY-80-432-CA (the Jarvis Christian litigation). On February 6, 1981, decedent, individually and as executrix for the estate of Jessamine Allen, along with Frankie and other members of the Allen family (the Allen parties), filed a motion to intervene
On March 25, 1983, the U.S. District Court for the District of Columbia ruled that Exxon had violated the two-tier pricing regulations. United States v. Exxon Corp.,
On February 27, 1986, Exxon paid the judgment, which amounted to just under $2.1 billion with interest. The amount paid consisted of $895,501,164 in overcharges, $771,997,881 in prejudgment interest, and $428,273,813 in postjudgment interest.
On January 26, 1988, Exxon filed suit in the U.S. District Court for the Eastern District of Texas (Tyler Division) against the owners of royalty and mineral interests in the HFU. Exxon v. Arnold, docket No. TY-88-110-CA (E.D. Tex., Jan. 26, 1988). Exxon’s suit was consolidated with the Jarvis Christian litigation at docket No. TY-80-432-CA (consolidated action).
Decedent, individually and as the executrix of the estate of Jessamine Allen, and Frankie were parties to the suit. The Jarvis Christian defendants vigorously contested Exxon’s claims. On July 22, 1988, the Jarvis Christian defendants filed a motion for judgment for lack of Federal statutory or common law claims, asserting that neither Federal statutory law nor common law authorized any of Exxon’s claims against them.
On November 7, 1989, the District Court issued an order granting an oral motion for reverse bifurcation. The District Court ordered that the trial on the damages issue in the case
Decedent died on November 16, 1990.
On February 15, 1991, the District Court issued an order determining in part that the royalty interest owners were liable to Exxon under Federal common law for restitution of overcharges received by them on account of the misclassified oil. Despite its previous order bifurcating the issues, the District Court rendered summary judgment on both the liability and damages issues. The District Court then referred the calculation of damages to a special master.
In April 1991, Michael Riddle, decedent’s attorney for estate tax purposes, and James Knowles, her attorney in the Jarvis Christian litigation, attended a meeting with representatives of Exxon in Houston, Texas, at which Exxon presented its calculation of the amounts owed by the Allen parties. Exxon claimed a total of $2,482,719 from decedent’s estate, which included interest.
On September 10, 1991, the special master in the Jarvis Christian litigation issued an order regarding the procedures to be followed in determining the damages, if any, concerning each defendant. On September 23, 1991, the Allen parties filed a response to the special master’s order, wherein they objected to Exxon’s damage calculations.
On February 10, 1992, petitioner and Exxon entered into a settlement agreement with respect to the litigation. Pursuant to the settlement, petitioner paid Exxon $421,276.60 and surrendered to Exxon for a period of 7 years Frankie Allen’s royalty interest in the HFU, which had a fair market value of approximately $260,563 when assigned. Petitioner thus resolved Exxon’s disputed claim for a total amount of $681,839.60. On April 6, 1992, Exxon and the Allen parties filed a stipulation of dismissal. On April 29, 1992, the District Court ordered that all claims presented by the parties with respect to the litigation were dismissed.
Discussion
The first issue we must decide is whether petitioner is entitled to a deduction pursuant to section 2053(a)(3) in the amount reported on the estate tax return ($2,482,719) or in the amount ultimately paid to Exxon in settlement of the relevant claim ($681,839.60). To do so, we must determine whether events subsequent to the date of decedent’s death are to be taken into account in establishing the amount of the deduction to which petitioner is entitled.
The Internal Revenue Code imposes a Federal estate tax on the transfer of the taxable estate of a decedent who is a citizen or resident of the United States. Secs. 2001 and 2002. Section 2053(a)(3) allows a deduction from the gross estate for claims against the estate that are allowable by the laws of the jurisdiction under which the estate is administered. Section 20.2053-4, Estate Tax Regs., provides that “The amounts that may be deducted as claims against a decedent’s estate are such only as represent personal obligations of the
Petitioner argues that it is entitled to a deduction pursuant to section 2053(a)(3) for the entire amount reported on the estate tax return. Petitioner relies upon Ithaca Trust Co. v. United States,
In Estate of Van Horne v. Commissioner,
In Estate of Cafaro v. Commissioner, supra, for instance, the taxpayer claimed several deductions pursuant to section 2053(a)(3) which exceeded the amounts for which the estate ultimately settled the claims in issue, and the Commissioner disallowed these deductions to the extent they exceeded the amounts of the settlements.
In Estate of Taylor v. Commissioner, supra at 372, a husband and wife had entered into a separation agreement requiring the husband to pay $500 a month to his wife for her life or until she remarried. Upon the husband’s death, the wife made a demand upon the executors for continuation of the monthly payments. The estate refused the wife’s claim on the ground that it was the intention of the parties to the separation agreement that the payments would cease with the death of the husband. While the matter was in litigation, the estate took a deduction of $95,982 on its Federal estate tax return, which represented the present value of the wife’s right to receive $500 monthly until she died or remarried. The following year the wife remarried, and approximately 2 years thereafter, the Supreme Judicial Court of Massachusetts ruled that the estate was liable for payments for the period up to the wife’s remarriage. Pursuant to this decree, the estate paid to the wife $12,500 in satisfaction of her claim.
We upheld the Commissioner’s determination that the estate was only entitled to a deduction of $12,500; i.e., the amount it actually paid. We stated that
because of the uncertainty as to whether the estate would ever pay any amount to Alice [the decedent’s wife] on her disputed claim, the estate’s liability was contingent, and the outcome of such dispute must be looked to before the estate would be entitled to a deduction.
Clearly the contesting of Alice’s claim was not a frivolous or capricious act, but was based upon legal arguments which the estate deemed of sufficient importance to merit the attention of the highest court of Massachusetts.
The value of the claim for deduction purposes was not reasonably ascertainable until the litigation ended and the estate finally recognized its liability to Alice. * * *
[Id. at 375; citations omitted.]
On brief, petitioner argues that Exxon’s claim was certain and enforceable on the date of decedent’s death, thereby entitling petitioner to deduct the entire amount of the claim in determining the value of decedent’s taxable estate. Petitioner posits several arguments in support of its position. We shall address each one in turn.
First, petitioner contends that the HFU interest owners’ liability for the overcharges was the actual basis for the litigation in Exxon I, which was decided in 1983. Petitioner asserts that Exxon was required to make restitution only because it was deemed necessary for the effective enforcement of the oil pricing regulations. Thus, petitioner maintains that Exxon’s claim was enforceable at the time of decedent’s death. We disagree.
The record clearly indicates that the issue in Exxon I was whether Exxon had overcharged its crude oil purchasers for oil produced in the HFU. Contrary to petitioner’s argument, Exxon I did not consider whether Exxon had overpaid its royalty and working interest owners in the HFU. While Exxon attempted to join the Jarvis Christian plaintiffs as indispensable parties, its efforts were unsuccessful. Rather, the Jarvis Christian plaintiffs were invited to intervene in Exxon I if they “desired ‘an earlier determination’ of their claims” that Exxon should continue paying them royalties based on the higher price under the two-tier system. United States v. Exxon Corp.,
Petitioner argues that “There is no doubt here about the legal enforceability of Exxon’s contractual claims for reimbursement of the overpayment of its oil royalties under the provisions of the leases during the price regulation under Texas law.” Petitioner’s argument represents a dramatic shift from the position taken by the Allen parties in the Jarvis Christian litigation. In count II of its complaint in that litigation, Exxon alleged that the HFU interest owners had breached their contractual obligations to Exxon by refusing to restore the amounts of their overcharges. However, the Allen parties denied any contractual breach on the part of the interest owners and contended that Exxon was not entitled to any recovery from them. The Allen parties also adopted the January 16, 1990, motion for summary judgment and accompanying memorandum filed by the defendants in the Jarvis Christian litigation, which stated that “Exxon mocks the fundamental equitable principles underlying this proceeding by even asking for restitution” of the HFU overcharges.
When claims under a contract are contested, as were Exxon’s in the instant case, the claims are not enforceable within the meaning of section 20.2053-4, Estate Tax Regs., until it is eventually determined whether and to what extent the claims have ripened into enforceable claims deductible pursuant to section 2053(a)(3). See Estate of Van Horne v. Commissioner,
Petitioner further alleges that certain provisions of the unit and unit operating agreements provided Exxon with an enforceable lien against the Allen parties’ interests in the HFU and entitled Exxon to restitution of the overcharges. Cf. Propstra v. United States,
We also reject petitioner’s attempt to find a lien within the Allen parties’ oil and gas leases. The relevant provision in the leases stated, in pertinent part:
Lessor hereby warrants and agrees to defend the title to said land and agrees that Lessee at its option may discharge any tax, mortgage or other lien upon said land, either in whole or in part, and if Lessee does so, it shall be subrogated to such lien with right to enforce same and apply rentals and royalties accruing hereunder toward satisfying same. * * *
This provision addresses a situation where the lessor would be responsible for a third-party lien; e.g., where the lessor failed to discharge a tax or mortgage obligation. Under those circumstances, Exxon, as lessee, would be entitled to satisfy the third-party lien and become subrogated to the third-party’s rights against the lessor. Thus, the provision does not contemplate a situation such as the instant one. Indeed, we note that in the complaint filed against the interest owners in the Jarvis Christian litigation, Exxon never claimed that the provision was applicable to the litigation.
Finally, petitioner contends that the opinion of the Court of Appeals for the Ninth Circuit in Propstra v. United States, supra, supports its position that it is entitled to a deduction on its Federal estate tax return in the amount claimed. In Propstra, at the time of his death, the decedent’s property had been encumbered by liens of the Salt River Valley Water Users Association (association) for past due assessments and penalties. The association’s bylaws denied it the power to adjust the claims. The estate’s executrix deducted the decedent’s one-half share of the liens on the Federal estate tax return. Twenty-two months later, the association’s bylaws were amended to permit the settlement of outstanding claims for less than the full amount owed. The estate ultimately settled the claim for less than the amount originally sought (and reported by the estate on its return). Id. at 1250.
The Court of Appeals for the Ninth Circuit found that the association’s lien claims were certain and enforceable when the decedent died. The Court of Appeals noted that at the time of the decedent’s death, the association lacked the authority to settle claims for less than their full amount. In addition, the estate lacked even a colorable defense against the association’s claims. The Court of Appeals ruled that “when claims are for sums certain and are legally enforceable as of the date of death, post-death events are not relevant in computing the permissible deduction.” Id. at 1254. The estate
Petitioner’s reliance on Propstra is misplaced. In Propstra, the Court of Appeals explained that the threshold determination to be made under section 2053(a)(3) is whether the claim in question was certain and enforceable at the time of the decedent’s death. See id. at 1253. The Court of Appeals precluded consideration of postdeath events only where a claim was found to be certain and enforceable on the date of death. Id. at 1254; see also Estate of Van Horne v. Commissioner,
The validity and enforceability of Exxon’s claim against decedent in the instant case were uncertain as of the date of her death. As a result, we hold that petitioner’s section 2053(a)(3) deduction in connection therewith is limited to the amount ultimately paid in settlement of that claim. Thus, we sustain respondent’s determination.
The next issue for decision is whether the income tax benefit derived by petitioner as a result of the application of section 1341(a) is an asset includable in the gross estate. Section 2031(a) provides that “The value of the gross estate of the decedent shall be determined by including to the extent provided for in this part, the value at the time of his death of all property, real or personal, tangible or intangible, wherever situated.” Section 2033 provides that “The value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of his death.” In the instant case, the parties have stipulated that all HFU royalties paid to decedent from Exxon for the calendar years 1975 through 1980 were reported as income on her Federal income tax returns for those years and that petitioner is entitled to section 1341(a) relief to the extent that these previously taxed royalties were repaid to Exxon in 1992.
On brief, petitioner contends that the gross estate is not increased by the amount of its section 1341(a) relief, because decedent’s right to such relief did not exist at the time of her death on November 16, 1990. Petitioner maintains that it was not entitled to any section 1341(a) relief until it repaid Exxon pursuant to the terms of the February 10, 1992, settlement agreement. This agreement was not entered into until almost 15 months after decedent’s death. Respondent, on the other hand, argues that petitioner’s section 1341(a) relief necessarily augments the gross estate. Neither party has cited, nor have we found, any case law squarely on point.
In support of his position, respondent relies on the decision of the District Court for the Eastern District of Michigan in Estate of Good v. United States,
The District Court rejected the Commissioner’s argument and concluded that section 1341(a) relief was appropriate. The District Court analyzed the estate and income tax consequences that would have resulted had the decedent repaid the amount in issue prior to his death. The District Court explained that the gross estate would have been decreased by the amount repaid and increased by the amount of the section 1341(a) credit to which the estate was entitled. Estate of Good v. United States, supra at 522. Since both parties acknowledged that the section 1341(a) credit, if available, would increase the gross estate, the District Court found that the Government would “not [be] prejudiced in the collection of the estate tax by the estate’s claiming both an estate tax deduction and an income tax credit on the same transaction.” Id. at 523.
The District Court in Estate of Good reasoned that the provisions of section 1341(a) should be available to an estate in order to ensure the same income tax consequences regardless of whether a taxpayer repays income prior to his death or the estate makes the restoration after his death.
In Estate of Curry v. Commissioner,
In Estate of Curry v. Commissioner, supra at 545, the taxpayer argued that the contingent legal fees were not includable in the gross estate, because the decedent was not entitled to any fees at the time of his death; i.e., any fees were contingent upon events that had not yet occurred as of the date of death. We explained:
The fact that the legal fees we are concerned with were contingent upon future recovery * * * is a critical consideration in trying to determine what the contract right was worth as of the date of death. However, the contingent nature of the contract right must bear on the factual question of valuation. It cannot, as a matter of law, preclude the inclusion of theinterest in the decedent’s gross estate or command that the value be fixed at zero. Although uncertainty as to the value of a contract right may postpone the inclusion of the income until it is actually realized for income tax purposes, for estate tax purposes, the value of an asset must be determined in order to close the estate. * * * [Id. at 546-547.]
This analysis is equally applicable to a contingent statutory right to relief under section 1341(a). In the instant case, the right to section 1341(a) relief was contingent at the date of decedent’s death. The contingency centered on decedent’s dispute over Exxon’s claim. However, the fact that this right to relief was contingent does not prevent its inclusion in the gross estate. See United States v. Simmons,
The facts giving rise to petitioner’s section 2053(a)(3) deduction and its right to section 1341(a) relief are inextricably linked. At the time of decedent’s death, Exxon was claiming that decedent was obligated to repay royalties, which decedent had previously reported as taxable income. Therefore, at the time of her death, decedent had statutory rights pursuant to section 1341(a) to receive tax benefits based on whatever amount she ultimately had to pay Exxon. Petitioner is entitled to an estate tax deduction in the amount paid to satisfy Exxon’s claim, as well as section 1341(a) relief for payment of the same claim. Exxon’s claim decreases the estate’s assets while the right to section 1341(a) relief increases the estate’s assets. Under these circumstances, it would be inappropriate to consider one in the determination of the taxable estate while excluding the other.
The amount for which a claim is ultimately settled is evidence of its value. See United States v. Simmons, supra at 218 (finding the amount for which a claim was eventually settled to be “highly indicative” of the value of the claim). In the instant case, there was no evidence introduced to show that the value of the contingent right to section 1341(a) relief at decedent’s death was less than the amount that will actually be received. On brief, petitioner confined its argument to whether the contingent right to section 1341(a) relief was or was not an asset includable in the gross estate. Petitioner did not argue that, in the event we find the right to section 1341(a) relief includable in the gross estate, the value of this
For the foregoing reasons, we hold that the taxable estate must be increased by the amount of section 1341(a) relief that is attributable to the amount petitioner paid to Exxon in settlement of its claim.
Decision will be entered under Rule 155 in docket No. 19200-94.
Decision will be entered for petitioner in docket No. 3976-95.
Notes
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect as of the date of decedent’s death, and all Rule references are to the Tax Court Rules of Practice and Procedure.
Respondent has conceded the accuracy-related penalty under sec. 6662(a).
Decedent, Jessamine, and Frankie were royalty interest owners.
Exxon was the HFU’s largest working interest owner.
Hereinafter, we shall refer to this consolidated action as the Jarvis Christian litigation.
The Allen parties expressly adopted the joint motion for summary judgment filed on Jan. 16. 1990.
The amount claimed by Exxon included amounts sought from Jessamine’s and Frankie’s interests, which decedent had inherited.
In Estate of Kyle v. Commissioner,
One claim was settled before the taxpayer filed its Federal estate tax return, while the other was settled after the return had been filed. Estate of Cafaro v. Commissioner,
Even then, the District Court’s determination was subject to appeal.
Indeed, we note that a substantial portion of the amount claimed by Exxon during its settlement conference with decedent’s attorneys in April 1991 represented interest. Exxon was seeking prejudgment interest beginning in February 1975 and postjudgment interest beginning in June 1983 with respect to the amounts it had paid to the Treasury in satisfaction of the judgment in Exxon I. However, in its Feb. 15, 1991, order, the District Court in the Jarvis Christian litigation had determined that Exxon was only entitled to prejudgment interest beginning on Feb. 27, 1986, and ending on the date of judgment in the Jarvis Christian litigation, and thereafter for postjudgment interest.
For instance, shortly after filing its Federal estate tax return in July 1991, petitioner filed a document with the special master in the Jarvis Christian litigation objecting to Exxon’s damage calculations.
Given our disposition of this issue, we need not consider respondent’s alternative argument that petitioner must recognize discharge of indebtedness income pursuant to sec. 61(a)(12) in connection with petitioner’s settlement of Exxon’s claim.
The amount of the deduction to which the taxpayer is entitled as a result of a repayment must exceed $3,000. Sec. 1341(a)(3).
Petitioner concedes that the computation of its sec. 1341(a) relief is limited to the amount paid to settle Exxon’s claim against decedent individually; petitioner is not entitled to sec. 1341(a) relief for amounts paid in satisfaction of Exxon’s claims against Jessamine and Frankie. The parties also appear to agree that a credit pursuant to sec. 1341(a)(5) would provide petitioner a greater benefit than a deduction under sec. 1341(a)(4).
The District Court stated: “when Congress passed Section 1341 it did not intend to recognize a debt of the Government to the taxpayer during his lifetime and deny the same obligation to his personal representatives and to his estate.” Estate of Good v. United States,
While we recognize that the parties in Estate of Good v. United States, supra at 523, agreed that the gross estate would be increased by the amount of any sec. 1341(a) relief, we nevertheless find the reasoning in the District Court’s opinion persuasive.
In United States v. Simmons,
After trial, the District Court submitted the issue of valuation to the jury, which found that the claim had no value at the time the decedent died. The Court of Appeals for the Fifth Circuit reversed, holding that there was no rational basis for the jury’s finding. The Court of Appeals stated: “When * * * [the decedent] died, his ‘property” included the claim for refund of federal income taxes.” Id. at 215. The Court of Appeals determined that postdeath facts and circumstances were to be taken into account for purposes of valuing the estate’s claim and found the amount for which the claim was eventually settled to be “highly indicative”, but not determinative, of such value. Id. at 218.