Estate of Algerine Allen Smith, Deceased; James Allen Smith, Executor, Petitioners

110 T.C. No.

UNITED STATES TAX COURT ESTATE OF ALGERINE ALLEN SMITH, DECEASED, JAMES ALLEN SMITH, EXECUTOR, Petitioner y. COMMISSIONER OF INTERNAL REVENUE, Respondent* Dòcket Nos. 19200-94, 3976-95.

Filed January 12, 1998.

in prior years.

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 our previous opinion in these cases, we held that P was entitled to an overpayment of application of sec. 1341, 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 R also seeks to amend the answer in the overpayment. order to decrease the credit for State death taxes that was previously allowed in the estate tax notice of deficiency.

I.R.C., and that such income tax pursuant to In 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).

SERVED (cid:16)042 Held, further, the amount of any orerpayment that results from the application of sec. 1341, not restricted to the amount computed uhder sec. 1341(b)(1), I.R.C.

I.R.C., is Held, further, Rule 155(c), Tax Coirt Rules of Practice and Procedure, prohibits a par y from raising new issues for purposes of making a computation pursuant R may not amend the answer.

to Rule 155.

Michael C. Riddle and Harold A. Chamberlain, for petitioner.

Carol Bingham McClure, for respondent.

SUPPLEMENTAL OPINION

RUWE, Judge:

On June 4, 1997, we issue our opinion in these consolidated cases. Estate of Smith M. 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 dannot 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 ¹Unless otherwise indicated, all Rule r ferences 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.

2As indicated in our prëvious 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.

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 computati-onal i.ssues.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.

SThe amount of the resulting overpayment will be determinative of the amount of a corresponding asset for estate tax purposes.

4A more complete statement of facts is contained in our previous opinion.

(1) an item was included in gross income for a prior taxable year the taxpayer had an unrestricted right to such item; (or years) because it appeared that (2) a deduction is allowable for the taxable year because it was established after the close of such prior taxable year that the taxpayer did not have an unrestricted right to such item or to a portion of such item; and (or years) (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 (lB) the decrease in tax under this chapter for the prior taxable year (or the corresponding provisions of prior revenue laws) would result solely from the exclusion of such item (or portion thereof) such prior taxable year from gross income for (or years).

(or years) which .

* * * * * * * (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 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 1-aw 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 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 299.8 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, sectionl1341 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 amoun¢s. We hold that only that portion of the $681,840 that repre$ents repayment of royalties previously received and reported by decedent can be used to provide benefits to petitioner under section 1341.

'As succinctly stated in Judge Nelson's concurring opinion:

For a taxpayer to take advantage of § 1341, he 'an item' was must show, among other things, 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 th taxpayer did not have an unrestricted right to 'such item' or portion thereof. Both sections clearly speak of the same 'item.'

that (1) included in the Krafts' gross income The 'item' 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. United States, 991 F.2d 292, 300 (6th Cir. 1993).]

[Kraft v.

* *l* _ 9 _ 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 :2.4 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 7Respondent'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.

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.

U der these circumstances, the Rule 155 computation cannot be based on the assumption that decedent received more royal .y income during the years 1975 through 1980 than she reported on her returns . 8 Based upon the available information, w¢ find that 24 percent of the $681, 840 settilement, or $163, 641, should be attributed to excess royalties received and (cid:16)040eportedby decedent during the years 1975 through 1980.' This $163,641 should then be allocated to each of the years 1975 throuÂh 1980 in proportion to the amount of gross royalties that decede t 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 teturns.

The resulting amounts should then be excluded frÂm reported income 8Respondent made no argument that this aspect of the computation was an attempt to determine whiclk portion of Exxon' s claims against decedent was attributable to (cid:16)041essamine's royalties. respondent's counsel ack$owledged that Jessamine's royalties could not be identifie$ and that respondent's computations give petitioner thë benefit of any doubt on this point.

Indeed, 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. Respondient's proposed computation made no allocation of the $681, 8d⁰ settlement interest and presented no arguments regardind how such an allocation should or could be made.

to 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 section 1341. Here that tax is $8,338, whidh petitioner previously reported and paid.

The second s ep 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. Petitioned's 1992 income tax liability is then determined by subtracting the decrease in tax in prior years (1975 through 1980) from $8, 38.

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 tha petitioner has overpaid its tax liability for 1992 by at least $8,338.

Section 1341(b)(1) prescribes the methöd for dealing with the amount by which the decrease in tax foriprior years exceeds the tax for 1992 as computed with no sectio 1341 deduction.

It provides that "such excess shall be conside ed 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 foh such taxable year."

Sec. 1341(b)(1). Respondent's position is that section 1341(b)(1) places a limit on the amount of hny overpayment to which petitioner is entitled.¹° We disagree. Section 1341(b)(1) 1°In the Written Statement In Support of Respondent's Rule 155 Calculation, respondent states:

Section 1341(b)(1) proVides in pertineht part that 'if the decrease in tax ascertained under subsection (a)(5)(B) exceeds the tax imposed for the taxable year (continued...)

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 tax on the last day 1°(...continued) (computed without the deduction) such exces·s shall be considered to be a payment of prescribed by law for the payment of taxable year, and shall be refunded or credited in the same manner as if it were an overpayment for such (Emphasis added.) taxable year.' the overpayment is not 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.

the entire amount computed the amount of tax for the Thus, * * * 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 cre it for state death taxes a·llowable, if substantiated." Had th s been done, the amount of the deficiency determined by resp¢ndent would have been increased by $120,172."

Respondent now wants to amend the answk.r to correct the error and increase the deficiency. Apparently, assuming that this will be permitted, respondent has inclúded this adjustment in the Rule 155 computation.

The problem with respondent's position is that Rule 155(c) precludes a pahty from raising a new issue in a proceeding under Rule 155.

The redit for State death taxes was previously uncontested and has no hing 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.

App opriate orders will be issued.

¹¹Respondent recognizes that the actual respondent's error will probably be far les a result of our prior opinion, petitioner's taxable estate will be increased. additional State death taxes, substantial amount of the credit already allowed.

To the extent petitioner is bbligated to pay impact of than this since, as it would be ehtitled to a See sec. 2011.

26. U.S.C. §§ 1341(a)(1) and (a)(2).