Court Opinion

ID: 9453473
Source: CourtListenerOpinion
Date Created: 2023-08-04 18:14:31.995715+00
Date Added: 2024-06-11T17:33:40.405276
License: Public Domain

HILL, Circuit Judge
(dissenting).
This is a close and difficult case and one that has caused each member of the panel to burn some midnight oil. After the case was first submitted to us I agreed with my brothers that by a strict interpretation of 26 U.S.C. § 1341(a) (4) appellant was entitled to prevail and the opinion of the court was so written. Thereafter, and by a unanimous vote, a petition for rehearing was granted and the case was reargued. I then became convinced that our original decision was not correct and that the trial court should be affirmed. Therefore, I must now respectfully dissent.
I believe the trial judge was correct in reasoning that § 1341(a) (4) did not create a new deduction and that thus the O’Meara decision1 applied in the determination of the deduction allowable. The majority fails to present any reason for divorcing the determination of the deduction from its initiating basis.
The cornerstone of appellant’s argument and the position apparently accepted by the majority is that “the statute utilizes interchangeably the phrase ‘item included in gross income in prior year’ with the term ‘deduction.’ ” It is my contention that these two phrases are not used interchangeably and that a more reasonable interpretation of the statute is that the “deduction” to be allowed may in appropriate situations differ significantly from the item included in gross income. At no time does the majority define “deduction” as it is used in § 1341. It is, however, asserted that “deduction” has a well defined meaning. This can only refer to the meaning developed in pre-1341 eases dealing with the problem of refund of prior “claim of right” income. Indeed the majority recognizes that “the current year deduction is recognized in (a) (4), as it existed before in a non-statutory form.” However, the majority’s further statement that prior to the enactment of § 1341 “a taxpayer in appellant’s position was permitted to deduct the amount of the item restored in the year it was so returned” without any reference to the O’Meara decision is misleading to say the least and is undoubtedly the crucial error in the majority’s reasoning. O’Meara is bypassed by my distinguished brothers with the statement that “The point with which we are here concerned is not developed in the opinion as the court does not indicate *135how the deduction for depletion should be applied. In any event the subsequent enactment of Section 1341 without stating any conditions or adjustments makes the cited case of doubtful authority.”
To me it is much more reasonable to say that the existence of O’Meara in the case law pre-dating the enactment of § 1341 means that it must be considered as a part of the definition of “deduction” that arises from the case law. Certainly an examination of O’Meara shows that the court considered the problem of the effect of taking a prior depletion deduction on claim of right income which was later returned. The O’Meara case concerned a suit for refund of taxes which had been previously paid by O’Meara on royalties received from certain oil properties which had been acquired by O’Meara by warranty deed. During the years when such income was included O’Meara had taken the allowable depletion allowance on such royalties. Subsequently as a result of litigation O’Meara was held to have had unlawful possession of the mineral properties and was required to pay over all royalties received from such property. On his later return O’Meara deducted the amount so repaid and this deduction was disallowed by the Commissioner. The Tax Court reversed the Commissioner’s rule and allowed the deduction,2 limiting it and reducing it by the amount that O’Meara had previously taken as a depletion allowance.
Concerning the problem of reduction of the allowable deduction the court in O’Meara stated:
“[T]he amount of loss for which petitioner is entitled to the deduction must be limited by the amount of the royalty income reported for tax purposes after deducting for depletion. It makes little difference whether the depletion deduction be viewed as a diminution of income, thereby resulting in effect in a reporting by petitioner of only the net amount of 72V2% of the royalties received rather than 100%, or whether we recognize that the depletion deduction is permitted to one in the position of the owner of the oil in place or of a depletable interest therein, and that when it developed that petitioner was not the owner the deduction became erroneous, and petitioner is required to include the deducted amount as income in the year when that situation appears; see Douglas v. Commissioner [of Internal Revenue], 322 U.S. 275, [64 S.Ct. 988, 88 L.Ed. 1271]; or whether the adjustment is viewed as required by the statutory definition of basis. Section 113(b) (1) (B), I.R.C. See Virginian Hotel Corp. v. Helvering, 319 U.S. 523 [63 S.Ct. 1260, 87 L.Ed. 1561]. In any event, the net amount of the loss for which petitioner is entitled to take a deduction is the total of the royalties reported less the amount deducted for depletion.” O’Meara, supra, at 634-635.
Appellant asserts that only the second of the above mentioned grounds for the reduction is valid; since in the instant case there was no question but that Skelly was at all times the legal owner of the land the O’Meara case is distinguishable and not applicable to the instant case. Apparently the court in O’Meara, however, felt that any of the above three mentioned grounds would be sufficient to uphold the government’s argument that the deduction should be reduced by the amount of the deplétion deduction previously taken.
I suggest that O’Meara stands for the basic principle that a basis established for gain or loss by the inclusion of income under a claim of right, which income has been the basis for a percentage depletion deduction, must be limited by that *136amount of the directly related deduction,3 and that the reasoning and applicability of the O’Meara decision is just as valid today as it was before the enactment of § 1341. I agree entirely with Judge Daugherty when he states “Any other procedure would do violence to the spirit of the legislation and the intent of the Congress to afford equitable relief to a taxpayer who thought he had a right to keep certain of his income and paid taxes thereon but it later turns out that he had no such right and was required to restore or repay the same. Congress intended that a taxpayer should get at least equal tax benefit but cannot have intended that a taxpayer should get a deduction allowable for income on which he had not previously paid a tax because of some benefit accruing to the specific income such as a depletion allowance.” In fact any other position would appear to be totally unreasonable. The resulting effect would be that two measures intended to relieve and benefit the taxpayers can combine to result in a windfall to the taxpayer greatly exceeding the benefit which might result from the separate application of these measures. That such an overall result was intended seems unlikely.
It was argued by appellant that the statement of the court in O’Meara that “the process of establishing a basis for an income item consists * * * of reporting it in the taxpayer’s gross income * * * ” Id. 8 T.C. at 633, required that no further consideration be given to any depletion deduction taken from said income in the computation of the deduction allowable in the year of the repayment. The Tax Court in making this statement, however, was not considering the problem of the amount of deduction allowable but merely that the government did not have to receive any tax benefit from the inclusion of the income in the return in the prior year. The mere reporting of the item as gross income established a basis. The court, however, did not go on to say that the entire item included in gross income would establish the amount of the basis. This was not considered until the later portion of the opinion quoted above, where the court found that the deduction allowable was not equatable with the total amount included in gross income but was limited by the depletion deduction previously taken. No inconsistency results from saying that the inclusion of an item in gross income establishes a basis for later deductions notwithstanding lack of tax benefit to the government but not allowing a taxpayer to include the entire amount included in gross income as a basis for deduction.
*137Consideration of the percentage depletion deduction in determining the deduction allowable under § 1341 does not violate the annual accounting concept as established by Burnet v. Sanford & Brooks Co., 282 U.S. 359, 51 S.Ct. 150, 75 L.Ed. 383, as the consideration of the prior years’ returns is only for the purpose of determining the amount of the allowable deduction in the present year’s return. There is no reopening or refiguring of prior years’ taxes, merely a computation of the present year’s taxes. That consideration of the prior years’ returns may be made is clearly established by cases such as Arrowsmith v. Commissioner of Internal Revenue, 344 U.S. 6, 73 S.Ct. 71, 97 L.Ed. 6; Douglas v. Commissioner of Internal Revenue, 322 U.S. 275, 64 S.Ct. 988, 88 L.Ed. 1271; and Dobson v. Commissioner of Internal Revenue, 320 U.S. 489, 64 S.Ct. 239, 88 L.Ed. 248. Cases cited by appellant such as Healy v. Commissioner of Internal Revenue, 345 U.S. 278, 73 S.Ct. 671, 97 L.Ed. 1007, concern the taxpayer’s proposition that the tax for the prior years be recomputed and that refunds be made from the taxes paid in the prior years. This situation is clearly not the one before us in the instant case. Here, as mentioned above, we are merely determining the amount of the allowable “deduction” in the present taxpaying year. The majority cites the case of Hugoton Production Co. v. United States, 349 F.2d 418, 172 Ct.Cl. 444, as authority for the proposition that consideration may not be given of the prior taxpayer years. The Hugoton case, however, is not direct authority for this proposition. That case involved the determination of the price received by similarly situated producers for púrposes of establishing wellhead prices for depletion allowances. In the computation of such prices, the court stated that it could not consider refunds made by such other producers under situations similar to that of the instant case and gave as its reasons for not considering such refunds the annual accounting concept. The court went on to note, however, that such refunds would be reflected in any respect as they were considered in the subsequent years when the repayments were made. It should suffice for the Hugoton case to say that the question considered by the court there was not the question which we are considering in the instant case. One could go on to question, however, whether the application of the annual accounting concept to the situation found in the Hugoton case required the result reached by that eourt. In any respect it is reasonable to say that consideration of prior depletion deductions allowed in computing a “deduction” allowable under § 1341(a) (4) for a current tax year is not a violation of the annual accounting concept.
In summary, the deduction for refunded claim of right income as originally established by case law and continued by § 1341 was to provide relief for a taxpayer from the application of the strict claim of right doctrine. It is unreasonable to transfer such relief into a windfall for the taxpayer unless such a result is clearly and unavoidably required. A double deduction should not be given unless there is virtually no alternative. Here I believe the more reasonable decision to be to limit appellant’s allowable deduction by the amount of percentage depletion deduction previously claimed.

. Maurice P. O’Meara, 8 T.C. 622 (1947).

. It is interesting to note that in 1341(a) (1) the term “an item included in gross income” is used as a requirement for the application of the statute. This same requirement was established in O’Meara, supra, to be the sole requirement for the establishment of a basis for later gains or losses. As discussed later there is, however, a significant difference between establishing a basis and allowing the full amount as a deduction.