T.C. Memo. 1997-529
UNITED STATES TAX COURT
BOBBY E. SYPHRETT AND JANICE D. SYPHRETT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 16340-95. Filed November 24, 1997.
David C. Allie and Walter B. Thurmond, for petitioners.
Richard T. Cummings, for respondent.
MEMORANDUM OPINION
LARO, Judge: The parties submitted this case to the Court
without trial. See Rule 122. Petitioners petitioned the Court
to redetermine respondent's determination of a $126,510
deficiency in their 1989 Federal income tax. Following certain
concessions by petitioners, we must decide whether their 1989
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gross income includes certain proceeds that they received in
settlement of a lawsuit. We hold it does. Section references
are to the Internal Revenue Code in effect for 1989. Rule
references are to the Tax Court Rules of Practice and Procedure.
Dollar amounts are rounded to the nearest dollar.
Background
All facts have been stipulated.1 The stipulated facts and
exhibits submitted therewith are incorporated herein by this
reference. When they petitioned the Court, petitioners resided
in The Woodlands, Texas.
From 1982 through 1990, Bobby E. Syphrett was president,
sole shareholder, and sole employee of a Texas corporation named
Intrastate Gas Gathering, Inc. (Intrastate). Intrastate’s
principal business activity was gas transmission.
In approximately 1980, Mr. Syphrett and Intrastate planned
with Jack R. Wiewall to develop five gas-gathering projects (the
projects). The projects contemplated the construction of
pipeline systems and related plant to collect natural gas from
producing properties and transport it to large pipelines for
shipment to major distribution centers. Mr. Wiewall’s role was
1
Petitioners ask the Court to find as facts certain
allegations that were made in pleadings in two State court
actions. We decline to do so. The record does not reveal
whether the opposing parties in those actions admitted or denied
these allegations, and the record does not otherwise allow us to
determine independently the validity of these allegations.
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to manage construction of the pipelines and related plant.
Mr. Syphrett’s role was to secure contracts (the Contracts) with
the owners of gas-producing properties. The legal work related
to the projects was handled by W. Michael Stephens and his law
firm of Baker, Brown, Sharman, Wise & Stephens (Baker, Brown).
All of the projects were to be organized in the same way.
Each project would be organized as a limited partnership and
financed by selling limited partnership interests. After the
limited partnership interests in a project had been sold,
Mr. Syphrett would assign the related Contracts to the limited
partnership. Intrastate would then obtain an interest in the
limited partnership and become a partner.
By 1981, three of the projects had been completed to the
point where limited partnerships were organized and interests
therein sold; the remaining two projects were in the process of
being formed. In or about 1981, Mr. Syphrett learned that Mr.
Wiewall had allegedly been submitting false and inflated
construction invoices for one or more of the projects. When
Mr. Syphrett objected to Mr. Wiewall’s alleged overcharging of
costs, Mr. Stephens allegedly drafted legal documents regarding
the two uncompleted projects so as to exclude Mr. Syphrett and
Intrastate from participation. At that time, Mr. Syphrett had
assigned all but two of the Contracts to a limited partnership or
partnerships.
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In 1982, Mr. Syphrett and Intrastate (collectively, the
plaintiffs), as coplaintiffs, sued Mr. Wiewall in the District
Court of Harris County, Texas, seeking return of the plaintiffs'
interests in various limited partnerships (the Wiewall
litigation). The law firm of Bonham, Carrington & Fox
represented the plaintiffs in the Wiewall litigation. In 1983,
the plaintiffs, as coplaintiffs, sued Mr. Stephens and Baker,
Brown in a separate suit in the same court (the Stephens
litigation), seeking damages of at least $4.15 million and an
award of exemplary or punitive damages. Larry Doherty and his
law firm of Doherty & Williamson, P.C., represented the
plaintiffs in the Stephens litigation.
The plaintiffs entered into a written agreement (the Letter
Agreement) dated January 10, 1989, that "[set] out * * * [their]
understanding" regarding the Wiewall litigation and the Stephens
litigation. The Letter Agreement stated that the plaintiffs
hereby covenant and agree as follows:
1) Syphrett has been determined to be the client
in the * * * [Stephens litigation] and is entitled to
receive the benefits, if any, derived from such case.
Intrastate shall not seek nor receive any benefits from
said case.
2) Intrastate shall receive the benefits, if any,
derived from the * * * [Wiewall litigation]. Syphrett
shall not seek nor receive any benefits from said case.
3) Syphrett, if successful in the * * * [Stephens
litigation], shall pay to Intrastate a fee equal to the
legal cost including Salary and other fees paid by
Intrastate as of the date of this agreement. Syphrett
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shall pay all expenses in the * * * [Stephens
litigation] and Intrastate shall pay the expenses in
the * * * [Wiewall litigation] as of the date written
above.
The Letter Agreement was signed by Mr. Syphrett, in his
individual capacity, and by Mrs. Syphrett in her capacity as
Intrastate's vice president.
The Stephens litigation was settled on February 28, 1989,
for $1.5 million; after subtracting Mr. Doherty’s attorney's fees
and expenses of $413,375, the net recovery was $1,086,625 (the
Net Settlement Proceeds). On the same day, Mr. Doherty’s office
issued a check to the plaintiffs in the amount of the Net
Settlement Proceeds. Mr. Syphrett deposited this check in
petitioners’ personal bank account.
A Full Release and Agreement (Release) entered into on
February 28, 1989, in connection with the settlement of the
Stephens litigation was signed by Mr. Syphrett, both in his
individual capacity and in his capacity as Intrastate's
president. As part of the Release, the plaintiffs assigned to
the liability insurance carrier of Mr. Stephens and Baker, Brown
a 50-percent interest in the claims, causes of action, and
recoveries, up to a maximum of $1.5 million, in the Wiewall
litigation.
Intrastate sent Mr. Syphrett the following three invoices
totaling $497,667:
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Date/
Year 1989 Amount Period
Aug. 3 $197,500 7/81 through 6/83
Sept. 23 200,167 7/83 through 6/87
Nov. 5 100,000 7/87 through 6/89
Mr. Syphrett paid Intrastate the total amount of these invoices
through a series of checks dated August 28, September 1,
September 5, September 7, October 30, and December 27, 1989.
Four of these checks were drawn on Mr. Syphrett's financial
management account at Shearson Lehman Hutton (Shearson). One of
these checks was drawn on petitioners' personal account at First
Interstate Bank of Texas, N.A. (First Bank). The final check was
a bank check purchased by Mr. Syphrett at the First Gibraltar
Bank, FSB (First Gibraltar). A summary of these checks is as
follows:
Date of the Check/
Year 1989 Amount Drawer
Aug. 28 $52,500 Shearson
Sept. 1 45,000 Shearson
Sept. 5 50,000 Shearson
Sept. 7 50,000 Shearson
Oct. 30 200,167 First Bank
Dec. 27 100,000 First Gibraltar
497,667
Intrastate reported its receipt of the $497,667 as gross
income on its tax return for its taxable year ended June 30,
1990. Intrastate deducted on that return legal fees totaling
$419,765 and reported that it had no tax liability. Intrastate's
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tax return for the prior year also reported no tax liability; the
return showed a net loss of $67,570.
Petitioners' 1989 tax return, as originally filed, reported
that they had no taxable income and no tax liability. On a
schedule attached to that return, petitioners listed the
following information in support of $586,325 that they included
as other income, and that they offset by a $383,073 net operating
loss:
Lawsuit settlement:
Gross proceeds.................... $1,500,000
Less legal fees.............. 413,675
1
Less reimbursements.......... 500,000
Net other income............ 586,325
1
Petitioners concede that they incorrectly deducted $2,333
more than they actually paid to Intrastate as "Reimbursements".
Intrastate paid all legal fees as they were incurred, and it
deducted these fees on its tax returns for the years in which the
fees were paid. Intrastate deducted all salary and other
compensation paid to Mr. Syphrett, along with related employment
taxes, on its tax returns for the years in which these amounts
were paid.
The parties to the Wiewall litigation moved to dismiss that
case on December 13, 1990, with prejudice to their rights to
refile any claim, counterclaim, or any part thereof. In
connection with this dismissal, Intrastate recovered all of the
Contracts, and Mr. Syphrett received nothing.
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Petitioners are subject to the alternative minimum tax for
1989.
Discussion
Petitioners argue primarily that the proceeds from the
Stephens litigation were to be shared between Mr. Syphrett and
Intrastate, and that Mr. Syphrett transferred the $497,667 to
Intrastate to effectuate a "global allocation" of the proceeds of
the Stephens litigation and the Wiewall litigation. Petitioners
argue alternatively that Mr. Syphrett paid the $497,667 to
Intrastate to reimburse it for the following amounts that it paid
during and in connection with the Stephens litigation: $112,245
for legal fees to attorneys other than Mr. Doherty, $349,072 for
part of Mr. Syphrett's salary and related payroll taxes, and
$36,350 for miscellaneous expenses. Petitioners conclude with
respect to their alternative argument that they may deduct the
$497,667 amount as: (1) An ordinary and necessary expense in
carrying on Mr. Syphrett's trade or business as an employee of
Intrastate, see sec. 162, or (2) an expense for the production or
collection of income, or the management, conservation, or
maintenance of property held for the production of income, see
sec. 212.
Respondent counters that all of the settlement proceeds
belonged to petitioners, and that they transferred the $497,667
amount to Intrastate in an attempt to shelter this amount from
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taxation by use of large deductions that were available to
Intrastate. Respondent also argues, with respect to petitioners'
alternative argument, that neither section 162 nor section 212
lets petitioners deduct the $497,667 amount.
Turning first to petitioners' primary argument, we agree
with respondent. Our detailed review of the record persuades us
that petitioners' 1989 gross income includes the full amount of
the Net Settlement Proceeds. We look to petitioners' outward
manifestations with respect to these proceeds, and we see that
they received these proceeds on February 28, 1989, without any
restricted use. Petitioners deposited the check into their
personal account, and they used the proceeds for several months
before transferring any money to Intrastate. Petitioners
transferred the money to Intrastate in several installments that
extended over a period of 4 months, rather than through a lump
sum at or near the date of settlement, and the first installment
was carefully crafted to fall within Intrastate's taxable year
beginning July 1, 1989. If part of the settlement proceeds
belonged to Intrastate, as petitioners contend, it was entitled
to its share immediately upon settlement. Yet, petitioners
controlled all the proceeds, even investing at least $197,500 of
the Net Settlement Proceeds in their personal brokerage account,
exposing this amount to the same risks as their personal
investments.
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Our reading of the Letter Agreement further supports our
conclusion, as does petitioners' reporting of the settlement
proceeds on their 1989 tax return. The first paragraph of the
Letter Agreement states clearly that Mr. Syphrett, who is
described as "the client" in the Stephens litigations, would
receive all of the benefits from the Stephens litigation, and
that Intrastate would receive none of the benefits from that
suit. Petitioners' 1989 tax return reports the full amount of
the settlement as gross proceeds. These documents, which
evidence petitioners' intent and understanding at the time of the
events with the events, support the inclusion of the full amount
of the settlement proceeds in their gross income.
We hold for respondent on the first issue. In so holding,
we need not decide petitioners' alternative argument that they
may deduct the amount that Mr. Syphrett transferred to Intrastate
under either section 162 as an employee business expense or
section 212. Even if we were to side with petitioners on this
second issue, which we do not intend to do, petitioners could
only deduct the $497,667 amount only as a miscellaneous itemized
deduction, see secs. 62(a)(2)(A) and 67, and they would receive
no benefit from such a deduction in 1989 because they are subject
to the alternative minimum tax, see sec. 56(b)(1)(A)(i).
Alexander v. Commissioner, T.C. Memo. 1995-51, affd. 72 F.3d 938,
946-947 (1st Cir. 1995).
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We have considered all arguments by petitioners for holdings
contrary to those expressed herein, and, to the extent not
addressed above, find them to be irrelevant or without merit.
To reflect the foregoing,
Decision will be entered
for respondent.