T.C. Memo. 2015-81
UNITED STATES TAX COURT
DAVID H. METHVIN, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 28477-13. Filed April 27, 2015.
David H. Methvin, pro se.
Miles B. Fuller, for respondent.
MEMORANDUM OPINION
KERRIGAN, Judge: Respondent determined a deficiency of $690 with
respect to petitioner’s Federal income tax for tax year 2011.
-2-
[*2] Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect for the year in issue, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
The sole issue for consideration is whether petitioner is liable for self-
employment tax on net income from his oil and gas interests.
Background
This case was fully stipulated under Rule 122. The stipulated facts are
incorporated in our findings by this reference. Petitioner resided in Colorado
when he filed the petition.
For most of his professional life petitioner was the chief executive officer of
a computer company. He does not have any special knowledge or expertise in the
area of oil and gas drilling or extraction.
In the early 1970s petitioner acquired working interests in several oil and
gas ventures. These interests were no more than about 2% to 3% in any single
venture. These working interests were not part of a business organization (such as
a partnership, a limited partnership, a limited liability company, or a corporation)
that is registered under the laws of any State. Rather, petitioner’s working
interests were governed by a purchase and operation agreement entered into by
petitioner and Stewart Varn d.b.a. Varn Petroleum Co. of Wichita, Kansas (Varn),
-3-
[*3] with Varn serving as the operator of the interests. Varn transferred its interest
in the operating agreement to Egan Resources, Inc. (Egan). Egan was the operator
of the interests during 2011.
Under the agreement Egan managed the operations of the ventures and
allocated to petitioner income and expenses from his working interests. Petitioner
had no right of involvement in the management or operation of the ventures. In
article 14 of the agreement the parties elected “to be excluded from the application
of sub-chapter K” of the Code. Each year Egan provided petitioner with a yearend
accounting indicating both the revenues and expenses allocated to petitioner’s
working interests.
During 2011 petitioner’s working interests under the agreements generated
$10,797 in revenues. Egan, as the operator, incurred expenses totaling $4,037 that
were allocable to petitioner’s working interests. For 2011 Egan identified the
revenues as nonemployee compensation and issued petitioner a Form 1099-MISC,
Miscellaneous Income, relating to his working interests. Petitioner did not receive
a Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., from Egan,
and Egan did not file a Form 1065, U.S. Return of Partnership Income, relating to
any of petitioner’s working interests.
-4-
[*4] Petitioner timely filed his 2011 tax return. He reported $6,760 of net
income ($10,797 in revenues less $4,037 in expenses) from his working interests
as “other income” on line 21 of his Form 1040, U.S. Individual Income Tax
Return. Petitioner did not pay any self-employment tax on his net income from the
oil and gas venture.
Respondent determined that petitioner’s income from his working interests
was subject to self-employment tax. Respondent issued a notice of deficiency on
September 3, 2013.
Discussion
I. Sections 1401(a) and 7701(a)
Section 1401(a) imposes a tax on the self-employment income of every
individual. “Net earnings from self-employment” is generally defined as the gross
income derived by an individual from any trade or business carried on by the
individual, less allowed deductions attributable to such trade or business, plus his
distributable share of income or loss from any trade or business carried on by the
partnership of which he is a member. Sec. 1402(a).
A partnership is broadly defined in the Code as “a syndicate, group, pool,
joint venture, or other unincorporated organization, through or by means of which
any business, financial operation, or venture is carried on, and which is not, within
-5-
[*5] the meaning of this title, a trust or estate or a corporation; and the term
‘partner’ includes a member in such a syndicate, group, pool, joint venture, or
organization.” Sec. 7701(a)(2); see sec 1.1402(a)-2(f), Income Tax Regs. Thus,
for Federal tax purposes, the term “partnership” is not limited to the common law
meaning of partnership but is broader in scope and includes groups not commonly
called partnerships. Sec. 301.7701-1(a)(1) and (2), Proced. & Admin. Regs.
The parties do not dispute that the arrangement between petitioner and Varn
was exempt from the application of subchapter K because of the election in article
14 of the agreement.
Generally, the Commissioner’s determinations in a notice of deficiency are
presumed correct, and a taxpayer bears the burden of proving those determinations
are erroneous. Rules 122(b), 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115
(1933). Petitioner has not claimed or shown that he meets the requirements of
section 7491(a) to shift the burden of proof to respondent on any relevant factual
issues.
II. The Parties’ Arguments
Respondent determined that petitioner’s net profits from his oil and gas
working interests are subject to self-employment tax as income from a trade or
business carried on by a partnership or a joint venture taxable as a partnership or
-6-
[*6] through an agent. Petitioner contends that he was not engaged in a trade or
business and was not a partner in a partnership. He argues that his minority
working interests were merely investments and that his activity in connection with
them does not rise to the level of a trade or business.
In support of his contention petitioner emphasizes his lack of active
involvement in the operation of the wells, his lack of knowledge and expertise in
the oil industry, and the fact that his working interests were small, minority
interests in each well. The record supports petitioner’s contention that his
personal involvement in the day-to-day operation of the wells was minimal.
However, a taxpayer who is not personally active in the management or operation
of a trade or business may be liable for self-employment tax if the trade or
business is carried out on his behalf through his agents or employees or constitutes
his distributive share of income from a partnership in which he was a member.
Sec. 1402(a); Cokes v. Commissioner, 91 T.C. 222 (1988); Perry v.
Commissioner, T.C. Memo. 1994-215; Moorhead v. Commissioner, T.C. Memo.
1993-314; secs. 1.1402(a)-2(b), 1.1402(c)-1, Income Tax Regs.
Cokes presented a very similar factual and legal situation. Petitioner
attempts to distinguish his case from Cokes on two grounds. First, he argues that
the taxpayer in Cokes owned a 42.29% working interest, while petitioner’s
-7-
[*7] interests were only between 2% and 3%. Second, he argues that the operating
agreement in Cokes allowed the interest holders to have more rights and
involvement in the venture, such as the right to vote, than does his operating
agreement. Here, as in the Cokes case, “[t]he question before us is whether
petitioner was a member of a partnership or of a joint venture treated as a
partnership, and petitioner’s lack of control does not affect that question.” Cokes
v. Commissioner, 91 T.C. at 233; Perry v. Commissioner T.C. Memo. 1994-215.
Therefore, this case is not distinguishable from Cokes on the ground that
petitioner owned only a small minority interest or that the operating agreement
provided fewer rights to the interest holders.
Petitioner also argues that in article 14 of the operating agreement the
parties specifically elected to be excluded from the application of subchapter K
and therefore cannot be considered a partnership. We have held that making this
election “‘does not operate to change the nature of the entity. A partnership
remains a partnership; the exclusion simply prevents the application of subchapter
K. The partnership remains intact and other sections of the Code are applicable as
if no exclusion existed.’” Cokes v. Commissioner, 91 T.C. at 230-231 (quoting
Bryant v. Commissioner, 46 T.C. 848, 864 (1966), aff’d, 399 F.2d 800 (5th Cir.
-8-
[*8] 1968)). Accordingly, the parties’ election under section 761(a) does not
prevent us from finding that the operating agreements created a partnership.
Finally, petitioner points out that respondent has examined this same issue
for previous tax years and one subsequent tax year. Petitioner states that for
previous years respondent has conceded the issue administratively and therefore
should be precluded from prevailing in this case because of these prior
concessions. It is well established that the Commissioner’s administrative
concession of an issue for one tax year does not preclude his pursuing the same
issue for a different tax year. See Burlington N. R.R. Co. v. Commissioner, 82
T.C. 143, 146 (1984).
We conclude that the working interest owners and well operator created a
pool or joint venture for operation of the wells. Accordingly, petitioner’s income
from the working interests was income from a partnership of which he was a
member under the broad definition of “partnership” found in section 7701(a)(2).
See Cokes v. Commissioner, 91 T.C. at 232; Bentex Oil Corp. v. Commissioner,
20 T.C. 565 (1953). Therefore, petitioner is liable for self-employment tax on the
net income received from his working interests.
-9-
[*9] Any contentions we have not addressed are irrelevant, moot, or meritless.
To reflect the foregoing,
Decision will be entered
for respondent.