1940 BTA LEXIS 1153">*1153 1. In 1932 each petitioner owned an undivided one-fourth interest in a Texas ranch as his or her separate property. They conveyed the ranch to trustees for a period of ten years. The trust was named "jas. F. Welder Heirs." The trustees were to hold the lands together in their entirety; they were to conduct a ranch and farm business thereon with full powers to collect all moneys, pay all bills, and remit to each petitioner annually one-fourth of such profits as in the discretion of the trustees were not needed in the business; they were given authority to lease the lands for oil and gas purposes, which they did; and upon the termination of the trust, the trustees were to "re-convey to said respective beneficiaries, or to the person or persons entitled thereto, their respective shares in said properties." Held, Jas. F. Welder Heirs was properly classified as a partnership by the Commissioner under section 1001(a)(3), Revenue Act 1936; held, further, Jas F. Welder Heirs was not a partnership under Texas laws because three of those entering into the trust agreement were married women who had not had their disabilities of coverture removed as required by Texas statutes: held,1940 BTA LEXIS 1153">*1154 further, petitioners' distributive shares of the net income of Jas. F. Welder Heirs, in so far as it was received from oil royalties and bonuses, was separate income rather than community income. Commissioner v. Wilson, 76 Fed.(2d) 766, followed.
2. Where, in computing the net income of Jas. F. Welder Heirs for 1934, depletion deductions of 27 1/2 percent were properly allowed on cash bonuses paid Jas. F. Welder Heirs for granting two certain oil and gas leases, held, the Commissioner is sustained in his action in restoring to income in 1936 the depletion which was allowed in 1934 as to one of the leases, where the lease was abandoned by the lessee in 1936 and there had been no production therefrom; held, further, the Commissioner erred in restoring to income depletion deduction which was taken as to another of the leases in 1934, where the lessee abandoned the lease in 1936 but the evidence showed there had been actual production therefrom, though small in amount.
41 B.T.A. 686">*687 1940 BTA LEXIS 1153">*1155 The respondent determined deficiencies in income tax against petitioners for the calendar year 1936 in the amounts of $10,925.58, $10,941.62, $10,800.77, and $12,429.36, respectively. The errors assigned in each petition are the same except as noted in (b) below and are as follows:
(a) - The Respondent erroneously determined the amount of net income received by Jas. F. Welder Heirs, a partnership, in 1936, and, consequently, Petitioner's distributive share thereof as a partner, in that:
(1) - Respondent included in the taxable income of the partnership for 1936 amounts equivalent to depletion allowed in 1934, with respect to cash bonuses received in that year for oil and gas leases made by the said partnership upon its lands.
(2) - The allowances made to said partnership for depreciation were inadequate.
(b) - Respondent erroneously failed to hold and determine that Petitioner's distributive share of the profits of Jas. F. Welder Heirs was the community property and income of Petitioner and husband (wife in Docket No. 95005), and that she (he in Docket No. 95005) was taxable upon one-half (1/2) thereof.
The assignment of error (a)(2), relating to alleged inadequate depreciation1940 BTA LEXIS 1153">*1156 allowances, was waived. Instead of the deficiencies, each petitioner claims an overpayment. On motion, the proceedings were consolidated.
FINDINGS OF FACT.
Petitioners are the children of the late James F. Welder, Sr., of Victoria, Texas, and his surviving widow, Kate B. Welder. James F. Welder, Sr., died May 26, 1931. Each petitioner has always resided in Texas, each was married prior to the date of his father's death, and each has resided with his or her spouse in Texas since that time.
Petitioners Dolores Crabb, Madeline Welder Smith, and Elizabeth Wood prior to the close of the taxable year 1936 had not had their disabilities of coverture removed, provision for which is made in article 4626 of Vernon's Annotated Texas Statutes, vol. 13. 1
1940 BTA LEXIS 1153">*1157 Each petitioner filed separate tax returns upon a community property basis for the year 1936, reporting what each was advised was 41 B.T.A. 686">*688 his or her separate income, and one-half of what each was advised was community income.
Petitioners paid to the collector of internal revenue for the first collection district of Texas at Austin in due course in 1937 the following amounts as income tax for 1936:
| Dolores Crabb | $36,636.88 |
| Madeline Welder Smith | 36,720.53 |
| Elizabeth Wood | 31,876.60 |
| James F. Welder, Jr. | 33,710.51 |
James F. Welder, Sr., bequeathed all of his property to his surviving wife, Kate B. Welder. On October 28, 1931, Kate B. Welder, the mother of petitioners, conveyed by way of gift to her four children, the petitioners herein, "as their separate property and estate and for their sole and separate use and benefit, and unto their heirs and assigns forever," a ranch in Duval County, containing some 28,773 acres of land, hereinafter sometimes referred to as the Duval ranch, with the understanding that the land was to be kept together and that some satisfactory and reasonable arrangement was to be devised to accomplish this.
Thereafter, on February 15, 1932, petitioners, 1940 BTA LEXIS 1153">*1158 joined by their respective spouses (except the wife of James F. Welder, Jr.), and Kate B. Welder, executed an instrument by which this Duval ranch was conveyed in trust for a period of 10 years from February 15, 1932, to Kate B. Welder and James F. Welder, Jr., as trustees, under terms and for purposes fully set out in the instrument, a copy of which instrument was introduced in evidence as a part of respondent's Exhibit B and is incorporated herein by reference.
Among other things, the trust instrument recited that petitioners were "each the owners as their separate property and estate, of an undivided one-fourth" interest in the Duval ranch; that it was their desire and intention that the Duval ranch including the personal property connected therewith, for a term of 10 years from February 15, 1932, "be managed, handled, controlled, and conducted as a ranch and farm business as an entirety, without partition of any kind of said property, nor interruption of said business in any manner * * * all to be done if deemed advisable by the said Mrs. Kate B. Welder and James F. Welder Jr., hereinafter appointed trustees and by their successors as such trustees"; that it was their desire1940 BTA LEXIS 1153">*1159 and intention "that the said Mrs. Kate B. Welder and James F. Welder Jr., and their successors hereinafter appointed, have the sole and absolute management and control of the properties * * * with the fullest power and authority to handle, manage, control and conduct said businesses; and for such purposes the said four owners hereby convey their shares and interests in" the Duval ranch including the personal property in connection therewith "to the said Mrs. Kate B. 41 B.T.A. 686">*689 Welder and James F. Welder, Jr., in trust, and are hereby delivered to them in trust, and upon the terms and conditions hereinafter set forth"; that the trust was not to terminate for the lack of trustees "but shall continue to the end of said 10 year term"; that the "trust upon which said shares and interests in said lands are conveyed is for the purpose of using the same, without charge to said trust estate, by said trustees for the purpose of carrying on and conducting certain farming and ranch businesses as hereinafter more specifically set forth"; that "Said trustees shall conduct a cattle and ranch business for said trust estate on said lands"; and that the trustees "shall have full power and authority1940 BTA LEXIS 1153">*1160 to employ ranch and farm superintendents, foremen, and laborers, both skilled and unskilled, in such numbers, and at such salaries and wages, and to render such services and to do such work, as they, in their sole discretion, may see fit in the conduct of said farming and ranch operations; also such bookkeepers and other assistants as they may deem reasonably necessary to enable them to carry on said businesses. Also to employ such attorneys and other agents as may be reasonably necessary in the proper conduct of any litigation in behalf of said trust estate, or in defense of any litigation against said trust estate."
Paragraph eleventh of the trust instrument was captioned "Financial matters." This paragraph gave the trustees full power and authority to collect all moneys due the trust estate; to sue for and recover and adjust, compound, or compromise any and every claim, debt, and chose in actioin which may at any time accrue to the trust estate; and to pay, settle, and discharge and adjust or compromise any and all debts and liabilities of every kind and nature. Subdivision 3 of paragraph eleventh required the trustees to cause to be kept books of account showing their conduct1940 BTA LEXIS 1153">*1161 and management of the trust estate, and to render to each beneficiary a statement in each January "of the business done by said trust estate during the previous year", and:
Upon the rendering of such statements, said trustees shall make the following settlement; They shall retain out of the moneys of said trust estate on hand, a sum sufficient to pay all unpaid indebtedness and liabilities of said estate, and shall also retain a sum of money, which, together with the estimated collections for the ensuing year, will be sufficient to pay the estimated current expenses of, and for any contemplated improvements upon, said trust estate, to be incurred and made during said ensuing year, and shall have the right to set aside money for a surplus.
The remainder of the moneys on hand shall be divided equally among the beneficial interests in said trust estate, that is to say, one-fourth to James F. Welder, Jr., one-fourth to Mrs. Elizabeth Wood, one-fourth to Mrs. Madeline Smith and one-fourth to Mrs. Dolores Crabb, and shall be paid to said beneficiaries, or in case any of them be dead, then to the person or persons entitled thereto, as finally judicially ascertained.
41 B.T.A. 686">*690 Paragraph1940 BTA LEXIS 1153">*1162 twelfth of the trust instrument was captioned "GENERAL PROVISIONS" and contained 15 subdivisions. Under subdivision 2 it was provided that the trustees could sue and be sued in their own names. Subdivisions 7, 10, 11, 12, and a part of 14 are as follows:
7. Any beneficiary under this trust or any trustee shall have the right to withdraw from the commercial feature of this trust, that is the farming and ranch operations at the end of any calendar year by giving six months notice to the other beneficiaries and trustees. This withdrawal shall in no way affect the original arrangement for the control of the real estate and improvements for the remaining period of the trust, but the beneficiary withdrawing from the trust shall be paid rents for his or her beneficial interest in the land, based on lease rentals for like land in the vicinity, less taxes and permanent improvements.
10. The parties hereto, without the consent or concurrence of any trustee shall have and hereby reserve the right to terminate this trust prior to said ten year period expiration, and reserve the right to change, alter and amend this trust instrument all of same to be done by the unanimous consent of the1940 BTA LEXIS 1153">*1163 beneficiaries hereunder, or by the persons then holding their beneficial interests.
11. Upon the termination of this trust by expiration of the term for which it is created, or by reason of any other cause, said trustees shall re-convey to said respective beneficiaries, or to the person or persons entitled thereto, their respective shares in said properties.
12. The name of this trust estate shall be Jas. F. Welder Heirs.
14. It is provided that by the act of all parties to this instrument, (except successor trustees who need not join until after qualification as such) portions of the real property of this trust may be either sold or exchanged for other real property, and further oil leases may be given and granted on the lands of the trust estate.
But it is further controllingly provided that the trustees herein named, Mrs. Kate B. Welder and James F. Welder Jr., or the said James F. Welder Jr., alone and their successor trustees shall have and are hereby given and granted full power and authority from time to time, to lease, rent and let the lands of this trust estate, or any part thereof, for oil, gas and minerals, for such prices, bonuses, rentals and royalties and1940 BTA LEXIS 1153">*1164 on such terms, time and conditions as to them or him shall seem proper, and shall receive all such bonuses, rentals and royalties, and any such lease or leases so executed, shall not be terminated by the expiration of the ten year term of this trust, or its earlier termination, but such lease or leases shall continue in effect, notwithstanding the termination of this trust, until terminated by the particular terms of such lease. In case of such leases executed by the said Mrs. Kate B. Welder and James F. Welder Jr. or by the said James F. Welder Jr. alone, even if the said Mrs. Kate B. Welder be at that time a trustee hereunder or executed by the successor trustees it shall not be necessary for the beneficiaries hereunder or any party to this instrument to join in any such leases, but they or he as the case may be, are hereby appointed attorneys in fact or attorney in fact of each and every party hereto, to execute such lease or leases * * *.
The trust instrument was signed by Kate B. Welder, Jas. F. Welder, Jr., Elizabeth Wood, J. B. Wood, Madeline Smith, W. A. Smith, Dolores Welder Crabb, and W. J. Crabb.
41 B.T.A. 686">*691 On June 7, 1932, Kate B. Welder and James F. Welder, Jr. 1940 BTA LEXIS 1153">*1165 , executed an instrument wherein it was recited that Kate B. Welder "is the owner of the entirety" of 11,174.13 acres of land in San Patricio County, Texas, hereinafter referred to as the Angelita ranch, and 13,936.6 acres of land in Refugio County, Texas; that it was the desire and intention of the parties thereto that these lands "be and constitute a part of the trust estate known as the 'Jas. F. Welder Heirs', with the exception as to handling cattle as hereinafter stated"; that it was the desire and intention that the lands "be handled, managed, sold and controlled by the trustee of the 'Jas. F. Welder Heirs' trust for a period of ten years from February 15, 1932, for the benefit of the beneficiaries and owners of the 'Jas. F. Welder Heirs' trust"; and that, "Accordingly, I, the said Mrs. Kate B. Welder * * * do grant, bargain, sell and convey, subject to the provisions and limitations hereinafter set out, unto the said James F. Welder, Jr., and to his successor trustee and to his successors and to the said James F. Welder, Jr., individually" the above mentioned lands "To have and to hold the said lands * * *. Subject to the trust imposed herein, I, the said Mrs. Kate B. Welder1940 BTA LEXIS 1153">*1166 do convey the beneficial interests in said property to the said James F. Welder, Jr., Mrs. Elizabeth Wood, Mrs. Madeline Smith and Mrs. Dolores Crabb as their separate property and estate." A copy of this instrument was introduced in evidence as a part of the respondent's exhibit B and is incorporated herein by reference. Paragraph fifth of this instrument provided that James F. Welder, Jr. "shall treat the property herein conveyed to him and rights in the above conveyed property hereby conveyed in trust as an entirety and constituting the trust of the 'Jas. F. Welder Heirs.'" Paragraph sixth of this instrument is as follows:
Sixth. The various parties hereto have created heretofore on the 15th day of February, 1932, a trust known as the "Jas. F. Welder Heirs" trust, whereby certain real and personal property in Duval County, Texas, was conveyed by the said James F. Welder, Jr., Mrs. Elizabeth Wood, Mrs. Madeline Smith and Mrs. Dolores Crabb to Mrs. Kate B. Welder and James F. Welder, Jr., as trustee, and said trust instrument is hereto attached and made a part thereof just as if incorporated herein. And as to said lands conveyed, the said James F. Welder, Jr., as such trustee1940 BTA LEXIS 1153">*1167 of the above described lands shall have and exercise alone with reference to the lands herein conveyed, each and every right, power, discretion and duty as conferred upon him in said original instrument creating the trust of "Jas. F. Welder Heirs", including specifically, without limiting his other powers in any way, said powers to lease said lands for oil, gas and other minerals as given in said trust agreement and as provided in Paragraph Eighth thereof and in Subdivision Fourteen of Paragraph Twelfth thereof.
41 B.T.A. 686">*692 Paragraph eighth of the June 7, 1932, instrument provided that "At the termination of said ten year period or by reason of the termination of this trust or for any other cause, said trustee shall convey to said respective beneficiaries or to the person or persons entitled thereto their respective shares in said properties above conveyed as finally judicially ascertained."
Under paragraph ninth of the June 7, 1932, instrument, it was stated that Kate B. Welder "does not enter into the commercial feature of said trust * * * that is, the operation of the cattle business, etc., but may so enter into same later should she elect." Paragraph ninth also stated that1940 BTA LEXIS 1153">*1168 in all other features Kate B. Welder and James F. Welder, Jr., "shall have and exercise with reference to the lands above conveyed each and every right, power and discretion set forth in said original trust agreement."
In addition to the Duval ranch (28,773 acres), Angelita ranch (11,174.13 acres), and the Refugio County lands above mentioned (13,936.6 acres), Jas. F. Welder Heirs has acquired other lands, so that it now owns approximately 75,000 acres of land on which it runs approximately 6,000 head of cattle.
The husbands of petitioners Dolores Crabb, Madeline Welder Smith, and Elizabeth Wood knew at all times that their wives were interested in Jas. F. Welder Heirs. James F. Welder, Jr., handled the financial end of Jas. F. Welder Heirs and consulted the husbands of his three sisters on certain major problems, but as a rule did not bother them. The husbands aside from such consultations had nothing to do with the operation of the ranches.
For the year 1936, in accordance with the practice followed in prior years, Jas. F. Welder Heirs filed a partnership return on form 1065 in which the respective petitioners were listed as equal partners, but none of the spouses of petitioners1940 BTA LEXIS 1153">*1169 were listed as partners. On this return the business or profession was stated as "Cattle raising and farming" and the nature of the organization was stated as "Partnership." The return showed a net income of $399,183.50, and each petitioner's distributive share as a partner therein as one-fourth of that amount. The net income resulted from reported items of gross income and deductions, as follows:
| GROSS INCOME | |
| Loss from cattle raising and farming | ($13,799.17) |
| Interest received | 1,701.39 |
| Rents received | 19,477.86 |
| Royalties (explained in statement attached) | 420,360.62 |
| Total gross income | $427,740.70 |
| DEDUCTIONS | |
| Rent on business property | $2,164.82 |
| Taxes paid | 11,271.62 |
| Loss on Cattle that died | 9,047.50 |
| Depreciation | 1,073.26 |
| Commission paid agent for securing oil lease | 5,000.00 |
| Total deductions | 28,557.20 |
| Net income | $399,183.50 |
41 B.T.A. 686">*693 The attached statement explaining the item of royalties was as follows:
| Oil and gas royalties and bonus | $241,878.15 |
| Bonus for oil and gas leases | 337,929.59 |
| $579,807.74 | |
| Less depletion 27 1/2% | 159,447.12 |
| NET INCOME | $420,360.62 |
All of the bonus for oil and gas leases in the amount1940 BTA LEXIS 1153">*1170 of $337,929.59 and about 97 or 98 percent of the oil and gas royalties and bonus in the amount of $241,878.15 came from the Duval ranch.
On April 24, 1934, Jas. F. Welder Heirs, reserving a one-eighth royalty interest, leased 150 acres of the Angelita ranch to the Circle W. Oil Corporation for oil and gas purposes, for a cash bonus of $15,000, and an additional consideration of $7,500 to be paid out of one-fourth of seven-eights of the first oil, gas, or other minerals when, as, and if produced and sold or removed. On the same day, April 24, 1934, Jas. F. Welder Heirs, reserving a one-eighth royalty interest, leased 7,024.13 acres of the Angelita ranch to the Humble Oil & Refining Co. for oil and gas purposes, for a cash bonus of $250,000 and an additional consideration of $250,000 to be paid out of one-fourth of seven-eighths of the first oil, gas, or other minerals when, as, and if produced, sold, or removed. The cash bonuses so received were reported in the 1934 partnership return filed by Jas. F. Welder Heirs. In this return they claimed and were allowed a deduction for depletion with respect to these bonuses of 27 1/2 percent thereof, amounting to $4,125 and $68,750, respectively, 1940 BTA LEXIS 1153">*1171 or a total of $72,875.
The Circle W. Oil Corporation drilled a well upon the 150 acres leased to it, which produced some oil but was abandoned shortly after completion due to the unskillful method by which it was completed, letting in salt water and making further operations unprofitable. Jas. F. Welder Heirs in 1934 received $13.81 as its share of the royalty oil from this well and $23.17 to apply upon the oil payment of 41 B.T.A. 686">*694 $7,500. The Humble Oil & Refining Co. drilled a dry hole upon the land leased to it, completing it in 1935.
Both the Circle W. Oil Corporation and the Humble Oil & Refining Co. released and surrendered to Jas. F. Welder Heirs, in 1936, the lands so leased to them in 1934. No oil whatsoever had been produced under the Humble oil lease and only the small amount indicated by the above mentioned royalty and oil payments totaling $36.98 under the Circle W. lease.
Upon audit and examination of the partnership return filed by Jas. F. Welder Heirs for 1936, and the individual returns filed by petitioners, the respondent increased the net income of Jas. F. Welder Heirs by $72,875 to $472,058.50 "to restore to income that portion of leasehold bonuses1940 BTA LEXIS 1153">*1172 withheld for statutory depletion", with respect to the bonuses received in 1934 from the Circle W. Oil Corporation and Humble Oil & Refining Co. In this revenue agent's report the enterprise was classified as a partnership and the respondent's adjustment increased the distributive share of the income of each of the petitioners as partners to $118,014.62, composed of separate net income of $119,241 and a community loss of $1,226.38. He carried out this adjustment in the reports with respect to the individuals and in the deficiency notices. In so doing, he classified $476,964 as the separate income of petitioners and $4,905.50 as a community loss of petitioners, computed as follows:
| Separate | Community | |
| Gross income: | ||
| Loss from cattle raising and farming | ($13,799.17) | |
| Interest received | 1,701.39 | |
| Rents received | 19,477.86 | |
| Royalties (see statement above) | $420,360.62 | |
| Restored depletion | 72,875.00 | |
| Total | 493,235.62 | 7,380.08 |
| Deductions: | ||
| Rent on business property | $2,164.82 | |
| Taxes paid | $11,271.62 | |
| Loss on cattle that died | 9,047.50 | |
| Depreciation | 1,073.26 | |
| Commission for oil lease | 5,000.00 | |
| Total | 16,271.62 | 12,285.58 |
| Net income and (loss) | $476,964.00 | ($4,905.50) |
| One-fourth of net income and (loss) | 119,241.00 | (1,226.38) |
1940 BTA LEXIS 1153">*1173 In a statement attached to each deficiency notice each petitioner was advised as follows:
Your contention that your entire distributive income from Jas. F. Welder Heirs should be considered as community income is denied. This office concludes that since an amount of $119,241.00 of your distributive income represents income from oil royalties and bonuses this portion of the income constitutes your separate income. In this connection you are referred to decision in the case of Commissioner v. Wilson, 76 Fed.(2d) 766, 15 A.F.T.R. (RIA) 1228, decided April 4, 1935.
41 B.T.A. 686">*695 There was actually distributed to each petitioner by Jas. F. Welder Heirs in 1936 the sum of $95,000.
OPINION.
BLACK: We shall first consider assignment of error (b). In approaching this issue a brief review of what the parties have done and are now contending may be helpful. A partnership return for Jas. F. Welder Heirs was filed for 1936 showing a net income of $399,183.50, on which return each petitioner was listed as being entitled to a one-fourth distributive share in its net income. Petitioners in their individual returns reported their so-called distributive share as if the1940 BTA LEXIS 1153">*1174 net income of $399,183.50 was composed of the difference between separate net income of $409,089 and a community loss of $9,905.50. This classification as between separate and community is identically the same as determined by the respondent except that the respondent added $72,875 as restored depletion to the separate income, which is the subject of assignment of error (a)(1), and treated the $5,000 commission paid as a deduction from separate income rather than as a deduction from community income, which treatment of the $5,000 petitioners do not question. Accordingly, each petitioner in reporting his or her so-called distributive share of Jas. F. Welder Heirs reported on the basis of a separate net income of $102,272.25 and a community loss of $2,476.38. The respondent, as indicated in our findings, determined that each petitioner should have reported on the basis of a separate net income of $119,241 and a community loss of $1,226.38. Petitioners now contend that the respondent erred in restoring the $72,875 item to income (which contention we shall consider when we take up assignment of error (a)(1)); that petitioners and respondent all erred in treating any of the1940 BTA LEXIS 1153">*1175 income of Jas. F. Welder Heirs as separate income; that all of the income of Jas. F. Welder Heirs was partnership income and therefore community income; that each petitioner should have reported as his or her taxable income only one-half of one-fourth of $399,183.50, or $49,897.94; and that each petitioner is, therefore, due a refund instead of a deficiency. The respondent contends that his determinations are correct.
Is any of the income from Jas. F. Welder Heirs separate income to these petitioners, or is it all community income? We must look to the laws of the State of Texas for the answer. Poe v. Seaborn,282 U.S. 101">282 U.S. 101; Hopkins v. Bacon,282 U.S. 122">282 U.S. 122. It is petitioners' position that under the Federal taxing act Jas. F. Welder Heirs has been properly classified as a partnership and that also under Texas laws Jas. F. Welder Heirs was a partnership, but if, because the wives had not had their coverture disabilities removed, Jas. F. Welder Heirs, can not be considered a partnership under Texas law, 41 B.T.A. 686">*696 nevertheless all of the income in question must be classed the same as partnership profits and, as such, community income, citing1940 BTA LEXIS 1153">*1176 as authority for the latter proposition 32 Texas Jurisprudence 223, par. 6. As shown in the above quoted statement from the deficiency notices the respondent's position is that the question at issue is controlled by Commissioner v. Wilson, 76 Fed.(2d) 766.
At the outset we think it should be made clear that from the Federal tax standpoint Jas. F. Welder Heirs must be classified as either a partnership, trust, or corporation, as those terms are defined in section 1001(a)(1), (2) and (3) of the Revenue Act of 1936. 2 This classification is controlled by Federal and not state law. Burk-Waggoner Oil Association v. Hopkins,269 U.S. 110">269 U.S. 110; Pierce Oil Corporation,32 B.T.A. 403">32 B.T.A. 403, pp. 429, 430. If classed as a partnership, it would not be taxed as a separate entity, but there would be included in computing the net income of each partner his distributive share, whether distributed or not, of the net income of the partnership. See secs. 181, 182, 183, and 187, Revenue Act of 1936. If classed as a trust, it would be taxed as a separate entity unless all of its income by the terms of the trust instrument was to be distributed currently1940 BTA LEXIS 1153">*1177 by the fiduciary to the beneficiaries, or unless it was a revocable trust or one relating to income for the benefit of the grantors. See secs. 161, 162, 166, and 167, Revenue Act of 1936. If classed as a corporation, all of its net income would be taxed to it as a separate entity, and only the amounts actually distributed to the petitioners, namely, 95,000 to each petitioner, would, after being classed as either community or separate property, be taxed to petitioners as dividends. See secs. 13 and 115, Revenue Act of 1936. From this Federal tax standpoint the record clearly shows that Jas. F. Welder Heirs filed a return for 1936 and prior years as a partnership, and that this classification was accepted by the respondent in arriving at his determinations of the deficiencies, notwithstanding statements made by counsel for the respondent, both at the hearing and in his brief, to the effect that the respondent has not determined that Jas. F. Welder Heirs was a partnership. Moreover, we think respondent was correct in determining that Jas. F. Welder Heirs was a partnership as defined by section 1001(a)(3) of the Revenue Act of 1936. He has so treated it in his determination of the1940 BTA LEXIS 1153">*1178 deficiencies. Petitioners 41 B.T.A. 686">*697 agree to that much of the treatment, and no sufficient reason why we should hold otherwise in these procedings has been pointed out.
If we should hold, as respondent's counsel now contends in his brief, that Jas. F. Welder Heirs should not be treated as a partnership for Federal taxation, then that would mean that it must be classed either as an association taxable as a corporation or as a strict trust under the applicable revenue act. That would in turn mean that each petitioner would be1940 BTA LEXIS 1153">*1179 taxable on only $95,000 which was distributed to him in the taxable year and respondent's whole case would fall. Petitioners, however, make no such contention and freely concede that Jas. F. Welder Heirs should be taxed as a partnership under section 1001, and that each petitioner is taxable on his part of the gains and profits, whether actually distributed or not, but upon the community property basis. As we have already said, the fact that Jas. F. Welder Heirs is properly classed as a partnership for taxation under Federal law does not mean that Jas. F. Welder Heirs was a partnership under the laws of Texas. For reasons which we shall later point out, we think it is clear that Jas. F. Welder Heirs was not a partnership under Texas laws and the property rights of the respective petitioners in the income received from Jas. F. Welder Heirs are not governed by Texas laws relating to partnerships but by its general property laws.
The Revised Statutes of Texas in effect during the taxable year define the separate property of the husband and wife and their community property in the following language:
Article 4613: All property of the husband, both real and personal, owned or claimed1940 BTA LEXIS 1153">*1180 by him before marriage, and that acquired afterwards by gift, devise, or descent, as also the increase of all lands thus acquired, shall be his separate property. * * *
Article 4614: All property of the wife, both real and personal, owned or claimed by her before marriage, and that acquired afterward by gift, devise, or descent, as also the increase of all lands thus acquired, shall be the separate property of the wife. * * *
Article 4619: All property acquired by either the husband or wife during marriage, except that which is the separate property of either, shall be deemed the common property of the husband and wife * * *.
Petitioners and the respondent agree that under the Texas law oil and gas bonuses and royalties as distinguished from rents and revenues received from leases on the separate land of either husband or wife, constitute increase of lands and as such the separate income of the owner of the land rather than community income. Cf. Stephens v. Stephens,292 S.W. 290">292 S.W. 290; E. Michna,24 B.T.A. 715">24 B.T.A. 715, 24 B.T.A. 715">719; 1940 BTA LEXIS 1153">*1181 Chesson v. Commissioner, 57 Fed.(2d) 141; Turbeville v. Commissioner, 84 Fed.(2d) 307; certiorari denied, 299 U.S. 581">299 U.S. 581. But petitioners argue that this doctrine has no application here for the reasons that they conveyed away their separate lands to a partnership; that from then 41 B.T.A. 686">*698 on they owned no specific interest in the lands, but had with respect to them, as well as all other partnership property, only a chose in action; and that when the lands were so conveyed away and invested in the partnership, under 32 Texas Jurisprudence 223, "Such separate property becomes community property and the profits become community property." We think this would probably be true, although respondent argues strongly to the contrary, if Jas. F. Welder Heirs is properly classed as a partnership under Texas laws.
The only agreement that petitioners had regarding their relationship was the trust instrument executed on February 15, 1932. Nowhere in this lengthy instrument was it ever suggested that the parties intended to enter into any partnership relation. It is stated in 32 Texas Jurisprudence 221, par. 5, that "A partnership at common1940 BTA LEXIS 1153">*1182 law is only a contractual status which exists in respect of the several persons who compose the firm and who create it by their contract", and in 32 Texas Jurisprudence 234, par. 13, that "As between the parties themselves there must be a voluntary agreement and an actual intention to become partners. Their actual intention determines as among themselves the question as to whether a partnership or some other relation has been formed by their agreement. What they call their agreement and make it determines their relation unless their actual intent is nevertheless to be partners."
Furthermore, three of the grantors were married women who had never made application for removing their disabilities of coverture, 3 and could not, therefore, under the Texas law, enter into a partnership with their husbands or with anyone else. Wright v. State,71 S.W.(2d) 352. Neither did the instrument of February 15, 1932, indicate in any manner that James F. Welder, Jr., and the respective husbands of his three sisters were to enter into a partnership among themselves, with the three sisters as creditors. The instrument plainly indicates an intention that for a period of 101940 BTA LEXIS 1153">*1183 years the properties conveyed to the trustees "be managed, handled, controlled and conducted as a ranch and farm business as an entirety, without partition of any kind" and upon the termination of "this trust * * * said trustees shall reconvey to said respective beneficiaries, or to the person or persons entitled thereto, their respective shares in said properties." The main idea which the parties had in mind was to hold the lands together as their mother had requested them to do when she deeded them the Duval ranch in October 1931. Provision was made for successor trustees in case either Kate B. Welder or James F. Welder, Jr., or both, became incapacitated, and the trust was not to terminate by reason of the death of any of the parties thereto, but was to continue to the end of the ten-year term. One does not find such provisions in a partnership agreement, it being fundamental in partnership law 41 B.T.A. 686">*699 that the death of a partner dissolves the partnership. We think Jas. F. Welder Heirs was, under the Texas law, a joint venture, group, or pool rather than a partnership.
We think that under these circumstances the question as to whether the1940 BTA LEXIS 1153">*1184 oil and gas bonuses and royalties in question (including whatever restored depletion we hold to be imcome in our discussion of that issue below) constitute community or separate income is controlled by Commissioner v. Wilson, supra.Petitioners attempt to distinguish that case from the instant case on the ground that the beneficiaries of the trust involved in the Wilson case did not create the trust, as was the case here, and that there was no contention made in the Wilson case that the trust there was a partnership. We have already held that in the instant case the petitioners were not partners under Texas law but members of a group or joint venture or pool. In either such event petitioners were the equitable owners of the properties held by the trustees. Cf. Commissioner v. Terry, 69 Fed.(2d) 969; Eva Lavino Griffiths,30 B.T.A. 852">30 B.T.A. 852. The moneys paid as lease bonuses and royalties represented the conversion into cash of a portion of the corpus of their separate estate. The separate estate may undergo mutations, but it still retains its separate character so long as it can be traced and identified. Cf. 1940 BTA LEXIS 1153">*1185 Stanolind Oil & Gas Co. v. Simpson-Fell Oil Co.,85 S.W.(2d) 325; affirmed by the Supreme Court of Texas, 125 S.W.(2d) 263. It was so traced and identified in the instant proceedings. It, therefore, remained the separate estate of these petitioners, and is taxable to them as their separate income. The respondent's determination as to this issue is sustained. Commissioner v. Wilson, supra.
We shall now consider assignment of error (a)(1). As far as this issue concerns the restored depletion of $68,750 in connection with the lease to the Humble Oil & Refining Co. for a cash bonus of $250,000, it is controlled by our decisions in Grace M. Barnett,39 B.T.A. 864">39 B.T.A. 864, and J. T. Sneed, Jr.,40 B.T.A. 1136">40 B.T.A. 1136, and upon the basis of those decisions we hold for the respondent. There was no production whatever from the Humble lease prior to its surrender in 1936.
As far as this issue concerns the restored depletion of $4,125 in connection with the oil and gas lease to the Circle W. Oil Corporation for a cash bonus of $15,000, the undisputed evidence shows that Circle W. Oil Corporation drilled a well upon1940 BTA LEXIS 1153">*1186 the tract in 1934 and that well produced oil sufficient that Jas. F. Welder Heirs received therefrom royalties amounting to $13.81 and payments out of oil to apply on the reserved oil payment amounting to $23.17. It was also definitely established by the evidence that the well so drilled was capable of producing substantial quantities of gas which could not then be utilized profitably in that field but at the present time could be utilized with a substantial profit.
41 B.T.A. 686">*700 Under these circumstances we do not think that article 23(m)-10(c) of Regulations 94, upon which respondent relies, authorizes a restoration to income in 1936 of the $4,125 depletion deducted in 1934 because of the Circle W. Oil Corporation bonus. Percentage depletion is not based on cost and has no relationship to cost. There has been actual depletion, though small in amount, from this 150-acre tract, and this depletion took place under the Circle W. Oil Corporation lease. Under the respondent's own ruling as contained in G.C.M. 14484, C.B. XIV-1, p. 98, the depletion allowed in 1934 with respect to this particular lease should not be restored to income, because there has been actual1940 BTA LEXIS 1153">*1187 production from the lease. As to this part of the Commissioner's determination, petitioners' assignment of error is sustained.
Reviewed by the Board.
Decisions will be entered under Rule 50.
STERNHAGEN and LEECH, dissenting: We are of opinion that the consideration and decision should not proceed upon the postulate that "Jas. F. Welder Heirs" is a partnership within section 1001(a)(3) of the Revenue Act of 1936, even though that postulate was apparently adopted by the parties. To us the facts found indicate more probably that the organization is an association, taxable as a corporation within section 1001(a)(2), the income of which is taxable to it and the distributions from which are taxable to the recipient members as dividends. Pierce Oil Corporation,32 B.T.A. 403">32 B.T.A. 403, at page 429. Since in the present posture of the proceeding that proposition has not been litigated, we do not reach a conclusion upon it.
Footnotes
1. Art. 4626. Application to be feme sole.
Any married woman within this State may, with the consent of and joined by her husband, apply by written petition addressed to the district court of the county in which she may be a bona fide resident for judgment or orders of the said court removing her disabilities of coverture and declaring her feme sole for mercantile and trading purposes. Such petition shall set out the causes which make it to the advantage of said married woman to be so declared feme sole, and shall be filed and docketed as in other cases, and at any time thereafter the district court may, in term time, take up and hear said petition and evidence in regard thereto. If upon a hearing of said petition and evidence relating thereto, it appears to the court that it would be to the advantage of the woman applying, then said court shall enter its decree declaring said married woman feme sole for mercantile or trading purposes, and thereafter she may, in her own name, contract and be contracted with, sue and be sued, and all of her separate property not exempt from execution under the laws of Texas shall thereafter be subject to her debts and liable under execution therefor, and her contracts and obligations shall be binding on her. ↩
2. SEC. 1001. DEFINITIONS.
(a) When used in this Act -
(1) The term "person" means an individual, a trust or estate, a partnership, or a corporation.
(2) The term "corporation" includes associations, joint-stock companies, and insurance companies.
(3) The term "partnership" includes 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 the meaning of this Act, a trust or estate or a corporation; and the term "partner" includes a member in such a syndicate, group, pool, joint venture, or organization. ↩
3. See footnote 1, p. 2. ↩