1941 BTA LEXIS 1200">*1200 In addition to petitioner's farming activities, which are conceded to constitute a business carried on by him, he managed his own personal investments and collected proceeds from oil royalties produced from lands in which he had a life estate and invested and reinvested such royalty proceeds for his own use and benefit. The Kansas courts had decreed, in two cases in 1916 and one in 1919, that the royalty proceeds belonged to the remaindermen and that petitioner, as life tenant, was entitled to use thereof and to the gains and profits therefrom, and they appointed petitioner trustee in the two cases and his wife trustee in the other, to receive the royalty proceeds. Petitioner invested and reinvested the royalty proceeds and retained the gains and profits therefrom as his income. Held, under the facts, petitioner's activities other than his farming operations did not constitute a trade or business carried on by him during the taxable years, and 75 percent of the necessary office expenses should be allocated to business and deducted from gross income in each of the years and the remainder is not deductible as a necessary business expense.
44 B.T.A. 1279">*1279 This proceeding involves income tax deficiencies for the years 1936 and 1937 in the respective amounts of $934.96 and $868.32. The question involved is the right to the deduction of certain office expenses claimed by petitioner in his returns for each of the years and disallowed by the Commissioner. The case was heard on oral testimony and exhibits, from which we make the following findings of fact.
FINDINGS OF FACT.
Petitioner resides in Peoria, Illinois. He filed his separate income tax returns for 1936 and 1937 with the collector at Springfield, Illinois.
During the taxable years he owned and operated by tenants several farms in Illinois, Kansas, and Nebraska. His Illinois farms were operated on a share crop basis and, in addition to his share of the crops, he received cash rentals for the use of the buildings. He had agents to look after the renting of his Kansas and Nebraska farms.
As early as 1899 he inherited two farms in Logan County, Illinois, aggregating 220 acres, a 134-acre farm in Marion County, Kansas, a 150-acre farm in Butler County, Kansas, and 5 farms1941 BTA LEXIS 1200">*1202 in Nuckolls County, Nebraska, aggregating about 1,000 acres. In 1906 he acquired by gift a life estate in several farms in the western part of 44 B.T.A. 1279">*1280 Butler County, Kansas, comprising about 9,025 acres. His children owned the fee, subject to his life estate. In 1909 he bought 360 acres in Marion County, Kansas, and in 1910 a 200-acre farm in Tazewell County, Illinois. In 1935 he bought a 210-acre farm in Peoria County, Illinois, and in 1936 a 394-acre farm in Stark County, Illinois, and a 343-acre farm in Tazewell County, Illinois. In 1937 he bought a 240-acre farm in Logan County, Illinois, and computed the purchase of 1,440 acres in Bureau County, Illinois. The Illinois farms were all high grade farm lands. He paid about $350,000 for the lands so purchased. He was familiar with farming and acquired the lands as an investment and to operate for a profit. During the taxable years his farming operations were carried on through about 47 tenants. The Kansas farms were operated where oil operations did not interfere with farming operations. He personally directed the operation of the several Illinois farms as to the manner of cultivation, soil conservation, and crop rotation, 1941 BTA LEXIS 1200">*1203 and purchased limestone when needed. He selected his own tenants, looked after the division of the crops, sold his portion, and collected the cash rentals on the farm buildings. He visited the Illinois farms frequently - practically every day during the harvest season. He superintended the repair work and erection of new farm buildings and fences. He conferred with laborers, material men, and others, and hired the necessary labor and purchased the material in connection with the upkeep, repair, and improvements on the farms. He paid the taxes and looked after the insurance on the farm buildings.
He began the practice of law in Peoria, Illinois, in 1905. In 1915 the Butler County, Kansas, lands, in which he had a life estate, had prospects for oil. He then gave up the practice of law and spent much of his time in Kansas watching developments and studying oil trends. In 1914 he leased a portion of the lands to the Wichita Natural Gas Co. for development on a royalty basis. Oil was produced in paying quantities. In 1916 he leased a portion of the lands to the Prairie Oil & Gas Co. on a royalty basis, for which he received a bonus of $200,000. In 1916 two actions were brought1941 BTA LEXIS 1200">*1204 in the Kansas courts for confirmation of the leases and to establish the rights as between petitioner as life tenant and the remaindermen to the royalty produced and sold from the leased premises. About 1919 prospects for oil appeared good on another part of the Butler County, Kansas, lands which he prospected and developed personally under a lease he made to himself. In 1919 an action was brought to confirm the lease and establish the rights to the royalty. The decrees rendered in each case provided that the royalty produced therefrom belonged to the remaindermen and that petitioner, as life tenant, was entitled to the use of the proceeds and to gains and profits therefrom 44 B.T.A. 1279">*1281 for and during his natural life. He was appointed trustee in the cases involving the Wichita Natural Gas Co. and the Prairie Oil & Gas Co. leases, with authority to receive and collect the royalties. His wife, Florence P. Scully, was appointed trustee, with like authority, in the case involving lands operated by him individually. He was to have the use of the royalty proceeds and the income from the investments of the royalty produced in all three cases. He spent about a year in Kansas in 1919, 1941 BTA LEXIS 1200">*1205 and during 1920 and 1921 he lived there about half of the time. He collected the royalty proceeds, invested and reinvested the funds, and retained the gains and profits from such investments as his own personal income, pursuant to the court decrees.
From the beginning of oil operations petitioner kept in touch with the developments and operations of the lands for oil, received monthly reports from the pipe line companies, and from time to time employed gaugers to gauge the tanks. He checked reports and statements as to the amount of oil royalty produced and sold and the price therefor. He ceased operations for oil on the lands included in the lease to himself prior to the taxable years.
Petitioner served as trustee of the Proctor Endowment Trust, a charitable organization having investments of about three million dollars. He was likewise a director of the First National Bank of Peoria, and a member of the discount and trust committees. From these connections he acquired investment information and knowledge of financial matters which were beneficial to him in making investments. He took periodicals, financial magazines, and publications relating to agriculture and oil and1941 BTA LEXIS 1200">*1206 gas matters, and publications Chicago banks and other trust committees to familiarize himself as to investments. Limited shiftings of investments from time to time necessitated by maturities and other reasons were made as he deemed advisable from the standpoint of security and returns.
His fortune was built up by his farming operations, his oil operations in prior years, gains and profits derived from his investment of the royalty proceeds, and his own investments.
In the taxable years the assets belonging to the remaindermen consisted of cash and bonds in various public and private corporations in an amount in excess of $1,650,000, and were built up from oil royalties received from the time oil was first produced on the Kansas lands down to and through the taxable years. Proceeds from royalties amounted to $24,077.66 in 1936 and to $19,671.94 in 1937. Petitioner collected the royalties and kept books and records of the moneys received. In 1936 the investments consisted of bonds in about 45 public and private corporations, including Government bonds, aggregating $1,377,450 par value. In 1937 the investments 44 B.T.A. 1279">*1282 consisted of bonds in 41 public and private corporations, 1941 BTA LEXIS 1200">*1207 including Government bonds, aggregating $1,223,950 par value. Interest was received from these securities, amounting to approximately $60,000 in 1936 and $50,000 in 1937. Five securities were sold or called for payment in 1936 and a like number in 1937. It does not appear that any new securities were purchased in either year.
Petitioner's records show that in the year 1936 he personally owned bonds in 34 public and private corporations, including Government bonds, having a par value of $813,400, and stocks in about 30 corporations from which he received dividends in excess of $12,500. He sold or had called for payment six securities and made four purchases. In 1937 he personally owned bonds in about 30 public and private corporations, including Government bonds, of a par value of over $700,000, and stock in about 30 corporations from which he received dividends in excess of $14,500. Eight different securities were sold or called for payment and eight purchases were made and one exchange was effected. He received from all sources interest in the following approximate amounts: In 1936, $32,000 taxable interest and $65,000 nontaxable interest; in 1937, $29,000 taxable interest1941 BTA LEXIS 1200">*1208 and $53,000 nontaxable interest.
Approximately 75 percent of his time was devoted to his farming operations, the balance to the management of his own personal affairs and investments. The items taken as deductions in the returns and disallowed by the Commissioner, are as follows:
| 1936 | 1937 | |
| Salary bookkeeper and stenographer | $1,625.00 | $1,560.00 |
| Office rent | 720.00 | 720.00 |
| Telephone and telegraph | 148.25 | 190.22 |
| Postage and stamped envelopes | 41.82 | 19.68 |
| Office supplies | 25.46 | |
| Association dues | 58.91 | |
| Business service | 58.00 | |
| Miscellaneous office expenses | 212.58 | 324.98 |
| Traveling expenses | 92.85 | 345.34 |
| Legal expenses | 75.00 | 403.03 |
| Total | 3,057.87 | 3,563.25 |
Petitioner agrees that $396.25 of the legal expense item for 1937 was improperly deducted. The remaining items are in controversy.
Similar deductions were made and allowed for prior years, with some variations in amounts. The items claimed as deductions were paid by petitioner in the taxable years and were reasonable in amount.
Petitioner maintains an office of two rooms in the Alliance Life Building in Peoria, Illinois, with the necessary office equipment, consisting of desks, book1941 BTA LEXIS 1200">*1209 cases, fireproof safes and letter files, in which he keeps the records and files pertaining to his activities. He used the office at all times during the taxable years before us for the purposes 44 B.T.A. 1279">*1283 hereinabove mentioned and as a place to meet his tenants and business callers. He employed a secretary-bookkeeper, who kept all records and books and attended to office affairs. She had been with him in that capacity for several years. He had telephone, telegraph, postage, and other incidental expenses in connection with his activities. He had to travel to various places to supervise his farms and in connection with his investment activities.
At the hearing respondent conceded that $728 of $1,700 reported as dividend income from "The Chicago corporation" was a return of capital and should be eliminated from 1939 income, and that a timely refund claim was filed by petitioner for the tax due by reason of his overstatement of dividend income for 1936.
Petitioner's farming activities constituted a trade or business in which he was engaged during the taxable years. His activities in connection with his own investments, collection of royalties, and investment and reinvestment1941 BTA LEXIS 1200">*1210 of the proceeds therefrom did not constitute a trade or business carried on by him during the taxable years.
OPINION.
ARNOLD: Petitioner claims as deductions from gross income in the respective years under section 23(a) of the Revenue Act of 1936, set forth in the margin, 1 the items listed in our findings of fact.
Respondent now concedes that petitioner's farming activities constituted the carrying on of a trade or business during the taxable years and that the proportionate part of petitioner's expenses which is attributable thereto, not exceeding 60 percent, is deductible. He contends that the remaining 40 percent is not attributable to ordinary and necessary expenses paid1941 BTA LEXIS 1200">*1211 during the taxable year in carrying on a trade or business, and that the problem presented is primarily one of allocation, the formula for which has been approved by the Supreme Court in .
He contends that , sets at rest the many confusing and conflicting conclusions reached by the Board and the courts in prior decisions as to what constitutes the carrying on of a trade or business. The questions we have for determination are (1) whether any part of the expenses not allocable to petitioner's farming activities is attributable to a trade or business carried on by petitioner during the taxable years, and, if no part is so allocable, then (2) the portion of his expenses that is attributable to his farming operations. 44 B.T.A. 1279">*1284 The Higgins case holds, in line with numerous Board and court cases, that what constitutes carrying on a trade or business depends upon the facts and circumstances in each particular case. While it does not lay down a controlling principle of law applying to cases generally nor define business, it does determine that collecting interest and dividends1941 BTA LEXIS 1200">*1212 on securities, keeping accounts, and making limited shifts of securities from time to time in the interest of safety and returns, do not constitute the carrying on of a trade or business, regardless of the amounts involved.
There the taxpayer, in addition to his real estate activities in New York, which were held to constitute a business, owned approximately $16,000,000 of nontaxable securities and $10,000,000 taxable securities. He resided in Paris, France, and his activities were transacted through employees in a New York office maintained by him, and an office in Paris where duplicates of some of his records were kept. He was in almost daily communication with his New York office and personally directed the most important matters both as to his real estate and investment activities. His purchases of securities were small as compared with his total investments. The Commissioner disallowed the deductions claimed on the ground they were not necessary expenses paid in carrying on a trade or business, as the Commissioner did here. On review the 1941 BTA LEXIS 1200">*1213 , likewise determined and the , affirmed, and the Supreme Court approved.
We think petitioner's activities outside his farming operations did not constitute a trade or business carried on by him, under the authority of ;, and . He received the royalties, but the gains and profits derived from investments thereof belong to him as life tenant. The remaindermen had no interest in such earnings and profits. This was true as to the accumulated royalties in the form of securities in which petitioner had invested them. All such earnings and profits inured to the benefit of petitioner. Petitioner had ceased operating the lands included in the lease to him for oil prior to the taxable years and nothing thereafter remained to be done by him except to receive, as a matter of routine, the royalty proceeds from time to time as the royalty was produced and sold. They were his to invest and he invested them for his own use and benefit.
1941 BTA LEXIS 1200">*1214 Petitioner kept records of all investments and the interest and dividends received, keeping in separate lists the securities belonging to the remaindermen and himself. The securities of the remaindermen were in bonds, while his own consisted of both bonds and stock. 44 B.T.A. 1279">*1285 But five securities belonging to the remaindermen were sold or called for payment in 1936 and the same number in 1937, and it does not appear that any purchases were made out of funds belonging to the remaindermen in either year. Of his own securities but six were sold or called for payment in 1936 and four purchases were made, and in 1937, eight securities were sold or called for payment and eight purchases were made, and one exchange was effected. These shiftings of securities constituted a very small percentage of his entire holdings, and were not made for profit, but to conserve investments and get interest and dividends therefrom. In 1936 he received approximately $32,000 taxable interest and $65,000 nontaxable interest, and in 1937 his taxable interest was approximately $29,000 and his nontaxable interest $53,000. His investment activities were largely in long term securities, with a view to1941 BTA LEXIS 1200">*1215 security and interest and dividend earnings.
Petitioner contends that, as he managed the trusts and conserved the estate for the remaindermen, he was engaged in trade or business. He received the royalty proceeds from time to time as paid, it is true, and kept a separate account of the investments belonging to the remaindermen, but as life tenant, entitled to their use and benefit and all the gains and profits therefrom, such management activities were in his own behalf and did not constitute carrying on a trade or business under the applicable revenue act. An impairment of the remaindermen's assets would correspondingly reduce his own income, as all the gains and profits therefrom were his personal income and he was interested in conserving it and making it yield as high returns as possible. In the cases above cited the taxpayers likewise managed and conserved the property involved and it was held that in so doing they were not engaged in carrying on a trade or business.
The association dues in the amount of $58.91 and business service in the amount of $58 are not shown to be necessary expense in connection with his business of farm management. These items should be eliminated1941 BTA LEXIS 1200">*1216 from 1936 and 1937 deductions. They do not appear itemized as such in his 1937 return but, as we understand the evidence, expenditures were made for these purposes in 1937 and are reflected in the increased amount of miscellaneous office expenses in that year over that of 1936. Eliminating the sum of these two items, $116.91 for both years, and the $396.25 legal expense for 1937, which, petitioner concedes was improperly deducted, leaves total expenses for 1936 of $2,940.96 and for 1937 of $3,050.09 which should be allocated between business and personal expenses of the respective years.
We have found as a fact, based on the evidence in the record and the facts and circumstances deducible therefrom, that approximately 44 B.T.A. 1279">*1286 75 percent of petitioner's time and activity was devoted to his farming operations and that percentage of the above amounts should be allocated to business expense, and the remainder should be disallowed as a deduction in each of the years. In redetermining the deficiency for 1936 effect should be given to the stipulation of the parties eliminating $728 from dividend income of that year.
Decision will be entered under Rule 50.
Footnotes
1. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) EXPENSES. - All the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including a reasonable allowance for salaries or other compensation for personal services actually rendered; traveling expenses (including the entire amount expended for meals and lodging) while way from home in the pursuit of a trade or business; * * * ↩