*46 Decision will be entered under Rule 50.
1. Fair market value of petitioner's interest in iron ore lands determined as of March 2, 1919.
2. Held, the respondent did not err in applying the "dilution theory" in section 23 (m), I. R. C., in reducing the petitioner's allowance for depletion.
3. Under the terms of a compromise agreement by which petitioner acquired iron ore lands and cash from the estate of her father, it was provided that petitioner would pay the proportionate share of Federal estate and State inheritance taxes. It was further provided in the agreement that the trustee (under the will of petitioner's father) would advance the money for payment of these taxes and be repaid by withholding certain amounts from the royalties received from the iron ore lands. Held, the sums withheld by the trustee in repayment of the money advanced for payment of petitioner's share of taxes on the inherited property was income to petitioner and taxable to her. Held, further, the taxes so paid by the petitioner are not additional cost of the inherited property so as to be the subject of "exhaustion" or depletion allowance. Held, further, the amounts so paid are not an*47 expense and deductible under section 23 (a) (2).
4. The petitioner created trusts in 1932, 1937, and 1938 for the benefit of her husband. The trust property consisted of a part of the petitioner's interest in certain iron ore lands. The trusts created in 1937 and 1938 were for the life of the husband, with reversion in the wife. The 1932 trust, as provided for by its terms, was revoked in 1938 and the trust income accrued for last quarter of 1937 was paid to the husband in 1938.
Held, the income from the 1937 and 1938 trusts is not taxable to petitioner.
Held, further, the income from the 1932 trust is taxable to the petitioner and since she was on a cash basis, the income accrued by the trust in 1937 but paid the husband in 1938 is taxable to petitioner in 1938.
5. The petitioner believed, and was so advised by competent legal counsel, that she had a vested interest in the trust of personalty under her father's will. A suit for construction of that will resulted in a five to two decision by the Michigan Supreme Court in 1947, holding that the "legal heirs" in the will of petitioner's father would be determined as of the termination of the trust of his personalty. The*48 remoteness of the date of the termination of the trust precludes petitioner from ever succeeding to an interest therein. Petitioner planned to devise the home to Harvard University for the furtherance of oriental art. In order to provide the recipient of the property on her death with funds to carry on the art project, petitioner created trusts in 1939, 1940, and 1941, to which, in each year, she transferred an undivided one-fiftieth of her asserted remainder interest in the trust of her father's personalty. Held, the value of the interest is not deductible under section 23 (o) as a contribution to a trust operated for educational purposes.
6. Held, the payment for legal services, incurred in a suit for construction of a will, is not deductible as a non-trade or business expense under section 23 (a) (2).
*643 The*50 respondent determined deficiencies in the petitioner's income tax liabilities as follows:
| Year | Amount |
| 1938 | $ 11,886.73 |
| 1939 | 16,377.08 |
| 1940 | 27,206.92 |
| 1941 | 35,612.16 |
The issues are:
(1) The fair market value on March 2, 1919, of the petitioner's interest in certain Minnesota iron ore lands.
*644 (2) Whether the respondent erred in reducing the depletion allowance in the taxable years under the provisions of section 23 (m) of the Internal Revenue Code and the Revenue Act of 1938.
(3) Whether certain amounts representing the Federal estate and the State inheritance taxes on petitioner's inherited property, paid for petitioner by the trustee who was repaid out of petitioner's royalties, should be included in petitioner's gross income.
(4) Whether the income from certain trusts created by petitioner should be taxed to her.
(5) Whether, under section 23 (o), the petitioner is entitled to a deduction for gifts to an educational trust of her supposed interest in the residuary trust of property under her father's will.
(6) Whether the petitioner is entitled to a deduction under section 23 (a) (2) for payment for legal services rendered.
The case was submitted on a stipulation*51 of facts, exhibits and oral testimony.
The stipulated facts are so found and in so far as they appear pertinent to the issues are incorporated in the following findings of fact. The other facts are found from the evidence.
FINDINGS OF FACT.
The petitioner is an individual residing in Millbrook, New York, and was born on June 30, 1877. She is the wife of Walter Beck who was born on March 11, 1864. She is the daughter of Wellington R. Burt of Saginaw, Michigan, who died March 2, 1919, leaving a large estate consisting principally of stocks and bonds and valuable iron ore lands on the Mesaba range in the State of Minnesota. The bulk of these iron ore lands had been leased by Burt to two subsidiaries of the United States Steel Corporation. In his last will Burt left most of his estate in trust, a large part of the income of which was to be accumulated for nearly one hundred years (until the death of the survivor of his two grandsons) before final distribution to his heirs to be then determined. His children and grandchildren were left with comparatively small annuities.
Burt's four surviving children, the child of a deceased daughter, and the three children of a deceased son (referred*52 to hereinafter as the heirs 1), joined in a contest of his will which resulted finally in a compromise agreement with the Second National Bank of Saginaw, the executor and trustee under Burt's will. By the terms of this compromise agreement, the heirs surrendered the annuities to the estate *645 and received all of the iron ore lands and $ 720,000 in cash. The petitioner, as one of Burt's surviving children, acquired under the compromise agreement one-sixth of the cash and a one-sixth undivided interest in the iron ore lands.
This compromise*53 dated July 1, 1920, was approved by the Circuit Court, in Chancery, for the County of Saginaw, Michigan, on July 27, 1920, and an order was entered in the Probate Court in accordance with the Circuit Court's judgment admitting to probate as the will of Wellington R. Burt, the will (including the codicils), as modified by the compromise agreement. No appeal was taken and these orders became final.
The settlement and distribution of the Burt estate in Minnesota was closed by the final order of the Probate Court on February 3, 1922, in which there is set forth a detailed description of the property in Minnesota owned by Wellington R. Burt at the time of his death (consisting principally of the iron ore mines referred to above). The concluding paragraphs are as follows:
NOW THEREFORE, by virtue of the power and authority vested in this court by law,
IT IS HEREBY ORDERED, ADJUDGED AND DECREED, and the said court does hereby order, adjudge and decree that all and singular the above described property, including all of decedent's rights, ownership and interest in said mining leases hereinbefore mentioned and described, together with all other estate of said decedent in the State of Minnesota, *54 be, and the same hereby is, assigned to and vested in the above named persons in the following proportions, to wit:
To Jane Burt Hay, George R. Burt, Emma Burt Hutchings, Marion Burt Stone [the petitioner herein] and Margaret Ashley Paddock, each an undivided one-sixth (1/6) thereof, and to Alice Burt McDowell, Mary Bell LeBus and Marion Stone Burt, each, an undivided one-eighteenth (1/18) thereof.
TO HAVE AND TO HOLD THE SAME, together with all the hereditaments and appurtenances thereunto belonging or in anywise appertaining, to the above-named persons, their heirs, and assigns, without prejudice, however, to any lawful conveyance of said property, or any part thereof, or any interest therein or lien thereon, or any assignment of any income, royalty, or profit therefrom by said persons or any of said persons made, more specifically set forth in that certain indenture recorded in the office of the Register of Deeds of St. Louis County, Minnesota, in Book 442 of Mortgages, on pages 34 et seq.
Under the terms of the compromise agreement the Burt heirs were charged with that proportion of the Federal estate tax and State inheritance taxes which the value of the money and the iron ore*55 lands they received under the agreement bore to the total value of the estate. Also under the terms of the compromise agreement and as a means of financing the payment of these taxes, the trustee agreed to advance and loan to the heirs from the general funds of the estate in its possession an amount sufficient to pay the heirs' proportionate share of the taxes due from Burt's estate. This money was to be repaid by the heirs in 26 annual payments to begin 5 years from the date of the final decree *646 approving the compromise agreement. As security for the repayment of this loan and in accordance with the compromise agreement, the trustee under the will held in trust the iron ore lands received under the terms of the compromise agreement. In a separate instrument the heirs also gave the trustee a mortgage on the lands as further security. Under the compromise agreement the trustee also had the full power to manage those lands to protect its security.
The bulk of those iron ore lands had been leased by Burt to two subsidiaries of the United States Steel Corporation. One of the leases was dated January 1, 1900, to the Lake Superior Consolidated Mines. The other lease dated*56 July 19, 1902, to the Oliver Iron Mining Co. was of a seven-sixteenths interest owned by Burt in a smaller and less valuable parcel of land, known as the Morris seven-sixteenths lease. There are no questions which concern specifically the latter parcel of land.
On January 1, 1926, the lease to the Lake Superior Consolidated Iron Mines was extended by agreement with the heirs who owned the lands under the terms of the compromise of July 1, 1920. The new lease extended to January 1, 1980, and provided for a minimum royalty payment of $ 687,500 per year. The lease extension agreement further provided that:
As part of the consideration for the making of this agreement the Lessee has loaned to the Trustee, for the benefit of [the heirs], contemporaneously with the execution and delivery of this instrument, the sum of three hundred thousand dollars ($ 300,000.00), the receipt of which is hereby acknowledged; and it is agreed that at the option of the Trustee, at any time on or before January 1, 1930, said loan may be repaid in whole or in part in cash without interest, but if not so repaid then it shall be repaid without interest in the following manner; the Lessee shall be entitled *57 to and shall have credit for said amount at the rate of one dollar ($ 1.00) of credit upon every forty-five and 83 1/3/100 dollars ($ 45.83 1/3) becoming payable by the Lessee to the Trustee on and after April 20, 1930, under the foregoing provisions of this Article "Second" (whether payable as advance royalty or ground rent or as royalty on ore shipped) until credit is thus taken for said entire sum of three hundred thousand dollars ($ 300,000.00).
It is agreed that this loan is made principally for the purpose of enabling [the heirs] to pay the interest owing by them to the [trustee] amounting to two hundred seventy-one thousand two hundred eighty dollars ($ 271,280.00) as of July 1, 1925, and this writing is authority and direction to the Trustee to apply so much of said three hundred thousand dollars ($ 300,000.00) as may be necessary to pay said indebtedness with interest thereon up to the date of the receipt of said three hundred thousand dollars ($ 300,000.00) the remainder, if any, to be paid over to [the heirs] ratably in proportion to their respective interests hereinbefore set forth.
On February 8, 1926, the heirs wrote a letter to the Second National Bank of Saginaw which*58 reads in part as follows:
As you will recall, under our contract of July 1, 1920, we agreed to pay you $ 1,356,400.00 (the amount of our loan made by you to us for the purpose of paying the Federal Estate and Inheritance Taxes) -- in fifty (50) equal payments beginning July 1, 1925.
*647 Owing to the royalty payments being much less than we had anticipated, we have not met the payments due July 1, 1925, and January 1, 1926, of either principal or interest, but we will be able under the new contract recently made with the Lake Superior Consolidated Iron Mines, a New Jersey corporation, to pay this and all other indebtedness that may be owing to you, by January 1, 1927, and accordingly we request that you will consent to a readjustment of these payments upon the following basis:
We to pay the full amount of the principal of this loan in forty-eight (48) equal payments of $ 28,258.33 each, beginning July 1, 1926, and payable on the first of January and first of July of each year thereafter until the full principal is extinguished; we to pay also in addition, the interest on unpaid balances that may be due on July 1, 1926, and on every succeeding January and July until full amount*59 of principal and interest is satisfied.
If this is satisfactory to you, we authorize you out of the royalties that may be hereafter received, to deduct and pay yourselves the above amounts out of the royalties collected in July and January, beginning July 1, 1926.
Pursuant to the letter of February 8, 1926, the Second National Bank of Saginaw, out of the royalties paid by the lessees, credited to its account in reduction of the loan to the heirs, amounts of $ 56,516.67 annually, in two equal installments, beginning July 1, 1926, through July 1, 1949.
For the years involved in this proceeding, petitioner did not include in her income any part of the royalty payments withheld by the trustee in repayment of the loan. The respondent added $ 9,419.44 (one-sixth of the annual payments of $ 56,516.67) to petitioner's taxable income for each of the years involved herein, and such amounts are included as part of the "Unallowable deductions and additional income (a) Trust income * * * (c) Royalties" in the deficiency notice.
On February 23, 1926, the heirs conveyed their interest in the Minnesota iron ore lands to the Second National Bank of Saginaw, Michigan, in trust for the benefit of themselves*60 and their successors and assigns. This trust was to continue until 21 years after the death of the survivor of the grantors but to terminate on January 1, 1980, in any event. The trust was subject to the original lease on the lands given to the Lake Superior Consolidated Iron Mines by Burt and his wife on January 1, 1900, and the extension of that lease given by the heirs on January 1, 1926; the lease on another part of the iron ore lands given to the Oliver Iron Mining Co. by Burt and his wife on July 19, 1902; the compromise agreement of July 1, 1920, and the mortgage given by the heirs to the trustee under the Burt will to secure repayment of the money advanced by the trustee for estate and inheritance taxes.
The petitioner's husband is an artist and was interested in oriental garden art and landscape architecture. He used his talents in this field to develop the grounds of petitioner's home known as "Innisfree" as a show place of oriental garden art. It was the petitioner's intention to make a testamentary disposition of the property to Harvard *648 University for the furtherance of the interests of oriental garden art. In a purported attempt to provide the recipient*61 of "Innisfree" on her death with funds to continue the art work, the petitioner in each of the years 1939, 1940, and 1941, transferred to Walter Beck (her husband), Wellington R. Burt (her nephew) and Watson Washburn (her attorney), as trustees, an undivided one-fiftieth interest of her asserted remainder interest in the trust of personalty under the will of her father, Wellington R. Burt. Each of these three trusts provided in part as follows:
[If at the time the trust of the personalty of Wellington R. Burt, deceased, is terminated and my share of the property so held in trust is distributed] * * * my residential estate known as "Innisfree", at Millbrook, New York, or any substantial part thereof, is being used by Harvard University, of Cambridge, Massachusetts, or by any other educational or charitable corporation, association or trust organized or existing under the laws of the State of New York, or any other state, or of the United States, for the furtherance of the interests of the fine arts, and in particular, of Oriental garden art and landscape architecture, the Trustee shall forthwith assign, transfer and pay over to Harvard University, or such other corporation, association*62 or trust, the entire trust fund, as a special endowment fund, the income of which shall be used for such purposes on my said estate.
SECOND: In case at such time of distribution my said estate of "Innisfree" at Millbrook, New York is not being used or maintained for such charitable and educational purposes specified in Paragraph First hereof, the Trustees may in their discretion, so long as they believe there is a reasonable chance of such use, invest and reinvest said trust fund and accumulate the income thereof for a period not exceeding 25 years, during any part of which period they may at any time assign, transfer and pay over the entire trust fund, with its accumulated income, to Harvard University or any other of the types of charitable corporations described in Paragraph First hereof, for the purposes and in the manner therein specified, or they may organize a charitable or educational corporation, association or trust to carry out said purposes.
THIRD: In case at such time of distribution my said estate of "Innisfree" is not being used or maintained for such purposes specified in Paragraph First hereof, and whenever the Trustees deem that there is no longer a reasonable chance*63 of effectuating such purposes, and in any event if the Trustees have not exercised the powers granted to them under Paragraphs First and Second hereof within 25 years after such distribution, the Trustees shall then distribute the entire trust fund to such educational or charitable corporation or corporations, associations or trusts organized and existing under the laws of the State of New York, or any other state, or of the United States, whose purposes are charitable purposes within the purport of Section 12 of the Personal Property Law of the State of New York, as they in their judgment deem most suitable, as a special endowment fund, of which the income shall be used for the furtherance of the interests of the fine arts, and in particular, of Oriental garden art and landscape architecture; if the Trustees in their judgment deem such special endowment fund and such use of its income impracticable, they are authorized to assign, transfer and set over the entire trust fund, without any restrictions, to such educational or charitable corporation or corporations, associations or trusts (organized and existing under the laws of the State of New York, or any other state, or of the United*64 States) as may include among *649 their purposes the furtherance of the interests of the fine arts, and in particular, of Oriental garden art and landscape architecture; and if the Trustees are unable to choose any such educational or charitable corporation or corporations, associations or trusts to receive all of the said trust fund, they shall apply to the Supreme Court of the State of New York and employ the trust fund in such manner as the court may direct to carry out as nearly as may be done the charitable and educational purposes hereinabove set forth.
The corpus of the trust of the personalty under the will of petitioner's father had a value on May 31, 1940, of approximately $ 6,900,000; on May 30, 1941, approximately $ 7,100,000, and on May 31, 1942, a value of approximately $ 7,300,000. In each of the years 1939, 1940, and 1941, when she transferred a one-fiftieth of her interest to the trusts, petitioner filed a Federal gift tax return reporting a valuation of the interest transferred in each year of $ 20,000 and paid, under protest, a tax based on that value, contending that the gifts were exempt from tax. The respondent asserted deficiencies based on a higher value. *65 Petitioner appealed this determination of deficiency to this court.
In 1940 the petitioner was advised by competent legal counsel that the "legal heirs," who, under her father's will, would succeed to a proportionate interest in a large trust of his personalty, "are ascertainable as of the date of his death and that they took and now have vested remainder interests."
The petitioner and others claiming to be legal heirs of Wellington R. Burt retained legal counsel to represent their interests and agreed to pay an initial fee of $ 5,000 with additional fees on a contingent basis. The petitioner's share of this fee was $ 1,000 which she paid in 1940.
On February 14, 1941, petitioner and others claiming to be legal heirs of Wellington R. Burt brought suit in the Michigan State Court, for a construction of Burt's will to the effect that the petitioner and the others were the remaindermen designated in the will of Wellington R. Burt as the "legal heirs" to whom the trust of personalty therein established was to be distributed upon its termination.
The trustee and a guardian ad litem for the unborn issue of Wellington R. Burt contested the suit, alleging that the words "legal heirs", *66 as used in the will, meant the legal heirs of the testator determined as of the termination of the trust, and not of the date of the testator's death.
Thereafter, the petitioner and the other alleged legal heirs of Wellington R. Burt applied to the Michigan State Court for approval of a compromise agreement between them and certain parties representing interested minors. The trustee under the will and the guardian ad litem for the unborn issue contested this proceeding also.
*650 After extended litigation, the two cases reached the Supreme Court of Michigan, which decided in a five to two decision on April 8, 1947 ( Hay v. Hay, 317 Mich. 370">317 Mich. 370, 26 N. W. (2d) 908) that the words "legal heirs" meant the legal heirs determined as of the termination of the trust.
Thereafter, on May 16, 1947, the Michigan Supreme Court unanimously disapproved and rejected the compromise agreement proposed by the heirs for present termination of the estate. ( Hay v. LeBus, 317 Mich. 698">317 Mich. 698, 27 N. W. (2d) 309).
Following the 1947 decision of the Michigan Supreme Court, the parties agreed, and so stipulated, *67 in the controversy then pending in this Court concerning gift taxes, that there was no deficiency in the Federal gift taxes based on the gifts to the "Innisfree" trusts of petitioner's purported interest in the trust of her father's personalty. The respondent subsequently refunded the gift taxes paid thereon.
In her income tax returns for the taxable years 1939, 1940, and 1941, the petitioner listed among her other charitable contributions in each year, the sum of $ 20,000 as the present value of the interest transferred in each year to the "Innisfree" trusts. The respondent disallowed the deduction for that part of the maximum of 15 per cent of net income represented by these gifts.
On March 25, 1932, petitioner transferred to herself and Watson Washburn, as trustees, an undivided one-half interest of her share in the iron ore lands in trust to pay over the net income to the petitioner's husband, Walter Beck, during his life, and to convey the principal thereof to the survivor of the petitioner and her husband. The fifth paragraph of the trust is as follows:
The Donor reserves the right at any time during her lifetime after the 31st day of December, 1937, by an instrument in writing*68 executed and acknowledged and delivered to the Trustees, to revoke this trust indenture in whole or in part or to amend it in any respect, including the revesting of the trust property in herself. From the date hereof, the Donor reserves the right to assign additional property to the trust and to extend the period of irrevocability by an instrument in writing. The Trustees agree upon delivery to them of such instrument of revocation or amendment, to carry out all its terms as fully as though they were incorporated in this present deed of trust.
On January 8, 1938, the petitioner duly revoked the trust agreement of March 25, 1932, in accordance with the provisions of the fifth paragraph thereof, and on January 25, 1938, petitioner and Watson Washburn, as trustees under the trust indenture of March 25, 1932, the petitioner as donor thereof, and the petitioner's husband, Walter Beck, the beneficiary thereunder, executed an agreement duly acknowledged, whereby Walter Beck waived his right to receive any part of the income of said trust accruing after December 31, 1937, and consented that such part of said net income be paid to the petitioner. The petitioner and *651 Walter Beck*69 released the trustees from all further claims, and agreed that they had fully accounted for the entire trust estate.
On November 22, 1937, the petitioner transferred to herself and Watson Washburn, as trustees, an undivided one-twentieth interest of her one-sixth interest in all the leased iron ore lands upon trust to pay over the net income to the petitioner's husband, Walter Beck, during his life, and upon his death to convey the principal thereof to the petitioner.
The petitioner, on January 8, 1938, transferred to herself and Watson Washburn, as trustees, an additional undivided four-twentieths interest of her one-sixth interest in all the leased iron ore lands under the terms of a trust identical with that of November 22, 1937.
The respondent, for each of the taxable years 1938 through 1941, included in petitioner's gross income, the income of the trusts created by petitioner on March 25, 1932, November 22, 1937, and January 8, 1938.
The accrued income from the 1932 trust for the last quarter of 1937 was paid to petitioner's husband in 1938 and included by respondent in petitioner's 1938 gross income.
On November 8, 1935, the petitioner transferred to herself and Watson Washburn, *70 as trustees, securities worth $ 56,498.75 in trust, to pay $ 100 a month from the net income of said trust fund to the petitioner's sister-in-law, Matilde Beck, during her life, and to pay over the balance of the net income during her life and the entire income after her death, to petitioner's husband, Walter Beck, during his life, and to pay over the principal to his next of kin or appointees by will, if he survived her, and to the petitioner herself if she survived him.
Matilde Beck died on November 24, 1937.
The net income of the Matilde Beck trust for the years 1936 to 1941, inclusive, after deductions for expenses in each year were as follows:
| 1936 | $ 2,639.28 |
| 1937 | 2,927.45 |
| 1938 | 1,755.49 |
| 1939 | 2,420.73 |
| 1940 | 2,857.28 |
| 1941 | 2,945.43 |
The net income after 1941 (after deducting total expenses aggregating $ 200 a year for the management of the trust) has been approximately $ 3,000 a year. Since the death of Matilde Beck, the entire income of the trust has been paid to Walter Beck. The net income of the Matilde Beck trust received by petitioner's husband, Walter Beck, was not included by the respondent in petitioner's gross income. Substantially all of Walter Beck's income*71 was derived from the trusts created by petitioner. The remaining income was reported as coming from "Interest on bank deposits, notes, mortgages, etc."
*652 On December 10, 1931, petitioner assigned to the Central Hanover Bank & Trust Co., all her right, title and interest of and in the compromise agreement dated July 1, 1920, as supplemented by the supplemental trust agreement dated February 23, 1926, as part security for the repayment of a loan of $ 100,000. Under the terms of this assignment it was agreed with the Central Hanover Bank & Trust Co. that the loan should be repaid out of the royalty payments being received by petitioner at the rate of $ 18,500 every 3 months. This loan was paid off in full during the year 1935, and the Central Hanover Bank & Trust Co. thereafter reassigned its security interest to the petitioner.
In the years 1938, 1939, 1940, and 1941, the petitioner paid the respective amounts of $ 134.36, $ 110.12, $ 121.70, and $ 124.60 to the Central Hanover Bank & Trust Co. for certain safe keeping fees.
In the years 1938, 1939, 1940, and 1941, the petitioner paid the respective amounts of $ 150, $ 151.77, $ 150, and $ 200 in attorneys' fees incident *72 to the preparation of her income tax returns.
Deductions for these safe keeping and attorneys' fees were not claimed in the original returns. Respondent concedes that they are allowable deductions and provision will be made in the computation under Rule 50.
The petitioner filed her income tax returns for the years 1938 through 1941 on a cash receipts and disbursements basis.
The following additional facts relate more specifically to the questions concerning the valuation as of March 2, 1919, of the petitioner's interest in the iron ore lands and the revision of the depletion rate.
Pursuant to the terms of a compromise agreement the petitioner acquired a one-sixth interest in the Minnesota iron ore lands owned by her father, Wellington R. Burt, at his death on March 2, 1919. The lands had been leased by Burt to two mining companies, the Lake Superior Consolidated Iron Mines and the Oliver Iron Mining Co. The latter company took over the Consolidated lease prior to March 2, 1919. The lessee is sometimes referred to hereinafter as Oliver. Both companies are subsidiaries of the United States Steel Corporation. The original Burt lease to Consolidated was to extend for a period of *73 50 years from January 1, 1900, and it provided for a royalty of 25 cents per ton on ore shipped and a minimum annual royalty payment of $ 50,000. As of March 2, 1919, the executors (who did not include petitioner or any of her co-heirs) of Burt's estate valued his fee interest in the lands subject to this lease at $ 5,195,479 based on an estimate of 54,012,682 tons of ore. The respondent finally determined the value at $ 5,497,576.43 on which latter value the Federal estate tax was paid. This value was arrived at by use of the Hoskold formula, with a 6 per cent discount and 4 per cent yield factor, 3 per cent *653 collection expense, 25 cents royalty and 31-year life (the lease of January 1, 1900, expiring January 1, 1950) as follows:
54,012,682 tons x $ .25 x .419724 (31 years) x 97% = $ 5,497,576.43
The above valuation assumed an average yearly production through the 31-year life of 1,742,344.58 tons with a resulting depletion unit of $ .1018 per ton.
On the basis of the valuation of Wellington R. Burt's fee ownership (subject to the lease), as described in the preceding paragraph, petitioner's one-sixth ownership thereof was $ 916,262.74 as of March 2, 1919. For the years*74 1919 to 1937, inclusive, an aggregate amount of $ 590,140.42 has been allowed as depletion to petitioner by respondent.
The tonnage estimate made by the executors of Burt's will and which was accepted by the respondent, was based on the lessee's annual report to the Minnesota Tax Commission. The primary purpose of the lessee's annual estimate of iron ore on the leased lands was to fix the basis for a state ad valorem tax. The reports to the Minnesota Tax Commission were checked by the School of Mines of the University of Minnesota. The estimate of 54,012,682 tons as of March 2, 1919, by the lessee included only ore the existence of which had been proven. It did not include probable or possible ore.
The following table shows the ore mined and the ore reserves estimated by the lessee (as submitted to and accepted by the Minnesota tax authorities):
| Estimate of | ||
| Date | reserves | Tons mined |
| Jan. 1, 1919 | 54,012,682 | 1,229,224 |
| Jan. 1, 1920 | 54,485,442 | 1,656,563 |
| Jan. 1, 1921 | 53,621,093 | 146,067 |
| Jan. 1, 1922 | 53,604,171 | 335,939 |
| Jan. 1, 1923 | 53,393,811 | 356,021 |
| Jan. 1, 1924 | 52,999,154 | 593,222 |
| Jan. 1, 1925 | 52,580,583 | 952,368 |
| Jan. 1, 1926 | 54,304,543 | 1,060,196 |
| Jan. 1, 1927 | 53,207,031 | 594,304 |
| Jan. 1, 1928 | 52,807,712 | 1,865,477 |
| Jan. 1, 1929 | 52,180,778 | 1,906,689 |
| Jan. 1, 1930 | 50,944,198 | 1,919,497 |
| Jan. 1, 1931 | 52,531,010 | 1,808,708 |
| Jan. 1, 1932 | 53,349,690 | 620,119 |
| Jan. 1, 1933 | 56,875,369 | 2,636,520 |
| Jan. 1, 1934 | 54,136,860 | 2,523,327 |
| Jan. 1, 1935 | 51,996,644 | 2,750,715 |
| Jan. 1, 1936 | 49,431,972 | 2,064,459 |
| Jan. 1, 1937 | 52,612,458 | 1,904,272 |
| Total | 26,943,687 |
*75 Prior to 1938 the petitioner knew that the ore reserves were greater than indicated by the prior estimates. The lease under which the mines operated provided that the lessee would furnish the lessors (including petitioner) with monthly statements of ore shipped.
*654 On January 1, 1926, the lessors (including petitioner) and the lessee amended the lease by extending it for 30 years to January 1, 1980. The new lease provided for a minimum annual royalty payment of $ 687,500. The new lease also provided for an advance payment of royalties in the amount of $ 300,000 which was to be repaid by the lessee's withholding approximately $ 15,000 from each year's royalty payment. The value placed on the lessee's interest in the lease on March 1, 1931, by the respondent in settling the income tax liability of the United States Steel Corporation was $ 19,629,199.36.
In making estimates of ore reserves it was the practice of Oliver to include only the merchantable ore. Merchantable ore is ore that can be mined and sold at a profit at the time it is mined.
Ore is an aggregate of one or more minerals that can be exploited at a profit. Under certain economic conditions ore may be ore at*76 one time and waste at another.
The tonnages in the Burt lease as submitted to the Minnesota State Tax Commission were estimated by the lessee, Oliver, in accordance with the best engineering and mining practices available.
Oliver never gave any instructions to its mining engineers to underestimate the amount of ore reserves in any reports they handled.
In addition to being used as a basis for ad valorem taxes the importance to Oliver of having accurate ore estimates made was to have a basis to lay out the work in order to get the different grades of ore as they were needed from time to time in its mining operations.
The quantity of ore in the ground is determined by the volume occupied by the ore. The volume is determined by three dimensional measurements, the data being derived from exploration and the development of the mine by excavation.
Paint rock is ore material that is derived from the black slaty bottom of the lower slaty horizon in the geological column on the Mesaba Range and is seldom shipped as ore unless it contains 55 or 56 per cent of iron. Paint rock ordinarily contains much less iron and as much as 18 to 20 per cent of moisture which gives it a low natural iron*77 content. It also has a high phosphorous content and a high alumina content which is not desirable. Paint rock of less than 53 per cent iron is generally mined in open pit operations and put into stock piles but is seldom sold as merchantable ore. In underground operations paint rock under 53 per cent iron is usually "caved" or "wasted."
Oliver did not include paint rock ore in 1919 in its report to the Minnesota State Tax Commission on the Burt Lease properties for the reason that such ore was considered non-merchantable.
The fair market value as of March 2, 1919, of the iron ore lands subject to the lease was $ 5,497,576.43, of which the petitioner's one-sixth interest was $ 916,262.74.
*655 For each of the taxable years the respondent recomputed petitioner's depletion allowance under the provisions of section 23 (m). The recomputation was based on the estimates of ore reserves as submitted to the Minnesota Tax Commission. The effect of this recomputation was to allocate the remaining undepleted balance of the petitioner's share of the 1919 value over the remaining years of production on the basis of the current estimates of ore reserves. The depletion rate arrived at *78 by the respondent for each of the taxable years was as follows:
| 1938 | .0096048 |
| 1939 | .0086883 |
| 1940 | .0083148 |
| 1941 | .0070086 |
OPINION.
The first question is the determination, for the purpose of computing depletion, of the fair market value of the petitioner's interest in the iron ore lands as of March 2, 1919, when she inherited it.
The petitioner, as owner of a one-sixth interest in the iron ore lands, reported a proportionate share of the royalty payments in her tax returns and took a deduction on her share of a depletion allowance of $.1018 per ton of ore. Beginning with the taxable year 1938 through the taxable year 1941 the respondent disallowed a portion of the deduction for depletion taken by the petitioner. In so doing the respondent applied what is sometimes referred to as the dilution theory provided for in section 23 (m). This action of the respondent was in recognition of the fact that the recoverable units of ore were greater than the initial estimate in 1919. He accordingly revised the prior estimate with the result that the depletion allowance for the taxable years was reduced so as to be more in accord with the number of units of ore estimated to remain. *79 Deficiencies based in part on this disallowance of a portion of the former depletion allowance were asserted. The petitioner contends that the valuation placed on her interest at the time she inherited it in 1919 was in error and that instead of a valuation of $ 916,262.74, the value should be $ 2,092,802.70. The petitioner urges that a depletion allowance based upon the latter figure is more nearly correct, resulting in a higher amount against which the respondent might apply the dilution theory of section 23 (m).
The executors of the estate of petitioner's father adopted as an estimate of the amount of iron ore then in the lands, the report of the ore remaining made by the lessees of the lands to the State of Minnesota. This report was reviewed by the School of Mines of the University of Minnesota and the tonnage therein of 54,012,682 was agreed to by the respondent in settling the estate of petitioner's father. The property was then under a lease which was to expire in 1950 *656 and was to pay a royalty to the lessors of 25 cents per ton, and a minimum royalty payment of $ 50,000 a year. This interest was given a present value of $ 5,195,479 by the executors in the estate*80 tax return. The respondent finally determined the value at $ 5,497,756.43, the increase being based on the use of a more conservative yield factor in the empirical discount formula used in the computation of the present value of the royalty payments.
The determination of the fair market value of a property of the nature of petitioner's interest in the iron ore lands is difficult even if based on contemporary values. The task becomes increasingly difficult as the valuation date recedes in point of time. Here we are asked to fix the fair market value of this interest as of the time 31 years ago.
The respondent relies on the valuation as finally determined in the estate tax return in 1919 based on an estimate of 54,012,682 tons of ore remaining. That estimate, prepared by the lessee and adopted by the lessor in the estate tax return, was carefully prepared on the basis of the best information then available. The lessee used this estimate as a basis for the State tax paid by it on the value of its interest and also in formulating its work program.
The estimate adopted by the estate and respondent appears to have been tantamount to an arm's length transaction. The interests of the*81 estate were best served by as conservative an estimate as possible. On the other hand, it was in the respondent's best interests to see that all the ore then known to exist was included in the estimate. It is important to note that there was no disagreement between the parties as to the estimate of tonnage. The relatively small increase in the value of the lessor's interest made by the respondent was acceded to by the estate. As might be expected from the nature of these large ore interests, there was no evidence as to the contemporaneous selling price of anything comparable.
In attempting to show that the value fixed in the estate tax return was erroneous, the petitioner emphasized the valuation of $ 19,629,199.36 given the lessee's interest in the lease by the respondent as of 1913 in settling the income tax liability of the United States Steel Co. (The lessee was a subsidiary of United States Steel.) This value is not persuasive in the present inquiry. The amount that the lessors (including petitioner) received in royalty payments was fixed by the lease and had no relation to the value of the lease to the lessee.
The other valuation relied on by the petitioner concerns*82 the lease extension agreed to in 1926. Under this lease extension the 25 cents per ton royalty continued until 1950 but the minimum royalty payment was increased from $ 50,000 to $ 687,500 per annum. The petitioner contends that this transaction shows the true value of her interest *657 in the lands as of a time 7 years earlier. It must be pointed out initially that in relying on the terms of the lease extension, petitioner is using facts not known to exist as of the basic date of March 2, 1919, although there was some evidence that in 1919 an extension could have been anticipated. As a general rule in valuation cases, it can be said that facts reasonably capable of being anticipated as of the valuation date may be used in corroborating the original valuation. They cannot, however, be used as a basis for computing a new valuation to supplant the original based on facts then known.
Even if we give to a value, based on the lease extension, the weight urged by the petitioner, she has still not established that the value given her interest in the estate tax proceeding was not reasonably correct. The evidence clearly shows that the estimate of tonnage, (and consequently the *83 present value of an interest therein), as checked by the College of Mines of the University of Minnesota and accepted by the Minnesota Tax Commission, was used in the industry as being the most accurate measurement based on information then known. Acceptance of the accuracy of this estimate by the executors of the estate and the respondent in 1919 supports the view that a fair market value based thereon would be correct.
It is our considered opinion, after weighing the evidence carefully, that the petitioner has not established that the valuation of her interest by the respondent was in error, nor has she proved a more correct valuation. We have found as a fact that the fair market value as of March 2, 1919, of the iron ore lands subject to the lease was $ 5,497,576.43, of which the petitioner's one-sixth interest was $ 916,262.74. On this issue, therefore, the respondent is sustained.
The second issue is whether the respondent erred in reducing the depletion allowance in the taxable years under the provisions of section 23 (m)2 of the Code and the Revenue Act of 1938, supra.
*84 As of March 2, 1919, the petitioner's interest in the iron ore lands had a value of $ 916,262.74. In the period from 1919 to 1937, inclusive, the respondent allowed petitioner depletion of $ 590,140.42. The table set forth in our Findings of Fact shows the ore mined and the ore reserves estimated by the lessee (as submitted to and accepted by the Minnesota tax authorities).
*658 In 1943, the respondent proposed for the first time a reduction in the petitioner's depletion allowance in order to distribute the remaining undepleted balance of the 1919 value over the remaining years of production on the basis of the current estimates of ore reserves. Extensions of time (waivers) had been agreed upon by the parties for the determination of the petitioner's tax liability for the years 1938 through 1941. Accordingly, the taxable years were still open.
The petitioner's argument on this issue is, first, she had not "ascertained" before the taxable years, that there were greater ore reserves than previously estimated; and second, that to reduce the depletion in the taxable years 1938 through 1941 would be a retroactive reduction since the respondent first proposed a revision of depletion*85 allowances in 1943.
The petitioner relies on Petit Anse Co. v. Commissioner, 155 Fed. (2d) 797, certiorari denied, 329 U.S. 732">329 U.S. 732. The facts of that case show that at a hearing in the Tax Court on another issue the evidence was brought out that deposits in the taxpayer's mine were greatly in excess of the amount agreed upon in prior years by the taxpayer and the respondent. After all the evidence was in, the Tax Court granted respondent permission to amend his answer so as to ask for an increased deficiency based on the lower rate of depletion resulting from the increased estimate of salt deposits. The Tax Court sustained the respondent. The Circuit Court, in reversing the Tax Court, said:
We interpret this statute to mean that the revision for depletion when discovered as a result of operations or development work will be only as to the allowance for depletion in subsequent taxable years, and that there would be no retroactive revision of the depletion allowance for the years before the discovery of the existence of recoverable units in excess of the prior estimate.
The statute provides that the prior estimate shall*86 be revised and the allowance "for subsequent taxable years shall be based upon such revised estimate."
* * * *
Counsel for the Commissioner, however, undertake to support the decision on the theory that it was a factual finding. They argue that the taxpayer must have learned before the tax years in question of the later estimate by the engineer of its lessee of the additional amount of economically recoverable units of salt in the mine, and having discovered the existence of salt greatly in excess of the previous estimate before the tax years in question, the revision of the depletion allowance should occur as of the time of the discovery of such excess in the course of operations. There are two answers to this contention, viz: (1) There is no evidence to support a finding that the taxpayer had discovered it before the tax years, or at any time before trial; and (2) the Judge of the Tax Court never undertook to make any such finding.
In our opinion, the petitioner derives no support from the Petit Anse case. In that case the manner in which the question of revision of depletion arose is sufficient in itself to distinguish the two cases. The record in the Petit Anse*87 case shows that the witness, from whom came the evidence of greater reserves, surprised both parties by his testimony *659 based on facts which the witness had uncovered only a month before the hearing. In the present proceeding the whole record clearly supports the view that it was apparent to every one concerned, when the annual estimate of reserves decreased only slightly over the years, despite continual removal of large amounts of ore, that, in the words of the statute, "the recoverable units were greater * * * than the prior estimate thereof."
In the Petit Anse case the subject of depletion allowance was a salt reserve. There was no evidence in that case of a system of an estimate of reserves for purposes of a State tax, which estimate was a matter of public knowledge. The petitioner in these proceedings attempts to minimize the public nature of the estimates of ore accepted by the Minnesota authorities, but the record indicates on the contrary that they were accepted and used in the industry. It is well to note that the petitioner's argument on the first issue was that the 1919 estimate was incorrect because it was ascertainable on that date, on facts then known, *88 that the ore reserves were much greater than previously estimated. Yet on this issue, petitioner, as above stated, contends that it "is in no sense, an 'ascertainment'" of the veracity of the facts on which the argument is based, "much less an effective 'revision' [of depletion] retroactively binding on her."
In other words, petitioner argues on the first issue that on facts known in 1919 the reserves were greater than estimated but on this issue she argues that she had not "ascertained" those same facts in 1938.
The petitioner's argument on this point seems to anticipate the damaging result of a finding that she knew, prior to the tax years, "that the recoverable units [were] greater * * * than the prior estimate thereof" -- section 23 (m). We believe that the record amply supports our finding of fact that the petitioner, on the basis of facts known and reasonably ascertainable in the taxable years, had discovered that the recoverable units of ore were in excess of the prior estimate. Our conclusion in this respect disposes of the petitioner's argument on this point.
The petitioner's other argument on this issue is that, assuming that she had "ascertained" the need for a new depletion*89 rate, nevertheless, the "subsequent taxable years" of section 23 (m), to which the revised depletion shall apply, means the years subsequent to the determination by the respondent that a revision of depletion should be made.
The petitioner seems to imply that before there can be any adjustment of depletion, there must be some sort of formal action, meeting of the minds or agreement of the parties to the effect that it has been "ascertained" that the number of recoverable units are more or less than originally estimated.
*660 The statute contemplates no controversy as to when the "ascertainment" was made. It implies that the taxpayer himself, under our system of self-levy, makes the correct adjustment when he himself ascertains the need for correction in depletion rate. The statute does not imply that the party to whom it would be an immediate tax-wise advantage to suppress the information of a need for adjustment, has any privilege not to come forward and make the necessary correction in the return. Petitioner here tacitly admits that an adjustment in depletion is indicated and it is apparent from the facts that an adjustment has been warranted since the early 1920s when*90 it was clearly apparent that the amount of ore estimated to remain continued fairly constant despite continual mining.
By no possible interpretation of the statute can it be said that it is the duty of the Government to ferret out the fact that a correction in depletion is in order. If the petitioner's view of the statute were to prevail she could wait in vain for the Government to "ascertain" that the recoverable units happened to be less than estimated, which latter happenstance would otherwise dictate a correction to the immediate tax advantage.
The pertinent section of the respondent's regulations have been in effect in substantially the same form since the 1932 Act. The current Regulation is 111, sec. 29.23 (m)-9, which reads, in part, as follows:
If the number of recoverable units of mineral in the property has been previously estimated for the prior year or years, and if there has been no known change in the facts upon which the prior estimate was based, the number of recoverable units of mineral in the property as of the taxable year will be the number remaining from the prior estimate, but in any case in which it is ascertained either by the taxpayer or the Commissioner*91 as the result of operations or development work prior to the close of the taxable year that the remaining recoverable mineral units as of the taxable year are materially greater or less than the number remaining from the prior estimate, then the estimate of the remaining recoverable units shall be revised and the annual depletion allowance with respect to the property for the taxable year and for subsequent taxable years will be based upon the revised estimate unless a change in the facts requires another revision. Such revised estimate will not, however, affect the basis for depletion. [Emphasis added.]
It is apparent that it was not intended that there was to be any right on the part of the taxpayer not to make an indicated correction in depletion simply because to do so would spread his undepleted capital over a longer period of time. The regulation uses the same mandatory language as the Code in section 23 (m), viz: [The erroneous depletion rate] "shall be revised." There is no room for an interpretation that a change in depletion rate may be sought only by the taxpayer and then only if it suits his present tax planning. This point was dealt with in Big Four Oil & Gas Co., 28 B. T. A. 61,*92 *661 affd., 83 Fed. (2d) 891. There we said, in language which is suggestive of the current regulations, that:
Article 230 of Regulations 74 provides:
Determination of quantity of oil in ground. -- In the case of either an owner or lessee it will be required that an estimate, subject to the approval of the Commissioner, shall be made of the probable recoverable oil contained in the territory with respect to which the investment is made as of the basic date. The oil reserves must be estimated for all undeveloped proven land as well as producing land. When information subsequently obtained clearly shows the estimate to have been materially erroneous, it may be revised with the approval of the Commissioner.
From the foregoing the petitioner reaches the conclusion that a revised estimate may be made by the owner or lessee but not by the Commissioner, and that the latter's function is restricted to approving or disapproving the estimate submitted.
We can not concur in that viewpoint. The regulation does not specify who shall make the revised estimate, should one be necessary. It simply provides that an erroneous estimate may be revised with the *93 approval of the Commissioner. If the latter makes the revision himself, fairly and without arbitrary caprice, it may be assumed that he approves his own handiwork. In such case the requirements of the regulation will have been fully met. If the taxpayer submits a revised estimate which the Commissioner does not approve, and then another, and keeps on until approval is finally won, the ultimate result is that the Commissioner has, in effect, made the revision. We find nothing in the regulations to prevent the Commissioner from doing directly that which, as petitioner contends, he might do circuitously.
We said further in that case that:
Petitioner further contends that the changed unit rate of depletion can not be applied to the year 1928, on the ground that it was not until February 7, 1931 (date of the 60-day letter), that the Commissioner determined new estimates of the oil reserves of the leases and changed the unit rate of depletion as of January 1, 1928. Several decisions are cited to the effect that revised estimates and depletion rates may not be applied retroactively.
The evidence discloses that during the year 1928 an error in the original oil estimate was discovered. *94 It does not appear just when the new estimate was made, but certainly there was no acceptance of the original estimate as a basis for allowing depletion deductions for 1928. But although the reestimate may have been computed subsequent to the taxable year, it was a part of the due consideration given to the determination of the proper tax for that year. * * * [There follows a discussion of Sterling Coal Co., Ltd., 8 B. T. A. 549; Staub Coal Co., 16 B. T. A. 584; Stouts Mountain Coal Co., 4 B. T. A. 1292; and Kehota Mining Co. v. Lewellyn, 28 Fed. (2d) 995, affd., 30 Fed. (2d) 817]
* * * In the light of the above decisions it seems clear that the revised estimate in the present proceeding, made upon facts appearing during 1928, may properly be applied in determining the depletion allowance for that year, and we so hold. * * *
We believe that it is apparent from the foregoing that the respondent did not err in reducing the petitioner's depletion allowance in the taxable years, and we so hold.
*662 The third issue is whether*95 the petitioner's share of the Federal estate taxes and the State inheritance taxes paid by the trustee for the heirs (including petitioner), should be included in petitioner's gross income.
The petitioner and her co-heirs contested the will of the petitioner's father. This contest resulted in a compromise agreement dated July 1, 1920, by the terms of which the Minnesota iron ore lands and $ 720,000 in cash were conveyed to petitioner and her co-heirs. The compromise agreement also provided that the trustee under the will of petitioner's father was to pay the Federal estate taxes and the State inheritance taxes due on the share of the estate distributed to petitioner and her co-heirs. The agreement further provided that the trustee was to be repaid this money advanced for taxes by withholding certain sums from the royalty payments, which, as trustee of the ore lands, it was to pay to petitioner and her co-heirs. The trustee paid taxes, Federal and State taxes, for the heirs in the amount of $ 1,356,400.
In 1926 the heirs modified the agreement for the repayment of the money advanced by the trustee for payment of taxes. Under the terms of the 1926 agreement, the trustee credited*96 to its account in reduction of the loan, amounts of $ 56,516.67 annually, beginning July 1, 1926, through July 1, 1949. For the taxable years 1937 through 1941, petitioner did not include in her income any part of the royalty payment withheld by the trustee in repayment of the loan. The respondent added $ 9,419.44 (one-sixth of the annual payments of $ 56,516.67) to petitioner's taxable income for each of the years involved herein.
It is clear that the heirs were to pay the Federal and State taxes on the share of the estate received by them. The manner of payment of these taxes is a thing apart from the nature of the obligation itself. The obligation arose out of the settlement agreement and was one of the conditions attached to the distribution of the property to the heirs. The manner of financing this payment of taxes can have no bearing on the nature of the obligation. It was so arranged that the trustee under the will would also hold in trust and manage the iron ore lands distributed to petitioner and her co-heirs, but this trust relation does not obscure the fact that the heirs were indebted to the trustees.
The petitioner argues that there was no debtor-creditor relationship*97 and that there was no personal obligation on the part of petitioner and her co-heirs to pay anything. This view is without merit and is directly opposed to the patent purpose and method in the advance and repayment thereof involved here. The argument cannot be seriously urged that this arrangement consisted of anything more or less than: an obligation to pay certain taxes which obligation was but one of the terms of a compromise; a loan of funds to pay those taxes, *663 and repayment of the loan out of royalties due the petitioner and her co-heirs from property mortgaged to the lender as security for repayment. The cases cited by the petitioner are not persuasive of any other view.
It follows that the amounts representing the petitioner's share of the royalty payments withheld by the lender-trustee in repayment of the loan were income to the petitioner, and we so hold.
This is not an end of this question, however, for the petitioner contends, in the alternative, that her proportionate share of the Federal estate taxes constituted additional cost of iron ore lands which cost should be "returned to her by way of exhaustion allowances."
If the petitioner intends the term "exhaustion*98 allowances" to be interpreted as subject to depletion her contention is without basis because depletion in this case is not based on what she had to pay out to get her inheritance. The basis for depletion is the basis used for determining the gain upon the sale of the property, section 114 (b) (1). But the basis for determining the gain upon sale is, in the case of inherited property, the fair market value when it was acquired, section 113 (a) (5). It is not the petitioner's out-of-pocket costs added to the fair market value which total amount is subject to a depletion allowance; it is the fair market value of the property.
The heirs paid the taxes on the property they inherited. The difference between that amount and the fair market value of their property was the extent to which they benefited by the inheritance but this, by the clear meaning of the statute, has no relation to the basis for depletion.
The petitioner cites Irene C. Moffett, 14 T. C. 445 (on appeal CA-2, August 9, 1950) in support of her contention. In that case the taxpayer was required to pay the estate tax deficiency to prevent transferee assessment and the filing*99 of a lien against annuity contracts which were included in her husband's estate. It was held that the payment was made for the protection of the taxpayer's rights as annuitant and constituted a capital expenditure recoverable by amortization.
The petitioner contends that the Moffett case supports her view "by analogy." If by this it is proposed that the amount paid in taxes should be amortized, then this contention, too, must fail. The Moffett case lends no support to petitioner's argument since that decision is based on such a different factual situation that the reasoning cannot be considered to apply here. There was here no payment "made for the protection and preservation" of petitioner's rights which, as such "constitutes a capital expenditure." Petitioner agreed to be charged with and later paid the taxes here because it was so provided by the terms of the compromise agreement. There is no way this payment of taxes can be considered analogous to an expenditure to protect and preserve.
*664 A further reason why petitioner's view should not prevail suggests itself. If estate taxes, paid proportionately by agreement between the recipients of legacies, *100 were considered to be subject to "exhaustion allowances" then as to every such case the estate tax provisions of the law would come to naught for the original payments of those taxes would be recovered by the taxpayer by deductions over the years and the net gain in revenue to the government from the estate tax would be nil.
Accordingly, we hold that the petitioner may not deduct as an "exhaustion allowance," any part of the Federal estate taxes paid on her share of the property.
Further, in the alternative, petitioner claims that the amounts withheld from her royalties by the trustee in payment to it for the money advanced for the payment of estate taxes "should be allowed to her as a deduction in each of the taxable years herein, under section 23 (a) (2) of the Internal Revenue Code, as an ordinary and necessary expense paid or incurred for the production or collection of income from said ore lands."
The contention is without merit for the reason given above, viz, the petitioner would in this manner recoup the estate taxes previously paid with no gain resulting to the government therefrom. This clearly is not within the purview of the law and there were no cases cited nor reasoning*101 offered to support the view. Such a deduction for Federal estate taxes has never been allowed. A deduction cannot be sustained here by calling the amounts repaid on a loan made for the purpose of financing payment of estate taxes an ordinary and necessary expense.
The fourth issue is whether the income from certain trusts created by the petitioner should be taxed to her.
The following explanation was made in the deficiency notice for the inclusion in each of the taxable years of additional income:
The income from the trusts created by you on March 25, 1932, November 22, 1937 and January 8, 1938, for the benefit of your husband Walter Beck, is held to be taxable to you under the provisions of the Revenue Act of 1938 and the Internal Revenue Code.
On March 25, 1932, petitioner conveyed to herself and Watson Washburn (her attorney), as trustees, an undivided one-half interest in her share in all the leased iron ore lands. This trust provided that the net income was to be paid to petitioner's husband, Walter Beck, for his life and that the trust principal would be conveyed to the survivor of the petitioner and her husband. The petitioner reserved the right at any time during her*102 lifetime after December 31, 1937, to revoke the trust indenture. Pursuant to this power, the trust was revoked on January 8, 1938, by an agreement between the parties, *665 which agreement further provided that the husband waived his right to any part of the trust income accruing after December 31, 1937.
The only question as to the 1932 trust is whether the income accruing to the husband for the last quarter of 1937 but paid him in 1938, should be included in petitioner's 1938 gross income. In order to answer this question it will be necessary to consider the 1932 trust along with the trusts of 1937 and 1938 for if the decision as to the 1932 trust is that the income therefrom is taxable to petitioner, then the 1937 income from that trust paid in 1938 is taxable to petitioner in the latter year inasmuch as petitioner is on a cash basis and could not have constructively received it in the prior year.
On November 22, 1937, the petitioner transferred to herself and Watson Washburn, as trustees, an undivided one-twentieth interest of her one-sixth interest in all the leased iron ore lands upon trust to pay over the net income to the petitioner's husband, Walter Beck, during his*103 life and upon his death to convey the principal thereof to the petitioner.
On January 8, 1938 (the date she revoked the 1932 trust), petitioner created another trust with terms the same as those of the 1937 trust except that it was for an undivided four-twentieths interest. Thus under the terms of the two trusts the husband received five-twentieths of the income from the petitioner's one-sixth share in the iron ore lands. Substantially, the only income received by the petitioner's husband, Walter Beck, in the taxable years was derived from the trusts.
The problem presented by the trusts is a familiar one. It has been expressed in various ways but in substance it requires a decision whether, in reality, the income from the trust created by the taxpayer-grantor should properly be considered income to the grantor or to the trust beneficiary. It is generally accepted that, although the precise situation is not governed by statute, the problem is within the purview of section 22 (a), which provides for the inclusion of income of "whatever kind and in whatever form paid."
The respondent relies chiefly on the following cases: Lucas v. Earl, 281 U.S. 111">281 U.S. 111;*104 Burnet v. Leininger, 285 U.S. 136">285 U.S. 136; Helvering v. Clifford, 309 U.S. 331">309 U.S. 331; Helvering v. Horst, 311 U.S. 112">311 U.S. 112; Harrison v. Schaffner, 312 U.S. 579">312 U.S. 579; and Commissioner v. Tower, 327 U.S. 280">327 U.S. 280.
In our opinion, respondent extends the force of his cited cases to a degree which encroaches upon the authority of Blair v. Commissioner, 300 U.S. 5">300 U.S. 5. In that case the beneficiary of a trust assigned for the period of his life, a part of the trust income. It was held that the income so assigned was not taxable to the assignor. In the solution of this problem the courts have generally based the result on either the nature of the property transferred (i. e., assignment of future earnings held taxable to assignor in Helvering v. Horst) or the period *666 for which the property was transferred. In Harrison v. Schaffner, the life beneficiary of a trust assigned specified amounts of income for one year at a time. The income was held taxable to the donor, the Court saying "We think*105 that the gift by a beneficiary of a trust of some part of the income derived from the trust property for the period of a day, a month, or a year involves no such substantial disposition of the trust property * * *," impliedly, as in the Blair case. The Court prescribed no rule but left it for "* * * future judicial decisions to determine precisely where the line shall be drawn between gifts of income-producing property and gifts of income from property of which the donor remains the owner, for all substantial and practical purposes." In most of the cited cases the question concerns the assignment by the life beneficiary of the trust of the income therefrom for a definite period. In Harrison v. Schaffner, an assignment of one year was insufficient. In Hawaiian Trust Co., Ltd. v. Kanne, 172 Fed. (2d) 74, assignments by a trust beneficiary of trust income for a period of approximately 10 years were held to exclude the income from taxability to the donor. A similar assignment for 10 years was also held to be a sufficient period of time in Farkas v. Commissioner, 170 Fed. (2d) 201.
In the present case*106 the transfers by the wife to the husband in two of the trusts of a part of the wife's interest in the iron ore lands were for the life of the donee, the husband. In our opinion, this is sufficient to exclude the income from 1937 and 1938 trusts from taxability to the donor under the principles of Blair v. Commissioner, supra, and Harrison v. Schaffner, supra, and we so hold. The 1932 trust is somewhat different, however. This trust was revocable after 1937 and was revoked by petitioner in 1938. In our opinion, the length of time for which petitioner parted with control of the property transferred by the 1932 trust is insufficient to cause the income to be taxable to the transferee in trust on the authority of the cases cited above. The income of the 1932 trust being taxable to petitioner, the accrued income of that trust for the last quarter of 1937, but paid petitioner's husband in 1938, is taxable to petitioner, who was on a cash basis in the latter year.
The fifth issue is whether the petitioner is entitled to a deduction for gifts to an educational trust of her supposed interest in the residuary trust of*107 personal property under her father's will. The pertinent section of the Code is section 23 (o) as set forth in the margin. 3
*108 *667 The petitioner's husband is an artist and was interested in oriental garden art and landscape architecture. He used his talents in this field to develop the grounds of petitioner's home known as "Innisfree" as a showplace of oriental garden art. It was the petitioner's intention to make a testamentary disposition of the property to Harvard University for the furtherance of interests of this type of art.
In each of the years 1939, 1940, and 1941, the petitioner transferred to Walter Beck (her husband), Wellington R. Burt (her nephew), and Watson Washburn (her attorney), as trustees, an undivided one-fiftieth interest in what she believed to be her remainder interest in the trust of personalty under her father's will. The purpose of these trusts was to provide the recipient of the home on the death of petitioner with funds to continue this project in landscape architecture.
In 1940 the petitioner was advised by competent legal counsel that the "legal heirs" who, under her father's will, would succeed to a proportionate interest in a large trust of his personalty, "are ascertainable as of the date of his death and that they took and now have vested remainder interests." *109 A suit for construction of the will was brought, resulting finally in a decision in the Michigan Supreme Court which held, by a vote of five to two, that the words "legal heirs" in the will of petitioner's father meant the legal heirs determined as of the termination of the trust of his personalty. This decision made it practically impossible for petitioner ever to realize anything from her father's trust of personalty since the petitioner's life expectancy is much less than the probable term of her father's trust. In any event, the petitioner concedes that after the Michigan decision her interest in the trust had no value and that she transferred nothing to these trusts. That, however, does not solve the problem because we must determine what the value was, if any, in the petitioner's asserted interest in the trust under her father's will as that value was measured at the time the petitioners' trusts were created and prior to the Michigan decision.
The corpus of the trust of the personalty under the will of petitioner's father had a value on May 31, 1940, of approximately $ 6,900,000; on May 30, 1941, approximately $ 7,100,000, and on May 31, 1942, a value of approximately *110 $ 7,300,000. The petitioner's interest in this trust would have been one-sixth had she been held to have a vested interest. In each of the years 1939, 1940, and 1941, when she transferred one-fiftieth of her then asserted interest to the charitable *668 trust, she filed a gift tax return reporting a valuation of the interest transferred in each year of $ 20,000 and paid, under protest, a tax based on that value, contending that the gifts were exempt from tax. The respondent asserted deficiencies based on a higher value. The controversy over the gift taxes was pending in this court when the Michigan decision was rendered. Following the Michigan decision it was stipulated that there were no deficiencies in gift taxes for the years 1939, 1940, and 1941 and respondent refunded the gift taxes paid on these gifts.
In her income tax returns for the taxable years 1939, 1940, and 1941, the petitioner listed among her other charitable contributions in each year, the sum of $ 20,000 as the present value of the interest transferred in each year to the trust for the maintenance of "Innisfree." The respondent has disallowed the deductions for that part of the maximum of 15 per cent of *111 net income represented by these gifts.
The petitioner contends that this amount should be no less than $ 10,000 and that this amount represents the fair market value of these gifts in each of the years 1939, 1940, and 1941. We cannot agree.
True it is petitioner thought she had given away something of value. The subsequent court decision held contra. Its effect is retroactive in logic and in consequence. As a matter of fact, she gave away nothing of value. Were we to be mistaken in this aspect, there is another reason for sustaining the respondent, i. e., there is no basis in the record by which to fix a value even though a speculative value be indicated. We sustain the respondent.
The sixth issue is whether the petitioner is entitled to a deduction for an alleged payment of $ 1,500 made in 1940 for legal services rendered. The pertinent section of the Code is 23 (a) (2), as set forth in the margin. 4 Section 121 (d) of the Revenue Act of 1942 made the amended section 23 (a) (2) of the Code applicable to taxable years beginning after December 31, 1938.
*112 The first question under this issue is the matter of proof of payment.
The petitioner agreed to pay a one-fifth share of a legal fee of $ 5,000. This was the fee charged petitioner and others who sought a construction of the Burt will in Michigan. This suit terminated in a decision of the Michigan Supreme Court to the effect that petitioner was not a "legal heir" within the meaning of that term as used in *669 her father's will and so had no vested interest in her father's trust of personalty. It is apparent that the petitioner must have paid at least her share of the legal fee in the amount of $ 1,000 in 1940. She contends, however, that the total amount paid was $ 1,500. We are unable to find in the record any support for the contended payment of $ 500 above the amount of fee contracted for, other than petitioner's testimony that "I think [the expense of litigation I paid was] about $ 1,500." Petitioner suggests on brief that the additional $ 500 was her share of the attorneys' expenses but this is not supported by any proof, much less sufficient proof to sustain a deduction. Accordingly, we have found that petitioner in 1940 paid attorneys' fees in the amount of $ 1,000*113 only.
The next question under this issue is whether the payment is deductible under the pertinent section of the Code. The respondent contends that no part of the attorneys' fees should be allowable as a deduction, relying only on the part of Regulations 111, section 29.23 (a)-15 which reads as follows:
* * * Expenditures incurred in protecting or asserting one's rights to property of a decedent as heir or legatee, or as beneficiary under a testamentary trust, are not deductible expenses. * * *
The petitioner, in support of the view that the payment is deductible, cites Bingham v. Commissioner, 325 U.S. 365">325 U.S. 365; Howard E. Cammack, 5 T. C. 467; Heller v. Commissioner, 147 Fed. (2d) 376, certiorari denied, 325 U.S. 868">325 U.S. 868; Hochschild v. Commissioner, 161 Fed. (2d) 817, Rassenfoss v. Commissioner, 158 Fed. (2d) 764; and Mary deF. Harrison Geary, 9 T. C. 8.
Section 23 (a) (2) is generally considered to have been enacted following the repercussions of Higgins v. Commissioner, 312 U.S. 212">312 U.S. 212,*114 where it was held that a taxpayer holding investments and subject to tax on their income was not entitled to deduct the expenses in connection therewith because he was not deemed to be engaged in "business". Cf. Mertens "Law of Federal Income Taxation" sec. 25.120 1949 Supp. We mention the Higgins case here because in our opinion it is a clearly defined example of the nature of deductions for which Congress intended to provide, i. e., a deduction for the expenses of an individual incident to the production of income against which, had the individual been a "business," the deductions would be allowable as a business expense under section 23 (a) (1). The Supreme Court in Bingham v. Commissioner, 325 U.S. 365">325 U.S. 365, said "Section 23 (a) (2) is comparable and in pari materia with § 23 (a) (1), authorizing the deduction of business or trade expenses." In that case, cited by the petitioner, trustee paid for legal fees incident to the contest of a tax deficiency of the trust; legal fees in connection with payment of a cash legacy, and legal fees in connection with tax *670 and other problems arising upon expiration of the trust and relating to*115 final distribution of the trust fund. The court said that "* * * the trust, a taxable entity like a business, may deduct litigation expenses when they are directly connected with or proximately result from the enterprise -- the management of property held for production of income. [Citing cases.]"
There is no analogy to "management of property" in the present proceedings. Petitioner here paid legal fees in attempting to get the property -- not to manage what she had. In McDonald v. Commissioner, 323 U.S. 57">323 U.S. 57, it was held that the campaign expenses of one unsuccessfully seeking reelection as a Pennsylvania court of common pleas judge for a 10-year term was not allowable as a deduction under section 23 (a) (2). The court said "* * * his campaign contributions were not expenses incurred in being a judge but in trying to be a judge for the next ten years."
In Mary deF. Harrison Geary, supra, cited by petitioner, the taxpayer was a life beneficiary of a trust which owned unproductive realty. In 1942 the taxpayer procured a court decree holding that the carrying charges on trust property had been improperly paid by the*116 trustee from trust income instead of principal. Under the decree the taxpayer was awarded her share of amounts equal to the trust income which had been improperly used. The Tax Court held inter alia that the attorneys' fees paid by the taxpayer in procuring the court decree were deductible under section 23(a)(2) as an expense incurred for the collection of income, relying on Stella Elkins Tyler, 6 T.C. 135">6 T. C. 135.
In the Tyler case we said:
[The attorney's fees were] directly connected with income currently distributable to petitioner under the terms of the trust, and without such outlay it appears that she would have collected one-eighth of the trust income rather than the one-sixth interest to which she was entitled. She brought the suit for the purpose of having the will construed to determine the extent of her interest thereunder, and the expense to which she was put gave rise not to a new interest, but only to the payment of that portion settled upon her by the trustor. It was an expense directly connected with the collection of income that was hers by bequest and was not a cost of creating or acquiring property, or an interest therein itself.
*117 These two cases bring out the basic distinction between the theory that allows a deduction for the expense of collecting income to which one already has a right and petitioner's theory in the present proceedings. In our opinion section 23(a)(2) was not intended to allow a deduction for attorneys' fees of the nature of those incurred by petitioner here, and we so hold.
Decision will be entered under Rule 50.
Footnotes
1. This definition is admittedly not precise in that the Michigan Supreme Court held (see below our reference to Hay v. Hay, 317 Mich. 370↩, 26 N. W. (2d) 908) that the "legal heirs" to whom the Burt estate would be finally distributed, would be determined as of the termination of the trust -- not as of Burt's death. The definition of Burt's survivors as his heirs is used herein for want of a better descriptive expression.
2. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * * *
(m) Depletion. -- In the case of mines, oil and gas wells, other natural deposits, and timber, a reasonable allowance for depletion and for depreciation of improvements, according to the peculiar conditions in each case; such reasonable allowance in all cases to be made under rules and regulations to be prescribed by the Commissioner, with the approval of the Secretary. In any case in which it is ascertained as a result of operations or of development work that the recoverable units are greater or less than the prior estimate thereof, then such prior estimate (but not the basis for depletion) shall be revised and the allowance under this subsection for subsequent taxable years shall be based upon such revised estimate. * * *↩
3. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
* * * *
(o) Charitable and Other Contributions. -- In the case of an individual, contributions or gifts payment of which is made within the taxable year to or for the use of:
* * * *
(2) A corporation, trust, or community chest, fund, or foundation, created or organized in the United States or in any possession thereof or under the law of the United States or of any State or Territory or of any possession of the United States, organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, and no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation;
* * * *↩
4. SEC. 23. DEDUCTIONS FROM GROSS INCOME.
In computing net income there shall be allowed as deductions:
(a) Expenses. --
* * * *
(2) Non-trade or non-business expenses. -- In the case of an individual, all the ordinary and necessary expenses paid or incurred during the taxable year for the production or collection of income, or for the management, conservation, or maintenance of property held for the production of income.↩