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Howe v. Commissioner of Internal Revenue

decided: March 17, 1987.

CLARENCE K. HOWE AND MARGARET C. HOWE, PETITIONERS-APPELLANTS,
v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT-APPELLEE



Taxpayers appeal from a judgment entered August 12, 1985, in the united States Tax Court, Peterson, Special Trial Judge, which held that taxpayers' claimed deductions were not allowable because they were not "advance minimum royalties" within the meaning of Treas. Reg. ยง 1.612(b)(3).

Oakes, Meskill and Mahoney, Circuit Judges.

Author: Meskill

MESKILL, Circuit Judge:

This appeal is from an August 12, 1985, judgment of the United States Tax Court, Peterson, Special Trial Judge, which granted partial summary judgment to the appellee, Commissioner of Internal Revenue, holding that appellants, Clarence K. Howe and Margaret C. Howe, had improperly deducted $42,620.02 for a claimed advanced minimum royalty payment. Thereafter, the parties stipulated to a settlement of the remaining issues in the case and a final order was entered July 1, 1986. We affirm.

BACKGROUND

Appellants, accrual basis taxpayers, claimed a loss of $42,620.02 on their joint tax return for 1977. The loss was composed of $42,075.34 in advanced minimum royalties and associated expenses of $544.68. Appellants attribute their claimed deduction to their participation in an unsuccessful coal mining venture, the Plaza Coal Program (Program). The Commissioner denied the deduction in its entirety.

The Program was a joint venture formed to develop and commercially exploit coal-bearing deposits in Pennsylvania. The tax court found the following facts: On December 15, 1977, appellants entered into a sublease agreement with Fairchild Coal Corporation (the sublessor of certain rights to mine coal) for the right to mine coal for a period of eleven and one-half years unless the sublease was terminated sooner. Appellants agreed to pay Fairchild a pro rata share of a royalty for the right to mine coal based on the number of tons of coal mined, removed and sold and on the price at which such coal was sold.

Appellants also agreed to pay a pro rata share of a royalty, referred to as a "minimum annual royalty," of $177,650 for eleven and one-half years with $1,598,850 (the first nine years of minimum payment) being due immediately. The $1,598,850, characterized as an "advanced minimum royalty," was to be paid simultaneously with the execution of the sublease by all of the investors in the Program as follows: (1) non-recourse notes in the aggregate amount of $1,292,000, and (2) cash in the aggregate amount of $306,850. Appellants purchased one-half of one investment unit resulting in their obligation to pay $11,000 cash and a $34,000 non-recourse note to Fairchild. The minimum payments for the tenth and succeeding years were to be paid on December 31 of each such year. The minimum payments described above were to offset and reduce the regular tonnage royalty of $5.50 per ton for the first 32,300 tons of coal mined, removed and sold for each year during the first ten years of the sublease. The minimum payments for the tenth and succeeding years were to be reduced by the tonnage royalty payable during each such year of the sublease.

The non-recourse notes used to satisfy the minimum royalty obligation bore an interest rate of six percent and were payable thirty days after the end of each month beginning December 31, 1977, in an amount equal to $5.65 multiplied by the number of tons of coal up to 1,700 tons mined and removed during the year, in proportion to the debtor's share of the sublease. To the extent the payments described above made during the year totaled an amount less than a minimum amount specified in the note, the difference was due and payable on December 1 of the year in which the shortfall occurred. The note set out the minimum payments for owners of one investment unit as follows:

1978 4,000

1979 8,000

1980 8,000

1981 8,00 0

1982 ...


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