Thank You For Submiting Feedback!
While it is true that the parties may enter into any legal arrangement they see fit even though the particular form in which it was cast was selected with the hope of a reduction in taxes, it is also true that if a consideration for which one of the parties bargains is the equivalent of cash it will be subjected to taxation to the extent of its fair market value.
Petitioner taxpayers received a contract for oil and gas royalty payments, with bonuses of fixed sums payable in two subsequent years. Six months later, they assigned these contracts to a bank, reporting the amounts they received for these assignments as long-term capital gains. The respondent Commissioner of Internal Revenue argued that these payments represented ordinary income, subject to depletion, to the extent of the fair market value of the obligations at the time they were created, a value which respondent would discount by four percent. The tax court determined that the bonus payments were immediately convertible to cash and should be taxed at full face value with no allowance for depletion. Petitioner taxpayers appealed.
Was the tax court correct in its assessment that the bonus payments were immediately convertible to cash and should be taxed at full face value with no allowance for depletion?
On appeal, the United States Supreme Court reversed and remanded for a determination whether the bonus obligations were transferable as the equivalent of cash, and what their cash value would have been. If they were cash equivalents, the income would be ordinary income, and would be subject to depletion.