                         110 T.C. No. 2



                     UNITED STATES TAX COURT



ESTATE OF ALGERINE ALLEN SMITH, DECEASED, JAMES ALLEN SMITH,
EXECUTOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE,
Respondent*



     Docket Nos. 19200-94, 3976-95.       Filed January 12, 1998.



          P (decedent's estate) settled and paid claims that
     were based in part on excessive royalties that had been
     paid to and reported by decedent in prior years. In
     our previous opinion in these cases, we held that P was
     entitled to an overpayment of income tax pursuant to
     application of sec. 1341, I.R.C., and that such
     overpayment was includable in the taxable estate.
     Estate of Smith v. Commissioner, 108 T.C. 412 (1997).
     The parties now disagree on the method of calculating
     the overpayment. R also seeks to amend the answer in
     order to decrease the credit for State death taxes that
     was previously allowed in the estate tax notice of
     deficiency.

          Held: Relief under sec. 1341, I.R.C., is
     restricted to the portion of P's settlement payments
     that represents items of income that were previously
     included in decedent's income.

     *
      This opinion supplements our opinion in Estate of Smith v.
Commissioner, 108 T.C. 412 (1997).
                                - 2 -


          Held, further, the amount of any overpayment that
     results from the application of sec. 1341, I.R.C., is
     not restricted to the amount computed under sec.
     1341(b)(1), I.R.C.

          Held, further, Rule 155(c), Tax Court Rules of
     Practice and Procedure, prohibits a party from raising
     new issues for purposes of making a computation
     pursuant to Rule 155. R may not amend the answer.



     Michael C. Riddle and Harold A. Chamberlain, for petitioner.

     Carol Bingham McClure, for respondent.


                        SUPPLEMENTAL OPINION


     RUWE, Judge:    On June 4, 1997, we issued our opinion in

these consolidated cases.    Estate of Smith v. Commissioner, 108

T.C. 412 (1997).    Pursuant to that opinion, the parties filed

separate computations pursuant to Rule 155.1     These cases are

before the Court again because the parties cannot agree on the

proper method for computing the overpayment of income tax and the

deficiency in estate tax.2

     The issues presented concern:      (1) The proper method for

computing an income tax credit and resulting overpayment under




     1
      Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code in effect as of the
date of decedent's death.
     2
      As indicated in our previous opinion, we believed based on
representations of the parties in their posttrial briefs that the
parties were in agreement as to the computational aspects of
these cases.
                               - 3 -


section 1341(a)(5) and (b),3 and (2) whether respondent may now

amend the answer to reduce the amount of the credit for State

death taxes that was determined in the notice of deficiency.

Respondent's Rule 155 computation uses the reduced credit in

computing the estate tax deficiency.

     These cases were submitted fully stipulated.   Neither party

alleges any factual dispute, and neither party argues that

additional evidence is necessary to resolve the computational

dispute.   We shall summarize the relevant facts and our holdings

for each of the remaining computational issues.4


Section 1341 Credit


     In 1970, decedent and her two aunts, Jessamine and Frankie

Allen, entered into oil and gas leases from which they derived

royalties during the years 1975 through 1980.   Jessamine and

Frankie Allen died in 1979 and 1989, respectively, and decedent

served as the independent executrix of both their estates.     Upon

Jessamine's death, decedent inherited a portion of Jessamine's

interest in the leased property.    Upon Frankie's death, decedent

inherited all of Frankie's interest in the leased property,

including the remaining portion of Jessamine's interest which

Frankie had previously inherited.

     3
      The amount of the resulting overpayment will be
determinative of the amount of a corresponding asset for estate
tax purposes.
     4
      A more complete statement of facts is contained in our
previous opinion.
                                - 4 -


     In 1988, Exxon filed suit against certain owners of royalty

and mineral interests, including decedent and Frankie

individually and against decedent as executrix of the estate of

Jessamine.    Exxon claimed that it had overpaid royalties during

the years 1975 through 1980.    Exxon's base claims for overpaid

royalties were made against decedent and Frankie in the following

amounts:


             Algerine Allen Smith         $249,304
             Frankie Allen                 783,013

               Total Damages Sought     $1,032,317


Exxon's claim against decedent represented 24 percent of the

total damages sought against decedent and Frankie.5

     Decedent died in 1990 after she had inherited Jessamine's

and Frankie's interests in the oil and gas properties.    Thus, by

1992, Exxon's claims for excess royalties paid to Jessamine,

Frankie, and decedent were all being pursued against petitioner

(decedent's estate).    In 1992, petitioner settled and paid the

above claims for $681,840.

     On her 1975 through 1980 Federal income tax returns,

decedent reported gross royalties from the oil and gas leases in

question in the following amounts:




     5
      The record does not disclose how much of Exxon's stated
claims related to excess royalties received by Jessamine prior to
her death in 1979 or by Jessamine's estate after her death.
                                 - 5 -


                      Year                Amount

                      1975                $58,512
                      1976                 62,302
                      1977                 45,061
                      1978                 36,734
                      1979                 36,846
                      1980                 44,725

                        Total            $284,180


On her returns for those years, decedent deducted an allowance

for depletion in an amount which was 22 percent of the gross

royalties reported.

     Petitioner filed a Federal income tax return for the taxable

year 1992 on which it reported and paid a tax of $8,338.     This

1992 tax was computed without taking a deduction for any portion

of the amount paid to Exxon in 1992.

     Section 1341 provides relief to taxpayers who are forced to

repay an item previously reported as income under a claim of

right.   Both parties agree that for purposes of section 1341,

petitioner and decedent should be treated as one and that

petitioner is entitled to section 1341 relief.      Both parties also

agree that relief should be in the form of a credit computed

pursuant to section 1341(a)(5) and (b).

     The pertinent provisions of section 1341 provide as follows:


     SEC. 1341.    COMPUTATION OF TAX WHERE TAXPAYER RESTORES
                   SUBSTANTIAL AMOUNT HELD UNDER CLAIM OF
                   RIGHT.

           (a)    General Rule.--If--
                                - 6 -


               (1) an item was included in gross income for a
          prior taxable year (or years) because it appeared that
          the taxpayer had an unrestricted right to such item;

               (2) a deduction is allowable for the taxable year
          because it was established after the close of such
          prior taxable year (or years) that the taxpayer did not
          have an unrestricted right to such item or to a portion
          of such item; and

               (3) the amount of such deduction exceeds $3,000,

     then the tax imposed by this chapter for the taxable
     year shall be the lesser of the following:

               (4) the tax for the taxable year computed with
          such deduction; or

               (5) an amount equal to--

                    (A) the tax for the taxable year computed
               without such deduction, minus

                    (B) the decrease in tax under this chapter
               (or the corresponding provisions of prior revenue
               laws) for the prior taxable year (or years) which
               would result solely from the exclusion of such
               item (or portion thereof) from gross income for
               such prior taxable year (or years).

                 *    *     *    *      *   *   *

     (b) Special Rules.--

               (1) If the decrease in tax ascertained under
          subsection (a)(5)(B) exceeds the tax imposed by this
          chapter for the taxable year (computed without the
          deduction) such excess shall be considered to be a
          payment of tax on the last day prescribed by law for
          the payment of tax for the taxable year, and shall be
          refunded or credited in the same manner as if it were
          an overpayment for such taxable year.


     Petitioner argues that the entire 1992 payment of $681,840

was in satisfaction of a claim against decedent's estate and,

therefore, the entire amount is eligible to be used to reduce

royalty income previously reported by decedent for purposes of
                                - 7 -


recomputing the amount of decedent's income tax for the years

1975 through 1980 pursuant to section 1341(a)(5).    Respondent

argues that the section 1341(a)(5) adjustment is limited to the

portion of the $681,840 settlement that represents excess

royalties that were paid to and reported by decedent during the

years 1975 through 1980.    We agree with respondent.

     Neither party cites any case law to support their respective

positions.   Nevertheless, the language of the statute indicates

that its relief is focused on a "taxpayer", who reported an

"item" in "gross income" for a "prior taxable year" where it is

established after the close of that taxable year "that the

taxpayer did not have an unrestricted right to such item".    Sec.

1341(a).   The computation contained in section 1341(a)(5) directs

the taxpayer to recompute the tax for the "prior taxable year (or

years) which would result solely from the exclusion of such item

(or portion thereof) from gross income for such prior taxable

year (or years)."   From this, we believe it is clear that section

1341 relief is restricted to items of income previously received

and reported by a taxpayer who must repay those same items in a

subsequent year.

     Kraft v. United States, 991 F.2d 292 (6th Cir. 1993),

supports this analysis.    In Kraft, the taxpayer invoked section

1341 based upon amounts he was required to repay because of a

fraud perpetrated in prior years.    The fraudulently obtained

funds had been deposited into a corporate account and reported as

corporate income.   The taxpayer's benefit came in the form of
                                 - 8 -


salary from the corporation.     Under these circumstances, the

court held section 1341 inapplicable because it was the

corporation, rather than the taxpayer, who had previously

reported the item being repaid.     Kraft v. United States, supra at

299.6

        It is undisputed that petitioner, as decedent's estate,

stands in the same position as decedent for purposes of applying

section 1341.     Thus, in these cases, section 1341 relief is

restricted to that part of the $681,840 that represents the

royalties that decedent had personally received and reported for

the years 1975 through 1980.     Decedent did not receive royalties

paid to Jessamine and Frankie during the years 1975 through 1980,

nor did she report or pay tax on those amounts.     We hold that

only that portion of the $681,840 that represents repayment of

royalties previously received and reported by decedent can be

used to provide benefits to petitioner under section 1341.


        6
         As succinctly stated in Judge Nelson's concurring opinion:


             For a taxpayer to take advantage of § 1341, he
        must show, among other things, (1) that 'an item' was
        included in a prior year's gross income because of an
        apparent unrestricted right to the item, and (2) that
        it was subsequently established that the taxpayer did
        not have an unrestricted right to 'such item' or
        portion thereof. 26 U.S.C. §§ 1341(a)(1) and (a)(2).
        Both sections clearly speak of the same 'item.'

             The 'item' included in the Krafts' gross income
        for the prior year at issue here was not a fee received
        from Blue Cross; it was, rather, a salary item received
        by Dr. Kraft from his corporation. * * * [Kraft v.
        United States, 991 F.2d 292, 300 (6th Cir. 1993).]
                                - 9 -


     There is nothing in the record to indicate how much of

Exxon's claim related to excess royalties paid to Jessamine or

her estate, and respondent does not factor this into respondent's

computation.   Since it appears likely that some part of the claim

against decedent was attributable to royalties paid to Jessamine

or her estate, respondent's decision not to allocate any portion

of the settlement to Jessamine works in petitioner's favor.7

Respondent's computation uses Exxon's allocation of its claims as

between decedent and Frankie, which, as previously stated,

attributes to decedent 24 percent of the excess royalty claims

against decedent and Frankie.   Under these circumstances, we find

that 24 percent is the most appropriate percentage for purposes

of determining the portion of the settlement that is available

for purposes of computing petitioner's section 1341 relief.

     While we reject petitioner's argument that the entire

$681,840 is available to adjust decedent's previously reported

income, we also reject part of the computational method proposed

by respondent.   Respondent's Rule 155 computation seems to assume

that decedent received royalties in excess of what she reported

for the years 1975 through 1980.   This assumption is based on

unexplained allegations made by Exxon in its lawsuit.   Relying on

Exxon's apparent claim that it paid more royalties to decedent

than she reported, respondent's computation reduces the portion


     7
      Respondent's counsel explained that there was no
information upon which to allocate any of Exxon's claims to
royalties paid to Jessamine or her estate.
                              - 10 -


of the settlement that respondent attributes to decedent's

previously reported royalties.   However, the parties have

stipulated that decedent reported all the royalties that she

received for the years 1975 through 1980.   Under these

circumstances, the Rule 155 computation cannot be based on the

assumption that decedent received more royalty income during the

years 1975 through 1980 than she reported on her returns.8

     Based upon the available information, we find that 24

percent of the $681,840 settlement, or $163,641, should be

attributed to excess royalties received and reported by decedent

during the years 1975 through 1980.9   This $163,641 should then

be allocated to each of the years 1975 through 1980 in proportion

to the amount of gross royalties that decedent reported during

each of these years.   For purposes of making the computations

required by section 1341(a)(5), these respective amounts should

be reduced by the proportionate amount of depletion allowance

that decedent took on her 1975 through 1980 returns.   The

resulting amounts should then be excluded from reported income

     8
      Respondent made no argument that this aspect of the
computation was an attempt to determine which portion of Exxon's
claims against decedent was attributable to Jessamine's
royalties. Indeed, respondent's counsel acknowledged that
Jessamine's royalties could not be identified and that
respondent's computations give petitioner the benefit of any
doubt on this point.
     9
      This allocation does not attribute any portion of the
$681,840 settlement to interest that Exxon claimed in addition to
its base claim for excess royalties. Respondent's proposed
computation made no allocation of the $681,840 settlement to
interest and presented no arguments regarding how such an
allocation should or could be made.
                              - 11 -


for each year, and the resulting tax decrease should be computed

for each year.   The total of these tax decreases for prior years

is the amount that is available as a credit for 1992 pursuant to

section 1341(a)(5)(B).

     Both parties agree that petitioner will be entitled to an

overpayment as a result of applying section 1341(a)(5) and

(b)(1), but they disagree about whether section 1341(b)(1) sets

the limit on the amount of the overpayment.

     For purposes of applying section 1341(b)(1) to these cases,

the "taxable year" is 1992.   Section 1341(b)(1) provides in

pertinent part that "If the decrease in tax ascertained under

subsection (a)(5)(B) exceeds the tax imposed by this chapter for

the taxable year (computed without the deduction) such excess

shall be considered to be a payment of tax on the last day

prescribed by law for the payment of tax for the taxable year,

and shall be refunded or credited in the same manner as if it

were an overpayment for such taxable year."   Respondent argues

that the amount of the overpayment for 1992 is limited to the

amount described in section 1341(b)(1).   Petitioner disagrees.

Again, neither party cites any previous cases dealing with this

issue, and we have found none.

     Section 1341 provides a method for determining the tax for a

year in which a taxpayer repays items that had been reported as

income in prior years under claim of right.   Under section

1341(a)(5), the first step is to compute the tax for the taxable

year (1992) without regard to any deduction allowable pursuant to
                                - 12 -


section 1341.   Here that tax is $8,338, which petitioner

previously reported and paid.     The second step is to determine

the amount of the decrease in tax for the prior years, which

would result solely from the exclusion of the previously

reported, but now repaid, items.     Petitioner's 1992 income tax

liability is then determined by subtracting the decrease in tax

in prior years (1975 through 1980) from $8,338.     We know that the

decrease in tax from prior years exceeds $8,338.     Therefore, we

know that there will be no tax liability for 1992 even though

petitioner has paid $8,338.   It follows that petitioner has

overpaid its tax liability for 1992 by at least $8,338.

     Section 1341(b)(1) prescribes the method for dealing with

the amount by which the decrease in tax for prior years exceeds

the tax for 1992 as computed with no section 1341 deduction.     It

provides that "such excess shall be considered to be a payment of

tax on the last day prescribed by law for the payment of tax for

the taxable year [1992], and shall be refunded or credited in the

same manner as if it were an overpayment for such taxable year."

Sec. 1341(b)(1).   Respondent's position is that section

1341(b)(1) places a limit on the amount of any overpayment to

which petitioner is entitled.10    We disagree.   Section 1341(b)(1)

     10
      In the Written Statement In Support of Respondent's Rule
155 Calculation, respondent states:


     Section 1341(b)(1) provides in pertinent part that 'if
     the decrease in tax ascertained under subsection
     (a)(5)(B) exceeds the tax imposed for the taxable year
                                                   (continued...)
                               - 13 -


simply allows the amount of tax decrease from prior years that is

not used up in computing the correct 1992 tax liability under

section 1341(a)(5) to also be "considered" to be an overpayment.

Nothing in section 1341(b)(1) limits the tax computation under

section 1341(a)(5) from independently producing an incremental

amount of the final overpayment.


Credit for State Death Taxes


     On its estate tax return, petitioner claimed a credit for

State death taxes that it had paid in the amount of $23,917.    In

the notice of deficiency for estate tax, respondent determined

that petitioner was entitled to a "Credit for state death taxes

substantiated" in the amount of $144,089 and allowed this amount

in computing the amount of the deficiency.   In effect,

respondent's notice of deficiency reflected a determination that

petitioner had fully substantiated a right to the credit.   The

$144,089 amount was apparently based upon the total amount of

State death taxes that petitioner would be liable for if
respondent's adjustments were upheld.   As part of the Rule 155


(...continued)
     (computed without the deduction) such excess shall be
     considered to be a payment of tax on the last day
     prescribed by law for the payment of tax for the
     taxable year, and shall be refunded or credited in the
     same manner as if it were an overpayment for such
     taxable year.' (Emphasis added.) Thus, the amount of
     the overpayment is not the entire amount computed
     pursuant to section 1341(a)(5) as petitioner contends,
     but only the excess of that amount over petitioner's
     income tax liability for 1992 in the amount of
     $8,338.00. * * *
                               - 14 -


computation, respondent, for the first time, alleges that the

notice of deficiency was in error, and that $120,172 of the

credit allowed should have been reflected on a different line in

the notice of deficiency as "Additional credit for state death

taxes allowable, if substantiated."      Had this been done, the

amount of the deficiency determined by respondent would have been

increased by $120,172.11
     Respondent now wants to amend the answer to correct the

error and increase the deficiency.      Apparently, assuming that

this will be permitted, respondent has included this adjustment

in the Rule 155 computation.    The problem with respondent's

position is that Rule 155(c) precludes a party from raising a new

issue in a proceeding under Rule 155.      The credit for State death

taxes was previously uncontested and has nothing to do with the

other computational issues.    We, therefore, deny respondent's

motion for leave to amend answer.    The Rule 155 computation

should not include any change to the credit for State death taxes
as determined in the notice of deficiency.



                                            Appropriate orders will

                                      be issued.



     11
      Respondent recognizes that the actual impact of
respondent's error will probably be far less than this since, as
a result of our prior opinion, petitioner's taxable estate will
be increased. To the extent petitioner is obligated to pay
additional State death taxes, it would be entitled to a
substantial amount of the credit already allowed. See sec. 2011.
