                         T.C. Memo. 2004-126



                       UNITED STATES TAX COURT



               JACK CARSON COLEMAN, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10258-02.               Filed May 25, 2004.



     Jack Carson Coleman, pro se.

     Robert A. Varra, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GERBER, Judge:    Respondent determined a deficiency in

petitioner’s Federal income tax in the amount of $398 for the

taxable year 1999.    The issues presented for our consideration
                               - 2 -

are:1 (1) Whether payments received by petitioner are income in

respect of a decedent and therefore includable in his gross

income under section 691(a);2 and (2) whether petitioner’s 1998

State income tax refund received during the taxable year 1999 is

includable in his 1999 gross income.

                         FINDINGS OF FACT

     Petitioner Jack Carson Coleman resided in Colorado Springs,

Colorado, at the time his petition was filed.    Petitioner’s

father (decedent) died intestate on January 3, 1993.    Before his

death, decedent sold Grossmont Animal Hospital to another

veterinarian.   As part of the sales transaction, decedent signed

a 10-year agreement not to compete (agreement) in consideration

of 120 monthly payments of $1,000.

     As of the date of decedent’s death, the unexpired portion of

the agreement consisted of 108 monthly payments and was included

in decedent’s estate.   For estate tax purposes the remaining

payments were assigned a value of $81,000, which reflected 75

percent of their face value (108,000 x 75%).    On February 10,

1998, decedent’s estate was closed and petitioner received, inter


     1
       On the basis of petitioner’s failure to file a responding
brief, respondent moved for dismissal of this case for lack of
prosecution. Petitioner filed an objection to the motion and
requested a decision based on the hearing testimony and
respondent’s brief. We deny respondent’s motion and will decide
this case on its merits.
     2
       All section references are to the Internal Revenue Code in
effect for the year at issue.
                                 - 3 -

alia, a one-third interest in the unexpired portion of the

agreement.   During 1999, petitioner received payments totaling

$3,666 from Grossmont Animal Hospital in accordance with the

agreement.   Petitioner did not report these payments on his 1999

Federal income tax return.

      On his 1998 Federal income tax return petitioner claimed an

itemized deduction for State and local taxes in the amount of

$789.   During 1999 petitioner received a refund of State and

local taxes in the amount of $355.       He did not report the $355

refund as income on his 1999 Federal income tax return.

                              OPINION

      This controversy concerns whether payments received by

petitioner in connection with the agreement are income in respect

of a decedent (IRD) and therefore includable in his gross income.

A second issue concerns whether petitioner’s State income tax

refund for his 1998 tax year is includable in petitioner’s 1999

gross income.

I.   Income in Respect of a Decedent

      As of the date of decedent’s death, 75 percent of the value

of the unexpired portion of the agreement not to compete was

included in decedent’s estate.    On the basis of petitioner’s

testimony, we interpret his arguments to be as follows:       (1) As

of the date of decedent’s death, the basis in the unexpired

portion of the agreement was “stepped up” to 75 percent of its
                                   - 4 -

value; and (2) 25 percent of the payments petitioner received in

1999 is includable in his 1999 gross income.      Conversely,

respondent asserts that pursuant to section 691(a), the payments

received by petitioner constitute IRD and are includable in their

entirety in petitioner’s 1999 gross income.      Sec. 691(a).

       We first address whether the payments received by petitioner

constitute IRD.    A main principle underlying our system of income

taxation is that an item of gross income becomes taxable when a

taxpayer includes it in gross income under his or her method of

accounting.    Sec. 451.   This principle should still apply in

situations where an individual has a legal right to an item of

gross income, but dies before reporting it.      Kitch v.

Commissioner, 104 T.C. 1, 10 (1995), affd. 103 F.3d 104 (10th

Cir. 1996) (citing Rollert Residuary Trust v. Commissioner, 80

T.C. 619, 636-637, 642-643 (1983), affd. 752 F.2d 1128 (6th Cir.

1985)).    “Section 691 promotes this principle by taxing property

received after an individual’s death if the property would have

been includable in gross income had the individual lived.”        Kitch

v. Commissioner, supra at 10.

       Section 691 provides that a taxpayer’s gross income includes

IRD.    See also sec. 61(a)(14).    IRD consists of amounts:    “(1) Of

gross income, (2) which the decedent was entitled to receive at

the time of death, (3) but were not properly includable in the

decedent’s gross income under the decedent’s method of accounting
                                - 5 -

before death, and (4) which were received by the taxpayer as the

decedent’s successor in interest.”      Kitch v. Commissioner, supra

at 10; see sec. 691(a); sec. 1.691(a)-1(b), Income Tax Regs.       IRD

must be included in the gross income of a person “who acquires

from the decedent the right to receive the amount by bequest,

devise, or inheritance, if the amount is received after a

distribution by the decedent’s estate of such right.”     Sec.

691(a)(1)(C); see sec. 1.691(a)-2(a)(3), Income Tax Regs.

     We conclude that the payments received by petitioner in

accordance with the agreement constitute IRD under section

691(a).    First, payments received in accordance with an agreement

not to compete are includable in gross income.     See Kinney v.

Commissioner, 58 T.C. 1038, 1041-1042 (1972); Rev. Rul. 69-643,

1969-2 C.B. 10.    Second, the agreement vested decedent with a

legally enforceable right to receive monthly payments over a 10-

year period.    Third, the value of the unexpired portion of the

agreement was not included in decedent’s gross income before his

death.    Lastly, decedent’s estate distributed, and petitioner

became a successor in interest to, one-third of the unexpired

portion of the agreement.    Accordingly, we hold that the payments

received by petitioner constitute IRD and are includable in

petitioner’s gross income for his 1999 tax year.

     The character of an item of IRD to the successor is the same

character as the item would have had in the decedent’s hands “if
                                 - 6 -

the decedent had lived and received such amount.”    Sec.

691(a)(3); Kitch v. Commissioner, supra at 10.    Payments received

pursuant to an agreement not to compete are ordinary income in

the year of receipt.     See Kinney v. Commissioner, supra at 1041-

1042; Rev. Rul. 69-643, 1969-2 C.B. 10.    Accordingly, we hold

that the character of the payments received by petitioner was

that of ordinary income.

      We next address whether petitioner received a step-up in

basis of 75 percent of the value of the payments.    Section

1014(a) generally provides that the basis in property acquired

from a decedent shall be “stepped up” to the fair market value of

the property at the date of the decedent’s death.    However,

section 1014(c) specifically excludes the application of section

1014(a) to property representing IRD under section 691.     Because

the payments received by petitioner constitute IRD, we

accordingly hold that petitioner did not receive a stepped-up

basis of 75 percent of the value of the payments.3    See Rollert

Residuary Trust v. Commissioner, supra at 647-648.

II.   State Income Tax

      Petitioner deducted State income tax of $789 on his 1998

Federal income tax return.    During 1999, petitioner received a



      3
       Decedent’s estate did not pay estate tax with respect to
the inclusion of 75 percent of the payments in decedent’s gross
estate. Therefore, petitioner is not eligible for a deduction
for estate tax paid under sec. 691(c).
                                - 7 -

State income tax refund of $355, which he did not report as

income on his 1999 Federal income tax return.      In controversy is

whether petitioner’s refund of $355 is includable in his 1999

gross income.   The “tax benefit rule” dictates that refunds of

State and local taxes are includable in gross income in the year

received to the extent they reduced the taxpayer’s income tax

liability for the prior year.   See Francisco v. Commissioner, 119

T.C. 317, 334 (2002); Kadunc v. Commissioner, T.C. Memo. 1997-92.

Petitioner received an itemized deduction of $789 with respect to

his State income tax, which reduced his 1998 Federal income tax

liability.   Therefore, pursuant to the “tax benefit rule”

petitioner must include his $355 refund of 1998 State income tax

in his 1999 gross income, and we so hold.

     In summary, we hold that the payments received by petitioner

constitute income in respect of a decedent.      Further, because

petitioner did not receive a step-up in basis with respect to the

payments, the full amounts of the payments are includable in

petitioner’s 1999 gross income and are ordinary in character.

Lastly, we hold that petitioner’s 1999 State income tax refund is

includable in his 1999 gross income.      To the extent not herein

discussed, we have considered all other arguments made by the

parties and conclude that they are moot or without merit.


                                        Decision will be entered

                                for respondent.
