                         T.C. Memo. 1997-529



                       UNITED STATES TAX COURT



    BOBBY E. SYPHRETT AND JANICE D. SYPHRETT, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No.   16340-95.               Filed November 24, 1997.



     David C. Allie and Walter B. Thurmond, for petitioners.

     Richard T. Cummings, for respondent.



                         MEMORANDUM OPINION


     LARO, Judge:    The parties submitted this case to the Court

without trial.    See Rule 122.   Petitioners petitioned the Court

to redetermine respondent's determination of a $126,510

deficiency in their 1989 Federal income tax.     Following certain

concessions by petitioners, we must decide whether their 1989
                               - 2 -


gross income includes certain proceeds that they received in

settlement of a lawsuit.   We hold it does.   Section references

are to the Internal Revenue Code in effect for 1989.    Rule

references are to the Tax Court Rules of Practice and Procedure.

Dollar amounts are rounded to the nearest dollar.

                            Background

     All facts have been stipulated.1    The stipulated facts and

exhibits submitted therewith are incorporated herein by this

reference.   When they petitioned the Court, petitioners resided

in The Woodlands, Texas.

     From 1982 through 1990, Bobby E. Syphrett was president,

sole shareholder, and sole employee of a Texas corporation named

Intrastate Gas Gathering, Inc. (Intrastate).    Intrastate’s

principal business activity was gas transmission.

     In approximately 1980, Mr. Syphrett and Intrastate planned

with Jack R. Wiewall to develop five gas-gathering projects (the

projects).   The projects contemplated the construction of

pipeline systems and related plant to collect natural gas from

producing properties and transport it to large pipelines for

shipment to major distribution centers.    Mr. Wiewall’s role was


     1
       Petitioners ask the Court to find as facts certain
allegations that were made in pleadings in two State court
actions. We decline to do so. The record does not reveal
whether the opposing parties in those actions admitted or denied
these allegations, and the record does not otherwise allow us to
determine independently the validity of these allegations.
                                 - 3 -


to manage construction of the pipelines and related plant.

Mr. Syphrett’s role was to secure contracts (the Contracts) with

the owners of gas-producing properties.    The legal work related

to the projects was handled by W. Michael Stephens and his law

firm of Baker, Brown, Sharman, Wise & Stephens (Baker, Brown).

     All of the projects were to be organized in the same way.

Each project would be organized as a limited partnership and

financed by selling limited partnership interests.    After the

limited partnership interests in a project had been sold,

Mr. Syphrett would assign the related Contracts to the limited

partnership.    Intrastate would then obtain an interest in the

limited partnership and become a partner.

     By 1981, three of the projects had been completed to the

point where limited partnerships were organized and interests

therein sold; the remaining two projects were in the process of

being formed.    In or about 1981, Mr. Syphrett learned that Mr.

Wiewall had allegedly been submitting false and inflated

construction invoices for one or more of the projects.    When

Mr. Syphrett objected to Mr. Wiewall’s alleged overcharging of

costs, Mr. Stephens allegedly drafted legal documents regarding

the two uncompleted projects so as to exclude Mr. Syphrett and

Intrastate from participation.    At that time, Mr. Syphrett had

assigned all but two of the Contracts to a limited partnership or

partnerships.
                                - 4 -


     In 1982, Mr. Syphrett and Intrastate (collectively, the

plaintiffs), as coplaintiffs, sued Mr. Wiewall in the District

Court of Harris County, Texas, seeking return of the plaintiffs'

interests in various limited partnerships (the Wiewall

litigation).    The law firm of Bonham, Carrington & Fox

represented the plaintiffs in the Wiewall litigation.      In 1983,

the plaintiffs, as coplaintiffs, sued Mr. Stephens and Baker,

Brown in a separate suit in the same court (the Stephens

litigation), seeking damages of at least $4.15 million and an

award of exemplary or punitive damages.    Larry Doherty and his

law firm of Doherty & Williamson, P.C., represented the

plaintiffs in the Stephens litigation.

     The plaintiffs entered into a written agreement (the Letter

Agreement) dated January 10, 1989, that "[set] out * * * [their]

understanding" regarding the Wiewall litigation and the Stephens

litigation.    The Letter Agreement stated that the plaintiffs

     hereby covenant and agree as follows:

          1) Syphrett has been determined to be the client
     in the * * * [Stephens litigation] and is entitled to
     receive the benefits, if any, derived from such case.
     Intrastate shall not seek nor receive any benefits from
     said case.

          2) Intrastate shall receive the benefits, if any,
     derived from the * * * [Wiewall litigation]. Syphrett
     shall not seek nor receive any benefits from said case.

          3) Syphrett, if successful in the * * * [Stephens
     litigation], shall pay to Intrastate a fee equal to the
     legal cost including Salary and other fees paid by
     Intrastate as of the date of this agreement. Syphrett
                                - 5 -


     shall pay all expenses in the * * * [Stephens
     litigation] and Intrastate shall pay the expenses in
     the * * * [Wiewall litigation] as of the date written
     above.

The Letter Agreement was signed by Mr. Syphrett, in his

individual capacity, and by Mrs. Syphrett in her capacity as

Intrastate's vice president.

     The Stephens litigation was settled on February 28, 1989,

for $1.5 million; after subtracting Mr. Doherty’s attorney's fees

and expenses of $413,375, the net recovery was $1,086,625 (the

Net Settlement Proceeds).    On the same day, Mr. Doherty’s office

issued a check to the plaintiffs in the amount of the Net

Settlement Proceeds.    Mr. Syphrett deposited this check in

petitioners’ personal bank account.

      A Full Release and Agreement (Release) entered into on

February 28, 1989, in connection with the settlement of the

Stephens litigation was signed by Mr. Syphrett, both in his

individual capacity and in his capacity as Intrastate's

president.    As part of the Release, the plaintiffs assigned to

the liability insurance carrier of Mr. Stephens and Baker, Brown

a 50-percent interest in the claims, causes of action, and

recoveries, up to a maximum of $1.5 million, in the Wiewall

litigation.

     Intrastate sent Mr. Syphrett the following three invoices

totaling $497,667:
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       Date/
     Year 1989             Amount           Period
      Aug. 3              $197,500      7/81 through 6/83
      Sept. 23             200,167      7/83 through 6/87
      Nov. 5               100,000      7/87 through 6/89

Mr. Syphrett paid Intrastate the total amount of these invoices

through a series of checks dated August 28, September 1,

September 5, September 7, October 30, and December 27, 1989.

Four of these checks were drawn on Mr. Syphrett's financial

management account at Shearson Lehman Hutton (Shearson).    One of

these checks was drawn on petitioners' personal account at First

Interstate Bank of Texas, N.A. (First Bank).    The final check was

a bank check purchased by Mr. Syphrett at the First Gibraltar

Bank, FSB (First Gibraltar).   A summary of these checks is as

follows:

 Date of the Check/
     Year 1989                 Amount             Drawer

     Aug. 28                   $52,500          Shearson
     Sept. 1                    45,000          Shearson
     Sept. 5                    50,000          Shearson
     Sept. 7                    50,000          Shearson
     Oct. 30                   200,167          First Bank
     Dec. 27                   100,000          First Gibraltar
                               497,667

     Intrastate reported its receipt of the $497,667 as gross

income on its tax return for its taxable year ended June 30,

1990.   Intrastate deducted on that return legal fees totaling

$419,765 and reported that it had no tax liability.    Intrastate's
                               - 7 -


tax return for the prior year also reported no tax liability; the

return showed a net loss of $67,570.

     Petitioners' 1989 tax return, as originally filed, reported

that they had no taxable income and no tax liability.    On a

schedule attached to that return, petitioners listed the

following information in support of $586,325 that they included

as other income, and that they offset by a $383,073 net operating

loss:

          Lawsuit settlement:
          Gross proceeds.................... $1,500,000
               Less legal fees..............     413,675
                                               1
               Less reimbursements..........     500,000
               Net other income............      586,325
     1
      Petitioners concede that they incorrectly deducted $2,333
more than they actually paid to Intrastate as "Reimbursements".

     Intrastate paid all legal fees as they were incurred, and it

deducted these fees on its tax returns for the years in which the

fees were paid.   Intrastate deducted all salary and other

compensation paid to Mr. Syphrett, along with related employment

taxes, on its tax returns for the years in which these amounts

were paid.

     The parties to the Wiewall litigation moved to dismiss that

case on December 13, 1990, with prejudice to their rights to

refile any claim, counterclaim, or any part thereof.    In

connection with this dismissal, Intrastate recovered all of the

Contracts, and Mr. Syphrett received nothing.
                               - 8 -


     Petitioners are subject to the alternative minimum tax for

1989.

                            Discussion

     Petitioners argue primarily that the proceeds from the

Stephens litigation were to be shared between Mr. Syphrett and

Intrastate, and that Mr. Syphrett transferred the $497,667 to

Intrastate to effectuate a "global allocation" of the proceeds of

the Stephens litigation and the Wiewall litigation.    Petitioners

argue alternatively that Mr. Syphrett paid the $497,667 to

Intrastate to reimburse it for the following amounts that it paid

during and in connection with the Stephens litigation:    $112,245

for legal fees to attorneys other than Mr. Doherty, $349,072 for

part of Mr. Syphrett's salary and related payroll taxes, and

$36,350 for miscellaneous expenses.    Petitioners conclude with

respect to their alternative argument that they may deduct the

$497,667 amount as:   (1) An ordinary and necessary expense in

carrying on Mr. Syphrett's trade or business as an employee of

Intrastate, see sec. 162, or (2) an expense for the production or

collection of income, or the management, conservation, or

maintenance of property held for the production of income, see

sec. 212.

     Respondent counters that all of the settlement proceeds

belonged to petitioners, and that they transferred the $497,667

amount to Intrastate in an attempt to shelter this amount from
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taxation by use of large deductions that were available to

Intrastate.    Respondent also argues, with respect to petitioners'

alternative argument, that neither section 162 nor section 212

lets petitioners deduct the $497,667 amount.

     Turning first to petitioners' primary argument, we agree

with respondent.    Our detailed review of the record persuades us

that petitioners' 1989 gross income includes the full amount of

the Net Settlement Proceeds.    We look to petitioners' outward

manifestations with respect to these proceeds, and we see that

they received these proceeds on February 28, 1989, without any

restricted use.    Petitioners deposited the check into their

personal account, and they used the proceeds for several months

before transferring any money to Intrastate.    Petitioners

transferred the money to Intrastate in several installments that

extended over a period of 4 months, rather than through a lump

sum at or near the date of settlement, and the first installment

was carefully crafted to fall within Intrastate's taxable year

beginning July 1, 1989.    If part of the settlement proceeds

belonged to Intrastate, as petitioners contend, it was entitled

to its share immediately upon settlement.    Yet, petitioners

controlled all the proceeds, even investing at least $197,500 of

the Net Settlement Proceeds in their personal brokerage account,

exposing this amount to the same risks as their personal

investments.
                              - 10 -


     Our reading of the Letter Agreement further supports our

conclusion, as does petitioners' reporting of the settlement

proceeds on their 1989 tax return.     The first paragraph of the

Letter Agreement states clearly that Mr. Syphrett, who is

described as "the client" in the Stephens litigations, would

receive all of the benefits from the Stephens litigation, and

that Intrastate would receive none of the benefits from that

suit.   Petitioners' 1989 tax return reports the full amount of

the settlement as gross proceeds.    These documents, which

evidence petitioners' intent and understanding at the time of the

events with the events, support the inclusion of the full amount

of the settlement proceeds in their gross income.

     We hold for respondent on the first issue.    In so holding,

we need not decide petitioners' alternative argument that they

may deduct the amount that Mr. Syphrett transferred to Intrastate

under either section 162 as an employee business expense or

section 212.   Even if we were to side with petitioners on this

second issue, which we do not intend to do, petitioners could

only deduct the $497,667 amount only as a miscellaneous itemized

deduction, see secs. 62(a)(2)(A) and 67, and they would receive

no benefit from such a deduction in 1989 because they are subject

to the alternative minimum tax, see sec. 56(b)(1)(A)(i).

Alexander v. Commissioner, T.C. Memo. 1995-51, affd. 72 F.3d 938,

946-947 (1st Cir. 1995).
                             - 11 -


     We have considered all arguments by petitioners for holdings

contrary to those expressed herein, and, to the extent not

addressed above, find them to be irrelevant or without merit.

To reflect the foregoing,

                                        Decision will be entered

                                   for respondent.
