                        T.C. Memo. 2006-119



                       UNITED STATES TAX COURT



         WILLIAM C. AND JOSEPHINE HOUCHIN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

              W.C. HOUCHIN CORPORATION, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 11944-03, 11945-03.   Filed June 12, 2006.


     H. Cranston Pope, for petitioners.

     Stephen R. Takeuchi, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     VASQUEZ, Judge:    Respondent determined a deficiency of

$267,6611 and an accuracy-related penalty under section 6662(a)2


     1
         All amounts are rounded to the nearest dollar.
     2
         Unless otherwise indicated, all section references are to
                                                    (continued...)
                               - 2 -

of $53,532 with regard to petitioners William and Josephine

Houchin’s 1999 Federal income tax.     Respondent determined the

following deficiencies in and accuracy-related penalties on

petitioner W.C. Houchin Corp.’s Federal income taxes:

                                             Penalty
         Year        Deficiency            Sec. 6662(a)

         1998        $1,211,643              $242,329
         1999         1,276,748               255,350

After concessions,3 we must decide (1) whether petitioner W.C.

Houchin Corp. should recognize $6,145,315 of lawsuit settlement

proceeds in income in 1998, (2) whether petitioners William and

Josephine Houchin are liable for the accuracy-related penalty

pursuant to section 6662(a) for 1999, and (3) whether W.C.

Houchin Corp. is liable for the accuracy-related penalty pursuant

to section 6662(a) for 1998.

                        FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.     Petitioners William and

     2
      (...continued)
the Internal Revenue Code, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
     3
        On brief, respondent conceded the 1999 deficiency and
penalty related to W.C. Houchin Corp. Petitioners and respondent
stipulated the treatment of several adjustments in the notices of
deficiency issued to W.C. Houchin Corp. for the year 1998 and to
William and Josephine Houchin for the year 1999 if the Court
finds for respondent with regard to the recognition of income by
W.C. Houchin Corp. in 1998.
                                - 3 -

Josephine Houchin resided in Lynn Haven, Florida, at the time

they filed their petition.   Petitioner W.C. Houchin Corp.’s

principal place of business was in Colorado at the time the

petition was filed.

     W.C. Houchin Corp. was incorporated in Texas in 1987 as a C

Corporation.    William Houchin conveyed personal and real property

located in Huerfano County, Colorado (Huerfano property),

including “all oil, gas and other minerals”, to W.C. Houchin

Corp. on August 28, 1987.    W.C. Houchin Corp. converted to an S

Corporation effective January 1, 1999.     William Houchin is the

president and sole shareholder of W.C. Houchin Corp.     From 1987

to 2000, W.C. Houchin Corp. used the accrual method of

accounting.

     The Huerfano property conveyed to W.C. Houchin Corp. was

subject to a carbon dioxide gas lease to Atlantic Richfield Co.

(ARCO).   The gas lease permitted ARCO to enter onto the Huerfano

property and explore for oil and gas.     The gas lease also

permitted ARCO to produce any discovered carbon dioxide gas and

lay pipelines to transport the gas.     The terms of the lease

required ARCO to pay a royalty when any discovered carbon dioxide

gas was sold.   The 1987 transfer by William Houchin to W.C.

Houchin Corp. included the rights to receive the royalties paid

by ARCO under the lease.
                                - 4 -

     At a certain period prior to the years in issue, ARCO

discovered carbon dioxide gas under the Huerfano property and

transported the gas via pipeline from Colorado into west Texas.

ARCO sold the gas to oil producers in west Texas.    The oil

producers injected the carbon dioxide gas into oil reservoirs via

injection wells to increase oil production from nearby producing

wells.

     The Huerfano property gas lease was part of a group of gas

leases consolidated into the “Sheep Mountain Operating Unit

Area”.    That group of leases on adjacent land determined the

share of royalties the landowners received for carbon dioxide gas

produced from the common reservoir beneath the adjacent lands.

     The leases required ARCO to pay the Sheep Mountain Operating

Unit Area owners, including W.C. Houchin Corp., the owners’

royalties.    In 1981, Exxon purchased a 50-percent interest in

carbon dioxide production from the Sheep Mountain Operating Unit

Area.    Exxon, as a result of the purchase, was required to

reimburse ARCO for 50 percent of the royalties paid for the

carbon dioxide gas produced.

     On July 14, 1995, ARCO filed a complaint in the U.S.

District Court for the District of Colorado against several

carbon dioxide gas lessees, including William Houchin.4   In the

     4
        We note that “William C. Houchin” is the named defendant
in the civil action brought by ARCO. W.C. Houchin Corp.,
                                                   (continued...)
                                 - 5 -

complaint, ARCO requested a declaratory judgment declaring as

proper the deductions that decreased the royalties paid to the

gas lessees.   The disputed deductions were related to the cost of

transporting the carbon dioxide gas from Colorado to west Texas.

The defendant gas lessees, including William Houchin,

counterclaimed against both ARCO and Exxon for, inter alia,

alleged unpaid royalties for past production as a result of

improper transportation deductions (transportation portion) and

allegedly undervaluing the carbon dioxide gas sold (valuation

portion) for purposes of computing the royalties paid to the

lessees.

     The U.S. District Court for the District of Colorado

dismissed Exxon from the case.    However, Exxon was obligated to

pay 50 percent of any royalties determined to be due in the case,

and therefore Exxon remained involved in the resolution of the

lawsuit.

     In November of 1997, the court granted defendants’ motion

for summary judgment on the transportation portion of the case.

The parties engaged the services of an arbitrator and commenced


     4
      (...continued)
however, received the rights to “all oil, gas and minerals”
related to the Huerfano property prior to the filing of ARCO’s
civil action. The parties negotiated and settled the case with
William Houchin. W.C. Houchin Corp., however, is the owner of
the royalty income from the gas lease and reported the settlement
agreement on its 1999 U.S. Income Tax Return for an S
Corporation.
                               - 6 -

settlement negotiations in January of 1998.   In April of 1998,

the court granted ARCO’s motion to exclude the defendants’ expert

witness testimony that related to the valuation portion of the

case.

     ARCO and Exxon desired to obtain simultaneously a settlement

agreement with William Houchin and a codefendant.   By letter

dated October 28, 1998, William Houchin’s attorney, Gary C.

Davenport, communicated to him a combined $8 million settlement

offer from ARCO and Exxon separately made to both William Houchin

and the codefendant.   On October 29, 1998, William Houchin and

the codefendant separately accepted the combined settlement offer

of $8 million, to be divided between William Houchin and the

codefendant.

     On December 18, 1998, William Houchin received the

settlement agreement for his separate settlement.   The settlement

agreement contains the following language:

          3. Payment. In consideration of the release and
     agreements described above, ARCO and Exxon agree to
     wire transfer to Houchin’s attorneys * * * a total of
     $8 million ($8,000,000.00) on January 4, 1999 in full
     and complete compromise and satisfaction of his
     Counterclaim that his Royalty has been underpaid and in
     full and complete compromise and satisfaction of the
     [codefendant’s] Claim that its Royalty has been
     underpaid. * * *

           *      *       *      *      *      *      *

          18. Counterparts. This Settlement Agreement may
     be executed by the Settling Parties in any number of
     counterparts, each of which shall be deemed an original
     instrument, but all of which together shall constitute
                               - 7 -

     one and the same instrument. This Settlement Agreement
     shall become effective immediately upon execution by
     all the Settling Parties.

          19. Applicable Law. This Settlement Agreement
     shall be interpreted, construed and enforced in
     accordance with the laws of the State of Colorado.

           IN WITNESS WHEREOF, the Settling Parties have
     executed this Settlement Agreement as of December 21,
     1998.

     Petitioner William Houchin executed the settlement agreement

on December 21, 1998.   The codefendant executed a separate

settlement agreement on December 21, 1998.   G.B. Weeden,

representative of Exxon, executed both settlement agreements on

December 22, 1998.   T.L. Holland, Attorney-in-Fact for ARCO,

executed both settlement agreements on December 31, 1998.

     The law firm that represented William Houchin in the

negotiations with ARCO and Exxon, namely, McGloin, Davenport,

Severson, & Snow, calculated William Houchin’s portion of the

combined $8 million settlement as $6,145,315 and so informed him

in a document dated December 31, 1998, entitled “Houchin

Disbursement Statement”.   On January 4, 1999, McGloin, Davenport,

Severson, & Snow received by wire transfer the $8 million

settlement amount.   On January 5, 1999, McGloin, Davenport,

Severson, & Snow sent William Houchin a check in the amount of

his net settlement proceeds.   On January 6, 1999, William Houchin

received the settlement proceeds check.   On January 12, 1999,

McGloin, Davenport, Severson, & Snow, and ARCO signed and filed a
                                 - 8 -

stipulated dismissal with prejudice.      On February 3, 1999, the

U.S. District Court for the District of Colorado dimissed William

Houchin from the lawsuit with prejudice.

      The parties stipulated that the correct amount of income

received by W.C. Houchin Corp. from the settlement agreement with

Exxon and ARCO for the purpose of calculating any income

adjustment is $6,145,315.5

      Petitioner W.C. Houchin Corp. did not report the royalty

income received from the settlement on its 1998 corporate income

tax return.     Petitioner W.C. Houchin Corp. reported the royalty

income and related settlement expenses on its corporate return

for 1999, the first year for which the corporation elected S

corporation status.     Petitioners William and Josephine Houchin

reported the royalty income received from the settlement, among

other settlement-related items, as flowthrough items on their

1999 individual Federal income tax return.

                                OPINION

I.   Settlement-Related Deficiency

      A.    Burden of Proof

      Section 7491(a) places the burden of proof on the

Commissioner with regard to certain factual issues relevant to

ascertaining liability for tax in the case of Court proceedings

arising from examinations commenced after July 22, 1998.


      5
           See supra note 4.
                                - 9 -

Petitioners, however, do not assert or show that section 7491(a)

shifts the burden of proof to respondent.    Therefore, petitioners

bear the burden of proof.   Rule 142(a); see also Thor Power Tool

Co. v. Commissioner, 439 U.S. 522, 532-533 (1979) (noting that

the Commissioner is afforded much latitude for discretion and the

taxpayer bears a heavy burden of proof with respect to accounting

issues).

     B.    Parties’ Assertions and Relevant Internal Revenue Code
           Sections and Regulations

     Respondent asserts that W.C. Houchin Corp. should recognize

the settlement payment from ARCO and Exxon as income in 1998.

W.C. Houchin Corp. was a C corporation in 1998.    Petitioners

maintain that the settlement payment should be recognized in 1999

when W.C. Houchin Corp. elected to become an S corporation.

     Section 451(a) provides that the amount of any item of

income shall be included in gross income for the taxable year in

which received by the taxpayer unless, under the method of

accounting used in computing taxable income, the amount is

properly accounted for as of a different period.    Under the

accrual method of accounting, income is to be included for the

taxable year when (1) all events have occurred that fix the right

to receive the income and (2) the amount of the income can be

determined with reasonable accuracy.    Secs. 1.446-1(c)(1)(ii),

1.451-1(a), Income Tax Regs.   W.C. Houchin Corp. was an accrual

method taxpayer in 1998 and 1999.
                                   - 10 -

          1.    All-Events Test

                  a.     Application to W.C. Houchin Corp.

     Under the all-events test, the fixed right to receive the

income is controlling and not whether there has been actual

receipt of the income.        Spring City Foundry Co. v. Commissioner,

292 U.S. 182, 184-185 (1934).       Typically, all the events that fix

the right to receive income have occurred when the income is:

(1) Actually or constructively received, (2) due, or (3) earned

by performance.        Schlude v. Commissioner, 372 U.S. 128 (1963);

Johnson v. Commissioner, 108 T.C. 448, 459 (1997), affd. in part,

revd. in part and remanded on another ground 184 F.3d 786 (8th

Cir. 1999).    When the right to receive a set amount of income

becomes fixed, the income ordinarily accrues.        Spring City

Foundry Co. v. Commissioner, supra at 184-185; Resale Mobile

Homes, Inc. v. Commissioner, 91 T.C. 1085, 1093 (1988), affd. 965

F.2d 818 (10th Cir. 1992).       An accrual basis taxpayer must report

income in the year the right to such income accrues, despite the

necessity for mathematical computations or ministerial acts.

Contl. Tie & Lumber Co. v. United States, 286 U.S. 290, 295-297

(1932); Dally v. Commissioner, 227 F.2d 724 (9th Cir. 1955),

affg. 20 T.C. 894 (1953); Charles Schwab Corp. & Subs. v.

Commissioner, 107 T.C. 282, 292 (1996), affd. 161 F.3d 1231 (9th

Cir. 1998); Resale Mobile Homes, Inc. v. Commissioner, supra at

1095.
                               - 11 -

     The terms of the Houchin settlement agreement dictate when

the right of W.C. Houchin Corp. to the income accrued.6       The

settlement agreement states that “the Settling Parties have

executed this settlement Agreement as of December 21, 1998.”

Petitioner William Houchin executed the settlement agreement on

December 21, 1998.   The codefendant executed a separate

settlement agreement on December 21, 1998.     Representatives of

Exxon and ARCO executed both settlement agreements on December 22

and 31, 1998, respectively.    Paragraph 18 states:   “This

Settlement Agreement shall become effective immediately upon

execution by all the Settling Parties.”     The settlement agreement

was effective by December 31, 1998.     Therefore, W.C. Houchin

Corp.’s right to the settlement agreement income became fixed in

1998.

     The settlement agreement states that “ARCO and Exxon agree

to wire transfer to Houchin’s attorneys * * * a total of $8

million ($8,000,000) on January 4, 1999 in full and complete

compromise and satisfaction of * * * [Houchin’s] Counterclaim

that his Royalty has been underpaid and in full and complete

compromise and satisfaction of the [codefendant’s] Claim that its

Royalty has been underpaid”.   For purposes of the all-events



     6
        The codefendant had a separate settlement agreement and
was not a party to the “Houchin” settlement agreement. Even so,
the codefendant executed his settlement agreement on Dec. 21,
1998.
                                - 12 -

test, once the settlement agreement became effective, as it did

on or before December 31, 1998, it fixed W.C. Houchin Corp.’s

right to receive the settlement amount, regardless of the agreed

upon delivery date.    Therefore, the all-events test was satisfied

in 1998.

               b.     Petitioners’ Arguments and Applicable Law

     Petitioners argue that, under Colorado law, a contract must

be signed and delivered to take effect.    Whether parties have

entered into a contract is a question of fact.     S. Colo. MRI,

Ltd. v. Med-Alliance, Inc., 166 F.3d 1094 (10th Cir. 1999).

     The settlement agreement states that “the Settling Parties

have executed this Settlement Agreement as of December 21, 1998”

and that “This Settlement Agreement shall become effective

immediately upon execution by all Settling Parties”.    As all

parties signed the agreement on or before December 31, 1998, and

the agreement states that it is effective in 1998, we find that

all provisions of the settlement agreement were effective and

accordingly in force in 1998.    Assuming arguendo that delivery is

required for a contract to take effect under Colorado law and

that delivery did not occur until 1999, the above-mentioned

provisions of the settlement agreement cause the effective date

of the contract to be in 1998, and therefore the all-events test

was satisfied in 1998.
                                 - 13 -

            2.    Amount of Income

     The amount of income received by William Houchin,7 on behalf

of his corporation, from ARCO and Exxon in satisfaction of his

counterclaim that his royalties were underpaid is determined by

the terms of the settlement agreement.     The settlement agreement

details an $8 million amount transferred to William Houchin and a

codefendant in satisfaction of their counterclaims that their

royalties were underpaid.     The calculation detailed on the

“Houchin Disbursement Statement” dated December 31, 1998, shows

that William Houchin’s portion of the total settlement was

$6,145,315.      In the notice of deficiency issued to W.C. Houchin

Corp. for the year ending December 31, 1998, respondent

determined a $6,145,315 adjustment to income for “ARCO

settlement-royalty income”.     The parties stipulated that the

correct amount of income received by William Houchin from the

settlement agreement with ARCO and Exxon is $6,145,315.     The

amount of income due William Houchin could be determined with

reasonable accuracy by the end of 1998.8

     C.    Conclusion

     We hold that because the all-events test was satisfied in

1998 and the amount of income could be determined with reasonable

accuracy as of the end of 1998, the settlement agreement income


     7
          See supra note 4.
     8
          See supra note 4.
                                    - 14 -

of $6,145,315 is includable in W.C. Houchin Corp.’s gross income

for the 1998 taxable year.

II.    Section 6662(a) Accuracy-Related Penalty

       A.    Burden of Production

       Section 7491(c) provides that the Commissioner will bear the

burden of production with respect to the liability of any

individual for additions to tax and penalties.        “The

Commissioner’s burden of production under section 7491(c) is to

produce evidence that it is appropriate to impose the relevant

penalty, addition to tax, or additional amount”.         Swain v.

Commissioner, 118 T.C. 358, 363 (2002); see also Higbee v.

Commissioner, 116 T.C. 438, 446 (2001).        Once the Commissioner

has done so, the burden of proof is upon the taxpayer to

establish reasonable cause and good faith.         Higbee v.

Commissioner, supra at 449.         W.C. Houchin Corp. is not an

individual; accordingly, section 7491(c) does not apply to its

case.       See NT, Inc. d.b.a. Natures Touch v. Commissioner, 126

T.C. 191 (2006); Beiner, Inc. v. Commissioner, T.C. Memo. 2004-

219.

       B.    Penalty Analysis

       Pursuant to section 6662(a), a taxpayer may be liable for a

penalty of 20 percent on the portion of an underpayment of tax

(1) attributable to a substantial understatement of tax or (2)

due to negligence or disregard of rules or regulations.        Sec.
                              - 15 -

6662(b).   The term “understatement” means the excess of the

amount of tax required to be shown on a return over the amount of

tax imposed which is shown on the return, reduced by any rebate

(within the meaning of section 6211(b)(2)).    Sec. 6662(d)(2)(A).

Generally, an understatement is a “substantial understatement”

when the understatement exceeds the greater of $5,000 or 10

percent of the amount of tax required to be shown on a return.

Sec. 6662(d)(1)(A).   An understatement is a “substantial

understatement” for a C corporation when the understatement

exceeds the greater of $10,000 or 10 percent of the amount of tax

required to be shown on a return.   Sec. 6662(d)(1)(B).

     Whether applied because of a substantial understatement of

tax or negligence or disregard of rules or regulations, the

accuracy-related penalty is not imposed with respect to any

portion of the underpayment as to which the taxpayer acted with

reasonable cause and in good faith.    Sec. 6664(c)(1).   The

decision as to whether the taxpayer acted with reasonable cause

and in good faith depends upon all the pertinent facts and

circumstances.   Sec. 1.6664-4(b)(1), Income Tax Regs.    Relevant

factors include the taxpayer’s efforts to assess his proper tax

liability, including the taxpayer’s reasonable and good faith

reliance on the advice of a professional such as an accountant.

See id.
                                 - 16 -

            1.   William C. and Josephine Houchin

     Respondent determined an accuracy-related penalty under

section 6662(a) of $53,532 with regard to petitioners William C.

and Josephine Houchin’s 1999 Federal income tax.9      It is clear

from the record that William and Josephine Houchin provided their

accountant, Jim Garner, all records and information necessary to

prepare their 1999 Federal income tax return.       Mr. Garner

conversed with William and Josephine Houchin to determine the

correct treatment of the settlement agreement proceeds.       William

and Josephine Houchin relied upon Mr. Garner to prepare the

return, and Mr. Garner was aware of William and Josephine

Houchin’s reliance.     It is clear from the record that William and

Josephine Houchin reasonably relied in good faith on their

accountant.      We conclude that for the year in issue William and

Josephine Houchin had reasonable cause and acted in good faith as

to any underpayment resulting from the settlement agreement

proceeds.    Accordingly, we hold that William and Josephine

Houchin are not liable for the penalty pursuant to section

6662(a).




     9
        Because we find for respondent with regard to the
recognition of income by W.C. Houchin Corp. in 1998, we need not
decide the deficiency issued to William and Josephine Houchin for
the year 1999 as petitioner and respondent stipulated the
treatment of the adjustments asserted in the notice of
deficiency.
                                - 17 -

            2.   W.C. Houchin Corp.

     Respondent determined a tax deficiency of $1,211,643 for

1998.

     William Houchin provided the accountant that prepared W.C.

Houchin Corp.’s Federal income tax return, Jim Garner, all

records and information necessary to prepare its 1998 Federal

income tax return.    Mr. Garner conversed with William Houchin to

determine the correct treatment of the settlement agreement

proceeds.    William Houchin relied upon Mr. Garner to prepare the

return, and Mr. Garner was aware of Mr. Houchin’s reliance.    It

is clear from the record that W.C. Houchin Corp. reasonably

relied in good faith on its accountant.    Consequently, we

conclude that for 1998 W.C. Houchin Corp. had reasonable cause

and acted in good faith as to any underpayment resulting from the

settlement agreement proceeds.    Accordingly, we hold that W.C.

Houchin Corp. is not liable for the penalty pursuant to section

6662(a).

     In reaching our holding herein, we have considered all

arguments made, and, to the extent not mentioned above, we

conclude that they are irrelevant or without merit.

     To reflect the foregoing,

                                           Decisions will be entered

                                      under Rule 155.
