This post was originally published on Forbes Oct 27, 2015
Maureen O'Hara, who died Saturday, was a classic actress in some classic movies. So I guess it shouldn't be a surprise that she took a whirl at the classic tax shelter - oil wells. Julian Block sometime ago got me into checking whether celebrities who pass away played a role in tax history. That led me to Fitzsimons v Commissioner (37 TC 179), which was decided by Judge William Fay in 1961 in the first year of his service on the court. Judge Fay helpfully mention that "The petitioner is a motion picture actress known professionally as Maureen O'Hara.
The Need For Shelter
The years at issue were 1954 and 1955 and you can understand why Ms. O'Hara would have been seeking shelter. There are 14 films in her filmography from 1950 to 1955 including the classic Quiet Man in 1952
and two of my favorites The Long Gray Line in 1955
and Rio Grande in 1950
The top marginal rate in those days was 91%. A big attraction of oil as an investment was the percentage depletion deduction. What is great about percentage depletion is that you can keep deducting even after you have recovered your cost, which is why owning a gold mine is like owning a gold mine , while owning an oil well can be even better. Percentage depletion for oil wells was 27.5% of revenue limited to 50% of net income from the property. And this was before they started with all those silly alternative minimum tax things and passive activity loss rules were not even on the horizon.
The problem for Ms. O'Hara was that her advisers (I'm thinking it was her advisers anyway) were a bit too aggressive. She made two $50,000 lease payments in 1954 and 1955
On December 20, 1954, the petitioner acquired a lease from the Cuban Corporations under which she would have the right to select 250,000 hectaries of the land covered by the grants from the Cuban Government. The lease was to run for 2 years and for so long as exploration or drilling operations were being conducted and thereafter for so long as oil, gas, or other hydrocarbon substance was being produced in commercial quantities from the selected land.
Judge Fay ruled that since the payments would provide benefits beyond the two years they had to be capitalized.
In any event, these bonus payments are not deductible. A payment may not be deducted solely on the grounds that it is not a capital payment. It must be shown further that the payment is an ordinary and necessary expense.York Water Co. , 36 T.C. 1111 (1961). In the present case the payment of the bonus resulted in a longstanding direct benefit to the petitioner. This benefit was to extend into the indefinite future. Therefore, it cannot reasonably be said that the payment was an ordinary and necessary expense to be deducted in a single year.
There has to be a sort of cruel irony about Ms. O'Hara being told that she needed to have capitalized her 1954 and 1955 payments to acquire Cuban oil interests in 1961 of all years just a few months after the ill-fated Bay of Pigs Invasion and less than a year before the missile crisis. Hopefully, the deficiency didn't eat up everything from the Parent Trap.
About Oil Deals And High Marginal Rates
I remember learning about what an abuse oil and gas depletion was when I was a high school lad, before I knew anything else about taxes (There was an article about it in Ramparts). The rate was cut to 22% in 1969 and 15% in 1975 and percentage depletion in excess of basis became an AMT preference. Tax shelters became such an important factor in the oil industry that when the Tax Reform Act of 1986 killed most classic shelters, a special exception for "working interests in oil and gas property" was carved out (Section 469(c)(3)). You will still see things about limiting oil and gas tax breaks as in this discussion of President Obama's budget.
Republican presidential candidates have been calling for cuts in the top marginal rate from 39.6%. Democrats, except for Lincoln Chafee, who has dropped out, have not come out with any proposed rates. Bernie Sanders has indicated that his top rate might be over 50%.
I'm afraid that a move like that would send us back to the days of obsessive sheltering, but we'll see.