## Facts

- Skelly Oil Company, an Oklahoma natural gas producer, sold gas at prices set by an Oklahoma Corporation Commission minimum price order.
- After the minimum price order was vacated, Skelly faced customer claims for refunds of prior “overcharges.”
- In 1958, Skelly refunded $505,536.54 to two customers for overcharges spanning 1952–1957.
- In the earlier years, Skelly included the refunded amounts in gross income under a claim of right.
- Skelly also treated the receipts as “gross income from the property” and took a 27.5% percentage depletion deduction under I.R.C. § 613 on those same receipts, so the receipts increased taxable income by less than their gross amount.
- For 1958, Skelly claimed a deduction for the full $505,536.54 under I.R.C. § 1341.
- The Commissioner allowed a deduction but reduced it by the prior percentage depletion attributable to the refunded receipts and assessed a deficiency.
- The district court upheld the Commissioner; the Tenth Circuit reversed; the Supreme Court reversed the Tenth Circuit.

## Issues

1. Whether I.R.C. § 1341 permits a taxpayer to deduct the full amount of a repayment when the income repaid previously generated percentage depletion deductions, or whether the repayment deduction must be reduced to reflect the portion not effectively taxed when received.

## Decision

- The Supreme Court reversed the Tenth Circuit and ruled for the United States.
- The Court held that the § 1341 deduction in the year of repayment must be reduced by the percentage depletion previously allowed on the refunded receipts.
- The Court reasoned that § 1341 is intended to approximate the tax outcome that would have occurred had the taxpayer not received the income, not to provide an additional tax advantage.
- Allowing a full deduction would produce the practical equivalent of a double deduction because part of the income had not increased taxable income due to prior percentage depletion.
- Skelly’s allowable repayment deduction was limited to the portion of the receipts that had actually increased taxable income in the years of receipt.

## Legal Principles

- I.R.C. § 1341 relief is coordinated with other Code provisions; it does not authorize deductions that exceed the prior taxable impact of the item included under a claim of right.
- A repayment deduction under § 1341 must be reduced to prevent the practical equivalent of a double deduction when prior allowances (such as percentage depletion) already reduced the taxable effect of the income.
- The Code should not be construed to allow a deduction for repaying amounts that were not taxed when received due to statutory deductions.

## Conclusion

The Court held that § 1341 does not permit a full deduction for refunded amounts when prior percentage depletion reduced the taxable effect of the original receipts; the repayment deduction must be limited to the portion that previously increased taxable income.


United States v. Skelly Oil Co., 394 U.S. 678 (1969)