Bot v. Commissioner

T.C. Memo. 1999-256

UNITED STATES TAX COURT

VINCENT E. & JUDY BOT, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7970-98. Filed August 3, 1999.

Garry A. Pearson and Jon J. Jensen, for petitioners.

Blaine C. Holiday, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

PAJAK, Special Trial Judge: This case was heard pursuant to

section 7443A(b)(3) and Rules 180, 181, and 182. All section

references are to the Internal Revenue Code in effect for the

years in issue. All Rule references are to the Tax Court Rules

of Practice and Procedure.
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FINDINGS OF FACT

Respondent determined deficiencies in petitioners' 1993,

1994, and 1995 Federal income taxes in the amounts of $2,106,

$2,204, and $2,223, respectively.

The sole issue for decision is whether rental payments

received by petitioner Judy Bot (Mrs. Bot) from petitioner

Vincent E. Bot (Mr. Bot) are includable in Mrs. Bot's net

earnings from self-employment under section 1402(a)(1) and thus

subject to self-employment taxes.

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

Petitioners resided in Minnesota at the time the petition was

filed.

Mr. and Mrs. Bot have farmed for approximately 38 years.

During the taxable years at issue, Mr. Bot operated a 460-acre

crop and livestock farm as a sole proprietorship in Minneota,

Minnesota. Mr. Bot owned 160 acres of the farm. Mr. Bot rented

the remaining 300 acres of the farm, under cash rental agreements

at approximately $90 per acre, from Mrs. Bot and Bruce B. Bot.

During the taxable years at issue, Mr. Bot rented 240 acres of

farmland from Mrs. Bot for $90 per acre for a total of $21,600

per year.

Mrs. Bot owned the farmland in her own name. She inherited

one-eighth of the farmland from her parents, and purchased the

remaining seven-eighth from her siblings sometime about 1974.
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Soon thereafter Mr. Bot entered into an oral agreement to lease

the farmland from Mrs. Bot. When petitioners entered into this

oral agreement, petitioners expected that Mrs. Bot would perform

the duties she had been performing in the farming operations.

Since Mr. and Mrs. Bot began farming, Mrs. Bot has provided

general farming services to the endeavor. This includes raising

livestock, farrowing, nursing, cleaning and moving pigs,

operating machinery in the farm yard and in field work, and

harvesting and bailing crops, on the farm. She drives a tractor

mowing, moving snow, and dragging a disk. She also drives the

bailer tractor. Mrs. Bot hauls grain to the bins during the

wheat harvest. She drives to town to pick up parts and supplies.

Mrs. Bot did not participate in planting, weeding, or spraying

crops. Mrs. Bot worked on the farm approximately 1,862 hours per

year.

In 1992, Mrs. Bot entered into a purported Employment

Agreement (Agreement) with Mr. Bot. The Agreement said Mrs. Bot

was to perform various farming services, including raising

livestock, operating machinery, and picking up supplies. In

essence, the Agreement memorialized almost the same duties that

Mrs. Bot had been performing since Mr. and Mrs. Bot began farming

together. The Agreement also said Mrs. Bot could participate in

her husband's medical insurance and medical reimbursement plans.
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Mrs. Bot would have continued to do the same farming jobs even if

there were no Agreement.

For all 3 years in issue, petitioners filed their Forms 1040

income tax returns on a married, filing jointly basis. On their

Schedules E, Supplemental Income and Loss, petitioners reported

that Mrs. Bot received net rental income in the amounts of

$17,825, $18,079 and $18,211 in 1993, 1994, and 1995,

respectively. On line 7, Wages, salaries, tips, etc., of their

Forms 1040, petitioners reported that Mrs. Bot received wages in

the amounts of $15,074, $15,165, and $15,296 for 1993, 1994, and

1995, respectively. The identical amounts reported as wages were

deducted as labor hired on the respective Schedules F, Profit or

Loss From Farming, for the years in issue. Mr. Bot failed to

withhold Federal income taxes, State income taxes, Federal

Insurance Contribution Act taxes, and Medicare tax for all 3

years.

In the notice, respondent, inter alia, determined that the

real estate rental payments Mrs. Bot received from Mr. Bot during

the taxable years at issue are includable in Mrs. Bot's net

earnings from self-employment under section 1402(a)(1), and thus

subject to self-employment tax. Respondent also allowed

petitioners a deduction for one-half of the self-employment taxes

imposed for the taxable years at issue.
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On the Forms 4797, Sales of Business Property, attached to

their returns, Mr. and Mrs. Bot reported gains from the sales of

sows in 1993, gains from sales of sows in 1994, losses from sales

of gilts and boars in 1994, and losses form the sale of boars in

1995. One of the adjustments to their income which is not in

issue was that Mr. and Mrs. Bot each received Minnesota Corn

Processors Income.

OPINION

Section 1401 provides that a tax shall be imposed on the

self-employment income of every individual. Generally, rentals

from real estate are excluded from the computation of net

earnings from self-employment. Sec. 1402(a)(1). However,

section 1402(a)(1) also provides that rentals derived by the

owner or tenant of land are not excluded from the computation of

net earnings from self-employment if:

(A) such income is derived under an arrangement, between the
owner or tenant and another individual, which provides that
such other individual shall produce agricultural * * *
commodities (including livestock * * *) on such land, and
that there shall be material participation by the owner or
tenant * * * in the production or the management of the
production of such agricultural * * * commodities, and (B)
there is material participation by the owner or tenant * * *
with respect to any such agricultural * * * commodity;

In other words, as the regulations provide in pertinent

part, if the rental income is derived under an arrangement

between the owner of land (owner) and another person which
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provides that such other person shall produce agricultural

commodities on such land, and that there shall be material

participation by the owner in the production or the management of

the production of such agricultural commodities, and there is

such material participation by the owner, then the rental income

received by the owner pursuant to the arrangement is considered

earnings from self-employment. Sec. 1.1402(a)-4(b), Income Tax

Regs. Such income is characterized as "includible farm rental

income". Id.

In determining whether compensation is includable in

self-employment income under sections 1401-1403 such provisions

are to be broadly construed so as to favor coverage for Social

Security purposes. Braddock v. Commissioner, 95 T.C. 639, 644

(1990). The rental exclusion in section 1402(a)(1) is to be

strictly construed to prevent this exclusion from interfering

with the congressional purpose of effectuating maximum coverage

under the Social Security umbrella. Johnson v. Commissioner, 60

T.C. 829, 832 (1973).

Petitioners contend that the oral lease agreement does not

require material participation by Mrs. Bot in the farming

operations. Petitioners further contend that the rental income

that Mrs. Bot received from Mr. Bot was rental from real estate,

and therefore should be excluded in determining whether Mrs. Bot
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had any net earnings from self-employment as that term is used in

section 1402(a)(1).

In light of all the facts and circumstances, we must decide

whether Mrs. Bot received rental income from Mr. Bot pursuant to

an "arrangement" between the parties to produce agricultural

commodities on the farm within the meaning of section

1402(a)(1)(A).

In Mizell v. Commissioner, T.C. Memo. 1995-571, this Court

explained that:

The word "arrangement" is defined as an agreement.
Webster's Third New International Dictionary 120 (1993).
While the concept of an agreement certainly includes a
contractual agreement, it is a broader concept that would
also include other forms of agreements not necessarily
arising from strict contractual relationships. Consistent
with its dictionary definition, in most of the instances
where it is used in the Internal Revenue Code, the word
"arrangement" refers to some general relationship or overall
understanding between or among parties in connection with a
specific activity or situation. Generally, it is not
limited only to contractual relationships, or used in a way
that suggests that its terms and conditions must be included
in a single agreement, contractual or otherwise. Congress
obviously recognized a distinction between a contract and
the broader concept of an "arrangement", as is evident from
those sections of the Internal Revenue Code that make
reference to both. * * *

The parties stipulated that Mr. Bot used the farmland to

produce agricultural commodities such as livestock and crops.

With respect to whether under the arrangement Mrs. Bot was to

materially participate in the farming operations, we look not

only to the obligations imposed upon Mrs. Bot by the oral lease,
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"but to those obligations that existed within the overall scheme

of the farming operations which were to take place" on Mrs. Bot's

property. Mizell v. Commissioner, T.C. Memo. 1995-571.

(Emphasis supplied.) These include Mrs. Bot's obligations as a

longstanding participant in the farming business as well as the

"general understanding between * * * [Mr. Bot and Mrs. Bot] with

respect to the production of agricultural products". Id. Viewed

in this light, the arrangement between Mr. and Mrs. Bot provided,

or contemplated, that Mrs. Bot materially participate in the

production of agricultural commodities on the farmland.

Mr. Bot claimed he made all the management decisions and,

despite 38 years of history to the contrary, asserted that he

could operate his farm without help from his wife. Under these

circumstances, we are not required to accept the self-serving

testimony of Mr. Bot as gospel. Tokarski v. Commissioner, 87

T.C. 74, 77 (1986). Although petitioners contend that the

purported oral lease agreement did not require Mrs. Bot to

materially participate in the farming operations, the record

supports a finding that Mrs. Bot played a material role in the

production of agricultural commodities under an arrangement with

her husband.

For about 38 years through the taxable years at issue, Mrs.

Bot performed general farming services on the farm on a regular

and intermittent basis, as we detailed in the findings of fact.
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Petitioners admitted that in addition to farrowing and other

activities concerning their swine, Mrs. Bot operated farm

machinery, harvested and bailed crops, and picked up supplies on

a semiweekly basis. As noted, Mrs. Bot worked on the farm

approximately 1,862 hours per year. We deem it immaterial that

Mrs. Bot also purportedly was paid a salary for her services with

a corresponding deduction taken on their tax returns. In our

view, these "regularly performed services are material to the

production of an agricultural commodity, and the intermittent

services performed are material to the production operations to

which they relate." Sec. 1.1402(a)-4(b)(6) Example (1), Income

Tax Regs.

The regulations provide in pertinent part, that if the

rental income is derived under an arrangement between the owner

of land and another person which provides that such other person

shall produce agricultural commodities on such land, and that

there shall be material participation by the owner in the

production or the management of the production of such

agricultural commodities, and there is such material

participation by the owner, then the rental income received by

the owner pursuant to the arrangement is considered earnings from

self-employment. Sec. 1.1402(a)-4(b), Income Tax Regs.

Accordingly, we find that the rental income is includable farm

rental income that is part of Mrs. Bot's net earnings from self-
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employment under section 1402(a)(1) for each of the taxable years

at issue.

We have considered all of the arguments presented by the

parties, and, to the extent not discussed above, they are without

merit or not relevant.

To reflect the foregoing,

Decision will be entered

for respondent.