T.C. Memo. 2004-56
UNITED STATES TAX COURT
GERALD E. JOHNSON AND DOROTHY JOHNSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7536-98. Filed March 9, 2004.
Garry A. Pearson, Jon J. Jensen, and Alexander F. Reichert,
for petitioners.
Blaine C. Holiday, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
CHIECHI, Judge: Respondent determined deficiencies of
$3,764, $3,755, and $8,068 in petitioners’ Federal income tax
(tax) for 1993, 1994, and 1995, respectively.
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We must decide1 whether certain amounts (reduced by the
deductions attributable to such amounts) that petitioners re-
ceived during the years at issue and that they characterized as
rent are subject to self-employment tax under section
1402(a)(1).2 We hold that they are not.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
At the time petitioners filed the petition in this case,
they resided in Hector, Minnesota.
In 1962, Gerald E. Johnson (Mr. Johnson) began farming. In
1963, Dorothy Johnson (Ms. Johnson) began farming with Mr.
Johnson. Prior to 1989, petitioners farmed 1,030 acres of land,
537 acres of which they owned. Third parties owned the remaining
493 acres.
From the time Mr. Johnson began farming in 1962, he under-
took everything pertaining to running a crop farm by performing
the following farm-related activities in the production of
agricultural commodities: Purchasing crop inputs; selling,
planting, and harvesting crops; hiring, managing, and firing
1
In addition to the issue that we address herein, there are
other determinations in the notice of deficiency (notice) that
are computational in that their resolution flows automatically
from our resolution of that issue.
2
All section references are to the Internal Revenue Code in
effect for the years at issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
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employees; assisting with computer bookkeeping; driving trucks;
securing the farmland; and making the business profitable. From
the time Ms. Johnson began farming in 1963, she performed the
following farm-related activities in the production of agricul-
tural commodities: Maintaining the books and preparing monthly
reports for the accountant; preparing payroll; paying employees;
depositing employment taxes; banking; preparing food for employ-
ees; picking up supplies; driving trucks and tractors; hauling
employees from field to field; monitoring the radio and respond-
ing to communications; maintaining the farmyard by mowing lawns;
and other farm help as needed.
In October 1989, petitioners formed G.E. Johnson, Inc., and
each of them owned 50 percent of the stock of that corporation.
At all relevant times, G.E. Johnson, Inc., engaged in the farming
business, specifically the production of cash crops. During each
of the years at issue, G.E. Johnson, Inc., farmed 1,813 acres of
land, 617 acres of which petitioners owned. Third parties owned
the remaining 1,196 acres.
After the formation of G.E. Johnson, Inc., that company
hired Mr. Johnson and Ms. Johnson pursuant to an oral arrangement
(oral employment arrangement)3 under which they were to serve as
its chief executive officer (CEO) and chief financial officer
3
During the years at issue, petitioners had no written
employment agreement with G.E. Johnson, Inc.
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(CFO), respectively, and were to perform in such respective
capacities the same farm-related activities in the production of
agricultural commodities that they had been performing since they
began farming in the early 1960's (petitioners’ farm-related
activities).4 Pursuant to that arrangement, at all relevant
times, including during the years at issue, Mr. Johnson,5 as CEO,
and Ms. Johnson,6 as CFO, performed those activities.
At all relevant times before and after petitioners incorpo-
rated their farming operations, the success of those operations
depended upon petitioners’ farm-related activities.
During the years at issue, G.E. Johnson, Inc., did not pay
any wages or other compensation to petitioners in exchange for
petitioners’ farm-related activities in the production of agri-
cultural commodities, except for $1,000 of wages paid to Mr.
Johnson and $44,878 of compensation paid to Mr. Johnson and/or
Ms. Johnson during 1994 and 1995, respectively.
During each of the years at issue, petitioners leased to
G.E. Johnson, Inc., pursuant to an oral arrangement (oral rental
4
G.E. Johnson, Inc., did not interview any other individuals
to perform the farm-related activities that it hired petitioners
to perform.
5
At all relevant times, Mr. Johnson spent virtually 100
percent of his time working for G.E. Johnson, Inc.
6
At all relevant times, Ms. Johnson spent 100 percent of her
time working for G.E. Johnson, Inc.
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arrangement) farmland7 and certain personal property that they
owned (petitioners’ farmland and personal property) located in
Renville, Minnesota.8 Pursuant to that arrangement, at all
relevant times, including during the years at issue, that company
paid rent to petitioners for the lease of petitioners’ farmland
and personal property, irrespective of whether or not that
company had a good farming year or had income. During the years
at issue, petitioners did not believe that they were, and they
were not, obligated or compelled to perform petitioners’ farm-
related activities in the production by G.E. Johnson, Inc., of
agricultural commodities as a condition to that company’s being
obligated pursuant to the oral rental arrangement to pay rent to
petitioners.9
Petitioners jointly filed Form 1040, U.S. Individual Income
Tax Return, for each of their taxable years 1993 (petitioners’
1993 return), 1994 (petitioners’ 1994 return), and 1995 (peti-
tioners’ 1995 return). In petitioners’ 1993 return, petitioners
7
G.E. Johnson, Inc., also leased certain other farmland from
third-party landlords pursuant to oral rental arrangements with
those third-party landlords.
8
During the years at issue, petitioners had no written
rental agreement with G.E. Johnson, Inc.
9
Even if during the years at issue petitioners became sick
or incapacitated or otherwise were unable to perform for G.E.
Johnson, Inc., petitioners’ farm-related activities in the
production of agricultural commodities, that company was nonethe-
less obligated pursuant to the oral rental arrangement to pay
rent to them.
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reported that Mr. Johnson received $635 of “Wages, salaries,
tips, etc.” from “HECTOR PUBLIC SCHOOLS” and $330 of “Wages,
salaries, tips, etc.” from “BUFFALO LAKE-HECTOR SCHOOLS”. In
that return, petitioners did not report any wages or other
compensation for services from G.E. Johnson, Inc. In Schedule E,
Supplemental Income and Loss (Schedule E), included as part of
petitioners’ 1993 return, petitioners reported $66,715 in rent
received from the rental of petitioners’ farmland and personal
property (1993 claimed rent), $34,265 in expenses, and $32,450 in
total rental real estate income.
In petitioners’ 1994 return, petitioners reported that Mr.
Johnson received $420 of “Wages, salaries, tips, etc.” from “IND.
SCHOOL DISTRICT #2159". In that return, petitioners reported
that Ms. Johnson did not receive any wages or other compensation
for services from G.E. Johnson, Inc., and that Mr. Johnson
received $1,000 of wages from G.E. Johnson, Inc. In Schedule E
included as part of petitioners’ 1994 return, petitioners re-
ported $60,000 in rent received from the rental of petitioners’
farmland and personal property (1994 claimed rent), $31,240 in
expenses, and $28,760 in total rental real estate income.
In petitioners’ 1995 return, petitioners reported that they
received no wages or compensation from any source. In Schedule E
included as part of petitioners’ 1995 return, petitioners re-
ported $104,878 in rent received from the rental of petitioners’
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farmland and personal property (1995 claimed rent), $32,018 in
expenses, and $72,860 in total rental real estate income.
Immediately prior to the trial in this case, petitioners conceded
that $44,878 of the $104,878 of the 1995 claimed rent was not
received for the lease of petitioners’ farmland and personal
property pursuant to the oral rental arrangement and is subject
to self-employment tax. (For convenience, we shall refer to the
$60,000 balance ($104,878 minus $44,878) of such claimed rent as
the modified 1995 claimed rent.)
The 1993 claimed rent, the 1994 claimed rent, and the
modified 1995 claimed rent that petitioners received during the
respective years at issue from G.E. Johnson, Inc., pursuant to
the oral rental arrangement represented fair market rents and are
consistent with the rents paid during those years by G.E. John-
son, Inc., to other third-party landlords.
G.E. Johnson, Inc., filed Form 1120, U.S. Corporation Income
Tax Return, for each of its taxable years ended October 31, 1993
(G.E. Johnson, Inc.’s 1993 return), October 31, 1994 (G.E.
Johnson, Inc.’s 1994 return), October 31, 1995 (G.E. Johnson,
Inc.’s 1995 return), and October 31, 1996 (G.E. Johnson, Inc.’s
1996 return). In G.E. Johnson, Inc.’s 1993 return, G.E. Johnson,
Inc., reported that it paid $20,000 of compensation to Mr.
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Johnson as an officer of that company10 and that it did not pay
any compensation to Ms. Johnson as an officer. In that return,
G.E. Johnson, Inc., reported that it paid $38,082 of salaries and
wages, although it did not identify in that return the person or
persons to whom it paid those wages. In G.E. Johnson, Inc.’s
1993 return, G.E. Johnson, Inc., reported that it paid $145,628
in rent, although it did not specify in that return the amount of
such rent that it paid to petitioners during its taxable year
ended October 31, 1993.
In G.E. Johnson, Inc.’s 1994 return, G.E. Johnson, Inc.,
reported that it paid $1,000 of compensation to Mr. Johnson as an
officer of that company and that it did not pay any compensation
to Ms. Johnson as an officer. In that return, G.E. Johnson,
Inc., reported that it paid $43,544 of salaries and wages,
although it did not identify in that return the person or persons
to whom it paid those wages. In G.E. Johnson, Inc.’s 1994
return, G.E. Johnson, Inc., reported that it paid $122,014 in
rent, although it did not specify in that return the amount of
such rent that it paid to petitioners during its taxable year
ended October 31, 1994.
10
As discussed above, petitioners’ 1993 return did not
report any wages or other compensation received from G.E. John-
son, Inc. Although not clear from the record, we presume that
G.E. Johnson, Inc., paid to Mr. Johnson sometime during the last
two months of 1992 the $20,000 of compensation that it reported
it paid to him as an officer during its taxable year ended Oct.
31, 1993.
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In G.E. Johnson, Inc.’s 1995 return, G.E. Johnson, Inc.,
reported that it did not pay any compensation to Mr. Johnson or
Ms. Johnson as officers of that company. In that return, G.E.
Johnson, Inc., reported that it paid $47,040 of salaries and
wages, although it did not identify in that return the person or
persons to whom it paid those wages. In G.E. Johnson, Inc.’s
1995 return, G.E. Johnson, Inc., reported that it paid $175,497
in rent, although it did not specify in that return the amount of
such rent that it paid to petitioners during its taxable year
ended October 31, 1995.
In G.E. Johnson, Inc.’s 1996 return, G.E. Johnson, Inc.,
reported that it did not pay any compensation to Mr. Johnson or
Ms. Johnson as officers of that company. In that return, G.E.
Johnson, Inc., reported that it paid $49,816 of salaries and
wages, although it did not identify in that return the person or
persons to whom it paid those wages. In G.E. Johnson, Inc.’s
1996 return, G.E. Johnson, Inc., reported that it paid $181,763
in rent, although it did not specify in that return the amount of
such rent that it paid to petitioners during its taxable year
ended October 31, 1996.
On January 22, 1998, respondent issued a notice to petition-
ers with respect to their taxable years 1993, 1994, and 1995. In
that notice, respondent determined that the 1993 claimed rent,
the 1994 claimed rent, and the 1995 claimed rent, reduced by the
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deductions attributable to such respective rents, are subject to
self-employment tax for the respective years at issue because
they constitute net earnings from self-employment under section
1402(a)(1).
OPINION
Petitioners bear the burden of proving that the determina-
tions in the notice that remain at issue are erroneous.11 See
Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
The ultimate dispute between the parties that we must
resolve is whether the 1993 claimed rent, the 1994 claimed rent,
and the modified 1995 claimed rent, reduced by the deductions
attributable to such respective rents, are subject to self-
employment tax because they constitute net earnings from self-
employment under section 1402(a)(1).
As applicable here, section 1402(a)(l) defines the term “net
earnings from self-employment” to mean
the gross income derived by an individual from any
trade or business carried on by such individual, less
the deductions allowed by this subtitle which are
attributable to such trade or business * * * except
that in computing such gross income and deductions
* * *--
(1) there shall be excluded rentals from real
11
Sec. 7491(a) is not applicable in the instant case. That
is because respondent issued the notice to petitioners on Jan.
22, 1998, and a fortiori the examination of the years at issue
would have commenced before July 23, 1998. See Internal Revenue
Service Restructuring and Reform Act of 1998, Pub. L. 105-206,
sec. 3001(c), 112 Stat. 727.
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estate and from personal property leased with the
real estate * * * together with the deductions
attributable thereto * * * except that the preced-
ing provisions of this paragraph shall not apply
to any income derived by the owner or tenant of
land if (A) such income is derived under an ar-
rangement, between the owner or tenant and another
individual, which provides that such other indi-
vidual shall produce agricultural * * * commodi-
ties * * * 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;
(The regulations under section 1402(a)(1), and we, refer to the
farm rental income that is included under that section in the
definition of net earnings from self-employment as includible
farm rental income.)
The regulations under section 1402(a)(1) elaborate on the
meaning of includible farm rental income, as follows:
(b) Special rule for “includible farm rental
income”--(1) In general. * * * there shall be included
in determining net earnings from self-employment for
taxable years ending after 1955 any income derived by
an owner or tenant of land, if the following require-
ments are met with respect to such income:
(i) The income is derived under an arrangement
between the owner or tenant 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 or
tenant in the production or the management of the
production of such agricultural * * * commodities; and
(ii) There is material participation by the owner
or tenant with respect to any such agricultural * * *
commodity.
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Income so derived shall be referred to in this section
as “includible farm rental income”.
(2) Requirement that income be derived under an
arrangement. In order for rental income received by an
owner or tenant of land to be treated as includible
farm rental income, such income must be derived pursu-
ant to a sharefarming or other rental arrangement which
contemplates material participation by the owner or
tenant in the production or management of production of
agricultural * * * commodities.
(3) Nature of arrangement. (i) The arrangement
between the owner or tenant and the person referred to
in subparagraph (1) of this paragraph may be either
oral or written. The arrangement must impose upon such
other person the obligation to produce one or more
agricultural * * * commodities * * * on the land of the
owner or tenant. In addition, it must be within the
contemplation of the parties that the owner or tenant
will participate in the production or the management of
the production of the agricultural * * * commodities
required to be produced by the other person under such
arrangement to an extent which is material with respect
either to the production or to the management of pro-
duction of such commodities or is material with respect
to the production and management of production when the
total required participation in connection with both is
considered.
* * * * * * *
(4) Actual participation. In order for the rental
income received by the owner or tenant of land to be
treated as includible farm rental income, not only must
it be derived pursuant to the arrangement described in
subparagraph (1) of this paragraph, but also the owner
or tenant must actually participate to a material
degree in the production or in the management of the
production of any of the commodities required to be
produced under the arrangement, or he must actually
participate in both the production and the management
of the production to an extent that his participation
in the one when combined with his participation in the
other will be considered participation to a material
degree. * * *
Sec. 1.1402(a)-4(b), Income Tax Regs.
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The parties agree that during the years at issue petitioners
were to, and did, participate materially within the meaning of
section 1402(a)(1) in the production by G.E. Johnson, Inc., of
agricultural commodities by performing petitioners’ farm-related
activities. They disagree over whether the 1993 claimed rent,
the 1994 claimed rent, and the modified 1995 claimed rent were
derived under an arrangement within the meaning of section
1402(a)(1)(A) and section 1.1402(a)-4(b)(2), Income Tax Regs.,
between petitioners and G.E. Johnson, Inc., which provided or
contemplated that G.E. Johnson, Inc., was to produce agricultural
commodities on petitioners’ land and that petitioners were to
participate materially in the production of such commodities.
It is petitioners’ position that the claimed rents at issue
were not derived under such an arrangement and that consequently
such claimed rents, reduced by the deductions attributable to
such respective rents, are not subject to self-employment tax
because they do not constitute includible farm rental income
under section 1402(a)(1) and the regulations thereunder. In
support of their position, petitioners rely on the opinion of the
Court of Appeals for the Eighth Circuit in McNamara v. Commis-
sioner, 236 F.3d 410 (8th Cir. 2000), revg. and remanding Bot v.
Commissioner, T.C. Memo. 1999-256, Hennen v. Commissioner, T.C.
Memo. 1999-306, and McNamara v. Commissioner, T.C. Memo. 1999-
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333.12 In reliance on McNamara II, petitioners contend that
the Johnsons are receiving fair market value rental
payments. Although this may result in little or no
other compensation being paid to the taxpayers for the
services they provide to the corporation, this does not
establish the required nexus between the rental pay-
ments and the material participation required to trig-
ger the inclusion of the payments within the definition
of self-employment income. To the contrary, adoption
of the Commissioner’s position would compel the conclu-
sion that the taxpayers, as landlords, are required to
rent property to the corporation at below fair market
value and below the rates paid to third parties. The
“missing link” in the Commissioner’s argument is the
same as in the McNamara case: the corporation’s obli-
gation to make the rental payments is separate and
distinct from the taxpayers’ participation in the
farming operation.
Respondent counters that McNamara II does not require the
result advocated by petitioners in the instant case. Respondent
argues that
The Eighth Circuit in McNamara * * * created a
judicial exception for fair rental value when the
landlord has two independent arrangements with the
lessee for rent and wages and there is no nexus between
the two arrangements.
Petitioners fail to meet the Eighth Circuit’s
standard because they failed to enter into a separate
employment agreement with their corporation, and to the
extent they did, it was so inextricably interrelated
with the oral lease that the nexus is obvious and
cannot be overlooked. Petitioners’ classification of
all funds from the corporation as rent and none as
wages demonstrates that there were not independent
arrangements with respect to real estate rentals and
compensation for services. Moreover, the transaction
12
We shall refer to our respective opinions that the Court
of Appeals for the Eighth Circuit reversed and remanded as Bot I,
Hennen I, and McNamara I and to the opinion of that Court as
McNamara II.
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does not pass muster given the strict scrutiny applied
to such related-party transactions, and given that
exceptions from self-employment tax under section
1402(a)(1) are narrowly construed.
Bot I, Hennen I, and McNamara I involved taxpayers who,
pursuant to certain agreements or arrangements, were to, and did,
participate materially in the production of agricultural commodi-
ties involved in those respective cases. In Bot I and Hennen I,
the taxpayer-owners of the farmland in question entered into
(1) employment agreements or arrangements with their respective
taxpayer-spouses and (2) rental agreements or arrangements with
those spouses. In McNamara I, the taxpayer-owners of the farm-
land in question entered into (1) an employment agreement or
arrangement with their wholly owned corporation and (2) a rental
agreement or arrangement with that corporation.
In Bot I and Hennen I, the taxpayer-owners of the farmland
in question contended that the respective rental agreements or
arrangements involved in those cases did not require their
material participation in the production of the agricultural
commodities in question. We found that the respective taxpayer-
owners in Bot I and Hennen I played a material role in the
production of such commodities under an agreement or arrangement
with their taxpayer-spouses. We further found in Bot I and
Hennen I that the income received from the rental of the respec-
tive taxpayer-owners’ farmland in question was derived under an
arrangement between the taxpayer-owners of the farmland and their
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taxpayer-spouses, which provided that those spouses were to
produce agricultural commodities on that land and that the
taxpayer-owners were to participate materially in the production
of such commodities. We held in Bot I and Hennen I that the
rents at issue in those cases, reduced by the deductions attrib-
utable to such respective rents, were subject to self-employment
tax because they constituted includible farm rental income under
section 1402(a)(1).
In McNamara I, the taxpayer-owners of the farmland in
question contended that the rental agreement or arrangement
involved in that case did not require their material participa-
tion in the production of the agricultural commodities in ques-
tion. We found that the taxpayer-owners played a material role
in the production of such commodities under an agreement or
arrangement with their wholly owned corporation. We further
found in McNamara I that the income received from the rental of
the taxpayers’ farmland in question was derived under an arrange-
ment between the taxpayer-owners and their wholly owned corpora-
tion, which provided that that corporation was to produce agri-
cultural commodities on that land and that the taxpayer-owners
were to participate materially in the production of such commodi-
ties. We held in McNamara I that the rent at issue in that case,
reduced by the deductions attributable to such rents, was subject
to self-employment tax because it constituted includible farm
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rental income under section 1402(a)(1).
The taxpayers in Bot I, Hennen I, and McNamara I appealed
our respective decisions in those cases to the Court of Appeals
for the Eighth Circuit. That Court decided those appeals in one
opinion in McNamara II. In McNamara II, the Court of Appeals for
the Eighth Circuit concluded:
we cannot say the Tax Court clearly erred in conclud-
ing, as a factual matter, that Mrs. McNamara, Mrs. Bot,
and Mrs. Hennen were required–-by their respective
employment agreements or by more informal “arrange-
ments”–-to materially participate in agricultural
production and management, and that all three did in
fact materially participate in those activities. See
Treas. Reg. § 1.1402(a)-4(b) (as amended in 1980).
More promising, however, is taxpayers’ argument
that the lessor-lessee relationships should stand on
their own apart from the employer-employee relation-
ships. To this end, taxpayers insist that the rents in
question were consistent with market rates for agricul-
tural land. In fact, the transcripts of each trial
contain uncontradicted testimony that the rents were at
or slightly below fair market value. * * * The Tax
Court’s decision, however, contains no factual finding
in this regard. Moreover, the Commissioner apparently
did not pursue the issue at trial because, as it con-
tended at oral argument, the amount of the rent is
irrelevant. We disagree.
What is missing from both the Commissioner’s and
the Tax Court’s analyses is any mention of a nexus
between the rents received by Taxpayers and the “ar-
rangement” that requires the landlords’ material par-
ticipation. We believe this omission overlooks §
1402(a)(1)’s requirement that rents be “derived under”
such an arrangement. That is to say, the mere exis-
tence of an arrangement requiring and resulting in
material participation in agricultural production does
not automatically transform rents received by the
landowner into self-employment income. It is only
where the payment of those rents comprise part of such
an arrangement that such rents can be said to derive
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from the arrangement.
Rents that are consistent with market rates very
strongly suggest that the rental arrangement stands on
its own as an independent transaction and cannot be
said to be part of an “arrangement” for participation
in agricultural production. Although the Commissioner
is correct that, unlike other provisions in the Code,
§ 1402(a)(1) contains no explicit safe-harbor provision
for fair market value transactions, we conclude that
this is the practical effect of the “derived under”
language.
McNamara v. Commissioner, 236 F.3d at 412-413.
The Court of Appeals for the Eighth Circuit remanded Bot I,
Hennen I, and McNamara I in order to provide the Commissioner of
Internal Revenue the opportunity to show that a connection
existed between the respective rents and the respective employ-
ment agreements or arrangements involved in those cases. Id. On
remand, the respective parties in Bot I, Hennen I, and McNamara I
declined our invitation to conduct additional trials. As a
result, we found that the rent at issue in each of those cases
was at or below market rates and decided that no deficiency in
self-employment tax existed in any of those cases.
In Golsen v. Commissioner, 54 T.C. 742, 757 (1970), affd.
445 F.2d 985 (10th Cir. 1971), we concluded that we would follow
a Court of Appeals opinion which is squarely in point where
appeal from our decision would lie to that Court of Appeals and
to that court alone. In the instant case, during the years at
issue petitioners had two arrangements with G.E. Johnson, Inc.:
(1) An oral employment arrangement under which petitioners were
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to, and did, participate materially in the production by G.E.
Johnson, Inc., of agricultural commodities by performing peti-
tioners’ farm-related activities; and (2) an oral rental arrange-
ment under which petitioners leased to G.E. Johnson, Inc.,
petitioners’ farmland and personal property. There were two
identical types of arrangements involved in McNamara II. The
issue presented here is whether the claimed rents at issue,
reduced by the deductions attributable to such respective rents,
are subject to self-employment tax because they constitute
includible farm rental income under section 1402(a)(1). That was
the identical issue presented in McNamara II. We conclude that
McNamara II is squarely in point. Moreover, the court to which
an appeal in this case would normally lie is the Court of Appeals
for the Eighth Circuit. We shall follow McNamara II. Golsen v.
Commissioner, supra.
As required by McNamara II, we must determine whether there
was a nexus between (1) the 1993 claimed rent, the 1994 claimed
rent, and the modified 1995 claimed rent that petitioners re-
ceived pursuant to the oral rental arrangement and (2) the oral
employment arrangement under which petitioners were to, and did,
participate materially in the production by G.E. Johnson, Inc.,
of agricultural commodities.13 In making that determination, we
13
We note that in McNamara I there is no indication that the
parties advanced, and the Court did not address, any argument
(continued...)
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bear in mind the conclusions of the Court of Appeals for the
Eighth Circuit in McNamara II that
Rents that are consistent with market rates very
strongly suggest that the rental arrangement stands on
its own as an independent transaction and cannot be
said to be part of an “arrangement” for participation
in agricultural production. Although the Commissioner
is correct that, unlike other provisions in the Code,
§ 1402(a)(1) contains no explicit safe-harbor provision
for fair market value transactions, we conclude that
this is the practical effect of the “derived under”
language.
13
(...continued)
that, because the taxpayer-owners of the farmland in that case
materially participated within the meaning of sec. 1402(a)(1) in
the production of agricultural commodities as employees of their
wholly owned corporation and not in their individual capacities,
the analysis under sec. 1402(a)(1) should be different from the
analysis in Bot I and Hennen I, where the taxpayer-owners of the
farmland involved in those two cases materially participated
within the meaning of sec. 1402(a)(1) in the production of
agricultural commodities in their individual capacities. In
McNamara II, there is no indication that the taxpayers appealing
McNamara I advanced, and the Court of Appeals for the Eighth
Circuit did not address, any argument that the analysis under
sec. 1402(a)(1) with respect to such taxpayers should be any
different from the analysis with respect to the taxpayers appeal-
ing Bot I and Hennen I.
In the instant case, neither petitioners nor respondent
advances any argument that the analysis under sec. 1402(a)(1)
should be different from the analysis in McNamara II because
petitioners materially participated within the meaning of sec.
1402(a)(1) in the production by G.E. Johnson, Inc., of agricul-
tural commodities as employees of G.E. Johnson, Inc., and not in
their individual capacities. Indeed, petitioners rely solely on
the analysis in McNamara II to support their position in the
instant case. Consequently, we shall not address whether our
analysis would be different in the instant case because petition-
ers materially participated within the meaning of sec. 1402(a)(1)
in the production of agricultural commodities by G.E. Johnson,
Inc., as employees of G.E. Johnson, Inc., and not in their
individual capacities.
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McNamara v. Commissioner, 236 F.3d at 413.
We have found based on the stipulation of the parties that
the 1993 claimed rent, the 1994 claimed rent, and the modified
1995 claimed rent represented fair market rents and are consis-
tent with the rents paid during those years by G.E. Johnson,
Inc., to other third-party landlords. On the record before us,
we further find that petitioners have established that during
each of the years at issue there was no nexus between (1) the
1993 claimed rent, the 1994 claimed rent, and the modified 1995
claimed rent that petitioners received pursuant to the oral
rental arrangement and (2) the oral employment arrangement under
which petitioners were to, and did, participate materially in the
production by G.E. Johnson, Inc., of agricultural commodities.
Pursuant to the oral rental arrangement, during the years at
issue G.E. Johnson, Inc., paid rent to petitioners for the lease
of petitioners’ farmland and personal property, irrespective of
whether or not that company had a good farming year or had
income. Moreover, during those years, petitioners did not
believe that they were, and they were not, obligated or compelled
to perform petitioners’ farm-related activities in the production
by G.E. Johnson, Inc., of agricultural commodities as a condition
to that company’s being obligated to pay rent to petitioners
pursuant to the oral rental arrangement.
Based upon our examination of the entire record in this
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case, we find that petitioners have shown that the 1993 claimed
rent, the 1994 claimed rent, and the modified 1995 claimed rent
were not derived under an arrangement within the meaning of
section 1402(a)(1)(A) and section 1.1402(a)-4(b)(2), Income Tax
Regs., between petitioners and G.E. Johnson, Inc., which provided
or contemplated that G.E. Johnson, Inc., was to produce agricul-
tural commodities on petitioners’ land and that petitioners were
to participate materially in the production of such commodities.
On that record, we hold that the 1993 claimed rent, the 1994
claimed rent, and the modified 1995 claimed rent, reduced by the
deductions attributable to such respective rents, are not subject
to self-employment tax because they do not constitute includible
farm rental income and therefore are not net earnings from self-
employment under section 1402(a)(1).
We have considered all of the contentions and arguments of
the parties that are not discussed herein, and we find them to be
without merit, irrelevant, and/or moot.
To reflect the foregoing and the concession of petitioners,
Decision will be entered
under Rule 155.