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DOJ Maintains Wife's Farm Rental Income Self-Employment Income

FEB. 17, 2000

John P. Hennen, et ux. v. Commissioner

DATED FEB. 17, 2000
DOCUMENT ATTRIBUTES
  • Case Name
    JOHN P. HENNEN AND TERESA HENNEN, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee
  • Court
    United States Court of Appeals for the Eighth Circuit
  • Docket
    No. 99-3968
  • Institutional Authors
    Department of Justice
  • Cross-Reference
    John P. Hennen, et ux. v. Commissioner, T.C. Memo 1999-306 (For the

    full text, see Doc 1999-30375 (10 original pages) or 1999 TNT 180-7 Database 'Tax Notes Today 1999', View '(Number'.)
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    self-employment income
  • Industry Groups
    Agriculture
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2000-5480 (49 original pages)
  • Tax Analysts Electronic Citation
    2000 TNT 48-26

John P. Hennen, et ux. v. Commissioner

 

=============== SUMMARY ===============

 

In a brief for the Eighth Circuit, the Justice Department has argued that the rental income a wife received from leasing farmland to her husband was self- employment income.

Teresa Hennen owns 200 acres of farmland that she leased to her husband, John, who operated a crop and livestock farm as a sole proprietorship. Teresa worked approximately 1,000 hours a year on the farm. In each of the years at issue (1993-95), Teresa entered into purported employment agreements with her husband. For the years at issue, they reported the net rental income Teresa received from her husband, and the wages she received.

The IRS determined that the rental payments constituted self- employment income under section 1402(a)(1). The Tax Court agreed, ruling that the rental payments were "includable farm rental income" under Reg. Section 1.1402(a)-4(b) because Teresa materially participated in the production of agricultural commodities on the farmland. (For the full text of that memorandum opinion, see Doc 1999-25965 (10 original pages) or 1999 TNT 149-6 Database 'Tax Notes Today 1999', View '(Number'.)

The Justice Department argues that the rental income was clearly subject to self-employment taxes because Teresa materially participated in the production of agricultural commodities under an arrangement with her husband that contemplated or required her material participation in the production of agricultural commodities. The DOJ disputes the Hennens' argument that Congress intended to limit the farm rental income that must be included in "net earnings from self-employment" under section 1402(a)(1) to sharecropping arrangements as contrary to the plain language of the statute. The Justice Department also emphasizes that there is no requirement in the statute that the lease provisions and the material participation provisions of the arrangement be contained in one document.

 

=============== FULL TEXT ===============

 

IN THE UNITED STATES COURT OF APPEALS

 

FOR THE EIGHTH CIRCUIT

 

 

ON APPEAL FROM THE DECISION OF THE

 

UNITED STATES TAX COURT

 

 

BRIEF FOR THE APPELLEE

 

 

PAULA M. JUNGHANS

 

Acting Assistant Attorney

 

General

 

 

THOMAS J. CLARK (202) 514-9084

 

SARA ANN KETCHUM (202) 514-9838

 

Attorneys

 

Tax Division

 

Department of Justice

 

Post Office Box 502

 

Washington, D.C. 20044

 

 

SUMMARY AND REQUEST FOR ORAL ARGUMENT

[1] John P. and Teresa Hennen, taxpayers, brought the instant suit in the United States Tax Court seeking review of the Commissioner's determination that income they reported from the rental of real estate was includible farm rental income under Section 1402(a)(1) of the Internal Revenue Code and, thus, was subject to self-employment tax. After a hearing, the Tax Court held that the income in issue was includible farm rental income because Mrs. Hennen materially participated in the production of agricultural commodities on the rented land under an arrangement with Mr. Hennen which contemplated her material participation in the operation of the farm. Taxpayers now appeal.

[2] The Commissioner of Internal Revenue, appellee herein, hereby respectfully informs the Court that he believes that oral argument of twenty minutes per side would be helpful in this case because it (together with McNamara v. Commissioner (8th Cir. No. 99- 3876), and Bot v. Commissioner (8th Cir. No. 99-3891)) presents an issue of first impression which is of broad administrative importance. The issue affects not only agricultural landlords' liability for self-employment tax, but also their eligibility for social security benefits.

TABLE OF CONTENTS

Summary and request for oral argument

 

Table of contents

 

Table of authorities

 

Jurisdictional statement

 

Statement of the issue

 

Statement of the case

 

Statement of facts

 

Summary of argument

 

Argument

 

 

     The Tax Court correctly found that Mrs. Hennen's income

 

     from renting land to her husband for use in the family

 

     farming operation was includible farm rental income subject

 

     to self-employment tax

 

 

     Standard of review

 

 

     A. Introduction

 

        1. The statutory scheme

 

        2. The history of coverage of farm income under social

 

           security

 

 

     B. The Tax Court correctly found that the "arrangement" between

 

        Mr. and Mrs. Hennen required or contemplated Mrs. Hennen's

 

        material participation in the production of argricultural

 

        commodities on the rented land

 

 

     C. The Tax Court correctly found that Mrs. Hennen "materially

 

        participated" in the production of agricultural commodities

 

        on the rented land

 

 

     D. Taxpayers's remaining arguments are meritless

 

 

Conclusion

 

Certificate of compliance

 

 

                        TABLE OF AUTHORITIES

 

 

CASES:

 

 

American Tobacco Co. v. Patterson, 456 U.S. 63 (1982)

 

Campbell v. Commissioner, 164 F.3d 1140 (8th Cir. 1999)

 

Celebrezze v. Maxwell, 315 F.2d 728 (5th Cir. 1963)

 

Celebrezze v. Miller, 333 F.2d 29 (5th Cir. 1964)

 

Estate of Coffing v. Commissioner, 53 T.C.M. (CCH) 1314 (1987)

 

Delno v. Celebrezze, 347 F.2d 159 (9th Cir. 1965)

 

Foster v. Celebrezze, 313 F.2d 604 (8th Cir. 1963)

 

Foster v. Fleming, 190 F. Supp. 909 (N.D.Iowa 1960)

 

Gill v. Commissioner, 70 T.C.M. (CCH) 120 (1995)

 

Heffley v. Commissioner, 884 F.2d 279 (7th Cir. 1989)

 

Henderson v. Flemming, 283 F.2d 882 (5th Cir. 1960)

 

Hoffman v. Gardner, 369 F.2d 837 (8th Cir. 1966)

 

Johnson v. Commissioner, 60 T.C. 829 (1973)

 

McCormick  v. Richardson, 460 F.2d 783 (10th Cir. 1972)

 

Mizell v. Commissioner, 70 T.C.M. (CCH) 1479 (1995)

 

Newberry v. Commissioner, 76 T.C. 441 (1981)

 

Rasmussen v. Gardner, 374 F.2d 589 (10th Cir. 1967)

 

United States v. Janis, 428 U.S. 433 (1976)

 

United States v. Merriam, 263 U.S. 179 (1923)

 

Wuebker v. Commissioner, 110 T.C. 431 (1998)

 

 

STATUTES:

 

 

Internal Revenue Code (26 U.S.C.):

 

     Section 401(a)(30)

 

     Section 465(c)(6)(B)

 

     Section 1401

 

     Section 1402

 

     Section 1402(a)

 

     Section 2032A

 

     Section 3121

 

     Section 4003(d)

 

     Section 4975(d)(2)

 

     Section 6213(a)

 

     Section 7482(a)(1)

 

     Section 7483

 

     Section 7701(e)(3)

 

 

Social Security Act (42 U.S.C.):

 

     Section 210

 

     Section 211

 

     Section 410(a)

 

     Section 411(a)(2)

 

 

P.L. 761, 83d Cong. section 201(a)

 

 

Social Security Act Amendments of 1950, ch. 809,

 

     Section 208, 64 Stat. 477

 

 

MISCELLANEOUS:

 

 

Fed. R. App. P.:

 

     Rule 13(a)

 

     Rule 28A(c)

 

     Rule 32(a)(7)(C)

 

 

H.R. 1189, 84th Cong., 1st Sess. (1956-2 C.B. 1248)

 

 

S. Rep. 2133, 84th Cong., 2nd Sess. (1956-2 C.B. 1255)

 

 

S. Rep. No. 1669, 81st Cong., 2d Sess. 153-163 (1950-2 C.B. 302)

 

 

7 C.F.R. section 1412.303

 

 

Treasury Regulations (26 C.F.R.):

 

     Section 1.1402(a)-4(b)

 

     Section 1.1402(a)-4

 

 

JURISDICTIONAL STATEMENT

(1) Jurisdiction in court below

[3] The Commissioner sent a notice of deficiency for the years 1994, 1995, and 1996 to John P. and Teresa Hennen (taxpayers), on January 26, 1998. (A. 11.) 1 On April 23, 1998, taxpayers filed a petition in the Tax Court contesting the deficiencies. (A. 1, 3-5.) The petition was timely pursuant to Internal Revenue Code Section 6213(a) (26 U.S.C.).

[4] The Tax Court had jurisdiction pursuant to I.R.C. Sections 6213, 6214, and 7442.

(2) Jurisdiction in this Court

[5] The decision appealed from is a final, appealable order.

[6] This Court has jurisdiction over this appeal pursuant to I.R.C. section 7482(a)(1).

(3) Timeliness of appeal

[7] On September 16, 1999, the Tax Court (Special Trial Judge John J. Pajak) filed memorandum findings of fact and opinion in favor of the Commissioner (Add. 1-10) and, on September 20, 1999, entered a decision accordingly (Add. 11; A. 2). Taxpayers filed a notice of appeal on October 20, 1999. (A. 2, 9-10.) The notice was timely pursuant to Federal Rule of Appellate Procedure 13(a) and I.R.C. section 7483 because it was filed within 90 days after the filing of the decision.

STATEMENT OF THE ISSUE

[8] Whether the Tax Court correctly held that Mrs. Hennen's farm rental income was self-employment income under Section 1402(a)(1) of the Internal Revenue Code because she entered into an arrangement with her husband whereby she materially participated in the production of agricultural commodities on the rented land.

[9] On this issue, the appellee relies on the following authorities:

Campbell v. Commissioner, 164 F.3d 1140 (8th Cir. 1999).

 

Foster v. Celebrezze, 313 F.2d 604 (8th Cir. 1963)

 

Henderson v. Flemming, 283 F.3d 882 (5th Cir. 1960)

 

Mizell v. Commissioner, 70 T.C.M. (CCH) 1479 (1995)

 

I.R.C. section 1402(a) (26 U.S.C.)

 

Treas. Reg. section 1.1402(a)-4(b)

 

 

STATEMENT OF THE CASE

[10] Taxpayers commenced this case by filing a Tax Court petition contesting the Commissioner's determination of deficiencies in self-employment tax for tax years 1994, 1995, and 1996. (A. 3-5.) After a short hearing (Supp. A., 1-20) at which the parties submitted a stipulation of facts, with exhibits (Supp. A. 21-23), 2 the Tax Court ruled in favor of the Commissioner (Add. 1-10), and entered a decision accordingly (Add. 11). Taxpayers now appeal. (A. 9-11.)

STATEMENT OF FACTS

[11] Taxpayers have farmed together for approximately 38 years. (Add. 2; Supp. A. 7, 16.) During the taxable years at issue, Mr. Hennen operated an 1,100-acre crop and livestock farm as a sole proprietorship in Lyon County, Minnesota. (Add. 2; Supp. A. 5.) Mr. Hennen owned approximately 320 acres of the farm; Mrs. Hennen owned approximately 200 acres. 3 (Add. 2; Supp. A. 3, 13.) Mr. Hennen rented Mrs. Hennen's 200 acres of farmland during the years in issue. (Add. 2; Supp. A. 4, 6, 13, 22.)

[12] Mrs. Hennen owned her 200 acres in her own name. (Supp. A. 3-4.) She purchased the land from her uncle in 1972. (Add. 3; Supp. A. 8.) Mrs. Hennen then entered into an oral agreement with her husband to lease the farmland to him for use in the family farm. (Add. 3; Supp. A. 8.) When taxpayers entered into the oral lease, both taxpayers expected that Mrs. Hennen would continue to perform the duties she had been performing in the farming operations. (Add. 3; Supp. A. 9-10, 12, 17.) Since Mr. and Mrs. Hennen began farming, Mrs. Hennen has provided general farming services to the endeavor, including buying, loading, and vaccinating cattle, cleaning the shop, spraying weeds, picking up parts, unloading grain, and driving a tractor. (Add. 3; A. 97; Supp. A. 9, 16.) In addition, Mrs. Hennen performed the farm bookkeeping. (Add. 3; A. 97; Supp. A. 9, 16.) She performed these duties prior to renting the land to her husband. (Add. 3; Supp. A. 4, 9, 16-17.) In short, in Mr. Hennen's words, Mrs. Hennen "has done whatever it takes to make the farm operation run more smoothly," during the 38 years they operated the farm together. (Supp. A. 9.) Mrs. Hennen worked on the farm approximately 1,000 hours per year, or approximately 20 hours per week. (Add. 3; Supp. A. 9, 16.)

[13] In each of the years in issue, Mrs. Hennen entered into a purported Employment Agreement with Mr. Hennen. (Add. 3; A. 98-103.) The agreements said that Mrs. Hennen was to perform bookkeeping, run errands, and help with livestock chores and field work for Mr. Hennen's farming business. (Add. 3-4; A. 98, 100, 102.) In essence, the agreements memorialized almost the same duties that Mrs. Hennen had been performing since Mr. and Mrs. Hennen began farming together. (Add. 4; Supp. A. 17.) The agreements provided, as compensation, that Mrs. Hennen could participate in her husband's medical insurance and medical reimbursement plans and, as "direct compensation," "600 bushels of #2 soybeans" for 1994 (A. 98), and 500 bushels for 1995 and 1996 (A. 100, 102). Mrs. Hennen would have continued to do the same farming jobs even if there had been no agreement and no wages from her husband. (Add. 4; Supp. A. 17-18.)

[14] For all 3 years in issue, taxpayers filed their Forms 1040 income tax returns on a married, filing jointly basis. (Add. 4; A. 27-96.) On their Schedules E, Supplemental Income and Loss, and on the corresponding line on the first page of their returns, taxpayers reported that they received net rental income for 1994, 1995, and 1996, from "FARM AND HOUSE," "FARMS," and "FARMS," in the amounts of $14,322, $12,940, and $12,766, respectively. (Add. 4; A. 37, 62, 83.) On line 7 of their Forms 1040 (Wages, salaries, tips, etc.), taxpayers reported that Mrs. Hennen received wages from Mr. Hennen in the amounts of $3,137.11, $3,250, and $3,487 for 1994, 1995, and 1996, respectively, and, in 1994, petitioners also reported that Mrs. Hennen received wages from World Book, Inc. in the amount of $221.45. (Add. 4; A. 27, 38, 56, 57, 74, 75.) Except for 1996, 4 the amounts deducted as hired labor on the respective Schedules F, Profit or Loss From Farming, for the years in issue exceeded the amounts reported as wages to Mrs. Hennen. (Add. 4; 39, 63.) Mr. Hennen failed to withhold Federal income taxes, State income taxes, Federal Insurance Contribution Act taxes, and Medicare tax from Mrs. Hennen's wages for any of the 3 years. (Add. 4-5; A. 28, 57, 75.)

[15] In the notice of deficiency, the Commissioner determined that the real estate rental payments Mrs. Hennen received from Mr. Hennen during the taxable years at issue were includible in Mrs. Hennen's net earnings from self-employment under Section 1402(a)(1), and thus were subject to self-employment tax. 5 (Add. 5; A. 18, 21, 24, 26.) The Commissioner also allowed taxpayers a deduction for one- half of the self-employment taxes imposed for the taxable years at issue. (Add. 5; A. 14, 26.)

[16] Taxpayers filed a timely petition in Tax Court. (A. 3-5.) The parties submitted a stipulation of facts, with exhibits. (Supp. A. 21-23.)

[17] After a short (approximately half an hour) trial, the Tax Court issued an opinion upholding the deficiencies determined by the Commissioner. The Court noted that the provisions of Section 1402(a) are to be construed in line with the "congressional purpose of effectuating maximum coverage under the Social Security umbrella." (Add. 6.) The Court, therefore, rejected taxpayers' argument that the rental income in question failed to qualify as self-employment income because the lease agreement itself did not require Mrs. Hennen to materially participate in farming operations. The Court observed that the pertinent statutory provision, Section 1402(a)(1), uses the word "arrangement" (as opposed to "lease agreement"). Relying on Mizell v. Commissioner, T.C. Memo 1995-571, the Court held that the word "arrangement" is a broad concept that includes agreements not necessarily arising from strict contractual relationships. (Add. 7.) It includes, the Court said, a "general relationship or overall understanding between or among parties in connection with a specific activity or situation." (Ibid.) On the record in this case, including "Mrs. Hennen's obligations as a longstanding participant in the farming business," the Tax Court concluded that Mrs. Hennen had an "arrangement" with Mr. Hennen whereby she was to materially participate in the production of agricultural commodities. (Add. 8.)

[18] In support of its further finding that Mrs. Hennen's participation in the work of the farm was material, the Court noted that for 38 years, and through the taxable years in question, Mrs. Hennen performed "general farming services" (Add. 9), and that she worked on the farm about 1,000 hours per year (Add. 9). The Court found that, based on taxpayers' admissions, Mrs. Hennen "purchased cattle, loaded cattle, vaccinated cattle, cleaned shop, picked up parts, and unloaded grain, . . . drove a tractor and performed the farm bookkeeping." (Add. 9.) The Court further relied on Mr. Hennen's "candid[]" testimony in the following exchange (Add. 8; Supp. A. 10):

Q [counsel for the Commissioner] And in fact, she does

 

materially participate and help out and pull her share.

 

 

A If you are familiar with the farm, sir, that's what makes

 

a farm successful. Everybody carries their weight.

 

 

The Court further found that Mrs. Hennen regularly performed these services, and that they were material to the production of agricultural commodities. (Add. 9.) The Court held, therefore, that Mrs. Hennen's rental income was self-employment income under Section 1402(a)(1). (Add. 10.)

[19] The Tax Court filed a decision finding deficiencies in taxpayers' federal taxes in the amounts of $1,583 for 1994, $1,562 for 1995, and $1,551 for 1996. (Add. 11.) Taxpayers now appeal. (A. 9-10.)

SUMMARY OF ARGUMENT

[20] Taxpayers are a married couple who operate a farm producing livestock and crops. Mr. Hennen owns 320 acres, and rents 200 acres from Mrs. Hennen. After Mrs. Hennen acquired the property in issue in 1972, taxpayers entered into an oral lease whereby Mr. Hennen rented the land from Mrs. Hennen for use in the family farming operation. Mrs. Hennen reported the rent received from Mr. Hennen as rental income, but she did not pay self-employment tax on this income. The Tax Court correctly held that the rental income was subject to self-employment taxes because Mrs. Hennen materially participated in the production of agricultural commodities under an arrangement with her husband that contemplated or required her material participation in the production of agricultural commodities. Taxpayers now appeal.

[21] The purpose of the self-employment tax is to fund social security benefits for self-employed taxpayers. Both liability for self-employment tax and eligibility for social security benefits hinge on whether the taxpayer has received self-employment income. Self-employment income is defined as "net income from self- employment." Although rental income is normally not subject to self- employment tax, Section 1402(a)(1) of the Internal Revenue Code (and Section 411(a)(1) of the Social Security Act) expressly includes in "net income from self-employment" income from the rental of agricultural property if the following conditions are met: (1) the rental income is derived from an "arrangement" which requires the tenant to produce agricultural commodities on the land and contemplates material participation by the owner in the production of the agricultural commodities and (2) the owner does materially participate in the production or management of the production. Treas. Reg. section 1.1402(a)-4(b)(3) provides that the arrangement may be either written or oral, and that "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.

[22] The two statutory conditions are plainly satisfied in this case. Taxpayers testified that throughout the 38 years they farmed together, Mrs. Hennen performed extensive work on the farm. Indeed, taxpayers stipulated to an exhibit in the Tax Court showing that, during the years in issue, Mrs. Hennen spent about 1,000 hours per year working on the farm, and that the farm tasks she performed were substantial. Moreover, both taxpayers testified that at the time of entering the lease, they expected Mrs. Hennen to continue her substantial work for the farming operation. Accordingly, the Tax Court properly held that Mrs. Hennen had an arrangement with Mr. Hennen whereby she was to materially participate in the production of agricultural commodities and that she did materially participate in that production.

[23] Taxpayers' argument that Congress intended to limit the farm rental income that must be included in "net earnings from self- employment" under Section 1402(a)(1) to sharecropping arrangements is contrary to the plain language of the statute. Moreover, contrary to taxpayers' assertion, there is no requirement in the statute, either explicit or implicit, that the "arrangement" be found within the four corners of the lease agreement.

[24] The Tax Court decision is correct and should be affirmed.

ARGUMENT

THE TAX COURT CORRECTLY FOUND THAT MRS. HENNEN'S INCOME FROM

 

RENTING LAND TO HER HUSBAND FOR USE IN THE FAMILY FARMING

 

OPERATION WAS INCLUDIBLE FARM RENTAL INCOME SUBJECT TO SELF-

 

EMPLOYMENT TAX

 

 

Standard of Review

 

 

[25] Whether farm rental income is includible in self- employment income only if the lease agreement itself (as opposed to an "arrangement" between the parties) requires the owner to materially participate in the production of agricultural commodities is a question of law reviewable de novo. Whether Mrs. Hennen had an arrangement whereby she was to materially participate in the production of agricultural commodities, and whether she did, in fact, materially participate, are questions of fact reviewable only for clear error. See, e.g., Campbell v. Commissioner, 164 F.3d 1140, 1142 (8th Cir. 1999).

A. Introduction

1) The statutory scheme

[26] Section 1401 of the Internal Revenue Code imposes a tax on the "self-employment income" of every individual. The purpose of the self-employment tax is to fund social security benefits for self- employed taxpayers. See Newberry v. Commissioner, 76 T.C. 441, 443 (1981). Both liability for self-employment tax and eligibility for social security benefits based on self-employment income hinge on whether the individual has "self-employment income." Self-employment income is defined as "net earnings from self-employment derived by an individual . . . during any taxable year." I.R.C. section 1402(b). Section 1402(a), in turn, defines "net earnings from self- employment," in pertinent part, as "the gross income derived by an individual from any trade or business carried on by such individual," less any deductions attributable to the business, "plus his distributive share (whether or not distributed) of income or loss . . . from any trade or business carried on by a partnership of which he is a member," with certain exceptions. Section 411(a) of the Social Security Act (42 U.S.C.A. section 411(a)), which deals with eligibility of self-employed persons for social security benefits, contains the same definition.

[27] There are a number of exceptions to the definition of earnings from self-employment in Section 1402 of the Code and 42 U.S.C.A. section 411(a). Generally, these exceptions are intended to exclude sources of income (such as dividends or capital gains) that do not depend on the individual's labor.

[28] As relevant here, Section 1402(a)(1) excludes from self- employment income rentals from real estate "(including such rentals paid in crop shares)." The same provision, however, expressly includes in self-employment income (or, in other words, excepts from this rental income exclusion), rentals of agricultural property in which the owner "materially participates" in the production of agricultural commodities under an "arrangement" with his tenant. Specifically, "any income derived by the owner or tenant of land" is includible farm rental income, and therefore is included in the social security system and is subject to self-employment tax if (I.R.C. section 1402(a)(1)):

(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 or horticultural

 

commodities (including livestock, bees, poultry, and fur-bearing

 

animals and wildlife) on such land, and that there shall be

 

material participation by the owner or tenant (as determined

 

without regard to any activities of an agent of such owner or

 

tenant) in the production or the management of the production of

 

such agricultural or horticultural commodities, and (B) there is

 

material participation by the owner or tenant (as determined

 

without regard to any activities of an agent of such owner or

 

tenant) with respect to any such agricultural or horticultural

 

commodity;

 

 

Thus, to be included in the social security system, farm rental income must meet two criteria, the owner must materially participate in the production of agricultural products on the rented land, and this material participation must be required or contemplated as part of the "arrangement" between the landlord and the tenant. See also Treas. Reg. section 1.1402(a)-4(b)(1)(i) and (ii).

[29] The farm rental income at issue in this case readily satisfies both of these criteria. When Mrs. Hennen leased her land to her husband, both of them expected that she would continue to perform the duties she had been performing in the farming operations. (Add. 3; Supp. A. 9-10, 17.) In the 38 years she has been farming with her husband, including the years in issue here, Mrs. Hennen has provided general farming services to the family farm, including buying, loading, and vaccinating cattle, cleaning the shop, spraying weeds, picking up parts, unloading grain, driving a tractor, and keeping the books for the farm. (Add. 3; A. 97; Supp. A. 9, 16.) According to a summary prepared by taxpayers, Mrs. Hennen worked on the farm an average of 1,000 hours per year during the years in issue. (A. 97.) In these circumstances, Mrs. Hennen plainly had an "arrangement" with Mr. Hennen whereby she was to materially participate in the production of agricultural commodities on the farm. Under the plain language of the statute, therefore, the rent that Mr. Hennen paid to Mrs. Hennen is to be treated as self-employment income.

2. The history of coverage of farm income under social

 

security

 

 

[30] Aside from the plain language of the governing statute, the history regarding the manner in which farm income came to be included in the social security system supports the conclusion that the farm rental income at issue here is self-employment income.

[31] The self-employment tax was originally enacted as part of the Social Security Act Amendments of 1950, ch. 809, section 208, 64 Stat. 477, in order to finance the extension of social security benefits to self-employed individuals. S. Rep. No. 1669, 81st Cong., 2d Sess. 153-163 (1950-2 C.B. 302, 352-360). Prior to the 1950 amendments, self-employed individuals were not covered under the Social Security Act. Henderson v. Flemming, 283 F.2d 882, 884 (5th Cir. 1960). The 1950 Amendments, however, still excluded self- employed farmers from coverage. Farmers were not brought under coverage of the Act until 1954, when Congress deleted an express exclusion from self-employment income of any income derived from agricultural labor. Id, at 884; P.L. 761, 83d Cong. section 201(a).

[32] At the time Congress amended the self-employment provisions of the Social Security Act and the Internal Revenue Code to include income from agricultural labor, income from real estate rentals was already excluded from "self-employment income" by Section 1402(a)(1) of the Code and 411(a)(2) of the Social Security Act. When Congress included income from agricultural labor, it expanded the exclusion for rental income to "rentals paid in crop shares." P.L. 761, 83d Cong. section 201(a). Congress was, thus, "careful . . . to continue to exclude as self-employment income any amounts received as 'rentals from real estate and from personal property leased with the real estate' whether such rental was paid in cash or as a share in crops." Henderson v. Flemming, 283 F.2d at 884.

[33] The provision in issue here was added in 1956 out of concern that the blanket exclusion of rental income for individuals who were not real estate dealers did not adequately reflect the reality of many agricultural arrangements in which the landlord and the tenant shared in the physical or managerial labor. As the Fifth Circuit, explained in Celebrezze v. Maxwell, 315 F.2d at 728,

in 1956, in order not to treat so harshly landlords who were

 

actively involved in commodity production, and who would have an

 

income loss with the onset of old-age or disability, Congress

 

included the 'material participation' exception to the exclusion

 

of real estate rentals.

 

 

Consequently, Congress amended the definition of "net earnings from

 

self-employment" in Section 211 of the Act (now 42 U.S.C. section

 

411(a)(1)) and I.R.C. section 1402(a)(1). As the Fifth Circuit

 

explained, in Celebrezze v. Maxwell, 315 F.2d at 728, the parallel

 

provision of the Social Security Act (42 U.S.C. section 411(a)(2)),

 

 

although worded in the form of an exception to an exclusion, is

 

still clear enough to evince the . . . Congressional intent to

 

protect those persons whose income diminishes or is wiped away

 

because of old age or disability, and to exclude those whose

 

income continues to come in spite of old age or disability. In

 

other words the fruits of someone else's labor or talents were

 

not to be included in 'net earnings from self-employment' of

 

self-employed farmers any more than income from dividends on

 

shares of stock or interest on bonds.

 

 

(Footnote omitted). See also Henderson v. Flemming, 283 F.3d at 887 ("it is perfectly plain that" in passing the 1956 amendments "Congress was intending to bring a new and major group of persons under the Act.")

[34] Although this provision is drafted as an exception to an inclusion, the courts have consistently construed it as including the income described therein. As one of the early cases interpreting the parallel provisions in the Social Security Act, Henderson v. Flemming, 283 F.2d at 887, explained:

It was as though the legislation affirmatively prescribed that

 

net earnings from self-employment shall include such income

 

derived under an arrangement between the owner of land and a

 

tenant which requires that there be material participation by

 

the landowner and in actual operation thereunder, there is in

 

fact material participation by the owner in the production or

 

management of the production of agricultural commodities. As

 

thus phrased, it is an automatic self-executing definition of

 

self-employment income of a particular kind and being self-

 

employment income, it is not 'rentals.' That is all, we think,

 

that Congress undertook to do by the grammatical device of an

 

exception to an exclusion.

 

 

[35] The definition of net earnings from self-employment in the provisions imposing the self-employment tax is identical to the definition of the same term in the provisions governing eligibility for social security benefits. Consistent interpretation of the two provisions by the courts is desirable because it "promotes a symmetrical parallel between the social security eligibility provisions for self-employed persons and the corresponding income tax provisions for taxing self-employed persons for social security purposes, [and] enhances the congressional policy of insuring that the optimum number of potentially eligible persons will be provided for under the social security provisions in the event of their ultimate dependency." Johnson v. Commissioner, 60 T.C. 829, 832-833 (1973); accord Gill v. Commissioner, 70 T.C.M. (CCH) 120, 125 (1995). Social Security provisions are to be interpreted broadly, so as to include the greatest number of individuals in social security coverage. See e.g., Foster v. Celebrezze, 313 F.2d 604, 607 (8th Cir. 1963) (narrow construction of term "material participation" rejected as contrary to principle that the Social Security Act "should be liberally construed"); Rasmussen v. Gardner, 374 F.2d 589, 594 (10th Cir. 1967)("The Congressional policy underlying federal social security legislation requires the courts to interpret the Act liberally, and any doubts should be resolved in favor of coverage."); Henderson v. Flemming, 283 F.3d at 887 n.7 ("'coverage of the [social security] program should be as nearly universal as is practicable'") (quoting from The Report of the Committee on Finance, Senate Calendar No. 2156, 84th Cong., 2d Sess., Rpt. 2133, p. 1.).

[36] The Commissioner's deficiency determination carries with it a presumption of correctness and the taxpayer bears the burden of proving that the determination is incorrect. United States v. Janis, 428 U.S. 433, 440-441 (1976); Campbell v. Commissioner, 164 F.3d 1140, 1142 (8th Cir. 1999).

[37] Taxpayers contend that the farm rental payments in issue fall within the exception from social security coverage and self- employment tax for passive real estate rentals rather than within the material participation inclusion (or "exception to the exclusion") for agricultural rentals. They have the burden of proof as to the factual issues, and have a difficult task in urging a restrictive interpretation of the provisions including income from certain agricultural rentals in self-employment income. They have not met their burden.

B. The Tax Court correctly found that the "arrangement" between

 

Mr. and Mrs. Hennen required or contemplated Mrs. Hennen's

 

material participation in the production of agricultural

 

commodities on the rented land

 

 

[38] Taxpayers argue (Br. 13) that the oral lease agreement Mrs. Hennen entered into with her husband did not require her to engage in any farming operations and therefore they had no "arrangement" whereby she was to materially participate in the production of agricultural commodities. Taxpayers err in interpreting the word "arrangement" so narrowly.

The arrangement provision in Section 1402(a)(1)(A) is as

 

follows: an arrangement, between the owner or tenant and another

 

individual, which provides that such other individual shall

 

produce agricultural or horticultural 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 or horticultural commodities,

 

 

Treas. Reg. section 1.1402(a)-4(b)(3) further explains the

 

arrangement prong of the test, as follows (emphasis added):

 

 

(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 or horticultural 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 or horticultural 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 production 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.

 

 

[39] Neither the Code nor the regulations expressly define the term "arrangement." Under these circumstances, courts look to the plain, obvious and rational meaning of the word. American Tobacco Co. v. Patterson, 456 U.S. 63, 68 (1982); United States v. Merriam, 263 U.S. 179, 187-188 (1923). In Mizell v. Commissioner, 70 T.C.M. (CCH) 1479, 1471-1472 (1995), the Tax Court undertook such an examination:

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.

 

 

Consequently, "in examining an arrangement" under Section 1402(a)(1)(A), the courts should look at the obligations existing "within the overall scheme of the farming operations," and not confine the examination to the leases or to any specific contract. 70 T.C.M. at 1472. 6

[40] Where, as is the case here, the arrangement in issue is not reduced to writing, it is more difficult for the party bearing the burden of proof, such as taxpayers here, to prove what its provisions are, and thus whether it qualifies under the statutory language. Foster v. Celebrezze, 303 F.2d at 606. The courts in such circumstances look to what was "understood" between the parties. Celebrezze v. Miller, 333 F.2d 29, 30-31 (5th Cir. 1964). As this Court in Foster explained (313 F.2d at 606-607)(quoting from Social Security pamphlet OASI-33d):

'The mutual understanding you had with your tenant is your

 

arrangement. Your understanding is shown by your acts, those of

 

your tenant, how you and your tenant acted in previous years on

 

similar matters, common practices in the area, and statements by

 

you, your tenant, or even third persons who may know the facts

 

as to how you intended to operate.'

 

 

Thus, if Mr. and Mrs. Hennen understood that Mr. Hennen would produce agricultural commodities on the rented land, and that Mrs. Hennen would materially participate in the farm work, then they had the type of arrangement contemplated by the statute and regulations.

[41] Taxpayers do not dispute that Mr. Hennen's use of the land for agriculture was part of their arrangement. As noted above, Treas. Reg. section 1.402(a)-4(b)(3) provides that the arrangement prong of the test is met if material participation by the owner in the production of agricultural commodities is "within the contemplation of the parties." Mrs. Hennen testified that, at the time she entered into the lease agreement with her husband, she expected to continue to work on the farm (Supp. A. 16), and Mr. Hennen testified that he expected his wife to continue to work on the farm as she had before the lease (Supp. A. 9, 10, 12). Indeed, Mr. Hennen testified that, on a family farm, such as taxpayers' farm, "everyone" is expected to "pitch[] in" and "carr[y] their weight." (Supp. A. 9-10.) Thus, Mrs. Hennen's material participation was at all times "within the contemplation of the parties." This understanding was confirmed in writing in each of the years in issue, when Mrs. Hennen entered into employment contracts with her husband which required her to perform services on the farm that were essentially the services that she had already been performing throughout their 38 years of farming. (A. 98- 103; Supp. A. 8-9, 17-18.) Thus, based on taxpayers' own testimony, they contemplated that Mrs. Hennen would be required to work on the farm. Consequently, the arrangement prong of the test was met.

[42] The only legal authority taxpayers cite (Br. 19-20) for their contention that an "arrangement" exists only if it is set forth in the four corners of the lease agreement is Foster v. Fleming, 190 F.Supp. 909, 924 (N.D.Iowa 1960). This decision, however was reversed by Foster v. Celebrezze, 313 F.2d 604 (8th Cir. 1963), and therefore is not good law. In any event, that case does not support taxpayers' thesis. Although taxpayers correctly state (Br. 20) that the district court in Foster "looked entirely to the written lease agreement" in its analysis of the arrangement in issue, they do not say why the court did so. The district court made clear that its reliance on the four corners of the lease for the terms of the arrangement was necessitated by the record in the case (which, unlike the record here, contained no other evidence on the issue) (190 F.Supp. at 924), and was not, as taxpayers suggest (Br. 19), based on a legal holding that the terms of the "arrangement" must be found within the four corners of the lease even if there is other evidence in the record about the terms and expectations of the arrangement. The quotation on which taxpayers rely (Br. 19) suggests that conclusion only because they omitted the qualifying introductory phrase "In the present case, as heretofore noted." See 190 F.Supp. at 924. Thus, Foster does not imply, as taxpayers suggest, that the Tax Court here was required to ignore the ample evidence in the record in this case of the arrangement between Mr. and Mrs. Hennen.

[43] In short, the Tax Court correctly looked beyond the lease agreement in this case in finding that there was an "arrangement" between Mr. and Mrs. Hennen that required or contemplated her material participation in the production of agricultural commodities on the rented land.

C. The Tax Court correctly found that Mrs. Hennen "materially

 

participated" in the production of agricultural commodities

 

on the rented land

 

 

[44] As discussed above, the statute applies a two-pronged test to determine whether rental income is includible farm income. The landlord must (1) materially participate in the production of agricultural commodities (the material participation prong) under (2) an arrangement which requires the tenant to produce agricultural commodities and which contemplates the material participation of the landlord (the arrangement prong). Treas. Reg. section 1.1402(a)- 4(b)(4) explains the material participation prong of the test as requiring that (emphasis added):

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.

 

 

Taxpayers' contention (Br. 12-13) that material participation requires participation in management decisions ignores the word "or" in the regulation (and statute). See also, H.R. 1189, 84th Cong., 1st Sess. (1956-2 C.B. 1248, 1253)(A. 106)("it is contemplated that" the landlord "must participate to a material degree in the management decisions or physical work")(emphasis added); S.Rep. 2133, 84th Cong., 2nd Sess. (1956-2 C.B. 1255, 1268-1269)(A. 114)(same); Cf. McCormick v. Richardson, 460 F.2d 783, 787 (10th Cir. 1972) (interpreting the parallel provision under the Social Security Act as contemplating two kinds of participation: physical participation and participation in management). 7

[45] This Court has interpreted "material" as "'of solid or weighty character; substantial; of consequence; not to be dispensed with; important.'" Foster v. Celebrezze, 313 F.2d at 607 (quoting Webster's New International Dictionary, 2d Ed.). The Court further noted that (313 F.2d 607):

We find nothing in the statute or the legislative history to

 

establish a Congressional intention to give the words 'material

 

participation' a strict, unnatural or narrow construction. We

 

believe that the word 'material' should be given its common and

 

well-understood meaning.

 

 

See also Hoffman v. Gardner, 369 F.2d 837, 841 (8th Cir. 1966) (in order to be material, the landlord's "participation need only be of substantial value or importance"). Taxpayers bear the burden of proving that they did not fall under this provision.

[46] Far from being contrary to "uncontradicted" evidence as claimed by taxpayers (Br. 33), the Tax Court's finding (Add. 9) that Mrs. Hennen materially participated in the farming operation during the years in issue is amply supported by the record. Since Mr. and Mrs. Hennen began farming, Mrs. Hennen has provided general farming services to the endeavor, including buying, loading, and vaccinating cattle, cleaning the shop, spraying weeds, picking up parts, unloading grain, and driving a tractor. (Add. 3; A. 97; Supp. A. 9, 16.) In addition, Mrs. Hennen performed the farm bookkeeping. (Add. 3; A. 97; Supp. A. 9, 16.) In short, in Mr. Hennen's words, Mrs. Hennen "has done whatever it takes to make the farm operation run more smoothly," during the 38 years they operated the farm together. (Supp. A. 9.)

[47] Indeed, Mrs. Hennen candidly testified at trial that she has always participated in the production of agricultural products on the land she rents to her husband (Supp. A. 17):

Q So you participated -- so your husband uses the land for

 

agricultural/horticultural products?

 

 

A Yes, he does.

 

 

Q And you expected to continue your participation in those

 

activities after renting the land to your husband?

 

 

A Yes, I did.

 

 

Q And, in fact, you did continue to provide those

 

services?

 

 

A Right, correct.

 

 

[48] On taxpayers' own estimate, Mrs. Hennen worked on the farm approximately 1,000 hours per year (Add. 3; Supp. A. 9, 16, 22), which averages out to slightly fewer than 20 hours a week, performing a variety of farm tasks. Thus, taxpayers have conceded that Mrs. Hennen performed extensive tasks on the farm and that she worked the equivalent of nearly a 20-hour work week, or half-time. These concessions are sufficient to support the Tax Court's conclusion that she materially participated in the production of agricultural commodities on the farm.

[49] Contrary to taxpayers' contention (Br. 32), the Tax Court did not disregard "'the self-serving testimony of Mr. Hennen.'" Indeed, the Tax Court described (Add. 8) Mr. Hennen's testimony as "candid[]." In particular the court noted his testimony in the following exchange (Add. 8; Supp. A. 10):

Q [counsel for the Commissioner] And in fact, she does

 

materially participate and help out and pull her share.

 

 

A If you are familiar with the farm, sir, that's what

 

makes a farm successful. Everybody carries their weight.

 

 

Because Mr. Hennen was candid about the importance of Mrs. Hennen's work on the farm and about his expectation that his wife would contribute to the work of the farm, taxpayers' suggestion that the Tax Court's conclusions were contrary to Mr. Hennen's testimony has no basis in the record.

[50] In short, taxpayers fell far short of showing either legal mistake or clear error in the Tax Court's determination that Mrs. Hennen materially participated in the production of agricultural commodities on the rented land pursuant to an arrangement with Mr. Hennen.

D. Taxpayers' remaining arguments are meritless

[51] 1. Taxpayers devote a substantial portion of their brief on appeal (Br. 9-12, 24-29) to urging this Court to restrict includible farm rental income to amounts that are paid in crop shares, or to arrangements whereby the amount of rent the landlord receives is dependent on the success of the farm. The statute in issue here, however, does not contain any such restriction.

[52] As already noted, this Court has held that a restrictive interpretation of the provision in issue here, as it appears in the Social Security Act, is improper because it "place[s] a qualification upon coverage not contemplated by the statute" and thus violates the principle that such provisions should be liberally construed. Foster v. Celebrezze, 313 F.2d at 607-608. The restrictive interpretation espoused by taxpayers here cannot be squared with this Court's decision in Foster.

[53] Moreover, contrary to taxpayers' contention (Br. 13-14), the legislative history supports the conclusion that the omission from the statute of any restriction to share-cropping is intentional. Congress included in the bill that created the provision in issue here an amendment to Section 3121 of the Internal Revenue Code (definitions regarding employment taxes) and Section 210(a) of the Social Security Act (now 42 U.S.C. section 410(a)) (which defines "employment") providing that tenants under sharecropping arrangements, but not those in agricultural arrangements which pay them cash, are not employees. H.R. 1189, 84th Cong., 1st Sess. (1956- 2 C.B. 1248, 1253)(A. 106); S.Rep. 2133, 84th Cong., 2nd Sess. (1956- 2 C.B. 1255, 1268-1269)(A. 114). Taxpayers' quotation (Br. 14) of a portion of the Senate report (C.B. 1952-2 at 1262; A. 111) discussing crop shares fails to support their thesis because the quotation comes from a discussion of the amendment to Section 210 of the Act, and deals with the status of agricultural tenants -- not landlords -- as employees. In other words, the legislative history upon which taxpayers rely has nothing to do with the status of farm rental income as self-employment income. That Congress included in other provisions of the same bill precisely the restrictions urged by taxpayers shows that, at the time of drafting the provision in issue here, Congress was well aware of the distinction between share-crop arrangements and fixed cash rentals and chose not to include such a restriction in the definition of includible farm rental income. Thus, contrary to taxpayers's contentions (Br. 13-14), the conclusion is inescapable that the failure to restrict includible farm rental income for purposes of social security coverage and self-employment tax to crop-share arrangements was fully intentional.

[54] 2. Taxpayers' reliance (Br. 7, 28-29) on a provision in 7 C.F.R. section 1412.303 denying eligibility for payment on certain "production flexibility contracts" with the USDA to agricultural landlords with cash rent leases is misguided. Contrary to their contention, 7 C.F.R. section 1412.303 does not even contain the phrase "material participation," let alone define it in terms of share leases. Their reliance (Br. 18 n.2) on Heffley v. Commissioner, 884 F.2d 279 (7th Cir. 1989) and Estate of Coffing v. Commissioner, 53 T.C.M. (CCH) 1314 (1987), is similarly misguided. These cases interpret provisions of I.R.C. section 2032A, which provides a special valuation, for purposes of calculating the value of an estate for estate tax purposes, for family farms if certain conditions are met. Section 2032A includes, as one of those conditions, a "material participation" requirement similar to that in the statute in issue, and a "qualified use" requirement, which has no parallel in Section 1402(a)(1). Heffley held that "[t]here is no qualified use during the lease of a farm under a fixed-rental agreement." 884 F.2d at 284 (emphasis added). Because Heffley also made clear that the "qualified use" and "material participation" requirements of the statute are separate and that fulfillment of one does not entail fulfillment of the other, taxpayers' contention (Br. 18 n.2) that it stands for the principle that "a cash rent lease will never involve material participation" is unfounded. Taxpayers' reliance on Coffing for the same principle is unfathomable. The Tax Court opinion in Coffing does not distinguish between cash rent leases and share leases.

[55] 3. Taxpayers' contention (Br. 20-22) that the Tax Court's opinion improperly assumes that a taxpayer may not wear two hats is without merit. Indeed, the underlying assumption of the statutory provision is that many agricultural landlords "wear two hats" -- i.e., that they are not simply landlords. Nor does the fact that the income included in the social security system by the material participation provisions of Section 1402(a) is derived from both capital and labor distinguish it from other sources of self- employment income. "Congress realized that the income of self- employed persons is in most instances a combination of income from both labor and invested capital, and deliberately chose not to attempt the difficult, if not impossible, task of separating one from the other." Delno v. Celebrezze, 347 F.2d 159, 166 n.10 (9th Cir. 1965)(citing Hearings on H.R. 2893 (Social Security) Before the House Committee on Ways and Means, 81st Cong., 1st Sess. 1362-65 (1949); Hearings Before the Subcommittee on the Analysis of the Social Security System of the House Committee on Ways and Means, 83d Cong., 1st Sess., at 459, 504-07 (1953)). Thus, taxpayers' suggestion (Br. 20-21) that the Tax Court erred by allowing the worker role to "taint" the landlord role is wrong. The courts are bound by the choice Congress made, which was to include in the social security system all rental income received by agricultural landlords under arrangements in which their material participation (i.e., their labor, whether physical or managerial) in the production of agricultural commodities is contemplated, when they do actually materially participate in the production.

[56] 4. Taxpayers' reliance (Br. 22-24) on Wuebker v. Commissioner, 110 T.C. 431 (1998), appeal pending, 6th Cir. No. 98- 2287, is misplaced. Contrary to their suggestion (Br. 22), Wuebker, is entirely inapposite. At issue in Wuebker was whether payments received from the USDA under a Conservation Reserve Program contract had a sufficient "nexus" with taxpayers' "trade or business" of farming that the payments should be treated as income "derived from their trade or business," rather than as unrelated rental payments. 110 T.C. at 435-436. Contrary to taxpayers' assertion (Br. 24) that the Tax Court in Wuebker rejected "essentially the same argument" as the one urged here, the Commissioner in Wuebker agreed that the material participation provision in issue here did not apply in that case because there was no agreement to produce agricultural commodities on the land. 110 T.C. at 436. Taxpayers' assertion (Br. 24) that the Tax Court in Wuebker held that "as long as the payments were for rents of real estate as defined by section 1402(a)(1), the payments would be immune from the self-employment tax even if derived from Wuebker's farming activities," similarly overlooks this fact. Thus, the material participation exception to the exclusion of rental income was not in issue in Wuebker and, contrary to taxpayers' suggestion, Wuebker did not hold that rental exclusion applies even where, as here, the income falls within the material participation inclusion (or exception to the exclusion).

[57] 5. Taxpayers err in placing reliance (Br. 26-28) on the instructions to IRS Form 4835. (A. 117-118.) The purpose of this form is to report farm rental income where the rent is paid in the form of crops or livestock. The instructions to the form state (A. 118) that when rent is paid in cash, rather than in crops or livestock, the rental income is to be reported in Schedule E, which, as taxpayers recognize (Br. 27), is the form otherwise used to report rental income. These instructions, taxpayers assert (Br. 27-28), "specifically preclude the imposition of the self-employment [sic] on cash rent leases for farmland." To the contrary, the instructions to Form 4835 do not purport to override -- and, indeed, could not override -- the statutory rule that farm rental income is to be treated as self-employment income when the owner has an arrangement to materially participate in the production of agricultural commodities, and does, in fact, materially participate. The instructions merely advise taxpayers of the form on which they are to report farm rental income where the rent is paid in cash. They say nothing about whether such income is to be treated as self-employment income.

[58] 6. Taxpayers also contend (Br. 29-30) that their rental income should be dealt with under Treas. Reg. section 1.1402(a)-4(d), which applies "where an individual or a partnership is engaged in a trade or business the income of which is classifiable in part as rentals from real estate." This regulation, however, plainly does not apply to this case. It is subsection (b) of the section 1.1402(a)-4 regulations -- which is entitled "Special rule for 'includible farm rental income'" -- that applies here. The general rule set forth in subsection (d) of the regulation does not purport to override the special rule for farm rental income in subsection (b).

CONCLUSION

[59] For the foregoing reasons, the decision of the Tax Court is correct and should be affirmed.

Respectfully submitted,

 

 

PAULA M. JUNGHANS

 

Acting Assistant Attorney

 

General

 

 

THOMAS J. CLARK (202) 514-9084

 

SARA ANN KETCHUM (202) 514-9838

 

Attorneys

 

Tax Division

 

Department of Justice

 

Post Office Box 502

 

Washington, D.C. 20044

 

 

FEBRUARY 2000

 

 

CERTIFICATE OF COMPLIANCE

[60] Pursuant to Rule 32(a)(7)(C) of the Federal Rules of Appellate Procedure and Rule 28A(c) of the Eighth Circuit Rules of Appellate Procedure, I certify that this brief was prepared with WordPerfect 6.1, uses Times New Roman 14 point typeface, and contains 8,269 words. Pursuant to Eighth Circuit Rule 28A(d), I further certify that the computer diskettes provided to the Court and to counsel for the appellee have been scanned for viruses using a commercial virus scanning program, which reports the diskettes are virus-free.

SARA ANN KETCHUM

 

Attorney

 

 

CERTIFICATE OF SERVICE

[61] It is hereby certified that service of the foregoing brief has been made on counsel for the appellant, on this 17th day of February, 2000, by mailing two copies, and one computer readable disk copy, in an envelope properly addressed to them as follows:

Garry A. Pearson, Esquire

 

Jon J. Jensen, Esquire

 

24 N. 4th St.

 

P.O. Box 5758

 

Grand Forks, North Dakota 58206-5758

 

 

SARA ANN KETCHUM

 

Attorney

 

FOOTNOTES

 

 

1 "Add." references are to the addendum attached to appellant's brief. "A." references are to the separately bound record appendix. "Supp. A." references are to the supplemental appendix submitted with this brief.

2 The stipulation of facts included in the appendix of the appellants (Add. 19-21) is an unsigned early draft. We are including in the supplemental appendix (Supp. A. 21-23) a copy of the signed stipulation of facts file-stamped by the Clerk of the Tax Court.

3 Mr. Hennen rented the remaining farmland from others.

4 On the Schedule F to their 1996 return, taxpayers deducted $231 for "Labor hired (less employment credits)." (A. 85.)

5 I.R.C. section 1402(a)(1) provides, in relevant part, that the exclusion from self-employment income (for purposes of self- employment tax) for income from rental of real estate:

shall not apply to any income derived by the owner or tenant of

 

land 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 or

 

horticultural commodities (including livestock, bees, poultry,

 

and fur-bearing animals and wildlife) on such land, and that

 

there shall be material participation by the owner or tenant (as

 

determined without regard to any activities of an agent of such

 

owner or tenant) in the production or the management of the

 

production of such agricultural or horticultural commodities,

 

and (B) there is material participation by the owner or tenant

 

(as determined without regard to any activities of an agent of

 

such owner or tenant) with respect to any such agricultural or

 

horticultural commodity[.]

 

 

6 The Tax Court in Mizell also examined the use of the term "arrangement" in the Internal Revenue Code and concluded that "Congress obviously recognized a distinction between a contract and the broader concept of an 'arrangement.'" 70 T.C.M. at 1471-1472. The court cited, as examples, section 401(a)(30) ("all other plans, contracts, or arrangements"), section 4003(d) ("a contract, sale, or arrangement"), section 4975(d)(2) ("any contract, or reasonable arrangement"), and section 7701(e)(3) ("contracts or arrangements involving solid waste disposal, energy, and clean water facilities"). 70 T.C.M. at 1472 n. 3. Moreover, in those sections where only a contractual relationship is contemplated, "arrangement" is modified by the word "contractual." 70 T.C.M. at 1472. The court cited, as examples, section 465(c)(6)(B) ("The term 'equipment leasing' does not include the leasing of master sound recordings, and other similar contractual arrangements"), and section 4216(b)(5)(B) ("the lowest price shall be determined . . . without including any fixed amount to which the purchaser has a right as a result of contractual arrangements existing at the time of sale.") 70 T.C.M. at 1472 n. 4.

7 Treas. Reg. section 1.1402(a)-4(b)(3)(iii), which taxpayers cite (Br. 12) is not to the contrary, but merely defines the term "the management of the production." It does not purport to define the term "material participation." Thus, taxpayers' reading of this provision as "provid[ing] that material participation in the 'management of the production' must exist to meet the requirement of material participation" is wide of the mark.

 

END OF FOOTNOTES
DOCUMENT ATTRIBUTES
  • Case Name
    JOHN P. HENNEN AND TERESA HENNEN, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee
  • Court
    United States Court of Appeals for the Eighth Circuit
  • Docket
    No. 99-3968
  • Institutional Authors
    Department of Justice
  • Cross-Reference
    John P. Hennen, et ux. v. Commissioner, T.C. Memo 1999-306 (For the

    full text, see Doc 1999-30375 (10 original pages) or 1999 TNT 180-7 Database 'Tax Notes Today 1999', View '(Number'.)
  • Code Sections
  • Subject Area/Tax Topics
  • Index Terms
    self-employment income
  • Industry Groups
    Agriculture
  • Jurisdictions
  • Language
    English
  • Tax Analysts Document Number
    Doc 2000-5480 (49 original pages)
  • Tax Analysts Electronic Citation
    2000 TNT 48-26
Copy RID