Bot v. C.I.R.

• Decision Date: 22 December 2003
• Docket Number: No. 02-2956.,02-2956.
• Citation: 353 F.3d 595
• Parties: Richard J. BOT; Phyllis Bot, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

353 F.3d 595

Richard J. BOT; Phyllis Bot, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 02-2956.

United States Court of Appeals, Eighth Circuit.

Submitted: May 15, 2003.

Filed: December 22, 2003.

was Mark L. Astling, argued, Minneapolis, MN (Kathryn J. Sedo, on the brief), for appellant.

Michael J. Haungs, Tax Division, argued, DOJ, Washington DC (Bruce R. Ellisen, on the brief), for appellee.

Before MORRIS SHEPPARD ARNOLD and HANSEN, Circuit Judges, and READE,¹ District Judge.

HANSEN, Circuit Judge.

Richard J. Bot and Phyllis Bot appeal from the tax court's² decision upholding the Internal Revenue Service's assessment of self-employment tax on the value-added payments the Bots received from the Minnesota Corn Processors Cooperative Association ("MCP") in 1994 and 1995. The Bots argue that the tax court erred in finding that they earned the value-added payments from the carrying on of a trade or business. We agree with the tax court and affirm its judgment.

I.

The Internal Revenue Code imposes self-employment tax on the self-employment income earned by an individual, 26 U.S.C. (I.R.C.) § 1401, which is a corollary to the Federal Insurance Contributions Act, or FICA, tax paid by employers and employees to fund social security benefits. The sole issue in this case is whether the value-added payments that the Bots received from MCP were derived from a trade or business carried on by the Bots, and thus were subject to self-employment tax, or if the payments represented investment income not subject to self-employment tax.

Richard and Phyllis Bot are a married couple who filed joint tax returns for 1994 and 1995, the years at issue in this case. The Bots are retired farmers who own 700 acres of farmland in Minnesota that they have sharecropped with two of their sons since 1987, when the Bots retired from daily farming activities. The crop share agreement effective for the years at issue provided that the Bots were entitled to one-half of the crops grown on the farm.

The Bots were members of MCP at all times relevant to this appeal. They bought common stock in MCP in 1982, which stock can only be held by "producers of agricultural products," including lessors of land who receive part of the crops produced on their land as rent. (Appellants' App. at 88, Art. V § 2.) In various years since 1982, they also entered into numerous Uniform Marketing Agreements (UMA) with MCP which obligated the Bots to supply to MCP one bushel of corn for each equity unit the Bots owned. The Bots purchased the equity units at an average cost of $2.06 per unit. The UMA required MCP to market and process the corn supplied under the UMAs into corn products to sell. The UMAs had a five-year rolling term, such that after the first year, the agreement was automatically renewed for an additional year, and the UMA maintained its five-year term. Upon notice of termination, the Grower was still obligated to supply corn for a period of four years following his or her notice of termination. (Id. at 107, ¶ 9.) Pursuant to a Supplement to the UMA, the Bots agreed to a pro rata change in the number of bushels they were obligated to supply depending on MCP's total corn needs. Under the UMA, the "Grower appoints and designates the Cooperative to act as Grower's sole agent in the sale and marketing of the corn committed to the Cooperative under this Agreement." (Id. at 104, ¶ 1.) Members satisfied their obligation to supply corn to MCP with corn grown by the member, corn purchased by the member on the open market, or through MCP's "option pool corn," which is corn MCP buys on the open market and makes available to members to use to meet their delivery obligations. If option pool corn was used, the grower paid MCP $.05 per bushel as a service fee and MCP retained title to the corn. Regardless of the source of the corn, the grower warranted in the UMA that he or she was the producer or owner of the corn. (Id. at 107.)

MCP paid the members under the UMA as follows: (1) an initial payment of at least 80% of the loan value of the non-option pool corn on delivery; (2) storage and interest fees for corn required to be delivered after October 1; (3) a value-added payment, which is "such payment [from MCP's net operating proceeds] ... which will further compensate Grower for Grower's corn and still allow [MCP] to retain its financial integrity" (Appellants' App. at 106); and (4) patronage dividends. Because the Bots used only option pool corn to meet their UMA obligations, the only payments they received from MCP were the value-added payments and the separately determined patronage dividends. The Bots reported the patronage dividends on Form 4835, Farm Rental Income and Expenses, along with the income earned under the crop share agreement with their sons, which the Internal Revenue Service ("IRS") does not dispute. Only the value-added payments received by the Bots from MCP are at issue in this case.

As indicated above, the Bots entered the first UMA in 1982 and always satisfied their obligation to supply corn to MCP with option pool corn. In 1994, the Bots held 250,000 active equity units, for which they had paid $515,000. In 1995, the Bots held 395,000 active units, at a total cost of $813,700. They delivered 325,000 bushels in 1994 (130% of the number of their equity units) and 379,200 bushels in 1995 (96% of the number of their equity units) from MCP's option pool corn. They received $132,375 and $249,152 in 1994 and 1995, respectively, as value-added payments. They reported those receipts as gross proceeds from the sale of capital assets on Schedule D of their 1994 and 1995 tax returns. They reported their basis in the assets as $68,070 in 1994 and $86,431 in 1995. The bases were derived from the $.05 handling fee paid to MCP to use the option pool corn to meet their obligations ($18,070 in 1994 and $16,431 in 1995) plus payments the Bots made to their sons for their half of the seed, fertilizer, and weed spray as required by the crop share agreement ($50,000 in 1994 and $70,000 in 1995).³ The Bots separately reported their income from the crop share agreement on Form 4835 (Farm Rental Income and Expense), which income is not at issue in this appeal.

On audit, the IRS determined that the Bots were in the trade or business of producing, marketing, processing, and selling corn and that the value-added payments should be reported on Schedule C instead of Schedule D, thus subjecting the payments, less any allowable deductions, to self-employment tax. The IRS simply moved the net income from Schedule D to Schedule C, allowing the Bots to deduct the claimed bases for each year as expenses against the value-added payments received to arrive at net income subject to self-employment tax.

Upon appeal of the assessment, the Bots argued to the tax court that the value-added payments represented investment income on their shares held in the MCP cooperative, not income from a trade or business subject to self-employment tax. The tax court determined that the Bots' activities of regularly and continuously acquiring and selling corn and corn products through the MCP with the intent of making a profit qualified as engaging in the trade or business of dealing and processing corn, even though they retired from daily farming activities in 1987. The court also relied on the unique nature of the relationship between a cooperative and its members to find that the Bots engaged in the trade of dealing in corn through MCP acting as their agent. The court found a direct nexus between the Bots' trade of dealing corn and the value-added payments because the value-added payments were distributed based on the number of bushels of corn delivered to MCP by the Bots. The Bots appeal.

II.

We review the tax court's legal conclusions de novo and its fact-findings for clear error. The Bots have the burden of establishing that the IRS's characterization of the value-added payments as self-employment income is erroneous. See Campbell v. Comm'r, 164 F.3d 1140, 1142 (8th Cir.), cert. denied, 526 U.S. 1117, 119 S.Ct. 1765, 143 L.Ed.2d 796 (1999).

The Internal Revenue Code imposes self-employment tax on the "net earnings from self-employment derived by an individual." §§ 1401(a), 1402(b). The term "net earnings from self-employment" is defined as "the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed." § 1402(a). The term "trade or business" is defined only by reference to I.R.C. § 162 (relating to trade or business expenses), see § 1402(c), but is not otherwise defined in either section 162 or section 1402. "Self-employment income is determined by the source of the income, not the taxpayer's status at the time the income is realized." Schelble v. Comm'r, 130 F.3d 1388, 1392 (10th Cir.1997) (internal quotations omitted). The "derived from" requirement necessitates a nexus between the income and the trade or business actually carried on by the taxpayer. That is, the trade or business activity must give rise to the income. Milligan v. Comm'r, 38 F.3d 1094, 1098 (9th Cir.1994). Treasury regulations provide that the "trade or business must be carried on by the individual, either personally or through agents or employees." Treas. Reg. § 1.1402(a)-2(b). Thus, the value-added payments are self-employment income if they: 1) are derived 2) from a trade or business 3) carried on by the Bots or their agents. The self-employment tax provisions are broadly construed to favor treatment of income as earnings from self-employment. See Braddock v. Comm'r, 95 T.C. 639, 644, 1990 WL 210322 (1990); Hornaday v. Comm'r, 81 T.C. 830, 834, 1983 WL 14895 (1983); see also Comm'r v. Groetzinger, 480 U.S. 23, 31, 107 S.Ct. 980, 94 L.Ed.2d 25 (1987) (discussing the meaning of a "trade or business" and concluding that the "statutory words are broad and comprehensive").

On their tax returns, the Bots claimed that the...