Harlan E. Moore Charitable Trust v. US

Citation812 F. Supp. 130
Decision Date19 January 1993
Docket NumberNo. 91-2330.,91-2330.
PartiesHARLAN E. MOORE CHARITABLE TRUST, Plaintiff, v. UNITED STATES of America, Defendant.
CourtUnited States District Courts. 7th Circuit. United States District Courts. 7th Circuit. Central District of Illinois

Tracy Nugent, Meyer, Capel, Hirschfeld, Muncy, Jahn & Aldeen, Champaign, IL, for plaintiff.

Benjamin R. Norris, U.S. Dept. of Justice, Tax Div., Washington, DC, for defendant.

ORDER

BAKER, District Judge.

This matter is before the court on cross-motions for summary judgment. The plaintiff, Harlan E. Moore Charitable Trust, is a qualified tax exempt organization and has filed this suit seeking a refund of $19,824.71 ($16,033.66 plus interest) on assessed income tax deficiencies it paid for the years 1986 through 1989.

The tax was assessed on rent from a farm the plaintiff owns in Piatt county as an unrelated business income tax (UBIT) under 26 U.S.C. § 512. The legal issue in this case is narrow: whether the rent, in the form of 50% of the farm's production under a crop-share lease, is non-taxable as a fixed percentage of receipts or sales, or is taxable as an amount dependent on the income or profits of the lessee.

The plaintiff argues the income falls within the parenthetical exclusion of § 512(b)(3)(B)(ii)1 as a rent based on a fixed percentage of receipts, that is 50% of the crop production. Alternatively, the plaintiff claims the crops are excludable rent from real property under § 512(b)(3)(A)(i).

The government contends that the relationship between the Trust and the farmer is not landlord-tenant but a partnership or joint venture and the crops are not true rents. The government asserts that, under 26 C.F.R. 1.512(b)-1, the farm operation generates income, not true rents, that is not within the modifications for rents. Alternatively, the government maintains that the rent from the crop-share agreement is dependent on the income or profits of the lessee, not on a percentage of receipts or sales, and therefore the exception in § 512(b)(3)(B)(ii) governs.

BACKGROUND

The Harlan E. Moore Charitable Trust was founded in 1976 and has tax-exempt status under § 501(c)(3). The Trust owns a 400-acre farm in Piatt County, Illinois that is managed by Daryl Mealiff of the farm management department at the Bank of Illinois. Steven Dodge farms the land. Dodge and his father-in-law entered into a crop share agreement with the Trust in 1979.

According to the terms of the agreement, Dodge lives in the farm house and works the land but does not pay any cash rent to the Trust; instead, Dodge's rent is 50% of farm production after the crop is divided at the grain elevator. The Trust and Dodge have signed two leases, with essentially similar terms, the first in 1979 and the second in 1989.2

The lease refers to the plaintiff as "Owner" and Steven Dodge as "Tenant." Dodge has possession and control of the farm-house and farm. The lease specifies the division of responsibilities: the Trust pays the property taxes and building maintenance expense and the tenant supplies all of the labor, machinery, fuel and hauling expenses. The cost of seed, fertilizer, limestone, herbicides, insecticides, soil tests and grain drying are split equally between the Trust and Dodge.

Dodge decides what seed to plant, when to apply fertilizer, herbicides and insecticides, when to harvest the crop and when to sell his half of the production. Deposition of Mealiff at 22-27; Deposition of Dodge at 12-17. Dodge and the Trust each carry hail insurance for their half of the crop. Mealiff at 30-31; Dodge at 32. The Trust and Dodge are billed separately for their portion of the shared costs. Dodge at 18. Mealiff and Dodge intend the lease to create a landlord-tenant relationship. Mealiff at 12; Dodge at 37. Neither party holds itself out as the other's partner, nor has one paid the other's expenses or undertaken the other's responsibilities. Mealiff at 64.

ANALYSIS
A. Relationship between the Trust and Dodge

The government contends that the parties are not actually landlord and tenant but in fact are partners or joint venturers. The government points to the shared cost of seed, fertilizer, herbicides and drying as evidence of the joint venture. The most important element in determining whether a landlord-tenant relationship or joint venture exists is the intention of the parties. Petry v. Chicago Title & Trust Co., 51 Ill.App.3d 1053, 1057, 9 Ill.Dec. 951, 367 N.E.2d 385 (2d Dist.1977). The burden of proving the existence of a joint venture is on the party who claims the relationship exists. Id.

Landowners and farmers have undertaken crop-share arrangements in Illinois for well over a hundred years. Alwood v. Ruckman, 21 Ill. 200 (1859). Illinois courts find it obvious that farming on shares creates a landlord-tenant relationship. Baker Farmers Co. v. ASF Corp., 28 Ill.App.3d 393, 395, 328 N.E.2d 369 (3d Dist.1975). However, an agreement to carry on farming operations can become a joint venture. Id.; Petry, 51 Ill.App.3d at 1057, 9 Ill.Dec. 951, 367 N.E.2d 385.

A joint venture contemplates an enterprise jointly undertaken; that it is an association of such joint undertakers to carry out a single project for profit; that there must be a community of interest in the performance of a common purpose, a proprietary interest in the subject matter, a right to direct and govern the policy in connection therewith, a duty, which may be altered by agreement, to share both in profit and losses.

Petry, 51 Ill.App.3d at 1056-57, 9 Ill.Dec. 951, 367 N.E.2d 385 (citing Carroll v. Caldwell, 12 Ill.2d 487, 496-497, 147 N.E.2d 69 (1957)). One member of the joint venture is liable to third parties for acts of the other venturer, especially payment of debts. Baker, 28 Ill.App.3d at 396, 328 N.E.2d 369. In a joint venture as in a partnership, where one person holds him or herself out as a partner, others who permit such holding out are liable for the actions or debts incurred in the course of the partnership. Id.

There is no evidence that the relationship between the Trust and Dodge is a partnership or joint venture. The deposition testimony establishes that both parties to the lease intend a landlord-tenant relationship. Dodge makes the farming decisions. Dodge and Mealiff are billed separately for the shared expenses and never have assumed one another's debts. The government has adduced no evidence that Dodge and the Trust have held themselves out as partners or have assumed the debts of each other. Although the government contends that decisions made by mutual agreement between Dodge and the farm manager evidence a partnership or joint venture instead of a landlord-tenant relationship, there is nothing unusual about an owner employing farm managers to supervise and protect the owners interest. See Affidavit of C. Allen Bock.

The parties to the lease do not share in each other's profits or losses and consider their relationship to be landlord/tenant. There are no indications to the contrary. The crop-share agreement generates true rents that qualify as an exclusion under § 512(b)(3)(A)(i).

B. Crop share rents: receipts or profits?

In the alternative, the government claims that rent from the crop-share agreement is based on a percentage of income or profits and therefore not exempt from the UBIT under § 512(b)(3)(B)(ii). The Trust asserts that rent in the form of crops is more analogous to receipts or sales within the parenthetical exclusion of that same Code section. The court agrees with the plaintiff. Although neither categorization is perfect in this situation, the language of 512(b)(3)(B)(ii), its legislative history and the few cases that have addressed this issue indicate that rent under a crop-share agreement should fall within the purview of the parenthetical exclusion of § 512(b)(3)(B)(ii).3

Before 1950, tax-exempt organizations were not subject to unrelated business income taxes. In 1950, Congress imposed the UBIT on certain exempt organizations but excluded "all rents from real property (including personal property leased with the real property), and all deductions directly connected with such rents." 26 U.S.C. § 512(b)(3) (1954).

This broad exclusion lead to abuses. In 1969, Congress responded to the inequity of taxing some exempt organizations and not others and to cases such as University Hill,4 by extending the UBIT in 1969 to all exempt organizations and through enactment of the current modifications in § 512(b)(3). H.R.Rep. No. 91-413, 91st Cong., 1st Sess. (1969) U.S. Code Cong. & Admin. News pp. 1645, 1692. The House Report intended investment income such as "dividends, interest, annuities, royalties, and most passive rental income to be free of the unrelated business income tax." Id. The House Report on the 1969 amendment emphasized the damaging consequences "feeder organizations" had on tax revenue and sought to eliminate the unfair business competitive advantage some businesses enjoyed by paying "rent" to a tax-exempt organization which in reality funnelled money from the taxable entity to the exempt one. Id. at 1691.

The Senate report incorporated the concept of "passive" rentals but differentiated taxable rent that is measured by the property's net income from excludable rent based on a percentage of gross receipts. S.Rep. No. 91-552, 91st Cong., 1st Sess. (1969) U.S. Code Cong. & Admin. News p. 2067. Congress wanted to tax property rentals that are "measured by reference to the net income from the property." Id.

Whether a particular item of income falls within any of the modifications provided in § 512(b) is determined by all the facts and circumstances of each case. 26 C.F.R. 1.512(b)-1. Nowhere in the Code or Regulations is "rent" defined. United States v. Myra Foundation, 382 F.2d 107, 109 (8th Cir.1967). Illinois, however, recognizes that rent may be paid as a portion of the crops. Alwood, 21 Ill. at 201 (1859). While the Code generally excludes "all rents from real property" from the UBIT, it does not distinguish between commercial and...

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