Strong v. Comm'r of Internal Revenue
| Decision Date | 14 September 1988 |
| Docket Number | 34544-84.1,Docket Nos. 34393-84 |
| Citation | 91 T.C. No. 39,91 T.C. 627 |
| Parties | DUANE A. AND SARA STRONG, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, RespondentGARY L. AND MARLYS L. KARKOSH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
OPINION TEXT STARTS HERE
Petitioners acquired gilts and calves as rental payments from their closely-held farm corporations. HELD, petitioners must recognize rental income on their transfers of gilts and calves to their leased breeding herds. HELD FURTHER, the amount of rental income recognized is determined in accordance with the lease agreements. C. Kevin McCrindle, for the petitioners.
Vincent E. Mauer, for the respondent.
Respondent determined deficiencies in petitioners' Federal income taxes as follows:
+-----------------------------------------------+
¦Petitioner ¦TYE Dec. 31—¦Deficiency¦
+-----------------------+------------+----------¦
¦Duane and Sara Strong ¦1982 ¦$1,501 ¦
+-----------------------+------------+----------¦
¦Gary and Marlys Karkosh¦1981 ¦436 ¦
+-----------------------------------------------+
The primary issue for our determination is whether petitioners were correct in not reporting any rental income from their acquisitions of livestock which they designated as replacements or additions to their breeding herds.
Some of the facts are stipulated and are found accordingly. The stipulation of facts and attached exhibits are incorporated herein by this reference.
Petitioners, Duane and Sara Strong, are husband and wife and resided in Elgin, Iowa, at the time they filed their petition. They timely filed their joint Federal income tax return for the calendar year 1982. Petitioners, Gary and Marlys Karkosh, are husband and wife and resided in Hudson, Iowa, at the time they filed their petition. These same two petitioners timely filed their joint Federal income tax return for the calendar year 1981. All petitioners used the cash method of accounting.
Mr. and Mrs. Strong each own 50 percent of the outstanding shares of Four Strong, Ltd., an Iowa farm corporation engaged in grain and livestock operations and formed in February 1981. On their tax return for the calendar year 1982, these two petitioners each listed their occupations as corporate officers. Additionally, Mr. Strong was involved in farming in 1982 and had been so since 1958.
Upon incorporating Four Strong, Ltd., the Strongs transferred to the corporation their livestock and other farming assets, except for brood sows and brood cows. 2 The couple retained title to these breeding animals which they later let to Four Strong, Ltd. under agreements labelled ‘leases‘ and dated February 9, 1981. The Strongs had decided to retain title to and lease these brood animals as a way to draw additional income from their wholly-owned corporation. The Strongs' animal leases covered 170 sows and 80 cows.
Under their sow lease, the Strongs were entitled to one gilt annually per sow leased to the corporation, regardless of the actual number of piglets farrowed alive by the corporation. 3 The Strongs acquired title to these gilts when each gilt weighed approximately 40 pounds. However, in accordance with the lease agreement, Four Strong, Ltd., at its own expense, was to raise the gilts to a specified weight in excess of 200 pounds. Additionally, Four Strong, Ltd. was to guarantee the lives of these gilts to this specified weight. The sow lease did not provide for the payment of cash by Four Strong, Ltd. to the Strongs, if the farm corporation was unable to provide the Strongs with the requisite number of rental gilts.
In 1982, the Strongs acquired 170 gilts from their wholly-owned corporation pursuant to the terms of the sow lease. Of these 170 gilts, 50 were designated as replacements or additions to the Strongs' leased breeding herd, and the remainder were sold in 1982. The Strongs reported as ordinary income in 1982 the amounts received from the sale of the 120 marketed gilts. The replacement gilts became part of the leased breeding herd when these animals were transferred to this herd.
Under their cow lease, the Strongs were entitled annually to one calf for each eight cows leased to Four Strong, Ltd., regardless of the actual number of calves born. The calves were titled to the Strongs during the corporation's normal calf marketing season. If the corporation was unable to provide the Strongs with the requisite number of calves, the cow lease required Four Strong, Ltd. to pay the Strongs an amount of cash equal to the fair market value of the unprovided calves. 4 The cow lease did not provide that Four Strong, Ltd. was to incur further costs or bear the risk of loss from death associated with raising the calves it was eventually to transfer to the Strongs to a weight in excess of that which these calves had attained at the time the Strongs acquired legal title to the animals.
In 1982, the Strongs acquired ten calves from Four Strong, Ltd. under the terms of the cow lease; none of these ten calves was marketed in 1982; all ten calves were replacements or additions to the Strong's leased cattle breeding herd. The calves became part of the leased breeding herd when the animals were transferred to this herd.
The Karkoshes, 5 along with the Owens, formed K & O Farms, Inc., an Iowa farm corporation which raised sows and other agricultural products. Stock ownership in K & O Farms, Inc. was divided equally between the Karkoshes and the Owens; each family group owns 50 percent of the corporation's stock. Mr. Karkosh was the president of this farm corporation in 1981. On their tax return for the calendar year 1981, Mr. Karkosh listed his occupation as a farm employee; his wife listed her occupation as a teacher's aid.
The Karkoshes transferred their livestock and other farming assets, except brood sows, to K & O Farms, Inc. Pursuant to an agreement labelled a ‘lease‘ and dated January 20, 1977, the Karkoshes then let these brood sows, in which they retained title, to K & O Farms, Inc. The leased sows, thus, represented a vehicle for the Karkoshes to draw income from the corporation.
Under the terms of the sow lease with K & O Farms, Inc., the Karkoshes and the Owens initially were to lease a total of 78 sows to the corporation. Being 50 percent owners of the corporation, the Karkoshes were to receive one-half of the rental payments made by K & O Farms, Inc. under the lease. The lease provided that the lessee was to pay in rent annually one gilt for each sow leased, regardless of the size of the broods produced under the lessee's breeding program. 6 The gilts the Karkoshes acquired were titled to these petitioners when the gilts reached the age of two weeks. However, in accordance with the lease agreement, K & O Farms, Inc., at its own expense, was to raise the gilts to a specified weight in excess of 200 pounds. Additionally, K & O Farns, Inc. was to guarantee the lives of these gilts to this specified weight. The sow lease did not provide for the payment of cash by K & O Farms, Inc. to the lessors, if the farm corporation was unable to provide the lessors with the requisite number of rental gilts.
In 1981, the Karkoshes acquired 23 gilts from K & O Farms, Inc. under the terms of the sow lease. Of these 23 gilts, 13 were placed into the Karkoshes' leased breeding herd and the remainder were sold in 1981. The Karkoshes reported as ordinary income in 1981 the amounts received from the sale of the 10 marketed gilts. The 13 replacement gilts became part of the Karkoshes' breeding herd when the animals were transferred to this herd.
Neither the Karkoshes nor the Strongs reported any rental income from their acquisitions under the leases of livestock which they designated as replacements or additions to their breeding herds. Petitioners instead reported income tied to these replacement animals when the animals were culled from the breeding herds and later marketed. Petitioners characterized the income recognized on the sale of these culled, breeding animals under section 1231.
OPINIONWe must decide whether petitioners were correct in not reporting any rental income from their acquisitions of livestock which they designated as replacements or additions to their breeding herds. We shall address this issue in an analytical fashion clearly delineating the steps in our inquiry.
Petitioners argue that they were correct in not reporting any rental income and first cite as support our decision in Vaughan v. Commissioner, 36 T.C. 350 (1961), affd. in part and vacated in part 333 F.2d 714 (9th Cir. 1964). In Vaughan, the taxpayers leased their cattle as a single operating unit to a lessee, Milford. The Vaughan lessors and lessee were each to receive one-half of the cash proceeds from the lessee's sale of cattle produced from the leased herd and one-half of the surplus of cattle remaining after replacement of the leased herd.
In reaching our decision in Vaughan, we found that though the Vaughan contract ‘was called a 'lease agreement,’ referred to the parties as 'lessors' and 'lessees,' and was generally couched in language similar to that used in rental agreements»,† * * * the agreement imposed upon »the Vaughan lessee† no obligation to pay any rent‘ and the cattle involved were not leased or hired. Vaughan v. Commissioner, 36 T.C. at 361. We decided that the Vaughan taxpayers and Milford contemplated a relationship other than that of lessor and lessee and that the agreement in Vaughan most nearly resembled a management contract. Vaughan v. Commissioner, 36 T.C. at 361. Consequently, the proceeds received by the Vaughan taxpayers were not ordinary income amounts arising as rentals from a lease, but instead constituted proceeds which must be taxed as amounts received from the sale of cattle. Vaughan v. Commissioner, 36 T.C. at 359-360.
With regard to the Vaughan taxpayers' receipts of one-half...
To continue reading
Request your trial
-
MALLORIE AND MALLORIE
...a taxable event on two cases, Dudden v. Commissioner of Internal Revenue, 893 F.2d 174 (8th Cir.1990), and Strong v. Commissioner of Internal Revenue, 91 TC 627, 1988 WL 93995 (1988). Those cases support the expert's conclusion that, in fact, the cow owners realized rental income when the d......
-
Sundstrand Corporation v. Commissioner
...rely pertain to CAS or TINA violations. We found them factually distinguishable from the instant case. Cf. Strong v. Commissioner [Dec. 45,057], 91 T.C. 627, 637 n. 16 (1988). Petitioners have failed to establish otherwise in their memorandum in support of their motion for We have considere......
-
Dudden v. Comm'r of Internal Revenue
...In 1981, the report was based on auctions in these same six Iowa cities and in Dunlap, Iowa.OPINION This case parallels Strong v. Commissioner, 91 T.C. 627 (1988), decided this date. In Strong, taxpayers acquired cows and gilts under livestock lease agreements entered into between these tax......
-
Applegate v. Comm'r of Internal Revenue, Docket No. 12721-88.
...736 (1966). See Parmer v. Commissioner, 468 F.2d 705, 707 (10th Cir. 1972), affg. a Memorandum Opinion of this Court; Strong v. Commissioner, 91 T.C. 627, 638-639 (1988). Consequently, it would appear that, at least in the hands of petitioners, the crop share rentals should not be treated a......