TAX COURT OPINION

Case: Robert J. & Karen L. Metz
Docket Number: 16318-09S
Judge: Colvin
Opinion Type: bench
Filed: 05/28/2010
Pages: 12

UNITED STATES TAX COURT WASHINGTON , DC 2021 7 ROBERT J . & KAREN L . METZ, Petitioners, v . ) Docket No . 16318-09 S COMMISSIONER OF INTERNAL REVENUE, Respondent . O R D E R Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it i s ORDERED that the Clerk of the Court shall transmit herewith to petitioners and to respondent a copy, of the pages of the transcript of the proceedings in the above case before Judge Laurence J . Whalen at St . Paul, Minnesota, containing his oral findings of fact and opinion rendered on April 15, 2010 . In accordance with the oral findings of fact and opinion, decision will be entered under Rule 155 . (Signed ) Laurence J . Whalen Judg e Dated : Washington, D .C . May 28, 2010 SERVED JUN ® 2 2010 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 3 Bench Opinion by Senior Judge Laurence J . Whale n Robert J . & Karen L . Metz , Docket 16318-09 S April 15 , 201 0 The Court has decided to render ora l findings of fact and opinion in this case , and th e following represents the Court ' s oral findings of fac t and opinion . II . This case was heard as a small tax cas e pursuant to the provisions of,section 7463 of th e Internal Revenue Code of 1986, . as amended , and Rule s 170 through 175, of the Tax Court Rules of Practic e and Procedure . Hereinafter , all section numbers refe r to the Internal Revenue Code ,~ as amended , and all Rul e references are to the Tax Court Rules of Practice an d Procedure . III . This bench opinion is made pursuant to th e authority granted by section 7459 ( b) and Rule 152 . IV . Mr . Bob A . Goldman, Esquire , appeared on behalf of petitioners and Mr . Blaine C . Holiday , Esquire , appeared on behalf of respondent . Heritage Reporting Corporation (202) 628 ;-4888 4 1 V . 2 Respondent determineid a deficiency i n 3 petitioners' income tax for taxable year 2005 in the 4 amount of $12,336, together with a penalty o f 5 $2,467 .20 pursuant to section 6662 . Respondent als o 6 determined a deficiency in petitioners' income tax for 7 taxable year 2006 in the amount of $17,178, togethe r 8 with a penalty of $3,435 .60 pursuant to section'6662 . 9 Following concessions, there are two issues remaining 10 for decision . The first issue is whether petitioners 11 are subject to self-employment tax, pursuant t o 12 section 1401, on the net income realized from the 13 rental of certain machinery and equipment to thei r 14 wholly owned corporation, Metz Farms, Inc . This issue 15 turns on the definition of "net earnings from self- 16 employment" set forth in section 1402(a)(1) . 17 The second issue for decision is whether 18 petitioners are entitled to expense certai n 19 depreciable business assets pursuant to section 179 . 20 .This issue turns on the application of the special 21 rule set forth in section 179(d)(5) . 22 VI . 23 Petitioner and his wife are farmers . They 24 are the fifth generation of their family to operate 25 the same farm . During 2001, they incorporated Met z Heritage Reporting Corporation (202) 628-4888 1 Farms, Inc ., a wholly owned Cicorporation, throug h 2 which they conduct the actual farm operations . During 3 the years in issue, both petitioners were employed by 4 Metz Farms but there was no written employmen t 5 agreement setting forth the terms of their employment . 6 With the exception of certain pieces of farm equipment 7 that are inherently dangerous, Metz Farms owns no real 8 property, or machinery or equipment . Metz Farm s 9 leases 1,500 acres of farmland from petitioners, and 10 it leases from third parties,,or subleases fro m 11 petitioners, an additional 700 acres of land . I n 12 addition, Metz Farms leases from petitioners certain 13 farm buildings, including grain handling and storage 14 facilities . Finally, Metz Farms leases the farm 15 machinery and equipment necessary to conduct the farm 16 operation from petitioners . The record of this case 17 contains no lease agreement for any of the assets . 18 leased from petitioners . 19 For taxable year 2005 , petitioners reported 20 on the Schedule E, Supplemental Income and Loss, filed 21 with their Federal income tax return , aggregate gross 1 22 rental income from farmland , buildings, and equipmen t 23 of $175,668 . Petitioners also reported on Schedule E, 24 for that year, net income from farm equipment rental 25 in the amount of $24,736 . For taxable year 2006 , Heritage Reporting Corporation (202) 628174888 I 6 1 petitioners reported on the Schedule E filed wit h 2 their Federal income tax return aggregate gross income 3 from farmland, buildings, and equipment of $120,299 . 4 Petitioners also reported on schedule E, for tha t 5 year, net income from farm equipment rental in the 6 amount of $14,895 . 7 According to the notice of deficiency , 8 respondent determined self-employment tax for 2005 of 9 $5,067, based on self-employment income of $35,861 . 10 For 2006, respondent determined self-employment tax of 11 $4,795, based upon self-employment income of $33,936 . 12 It is not evident from the record how the amounts of 13 self-employment income were computed in view of th e 14 fact that, as mentioned above, ; the net income from 15 equipment rental was $24,736 and $14,895 , 16 respectively . Nevertheless, petitioners raise no 17 issue concerning the computation of the amount of 18 self-employment tax determined by respondent . 19 For both of the years at issue, petitioners 20 expensed certain depreciable business assets pursuant 21 to section 179 . On the Schedule F, Profit or Los s 22 From Farming, filed with their return for 2005, 23 petitioners reported depreciation and section 17 9 24 expense deduction in the aggregate amount of $ 54,612 . 25 Of that amount , the section 179 expense deductio n Heritage Reporting Corporation (202) 628-488 8 1 7 1 amounted to $48,314 . For taxable year 2006, 2 petitioners reported on Schedule F aggregat e 3 depreciation and section 179 expense deduction o f 4 $90,929 . Of that amount, th e section 179 expens e 5 deduction amounted to $87,986 .; 7 The first issue for decision , involving the 8 application of self-employment tax to petitioners ' 9 equipment rental income , is controlled by th e 10 definition of "net earnings from self - employment" i n 11 section 1402 ( a)(1) . Respondent ' s position is that the 12 portion of the rental income received from Metz Farms 13 for the lease of farm machinery and equipment i s 14 derived under a rental agreement which is separate 15 from, and independent of, the rental agreemen t 16 covering the real estate . Thus, respondent argues, 17 the net income from farm equipment rental is not 18 excluded from the definition of "net earnings from 19 self-employment " as "rentals ~ . . from persona l 20 property leased with the real estate" . See section 21 1402(a)(1) . 22 Petitioners, on the other hand, argue that 23 their net income from equipment rentals falls withi n 24 the exclusion from the definition of "net earnings 25 from self -employment " that is set forth in sectio n Heritage Reporting corporation (202) 628,4888 8 1 1402(a)(1) . Petitioners further argue that thei r 2 equipment rental income is not described in th e 3 exception to the exclusion dealing with income derive d 4 by the landowner under an "arrangement" with th e 5 tenant calling for .material participation by the owne r in the farm operation . Petitioners cite McNamara v . 7 Commissioner , 236 F .3d 410 (8th Cir . 2000), rev'g and 8 rem'g, T .C . Memo . 1999-33, T .C . Memo . 1999-306 C-- 3 9 1 0 11 1999-256, and they argue that the "arrangement " 12 between the owner and the tenant in this case is the 13 same as the arrangement described by the Court in 14 15 16 McNamara v . Commissioner ., supra . Also see Johnson v . Commissioner , T .C . Memo . 2004-56, and Solvie v . Commissioner , T .C . Memo . 2004-55 . 17 In McNamara v . Commissioner , supra at 413, 18 the Court stated as follows : 19 "The mere existence,of an arrangemen t 20 requiring and resulting in material participation in 21 agricultural production does not automaticall y 22 transform rents received by the landowner into self- 23 employment income . It is only where the payment o f 24 those rents comprise part of such an arrangement that 25 such rents can be said to be derived from th e Heritage Reporting Corporation (202) 628'-4888 9 1 arrangement . 2 "Rents that are consistent with market rates 3 very strongly suggest that the rental arrangement 4 stands on its own as an independent transaction an d 5 cannot be said to be part of an 'arrangement' for 6 participation in agricultural! production . " 7 Based upon the record of this case, we agree 8 that petitioners' "personal property [was] leased with 9 the real estate" . See section 1402(a)(1) . Thus, we 10 disagree with the .premise of respondent's principa l 11 argument . In our view, Metz Farms was formed to take 12 over petitioners' farming operation and both th e 13 farmland and farm machinery and equipment wer e 14 necessary for it to do that . IWe find nothing in the 15 stipulation that causes us to think differently . 16 Nevertheless, we can not find fo r 17 petitioners . For them to prevail, in this case, w e 18 would have to find that "the rental arrangement stands .19 on its own as an independent transaction" and not part 20 of "an 'arrangement' for participation in agricultural 21 production' ." McNamara v . Commissioner , supra at 413 . 22 We are not able to make that,finding, based upon th e 23 record before us . 24 The record does not show that the rents paid 25 to petitioners by Metz Farms were necessarily based o n Heritage Reporting Corporation (202) 628 11-4888 1 0 1 market rates, nor does it show that the renta l 2 arrangement was not part of the "arrangement " betwee n 3 petitioners and their wholly owned corporation . Thus , 4 we can not find that the rental transaction wa s 5 independent from the arrangement requiring material 6 participation in the farming activity . 7 In this connection we note that petitioner s 8 have stipulated that the "lease agreement" called for aggregate rents of $230,000 per year, whereas th e 10 actual gross rental income was substantially less in 11 each of the years in issue, that is, $175,668 an d 12 $120,299, respectively . As to this discrepancy , 13 petitioners have stipulated : 14 "Petitioners were willing to accept less 15 rent than required under the arrangement rather than 16 cause the Corporation [i .e ., Metz Farms] to borrow 17 funds to make the required payments . " 18 In effect , petitioners and Metz Farms agreed 19 that the aggregate rents would be $230,000, bu t 20 petitioners agreed to accept less if the corporation' s 21 earnings did not permit it toj'pay full rents without 22 borrowing . This shows a close relationship between 23 the lease transaction and the !arrangement betwee n 24 petitioners and Metz Farms for the production o f 25 agricultural products . Heritage Reporting Corporation ( 202) 62814888 J 1 1 1 Thus, we agree with) respondent that th e 2 exclusion for rentals from rea 1 property leased with 3 the real estate in section 140 2 (a) (1) is no t 4 applicable in this case with t he result that th e 5 rental income at issue is subject to self-employment 6 tax . 7 VIII . 8 The second issue ford decision in this cas e 9 is whether petitioners were el igible to claim expens e 10 deductions with respect to certain depreciabl e 11 business assets under section 179 . The parties agre e 12 that this issue turns on the application of sectio n 13 179(d)(5) which states as folk ws : 14 "(5) Section not to apply to certai n 15 noncorporate lessors .--This se1ction shall not apply to 16 any section 179 property which is purchased by a 17 person who is not a corporation and with respect to 18 which such person is the lessolr unless -- 19 (A) the property subject to the lease has 20 been manufactured or produced by the lessor, o r 21 (B) the term of the lease (taking int o 22 account options to renew) is less than 50 percent of 23 the class life of the propert' (as defined in section 24 168(i)(1)), and for the period consisting of the first 25 12 months after the date on which the property i s Heritage Reporting Corporation (202) 628-4888 s 1 2 1 transferred to the lessee the sum of the deduction s 2 with respect to such property which are allowable t o 3 the lessor solely by reason of section 162 (other tha n 4 rents and reimbursement amounts with respect to such 5 property) exceeds 15 percent of the rental income 6 produced by such property . " 7 In effect, section 179(d)(5) provides that a 8 person who is not a corporation is not entitled t o 9 expense the cost of property which is leased, unless 10 the taxpayer meets the conditions enumerated i n 11 subparagraphs (A) or (B) . Petitioners did no t 12 manufacture the real and personal property leased to 13 Metz Farms and , thus, they do not meet sectio n 14 179( d)(5)(A) . Furthermore , there is nothing in th e 15 record to show that, during 2005 and 2006, petitioners 16 met the conditions set forth in section 179(d)( 5)(B) . 17 Accordingly, petitioners are not eligible to clai m 18 the benefits under section 179 . 19 We note that the adjustment determined i n 20 the subject Notice of Deficiency overstates th e 21 expense amounts claimed by petitioners under section 22 179 during the years at issue . As mentioned above, 23 the expense dedu tion claimed by petitioners for 2005 24 not'54 612, the amount on which the was48,314 , 25 adjustment was based . Similarly, the expens e Heritage Reporting Corporation (202) 628L4888 1 3 7 deduction claimed by petitioners for 2006 was r8A,986 , t on which the adjustmen t not 90,929 , the amount 3 was based . The final computation of petitioners' tax 4 liability should be based on the amounts actuall y 5 claimed by petitioners under section 179 . 6 7 Ix . To reflect the foregoing, decision in thi s 8 case will be entered under Rule 155 . 9 X . 10 This concludes the Court's oral findings o f 11 fact and opinion in this cas e 1 2 1 3 14 1 5 16 1 7 1 8 1 9 2 0 2 1 2 2 2 3 2 4 25 (Whereupon , at 6 :00 p .m ., the bench opinion in the above - entitled matter was concluded . ) /I Heritage Reporting Corporation (202) 628,-4888