In Uncategorized on 09/27/2017 at 22:54

It was only yesterday that I blogged about modest Judge David Gustafson declining to follow 2 Cir.’s decision in Chai, despite the encomia heaped upon his head by that august panel. It seems longer, but that’s because preparation for today’s closing was a bit wearying. See my blogpost “Misplaced Modesty?” 9/26/17.

Howbeit, Judge Paris is nowise loth to jump the geographic fences in Charles D. Martin and Laura J. Martin, 149 T. C. 12, filed 9/27/17.

Chas and Laura had a farm, and raised chickens under a particularly particularized contract with a poultry processing giant, which regulated each and every moment of the chickens’ lives from egg to slaughter. Chas and Laura spent $1.2 million to build a chicken shack to the exacting specifications of the giant.

Chas and Laura set up a S Corp that they owned, and handed over the chicken deal to said Corp, with giant’s consent. S Corp then leased all but ten acres of the farm and Chas’ and Laura’s farmhouse at market rent.

Although in 5 Cir country, Chas and Laura structured their lease to comply with the nexus dodge 8 Cir crafted in McNamara v. Commissioner, T.C. Memo. 1999-333, Rev’d, 236 F.3d 410 (8th Cir. 2000), to get out of SE for the rent.

Section 1402(a)(1) subjects rental income, ordinarily exempt, to SE, where personal services are part of an arrangement to carry on agricultural activities. But 8 Cir. decided that if the rent was equal to or less than market, the rent was separate from the agricultural activity.

IRS disagreed, of course. But it doesn’t help. After tracing the history of Social Security as it impacts the farmer, Judge Paris decides that Tax Court will ignore the precedents that obtain everywhere but in AR, IA, MN, MO, NE, ND and SD.

“As shown by the evidence, the rent payments petitioners received represented fair market rent and were consistent with amounts paid by other [giant] growers for the use of similar premises. This is sufficient under McNamara II to establish that the agreement stands on its own, but the Court finds that additional facts further support the Court’s conclusion.

“Petitioners invested a significant amount of money–over $1.2 million–in the eight 22,000-square-foot broiler houses and other improvements, which were all built according to the exacting specifications of [giant]. And although the rental agreement covered petitioners’ farm (excluding their residence, access to the residence, and 10 acres), structures, 176,000 square feet of poultry houses, and equipment, [S Corp] used approximately 10 acres and these single-use structures for purposes of the [chicken contract]. Practically speaking, this agreement functions as a return on investment rather than a method of income recharacterization.” 149 T. C. 12, at pp. 27-28.

Judge Paris and the majority find that IRS didn’t establish a nexus between the agricultural activity and the rent. If the rent was truly market or below, without reference to the chicken farm, even if the chicken giant chickened out, S Corp could have found another tenant. Maybe.

And of course Chas and Laura got appraisals, estimates and comparables.

OK, Chas and Laura win, and McNamara strikes up the band.

But wait, there’s more. I just said “majority.” There was a dissent.

Guess who? No, not the Great Dissenter, he’s with Judge Paris.

It’s Judge David Gustafson, yes, he who worships Golsen. What a difference a day makes.

“…I assume, along with the majority, that the fair-market rent is evidence that the arrangement may not involve disguised compensation for labor. That is, the fact of fair-market rent may be relevant to the question of whether, for purposes of section 1402(a)(1), there is no arrangement linking rent and labor.

“But relevancy should not be equated with sufficiency. It is entirely possible (as the opinion of the Court effectively admits, by inviting the IRS to offer counter-evidence) that, notwithstanding the ostensibly reasonable rent, a fair-market rental agreement could be part of an ‘arrangement’ under which the rental agreement is contingent on (and is therefore linked to) an agreement providing compensation for labor. Given that possibility, there is nothing in the statute, in logic, in custom, or in common experience that makes the absence of an arrangement so probable that, on the taxpayer’s mere showing of a fair-market rent, we necessarily relieve him of the burden of producing additional evidence of such absence unless the Commissioner can come forward with some evidence that there is an arrangement–but that is the nature of an evidentiary presumption, and the opinion of the Court gives no reason for it.” 149 T. C. 12, at pp. 33-34.

Bottom line: if there were no giant feeding chickens through Chas’ and Laura’s farm, what would the fair market rent be? And would that rent be return on investment if Chas and Laura never spent $1.2 million for chicken shacks because no chicken would ever set foot therein? And could the S Corp pay any rent at all without the income from the chicken giant? No giant, no chickens, no shacks, no rent.

Judge Nega is also dissident.

“On its face the statute does not provide a special rule for ‘at or below fair market rents’. Had Congress wanted to provide such a special rule, I see no reason for its absence from the current statute.

“Focusing only on the plain wording of the Code, I do not believe that the Court of Appeals’ interpretation is the best reading. Under our caselaw, I would still treat McNamara II as binding in the circuit in which it was decided. See Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971). I would not, however, expand its application beyond the Eighth Circuit.” 149 T. C. 12, at p. 36.

If I were IRS, I’d appeal. Judge Gustafson is on a roll when it comes to dissents.



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