118 T.C. No. 8



                UNITED STATES TAX COURT



    RICHARD J. BOT AND PHYLLIS BOT, Petitioners v.
     COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 14155-98.                Filed February 15, 2002.




     Ps maintained active memberships in an
agricultural cooperative, which processed and sold corn
produced by its members. As active members, Ps were
obligated to produce and deliver corn to the
cooperative regularly, and, during 1994 and 1995, they
met that obligation with corn they acquired from a
“pool” maintained by the cooperative. The cooperative
processed and sold the corn for Ps’ benefit and paid to
Ps value-added payments for the corn. For Federal tax
purposes, Ps reported the value-added payments they
received during 1994 and 1995 as proceeds from the sale
of capital assets and did not treat the amounts
received as self-employment income.
     Held:   During 1994 and 1995, Ps were engaged in
the business of acquiring and selling corn and corn
products for a profit. The value-added payments were
derived from Ps’ business and must be included in the
calculation of Ps’ net earnings from self-employment
for purposes of determining Ps’ liability for self-
employment tax.
                               - 2 -

     Kathryn J. Sedo, for petitioners.

     Blaine C. Holiday, for respondent.



     MARVEL, Judge:   Respondent determined deficiencies in

petitioners’ Federal income tax for 1994 and 1995 of $7,239 and

$13,716, respectively.

     The sole issue for decision is whether petitioners are

liable for self-employment tax under section 14011 on value-added

payments that they received in 1994 and 1995 from an agricultural

cooperative of which they were active members.

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts is incorporated in our opinion by this

reference.   Petitioners resided in Marshall, Minnesota, when the

petition in this case was filed.2

     During all relevant years, Richard J. Bot (Mr. Bot) and

Phyllis Bot (Mrs. Bot) owned and lived on a 700-acre farm in

Minnesota.   Before 1988, petitioners ran their farm operation,

growing crops such as corn, alfalfa, and soybeans and raising

livestock.   In the fall of 1987, however, petitioners decided to


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure. Monetary amounts are rounded to the nearest dollar
where appropriate.
     2
      Petitioners live in Texas from November to April.
                               - 3 -

retire from daily farming and entered into a written farm

agreement (the 1987 farm agreement) with two of their sons,

Richard F. Bot and Bennett Bot (hereinafter referred to as the

sons).   This agreement was renewed orally each year.   The 1987

farm agreement required the sons to operate petitioners’ farm “in

a good and husband-like manner, and according to the usual course

of husbandry” and required petitioners to compensate the sons by

paying them with a “one-half part or share of all grains,

vegetables, corn, soy beans and other crops so raised and secured

upon said farm”.

     The 1987 farm agreement required petitioners to pay for half

of the costs of seed, fertilizer, and weed sprays and to provide

land and machinery for the farming operation.   The 1987 farm

agreement also gave petitioners the option of making major

repairs to or replacing equipment, when necessary, but did not

require them to do so.   The 1987 farm agreement required the sons

to pay for half of the costs of seed, fertilizer, and weed

sprays; to furnish all labor and pay all operating costs; to haul

and deliver crops for petitioners; and to keep petitioners’ farm

implements in good repair.   Under the 1987 farm agreement,

petitioners and the sons were supposed to divide all Government

program aid equally.

     The arrangement between petitioners and the sons during 1994

and 1995 followed the basic parameters of the 1987 farm agreement

but was broader.   Under the arrangement in effect for 1994 and
                               - 4 -

1995, petitioners and the sons contributed equally to farm

expenses and shared equally in farm profit or loss.   During 1994

and 1995, crops grown on the farm were either fed to farm

livestock or sold, and any profit generated from the farm

operation, including profit from the sale of crops and livestock,

was split approximately equally between petitioners and the sons.

Petitioners delegated to their sons the authority to decide

whether crops raised on the farm were to be fed to livestock or

sold on the open market.   During 1994 and 1995, the sons sold

corn and soybeans in petitioners’ names because it was

economically advantageous to do so.

     Pursuant to the arrangement in effect for 1994 and 1995,

petitioners paid part of the farm expenses.   In November 1994 and

again in November 1995, petitioners estimated the results of the

farming operation and wrote checks to the sons to reimburse them

for petitioners’ share of farm expenses.   In November 1994,

petitioners paid $25,000 to each son; in November 1995,

petitioners paid $35,000 to each son.3   At the end of the year,

petitioners and the sons added up the income earned from the farm

operation, subtracted the farm expenses petitioners and the sons



     3
      Although the memo portion of each personal check written in
1994 states that the check was for “corn purchased”, petitioners
admitted at trial that they paid the money to reimburse the sons
for petitioners’ share of expenses incurred in the farming
operation.
                                - 5 -

had paid, and calculated how much of the farm operation’s profit

they each were entitled to receive.

     With the exception of proceeds generated from the sale of

corn in 1995 that were reported as proceeds from the sale of

capital assets on Schedule D, Capital Gains and Losses,

petitioners reported their share of farm income and expenses as

farm rental income and expenses on Forms 4835, Farm Rental Income

and Expenses, attached to their 1994 and 1995 Forms 1040, U.S.

Individual Income Tax Return.

Minnesota Corn Processors

     In approximately 1982, a group of Minnesota farmers formed

Minnesota Corn Processors (MCP), an agricultural cooperative

organized under the laws of Minnesota.4   MCP was incorporated to

handle all aspects of dealing with agricultural products produced

by its members and to perform services for its members.

     Under its articles of incorporation, MCP was authorized to

issue 30,000 shares of common stock and 100,000 shares of

nonvoting preferred stock.   Only “producers of agricultural

products * * * who reside in the territory served” by MCP could

hold shares.   A producer is any person “actually engaged in the

     4
      MCP’s objective was to accomplish collectively what none of
its members could accomplish individually–-process corn and
realize profits from the increased value of that processed corn.
Without MCP’s pooled funds and processing facilities, its members
would have had to sell their corn, if any, to an elevator. Then,
any value added to the corn by processing the corn would have
been realized by others.
                               - 6 -

production of one or more of the agricultural products handled”

by MCP and includes lessors of land who receive crop shares as

rent.   A member is any producer of agricultural products who is

eligible for membership in MCP and who has acquired a minimum of

5 shares of MCP’s common stock.

     Under its bylaws in effect during 1994 and 1995, MCP was

authorized to terminate any membership if an existing member was

no longer eligible for membership, a member failed to patronize

MCP for 1 year or more, a member moved from the territory served

by MCP, or died, or ceased to be an agricultural producer, or a

member violated MCP’s bylaws, breached a contract with MCP, owed

MCP a delinquent debt, or willfully obstructed MCP’s purposes or

activities.   In such an event, MCP’s board of directors had the

right, at its option, to purchase the member’s stock or to

require the member to convert his common stock to either

preferred stock or a nonvoting certificate of interest.

     Petitioners became members of MCP in 1982.   Mr. Bot

purchased 40 shares of common stock on August 26, 1982, and Mrs.

Bot purchased 15 shares on August 28, 1982.   As members,

petitioners were also required to purchase units of equity

participation and to enter into a uniform marketing agreement

(UMA) with respect to each unit.   The units of equity

participation and the UMAs collectively defined the scope of

petitioners’ obligation to patronize MCP.   Each unit of equity
                                   - 7 -

participation specified the maximum number of bushels of corn the

member could be required to produce and deliver to MCP each

processing year,5 and the related UMA set forth the terms

governing the production, processing, and marketing of the corn.

During 1994 and 1995, petitioners were active members of MCP who

owned MCP common stock.   As active members, petitioners continued

to have ongoing production obligations to MCP and its membership.

     Beginning in 1982 and continuing through and including 1995,

petitioners periodically purchased units of equity participation

as follows:

            Richard J. Bot                        Phyllis Bot
     Date        Units purchased           Date      Units purchased

    8/26/82          40,000             8/28/82          15,000
                                       12/20/85          20,000
     2/1/901         20,000              2/1/90          17,500
    10/1/90          30,000             10/1/90          26,250
    12/1/91           5,000             12/1/91          20,000
     6/1/92          30,000              6/1/92          26,250
     3/1/94          10,000              3/1/94          10,000
     6/1/94          62,500              6/1/94          62,500
     6/1/95          79,000              6/1/95          79,000
    9/18/95          16,500             9/18/95          12,750
    12/1/95          20,000             12/1/95          20,000
     1
      Petitioners testified they purchased additional units after
1987 because they thought the units would make good investments.

     As MCP members, petitioners were required to produce and

deliver corn three times each year as determined by MCP.          The

timing of the deliveries was also within MCP’s discretion.


     5
      MCP’s processing year begins Oct. 1 and ends Sept. 30.
MCP’s fiscal year begins Jan. 1 and ends Dec. 31.
                               - 8 -

Petitioners could meet their production and delivery obligations

with corn that was grown on their farm, that they acquired

elsewhere, or that MCP already held in its option pool.6   “Option

pool corn” is corn maintained by MCP and made available for sale

only to MCP members for use in meeting their production and

delivery obligations under the UMAs.   A member who wished to

satisfy his production and delivery obligation using option pool

corn completed a form to that effect and paid an acquisition fee

of 5 cents per bushel of option pool corn purchased.   If either

petitioner failed to meet the production and delivery obligations

under the UMA, the UMA authorized MCP to act as that petitioner’s

agent in acquiring corn, charging all related expenses to Mr. Bot

or Mrs. Bot, as appropriate.

     In 1994 and 1995, petitioners met their production and

delivery obligations under their UMAs with option pool corn.    In

1994 and 1995, petitioners paid acquisition fees of $18,070 and

$16,431, respectively, for the option pool corn used to satisfy

their combined production and delivery obligations.

     MCP was obligated, pursuant to the UMAs, to process the corn

produced by its members each year as dictated by the market and

in a manner MCP deemed in the best interest of the cooperative


     6
      Regardless of how petitioners acquired the corn they
delivered to MCP, petitioners warranted to MCP that they were the
producers or owners of the corn they delivered to MCP under the
UMAs.
                                 - 9 -

and its membership as a whole.    MCP also was obligated to market

the processed corn at the best rate obtainable on the open

market.   In the UMAs, petitioners appointed MCP as their agent to

market and sell the corn they delivered to satisfy their

production and delivery obligations.     MCP determined how much

corn petitioners had to produce and deliver and had “sole and

complete discretion in all phases of the marketing activity”.

     In return for petitioners’ meeting their production and

delivery obligations, MCP was obligated under the UMA to pay each

petitioner:   (1) At least 80 percent of the loan value per bushel

of corn delivered by each petitioner; (2) a storage fee and

interest in some cases; (3) an additional payment (“value-added

payment”) for value added to the corn as a result of its

processing, and as further compensation for corn delivered by

petitioners, if MCP determined that such a payment was warranted

after calculating the net proceeds from all of its operations for

the processing year and if MCP’s lenders approved; and (4)

payments from MCP’s earnings as patronage dividends in accordance

with MCP’s bylaws.   During 1994 and 1995, petitioners received

value-added payments of $132,375 and $207,612, respectively,

attributable to the option pool corn they acquired and delivered

to MCP.
                              - 10 -

Petitioners’ 1994 and 1995 Tax Returns

     Petitioners reported the value-added payments on Schedules D

as proceeds from the sale of capital assets.   Petitioners

subtracted from those proceeds the following amounts, which they

claimed represented their adjusted basis for purposes of

calculating their capital gain or loss:

          Description            1994                1995

     Option pool corn fees     $18,070             $16,431
     Payments to sons           50,000              70,000
       Total basis claimed      68,070              86,431

Petitioners acknowledged during the trial, however, that they had

erroneously increased their basis by the payments made to the

sons, which had nothing to do with option pool corn purchased

from MCP but rather were to reimburse the sons, at least in part,

for petitioners’ share of farm-related expenses the sons had

paid.7

     With the exception of some corn sale proceeds reported on

the Schedules D, petitioners reported their farm income and

expenses for 1994 and 1995 as farm rental income and expenses on

Forms 4835.   On the Forms 4835, petitioners checked the box

acknowledging that they actively participated in the operation of



     7
      Although petitioners conceded at trial that they
erroneously increased their basis in the option pool corn they
acquired to satisfy their MCP obligations by the amounts paid to
the sons for farm expenses, respondent did not move for an
increased deficiency in this case.
                                - 11 -

their farm during 1994 and 1995 although they testified at trial

that they had made a mistake in doing so.

Notice of Deficiency

     In the notice of deficiency, respondent reduced petitioners’

capital gain income for 1994 and 1995 by the reported capital

gains of $64,305 and $121,180, respectively, resulting from

petitioners’ receipt of the value-added payments.     Respondent

reclassified the capital gain as Schedule C, Profit or Loss From

Business, income, treated that income as net earnings from self-

employment, and determined that petitioners were liable for self-

employment tax on that income.    Respondent did not determine that

the income petitioners reported as net farm rental income must be

included in calculating petitioners’ net earnings from self-

employment for 1994 and 1995.

                                OPINION

     Self-employment tax is imposed on the “self-employment

income” of every individual.    Sec. 1401(a).   “Self-employment

income” is defined as “the net earnings from self-employment

derived by an individual * * * during any taxable year”.     Sec.

1402(b).   “Net earnings from self-employment” is “the gross

income derived by an individual from any trade or business

carried on by such individual, less the deductions allowed by

this subtitle which are attributable to such trade or business”.

Sec. 1402(a).   For purposes of section 1402, “The trade or
                               - 12 -

business must be carried on by the individual, either personally

or through agents or employees.”   Sec. 1.1402(a)-2(b), Income Tax

Regs.    The self-employment tax provisions are broadly construed

in favor of treating income as earnings from self-employment.8

Braddock v. Commissioner, 

, 644 (1990); Hornaday v.

Commissioner, 

, 834 (1983); Hennen v. Commissioner,

T.C. Memo. 1999-306; S. Rept. 1669, 81st Cong., 2d Sess. (1950),

1950-2 C.B. 302, 354.

     Respondent does not directly dispute that petitioners

retired from daily farming in 1988.     Respondent contends only

that petitioners engaged in a trade or business of acquiring and

selling corn and corn products for profit during 1994 and 1995

and that petitioners derived the value-added payments from that

trade or business.

     Petitioners claim that they were not engaged in a trade or

business from which they derived the value-added payments.

Petitioners assert that the value-added payments constituted

investment income attributable to their ownership of MCP common

stock.    Petitioners maintain they correctly reported the value-

added payments on their 1994 and 1995 tax returns as proceeds

from the sale of capital assets excludable from net earnings from


     8
      We do not consider the provisions of subch. T of the Code,
secs. 1381-1388, pertaining to the income taxation of
cooperatives and their patrons, since none of the parties to this
case place any reliance on those provisions.
                                - 13 -

self-employment under section 1402(a)(3).9    In the alternative,

petitioners argue on brief that the value-added payments are

dividends paid with respect to their MCP stock, which are

excludable from net earnings from self-employment under section

1402(a)(2).10

     We examine the parties’ contentions below, taking into

account the burden of proof, which rests upon petitioners.       Rule

142(a)(1).11    Respondent’s determinations are presumed to be

     9
      Sec. 1402(a)(3) provides that, in computing a taxpayer’s
net earnings from self-employment,

          (3) there shall be excluded any gain or
     loss-–
               (A) which is considered as gain or loss
          from the sale or exchange of a capital asset,

                 *    *    *    *    *    *    *

               (C) from the sale, exchange, involuntary
          conversion, or other disposition or property
          if such property is neither-–

                      (i) stock in trade or other
                 property of a kind which would properly
                 be includible in inventory if on hand at
                 the close of the taxable year, nor

                      (ii) property held primarily for sale to
                 customers in the ordinary course of the trade
                 or business;
     10
      Sec. 1402(a)(2) provides that, in calculating a taxpayer’s
net earnings from self-employment, “there shall be excluded
dividends on any share of stock”.
     11
      Sec. 7491 does not place the burden of proof on respondent
because the examination in this case began before July 22, 1998.
Internal Revenue Service Restructuring & Reform Act of 1998, Pub.
                                                   (continued...)
                               - 14 -

correct; petitioners must prove that respondent’s determinations

are erroneous in order to rebut the presumption and satisfy their

burden of proof.    Id.; Welch v. Helvering, 

, 115

(1933).

I.   Trade or Business

     Because only gross income derived from a trade or business

carried on by the taxpayer is taken into account in calculating

net earnings from self-employment, we first consider whether

petitioners carried on a trade or business during the years at

issue.    The term “trade or business” has the same meaning for

purposes of section 1402 as it has for purposes of section 162.

Sec. 1402(c).    “Trade or business” under section 162 has been

interpreted to mean an activity that is conducted “with

continuity and regularity” and with the primary purpose of making

income or a profit.    Commissioner v. Groetzinger, 

, 35

(1987).

     Courts have sometimes struggled to differentiate a trade or

business from a passive investment.     E.g., Hendrickson v.

Commissioner, T.C. Memo. 1987-566 (“It is often difficult to

distinguish a ‘trade or business’ from passive investments held

for the production of income.”    (citing Higgins v. Commissioner,

, 217 (1941))).    Whether a taxpayer is engaged in a


     11
      (...continued)
L. 105-206, sec. 3001(c), 112 Stat. 685, 724.
                              - 15 -

trade or business must be ascertained from a review of all the

relevant facts and circumstances.     Commissioner v. Groetzinger,

supra (“in the absence of guidance, * * * We would defer * * * to

the Code’s normal focus on what we regard as a common-sense

concept of what is a trade or business”).

     Neither party addressed directly whether petitioners’ rental

of their farm to the sons (rental activity), standing alone,

constituted a trade or business for purposes of the self-

employment tax.   However, respondent appears to have accepted the

proposition that income generated by petitioners’ rental activity

is not subject to self-employment tax, presumably because of the

provisions of section 1402(a)(1).12    Consequently, we focus our

analysis on petitioners’ activities with respect to MCP in order

to decide whether petitioners were engaged in a trade or business

     12
      Sec. 1402(a)(1) provides that excludable farm rental
income includes rent paid in crop shares. Sec. 1.1402(a)-4,
Income Tax Regs., provides:

     Rentals paid in crop shares include income derived by
     an owner or lessee of land under an agreement entered
     into with another person pursuant to which such other
     person undertakes to produce a crop or livestock on
     such land and pursuant to which (1) the crop or
     livestock, or the proceeds thereof, are to be divided
     between such owner or lessee and such other person, and
     (2) the share of the owner or lessee depends on the
     amount of the crop or livestock produced. * * *

Presumably because the sons leased petitioners’ farm during 1994
and 1995 and paid petitioners a portion of what was produced on
the farm as rent, respondent did not determine that the income
petitioners reported as farm rental income on Form 4835 was
subject to self-employment tax.
                              - 16 -

for purposes of the self-employment tax.

     Petitioners originally purchased stock and units of equity

participation in MCP and executed their first UMAs to enhance

their ability to profit from the corn they grew on their farm.

Their membership in MCP enabled them to arrange for cost-

effective processing of the corn they grew and for the marketing

and sale of their corn and corn products through MCP.   The

relationship apparently was so beneficial that, over the years,

petitioners continued to buy additional units of equity

participation, thereby increasing the amount of corn they would

be required to produce under the UMAs but also increasing the

amount of money they would be entitled to receive under the UMAs.

     Although petitioners retired from daily farming in 1987 and

turned over their farm operation to the sons, petitioners

nevertheless continued to maintain their membership in MCP from

1987 through at least 1995.   As active members of MCP during 1994

and 1995, petitioners, either directly or through the sons as

their agents,13 regularly and continuously (1) maintained their

status as producers under the UMAs, (2) made decisions regarding

how to satisfy their production and delivery obligations to MCP

under the UMAs, (3) acquired option pool corn which they used to

satisfy their production and delivery obligations to MCP several

     13
      Petitioners testified that the sons acted on their behalf
and do not dispute that the sons operated as their agents in
delivering and selling corn and other produce for their benefit.
                              - 17 -

times each year, and (4) sold corn and corn products for profit

through MCP.

     Under the UMAs, once petitioners satisfied their production

obligations by supplying corn they had either grown or acquired

from the option pool to MCP, MCP processed the corn and then

marketed and sold the corn and resulting products on behalf of

petitioners and its other members.     In fact, the UMAs

specifically appointed MCP as petitioners’ agents to market and

sell the corn and corn products.

     Respondent argues that petitioners’ involvement with MCP is

more than sufficient to qualify as a trade or business.

Moreover, respondent contends that MCP’s actions in processing,

marketing, and selling corn on behalf of its members can be

attributed to petitioners for purposes of this analysis because

the UMAs expressly designated MCP as petitioners’ agent to market

and sell the corn and corn products and because the contractual

designation is controlling.

     Petitioners disagree, arguing their involvement with MCP was

so limited that it cannot qualify as a trade or business and that

MCP’s actions in processing, marketing, and selling the corn and

corn products cannot be attributed to them.     Specifically,

petitioners contend that whether MCP was petitioners’ agent is

not controlled by the UMAs but must be decided by reference to

State law.   According to petitioners, the law of agency in
                                - 18 -

Minnesota requires a principal to retain some measure of control

over the agent for a valid agency relationship to exist.    See

Jurek v. Thompson, 

 (Minn. 1976).    Petitioners

claim they retained no control over the processing of the corn

and the marketing and sale of the resulting corn products;

therefore, MCP was acting on its own account and not as

petitioners’ agent.   According to petitioners’ analysis, unless

MCP was petitioners’ agent, petitioners’ limited involvement in

acquiring and delivering corn to satisfy their production

obligations is insufficient to constitute a trade or business

generating income subject to the self-employment tax.

     We disagree with petitioners for several reasons.    First,

whether MCP qualified as petitioners’ agent in processing,

marketing, and selling the corn petitioners acquired and

delivered to MCP in 1994 and 1995 is not essential to our

holding.   Regardless of whether MCP acted as petitioners’ agent,

the record establishes that petitioners, by satisfying their

production obligations under the UMAs during 1994 and 1995,

regularly and continuously purchased and sold corn with the

intention of making a profit.    Although petitioners may have

retired from daily farming in 1987, they did not cease to

function as dealers in corn following their retirement.    In fact,

in 1990, 1991, 1992, 1994, and 1995, petitioners bought

additional units of equity participation and entered into
                              - 19 -

additional UMAs, thereby obligating themselves to produce greater

quantities of corn to MCP each year.   Petitioners’ argument

regarding control fails to adequately acknowledge petitioners’

expanding role as dealers who bought and sold corn to customers

for a profit.

     The second reason is grounded in the unique nature of a

cooperative and its relationship to its members.   In Puget Sound

Plywood, Inc. v. Commissioner, 

, 306-309 (1965), we

examined the nature and attributes of a cooperative in general in

order to decide whether a workers cooperative association was a

nonexempt cooperative association entitled to exclude patronage

distributions from its gross income for Federal income tax

purposes.   In so doing, we quoted the following description of a

cooperative contained in 7 Ency. Am. 639 (1959):

     “A cooperative is an organization established by
     individuals to provide themselves with goods and
     services or to produce and dispose of the products of
     their labor. The means of production and distribution
     are those owned in common and the earnings revert to
     the members, not on the basis of their investment in
     the enterprise but in proportion to their patronage or
     personal participation in it. Cooperatives may be
     divided roughly into consumer cooperatives and producer
     cooperatives.

                *   *     *     *      *    *      *

     Producer [cooperative] organizations operate for the
     benefit of the members in their capacity as producers.
     Their function may be either the marketing or
     processing of goods produced individually (as in
     fishermen’s or farmers’ marketing associations, or
     associations which make butter or cheese from farm
     products received from farm members), or the marketing
                               - 20 -

     of goods processed or produced collectively (as in the
     so-called workers’ [cooperative] productive
     associations operating factories or mills).” [Emphasis
     supplied.]

Puget Sound Plywood, Inc. v. Commissioner, supra at 306-307.

We noted that three fundamental principles underlie a

cooperative: (1) Subordination of capital; (2) democratic control

by the cooperative’s members; and (3) the allocation among

members of the economic results in proportion to the members’

active participation in the cooperative endeavor.   Id. at 308.

Regarding the second element, we stated that a cooperative

effects democratic control by requiring the members to

“periodically assemble in democratically conducted meetings at

which each member has one vote and one vote only, and at which no

proxy voting is permitted; and these * * * [members] there deal

personally with all problems affecting the conduct of the

cooperative.”   Id.

     MCP was an agricultural cooperative characterized by

subordination of capital, democratic control by its members,14

and the distribution of its operational proceeds on the basis of

patronage.   MCP’s bylaws confirm that members had substantial

control over its operations.   Moreover, petitioners failed to

introduce evidence to support a finding that, as cooperative


     14
      Under MCP’s articles of incorporation, each MCP member was
entitled “to only one vote on each matter submitted to a vote at
any meeting of the members regardless of the number of shares of
common stock held by such member.”
                              - 21 -

members, they could not influence MCP’s operations.   Petitioners’

argument that they did not have a sufficient level of control

under Minnesota law to support the explicit contractual

designation of MCP as petitioners’ agent, even if relevant to our

analysis, is unsupported by any convincing proof in the record.

      Finally, petitioners have failed to convince us that

Minnesota law invalidates an express contractual agency

designation when both the designated agent and the designated

principal adhere to the terms of the contract.   Petitioners

voluntarily entered into multiple UMAs with MCP, which were in

effect for 1994 and 1995.   Each of those UMAs clearly designated

MCP as petitioners’ agent for the marketing and sale of the corn

petitioners had acquired and delivered pursuant to the UMAs.15

There is no dispute that petitioners produced corn as required by

the UMAs, or that MCP marketed and sold petitioners’ corn and

corn products as required by the UMAs, thereby generating the

value-added payments.   Given these undisputed facts, petitioners’

argument that the contractually based agency designation may be



     15
      Petitioners also argue that, because they designated MCP
as their agent for the marketing and sale of corn but not for its
processing, no agency relationship was created. This argument
makes no sense and we reject it. Petitioners appointed MCP as
their agent to market and sell the corn they had acquired and
delivered to MCP under the UMAs. Whether MCP was operating as
petitioners’ agent in processing the corn does not control our
analysis of whether petitioners were in the business of
acquiring, marketing, and selling corn and corn products for
profit.
                               - 22 -

disregarded under State law simply does not ring true.

     Petitioners rely primarily on Hansen v. Commissioner, T.C.

Summary Opinion 1998-91, which has no precedential value, see

sec. 7463(b), and Felber v. Commissioner, T.C. Memo. 1992-418,

affd. without published opinion 

 (8th Cir. 1993),

for the proposition that the value-added payments are not subject

to self-employment tax.   In Felber, we held that a wheat farmer

was not liable for self-employment tax on income received by him

and generated from the sale of wheat by a tenant farmer under a

crop-sharing agreement because we found that the taxpayer was

retired and was only minimally involved in the production of

wheat.    The issue, however, was whether the exclusion from net

earnings for rentals from real estate applied.16    See sec.

1402(a)(1); sec. 1.1402(a)-4(b), Income Tax Regs.    We did not

address any argument that the taxpayer operated a trade or

business of acquiring and selling agricultural products through

the cooperative as his agent, and/or through the tenant farmer as

his agent, employee, or partner.

     Unlike the parties in Felber v. Commissioner, supra, the

parties in this case have raised and argued issues focusing on

whether petitioners, after they retired from daily farming,

continued to carry on a trade or business by acquiring,



     16
      Petitioners do not contend that the value-added payments
qualify for this exclusion.
                                - 23 -

delivering, and selling corn.    The facts support a conclusion

that petitioners continued to acquire, market, and sell corn and

corn products either directly to MCP or through MCP as their

agent.   Consequently, our decision in Felber simply is not

applicable with respect to whether petitioners carried on a trade

or business during 1994 and 1995 involving MCP.      We hold that

petitioners were engaged, during 1994 and 1995, in continuing and

regular efforts to reap a profit from the acquisition, marketing,

and sale of corn and corn products and that those efforts

constituted a trade or business.

II.   Income Derived From a Trade or Business

      When faced with whether a taxpayer must treat a particular

item of income as net earnings from self-employment, we have

consistently stated that the taxpayer must derive the income in

question from a trade or business carried on by the taxpayer.

Newberry v. Commissioner, 

, 444 (1981); Ray v.

Commissioner, T.C. Memo. 1996-436.       In other words, there must be

a nexus between the trade or business and the income that the

taxpayer has received.   Newberry v. Commissioner, supra at 444.

      We are satisfied that the value-added payments were derived

from petitioners’ trade or business.      Petitioners, either

directly or through the sons as their agents, regularly acquired

and delivered option pool corn to MCP which MCP processed and

then marketed and sold for petitioners.      Under the UMAs, MCP was
                              - 24 -

required to make value-added payments as further consideration

for the corn delivered by petitioners.   The amount of value-added

payments petitioners received from MCP was based on petitioners’

patronage; i.e., the amount of corn acquired and delivered by

petitioners to MCP during the processing year.

     In Shumaker v. Commissioner, T.C. Memo. 1979-71, affd. on

this issue and revd. on another ground 

 (9th Cir.

1981), we concluded without discussion that patronage

distributions were subject to self-employment tax under sections

1401 and 1402.   On appeal, the Court of Appeals for the Ninth

Circuit affirmed our conclusion, holding that “patronage

dividends from farmer’s cooperatives was properly subject to

self-employment tax.”   Shumaker v. Commissioner, 648 F.2d at

1200.

     Because the value-added payments were directly related to

the volume of corn acquired and delivered by petitioners to MCP

and were paid in consideration for petitioners’ patronage, the

value-added payments had a direct nexus to petitioners’ trade or

business and, consequently, were derived from that trade or

business.   Therefore, unless the exclusion under either section

1402(a)(3) or (2) applies to the value-added payments, those

payments must be included in calculating petitioners’ net

earnings from self-employment.
                                - 25 -

III. Exclusions Under Section 1402

     A.    Introduction

     Section 1402 contains several provisions which exclude

specified types of income from the calculation of net earnings

from self-employment.     Petitioners contend that the value-added

payments are excludable under either section 1402(a)(3) or (2).

     B.   Section 1402(a)(3)

     Section 1402(a)(3) excludes from the calculation of net

earnings from self-employment any gain or loss (1) from the sale

or exchange of a capital asset, or (2) from the sale, exchange,

or other disposition of property if the property is neither stock

in trade or other property of a kind normally includable in

inventory if on hand at the close of the taxable year nor

property held primarily for sale to customers in the ordinary

course of the taxpayer’s trade or business.

     Although their argument is not entirely clear, petitioners

seem to contend that, because they acquired their MCP stock for

investment purposes, the corn they acquired during 1994 and 1995

and delivered to MCP for processing, marketing, and sale was a

capital asset.   Petitioners’ argument is confusing and erroneous,

and we reject it.

     Petitioners did not sell their MCP stock.    They sold option

pool corn acquired from MCP.    Petitioners’ motivation in

acquiring their MCP stock has no bearing on whether the option
                               - 26 -

pool corn they purchased to satisfy their production and delivery

obligations under the UMAs qualifies as a capital asset.     Rather,

it is the character of the property sold that controls the

analysis under section 1402(a)(3).

     Section 1221 defines capital asset broadly as “property held

by the taxpayer (whether or not connected with his trade or

business)” but excludes from that definition property described

in section 1221(a)(1) through (5).      The exclusions include stock

in trade of the taxpayer, other property of a kind normally

includable in inventory if on hand at the close of the taxable

year, and property held primarily for sale to customers in the

ordinary course of the taxpayer’s trade or business.     Sec.

1221(a)(1); see also sec. 1402(a)(3)(C).

     In this case, the property sold was corn and corn products.

The corn in question was acquired by petitioners to satisfy their

production and delivery obligations under the UMAs so that the

corn and any resulting corn products could be sold by MCP on

petitioners’ behalf to customers in the ordinary course of

petitioners’ business.   The value-added payments resulted from

those sales.   We hold, therefore, that the value-added payments

are not excludable under section 1402(a)(3) in calculating

petitioners’ net earnings from self-employment.

     C.   Section 1402(a)(2)

     Petitioners alternatively argue that, if the exclusion under
                              - 27 -

section 1402(a)(3) does not apply, the exclusion under section

1402(a)(2) operates to exclude the value-added payments because

those payments were really dividends paid with respect to

petitioners’ MCP stock.   Section 1402(a)(2) excludes from the

calculation of net earnings from self-employment dividends on

stock.

     Ordinarily, “dividend” is a term of art used to describe a

distribution of property made with respect to a shareholder’s

stock out of the current or accumulated earnings of a

corporation, which is taxed to the shareholder as ordinary

income.   See secs. 61(a)(7), 301(c), 316(a).   By its nature, a

dividend paid with respect to stock is a return on a

shareholder’s capital investment.   In contrast, a patronage

distribution17 is a payment of a cooperative’s net income

calculated by reference to a member’s participation in, or

patronage of, the cooperative’s activities.




     17
      Patronage distributions are described by a variety of
different names such as patronage dividends, patronage refunds,
and value-added payments. No matter what words are used to
describe a particular distribution, the controlling
characteristic appears to be whether the payment is determined by
the level of a member’s participation in a cooperative. See also
sec. 1388(a), which defines “patronage dividend” for purposes of
subch. T as an amount paid to a patron by a qualifying
cooperative on the basis of quantity or value of business done
with or for that patron under a preexisting obligation of the
cooperative to pay that amount, and the amount is determined by
reference to the cooperative’s net earnings from business done
with or for its patrons.
                              - 28 -

     In this case, petitioners have offered no evidence to

support their alternative argument that the value-added payments

were really dividends paid with respect to their MCP stock.     In

fact, the record contains compelling evidence against

petitioners’ argument.   For example, MCP’s articles of

incorporation provided that “No dividends shall be paid on the

common stock of this association” and permitted noncumulative

dividends, which could not exceed a specified percentage, only

with respect to MCP’s preferred stock.18   The articles also

provided that “All net proceeds (savings) of this association in

excess of dividends, if any, shall be distributed to patrons

annually or oftener on the basis of patronage”.   These provisions

reinforce other evidence in the record that establishes the

value-added payments were paid in consideration for the quantity

of business petitioners conducted with MCP.   The value-added

payments were calculated on the basis of the corn petitioners

acquired and delivered to MCP during 1994 and 1995.

     On the evidence before us, we conclude that the value-added

payments were paid with respect to and as additional

consideration for the corn petitioners acquired, delivered to

MCP, and sold; they were not paid with respect to petitioners’

MCP stock.   We hold, therefore, that the value-added payments are



     18
      Petitioners did not own any of MCP’s preferred stock
during the years at issue.
                              - 29 -

not excludable under section 1402(a)(2) in calculating

petitioners’ net earnings from self-employment.

IV.   Conclusion

      We find that petitioners were engaged in the business of

acquiring, marketing, and selling corn and corn products during

1994 and 1995, and that they derived the value-added payments

from that business.   We hold, therefore, that the value-added

payments of $132,375 and $207,612 in 1994 and 1995, respectively,

reduced by petitioners’ acquisition costs of $18,070 and

$16,431, respectively, constitute petitioners’ net earnings from

self-employment under section 1402.    However, because respondent

did not move for an increased deficiency in this case, any

deficiency determined as a result of this opinion may not exceed

the deficiencies determined in the notice of deficiency.

      We have considered the parties’ other arguments and, to the

extent not herein discussed, find them to be without merit.

      To reflect the foregoing,


                                        Decision will be entered

                                  under Rule 155.