                          T.C. Memo. 2002-83



                        UNITED STATES TAX COURT



        CURTIS BENNETT AND MARIE BENNETT, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

     GERHARD W. SCHMITZ AND BETTY J. SCHMITZ, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 574-00, 604-00.          Filed March 29, 2002.



     Paul J. Peter, for petitioners.

     J. Anthony Hoefer, for respondent.



                          MEMORANDUM OPINION


     SWIFT, Judge:     These cases were consolidated for trial,

briefs, and opinion.    Respondent determined deficiencies in

petitioners’ Federal income taxes as follows:
                                - 2 -

Curtis Bennett and Marie Bennett
                Year                    Deficiency
                1995                       $4,194
                1996                        3,492


Gerhard W. Schmitz and Betty J. Schmitz
                Year                Deficiency
                1995                  $4,226
                1996                   4,734


     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.

     The issue for decision is whether partnership activity

constituted a trade or business, triggering self-employment tax

liability on partnership income for the partners of the

partnership.


                           Background

     The facts of these cases were submitted fully stipulated

under Rule 122, and are so found.

     At the time the petitions were filed, petitioners Curtis and

Marie Bennett resided in Gering, Nebraska, and petitioners

Gerhard W. and Betty J. Schmitz resided in Scottsbluff, Nebraska

(hereinafter references to petitioners are generally to Curtis

Bennett and Gerhard Schmitz).

     On January 1, 1991, petitioners, as equal partners,

organized Lucky Keno (Lucky) as a general partnership to
                               - 3 -

establish Keno lotteries in various communities within the State

of Nebraska.

     Keno is a lottery game that originated in China in

approximately 1000 B.C.   In each Keno lottery, there are 80

numbers available.   A Keno player selects up to 20 numbers on a

Keno card and wages from $1 to $100 per lottery.   Using approved

lottery equipment, the winning numbers are selected randomly.

Payoffs to Keno players are based on mathematical probabilities.

     Under Nebraska’s County and City Lottery Act, Neb. Rev.

Stat. secs. 9-601 to 9-653 (1997), Keno lotteries are to be

conducted for “community betterment purposes.”   Under that

statutory authority, several Nebraska municipalities contracted

with Lucky for Lucky to establish and to operate and conduct Keno

lotteries within the municipalities.   In these contracts, Lucky

repeatedly is referred to as the entity responsible for all

aspects of the lottery.   For example, the contracts state that

“[Lucky] shall provide on a turnkey basis at no cost to the

[municipality] the design, production, installation, and

operation of a keno type lottery system.”

     In return, Lucky agreed to allocate and to distribute the

Keno lottery proceeds as follows:


                     To                      Percentage
      Lottery Players                            74
      Lucky                                      14
      Municipality                               10
      State of Nebraska as Lottery Tax            2
                              - 4 -

     Gross proceeds from the above lotteries, after certain

“instant” payoffs were distributed to players, were deposited and

maintained in a separate bank account owned by Lucky.   Large

payoffs to players were paid out by Lucky after the lottery

proceeds had been deposited into the bank account.   For the Keno

lotteries held in 1995 and 1996, total payoffs to players

exceeded $2 million.

     After obtaining the nonassignable right to establish Keno

lotteries, Lucky entered into contracts with various site

organizations (e.g., Eagles Lodges and Koala Clubs) relating to

the lotteries to be established within certain municipalities on

property owned by the site organizations.   Under these contracts,

Lucky agreed to provide all equipment, materials, and supplies

needed for operation of the Keno lotteries, to provide the

appropriate training, and to pay the site organizations a fee of

6 percent of Lucky’s 14-percent share of the lottery proceeds.

     The site organizations agreed to provide some personnel to

assist in operation of the lotteries, to provide Lucky with daily

reports of the lotteries, and to obtain liability and property

insurance relating to the lotteries.

     All of the equipment, materials, and supplies provided by

Lucky that were used in the Keno lotteries remained the property

of Lucky, and brochures used to advertise the Keno lotteries
                               - 5 -

referred to “Lucky Keno”, not to the site organizations, as the

provider of the Keno lotteries.

     The computer equipment and software provided by Lucky for

the Keno lotteries produced wager tickets for the Keno players,

recorded the wagers of the players, randomly drew 20 numbers,

displayed the winning numbers on a display board, produced a

record of the date, time, and amount of the wagers, and generated

daily summaries of each lottery.

     For 1995 and 1996, petitioners timely filed their joint

Federal income tax returns and reported their share of the income

of Lucky.   Petitioners, however, reported no self-employment tax

with regard to their respective share of Lucky’s income.

     In the notices of deficiency sent to petitioners, respondent

determined that the Keno lotteries constituted a trade or

business of Lucky and that petitioners’ respective share of

Lucky’s income was subject to self-employment tax under section

1401.


                            Discussion

     Section 1401 imposes a tax on self-employment income.    Self-

employment income includes gross income less allowable deductions

from a taxpayer’s trade or business and income derived from a

trade or business carried on by a partnership in which the

taxpayer is a partner.   Sec. 1402(a).   For purposes of the self-
                                - 6 -

employment tax provisions, the term “trade or business” generally

has the same meaning as used in section 162.    Sec. 1402(c).

     The Supreme Court in Commissioner v. Groetzinger, 480 U.S.

23, 35 (1987), defined a “trade or business” as a regular and

continual activity engaged in with the purpose of earning income

or profit.

     It is often difficult to distinguish between a passive

investment and a trade or business.     Although passive ownership

of rental property does not constitute a trade or business,

active management of rental property does constitute a trade or

business.    McCoach v. Minehill & Schuylkill Haven R.R. Co., 228

U.S. 295, 303 (1913); Drobny v. Commissioner, 86 T.C. 1326, 1343

(1986), affd. 113 F.3d 670 (7th Cir. 1997); Neill v.

Commissioner, 46 B.T.A. 197, 198 (1942).

     Petitioners argue that Lucky was merely a passive owner of

the Keno lottery equipment, that Lucky leased the Keno lottery

equipment to the site organizations, and that Lucky played no

part in the management and operation of the actual Keno lotteries

at the lottery sites.   We disagree.

     Petitioners oversimplify the role of Lucky in the Keno

lotteries.   The lotteries occurred primarily because of the

contracts Lucky entered into with the various municipalities

under which Lucky was to conduct and operate the lotteries.     The
                                 - 7 -

fact that the lotteries produced “easy” money for Lucky does not

equate to a passive role for Lucky.

     The contracts between Lucky and the site organizations

contained only minimal references to the Keno lottery equipment.

Lucky’s name was included in the brochures advertising the Keno

lotteries.   Funds representing the large payoffs were held and

distributed by Lucky to the winning players.       Lucky also made the

distributions to the municipalities, to the State of Nebraska,

and to the site organizations.

     Lucky’s rights and obligations under the contracts with the

municipalities relating to the Keno lotteries were nonassignable.

The activities of the site organizations under the contracts with

Lucky were dependent on Lucky’s contracts with the municipalities

and did not sufficiently alter Lucky’s involvement in the lottery

operations to qualify Lucky’s activity as a nonbusiness, passive

investment activity.

     We conclude that Lucky’s Keno lottery activity constituted a

trade or business and that petitioners’ respective shares of

Lucky’s income are subject to self-employment tax.

     To reflect the foregoing,

                                              Decisions will be entered

                                         under Rule 155.
