                         T.C. Memo. 2004-56



                       UNITED STATES TAX COURT



      GERALD E. JOHNSON AND DOROTHY JOHNSON, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7536-98.              Filed March 9, 2004.



     Garry A. Pearson, Jon J. Jensen, and Alexander F. Reichert,

for petitioners.

     Blaine C. Holiday, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     CHIECHI, Judge:    Respondent determined deficiencies of

$3,764, $3,755, and $8,068 in petitioners’ Federal income tax

(tax) for 1993, 1994, and 1995, respectively.
                                 - 2 -

     We must decide1 whether certain amounts (reduced by the

deductions attributable to such amounts) that petitioners re-

ceived during the years at issue and that they characterized as

rent are subject to self-employment tax under section

1402(a)(1).2   We hold that they are not.

                         FINDINGS OF FACT

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

     At the time petitioners filed the petition in this case,

they resided in Hector, Minnesota.

     In 1962, Gerald E. Johnson (Mr. Johnson) began farming.    In

1963, Dorothy Johnson (Ms. Johnson) began farming with Mr.

Johnson.   Prior to 1989, petitioners farmed 1,030 acres of land,

537 acres of which they owned.    Third parties owned the remaining

493 acres.

     From the time Mr. Johnson began farming in 1962, he under-

took everything pertaining to running a crop farm by performing

the following farm-related activities in the production of

agricultural commodities:   Purchasing crop inputs; selling,

planting, and harvesting crops; hiring, managing, and firing



     1
      In addition to the issue that we address herein, there are
other determinations in the notice of deficiency (notice) that
are computational in that their resolution flows automatically
from our resolution of that issue.
     2
      All section references are to the Internal Revenue Code in
effect for the years at issue. All Rule references are to the
Tax Court Rules of Practice and Procedure.
                                 - 3 -

employees; assisting with computer bookkeeping; driving trucks;

securing the farmland; and making the business profitable.    From

the time Ms. Johnson began farming in 1963, she performed the

following farm-related activities in the production of agricul-

tural commodities:   Maintaining the books and preparing monthly

reports for the accountant; preparing payroll; paying employees;

depositing employment taxes; banking; preparing food for employ-

ees; picking up supplies; driving trucks and tractors; hauling

employees from field to field; monitoring the radio and respond-

ing to communications; maintaining the farmyard by mowing lawns;

and other farm help as needed.

     In October 1989, petitioners formed G.E. Johnson, Inc., and

each of them owned 50 percent of the stock of that corporation.

At all relevant times, G.E. Johnson, Inc., engaged in the farming

business, specifically the production of cash crops.   During each

of the years at issue, G.E. Johnson, Inc., farmed 1,813 acres of

land, 617 acres of which petitioners owned.   Third parties owned

the remaining 1,196 acres.

     After the formation of G.E. Johnson, Inc., that company

hired Mr. Johnson and Ms. Johnson pursuant to an oral arrangement

(oral employment arrangement)3 under which they were to serve as

its chief executive officer (CEO) and chief financial officer



     3
      During the years at issue, petitioners had no written
employment agreement with G.E. Johnson, Inc.
                               - 4 -

(CFO), respectively, and were to perform in such respective

capacities the same farm-related activities in the production of

agricultural commodities that they had been performing since they

began farming in the early 1960's (petitioners’ farm-related

activities).4   Pursuant to that arrangement, at all relevant

times, including during the years at issue, Mr. Johnson,5 as CEO,

and Ms. Johnson,6 as CFO, performed those activities.

     At all relevant times before and after petitioners incorpo-

rated their farming operations, the success of those operations

depended upon petitioners’ farm-related activities.

     During the years at issue, G.E. Johnson, Inc., did not pay

any wages or other compensation to petitioners in exchange for

petitioners’ farm-related activities in the production of agri-

cultural commodities, except for $1,000 of wages paid to Mr.

Johnson and $44,878 of compensation paid to Mr. Johnson and/or

Ms. Johnson during 1994 and 1995, respectively.

     During each of the years at issue, petitioners leased to

G.E. Johnson, Inc., pursuant to an oral arrangement (oral rental




     4
      G.E. Johnson, Inc., did not interview any other individuals
to perform the farm-related activities that it hired petitioners
to perform.
     5
      At all relevant times, Mr. Johnson spent virtually 100
percent of his time working for G.E. Johnson, Inc.
     6
      At all relevant times, Ms. Johnson spent 100 percent of her
time working for G.E. Johnson, Inc.
                                - 5 -

arrangement) farmland7 and certain personal property that they

owned (petitioners’ farmland and personal property) located in

Renville, Minnesota.8    Pursuant to that arrangement, at all

relevant times, including during the years at issue, that company

paid rent to petitioners for the lease of petitioners’ farmland

and personal property, irrespective of whether or not that

company had a good farming year or had income.    During the years

at issue, petitioners did not believe that they were, and they

were not, obligated or compelled to perform petitioners’ farm-

related activities in the production by G.E. Johnson, Inc., of

agricultural commodities as a condition to that company’s being

obligated pursuant to the oral rental arrangement to pay rent to

petitioners.9

     Petitioners jointly filed Form 1040, U.S. Individual Income

Tax Return, for each of their taxable years 1993 (petitioners’

1993 return), 1994 (petitioners’ 1994 return), and 1995 (peti-

tioners’ 1995 return).    In petitioners’ 1993 return, petitioners


     7
      G.E. Johnson, Inc., also leased certain other farmland from
third-party landlords pursuant to oral rental arrangements with
those third-party landlords.
     8
      During the years at issue, petitioners had no written
rental agreement with G.E. Johnson, Inc.
     9
      Even if during the years at issue petitioners became sick
or incapacitated or otherwise were unable to perform for G.E.
Johnson, Inc., petitioners’ farm-related activities in the
production of agricultural commodities, that company was nonethe-
less obligated pursuant to the oral rental arrangement to pay
rent to them.
                               - 6 -

reported that Mr. Johnson received $635 of “Wages, salaries,

tips, etc.” from “HECTOR PUBLIC SCHOOLS” and $330 of “Wages,

salaries, tips, etc.” from “BUFFALO LAKE-HECTOR SCHOOLS”.    In

that return, petitioners did not report any wages or other

compensation for services from G.E. Johnson, Inc.    In Schedule E,

Supplemental Income and Loss (Schedule E), included as part of

petitioners’ 1993 return, petitioners reported $66,715 in rent

received from the rental of petitioners’ farmland and personal

property (1993 claimed rent), $34,265 in expenses, and $32,450 in

total rental real estate income.

     In petitioners’ 1994 return, petitioners reported that Mr.

Johnson received $420 of “Wages, salaries, tips, etc.” from “IND.

SCHOOL DISTRICT #2159".   In that return, petitioners reported

that Ms. Johnson did not receive any wages or other compensation

for services from G.E. Johnson, Inc., and that Mr. Johnson

received $1,000 of wages from G.E. Johnson, Inc.    In Schedule E

included as part of petitioners’ 1994 return, petitioners re-

ported $60,000 in rent received from the rental of petitioners’

farmland and personal property (1994 claimed rent), $31,240 in

expenses, and $28,760 in total rental real estate income.

     In petitioners’ 1995 return, petitioners reported that they

received no wages or compensation from any source.   In Schedule E

included as part of petitioners’ 1995 return, petitioners re-

ported $104,878 in rent received from the rental of petitioners’
                               - 7 -

farmland and personal property (1995 claimed rent), $32,018 in

expenses, and $72,860 in total rental real estate income.

Immediately prior to the trial in this case, petitioners conceded

that $44,878 of the $104,878 of the 1995 claimed rent was not

received for the lease of petitioners’ farmland and personal

property pursuant to the oral rental arrangement and is subject

to self-employment tax.   (For convenience, we shall refer to the

$60,000 balance ($104,878 minus $44,878) of such claimed rent as

the modified 1995 claimed rent.)

     The 1993 claimed rent, the 1994 claimed rent, and the

modified 1995 claimed rent that petitioners received during the

respective years at issue from G.E. Johnson, Inc., pursuant to

the oral rental arrangement represented fair market rents and are

consistent with the rents paid during those years by G.E. John-

son, Inc., to other third-party landlords.

     G.E. Johnson, Inc., filed Form 1120, U.S. Corporation Income

Tax Return, for each of its taxable years ended October 31, 1993

(G.E. Johnson, Inc.’s 1993 return), October 31, 1994 (G.E.

Johnson, Inc.’s 1994 return), October 31, 1995 (G.E. Johnson,

Inc.’s 1995 return), and October 31, 1996 (G.E. Johnson, Inc.’s

1996 return).   In G.E. Johnson, Inc.’s 1993 return, G.E. Johnson,

Inc., reported that it paid $20,000 of compensation to Mr.
                                - 8 -

Johnson as an officer of that company10 and that it did not pay

any compensation to Ms. Johnson as an officer.    In that return,

G.E. Johnson, Inc., reported that it paid $38,082 of salaries and

wages, although it did not identify in that return the person or

persons to whom it paid those wages.    In G.E. Johnson, Inc.’s

1993 return, G.E. Johnson, Inc., reported that it paid $145,628

in rent, although it did not specify in that return the amount of

such rent that it paid to petitioners during its taxable year

ended October 31, 1993.

     In G.E. Johnson, Inc.’s 1994 return, G.E. Johnson, Inc.,

reported that it paid $1,000 of compensation to Mr. Johnson as an

officer of that company and that it did not pay any compensation

to Ms. Johnson as an officer.    In that return, G.E. Johnson,

Inc., reported that it paid $43,544 of salaries and wages,

although it did not identify in that return the person or persons

to whom it paid those wages.    In G.E. Johnson, Inc.’s 1994

return, G.E. Johnson, Inc., reported that it paid $122,014 in

rent, although it did not specify in that return the amount of

such rent that it paid to petitioners during its taxable year

ended October 31, 1994.


     10
      As discussed above, petitioners’ 1993 return did not
report any wages or other compensation received from G.E. John-
son, Inc. Although not clear from the record, we presume that
G.E. Johnson, Inc., paid to Mr. Johnson sometime during the last
two months of 1992 the $20,000 of compensation that it reported
it paid to him as an officer during its taxable year ended Oct.
31, 1993.
                              - 9 -

     In G.E. Johnson, Inc.’s 1995 return, G.E. Johnson, Inc.,

reported that it did not pay any compensation to Mr. Johnson or

Ms. Johnson as officers of that company.   In that return, G.E.

Johnson, Inc., reported that it paid $47,040 of salaries and

wages, although it did not identify in that return the person or

persons to whom it paid those wages.   In G.E. Johnson, Inc.’s

1995 return, G.E. Johnson, Inc., reported that it paid $175,497

in rent, although it did not specify in that return the amount of

such rent that it paid to petitioners during its taxable year

ended October 31, 1995.

     In G.E. Johnson, Inc.’s 1996 return, G.E. Johnson, Inc.,

reported that it did not pay any compensation to Mr. Johnson or

Ms. Johnson as officers of that company.   In that return, G.E.

Johnson, Inc., reported that it paid $49,816 of salaries and

wages, although it did not identify in that return the person or

persons to whom it paid those wages.   In G.E. Johnson, Inc.’s

1996 return, G.E. Johnson, Inc., reported that it paid $181,763

in rent, although it did not specify in that return the amount of

such rent that it paid to petitioners during its taxable year

ended October 31, 1996.

     On January 22, 1998, respondent issued a notice to petition-

ers with respect to their taxable years 1993, 1994, and 1995.     In

that notice, respondent determined that the 1993 claimed rent,

the 1994 claimed rent, and the 1995 claimed rent, reduced by the
                             - 10 -

deductions attributable to such respective rents, are subject to

self-employment tax for the respective years at issue because

they constitute net earnings from self-employment under section

1402(a)(1).

                             OPINION

     Petitioners bear the burden of proving that the determina-

tions in the notice that remain at issue are erroneous.11    See

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

     The ultimate dispute between the parties that we must

resolve is whether the 1993 claimed rent, the 1994 claimed rent,

and the modified 1995 claimed rent, reduced by the deductions

attributable to such respective rents, are subject to self-

employment tax because they constitute net earnings from self-

employment under section 1402(a)(1).

     As applicable here, section 1402(a)(l) defines the term “net

earnings from self-employment” to mean

     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 * * * except
     that in computing such gross income and deductions
     * * *--

               (1) there shall be excluded rentals from real


     11
      Sec. 7491(a) is not applicable in the instant case. That
is because respondent issued the notice to petitioners on Jan.
22, 1998, and a fortiori the examination of the years at issue
would have commenced before July 23, 1998. See Internal Revenue
Service Restructuring and Reform Act of 1998, Pub. L. 105-206,
sec. 3001(c), 112 Stat. 727.
                             - 11 -

          estate and from personal property leased with the
          real estate * * * together with the deductions
          attributable thereto * * * except that the preced-
          ing provisions of this paragraph shall not apply
          to any income derived by the owner or tenant of
          land if (A) such income is derived under an ar-
          rangement, between the owner or tenant and another
          individual, which provides that such other indi-
          vidual shall produce agricultural * * * commodi-
          ties * * * on such land, and that there shall be
          material participation by the owner or tenant
          * * * in the production or the management of the
          production of such agricultural * * * commodities,
          and (B) there is material participation by the
          owner or tenant * * * with respect to any such
          agricultural * * * commodity;

(The regulations under section 1402(a)(1), and we, refer to the

farm rental income that is included under that section in the

definition of net earnings from self-employment as includible

farm rental income.)

     The regulations under section 1402(a)(1) elaborate on the

meaning of includible farm rental income, as follows:

          (b) Special rule for “includible farm rental
     income”--(1) In general. * * * there shall be included
     in determining net earnings from self-employment for
     taxable years ending after 1955 any income derived by
     an owner or tenant of land, if the following require-
     ments are met with respect to such income:

          (i) The income is derived under an arrangement
     between the owner or tenant of land and another person
     which provides that such other person shall produce
     agricultural * * * commodities on such land, and that
     there shall be material participation by the owner or
     tenant in the production or the management of the
     production of such agricultural * * * commodities; and

          (ii) There is material participation by the owner
     or tenant with respect to any such agricultural * * *
     commodity.
                             - 12 -

     Income so derived shall be referred to in this section
     as “includible farm rental income”.

          (2) Requirement that income be derived under an
     arrangement. In order for rental income received by an
     owner or tenant of land to be treated as includible
     farm rental income, such income must be derived pursu-
     ant to a sharefarming or other rental arrangement which
     contemplates material participation by the owner or
     tenant in the production or management of production of
     agricultural * * * commodities.

          (3) Nature of arrangement. (i) The arrangement
     between the owner or tenant and the person referred to
     in subparagraph (1) of this paragraph may be either
     oral or written. The arrangement must impose upon such
     other person the obligation to produce one or more
     agricultural * * * commodities * * * on the land of the
     owner or tenant. In addition, it must be within the
     contemplation of the parties that the owner or tenant
     will participate in the production or the management of
     the production of the agricultural * * * commodities
     required to be produced by the other person under such
     arrangement to an extent which is material with respect
     either to the production or to the management of pro-
     duction of such commodities or is material with respect
     to the production and management of production when the
     total required participation in connection with both is
     considered.

        *       *       *       *       *       *       *

          (4) Actual participation. In order for the rental
     income received by the owner or tenant of land to be
     treated as includible farm rental income, not only must
     it be derived pursuant to the arrangement described in
     subparagraph (1) of this paragraph, but also the owner
     or tenant must actually participate to a material
     degree in the production or in the management of the
     production of any of the commodities required to be
     produced under the arrangement, or he must actually
     participate in both the production and the management
     of the production to an extent that his participation
     in the one when combined with his participation in the
     other will be considered participation to a material
     degree. * * *

Sec. 1.1402(a)-4(b), Income Tax Regs.
                              - 13 -

     The parties agree that during the years at issue petitioners

were to, and did, participate materially within the meaning of

section 1402(a)(1) in the production by G.E. Johnson, Inc., of

agricultural commodities by performing petitioners’ farm-related

activities.   They disagree over whether the 1993 claimed rent,

the 1994 claimed rent, and the modified 1995 claimed rent were

derived under an arrangement within the meaning of section

1402(a)(1)(A) and section 1.1402(a)-4(b)(2), Income Tax Regs.,

between petitioners and G.E. Johnson, Inc., which provided or

contemplated that G.E. Johnson, Inc., was to produce agricultural

commodities on petitioners’ land and that petitioners were to

participate materially in the production of such commodities.

     It is petitioners’ position that the claimed rents at issue

were not derived under such an arrangement and that consequently

such claimed rents, reduced by the deductions attributable to

such respective rents, are not subject to self-employment tax

because they do not constitute includible farm rental income

under section 1402(a)(1) and the regulations thereunder.   In

support of their position, petitioners rely on the opinion of the

Court of Appeals for the Eighth Circuit in McNamara v. Commis-

sioner, 236 F.3d 410 (8th Cir. 2000), revg. and remanding Bot v.

Commissioner, T.C. Memo. 1999-256, Hennen v. Commissioner, T.C.

Memo. 1999-306, and McNamara v. Commissioner, T.C. Memo. 1999-
                                - 14 -

333.12    In reliance on McNamara II, petitioners contend that

     the Johnsons are receiving fair market value rental
     payments. Although this may result in little or no
     other compensation being paid to the taxpayers for the
     services they provide to the corporation, this does not
     establish the required nexus between the rental pay-
     ments and the material participation required to trig-
     ger the inclusion of the payments within the definition
     of self-employment income. To the contrary, adoption
     of the Commissioner’s position would compel the conclu-
     sion that the taxpayers, as landlords, are required to
     rent property to the corporation at below fair market
     value and below the rates paid to third parties. The
     “missing link” in the Commissioner’s argument is the
     same as in the McNamara case: the corporation’s obli-
     gation to make the rental payments is separate and
     distinct from the taxpayers’ participation in the
     farming operation.

     Respondent counters that McNamara II does not require the

result advocated by petitioners in the instant case.    Respondent

argues that

          The Eighth Circuit in McNamara * * * created a
     judicial exception for fair rental value when the
     landlord has two independent arrangements with the
     lessee for rent and wages and there is no nexus between
     the two arrangements.

          Petitioners fail to meet the Eighth Circuit’s
     standard because they failed to enter into a separate
     employment agreement with their corporation, and to the
     extent they did, it was so inextricably interrelated
     with the oral lease that the nexus is obvious and
     cannot be overlooked. Petitioners’ classification of
     all funds from the corporation as rent and none as
     wages demonstrates that there were not independent
     arrangements with respect to real estate rentals and
     compensation for services. Moreover, the transaction


     12
      We shall refer to our respective opinions that the Court
of Appeals for the Eighth Circuit reversed and remanded as Bot I,
Hennen I, and McNamara I and to the opinion of that Court as
McNamara II.
                               - 15 -

     does not pass muster given the strict scrutiny applied
     to such related-party transactions, and given that
     exceptions from self-employment tax under section
     1402(a)(1) are narrowly construed.

     Bot I, Hennen I, and McNamara I involved taxpayers who,

pursuant to certain agreements or arrangements, were to, and did,

participate materially in the production of agricultural commodi-

ties involved in those respective cases.   In Bot I and Hennen I,

the taxpayer-owners of the farmland in question entered into

(1) employment agreements or arrangements with their respective

taxpayer-spouses and (2) rental agreements or arrangements with

those spouses.   In McNamara I, the taxpayer-owners of the farm-

land in question entered into (1) an employment agreement or

arrangement with their wholly owned corporation and (2) a rental

agreement or arrangement with that corporation.

     In Bot I and Hennen I, the taxpayer-owners of the farmland

in question contended that the respective rental agreements or

arrangements involved in those cases did not require their

material participation in the production of the agricultural

commodities in question.   We found that the respective taxpayer-

owners in Bot I and Hennen I played a material role in the

production of such commodities under an agreement or arrangement

with their taxpayer-spouses.   We further found in Bot I and

Hennen I that the income received from the rental of the respec-

tive taxpayer-owners’ farmland in question was derived under an

arrangement between the taxpayer-owners of the farmland and their
                              - 16 -

taxpayer-spouses, which provided that those spouses were to

produce agricultural commodities on that land and that the

taxpayer-owners were to participate materially in the production

of such commodities.   We held in Bot I and Hennen I that the

rents at issue in those cases, reduced by the deductions attrib-

utable to such respective rents, were subject to self-employment

tax because they constituted includible farm rental income under

section 1402(a)(1).

     In McNamara I, the taxpayer-owners of the farmland in

question contended that the rental agreement or arrangement

involved in that case did not require their material participa-

tion in the production of the agricultural commodities in ques-

tion.   We found that the taxpayer-owners played a material role

in the production of such commodities under an agreement or

arrangement with their wholly owned corporation.   We further

found in McNamara I that the income received from the rental of

the taxpayers’ farmland in question was derived under an arrange-

ment between the taxpayer-owners and their wholly owned corpora-

tion, which provided that that corporation was to produce agri-

cultural commodities on that land and that the taxpayer-owners

were to participate materially in the production of such commodi-

ties.   We held in McNamara I that the rent at issue in that case,

reduced by the deductions attributable to such rents, was subject

to self-employment tax because it constituted includible farm
                                - 17 -

rental income under section 1402(a)(1).

     The taxpayers in Bot I, Hennen I, and McNamara I appealed

our respective decisions in those cases to the Court of Appeals

for the Eighth Circuit.   That Court decided those appeals in one

opinion in McNamara II.   In McNamara II, the Court of Appeals for

the Eighth Circuit concluded:

     we cannot say the Tax Court clearly erred in conclud-
     ing, as a factual matter, that Mrs. McNamara, Mrs. Bot,
     and Mrs. Hennen were required–-by their respective
     employment agreements or by more informal “arrange-
     ments”–-to materially participate in agricultural
     production and management, and that all three did in
     fact materially participate in those activities. See
     Treas. Reg. § 1.1402(a)-4(b) (as amended in 1980).

          More promising, however, is taxpayers’ argument
     that the lessor-lessee relationships should stand on
     their own apart from the employer-employee relation-
     ships. To this end, taxpayers insist that the rents in
     question were consistent with market rates for agricul-
     tural land. In fact, the transcripts of each trial
     contain uncontradicted testimony that the rents were at
     or slightly below fair market value. * * * The Tax
     Court’s decision, however, contains no factual finding
     in this regard. Moreover, the Commissioner apparently
     did not pursue the issue at trial because, as it con-
     tended at oral argument, the amount of the rent is
     irrelevant. We disagree.

          What is missing from both the Commissioner’s and
     the Tax Court’s analyses is any mention of a nexus
     between the rents received by Taxpayers and the “ar-
     rangement” that requires the landlords’ material par-
     ticipation. We believe this omission overlooks §
     1402(a)(1)’s requirement that rents be “derived under”
     such an arrangement. That is to say, the mere exis-
     tence of an arrangement requiring and resulting in
     material participation in agricultural production does
     not automatically transform rents received by the
     landowner into self-employment income. It is only
     where the payment of those rents comprise part of such
     an arrangement that such rents can be said to derive
                              - 18 -

     from the arrangement.

          Rents that are consistent with market rates very
     strongly suggest that the rental arrangement stands on
     its own as an independent transaction and cannot be
     said to be part of an “arrangement” for participation
     in agricultural production. Although the Commissioner
     is correct that, unlike other provisions in the Code,
     § 1402(a)(1) contains no explicit safe-harbor provision
     for fair market value transactions, we conclude that
     this is the practical effect of the “derived under”
     language.

McNamara v. Commissioner, 236 F.3d at 412-413.

     The Court of Appeals for the Eighth Circuit remanded Bot I,

Hennen I, and McNamara I in order to provide the Commissioner of

Internal Revenue the opportunity to show that a connection

existed between the respective rents and the respective employ-

ment agreements or arrangements involved in those cases.     Id.   On

remand, the respective parties in Bot I, Hennen I, and McNamara I

declined our invitation to conduct additional trials.   As a

result, we found that the rent at issue in each of those cases

was at or below market rates and decided that no deficiency in

self-employment tax existed in any of those cases.

     In Golsen v. Commissioner, 54 T.C. 742, 757 (1970), affd.

445 F.2d 985 (10th Cir. 1971), we concluded that we would follow

a Court of Appeals opinion which is squarely in point where

appeal from our decision would lie to that Court of Appeals and

to that court alone.   In the instant case, during the years at

issue petitioners had two arrangements with G.E. Johnson, Inc.:

(1) An oral employment arrangement under which petitioners were
                                 - 19 -

to, and did, participate materially in the production by G.E.

Johnson, Inc., of agricultural commodities by performing peti-

tioners’ farm-related activities; and (2) an oral rental arrange-

ment under which petitioners leased to G.E. Johnson, Inc.,

petitioners’ farmland and personal property.    There were two

identical types of arrangements involved in McNamara II.    The

issue presented here is whether the claimed rents at issue,

reduced by the deductions attributable to such respective rents,

are subject to self-employment tax because they constitute

includible farm rental income under section 1402(a)(1).    That was

the identical issue presented in McNamara II.    We conclude that

McNamara II is squarely in point.     Moreover, the court to which

an appeal in this case would normally lie is the Court of Appeals

for the Eighth Circuit.   We shall follow McNamara II.    Golsen v.

Commissioner, supra.

     As required by McNamara II, we must determine whether there

was a nexus between (1) the 1993 claimed rent, the 1994 claimed

rent, and the modified 1995 claimed rent that petitioners re-

ceived pursuant to the oral rental arrangement and (2) the oral

employment arrangement under which petitioners were to, and did,

participate materially in the production by G.E. Johnson, Inc.,

of agricultural commodities.13    In making that determination, we


     13
      We note that in McNamara I there is no indication that the
parties advanced, and the Court did not address, any argument
                                                   (continued...)
                             - 20 -

bear in mind the conclusions of the Court of Appeals for the

Eighth Circuit in McNamara II that

          Rents that are consistent with market rates very
     strongly suggest that the rental arrangement stands on
     its own as an independent transaction and cannot be
     said to be part of an “arrangement” for participation
     in agricultural production. Although the Commissioner
     is correct that, unlike other provisions in the Code,
     § 1402(a)(1) contains no explicit safe-harbor provision
     for fair market value transactions, we conclude that
     this is the practical effect of the “derived under”
     language.



     13
      (...continued)
that, because the taxpayer-owners of the farmland in that case
materially participated within the meaning of sec. 1402(a)(1) in
the production of agricultural commodities as employees of their
wholly owned corporation and not in their individual capacities,
the analysis under sec. 1402(a)(1) should be different from the
analysis in Bot I and Hennen I, where the taxpayer-owners of the
farmland involved in those two cases materially participated
within the meaning of sec. 1402(a)(1) in the production of
agricultural commodities in their individual capacities. In
McNamara II, there is no indication that the taxpayers appealing
McNamara I advanced, and the Court of Appeals for the Eighth
Circuit did not address, any argument that the analysis under
sec. 1402(a)(1) with respect to such taxpayers should be any
different from the analysis with respect to the taxpayers appeal-
ing Bot I and Hennen I.

     In the instant case, neither petitioners nor respondent
advances any argument that the analysis under sec. 1402(a)(1)
should be different from the analysis in McNamara II because
petitioners materially participated within the meaning of sec.
1402(a)(1) in the production by G.E. Johnson, Inc., of agricul-
tural commodities as employees of G.E. Johnson, Inc., and not in
their individual capacities. Indeed, petitioners rely solely on
the analysis in McNamara II to support their position in the
instant case. Consequently, we shall not address whether our
analysis would be different in the instant case because petition-
ers materially participated within the meaning of sec. 1402(a)(1)
in the production of agricultural commodities by G.E. Johnson,
Inc., as employees of G.E. Johnson, Inc., and not in their
individual capacities.
                              - 21 -

McNamara v. Commissioner, 236 F.3d at 413.

     We have found based on the stipulation of the parties that

the 1993 claimed rent, the 1994 claimed rent, and the modified

1995 claimed rent represented fair market rents and are consis-

tent with the rents paid during those years by G.E. Johnson,

Inc., to other third-party landlords.   On the record before us,

we further find that petitioners have established that during

each of the years at issue there was no nexus between (1) the

1993 claimed rent, the 1994 claimed rent, and the modified 1995

claimed rent that petitioners received pursuant to the oral

rental arrangement and (2) the oral employment arrangement under

which petitioners were to, and did, participate materially in the

production by G.E. Johnson, Inc., of agricultural commodities.

Pursuant to the oral rental arrangement, during the years at

issue G.E. Johnson, Inc., paid rent to petitioners for the lease

of petitioners’ farmland and personal property, irrespective of

whether or not that company had a good farming year or had

income.   Moreover, during those years, petitioners did not

believe that they were, and they were not, obligated or compelled

to perform petitioners’ farm-related activities in the production

by G.E. Johnson, Inc., of agricultural commodities as a condition

to that company’s being obligated to pay rent to petitioners

pursuant to the oral rental arrangement.

     Based upon our examination of the entire record in this
                             - 22 -

case, we find that petitioners have shown that the 1993 claimed

rent, the 1994 claimed rent, and the modified 1995 claimed rent

were not derived under an arrangement within the meaning of

section 1402(a)(1)(A) and section 1.1402(a)-4(b)(2), Income Tax

Regs., between petitioners and G.E. Johnson, Inc., which provided

or contemplated that G.E. Johnson, Inc., was to produce agricul-

tural commodities on petitioners’ land and that petitioners were

to participate materially in the production of such commodities.

On that record, we hold that the 1993 claimed rent, the 1994

claimed rent, and the modified 1995 claimed rent, reduced by the

deductions attributable to such respective rents, are not subject

to self-employment tax because they do not constitute includible

farm rental income and therefore are not net earnings from self-

employment under section 1402(a)(1).

     We have considered all of the contentions and arguments of

the parties that are not discussed herein, and we find them to be

without merit, irrelevant, and/or moot.

     To reflect the foregoing and the concession of petitioners,


                                   Decision will be entered

                              under Rule 155.
