                        130 T.C. No. 5



                    UNITED STATES TAX COURT



        JON W. AND KRISTI NELSON, ET AL.,1 Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



    Docket Nos. 2603-06, 2604-06,     Filed February 28, 2008.
                2605-06.


         In 2001, two farming partnerships received Federal
    crop insurance proceeds relating to sugar beet crops
    destroyed by excess moisture in 2001.

         Held: The partnerships and the partners thereof
    may not, under sec. 451(d), I.R.C., defer until 2002
    reporting as income the crop insurance proceeds
    received in 2001.


    Jon J. Jensen, for petitioners.

    Blaine Holiday, for respondent.




    1
       Cases of the following petitioners are consolidated
herewith: Steven P. and Jaime Nelson, docket No. 2604-06, and
Wayne E. and Joann Nelson, docket No. 2605-06.
                                - 2 -
                              OPINION

     SWIFT, Judge:   Respondent determined deficiencies in

petitioners’ 2001 Federal income taxes and penalties, as follows:


                                                     Penalty
           Petitioners              Deficiency   Sec. 6662(b)(1)
   Jon W. and Kristi Nelson           $23,707         $4,741
   Steven P. and Jaime Nelson          31,197          6,239
   Wayne E. and Joann Nelson           23,181          4,636


     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the relevant years, and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

     The issue for decision is whether two farming partnerships

and the partners thereof may, under section 451(d), defer

reporting as income until 2002 Federal crop insurance proceeds

the partnerships received in 2001 relating to their destroyed

sugar beet crops.


                            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 resided in

Minnesota.
                               - 3 -
     Petitioners Jon, Steven, and Wayne Nelson are brothers, and

petitioners Kristi, Jaime, and Joann Nelson are their respective

wives.

     Petitioners herein are partners in two related family

partnerships that are engaged in the business of farming--namely,

WJS Nelson, Ltd. LLP (WJS-LLP) and WJS Nelson Partnership (WJS-

Partnership).

     Jon, Steven, and Wayne are equal one-third partners in WJS-

LLP, and Jon, Steven, Wayne, and their respective spouses are

equal one-sixth partners in WJS-Partnership.

     WJS-LLP raises only sugar beets while WJS-Partnership raises

sugar beets and other crops.

     In 2001, the sugar beet crops of WJS-LLP and of WJS-

Partnership were destroyed by excess moisture.   Neither

partnership harvested any sugar beets in 2001, and neither

partnership received any proceeds in 2001 or in later years from

the sale of sugar beets the partnerships planted in 2001.

     Each partnership’s 2001 sugar beet crop, however, was

insured against loss by Federal crop insurance, and in 2001 WJS-

LLP and WJS-Partnership received $80,589 and $121,330,

respectively, a total of $201,919, in Federal crop insurance

proceeds relating to their sugar beet crops destroyed in 2001.

     In 2001, WJS-Partnership also planted and harvested other

crops.
                                 - 4 -
     The books and records of WJS-LLP and of WJS-Partnership were

maintained and their Federal income tax returns were filed using

the cash method of accounting.

     Each year, however, for Federal income tax purposes income

from the harvest and sale of sugar beet crops was and is reported

by WJS-LLP and by WJS-Partnership not on the basis of when the

partnerships sell the crops, receive the proceeds, or realize the

income therefrom but rather on the basis of the following

formula:   65 percent of the income realized from the sale of the

sugar beet crops is reported in the year of the harvest of the

crops, and the remaining 35 percent is reported in the year

following the harvest.

     Consistently, on information tax returns, Forms 1065, U.S.

Return of Partnership Income, submitted to respondent each year,

WJS-LLP and WJS-Partnership allocate among petitioners herein the

income from the harvest and sale of sugar beet crops not on the

basis of when the partnerships receive the proceeds or realize

income from the sale of the sugar beet crops, but rather on the

basis of the above formula:   namely, 65 percent in the year of

harvest and 35 percent in the year following the harvest.

     If WJS-LLP’s and WJS-Partnership’s 2001 sugar beet crops had

not been destroyed and if the crops had been sold in 2001, for

2001 WJS-LLP and WJS-Partnership would have allocated to

petitioners and reported to respondent a total of 65 percent of
                               - 5 -
the partnerships’ income relating thereto and for 2002 a total of

35 percent of the partnerships’ income relating thereto.

     The parties have stipulated that the above method and

percentages used by WJS-LLP and by WJS-Partnership for allocating

and reporting income relating to a particular year’s sugar beet

crop between the year of the harvest (65 percent) and the year

following the harvest (35 percent) (regardless of the year in

which the crops are sold and the proceeds and income are

received) are consistent with the partnerships’ above cash method

of accounting and with accounting and tax reporting practices

within the sugar beet industry and are recognized and accepted

generally by respondent.   See generally sec. 451(d); sec. 1.451-

6(a)(1), Income Tax Regs.; Rev. Rul. 74-145, 1974-1 C.B. 113.

     Each year for Federal income tax purposes WJS-Partnership

(and its individual partners) reports income from the harvest and

sale of its other farm crops not on the basis of when crops are

sold and the proceeds are received, but rather on the basis of

similar formulas that defer a percentage of the sales proceeds

and income until the following year.

     Under the various formulas used by WJS-Partnership for

reporting in the current year and deferring until the following

year a portion of crop proceeds and income, WJS-Partnership

typically defers until the following year over 50 percent of

total income relating to all crops grown in the current year.
                              - 6 -
     Specifically in and for 2001, WJS-LLP and WJS-Partnership

did not treat as income and did not report to respondent on

information returns, Forms 1065, any of the $201,919 in Federal

crop insurance proceeds that were received in 2001 with regard to

the sugar beet crops destroyed in 2001.

     Rather, with the 2001 partnership information tax returns of

WJS-LLP and of WJS-Partnership, Forms 1065, elections under

section 451(d) were filed with respondent to defer reporting the

entire $201,919 in Federal crop insurance proceeds received in

2001 until 2002.

     Petitioners filed their respective 2001 individual joint

Federal income tax returns, reporting thereon their respective

amounts of 2001 WJS-LLP and WJS-Partnership income, deductions,

and credits as reported by the partnerships (i.e., not reporting

any of the Federal crop insurance proceeds received in 2001).

     On audit of petitioners’ respective individual joint Federal

income tax returns for 2001, respondent treated as income for

2001 all $201,919 of the Federal crop insurance proceeds WJS-LLP

and WJS-Partnership received in 2001, charged each petitioner

with additional income for his or her respective allocation

thereof, and determined the tax deficiencies and penalties at

issue.
                                - 7 -


                             Discussion

     Generally, a cash method taxpayer reports income in the year

of receipt.   Sec. 451(a).   However, under section 451(d) an

exception is provided for farmers if they normally report income

from the sale of crops in a year following crop production.

Under the section 451(d) exception, a cash method farmer who

normally reports income from the sale of his crops in the year

following crop production may elect to defer treating as income

crop insurance proceeds received in a year until a following

year.   Section 451(d) provides as follows:



     SEC. 451.   GENERAL RULE FOR TAXABLE YEAR OF INCLUSION.

          (d) Special Rule for Crop Insurance Proceeds or
     Disaster Payments.--In the case of insurance proceeds
     received as a result of destruction or damage to crops, a
     taxpayer reporting on the cash receipts and disbursements
     method of accounting may elect to include such proceeds in
     income for the taxable year following the taxable year of
     destruction or damage, if he establishes that, under his
     practice, income from such crops would have been reported in
     a following taxable year. * * * An election under this
     subsection for any taxable year shall be made at such time
     and in such manner as the Secretary prescribes.


     Although the above statute does not expressly provide that

under the farmer’s normal tax reporting for crop income “all” (or

some particular percentage) of a farmer’s crop income must be

deferred to a following year in order to qualify for the section

451(d) 1-year deferral of crop insurance proceeds received, the
                               - 8 -
regulations under section 451(d) do use the definite article and

refer to “the” income from crops.    Section 1.451-6(a)(1), Income

Tax Regs., provides in relevant part as follows:


     § 1.451-6. Election to include crop insurance proceeds
     in gross income in the taxable year following the
     taxable year of destruction or damage.--(a) In
     general.--(1) For taxable years ending after
     December 30, 1969, a taxpayer reporting gross income on
     the cash receipts and disbursements method of
     accounting may elect to include insurance proceeds
     received as a result of the destruction of, or damage
     to, crops in gross income for the taxable year
     following the taxable year of the destruction or
     damage, if the taxpayer establishes that, under the
     taxpayer’s normal business practice, the income from
     those crops would have been included in gross income
     for any taxable year following the taxable year of the
     destruction or damage. * * * [Emphasis added.]


     Similarly, with regard to the time and manner of making an

election to defer crop insurance proceeds, section 1.451-

6(b)(1)(iii), Income Tax Regs., uses the definite article and

refers to “the” income.2


     2
        Sec. 1.451-6(b)(1), Income Tax Regs., provides in part as
follows:

     § 1.451-6. Election to include crop insurance proceeds
     in gross income in the taxable year following the
     taxable year of destruction or damage.--

              *     *      *     *      *     *     *

     (b)(1) Time and manner of making election.–-The
     election to include in gross income insurance proceeds
     received as a result of destruction of, or damage to,
     the taxpayer’s crops in the taxable year following the
     taxable year of such destruction or damage shall be
                                                   (continued...)
                              - 9 -
     The stated legislative purpose for the deferral of crop

insurance proceeds under section 451(d) was to allow farmers, in

and for the year they incur crop damage and receive insurance

proceeds, to avoid having to pay Federal income tax on 2 years’

worth of income relating to their crops (namely, income deferred

under their normal practice from the prior year into the current

year and also crop insurance proceeds received in the current


     2
      (...continued)
     made by means of a statement attached to the taxpayer’s
     return (or an amended return) for the taxable year of
     destruction or damage. The statement shall include the
     name and address of the taxpayer (or his duly
     authorized representative), and shall set forth the
     following information:

          (i) A declaration that the taxpayer is making an
     election under section 451(d) and this section;

          (ii) Identification of the specific crop or crops
     destroyed or damaged;

          (iii) A declaration that under the taxpayer’s
     normal business practice the income derived from the
     crops which were destroyed or damaged would have been
     included in his gross income for a taxable year
     following the taxable year of such destruction or
     damage;

          (iv) The cause of destruction or damage of crops
     and the date or dates on which such destruction or
     damage occurred;

          (v) The total amount of payments received from
     insurance carriers, itemized with respect to each
     specific crop and with respect to the date each payment
     was received;

          (vi) The name(s) of the insurance carrier or
     carriers from whom payments were received. [Emphasis
     added.]
                              - 10 -
year).   The 1969 Senate committee report explaining the policy

underlying section 451(d) makes it clear that Congress’s intent

was to provide a deferral of insurance proceeds in those

situations where the farmers were not receiving (and therefore,

under their cash method of accounting, were not reporting) any

income from current year crops until the following year when the

crops were sold.   S. Rept. 91-552, at 106-107 (1969), 1969-3 C.B.

423, 492; see also H. Conf. Rept. 91-782, at 299 (1969), 1969-3

C.B. 644, 657.

     The Senate report provides the following explanation:


          General reasons for change.--The requirement of
     present law that crop insurance proceeds must be
     included in income for the year of receipt in the case
     of taxpayers using a cash method of accounting results
     in a hardship where it is the normal practice of the
     farmer to sell his crop in the year following that in
     which it is raised. In this case the farmer normally
     would include the proceeds from the sale of the prior
     year’s crop in income for the taxable year and would
     include the proceeds from the sale of the current
     year’s crop in income for the following year when the
     crop is sold. If, however, the current year’s crop is
     damaged or destroyed, for instance by hail or windstorm
     and the farmer receives insurance proceeds to cover the
     loss, he must include the insurance proceeds in income
     for the current year. Thus, two years income must be
     reported in the current year as a result of an
     occurrence over which the farmer has no control. [S.
     Rept. 91-552, supra at 106-107, 1969-3 C.B. at 492.]


     As stated, under normal practice WJS-LLP, WJS-Partnership,

and petitioners did not report “the” income from the current

year’s sugar beet crops in the following year.   Rather, WJS-LLP,
                             - 11 -
WJS-Partnership, and petitioners reported 65 percent of the

income relating to the current year’s sugar beet crops in the

current year and only 35 percent thereof in the following year.

Accordingly, on the basis of the above-stated rationale for the

section 451(d) deferral of insurance proceeds, it would make more

sense for WJS-LLP and WJS-Partnership to be required to report

the insurance proceeds they received in 2001 in the year in which

most (namely, 65 percent) of the income from the crops would have

been reported had the crops not been damaged (i.e., 2001).

     In Rev. Rul. 74-145, 1974-1 C.B. 113, respondent concluded

that the deferral of recognition of crop insurance proceeds under

section 451(d) was available to a farmer who, under his normal

method of accounting for crop income, deferred to the following

year not all but more than 50 percent of his crop income, a

percentage which in the ruling respondent referred to as a

“substantial portion” of the farmer’s annual crop income.

     Also, the above revenue ruling concluded, consistently with

section 1.451-6(a)(2), Income Tax Regs., that a farmer who

receives in the current year crop insurance proceeds (that would

qualify for deferral under section 451(d)) relating to two or

more damaged crops, but who makes a section 451(d) deferral

election with respect to only a “portion” of the insurance

proceeds received, must defer and report in the following year

all of the insurance proceeds attributable to the crops
                               - 12 -
constituting a single trade or business for the farmer.

Sec. 1.451-6(a)(2), Income Tax Regs.3

     The referenced regulations and the above ruling would appear

to preclude prorating of the insurance proceeds which WJS-LLP and




     3
         Sec. 1.451-6(a)(2), Income Tax Regs., provides as follow:

     §. 1.451-6. Election to include crop insurance
     proceeds in gross income in the taxable year following
     the taxable year of destruction or damage.--

               *     *     *     *      *    *     *

     (2) In the case of a taxpayer who receives insurance
     proceeds as a result of the destruction of, or damage
     to two or more specific crops, if such proceeds may,
     under section 451(d) or this section, be included in
     gross income for the taxable year following the taxable
     year of such destruction or damage, and if such
     taxpayer makes an election under section 451(d) and
     this section with respect to any portion of such
     proceeds, then such election will be deemed to cover
     all of such proceeds which are attributable to crops
     representing a single trade or business under section
     446(d). A separate election must be made with respect
     to insurance proceeds attributable to each crop which
     represents a separate trade or business under section
     446(d).

     We note that this regulation does not help petitioners
(particularly WJS-Partnership, which does harvest each year more
than one crop and which does defer to the following year most of
its total income from all its crops), and petitioners do not rely
on it, because of the predicate in the regulation that it
pertains only to crop insurance proceeds received that first are
qualified for the sec. 451(d) deferral. Because, per our
holding, the crop insurance proceeds at issue do not qualify for
that deferral, the mandate of the regulation (that “all”
insurance proceeds received relating to a single trade or
business of a taxpayer be deferred until the following year) does
not apply.
                              - 13 -
WJS-Partnership received between the current year (65 percent)

and the following year (35 percent).

     Respondent also takes the position, relying on Rev. Rul.

74-145, supra, that a section 451(d) deferral to 2002 of the

$201,919 crop insurance proceeds which WJS-LLP and WJS-

Partnership received in 2001 is not available to petitioners

because, under normal business practice, petitioners would not

have deferred to 2002 more than 50 percent of the income from the

crops.

     Respondent acknowledges that Rev. Rul. 74-145, supra, has

relaxed the rule of section 451(d) to make available the section

451(d) deferral of crop insurance proceeds to a farmer who

normally treats as income in the year following crop production

less than all of the income from the sale of crops for a year,

but only where the farmer normally defers to the following year

more than 50 percent of the current year’s crop income.

     Petitioners point out that although Rev. Rul. 74-145, supra,

uses the terms “substantial portion” and “50 percent”, those

terms are not found in section 451(d) or in section 1.451-

6(a)(1), Income Tax Regs.   Petitioners argue that the 35 percent

of sugar beet income they normally defer should be treated as

substantial and should be sufficient to support the deferral to

2002 of all crop insurance proceeds received in 2001.
                              - 14 -
     We acknowledge that the word “substantial” appears in other

contexts throughout the Internal Revenue Code as well as

throughout the regulations and often is used to refer to “less

than 50 percent”.4

     Although the statutory and regulatory provisions are not

free of ambiguity, we agree with respondent’s position.    As

explained, the legislative history of the deferral provision of

section 451(d) makes it clear that Congress was concerned not

about “all” mismatches between years of a farmer’s income and

expenses.   Rather, Congress was concerned about farmers whose

crops were produced in one year but sold in and therefore

generated income only in the following year.

     The stipulated evidence does not tell us when WJS-LLP and

WJS-Partnership sold their sugar beet crops--in the year of

production or in the following year (or over the course of both

years).   The stipulated evidence does not explain to us the basis

for the apparent accounting and tax convention used in the sugar




     4
       For example, under sec. 45D(d)(2)(A)(ii) and (iii),
relating to the qualified status of an active low-income
community business in connection with the new markets tax credit,
“substantial” refers to 40 percent of tangible business assets
and services in a low-income community. Sec. 1.45D-1(d)(4)(i)(B)
and (C), Income Tax Regs.

     Under sec. 6662(d)(1)(A), “substantial” may refer to an
understatement of tax of just 10 percent of the tax required to
be shown on a return.
                             - 15 -
beet industry to report in the current year only 65 percent and

in the following year 35 percent of sugar beet income.

     The use in the related regulations of the definite article

“the” to describe crop income that a farmer normally must defer

to a year following crop production (in order to qualify for the

section 451(d) deferral of related insurance proceeds) is not

consistent with the holding petitioners seek under which even a

relatively small deferral percentage of normal crop income would

result in eligibility under section 451(d) for full deferral of

100 percent of the related crop insurance proceeds.

     For 2001, WJS-LLP and WJS-Partnership reported only

35 percent of sugar beet crop income from 2000 and (but for the

sugar beet crop damage) would have reported 65 percent of the

sugar beet crop income from 2001.   Both of these figures suggest

that the crop insurance proceeds WJS-LLP and WJS-Partnership

received in 2001 should be reported in 2001.   To hold otherwise

would further distort the income reported in 2001 and 2002

(namely, for 2001 only 35 percent of 2000 crop income would be

reported, but for 2002 100 percent of the insurance proceeds

received in 2001 and also 65 percent of 2002 sugar beet crop

income would be reported).

     We conclude that on the facts before us, WJS-LLP and WJS-

Partnership and petitioners are required to report as taxable
                                - 16 -
income in 2001 all $201,919 of the sugar beet crop insurance

proceeds received in 2001.

     Under section 6662(b)(1), a taxpayer may be liable for a

20-percent accuracy-related penalty where a tax underpayment was

related to negligence or to disregard of Federal income tax rules

or regulations.

     However, if there was reasonable cause for the underpayment

and the taxpayer acted in good faith, the taxpayer will not be

liable for the accuracy-related penalty.    Sec. 6664(c)(1); sec.

1.6664-4(b), Income Tax Regs.

     In light of the difficult interpretation of section 451(d)

at issue herein, we exercise our discretion not to sustain the

section 6662(b)(1) penalties determined by respondent.    We

believe petitioners acted with reasonable cause and in good faith

in reporting in 2002 the crop insurance proceeds received in

2001.

     To reflect the foregoing,

                                      Decisions will be entered

                                 under Rule 155.
