                          T.C. Memo. 1997-41



                        UNITED STATES TAX COURT



             KENNETH C. AND ELAINE SCHMIDT, Petitioners v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 2882-96.                    Filed January 23, 1997.



        Mark Kutschenreuter, for petitioners.

        James E. Schacht, for respondent.


                MEMORANDUM FINDINGS OF FACT AND OPINION


        ARMEN, Special Trial Judge:   This case was heard pursuant to

the provisions of section 7443A(b)(3) and Rules 180, 181, and

182.1


        1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
     Respondent determined deficiencies in petitioners' Federal

income taxes for the taxable years 1991, 1992, and 1993 in the

amounts of $1,621, $1,457, and $1,770, respectively.

     The sole issue for decision is whether petitioners are

liable for self-employment tax.    The resolution of this issue

depends on whether petitioner Kenneth C. Schmidt materially

participated in the production of beets on his farm.

                          FINDINGS OF FACT

     Some of the facts have been stipulated, and they are so

found.    Petitioners resided in Richfield, Wisconsin, at the time

that their petition was filed with the Court.

1.   General Background

     Petitioner Kenneth C. Schmidt (petitioner) is principally a

dairy farmer.    Petitioner also farms approximately 250 acres of

land.    Petitioner works on his farm every day of the week for

about 15 hours per day.

2.   The Beet Contracts

     In 1991, petitioner and Dean Foods Co. (Dean Foods) entered

into a "Canning Beet Contract" in which petitioner agreed to grow

200 tons of canning beets on 16 acres of land.    In 1992 and 1993,

petitioner entered into similar contracts with Dean Foods except

that he agreed to grow 250 tons of canning beets on 18 acres of

land during such years.    Each contract required petitioner to

furnish the "machinery, labor, and other facilities necessary for
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production of canning beets * * * on land * * * leased to the

Company".

     Petitioner grew one beet crop per year in 1991, 1992, and

1993.    Pursuant to the terms of the beet contracts, petitioner

supplied the farm equipment and labor necessary to produce a beet

crop in the years in issue.

     The following labor was required to produce a beet crop:

First, in the fall prior to planting, petitioner would plow the

field to "make [the soil] loose for the next spring's

[planting]".    The following spring, petitioner would till and

fertilize the soil in further preparation of planting.    Then

petitioner would plant and apply herbicide to the beets.     In late

spring or summer petitioner would decide whether it was necessary

to cultivate the beet crop in order to destroy any remaining

weeds.    Occasionally, petitioner would "pick stones" by hand to

clear his field.    Finally, in the fall, almost one full year

after the initial plowing, petitioner would harvest the beet crop

and arrange for its delivery to Dean Foods.    On average,

petitioner worked less than 100 hours per year to produce the

beet crop.

     Each of the contracts authorized Dean Foods to direct the

date or dates on which the beet crop should be planted and

harvested.    The contracts did not suggest dates on which

petitioner should plow and till the soil, apply fertilizer and

herbicide, pick stones, or cultivate.     Rather, petitioner made
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decisions regarding these farming procedures on his own without

consulting Dean Foods.

     Petitioner owned and maintained almost all of the equipment

that he needed in order to produce the beet crops.

     Petitioner paid for the beet seeds, fertilizer, and

herbicide.    Dean Foods did not reimburse petitioner for these

expenses.

3.   Petitioners' Federal Income Tax Returns

     Petitioner received a document from Dean Foods styled

"Notice to Growers" which stated:

     All payment under Dean Foods raw product contracts are
     for leased land. * * * Payments are considered rental
     income and as such are reportable to the Internal
     Revenue Service on Form 1099 in year of payment.

     In 1991, 1992, and 1993, Dean Foods mailed to petitioner

Forms 1099-MISC reporting "rental income" thereon in the amounts

of $12,423.67, $11,208.78, and $13,609.66, respectively.    On

their Federal income tax returns for those years, petitioners

reported such income from the company as rental income not

subject to self-employment tax.

     Initially, we note that there is no dispute between the

parties regarding the taxability of the "rental" receipts from

Dean Foods to petitioners in 1991, 1992, or 1993 as ordinary

income.     Petitioners so reported the amounts on their 1991, 1992,

and 1993 returns.    Rather, the dispute is whether such income is
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income from self-employment and therefore subject to the tax

thereon.                      OPINION

     Section 1401 provides that, in addition to other taxes, a

tax shall be imposed on the self-employment income of every

individual.   Generally, rentals from real estate are excluded

from the computation of net earnings from self-employment.    Sec.

1402(a)(1).   There is an exception to the exclusion, however,

with respect to:

     any income derived by the owner or tenant of land if
     (A) such income is derived under an arrangement,
     between the owner or tenant and another individual,
     which provides that such other individual 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 (B) there is material participation by the owner or
     tenant * * * with respect to any such * * * commodity.
     [Sec. 1402(a)(1).]

In other words, if the income is derived under an arrangement

which provides for the production of agricultural products on the

land of the owner or tenant (the owner), and if the arrangement

obligates the owner to materially participate in the production

or the management of the production of agricultural commodities,

and if the owner actually materially participates in the

production or the management of the production of agricultural

commodities, then the income received by the owner pursuant to

the arrangement is considered earnings from self-employment.     See

sec. 1.1402(a)-4(b)(3)(i), Income Tax Regs.

     "The term 'production' * * * refers to the physical work
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performed and the expenses incurred in producing a commodity * *

* [and] includes such activities as the actual work of planting,

cultivating, and harvesting crops, and the furnishing of

machinery, implements, [and] seed".    Sec. 1.1402(a)-4(b)(3)(ii),

Income Tax Regs.

     Respondent contends that the payments received by

petitioners under the contracts do not represent rentals from

real estate, but rather represent compensation for petitioner's

services in producing the beet crop.     In the alternative,

respondent contends that if the payments received by petitioners

are rentals from real estate, then such payments were received

under an arrangement obligating petitioner to materially

participate in the production of beets, and that petitioner did

materially participate in such production.

     Upon examination of the facts in this case, we are convinced

that petitioner was obligated to and did materially participate

in the production of beets on his farm.       The contracts between

Dean Foods and petitioner called for petitioner to supply the

"machinery, labor, and other facilities necessary for production

of canning beets".   Indeed, petitioner supplied most of the

necessary farm equipment and undertook all of the labor necessary

to produce beets on his farm, including:       plowing, tilling and

fertilizing the beet field, planting the beets, applying

herbicide, cultivating, harvesting, and arranging for delivery of
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the beet crop to Dean Foods.   Cf. Ray v. Commissioner, T.C. Memo.

1996-436.

     Petitioners emphasize that petitioner spent less than 100

hours per year working to produce the beets.    It is true that the

number of hours that petitioner worked towards producing the

beets represented a small fraction of the total number of hours

that he worked on his farm; however, this does not diminish the

pivotal role that petitioner played in producing the beet crops

in 1991, 1992, and 1993.   Petitioner performed all of the farming

procedures necessary to produce at least 200 tons of beets for

each of the years in issue.    Additionally, petitioner bore the

expenses of the beet seeds, fertilizer, and herbicide.    It is

clear that without petitioner's efforts, there would not have

been a beet crop in any of the years in issue.

     Because we think that petitioner was required to and did

materially participate in the production of beets on his farm,

the payments received by petitioners do not qualify as rentals

from real estate that may be excluded from the computation of net

earnings from self-employment.    In light of our conclusion, it is

not necessary for us to decide whether the payments received by

petitioners constituted rentals or compensation for services.

     To reflect our conclusion herein,
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                Decision will be entered

          for respondent.
