Summary of a Recent
Judicial Development in
Cooperatives

Value-Added Payments Are Subject to Self Employment Taxes

John Stacks
National AgLaw Center Research Associate

Summary of Decision

In Bot v. Commissioner of Internal Revenue, 353 F.3d 595 (8th Cir. 2003), the United States Court of Appeals for the Eight Circuit upheld the United States Tax Court's judgment in favor of the Internal Revenue Service.

Background

The Bots were retired farmers who owned 700 acres of farmland in Minnesota. Id. at 597. Beginning in 1987, they sharecropped the land with their sons and received one-half of the crops produced. Id. They were members of the Minnesota Corn Processors Cooperative Association (MCP), in which they held common stock as well as equity units. Id. The Bots entered Uniform Marketing Agreements (UMAs) with MCP, in which they agreed to provide MCP with one bushel of corn for each equity unit they owned. Id. MCP marked and processed the corn, and a member of MCP could satisfy its obligation to provide corn to MCP by supplying corn it grew, by supplying corn purchased on the open market, or through MCP option pool corn. Id.

Under the UMAs, MCP was obligated to make various payments, including "(1) an initial payment of at least 80% of the loan value of non-option pool corn upon delivery; (2) storage and interest fees for corn required to be delivered after October 1; (3) a 'value-added' payment [to further compensate growers] . . . ; and (4) patronage dividends." Id. The Bots only used option pool corn and only received value-added payments and patronage dividends. Id. In 1994, the Bots owned 250,000 equity units and delivered 325,000 bushels; in 1995, they owned 395,000 equity units and delivered 379,200 bushels. Id. They received $132,375 and $249,152 in value-added payments in 1994 and 1995, respectively. Id. at 598. They reported bases of $68,070 and $86,431 in 1994 and 1995, respectively, from a $0.05 per bushel handling fee for option pool corn and for payments to their sons for seeds, fertilizer, and weed spray required by the crop share agreement. Id.

The IRS audited the Bots and determined that they were in the "trade or business of producing, marketing, processing, and selling corn" and that value-added payments should have been reported on Schedule C instead of Schedule D; therefore, they were subject to the self-employment tax. Id. The Bots appealed, arguing that the value-added payments represented investment income on shares of MCP and were not income subject to the self-employment tax. Id. The tax court found that the "regular and continuous acquisition and sale of corn and corn products through the MCP with the intent of making a profit qualified as engaging in the trade or business of dealing and processing corn" even though the Bots retired in 1987, that MCP was the Bots' agent, and that payment was based on the number of bushels of corn delivered. Id.

Arguments

The Bots argued that value-added payments were the result of passive activity, like dividends, rather than the result of engaging in a trade or business. Id. at 599. They asserted that value-added payments were derived from MCP's corn processing rather than from the Bots merely supplying corn and that because they had no control over MCP's actions, there was no agency relationship. Id. at 600. The Bots also argued that their "intent to purchase the equity units as an investment rather than a business should be determinative." Id. at 601.

Analysis and Holdings

The court rejected the Bots' "attempt to equate the 'value added' payments to corporate dividends" because the Bots had to do more than hold equity units; they had to supply corn to MCP to receive the payments. Id. at 600. The court found that under these facts, MCP acted as the Bots' agent because the UMA referred to MCP as the "sole agent" and there was nothing to indicate a sale. Id. at 601.

The court also stated that the Bots were able to purchase equity units because they represented that they were producers of agricultural products. Id. The court found that they should be held to that representation, and that if they wanted to receive the benefits of the cooperative program, they must bear the burdens as well. Id. at 602.

The case was decided on December 22, 2003.