The Tax Court held a taxpayer’s net income from payments received under the U.S. Department of Agriculture’s Conservation Reserve Program (CRP) was self-employment income under Sec. 1402(a).
During 2006 and 2007, Rollin Morehouse, a resident of Minnesota, received “CRP annual rental” payments as consideration for agreeing to set aside from crop growing and implement soil conservation practices on tracts of farmland owned in South Dakota. In filing his Forms 1040, Morehouse reported the payments for both years as rental income on Schedule E, Supplemental Income and Loss, and not as self-employment income on Schedule SE, Self-Employment Tax. The IRS assessed deficiencies for both years, determining that because the CRP payments were not farm rental income, they should have been reported on Schedule F, Profit or Loss From Farming, and on Schedule SE. The taxpayer petitioned the Tax Court, arguing self-employment tax did not apply because he never actually farmed in a customary manner before or during the CRP term and his participation was de minimis. Alternatively, he argued the payments were not self-employment income under the exclusion of Sec. 1402(a)(1) for certain rents from real estate and personal property leased with the real estate.
In ruling for the IRS, the court first determined a trade or business existed because Morehouse’s participation was regular, continuous, profit-motivated, and not de minimis, then determined payments received were subject to self-employment tax because the trade or business activities he performed were clearly related to the income received. Morehouse negotiated and obligated himself to terms of contracts, filed annual certifications, participated in emergency programs, and requested cost-sharing payments. Although he hired a third party to do planting and maintenance, he purchased seed and performed regular inspections. He also expanded his participation in the CRP over time, as he believed it was more profitable than leasing to farmers.
The court followed the Sixth Circuit’s holding in Wuebker, 205 F.3d 897 (6th Cir. 2000) (which had reversed the Tax Court’s holding in that case). In Wuebker, the appellate court held CRP payments were self-employment income and not eligible for the Sec. 1402(a)(1) exclusion. Because the government could access the real estate only for inspections, the rents received were for services performed by the landowner meeting the obligations of the contract rather than for the lessee’s actual use of the real estate. In arriving at its decision, the Sixth Circuit found a link between the trade or business activities performed and income received. The Wuebkers engaged in farming before and during the contract term, performed the conservation practices on land owned and previously farmed, and used their own equipment in fulfilling their contractual obligations.
Similarly, the Tax Court determined that Morehouse was in the “business of participating in the CRP,” that there was a clear connection between the trade or business activities he performed and the income received, and that the income did not qualify for the rental exclusion.
Morehouse was not eligible for the Sec. 1402(a)(1) self-employment tax exclusion for Social Security retirement or disability benefit recipients receiving CRP payments, because the payments were made before the 2008 effective date of the exclusion. The court reasoned that Congress had signaled its intent to not exclude all CRP payments from self-employment tax by enacting that exclusion.
Unless reversed upon appeal, the Morehouse decision means all individual and partnership landowners, regardless of their levels of participation, will more than likely be subject to self-employment tax on CRP income, unless the landowner qualifies for the rental real estate exclusion permitted for taxpayers receiving Social Security retirement or disability benefits.
Morehouse, 140 T.C. No. 16 (2013)
By Kim T. Mollberg, CPA, CGMA, CMA, MBT, assistant professor, Minnesota State University Moorhead.