A taxpayer not engaged in the farming business who received payments from a government soil conservation program did not thereby have self-employment income.
A split decision of a three-judge panel of the Eighth Circuit held that U.S. Department of Agriculture (USDA) Conservation Reserve Program (CRP) payments were not self-employment income to a nonfarmer landowner, reversing a prior decision of the Tax Court. The appeals court’s holding followed prior IRS guidance that land conservation payments to nonfarmers are rental payments from real estate exempt from the self-employment tax.
Facts: In 1994, Rollin Morehouse inherited 1,223 acres in South Dakota, most of which was tillable cropland. Morehouse never farmed the land but rented portions of it to others who farmed it. In 1997, Morehouse enrolled a significant portion of the inherited land in the CRP, agreeing to (1) not produce any agricultural crops, (2) establish and maintain perennial plant cover, and (3) periodically control weeds and pests. To ensure compliance, he visited the properties about three times each year.
In both 2006 and 2007, he received CRP payments of $37,872, which he reported as rental income on his tax returns for each of those years. In 2010, the IRS assessed deficiencies for both years, treating the CRP payments as self-employment income. Morehouse petitioned the Tax Court for relief, but the IRS prevailed when the court held that the payments were not rentals from real estate and thus were not exempt from the self-employment tax (see “Tax Matters: Government Farm Payments Subject to SE Tax,” JofA, Nov. 2013, page 56).
Issues: If an individual engages in a trade or business activity, the net profit resulting from that activity is self-employment income subject to the self-employment tax. Sec. 1402(a)(1) specifically excludes rental real estate income and CRP payments to specified Social Security recipients from self-employment income. Concerning other CRP payments, the IRS, in Rev. Rul. 60-32, held that soil bank payments (the predecessor of CRP payments) to farmers (taxpayers who operate or materially participate in a farming operation) were self-employment income but that such payments to nonfarmers were not self-employment income. Rev. Rul. 65-149 held that soil bank payments to nonfarmers were rental income.
In 2000, a split decision of the Sixth Circuit in Wuebker, 205 F.3d 897 (6th Cir. 2000), held that CRP payments to individuals who were farmers before and during the time of the payments were self-employment income due to Rev. Rul. 60-32 and that the USDA’s restrictions on the property under the CRP agreement did not constitute “using” the property, a requirement for the payments to be rent under the revenue ruling’s plain meaning.
Holding: The court held in Morehouse that the CRP payments were not self-employment income because they were paid for the use and occupancy of the taxpayer’s land and as such were rentals from real estate, a holding consistent with the IRS’s position in Rev. Ruls. 60-32 and 65-149. According to the court, CRP contracts require farmers to perform some activities (tilling, seeding, fertilizing, and weed control) normally performed as part of their farming activities, but those activities would probably not be performed by nonfarmers absent a CRP agreement. Also, the CRP contracts gave the government the right of entry to inspect the land and that access, together with the mandated activities, probably gave the government “more physical possession for its own land conservation ‘uses’ than Morehouse [had],” according to the court.
- Morehouse, No. 13-3110 (8th Cir. 10/10/14), rev’g 140 T.C. 350 (2013)
By Charles J. Reichert, CPA , instructor of accounting, University of Minnesota–Duluth.