As a result of a recent U.S. Tax Court ruling, those people who sign a Conservation Reserve Program contract with USDA--whether they are involved in a farm business or just own the land--will find their CRP payments subject to self-employment tax.
Previously, at least until 2003, self-employment tax on CRP payments was only enforced on those people who were directly involved in a trade or business, and a non-farmer's CRP income was not subject to self-employment tax, says Roger McEowen.
He's director of the Center for Agricultural Law and Taxation at Iowa State University and is a professor of ag law. In a conversation earlier this week with the editor of Wallaces Farmer magazine, he explained the latest tax court ruling and what it means.
"The issue here is that people who are not in a trade or business should not need to pay self-employment taxes on CRP rents," McEowen says. McEowen notes that even if someone just owns the land that is in the CRP and is not a farmer, the court says they will be charged the tax.
New tax court ruling expands self-employment taxes on CRP payments
According the USDA's website, the CRP program pays landowners to halt all production on their environmentally sensitive lands to conserve and improve the quality of the land. The program is in place to help improve water quality, stop soil erosion and the loss of natural habitats. Landowners apply for the program by submitting a bid to USDA, who then accepts or denies the application. The participants then sign a 10 to 15 year CRP contract. The court has determined that the landowners participating in the CRP have the intent to make profit, and should be charged a self-employment tax.~~~PAGE_BREAK_HERE~~~
"The court says you are in the trade or business of creating environmentally friendly land and farms," says McEowen. "Once you sign the CRP contract, the court states that you are in the trade or business of CRP and the CRP rents are subject to self-employment tax."
New ruling on CRP payments doesn't affect landowners who are receiving Social Security or disability payments
With landowners being charged a self-employment tax, McEowen explains that when they apply their bids for the CRP, they would adjust their bids to incorporate the tax. USDA will then have to pay more for the land to become a part of the CRP. Others may simply not participate in the CRP and cash lease the land to a farmer so that the cash rent income is not subject to self-employment tax.
The tax court ruling doesn't affect landowners who are receiving Social Security retirement or disability payments because Congress included a provision in the 2008 farm bill specifying that CRP payments aren't subject to self-employment tax under those circumstances.
"The implication of the court's decision could be far reaching by subjecting mere passive investors in farmland and non-farming heirs to self-employment tax on CRP rental income," says McEowen. If the court's language is broad enough, it would also seemingly apply to other types of government contracts, such as urban housing.
This latest ruling contradicts the tax court's previous rulings on CRP rental payments
Previous court rulings consistently said that CRP rental payments weren't subject to the self-employment tax if the recipient wasn't engaged in farming. The recent tax court ruling came June 18 in "Morehouse vs. Commissioner," involving a non-farmer who inherited farmland in South Dakota. He never farmed the land himself, initially renting it to a farmer before putting the bulk of the property in the CRP in 1977. The landowner hired a local farmer to maintain the land consistent with CRP contract requirements.~~~PAGE_BREAK_HERE~~~
The tax court, in breaking with its own past precedent, determined that the petitioner (the landowner) was in the business of participating in maintaining "an environmentally friendly farming operation," says McEowen.
"The tax court's decision is the first court opinion holding that a non-farmer's CRP income is subject to self-employment tax simply by virtue of signing a CRP contract," he notes. "As a result of the decision in this Morehouse case, it's hard to imagine any situation where CRP rental income will not be subject to self-employment tax—especially in the Eighth Circuit, which is Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota and South Dakota."
Tax court decision could be appealed but it will take coalition of ag groups
If the landowner had cash-rented the farmland instead of putting it in CRP, he wouldn't have been subject to self-employment tax, says McEowen. The ruling doesn't affect landowners who are receiving Social Security retirement or disability payments because Congress included a provision in the 2008 farm bill specifying that CRP payments aren't subject to self-employment tax under those circumstances, he adds.
McEowen says the recent decision by the tax court could be appealed, but it would likely take a coalition of ag groups, conservation groups and lenders banding together to raise enough money to fund the appeal.