Landowner Wins Landmark Case

By Marcia Zarley Taylor
DTN Executive Editor

HADDONFIELD, N.J. (DTN) -- In a blow to the IRS, the Eighth Circuit Court of Appeals ruled Oct. 10 that Conservation Reserve Program payments to a non-farmer are rents from real estate and are not subject to self-employment tax.

If a 2013 Tax Court ruling in Morehouse v. Commissioner had been allowed to stand, many nonfarmers and other passive investors could have been subjected to a surprise 15.3% self-employment tax on their CRP payments, said Roger McEowen, director of the Center for Agricultural Law at Iowa State University. What's more, it could have established a precedent to redefine tax treatment of other types of passive income, such as cash rents or conservation easements.

"The court simply recognized that signing a CRP contract is not enough to trigger the definition of a trade or business," McEowen said. "At its core, CRP payments are rent, not farm income."

To bolster its point, the court called CRP the modern equivalent of the 1960s Soil Bank. Based on that close parallel, the court noted that Soil Bank payments to nonfarmers were exempt from self-employment taxes. "Active" farmers who hold CRP contracts have long been subject to self-employment tax on CRP payments, just as they were under the Soil Bank rules.

Nationwide the CRP is the largest land conservation program in the U.S. with about 27 million acres remaining under long-term contract. By some estimates, a third of all landowners in the Great Plains and Midwest states are nonfarm investors or retired farmers who no longer actively farm.

While the Tax Code specifically exempts rent from self-employment taxes, IRS had contended that retired taxpayers and other passive investors were running "environmentally friendly" businesses because they needed to maintain the property to be eligible for payments, including seeding a cover crop and applying weed control. The Morehouse case involved a nonfarmer and Minnesota resident who inherited land in South Dakota. He enrolled it in the CRP and hired custom operators to manage weeds and other contract requirements but never actively farmed.

For most of the past 35 years, legal scholars and agricultural accountants have advised nonfarmers that they were exempt from the 15.3% tax if they were not otherwise "materially participating" in an agricultural business.

The dispute over CRP "rent" has been dragging on since 2003, when IRS first issued a chief counsel memo contending that all CRP payments were subject to self-employment tax. A previous landmark case, Wuebker v. Commissioner, clarified that CRP payments were taxable for those landowners with existing farm operations. Congress relieved retirees of that obligation in the 2008 Farm Bill: After Dec. 31, 2007, anyone collecting Social Security or disability payments did not owe self-employment taxes. Investors not collecting Social Security remained a gray area.

Wildlife organizations had been particularly disturbed by IRS' definition of what constitutes legitimate business income and what constitutes a passive investment, such as rent. They argued it would make typical CRP payments much less competitive than cash rent.

"This verdict is good news for farmers who want to participate in conservation. Likewise, it's great news for wildlife. Pheasants Forever is pleased to see the court support the view that CRP payments are not subject to additional, incongruent self-employment taxes," said Howard Vincent, Pheasants Forever & Quail Forever's president.

Landowners in some of the biggest CRP states may be relieved, but the case isn't exactly closed nationwide. Technically, passive landowners within the Eighth Circuit -- Arkansas, Missouri, Iowa, Minnesota, the Dakotas and Nebraska -- are covered by this appeals court ruling. Outside the Eighth Circuit, taxpayers might have to use the Morehouse ruling if IRS challenges their position, said Andy Biebl, a principal with CliftonLarsonAllen LLP who assisted the landowner in the case. "But they definitely won't have to fold."

Marcia Taylor can be reached at marcia.taylor@dtn.com

Follow me on Twitter@MarciaZTaylor

(AG)

Copyright 2014 DTN/The Progressive Farmer. All rights reserved.