Farm investors hit; Tax court strikes blow to CRP contracts

Jul 5, 2013
by DTN

More than 27 million acres of farmland are under Conservation Reserve Program contracts now. Unlike cash rent, CRP rents constitute an “environmentally-friendly business” so are subject to SE taxes, the Tax Court ruled last week. (Graphic courtesy of FSA)

In a surprise reversal of tax policy, the U.S. Tax Court ruled that Conservation Reserve Program (CRP) payments don’t equate to cash rent, so even non-farm landowners who live out of state owe self-employment (SE) taxes on such income.

The decision shocked legal scholars and agricultural accountants who, for most of the past three decades, have advised farm investors that they were exempt from the 15.3 percent tax if they were not otherwise actively engaged in an agricultural business.

“This is a pretty unfortunate case,” said Roger McEowen, an Iowa State University law professor. He believed the taxpayer in question met classic IRS standards for a passive investor, so thus should have been exempt from SE taxes.

If the case is not appealed, a large number of non-farm landowners and off-farm heirs could be subject to the tax for the first time, McEowen added, and it could set a legal precedent for other types of government contracts. Nationwide, CRP is the largest land conservation program in the U.S. with 27 million acres remaining under long-term contract. By some estimates, a third of all landowners in some Great Plains and Midwest states are non-farm investors or retired farmers who no longer actively farm.

In Morehouse v. Commissioner, a non-farmer and Minnesota resident inherited farmland in South Dakota in 1994 and later purchased additional land nearby. He never farmed the land himself, instead renting it to a farm operator. In 1997, he put the bulk of his property in the CRP and continued to cash rent the remainder, hiring a local farmer to plant a cover crop and maintain weed control. He paid no SE taxes on CRP payments, just as he paid no SE tax on cash rents. The IRS claimed the taxpayer owed $6,000 of SE tax in 2006 and 2007 on the CRP rents, the years in question.

Until the ruling, tax practitioners classified three types of landowner situations differently, based on case law and clarifications from Congress over the 28-year history of the CRP, said Andy Biebl, DTN tax columnist and a tax partner with CliftonLarsonAllen LLP who assisted the tax payer in litigation.

Prior court cases have held that active farmers who placed a part of their land in a CRP contract owed SE taxes on the proceeds, since they were actively engaged in a farm business, Biebl noted. Likewise, since passage of the 2008 farm bill, there was no question that those collecting Social Security or disability payments did not owe SE taxes.

At the time, farm state congressmen said the bill was supposed to end IRS disputes on this matter.

The third category—investors who might cash rent part of their properties or who had only CRP contracts—fit the classic case of someone considered a passive investor for tax purposes, and thus should owe no SE tax, Biebl and many tax practitioners had argued.

However, IRS issued a proposed rule in 2006 saying that seeding a cover crop and maintaining weed control as stipulated in the CRP contract—even when performed by outside contractors— constituted an active trade or business. With the Morehouse ruling, the court described the CRP contract holder’s active business as “environmentally-friendly farming.”

Ironically, the IRS never published the revenue ruling and all the public comments received on the matter disagreed with the agency’s position, McEowen said.

“This might have been a gray area in the past, but the decision makes this pretty black and white now,” McEowen said.

“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,” McEowen said. “As a result of the Tax Court’s decision in Morehouse, it is hard to imagine any situation where CRP rental income will not be subject to SE tax.”

CRP contract holders shouldn’t panic. “Taxpayers that haven’t reported CRP as subject to SE tax don’t need to file amended returns for past years until IRS audits and asserts additional tax,” McEowen said. They should start paying the SE tax on their 2013 returns but could be eligible for a refund if the case is later overturned on appeal. — Marcia Taylor, DTN