Do Non-Farmers Pay Self-Employment Taxes on CRP Rental Payments?
Updated: Jul 9, 2020
This post should not be construed as legal advice
Maryland currently has over 65,000 acres enrolled in the Conservation Reserve Program (CRP), a federal land conservation program managed by Farm Service Agency. Landowners enroll environmentally sensitive land and remove the land from agricultural production in exchange for a yearly rental payment. The issue has been how to treat that yearly rental payment from CRP on tax returns as either self-employment tax or not.
Prior to 2003, the Internal Revenue Service (IRS) took the position that CRP rental payments paid to a person who did not materially participate in the farm would not be subject to self-employment tax. If you did materially participate, then the rental payment would be subject to self-employment tax. Recently, IRS had taken the opinion in a proposed rule (never finalized) that all CRP rental payments regardless of material participation should be considered subject to self-employment tax.
IRS’s view was recently rejected by a federal court of appeals. In Morehouse v. Commissioner of Internal Revenue, the 8th Court of Appeals found that CRP rental payments made to non-farmers should not be subject to self-employment tax. In Morehouse, the plaintiff was not an agricultural producer and had inherited some farmland in South Dakota. Morehouse decided to enroll much of this farmland in the CRP program. The issue came in 2006 and 2007 when Morehouse filed and did not report the CRP rental payments as self-employment income, and IRS began to send Morehouse notices of delinquency. Morehouse brought an action to review the IRS’s determination with the Tax Court and the Tax Court agreed with IRS. Morehouse appealed to the 8th Circuit Court of Appeals.
The 8th Circuit disagreed with the IRS, finding that IRS had a long history of viewing similar conservation program payments made to non-participating landowners as not taxable as self-employment income. The court embraced this longstanding tradition, finding that Morehouse would not be subject to self-employment tax on CRP rental payments.
The 8th Circuit Court also distinguished this case from a prior decision from the 6th Circuit. In that prior decision, the 6th Circuit found that an active agricultural producer with land enrolled in CRP would be subject to self-employment taxes on the CRP rental payments, based on the reasoning that the CRP contract required producers to complete activities similar to their active farming operations. The 8th Circuit found extending this reasoning to non-agricultural producers problematic.
So why is this ruling important? Although the ruling is limited to the 8th Circuit (Arkansas, Iowa, Missouri, Minnesota, Nebraska, and the two Dakotas), it potentially has implications reaching to Maryland (3rd Circuit). Similar to Morehouse, we potentially have landowners with inherited farmland who enrolled all or a portion of the land in the CRP program and are otherwise not currently active in agriculture. We also have high participation in the Conservation Reserve Enhancement Program (CREP), which provides an annual rental payment in return for adoption of conservation practices to reduce sediment and nutrient runoff into tributaries of the Chesapeake Bay. The Morehouse decision provides some guidance for the 3rd Circuit to decide how to handle CRP and CREP rental payments for non-farmers for tax purposes.
So how does IRS move forward from this ruling? Well, IRS could finalize the proposed rule and issue a final rule, taking the rejected position in Morehouse (which would give IRS a better leg to stand in future litigation involving this issue). IRS could ask for additional review by the 8th Circuit. Or, the IRS could be left to enforce their position in the other circuits and wait for additional courts to reject this position. IRS does have some options, and we will have to wait and see how they proceed.
If you are interested in learning more about this topic, please see McEowen, Roger, Eighth Circuit Reverses – CRP Rents Paid to a Non-Farmer Are Not Subject to Self-Employment Tax, Iowa State University Center for Agricultural Law and Taxation, Oct. 10, 2014, or https://www.calt.iastate.edu/sites/default/files/files-page/Morehouse%20Article.pdf.