In Morehouse, the Tax Court held that the payments received by the taxpayers from the United States Department of Agriculture (USDA) Conservation Reserve Program (CRP) constituted self-employment income subject to the self-employment tax imposed under Section 1401.
The taxpayer owned a number of acres of land in South Dakota, which he did not personally farm but rented the tillable portions to various individuals who farmed their rented portions. Subsequently, the taxpayer entered into a number of agreements with the USDA to refrain from using certain portions of the land pursuant to the CRP. Under the CRP, the USDA enters into contracts with owners and operators of land to conserve and improve the soil, water and wildlife resources of such land and to address issues raised by state, regional and national conservation initiatives. The USDA shares the cost of carrying out the conservation plan and pays to the owner or operator an “annual rental payment.” Pursuant to the conservation plans applicable to the taxpayer, the taxpayer had to carry out a number of activities such as maintaining already established grass and legume cover for the life of the contract, establishing perennial vegetative cover on land temporarily removed from agriculture production, including pubescent or intermediate wheat grass, alfalfa, and sweet clover, and engaged in pest control and pesticide management for the life of the contract.
On his return, the taxpayer identified his occupation as “self-employed” and reported income and expenses with respect to his properties but paid no self-employment tax on such amounts. The IRS, in its notice of deficiency, determined that the taxpayer erroneously reported the CRP payments as farm rental income on the returns, that the taxpayer should have reported the CRP payments as income on a Schedule F, Profit or Loss from Farming, for each year, and that the CRP payments constituted self-employment income subject to the self-employment tax.
Self-employment income is generally defined as “the net earnings from self-employment derived by an individual.” However, Section 1402(a)(1) provides net earnings from self-employment does not include rentals from real estate and from personal property leased with the real estate (including such rentals paid in crop shares). The IRS contended that the CRP payments were taxable as self-employment income because the taxpayer derived the CRP payments from his trade or business of conducting an environmentally friendly farming operation. On the other hand, the taxpayer contended that the CRP payments were not income from a trade or business and therefore are not includable in self-employment income, or alternatively, that the CRP payments were expressly excluded from the calculation of net earnings from self-employment under the “rentals from real estate” exclusion found in Section 1402(a)(1).
The court began by determining whether the taxpayer was engaged in a “trade or business” from which he derived income from the CRP payments. Under Section 1402(c), the term “trade or business” has the same meaning as used in Section 162. The applicable regulations provide that the trade or business must be carried on by the individual, either personally or through agents or employees. Based on these principles, the court found that payments would constitute self-employment income if they (1) are derived (2) from a trade or business (3) carried on by the taxpayer or his agent. Citing Notice 2006-108, Wuebker, Ray, and Bott, the court concluded that the taxpayer’s participation in the CRP program constituted a trade or business. Additionally, the court emphasized that participation in the CRP contract meets the criteria to be a trade or business irrespective of whether the participant performs the required activities personally or arranges for his obligations to be satisfied by a third party. The Tax Court found further support for its conclusion in the 2008 amendment made to Section 1402(a)(1), which excluded CRP payments from the calculation of a taxpayer’s net earnings from self-employment where the taxpayer is receiving Social Security, retirement or disability payments. By enacting only a limited exception with respect to taxpayers receiving Social Security, retirement or disability payments who are also receiving CRP payments, the court noted that Congress clearly evidenced an intent not to exclude all CRP payments in calculating a taxpayer’s net earnings from self-employment under Section 1402.
The court next turned to the taxpayer’s argument that the CRP payments were excluded from net earnings from self-employment under Section 1402(a)(1), which provides that rentals from real estate are excluded from the calculation of net earnings from self-employment. Citing the Wuebker case, the court concluded that CRP payments are not “rentals from real estate” since the participating owner who holds land in the CRP program does not relinquish control of the land to the USDA, and the USDA does not engage in any activities with respect to the land that constitute “use” of the land by the USDA.
Consequently, the Tax Court concluded that the CRP payments received by the taxpayer must be included in the calculation of his net earnings from self-employment under Section 1401 subject to the self-employment tax imposed under Section 1402.