The U.S. Court of Appeals for the Eighth Circuit on Oct. 10 overturned a 2013 U.S. Tax Court ruling that had been denounced as a dramatic reversal of a decades-long tax policy related to the Conservation Reserve Program (CRP). [Rollin J. Morehouse and Maureen B. Morehouse v. Commissioner of Internal Revenue, Case No. 13-3110].
In June 2013, the Tax Court ruled that payments received under the U.S. Department of Agriculture’s (USDA) CRP were includable as taxable self-employment income for even non-farmer landowners. According to legal scholars, the Tax Court’s ruling was unprecedented and came as a shock to non-farming landowners receiving CRP payments who, for the first time, were subject to taxes for those payments.
The taxpayer in this case, Rollin Morehouse, had from 1987 until 2003, worked in marketing and fundraising for the University of Texas. In 1994, he acquired various properties in South Dakota, which were mostly tillable cropland that he rented to others to farm.
Beginning in 1997, Morehouse enrolled some of his properties in CRP and received payments under the program. In 2003, according to court filings, Morehouse “retired from the corporate sphere” to be the primary caregiver for his four sons, although “he continued to manage his various investments and property interests.”
In the agency’s action that led to the court litigation, the Internal Revenue Service (IRS) determined that – based on the CRP payments received – Morehouse had unreported self-employment income of $25,604 and $28,391 for 2006 and 2007, respectively. In response, Morehouse petitioned the Tax Court to review the agency’s determination that the CRP payments were taxable as income from self-employment.
The Tax Court ultimately sustained the agency’s determination. The Tax Court concluded Morehouse was “engaged in the business of participating in the CRP … with the primary intent of making a profit” and that there was a sufficient nexus between this business and the CRP payments, thus categorizing the payments as net earnings from self-employment. Morehouse claimed that the CRP payments were not self-employment income because he was neither engaged in nor did the CRP payments derive from “operation of a trade or business.”
The Tax Court decided it was “immaterial” that Morehouse never personally farmed any of the land and hired someone else to carry out obligations under the program – including the seedbed preparation, seeding, weeding and maintenance work. The Tax Court further noted that Morehouse hired the individual to perform the work according to CRP specifications, and that Morehouse fulfilled other obligations under the contract – including purchasing and providing necessary materials, such as seed; collecting and preparing the certifications, applications and other documents; arranging for participation in CRP emergency haying programs and other components of the CRP programs; meeting with USDA officials; and regularly visiting the properties to ensure they complied with the CRP program.
By a majority of the three-judge panel, the appellate court reversed the Tax Court’s and IRS’s rulings. In its decision, the appellate court relied on provisions in the Internal Revenue Code that:
- Require a “nexus” between the income and the trade or business actually carried on by the taxpayer; and
- Exclude from “net earnings from self-employment” several types of income, including “rentals from real estate” and CRP payments to individuals receiving Social Security Act benefits.
The appellate court also relied on prior IRS agency rulings on earlier versions of federal soil conservation programs (i.e., the Soil Bank Act repealed in 1965), wherein the IRS concluded that payments to persons who did not operate or materially participate in a farming operation were not included in net earnings from self-employment. The appellate court noted that the only reason non-farmers, such as Morehouse, “even indirectly engage in or arrange for any ‘tilling, seeding, fertilizing, and weed control’ activities on their CRP land is because the agreement with the government requires them to do so.”
The court further referred to the government’s right of entry to inspect CRP lands, which further revealed “the government likely had more physical possession for its own land conservation uses than Morehouse did.” The appellate court stated, “in arriving at our conclusion, we embrace the agency’s longstanding position that land conservation payments made to non-farmers constitute rentals from real estate and are excluded from the self-employment tax.”
The CRP was established pursuant to the Food Security Act of 1985. Under the CRP, the USDA enters into contracts with owners and operators of land to “conserve and improve” the land’s soil, water and wildlife resources. The landowners agree to implement a conservation plan and refrain from using the land for agricultural purposes. In return, the USDA shares the costs of carrying out the conservation plan and pays the owner an “annual rental payment.”