On June 11, 2014, a three-judge panel of the U.S. Court of Appeals for the Eighth Circuit heard oral arguments in Morehouse v. Comr., 140 T.C. No. 16 (2013). In Morehouse, the Tax Court agreed with the IRS that Conservation Reserve Program (CRP) payments are subject to self-employment tax because a recipient is engaged in a trade or business simply by signing the CRP contract with the intent to profit from the CRP. The case involves a non-farmer who inherited farmland in South Dakota and enrolled it in the CRP.
In general, the panel (comprised of Judges Beam, Gruender and Loken) did not appear impressed by the arguments of the IRS. The taxpayer’s counsel opened her allotted 15-minute argument time by pointing out that the case primarily concerned the test to be applied when the issue involves determining the existence of a trade or business. In what appeared to be a set-up question, Judge Gruender pointed out that the CRP forms that the taxpayer signed indicated that he represented himself as being a farmer and asked whether that was determinative of the issue. The taxpayer’s counsel responded that there was a “landowner exemption” that applied in this situation and, therefore, the box checked on the form was not conclusive. While it didn’t come up in the response to the question, the taxpayer’s appellate brief also pointed out that what is indicated on the CRP sign-up forms is not controlling of the issue, but rather the matter is determined based on the facts of the particular situation.
In what also appeared to be a set-up question for the taxpayer’s counsel, Judge Beam asked, “you pay S.E. tax on investment income don’t you?” Counsel replied clearly that the answer to that question was “no.”
Judge Loken then asked, “If we held that receipt of CRP payments is not trade or business income, what would be the impact?” A short discussion on that question ensued, along with discussion of the 2008 Farm Bill provision that exempted recipients of Social Security from self-employment tax on CRP payments. Judge Beam ultimately chimed in saying, “If it’s rental income they don’t have to pay the tax.” Judge Beam continued by stating that “IRS appears to have fashioned this rule out of whole cloth.” He went on to say that he believed the matter was factually similar to a landowner receiving payments from a utility company and that income treated as rents is not subject to self-employment tax.
Judge Beam then shifted the discussion to the Soil Bank program that predated the CRP. He noted that under the Soil Bank program, an enrollee had to be an active farmer to have the payments received subjected to self-employment tax. The taxpayer’s counsel noted that the CRP was essentially similar to the former Soil Bank Program inasmuch as a participant is “paid for doing nothing” on the enrolled property.
The IRS then made their presentation. The IRS counsel immediately countered that a CRP participant doesn’t get paid for “doing nothing” – that the CRP contract requires certain contractual obligations to be satisfied on a periodic basis. However, on that point, Judge Loken pointed out that under the Soil Bank program “you didn’t get paid for doing nothing either” and the payments weren’t subject to self-employment tax unless you were an active farmer. Judge Loken asked the IRS counsel whether she could explain how the Soil Bank program operated. The IRS counsel replied, “I am not familiar with the Soil Bank.” Judge Beam then explained the Soil Bank program to the IRS counsel.
Judge Loken continued to reiterate that for self-employment tax to be applied “there still has to be a trade or business and IRS has flipped-flopped.” He then asked the IRS counsel, “Why is this flip-flop okay on the trade or business issue?” The IRS counsel replied that it was the agency’s prerogative and that if she knew why the IRS did certain things she “would be a lot richer than I am right now.” Judge Loken then hammered home the point that when an administrative agency changes its position on an issue, it usually provides an explanation of the rationale for the change of position and that on the CRP change of position, there “was no explanation of why IRS was changing its position.” Judge Beam added that the IRS change of position was “just a figment of the Commissioner’s imagination” and that only farmers could be engaged in a trade or business.
The IRS counsel then turned to the conduct of the South Dakota farmer’s activity. The taxpayer (who resided in Texas and subsequently moved to Minnesota) hired a local farmer to maintain the CRP ground and perform the required minimal contract requirements. The IRS counsel argued that the agent’s activities were imputed to the taxpayer and that was enough to constitute “active engagement.” There was no follow-up by the court on that point, but the test for self-employment tax is not one of “active engagement” but rather “material participation.”
The IRS counsel argued that CRP payments are not “rental payments” (which would be statutorily excluded from self-employment tax) because they weren’t payments for the use and occupancy of the taxpayer’s land. However, Judge Beam disagreed with that construction of the term by pointing out that the CRP program is synonymous with the situation where the “government comes on your land with rules and regulations.” He again pointed out that to him, the receipt of CRP payments is like receiving income from a power line easement and that those easement payments were not subject to self-employment tax.
The IRS counsel then referenced Bot v. Comr., 353 F.3d 595 (8th Cir. 2003). In that case, the Eighth Circuit held that a non-farmer (retired farmer) had self-employment income from value-added payments from a cooperative. The IRS counsel claimed that case was controlling on the Morehouse situation to subject Morehouse’s CRP rents to self-employment tax. However, Judge Loken noted that in Bot, the taxpayer’s value-added payments were “tied to production” and “the value-added payment was based on the amount of corn delivered.”
On rebuttal, the taxpayer’s counsel reiterated that income is only subject to self-employment tax if it is derived from a trade or business that the taxpayer conducts, and that participation in the CRP never rises to a level that is regular, continuous and substantial (the standard for self-employment tax). The taxpayer’s counsel also pointed out that, with respect to the Bot case, the taxpayer was involved with a cooperative, which is treated as a partnership with an agency relationship with its members such as the taxpayers in that case.
The taxpayer’s counsel also pointed out the existence of an IRS revenue ruling from 1960 where IRS held that easement payments generated rental income.
It would appear that the oral argument went well for the taxpayer. The three-judge panel appeared favorably disposed to the taxpayer’s arguments and did not appear to agree with much, if anything, of what the IRS counsel had to say on the matter. But, sometimes oral arguments can be surprising in terms of the ultimate outcome of the case. Clearly, counsel for the taxpayer could have made stronger arguments in favor of the taxpayer’s position and the court appeared to want those arguments to be made, even making the arguments for counsel in several instances. But, overall, it would appear that the presentation at oral argument was enough to get the taxpayer across the finish line with a favorable outcome. In any event, many times an appellate decision is won on the strength of the brief, and the panel appeared to be well versed with the briefs on both sides of the issue.
The possible outcomes are as follows:
A decision is expected within the next two to six months.
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