Tax Court excludes rental income from farmer’s self-employment income


The Tax Court recently found, in Martin, 149 TC No. 12, that the IRS failed to show a nexus between payments from renting farmland and the agricultural arrangement requiring the taxpayer’s material participation. Therefore, the payments were excluded from the taxpayer’s self-employment income …and the resulting self-employment taxes.

Background

The taxpayer owned a 300-acre farm. The taxpayer also raised chickens and constructed a number of poultry houses. The taxpayer organized an S corp to oversee the poultry operations. The taxpayer and hired laborers performed services for the S corp. The taxpayer and the S corp entered into a lease agreement, providing for annual rent payments to the taxpayer. The taxpayer reported the rental income on his federal returns. The IRS argued that the income was subject to self-employment tax. The taxpayer sought relief in the Tax Court.

Court’s analysis

The court first found that a taxpayer’s net earnings from self-employment generally exclude rental income. However, certain agriculture-related rental income is included in a taxpayer’s net earnings from self-employment if two requirements are met:

  • The rental income must be derived under an arrangement, between the owner or tenant and another individual. The arrangement must specify that the other individual will produce agricultural commodities on the rented land and the owner or tenant will materially participate in the production or management of the production of the commodities.
  • The owner must materially participate in that production or management of production.

Here, the court found that the rent payments represented fair market rent. Additionally, the court found that the IRS failed to show that a nexus or a close enough association between the rent payments and the agricultural arrangement requiring the taxpayer’s material participation. As a result, the court concluded that the taxpayer’s agriculture-related rental income was properly excluded from self-employment income.