The 2008 Farm Bill: Analysis of Tax-Related Conservation Reserve Program Proposals

This report discusses the 2008 Farm Bill, which contains two tax-related proposals for the Conservation Reserve Program.

Order Code RS22910 Updated July 3, 2008 The 2008 Farm Bill: Analysis of Tax-Related Conservation Reserve Program Proposals Carol A. Pettit Legislative Attorney American Law Division Summary The 2008 Farm Bill contained two tax-related proposals for the Conservation Reserve Program. One of these proposals, which excludes the payments from selfemployment tax, was included in the final bill that became P.L. 110-246. The other, which would have allowed participants in the program to choose to receive a tax credit in lieu of the contracted annual payments, was deleted in the conference committee. Background The Conservation Reserve Program began in 1985 as a program designed to remove highly erodible croplands from current crop production. It was established by the Food Security Act of 19851 and has been expanded and extended by subsequent legislation.2 The program provides for “annual rental payments” to land owners or operators who agree to enroll their qualifying land in the program. Enrollment requires them to remove land from production and, generally, refrain from using the land commercially. They must also follow an approved conservation plan. In return, they receive annual payments. These payments are referred to as “rent” in the statute, regulations, and contracts. However, from the beginning, the Internal Revenue Service (IRS) has treated this income as self-employment income for those who continued to farm other land connected to the CRP land. Although the IRS initially treated the payments as rental income for those not otherwise engaged in farming, and, therefore, not subject to self-employment tax, that 1 2 P.L. 99-198, 99 Stat. 1354. For more details on the expansion and extension of the CRP, please see CRS Report RL34457, Conservation Reserve Program Payments: Self-Employment Income, Rental Income, or Something Else? by Carol A. Pettit. See CRS Report RS21613, Conservation Reserve Program: Status and Current Issues, by Tadlock Cowan for general background of the CRP and procedures for enrolling land in the program. CRS-2 treatment has changed over the years.3 In 2006, the IRS issued a proposed revenue ruling that would treat virtually all CRP annual payments as self-employment income.4 Net self-employment income is subject to a 15.3% self-employment tax. Since CRP annual payments are also subject to income tax, the total tax an individual must pay on CRP payments is generally between about 25%5 and 56%6 of the total received if the CRP payments are subject to self-employment tax.7 Congressional Response Several bills have been introduced in recent Congresses to exclude CRP payments from self-employment income.8 Most were referred to committee, and no hearings were held.9 During the first session of the 110th Congress, two similar bills, H.R. 2659 and S. 1155, were introduced. Again, they were referred to committee. However, in S. 2242, the Heartland, Habitat, Harvest, and Horticulture Act of 2007, the issue was approached in a different manner. This approach was adopted in the Senate amendments to H.R. 2419.10 The final provisions of the 2008 Farm Bill came from the conference committee. Rather than exempting all CRP payments from self-employment tax, while still including them for income tax, Congress considered two different approaches to CRP payments. Each of these approaches would have provided some relief to some taxpayers. One became law; the other remains a possible policy option for future Congresses. The approach that was enacted explicitly exempts CRP payments from self-employment tax for certain taxpayers. The other approach offered an optional tax credit in lieu of CRP 3 See CRS Report RL34457 for more information about the IRS’s positions regarding including CRP payments as self-employment income. 4 I.R.S. Notice 2006-108, 2006-51 I.R.B. 1118. 5 This assumes no expenses to offset the CRP income, a federal marginal tax rate of 10% for the entire amount, and no state tax. 6 This assumes no expenses to offset the CRP income, a federal marginal tax rate of 35% for the entire amount, and a state marginal tax of 6%. 7 Some individuals would have an effective tax rate that was lower; for others it could be higher. Expenses to offset income would lower the taxes paid. Other income would affect the extent to which the income was taxed at the marginal rate. “Phase-outs” of itemized deductions and exemption amounts can result in more tax being paid because more is subject to higher marginal rates. 8 See e.g., H.R. 4073, H.R. 5169, S. 665, S. 1316 (108th Congress); H.R. 923, H.R. 2347, S. 312, S. 315 (107th Congress); H.R. 4064, S. 2344, H.R. 4212, S. 2422 (106th Congress). These were introduced after a Sixth Circuit Court case reversed the Tax Court’s holding that CRP payments were rent that was excludible from self-employment income. Wuebker v. Comm’r, 205 F.3d 897 (2000), rev’g 110 T.C. 431 (1998). 9 Hearings were held on S. 312 and S. 315 (both 107th Congress). 10 H.R. 2419 (Engrossed Amendment Agreed to by Senate). Hereinafter “H.R. 2419 (EAS).” CRS-3 payments. The credit would have been subject to neither income nor self-employment taxes. Exclusion from Self-Employment Income for Certain Taxpayers. P.L. 110-24611 excludes CRP payments from self-employment income for those receiving regular retirement benefits from Social Security as well as those receiving Social Security disability benefits.12 It is silent as to the treatment of CRP payments received by all others. Given the current position of the IRS, it seems likely that this silence would result in these payments being considered self-employment income for all others.13 The committee report for the Heartland, Habitat, Harvest, and Horticulture Act of 2007, in addressing that act’s identical provision, stated, “The treatment of conservation reserve program payments received by other entities is not changed.”14 Tax Credit. Although not passed as part of the final Farm Bill, a provision in the Senate amendments would have allowed participants in the CRP to elect to receive an annual tax credit15 rather than receiving the annual rental payments.16 This credit would have been subject to neither income nor self-employment tax.17 Those who did not elect to receive the credit would continue to receive the annual rental payments. The amount of the credit would have been the same as the amount of the annual rental payment each electing participant would otherwise have received.18 As proposed, the credit could have been used to offset current year’s taxes, but would not be refundable.19 However, any excess could be carried forward and used against taxes in future years.20 The credit would not have been allowed as either an original credit or as a carryforward in any fiscal year after FY2012.21 11 H.R. 2419 was passed by both houses of Congress and sent to the President, who vetoed it. Both houses then overrode the veto. However, one title of the bill had been inadvertently omitted when the bill was sent to the President. Congress then passed H.R. 6124, which included all 15 of the Farm Bill’s titles. As promised, the President vetoed this bill. Again, Congress overrode the veto and the provisions of the Farm Bill became P.L. 110-246. 12 P.L. 110-246 § 15301(a)-(b). H.R. 2419 (EAS) § 12202(a) (amending 26 U.S.C. § 1402(a)(1)); § 12202(b) (amending § 211(a)(1) of the Social Security Act). 13 Some, however, argue that CRP payments can be excluded from self-employment tax on current tax returns. George F. Patrick, Income Tax Management for Farmers in 2007 at 24-25, Available at CES-364-W, P U R D U E E X T E N S I O N P U R D U E U. (2007). [http://www.agecon.purdue.edu/extension/pubs/TAXPLAN2007final.pdf]. 14 S.Rept. 110-206, at 9(2007). 15 H.R. 2419 (EAS) § 12201(a) (adding 26 U.S.C. § 30D(a)). 16 H.R. 2419 (EAS) § 12201(b)(1) (adding 16 U.S.C. § 3834(c)(6)). 17 H.R. 2419 (EAS) § 12201(a) (adding 26 U.S.C. § 30D(e)(4)). 18 H.R. 2419 (EAS) § 12201(a) (adding 26 U.S.C. § 30D(a)). 19 H.R. 2419 (EAS) § 12201(a) (adding 26 U.S.C. § 30D(b)(1)). 20 H.R. 2419 (EAS) § 12201(a) (adding 26 U.S.C. § 30D(d)). 21 H.R. 2419 (EAS) § 12201(a) (adding 6 U.S.C. § 30D(c)(1), (3)). CRS-4 Early termination of a CRP contract generally involves repayment of all payments received from the program since the beginning of the contract.22 The proposed credit would have been treated differently — it would have been recaptured only on a prorated basis for the fiscal year in which the contract was terminated and the credit allowed.23 Analysis of the Tax-Related CRP Proposals in the Farm Bill Exclusion from Self-Employment Tax for Certain Individuals. Unlike earlier proposed legislation that would have excluded all CRP payments from selfemployment income, the Farm Bill’s provision explicitly excludes only those payments received by retirees and the disabled. Even these would be limited to those individuals who were receiving benefits from either regular retirement24 or disability25 under the Social Security Act.26 Both regular retirement benefits and disability benefits received from Social Security have links to other “earned income”27 received. In the case of regular retirement benefits received prior to reaching “full retirement” age, the benefits are reduced by $1 for every $2 by which the recipient’s earned income exceeds a statutory annual limit.28 Receipt of disability benefits from Social Security is predicated on a disability that prevents the recipient from any work that would result in earned income.29 Some might argue that excluding CRP payments from the definition of income subject to self-employment tax for those receiving regular Social Security retirement benefits will provide recipients with a double benefit: they will not be required to pay selfemployment tax on the income, and the income will not reduce their Social Security benefits. A further argument might be made that those receiving Social Security disability benefits will also be receiving a double benefit: they will not be required to pay selfemployment tax on the income and the income probably cannot be considered evidence of an ability to engage in substantial gainful activity. In each case, where income from the CRP is concerned, Social Security beneficiaries will be exempt from funding the program under which they receive benefits. 22 16 U.S.C. § 3832(a)(5)-(6). See CRS Report RS21613, Conservation Reserve Program: Status and Current Issues; CRS Report RL34457, Conservation Reserve Program Payments: SelfEmployment Income, Rental Income, or Something Else? 23 H.R. 2419 (EAS) § 12201(a) (adding 26 U.S.C. § 30D(e)(3)). 24 These benefits are received under § 202 of the Social Security Act (42 U.S.C. § 402). 25 These benefits are received under § 223 of the Social Security Act (42 U.S.C. § 423). 26 The proposed bill would not exclude CRP payments from self-employment income for other retirees — such as military, civil service, and state retirees — or those receiving disability benefits from Veterans Affairs or some other source unless they were concurrently receiving either Social Security retirement benefits or SSI benefits. 27 “Earned income” is income such as wages and net self-employment income. “Unearned income” is other income: interest, dividends, rents, royalties, pensions, etc. Unearned income has no effect on the amount received as regular Social Security retirement benefits, though it can affect the degree to which such benefits are subject to income tax. 28 For 2008, that limit is $13,560. How Work Affects Your Benefits, SSA Pub. No. 05-10069 (Jan. 2008). Available at [http://www.ssa.gov/pubs/10069.html#howmuch]. 29 See 42 U.S.C. § 423(d). CRS-5 Others may argue that excluding CRP payments from self-employment income for Social Security beneficiaries complies with the rationale behind the IRS’s position in an early private letter ruling30 — those who are retired are not in the trade or business of farming simply by virtue of having land enrolled in the CRP. It is possible, however, that the new provision may be broader than that early position. There appears to be no limitation on the exclusion from self-employment income; therefore, someone who has retired and is receiving Social Security retirement benefits might return to being actively engaged in farming and be able to exclude the CRP payments from farm income. At the same time, the Farm Bill exclusion may be narrower than the IRS’s earlier position because those who are retired under state, military, or some federal retirement systems and do not receive Social Security benefits do not enjoy the explicit exclusion. If the IRS moves forward with its stated intention to treat all CRP payments as self-employment income,31 all retirees who do not receive Social Security benefits will be required to pay self-employment tax on their CRP payments. The committee reports do not explain the considerations behind the exclusion provided in the Farm Bill. The Senate report on the identical provision in S. 2242 says that “[t]he Committee believes that the correct measurement of income for [selfemployment tax] purposes in the cases of retired or disabled individuals does not include conservation reserve program payments.”32 The report does not discuss why the payments are specifically excluded only for retirees and the disabled or why they are specifically excluded only for those receiving benefits from Social Security. The conference report accompanying H.R. 241933 does not provide information about the reasoning for including this provision in the bill.34 Tax Credit. A tax credit reduces taxes dollar-for-dollar. Most tax credits are not refundable and no current tax credit is subject to federal income tax or self-employment tax.35 In this regard, the proposed credit was no different. It was different than most credits, however, because it could be carried forward to a subsequent tax year if not used in full in the current one.36 Those opposing the proposed credit might argue that it is regressive in nature in that it would provide the most benefit to those whose income is highest. This benefit could occur in two different ways. Since the credit would not be subject to either income or 30 P.L.R. 88-22-064 (Mar. 7, 1988) (“[Y]ou are retired from farming. Accordingly, the payments you receive pursuant to your participation in the CRP are not includible in computing ‘net earnings from self-employment.’”). 31 See I.R.S. Notice 2006-108, 2005-51 I.R.B. 1118. 32 S.Rept. 110-206, at 9. 33 H.Rept. 110-627 (2008)(Conf. Rep.). 34 See H.Rept. 110-627, at 1030. 35 Credits may be indirectly subject to some states’ income taxes. In some states, federal tax liability (after credits) has been allowed as a deduction on the state income tax return and, thus, lowering net federal income tax would increase state taxable income. 36 At least one other credit, the foreign tax credit, can also be carried forward if not allowed in full in the current year. CRS-6 self-employment taxes, those in the higher tax brackets would receive a greater tax benefit from nontaxability than would those in lower tax brackets.37 Additionally, those with higher income would likely have tax liabilities that equal or exceed the credit amount.38 Because of the time value of money, those able to fully use the credit would receive a greater value than those who must carry part of the credit forward. Those in favor of the credit might point out that no one would be forced to take the credit and no one would be prevented from doing so. This would allow all parties to examine their own situations and determine whether the credit is more beneficial to them than is the direct annual payment. Arguably, even those who could not use the credit in full in the first year might still derive more net benefit from the credit than they would from the direct payment since they would have to pay income tax on that direct payment and in many cases would also have to pay self-employment tax. Thus, even those in the 10% marginal tax bracket could realize greater benefit from the credit than direct payment if they were able to use at least 75% of the credit in the initial year.39 Other arguments in favor of the credit might come from those who believe that the IRS’s treatment of CRP payments as self-employment income is wrong or has been expanded too far. They might argue that the credit provides an incentive needed to encourage enrollment in the CRP. The committee report indicated that the reason for this provision was to provide additional incentives “to encourage eligible producers to establish long-term, resource conserving covers on eligible farmland.”40 On the other hand, the effect on the credit if a contract is terminated early is rather mild when compared to the total repayment requirement for regular CRP payments; so it is arguable that the credit might encourage people to enroll, but might not encourage them to remain enrolled long term. Some may argue that there is no need for further incentives since there has been a competitive bidding process under which applicants have tried to assure acceptance of their bids by offering their land in return for annual payments below the allowed rental values.41 However, rising commodity prices may reduce interest in participating in the CRP.42 37 If the CRP payments are subject to income tax, someone whose marginal tax rate is 35% would only net 65% of the CRP payments (after federal income tax but before either self-employment or state income taxes). On the other hand, an individual whose marginal rate is 10% would net 90% of the CRP payments after federal income tax. The first person’s benefit from nontaxability would be 35% of the CRP payments, whereas the second’s benefit would be only 10%. 38 A taxpayer’s CRP tax credit could be as high as $50,000. H.R. 2419 (EAS) § 12201 (adding 26 U.S.C. § 30D(c)(2)(B)). 39 This assumes that the CRP annual payment would be subject to both federal income and selfemployment taxes, but not state taxes. 40 S.Rept. 110-206, at 8. 41 See CRS Report RS21613, Conservation Reserve Program: Status and Current Issues. 42 Id. See also Otto Doering, Overview of the 2007 USDA Farm Bill: A Perspective on the Past & Future of the Conservation Reserve Program, EC-747-W, PURDUE EXTENSION PURDUE U. Available at [http://www.ces.purdue.edu/extmedia/EC/EC_747_W_Conservation_Reserve_ Program.pdf].