Wuebker v. CIR

RECOMMENDED FOR FULL-TEXT PUBLICATION Pursuant to Sixth Circuit Rule 206 ELECTRONIC CITATION: 2000 FED App. 0078P (6th Cir.) File Name: 00a0078p.06

UNITED STATES COURT OF APPEALS FOR THE SIXTH CIRCUIT _________________

;  FREDERICK WUEBKER and  RUTH WUEBKER,  Petitioners-Appellees,  No. 98-2287

 v. >    COMMISSIONER OF INTERNAL

Respondent-Appellant.  REVENUE,   1 On Appeal from the United States Tax Court. No. 11472-96 Argued: December 10, 1999 Decided and Filed: March 3, 2000 Before: JONES, COLE, and GILMAN, Circuit Judges. _________________ COUNSEL ARGUED: Robert W. Metzler, U.S. DEPARTMENT OF JUSTICE, APPELLATE SECTION TAX DIVISION, Washington, D.C., for Appellant. John Anthony Logan, Russell N. Cunningham, WRIGHT & LOGAN, Dublin, Ohio, for Appellees. ON BRIEF: Robert W. Metzler, Teresa E.

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McLaughlin, U.S. DEPARTMENT OF JUSTICE, Wuebkers inter alia to seed and fertilize the acreage in APPELLATE SECTION TAX DIVISION, Washington, D.C., accordance with USDA dictates, further constricted the land’s for Appellant. John Anthony Logan, Russell N. Cunningham, utility. In my view, the USDA therefore exercised sufficient Paul L. Wright, WRIGHT & LOGAN, Dublin, Ohio, for control of the CRP land that it can properly be viewed as Appellees. Nan M. Still, Larry R. Gearhardt, OHIO FARM “us[ing]” the land. For this reason, characterization of the BUREAU FEDERATION, INC., Columbus, Ohio, for CRP payment as a “rental[]” payment is entirely consistent Amicus Curiae. with ordinary definitions of the term. Accordingly, I respectfully DISSENT from Part II.C. of the majority GILMAN, J., delivered the opinion of the court, in which opinion, but join the opinion in all other respects. COLE, J., joined. JONES, J. (pp. 14-15), delivered a separate opinion dissenting from Part II.C. of the majority opinion. _________________ OPINION _________________ RONALD LEE GILMAN, Circuit Judge. This dispute involves the proper tax treatment of payments received by Frederick and Ruth Wuebker under the United States Department of Agriculture’s Conservation Reserve Program (“CRP”), 16 U.S.C. §§ 3801, 3831-36. The Commissioner of Internal Revenue determined that the amounts received by the Wuebkers under their CRP contract, less the deductions attributable thereto, constituted income from the trade or business of farming that was subject to the self-employment tax pursuant to § 1401 of the Internal Revenue Code. To the contrary, the Tax Court agreed with the Wuebkers’ position that the payments constituted “rentals from real estate” that are specifically excludible from self-employment income pursuant to § 1402(a)(1) of the Internal Revenue Code. For the reasons set forth below, we REVERSE the Tax Court’s decision. I. BACKGROUND A. Factual background At all times relevant to this case, the Wuebkers resided in Fort Recovery, Ohio and jointly owned 258.67 acres of land, much of which was considered highly erodible. After farming

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________________ most of the property for approximately twenty years, they decided to enroll a substantial portion of the land into the DISSENT CRP. The CRP was established pursuant to the Food Security ________________ Act of 1985, Pub. L. No. 99-198, 99 Stat. 1354 (codified in scattered sections). It authorizes the Department of NATHANIEL R. JONES, Circuit Judge, dissenting. Agriculture to make payments to those owners and operators Because I believe that the substantial and wide-ranging of land who agree to refrain from farming their property in limitations imposed on the Wuebkers’ use of their land by the order “to conserve and improve the soil and water resources CRP signals that the USDA did “use” the land as of such lands.” 16 U.S.C. § 3831(a). The Wuebkers agreed contemplated by ordinary definitions of “rent,” I respectfully to enroll 214.9 of their acreage into the program because they DISSENT from Part II.C. of the majority opinion. felt that doing so would provide them with a more stable flow of income, benefit their land, and allow them to focus their The Internal Revenue Code does not define “rentals from efforts on their poultry operation. real estate” for the purposes of § 1402(a)(1), and we therefore look to ordinary definitions of “rent” to ascertain the statute’s The Wuebkers executed their CRP contract in November of meaning. See Smith v. United States, 508 U.S. 223, 228 1991. Frederick Wuebker was listed as the operator of the (1993) (“When a word is not defined by statute, we normally land and Ruth Wuebker was listed as the owner. Pursuant to construe it in accord with its ordinary or natural meaning.”). the contract, the Department of Agriculture—through the As the majority notes, “[r]ent normally connotes Commodities Credit Corporation (“CCC”) and the ‘[c]onsideration paid for use or occupation of property.” Ante Agricultural Stabilization and Conservation Service at 11; see Aujero v. CDA Todco, Inc., 756 F.2d 1374, 1376 (“ASCS”)—promised to pay the Wuebkers a “rental rate per (9th Cir. 1985) (quoting Black’s Law Dictionary 1166 (5th acre” of $85 for a period of ten years. Pursuant to the ed. 1979)); see also Black’s Law Dictionary (Westlaw 1999). contract, the “annual rental payment” is “based on an While the USDA did not possess or occupy the Wuebkers’ accepted bid multiplied by the number of determined acres property in the traditional sense that gives rise to a tenant- which, subject to the availability of funds, may be paid to a landlord relationship, see Restatement (Second) of Property participant to compensate such participant for placing eligible § 1.2 (1977) (“A landlord-tenant relationship exists only if the land in the Conservation Reserve Program.” landlord transfers the right to possession of the leased property.”), the CRP certainly placed a number of restrictions In exchange for that payment, the Wuebkers agreed to, on the way in which the Wuebkers could use their land. among other things, (1) implement a conservation plan, (2) establish vegetative cover, (3) “[n]ot engage in or allow As the Tax Court found, the Wuebkers were prohibited grazing, harvesting, or other commercial use of the crop from from allowing any “grazing, harvesting, or other commercial the cropland,” (4) “[n]ot harvest or sell, nor otherwise make use of the crop from the cropland,” see J.A. at 35, and were commercial use of trees on the CRP land,” (5) “[n]ot produce required to implement the numerous requirements of the any agricultural commodity on highly erodible land,”(6) conservation plan. The USDA also retained a limited right to “[c]ontrol on [the] land . . . all weeds, insects, pests and other access the land to ascertain CRP compliance. By prohibiting undesirable species,” and (7) file annual CRP reports. The all commercial farming, the USDA greatly reduced the range contract sets forth certain cost-sharing provisions, pursuant to of uses to which the Wuebkers could put their property. The which the CCC reimburses the Wuebkers for specific sundry dictates of the conservation plan, requiring the maintenance expenses. Furthermore, in order for an operator

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of land to be eligible, the participant is required to “provide (6th Cir. 1980) (“[C]ourts must look to the substance, rather satisfactory evidence that such person will be in control of than the form, of transactions to determine whether payments such cropland for the full term of the CRP contract period to a taxpayer constitute capital gain or ordinary income.”); . . . .” The contract also grants the CCC access to inspect the Mitchell v. Commissioner, 428 F.2d 259, 263 (6th Cir. 1970) CRP land: (“It is a fundamental rule of taxation that form and labels must yield to reality.”). In fact, in setting forth the CRP Representatives of CCC shall have the right of access to payment rules, Congress expressly qualified its use of the [the] land subject to this contract and to examine any term “rental” by providing that “[t]he amounts payable . . . in other lands or records under the participant’s control for the form of rental payments under contracts entered into . . . the purpose of determining land classification and may be determined through . . . the submission of bids . . . or erosion rates and for the purpose of determining whether . . . [through] other means . . . .” 16 U.S.C. § 3834(c)(2) there is compliance with the terms and conditions of this (emphasis added). contract. The Tax Court also chose not to follow Ray and Revenue With respect to 181.9 of the 214.9 acres, the conservation Ruling 60-32, asserting that neither decision addressed plan established by the parties required the Wuebkers to (1) whether the payments fell within the rental exclusion. A maintain vegetation throughout the life of the CRP contract, close reading of those decisions, however, reveals that the (2) spot mow or chemically treat noxious weeds “at any both the Tax Court and the IRS were aware of the rentals- time,” (3) periodically seed and cultivate the land using the from-real-estate exclusion. In Ray, the Tax Court explicitly “disc” and “harrow” methods, and (4) lime and fertilize the noted that the taxpayers had asserted that the exclusion should land as needed pursuant to ASCS tests. The plan declared apply: “As to the year 1990, petitioners have conceded all that the remaining 33.0 acres had adequate existing cover, respondent’s adjustments to income except respondent’s requiring only spot mowing and vegetation maintenance. A determination that petitioners’ receipt of $43,469 of income revision of the plan in March of 1992, however, required the in that year constituted income subject to self-employment Wuebkers to seed the entire 214.9 acres. The Wuebkers tax, rather than rental income as claimed by petitioners.” accomplished these tasks by using their existing farming Ray, 1996 Tax Ct. Memo LEXIS 453, at *1 (emphasis equipment, and a portion of their costs were reimbursed. added). Similarly, the IRS in Revenue Ruling 60-32 Most of the work was completed during the first year of the specifically cites 26 U.S.C. § 1402(a)(1)—the rentals-from- contract. real-estate exclusion provision—making it highly unlikely that the exclusion was not considered when the decision was In 1992 and 1993, the Wuebkers received $18,190 and rendered. In sum, we find the Tax Court’s attempt to $18,267, respectively, under the CRP. On their joint tax distinguish these prior rulings unpersuasive. returns for those years, the Wuebkers reported the amounts as rents on Schedule E, the Supplemental Income Schedule. III. CONCLUSION They did not, however, include the payments in their computation of self-employment income. As a result of an For all of the reasons set forth above, we REVERSE the audit by the IRS, the Commissioner issued a notice of Tax Court’s decision. deficiency on March 4, 1996, claiming that the CRP payments constituted farm income rather than excludible rentals from real estate, and were therefore subject to the self-employment

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347 F.2d at 165. Although it is true that the Department of tax. The notice assessed additional taxes of $1,685 and Agriculture is seeking, and receiving, a public benefit by $1,640 for 1992 and 1993, respectively. conserving lands enrolled in the CRP, the Wuebkers continue to maintain control over and free access to their premises. B. Procedural background The dissent reasons that, because the government “greatly reduced the range of uses to which the Wuebkers could put On June 6, 1996, the Wuebkers filed a timely petition with their property,” it exercised a level of control akin to “use.” the Tax Court pursuant to 26 U.S.C. § 6213(a), challenging We remain unpersuaded, however, that the restrictions the additional assessments and contending that the CRP imposed by the Department of Agriculture on a farmer’s use payments constituted rental income that should be excluded of his own land somehow translate into “use” by the from net earnings subject to the self-employment tax. Department itself. Although they stipulated to many of the facts involved in the case, the parties presented additional evidence on May 19, The essence of the program is to prevent participants from 1997. farming the property and to require them to perform various activities in connection with the land, both at the start of the In an opinion entered on August 27, 1998, the Tax Court program and continuously throughout the life of the contract, agreed with the Wuebkers, concluding that because the plain with the government’s access limited to compliance language of the CRP statute, regulations, and contract all inspections. Given this arrangement, we disagree with the describe the payments as “rent,” it should be considered as Tax Court’s determination that the Wuebkers’ maintenance rental income for tax purposes. The Tax Court also noted that obligations were legally insignificant. the Wuebkers’ service obligations under the CRP contract “were not substantial and were incidental to the primary We also note the Wuebkers’ contention that their purpose of the contract.” It characterized the payments as involvement with the CRP land was insufficient to constitute “compensation for the use restrictions on the land, rather than “material participation” within the meaning of § 1402(a)(1). remuneration for the [Wuebkers’] labor.” Finally, the Tax This contention, however, has no bearing on whether the CRP Court distinguished the Wuebkers’ case from a prior Tax payments constituted rentals from real estate. The issue of Court decision and an earlier revenue ruling holding that material participation arises only when there is an payments to farmers under similar conservation plans are, in arrangement between an owner or tenant and another fact, taxable as self-employment income. individual whereby the other individual is to produce agricultural or horticultural commodities on the land. No In this appeal, the Commissioner contends that (1) the such arrangement is present in this case. description of the payments as “rent” in the various CRP provisions does not compel the conclusion that they are, in The Tax Court placed great emphasis on the fact that the substance, rentals from real estate for the purposes of the self- CRP statute, regulations, and contract refer to the amounts employment tax, (2) the CRP payments are in fact not “rent” received by participants in the program as “rental” payments. because they are not made in exchange for the use or Although such references favor a conclusion that the occupancy of land, and (3) the CRP payments are more payments should be treated as rent for the purposes of properly characterized as self-employment income because determining whether they should fall within the rentals-from- they are made in lieu of farming income. real-estate exclusion, they certainly do not compel such a conclusion. See Cline v. Commissioner, 617 F.2d 192, 195

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II. ANALYSIS “The term ‘net earnings from self-employment’ means the gross income derived by an individual from any trade or A. Standard of review business carried on by such individual, . . . except that in computing such gross income . . . there shall be excluded An order of the Tax Court is “subject to the same review rentals from real estate . . . together with the deductions . . . as a similar order of a district court.” 26 U.S.C. attributable thereto . . . .” 26 U.S.C. § 1402(a) (emphasis § 7482(a)(3). Thus, we will sustain the Tax Court’s findings added). “Rentals from real estate” is not defined by the of fact unless they are clearly erroneous and we review its statute and, therefore, the phrase must be interpreted “in legal conclusions de novo. See Kluener v. Commissioner, 154 accordance with its ordinary or natural meaning.” FDIC v. F.3d 630, 637 (6th Cir. 1998). Meyer, 510 U.S. 471, 476 (1994). The rentals-from-real- estate exclusion, however, is to be “narrowly construed.” B. The CRP payments constitute self-employment Johnson v. Commissioner, 60 T.C. 829, 833 (1973); see also income Delno v. Celebrezze, 347 F.2d 159, 165 (9th Cir. 1965) (noting with respect to the Social Security Act’s identical The decision in this case hinges on whether the CRP provision that “there is specific evidence that Congress payments are determined to be farm income or rental income. intended the rental exclusion to be narrowly restricted to Although the Wuebkers’ additional tax liability in the range payments for occupancy only”). of $1,600 to $1,700 for each tax year might appear to be relatively small, the implications of this decision loom large. Rent is defined as “[c]onsideration paid . . . for the use or The Commissioner in his brief asserts that the Department of occupancy of property . . . .” BLACK’S LAW DICTIONARY Agriculture pays approximately $1.8 billion per year to 1299 (7th ed. 1999); see also Aujero v. CDA Todco, Inc., 756 farmers under the CRP. With the self-employment tax F.2d 1374, 1376 (9th Cir. 1985) (“Rent normally connotes currently set at the rate of 15.3%, see 26 U.S.C. § 1401(a), ‘[c]onsideration paid for use or occupation of property.’” (b), the cumulative amount of tax dollars at stake—even after (citation omitted)). Here, the Wuebkers do not—and giving effect to the relevant caps and deductions—is cannot—contend that the Department of Agriculture obtained obviously substantial. the right to “occupy” the land enrolled in the CRP. The government’s access is limited to inspecting the property and In order to finance Social Security and Medicare benefits determining whether the Wuebkers are in compliance with the for the self-employed and their dependents, the government contract. taxes the self-employment income of every individual. See 26 U.S.C. § 1401; Patterson v. Commissioner, 740 F.2d 927, 929 Whether the CRP payments constitute consideration for the (11th Cir. 1984). “‘[S]elf-employment income’ means the net “use” of the Wuebkers’ land is a closer question. Citing the earnings from self-employment derived by an individual many objectives of the CRP, such as the reduction of soil . . . .” 26 U.S.C. § 1402(b). “‘[N]et earnings from erosion and the protection of the nation’s long-term food self-employment’ means the gross income derived by an production capabilities, the Wuebkers assert, and the dissent individual from any trade or business carried on by such agrees, that the government is “using” the land in question. individual, less the deductions allowed by this subtitle . . . .” We believe, however, that such an argument impermissibly Id. § 1402(a). Thus, “[t]o be taxable as self-employment stretches the plain meaning of the term “use,” especially in income, an individual’s income must be (1) derived, (2) from light of the narrow construction required of the rentals-from- a trade or business, (3) carried on by that individual.” real-estate exclusion. See Johnson, 60 T.C. at 833; Delno,

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set forth in Part II.C. below, we find that the Tax Court’s Milligan v. Commissioner, 38 F.3d 1094, 1097 (9th Cir. disregard of these prior decisions is unwarranted. 1994). In support of their argument, the Wuebkers rely primarily Despite setting forth the definition of self-employment on Milligan v. Commissioner, 38 F.3d 1094 (9th Cir. 1994), income and the general rules for determining whether monies and Gump v. United States, 86 F.3d 1126 (Fed. Cir. 1996). received by a taxpayer should be included as such, the Tax The Milligan court held that termination payments received Court did not expressly conclude in its opinion whether the by an insurance agent under a noncompetition agreement did CRP payments in this case constitute—in the first not derive from the taxpayer’s business activity of insurance instance—self-employment income. Although we would sales because they were not “tied to the quantity or quality of normally remand for such a preliminary conclusion, a remand the taxpayer’s prior labor . . . .” Milligan, 38 F.3d at 1098. In is not necessary where the lower court has implicitly made Gump, the court followed Milligan and ruled that monthly such a finding. See Brown v. Baltimore & Ohio R.R. Co., 805 payments received by the taxpayer from his former employer F.2d 1133, 1141 (4th Cir. 1986) (“The ordinarily preferred did not derive from his insurance trade because they arose course . . . is to remand for first instance determination of the from the cessation of said business. Gump, 86 F.3d at 1128- issue by the district court. . . . Nevertheless, where . . . the 29. issue is narrow and specific, and the implicit determination clear beyond any doubt, we may yet review to avoid the Both decisions, however, are factually distinguishable from expensive alternative of a remand for a practically assured pro the instant action. First, neither case involves the unique forma express determination conforming to that one aspects of the CRP and the maintenance obligations attendant necessarily implicit in the judgment.”). In proceeding directly to the program. Second, unlike the situations in Milligan and to an analysis of whether the CRP payments fell within the Gump, the Wuebkers continued to engage in their business rentals-from-real-estate exclusion, the Tax Court implicitly while they were receiving their CRP payments. Furthermore, found that, should the exclusion not apply, the payments although the Wuebkers argue that “the CRP payments were would be taxable as self-employment income. Based on this not conditioned upon any farming activity,” their position is conclusion, and in light of the fact the parties have briefed the weakened by the fact that they were required to perform tasks question on appeal, the issue is ripe for review. that are intrinsic to the farming trade or business (e.g., tilling, seeding, fertilizing, and weed control) that required the use of In response to the Commissioner’s appeal, the Wuebkers do their farming equipment. not assert that the “trade or business” or “carried on” requirements are lacking in this case. Rather, they argue that C. The CRP payments are not excludible as rentals from the CRP payments do not constitute self-employment income real estate because they do not “derive” from their farming business. The Commissioner contends, in reply, that a sufficient nexus The Tax Court, relying primarily on the language of the exists between the CRP payments and the Wuebkers’ farming CRP statute, regulations, and contract, concluded that the operations. As explained below, we believe that the CRP payments are not properly considered self-employment Commissioner’s contention represents the stronger argument. income because they fall within the rentals-from-real-estate exclusion. In his appeal, the Commissioner essentially argues “The term ‘derive’ requires ‘a nexus between the income that the nature, not the label, of the payments compel an received and a trade or business that is, or was, actually opposite conclusion. We agree. carried on.’” Milligan, 38 F.3d at 1098 (quoting Newberry v.

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Commissioner, 76 T.C. 441, 444 (1981)). Similarly, the Id. at *5. In conclusion, the Tax Court stated that “Ray was income “must arise from some actual (whether present, past, an active farmer/rancher with respect to additional acreage or future) income-producing activity of the taxpayer . . . .” [enrolled in the CRP], and the payments . . . had a direct Newberry, 76 T.C. at 446. nexus to his trade or business.” Id. at *7. In Ray v. Commissioner, 72 T.C.M. (CCH) 780, 1996 Tax The facts of Ray are almost identical to those in the case Ct. Memo LEXIS 453 (1996), the Tax Court considered the before us, and the decision’s reasoning is sound. Like Ray, nature of CRP payments such as those involved in this case. the Wuebkers were engaged in the business of farming prior Connie Ray, the taxpayer, was engaged in the business of to and during the term of their CRP contract. Their farming and cattle grazing. He eventually purchased agreement with the CCC required them to perform several additional property that had previously been enrolled in the ongoing tasks with respect to the land enrolled in the CRP, CRP by the seller. Ray became a party to a new contract with the very land they already owned and had previously farmed. the CCC, requiring him to assume obligations similar to those As the Tax Court concluded in Ray, the CRP payments to the undertaken by the Wuebkers in this case. During the years in Wuebkers were “in connection with” and had a “direct nexus question, Ray and his wife did not report the CRP payments to” their ongoing trade or business. as self-employment income. After the IRS assessed a deficiency, Ray filed a petition challenging the Revenue Ruling 60-32, 1960-1 C.B. 23, further supports the Commissioner’s characterization of the payments. The Tax above conclusion. Issued in connection with the CRP’s Court, in holding that the payments constituted self- predecessor agricultural plan, the Soil Bank Program, 7 employment income, focused on the relationship between the U.S.C. §§ 1801-37 (repealed 1965), the ruling expressed the CRP payments and Ray’s farming and ranching business: IRS’s opinion that “[p]ayments and benefits attributable to the acreage reserve program are includible in determining the Petitioner Connie Ray was a farmer and rancher and had recipient’s net earnings from self-employment if he operates apparently been so for some years. He owned and his farm personally or through agents or employees.” operated farmlands in Texas. As an addition to his Although not binding on this court, a revenue ruling holdings, he acquired the CRP tract and, by agreement constitutes the studied view of the IRS and is “entitled to with the CCC, he continued in effect the existing some deference unless ‘it conflicts with the statute it contractual relationship under the CRP program. Under supposedly interprets or with that statute’s legislative history this program, he was required to tend and nourish the or if it is otherwise unreasonable.’” CenTra, Inc. v. United land, fight diseases, and control soil erosion. What he States, 953 F.2d 1051, 1056 (6th Cir. 1992) (quoting could not do is to farm or graze the land. In other words, Threlkeld v. Commissioner, 848 F.2d 81, 84 (6th Cir. 1988)). in return for nurturing and conserving the CRP acreage, Because the Soil Bank Program was substantially the same as but not farming or grazing it, he would and did receive a the CRP, see Peterson v. Chater, 72 F.3d 675, 677 (8th Cir. fee from CCC. Since the CRP acreage was added to his 1995) (“CRP has been called ‘Son of Soil Bank.’”), and existing farmland, and since petitioner Connie Ray was because the judgment expressed in Revenue Ruling 60-32 is already in the business of farming and ranching, this was not an unreasonable interpretation, we find it persuasive. a payment to him in connection with his ongoing trade or business. The Tax Court’s decision under review expressly distinguishes Ray and Revenue Ruling 60-32. For the reasons