Thursday, June 14, 2018
Farmers, Self-Employment Tax and Personal Property Leases
Self-employment tax is a concern for many farmers and ranchers, with many having an as an objective the avoidance of self-employment tax through whatever planning techniques can be utilized. That’s especially the case for those farmers and ranchers that are fully “vested” in the Social Security system.
But, what about the farmer that leases out machinery and equipment to someone else? Is the income from machinery and equipment leases subject to self-employment tax? Such an arrangement may be entered into, for example, to assist another person get established in farming or supply a need that another person has with respect to that other person’s farming operation.
As is the case with many answers to tax questions, the answer is “it depends.” Today’s post takes a look at leases of farm machinery and equipment and the self-employment tax implications.
Under I.R.C. §1402(a) “net earnings” from self-employment” means the gross income derived by an individual from any trade or business that the individual conducts. However, rental income is generally reported on Schedule E of Form 1040. From there, it flows to page one of the Form 1040. As such, it is not subject to self-employment tax. A rental activity is just that – it’s a rental activity. Under I.R.C. §1402(a)(1), “rentals from real estate” are excluded from the I.R.C. §1402(a) definition of “net earnings from self-employment.”
Exception for Personal Property Leases
The I.R.C. §1402(a)(1) exception from self-employment tax for “rentals from real estate” says, in full, “there shall be excluded rentals from real estate and from personal property leased with the real estate…” [emphasis added]. But, the non-application of self-employment tax only applies to the rental of real estate or the rental of personal property in connection with real estate.
Inapplicability of Exception
If the personal property is not tied to a land lease, the income from leasing personal property is subject to self-employment tax if the rental activity is conducted as a regular business activity of the taxpayer. See, e.g., Stevenson v. Comr., T.C. Memo. 1989-357. Indeed, a notation at the top of Schedule E indicates that if the taxpayer has a business of renting personal property then the income should be reported on Schedule C. Those same instructions also direct a taxpayer to use Schedule C to report income an expense associated with renting personal property if the rental activity is a business activity of the taxpayer. The rental activity constitutes a business if it is engaged in with the primary purpose of making a profit and the activity is engaged in with regularity and continuity. See, e.g., Comr. v. Groetzinger, 480 U.S. 23 (1987).
But, if an activity is engaged in on a one-time only basis the income derived from the activity will not be subject to self-employment tax because the activity is not engaged in on a basis that is regular and continuous. See, e.g., Batok v. Comr., T.C. Memo. 1992-727. Thus, if the rental of personal property is merely casual the Schedule E instructions state that the rental receipts should be reported as “Other Income” on page 1 of Form 1040. Any related deductions are to be reported on the total deduction line (Total Adjustments) on the bottom of page 1 of Form 1040 and the notation “PPR” is to be entered on the dotted line next to the amount. That is what indicates a personal property rental.
For a farmer that owns machinery and equipment and leases it to someone else or to their own farming business entity, the risk is real that the rental income will be subject to self-employment tax. That will be the result if the rental activity in engaged in with regularity and continuity such that the activity rises to the level of a trade or business. Self-employment tax can be avoided if the lease of the personal property is tied in with a land lease. Alternatively, a farm taxpayer could transfer the machinery and equipment to a pass-through entity with the income flowing through to the taxpayer without self-employment tax. In that situation, however, compensation from the entity would be required for any personal services provided.
An additional consideration is that, at least in some states, paying rent to lease farm equipment and machinery is subject to sales tax at the state level. Also, income from a rental activity may trigger the application of the passive loss rules under I.R.C. §469. That last point is a topic for discussion in a subsequent post.