CRP in an S Corporation
Jun 30, 2013
We had a reader ask the following question in response to our posts on CRP payments being subject to SE tax:
"What about CRP income that is earned by an S corp which only rents out farmland and also collects CRP income. Will that CRP income be subject to SE tax while the land rent is not."
Rental income including CRP income received by an S corporation is not subject to SE tax. Therefore, based on the question brought up by the reader, CRP payments would normally not be subject to SE tax.
However, based on the Morehouse case, the IRS could argue that CRP payments represent a trade or business and thus, the services provided by the S corporation would require some type of appropriate compensation to the owners of the S corporation for providing services related to the CRP contracts. In most cases, this amount of compensation would be substantially less than the CRP payments received as income and thus, the S corporation would still result in less tax than CRP payments being directly received by an individual as a landlord/investor.
Second, if the S corporation was previously taxed as a C corporation and has retained earnings that were not paid out in the form of dividends, the collection of rent and/or CRP payments by the S corporation as its sole source of income will most likely subject the S corporation to a net passive income tax of 35% and if this occurs for three consecutive years, then the S corporation election will terminate. Many farmers are not aware of this tax and will convert their active farm C corporation to an S corporation and then start to cash rent their farm at some point in the future, and without proper planning, this may result in an adverse tax consequences.
Therefore, the collection of CRP payments by an S corporation will usually not result in any self-employment tax, however, it may result in additional payroll taxes and/or passive income taxes at the S corporation level based on the circumstances of each case. If you have a situation similar to this, make sure to discuss it with your tax advisor.