J, who owns a 120-acre farm, 80 acres of which had been in cultivation, became entitled to retirement insurance benefits in 1965 at age 67 on the basis of his net earnings from self-employment as a dairy farm operator. He uses the cash receipts and disbursements method of accounting. He has continued to operate the form after entitlement to benefits. In January 1966, J entered into a 10-year contract with the Department of Agriculture under the Cropland Adjustment Program provided by title VI of the Food and Agriculture Act of 1965 (PL 89-321), to reduce crop production on his land. To compensate the farmer for reducing crop production and thus foregoing expected income, provision is made for either lump-sum or annual payments, at the option of the farmer. J has elected to receive his adjustment payment under the contract as a lump-sum discounted advance payment amounting to $7,800 in the first year of the contract, in lieu of a $1,000 payment in each of the ten years.
The Cropland Adjustment Program is similar to the conservation reserve of the Soil Bank Act of 1956 in that it allows farmers to divert cropland to conservation uses under long-term agreements ranging from 5 to 10 years. (The Soil Bank Act was repealed by the Food and Agriculture Act of 1965 except that it remains in effect with respect to contracts entered into prior to such repeal.)
The questions to be resolved are (1) whether the lump-sum adjustment payment received by J in 1966 under his cropland adjustment agreement constitutes his net earnings from self-employment; if so, (2) whether the entire amount is to be allocated to 1966, the year in which it was received, or prorated over the 10-year period covered by the agreement; and (3) whether designation of the entire amount of the lump-sum payment as self-employment income is affected if J ceases to be self-employed as a farm operator of materially-participating landlord after the year in which the payment was received.
Section 211(a) of the Social Security Act provides in pertinent part that the term "net earnings from self-employment" means the gross income as computed under Subtitle A of the Internal Revenue Code of 1954, derived by an individual from any trade or business carried on by such individual, less the deductions allowed under such subtitle which are attributable to such trade or business.
Section 404.1051 of Regulations No. 4 (20 CFR 404.1051) provides that the gross income and deductions of an individual attributable to a trade or business for the purpose of ascertaining his net earnings from self-employment are to be determined by reference to the income tax provisions of the Internal Revenue code and regulations thereunder. Thus, the method of accounting applicable to the individual's computation of gross and net income for income tax purposes is equally applicable to the computation of his net earnings from self-employment for social security purposes. Section 451(a) of the Internal Revenue Code provides that any item of income is to be included in gross income for the taxable year in which it is received unless includible in a different taxable year under the taxpayer's method of accounting.
In accordance with the provisions of section 446 of the Internal Revenue Code, taxable income must be computed in accordance with the accounting method the taxpayer regularly uses in keeping his books, whether it be the cash or the accrual method, except where the method used does not clearly reflect his income. Under the cash method, income is accounted for in the taxable year the item of income is actually or constructively received. Under the accrual method accounting, on the other hand, cash, property or services earned during the taxable year, even though not then received, are considered as having accrued to the taxpayer and must be classified as his income for that year.
Since J has been using the cash method of accounting to report his farm income, it is held that the lump-sum payment of $7,800 to him is includable in his gross income for 1966, the year in which he received it and that it cannot be prorated for inclusion in his gross income for the balance of the years in the contract period. (No finding is made as to the treatment of such payment where the individual uses the accrual method of accounting or as to whether such method of accounting may be used in reporting said lump-sum payment.)
Payments under various Federal agriculture programs representing subsidies for price support or compensation for diverting cropland to approved uses, have been held includible in net earnings from self-employment if received by a self-employed farm operator or by a materially-participating farm landlord (SSR 61-28, C.B. 1960-61, p. 70, on soil bank payments and SSR 62-64, C.B. 1962, p. 63, on payments under wheat and feed grain programs). Whether such cropland adjustment income is includible in J's net earnings from self-employment for 1966, the year in which he received it, depends upon whether he was self-employed as a farm operator or a materially-participating landlord in that year. Since J was a farm operator in 1966, the year in which he received the lump-sum payment of $7,800, it is further held that the entire amount of such payment is includible in his net earnings from self-employment for 1966. The status of the lump-sum payment for purposes of social security coverage is not affected if J should cease to be a farm operator or materially-participating landlord during the remaining years of the contract.
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