Rev. Rul. 57-58

In view of the changes made in the Self-Employment Contributions Act of 1954 (chapter 2, subtitle A, Internal Revenue Code of 1954) by the Social Security Amendments of 1956, C.B. 1956-2, 1188, the Internal Revenue Service has been requested to outline guides for determining when income derived by an owner or tenant of land under a share-farming or other rental arrangement with another individual for the production of agricultural or horticultural commodities, by such other individual on such land, should be considered in computing net earnings from self-employment.

Section 1402 of the Act, as amended, provides, in part, as follows:

(a) NET EARNINGS FROM SELF-EMPLOYMENT.-The term `net earnings from self-employment' means the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, plus his distributive share (whether or not distributed) of income or loss described in section 702(a)(9) from any trade or business carried on by a partnership of which he is a member; except that in computing such gross income and deductions and such distributive share of partnership ordinary income or loss-

(1) there shall be excluded rentals from real estate and from personal property leased with the real estate (including such rentals paid in crop shares) together with the deductions attributable thereto, unless such rentals are received in the course of a trade or business as a real estate dealer; except that the preceding provisions of this paragraph shall not apply to any income derived by the owner or tenant of land if (A) such income is derived under an arrangement, between the owner or tenant and another individual, which provides that such other individual shall produce agricultural or horticultural commodities (including livestock, bees, poultry, and fur-bearing animals and wildlife) on such land, and that there shall be material participation by the owner or tenant in the production or the management of the production of such agricultural or horticultural commodities, and (B) there is material participation by the owner or tenant with respect to any such agricultural or horticultural commodity;

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In view of the language of the statute, it is obvious that the owner or tenant of land (hereinafter referred to as the landowner) on which agricultural or horticultural commodities are being produced by another individual must meet certain requirements before his rental income may be included in computing net earnings from self-employment.

In order for the rental income to be included, the written or oral arrangement between the landowner and the other individual must provide that such other individual shall produce one or more agricultural or horticultural commodities on the landowner's farm, and the arrangement must clearly contemplate that the landowner will materially participate in the production or the management of the production of such commodities. Furthermore, there must be actual participation by the landowner in the production or management of the production of a commodity to a degree which is material.

If the landowner, pursuant to the arrangement, participates to a material degree in the production of a commodity through physical work or management decisions, or a combination of both, the income derived by him under the arrangement is includible in computing net earnings from self-employment. However, no hard and fast rules can be laid down for determining in all cases the physical work and/or management decisions needed to establish the degree of participation contemplated by the statute. Also, while physical work and management decisions are the principal factors to be considered, the furnishing by the landowner of machinery, implements and livestock used in the production activities, or the furnishing or advancing of funds or the assuming of financial responsibility for expenses involved in the production of a commodity are additional factors which may be considered in arriving at a decision in a borderline case.

It is evident from the foregoing that, as a general rule, each case must be decided upon its own facts and circumstances. It may be stated, however, that a landowner, who establishes that he (1) periodically advises or consults with the other party regarding the production of the commodity, (2) periodically inspects the production activities on the land, and (3) furnishes a substantial portion of the machinery, implements and livestock used in the production activities, or furnishes or advances funds or assumes financial responsibility for a substantial portion of the expense involved in the production of the commodity, should include the income derived by him under the arrangement in computing net earnings from self-employment.

It is believed that the examples which follow will prove beneficial as guides in determining whether material participation exists in a specific case. The examples are all based upon the assumption that the rental arrangement between the landowner and the other individual involved provides for material participation by the landowner.

Example (1). After the death of her husband, Mrs. A rented her farm, together with its machinery and equipment, to B on a 60-40 basis. It was agreed that B would live in the tenant house on the farm and be responsible for the over-all operation of the farm, such as planting, cultivating and harvesting the field crops, caring for the orchard and harvesting the fruit, and caring for the livestock and poultry. It also was agreed that Mrs. A would continue to live in the farm residence and help B operate the farm. Pursuant to this agreement, Mrs. A regularly operates and cleans the cream separator, feeds the poultry flock and collects the eggs. When possible, she assists B in such work as spraying the fruit trees, penning livestock, culling the poultry and controlling weeds. She also assists in preparing the meals when B engages seasonal workers.

The agreement between Mrs. A and B clearly provides that she will materially participate in the production operations to be conducted on her farm by B . In actual practice, Mrs. A regularly performs substantial services which are material to the production of an agricultural commodity, as well as intermittent services which are, nevertheless, material to the production operations to which they relate. She also furnishes a substantial portion of the farm machinery and equipment. Accordingly, the income Mrs. A receives from her farm should be included in net earnings from self-employment.

Example (2). D agrees to produce a crop on C's cotton farm with each getting one-half of the proceeds. C furnishes all the necessary equipment and advises D when to plant the cotton and when it needs to be chopped, plowed, sprayed and picked. During the growing season, C inspects the crop every few days to determine whether D is properly taking care of the crop. D furnishes all labor needed to grow and harvest the crop.

The management decisions made by C in connection with the planting, plowing, etc., of the cotton crop and his regular inspection of the crop, together with the fact that he furnishes all the necessary equipment, establish that he participates to a material degree in the cotton production operations. Accordingly, the income C receives from his cotton farm is to be included in computing his net earnings from self-employment.

Example (3). X owns a grain farm and has turned its operation over to his son, Y . The oral arrangement provides that X will inspect the crops and be available for consultation and advice and will help harvest the crops. Although the final decisions are made by Y , he frequently consults with his father regarding the production of the crops. X furnishes most of the equipment, including a tractor, a combine, plows, wagons, drills and harrows. X continues to live on the farm and does some of the work such as repairing barns and farm machinery, going to town for supplies, cutting weeds, etc. During the growing season, X regularly inspects the crops. In accordance with the arrangement, X helps Y harvest the crops. An evaluation of all of X's activities indicates that they are sufficiently substantial and regular to support a conclusion that he is materially participating in the crop production operations. Accordingly, his income from the grain farm should be included in computing net earnings from self-employment.

Example (4). M owns a fully-equipped farm which he rents to N. M lives in town about five miles from the farm. About twice a month, he drives out to his farm and looks over the buildings and equipment. M may occasionally, in an emergency, discuss with N some phase of a crop production activity. N has complete charge of the farming operations although M pays one-half of the cost of the seed and fertilizer. N makes all necessary repairs and charges M for the cost of the purchased materials.

M's activities do not constitute material participation in the crop production activities. His inspection of the buildings and equipment does not count since it is not material to the production of the crops. His discussion with N , in an emergency, of a phase of a production activity does not constitute periodic consultation and advice. Furthermore, the payment by M of a portion of the production expenses (seed and fertilizer) is not sufficient, in and of itself, to constitute material participation. Accordingly, M's income from the crops should not be included in computing net earnings from self-employment.