Wednesday, March 15, 2017
How a farming operation is structured influences eligibility for federal farm program payment limitations and the amount of payments that can be received. The rules can become complex in their application, but a basic point should not be missed – each “separate person” is entitled to a payment limit. But, what does that mean? How is that term defined? How does the structure of the farming operation impact separate person status?
Those are all important questions when it comes to payment limitation planning, and a recent case from Montana illustrates why proper structuring matters in the realm of payment limitation planning. That’s the focus of today’s post.
Payment Limitation Basics
Monetary limits. For payment limitation and eligibility purposes, a "person" is separately entitled to receive payments up to the applicable limit. Under the 2014 Farm Bill, the total amount of payments received, directly and indirectly, by a person or legal entity (except joint ventures or general partnerships) for Price Loss Coverage (PLC) Agricultural Risk Coverage (ARC), marketing loan gains, and loan deficiency payments (other than for peanuts), may not exceed $125,000 per crop year. A person or legal entity that receives payments for peanuts has a separate $125,000 payment limitation ($250,000 for married persons). Cotton transition payments are limited to $40,000 per year. For the livestock disaster programs, a total $125,000 annual limitation applies for payments under the Livestock Indemnity Program, the Livestock Forage Program, and the Emergency Assistance for Livestock, Honey Bees and Farm-Raised Fish program. A separate $125,000 annual limitation applies to payments under the Tree Assistance Program.
What (or who) is a “person”? "Persons" may be individuals, corporations, limited liability companies, and certain other business organizations (such as trusts, estates, charitable organizations, and states and their agencies), but general partnerships, joint ventures, and similar “joint operations” may not be "persons." Notice the difference. Individuals, along with entities that limit liability, can be a separate person entitled to a payment limit. But, other business structures that don’t limit liability are not a separate person for payment limitation purposes. Let me restate that a different way to drive the key point home - C corporations, S corporations and Limited Liability Companies (i.e., any type of entity that limits liability) all have one payment limitation. The Farm Service Agency (FSA) then implements the direct attribution rule down to the shareholders/members to the fourth level for each of the respective entities. Thus, the entity has a limitation, and then each member has a limitation. If benefits are sought in the name of an entity and there are four shareholders or members of the entity, for example, there is a single payment limit.
However, general partnerships, joint ventures, cooperative marketing associations, and other entities that don’t limit liability are not eligible for "person" status.
Note: The definition of “person” is contained at 7 C.F.R. §1400.3
As a general rule, for farming operations other than those that are small, general partnerships and joint ventures are more advantageous for payment limitation and eligibility purposes than corporations, limited liability companies, and limited partnerships. Why? While a corporation, limited liability company, or limited partnership will be only one "person" irrespective of the number of its shareholders or members, each of the partnership's or joint venture’s members may be a separate "person" (unless there is a “combination” of “persons” under one of the so-called “combination rules”). Therefore, more "persons" are potentially available to a farming operation conducted by an entity that doesn’t limit liability than farming is a farming operation conducted by an entity that does limit liability. But, of course, with no limitation on liability comes joint and several liability. Farmers will generally not be comfortable with that, but it can be addressed by having the general partnership farming operation consist of single-member limited liability companies (or other types of limited liability structures) in lieu of individuals.
“Separate and distinct” requirement. Each “separate person" must have a "separate and distinct" economic investment in the farming operation. That is measured by a three-part test.
* Each separate person must have a separate and distinct interest in the land or the crop involved;
* Each separate person must exercise separate responsibility for the separate interest; and
* Each separate person must maintain funds or accounts separate from that of any other individual or entity for that interest.
Note: General partnerships and joint ventures may satisfy these requirements on behalf of their members.
Farmers and farm families sometimes jointly purchase inputs or exchange equipment or services. That is permissible under the rules, but farming operations that are separate have to stay that way – separate and distinct. Thus, it is important to make sure that transactions are done at arm’s-length and a paper trail is created that clearly shows that separate farming operations are, indeed, separate and that each one meets all of the applicable requirements. Care should be taken to avoid a USDA argument that there is a commingling of funds between farming operations. Promptly paying for joint purchases is a good idea, as is making sure any equipment exchanges are equivalent. The idea is to avoid the appearance that one farming operation is responsible for what another farming operation is doing.
In addition, to be a “separate person,” that “person” must “[m]aintain funds or accounts separate from that of any other individual or entity for such interest [in the land or crop involved].” This requirement is a prohibition against commingling of funds. It is not a bar on “financing.” The rules on financing are probably a topic for another blog post. In general, financing restrictions are in the payment limitation and payment eligibility rules as part of the definitions of “capital,” “equipment,” and “land” and apply to “actively engaged in farming” determinations, not “person” determinations.
In a recent case involving a Montana farming operation, Harmon v. United States Department of Agriculture, No. 14-35228, 2016 U.S. App. LEXIS 23105 (9th Cir. Dec. 22, 2016), the plaintiff received federal farm program payments from 2005 through 2008. The USDA determined that the plaintiff was not a separate “person” from his LLC which also received farm program payments for the same years. As a result, the USDA required the plaintiff to refund to the government the payments that he had received. The plaintiff exhausted his administrative remedies with the USDA to no avail, and the trial court upheld the USDA’s determination on summary judgment.
On appeal, the appellate court affirmed. The court noted that the plaintiff was required to show that he was “actively engaged in farming” and that he was a “separate person” from the LLC because the definition of “person” applied to all of part 1400 of the Code of Federal Regulations (C.F.R.) which contains the “separate person” rules and, consequently, the USDA’s interpretation of its own regulation defining “person” for payment limitation purposes that is set forth in 7 C.F.R. §1400.3 was consistent with the regulation and not plainly erroneous. The court also determined that substantial evidence supported the conclusion that the plaintiff was not a separate person from his LLC due to many unexplained transfers or loans between the plaintiff and the LLC without accompanying documentation. That suggested a commingling of funds, as did the making of operating loans back and forth between the plaintiff and the LLC. As such, the appellate court believed it was not possible to determine the true assets and liabilities of either the plaintiff or the LLC.
The appellate court also believed that the plaintiff had not made a good faith effort to comply with the per-person payment limitations, was not a separate person from the LLC and was entitled to only one payment limit instead of two. Also, the finality rule which makes a determination by a state or county FSA final and binding 90 days from the date an application for benefits was filed did not bar the FSA from evaluating the plaintiff’s program eligibility because the determination was based on misrepresentations that the plaintiff should have known were erroneous. On the application, the plaintiff had represented that he provided all of the capital and labor on his farm and didn’t receive any operating loans from related entities. In addition, while the decision of the Director of the USDA National Appeals Division did not meet the 30-day deadline, it was not void because the statute at issue (7 U.S.C. §6998(b)(2)) contains no remedy for failure to comply.
A key problem with the Montana farming operation was its structure. The LLC was a “person” under the rules, so the individual had to meet the tests for being a “separate person” from the LLC. He couldn’t do that with the result that only a single payment limitation applied. A better approach would have been to set the farming operation up as a general partnership. The general partnership would not have qualified as a “separate person,” but the individual farmer could have as a single-member LLC. That still would have resulted in one payment limitation, but additional family members could have been added as members with each having their own single-member LLC. That structure might also help address problems with commingling of funds with the operating entity.
In any event a professional that understands the rules can help to create a structure that can result in compliance with the rules and keep the farming operation from becoming tangled in needless litigation. That’s particularly the case for medium and larger-sized farming operations where the payment limit is in play.