Saturday, September 24, 2022

Farm and Ranch Estate Planning In 2022 (and 2023)

Overview

The Tax Cuts and Jobs Act (TCJA) has made estate planning much easier for most farm and ranch families.  Much easier, that is, with respect to avoiding the federal estate tax.  Indeed, under the TCJA, the exemption equivalent of the unified credit (i.e., the “basic exclusion amount”) was doubled from its prior level of $5 million and then indexed for inflation.  For deaths in 2022, it is is $12.06 million per decedent.  When that is combined with the unlimited marital deduction and the ability to “port” over the unused exclusion (if any) at the death of the first spouse to the surviving spouse, very few estates will incur federal estate tax.  Indeed, according to the IRS, there were 3,441 federal estate tax returns filed in 2020, and only 1,275 of those represented returns where federal estate tax was due.   

The TCJA also retains the basis “step-up” rule.  That means that property that is included in the decedent’s estate at death for tax purposes gets an income tax basis in the hands of the recipient equal to the property’s fair market value as of the date of death.  I.R.C. §1014. 

But, with the slim chance that federal estate tax will apply, should estate planning be ignored?    What are the basic estate planning strategies for 2022 (and into 2023), and for the life of the TCJA through 2025? 

Married Couples (and Singles) With Wealth Less Than $12.06 Million. 

Most people will be in this “zone.”  For these individuals, the possibility and fear of estate tax is largely irrelevant.  But, there is a continual need for the guidance of estate planners.  The estate planning focus for these individuals should be on basic estate planning matters.  Those basic matters include income tax basis planning – utilizing strategies to cause inclusion of property in the taxable estate so as to get a basis “step-up” at death. 

Existing plans should also focus on avoiding common errors and look to modify outdated language in existing wills and trusts.  For example, many estate plans utilize "formula clause" language.  That language divides assets upon the death of the first spouse (regardless of whether it is the husband or the wife) between a "credit shelter trust," which utilizes the remaining federal estate tax exemption amount, and a "marital trust," which qualifies for the (unlimited) federal estate tax marital deduction.  The intended result of the language is to cause that trust’s value to be taxed in the first spouse’s estate where it will be covered by the exemption and create a life estate in the credit shelter trust property for the surviving spouse that will “bypass” the surviving spouse’s estate upon death.  As for the martial trust assets, tax on those assets is postponed (if it is taxed at all) until the surviving spouse dies.

But, here’s the rub.  As noted above, the TCJA’s increase in the exemption could cause an existing formula clause to “overfund” the credit shelter trust with up to the full federal exemption amount of $12.06 million. This formula could potentially result in a smaller bequest for the benefit of the surviving spouse to the marital trust than was intended, or even no bequest for the surviving spouse at all.  It all depends on the value of assets that the couple holds.  The point is that couples should review any existing formula clauses in their current estate plans to ensure they are still appropriate given the increase in the federal exemption amount.  It may be necessary to have an existing will or trust redrafted to account for the change in the law and utilize language that allows for flexibility in planning.   

In addition, for some people, divorce planning/protection is necessary.  Also, a determination will need to be made as to whether asset control is necessary as well as creditor protection.  Likewise, a consideration may need to be made of the income tax benefits of family entities to shift income (subject to family partnership rules of I.R.C. §704(e)) and qualifying deductions to the entity.  The entity may have been created for estate and gift tax discount purposes, but now could provide income tax benefits.  In any event, family entities (such as family limited partnerships (FLPs) and limited liability companies (LLCs)) will continue to be valuable estate planning tools for many married couples in this wealth range.

Most persons in this zone will likely fare better by not making gifts and retaining the ability to achieve a basis step-up at death for the heirs.  That means income tax basis planning is far more important for most people.    Also, consideration should be made to determine whether insurance is still necessary to fund any potential estate tax liability   It also may be possible to recast insurance to fund state death taxes (presently, 11 states retain an estate tax and five states have an inheritance tax (one state (Maryland) has both)) and serve investment and retirement needs, minimize current income taxes, and otherwise provide liquidity at death.

Note:  In those states that have either an inheritance tax or an estate tax (or both in the case of Maryland), the exemption from tax is typically much lower than the federal exemption.  This fact requires additional planning for decedents in these states. 

Other estate planning points for moderate wealth individuals include:

  • For life insurance, it’s probably not a good idea to cancel the policy before having that move professionally evaluated. That’s particularly the case for trust-owned life insurance.  For pension-owned life insurance, for those persons that are safely below the exemption, adverse tax consequences can likely be avoided.
  • For durable powers of attorney, examine the document to see whether there are caps on gifted amounts (the annual exclusion is now $16,000) and make sure to not have inflation adjusting references to the annual exclusion.

Note:  The present interest annual exclusion for federal gift tax purposes is projected to be $17,000 per donee for gifts made in 2023. 

  • For qualified personal residence trusts (QPRTs) that were created when the estate tax exemption was $2 million, the conventional advice was to deed the house from the QPRT to the children or a remainder trust (which might have been a grantor trust), with a written lease agreement in favor of the parent/donor who would continue to live in the house. Now, it may be desired to have the home included in the estate for basis step-up purposes and the elimination of gain on sale.
  • While FLPs and LLCs may have been created to deal with an estate tax value-inclusion issue, it may not be wise to simply dismantle them because estate tax is no longer a problem for the client. Indeed, it may be a good idea to actually cause inclusion of the FLP interest in the estate.  This can be accomplished by revising the partnership or operating agreement and having a parent document control over the FLP.  Then, an I.R.C. §754 election can be made which can allow the heirs to get a basis step-up.

Other Planning Issues

While income tax basis planning (using techniques to cause inclusion of asset value in the estate at death) is now of primary importance for most people, asset protection may also be a major concern.  Pre-nuptial agreements have become more common in recent decades, and marital trusts are also used to ultimately pass assets to the heirs of the first spouse to die (who may not be the surviving spouse’s heirs) at the death of the surviving spouse.  A “beneficiary-controlled” trust has also become a popular estate planning tool.  This allows assets to pass to the beneficiary in trust rather than outright.  The beneficiary can have a limited withdrawal right over principal and direct the disposition of the assets at death while simultaneously achieving creditor protection.  In some states, such as Nebraska, the beneficiary can be the sole trustee without impairing creditor protection. 

Powers of attorney for both financial and health care remain a crucial part of any estate plan.  For a farm family, the financial power should be in addition to the FSA Form 211 and give the designated agent the authority to deal with any financial-related matter that the principal otherwise could. 

Impact of Inflation

The rampant inflation in the economy caused by numerous bad political choices over the past 20 months means that the inflation adjustment for the basic exclusion amount is projected to be $12.920,000 per decedent for deaths in 2023.  That is a significant increase, and it is likely that the basic exclusion amount will be in the $14 million range for 2025 (the last year of the TCJA).  On the flip side, the same disastrous political choices have caused the stock market to drop significantly.  So, not only are retirement savings being lost, but the remaining dollars are also being devalued by inflation.  However, for the few with significant wealth that would potentially be subjected to federal estate tax at death, it is imperative to not waste the higher exemption. This is particularly true given that the IRS has taken the position that gifts made during a year when the unified credit is high will not be clawed back into the donor’s estate at death if the credit is lower at that time.

Conclusion

While estate planning has been made easier by the TCJA, that doesn’t mean that it is no longer necessary.  Reviewing existing plans with an estate planning professional is important.  Also, the TCJA is only temporary.  The estate and gift tax provisions expire at the end of 2025. When that happens, the exemption reverts to what it was under prior law and then is adjusted for inflation.  For deaths in 2026, the federal estate and gift tax exemption is estimated to be somewhere between $7 and $8 million dollars.  While those numbers are still high enough to cover the vast majority of people, they are a far cry from the present $12.06 million amount.  One thing is for sure – a great deal of wealth is going to transfer in the coming decades.  One estimate is that approximately $30 trillion in asset value will transfer over the next 30-40 years.  That’s about a trillion per year over that timeframe.  A chunk of that will involve farm and ranch real estate, livestock, equipment and other personal property.

September 24, 2022 in Estate Planning | Permalink | Comments (0)

Sunday, September 18, 2022

Modifying an Irrevocable Trust – Decanting

Overview

Trusts are a popular part of an estate plan for many people.  Trusts also come in different forms.  Some take effect during life and can be changed whenever the trust grantor (creator or settlor) desires.  These are revocable trusts.  Other trusts, known as irrevocable trusts, also take effect during life but can’t be changed when desired.  Or, at least not as easily.  That’s an issue that comes up often.  People often change their minds and circumstances also can change.  In addition, the tax laws surrounding estates and trust are frequently modified by the Congress as well as the courts.  Also, sometimes drafting errors occur and aren’t caught until after the irrevocable trust has been executed.

So how can a grantor of an irrevocable accomplish a “do over” when circumstances change?  It involves the concept of “decanting” and it’s the topic of today’s post.

Decanting 101

Why decant?  Attempting to change the terms of an irrevocable trust is not a new concept.  “Decanting” involves pouring one trust into another trust with more favorable terms. To state it a different way, decanting involves distributing the assets of one trust to another trust that has the terms that the grantor desires, with the terms that the grantor no longer wants remaining in the old trust.  The reasons to decant a trust can be numerous.  For instance, decanting can be done to change a trust’s situs or trustee powers.  It can also be used to change the number of trustees or to consolidate different trusts.  Decanting can also be used to change the distributional scheme to provide greater asset protection and to better address the needs of a special needs beneficiary.     

Authority to decant.  The ability to “decant” comes from either an express provision in the trust, or a state statute or judicial opinions (common law).  Presently, 12 states have adopted the Uniform Trust Decanting Act (UTDA).  Those states are AL, CO, IL, ME, MA, MT, NE, NM, NC, VA, WA and WV.  24 other states have not adopted the UTDA but have their own specific decanting statutes.  These states are AL, AZ, CA, DE, FL, GA, IN, IA, KY, MI, MN, MO, NV, NH, NY, ND, OH, RI, SC, SD, TN, TX, WI and WY.  In these states, a key question is whether the statute allow the trustee to make the changes that the grantor desires.  If not, a determination must be made as to what the state courts have said on the matter, if anything.  But that could mean that litigation involving the changes is a more likely possibility with a less than certain outcome. 

Other states, such as Kansas, allow trust modification under common law.  In some of these states, courts have determined that decanting is allowed based upon the notion that the trustee’s authority to distribute trust corpus means that the trustee has a special power of appointment which allows the trustee to transfer all (or part) of the trust assets to another irrevocable trust for the same beneficiaries. Thus, a trustee attempting to decant a trust must do so consistent with the fiduciary obligations that govern a trustee – reasonableness and good faith. 

Note:  With respect to fiduciary duties, because some beneficiaries might be disaffected by decanting, it may be wise for the trustee to obtain consents or releases from trust beneficiaries.  But, if such consent is deemed to be a right to control property in the hands of the beneficiary, gift tax could be triggered.  This is a particular likelihood if the beneficiary causes or permits the beneficiary’s interest in the trust to pass to a different beneficiary, or if the beneficiary releases a general power of appointment. 

Ascertainable standard.  Many trusts have “ascertainable standard” provisions that direct the trustee to make distributions to a beneficiary in an accordance with certain standards typically tied to the beneficiary’s living conditions and needs.  If the trustee is also a beneficiary, any ascertainable standards established in the trust should not be changed by decanting.  Indeed, state law might require the ascertainable standards in the new trust to be either more restrictive or at least as restrictive as the prior trust if the trustee having the power to appoint trust property is also a beneficiary. 

Grantor’s rights.  Care should be taken to not change the grantor’s rights and interests in trust principal.  Likewise, the ability of the trustee to decant should not involve the grantor or be contingent upon the grantor’s consent so as to avoid the decanting process being deemed as a right to control property under I.R.C. §§2036 or 2038 that would cause inclusion of the trust corpus in the grantor’s gross estate upon death.  Similar issues can arise with respect to beneficiaries.  Decanting can create an estate tax issue for a beneficiary if the decanted trust (new trust) provides a beneficiary with a general power of appointment that wasn’t present in the original trust, or the property included in the beneficiary’s gross estate is treated as a gift by the beneficiary due to decanting, or the power to decant is deemed a general power of appointment, or decanting makes an incomplete gift a complete gift when the beneficiary dies. 

Note:  The decanting process cannot add beneficiaries without express authority in the original trust instrument.  Even then, only a non-beneficiary trustee may engage in the decanting process. 

GSTT.  Also, if assets are added (even indirectly) to a grandfathered generation-skipping transfer trust (GSTT), the grandfathered status is lost, and the trust is exposed to the GSTT. In 2011, the IRS announced that it was studying the implications of decanting that result in a change in the beneficial interest in the trust.  IRS requested comments regarding when (and under what circumstances) such transfers are not subject to the GSTT.  Notice 2011-101, 2011-52 IRB 932.

Trust protector.  If conditions are not favorable for decanting in a particular jurisdiction, it may be possible under the trust’s terms, or a “trust protector” provision, to shift the trust to a different jurisdiction where the desired changes will be allowed.  Absent favorable trust terms, it might be possible to petition a local court for authority to modify the trust to allow the governing jurisdiction of the trust to be changed.

Document preparation.  If decanting can be done, the process of changing the trust terms requires document preparation that will result in the pouring of the assets of the trust into another trust with different terms. Throughout the process, it is important to follow all applicable statutory rules.  Care must be taken when preparing deeds, beneficiary forms, establishing new accounts and conducting any other related business to complete the change. 

IRS Private Ruling – Judicial Reformation

In the fall of 2015, the IRS released a Private Letter Ruling that dealt with the need to change an error in the drafting of an irrevocable trust in order to repair tax issues with the trust. Priv. Ltr. Rul. 201544005 (Jun. 19, 2015).  The private ruling involved an irrevocable trust that had a couple of flaws.  The settlors (a married couple) created the trust for their children, naming themselves as trustees.  One problem was that the trust terms gave the settlors a retained power to change the beneficial interests of the trust.  That resulted in an incomplete gift of the transfer of the property to the trust.  In addition, the retained power meant that I.R.C. §2036 came into play and would cause inclusion of the property subject to the power in the settlors’ estates.  The couple intended that their transfers to the trust be completed gifts that would not be included in their gross estates, so they filed a state court petition for reformation of the trust to correct the drafting errors.  The drafting attorney submitted an affidavit that the couple’s intent was that their transfers of property to the trust be treated as completed gifts and that the trust was intended to optimize their applicable exclusion amount.  The couple also sought to resign as trustees.   The court allowed reformation of the trust.  That fixed the tax problems.  The IRS determined that the court reformation would be respected because the reformation carried out the settlors’ intent.

When to Decant

So, it is possible that an irrevocable trust can be changed to fix a drafting error and for other reasons if the law and facts allow.

What are common reasons decant an irrevocable trust?  Some of the most common ones include the following:

  • To achieve greater creditor protection by changing, for example, a support trust to a discretionary trust (this can be a big issue, for example, with respect to long-term health care planning);
  • To change the situs (jurisdiction where the trust is administered) to a location with greater pro-trust laws;
  • To adjust the terms of the trust to take into account the relatively larger federal estate exemption applicable exclusion and include power of appointment language that causes inclusion of the trust property in the settlor’s estate to achieve an income tax basis “step-up” at death (this has become a bigger issue as the federal estate tax exemption has risen substantially in recent years);
  • To provide for a successor trustee and modify the trustee powers;
  • To either combine multiple trusts or separate one trust into a trust for each beneficiary;
  • To create a special needs trust for a beneficiary with a disability;
  • To permit the trust to be qualified to hold stock in an S corporation and, of course;
  • To correct drafting errors that create tax problems and, perhaps, in the process of doing so create a fundamentally different trust.

Conclusion

The ability to modify an irrevocable trust is critical.  This is particularly true with the dramatic change in the federal estate and gift tax systems in recent years.  Modification may also be necessary when desires and goals change or to correct an error in drafting.  Fortunately, in many instances, it is possible to make changes even though the trust is “irrevocable.” 

September 18, 2022 in Estate Planning | Permalink | Comments (0)

Wednesday, September 14, 2022

Ag Law and Tax Developments

Overview

It’s been a while since I last did an case and ruling update. So, today’s post is one of several that I will post in the coming weeks. 

Some recent developments in the courts and IRS – it’s the topic of today’s post.

Retained Ownership of Minable Surface Negates Conservation Easement Deduction

C.C.A. 202236010 (Sept. 9, 2022)

The Chief Counsel’s office of IRS has taken the position that a conservation easement donation is invalid if the donor owns both the surface estate of the land burdened by the easement as well as a qualified mineral interest that has never been separated from the surface estate, and the deed retains any possibility of surface mining to extract subsurface minerals.  In that instance, the conservation easement doesn’t satisfy I.R.C. §170(h).  The IRS said the result would be the same even if the donee would have to approve the surface-mining method because the donated easement would not be donated exclusively for conservation purposes in accordance with I.R.C. §170(h)(5).  The IRS pointed out that Treas. Reg. §1.170A-14(g)(4) states that a donated easement does not protect conservation purposes in perpetuity if any method of mining that is inconsistent with the particular conservation purposes of the contribution is permitted at any time.  But, the IRS pointed out that a deduction is allowed if the mining method at issue has a limited, localized impact on the real estate and does not destroy significant conservation interests in a manner that can’t be remedied.  Surface mining, however, is specifically prohibited where the ownership of the surface estate and the mineral interest has never been separated.  On the specific facts involved, the IRS determined that the donated easement would not be treated at being made exclusively for conservation purposes because the donee could approve surface mining of the donor’s subsurface minerals.

Use of Pore Space Without Permission Unconstitutional

Northwest Landowners Association v. State, 2022 ND 150 (2022)

North Dakota law provides that a landowner’s subsurface pore space can be used for oil and gas waste without requiring the landowner’s permission or the payment of any compensation. The plaintiffs challenged the law as an unconstitutional taking under the Fourth and Fifth Amendments. The trial court held that the law was unconstitutional on its face and awarded attorney’s fees to the plaintiff.  On further review, the North Dakota Supreme Court determined that the plaintiffs had a property interest in subsurface pore space and that the section of the law specifying that the landowners did not have to provide consent to the trespassers to use the land unconstitutionally deprived them of their property rights as a per se taking.  However, the Supreme Court determined that the section of the law allowing oil and gas producers to inject carbon dioxide into subsurface pore space was constitutional.  The Supreme Court upheld the award of attorney fees. 

Net Operating Loss Couldn’t Be Carried Forward

Villanueva v. Comr., T.C. Memo. 2022-27

The petitioner sustained a loss from the disposition of a condominium he owned as a rental property. He reported the date of the loss as August 2013, but a mortgage lender had foreclosed on the condo in May 2009 and the taxpayer lost possession on that date. The IRS denied the deduction on the basis that the petitioner had not claimed the loss on either an original or amended return which meant that there was no loss that could be carried forward. The Tax Court agreed with the IRS, noting that the Treasury Regulations for I.R.C. §165 provide that a loss is treated as sustained during the tax year in which the loss occurs as evidenced by a closed and completed transaction and fixed by identifiable events occurring in such taxable year.  A loss resulting from a foreclosure sale is typically sustained in the year in which the property is disposed of, and the debt is discharged from the proceeds of the foreclosure sale.  Thus, the Tax Court determined that the loss had occurred in 2009 and should have been claimed at that time where it could have then been carried forward. 

Overtime Pay Rate Not Applicable to Construction Work on Farm

Vanegas v. Signet Builders, Inc., No. 21-2644, 2022 U.S. App. LEXIS 23206 (7th Cir. Aug. 19, 2022)

The plaintiff, the defendant’s employee, worked overtime in building a livestock fence for the defendant.  The defendant refused to pay the plaintiff time and a half for overtime. The plaintiff sued the defendant to recover the extra wages. The defendant’s refusal was based on the plaintiff being an agricultural worker not entitled to overtime.  The trial court agreed and dismissed the plaintiff’s claim.  The plaintiff appealed. The appellate court looked to the language of 29 U.S.C. § 213(b)(12) and the work of the plaintiff to determine if the plaintiff would be considered an agricultural employee. The appellate court found the plaintiff’s work was carried out as a separately organized activity outside of the defendant’s agricultural operations. The plaintiff worked for the defendant, but he built the fence on his own without any aid from any of the farm employees. The appellate court noted that another indication the work would not be considered exempt is whether farmers typically hire someone out for the work at issue. If so, it could be an indication the work is separate from agricultural work and would qualify for overtime pay. The appellate court found the defendant failed to provide much evidence to show that the plaintiff worked with agricultural employees and did not show the work was commonly done by a farmer. The appellate court also reasoned that just because the plaintiff was given a visa for agricultural work did not mean his work for the defendant was agricultural. The appellate court reversed the trial court’s decision to dismiss the complaint.

Early Distribution “Penalty” is a “Tax” and Does Not Require Supervisor Approval

Grajales v. Comr., No. 21-1420, 2022 U.S. App. LEXIS 23695 (4th Cir. Aug. 24, 2022), aff’g., 156 T.C. 55 (2021)     

The petitioner borrowed money from her pension account at age 42.  She received an IRS Form 1099-R reporting the gross distributions from the pension of $9,025.86 for 2015.  She didn’t report any of the amount as income in 2015.  The IRS issued her a notice of deficiency for $3,030.00 and an additional 10 percent penalty tax of $902.00.  The parties later stipulated to a taxable distribution of $908.62 and a penalty of $90.86.  The petitioner claimed that she was not liable for the additional penalty tax because the IRS failed to obtain written supervisory approval for levying it under I.R.C. §6751(b). The Tax Court determined that the additional 10 percent tax of I.R.C. §72(t) was a “tax” and not an IRS penalty that required supervisor approval before it would be levied.  The Tax Court noted that I.R.C. §72(t) specifically refers to it as a “tax” rather than a penalty and that other Code sections also refer to it as a tax.  The appellate court affirmed. 

U.S. Fish & Wildlife Service Can Regulate Ag Practices on Leased Land

Tulelake Irrigation Dist. v. United States Fish & Wildlife Serv., 40 F.4th 930 (9th Cir. 2022)

The plaintiffs sued the defendant, U.S. Fish and Wildlife Service, claiming the defendant violated environmental laws by regulating leased farmland in the Tule Lake and Klamath Refuge. The trial court granted summary judgment in favor of the defendant.  The plaintiff appealed.  The appellate court noted that the Kuchel Act and the Refuge Act allow the defendant to determine the proper land management practices to protect the waterfowl management of the area.  Under the Refuge Act, the defendant was required to issue an Environmental Impact Statement (EIS) and Comprehensive Conservation Plan (CCP). The defendant did issue an EIS and CCP for the Tule Lake and Klamath Refuge area, which included modifications to the agricultural use on the leased land within the region. The EIS/CCP required the leased lands to be flooded post-harvest, restricted some harvesting methods, and prohibited post-harvest field work, which the plaintiffs claimed violated their right to use the leased land. The plaintiffs argued that the language, “consistent with proper waterfowl management,” within the Kuchel Act was “nonrestrictive” and was not essential to the meaning of the Act. The appellate court held it was improper to read just that portion of the Act without considering the rest of the Act to understand the intent. The appellate court found the Kuchel Act was unambiguous and required the defendant to regulate the leased land to ensure proper waterfowl management. The Refuge Act allows the defendant to regulate the uses of the leased land, but the plaintiffs argued the agricultural practices were a “purpose” rather than a “use” so the defendant could not regulate it under the Refuge Act. The appellate court found the agriculture on the leased land was not a “purpose” equal to waterfowl management. The appellate court also held the language of the act was unambiguous and determined that agricultural activities on the land was to be considered a use that the defendant could regulate.   The appellate court affirmed the trial court’s award of summary judgment for the defendant.

Crop Salesman Sued for Ruining Relationship with Landowner

Walt Goodman Farms, Inc. v. Hogan Farms, LLC, No. 1:22-cv-01004-JDB-jay, 2022 U.S. Dist. LEXIS 134192 (W.D. Tenn. Jul. 28, 2022)

The plaintiff, a farm tenant, sued the defendant landlord and a third-party ag salesman.  The plaintiff claimed that the salesman wrongly advised the landlord and encouraged the landlord to complain about the plaintiff’s farming practices.  Specifically, the plaintiff’s claims against the salesman were for interference with contract, interference with business relationship, and fraud.  The salesman moved to dismiss each claim, but the trial court denied the motion with respect to the contract interference and interference with business relationship claims.  The trial court, however, dismissed the fraud claim involving the efficacy of corn seed.

Standard Default Interest Rate Not Unconscionable

Savibank v. Lancaster, No. 82880-1-I, 2022 Wash. App. LEXIS 1558 (Wash. Ct. App. Aug. 1, 2022)

The defendant obtained a loan from the plaintiff to purchase his father’s farm before the virus outbreak. The loan agreement stated that the interest rate would increase to 18 percent upon default. The defendant did default when the pandemic hit, and the plaintiff filed a foreclosure and repossession action against the plaintiff. The trial court ruled in favor the plaintiff. The defendant appealed and asserted the 18 percent default interest rate was unconscionable during a pandemic. During the appeal, the defendant claimed the plaintiff should have alerted the defendant to any better loan alternatives but failed to do so. The appellate court, affirmed, finding that the plaintiff had no contractual obligation to make the defendant aware of any better financing agreement.  The appellate court also upheld the trial court’s finding that the 18 percent default interest rate was not unconscionable and was common for agricultural loans with other banks in the area.  The appellate court also noted that the defendant had the opportunity to consult with a lawyer about the loan terms before signing.  The loan terms were standard and straightforward, and the defendant failed to show any evidence as to how the virus caused his default or how it made the default interest rate unconscionable.  In addition, the court noted that the defendant had stopped making loan payments before the virus began to impact the United States. The appellate court also held that the defendant failed to provide any evidence for an unconscionability defense. 

Conclusion

I’ll post additional developments in a subsequent post.

September 14, 2022 in Civil Liabilities, Income Tax, Real Property, Regulatory Law | Permalink | Comments (0)

Sunday, September 11, 2022

September 30 Ag Law Summit in Omaha (and Online)

Overview

On September 30, Washburn Law School with cooperating partner Creighton Law School will conduct the second annual Ag Law Summit.  The Summit will be held on the Creighton University campus in Omaha, Nebraska.  Last September Washburn Law School conducted it’s first “Ag Law Summit” and held it at Mahoney State Park in Nebraska. This year the Summit returns in collaboration with Creighton University School of Law.  The Summit will be held at Creighton University on September 30 and will also be broadcast live online.

The Summit will cover various topics of relevance to agricultural producers and the tax and legal counsel that represent them. 

The 2022 Ag Law Summit – it’s the topic of today’s post.

Agenda

Developments in agricultural law and taxation.  I will start off the day with a session surveying the major recent ag law and tax developments.  This one-hour session will update attendees on the big issues facing ag clients and provide insight concerning the issues that look to be on the horizon in the legal and tax world.  There have been several major developments involving agricultural that have come through the U.S Supreme Court in recent months.  I will discuss those decisions and the implications for the future.  Several of them involve administrative law and could have a substantial impact on the ability of the federal government to micro-manage agricultural activities.  I will also get into the big tax developments of the past year, including the tax provisions included in the recent legislation that declares inflation to be reduced!

Death of a farm business owner.  After my session, Prof. Ed Morse of Creighton Law School will examine the tax issues that arise when a farm business owner dies.  Income tax basis and the impact of various entity structures will be the focus of this session along with the issues that arise upon transitioning ownership to the next generation and various tax elections.  The handling of tax attributes after death will be covered as will some non-tax planning matters when an LLC owner dies.  There are also entity-specific issues that arise when a business owner dies, and Prof. Morse will address those on an entity-by-entity basis.  The transition issue for farmers and ranchers is an important one for many.  This session will be a good one in laying out the major tax and non-tax considerations that need to be laid out up front to help the family achieve its goals post-death.

Governing documents for farm and ranch business entities.  After a morning break Dan Waters with Lamson Dugan & Murray in Omaha will take us up to lunch with a technical session on the drafting of critical documents for farm and ranch entities.  What should be included in the operative agreements?  What is the proper wording?  What provisions should be included and what should be avoided?  This session picks up on Prof. Morse’s presentation and adds in the drafting elements that are key to a successful business succession plan for the farm/ranch operation.

Fence law issues.  After a provided lunch, Colten Venteicher who practices in Gothenburg, NE, will address the issues of fence line issues when ag land changes hands.  This is an issue that seems to come up over and over again in agriculture.  The problems are numerous and varied.  This session provides a survey of applicable law and rules and practical advice for helping clients resolve existing disputes and avoid future ones. 

Farm economics.  Following the afternoon break, a presentation on the current economy and economic situation facing ag producers, ag businesses and consumers will be presented by Darrell Holaday.  Darrell is an ag economist and his firm, Advanced Market Concepts, provides marketing plans for ag producers.   What are the economic projections for the balance of 2022 and into 2023 that bear on tax and estate planning for farmers and ranchers?  How will the war in Ukraine continue to impact agriculture in the U.S.?  This will be a key session, especially with the enactment of legislation that will add fuel to the current inflationary fire – unless of course, the tax increases in the legislation slow the economy enough to offset the additional spending. 

Ethics.  I return to close out the day with a session of ethics focused on asset protection planning.  There’s a right way and a wrong way to do asset protection planning.  This session guides the practitioner through the proper approach to asset protection planning, client identification, and the pitfalls if the “stop signs” are missed.

Online.  The Summit will be broadcast live online and will be interactive to allow you the ability to participate remotely. 

Reception

For those attending in person, a reception will follow in the Harper Center Ballroom on the Creighton Campus. 

Conclusion

If your tax or legal practice involves ag clients, the Ag Law Summit is for you.  As noted, you can also attend online if you can’t be there in person.  If you are a student currently in law school or thinking about it, or are a student in accounting, you will find this seminar beneficial. 

I hope to see you in Omaha on September 30 or see that you are with us online.

You can learn more about the Summit and get registered at the following link:  https://www.washburnlaw.edu/employers/cle/aglawsummit.html

September 11, 2022 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Saturday, September 10, 2022

Minnesota Farmer Protection Law Upheld

Overview

During the farm debt crisis of the 1980s numerous states in the Midwest and Plains enacted law designed to provide legal protection to farmers from various types of economic harm that others caused them.  Farmers are also particularly vulnerable to bad political choices.  During the 1970s the federal government was encouraging farmers to leverage heavily to expand and plant “fence row to fence row.”  Then the Carter Administration made bad economic choices and engaged in a Russian grain embargo. The economy suffered from stagflation and when the newly appointed Federal Reserve Chairman Paul Volcker announced he would “ring inflation out of the economy” by immediately and substantially raising interest rates in late 1979, farmers found themselves with collapsed collateral (land) values, increased debt payments and a decreased ability to continue financing farming operations.    

As the 1980s wore on, the structure of agricultural production began changing at an increasing pace.  The move was on towards contract production of agricultural production.  It had started in the 1970s in the poultry industry but started expanding into hog production.  Also, farm input and output markets began consolidating, largely because of lax enforcement of existing competition laws applicable to the agricultural industry.  Farmers buy inputs from highly concentrated markets and sell into highly concentrated markets.  They face “seller power” when it comes to purchasing inputs and “buyer power” as it relates to selling agricultural commodities. 

The Minnesota legislature, in 1990, enacted a set of laws designed to provide economic protection for farmers producing agricultural commodities under contract.  Recently, the U.S. Court of Appeals for the Eighth Circuit, in Pitman Farms v. Kuehl Poultry, LLC, et al., No. 21-1113, 2022 U.S. App. LEXIS 25167 (8th Cir. Sept. 8, 2022), said the laws applied to a parent corporation of a subsidiary that had canceled several million dollars’ worth of poultry grower contracts. 

The Minnesota Producer Protection Act – it’s the topic of today’s post.

Background

In early 1988, the Minnesota Legislature directed the Minnesota Department of Agriculture (MDA) to put together a task force to study the issue of agricultural contract production and recommend to the legislature how it might provide additional legal and economic protection to contract growers.  The MDA’s Final Report was issued in February of 1990.  During the 1990 legislative session, the Minnesota legislature approved various economic protections for farmers based on the task force recommendations focusing particularly on parent liability.  As signed into law, MN Stat. §17.93 provides as follows:

“Parent company liability.  If an agricultural contractor is the subsidiary of another corporation, partnership, or association, the parent corporation, partnership or association is liable to a seller for the amount of any unpaid claim or contract performance claim if the contractor fails to pay or perform according to the terms of the contract.” 

In addition, MN Stat. §17.90 specified as follows:

“’Producer” means a person who produces or causes to be produced an agricultural commodity in a quantity beyond the person’s own family use and: (1) is able to transfer title to another; or (2) provides management input for the production of an agricultural commodity.”

The MDA then prepared at “statement of need and reasonableness” (SONAR) to implement the new statutory provision.  The SONAR referred to the legislation as the “Producer Protection Act” (PPA) and the MDA’s implementing rule (MN Rule 1572.0040) for MN Stat §17.93 which went into effect on March 4, 1991, read as follows:

“A corporation, partnership, sole proprietorship, or association that through ownership of capital stock, cumulative voting rights, voting trust agreements, or any other plan, agreement, or device, owns more than 50 percent of the common or preferred stock entitled to vote for directors of a subsidiary corporation or provides more than 50 percent of the management or control of a subsidiary is liable to a seller of agricultural commodities for any unpaid claim or contract performance claim of that subsidiary.”

 During the same 1990 legislative session the Minnesota legislature approved and the governor signed into law MN Stat. §27.133.  This new law stated as follows:

“Parent company liability.  If a wholesale produce dealer is a subsidiary of another corporation, partnership, or association, the parent corporation, partnership, or association is liable to a seller for the amount of any unpaid claim or contract performance claim if the wholesale produce dealer fails to pay or perform in according to the terms of the contract and this chapter.”

Concerning this provision, the legislature stated, “It is therefore declared to be the policy of the legislature that certain financial protection be afforded those who are producers on the farm…”.

Also, under both MN Stat. §17.93 and MN Stat. §27.133, “contractor” and “wholesale produce dealer” were defined as “persons” and “person” was to be applied to corporations, partnerships and other unincorporated associations.”  MN Stat. §665.44, sub. 7. 

Facts of Pitman Farms v. Kuehl Poultry, LLC

In 2017, the defendants entered into chicken production contracts with Prairie’s Best Farm, Inc. to grow chickens in exchange for monthly payments and bi-monthly bonus payments.  In late 2017, Simply Essentials bought the assets of Prairie’s Best and assumed the grower contracts.  Simply Essentials, incorporated in Delaware and headquartered in California, was the subsidiary of the plaintiff, Pitman Farms, which owned more than 50 percent of Simply Essentials.  Shortly thereafter, the plaintiff bought Simply Essentials’ membership interests and became its sole owner.  In 2019, Simply Essentials encountered financial trouble, ceased processing activities and notified the defendants that it was terminating the contracts effective three months later.  The defendants’ demands for payment in excess of $6 million from the plaintiff for breach of contract failed. Both parties sought a declaratory judgment concerning the application of the PPA to the contracts. 

Trial Court Decision

The plaintiff claimed that the PPA did not apply because the defendants were not “sellers” and, even if they were, the PPA didn’t apply because Simply Essentials was an LLC rather than a “corporation, partnership, or association.  The plaintiff also asserted that the PPA’s parent company liability provisions didn’t apply to it because Delaware law applied, and that applying Minnesota law would violate the Dormant Commerce Clause.  The defendant’s counterclaim made the opposite arguments.

The trial court ruled for the plaintiff, finding that the PPA did not apply by its terms because the defendants were not “sellers” and because Simply Essentials was an LLC rather than a “corporation, partnership, or association.”

Eighth Circuit Opinion

On appeal, the appellate court unanimously reversed.  The appellate court read the various statutes together to determine the legislature’s purpose and intent.  The appellate court noted that the parent company liability statute of MN Stat. §27.133, the PPA of §§17.90-17.98 and the MDA’s implementing rule all arose from the same legislative session, addressed the same issue, and contained nearly identical language.  Accordingly, the appellate court determined that the trial court should have looked to MN Stat. §27.133 when construing the meaning of “seller” contained in MN Stat. §17.93 and in MDA Rule 1572.0040.  When the various provisions were taken together, the appellate court determined that “seller” can include “producer” under the PPA and the MDA’s implementing regulation. 

The appellate court also concluded that the trial court erred in finding that “seller” was limited to transferors of title.  Because the defendants did not have title to the chickens and could not therefore transfer title, the trial court held that the PPA did not apply.  The appellate court held that such a construction was plainly contrary to the legislature’s intent in creating the PPA which was to provide financial protections to agricultural producers in general and not merely agricultural commodity sellers.  Further, because the appellate court determined that “seller” included “producer,” the defendants were covered by the PPA as providing management services in accordance with MN Stat. §17.90 (2) for the growing of the chickens under contract.  In addition, the appellate court held that the growers were also “sellers” for purposes of the parent company liability provision of MN Stat. §27.133.

The plaintiff also asserted that “subsidiary of another corporation, partnership or association” contained in MN Stat. §17.93 and §27.133 meant that both the parent and the subsidiary had to be either a corporation, partnership or an association.  The trial court agreed with this interpretation.  The appellate court also agreed but pointed out that LLCs (which Simply Essentials was) did not exist in Minnesota when the PPA was enacted and, as such, the legislature had not purposefully excluded them from the statute. The appellate court also noted that an LLC had been found to be a “person” for purposes of the Minnesota Human Rights Act.  That law defined “person” to include a partnership, association, or corporation.  In addition, an unpublished decision of the Minnesota Court of Appeals had previously held that an LLC was an “association” for purposes of a Minnesota oil transportation statute. Thus, there was no apparent reason why the legislature would have singled out LLCs to not be covered under the parent company liability provisions of the PPA. 

The appellate court also noted the strong public policy statement of the Minnesota legislature in enacting the PPA – to protect producers of agricultural commodities from economic harm due to parent business entities using their organizational form to avoid liability for their subsidiaries’ actions. 

Conclusion

The farm debt crisis of the 1980’s produced legislative efforts in numerous states to address the legal and economic plight of farmers.  Over 30 years later, it’s refreshing to see how one of those laws has worked to protect farmers under chicken production contracts.  Other states without such protections for farmers should take note of the Eighth Circuit’s opinion.

September 10, 2022 in Contracts, Regulatory Law | Permalink | Comments (0)

Monday, September 5, 2022

Bibliography – January through June of 2022

Overview 

Periodically I post an article containing the links to all of my blog articles that have been recently published.  Today’s article is a bibliography of my articles from the beginning of 2022 through June.  Hopefully this will aid your research of agricultural law and tax topics.

A bibliography of articles for the first half of 2022 – it’s the content of today’s post.

Bankruptcy

“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 8 and 7

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-8-and-7.html

Other Important Developments in Agricultural Law and Taxation

https://lawprofessors.typepad.com/agriculturallaw/2022/01/other-important-developments-in-agricultural-law-and-taxation.html

Recent Court Cases of Importance to Agricultural Producers and Rural Landowners

https://lawprofessors.typepad.com/agriculturallaw/2022/06/recent-court-cases-of-importance-to-agricultural-producers-and-rural-landowners.html

Business Planning

Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

https://lawprofessors.typepad.com/agriculturallaw/2022/03/summer-2022-farm-income-taxestate-and-business-planning-conferences.html

Should An IDGT Be Part of Your Estate Plan?

https://lawprofessors.typepad.com/agriculturallaw/2022/03/should-an-idgt-be-part-of-your-estate-plan.html

Farm Wealth Transfer and Business Succession – The GRAT

https://lawprofessors.typepad.com/agriculturallaw/2022/03/farm-wealth-transfer-and-business-succession-the-grat.html

Captive Insurance – Part One

https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-one.html

Captive Insurance – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-two.html

Captive Insurance – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2022/04/captive-insurance-part-three.html

Pork Production Regulations; Fake Meat; and Tax Proposals on the Road to Nowhere

https://lawprofessors.typepad.com/agriculturallaw/2022/04/pork-production-regulations-fake-meat-and-tax-proposals-on-the-road-to-nowhere.html

Farm Economic Issues and Implications

https://lawprofessors.typepad.com/agriculturallaw/2022/04/farm-economic-issues-and-implications.html

Intergenerational Transfer of the Farm/Ranch Business – The Buy-Sell Agreement

https://lawprofessors.typepad.com/agriculturallaw/2022/04/intergenerational-transfer-of-the-farmranch-business-the-buy-sell-agreement.html

IRS Audit Issue – S Corporation Reasonable Compensation

https://lawprofessors.typepad.com/agriculturallaw/2022/04/irs-audit-issue-s-corporation-reasonable-compensation.html

Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

https://lawprofessors.typepad.com/agriculturallaw/2022/05/summer-2022-farm-income-taxestate-and-business-planning-conferences.html

Wisconsin Seminar and…ERP (not Wyatt) and ELRP

https://lawprofessors.typepad.com/agriculturallaw/2022/06/wisconsin-seminar-anderp-not-wyatt-and-elrp.html

S Corporation Dissolution – Part 1

https://lawprofessors.typepad.com/agriculturallaw/2022/06/s-corporation-dissolution-part-1.html

S Corporation Dissolution – Part Two; Divisive Reorganization Alternative

https://lawprofessors.typepad.com/agriculturallaw/2022/06/s-corporation-dissolution-part-two-divisive-reorganization-alternative.html

Farm/Ranch Tax, Estate and Business Planning Conference August 1-2 – Durango, Colorado (and Online)

https://lawprofessors.typepad.com/agriculturallaw/2022/07/farmranch-tax-estate-and-business-planning-conference-august-1-2-durango-colorado-and-online.html

Durango Conference and Recent Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/07/durango-conference-and-recent-developments-in-the-courts.html

Civil Liabilities

“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 8 and 7

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-8-and-7.html

Agritourism

https://lawprofessors.typepad.com/agriculturallaw/2022/03/agritourism.html

Animal Ag Facilities and the Constitution

https://lawprofessors.typepad.com/agriculturallaw/2022/03/animal-ag-facilities-and-the-constitution.html

When Is an Agricultural Activity a Nuisance?

https://lawprofessors.typepad.com/agriculturallaw/2022/04/when-is-an-agricultural-activity-a-nuisance.html

Ag Law-Related Updates: Dog Food Scam; Oil and Gas Issues

https://lawprofessors.typepad.com/agriculturallaw/2022/06/ag-law-related-updates-dog-food-scam-oil-and-gas-issues.html

Durango Conference and Recent Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/07/durango-conference-and-recent-developments-in-the-courts.html

Dicamba Spray-Drift Issues and the Bader Farms Litigation

https://lawprofessors.typepad.com/agriculturallaw/2022/07/dicamba-spray-drift-issues-and-the-bader-farms-litigation.html

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

 

Contracts

“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 6 and 5

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-6-and-5.html

What to Consider Before Buying Farmland

https://lawprofessors.typepad.com/agriculturallaw/2022/02/what-to-consider-before-buying-farmland.html

Elements of a Hunting Use Agreement

https://lawprofessors.typepad.com/agriculturallaw/2022/02/elements-of-a-hunting-use-agreement.html

Ag Law (and Medicaid Planning) Court Developments of Interest

https://lawprofessors.typepad.com/agriculturallaw/2022/05/ag-law-and-medicaid-planning-court-developments-of-interest.html

Cooperatives

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

Criminal Liabilities

Animal Ag Facilities and the Constitution

https://lawprofessors.typepad.com/agriculturallaw/2022/03/animal-ag-facilities-and-the-constitution.html

Is Your Farm or Ranch Protected From a Warrantless Search?

https://lawprofessors.typepad.com/agriculturallaw/2022/04/is-your-farm-or-ranch-protected-from-a-warrantless-search.html

Durango Conference and Recent Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/07/durango-conference-and-recent-developments-in-the-courts.html

Environmental Law

“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 6 and 5

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-6-and-5.html

“Top Tan” Agricultural Law and Tax Developments of 2021 – Numbers 2 and 1

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-2-and-1.html

The “Almost Top Ten” (Part 3) – New Regulatory Definition of “Habitat” under the ESA

https://lawprofessors.typepad.com/agriculturallaw/2022/01/the-almost-top-ten-new-regulatory-definition-of-habitat-under-the-esa.html

Ag Law and Tax Potpourri

https://lawprofessors.typepad.com/agriculturallaw/2022/02/ag-law-and-tax-potpourri.html

Farm Economic Issues and Implications

https://lawprofessors.typepad.com/agriculturallaw/2022/04/farm-economic-issues-and-implications.html

Constitutional Limit on Government Agency Power – The “Major Questions” Doctrine

https://lawprofessors.typepad.com/agriculturallaw/2022/07/constitutional-limit-on-government-agency-power-the-major-questions-doctrine.html

Estate Planning

Other Important Developments in Agricultural Law and Taxation

https://lawprofessors.typepad.com/agriculturallaw/2022/01/other-important-developments-in-agricultural-law-and-taxation.html

Other Important Developments in Agricultural Law and Taxation (Part 2)

https://lawprofessors.typepad.com/agriculturallaw/2022/01/other-important-developments-in-agricultural-law-and-taxation-part-2.html

The “Almost Top Ten” (Part 4) – Tax Developments

https://lawprofessors.typepad.com/agriculturallaw/2022/01/the-almost-top-ten-part-4-tax-developments.html

The “Almost Top 10” of 2021 (Part 7) [Medicaid Recovery and Tax Deadlines]

https://lawprofessors.typepad.com/agriculturallaw/2022/02/the-almost-top-10-of-2021-part-7-medicaid-recovery-and-tax-deadlines.html

Nebraska Revises Inheritance Tax; and Substantiating Expenses

https://lawprofessors.typepad.com/agriculturallaw/2022/02/recent-developments-in-ag-law-and-tax.html

Tax Consequences When Farmland is Partitioned and Sold

https://lawprofessors.typepad.com/agriculturallaw/2022/02/tax-consequences-when-farmland-is-partitioned-and-sold.html

Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

https://lawprofessors.typepad.com/agriculturallaw/2022/03/summer-2022-farm-income-taxestate-and-business-planning-conferences.html

Should An IDGT Be Part of Your Estate Plan?

https://lawprofessors.typepad.com/agriculturallaw/2022/03/should-an-idgt-be-part-of-your-estate-plan.html

Farm Wealth Transfer and Business Succession – The GRAT

https://lawprofessors.typepad.com/agriculturallaw/2022/03/farm-wealth-transfer-and-business-succession-the-grat.html

Family Settlement Agreement – Is it a Good Idea?

https://lawprofessors.typepad.com/agriculturallaw/2022/03/family-settlement-agreement-is-it-a-good-idea.html

Registration Open for Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

https://lawprofessors.typepad.com/agriculturallaw/2022/03/registration-open-for-summer-2022-farm-income-taxestate-and-business-planning-conferences.html

Captive Insurance – Part One

https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-one.html

Captive Insurance – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-two.html

Captive Insurance Part Three

https://lawprofessors.typepad.com/agriculturallaw/2022/04/captive-insurance-part-three.html

Pork Production Regulations; Fake Meat; and Tax Proposals on the Road to Nowhere

https://lawprofessors.typepad.com/agriculturallaw/2022/04/pork-production-regulations-fake-meat-and-tax-proposals-on-the-road-to-nowhere.html

Farm Economic Issues and Implications

https://lawprofessors.typepad.com/agriculturallaw/2022/04/farm-economic-issues-and-implications.html

Proposed Estate Tax Rules Would Protect Against Decrease in Estate Tax Exemption

https://lawprofessors.typepad.com/agriculturallaw/2022/04/proposed-estate-tax-rules-would-protect-against-decrease-in-estate-tax-exemption.html

Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

https://lawprofessors.typepad.com/agriculturallaw/2022/05/summer-2022-farm-income-taxestate-and-business-planning-conferences.html

Ag Law (and Medicaid Planning) Court Developments of Interest

https://lawprofessors.typepad.com/agriculturallaw/2022/05/ag-law-and-medicaid-planning-court-developments-of-interest.html

Joint Tenancy and Income Tax Basis At Death

https://lawprofessors.typepad.com/agriculturallaw/2022/05/joint-tenancy-and-income-tax-basis-at-death.html

More Ag Law Court Developments

https://lawprofessors.typepad.com/agriculturallaw/2022/06/more-ag-law-court-developments.html

Farm/Ranch Tax, Estate and Business Planning Conference August 1-2 – Durango, Colorado (and Online)

https://lawprofessors.typepad.com/agriculturallaw/2022/07/farmranch-tax-estate-and-business-planning-conference-august-1-2-durango-colorado-and-online.html

IRS Modifies Portability Election Rule

https://lawprofessors.typepad.com/agriculturallaw/2022/07/irs-modifies-portability-election-rule.html

Income Tax

“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 10 and 9

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-10-and-9.html

“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 8 and 7

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-8-and-7.html

“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 2 and 1

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-2-and-1.html

The “Almost Top Ten” (Part 4) – Tax Developments

https://lawprofessors.typepad.com/agriculturallaw/2022/01/the-almost-top-ten-part-4-tax-developments.html

The “Almost Top 10” of 2021 (Part 7) [Medicaid Recovery and Tax Deadlines]

https://lawprofessors.typepad.com/agriculturallaw/2022/02/the-almost-top-10-of-2021-part-7-medicaid-recovery-and-tax-deadlines.html

Purchase and Sale Allocations Involving CRP Contracts

https://lawprofessors.typepad.com/agriculturallaw/2022/02/purchase-and-sale-allocations-involving-crp-contracts.html

Ag Law and Tax Potpourri

https://lawprofessors.typepad.com/agriculturallaw/2022/02/ag-law-and-tax-potpourri.html

What’s the Character of the Gain From the Sale of Farm or Ranch Land?

https://lawprofessors.typepad.com/agriculturallaw/2022/02/whats-the-character-of-the-gain-from-the-sale-of-farm-or-ranch-land.html

Proper Tax Reporting of Breeding Fees for Farmers

https://lawprofessors.typepad.com/agriculturallaw/2022/02/proper-tax-reporting-of-breeding-fees-for-farmers.html

Nebraska Revises Inheritance Tax; and Substantiating Expenses

https://lawprofessors.typepad.com/agriculturallaw/2022/02/recent-developments-in-ag-law-and-tax.html

Tax Consequences When Farmland is Partitioned and Sold

https://lawprofessors.typepad.com/agriculturallaw/2022/02/tax-consequences-when-farmland-is-partitioned-and-sold.html

Expense Method Depreciation and Leasing- A Potential Trap

https://lawprofessors.typepad.com/agriculturallaw/2022/02/expense-method-depreciation-and-leasing-a-potential-trap.html

Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

https://lawprofessors.typepad.com/agriculturallaw/2022/03/summer-2022-farm-income-taxestate-and-business-planning-conferences.html

income Tax Deferral of Crop Insurance Proceeds

https://lawprofessors.typepad.com/agriculturallaw/2022/03/income-tax-deferral-of-crop-insurance-proceeds.html

What if Tax Rates Rise?

https://lawprofessors.typepad.com/agriculturallaw/2022/03/what-if-tax-rates-rise.html

Registration Open for Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

https://lawprofessors.typepad.com/agriculturallaw/2022/03/registration-open-for-summer-2022-farm-income-taxestate-and-business-planning-conferences.html

Captive Insurance – Part One

https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-one.html

Captive Insurance – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-two.html

Captive Insurance – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2022/04/captive-insurance-part-three.html

Pork Production Regulations; Fake Meat; and Tax Proposals on the Road to Nowhere

https://lawprofessors.typepad.com/agriculturallaw/2022/04/pork-production-regulations-fake-meat-and-tax-proposals-on-the-road-to-nowhere.html

Farm Economic Issues and Implications

https://lawprofessors.typepad.com/agriculturallaw/2022/04/farm-economic-issues-and-implications.html

IRS Audit Issue – S Corporation Reasonable Compensation

https://lawprofessors.typepad.com/agriculturallaw/2022/04/irs-audit-issue-s-corporation-reasonable-compensation.html

Missed Tax Deadline & Equitable Tolling

https://lawprofessors.typepad.com/agriculturallaw/2022/04/missed-tax-deadline-equitable-tolling.html

Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

https://lawprofessors.typepad.com/agriculturallaw/2022/05/summer-2022-farm-income-taxestate-and-business-planning-conferences.html

Joint Tenancy and Income Tax Basis At Death

https://lawprofessors.typepad.com/agriculturallaw/2022/05/joint-tenancy-and-income-tax-basis-at-death.html

Tax Court Caselaw Update

https://lawprofessors.typepad.com/agriculturallaw/2022/05/tax-court-caselaw-update.html

Deducting Soil and Water Conservation Expenses

https://lawprofessors.typepad.com/agriculturallaw/2022/05/deducting-soil-and-water-conservation-expenses.html

Correcting Depreciation Errors (Including Bonus Elections and Computations)

https://lawprofessors.typepad.com/agriculturallaw/2022/05/correcting-depreciation-errors-including-bonus-elections-and-computations.html

When Can Business Deductions First Be Claimed?

https://lawprofessors.typepad.com/agriculturallaw/2022/05/when-can-business-deductions-first-be-claimed.html

Recent Court Decisions Involving Taxes and Real Estate

https://lawprofessors.typepad.com/agriculturallaw/2022/05/recent-court-decisions-involving-taxes-and-real-estate.html

Wisconsin Seminar and…ERP (not Wyatt) and ELRP

https://lawprofessors.typepad.com/agriculturallaw/2022/06/wisconsin-seminar-anderp-not-wyatt-and-elrp.html

Tax Issues with Customer Loyalty Reward Programs

https://lawprofessors.typepad.com/agriculturallaw/2022/06/tax-issues-with-customer-loyalty-reward-programs.html

S Corporation Dissolution – Part 1

https://lawprofessors.typepad.com/agriculturallaw/2022/06/s-corporation-dissolution-part-1.html

S Corporation Dissolution – Part Two; Divisive Reorganization Alternative

https://lawprofessors.typepad.com/agriculturallaw/2022/06/s-corporation-dissolution-part-two-divisive-reorganization-alternative.html

Farm/Ranch Tax, Estate and Business Planning Conference August 1-2 – Durango, Colorado (and Online)

https://lawprofessors.typepad.com/agriculturallaw/2022/07/farmranch-tax-estate-and-business-planning-conference-august-1-2-durango-colorado-and-online.html

What is the Character of Land Sale Gain?

https://lawprofessors.typepad.com/agriculturallaw/2022/07/what-is-the-character-of-land-sale-gain.html

Deductible Start-Up Costs and Web-Based Businesses

https://lawprofessors.typepad.com/agriculturallaw/2022/07/deductible-start-up-costs-and-web-based-businesses.html

Using Farm Income Averaging to Deal with Economic Uncertainty and Resulting Income Fluctuations

https://lawprofessors.typepad.com/agriculturallaw/2022/07/using-farm-income-averaging-to-deal-with-economic-uncertainty-and-resulting-income-fluctuations.html

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

Insurance

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

Real Property

“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 4 and 3

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-4-and-3.html

Ag Law and Tax Potpourri

https://lawprofessors.typepad.com/agriculturallaw/2022/02/ag-law-and-tax-potpourri.html

What to Consider Before Buying Farmland

https://lawprofessors.typepad.com/agriculturallaw/2022/02/what-to-consider-before-buying-farmland.html

Elements of a Hunting Use Agreement

https://lawprofessors.typepad.com/agriculturallaw/2022/02/elements-of-a-hunting-use-agreement.html

Animal Ag Facilities and the Constitution

https://lawprofessors.typepad.com/agriculturallaw/2022/03/animal-ag-facilities-and-the-constitution.html

Recent Court Decisions Involving Taxes and Real Estate

https://lawprofessors.typepad.com/agriculturallaw/2022/05/recent-court-decisions-involving-taxes-and-real-estate.html

Recent Court Cases of Importance to Agricultural Producers and Rural Landowners

https://lawprofessors.typepad.com/agriculturallaw/2022/06/recent-court-cases-of-importance-to-agricultural-producers-and-rural-landowners.html

More Ag Law Court Developments

https://lawprofessors.typepad.com/agriculturallaw/2022/06/more-ag-law-court-developments.html

Ag Law-Related Updates: Dog Food Scam; Oil and Gas Issues

https://lawprofessors.typepad.com/agriculturallaw/2022/06/ag-law-related-updates-dog-food-scam-oil-and-gas-issues.html

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

Regulatory Law

The “Almost Top 10” of 2021 (Part 5)

https://lawprofessors.typepad.com/agriculturallaw/2022/01/the-almost-top-10-of-2021-part-5.html

The “Almost Top 10” of 2021 (Part 6)

https://lawprofessors.typepad.com/agriculturallaw/2022/02/the-almost-top-10-of-2021-part-6.html

Ag Law and Tax Potpourri

https://lawprofessors.typepad.com/agriculturallaw/2022/02/ag-law-and-tax-potpourri.html

Animal Ag Facilities and the Constitution

https://lawprofessors.typepad.com/agriculturallaw/2022/03/animal-ag-facilities-and-the-constitution.html

Pork Production Regulations; Fake Meat; and Tax Proposals on the Road to Nowhere

https://lawprofessors.typepad.com/agriculturallaw/2022/04/pork-production-regulations-fake-meat-and-tax-proposals-on-the-road-to-nowhere.html

Farm Economic Issues and Implications

https://lawprofessors.typepad.com/agriculturallaw/2022/04/farm-economic-issues-and-implications.html

Ag Law (and Medicaid Planning) Court Developments of Interest

https://lawprofessors.typepad.com/agriculturallaw/2022/05/ag-law-and-medicaid-planning-court-developments-of-interest.html

Wisconsin Seminar and…ERP (not Wyatt) and ELRP

https://lawprofessors.typepad.com/agriculturallaw/2022/06/wisconsin-seminar-anderp-not-wyatt-and-elrp.html

More Ag Law Court Developments

https://lawprofessors.typepad.com/agriculturallaw/2022/06/more-ag-law-court-developments.html

Ag Law-Related Updates: Dog Food Scam; Oil and Gas Issues

https://lawprofessors.typepad.com/agriculturallaw/2022/06/ag-law-related-updates-dog-food-scam-oil-and-gas-issues.html

Constitutional Limit on Government Agency Power – The “Major Questions” Doctrine

https://lawprofessors.typepad.com/agriculturallaw/2022/07/constitutional-limit-on-government-agency-power-the-major-questions-doctrine.html

The Complexities of Crop Insurance

https://lawprofessors.typepad.com/agriculturallaw/2022/07/the-complexities-of-crop-insurance.html

Secured Transactions

“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 6 and 5

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-6-and-5.html

Water Law

“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 4 and 3

https://lawprofessors.typepad.com/agriculturallaw/2022/01/top-ten-agricultural-law-and-tax-developments-of-2021-numbers-4-and-3.html

Durango Conference and Recent Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/07/durango-conference-and-recent-developments-in-the-courts.html

September 5, 2022 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Friday, September 2, 2022

Declaring Inflation Reduced and Being Forgiving – Recent Developments in Tax and Law

Overview

A lot has happened in the legal and tax world over the last couple of weeks. I fear that much of it is not good for many people or the country and is contrary to the principles of a democratic republic (if that is what we still have).   Agriculture is in the crosshairs of much of it over the long-term.  That last point is something I have been talking about for over 20 years – tax and energy policies that shift the problems of the urban areas of the coasts to the rural areas by using the space of those less populated and agricultural-heavy rural parts of the country and shifting the incidence of tax policy to those same areas disproportionately. 

Recent enacted legislation, an executive order and associated tax and legal issues - it’s all the topic of today’s post.

“Inflation Reduction Act”

I hesitate to call this Act by its name – the “Inflation Reduction Act” (Act).  If ever there has been a deceptively misnamed piece of legislation, this is it.  An Act with $750 billion of fake money to will not reduce inflation.  Words have no meaning.  I suppose that we are supposed to believe that the following provisions of the bill will reduce inflation:

  • $3 billion for the U.S. Postal Service to buy new electric mail trucks;
  • $3 billion for the EPA to oversee block grants for “environmental justice;”
  • $40 billion total to the EPA which includes $30 billion for “disadvantaged communities” (keep in mind that the total annual budget of the EPA is about $10 billion);
  • $750 million to the Interior Department for new hires;
  • $10 million to the USDA to be spent on “equity commissions” to “combat” racism;
  • $25 million to the Government Accountability Office to determine, “whether the economic, social and environmental impacts of the funds described in this paragraph are equitable;”
  • Via a budget gimmick to keep the amount outside of the Act’s price tag are amounts to the Energy Department for existing “green” energy loan programs and a new energy loan-guarantee program.

The above is only a listing of a few of the provisions in the several-hundred-page bill.  These are the ones that particularly stuck out to me.  Reduce inflation?  Not a chance.

Then there are numerous “renewable” energy-related tax credits that won’t reduce inflation either.  Indeed, it’s likely that the credits will increase inflation.  When education credits came on the scene several years ago, tuition increased, and university endowments began to bloat.  As of September 1, 2022, Harvard’s endowment is $53.2 billion, and Yale’s is $42.3 billion. 

Right after the Act was signed into law with an enhanced tax credit for electric vehicles, major U.S. automakers announced that the price of electric vehicles would be going up by almost exactly the amount of the new tax credit.  In an interesting twist, while CA has announced a ban on gas car sales after 2034, the state is already telling its citizens not to charge existing electric vehicles during a heat wave to avoid blackouts.   

Tax Provisions

The following provisions are some of the major tax provisions of the Act:

  • 15% minimum tax on corporate-book income (rather than taxable income) applicable to C corporations with annual adjusted financial statement income averaging over $1 billion in revenue over prior three years. The tax is on the higher of regular taxable income and financial statement income. In other words, it is a 15% tax on the excess of a corporation’s adjusted financial statement income over its corporate AMT foreign tax credit of I.R.C. §59(l)for the year. It’s also applicable to U.S. corporations with foreign parents if average 3-year revenue earned in the U.S. is $100 million or more.  R.C. §56A (new) defines "adjusted financial statement income” as a corporation's net income (or loss) as set forth in the taxpayer's applicable financial statement, as defined in Sec. 451(b)(3). Adjusted financial statement income is reduced by the amount of tax depreciation deductions the taxpayer claims when calculating taxable income for the year.

The provision also disallows the use of NOLs accruing before 2020.  That will have negative implications for companies that had virus-related shutdowns but had invested in 2018-2019 in equipment that created a loss. 

Note:  The provision is especially harmful to U.S. manufacturing firms, and will put pressure on U.S. manufacturers to cut labor costs or scale back U.S. operations.  The non-partisan Joint Committee on Taxation (JCT), in an initial report, determined that 49.7% of the tax would hit U.S. manufacturers that account for 11% of the economy.  By comparison, wholesale trade, information companies and retail trade get off relatively easy by comparison.  JCT says the biggest hit will be felt in IN, KY, MI, NC and WI.  In effect, the provision “claws back” part of the $280 billion subsidy for computer chip manufacturers (another bill that was signed into law before this one). While those numbers can be adjusted a bit due to the final provision exempting accelerated depreciation, the hit to the manufacturing sector will be big.  The Tax Foundation estimates that the provision will eliminate approximately 20,000 jobs.  The provision does not apply to a foreign company unless the company has significant U.S. operations. 

  • A nondeductible 1% excise tax on stock buybacks after 2022 of a “covered corporation.” That’s a domestic corporation with stock traded on an “established securities market.”  Under this provision, the value of stock that is treated as repurchased during the tax year for purposes of computing the excise tax is reduced by the value of any new issuances of stock by the corporation during the same tax year (“netting rule”).  The term “repurchase” is defined by reference to I.R.C. §317(b).  It includes any acquisition of stock by the corporation in exchange for cash or property other than the corporation’s own stock or stock rights, as well as any other “economically similar” transaction as Treasury determines.  Excluded from excise tax are repurchases if: 1) it’s part of a tax-free reorganization under I.R.C. 368(a) and no gain or loss is recognized by the shareholder as a result of the reorganization; 2) the repurchased stock (or an amount of stock equal to the value of the repurchased stock) is contributed to an ESOP or employer-sponsored retirement plan; 3) the total amount of repurchases within the tax year are $1 million or less; or 4) the repurchase is treated as  “dividend” for tax purposes. 

Note:  The Tax Foundation estimates that the provision will eliminate 7,000 jobs.

  • The excess business loss rule is extended for two more years – through 2028. That means that there will be a cap on net operating losses of $250,000 (single) and $500,000 (mfj).  Those amounts are adjusted for inflation.
  • Extension of the I.R.C. §25C energy-efficient property credit (personal credit for specified nonbusiness energy property expenditures) for property placed in service before 2033. It is renamed as the “energy-efficient home improvement credit” and is a 30% credit for qualified energy efficient improvements installed during the year, and the amount of residential energy property expenditures paid or incurred during the year. The credit is increased for amounts spent for home energy audit up to $150 and is limited to $1,200 per taxpayer/year.  The lifetime $500 limit on the credit is repealed.  Eligible property can be residential property that is not the taxpayer’s primary residence.  Other limits are $600 annually for residential energy property expenses such as windows and skylights; $250 for any exterior door ($500 total); and a $2,000 annual limit for amounts paid or incurred for specified heat pumps, heat pump water heaters and biomass stoves and boilers.
  • Extension of residential energy efficient property credit of I.R.C. §25D for property installed in years before 2035 - 26% through 2021; 30% if prop. placed in service from 2022-2032; 26% (2033); 22% (2034). Property that qualifies is solar electric; solar hot water; fuel cell; small wind energy; geothermal heat pumps; biomass fuel property; and qualified battery storage technology expenses.  The credit is renamed as the “residential clean energy credit.”
  • New energy efficient home credit under I.R.C. §45L for contractors that applies for qualified new energy efficient homes acquired before 2033. The credit varies from $500 to $5,000.
  • New clean-vehicle credit of I.R.C. §30D that is generally effective for vehicles places in service after 2022 and before 2033. This credit is the retitled qualified plug-in electric drive motor vehicle credit.  The maximum credit is $7,500 (2023-2032).  It eliminates the cap on the number of vehicles eligible (i.e., no per manufacturer credit).  For the credit to be available, a vehicle’s final assembly must be in the U.S. (effective upon enactment).  In addition, battery-making materials must be sourced in Canada or Mexico for full credit to apply.  However, presently most EV battery-making minerals (lithium, cobalt and nickel) are sourced from China.  No credit is available if a taxpayer’s lesser of MAGI for year of purchase or preceding year exceeds $300,000 (mfj or ss); $25,000 (hh) or $150,000 (others).  There is no phaseout.  No credit is available if a vehicle’s MSRP exceeds $55,000 ($80,000 for pickups, vans or SUVs).  Starting in 2024 the $7,500 credit only applies to vehicles made with parts and components sourced from U.S., Canada or Mexico, or countries with which U.S. has a free trade agreement.  The credit is split in half - $3,750 applies to vehicles having at least 40% of critical battery materials sourced from a free trade country or from material recycled in U.S.  This goes to 80% by 2026.  The remaining $3,750 applies to vehicles with 50% of battery component manufactured or assembled in North America.  The 50% goes to 100% after 2028

Note:  Sourcing requirements are dependent on the supply chain.  This will make it tough for manufacturers to comply with the requirement that almost all of the materials come from North America.  Manufacturers must prove that their vehicles comply with the sourcing requirements.  The Treasury is to develop guidelines by the end of 2022 to show how compliance will be measured.  Currently there are 72 EV models can be purchased in the U.S.  70% of them will become immediately ineligible.  100% will not qualify for the full credit

Note:  The credit is allowed once per vehicle, and taxpayers claiming the credit must include the vehicle identification number (VIN) on the return.    To verify whether a motor vehicle meets the final assembly requirement, dealers and consumers can follow a two-step process:  1) check to see if the vehicle appears on the Department of Energy's list of model year 2022 and 2023 electric vehicles that may qualify. But there may be vehicles on the Department of Energy list that do not meet the final assembly requirement in all circumstances; and 2) enter the vehicle's 17-character vehicle identification number (VIN) into the National Highway Traffic Safety Administration’s VIN Decoder tool and view the "Plant Information" field at the bottom of the results page.  A transition rule allows a buyer who entered into a written, binding contracts to buy a qualifying vehicle before August 16, 2022, but does not take possession of the vehicle until after that date, to avoid the final assembly requirement. 

  • Used clean vehicle credit of I.R.C. 25E. The credit is the lesser of $4,000 or 30 percent of the vehicle’s cost.  For the credit to apply, a vehicle’s sales price can’t exceed $25,000.

Comment on the vehicle tax credits:  The big issue is that the tax credits will increase inflation.  Electric vehicle manufacturers have already increased the price of their vehicles by the cost of the credit.  In essence, the government is paying a purchaser of an electric vehicle back their own money to buy an electric vehicle from a manufacturer that has raised the cost of the vehicle by the same amount.  Thus, the credit is a subsidy for the manufacturer.  It does not result in any real savings for the purchaser.

  • An extension of the credit for sales and use of biodiesel and renewable diesel used in a trade or business or sold at retails and placed in fuel tank of buyer through 2024. A refund of excise tax can be claimed for the use of biodiesel fuel mixtures for a purpose other than for which they were sold or for resale on or before 2025 and alternative fuel as that used in a motor vehicle or motorboat or as aviation fuel for a purpose other than for which they were sold or for resale on or before 2025.
  • The credit for energy produced from renewable resources under I.R.C. §45 is 1.5 cents per kilowatt hour. But, if prevailing wage paid to employees the credit is increased 10% by sourcing steel, iron or manufactured-product components from U.S. manufacturers or by locating in an “energy community” – area with significant employment in fossil fuel industry or which have experienced the closure of a coal mine or coal-fired plant.

Comment:  Apparently, the Administration is concerned that “green” energy jobs don’t actually generate “good-paying jobs” as the Administration likes to say.

  • With the research and development credit, for tax years beginning after December 31, 2022, an eligible small business can reduce payroll taxes by up to $500,000 annually (up from the prior limit of $250,000). An eligible small business is one having less than $5 million in revenue and revenue for less than five years.  The credit can now apply to the Medicare portion of taxes (previously, it only applied to the Social Security portion of payroll tax).  Unused amounts can be carried forward.  The credit can’t exceed tax imposed for any calendar quarter  The IRS will need to revise Forms 941, 6755 and 8794. 
  • Modifications to the I.R.C. §179D energy efficiency deduction. Previously, only commercial building owners or the designers of energy efficient systems in government-owned buildings qualified. Under the Act, designers of lighting, HVAC or building envelope systems in structures owned by other tax-exempt entities such as nonprofits, religious groups and educational institutions can also qualify.  The Act lowers the threshold for energy improvements needed to qualify. Under prior law, a building had to show a 50 percent energy savings over a benchmark structure.  The Act changes 50 percent to 25 percent and the base deduction begins at $.50/sq. foot for the 25 percent energy savings threshold, and increases by 2 cents per square foot for each percentage point above that, up to $1 per square foot.  Contractors can earn a “bonus” deduction by paying prevailing wages and meeting apprenticeship requirements on these jobs. This bonus deduction starts at $2.50 per square foot at the 25 percent threshold, and increases 10 cents per square foot beyond that, up to a $5 maximum.

The JCT has determined that the Act will reduce real GDP by $68.5 billion and cut labor income by $17.1 billion.  The JCT also says that average tax rates will increase for nearly every income category in 2023.  Specifically, the JCT says that taxes will rise by $16.7 billion in 2023 on those earning less than $200,000 annually and those making between $200,000 and $500,000 will pay $14.1 billion more.  The JCT also concluded that 61 percent of taxpayers making between $40,000 and $50,000 will see a tax increase, and that 91 percent of taxpayers making between $100,000 and $200,000 will see higher taxes. 

Ag Program Spending

The Act contains a great deal of spending on ag conservation-related programs.  Here are the primary provisions:

  • EQIP - $8.45 billion additional funding over Fiscal Years 2023-2026. Prioritizes funding for reduction of methane emissions from cattle (e.g., cattle passing gas) and nutrient management activities (e.g., diets to reduce bloating in cows).
  • CSP - $3.25 billion additional funding over same time frame.
  • Ag Conservation Easement Program (ACEP) - $1.4 billion over same time frame for easements or interests in land that will reduce, capture, avoid or sequester carbon dioxide, or methane oxide emissions with land eligible for the program. ACEP incorporates the Wetlands Reserve Program, the Grasslands Reserve Program and the Farm and Ranch Lands Protection Program. 
  • Regional Conservation Partnership Program - $4.95 billion over same timeframe for cover cropping, nutrient management, and watershed improvement.
  • $4 billion for drought relief that prioritizes the CO basin.
  • The U.S. Forest Service gets $1.8 billion for hazardous fuels reduction projects on USFS land.
  • $14 billion for rural development and lending projects.
  • $3.1 billion to USDA to provide payments to distressed borrowers.
  • $2.2 billion to USDA for farmers, ranchers and forest landowners that have been discriminated against in USDA lending programs (i.e., reparations).
  • $5 billion to USDA for National Forest System to fund forest reforestation and wildfire prevention.

Increased Obamacare taxpayer subsidies:

The Act provides $64 billion of taxpayer funds to extend expanded Obamacare subsidies.  Remember, President Obama said that the ACA would save the average family about $2,500 annually in health care costs.  Well, not so much.  In 2014, the first year of exchanges, the average premium was $353.  By 2019 it was $558.  Over the same time, the average subsidy increased from $383 to $524.  The subsidy is determined by taking cost of silver plan less the amount that Obamacare requires to be spent on an exchange plan (“expected contribution).  ARPA (2021) increased subsidies by $36 billion through 2022 (in other words the additional taxpayer subsidies cause the amount a person in an exchange pays to go down). 

Note:  From 2018-2020 the Trump Administration deregulated Obamacare exchanges and prices on the exchanges stabilized.  When the Biden Administration repealed the changes, prices began rising again.  The anticipated premium increase for 2023 is 10%. 

Under the Act, if a person is over 400 percent of the poverty line, the person can still qualify for the premium tax credit of I.R.C. §36B (through 2025) if the sliver plan would cost more than 8.5 percent of household income.  There is a lower applicable percentage of household income for all income levels.

Medicare provisions:

The Act allows Medicare to negotiate drug prices.  While that sounds good, the economics may not work out as anticipated.  In reality, while less expensive drugs may result, there will likely be fewer “miracle drugs” in the future due to a decreased incentive for pharmaceutical research and development.  The Act permits the Secretary of the Department of Health and Human Services to negotiate maximum “fair” prices for 50 drugs in Medicare Part D and 50 drugs in Medicare Part B on a phased schedule.  Drugs that are less than nine years (for small-molecule drugs) or 13 years (for biological products) from their U.S. Food and Drug Administration (FDA)-approval or licensure date would be held exempt from negotiation. To enforce the negotiation, the bill imposes a monetary penalty of 10 times the difference between the offered price and the “maximum fair price” for all applicable units.

The Act imposes rebates on drug manufacturers that increase prices faster than inflation to limit annual increases in drug prices for Medicare enrollees.  The rebate is based on the Average Sales Price beginning in 2023 relative to Q3 2021.  The rebates only apply to drugs in Medicare Part B without competition and Part D drugs that cost more than $100 a year.

The Act also makes a number of changes to the structure of Medicare Part D by eliminating the five percent cost-sharing in the catastrophic phase of Part D in 2024.  The Act also caps out-of-pocket costs at $2,000 in 2025, and limits premium growth to 6 percent each year for the next five years.

The Act also caps out-of-pocket costs for Medicare Part D purposes at $35 per month. 

Note:  On a related note, involving Medicaid, the Administration announced in mid-August its intent to stop paying for COVID vaccines and treatments.  Vaccines and treatments have been provided at no-charge to patients, but providers have been compensated with taxpayer dollars.  With any renewed mandates, private insurance companies will have to cover the costs of their insureds.  This will drive up premiums and create larger co-pays.  It’s practically a certainty that the Centers for Medicare and Medicaid Services will require all contracted insurance companies to provide vaccines, boosters and anti-viral drugs.  Fees will increase to do so, and the additional cost will be borne by taxpayers.  It is reasonable to anticipate that rural hospitals will be disaffected the most.    

More IRS funding and statute of limitation changes:

The IRS gets approximately $80 billion in IRS funding (over next 10 years) to hire 87,000 agents.  The IRS currently has 78,000 agents, but 50,000 are set to retire in the next few years.  $46 billion is to be dedicated to enforcement and is anticipated to increase the number of audits by $1.2 million annually.  $25 billion is earmarked for IRS operations, $5 billion for business systems modernization. IRS taxpayer services, which many tax practitioners would say as the most in need of funding, gets the short end of the stick with $4 billion.

Note:  Nikole Flax, most recently the deputy administrator in charge of the IRS’ Large Business & International Division, has been tabbed to lead the creation of a new centralized office for implementation of all IRS-related provisions in the Act.  Ms. Flax, it should be noted, worked alongside Lois Lerner during the Obama-era scandal involving the IRS targeting of conservative and tea party affiliated groups as a political arm of the Obama Administration.  She is one of several senior IRS officials during that scandal that had their emails conveniently “get lost.” 

Along with the increased IRS funding and additional taxpayer audits that will be forthcoming, the “PPP Bank Fraud and Harmonization Act of 2022” (HR7352) establishes a 10-year statute of limitations for criminal charges and civil enforcement against a borrower who engages in fraud with respect to a PPP loan.  Likewise, the “COVID-19 EIDL Fraud Statute of Limitations Act of 2022” (HR 7334) gives prosecutors 10 years to file fraud charges (from date offense was committed) connected to loan applications from the COVID-19-related EIDL program, including EIDL advances and targeted EIDL advances.

Student Loan Forgiveness

“People think that the President of the United States has the power for debt forgiveness. He does not.”  He can postpone, he can delay, but he does not have that power.  That has to be an act of Congress.”

U.S. House Speaker, Nancy Pelosi.  July 2021

On August 24, 2022, the Administration via the U.S. Department of Education announced that it would be canceling up to $20,000 in student debt for Pell Grant recipients and up to $10,000 in student loans for those making under $125,000 a year ($250,000 mfj).  The cost is projected to be more than $500 billion and effectively amounts to a debt transfer from borrowers to taxpayers.  Simultaneously with that announcement was the Administration’s announcement that the student-loan repayment moratorium would be extended through the end of 2022 (no interest has accrued since March of 2020 at a cost to the federal government of $5 billion per month).  The Committee for a Responsible Federal Budget estimates that since the moratorium on student-loan repayments began, those with medical degrees have received the equivalent of $48,500 in debt cancellation due to no interest payments required to be made, and those with law degrees have received the equivalent of $29,500. 

Note:  The Penn Wharton Budget Model estimates that about 70 percent of the borrowers qualifying for the $10,000 debt cancellation are in the top 60 percent of income earners because a disproportionate amount of debt is held by couples close to the applicable income threshold.  In addition, more than half of student-loan debt is held by households with graduate degrees.  Junlei Chen, “Forgiving Student Loans: Budgetary Costs and Distributional Impact,” Penn Wharton Budget Model, University of Pennsylvania, August 23, 2022, https://budgetmodel.wharton.upenn.edu/issues/2022/8/23/forgiving-student-loans. 

Constitutionality

The primary question, of course, is whether such executive action is constitutional or whether it is merely an unconstitutional exploitation of emergency powers. 

Administration’s position.  The administration is using a post-9/11 law, the Higher Education Relief Opportunities for Students (Heroes Act of 2003, to justify the action.  That Act gave the education Secretary authority to waive rules related to student financial aid programs in times of war or national emergency.  Because COVID was declared a national emergency in 2020, the Administration claims the forgiveness allows borrowers to not be placed in a worse position financially as a result of the emergency (“affected by an emergency”).    This is despite a memo from the Office of the General Counsel at the U.S Department of Education (DOE) detailing that the DOE has no authority to forgive or cancel student loans across the board.  Reed Rubinstein, “Memorandum to Betsy Devos, Secretary of Education, Re: Student Loan Principal Balance Cancellation, Compromise, Discharge, and Forgiveness Authority,” January 12, 2021, https://static.politico.com/d6/ce/3edf6a3946afa98eb13c210afd7d/ogcmemohealoans.pdf.  The current Administration now views the prior memo as “substantively incorrect” with no detailed legal analysis as to why.  Letter from Lisa Brown to Miguel A. Cardona, U.S. Department of Education, August 23, 2022, https://www2.ed.gov/policy/gen/leg/foia/secretarys-legal​-authority-for-debt-cancellation.pdf.   Specifically, the 2022 memo does not explain how forgiveness complies with the requirement of the HEROES Act that such forgiveness is necessary to protect borrowers that had the ability to repay their loans.    

SCOTUS opinion.  Article I of the Constitution states that, “All legislative powers herein granted shall be vested in…Congress…”.  This principle is commonly referred to as the “nondelegation doctrine.”  The Congress cannot delegate its legislative powers.  But, over the last 90 years, the Congress has delegated a great deal of legislative authority to administrative agencies with only an occasional pushback from the Supreme Court (SCOTUS).  See, e.g., Food and Drug Administration v. Brown and Williamson Tobacco, Co., 529 U.S. 120 (2000).  However, in West Virginia. v. Environmental Protection Agency, 142 S. Ct. 2587 (2022), the U.S. Supreme Court (SCOTUS) curtailed the EPAs authority to regulate greenhouse gas emissions at coal-fired plants without express Congressional authority under the “major questions” doctrine (a variation of the nondelegation doctrine).  Now, clear congressional authority is needed before executive branch agencies take “major” actions that will have large economic and political significance.  The Court’s analysis was not so much focused on whether a statute violates the nondelegation doctrine, but what is the specific scope of authority given to the Executive Branch via the administrative agency at issue.  

Note:  The SCOTUS opinion in West Virginia v. EPA is viewed as a big “win” for agriculture on issues such as wetlands and the WOTUS rule and other conflicts with federal government regulatory agencies (EPA; U.S. Army Corps of Engineers; U.S. Forest Service, USDA/NRCS, etc.). 

Application.  Does COVID-19 constitute a national emergency as of Aug. ’22 that justifies the action?  It’s really a big stretch to suggest that the U.S. of late Aug. ’22 is anything like the U.S. of post-9/11 or even the summer or fall of 2020.  Even if the virus is an emergency, is that enough post-West Virginia v. Environmental Protection Agency?  Now, merely fitting the text of the statute is just the first step.  It must also clear the “major question” hurdle.  The Administration’s legal counsel memo ignores the major questions doctrine which requires that the purpose of the governing statute must be taken into account along with the text in determining whether the Executive Branch (which includes administrative agencies) has the authority to bypass Congress on a particular issue.  In any event, basing it justification for the Executive Action on the HEROES Act is not likely to be bought by the SCOTUS.  The HEROES Act was written in and for the 9/11 context.  Using the HEROES Act for COVID is likely not a strong argument at the SCOTUS in the post-West Virginia v. EPA era. 

Note:     The Administration has already lost cases where it claimed to have emergency power – vaccine mandate imposed by the Occupational Safety and Health Administration; eviction moratorium imposed by the Centers for Disease Control and Prevention etc. 

The standing issue.  A lawsuit can only be brought if the party bringing the suit can prove that they have been harmed. This is known as “standing.”  In Lujan v. Defenders of Wildlife, 504 U.S. 555 (1992), the SCOTUS said that standing requires that the plaintiff suffer an injury in fact, that there be a causal connection between the injury and the complained-of conduct, and that that injury be “particularized.”   So, who has standing to challenge the student loan forgiveness hand-out?  Certainly, the U.S. House of Representatives and private banks or loan servicers that have a direct or indirect relationship to the loans have standing.  Remember, the U.S. House challenged Obamacare and was found to have standing to do so.  Also, any person with outstanding student loans with income slightly over the appliable threshold that lives in an area with a high cost of living would have standing.  $125,000 in New York City doesn’t go nearly as far as $125,000 does in Tightwad, MO. 

So, what happens if a lawsuit is filed?  First, the Administration must finalize the policy.  Then a court could issue an injunction forcing the Administration to either extend the repayment pause or have borrowers start repaying loans that may later be canceled.  This all may cause the Administration to more fully explain how COVID fits the purpose of the HEROES Act to better detail the legislative history of the statute to justify the current plan.  The Administration could also try to fit it under Section 432 of the Higher Education Act of 1965, where the Secretary of Education has the power to waive debts in non-emergency situations.  But, that still doesn’t meet the Administration’s conduct would pass muster under the rationale of recent SCOTUS opinions.  

Tax issues.  While debt forgiveness is normally taxable, this would not taxable on account of Sec. 9675 of the American Rescue Plan Act of 2021.  That provision modified I.R.C. §108(f) to exclude from gross income through 2025.  That’s amounts to another $34 billion in lost tax revenue.  While not taxable at the federal level, it would be in five states that don’t couple with the Internal Revenue Code (AR, MN, MS, NC and WI). 

Conclusion

The Act and the Executive action on student loan debt, are troubling on many fronts.  They essentially do nothing to address the core economic problems the nation faces at the present time.  Continuing to fund economically inefficient methods of energy production as a means of forcing the economy to shift to politically popular (currently) technologies will hit middle-to-lower income people the hardest.  It will also hit energy intensive industries (such as agriculture) particularly hard.  The massive increase in funding for the EPA also could be potentially very troublesome for agriculture.  Likewise, the increased funding of environmental ag programs will certainly come with strings.  Farmers that take the “carrot” will be more susceptible of being hit with the USDA’s regulatory “stick.”   Also, the tremendously enhanced funding of the IRS to be overseen by a political partisan with connections to a prior IRS scandal raises concerns as to how that additional resulting power will be used.

The Act and student loan forgiveness (if it withstands a court challenge) will pour more fuel on the current inflationary fire.  Stimulating inflation during an economic recession when inflation is already at a 40-year high is particularly a poor policy choice, as is increasing taxes on practically every income group.  The fourth quarter of 2022 promises to be very difficult for many people.  This Act does nothing to help that. 

While Midwest grain farmers look to have a high-income year for 2022, 2023 doesn’t look to be as good.   Also, while crop prices are good for Midwest grain farmers, livestock ranchers in the Plains and West don’t have it so good this year.   Drought and buyer-power being exerted by the major packers has caused economic pain for cattle ranchers.

For Midwest grain farmers, the traditional tax planning techniques in high-income years of deferring income and accelerating deductions don’t apply in the current economy.  Deferring taxes into next year with higher costs and taxes is not a good idea.  Likewise accelerating deductions related to input prices to the current year may not be a good idea either.  While it is not popular “medicine” for a farmer to take, 2022 may be a “good” year to pay tax.  It’s also a good year to pay down (or off) debt.  Interest rates will be going up further in the Federal Reserve’s attempt to reduce inflation.  Congress shows no interest in curbing spending or reducing tax rates.  This all means that “cash is king” and little-to-no debt will provide the greatest flexibility to adjust to future economic uncertainties.  Also, getting debt reduced or eliminated could provide an opportunity to buy land for cash as values fall in the future (which they will). 

One other problem that the Act does nothing to address are supply chain issues.  Getting needed parts and supplies on a timely basis is an issue for many farmers.  Throw in the possibility of a rail worker strike about the time harvest starts to heat up, and there is a toxic brew that could hit agriculture hard.  In addition, more IRS audits headed up by a person with an historic political bias spells trouble.   

Inflation Reduction?  About the only thing in the Act that will reduce inflation are the tax increases.  If those slow the economy enough, inflation might be reduced.  Indeed, that might be the quiet expectation of some.

And then there’s the continued funding of a war in Ukraine and its inflationary effect domestically.  And, what about China?  Will 2023 (or late 2022) involve a war on one side of world and another one on the other side?  What are the implications for U.S. agriculture if that happens? 

Much to think about and plan accordingly for.  2019 seems so far in the past….

September 2, 2022 in Income Tax | Permalink | Comments (0)

Tuesday, August 23, 2022

USDA’s Emergency Relief Program (Update on Gain from Equipment Sales)

Overview

The Extending Government Funding and Delivering Emergency Assistance Act (P.L. 117-43) (Act) was signed into law on September 30, 2021.  The Act includes $10 billion for farmers impacted by weather disasters during calendar years 2020 and 2021.  $750 million is to be directed to provide assistance to livestock producers for losses incurred due to drought or wildfires in calendar year 2021 (the Emergency Livestock Relief Program – (ELRP)).

USDA continues to release information about the ERP.  One bit of information came out last week and it involved the question of whether income from the sale of farm equipment counted as farm income for purposes of the ERP.  It was not the answer we were hoping for.

The ERP and the definition of farm income (among other aspects of the program) – it’s the topic of today’s post.

In General

Livestock provisions.  To receive a Phase 1 payment, a livestock producer must have suffered grazing losses in a county rated by the U.S. Drought Monitor as having a severe drought) for eight consecutive weeks or at least extreme drought during the 2021 calendar year been approved for the 2021 Livestock Forage Relief Program (LFP). Those who would have normally grazed on federal but couldn’t be due to drought are eligible for a Phase 1 payment if they were approved for a 2021 LFP.  Various FSA Forms will need to be submitted. 

ELRP Payment Calculation – Phase One

Payments are based on livestock inventories and drought-affected forage acreage or restricted animal units and grazing days due to wildfire reported on Form 2021 CCC-853.  A payment will equal the producer’s gross 2021 LFP calculated payment multiplied by 75% and will be subject to the $125,000 payment limitation. 

Crop insurance (or NAP) requirement.  In late 2021, the USDA provided some guidance to producers impacted by various weather-related events.  The former Wildfire and Hurricane Indemnity Program (WHIP+) was retooled and renamed as the ERP.  ERP will have two payments – two phases.  Phase 1 is presently underway, and Phase 2 may not happen until 2023.  ERP payments may be made to a producer with a crop eligible for crop insurance or noninsurance crop disaster assistance (NAP) that is subject to a qualifying disaster (which is defined broadly) and received a payment.  Droughts (a type of qualifying disaster) are rated in accordance with the U.S. Drought Monitor, where the qualifying counties can be found.

To reiterate, an ERP payment will not be made to any producer that didn’t receive a crop insurance or NAP payment in 2020 or 2021.  Because of this requirement, crop insurance premiums that an ERP recipient has paid will be reimbursed by recalculating the ERP payment based on the ERP payment rate of 85 percent and then backing out the crop insurance payment based on coverage level.     

In addition, the ERP requires that the producer receiving a payment obtain either NAP or crop insurance for the next crop years.  Also, a producer that received prevented planting payments can qualify for Phase 1 payments based on elected coverage. 

Note:  ERP payments are for damages occurring in 2020 and 2021 – so they are not deferable. 

Computation of Payment and Limits

Once a producer submits their data to the FSA, an ERP application will be sent out for the producer to verify.  Applications started going out to producers in late May.  An ERP payment replaces the producer’s elected crop insurance coverage.  It’s based on a percentage with the total indemnity paid using the recalculated ERP percentage with any crop insurance or NAP payment subtracted. 

Payment limit.  The ERP payment limit is $125,000 for specialty crops.  For all other crops, its $125,000 combined.  However, for an applicant with “average farm adjusted gross income” (average AGI) based on the immediate three prior years but skipping the first year back that is comprised of more than 75 percent from farming activities, the normally applicable $900,000 AGI limit is dropped, and the payment limit goes to $900,000 for specialty crops and $250,000 for all other crops.  There is separate payment limit for each of 2020 and 2021. 

Note:  ERP payments for “historically underserved producers” will be enhanced by an extra 15 percent.  Such producers include beginning farmers, veterans and “socially disadvantaged producers.”

Definition of farm income.  Farm income for ERP purposes includes net Schedule F income; pass-through income from farming activities; wages from a farming entity; IC-DISC income from an entity that materially participates in farming (has a majority of gross receipts from farming).  Also counting as farm income for ERP purposes is income from packing, storing, processing, transporting and shedding of farm products.  Gains from the sale of farm equipment count if farm income is at least two-thirds of overall AGI (excluding gains from equipment sales and the sale of farm inputs). 

Note:  Under the Tax Cuts and Jobs Act (TCJA) for tax years after 2017, a “trade-in” of farm equipment is treated as a sale that is reported on Form 4797.  As a result, many farmers may have little income reported on Schedule F for a tax year that they incurred a large gain from “trading in” farm equipment that is reported on Form 4797.  This could cause such a farmer to not receive an additional ERP payment. 

It is likely that the same rule will apply to income from custom farming or harvesting services as well as income derived from providing seed to farmers (offset by allocated expenses). 

Average AGI is “comparable to the net income from farming and related operations.”  FSA Handbook, 6-PL. This requires a determination of what qualifies as gross farm income from which net income from farming operations, or average AGI, can be derived.

Note:  Loss years can be used in the AGI calculation.  If negative farm AGI is greater than total negative AGI by at least 75 percent, the farmer qualifies.  In addition, the three-year computation is simply the applicant’s net income from farming compared with all of the applicant’s other sources of income as reported on the tax return. 

If an enhanced payment limit is sought on behalf of an entity, “all members of the entity must complete Form FSA-510 and provide the required certification according to their direct attributions of 7 C.F.R. 1400.105.”  This requires that the each of entity owners, up to four levels, also satisfy the more than 75 percent test.  For this purpose, wages the entity pays counts as farm income.  If one or more owners fails to satisfy the test, the extra payment limit is reduced by the disqualified owner(s) share(s), but there is no reduction to the original payment limit.  Wages and dividends paid by a materially participating farm corporation qualifies as farm income.  For this purpose, a materially participating farm corporation is one with more than 50 percent of gross receipts from farming.  If an entity has not been in existence for the three years for which average AGI is computed, AGI from processor entities can be used. 

Example:  Able Farm Co. is eligible for $300,000 of ERP related to crop insurance proceeds on account of drought damage to the farm’s 2021 wheat crop.  All of Able Farm Co.’s income is derived from farming.  Able Farm Co. is eligible for an original payment limit of $125,000 of ERP payments and could receive another $175,000 of the $250,000 additional payment limit depending on the facts.  Assume that Able Farm Co. has four shareholders.  Two of the shareholders that own 50 percent of Able Farm Co. actively farm and receive wages and dividends from the company.  They also rent land to the corporation.  Assume that their farm income meets the 75 percent of overall AGI test.  Conversely, the other two shareholders that also own 50 percent of Able Farm Co. are not involved in Able Farm Co.’s farming operations, have off-farm wages, and don’t satisfy the 75 percent test.  Their failure to meet the 75 percent test individually means that the additional $250,000 payment will be reduced by 50 percent ($250,000 - $125,000 = $125,000.  Thus, Able Farm Co. will receive $250,000 of ERP payments ($125,000 + $125,000). 

Example:  SunGro Cherry Farm qualifies for $950,000 of ERP because of weather damage to its cherry crop.  SunGro is owned equally by four owners, two of which meet the 75 percent test.  SunGro is eligible for the original payment limit of $125,000 and an additional payment limit of $775,000 ($900,000 - $125,000).  But, the additional payment limit must be reduced by the 50 percent ownership of the shareholders that don’t meet the 75 percent test.  Thus, the total ERP payment that SunGro Cherry Farm will receive is $125,000 + (.5 x $775,000) = $512,500.    

Certification.  To get the enhanced payment limit, a CPA or attorney must prepare a letter to be submitted with Form FSA-510 certifying that the applicant’s AGI is over the 75 percent threshold.  The FSA has a Form letter than can be used for this that is contained in its Handbook.  The FSA 6-PL, Apr. 29, 2022, Para. 489 discusses the 75 percent test and pages 8-73 through 8-74 is where the sample letter is located.  The “certification” may allow married farmers to eliminate the off-farm income of a spouse and make it possible to meet the 75 percent test if it otherwise would not be met.

Note:  An attorney may sign Form FSA-510, but a CPA should write the letter that FSA provides in the FSA Handbook, 6-P, pages 8-73 and 8-74. 

 Conclusion

The ERP is complicated and has a non-accounting measure of AGI in certain situations.  In addition, the exclusion of gains from equipment “trades” does not take into account the TCJA change on the matter.  Close monitoring of the USDA/FSA website and amendments to the 6-PL is a must.

August 23, 2022 in Income Tax, Regulatory Law | Permalink | Comments (0)

Sunday, August 21, 2022

LLCs and Self-Employment Tax – Part Two

Overview

In Part One of this two-part series, the discussion focused on how the determination is made of whether an LLC member is a limited partner.  There it was noted that the IRS/Treasury hadn’t yet finalized a regulation that was initially proposed in 1997 to address the issue.  The characterization of an LLC member’s interest is determinative of whether the member has self-employment tax liability on amounts distributed to the member (other than guaranteed payments). 

In today’s Part Two of this series, I dig into the self-employment tax issue further.  Proper structuring of the entity matters as does the drafting of the LLC operating agreement and the conduct of the members. 

Self-employment tax implications of LLCs – when is a member really a limited partner?   That’s the topic of today’s post.

LLCs and Self-Employment Tax

Net earnings from self-employment includes the distributive share of income or loss from a trade or business carried on by a partnership.  I.R.C. §1402(a).  Thus, the default rule is that all partnership income is included, unless it is specifically excepted.  Whether LLC members can avoid self-employment tax on their income from the entity depends on their member characterization.  Are they general partners or limited partners?  Under I.R.C. §1402(a)(13), a limited partner does not have self-employment income except for any guaranteed payments paid for services rendered to the LLC.  So, what is a limited partner?  The test of whether an interest in an entity treated as a partnership for tax purposes is treated as a limited interest or a general interest, for the purpose of applying the self-employment tax is stated at Prop. Reg. §1.1402(a)-2(h), issued in 1997. 

Note:  Immediately after the Proposed Regulation was issued, the Congress passed a statute prohibiting the IRS from finalizing the Regulation within one year.  Nothing further has been forthcoming.  Although still in Proposed Regulation form, this regulation remains the best available authority. 

The Proposed Regulation establishes a three-part general rule, with two exceptions, that may permit limited partner treatment under certain conditions.  A third exception to limited partner treatment applies in the context of professional service businesses (e.g., law, accounting, health, engineering, etc.).  Under the general rule, a member is not treated as a limited partner if:  (1) the member has personal liability for the debts or claims against the LLC by reason of being a member; (2) the member has authority under the state’s LLC statute to enter into contracts on behalf of the LLC; or (3) the member participated in the LLC’s trade or business for more than 500 hours during the LLC’s tax year.  Prop. Treas. Reg. §1.1402(a)-2(h)(2). 

An exception applies only if the interest-holder owns a single class of interest (regardless of whether there are multiple classes outstanding) and failure of the 500-hour test is the sole reason for treatment of the interest as a general interest.  In addition, the interest held must meet certain threshold requirements:

  • There must be at least one member holding the same class of interest who meets all three of the requirements under the general rule, without application of any exceptions;
  • The share of that class of interest held by those members must be “substantial” (with respect to the class of interest at issue and not with respect to the entity as a whole), based on the facts and circumstances (a safe harbor of 20 percent, in aggregate, is provided at Treas. Reg. 1.1402(a)-2(h)(6)(v)); and
  • The interests held by those members must be “continuing” (an undefined term).

Another exception to the general rule applies only if the member owns at least two classes of interests and the same threshold requirements are satisfied.  This exception may permit a member to treat the distributive share attributable to at least one class as a limited interest if the three requirements of the general rule are met with respect to any class that the member holds.  In that case the distributive share attributable to that interest is not subject to self-employment tax.  But, the distributive share attributable to any interest held by a member that does not meet the three requirements of the general rule is subject to self-employment tax.  This all means that a portion of a member’s total distributive share may be subject to self-employment tax, and some may not be.

Note:  Under the general rule, it is likely that the entire distributive share of all members of a member-managed LLC will be subject to self-employment tax because state law likely gives all members the authority to contract.  Likewise, LLP statutes likely give management rights which means that the second requirement of the general rule cannot be satisfied.  As a result, neither exception to the general rule can be met because both exceptions require at least one member to satisfy all three requirements of the general rule. 

The Castigliola case.  In Castigliola, et al. v. Comr, T.C. Memo. 2017-62, a group of lawyers structured their law practice as member-managed Professional LLC (PLLC).  On the advice of a CPA, they tied each of their guaranteed payments to what reasonable compensation would be for a comparable attorney in the locale with similar experience.  They paid self-employment tax on those amounts.  However, the Schedule K-1 showed allocable income exceeding the member’s guaranteed payment.  Self-employment tax was not paid on the excess amounts.  The IRS disagreed with that characterization, asserting self-employment tax on all amounts allocated. 

The Tax Court agreed with the IRS.  Based on the Uniform Limited Partnership Act of 1916, the Revised Limited Partnership Act of 1976 and Mississippi law (the state in which the PLLC operated), the court determined that a limited partner is defined by limited liability and the inability to control the business.  The members couldn’t satisfy the second test.  Because of the member-managed structure, each member had management power of the PLLC business.  In addition, because there was no written operating agreement, the court had no other evidence of a limitation on a member’s management authority.  In addition, the evidence showed that the members actually did participate in management by determining their respective distributive shares, borrowing money, making employment-related decisions, supervising non-partner attorneys of the firm and signing checks.  The court also noted that to be a limited partnership, there must be at least one general partner and a limited partner, but the facts revealed that all members conducted themselves as general partners with identical rights and responsibilities.  In addition, before becoming a PLLC, the law firm was a general partnership.  After the change to the PLLC status, their management structure didn’t change. 

The court did not mention the proposed regulations, but even if they had been taken into account the outcome of the case would have been the same.  Member-managed LLCs are subject to self-employment tax because all members have management authority.  It’s that simple.  In addition, as noted below, there is an exception in the proposed regulations that would have come into play. 

Note:  As a side-note, the IRS had claimed that the attorney trust funds were taxable to the PLLC.  The court, however, disagreed because the lawyers were not entitled to the funds.

Structuring to Minimize Self-Employment Tax – The Manager-Managed LLC

There is an entity structure that can minimize self-employment tax.  An LLC can be structured as a manager-managed LLC with two membership classes.  With that approach, the income of a member holding a manager’s interest is subject to self-employment tax, but if non-managers that participate less than 500 hours in the LLC’s business hold at least 20 percent of the LLC interests, then any non-manager interests held by members that participate more than 500 hours in the LLC’s business are not subject to self-employment tax on the pass-through income attributable to their LLC interest. Prop. Treas. Reg. §1.1402(a)-2(h)(4).  They do, however, have self-employment tax on any guaranteed payments.

Service businesses.  The manager-managed structure does not achieve self-employment tax savings for personal service businesses, such as the one involved in Castigliola.  Prop. Treas. Reg. §1.1402(a)-2(h)(5) provides an exception for service partners in a service partnership.  Such partners cannot be a limited partner under Prop Treas. Reg. §1.1402(a)-2(h)(4) (or (2) or (3), for that matter).  Thus, for a professional services partnership (such as the law firm at issue in the case), structuring as a manager-managed LLC would have no beneficial impact on self-employment tax liability.     

Note:  If a member of a services partnership (e.g. LLC) is merely an investor that is not involved in the operations of the LLC as a business and is separately paid for services rendered, any distributive share is not subject to self-employment tax.  See, e.g., Hardy v. Comr., T.C. Memo. 2017-16.  But, if the distributive share is received from fees from the LLC’s business, the distributive share is subject to self-employment tax.  See, e.g., Renkemeyer, Campbell & Weaver, LLP, 136 T.C 137 (2011). 

Farming and ranching operations.  For LLCs that are not a “service partnership,” such as a farming operation, it is possible to structure the business as a manager-managed LLC with a member holding both manager and non-manager interests that can be bifurcated.  The result is that a member holding both manager and non-manager interests is not subject to self-employment tax on the non-manager interest but is subject to self-employment tax on the pass-through income and a guaranteed payment attributable to the manager interest.

Example.  Here's what it might look like for a farming operation:

A married couple operates a farming business as an LLC.  The wife works full-time off the farm and does not participate in the farming operation.  But she holds a 49 percent non-manager ownership interest in the LLC.  The husband conducts the farming operation full-time and also holds a 49 percent non-manager interest.  But, the husband, as the farmer, also holds a 2 percent manager interest.  The husband receives a guaranteed payment for his manager interest that equates to reasonable compensation for his services (labor and management) provided to the LLC.  The result is that the LLC’s income will be shared pro-rata according to the ownership percentages with the income attributable to the non-manager interests (98 percent) not subject to self-employment tax.  The two percent manager interest is subject to self-employment tax along with the guaranteed payment that the husband receives.  This produces a much better self-employment tax result than if the farming operation were structured as a member-managed LLC. 

Additional benefit.  There is another potential benefit of utilizing the manager-managed LLC structure.  Until the net investment income tax of I.R.C. §1411 is repealed, it applies to a taxpayer’s passive sources of income when adjusted gross income exceeds $250,000 on a joint return ($200,000 for a single return).  While a non-manager’s interest in a manager-managed LLC is typically considered passive with the income from the interest potentially subject to the 3.8 percent surtax, a spouse can take into account the material participation of a spouse who is the manager.  I.R.C. §469(h)(5).  Thus, the material participation of the manager-spouse converts the income attributable to the non-manager interest of the other spouse from passive to active income that will not be subject to the 3.8 percent surtax.

Note:  Returning to the example above, the result would be that self-employment tax is significantly reduced (it’s limited to 15.3 percent of the husband’s reasonable compensation (in the form of a guaranteed payment) and his two percent manager interest) and the net investment income surtax is avoided on the wife’s income.

Conclusion

The manager-managed LLC provides a better result than the result produced by the member-managed LLC for LLCs that are not service partnerships.  For those that are, such as the PLLC in Castigliola, the S corporation is the business form to use to achieve a better tax result.  For an S corporation, “reasonable” compensation will need to be paid subject to S.E. tax, but the balance drawn from the entity can be received self-employment tax free.  But, for farming operations with land rental income, the manager-managed LLC can provide a better overall tax result than the use of an S corporation because of the ability to eliminate the net investment income tax.    

Of course, the self-employment tax and the net investment income tax are only two pieces of the puzzle to an overall business plan.  Other non-tax considerations may carry more weight in a particular situation.  But for some, this strategy can be quite beneficial.

The decision in Castigliola would appear to further bolster the manager-managed approach – an individual that is a “mere member” appears to now have an even stronger argument for limited partner treatment.  In addition, the court didn’t impose penalties on the PLLC because of reliance on an experienced professional for their filing position. 

Proper structuring of the LLC and careful drafting of the operating agreement is important

August 21, 2022 in Business Planning, Income Tax | Permalink | Comments (0)

Saturday, August 20, 2022

Ag Law Summit

Overview

Last September Washburn Law School conducted it’s first “Ag Law Summit” and held it at Mahoney State Park in Nebraska. This year the Summit returns in collaboration with Creighton University School of Law.  The Summit will be held at Creighton University on September 30, and will also be broadcast live online.

The Summit will cover various topics of relevance to agricultural producers and the tax and legal counsel that represent them. 

The 2022 Ag Law Summit – it’s the topic of today’s post.

Agenda

Survey of ag law and tax.  I will start off the day with a session surveying the major recent ag law and tax developments.  This one-hour session will update attendees on the big issues facing ag clients and provide insight concerning the issues that look to be on the horizon in the legal and tax world. 

Tax issues upon death of a farmer.  After my session, Prof. Ed Morse of Creighton Law School will examine the tax issues that arise when a farm business owner dies.  Income tax basis and the impact of various entity structures will be the focus of this session along with the issues that arise upon transitioning ownership to the next generation and various tax elections.

Farm succession planning drafting language.  After a morning break Dan Waters, and estate planning attorney in Omaha, NE, will take us up to lunch with a technical session on the drafting of critical documents for farm and ranch entities.  What should be included in the operative agreements?  What is the proper wording?  What provisions should be included and what should be avoided?  This session picks up on Prof. Morse’s presentation and adds in the drafting elements that are key to a successful business succession plan for the farm/ranch operation.

Fences and boundaries.  After a provided lunch, Colten Venteicher who practices in Gothenburg, NE, will address the issues of fence line issues when ag land changes hands.  This is an issue that seems to come up over and over again in agriculture.  The problems are numerous and varied.  This session provides a survey of applicable law and rules and practical advice for helping clients resolve existing disputes and avoid future ones. 

The current farm economy and future projections.  Following the afternoon break, a presentation on the current economy and economic situation facing ag producers, ag businesses and consumers will be presented by Darrell Holaday.  Darrell is an economist and his firm, Advanced Market Concepts, provides marketing plans for ag producers.   What are the economic projections for the balance of 2022 and into 2023 that bear on tax and estate planning for farmers and ranchers?  This will be a key session, especially with the enactment of legislation that will add fuel to the current inflationary fire – unless of course, the tax increases in the legislation slow the economy enough to offset the additional spending. 

Ethics.  I return to close out the day with a session of ethics focused on asset protection planning.  There’s a right way and a wrong way to do asset protection planning.  This session guides the practitioner through the proper approach to asset protection planning, client identification, and the pitfalls if the “stop signs” are missed.

Reception

For those attending in person, a reception will follow in the Harper Center Ballroom on the Creighton Campus. 

Conclusion

If your tax or legal practice involves ag clients, the Ag Law Summit is for you.  As noted, you can also attend online if you can’t be there in person.  If you are a student currently in law school or thinking about it, or are a student in accounting, you will find this seminar beneficial. 

I hope to see you in Omaha on September 30 or see that you are with us online.

You can learn more about the Summit and get registered at the following link:  https://www.washburnlaw.edu/employers/cle/aglawsummit.html

August 20, 2022 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Thursday, August 18, 2022

LLCs and Self-Employment Tax – Part One

Overview

Farmers and ranchers often desire to avoid the payment of self-employment tax.  Indeed, avoidance of self-employment tax sometimes seems to be a prerequisite for being engaged in a farming or ranching activity.  One way to structure the business to minimize self-employment tax might be as a limited liability company (LLC). For an LLC member that truly has a limited partnership interest, self-employment tax savings can be achieved.  But truly being a limited partner is the key.  The definition of a “limited partner” as an LLC member for self-employment tax purposes has been unclear and confusing for some time. 

In today’s Part One of a two-part series, I take a look at how the courts (and IRS) view a limited partner in the context of an LLC.  The analysis derives from the passive loss rules and from a proposed regulation issued in the late 1990s. 

LLCs and self-employment tax – Part One of a two-part series – it’s the topic of today’s post.

Background

In its 2017-2018 Priority Guidance Plan, the IRS stated that it planned to finalize regulations under I.R.C. §469(h)(2) – the passive loss rules.  That provision creates a per se rule of non-material participation for limited partner interests in a limited partnership unless the Treasury specifies differently in regulations.  Those regulations were initially issued in temporary form and became proposed regulations in 2012. 2012-9, IRB 434

Passive Loss Rules 

The passive loss rules of I.R.C. §469 can have a substantial impact on farmers and ranchers as well as investors in farm and ranch land.  The effect of the rules is that deductions from passive trade or business activities, to the extent the deductions exceed income from all passive activities, may not be deducted against other income.

The proper characterization of the loss depends on whether the taxpayer is materially participating in the business.  I.R.C. §469(h).  But, I.R.C. §469(h)(2) creates a per-se rule of non-material participation for limited partner interests in a limited partnership unless the Treasury specifies differently in regulations.  The statute was written before practically all state LLC statutes were enacted and before the advent of LLPs, and the Treasury has never issued regulations to detail how the statue is to apply to these new types of business forms.

Material participation tests.  The key question presented in the cases was whether the taxpayer satisfied the material participation test.  As mentioned above, a passive activity is a trade or business in which the taxpayer does not materially participate.  Material participation is defined as “regular, continuous, and substantial involvement in the business operation.” I.R.C. §469(h)(1).   The regulations provide seven tests for material participation in an activity. Temp. Treas. Reg. §1.469-5T(a)(1)-(7). 

The tests are exclusive and provide that an individual generally will be treated as materially participating in an activity during a year if:

  • The individual participates more than 500 hours during the tax year;
  • The individual’s participation in the activity for the tax year constitutes substantially all of the participation in the activity of all individuals (including individuals who are not owners of interests in the activity) for the tax year;
  • The individual participates in the activity for more than 100 hours during the tax year, and the individual’s participation in the activity for the tax year is not less than the participation in the activity of anyone else (including non-owners) for the tax year;
  • The activity is a significant participation activity and the individual’s aggregate participation in all significant participation activities during the tax year exceeds 500 hours;
  • The individual materially participated in the activity for any five taxable years during the ten taxable years that immediately precede the tax year at issue;
  • The activity is a personal service activity, and the individual materially participated in the activity for any three taxable years preceding the tax year at issue; or
  • Based on all the facts and circumstances, the individual participates in the activity on a regular, continuous, and substantial basis during the tax year

As noted, if the taxpayer is a limited partner of a limited partnership, the taxpayer is presumed to not materially participate in the partnership’s activity, “except as provided in the regulations.”  I.R.C. §469(h)(2). The regulations provide an exception to the general presumption of non-material participation of limited partners in a limited partnership if the taxpayer meets any of one of three specific material participation tests that are included in the seven-part test for material participation under Treas. Reg. 1.469-5T(a)(1)-(7).  Those three tests are:

  • The 500-hour test;
  • The five out of 10-year test; and
  • The test involving material participation in a personal service activity for any three years preceding the tax year at issue.

Thus, the standard of “material participation” for a limited partner is different than that for a general partner, and the question presented in the cases was whether the more rigorous standard for material participation for limited partners in a limited partnership under I.R.C. §469(h)(2) applied to the taxpayers (who held membership interests in LLCs and LLPs) with the result that their interests were per-se presumptively passive.

Relevant Court Opinions

Courts have concluded, in certain instances, that the holder of a limited liability company (LLC) interest is not treated as holding an interest in a limited partnership as a limited partner for purposes of applying the I.R.C. §469 material participation tests. 

For example, in Garnett v. Comr. 132 T.C. 368 (2009), the taxpayers were a married couple that owned interests in various LLCs and partnerships organized under Iowa law, as well as certain tenancy-in-common interests that were all engaged in agricultural production activities.  They held direct ownership interests in one LLP and LLC and indirect interests in several other LLPs and LLCs.  Their ownership interests were denoted as “limited partners” in the LLP and “limited liability company members” in the LLC – which did have a designated manager.  The interests that they held in the two tenancies-in-common were also treated similarly.  For tax years 2000-2002, the taxpayers ran up large losses and treated them as ordinary losses.

The IRS claimed that an LLC member is always treated as a limited partner because of limited liability under state law and because the Code specifies that a limited partnership interest never counts as an interest with respect to which the taxpayer materially participates. I.R.C. §469(h)(2).   Thus, the IRS characterized the losses as passive, basing their position on the regulation which, for purposes of I.R.C. §469, treats a partnership interest as a limited partnership interest if “the liability of the holder of such interest for obligations of the partnership is limited, under the law of the State in which the partnership is organized, to a determinable fixed amount.” Temp. Treas. Reg. §1.469-5T(e)(3)(i)(B).   On the other hand, the taxpayers argued that the Code and regulations did not apply to them because none of the entities that they had interests in were limited partnerships and because, in any event, they were general partners rather than limited partners.  The taxpayers also pointed out that the Federal District Court for Oregon had previously ruled that, under the Oregon LLC Act, I.R.C. §469(h)(2) did not apply to LLC members.  Gregg v. United States, 186 F. Supp. 2d 1123 (D. Ore. 2000).

The Tax Court first noted that I.R.C. §469(h)(2) was enacted at a time when LLCs and LLPs were either new or nonexistent business entities and, as such, did not refer to those entities.  The court also pointed out that the regulations did not refer explicitly to LLPs or LLCs.  Accordingly, the court rejected the IRS argument that a limitation on liability automatically qualifies an interest as a limited partnership interest under I.R.C. §469(h)(2).  On the contrary, the court held that the correct analysis involved a determination of whether an interest in a limited partnership (or LLC) is, based on the particular facts, actually a limited partnership interest.  That makes a state’s LLC statute particularly important.  Does it grant LLC and LLP members power and authority beyond those that limited partners have traditionally been allowed.?  The IRS conceded that the statute at issue in the case did just that.  Other distinguishing features were also present.  The court noted that limited partnerships have two classes of partners, one of which runs the business (general partners) and the other one which typically involves passive investors (limited partners).  The limited partners enjoy limited liability, but that protection can be lost by participating in the business.  By comparison, an LLP is essentially a general partnership in which the general partners have limited liability even if they participate in management.  Likewise, the court noted that LLC members can participate in management and retain limited liability.

Note:  The court made a key point that it was not invalidating the temporary regulations but was simply declining to write a regulation for the Treasury that applied to interests in LLCs and LLPs.  Importantly, the court refused to give deference to the Treasury’s litigating position in absence of such a regulation.

In Thompson v. United States, 87 Fed. Cl. 728 (2009), the taxpayer held a 99 percent interest in an LLC that was formed under the Texas LLC statute.  He held the other one percent interest indirectly through an S corporation.  The LLC’s articles of organization designated the taxpayer as the manager.  The LLC did not make an election to be taxed as a corporation and, thus, defaulted to partnership tax status.  The LLC, which provided charter air services, incurred losses in 2002 and 2003 of $1,225,869 and $939,878 respectively which flowed through to the taxpayer.  The IRS disallowed most of the losses on the basis that the taxpayer did not meet the more rigorous test for material participation that applied to limited partners in limited partnerships.  The taxpayer paid the additional tax of $863,124 and filed a refund claim for the same amount.  The IRS denied the refund claim and the taxpayer sued for the refund, plus interest.  Both the taxpayer and the IRS moved for summary judgment.

The IRS stood by its position that the more rigorous material participation test applied because the taxpayer enjoyed limited liability by owning the interests in the LLC just like he would if he held limited partnership interests.  Thus, according to the IRS, the taxpayer’s interest was identical to a limited partnership interest and the regulation applied triggering the passive loss rules.

The court disagreed with the IRS.  While both parties agreed that the statute and regulations trigger application of the passive loss rules to limited partnership interests, the taxpayer pointed out that he didn’t hold an interest in a limited partnership.  The court noted that the language of Treas. Reg. § 1.469-5T(e)(3) explicitly required that the taxpayer hold an interest in an entity that is a partnership under state law, and that the Treasury had never developed a regulation to apply to LLCs.  It was clear that the taxpayer’s entity was organized under Texas law as an LLC.  In addition, the court pointed out that the taxpayer was a manager of the LLC, and IRS had even conceded at trial that the taxpayer would be deemed to be a general partner if the LLC were a general partnership.  The court noted that the position of the IRS that an LLC taxed as a partnership triggers application of the Treas. Reg. §1.469-5T(e)(3)(ii) was “entirely self-serving and inconsistent.”  The court also stated that it was irrelevant whether the taxpayer was a manager of the LLC or not – by virtue of the LLC statute, the taxpayer could participate in the business and not lose the feature of limited liability.

Hegarty v. Comr., T.C. Sum. Op. 2009-153, is a Tax Court summary opinion where the Tax Court reiterated its position that the reliance by IRS on I.R.C. § 469(h)(2) to treat members of LLCs as automatically limited partners for passive loss purposes is misplaced.  Instead, the general tests for material participation apply and the petitioners in the case (a married couple) were determined to have materially participated in their charter fishing activity for the tax year at issue.  They participated more than 100 hours and their participation was not less than the participation of any other individual during the tax year.

In Newell v. Comr., T.C. Memo. 2010-23, the taxpayer’s primary business activity was managing various real estate investments.  He spent more than one-half of his time and more than 750 hours annually in real property trade or business activities.  During the years at issue, the taxpayer was the sole owner of an S corporation that manufactured and installed carpentry items, and his participation is that business qualified as a significant participation activity for purposes of the passive loss rules.  He also owned 33 percent of the member interests in a California-law LLC engaged in the business of owning and operating a golf course, restaurant and country club.  The LLC was treated taxwise as a partnership.  It was undisputed that the taxpayer was the managing member of the LLC.  For tax years 2001-2003, IRS claimed that the losses the taxpayer incurred from both the S corporation and the LLC were passive losses that were not currently deductible.  While the parties agreed that the taxpayer’s participation in both the S corporation and the LLC satisfied the significant participation activity test under the passive loss rules, IRS again asserted its position that I.R.C. §469(h)(2) required that the taxpayer’s interest in the LLC be treated as a passive limited partnership interest, even though IRS conceded that the taxpayer held the managing member interest in the LLC.

The Tax Court rejected the IRS’ argument, noting again that the general partner exception of Treas. Reg. §1.469-5T(e)(3)(ii) was not confined to the situation where a limited partner also holds a general partnership interest.  Under the exception, an individual who is a general partner is not restricted from claiming that the individual materially participated in the partnership.  Here, it was compelling that the taxpayer held the managing member interest in the LLC.  As such, the taxpayer’s losses were properly deducted.

In Chambers v. Comr., T.C. Sum. Op. 2012-91, the taxpayer owned rental property with his spouse that produced a loss. The taxpayer was also a managing member of an LLC that owned rental properties.  The LLC also owned rental property, and produced losses with one-third of the losses allocated to the taxpayer.  The taxpayer was also employed by the U.S. Navy.  He deducted his rental losses in full on the basis that he was a real estate professional.  In order to satisfy the “more than 50 percent test,” he combined his hours spent on his personally-owned rental activity with his management activity for the LLC.  The IRS invoked I.R.C. §469(h) to disallow the taxpayer’s LLC managerial hours, but the court disagreed.  The court held that the taxpayer’s LLC interest was not defacto passive.  Thus, his hours spent in LLC managerial activities counted toward his total “real estate” hours.  However, he still failed to meet more than 50 percent test.  In addition, the court noted that the fallback test of active participation allowing $25,000 of rental real estate losses was not available because the taxpayer’s AGI exceeded $150,000 for the year in issue.

Conclusion

Whether a member of an LLC is a limited partner or not boils down to the particular provisions of a state’s LLC statute and whether there are sufficient factors under the state statute that distinguish an LLC from a limited partnership.  That will be the case until IRS issues regulations dealing specifically with LLCs and similar entities.

As noted above, in late 2011, the Treasury Department proposed regulations defining “limited partner” for purposes of the passive loss rules. Notice of Proposed Rulemaking REG-109369-10 (Nov. 28, 2011).  The proposed definition would make it easier for LLC members and some limited partners to satisfy the material participation requirements for passive loss purposes, consistent with the court opinions that IRS has recently lost on the issue.  Specifically, the proposed regulations require that two conditions have to be satisfied for an individual to be classified as a limited partner under I.R.C. §469(h)(2): (1) the entity must be classified as a partnership for federal income tax purposes; and (2) the holder of the interest must not have management rights at any time during the entity’s tax year under local law and the entity’s governing agreement.  Thus, LLC members of member-managed LLCs would be able to use all seven of the material participation tests, as would limited partners that have at least some rights to participate in managerial control or management of a partnership.

In Part Two, I will dig deeper into the self-employment tax issue.

August 18, 2022 in Business Planning, Income Tax | Permalink | Comments (0)

Friday, August 12, 2022

Federal Farm Programs: Organizational Structure Matters – Part Three

Overview

In this final part of a three-part series on federal farm programs, the focus is on the “active personal management,” issues associated with maintaining good records, and planning implications for farms seeking to maximize payments.

Organizing the farm business with federal farm program payments in mind – it’s the topic of today’s post.

The Active Personal Management Requirement 

Three-part test for "active engagement."  Under 7 C.F.R. Part 1400, a person must be “actively engaged” in farming to receive farm program payments.  To satisfy the “actively engaged in farming” test, three conditions must be met. 

  • The individual's or entity's share of profits or losses from the farming operation must be commensurate with the individual's or entity's contribution to the operation. 
  • The individual's or entity's contributions must be “at risk.”
  • An individual must make a significant contribution of land, capital or equipment (the “left-hand” requirement) and active personal labor or active personal management (i.e., the “right-hand” requirement).

For a general partnership, each member is treated separately for purposes of the active engagement test. Thus, each partner with an ownership interest must contribute active personal labor and/or active personal management to the farming operation on a regular basis.  It is also important that the contribution be identifiable and documentable, as well as separate and distinct from the contributions made by any other partner. Any partner that fails to meet the active engagement requirement criteria is not eligible to participate in the federal farm programs. 

Note:  The payment of a guaranteed payment (i.e., “salary”) to a partner for providing active labor or management can bar the recipient partner from qualifying for payments.  A guaranteed payment for services could mean that the partner does not satisfy the requirement of having made a qualified contribution of active labor or management and may disqualify the partner for a payment. 

As noted above, a corporation is treated as a “person” for payment limitation purposes that is eligible for a single payment limit if each member with an ownership interest in the corporation makes a significant contribution of active personal labor or active personal management.  In the context of a corporation, it does not matter if a member is compensated for contributions of active personal labor or management.  But, it is still required that management or labor be performed on regularly, be identified and be documented.  A shareholder’s contribution of labor or management must also be separate and distinct from the contributions of other shareholders or members. In addition, the contribution of all corporate members must be significant and commensurate with contributions to the farming operation.

If any member of the corporation fails to meet the labor or management contribution requirements, any program payment or benefit to the corporation will be reduced by an amount commensurate with the ownership share of that member. An exception applies if (a) at least 50% of the entity’s stock or units is held by members that are “actively engaged in providing labor or management” and (b) the total annual farm program payments received collectively by the stockholders or members of the entity are less than one payment limitation.

Note:  A corporation can pay a salary to owners. 

Some farming operations are placed in trust for estate planning and business succession planning purposes.  For purposes of the farm programs, a revocable trust is treated as the grantor.  An irrevocable trust must satisfy the same requirements as does a decedent’s estate.  In addition, the interest of the beneficiaries of an irrevocable trust that provide active labor or management must be at least half of the trust’s income interest. 

Note:  While a revocable trust need not obtain an employer identification number (EIN), an irrevocable trust must do so.  Additionally, trusts must provide a tax identification number and in some cases this will come up with FSA in the context of a joint revocable trust where both spouses, as income beneficiaries are seeking program benefits.

A decedent’s estate can meet the active engagement test for two program years after the year of the decedent’s death if the estate makes a significant contribution of land, capital equipment (or a combination thereof).  The executor or the heirs collectively must make a significant contribution of active personal labor or active personal management (or a combination thereof) to the farming business.  The estate must also satisfy the profit (or loss) sharing rule and at-risk rule must also be satisfied.  If the estate remains open for more than two program years post-death, the FSA must be satisfied that the estate remains open for reasons other than to receive program payments. 

One spouse’s satisfaction of the active engagement test requirement allows the other spouse to meet the test.  If the non-participating spouse meets the ownership requirement with respect to land capital or equipment.

If a child under age 18 as of June 1 of a program year receives payments, the payment are attributed to the child’s parent (or a person appointed by a court).  A child under age 18 that is farming on their own is not subject to this rule (if certain other requirements are satisfied). 

As for the requirement that a capital contribution be made, the contributed capital must come from a fund or account that is separate and distinct from any other person or entity that has an interest in the farming operation.  The source of the capital can be via either a direct contribution of cash or the funds may be borrowed (carefully).  For contributions that derive from borrowed funds, the funds must not be a result of any loan that is made to or guaranteed by or co-signed by or secured by any other person, legal entity or joint operation that has an interest in the farming operation and the other person (or entity) must not have such an interest. 

Note:  Cross-collateralization clauses are frequently encountered in the ag borrowing context.  John Deere in particular has a rather egregious clause (from a farm borrower’s perspective) as does the Small Business Administration.  Those clauses will likely not be waived.  Similarly, security and guarantee clauses will likely not be waived.  A solution might be to put both the farm operating entity and the farmland into a general partnership (with each partner in an entity that limits liability). 

What is "management“?  Active personal management” is defined as significant contributions of management activities that are performed on a regular, continuous and substantial basis to the farming operation – basically the I.R.C. §1402 test for self-employment tax purposes.  In addition, the management activities must represent at least 25 percent of the total management time that is necessary for the success of the farming operation on an annual basis, or represent at least 500 hours of specific management activities annually.    

Multiple “person” determinations?  The rules also restrict the number of persons that may qualify for payment by making a significant contribution of active personal management.  For this purpose, the limit is one person unless the farming operation is large or complex.  A "large" farming operation is one that has crops on more than 2,500 acres (planted or prevented from being planted).  If the acreage limitation is satisfied, an additional person may qualify upon making a significant contribution of active personal management.  If the farming operation satisfies another test of being “complex,” an additional payment limit may be available.  This all means that, for large and complex, farming operations, a total of three payment limits may be obtained.  The determination of whether a farming operation is "complex" is  made by the State FSA Committee.  

Special rules.  Special rules apply to tenant-operated farms and family-owned operations with multiple owners.  In some situations, a person meeting specified requirements is considered to be actively engaged in farming in any event.  For example, a crop-share or livestock-share landlord who provides capital, equipment or land as well as personal labor, or active personal management meets the test.  But, a cash rent landlord does not meet the test nor does a crop share landlord is if the rent amount is guaranteed.   Also, if one spouse meets the active engagement test, the other spouse is deemed to meet the test.   

Exemption for family operations.  The active personal management test applies to non-family general partnerships and joint operations that seek to qualify more than one farm manager based solely on providing management or a combination of management and labor (another rule).  However, it does not apply to farming operations where all of the partners, stockholders or persons with an ownership interest in the farming operation (or any entity that is a member of the farming operation) are “family members.”  For this purpose, “family member” means a person to whom another member in the farming operation is related as a lineal ancestor, lineal descendant, sibling, spouse or otherwise by marriage.  Legally adopted children and step-children count as “family members.” 

The rule also doesn’t come into play where only one person attempts to qualify under the rule or when combined with a contribution of labor.  The rule also doesn't apply to farming operations that are operated by individuals or entities other than general partnerships or joint ventures. 

Record-Keeping Requirements 

When multiple payments are sought for a farming operation under the active management rule, the operation must maintain contemporaneous records or logs for all persons that make any contribution of management.  Those records must include, at a minimum, the location where the management activity was performed, and the amount of time put into the activity and its duration.  In addition, every legal entity that receives farm program payments must report to the local FSA committee the name and social security number of each person who owns, either directly or indirectly, any interest in the entity.  Also, the entity must inform its members of the payment limitation rules.

The FSA Handbook (5-PL, Amendment 3) specifies that the farming operation must maintain contemporaneous records or logs for all persons that make management contributions. The records must provide: (1) the location (either on-site or remote) where the management activity was performed; (2) the time spent on the activity and the timeframe in which it occurred; and (3) a description of the activity.  FSA Handbook, Paragraph 222A.  It is important that the records be maintained and be timely made available to the FSA for their review upon request.  FSA Handbook, Paragraph 222B.  The FSA provides a Form (CCC-902 MR) to track and maintain all of the necessary information.  Note that these are the present references to the applicable FSA Handbook Paragraphs and Form.  Those paragraph references and Form numbers can change.  FSA modifies its handbook frequently; Forms are modified and numbers often are changed.  Practitioners and their farm clients must be diligent in monitoring the changes.  

Two things happen if the necessary records aren’t maintained – (1) the person’s contribution of active personal management for payment eligibility purposes will be disregarded; and (2) the person’s payment eligibility status will be re-determined for that particular program year. 

Planning Implications

The “substantive change” rule.  In general, any structural change of the farming or ranching business that increases the number of payment limits must be bona fida and substantive and not a “scheme or device.”  See, e.g., Val Farms v. Espy, 29 F.3d 1570 (10th Cir. 1994).  In addition, reliance on the advice of local or state USDA officials concerning the payment limitation rules is at the farmer or rancher's own risk.  But the substantive change rule does not apply to spouses.  Thus, for example, a spouse of a partner that is providing active management to a farm partnership can be added to the partnership and automatically qualify as a partnership member for FSA purposes.  However, a “substantive change occurs when a “family member” is added to a partnership unless the family member also provides management or labor.

Note:  As s farming operation grows and want to add substantially more acres, consideration may need to be given to the creation of an additional entity. One approach might be to put all of the farming entities into a general partnership with the “farmer” as the general partner. 

"Scheme or device."  The USDA is adept at alleging that a farming operation has engaged in a "scheme or device" that have the purpose or effect of evading the payment limitation rules.  But this potential problem can be avoided if multiple payments are not sought, such as by having one manager for each entity engaged in farming.   Of course, this is not a concern if all of the members of a multi-person partnership are family members.  If non-family members are part of the farming operation, perhaps they can farm individually or with other non-family members that can provide labor to the farming business.  That might be a safe approach. 

"Combination" rule.  There is also a “combination” rule that can apply when the farming business is restructured. If the rule applies, it will result in the denial of separate “person” status to “persons” who would otherwise be eligible for a separate limit.  

Entity type based on size.  From an FSA entity planning standpoint, the type of entity structure utilized to maximize payment limits will depend on the size/income of the operation. 

For smaller producers, entity choice for FSA purposes is largely irrelevant.  Given that the limitation is $125,000 and that payments are made either based on price or revenue (according to various formulas), current economic conditions in agriculture indicate that most Midwestern farms would have to farm somewhere between 3,000 and 4,000 acres before the $125,000 payment limit would be reached.  Thus, for smaller producers, the payment limit is not likely to apply and the manner in which the farming business is structured is not a factor. 

For larger operations, the general partnership or joint venture form is likely to be ideal for FSA purposes.  If creditor protection or limited liability is desired, the partnership could be made up of single-member LLCs.  For further tax benefits, the general partnership’s partners could consist of manager-managed LLCs with bifurcated interests.

Conclusion

Farm program payment limitation planning is a complicated mix of regulatory and administrative rules and tax/entity planning.  It’s not an area that a producer should engage in without counsel if maximizing payments in conjunction with an estate/business plan is the goal.  Unfortunately, few practitioners are adept at navigating both the tax planning rules and the FSA regulatory web.  This makes it important that professionals advising farm clients on farm business organization and the associated tax rules work as a team to produce the best result for clients.  

August 12, 2022 in Business Planning, Regulatory Law | Permalink | Comments (0)

Tuesday, August 9, 2022

Federal Farm Programs: Organizational Structure Matters – Part Two

Overview

In Part One of this series earlier this week, I provided background on the basics of federal farm programs and how those benefits can be obtained.  The structure question bears on the amount of payments that can be obtained.  In today’s Part Two I dive into the monetary limits and the adjusted gross income limitation that applies.  That involves a discussion of the attribution rule, the definition of a person and the “separate and distinct” requirement.

Part Two of a Three part series on federal farm programs and the structure of the farm business – today’s post continues the discussion.

Monetary Limit

As previously noted, the Farm Bill established a payment limit of $125,000 per person or legal entity (excluding general partnerships and joint ventures).  This is the general rule.  Peanut growers are allowed an additional $125,000 payment limitation, and the spouse of a farmer is entitled to an additional $125,000 payment limit if the spouse is enrolled at the local Farm Service Agency (FSA) office.  The limit applies to all PLC, ARC, marketing loan gains, and loan deficiency payments. 

Note:  A farmer that files a tax return as married filing jointly can potentially double the payment limit.  Indeed, in a community property state (AZ, CA, ID, LA, NV, NM, TX, WA and WI) each spouse typically reports exactly one-half of the joint income on a separate return. This makes each spouse potentially eligible to receive payments, subject to the $900,000 AGI limit.  In separate property states, the $900,000 limit could come into play more often.  Also, if a joint return exceeds the AGI limits, a certification statement from a CPA or an attorney can be provided that specifies the manner in which income would have been declared and reported had the spouses filed two separate tax returns.  The statement must also certify that the total allocations of income are consistent with the information that supports the filed joint tax returns.

The payment limit is applied at both the entity level (for entities that limit liability) and then the individual level (up to four levels of ownership).  Thus, general partnerships and joint ventures have no payment limits.  Instead, the payment limit is calculated at the individual level.  However, an entity that limits the liability of its shareholders/members is limited to one payment limitation.  That means that the single payment limit is then split equally between the shareholders/members.  

The AGI Limitation 

To be eligible for a payment limit, an AGI limitation must not be exceeded.  That limitation is $900,000, and applies to commodity programs, conservation programs and disaster programs.   

The AGI limitation is an average of the three prior years, with a one-year delay.  In other words, farm program payments received in 2022 are based off the average of AGI for 2018, 2019 and 2020. 

Note:  While FSA had not treated the I.R.C. §179 deduction as allowed against AGI for S corporations and LLC’s taxed as partnerships, but did allow it for C corporations and individuals, beginning with 2017 crop year the deduction has been allowed against AGI for all entities.  It took threatened litigation to get FSA to change its position on this issue. 

The AGI limitation, which does not apply for crop insurance purposes, applies to both the entity and the owners of the entity.

Example.  Assume that FarmCo receives $100,000 of farm program payments in 2015.  FarmCo’s AGI is $850,000.  Thus, FarmCo is entitled to a full payment limitation.  But, if one of FarmCo’s owners has AGI that exceeds the $900,000 threshold, a portion of FarmCo’s payment limit will be disallowed in proportion to that shareholder’s percentage ownership.  So, if the shareholder with income exceeding the $900,000 threshold owns 25 percent of FarmCo,  FarmCo’s $100,000 of farm program payment benefits will be reduced by $25,000. 

Attribution Rule.  Under a rule of direct attribution, individuals and entities are credited with both the amount of payments received directly and also the amount received indirectly by holding an interest in an entity receiving payment.  In general, payments to a legal entity (defined as an individual, a partnership, a limited liability company or a corporation) are attributed to the persons who have a direct or indirect interest in the legal entity.  But, payments made to a joint venture or general partnership are determined by multiplying the maximum payment amount by the number of persons and entities holding ownership interests in the joint venture or general partnership.  That means that joint ventures and partnerships are not subject to the attribution rules.

Note:  The direct attribution rule originated in the 2008 Farm Bill and operates as a payment limitation for a farming operation and for each member of the farming operation.  The rule tracks payments to legal entities through (up to) four levels of ownership.  This means that if another entity has any ownership interest in the farming operating receiving payments, the payments to the farming operation are reduced by a proportionate percentage of that indirect interest.  Whether or not direct attribution exists is measured every June 1.

As applied to marketing cooperatives, the attribution rules apply to the producers as persons, and not to the cooperative association of producers.  Also, children under age 18 are treated the same as the parents.  It is also assumed that if one parent has filled their payment limit, payments made to a child could be attributed to the parent that has not filled their payment limit.  For payments made to a revocable trust, they are attributed to the trust’s grantor.  As applied to irrevocable trusts and estates, the Ag Secretary is directed to administer the rules so as to ensure "equitable treatment" of the beneficiaries.

What (or Who) is a “Person”? 

Definition of “person.”  The definition of a “person” under the payment limitation rules is the key to proper structuring of the farming business for maximum payment limits. The definition of “person” is contained at 7 C.F.R Sec. 1400.3.  "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."   Thus, 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.  This means that C corporations, S corporations and Limited Liability Companies (i.e., any type of entity that limits liability) all have one payment limitation. 

Note:  Almost all farming operations are either sole proprietorships, joint operations, corporations or a family operation involving multiple adult family members. 

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. For these entities, 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, but the members are.

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.  While a corporation, limited liability company, or limited partnership will be only one "person" irrespective of the number of its shareholders or members, each member of a partnership or joint venture 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 is a farming operation conducted by an entity that does limit liability.

Note:  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 (in states where the governing LLC statute provides for charging orders) 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.   The “separate and distinct” requirement is measured by a three-part test.

(1)       Each separate person must have a separate and distinct interest in the land or the crop involved;

(2)       Each separate person must exercise separate responsibility for the separate interest; and

(3)       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.  While this is permissible under the rules, 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 complex. 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.

Illustrative Case

In a 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 disagreed with the USDA finding and exhausted his administrative remedies with the USDA to no avail.  In court, 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.  The court determined that the definition of “person” applied to all of part 1400 of the Code of Federal Regulations (C.F.R.).  That’s the part of the C.F.R. containing the “separate person” rules.  As a result, the USDA’s interpretation of its own regulation defining “person” for payment limitation purposes that is set forth in 7 C.F.R. Sec. 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. Sec. 6998(b)(2)) contains no remedy for failure to comply. 

Observation: 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. 

Conclusion

In Part Three later this week, I will take a look at the management and recordkeeping requirements and planning issues for structuring the farm business.

August 9, 2022 in Regulatory Law | Permalink | Comments (0)

Sunday, August 7, 2022

Federal Farm Programs – Organizational Structure Matters - Part One

Overview

How a farming operation is legally structured influences eligibility for federal farm program payment limitations and the amount of payments that can be received.  The eligibility rules for participation in the federal farm programs date to 1970.   In essence, the rules are designed to ensure that the public taxpayer dollars flow to persons or entities that are actually engaged in farming activities.  The rules also cap the amount of payments that an eligible “person” can receive on an annual basis, and exclude from participation persons and entities with gross income exceeding a threshold amount.

The rules can become quite complex in their application, but a basic point should not be missed – each “separate person” is entitled to a payment limit.  The structure of the farming operation also can significantly impact separate person status and, in turn, the amount of payments a farming operation may receive. 

Note:  The longstanding payment limitation rules were relaxed for crop years 2018 and 2019 as an aid to farmers faced with retaliatory tariffs placed on U.S. ag goods by China in response to U.S. attempts to battle Chinese unfair trade practices, including theft of U.S. intellectual property.   

Today’s post is the first of a three-part series on the federal farm programs and how a farming operation can be organized to optimize government payments.  In Part one today I look at the available program benefits.  That will lay the groundwork at the farm program payment limitation rules and how a farm business can be structured within the rules to maximize payments.

Background – What’s at Stake

Primary programs.   The current farm program eligibility and payment limit rules were established under the 2014 Farm Bill and largely continued with the 2018 Farm Bill.  Under those rules, 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, there is no annual limitation applies for payments under the Livestock Indemnity Program, the Livestock Forage Program, or the Emergency Assistance for Livestock, Honeybees and Farm-Raised Fish program (but adjusted gross income (AGI) limits apply.  The same is true of the Tree Assistance Program.   A separate $50,000 limitation applies with respect to the Conservation Reserve Program (CRP).  There is also no payment limit for marketing assistance loans (marketing loan gain or deficiency payment). 

A farmer can also elect to participate in the non-insured crop disaster assistance program on any commodity for which crop insurance is not available. Coverage is available up to 65 percent of production and 100 percent of average market price.  The $125,000 per person payment limit applies on an entity-by-entity basis.  A farmer can buy additional protection that is subject to a separate $300,000 payment limit. 

Various environmental programs have separate limits.  For example, the Environmental Qualify Incentives Program (EQIP) has an overall payment limit of $300,000 over a six-year period.  The AGI limit is $1,000,000, but the limit is eliminated if at least two-thirds of AGI is from farming.  The Conservation Stewardship Program (CSP).  The limit for all CSP contracts combined is $40,000 per year ($200,000 over a five-year period.  For the Conservation Contract Program there is no limit.  This program allows a farmer to reduce FSA loans that are secured by real estate by up to one-third of the loan principal. 

Summary:  With the exceptions noted above, each “person” is, in general, entitled to a $125,000 payment limit.  Through legal structuring of the business, a farming operation may be entitled to multiple payment limits.  Conversely, improper (or no) planning could limit the farming operation to a single payment limit. 

Beginning in 2014, farmers were given a one-time opportunity to elect PLC or ARC for the 2014-2018 crop years.  If an election was not made, PLC applied beginning in 2015 with no payment available for 2014.  If ARC was elected, all producers with respect to a farm had to sign the election form. If PLC was elected, the owners of the farm had an option to update their yields to 90 percent of their average yields from 2008-2012.  All farm owners also could elect to reallocate their base acres based on the actual plantings for 2009-2012.  Under the 2018 Farm Bill the rule was changed.  For the 2019 and 2020 crop years, an election could be made.  Now, the 2021-2023 crop years have a separate election.  But, the combined annual payment limit for ARC/PLC remains $125,000 per person or entity.

PLC and ARC.  The PLC option works in tandem with a crop insurance Supplemental Coverage Option (SCO).  It is a risk management tool that is designed to address significant, multiple-year price declines.  It compliments crop insurance, which is not designed to cover multiple-year price declines.  A farmer that chooses the PLC option will receive a payment (consistent with payment limitations) when the effective price of a covered commodity is less than the target (“reference”) price for that commodity established in the statute.  The effective price is the higher of the mid-season price or the national average loan rate for the covered commodity.  Thus, the PLC payment rate is the reference price less the effective price, and the PLC payment amount is the payment rate times the payment acres.  Putting it another way, the PLC payment is equal to 85 percent of the base acres of the covered commodity times the difference between the target price and the effective price times the program payment yield for the covered commodity.  SCO provides additional county-level insurance coverage not to exceed the difference between 86 percent and the coverage level in the individual insurance policy.  Because SCO is a form of crop insurance, payment limits do not apply.  But, a farmer selecting the PLC option must pay an additional premium for SCO coverage (but, the cost of the additional premium is 65 percent taxpayer subsidized). 

ARC is a risk management tool that addresses revenue losses.  Under the ARC, payments are issued when the actual county crop revenue of a covered commodity is less than the ARC county guarantee for the covered commodity and are based on county data, not farm data.   A producer electing ARC must unanimously select whether to receive county-wide coverage on a commodity-by-commodity basis or choose individual coverage that applies to all of the commodities on the farm.  Payment acres are 85 percent of base acres for county coverage, and 65 percent for individual farm coverage.  Under ARC, a producer must incur at least a 14 percent loss (defined as 86 percent of benchmark revenue) for coverage to kick-in.  The ARC county guarantee equals 86 percent of the previous five-year average national farm price, excluding the years with the highest and lowest price (the ARC guarantee price), times the five-year average county yield, excluding the years with the highest and lowest yield (the ARC county guarantee yield).  This guarantee revenue is based on five-year Olympic production and average crop price excluding the high and low years.  Both the guarantee and actual revenue are computed using base acres, not planted acres.  The payment is equal to 85 percent of the base acres (this is for county-elected ARC) of the covered commodity times the difference between the county guarantee and the actual county crop rev­enue for the covered commodity, not to exceed 10 percent of the benchmark county revenue (the ARC guarantee price times the ARC county guarantee yield).   In other words, if revenue is less than 76 percent of the previous five-year average national farm price, then the maximum 10 percent of benchmark revenue is paid, subject to the payment limit of $125,000 per person.

Observation:  When covered crop prices are relatively high, ARC is more likely to result in a payment to a producer.  When prices are low, PLC will result in a payment.  In general, the bigger margin between expected prices and reference prices, the more likely it is that a producer would choose ARC.  The ARC/PLC decision was made by an irrevocable election – whatever a producer elected in 2014 applied through the 2018 crop year, and the only way to make a new election was by having acres come out of CRP that were then put back into production.  As noted, the irrevocable election is no longer the rule.

Payments for PLC and ARC are issued after the end of the respec­tive crop year, but not before Oct. 1.  Thus, the 2021 crop payment will not be made until after October 1, 2022.  From a practical/procedural standpoint, because a payment (if any) will not be issued until at or near the end of the producer’s marketing year, lenders could have a more difficult time determining a producer’s cash flow for crop loans.   

August 7, 2022 in Regulatory Law | Permalink | Comments (0)

Thursday, August 4, 2022

What is “Reasonable Compensation”?

Overview

One of the areas of “low-hanging fruit” for IRS auditors in recent years involves the issue of reasonable compensation in the S corporation context.  Salary that is too low in relation to the services rendered results in the avoidance of payroll taxes.  So, when shareholder-employees take flow-through distributions from the corporation instead of a salary, the distributions are not subject to payroll taxes (i.e., the employer and employee portions of Federal Insurance Contributions Act (FICA) taxes and the employer Federal Unemployment Tax Act (FUTA) tax. 

Note:  The issue of the reasonableness of compensation also can arise in the context of a C corporation.  Salaries and benefits to a C corporation shareholder/employee that is “too high” can bring an IRS challenge that some of the compensation is really disguised dividends.  An “ostensible salary” paid by a closely held C corporation to one of its few shareholders is likely to constitute a disguised dividend where the amount is “in excess of those ordinarily paid for similar services and the excessive payments correspond or bear a close relationship to the stockholdings of the officers or employees.”  Treas. Reg. §1.162-7(b)(1).

“Reasonable compensation” in the context of an S corporation (with a bit of C corporation discussion thrown in) – it’s the topic of today’s post.

Background

In accordance with Rev. Rul. 59-221, S corporation flow-through income is taxed at the individual level and is (normally) not subject to self-employment tax.  Also, in addition to avoiding FICA and FUTA tax via S corporation distributions, the 0.9% Medicare tax imposed by I.R.C. §3101(b)(2) for high-wage earners (but not on employers) is also avoided by taking income from an S corporation in the form of distributions.  These are the tax incentives for S corporation shareholder-employees to take less salary relative to distributions from the corporation.  With the Social Security wage base set at $147,000 for 2022, setting a shareholder-employee’s compensation beneath that amount with the balance of compensation consisting of dividends can produce significant tax savings.  The savings will likely increase in 2017.  It is currently projected that the Social Security wage base will be $155,100 in 2023.

Who’s an “Employee”?

Most S corporations, particularly those that involve agricultural businesses, have shareholders that perform substantial services for the corporation as officers and otherwise.  In fact, the services don’t have to be substantial.  Indeed, under a Treasury Regulation, the provision of more than minor services for remuneration makes the shareholder an “employee.”  Once, “employee” status is achieved, the IRS views either a low or non-existent salary to a shareholder who is also an officer/employee as an attempt to evade payroll taxes and, if a court determines that the IRS is correct, the penalty is 100 percent of the taxes owed.   Of course, the burden is on the corporation to establish that the salary amount under question is reasonable.  

Determining Reasonableness

Before 2005, the court cases involved S corporation owners who received all of their compensation in form of dividends.  Most of the pre-2005 cases involved reclassifications on an all-or-nothing basis.  In 2005, the IRS issued a study entitled, “S Corporation Reporting Compliance.”  Now the courts’ focus is on the reasonableness of the compensation in relation to the services provided to the S corporation.  That means each situation is fact-dependent and is based on the type of business the S corporation is engaged in and the amount and value of the services rendered. 

So what are the factors that the IRS examines to determine if reasonable compensation has been paid?  Here’s a list of some of the primary ones:

  • The employee’s qualifications;
  • the nature, extent, and scope of the employee’s work;
  • the size and complexities of the business; a comparison of salaries paid;
  • the prevailing general economic conditions;
  • comparison of salaries with distributions to shareholders;
  • the prevailing rates of compensation paid in similar businesses;
  • the taxpayer’s salary policy for all employees; and
  • in the case of small corporations with a limited number of officers, the amount of compensation paid to the particular employee in previous years.

According to the IRS, the key to establishing reasonable compensation is determining what the shareholder/employee did for the S corporation.  That means that the IRS looks to the source of the S corporation’s gross receipts. If they came from services of non-shareholder employees, or capital and equipment, then they should not be associated with the shareholder/employee’s personal services, and it is reasonable that the shareholder would receive distributions as well as compensation.  Alternatively, if most of the gross receipts and profits are associated with the shareholder’s personal services, then most of the profit distribution should be allocated as compensation. In addition to the shareholder/employee’s direct generation of gross receipts, the shareholder/employee should also be compensated for administrative work performed for the other income-producing employees or assets.  As applied in the ag context, for example, this means that reasonable compensation for a shareholder/employee in a crop farming operation could differ from that of a shareholder-employee in a livestock operation.

Recent Cases

Over the past decade there have been some significant cases involving the issue of reasonable compensation in the S corporation context.  Some of the prominent ones include:

  • David E. Watson, P.C. v. United States, 668 F.3d 1008 (8th Cir. 2012), cert. den., 568 U.S. 888 (2012)
  • Sean McAlary Ltd., Inc. v. Comr., T.C. Sum. Op. 2013-62
  • Glass Blocks Unlimited v. Comr., T.C. Memo. 2013-180
  • Scott Singer Installations, Inc. v. Comr., T.C. Memo. 2016-161

Each of these cases provides insight into the common issues associated with the reasonable compensation issue.  The last two also address distributions and loan repayments in the context of reasonable compensation of unprofitable S corporations with one case being a taxpayer victory and the other a taxpayer loss. 

In early 2021, the U.S. Tax Court issued its opinion in Ward v. Comr., 2021-32.  In Ward, the petitioner conducted her law practice as an S corporation.  She was the sole shareholder.  For the three tax years at issue, the petitioner reported the net profit or loss from the S corporation on her Form 1040.  In addition, for 2011, the S corporation did not treat any of the amount paid to her as wages on Form 941 and did not report any of it as income.  In 2012, the petitioner reported $73,448 in payments as income, but neither she nor the S corporation reported the amounts as wages.  The petitioner conceded that she was an officer of the S corporation.  The IRS asserted that the amounts were wages, and the Tax Court agreed.  The de minimis exception of Treas. Reg. §31.3121(d)-1(b) didn’t apply because, as the sole shareholder, she was performing services for the corporation.  While the S corporation employed an associate attorney, the petitioner could have claimed that some of the firm’s net profit distributed to the petitioner attributable to the associate attorney’s efforts would not be wages.  However, the petitioner provided no evidence of the value that the associate attorney added to the S corporation or whether that value exceeded the associate’s compensation.  Thus, the salary payments reported to the petitioner by the S corporation were reportable as compensation. 

Note:  A side issue in Ward was that the petitioner also had canceled debt income in years when lenders discharged portions of her debt.  She failed to provide sufficient evidence of her assets and liabilities for a solvency determination to be made. 

And…a C Corporation Reasonable Compensation Case

Another recent case on the reasonable compensation issue illustrates that the matter, as indicated above, can also be a concern for C corporations.  In Clary Hood, Inc. v. Comr., T.C. Memo. 2022-15, a married couple were the sole shareholders of a corporation engaged in the construction business that graded and prepared land.  The corporation’s growth was irregular from 2000 on. The principal took a relatively modest salary between 2000 and 2012 but took a big increase in the years 2013 to 2016, ostensibly to compensate for earlier years. The company had an outside consulting firm perform an analysis to determine what the principal's compensation should be.

The IRS challenged the compensation amounts for 2015 and 2016. The Tax Court examined the usual factors considered in such a case including the employee's qualifications; the nature, extent, and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with gross income and net income; the prevailing general economic conditions; comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; and the salary policy of the taxpayer as to all employees.  On these points, the relevant facts showed that the corporation had revenue of almost $44 million (net revenue of $7 million) in 2015 and $68 million (net revenue of $14 million in 2016.  The principal’s compensation was set at $168,559 with a $5 million bonus in 2015.  A comparable arrangement was established for 2016.  The principal set the compensation of the other four executives, and none of them were compensated in excess of $234,000.  None of them had a bonus exceeding $100,000. 

The Tax Court denied a deduction for the full amount of the compensation.  While certain factors favored the corporation, the factors addressing comparable pay by comparable concerns, the corporation’s shareholder distribution history, the manner of setting compensation, and the principal’s involvement in the corporation’s business were the most relevant and persuasive factors for the Court.  The Tax Court allowed a deduction of no more than $3,681,269 for the 2015 tax year and $1,362,831 for the 2016 tax year.  

In addition, the IRS assessed an accuracy-related penalty for both years. The taxpayer was able to show that he relied in good faith on the advice of the accounting firm and the Tax Court did not sustain the penalty. However, for the second year the corporation could not substantiate its reliance on the outside adviser and was responsible for an accuracy-related penalty under I.R.C. §6662 for 2016. 

Conclusion

The bottom line is that “reasonable compensation” means that is must be reasonable for all of the services the S corporation owner performs for the corporation.  Because there is no safe harbor for reasonable compensation, the best strategy is to research and document reasonable compensation every year.  That will provide a defensible position if the IRS raises questions on audit. 

August 4, 2022 in Business Planning, Income Tax | Permalink | Comments (0)

Sunday, July 31, 2022

Is a C Corporation a Good Entity Choice For the Farm or Ranch Business?

Overview

The question often arises with farm and ranch clients that engage in estate, business or succession planning as to what the optimal entity structure is for the business?  There’s no easy, one-size-fits-all answer to that question.  It simply depends on numerous factors.  In fact, the question is best answered by asking a question in return – what do you want the farming or ranching business to look like after you and your spouse are gone?  What are your goals and objectives.  If planning starts from that standpoint, then it is often much easier to get set on a path for creating an “optimal” entity structure.

One of the recurring questions is whether a C corporation is a good entity choice for the farm or ranch business.

Some thoughts on utilizing a C corporation for the farming or ranching business – that’s the topic of today’s post

Food For Thought

In many planning scenarios it is useful to create a checklist of points to consider that are relevant in the entity selection decision making process.  The next step would then be to apply those points to the goals and objectives of the parties.  For starters, consider the following:

C corporations.  The following are relevant to C corporations:

  • A C corporation can be formed tax free if: (1) property is exchanged for property; (2) the transferors (as a group) hold 80 percent or more of the stock immediately after the exchange of property for stock; and (3) the formation is for a business purpose.

Note:  Be mindful about making stock gifts shortly after incorporation if doing so would drop the transferor group beneath the 80 percent threshold.  How long is “shortly”?  There is no clear answer to that question.

  • C corporate income is subject to tax at a flat rate of 21 percent.
  • A C corporation is not eligible for the 20 percent qualified business income deduction of I.R.C. §199A that is available to a sole proprietor or the member of a pass-through entity (such as a partnership or S corporation).
  • While gain that is realized on the sale of stock of a farming corporation can’t be excluded under the special rules that apply to qualified small business stock (I.R.C. §1202), if the stock is that of a corporation engaged in processing activities, the gain can be excluded. There are other rules that can limit (or eliminate) this capital gain exclusion.
  • When a C corporation converts to S corporation status, the built-in gains (BIG) tax applies to the built-in gains or income items. R.C. §1374(a). The Tax Cuts and Jobs Act (TCJA) didn’t eliminate the BIG tax, but it did lower it to 21 percent. 
  • A C corporation has good flexibility in establishing its capitalization structure as well as how it allocates income, losses, deductions and credits.
  • A C corporation is potentially subject to additional penalty taxes if too much earnings are accumulated without legitimate, well documented business reasons, or If too much income is passive.
  • The alternative minimum tax presently doesn’t apply to C corporate income, but a current proposal would restore it for some corporations starting for tax years after 2022.
  • A C corporation can deduct state income tax. This should be contrasted with the TCJA limitation on the deduction of such taxes for individuals that is pegged at $10,000 (including real property taxes on property that is not used in the conduct of the taxpayer’s trade or business).  R.C. §164(b)(6).   
  • A C corporation can provide employees with the tax-free fringe benefits of meals (limited to 50 percent by I.R.C. §274(n)) and lodging that are supported by legitimate business reasons (and satisfy other conditions). This benefit is not available to sole proprietors and partners in a partnership. See, e.g., Rev. Rul. 69-184, 1969-1 C.B. 256.  That is also the result for S corporation employees who own, directly or indirectly, more than 2% of the outstanding stock of the S corporation – such persons may not receive certain otherwise tax-free fringe benefits (including meals and lodging).  See I.R.C. §1372.  Attribution rules apply for determining who is considered to be an S corporation shareholder.  R.C. §318.
  • A farming or ranching C corporation can generally use the cash method of accounting.
  • In some states, a C corporation cannot own or operate agricultural land unless members of the same family own a majority of the corporate stock. State laws differ on the specific rules barring C corporations from being involved in agriculture, and many states not located in the Midwest or the Great Plains don’t have such rules.
  • A C corporation faces the potential of a double layer of tax upon liquidation.
  • The C corporation generally does provide good estate planning opportunities. In other words, it tends to be a good organizational vehicle for transitioning ownership from one generation to the next.

What About Income Tax Basis?

Given the currently high level of the federal estate tax exemption equivalent of the unified credit (12.06 million per decedent for deaths in 2022), income tax basis planning is high on the priority list.  Thus, when federal estate tax is not a potential concern, planning generally focuses on making sure that property is included in a decedent’s estate.  This raises some basic planning rules that must be considered:

  • For property that is included in a decedent’s estate for purposes of federal estate tax, the basis of that property in the hands of the person inheriting the property is generally the fair market value (FMV) as of the date of the decedent’s death. R.C. §Sec. 1014(a)(1)). 
  • But, the “stepped-up” basis rule (to the date-of-death value) doesn’t apply to property that is income in respect of a decedent (IRD) under §691. R.C. §1014(c).  An item is IRD if it is something that the decedent was entitled to as gross income but wasn’t included in income due to death in accordance with the decedent’s method of accounting.  See Treas. Reg. §1.691(a)-1(b).  Farmers and ranchers have some common occurrences of IRD such as:
    • Deferred gain to be reported from installment sales and deferred sales of crops and livestock;
    • The portion (on a pro rata) basis or crop-share rentals due at the time of death;
    • Receivables for a cash basis farmer;
    • Unpaid wages;
    • The value of commodities stored at an elevator (cooperative). Reg. §1.691(a)-2(b), Example 5 (canning factory and processing cooperative).
    • Accrued interest income on Series E/EE bonds;
  • When a decedent’s estate makes an election under I.R.C. §2032A to value ag land in the estate at its value as ag property (known as the “special use” value) rather than at its fair market value, the basis of the land in the hands of the heir is the special use value. There is no basis “step-up” to fair market value at the time of death.  Reg. §§1014(a)(3); 1.1014-3(a).
  • While the income of a pass-through entity is taxed only at the owner level, and the pass-through income increases the owner’s tax basis in the owner’s interest in the pass-through entity, a C corporation pays tax at the corporate level and then tax is also paid at the shareholder level on dividends or proceeds of liquidation. In addition, C corporate income does not increase the shareholder’s stock basis.

Just Starting Out – Creating a New Entity

If an organizational structure is initially being put into place, again there are numerous factors to consider in determining whether the farming or ranching business should operate as a C corporation or a pass-through entity.  In addition to those factors pointed out above, the following factors should also be considered:

  • Is it anticipated that the primary or sole shareholder will hold the corporate stock until death?
  • Where will the business be incorporated and do business? If the business will be a C corporation, does the state of incorporation or other states in which the corporation will do business have a state income tax?
  • What tax bracket(s) will apply to the shareholders?
  • If the underlying business of the corporation would qualify for the 20 percent qualified business income deduction of I.R.C. §199A, what’s the differential between the corporate tax rate of 21 percent and the individual rate less the 20 percent deduction? Will that full 20 percent deduction be available if the entity weren’t a C corporation?  This can involve a rather complex analysis.
  • What type of assets are involved? Will they appreciate in value?  If so, the corporate tax rate of 21 percent plus the second layer of tax on gain of the appreciated asset value at the shareholder level upon liquidation (or on a qualified dividend) will exceed the maximum 23.8 percent capital gain rate that applies to an individual (20 percent rate plus an additional 3.8 percent on passive gain under Obamacare.  (I.R.C. §1411)). 

Note:  A current proposal would apply the 3.8 percent tax to active business income in addition to passive income for tax years beginning after 2022.

  • Is it anticipated that the business would retain earnings or pay it out in the form of compensation, rents or other expenses? Growing businesses tend to retain earnings.  Paid-out earnings of a C corporation are taxed again at the shareholder level.
  • Is income expected to fluctuate widely? If so, remember that the C corporate tax rate is a flat 21 percent. 
  • Will there be sufficient funds to pay consistent income to the owners of the business? If so, that can mean that (if a C corporation structure is utilized) shareholder-employees can receive tax benefits at the individual level.  If a corporate-level loss is incurred in doing so, that loss can be used to offset future taxable income. 
    • Under the TCJA, losses can offset up to 80 percent of pre-NOL taxable income.
    • The loss (for a farming corporation) can be carried back two years. R.C. §172(b)(1)(B). 
  • From an accounting and tax planning standpoint, is a fiscal year desired? A C corporation can have a fiscal year-end and the individual shareholders can have a calendar year-end.
  • If the farming/ranching operation participates in federal farm programs, a C corporation and any other entity type that limits liability (S corporation; limited partnership; limited liability company) will restrict the entity to a single payment limit. That amount will then be split among the owners of the entity.  Entity structures that don’t limit liability (e.g., a general partnership) are not subject to a single payment limit. 

Note:  This is an issue for farming/ranching operations that are potentially eligible for more than $125,000 (the current general payment limit) in federal farm program subsidies annually.

One Entity or Multiple?

Another question that sometimes needs to be addressed is whether the farming/ranching operation should be structured as a single entity or as two or more entities.  This question often arises  when the family has some heirs that want to operate the farm for the next generation and some heirs that don’t – the classic on-farm, off-farm heir situation.  For these families, one approach might be to put the land in one entity (not a C corporation) and the operating assets in another entity (such as a general partnership).  The two entities would be tied together with a lease that is (often) designed to minimize self-employment tax.  This structure can provide income (in the form of rents) to the off-farm heirs, and control of the operating entity to the on-farm heirs. 

Conclusion

So, what is the best entity structure for your farming or ranching operation?  The above discussion merely scratches the surface of a very complex matter.  However, if you clearly articulate your goals and objectives for the future of your business to your planners, and provide complete information on assets, liabilities, land ownership, current arrangements, family data and dynamics, cropping and livestock history and tax history, then a good plan can be put in place that can, at least in the short-term satisfy your objectives.  Then, there must be a commitment to routinely review and update the plan as necessary.  There is no “one-size-fits-all” business plan, and plans aren’t static.  There is cost involved, of course, but the successful operations realize that the cost is a small compared to the benefits.

July 31, 2022 in Business Planning | Permalink | Comments (0)

Thursday, July 28, 2022

Tax Deal Struck? – and Recent Ag-Related Cases

Overview

Reports are that Senator Joe Manchin has come to an agreement with Senate leadership on tax legislation that is part of a larger package, termed the “Inflation Reduction Act of 2022.”  It’s apparently part of the 2022 budget reconciliation bill which only requires a simple majority of the Senate to pass.  What are the tax provisions that have been agreed to? 

Proposed tax provisions apparently agreed to, and some recent ag-related court decisions – it’s the topic of today’s post.

Tax Agreement

Reports are that the agreed upon tax package includes a 15 percent corporate alternative minimum tax (AMT) applied to adjusted financial statement income of corporations with profits exceeding $1 billion.  A corporation subject to the AMT would be able to claim net operating losses and tax credits against the AMT.  In addition, a corporation subject to the AMT would be able to claim tax credits against the AMT as well as regular corporate tax for AMT paid in prior years to the extent the regular tax liability in any year exceeds 15 percent of the corporation’s adjusted financial statement income.  The provision would be effective for tax years after 2022.

Also included in the agreement is a change in the tax treatment of carried interest (e.g., the share of profit that general partners receive to compensate them for managing a venture capital fund). 

Another proposal would apply the net investment income tax (NIIT) of I.R.C. §1411 to all income.  Presently this 3.8 percent tax (which was created as part of Obamacare) applies only to passive income above a threshold.  Under the proposal, the additional 3.8 percent tax would apply to adjusted gross income over $400,000 (single) and $500,000 (mfj).  This means that there is a substantial “marriage penalty.”  In addition, the qualified business income deduction (QBID) of I.R.C. §199A is not part of a taxpayer’s AGI computation.  In other words, AGI is not reduced by the 20 percent QBID – AGI is computed before accounting for the QBID. Thus, for a taxpayer that has taxable income at or below the threshold for application of the NIIT as a result of the QBID, the NIIT would be computed on AGI first. 

Note:  Applying the NIIT to adjusted gross income (including income from both passive and active sources) could result in a sizeable tax increase for many farmers – particularly dairy operations.

There are other tax provisions reported to be in the agreement, including those dealing with “renewable” energy credits.  The projected additional revenue from the tax increases is to fund certain “green energy” initiative.  The actual text of the legislation is presently slated for the Senate parliamentarian to review on August 3.  Full Senate consideration would occur after that date. 

Note:  There presently is no word on how Senator Sinema views the proposal, although she has stated in the past that she will not support legislation that increases corporate or personal tax rates.  While the proposals don’t increase actual rates, they do increase effective rates on certain corporations and individuals. 

Also, Senate Finance Committee Chairman Charles Grassley has introduced legislation that would index certain tax benefits to adjust for inflation.  The indexed provisions include certain tax credits and deductions such as the Child Tax Credit and the Non-Child Dependent Credit.  The bill, known as the “Family and Community Inflation Relief Act,” would also adjust for inflation the American Opportunity Tax Credit, Lifetime Learning Credit, and the Student Loan Interest Deduction.  The proposal would also extent the current $10,000 limitation on state and local taxes through 2026. 

 Recent Ag-Related Court Opinions

Child Support Obligation Computed Based on All Income and Loss from Farming. 

Gerving v. Gerving, 969 N.W.2d 184 (N.D. 2022) 

The issue in this case was the proper way to calculate a father’s child support obligation.  The father conducted a farming operation, and a primary issue was whether only income and gains from farming should count for purposes of child support, or whether losses should also be accounted for. Under child support guidelines, the court must determine the payor’s net income and use that amount to calculate the child support obligation.  The trial court calculated the father’s income based only on gains and did not include any related losses incurred from equipment trades and other farm-related transactions.  The appellate court held that the trial court erred by not including the farm losses to calculate the father’s self-employment income because those losses must be considered to show actual profit from the farming operation.  The appellate court also determined that the father had no income from subleases of farmland.  

Deduction for Full Amount of C Corporate Shareholder Compensation Not Deductible 

Clary Hood, Inc. v. Comr., T.C. Memo. 2022-15

A big audit issue for farming (and other) corporations is reasonable compensation.  This case illustrates that point in a non-farm context.  Here, a married couple were the sole shareholders of the petitioner, a corporation engaged in the construction business that graded and prepared land.  The petitioner’s growth was irregular from 2000 on. The principal took a relatively modest salary between 2000 and 2012 but took a big increase in the years 2013 to 2016, ostensibly to compensate for earlier years. The company had an outside consulting firm perform an analysis to determine what the principal's compensation should be. The IRS challenged the amount in 2015 and 2016.

The Tax Court examined the usual factors considered in such a case including the employee's qualifications; the nature, extent, and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with gross income and net income; the prevailing general economic conditions; comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; and the salary policy of the taxpayer as to all employees. The Tax Court denied a deduction for the full amount of the compensation. In addition, the IRS assessed an accuracy-related penalty for both years. The taxpayer was able to show that he relied in good faith on the advice of the accounting firm and the Tax Court did not sustain the penalty. However, for the second year the taxpayer could not substantiate its reliance on the outside adviser. 

Homeowner’s Policy Doesn’t Cover Farming Injury

Mills v. CSAA General Insurance. Co., No. 21-CV-0479-CVE-JFJ, 2022 U.S. Dist. LEXIS 114741 (N.D. Okla. Jun. 29, 2022)

It’s always good to make sure you understand the extent of coverage you have under an insurance policy, and what is excluded from coverage.  This case illustrates that point.  Here, the plaintiff became pinned between a trailer and barn while loading cattle, and was hospitalized for several days as a result of his resulting injuries.  The plaintiff had a homeowner’s insurance policy with the defendant and filed a claim for coverage under the policy for his injuries.  The defendant denied coverage on the basis that the policy only covered claims for bodily or personal injury brought by third parties against the plaintiff, and that the farming endorsement did not extend coverage for the plaintiff’s own bodily injury and incorporated the policy’s exclusion for bodily injury into the farming endorsement. 

The plaintiff sued, claiming that he intended to purchase coverage for personal injuries he might suffer while operating his farm and that he had a reasonable expectation of coverage under the policy.  He also claimed that the exclusions were “buried in the more than 100 pages of the policy.”  The trial court disagreed, determining that the policy’s liability provisions applied only to claims for bodily or personal injury brought by third parties against the plaintiff.   The trial court also determined that the policy language was not ambiguous and was not “buried deep” into the policy documents. 

Gross Acres, not Tillable Acres, Used for Partition-in-Kind

Mueggenberg v. Mueggenberg, No. 21-0887, 2022 Iowa App. LEXIS 510 (Iowa Ct. App. Jun. 29, 2022)

The two parties were comprised of five siblings, who each had an undivided one-fifth interest in 179.61 acres of farmland. The plaintiffs, three of the siblings, filed for a partition in kind. The court appointed an appraiser to analyze and equally divide the farmland between the three parties. The appraiser determined that partitioning the land into five equal sections would be unworkable because the land’s topography varied greatly. The appraiser recommended the defendants should receive an approximate share of 40 percent comprised of 62 gross acres and all the future easement payments from the energy company that operated a windmill on the land. The appraiser allocated 117.61 gross acres to the plaintiffs. The defendants claimed that they were entitled to 68.64 tillable acres. The appraiser explained that while the acre division was not necessarily 40/60, the land awarded to the defendants was overall more desirable and expensive as it had a higher CSR2 rating.

The trial court agreed with the appraiser and assessed fees and costs to the defendants.  On appeal, the appellate court found the defendants’ calculations for a different split were inaccurate as the defendants used tillable acres when they should have used gross acres in the calculation. The defendants also failed to account for the difficulty of dividing the land caused by a non-uniform property line and the existence of terraces. The appellate court affirmed the trial court’s decision to adopt the appraiser’s division but reversed the trial court’s award of attorney’s fees and costs. Accordingly, the appellate court vacated the trial court’s assessment of costs and remanded the case with instructions that only costs arising from the contested matter be assessed to the defendants.  The parties were to share all remaining costs proportionately. 

Conclusion

Keep your eyes on what, if any, tax proposals come out of the Senate.  Increasing taxes on individuals whether via the NIIT or the corporate tax in a recessionary economy (despite the changed definition from the White House) is not a good idea.  It’s particularly a bad idea when any additional revenue is to be used to fund inefficient and costly energy proposals to further energy policies that are the driver to the current inflationary problems in the economy. 

On the ag law front, make sure to understand how child support is computed in the context of a farmer’s divorce; pay reasonable compensation to shareholder/offices for services rendered; know what is and what is not covered under an insurance policy; and avoid partition actions – they rarely end up in family harmony. 

July 28, 2022 in Civil Liabilities, Income Tax, Insurance, Real Property | Permalink | Comments (0)

Sunday, July 24, 2022

The Complexities of Crop Insurance

Overview

Crop insurance for farmers is a complex mix of private insurance companies and government administration through the USDA and its sub-agencies.  The complexity can be confusing for farmers as well as the bureaucrats responsible for administering the crop insurance program.  A recent case illustrates those complexities as well as the challenges for attorneys trying to assist farmers with crop insurance legal issues.

Crop insurance and legal issues as illustrated by a recent case – it’s the topic of today’s post

Background

The Federal Crop Insurance Corporation (FCIC) is a wholly-owned government corporation that the Risk Management Agency (RMA) of the United States Department of Agriculture (USDA) manages.  The FCIC manages the federal crop insurance program and provides reinsurance for crop insurance policies that are approved under the Federal Crop Insurance Act. 7 U.S.C. §1501 et seq.  The FCIC itself is managed by a Board of Directors (Board) subject to the direction of the USDA Secretary.  The Board, in turn, delegates to the RMA Administrator (the manager of the FCIC) certain authorities and powers.  The Board approves any new policy, plan of insurance or major modification to an existing plan or other materials under procedures that the Board establishes.  Private parties design the policies and submit them to the Board via a “508(h) submission.”  The Board must approve a 508(h) submission if the Board determines that, among other things, the crop insurance policy will adequately protect the interests of producers. 

Recent Case

Elbert v. United States Department of Agriculture, No. 18-1574 (JRT/TNL), 2022 U.S. Dist. LEXIS 121433 (D. Minn. July 11, 2022) involved a set of acts where a private company along with the Northarvest Bean Growers Association and the USA Dry Pea and Lentil Council made a 508(h) proposed policy submission to the Board in 2011.  The submission proposed to offer revenue protection to pulse-crop farmers to insure against a drop in price of crops measured by the projected Spring price and the Fall harvest price.   The proposed policy also established a contingency in case there was not enough data to establish the harvest price from the AMS Bean Market News (AMS Method).  In that event, an agency would set the harvest price.  But, in the “rating methods” section of the proposed policy, the projected price was to be substituted for the harvest price if the AMS Method failed. 

While the proposed policy was being reviewed, it was noted that substituting the projected price would convert the policy into a yield protection policy even though farmers would have paid for revenue protection.  It was also noted that such a result would be unfair to farmers.  In response, the private company replied that the policy would have the harvest price set by the FCIC whenever a harvest price couldn’t be calculated, and that revenue protection would still be available. 

The Board approved the policy in 2012 but permitted the RMA to make technical changes to the policy to make it legally sufficient so that it could be sold to farmers.  In response to farmer questions, the private company stated that if the AMS method failed, the FCIC would set the harvest price instead of defaulting to the projected price.  However, for some unknown reason the contingency provision was rewritten to read that, “If the harvest price cannot be calculated in accordance with [the AMS Method,] the harvest price will be equal to the projected price.”  The change, however, was not resubmitted to the Board. 

The plaintiffs, dark red kidney been farmers in Minnesota, purchased the policy in 2015 thinking that the policy would provide protection against a decline in bean prices as measured by the difference between the Spring projected price and the Fall harvest price.  Dark red kidney beans dropped in price in 2015 and there was a lack of published pricing data to establish a harvest price.  As a result, the defendant (collectively the USDA, FCIC and RMA) set the harvest price equal to the spring projected price.  That had the effect of converting the policy from revenue coverage to yield protection and as a result, eliminated any payment under the policy. 

The plaintiffs filed an Administrative Procedure Act (APA) claim against the defendant arguing that it was arbitrary and capricious for the defendant to convert the policy from revenue coverage to yield protection. Both parties moved for summary judgment.  In 2020, the trial court granted summary judgment to the defendant, relying on regulatory language not yet in effect at the time of the policy’s creation.  But, the trial court also noted the additional key fact that substantial changes had been made to the relevant policy provision after the Board had approved a markedly different one.  That fact was introduced at the last minute, months after oral argument.  Consequently, the trial court gave the plaintiffs permission to file a motion to reconsider.  The trial court also ordered the parties to submit additional briefing to address what remedy the court should grant. On the remedy issue, the defendant sought a remand to the FCIC for further consideration without vacating the existing policy. Conversely, the plaintiffs wanted the court to order a reformation of the insurance policy to state that the FCIC will establish a harvest price when there is insufficient published data to otherwise set a harvest price and then order the FCIC to establish a price for 2015. Plaintiffs also moved to certify a class.

Upon reconsideration, the trial court determined that the policy language approved by the Board was not the same as that finalized in the policy offered for sale; that post-approval changes made to the language were "significant" under the regulations then in effect and therefore required resubmission to the Board, which did not occur.  The trial court also determined that the RMA did not have the authority to independently approve and help finalize the policy changes. As such, the defendant violated the APA.  The court denied summary judgment to the defendant and granted the plaintiffs’ summary judgment motion.  The court decided to vacate policy but not force the FCIC to announce a harvest price. The court vacated the agency action and remanded the matter to the FCIC for further consideration.   The court sought to place the responsibility of making the plaintiffs whole again on the FCIC and, on reconsideration, the FCIC must review the policy as if it were an entirely new 508(h) submission and ensure that the policy is not unfair to farmers who purchase the policy.

Conclusion

Crop insurance is very important to many farmers.  However, it is very complex and confusing.  Because it involves the USDA and sub-agencies, the APA must be complied with when approving and making changes to proposed policies. 

July 24, 2022 in Regulatory Law | Permalink | Comments (0)

Saturday, July 23, 2022

Dicamba Spray-Drift Issues and the Bader Farms Litigation

Overview

Dicamba is a broad-spectrum herbicide that was first registered in 1967.  But, over the past several years, spray-drift issues associated with Dicamba have been happening.  Around 2016, Dicamba's use came under significant scrutiny due to its tendency to vaporize from treated fields and spread to neighboring crops.  Incidents in which dicamba affected neighboring fields led to complaints from farmers and fines in some states. A lower volatility formulation, M1768, was approved by the EPA in November 2016.  Dicamba formulations, including those registered in the late 2010s, can be especially prone to volatility, temperature inversions and drift.

Much of the problem has been with the use of XtendiMax with VaporGrip (Monsanto (now Bayer)) and Engenia (BASF) herbicides for use with Xtend soybeans and cotton as Dicamba usage increased in an attempt to control weeds in fields planted with crops that are engineered to withstand it.  Monsanto began offering crops resistant to Dicamba before a reformulated and drift resistant herbicide had gained Environmental Protection Agency (EPA) approval.  The drift issues became bad enough that some states (e.g., Missouri and Arkansas) banned Dicamba because of drift-related damage issues.  The U.S. Environmental Protection Agency imposed restrictions on the use of dicamba in November 2018.

What factors help determine the proper application of Dicamba?  If drift occurs and damages crops in an adjacent field, how should the problem be addressed?  Can the matter be settled privately by the parties involved?  If not, what legal standard applies in resolving the matter – negligence or strict liability?  Will punitive damages be awarded?  If so, will a large jury verdict awarding punitive damages be upheld?

Issues associated with Dicamba drift – that’s the focus of today’s post.

Uniqueness of Dicamba

In many instances, spray drift is a straightforward matter.  The typical scenario involves either applying chemicals in conditions that are unfavorable (such as high wind), or a misapplication (such as not following recommended application instructions).  But, Dicamba is a unique product with its own unique application protocol. 

Consider the following observations: 

  • Dicamba is a very volatile chemical and is rarely sprayed in the summer months. This is because when the temperature reaches approximately 90 degrees Fahrenheit, dicamba will vaporize such that it can be carried by wind for several miles.  This can occur even days after application.
  • The typical causes of spray drift are application when winds are too strong or a misapplication of the chemical.
  • For the newer Dicamba soybeans, chemical manufacturers reformulated the active ingredient to minimize the chance that it would move off-target due to it volatility.
  • Studies have concluded that the new formulations are safe when applied properly, but if a user mixes-in unapproved chemicals, additives or fertilizer, the safe formulations revert to the base dicamba formulation with the attendant higher likelihood of off-target drift.
  • Soybeans have an inherit low tolerance to dicamba. As low as 1/20,000 of an application rate can cause a reaction.  A 1/1000 of rate can cause yield loss.
  • The majority of damaged crops are may not actually result in yield loss. That’s particularly the case if drift damage occurs before flowering.  However, if the drift damage occurs post-flowering the likelihood of yield loss increases. 

Damage Claims – Building a Case

Negligence.  For a person to be deemed legally negligent, certain elements must exist. These elements can be thought of as links in a chain. Each element must be present before a finding of negligence can be obtained.  The first element is that of a legal duty giving rise to a standard of care.  To be liable for a negligent tort, the defendant's conduct must have fallen below that of a “reasonable and prudent person” under the circumstances.  A reasonable and prudent person is what a jury has in mind when they measure an individual's conduct in retrospect - after the fact, when the case is in court. The conduct of a particular tortfeasor (the one causing the tort) who is not held out as a professional is compared with the mythical standard of conduct of the reasonable and prudent person in terms of judgment, knowledge, perception, experience, skill, physical, mental and emotional characteristics as well as age and sanity. For those held out as having the knowledge, skill, experience or education of a professional, the standard of care reflects those factors. For example, the standard applicable to a farmer applying chemicals to crops is what a reasonably prudent farmer would have done under the circumstances, not what a reasonably prudent person would do.

If a legal duty exists, it is necessary to determine whether the defendant's conduct fell short of the conduct of a “reasonable and prudent person (or professional) under the circumstances.”  This is called a breach, and is the second element of a negligent tort case.

Once a legal duty and breach of that duty are shown to exist, a causal connection (the third element) must be established between the defendant's act and (the fourth element) the plaintiff's injuries (whether to person or property).  In other words, the resulting harm to the plaintiff must have been a reasonably foreseeable result of the defendant's conduct at the time the conduct occurred. Reasonable foreseeability is the essence of causality (also known as proximate cause).

For a plaintiff to prevail in a negligence-type tort case, the plaintiff bears the burden of proof to all four elements by a preponderance of the evidence (just over 50 percent).

Typical drift case.  In a straightforward drift case, the four elements are typically satisfied – the defendant misapplied the chemical or did so in high winds (breach of duty to apply chemicals in a reasonable manner in accordance with industry standards/requirements) resulting in damages to another party’s crops.  In addition, the plaintiff is able to pin-down where the drift came from by weather reports for the day of application combined with talking with neighbors to determine the source of the drift (causation).  In many of these situations, a solution is worked out privately between the parties.  In other situations, the disaffected farmer could file a complaint with the state and the state would begin an investigation which could result in a damage award or litigation.

Generally, what are contributing factors to ag chemical drift?  For starters, the liquid spray solution of all herbicides can physically drift off-target.   This often occurs due to misapplication including such things as applying when wind speed exceeds the recommended velocity, improper spray pressure, and not setting the nozzle height at the proper level above the canopy of the intended plant target.  Clearly, not shielding sprayers and aerial application can result in an increased chance of off-site drift.  Also, the possibility of drift to an unintended field can be influenced by droplet size if the appropriate nozzle is not utilized. 

Dicamba drift cases.  As noted above, dicamba is a different product that is more volatile than other crop chemicals.  That volatility and the increased likelihood of drift over a broader geographic area makes it more difficult for a plaintiff to determine the source of the drift.  Thus, the causation element of the plaintiff’s tort claim is more difficult to establish.  In addition, soybeans are inherently sensitive to extremely low dicamba concentrations, thus elevating the potential for damages. 

Dicamba manufacturers have protocols in place to aid in the safe application of the products.  Thus, in quantifiable damage cases, it is likely that an application protocol was not followed.  But, establishing that breach to the satisfaction of a jury could be steep uphill climb for a plaintiff.  That’s particularly the case with dicamba given its heightened volatility.  Damages could be caused by physical drift, temperature, volatility or temperature inversions.  Is a particular cause tied to the defendant’s breach of a duty owed to the plaintiff? 

Clear patterns of injury indicate physical drift which could make the causation element easier to satisfy.  Wind speed at time of application, sprayer speed, sprayer boom height above the plant canopy and nozzle height are also factors that are within the applicator’s control.  Failure to meet common industry standards or manufacturer guidance on any of those points could point toward the breach of a duty and could also weigh on the causation element of a tort claim.

Relatedly, another factor with dicamba, as noted above, is whether it was applied on a hot day.  The chemistry of dicamba has a “vapor curve” that rises with the temperature.  While I have not seen that vapor curve, it would be interesting to see whether that curve has a discernibly steeper slope at a particular temperature.  If so, that would indicate the point at which dicamba becomes very volatile and should not be applied.  To the extent any particular defendant can establish would be able to establish application beyond that temperature, the duty and breach elements of the plaintiff’s tort claim would be easier to satisfy.

Strict liability.  Most pesticide drift cases not involving aerially-applied chemicals are handled under the negligence standard.  However, a strict liability approach is sometimes utilized for aerially applied chemicals.  See, e.g., Langan v. Valicopters, Inc., 567 P.2d 218 (Wash. 1977); but see Mangrum v. Pique, et al., 359 Ark. 373, 198 S.W.3d 496 (2006)(the aerial application of chemicals commonly used in farming communities that are available for sale to the general public is not an ultrahazardous activity triggering application of strict liability).  In such a situation, liability results from damages to others as a result of the chemicals.  It makes no difference whether the applicator followed all applicable rules for applying the chemicals and did so without negligence.  The strict liability rule is harsh, and is normally reserved for ultra-hazardous activities.

The Bader Farms Litigation

The lawsuit – claims and motions.  In Bader Farms, Inc. v. Monsanto Co., et al., No. MDL No. 1:18md2820-SNLJ, 2019 U.S. Dist. LEXIS 114302 (E.D. Mo. July 10, 2019), the plaintiff is Missouri’s largest peach farming operation and is located in the southeast part of the state.  claimed that his peach orchard was destroyed after the defendants (Monsanto and BASF) allegedly conspired to develop and market Dicamba-tolerant seeds and Dicamba-based herbicides. The suit alleged that the two companies collaborated on Xtend (herbicide resistant cotton seed) that was intended for use with a less volatile form of Dicamba with less drift potential.  But, as of 2015 neither Monsanto nor BASF had produced the new, less volatile, form of Dicamba.  That fact led the plaintiff to claim that the defendants released the Dicamba-tolerant seed with no corresponding Dicamba herbicide that could be safely applied.  As a result, the plaintiff claimed, farmers illegally sprayed an old formulation of Dicamba that was unapproved for in-crop, over-the-top, use and was highly volatile and prone to drift.    The plaintiff claimed its annual peach crop revenue exceeded $2 million before the drift damage, and an expert at trial asserted that the drift caused the plaintiff to lose over $20 million in profits.  While many cases had previously been filed on the dicamba drift issue, the plaintiff did not join the other litigation because it focused on damages to soybean crops.  The plaintiff’s suit also involved claims for failure to warn; negligent training; violation of the Missouri Crop Protection Act (MCPA); civil conspiracy; and joint liability for punitive damages. 

Monsanto moved to dismiss the claims for failure to warn; negligent training; violation of the MCPA; civil conspiracy; and joint liability for punitive damages.  BASF moved to dismiss those same counts except the claims for failure to warn. The trial court granted the motion to dismiss in part.  Monsanto argued that the failure to warn claims were preempted by the Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA), but the plaintiff claimed that no warning would have prevented the damage to the peaches. The trial court determined that the plaintiff had adequately plead the claim and denied the motion to dismiss this claim.  Both Monsanto and BASF moved to dismiss the negligent training claim, but the trial court refused to do so. However, the trial court did dismiss the MCPA claims.  The trial court noted that civil actions under the MCPA are limited to “field crops” which did not include peaches.   The trial court, however, did not dismiss the civil conspiracy claim based on concerted action by agreement, but did dismiss the aiding and abetting portion of the claim because that cause of action is not recognized under Missouri tort law.  The parties agreed to a separate jury determination of punitive damages for each defendant

Note:  The case went to trial in early 2020 and was one of more than 100 similar Dicamba lawsuits.  Bayer, which acquired Monsanto in 2018 for $63 billion, announced in June of 2020 that it would settle dicamba lawsuits for up to $400 million.

The jury trial.  At trial, the jury found that Monsanto had negligently designed or failed to warn for 2015 and 2016 and that both defendants had done so for 2017 to the time of trial.  The jury awarded the plaintiff $15 million in compensatory damages and $250 million in punitive damages against Monsanto for 2015 and 2016.  The jury also found that the defendants were acting in a joint venture and in a conspiracy.  The plaintiff submitted a proposed judgment that both defendants were responsible for the $250 million punitive damages award.  BASF objected, but the trial court found the defendants jointly liable for the full verdict considering the jury’s finding that the defendants were in a joint venture.  Bader Farms, Inc. v. Monsanto Co., et al., MDL No. 1:18-md-02820-SNJL, 2020 U.S. Dist. LEXIS 34340 (E.D. Mo. Feb. 28, 2020). 

BASF then moved for a judgment as a matter of law on punitive damages or motion for a new trial or remittitur (e.g., asking the court to reduce the damage award), and Monsanto moved for a judgment as a matter of law or a new trial.  The trial court, however, found both defendants jointly liable, although the court lowered the punitive damages to $60 million (from $250 million) after determining a lack of actual malice.  The trial court did uphold the $15 million compensatory damage award upon finding that the correct standard under Missouri law was applied to the farm’s damages.  Bader Farms, Inc. v. Monsanto Co, et al., MDL No. 1:18md2820-SNLJ, 2020 U.S. Dist. LEXIS 221420 (E.D. Mo. Nov. 25, 2020).  The defendants filed a notice of appeal on December 22, 2020.     

Appellate decision.  In Hahn v. Monsanto Corp., No. 20-3663, 2021 U.S. App. LEXIS 18621 (8th Cir. Jul. 7, 2022), the appellate court partially affirmed the trial court, partially reversed, and remanded the case.  The appellate court determined that the trial court incorrectly instructed the jury to assess punitive damages for Bayer (i.e., Monsanto) and BASF together, rather than separately, and that a new trial was needed to determine punitive damages for each company.  Indeed, the appellate court vacated the punitive damages award and remanded the case to the trial court with instructions to hold a new trial only on the issue of punitive damages. 

However, the appellate court did not disturb the trial court’s jury verdict of $15 million in compensatory damages.  On the compensatory damages issue, the appellate court held that the trial court properly refused to find intervening cause as a matter of law for the damage to the plaintiff’s peaches.  On that point, the appellate court determined that the spraying of Dicamba on a nearby farm did not interrupt the chain of events which meant that the question of proximate cause of the damage was proper for the jury to determine.  The appellate court also held that the was an adequate basis for the plaintiff’s lost profits because the award was not based on speculation.  The appellate court noted that the peach orchard had been productive for decades, and financial statements along with expert witness testimony calculated approximately $20.9 million in actual damages.  The appellate court also determined that the facts supported the jury’s determination that the defendants engaged in a conspiracy via unlawful means – knowingly enabling the widespread use of Dicamba during growing season to increase seed sales.

Conclusion

The Dicamba drift issue has been an important one in agriculture for a few years, particularly with respect to soybean and cotton crops.  But, as the Bader Farms litigation shows, Dicamba drift can also impact other crops.  While the new Dicamba formulations will not eliminate the problem of physical drift, proper application procedures can go a long way to minimizing it.  Likewise, drift issues can also be minimized by communication among farmers to help determine the planting location of particular crops, their relative sensitivities to Dicamba and the necessary setbacks.

July 23, 2022 in Civil Liabilities | Permalink | Comments (0)

Saturday, July 16, 2022

IRS Modifies Portability Election Rule

Overview

With the increase in the exemption equivalent of the unified credit to $12.06 million per person for deaths in 2022, very few estates have any federal estate tax liability.  That means it is often the case that there is a “leftover” (unused) exemption amount at death.  Normally, that unused amount would simply be lost.  However, starting in 2011, upon the death of the first to die of a married couple the estate of the first spouse to die can elect to “port” (transfer) the unused exclusion amount to the surviving spouse.  The amount ported over is added to the existing exclusion amount of the surviving spouse for the surviving spouse to use to either offset lifetime gifts (the federal estate tax and gift tax are “coupled”) or offset estate tax at death. 

Often, the amount ported over is the full $12.06 million that can be ported to the surviving spouse, either because the estate was unplanned and everything automatically passes to the surviving spouse (and is covered by the marital deduction), or because the first spouse’s estate has been intentionally planned with that result in mind.  But, sometimes there are larger estates where some of the first-spouse’s exemption is used to offset federal estates tax.  The unused balance can be ported to the surviving spouse and added to the surviving spouse’s exemption.

But the “porting” of the deceased spouse’s unused exclusion amount (DSUEA) is not automatic.  As indicated above, an election must be made in the deceased spouse’s estate to transfer the DSUEA to the surviving spouse.  The timeframe for making the portability election had been two years from the date of the first spouse’s death.  Now, the IRS has changed that two-year timeframe to five.

The IRS modification of the timeframe for filing a portability election – it’s the topic of today’s post.

The DSUEA Election

Two-year rule.  The Treasury Regulations set the rules for making the DSUEA portability election.  The executor of the estate of the first spouse to die must make the election on a timely-filed federal estate tax return (Form 706).  Treas. Reg. §20.2010-2(a).  To make the election, the deceased spouse must be a U.S. citizen or resident as of the date of death; a federal estate tax return is not required to be filed (because the estate is not large enough to have federal estate tax liability); and no federal estate tax return was filed.  If no Form 706 is filed, the portability election cannot be made.  Treas. Reg. §20.2010(a)(3).  For larger estates that trigger an estate tax liability and the filing of Form 706, any unused DSUEA is automatically ported to the surviving spouse.

As for the portability election, “timely-filed” means nine months after death or, by extension, 15 months after death.  The IRS can grant extensions of time from those deadlines and has done so on numerous occasions by issuing private letter rulings.  Indeed, the IRS grew weary of granting so many extensions that it issued Rev. Proc. 2017-34 in 2017 providing a simplified method for estates to get an automatic extension of time to make the portability election.  2017-26, I.R.B. 1282. With Rev. Proc. 2017-34, the IRS also granted an automatic two-year “grace” period to make the portability election – two years from the date of the decedent’s death.

Note:  If a portability election is not desired upon the death of the first spouse, the executor must state affirmatively on a timely filed Form 706 (or attachment) that the estate is not electing portability under I.R.C. §20.10(c)(5).  For larger estates where there is a Form 706 filing requirement, a box on part 6, section A of Form 706 can be checked if the executor does not want to port over the DSUEA. 

Five-year rule.  Even with the two-year “grace” period provided in Rev. Proc. 2017-34, the IRS still received many requests for an extension of time to make the election.  Those requests, coupled with the shortage of IRS personnel in the Estate and Gift Tax branch has led IRS to supersede Rev. Proc. 2017-34 with Rev. Proc. 2022-32, 2022-30 I.R.B. ___.   Under Rev. Proc. 2022-32, the timeframe for making the portability election is extended to five years from the date of the decedent’s death.  Rev. Proc. 2022-32 is effective for estates of decedents dying on or after July 8, 2022. 

Note:  It continues to be the case that the Form 706 that is filed to make the DSUEA election for a non-taxable estate is a simplified Form 706.  There is no need for any appraisals, and amounts can be rounded down to the nearest $250,000.   Also, the requirement for making the electing referenced above that were contained in Rev. Proc. 2017-34 remain unchanged. 

Conclusion

The DSUEA election is an important part of estate planning for a surviving spouse.  While the federal estate tax exclusion amount is schedule to drop to $5 million (adjusted for inflation in 2011 dollars) for deaths after 2025, any amount ported over presently would remain.  That could be a big deal for a surviving spouse with a sizable estate that dies in a year when the applicable exclusion amount is lower than it is now.  It can also be important when a surviving spouse comes into unexpected wealth that substantially increases the size of the taxable estate.  In any event, the DSUEA portability election is an election that should be made in practically every estate of the first spouse to die of a married couple.  While it may ultimately prove to have been unnecessary, it is always better to be safe than sorry.  Now, IRS has provided a five-year period from the death of the first spouse to make the election.  That’s good news for many estates, farm and non-farm.      

July 16, 2022 in Estate Planning | Permalink | Comments (0)