Saturday, July 31, 2021
An issue that is problematic for many taxpayers that find themselves under audit with the IRS are the potential litigation and administrative costs if the matter were to end up in court. The IRS knows this and, as a result, sometimes asserts a tenuous position in situations where the amount in controversy is not enough to make it worth the taxpayer challenging the IRS position.
When can a taxpayer recover litigation costs against the IRS – it’s the topic of today’s post.
Tax Code Requirements
Under I.R.C. §7430, a taxpayer can receive an award of litigation costs in cases against the United States that involve the determination of any tax, interest or penalty. To be eligible to recover litigation costs, a taxpayer must satisfy four requirements: 1) be the “prevailing party”; 2) have exhausted available administrative remedies within the IRS; 3) not have unreasonably protracted the proceeding; and 4) make a claim for “reasonable” costs. The taxpayer must satisfy all four requirements. See, e.g., Minahan v. Comr., 88 T.C. 492 (1987). The decision to award fees is within the discretion of the Tax Court. That means any decision denying attorney fees to a prevailing taxpayer is reviewed under an abuse of discretion standard.
Note. Under the Tax Court’s rules, a party seeking to recover reasonable litigation costs must file a timely motion in the proper manner. U.S. Tax Court Rules, Title XXIII, Rule 231(a).
Exhaustion. Litigation costs will not be awarded unless the court determines that the prevailing party has exhausted available administrative remedies within the IRS. I.R.C. § 7430(b)(1). For example, when a conference with the IRS Office of Appeals is available to resolve disputes, a party is deemed to have exhausted administrative remedies only by participating in the conference before filing a Tax Court petition or requesting a conference (even if it isn’t granted) before the IRS issues a statutory notice of deficiency. See, e.g, Veal-Hill v. Comr., 812 Fed. Appx. 387 (7th Cir. 2020).
Unreasonable protraction. To be rewarded litigation costs, the taxpayer must not unreasonably protract the proceeding. I.R.C. §7430(b)(3). In Estate of Lippitz, et al. v. Comr., T.C. Memo. 2007-293, the petitioner sought innocent spouse relief and the IRS conceded the case. The petitioner sought to recover litigation costs and the IRS objected. The Tax Court largely rejected as meritless an IRS argument that the petitioner was otherwise disqualified from recovery due to her unreasonable protraction of proceedings. The dispute involved tax deficiencies from 1980-1985 stemming from the now-deceased spouse’s assignment of income to various trusts. The IRS based its argument on the taxpayer's failure to comply with an almost 20-year old summons that the taxpayer had no reason to know about concerning the couple’s joint liability until the IRS later “resurrected” it in 2003.
Prevailing party. Perhaps the requirement that is the most complex and generates the most litigation is that the taxpayer must be the “prevailing party.” A taxpayer can be a “prevailing party” only if the taxpayer satisfies certain net worth requirements or “substantially prevails” with respect to the amount in controversy on “the most significant issue or set of issues presented. I.R.C. §7430(c)(4)(A). An application to recover an award for fees and other expenses must be filed with the court within 30 days of the final judgment in the case. 28 U.S.C. §2412(d)(1)(B).
The net worth requirement is incorporated into the “prevailing party” requirement and specifies that a taxpayer’s net worth must not exceed $2 million. I.R.C. §7430(c)(4)(A)(ii). For this purpose, “net worth” is determined on the basis of the cost of acquisition of assets under generally accepted accounting principles (GAAP) rather than the fair market value of assets. See, e.g, Swanson v. Commissioner, 106 T.C. 76 (1996); see also H.R. Rept. No. 96-1418, 96th Cong., 2d Sess. 15 (1980). Depreciation is taken into account. Also, notes receivable are taken into account under GAAP. The acquisition cost of a note exchanged for cash is the amount of cash received in exchange for the note. If the interest on the note is unstated, it is recorded in the books as having value in an amount that reasonably approximates the fair value of the note.
A taxpayer cannot meet the prevailing party requirement, however, if the IRS takes a position with respect to the taxpayer’s return that is “substantially justified.” In other words, a taxpayer can’t “substantially prevail” if the IRS position is substantially justified.
For the IRS, a substantially justified position is one that has a reasonable basis in fact – one that is supported by sufficient relevant evidence that a reasonable mind might accept as adequate to support a conclusion. See Pierce v. Underwood, 487 U.S. 552 (1988). Reasonableness is based on the facts of the case and legal precedent. Maggie Management Co. v. Comr., 108 T.C. 430 (1997). The IRS position must also have a reasonable basis in law – the legal precedent must substantially support the IRS position based on the facts of the case. The courts have interpreted this standard as requiring sufficient relevant evidence that a reasonable mind might accept as adequate to support a conclusion. See, e.g., Pierce v. Underwood, 487 U.S. 552 (1988). Thus, the IRS could take a position that is substantially justified even if it is incorrect if a reasonable person could believe it to be correct. See, e.g., Maggie Management Co. v. Comr., 108 T.C. 430 (1997). Likewise, the IRS position could be substantially justified where only factual issues are in question. See, e.g., Bale Chevrolet Co. v. United States, 620 F.3d 868 (8th Cir. 2010). Also, the IRS concession of a case or an issue doesn’t mean that its position was unreasonable. It’s merely a factor for consideration.
What the IRS does at the administrative level have no bearing on whether its litigating position is substantially justified. The administrative process and the court process are two separate matters. I.R.C. §7430 distinguishes between administrative and judicial proceedings. See, e.g., Pacific Fisheries, Inc. v. United States, 484 F.3d 1103 (9th Cir. 2007). IRS conduct occurring after the petition is filed is all that matters. This means that the IRS can create a multitude of problems for a taxpayer, justified or not, at the administrative level and fees cannot be recovered because the conduct occurred pre-petition. That is the case even if the IRS conduct during the administrative process caused the litigation. See, e.g., Friends of the Benedictines in the Holy Land, Inc. v. Comr., 150 T.C. 107 (2018).
All of this means that the bar is set rather low for the IRS to establish a litigating position that is substantially justified. Conversely, the bar is set high for a taxpayer to be a “prevailing party” to be able to recover litigation costs.
Note. An exception exists for a “qualified offer.” A qualified offer is one that is made pre-trial. If the taxpayer makes such an offer and the IRS rejects it and the taxpayer goes on to win at the Tax Court, the taxpayer can be compensated for litigation fees that are incurred after the offer was made. I.R.C. §§7430(c)(4)(B)(i); 7430(c)(4)(E)(i).
The Tax Court recently issued an opinion in a case involving the issue of whether the petitioner was entitled to litigation fees. In Jacobs v. Comr., T.C. Memo. 2021-51, the petitioner had been a trial lawyer with the U.S. Department of Justice before becoming a full-time professor at a university in Washington, D.C. During this time, he was also an adjunct professor at another university in Washington, D.C., and a “Visiting Scholar” at yet another university for three months on the West Coast. He ultimately became a professor at a second West Coast university. On his tax returns for these years (2014 and 2015), he claimed $54,000 Schedule C deductions related to payments for meals and lodging for his Visiting Scholar position, the business use of his home, bar association dues and other professional fees, and travel expenses. The IRS audited the returns and denied the deductions.
After a tortured appeals process involving the Taxpayer Advocate Service, the U.S. Treasury Inspector General for Tax Administration, and four IRS Appeals offices, the IRS offered the petitioner a settlement proposal allowing most of the claimed deductions. The petitioner confirmed receipt of the settlement offer, but didn’t respond further. Five months later, the IRS Appeals Office turned the matter over to the IRS Chief Counsel’s Office to prepare the case for trial. At a Tax Court status conference a few days later, the IRS Chief Counsel conceded the case in its entirety and filed a stipulation of settled issues a couple of weeks later.
The petitioner then filed a motion for $32,000 of litigation costs. Those costs included fees for expert witnesses and lawyers. The IRS objected to the motion on the basis that its position in the Tax Court proceedings at the time the answer was filed (that the petitioner was not entitled to the deductions) was substantially justified.
The Tax Court noted that the petitioner bore the burden to establish that his expenses were deductible as ordinary and necessary business expenses under I.R.C. §162 and were not associated with the taxpayer’s activities as an employee. See, e.g., Weber v. Comr., 103 T.C. 378 (1994), aff’d., 60 F.3d 1104 (4th Cir. 1995). The Tax Court determined that a reasonable person could have concluded that a reasonable person could have concluded that the petitioner had not satisfied this burden by the time the IRS filed its answer. Accordingly, the Tax Court denied the petitioner’s motion for litigation costs.
The Jacobs case, although a negative result for the petitioner, is instructive on how difficult it is for a taxpayer to recover litigation costs from the IRS. It’s also an example of how the IRS can create an administrative “nightmare” for the taxpayer causing the taxpayer to ring up thousands of dollars of fees and costs with no hope of recovering those expenses. Litigation fees are only awarded for “litigation” – matters that happen after the IRS files its answer to the taxpayer’s Tax Court petition.
Many taxpayers would conclude that the system is “rigged.” Indeed, the present statutory construct allows the IRS to continue to assert positions with little basis in law when the amount in controversy is less than the anticipated attorney fees without much risk of being challenged in court.
Thursday, July 22, 2021
The scope of the federal government’s regulatory authority via the Clean Water Act (CWA) over “Waters of the United States” (WOTUS) has been controversial for many years. What’s the current status of the law on this issue? It’s an important issue for farmers, ranchers and rural landowners.
Status update of the regulatory definition of a WOTUS – it’s the topic of today’s post.
The scope of the federal government’s CWA regulatory authority over wet areas on private land, streams and rivers has been controversial for more than 40 years. Many court opinions have been filed attempting to define the scope of the government’s jurisdiction. On two occasions, the U.S. Supreme Court attempted to clarify matters, but in the process of rejecting the regulatory definitions of a WOTUS proffered by the Environmental Protection Agency (EPA) and the U.S. Army Corps of Engineers (COE) didn’t provide clear direction for the lower courts. See Solid Waste Agency of Northern Cook County v. United States Army Corps of Engineers, 531 U.S. 159 (2001); Rapanos v. United States, 547 U.S. 175 (2006).
Particularly with its Rapanos decision, the Court failed to clarify the meaning of the CWA phrase “waters of the United States” and the scope of federal regulation of isolated wetlands. The Court did not render a majority opinion in Rapanos, instead issuing a total of five separate opinions. The plurality opinion, written by Justice Scalia and joined by Justices Thomas, Alito and Chief Justice Roberts, would have construed the phrase “waters of the United States” to include only those relatively permanent, standing or continuously flowing bodies of water that are ordinarily described as “streams,” “oceans,” and “lakes.” In addition, the plurality opinion also held that a wetland may not be considered “adjacent to” remote “waters of the United States” based merely on a hydrological connection. Thus, in the plurality’s view, only those wetlands with a continuous surface connection to bodies that are “waters of the United States” in their own right, so that there is no clear demarcation between the two, are “adjacent” to such waters and covered by permit requirement of Section 404 of the CWA.
Justice Kennedy authored a concurring opinion, but on much narrower grounds. In Justice Kennedy’s view, the lower court correctly recognized that a water or wetland constitutes “navigable waters” under the CWA if it possesses a significant nexus to waters that are navigable in fact or that could reasonably be so made. But, in Justice Kennedy’s view, the lower court failed to consider all of the factors necessary to determine that the lands in question had, or did not have, the requisite nexus. Without more specific regulations comporting with the Court’s 2001 SWANCC opinion, Justice Kennedy stated that the COE needed to establish a significant nexus on a case-by-case basis when seeking to regulate wetlands based on adjacency to non-navigable tributaries, in order to avoid unreasonable application of the CWA. In Justice Kennedy’s view, the record in the cases contained evidence pointing to a possible significant nexus, but neither the COE nor the lower court established a significant nexus. As a result, Justice Kennedy concurred that the lower court opinions should be vacated, and the cases remanded for further proceedings.
Justice Kennedy’s opinion was neither a clear victory for the landowners in the cases or the COE. While he rejected the plurality’s narrow reading of the phrase “waters of the United States,” he also rejected the government’s broad interpretation of the phrase. While the “significant nexus” test of the Court’s 2001 SWANCC opinion required regulated parcels to be “inseparably bound up with the ‘waters’ of the United States,” Justice Kennedy would require the nexus to “be assessed in terms of the statute’s goals and purposes” in accordance with the Court’s 1985 opinion in United States v. Riverside Bayview Homes. 474 U.S. 121 (1985).
The “WOTUS Rule”
The Obama Administration attempted take advantage of the lack of clear guidance on the scope of federally jurisdictional wetland by dramatically expanding the federal government’s reach by issuing an expansive WOTUS rule. The EPA/COE regulation was deeply opposed by the farming/ranching and rural landowning communities, and triggered many legal challenges. The courts were, in general, highly critical of the regulation and it became a primary target of the Trump Administration.
The “NWPR Rule”
The Trump Administration essentially rescinded the Obama-era rule with its own rule – the “Navigable Waters Protection Rule” (NWPR). 85 Fed. Reg. 22, 250 (Apr. 21, 2020). The NWPR redefined the Obama-era WOTUS rule to include only: “traditional navigable waters; perennial and intermittent tributaries that contribute surface water flow to such waters; certain lakes, ponds, and impoundments of jurisdictional waters; and wetlands adjacent to other jurisdictional waters. In short, the NWPR narrowed the definition of the statutory phrase “waters of the United States” to comport with Justice Scalia’s approach in Rapanos. Thus, the NWPR excludes from CWA jurisdiction wetlands that have no “continuous surface connection” to jurisdictional waters. The rule much more closely followed the Supreme Court’s guidance issued in 2001 and 2006 that did the Obama-era rule, but it was challenged by environmental groups. Indeed, the NWPR has been challenged in 15 cases filed in 11 federal district courts.
In early 2020, the U.S. Court of Appeals for the Tenth Circuit reversed a Colorado trial court that had entered a preliminary injunction barring the NWPR from taking effect in Colorado as applied to the discharge permit requirement of Section 404 of the CWA. The result of the appellate court’s decision is that the NWPR is effective in every state. Colorado v. United States Environmental Protection Agency, 989 F.3d 874 (10th Cir. 2021).
A primary aspect of the litigation involving the NWPR is whether it should apply retroactively or whether it is limited in its application on a prospective basis. For example, in United States v. Lucero, No. 10074, 2021 U.S. App. LEXIS 6307 and 6327 (9th Cir. Mar. 4, 2021), the defendant, in 2014, operated a business that charged construction companies for the dumping of soil and debris on dry lands near San Francisco Bay. The Environmental Protection Agency (EPA) later claimed that the dry land was a “wetland” subject to the dredge and fill permit requirements of Section 404 of the Clean Water Act (CWA). As a result, the defendant was charged with (and later convicted of) violating the CWA without any evidence in the record that the defendant knew or had reason to know that the dry land was a wetland subject to the CWA. On further review, the appellate court noted that the CWA prohibits the “knowing” discharge of a pollutant into covered waters without a permit. At trial, the jury instructions did not state that the defendant had to make a “knowing” violation of the CWA to be found guilty of a discharge violation. Accordingly, the appellate court reversed on this point. However, the appellate court ruled against the defendant on his claim that the regulation defining “waters of the United States” was unconstitutionally vague, and that the 2020 Navigable Waters Protection Rule should apply retroactively to his case.
The NWPR was also held to apply prospectively only in United States v. Acquest Transit, LLC, No. 09-cv-555, 2021 U.S. Dist. LEXIS 40143 (W.D. N.Y. Mar. 3, 2021) and United States v. Mashni, No. 2:18-cv-2288-DCN, 2021 U.S. Dist. LEXIS 123345 (S.D. S.C. Jul. 1, 2021).
Most recently, a federal district court in South Carolina remanded the NWPR to the EPA. South Carolina Coastal Conservation League, et al. v. Regan, No. 2:20-cv-016787-BHH (D. S.C. Jul. 15, 2021). The NWPR was being challenged on the scope issue. Even though the NWPR was remanded, the court left the rule intact. That fit with the strategy of the present Administration. If the court had invalidated the NWPR, then the Administration would have had to defend the indefensible Obama-era rule in court. That wouldn’t have turned out well for the Administration. Last week’s opinion not vacating the NWPR allows the Administration to proceed in trying to write a new rule without bothering to defend the Obama-era rule in court.
The litigation involving WOTUS will continue, as will the rule-writing. Ultimately, the issue on the scope of the federal government’s regulatory control over wet areas on private property as well as streams and lakes may be back before the Supreme Court.
Saturday, July 17, 2021
Three recent court cases touch on issues that often face clients. One involves the tricky issue of what is a taxpayer’s “tax home.” Another case involves the issue of unforeseen circumstances as an exception to the two-year ownership and usage requirement for the principal residence gain exclusion provision. The final case for discussion today involves the deduction for gambling losses, and a rather unique set of facts.
Recent tax decisions in the courts – it’s the topic of today’s blog post.
Tax “Home” At Issue
Geiman v. Comr., T.C. Memo. 2021-80
An individual’s “tax home” is the geographical area where the person earns the majority of their income. The location of the permanent residence doesn’t matter for this purpose. The tax home is what the IRS uses to determine whether travel expenses for business are deductible. It’s the taxpayer’s regular place of business – the general area where business or work is located.
This distinction between a taxpayer’s personal residence and their tax home often comes into play for those that have an indefinite work assignment(s) that last more than a year. In that situation, the place of the assignment becomes the taxpayer’s tax home. That means that the taxpayer can’t deduct any business-related travel expenses. This points out another key distinction – the costs of traveling back and forth from the tax home for business are deductible, but commuting expenses associated from home to work are not.
That brings us to Mr. Geiman, the petitioner in this case. He was a licensed union journeyman electrician who owned a trailer home and a rental property in Colorado. His membership in his local union near his home gave him priority status for jobs in and around that area. When work dried up in the area near his home, he traveled to jobs he could obtain through other local unions. As a result, he spent most of 2013 working jobs in Wyoming and elsewhere in Colorado. On his 2013 return, he claimed a $39,392 deduction for unreimbursed employee business expenses – meals; lodging; vehicle expenses (mileage); and union dues. He also claimed a deduction of $6,025 for “other” expenses such as a laptop computer, tools, printer and hard drive. The petitioner claimed a home mortgage interest deduction on the 2013 return for the Colorado home. He voted in Colorado, his vehicles were registered there, and he received his mail at his Colorado home. The IRS disallowed the deductions.
The Tax Court noted that a taxpayer can deduct all reasonable and necessary travel expenses “while away from home in pursuit of a trade or business” under I.R.C. §162(a)(2). As noted above, a taxpayer’s “tax home” for this purpose means the vicinity of the taxpayer’s principal place of business rather than personal residence. In addition, when it differs from the vicinity of the taxpayer’s principal place of employment, a taxpayer’s residence may be treated (as noted above) as the taxpayer’s tax home if the taxpayer’s principal place of business is temporary rather than indefinite. If a taxpayer cannot show the existence of both a permanent and temporary abode for business purposes during the tax year, no deductions are allowed.
The Tax Court cited three factors, based on Rev. Rul. 73-529, 1973-2 C.B. 37, for consideration in determining whether a taxpayer has a tax home – (1) whether the taxpayer incurred duplicative living expenses while traveling and maintaining the home; (2) whether the taxpayer has personal and historical connections to the home; and 3) whether the taxpayer has a business justification for maintaining the home. Upon application of the factors, the Tax Court held that the petitioner’s tax home was his Colorado home for 2013. His work consisted of a series of temporary jobs, each of which lasted no more than a few months. That meant that he did not have a principal place of business in 2013. He paid a mortgage on the Colorado home, and had significant personal and historical ties to the area of his Colorado home where he had been a resident since at least 2007. Also, his relationship with the local union near his Colorado home gave him a business justification for making his home where he did in Colorado. Thus, the Tax Court concluded that the petitioner was away from home for purposes of I.R.C. §162(a)(2), allowing him to deduct business-related travel expenses.
But, Geiman had a problem. He didn’t keep good records of his expenses. Ultimately, the Tax Court said what he had substantiated could be deducted. Thus, the Tax Court allowed substantiated meal expenses which were tied to a business purpose to be deducted. The Tax Court also allowed lodging expenses to be deducted to the extent they were substantiated by time, place and business purpose for the expense. The Tax Court also allowed a deduction for business mileage at the IRS rate where it was substantiated by starting and ending point – simply using Google maps was insufficient on this point. The Tax Court also allowed the petitioner’s claimed deductions for union and professional dues, but not “other expenses” for lack of proof that they were incurred as an ordinary and necessary business expense. The end-result was that the Tax Court allowed deductions totaling approximately $7,500.
Unforeseen Circumstances Exception to Two-Rule Home Ownership Rule At Issue
United States v. Forte, No. 2-:18-cv-00200-DBB, 2021 U.S. Dist. LEXIS (D. Utah Jun. 21, 2021)
Upon the sale of the principal residence, a taxpayer can exclude up to $500,000 of the gain from tax. That’s the limit for a taxpayer filing as married filing jointly (MFJ). For a single filer, the limit is $250,000. I.R.C. §121(b)(1-2). To qualify for the exclusion, the taxpayer must own the home and use it as the taxpayer’s principal residence for at least two years before the sale. I.R.C. §121(a). If the two-year requirement can’t be met, a partial exclusion is possible and there are some exceptions that can, perhaps, apply. For example, if the taxpayer’s job changed that required the taxpayer to move to a new location, or health problems required the sale, those are recognized exceptions to the two-year rule. There’s also another exception – an exception for “unforeseen” circumstances. I.R.C. §121(b)(5)(C)(ii)(III). The unforeseen circumstances exception was at issue in a recent case.
In this case, the defendants, a married couple, bought a home in 2000 and lived there until 2005 when they sold it. They put about $150,000 worth of furniture in the home. In 2003, they bought a lot with the intent to build a home. They took out a loan an began construction on the home. They also did not get paid the full contract amount for the 2005 home sale and couldn’t collect fully on the seller finance notes. They experienced financial trouble in 2005, but moved into the new home in December of 2005 and purchased an adjacent lot for $435,000 with the intent to retain a scenic view from their new home.
After moving into their new home, the defendants sought to refinance the loan to a lower interest rate, but were unable to do so due to bad credit. Thus, a friend helped them refinance by allowing them to borrow in his name. They then executed a deed conveying title to the friend. A trust deed named the friend as Trustor for the defendants as beneficiaries. The friend obtained a $1.4 million loan, kept $20,000 of the proceeds and used the balance to pay off the defendants’ loans. The defendants made the mortgage payments on the new loan. In 2006, they also executed a deed for the adjacent lot in the friend’s favor. In 2007, the friend signed a quitclaim deed conveying the home’s title to the defendants. The loan on the home went into default, and the defendants then transferred title to an LLC that they owned. They then sold the home and the adjacent lot for $2.7 million later in September of 2007 and moved out.
An IRS agent filed a report allowing a basis increase in the initial home for the furniture that was sold with that home, and determined that the defendants could exclude $458,333 of gain on the 2007 sale of the new home even though they had not lived there for two years before the sale. Both the IRS and the defendants challenged the agent’s positions and motioned for summary judgment. The defendants claimed that they suffered unexpected financial problems requiring the sale before the end of the two-year period for exclusion of gain under I.R.C. §121. As such, the defendants claimed that they were entitled to a partial exclusion of gain for the period that they did own and use the home.
The court noted that the defendants’ motion for summary judgment required them to show that there was no genuine issue of material fact that the home sale was not by reason of unforeseen circumstances. The court denied the motion. A reasonable jury, the court determined, could either agree or disagree with the agent’s report. While the defendants were experiencing financial problems in 2005 before moving into the new home, the facts were disputed as to when they realized that they would not be able to collect the remaining $695,000 of holdbacks from the buyers of the first home. The court also denied the defendants’ motion that they were entitled to a basis increase for the cost of the furniture placed in the initial home. The defendants failed to cite any authority for such a basis increase.
Drug-Induced Gambling Losses Disallowed
Mancini v. Comr., No. 19-73302, 2021 U.S. App. LEXIS 19362 (9th Cir. Jun. 29, 2021), aff’g., T.C. Memo. 2019-16
All gambling winnings are taxable income. Unless a taxpayer is in the trade or business of gambling, and most aren’t, it’s not correct to subtract losses from winnings and only report the difference. But, a taxpayer that’s not in the trade or business of gambling can list annual gambling losses as an itemized deduction on Schedule A up to the amount of winnings. But, to get around the limitations, can a gambling loss be characterized as casualty loss? This last point was at issue in this case.
The petitioner was diagnosed with Parkinson’s disease in 2004 and began taking prescription medicine to help him control his movements. Over time, the medication dosage was increased. The petitioner had been a recreational gambler, but in 2008 he began gambling compulsively. By the end of 2010 he had drained all of his bank accounts and almost all of his retirement savings. In 2009, he started selling real estate holdings for less than fair market value and used the proceeds to pay his accumulated gambling debt. In 2010, his doctor took him off his medication and his compulsive gambling ceased along with his compulsive cleanliness, and suicidal thoughts. The medication he had been on was known to lead to impulse control disorders, including compulsive gambling.
On his 2008-2010 returns he reported gambling winnings and also deducted gambling losses to the extent of his winnings. He later filed amended returns characterizing the gambling losses as casualty losses. While the Tax Court determined that the compulsive gambling was a likely side effect of the medication, the Tax Court agreed with the IRS that the gambling losses were not deductible under I.R.C. §165. Also, the gambling losses over a three-year period failed the “suddenness” test to be a deductible casualty loss. In addition, the Tax Court found that the petitioner had failed to adequately substantiate the losses. On appeal, the appellate court affirmed.
Tax Court cases with good discussion of issues of relevance to many never cease to keep rolling in.
Thursday, July 15, 2021
The second of the two national conferences on Farm/Ranch Income Tax and Farm/Ranch Estate and Business Planning is coming up on August 2 and 3 in Missoula, Montana. A month later, on September 3, I will be conducting an “Ag Law Summit” at Mahoney State Park located between Omaha and Lincoln, NE.
Upcoming conferences on agricultural taxation, estate and business planning, and agricultural law – it’s the topic of today’s post.
The second of my two 2021 summer conferences on agricultural taxation and estate/business planning will be held in beautiful Missoula, Montana. Day 1 on August 2 is devoted to farm income taxation, with sessions involving an update of farm income tax developments; lingering PPP and ERC issues (as well as an issue that has recently arisen with respect to EIDLs); NOLs (including the most recent IRS Rev. Proc. and its implications); timber farming; oil and gas taxation; handling business interest; QBID/DPAD planning; FSA tax and planning issues; and the prospects for tax legislation and implications. There will also be a presentation on Day 1 by IRS Criminal Investigation Division on how tax practitioners can protect against cyber criminals and other theft schemes.
On Day 2, the focus turns to estate and business planning with an update of relevant court and IRS developments; a presentation on the farm economy and what it means for ag clients and their businesses; special use valuation; corporate reorganizations; the use of entities in farm succession planning; property law issues associated with transferring the farm/ranch to the next generation; and an ethics session focusing on end-of life decisions.
If you have ag clients that you do tax or estate/business planning work for, this is a “must attend” conference – either in-person or online.
For more information about the Montana conference and how to register, click here: https://www.washburnlaw.edu/employers/cle/farmandranchtaxaugust.html
On September 3, I will be holding an “Ag Law Summit” at Mahoney St. Park, near Ashland, NE. The Park is about mid-way between Omaha and Lincoln, NE on the adjacent to the Platte River and just north of I-80. The Summit will be at the Lodge at the Park. On-site attendance is limited to 100. However, the conference will also be broadcast live over the web for those that would prefer to or need to attend online.
I will be joined at the Summit by Prof. Ed Morse of Creighton Law School who, along with Colten Venteicher of the Bacon, Vinton, et al., firm in Gothenburg, NE, will open up their “Ag Entreprenuer’s Toolkit” to discuss the common business and tax issues associated with LLCs. Also on the program will be Dan Waters of the Lamson, et al. firm in Omaha. Dan will address how to successfully transition the farming business to the next generation of owners in the family.
Katie Zulkoski and Jeffrey Jarecki will provide a survey of state laws impacting agriculture in Nebraska and key federal legislation (such as the “30 x 30” matter being discussed). The I will address special use valuation – a technique that will increase in popularity if the federal estate tax exemption declines from its present level. I will also provide an update on tax legislation (income and transfer taxes) and what it could mean for clients.
The luncheon speaker for the day is Janet Bailey. Janet has been deeply involved in Kansas agriculture for many years and will discuss how to create and maintain a vibrant rural practice.
If you have a rural practice, I encourage you to attend. It will be worth your time.
For more information about the conference, click here: https://www.washburnlaw.edu/employers/cle/aglawsummit.html
The Montana and Nebraska conferences are great opportunities to glean some valuable information for your practices. As noted, both conferences will also be broadcast live over the web if you can’t attend in person.
Sunday, July 11, 2021
Farmers use the public roadways to move farm machinery and equipment. Sometimes, mailboxes present issues. What are the rules for placement of mailboxes along rural roads? What if a mailbox is hit? The resolution of the matter will be fact based. Was the mailbox intentionally damaged or destroyed? Was the mailbox located in the proper place? Was the mailbox at the proper height and of the correct size? Was the farm machinery and equipment operating on the public roadway within applicable size and weight limitations? These are all relevant questions.
Moving farm machinery and equipment along a public roadway and the potential hazard presented by mailboxes- it’s the topic of today’s post.
Postal Service Rules
If a mailbox is struck with farm equipment, one issue to check is whether the mailbox was in the proper location and was of the proper height and size. The United States Postal Service (USPS) has rules for the placement of mailboxes. But, the matter is also a mixture of state law. Generally, a mailbox must be 41-45 inches above the road surface and 6-8 inches from the edge of the road. See, e.g., Mailbox Installation, USPS.COM; Section 632, USPS Postal Operations Manual. The meaning of “edge of the road” depends on state law – “shoulder” is defined differently from state-to-state. For rural postal routes, all mailboxes are to be on the right side of the road in the carrier’s direction of travel and be placed in conformity with state laws and highway regulations. If state law is more restrictive than the USPS Operations Manual, state law controls.
The posts for a mailbox are to be made from wood no larger than 4” x 4,” but can also be made out of steel or aluminum no larger than 2” in diameter. However, the posts should be designed to easily bend or fall away in the event of a collision. USPS Operations Manual. The mailbox cannot be constructed in a manner that it is a fixed object that won’t break away when it is struck.
The USPS also has specific mailbox size limitations. All dimensions and designs must be in accordance with USPS rules before a mailbox can be sold to the public at retail. For those that wish to build their own, the mailbox must be approved by the local postmaster. This can be a key point when it comes to large farm equipment utilizing rural roads.
A mailbox that is not in compliance with USPS rules could be creating a “traffic” hazard. The hazard issue not only involves size and height restrictions but can also instruct the issue of where a mailbox is placed. Each state has its own set of regulations on this issue. In some states, a mailbox cannot be placed within a certain distance of an intersection. The distance requirement might expand if the daily traffic is of a particular volume.
If farm equipment accidentally strikes a mailbox that is out of compliance with either federal or state requirements, that fact could absolve the farmer from responsibility for replacing the mailbox.
Roadway Size and Weight Limitations
On the other side of the coin, each state also has regulations governing the weight and size of farm equipment that can travel public roads. A farmer utilizing the public roadways with equipment and machinery exceeding applicable size and/or weight limitations that strikes a mailbox has little defense. The size and weight limitations have come into greater relevance in recent years as farm machinery and equipment have enlarged (in size and weight) along with the size of farming operations. Public roads have not correspondingly widened. Weight limitations are often tied to the number of axles and the distance between the axles. See, e.g., Kan. Stat. Ann. §8-1908. Vehicles exceeding the limitations are not to be driven on public roads. But, in states where the agricultural industry predominates, agricultural equipment and machinery is often exempted. See., e.g., Kan. Stat. Ann. §8-1908. Civil damages to the road are possible for violations. See, e.g., Kan. Stat. Ann. §8-1913.
As for size limitations, the maximum width permitted is generally eight and one-half feet under federal law. But, that limit is inapplicable to “special mobile equipment” including farm equipment or instruments of husbandry. See Federal Size Regulations for Commercial Motor Vehicles, U.S. Department of Transportation: Federal Highway Administration (Oct. 9, 2019); Kan. Stat. Ann. §8-1902(b). However, a state may require a permit for “over-width” farm equipment to be operated on a public roadway in the state, and may adopt additional requirements for width and height than the federal rules. Common rules apply to the transporting of hay loads and combine headers. See, e.g., Kan. Stat. Ann. §§8-1902(d)(2)-(3); 8-1902(e).
Sometimes, existing size and weight limitations are lifted for farm equipment (including farm trucks) during planting and harvesting seasons, and other unique exemptions might apply in certain situations. It’s important to pay attention to a particular state’s rules as well as administrative notices concerning any modification (whether permanent or temporary) to existing rules.
If the operator of farm equipment on a public road is not in compliance with those regulations and strikes a non-compliant mailbox, sorting out the legal liability gets murkier.
Colliding With A Mailbox
A mailbox is federal property. Under federal law, it is unlawful to intentionally destroy a mailbox. Doing so could result in a substantial fine and/or imprisonment of up to three years. 18 U.S.C. §1705. Unintentional damage or destruction to a mailbox will typically require the notification of the property owner and the local police. In addition, local regulations may impose other requirements.
But, for those operating farm equipment and machinery on public roads within the applicable rules that happen to strike a mailbox, being required to pay for the damage caused is probably the worst that will happen.
Farmers often must use the public roads to move farm equipment from field-to-field, to get harvested crops to a local elevator, or for other reasons. The increased size of farm equipment and natural limitations to the width of roads (particularly in the eastern third of the U.S.) present challenges to avoiding mailboxes. It’s good to know the rules that can apply in such situations.
Friday, July 9, 2021
The IRS has finally issued guidance on how farm taxpayers are to handle carryback elections related to farm net operating losses (NOLs) in light of all of the legislative rule changes in recent years.
Handling farm NOLs – it’s the topic of today’s post
The Tax Cuts and Jobs Act (TCJA) limited the deductibility of an NOL arising in a tax year beginning after 2017 to 80 percent of taxable income (computed without the NOL deduction). Under the TCJA, no NOL carryback was allowed unless the NOL related to the taxpayer’s farming business. A farming NOL could be carried back two years, but a taxpayer could make an irrevocable election to waive the carryback. The 80 percent provision also applied to farm NOLs that were carried back for NOLs generated in years beginning after 2017. Under the TCJA, post-2017 NOLs do not expire.
The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) suspended the 80 percent limitation for NOLs through the 2020 tax year. The suspension applies to all NOLs, farm or non-farm, arising in tax years beginning in 2018-2020. The CARES Act also removed the two-year carryback option for farm NOLs and replaced it with a five-year carryback for all NOLs arising in a tax year beginning after 2017 and before 2021. Under the carryback provision, an NOL could be carried back to each of the five tax years preceding the tax year of the loss (unless the taxpayer elected to waive the carryback). That created an issue – some farmers had already carried back an NOL for the two-year period that the TCJA allowed.
The COVID-Related Tax Relief Act (CTRA) of 2020 amended the CARES Act to allow taxpayers to elect to disregard the CARES Act provisions for farming NOLs. This is commonly referred to as the “CTRA election.” Under the CTRA election, farmers that had elected the two-year carryback under the TCJA can elect to retain that carryback (limited to 80 percent of the pre-NOL taxable income of the carryback year) rather than claim the five-year carryback under the CARES Act. In addition, farmers that previously waived an election to carryback an NOL can revoke the waiver.
The CTRA also specifies that if a taxpayer with a farm NOL filed a federal income tax return before December 27, 2020, that disregards the CARES Act amendments to the TCJA, the taxpayer is treated as having made a “deemed election” unless the taxpayer amended the return to reflect the CARES Act amendments by the due date (including extensions of time) for filing the return for the first tax year ending after December 27, 2020. This means that the taxpayer is deemed to have elected to utilize the two-year carryback provision of the TCJA.
On June 30, 2021, the IRS issued Rev. Proc. 2021-14, 2021-29 I.R.B. to provide guidance for taxpayers with an NOL for a tax year beginning in 2018-2020, all or a portion of which consists of a farming loss. The guidance details how the taxpayer can elect to not apply certain NOL rules of the CARES Act, and how the CTRA election can be revoked. Rev. Proc. 2021-14 is effective June 30, 2021.
Affirmative election. The Rev. Proc. specifies that a taxpayer with a farming NOL, other than a taxpayer making a deemed election, may make an “affirmative CTRA election” to disregard the CARES Act NOL amendments if the farming NOL arose in any tax year beginning in 2018-2020. An affirmative election allows the farm taxpayer to carryback a 2018-2020 farm NOL two years instead of five years. To make an affirmative election, the taxpayer must satisfy all of the following conditions:
- The taxpayer must make the election on a statement by the due date, including extensions of time, for filing the taxpayer’s Federal income tax return for the taxpayer’s first tax year ending after December 27, 2020. This means that for calendar year individuals and C corporations, the date is October 15, 2021.
- The top of the statement must state: "The taxpayer elects under § 2303(e)(1) of the CARES Act and Revenue Procedure 2021-14 to disregard the amendments made by § 2303(a) of the CARES Act for taxable years beginning in 2018, 2019, and 2020, and the amendments made by § 2303(b) of the CARES Act that would otherwise apply to any net operating loss arising in any taxable year beginning in 2018, 2019, or 2020. The taxpayer incurred a Farming Loss NOL, as defined in section 1.01 of Rev. Proc. 2021-14 in [list each applicable taxable year beginning in 2018, 2019, or 2020]."
Note. The election is all-or-nothing. The taxpayer must choose either the two-year farm NOL carryback provision for all loss years within 2018-2020, or not.
- The taxpayer attaches a copy of the statement to any original or amended federal income tax return or application for tentative refund on which the taxpayer claims a deduction attributable to a two-year NOL carryback pursuant to the affirmative election.
For taxpayers that follow the Rev. Proc. and make an affirmative election, the Rev. Proc. specifies that the 80 percent limitation on NOLs will apply to determine the amount of an NOL deduction for tax years beginning in 2018-2020, to the extent the deduction is attributable to NOLs arising in tax years beginning after 2017. In addition, the CARES Act carryback provisions will not apply for NOLs arising in tax years beginning in 2018-2020.
Deemed election procedure. In §3.02 of the Rev. Proc., the IRS sets forth the procedure for a taxpayer to follow to not be treated as having made a deemed election. For taxpayers that made a deemed election under the CARES Act, the election applies unless the taxpayer amends the return the deemed election applies to reflecting the CARES Act amendments by due date specified in the Rev. Proc. Also, for taxpayers that made a deemed election under the CARES Act and IRS rejected the two-year carryback claims, Rev. Proc. 2021-014 establishes the steps the taxpayer may take to pursue those claims. Those steps require the taxpayer to submit complete copies of the rejected applications or claims, together with income tax returns for the loss year(s). The top margin of the first page of a complete copy of each application or claim should include, “Deemed Election under Section 3.02(2) of Rev. Proc. 2021-14.” The Rev. Proc. states that resubmission of previously rejected claims should be sent by the Rev. Proc. due date.
Note. The taxpayer is not treated as having made a deemed election if the taxpayer subsequently files an amended return or an application for tentative refund by the due date of the Rev. Proc.
For a taxpayer that elected not to have the two-year carryback period apply to a farming NOL incurred in a tax year beginning in 2018 or 2019, the Rev. Proc. specifies that the taxpayer may revoke the election if the taxpayer made the election before December 27, 2020, and makes the revocation on an amended return by the date that is three years after the due date, including extensions of time, for filing the return for the tax year the farming NOL was incurred. If the NOL is not fully absorbed in the five-year earlier carryback year, the balance carries forward to the fourth year back and subsequent years in the carryback period until it is fully absorbed. The taxpayer may also amend the returns for the years in the five-year carryback period, if needed, to utilize the benefits of I.R.C. §1301 (farm income averaging).
Note. A statement must be attached to the return to revoke the prior election to waive the carryback period. The statement must read as follows: “Pursuant to section 4.01 of Rev. Proc. 2021-14 the taxpayer is revoking a prior I.R.C. §172(b)(1)(B)(iv) or I.R.C. §172(b)(3) election to not have the two-year carryback period provided by I.R.C. §172(b)(1)(B)(i) apply to the farm NOL, as defined in section 1.01 of Rev. Proc. 2021-14, incurred in the taxable year.”
Area of uncertainty. What remains unclear after the issuance of Rev. Proc. 2021-14 is whether the affirmative CTRA election can be made to use the two-year carryback if a farmer had previously waived the five-year carryback. The Rev. Proc. is not clear on this point.
Example. Hamilton Beech is a calendar year farmer. He sustained a farming NOL in 2019. 2017, however, was a good year financially and Hamilton wanted to use the TCJA two-year carryback provision so that he could use the 2019 NOL to offset the impact of the higher tax brackets on his taxable income for 2017. Unfortunately, the CARES Act (enacted into law on March 27, 2020) eliminated the two-year carryback provision leaving Hamilton with the choice of either carrying the 2019 NOL to 2014 or forgoing the five-year carryback. 2014 was a low-income year for Hamilton. Thus, Hamilton elected to waive the five-year NOL carryback provision on his 2019 return that he filed after March 27, 2020 (but before December 27, 2020) and the attached statement made reference to I.R.C. §172(b)(3) and not I.R.C. §172(b)(1)(B)(iv).
Because Hamilton filed his 2019 return after March 27, 2020, and before December 27, 2020, uncertainty exists concerning his ability to make an affirmative election under the Rev. Proc. to disregard the CARES Act five-year NOL carryback provision. If he can, he would be able to use the two-year carryback rule to offset his higher income in 2017. One approach for Hamilton would be for him to amend his 2019 return, citing Rev. Proc. 2021-14, Section 3.01 and state that he has met the conditions of Section 3.01(2).
Note. The taxpayer must also attach a statement to an amended return for the loss year, that states at its top: “Pursuant to section 4.01 of Rev. Proc. 2021-14, the taxpayer is revoking a prior I.R.C. §172(b)(1)(B)(iv) or I.R.C. §172(b)(3) election not to have the two-year carryback period provided by I.R.C. §172(b)(1)(B)(i) apply to the Farming Loss NOL, as defined in section 1.01 of Rev. Proc. 2021-14, incurred in the taxable year.”
Mixed NOLs. If a taxpayer has an NOL that is a mixture of farm and non-farm activities, the portion of the NOL that is attributable to the farming activity may be carried back either two or five years consistent with the guidance of the Rev. Proc. The non-farm portion of the NOL may not be carried back two years. Also, the election to waive the carryback period is all-or-nothing. It is not possible to separately waive a farm NOL carryback from a non-farm NOL.
The Congress has made tax planning with farm NOLs difficult in recent years with numerous rule changes. The recent guidance from the IRS, though issued late, is helpful on several points.
Wednesday, July 7, 2021
The CARES Act that was signed into law in early 2020 is a massive “stimulus” bill designed to help offset the negative economic fallout of the shutdowns decreed by various state governors. An aspect of the CARES Act was an expansion of the Economic Injury Disaster Loans (EIDLs) of the Small Business Administration (SBA). Later legislation provided that EIDL “grants” are not included in gross income and that the exclusion will not result in a denial of a deduction (e.g., deductions are allowed for otherwise deductible expenses paid with loan proceeds), reduction of tax attributes, or denial of a basis increase (e.g., tax basis and other attributes are not reduced as a result of the EIDL being excluded from income).
However, for some farmers and ranchers that receive an EIDL, the accompanying blanket security agreement can create a potential trap for unwary recipients. Recently, Joe Peiffer, founder of Ag & Business Legal Strategies of Hiawatha, Iowa, brought to my attention potential problems for farmers that receive an EIDL based on the language of the SBA’s security agreement that a borrower must sign to receive a secured EIDL.
EIDLs and potential issues with associated security agreements – it’s the topic of today’s post.
An eligible applicant for an EIDL is a small business, small agricultural cooperative, and most private organizations that suffered “substantial economic injury” as a result of the virus and is not able to obtain credit elsewhere.
Note: A qualified agricultural business is one with 500 or fewer employees that is engaged in the production of food and fiber, ranching, raising of livestock, aquaculture, and all other farming and agricultural related industries. 15 U.S.C. §647(b).
“Substantial economic injury” is defined as the business not being able to satisfy its obligations and pay ordinary and necessary operating expenses. For loans approved after April 6, 2021, the maximum loan amount is $500,000 with a term of 30 years at a 3.75 percent fixed rate (2.75 percent for non-profit businesses). There are no fees and no prepayment penalty.
The proceeds of an EIDL are to be used for working capital of the borrower’s business and to cover normal operating expenses – such things as continuing health care benefits for workers; rent; utilities; and fixed debt payments. The loan is not forgivable, as is a Paycheck Protection Program (PPP) loan.
The “EIDL Trap”
SBA security agreement language. An unsecured EIDL can be for up to $25,000, but collateral is required for an EIDL exceeding that threshold. Indeed, for EIDLs exceeding the $25,000 amount, the borrower must sign an SBA blanket security agreement. The security agreement states the following in Paragraph 4:
“The Collateral in which this security interest is granted includes the following property that Borrower now owns or shall acquire or create immediately upon the acquisition or creation thereof: all tangible and intangible personal property, including, but not limited to: (a) inventory, (b) equipment, (c) instruments, including promissory noted (d) chattel paper, including tangible chattel paper and electronic chattel paper, (e) documents, (f) letters of credit rights, (g) accounts, including health-care insurance receivables and credit card receivables, (h) deposit accounts, (i) commercial tort claims, (j) general intangibles, including payment intangibles and software and (k) as-extracted collateral as such terms may from time to time be defined in the Uniform Commercial Code. The security interest Borrower grants includes all accessions, attachments, accessories, parts, supplies and replacements for the Collateral, all products, proceeds and collection thereof and all records and data relating thereto.”
Also included in the SBA security agreement is Paragraph 5 entitled, “Restrictions on Collateral Transfer. This paragraph requires the SBA’s consent before the borrower can sell or encumber the collateral subject to the agreement and reads in pertinent part as follows:
“Borrower will not sell, lease, license or otherwise transfer (including by granting security interests, liens, or other encumbrances in) all or any part of the Collateral or Borrower’s interest in the Collateral without Secured Party’s written or electronically communicated approval, except that Borrower may sell inventory in the ordinary course of business on customary terms…”.
The terms of Paragraph 8, entitled “Perfection of Security Interest,” states as follows:
Borrower consents, without further notice, to Secured Party’s filing or recording of any documents necessary to perfect, continue, amend or terminate its security interest. Upon request of Secured Party, Borrower must sign or otherwise authenticate all documents that Secured Party deems necessary at any time to allow Secured Party to acquire, perfect, continue or amend its security interest in the Collateral. Borrower will pay the filing and recording costs of any documents relating to Secured Party’s security interest. Borrower ratifies all previous filings and recordings, including financing statements and notations on certificates of title. Borrower will cooperate with Secured Party in obtaining a Control Agreement satisfactory to Secured Party with respect to any Deposit Accounts or Investment Property, or in otherwise obtaining control or possession of that or any other Collateral.
Paragraph 14 is entitled, “Borrower Certifications,” and reads as follows:
“Borrower certifies that: (a) its Name (or Names) as stated above is correct; (b) all Collateral is owned or titled in the Borrower’s name and not in the name of any other organization or individual; (c) Borrower has the legal authority to grant the security interest in the Collateral; (d) Borrower’s ownership in or title to the Collateral is free of all adverse claims, liens, or security interests (unless expressly permitted by the Secured Party); (e) none of the Obligations are or will be primarily for personal, family or household purposes; (f) none of the Collateral is or will be used, or has been or will be bought primarily for personal, family or household purposes; (g) Borrower has read and understands the meaning and effect of all terms of this Agreement.”
Implications. This is where Joe’s “heads up” comes into play. He points out that clearly, in accordance with Paragraph 5 of the security agreement, the SBA is requiring a borrower to obtain SBA’s consent before selling or encumbering any EIDL collateral. As noted above, an EIDL is for a term of 30 years – outlasting much farm equipment and other tangible and intangible farm personal property. This poses significant problems for farmers as well as creditors of farm equipment dealers. An SBA release will need to be obtained before engaging in common transactions such as an equipment “trade” – which, for tax years beginning after 2017, is treated as a “sale” of the property and not as a like-kind exchange.
Note: Obtaining the necessary consents from the SBA could be difficult and time-consuming, creating further complications for otherwise ordinary financial transactions.
The requirement contained in Paragraph 8 requiring the EIDL borrower to cooperate with the SBA in obtaining a “Control Agreement” that meets SBA’s approval concerning any deposit accounts or investment property, as well as assisting the SBA in obtaining control or possession of any collateral also raises particular concern. For instance, if a default occurs, all commodity positions of the borrower that are secured by funds in the borrower’s commodity market transactions account (the “hedge” account) would be subject to SBA’s discretion to withdraw. Such a withdrawal would eliminate the farm borrower’s risk management protection via commodity market positions taken in commodities on the Board of Trade.
Uniform Commercial Code, Article 9, Section 320 (UCC §9-320) contains a provision governing a “buyer in the ordinary course of business.” That provision states in subsection (a) that, “Except as otherwise provided in subsection (e), a buyer in ordinary course of business, other than a person buying farm products from a person engaged in farming operations, takes free of a security interest created by the buyer's seller, even if the security interest is perfected and the buyer knows of its existence.
Joe also notes that the protection under UCC §9-320 is not solid. It provides no protection for purchases not within the ordinary course of business. In addition, an exception applies for farm products that are purchased from a person engaged in farming operations. This would include, for example, a livestock operator buying feed or bedding directly from a farmer. Also, the provision only protects security interests that the buyer’s seller creates. It does not afford protection for the seller’s seller or any other party further up the chain. Thus, if a transaction falls within one of these “gaps” and the seller failed to satisfy or obtain lien releases from all of the creditors, those liens and interests will continue in the property.
Note: A buyer of collateral will need to determine how the collateral was acquired and the circumstances surrounding the sale of the collateral. For instance, if a farmer that obtained an EIDL trades equipment to an implement dealer that is subject to SBA’s blanket security agreement, and the dealer does not obtain the release of the SBA’s security interest, the SBA’s interest will continue in the equipment when the dealer sells to its purchasers in the ordinary course of business.
The EIDL program was created in response to the economic shutdowns instituted in many states. It is intended to provide relief to disaffected businesses. However, obtaining an EIDL comes with “strings” that can create a trap for the unwary. The terms of the EIDL security agreements puts significant constraints on EIDL borrowers and can also have implications for others that an EIDL borrower transacts business with.
Thursday, July 1, 2021
Two interesting issues that sometimes come up in the agricultural setting are those involving claims in a decedent’s estate as well as those involving drainage district assessments. Matters involving ag estates are often difficult because family members tend to be involved. Drainage issues can also become contentious and can become tangled in numerous ways.
Reimbursement claims in an estate and drainage district assessments – it’s the topic of today’s post.
Former Trustee Fails to Establish Claims for Reimbursement
In Re Estate of Bronner, No. 20-0747, 2021 Iowa App. LEXIS 488 (Iowa Ct. App. Jun. 16, 2021)
A married couple as operated a 276-acre family farm. Upon the husband’s death, his one-half interest in the farm passed to a family trust for his wife for life, and named a son as trustee. Upon the surviving spouse’s death, the trust would terminate with the remaining assets distributed to the couple’s then surviving children. The surviving spouse and trustee son continued to operate the trust’s farmland. In addition, the trustee rented other land from his mother for his own farming operation, and he paid his annual farm rent by depositing into his mother’s account the amount necessary to cover the loan payment and real estate taxes on the trust’s farmland. The trustee also made insurance premium payments.
Ultimately, the surviving spouse’s cognitive function declined, and she was no longer competent to enter into contracts. The trustee then arranged for the sale of a 76.11-acre parcel of trust farm property to an adjoining landowner through a private sale for $275,000. The net sale proceeds were paid to reduce the amount owed on the existing farm loan. Shortly before the surviving spouse’s death, another son sued the trustee for elder abuse, but later agreed to dismiss his claim in exchange for a court-appointed guardian and conservator for his mother. When the surviving spouse died, the trustee was appointed executor of her estate. The other son sued to remove the trustee son as executor, alleging that he breached his fiduciary duties as trustee by paying farm rent at less than market value and in selling the 76.11-acre parcel of land for less than its market value.
The trial court found that the trustee had breached his fiduciary duties and removed him as trustee. He was not compensated for his services. He was also removed as executor. He then sued to recover for expenditures he made on behalf of his mother and the family trust totaling over $199,000 for farm maintenance/capital improvements; taxes and insurance; appraisal costs; costs associated with prior litigation; and funeral and nursing home/medical expenses. The trial court denied the claims for maintenance and capital improvements, and the appellate court affirmed noting that most of the expenses went to improve his own farming operations or to benefit himself personally, and the invoices he submitted did not establish that he paid the expenses. The appellate court also affirmed the trial court’s denial of reimbursement for taxes and insurance as they were considered part of his farm rent payments and the evidence showed that some were paid by the estate. The appellate court also affirmed the trial court’s denial of appraisal costs because the costs didn’t benefit the trust, and the trial court’s refusal to allow reimbursement for legal expenses because the expenses were court-ordered as part of prior litigation. The former trustee/executor also failed to substantiate that he had paid funeral expenses, and the appellate court affirmed the trial court’s decision to he was not entitled to reimbursement of these costs.
Observation: Keeping good records of transactions personally entered into on behalf of an estate or trust is an essential part of successfully being reimbursed for expenses incurred.
Drainage District Incorrectly Makes Improper Assessment
Union Pacific Railroad Co., et al. v. v. Drainage District 67 Board of Trustees, No. 20-0814, 2021 Iowa App. LEXIS 458 (Iowa Ct. App. Jun. 16, 2021).
In 1913, a wholly owned subsidiary of the plaintiff built a railway within its right-of-way. The right-of-way became included in the defendant’s drainage district that was established in 1915. State law requires drainage districts to keep any improvements in good condition and to pay for repairs, and when a drainage district has insufficient funds to pay for a repair, it must assess the costs of repairs to the property located within it in proportion to the benefit the land receives from the improvement. A classification of benefit remains the same unless the drainage district reclassifies the land. A reclassification commission determines the percentage of actual benefits received by each tract of land and makes an equitable apportionment of the costs of repairs. Apportionment of costs must be made strictly in accordance with the benefits reasonably expected or actually enjoyed.
The defendant constructed an artificial tile to drain the agricultural lands in the district with the main tile crossing the railroad’s right of way. The railroad had been originally assessed 5.81 percent for its share of the drainage benefits in the district. In 2018, the defendant discovered that tile needed repaired or replaced, including a collapse in the tile under the plaintiff’s tracks that, if not repaired, would cause soil to enter the main tile. To comply with federal safety requirements, the portion of the repair running under the right-of-way required steel casing and mechanical restrained leak resistant joints. Use of these materials approximately doubled the cost of using just corrugated plastic pipe. The drainage district received a base bid price of $200,891 for the project. Of that figure, $98,343 was for items necessary to prevent erosion at the railroad crossing – about 49 percent of the project cost. The reclassification commission found that about one-half of the construction costs resulted from federal regulations and determined that the railroad would receive 100 percent of the benefit of compliance. Thus, the reclassification commission recommended that the railroad be assessed one-half of the total cost of repair.
At a public hearing, the railroad objected to the assessment, but the defendant approved it. The plaintiff sued, and the trial court noted that the defendant had the authority to modify an assessment if there was evidence of an erroneous assessment or inequitable apportionment. However, the trial court determined that the plaintiff had satisfied its burden to show that the cost had not been properly assessed. Specifically, the trial court found that the defendant had reclassified the land based on “extra costs” driven by compliance with federal requirements that were not a benefit to the plaintiff so as to lower the assessments to other lands in the district. The appellate court affirmed the trial court’s award of summary judgment for the plaintiff, noting that construction costs are not benefits that may be considered in a reclassification, nor are the costs of federal compliance.
The law intersects with agriculture in many ways. Sometimes production activities are involved, sometimes the two meet at the point of family relationships and transactions, and other times it’s a matter of only tangential connections that can ultimately have an impact on production activities. Often, state law is involved. The two cases discussed in today’s post are an illustration of the myriad of ways that the law can touch agriculture and those involved in it.
Monday, June 28, 2021
The U.S. Tax Court has issued several interesting and important decisions in recent days. Among other matters, the Tax Court has addressed when cost of goods sold can be deducted; when basis reduction occurs as a result of debt forgiveness; the requirements for a theft loss deduction; and the substantiation required for various deductions.
Recent Tax Court cases of interest – it’s the topic of today’s post.
To Recover Cost of Goods Sold, Taxpayer Must Have Gross Receipts From Sale of Goods
BRC Operating Company LLC v. Comr., T.C. Memo. 2021-59
During tax years 2008 and 2009, the petitioner paid about $180 million to acquire minerals and lease interests in West Virginia, Pennsylvania, Ohio and Kentucky. The petitioner planned to explore for, mine and produce natural gas for sale. On Form 1065, the petitioner reported, as costs of goods sold, estimated drilling costs for natural gas exploration and mining in the amount of $100 million for tax year 2008 and $60 million for tax year 2009 and passed those amounts through to investors. However, the petitioner did not drill (except for two test wells), receive drilling services from third parties or receive drilling property during these years. In addition, the petitioner didn’t report any gross receipts or sales during these years that were attributable to the sale of natural gas. The IRS fully disallowed the amounts claimed for costs of goods sold on the basis that the petitioner had failed to satisfy the “all-events” test and the economic performance requirement of I.R.C. §461(h)(1).
The Tax Court upheld the IRS determination, noting that the petitioner conceded that the drilling of the test wells was irrelevant and that it had not received any income from the wells. Thus, it was inappropriate to characterize the passed-through amounts as costs of goods sold in the amount of $100 million for 2008 and $60 million in 2009 for drilling costs for natural gas mining. There were no gross receipts for natural gas for either 2008 or 2009. There were no receipts from the sale of goods to offset by costs.
The Timing of Basis Reduction Associated With Discharged Debt
Hussey v. Comr., 156 T.C. 12 (2021)
In 2009 the petitioner purchased 27 investment properties on which he assumed outstanding loans totaling $1,714,520. By 2012 he was struggling to make payments on the loans. He sold 16 of the properties in 2012, with 15 of them being sold at a loss. After the sales, the lender restructured the the debt and issued a Form 1099-C for each property sold at a loss evidencing the amount of debt forgiven. The petitioner sold additional investment properties in 2013 at a loss. The lender again restructured the debt, but didn’t issue Form 1099-Cs for 2013. In late 2015, the lender noted that $493,141 was the remaining amount to be booked as a loan loss reserve recovery as of October 25, 2015.
After filing an initial return for 2012, the petitioner filed Form 1040X for 2012 on January 14, 2015. The Form 4797 attached to the amended return stated that petitioner had sold 17 properties for a loss totaling $613,263. On Form 982 petitioner reported that he had excludable income of $685,281 "for a discharge of qualified real property business indebtedness applied to reduce the basis of depreciable real property" (i.e., the debt discharged from the lender). On October 15, 2014, the petitioner filed Form 1040 for 2013. On Form 4797 included with that return, petitioner reported that in 2013 he had sold six investment properties and his primary residence (which was also listed as an investment property) for a loss totaling $499,417 ($437,650 for the investment properties and $61,767 for his primary residence). On October 15, 2015, the petitioner filed Form 1040 for 2014. The petitioner reported a net operating loss carryforward of $423,431 from 2013. On Form 982 petitioner reported he had excludable income of $65,914 from a discharge of qualified real property business debt. A Form 1099-C showed that the petitioner received a discharge of debt of $65,914 from the 2014 sale of his primary residence (the same residence reported as sold in his 2013 tax return). The IRS disallowed the loss deductions claimed on petitioner’s 2013 Form 4797. For 2014, the IRS disallowed the loss carryover deduction from 2013.
The issue was whether the basis reduction as a result of the debt discharge occurred in 2012 or 2013. Also, at issue was whether there was any debt discharge in 2013. The Tax Court, in a case of first impression, laid out the statutory analysis. The Tax Court noted that, in general, a taxpayer realizes gross income under I.R.C. §61(a)(11) when a debt is forgiven. But, under I.R.C. §108(a)(1)(D), forgiveness of qualified real property business debt is excluded from income. However, the taxpayer must reduce basis in the depreciable real property under I.R.C. §108(c)(1)(A). I.R.C. §1017 requires the reduction of basis to occur at the beginning of the tax year after the year of discharge. But, I.R.C. §1017(b)(3)(F)(iii) provides that in the case of property taken into account under I.R.C. §108(c)(2)(B) which is related to the exclusion for qualified real property business debt, the reduction of basis occurs immediately before the disposition of the property (if earlier than the beginning of the next taxable year).
The Tax Court reasoned that because the petitioner received a discharge of qualified real property debt and sold properties in 2012, he was required to reduce his bases in the disposed properties immediately before the sales of those properties in 2012. The Tax Court rejected the taxpayer’s arguments that because the aggregated bases in his unsold properties in 2012 exceeded the discharged amount, he did not need to reduce his bases until 2013. The Tax Court noted instead that selling properties from the group triggered I.R.C. §1017(b)(3)(F)(iii) with respect to the bases of the properties sold regardless of the remaining bases in the properties not sold.
Note. The key point of the case is that the basis reduction rule associated with the forgiveness of qualified real property debt is an exception to the general rule that basis reduction occurs in the year following the year of debt discharge.
No Deductible Theft Loss Associated With Stock Purchase
Baum v. Comr., T.C. Memo. 2021-46.
The petitioners, a married couple, bought corporate stock from a third party’s mother after the third party “encouraged” them to do so. The petitioners lost money on the stock and deducted the losses as theft losses on the basis that they were defrauded in the purchase based on false pretenses. The IRS denied the deductions.
Under state (CA) law, theft by false pretenses requires that the defendant to have made a false pretense or representation to the owner of property with the intent to defraud the owner of that property, and that the owner transferred the property to the defendant in reliance on the representation. Here, the Tax Court noted, the petitioners did their own investigation, confirming the information presented to them. They also provided records of communications between them and the promoter about the investments. But they failed to provide specific evidence that the third party’s representations were false or that they were made with the intent to defraud. The Tax Court held that the taxpayers failed to prove the elements for theft by false pretenses and that there was no reasonable prospect of recovery. Accordingly, the Tax Court upheld the IRS position.
Deductions Fail For Lack of Substantiation
Chancellor v. Comr., T.C. Memo. 2021-50
It’s a well-known principle that deductions are a matter of legislative grace. For a taxpayer to take advantage of that grace, the deductions must be substantiated. This grace isn’t freely bestowed. It’s also important to properly categorize deductions. Some reduce gross income to adjusted gross income, while others are of the “below-the-line” type that reduce adjusted gross income to taxable income. Most of the business-related deductions are “above-the-line” while most of those that are non-business are below-the line. There are also substantiation requirements that apply, and another rule that can come into play when the taxpayer doesn’t have the proper documentation to substantiate deductions – the “Cohan” rule (named after entertainer George M. Cohan). The Cohan rule allows the Tax Court to guess at the correct amount of a deduction for a taxpayer when the taxpayer can show that expenses were actually incurred and meet the legal requirement for the deduction being claimed. But, the Cohan rule can be wiped-out by a statute that has very specific substantiation requirements. One such statute is I.R.C. §274(d).
In this case, the petitioner reported approximately $40,000 of income on her 2015 return and claimed about $33,000 of deductions. The deductions included Schedule A deductions of $6,500 for charitable donations and $4,500 for sales taxes. Schedule C deductions were claimed for meals and entertainment; car and truck expense; utilities for a home office; legal fees; advertising; and “other” expenses. The IRS disallowed all of the Schedule C deductions and the Schedule A deductions for charity and sales taxes.
The Tax Court determined that the petitioner could not meet the specific receipt substantiation requirements for the cash donations to charity under I.R.C. §170(f) or for sales taxes. However, the Tax Court could use the sales tax tables to substantiate the sales tax deduction. The Tax Court determined that the petitioner could not satisfy the heightened substantiation deduction requirements of I.R.C. §274(d) or §280A for the Schedule C (business-related) deductions. Claimed deductions associated with the petitioner’s home office, advertising, legal and post office expense could be estimated under the Cohan rule. For those expenses, the petitioner could show some expenditures that were connected to the legal requirements for the particular deduction.
Note. The case is a good one for how the Tax Court sorted out the various types of deductions in terms of the applicable substantiation rules, and whether or not the Cohan rule would apply.
These recent Tax Court decisions are a continuing illustration of the interesting and important issues that are seemingly constantly before the court.
Thursday, June 24, 2021
The power to “take” private property for public use (or for a public purpose) without the owner's consent is an inherent power of the federal and state governments. However, the United States Constitution limits the government's eminent domain power by requiring federal and state governments to pay for what is “taken.” The Fifth Amendment states in part “...nor shall private property be taken for public use without just compensation.”
Whether a taking has occurred is not an issue when the government physically takes the property, with the only issue being whether the taking is compensable and the amount of compensation due to the landowner. However, for non-physical (regulatory) takings, the issue is murkier. At what point does government regulation of private property amount to a compensable taking?
Earlier this week, the U.S. Supreme Court addressed the issue of physical/non-physical takings in a case involving a California strawberry growing operation.
Takings and the constitution – it’s the topic of today’s post.
The power to “take” private property for public use (or for a public purpose) without the owner's consent is an inherent power of the federal and state government. However, the United States Constitution limits the government's eminent domain power by requiring federal and state governments to pay for what is “taken.” The Fifth Amendment states in part “...nor shall private property be taken for public use without just compensation.” The clause has two prohibitions: (1) all takings must be for public use, and (2) even takings that are for public use must be accompanied by compensation. Historically, the “public use” requirement operated as a major constraint on government action. For many years, the requirement was understood to mean that if property was to be taken, it was necessary that it be used by the public – the fact that the taking was “beneficial” was not enough. Eventually, however, courts concluded that a wide range of uses could serve the public even if the public did not, in fact, have possession. Indeed, so many exceptions were eventually built into the general rule of “use by the public” that the rule itself was abandoned.
Actual physical takings of property by the government are easy to identify. When a non-physical taking has occurred is not as easy to spot.
Regulatory (Non-Physical) Takings
A non-physical taking may involve the governmental condemnation of air space rights, water rights, subjacent or lateral support rights, or the regulation of property use through environmental restrictions. How is the existence of a regulatory taking determined? There are several approaches that the Supreme Court has utilized.
Multi-factor balancing test. In a key case decided in 1978, the U.S. Supreme Court set forth a multi-factored balancing test for determining when governmental regulation of private property effects a taking requiring compensation. In Penn Central Transportation Co. et al. v. New York City, 438 U.S. 104 (1978), the Court held that a landowner cannot establish a “taking” simply by being denied the ability to exploit a property interest believed to be available for development. Instead, the Court ruled that in deciding whether particular governmental action effects a taking, the character, nature and extent of the interference with property rights as a whole are the proper focus rather than discrete segments of the owner’s property rights. In 2005, the Court confirmed the multi-factor test and noted that the touchstone for deciding when a regulation is a taking is whether the restriction on property usage is functionally equivalent to a physical taking of the property. Lingle, et al. v. Chevron U.S.A., Inc., 544 U.S. 528 (2005).
Total regulatory taking. In Lucas v. South Carolina Coastal Council, 505 U.S. 1003 (1992), the landowner purchased two residential lots with an intent to build single-family homes. Two years later, the state legislature passed a law prohibiting the erection of any permanent habitable structures on the Lucas property. The law's purpose was to prevent beachfront erosion and to protect the property as a storm barrier, a plant and wildlife habitat, a tourist attraction, and a “natural health environment” which aided the physical and mental well-being of South Carolina's citizens. The law effectively rendered the Lucas property valueless. Lucas sued the Coastal Council claiming that, although the act may be a valid exercise of the state's police power, it deprived him of the use of his property and thus, resulted in a taking without just compensation. The Coastal Council argued that the state had the authority to prevent harmful uses of land without having to compensate the owner for the restriction.
The Supreme Court ruled for Lucas and opined that the state's interest in the regulation was irrelevant since the trial court determined that Lucas was deprived of any economically viable alternative use of his land. The Lucas case has two important implications for environmental regulation of agricultural activities. First, the Lucas court focused solely on the economic viability of the land and made no recognition of potential noneconomic objectives of land ownership. However, in the agricultural sector land ownership is typically associated with many noneconomic objectives and serves important sociological and psychological functions. Under the Lucas approach, these noneconomic objectives are not recognized. Second, under the Lucas rationale, environmental regulations do not invoke automatic compensation unless the regulations deprive the property owner of all beneficial use.
Under the Lucas approach, an important legal issue is whether compensation is required when the landowner has economic use remaining on other portions of the property that are not subject to regulation.
Unconstitutional conditions. In Nollan v. California Coastal Commission,483 U.S. 825 (1987), the plaintiff owned a small, dilapidated beach house and wanted to tear it down and replace it with a larger home. However, the defendant was concerned about preserving the public's viewing access over the plaintiff's land from the public highway to the waterfront. Rather than preventing the construction outright, the defendant conditioned the plaintiff's right to build on the land upon the plaintiff giving the defendant a permanent, lateral beachfront easement over the plaintiff's land for the benefit of the public. Thus, the issue was whether the state could force the plaintiffs to choose between their construction permit and their lateral easement. The Court held that this particular bargain was impermissible because the condition imposed (surrender of the easement) lacked a “nexus” with, or was unrelated to the legitimate interest used by the state to justify its actions - preserving the view. The Court later ruled similarly in Dolan v. Tigard, 512 U.S. 374 (1994). These cases hold that the government may not require a person to give up the constitutional right to receive just compensation when property is taken for a public use in exchange for a discretionary benefit that has little or no relationship to the property. The rule of the cases does not apply to situations involving impact fees and other permit conditions that do not involve physical invasions, but it would apply to monetary exactions where none of the plaintiff’s property is actually taken. See, e.g., Koontz v. St. Johns River Water Management District, 133 S. Ct. 2586 (2013).
State/Local Takings – Seeking a Remedy
For a landowner that has sustained a state/local regulatory (or physical) taking, can compensation be sought initially in federal court or must legal procedures be first pursued in state court with federal courts only available if compensation is denied at the state level? The U.S. Supreme Court answered this question in 1985. In Williamson Regional Planning Commission v. Hamilton Bank of Johnson City, 473 U.S. 172 (1985), the Court held that if a state provides an adequate procedure for seeking just compensation, there is no Fifth Amendment violation until the landowner has used the state procedure and has been denied just compensation. However, 28 U.S.C. §1738, would then be applied with the resulting effect that the failure to receive compensation at the state level generally meant that there was no recourse in the federal courts because of the preclusive effect of the landowner having already litigated the same issue(s) in the state courts. See, e.g., San Remo Hotel L.P., v. City and County of San Francisco, 545 U.S. 323 (2005).
The Court dealt with this “catch-22” in 2019 in Knick v. Township of Scott, 139 S. Ct. 2162 (2019, pointing out that there is a distinction between the substance of a right and the remedy for the violation of that right. It’s the takings clause of the Fifth Amendment that establishes that the government can only take (either physically or via regulation) private property by paying for it. The government’s infringement on private property is what triggers possible compensation. The Constitutional violation has occurred and a state court decision that makes the landowner financially whole simply remedies that violation. It doesn’t redefine the property right. Thus, the majority opinion reasoned, laws confer legal rights and when those rights are violated there must be legal recourse. See, e.g., Marbury v. Madison, 5 U.S. 137 (1803). As the majority noted, “a government violates the Takings Clause when it takes property without compensation, and…a property owner may bring a Fifth Amendment claim [in federal court]… at that time.”
California case. Earlier this week, the Court again dealt with the takings issue in Cedar Point Nursery, et al. v. Hassid, et al., No. 20-107, 2021 U.S. LEXIS 3394 (U.S. Sup. Ct. Jun. 23, 2021). The lead plaintiff is a large strawberry growing operation in California, employing over 400 seasonal workers and about 100 full-time workers. A California labor regulation, based on the California Agricultural Labor Relations Act of 1975 that gives ag employees a right to self-organize, grants labor organizations a “right to take access” to an ag employer’s property in order to solicit support for unionization. Cal Code Regs., tit. 8, §20900(e)(1)(C). Under the regulation, an ag employer must allow union organizers onto their property for up to three hours daily, 120 days per year. In the fall of 2015, at 5 a.m., members of the United Farm Workers entered the plaintiff’s property without any prior notice being given. They entered the plaintiff’s trim shed where hundreds of workers were preparing strawberry plants. The organizers used bullhorns to stir up the workers and encourage them to join in a protest. Other workers left the worksite. The plaintiff filed charges against the union for taking access without notice. In return, the union claimed that the plaintiff had committed an unfair labor practice similar to the claim it had made during the summer of 2015 against a California grower and shipper of table grapes and citrus.
The ag businesses believed that the union would try to enter their properties again in the future, they sued claiming that the access regulation was an unconstitutional per se physical taking of an easement that was given, without compensation, to union organizers. The trial court held that the regulation did not amount to a per se physical taking because it did not “allow the public to access their property in a permanent and continuous manner for whatever reason.” Instead, the trial court held that the regulation was a non-physical taking to be evaluated under the muti-factor balancing test of Penn Central. A majority of the appellate court affirmed, identifying the various types of non-physical takings discussed above and again determining that the balancing test of Penn Central applied. The U.S. Supreme Court agreed to hear the case and reversed.
The Supreme Court determined that an actual physical appropriation of private property was involved. It was a per se governmental taking. The Court noted that the regulation didn’t merely restrict the use of private property, it appropriated it for the use and enjoyment of third parties. One aspect of property ownership is the right to exclude others, and the Court determined that the ability of the union to take access of a part of an ag operation’s private property took that right away. In addition, the right of access, even though temporary, still constitutes a taking. There was no benefit of the loss of a property right flowing back to the ag businesses.
The distinction between outright physical and non-physical takings is not always clear. But, the Court’s decision in Cedar Point Nursery is a clear indication that the loss of the right to exclude others, even on a temporary basis, when no benefit inures to the property owner, is a fundamental property right that will be classified and protected as a physical taking with no balancing test required.
Wednesday, June 23, 2021
I wrote last fall about a legal theory that could have significant negative implications for private property rights in general and agricultural production activities in particular. I was writing about the “public trust” doctrine and you can read last fall’s article here: https://lawprofessors.typepad.com/agriculturallaw/2020/10/the-public-trust-doctrine-a-camels-nose-under-agricultures-tent.html.
I mentioned in last fall’s article that some activist groups and academics are pushing the courts to expand the public trust doctrine beyond its historic application to accomplish certain environmental and conservation objectives. But as I mentioned then, any judicial expansion of the public trust doctrine will result in curtailing vested property rights. That’s a big deal for agriculture because of agriculture’s use of natural resources such as land, air, water, minerals and the like. Expanding the public trust doctrine also takes the power away from citizens and their elected officials to determine environmental and conservation policy.
Recently, the Iowa Supreme Court refused to expand the doctrine to apply to farming practices in the state concluding that the issues involved were political ones that should be left up to the legislature.
The public trust doctrine and a recent Iowa Supreme Court decision – it’s the topic of today’s post.
As I noted last fall, the public trust doctrine is not new. It derives from the seas being viewed as the common property of the public that cannot be privately used or owned. They are held in “public trust.” This concept from England ultimately became part of the U.S. common law and has its primary application to the access of the seashore and intertidal waters.
The U.S. Supreme Court’s first application of the public trust doctrine was in 1842 in Martin v. Lessee of Waddell, 41 U.S.367 (1842). In the case, the issue was who had the right to submerged land and oyster harvesting off the coast of New Jersey. The Court, largely based on the language in the charter granted by the King to a Duke to establish a colony and for policy and economic reasons, determined that the land area in issue belonged to the state of New Jersey for the benefit of the people of the state. The Court dealt with the issue again in 1892 in a case involving a railroad that had been granted a large amount of the Chicago harbor. Illinois Central Railroad Company v. Illinois, 146 U.S. 387 (1892). The Court determined that the government cannot alienate (interfere with) the public’s right to access land under waters that are navigable in fact except for situations where the land involved wouldn’t interfere with the public’s ability to access the water or impair navigation.
As generally applied in the United States (although there are differences among the states), an oceanfront property owner can exclude the public below the mean high tide (water) line. See e.g., Gunderson v. State, 90 N.E. 3d 1171 (Ind. 2018). That’s the line of intersection of the land with the water's surface at the maximum height reached by a rising tide (e.g., high water mark). Basically, it’s the debris line or the line where you would find fine shells. However, traceable to the mid-1600s, Massachusetts and Maine recognize private property rights to the mean low tide line even though they do allow the public to have access to the shore between the low and high tide lines for "fishing, fowling and navigation.” In addition, in Maine, the public can cross private shoreline property for scuba diving purposes. McGarvey v. Whittredge, 28 A.3d 620 (Me. 2011).
Other applications of the public trust doctrine involve the preservation of oil resources, fish stocks and crustacean beds. Also, many lakes and navigable streams are maintained via the public trust doctrine for purposes of drinking water and recreation. But, whether the doctrine applies in such situations is a matter of state law. That’s where the recent Iowa Supreme Court decision comes into play.
Iowa Citizens for Community Improvement, et al. v. State
A long-standing battle in Iowa over the level of nitrates and phosphorous in an Iowa waterway and farm filed runoff came to a head in Iowa Citizens for Community Improvement, et al. v. State,
No. 19-1644, 2021 Iowa Sup. LEXIS 84 (Jun. 18, 2021). For approximately the past decade activist groups and certain academics have sought more regulatory control over farming practices that they deem contribute to excessive nutrients in an Iowa river and higher drinking water prices in Des Moines and elsewhere. They have sought to remove from the state legislature the power to make these decisions and have also sought more federal control.
The plaintiffs, two social justice organizations, sued the State of Iowa and state officials and agencies associated with agriculture and the environment claiming that the public trust doctrine required them to enact legislation and rules forcing farmers to adopt farming practices that would significantly reduce levels of nitrogen and phosphorous runoff into the Raccoon River. The plaintiffs claimed that such a requirement would improve members’ feelings by enhancing aesthetics and recreational uses of the river and by reducing members’ water bills (at least in the Des Moines area). They sought declaratory and injunctive relief.
In response, the State argued that the plaintiffs lacked standing to sue and that the issue was nonjusticiable (i.e., not capable of being decided by a court). After the trial court denied the defendants’ motion to dismiss, the defendants sought an interlocutory appeal (i.e., an appeal of the trial court’s ruling while other aspects of the case proceeded).
On review, the state Supreme Court first noted that the scope of the public trust doctrine in Iowa is narrow, and that the doctrine should not be overextended. The Supreme Court noted that for a party to have standing to sue, they must have a specific personal or legal interest in the litigation and be “injuriously affected.” For a party to be injuriously affected, the Supreme Court stated that the injury complained of must be likely to be redressed by the court’s favorable decision. On that point, the Supreme Court determined that it would be speculative that a favorable court decision would result in a more aesthetically pleasing river or lower water rates.
Further, the Supreme Court determined the injunctive relief was not appropriate and that what the plaintiffs were seeking could only be accomplished through legislation. The Supreme Court pointed out that the plaintiffs admitted that the defendants lacked authority to require limits for nitrogen and phosphorous from agricultural nonpoint sources – the matter was up to the legislature. As a result, the Supreme Court determined the plaintiffs’ claims must be dismissed due to lack of standing.
The plaintiffs also claimed that constitutional due process rights were at stake and the Court should address them. The Supreme Court disagreed, pointing out that the plaintiffs’ own arguments cut against the Court being able to address such a claim. Because the plaintiffs were asking the Court to broaden the application of the public trust doctrine, the plaintiffs were essentially asking the Court to inject itself into political matters where there would be a lack of judicially discoverable and manageable standards. As the Supreme Court pointed out, “different uses matter in different degrees to different people.” Publicly elected policy makers decide these matters. Not the courts.
Consequently, the Court determined that granting any meaningful relief to the plaintiffs would result in the judicial branch asserting superiority over the legislature. An impermissible outcome under the co-equal system of government.
The push for an expansion of the public trust doctrine is not likely to subside. Activists that are unable to win at the ballot box have long tried to use the judicial system to do their policy work for them. Many agricultural activities and uses of natural resources on private property remain at risk of an expanded doctrine. State legislators and all citizens should be aware of the court battles going on over the public use doctrine and what an expansion of the doctrine would do to limit property rights (without compensation).
Sunday, June 20, 2021
The American Rescue Plan Act of 2021 (ARPA) allocated approximately $29 billion to a “Restaurant Revitalization Fund” for grants to help restaurant owners meet payroll and other expenses. ARPA, §5003(b)(2)(A). Another section of ARPA, §1005, is a USDA loan “pay-off” program. But, priority is given to certain restaurants and only certain people can get their ag loans paid off. There’s the rub. If you’re in the select group, all is well. If you’re not, then you are out of luck. But, are the programs constitutional?
The constitutionality of parts of ARPA – that’s the focus of today’s blog post.
Restaurant Revitalization Fund (RRF)
As noted above, ARPA creates a fund for grants to help restaurant owners meet payroll and other expenses. The funded grants are to aid small, privately owned restaurants rather than large chain restaurants. ARPA, §5003(a)(4)(C). The Small Business Administration (SBA) processes the applications and distributes the funds. During the application process, restaurant owners must certify to the SBA that the grant is necessary to support ongoing operations. ARPA, §5003(c)(2)(A).
The fund is not unlimited – the SBA distributes the money from the fund on a first-come, first-served basis, with a catch. The catch is that fund distributions during the first 21 days are restricted to applicants that are at least 51 percent owned and controlled by women, veterans, or the “socially and economically disadvantaged.” ARPA §5003(c)(3)(A). Non-priority restaurants may apply during the initial 21-day period, but they will not receive a grant until the initial period expires. Id. If the fund is depleted by then, the non-priority restaurants will not receive any funds – the fund will not be replenished.
The Vitolo case. In Vitolo v. Guzman, Nos. 21-5517/5528, 2021 U.S. App. LEXIS 16101 (6th Cir. May 27, 2021), the plaintiffs, a married couple, owned a restaurant. The husband is white and his wife is Hispanic, and they each owned 50 percent of the restaurant. They submitted an application on May 3, the first day the RRF became available. That’s when they learned that restaurants that are majority owned by women and minorities would be prioritized and that they weren’t eligible for any grant funds during the priority period. They were notified that they would be eligible for $104,590 from the RRF if money remained in the fund after the priority distribution period. Because the restaurant was not at least 51 percent owned by a woman or veteran, the plaintiffs had to qualify as “socially and economically disadvantaged” to get priority status. ARPA defines social and economic disadvantage by reference to the Small Business Act. Under that legislation, “socially disadvantaged” is defined as a person having been “subjected to racial or ethnic prejudice” or “cultural bias” based solely on immutable characteristics. 15 U.S.C. §637(a)(5); 13 C.F.R. §124.103(a). A person is considered “economically disadvantaged” if (1) he is socially disadvantaged; and (2) he faces “diminished capital and credit opportunities” compared to non-socially disadvantaged people who operate in the same industry. 15 U.S.C. §637(a)(6)(A). If a person falls into one of the racial or ethnic groups, the SBA simply presumes that the person qualifies as socially disadvantaged. If the presumption doesn’t apply, an applicant must prove that they have experienced racial or ethnic discrimination or cultural bias by a preponderance of the evidence.
The plaintiffs sued to end the explicit racial and sex/ethnic priority preferences in the RRF’s grant funding process (13 C.F.R. §124.103) on the basis that the funding was unconstitutionally discriminatory. The trial court did not issue a restraining order or injunction. On appeal, the appellate court granted the plaintiff’s motion for an expedited appeal. The court concluded that the government had no compelling interest in giving some races of people priority access to the RRF, and that the SBA was engaged in nothing less than “racial gerrymandering.” In addition, the appellate court concluded that granting priority to RRF funds to women constituted sex-based discrimination that was presumptively invalid, and that the government failed to provide any “exceedingly persuasive justification” for such discrimination. Indeed, the appellate court pointed out that all women-owned restaurants were prioritized even if they were are not economically disadvantaged. Thus, the government failed to carry its burden of showing that its discriminatory policy passed the substantial-relation test.
Accordingly, the appellate court granted the plaintiff an injunction pending appeal, noting that the plaintiffs will win on the merits of their constitutional claim. The appellate court ordered the government to fund the plaintiff’s grant application upon approval before all later-filed applications without regard to processing time or the applicant’s race or sex. Veteran-owned restaurants can continue to receive priority funding. The preliminary injunction is to remain in place until the case is resolved on the merits, or all appeals are exhausted.
USDA Loan Forgiveness
Section 1005 of ARPA directs the U.S. Secretary of Agriculture to pay up to 120 percent of the outstanding debt in existence as of January 1, 2021, of a “socially disadvantaged farmer or rancher.” H.R. 1319, §1005(a)(2). A “socially disadvantaged farmer or rancher” is defined as a person that is a member of a “socially disadvantaged group” which is defined, in turn, as a group whose members have been subjected to racial or ethnic prejudice because of their identity as members of a group without regard to their individual qualities. H.R. 1319, §1005(b)(3), referencing 7 U.S.C. 2279(a). In short, the loan forgiveness program is based entirely on the race of the farm or ranch borrower.
The payment is to either be a direct pay-off of the borrower’s loan or be paid to the borrower with respect to any of the borrower’s USDA direct farm loans and any USDA-guaranteed farm loan. H.R. 1319, §§1005(a)(2)(A)-(B). Also included is a Commodity Credit Corporation Farm Storage Facility Loan.
On it’s website (https://www.farmers.gov /americanrescueplan), the USDA stated that, “Eligible Direct Loan borrowers will begin receiving debt relief letters from FSA in the mail on a rolling basis, beginning the week of May 24. . . . After reviewing closely, eligible borrowers should sign the letter when they receive it and return to FSA.” It advises that, in June 2021, the FSA will begin to process signed letters for payments, and “about three weeks after a signed letter is received, socially disadvantaged borrowers who qualify will have their eligible loan balances paid and receive a payment of 20% of their total qualified debt by direct deposit, which may be used for tax liabilities and other fees associated with payment of the debt.” Id. $3.8 billion was allocated to the program.
The Foust case. In May the loan forgiveness program was challenged on constitutional grounds as being racially discriminatory. In Foust, et al. v. Vilsack, No. 21-C-548, 2021 U.S. Dist. LEXIS 108719 (E.D. Wisc. Jun. 10, 2021), the court entered a universal temporary restraining order barring the USDA from forgiving any loans pursuant to ARPA §1005 until the court rules on the plaintiffs’ motion for a preliminary injunction. The court noted that the plaintiffs’, twelve white farmers from nine states, would suffer irreparable harm without the issuance of the restraining order; did not have adequate traditional legal remedies; and had likelihood of success on the merits. The court concluded that the USDA lacked a compelling interest for the racial classifications of the loan forgiveness program and failed to target any specific episode of past or present discrimination. The court also determined that the USDA had no evidence of intentional discrimination by the USDA in the implementation of recent ag subsidies and pandemic relief efforts. As such, the USDA failed to establish that it had a compelling interest in remedying the effects of past and present discrimination through the distribution of benefits on the basis of racial classifications.
The court also determined that the plaintiffs were likely to succeed on the merits of their claim that the USDA’s use of race-based criteria in the administration of the program violates their right to equal protection under the law. The court further determined that if it did not issue the injunction, the USDA would spend the allocated funds for the loan forgiveness program and forgive the loans of minority farmers while the case is pending and would have no incentive to provide similar relief on an equitable basis to others. The court stated, “Plaintiffs are excluded from the program based on their race and are thus experiencing discrimination at the hands of their government.” Accordingly, the court held that the plaintiffs had established a strong likelihood that Section 1005 of the ARPA is unconstitutional and that the public interest favored the issuance of a temporary restraining order.
The court’s order bars the USDA from forgiving any loans pursuant to Section 1005 of ARPA until the court rules on the plaintiffs’ motion for a preliminary injunction.
One would think that in 2021, the U.S. government would not be discriminating in its programs based on immutable characteristics. I guess not.
Friday, June 11, 2021
Much environmental legislation and regulation restricting private land use activities is created pursuant to the commerce clause of the United States Constitution. Article I Section 8 of the U.S. Constitution provides in part, “the Congress shall have Power...To regulate Commerce with foreign Nations and among the several states, and with the Indian Tribes.” But, there’s also something known as the “Dormant” Commerce Clause. What is it and how is it relevant to agricultural law and policy?
The Dormant Commerce Clause – it’s the topic of today’s post.
The Dormant Commerce Clause cannot be found in the Constitution. It is a judicially-created doctrine that several U.S. Supreme Court Justices don’t believe in and that special interests groups have utilized to achieve an outcome in the courts that they could not obtain in state legislatures. In essence, the doctrine has been used to create law where there is none with the result of a further expansion of the federal government into what should be purely a state matter. The outcome is that elected state legislators are stripped from establishing policy for their own citizens. For example, with respect to agriculture, this has been evident in the past couple of decades with respect to agricultural “checkoff” programs and anti-corporate farming laws
So what is the “Dormant Commerce Clause”? It is a constitutional law doctrine that says Congress's power to "regulate Commerce ... among the several States" implicitly restricts state power over the same area. In general, the Commerce Clause places two main restrictions on state power – (1) Congress can preempt state law merely by exercising its Commerce Clause power by means of the Supremacy Clause of Article VI, Clause 2 of the Constitution; and (2) the Commerce Clause itself--absent action by Congress--restricts state power. In other words, the grant of federal power implies a corresponding restriction of state power. This second limitation has come to be known as the "Dormant" Commerce Clause because it restricts state power even though Congress's commerce power lies dormant. Willson v. Black Bird Creek Marsh Co., 27 U.S. 245 (1829). The label of “Dormant Commerce Clause” is really not accurate – the doctrine applies when the Congress is dormant, not the Commerce Clause itself.
Rationale. The rationale behind the Commerce Clause is to protect the national economic market from opportunistic behavior by the states - to identify protectionist actions by state governments that are hostile to other states. Generally, the dormant Commerce Clause doctrine prohibits states from unduly interfering with interstate commerce. A recent example on this point is the California legislature enacting Proposition 12 specifying how laying hens are to be raised in other states if those producers want access to the California market.
The U.S. Supreme Court has developed two tests to determine when state regulation has gone too far. Under the first test, states are generally prohibited from enacting laws that discriminate against interstate commerce. City of Philadelphia v. New Jersey, 437 U.S. 617 (1978). Under the second test, the Court balances the burden on interstate commerce against the state's interest in its regulation. Kassel v. Consolidated Freightways Corp., 450 U.S. 662 (1981).
The Court has never held that discrimination between in-state and out-of-state commerce, without more, violates the Dormant Commerce Clause. Instead, the Court has explained that the Dormant Commerce Clause is concerned with state laws that both discriminate between in-state and out-of-state actors that compete with one another, and harm the welfare of the national economy. Thus, a discriminatory state law that harms the national economy is permissible if in-state and out-of-state commerce do not compete. See, e.g., General Motors Corp. v. Tracy, 117 S. Ct. 811, 824-26 (1997).
Conversely, a state law that discriminates between in-state and out-of-state competitors is permissible if it does not harm the national economy. H.P. Hood & Sons, Inc. v. Du Mond, 336 U.S. 525 (1949). That was the basis for the court’s decision in the California Proposition 12 case mentioned above. In that case, National Animal Meat Institute v. Becerra, 825 Fed. Appx. 518 (9th Cir. 2020), aff’g. sub. nom., National Animal Meat Institute v. Becerra, 420 F. Supp. 3d 1014 (C.D. Cal. 2019), Proposition 12 established minimum requirements on farmers to provide more space for egg-laying hens, breeding pigs, and calves raised for veal. Specifically, the law requires that covered animals be housed in confinement systems that comply with specific standards for freedom of movement, cage-free design and minimum floor space. The law identifies covered animals to include veal calves, breeding pigs and egg-laying hens. The implementing regulations prohibit a farm owner or operator from knowingly causing any covered animal to be confined in a cruel manner, as specified, and prohibits a business owner or operator from knowingly engaging in the sale within the state of shell eggs, liquid eggs, whole pork meat or whole veal meat, as defined, from animals housed in a cruel manner. In addition to general requirements that prohibit animals from being confined in a manner that prevents lying down, standing up, fully extending limbs or turning around freely, the measure added detailed confinement space standards for farms subject to the law.
Under Proposition 12, effective January 1, 2022, all pork producers selling in the California market must raise sows in conditions where the sow has 24 square feet per sow. The law also applies to meat processors – whole cuts of veal and pork must be from animals that were housed in accordance with the space requirements of Proposition 12. The plaintiff challenged Proposition 12 as an unconstitutional violation of the Dormant Commerce Clause by imposing substantial burdens on interstate commerce “that clearly outweigh any valid state interest.” The trial court rejected the challenge, finding that the plaintiff failed to establish that the law discriminated against out-of-state commerce for the purpose of economic protectionism. On appeal, the appellate court affirmed. The appellate court determined that the trial court did not abuse its discretion in finding that the plaintiff was not likely to succeed on the merits of its Dormant Commerce Clause claim. The appellate court also stated that the plaintiff acknowledged that Proposition 12 was not facially discriminatory, and had failed to produce sufficient evidence that California had a protectionist intent in enacting the law. The appellate court noted the trial court’s finding that the law was not a price control or price affirmation statute. Similarly, the appellate court held that the trial court did not abuse its discretion in holding that Proposition 12 did not substantially burden interstate commerce because it did not impact an industry that is inherently national or requires a uniform system of regulation. The appellate court noted that the law merely precluded the sale of meat products produced by a specific method rather than burdening producers based on their geographic location.
Unfortunately, the Supreme Court has been careless in applying the anti-discrimination test, and in many cases, neither of the two requirements--interstate competition or harm to the national economy--is ever mentioned. See, e.g., Hughes v. Oklahoma, 441 U.S. 322 (1979). The reason interstate competition goes unstated is obvious – in most cases the in-state and out-of-state actors compete in the same market. But, the reason that the second requirement, harm to the national economy, goes unstated is because the Court simply assumes the issue away. Specifically, the Court assumes that discrimination between in-state and out-of-state competitors necessarily harms the welfare of the national economy, making the second requirement superfluous. The Court simply assumes that free competition among rational economic actors will necessarily improve the national economy. In other words, the Court assumes that individuals can have no impact on the results of the market, and that the rational pursuit of individual self-interest will result in society being better off. But, this is an incorrect assumption – and it’s the primary reason for the existence of anti-trust laws, including the Packers and Stockyards Act, and the real reason behind why, historically, some states have taken action to enact corporate farming laws.
For example, assume that Mary goes to the grocery store to buy steak for Sunday dinner. Mary will evaluate the information that is available in the marketplace by comparing the prices of the different brands along with her perception of their various qualities. Based on her analysis, she will decide which steak product to buy. Price and quality are set by the market, and Mary does not act strategically – she does not take into account any future behavior of the meat department manager or the supplier. However, the purchasing agent for the grocery store who buys meat from suppliers not only considers price and quality, but also the supplier’s future behavior. The purchasing agent will want to know whether the supplier is likely to breach a contract with the grocery store which would result in empty shelves and lost sales. If a breach is anticipated, the purchasing agent may refuse to deal with the supplier regardless of price and quality. So, the purchasing agent will act strategically by considering how the supplier is anticipated to behave. The outcome is that Mary may not actually be getting the best deal that she otherwise could.
Economic theory has a blind spot for strategic behavior – it does not address situations in which people anticipate another’s future conduct. It simply assumes that free competition among rational actors will be efficient. But, the presence of strategic behavior undermines that assumption. That’s where the legal system comes in - to establish appropriate legal rules to provide incentives or disincentives for appropriate economic conduct.
So what does all of this mean? Why is this relevant? The application is that, in some cases, states act strategically. That is, they act in response to the anticipated behavior of other states. In these situations, it is incorrect for any court to build economic assumptions about free competition into its Dormant Commerce Clause anti-discrimination test. In these cases, state discrimination between in-state and out-of-state competitors may actually improve national welfare.
With that much said, in recent years, the most conservative Justices on the Supreme Court have argued for the complete elimination of the dormant Commerce Clause. Former Chief Justice Rehnquist, and former Justice Scalia as well as the most senior member of the current Supreme Court, Justice Thomas, believe that not only is there no textual basis for the Dormant Commerce Clause, but that it actually contradicts, and therefore directly undermines, the Constitution's carefully established textual structure for allocating power between federal and state governments. In a dissent joined by Rehnquist and Scalia, Justice Thomas concluded: "The negative Commerce Clause has no basis in the text of the Constitution, makes little sense, and has proved virtually unworkable in application.” Camps Newfound/Owatonna, Inc. v. Town of Harrison, 117 S. Ct. 1590, 1615 (1997).
How would the Court rule on a Dormant Commerce Clause case if it were to have one? Who knows? But, using the Dormant Commerce Clause to strike down state legislation impacting agriculture, would lead to an expansion of the federal government, a reduction of the role of state legislatures to set policy for their citizens and a further push down the path of globalization. See McEowen, Roger A., South Dakota Amendment E Ruled Unconstitutional – Is There a Future for Legislative Involvement in Shaping the Structure of Agriculture?, 37 Creighton Law Review, 285 (2004). The recent inclusion by the current Administration of including a provision in federal legislation purporting to provide economic relief from the virus barring states from using the funds to enact tax breaks at the state level is an example of the expansion of the power of the federal government over states.
In a 1932 dissenting opinion, Justice Brandeis sounded a warning that remains true today.
“To stay experimentation in things social and economic is a grave responsibility. Denial of the right to experiment may be fraught with serious consequences to the nation. It is one of the happy incidents of the federal system that a single courageous state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country. This Court has the power to prevent an experiment. We may strike down the statute which embodies it on the ground that, in our opinion, the measure is arbitrary, capricious, or unreasonable…. But, in the exercise of this high power, we must be ever on our guard, lest we erect our prejudices into legal principles…”. New State Ice Co. v. Liebmann, 285 U.S. 262 (1932)
The Dormant Commerce Clause is something to watch for in court opinions involving agriculture. As states, enact legislation designed to protect the economic interests of agricultural producers in those states, those opposed to such laws could challenge them on Dormant Commerce Clause grounds. This is one of those legal theory issues that is “floating” around out there that can have a real impact in the lives of farmers and ranchers and how economic activity is conducted.
Wednesday, June 9, 2021
Periodically, I cover recent “happenings” in ag law and tax. It’s been a while since a selected a few developments for summary on this blog. So, today is the day. A snippet of taxes, environmental law and property law
Recent developments in the courts of relevance to agricultural producers, rural landowners and taxpayers in general – it’s the topic of today’s post.
“Roberts Tax” is a “Tax” Entitled to Priority in Bankruptcy
In re Szczyporski, No. 2:20-cv-03133, 2021 U.S. Dist. LEXIS 61628 (E.D. Pa. Mar. 31, 2021).
As you likely recall, in 2012, Chief Justice Roberts of the U.S. Supreme Court badly twisted the law to salvage Obamacare by concluding that Obamacare’s requirement that certain persons buy government-mandated health insurance was constitutional because the mandate was a “tax” withing the taxing power of the Congress – even though Obamacare calls it a “penalty.” National Federation of Independent Businesses v. Sebelius, 567 U.S. 519 (2012). The cost of that “shared responsibility payment” was offset by a credit under I.R.C. §36B. I.R.C. §36B of the grants “premium tax credits” to subsidize certain purchases of health insurance made on “Exchanges.” The tax credit consists of “premium assistance amounts” for “coverage months.” I.R.C. §36B(b)(1). An individual has a coverage month only when he is covered by an insurance plan “that was enrolled in through an Exchange established by the State. I.R.C. §36B(c)(2)(A). The law ties the size of the premium assistance amount to the premiums for health plans which cover the individual “and which were enrolled in through an Exchange established by the State. I.R.C. §36B(b)(2)(A). The credit amount further depends on the cost of certain other insurance plans “offered through the same Exchange. I.R.C. §36B(b)(3)(B)(i).
The tax Code provision that Obamacare created clearly states that the credit is available to a taxpayer only if the taxpayer has enrolled in an insurance plan through “an Exchange established by the State.” I.R.C. §36B(b)(2)(A). When several persons living in a state that didn’t have a state exchange claimed they were exempt from the mandate to buy health insurance because of its cost absent the credit, Chief Justice Roberts again applied his contorted legal logic to conclude that “an Exchange established by the State” meant “an Exchange established by the State or Federal Government.” King v. Burwell, 576 U.S. 473 (2015). In other words, he completely rewrote the law a second time to salvage it.
Note. Justice Scalia had enough of the nonsense of Chief Justice Roberts when he wrote in his dissent in King, “The Court holds that when the Patient Protection and Affordable Care Act says “Exchange established by the State” it means “Exchange established by the State or the Federal Government.” That is of course quite absurd, and the Court’s 21 pages of explanation make it no less so.” He also stated, “Words no longer have meaning if an Exchange that is not established by a State is “established by the State” and “The Court’s next bit of interpretive jiggery-pokery involves other parts of the Act that purportedly presuppose the availability of tax credits on both federal and state Exchanges.”
This all brings us to the current case. In Szczyporski, the debtor was required to file an income tax return in 2018, but hadn’t obtained the government-mandate health insurance resulting in the IRS assessing the “Roberts Tax” for 2018. In 2019, the debtor filed Chapter 13 bankruptcy and the IRS filed a proof of claim for taxes in the amount of $18,027.08 which included the Roberts Tax of $927. The IRS listed the Roberts Tax as an excise tax and the balance of the tax claim as income taxes. The debtors objected on the basis that the Roberts Tax is a penalty that is not qualify for priority treatment under 11 U.S.C. §507(a)(8). The debtor’s Chapter 13 plan was confirmed in 2020, and the IRS filed a brief objecting to the debtor’s tax treatment of the Roberts Tax.
The bankruptcy court ruled that the Roberts Tax was a “tax” under the bankruptcy Code entitled to priority treatment. In re Szczyporski, 617 B.R. 529, 2020 Bankr. LEXIS 1725 (Bankr. E.D. Pa., Jun. 23, 2020). On appeal, the federal district court affirmed, citing National Federation of Independent Businesses v. Sebelius, 567 U.S. 519 (2012). While that decision involved facts outside of the bankruptcy context, the Supreme Court concluded that the Roberts Tax was a “tax” because it was enacted according to the taxing power of the Congress. Thus, it was either an excise or income tax, both of which are entitled to priority in bankruptcy. Here, the district concluded it was an income tax.
Settlement Proceeds Are Taxable Income
Blum v. Comr., T.C. Memo. 2021-18
A damage award that a taxpayer receives that is not attributable to physical injury or physical sickness is includible in gross income. In many lawsuits, there is almost always some lost profit involved and recovery for lost profit is ordinary income. See, e.g., Simko v. Comr., T.C. Memo. 1997-9. For recoveries in connection with a business, if the taxpayer can prove that the damages received were for injury to capital, no income results except to the extent the damages exceed the income tax basis of the capital asset involved. The recovery is, in general, a taxable event except to the extent the amount recovered represents a return of basis. Recoveries representing a reimbursement for lost profit are taxable as ordinary income.
In Blum, the petitioner was involved in a personal injury lawsuit and received a payment of $125,000 to settle a malpractice suit against her attorneys. She did not report the amount on her tax return for 2015 and the IRS determined a tax deficiency of $27,418, plus an accuracy-related penalty. The IRS later conceded the penalty, but maintained that the amount received was not on account of personal physical injuries or personal sickness under I.R.C. §104(a)(2). The Tax Court agreed with the IRS because the petitioner’s claims against the law firm did not involve any allegation that the firm’s conduct had caused her any physical injuries or sickness, but merely involved allegations that the firm had acted negligently in representing her against a hospital.
EPA Properly Approved Missouri Water Quality Standards
Missouri Coalition for the Environment Foundation v. Wheeler, No. 2:19-CV-04215-NKL, 2021 U.S. Dist. LEXIS 102806 (W.D. Mo. Jun. 1, 2021)
In 2009, the state of Missouri proposed water quality standards for nutrient standards for nutrient pollutants in Missouri lakes. The Environmental Protection Agency (EPA) originally rejected the proposed standards, but ultimately accepted a revised version of the standards in 2018. The plaintiffs, a coalition of environmental groups, sued claiming that the water quality standards should be set aside on the basis that the EPA’s determination was arbitrary and capricious. The court upheld the state standards, finding them to have been grounded upon a rational basis that they would adequately protect the designated uses of protected waterbodies.
Plaintiffs’ Use of Road on Defendant’s Property Deemed a Prescriptive Easement
Ramsey v. Keesee, 2021 Ky. App. Unpub. LEXIS 231 (Ky. Ct. App. Apr. 16, 2021)
The plaintiffs each owned property adjacent to the defendant’s eastern boundary line. A road ran along the boundary on the defendant’s property, which was the only local road that connected to a state highway. One of the plaintiffs began maintaining the road without the defendant’s consent. In response, the defendant closed the gate on the road with a lock on it to prevent the plaintiffs from using it. The plaintiffs sued and sought to remove the gate from the road. The trial court determined the plaintiffs had acquired a prescriptive easement over the road by actual, hostile, open and notorious, exclusive and continuous possession of the road for the statutory period of 15 years. As a result, the trial court held that the plaintiffs had the right to use the road for agricultural purposes and to maintain the road in a reasonable manner.
On appeal, the defendant argued that one of the plaintiff’s use of the road two or three times per week did not constitute open and notorious possession because it was insufficient to put the defendant on notice. The appellate court noted that under state common law, it is the legal owner’s actual or imputable knowledge of another’s possession of lands that affects the ownership. As a result, the appellate court held that the plaintiff’s use of the road put the defendant on constructive notice. The defendant then argued that one of the plaintiff’s use of the road was permissive as she had maintained the gates on the road. The plaintiff argued that he always believed the road at issue was an old county road and that he never sought permission to use the road. The appellate court determined that the gates on the road were never intended to prevent the plaintiffs from using the road, but were primarily for farm purposes. The defendant also claimed that the trial court erred in determining the use and location of the prescriptive easement as two of the plaintiffs had not maintained the road. The appellate court noted that maintenance of the road was not a necessary element to establish an easement by prescription. Lastly, the defendant argued that the plaintiffs’ nonuse of the north part of the road resulted in an abandonment of the prescriptive easement. The appellate court noted that mere non-use of an easement does prove that an easement has been abandoned, and held that the plaintiffs occasional use of the road rebutted the defendant’s abandonment claim.
The developments never cease. There will be more as time goes on.
Monday, June 7, 2021
The U.S. legal system has a long history of allowing debtors to hold specified items of property exempt from creditors (unless the exemption is waived). This, in effect, gives debtors a “head start” in becoming reestablished after suffering economic reverses. But, how extensive is the list of exempt property, and does it include federal and state refunds.
The ability (or not) to treat tax refunds as exempt from creditors in bankruptcy – it’s the topic of today’s post.
Bankruptcy Exemptions – The Basics
Typically, one of the largest and most important exemptions is for the homestead. Initially even the exempt property is included in the debtor's estate in bankruptcy, but the exempt assets are soon returned to the debtor. Only nonexempt property is used to pay the creditors.
Each of the 50 states has developed a unique list of exemptions available to debtors. 18 states and the District of Columbia allow debtors to choose between their state exemptions or the federal exemptions. The remaining states have chosen to “opt-out” of the federal exemptions. Under the 2005 Bankruptcy Act, to be able to utilize a state’s exemptions, a debtor must have resided in the state for 730 days preceding the bankruptcy filing. If the debtor did not reside in any one state for 730 days immediately preceding filing, then the debtor may use the exemptions of a state in which the debtor resided for at least 180 days immediately preceding filing. If those requirements cannot be met, the debtor must use the federal exemptions.
Tax Refunds as Exempt Property – The Moreno Case
Each state’s statutory list of exempt assets in bankruptcy will determine the outcome of whether tax refunds are exempt. But, a recent case involving the state of Washington’s exemption list is instructive on how other states might approach the matter.
Facts of Moreno. In In re Moreno, No. 20-42855-BDL, 2021 Bankr. LEXIS 1262 (Bankr. W.D. Wash. May 11, 2021), the debtor filed Chapter 7 (liquidation) bankruptcy in late 2020. The debtor then filed her 2020 federal income tax return on January 28, 2021, and later received a tax refund of $10,631.00. That refund was made up of $572 of withheld taxes; $2,800 of a “Recovery Rebate Credit” (RRC); $1.079 of an Additional Child Tax Credit (ACTC); and $5,500 of an Earned Income Tax Credit (EITC). The bankruptcy trustee sought to include almost all of the debtor’s tax refund in the bankruptcy estate, excluding only 0.3 percent of the total amount ($31.89) based on the debtor’s Chapter 7 filing being December 30, 2020 (i.e., only one day of 2020 fell after the date the debtor filed bankruptcy).
Timing of filing. The debtor claimed that the tax refund arose post-petition because she filed the return post-petition. Consequently, the debtor claimed, the tax refund was not property of the bankruptcy estate. The court disagreed, noting that under 11 U.S.C. §541(a)(1), the bankruptcy estate includes all legal or equitable interests of the debtor in property as of the date the case commences. Based on that, the court determined that the debtor had obtained an interest in the tax refund as she earned income throughout 2020. Thus, the tax refund for the prepetition portion of the tax year were rooted in her prepetition earnings and were property of the bankruptcy estate regardless of the fact that she had to file a return to receive the refund.
RRC. The debtor used the state’s list of exemptions and the trustee conceded that certain portions of the debtor’s prorated tax refund were exempt. Specifically, the trustee did not dispute the debtor's right to retain the full RRC in the amount of $2,800. 11 U.S.C. §541(b)(11), enacted December 27, 2020, specifically excluded the RRC from the debtor’s bankruptcy estate.
Withheld taxes. The debtor filed an amended Schedule C on which she claimed that $572 of her 2020 refund attributable to withheld tax was exempt under state law. The trustee disagreed and the debtor failed to explain how state law applied to withheld taxes. However, the trustee conceded that amount was exempt as personal property (up to a dollar limitation). Rev. Code Wash. §6.15.010(1)(d)(ii). This same part of the state exemption statute, the trustee concluded, entitled the debtor to an additional exemption of $2,630, the balance allowable as exempt personal property after allowing the debtor to exempt $370 in cash and checking accounts.
ACTC and EITC. As for the part of the refund attributable to the ACTC and the EITC, the debtor claimed that it was exempt under Rev. Code Wash. §6.15.010(1)(d)(iv) as any past-due, current or future child support “that is paid or owed to the debtor” or as “public assistance” under Rev. Code Wash. §74.04.280 and 74.04.005. The trustee claimed that the ACTC was encompassed by the remaining “catch-all” exemption for personal property of Rev. Code Wash. §6.15.010(1)(d)(ii). However, the court noted that if the catch-all provision didn’t apply to the ACTC, it could be applied to the debtor’s other debts to the benefit of the debtor. Thus, the court needed to determine whether both the ACTC and the EITC were exempt under state law.
The Court first concluded that neither the ACTC nor the EITC portions of the tax refund constituted “child support” under RCW § 6.15.010(1)(d)(iv). Instead, the court determined that the plain meaning of “child support” refers to payments legally required of parents. That was not the case with neither the ACTC nor the EITC. The court likewise concluded that the credits were not “public assistance” as defined by Rev. Code Wash. §§ 74.04.280 and 74.04.005. Based on state law, the court noted, the credits would have to be “public aid to persons in need thereof for any cause, including…federal aid assistance.” Rev. Code Wash. §74.04.005(11). The court determined that the credits, under this statute, could only possibly be exempt as “federal aid assistance” which is defined under Rev. Code Wash. § 74.04.005(8) to include “[T]he specific categories of assistance for which provision is made in any federal law existing or hereafter passed by which payments are made from the federal government to the state in aid or in respect to payment by the state for public assistance rendered to any category of needy persons for which provision for federal funds or aid may from time to time be made, or a federally administered needs-based program.”
The court determined that the state definition of “federal aid and assistance” applied to assistance in the form of monetary payments from the federal government to needy persons, but did not describe federal tax credits. Instead, tax credits are paid by the federal government directly to taxpayers. However, the court also noted that the statutory definition also included “federal aid assistance” and any “federally administered needs-based program.” As such, it was possible that the credits could be exempt as “assistance” from a “federally administered needs-based program.” On this point, the court noted that there was no statutory language nor legislative history associated with the credits indicating that they were part of a federally administered needs-based program. In addition, there was no caselaw on point that provided any light on the subject. However, disagreeing with the trustee’s objection to the categorization of any federal tax credit as a federally administered needs-based program, the court relied on court opinions from other states construing similarly worded state statutes to conclude that both the ACTC and the EITC were “federally administered needs-based programs” exempt from bankruptcy under Rev. Code Wash. §74.04.280. See In re Farnsworth, 558 B.R. 375 (Bankr. D. Idaho 2016); In re Hardy, 787 F.3d 1189 (8th Cir. 2015); In re Hatch, 519 B.R. 783 (Bankr. S.D. Iowa 2014); In re Tomczyk, 295 B.R. 894 (Bankr. D. Minn. 2003).
The Moreno case, even though it involved the particular language of one state’s exemption statute, provides good insight as to how bankruptcy courts in other states would analyze the issue of whether federal tax credits (and other tax benefits) are exempt from a debtor’s bankruptcy estate.
Saturday, June 5, 2021
Agricultural law is often “law by the exception.” One of those areas of exception involves the exemption from paying overtime wages to workers engaged in agricultural employment. Recently, a federal court issued a decision involving the issue of whether transporting field workers for non-work related activities was within the exemption.
The scope of the exemption for paying overtime for agricultural employment – it’s the topic of today’s post.
Fair Labor Standards Act (FLSA)
The FLSA (29 U.S.C. §§ 201 et seq.) requires that agricultural employers who use 500 man-days or more of agricultural labor in any calendar quarter of a particular year must pay the agricultural minimum wage to certain agricultural employees in the following calendar year. Man-days are those days during which an employee performs any agricultural labor for not less than one hour. The man-days of all agricultural employees count in the 500 man-days test, except those generated by members of an incorporated employer's immediate family. 29 U.S.C. § 203(e)(3). Five hundred man-days is roughly equivalent to seven workers working five and one-half days per week for thirteen weeks (5.5 x 7 x 13 = 501 man-days).
Under the FLSA, “agriculture” is defined to include “among other things (1) the cultivation and tillage of the soil, dairying, the production, cultivation, growing and harvesting of any agricultural or horticultural commodities; (2) the raising of livestock, bees, fur-bearing animals, or poultry; and (3) any practices (including any forestry or lumbering operations) performed by a farmer or on a farm as an incident to or in conjunction with such farming operations, including preparation for market, delivery to storage or to market or to carriers for transportation to market.” 29 U.S.C. § 203(f). For related entities, where not all of the entities involve an agricultural trade or business, the question is whether the business operations are so intertwined that they constitute a single agricultural enterprise exempt from the overtime rules. See, e.g., Ares v. Manuel Diaz Farms, Inc., 318 F.3d 1054 (11th Cir. 2003).
The minimum wage must be paid to all agricultural employees except: (1) members of the employer's immediate family, unless the farm is incorporated; (2) local hand-harvest, piece-rate workers who come to the farm from their permanent residences each day, but only if such workers were employed less than 13 weeks in agriculture in the preceding year; (3) children, age 16 and under, whose parents are migrant workers, and who are employed as hand-harvest piece-rate workers on the same farm as their parents, provided that they receive the same piece-rate as other workers; and (4) employees engaged in range production of livestock. 29 U.S.C. § 213(a)(6). Where the agricultural minimum wage must be paid to piece-rate employees, the rate of pay for piece-rate work must be sufficient to allow a worker reasonably to generate that rate of hourly income.
The FLSA requires covered employers to compensate employees for activities performed during the workday. But, the FLSA does not require that compensation be paid to employees for activities performed outside the workday such as walking, riding or traveling to and from the actual place of performance of the employee’s principal activity, and for activities which occur before and after the employee’s principal activity. On the question of whether an employee is entitled to compensation for time spent waiting at stations where required safety and health equipment is distributed, donned and doffed, and traveling to and from these stations to work sites at the beginning and end of each workday, the U.S. Supreme Court has ruled that such activities are indispensable to an employee’s principal activity and are, therefore, a principal activity itself. However, the Court ruled that unless an employee is required to report at a specific time and wait to don required gear, the time spent waiting to don gear is preliminary to the first principal activity of the workday and is not compensable unless compensation is required by the employment agreement or industry custom and practice. See, e.g., IBP, Inc. v. Alvarez, et al., 546 U.S. 21 (2005). See also De Asencio v. Tyson Foods, Inc., 500 F.3d 361 (3d Cir. 2007), cert. den., sub nom. Tyson Foods, Inc., v. De Asencio, 128 S. Ct. 2902 (2008).
Overtime. The FLSA requires payment of an enhanced rate of at least one and one-half times an employee’s regular rate for work over 40 hours in a week. However, an exemption denies persons employed in agriculture the benefit of mandatory overtime payment. 29 U.S.C. §213(b)(12). The 500 man-days test is irrelevant in this context. In addition, there are specific FLSA hour exemptions for certain employment that is not within the FLSA definition of agriculture.
The 1977 “strawberry” amendment allows an agricultural employer who is required to pay the federal agricultural minimum wage to apply for an administrative waiver permitting the employment of children of others, ages 10 and 11, outside of school hours and for not more than eight weeks in the calendar year. 29 U.S.C. § 213(c)(4). Applicants for the waiver must submit objective data showing a crop with a short harvesting season, unavailability of employees ages 12 and above, a past tradition of employing younger children, and the potential of severe economic disruption if this work force is not available. In addition, the applicant must demonstrate that the level and type of pesticides and other chemicals used will not have an adverse effect on the health or well-being of the individuals to whom the waiver would apply. Compliance with adult field worker standards will not necessarily satisfy this requirement.
In Ramirez v. Statewide Harvesting & Hauling, No. 20-11995, 2021 U.S. App. LEXIS 15215 (11th Cir. May 21, 2021), aff’g., 2019 U.S. Dist. LEXIS 235412 (M.D. Fla., Sept. 30, 2019), the defendant, a fruit-harvesting company, employed primarily temporary foreign guest workers as H-2A harvest workers. As such, the defendant was required to provide housing (and housing amenities) and meals (or free access to a kitchen). The defendant provided cooking facilities rather than meals and contracted for crew leaders to transport the harvest workers to such places as grocery stores, laundromats and banks on a weekly basis. Each trip took four hours, and the crew leaders were not paid overtime when they worked over forty hours in a week. The defendant acknowledged that the crew leaders worked over 40 hours per week on occasion, but claimed that the crew leaders were engaged in “agricultural” employment and, as such, the defendant was exempt from paying overtime wages. Both parties motioned for summary judgment.
The federal trial court referred the motions to a magistrate. The magistrate concluded that the defendant did not fall within the definition of a “farmer.” The magistrate also determined that the transportation of the field workers did not involve work performed on a farm and that the trips were more than just a minor part of the workers job responsibilities. While this indicated that that exemption would not apply, the magistrate recommended that time spent transporting the workers was exempt from the requirement to pay overtime wages because the defendant provided the transportation to be compliant with the H-2A program.
The trial court determined that the activities of the crew leaders were not performed by a farmer. As such, the transportation activities that occurred wholly off of the farm were not exempt from the requirement to pay the overtime wage rate of time and a half for the hours worked exceeding 40 hours per week. 29 U.S.C. §207((a)(1).
The appellate court affirmed, finding that the transportation of the workers did not involve “farming.” The appellate court also determined that the transportation activity did not constitute “secondary agriculture” because it wasn’t performed by a farmer or performed on the farm. In addition, the appellate court concluded that the defendant was not a “farmer” because it did not “own, lease, or control” the farms or crops that the workers harvested. See 29 C.F.R. §780.131. The appellate court also determined that the defendant could not utilize the primary and secondary definition of “agriculture.” The activity at issue did not occur on a “farm.” Thus, because the activity of the crew leaders in transporting the field workers to town and back was not performed on a farm or by a farmer, the appellate court affirmed the plaintiff’s motion for summary judgment.
Agriculture often has special rules that apply in the context of the law, including tax law. The overtime exemption under the FLSA is just one of those unique areas. But, to use the rule for agriculture, one must satisfy the applicable definitions.
Monday, May 31, 2021
The donation of a permanent conservation easement on farm or ranch land can provide a significant tax benefit to the donor. The rules are complex and must be carefully complied with to obtain the tax benefits that are possible – qualified farmers and ranchers can deduct up to 100 percent of their income (i.e., the contribution base). For others, the limit is 50 percent of annual income.
But, the IRS has a history of auditing returns claiming deductions for conservation easements, and winning in court on the issue. But, is the tide starting to turn with respect to one of the IRS “arrows” it uses to attack conservation easement deductions?
The trouble with permanent conservation easement donations and current litigation on the “extinguishment” regulation – it’s the topic of today’s post.
The donation of a permanent conservation easement is accomplished via a transaction that involves a legally binding agreement that is voluntarily entered into between a landowner and qualified charity – some form of land trust or governmental agency. Under the agreement, the landowner allows a permanent restriction on the use of the donated land so as to protect conservation characteristics associated with the tract. See I.R.C. §170(h). But, all of the applicable tax rules must be precisely complied with in order to generate a tax deduction. This is one area of tax law where a mere “foot-fault” can be fatal.
The key to securing a tax deduction for the donation of a permanent conservation easement is the proper drafting of the easement deed (as well as an accurate and detailed appraisal of the property). That’s the instrument that conveys the legal property interest of the easement to the qualified charity (qualified land trust, etc.). This document must be drafted very precisely. For example, the donor must not reserve rights that are conditioned upon the donee’s consent. This is termed a deemed consent provision and it will cause the donated easement to fail to be a perpetual easement – one of the requirements to get a charitable contribution deduction. See Treas. Regs. §§1.170A-14(e)(2); 1.170A-14(g)(1); 1.70A-14(g)(6)(ii).
The IRS also takes the position that the perpetuity requirement is not met if a mortgage on the property is not subordinated. For instance, in Palmolive Building Investors, LLC v. Comr., 149 T.C. 380 (2017), a charitable deduction was denied because the mortgages on the property were not subordinated to the donated façade easements as Treas. Reg. §1.170A-14(g)(2) requires. In addition, the deed at issue stated that the mortgagees had prior claims to extinguishment proceeds. That language violated the requirement set forth in Treas. Reg. §1.170A-14(g)(6)(ii). A savings clause in the deed did not cure the defective language because the requirements of I.R.C. §170 must be satisfied at the time of the easement is donated.
The caselaw also supports the IRS position that development rights and locations for development cannot be reserved on the property subject to the easement if it changes the boundaries for the easement. In other words, the IRS position is that the easement deed language must place a perpetual encumbrance on specifically defined property that is fixed at the time of the grant. However, if the easement only allows the boundary of potential development to be changed on a portion of a larger parcel that is subject to the easement restrictions and neither the acreage of potential development nor the easement is enhance, the perpetuity requirement remains satisfied. See, e.g., Bosque Canyon Ranch II, L.P. v. Comr., 867 F.3d 547 (5th Cir. 2017); Treas. Reg. §1.170A-14(f).
Another problem with easement deeds that the IRS watches for is whether the deed language allows the donor and donee to mutually agree to amend the deed. If this reserved right is present, the IRS takes the position that the easement is not perpetual in nature and does not satisfy the perpetuity requirement of I.R.C. §170(h)(2)(C). But, there is an exception. Amendment language is allowed if any subsequent transfer by the donee (via amendment language in the deed) facilitates the conservation purpose of the original transfer to the donee organization. Treas. Reg. 1.170A-14(c)(2); see also Butler v. Comr., T.C. Memo. 2012-72.
The Extinguishment Regulation
Another requirement of securing a charitable deduction for a donated conservation easement is that the charity must be absolutely entitled to receive a portion of any proceeds received on account of condemnation or casualty or any other event that terminates the easement. Treas. Reg. §1.170A-14(g)(6). This is required because of the perpetual nature of the easement. But, exactly how the allocation is computed is difficult to state in the easement deed. The basic point, however, is that the allocation formula cannot result in what a court (or IRS) could deem to be a windfall to the taxpayer. See, e.g., PBBM-Rose Hill, Ltd. v. Comr., 900 F.3d 193 (5th Cir. 2018); Carroll v. Comr., 146 T.C. 196 (2016). In addition, the allocation formula must be drafted so that it doesn’t deduct from the proceeds allocable to the donee an amount that is attributable to “improvements” that the donor makes to the property after the donation of the permanent easement. If such a reduction occurs, the IRS presently takes the position that no charitable deduction is allowed because the specific requirements of the proceeds allocation formula are not satisfied. This seems counter-intuitive, but it is an IRS audit issue with respect to donations of permanent conservation easements.
If the donee acquires the fee simple interest in the real estate that is subject to the easement, the donee’s ownership of both interests would merge under state law and thereby extinguish the easement. This, according to the IRS, would trigger a violation of the perpetuity requirement. Consequently, deed language may be included to deal with the merger possibility. But, such language is problematic if it allows the donor and donee to contractually agree to extinguish the easement without a court proceeding. Leaving merger language out of the easement deed would seem to result in the IRS not raising the merger argument until the time (if ever) the easement interest and the fee interest actually merge.
Litigation on the extinguishment regulation. The Tax Court has decided a couple of cases recently involving the extinguishment regulation. In Oakbrook Land Holdings, LLC v. Comr., 154 T.C. No. 10 (2020), various investors created the petitioner in 2007 and bought 143 cares on a mountain near Chattanooga, Tennessee for $1.7 million. The following year, the petitioner donated 106 acres to a qualified land trust as a permanent conservation easement and claimed a $9.5 million deduction. The easement deed specified that upon extinguishment of the conservation restriction the donee would receive a share of the proceeds equal to the fair market value of the easement as of the date of the contribution. That value, the deed specified, was to be reduced by the value of any improvements that the donor made after granting the easement.
The IRS denied the charitable deduction for violating the extinguishment regulation of Treas. Reg. §1.170A-14(g)(6), because the qualified land trust was not entitled to a proper proportionate share of proceeds if the easement were acquired through eminent domain at some future date. On the contrary, the easement language in the deed had the effect of allocating to the petitioner all of the value of any land improvements made after the easement was donated. The full Tax Court agreed with the IRS position on the allocation issue, and also upheld the validity of the regulation on the basis that the extinguishment regulation had been properly promulgated and did not violate the Administrative Procedure Act (APA). The full Tax Court also determined that the construction of I.R.C.§170(h)(5), as set forth in the extinguishment regulation, was valid under the agency deference standard set forth in Chevron, U.S.A. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984).
In a related memorandum opinion, Oakbrook Land Holdings, LLC v. Comr., T.C. Memo. 2020-54, the Tax Court held that the easement deed did not create a perpetual easement because the donee’s share of the extinguishment proceeds was based on fixed historical value, reduced by the value of improvements that the donor made. It was not, as it should have been, based on a proportionate share of extinguishment proceeds that are at least equal to the total proceeds (unadjusted by the value of the petitioner’s improvements), multiplied by a fraction defined by the ratio of the fair market value of the easement to the fair market value of the unencumbered property determined as of the date of the execution of the deed. However, the Tax Court did not uphold penalties that the IRS imposed, finding that the petitioner’s position was reasonable.
The Tax Court again upheld its proportionate value approach in a case where the deed granting the easement reduced the donee’s share of the proceeds in the event of extinguishment by the value of improvements (if any) that the donor made. Smith Lake, LLC v. Comr., T.C. Memo. 2020-107. As such, the petitioner had not satisfied the perpetuity requirement of I.R.C. §170(h)(5)(A). The Tax Court upheld the validity of the regulation and the petitioner’s claimed deduction was denied.
Litigation continues at the appellate court. The petitioner in the Oakbrook case has appealed the Tax Court’s opinion to the U.S. Circuit Court of Appeals for the Sixth Circuit, claiming that the Treasury violated the APA in creating the extinguishment regulation by not soliciting comments and failing to reasonably interpret the underlying statute. The petitioner latched onto the Judge Holmes’ dissent in the full Tax Court opinion, that determined that the IRS had not properly considered public comments as the APA required. Judge Holmes viewed the majority interpretation as having the future effect of denying many more charitable deductions associated with conservation easements. The petitioner is also claiming on appeal that the deed language satisfied the perpetuity requirement, and that the petitioner shouldn't be liable to "predict and compensate the donee for hypothetical events outside of the donor's control." The petitioner is also claiming that the IRS arguments concerning the deed language relating to the perpetuity requirement weren’t raised at the Tax Court level and should be barred on appeal. The petitioner also claims that the deed language has been commonly used for over 30 years, and, as such, the current IRS position is contrary to the Congressional purpose of the statute to incentivize conservation.
It will be interesting to see how the Oakbrook case is decided at the Sixth Circuit. A decision is expected by the end of summer. Thousands of permanent conservation easement donations hang in the balance.
Monday, May 24, 2021
For federal estate tax purposes, valuation is typically the primary issue. Quite often, there are more dollars at stake with respect to the valuation issue than with respect to all other issues combined. As such, the facts of a particular case concerning valuation may be more important than applicable law and IRS rulings.
What if ag land has an environmental issue associated with it? Such things as the presence of hazardous materials and wetlands can have a significant impact on land value. But, what is the degree of the impact on value, and how is it measured?
Valuing ag land with environmental concerns – it’s the topic of today’s post.
When valuing agricultural land, it is important to preserve all contemporaneous data applicable to the decedent’s estate. This includes creating a checklist of assets requiring action by others as to evaluation. The checklist should include appraisals, environmental land-use restrictions recorded in the real estate records; environmental audits; and assessment figures for property tax purposes.
If a decedent’s estate contains contaminated real estate, or real estate subject to use restrictions, the estate executor will need to justify a reduction in value for estate tax purposes. That will require sufficient proof of the existence of contamination and any associated land use restrictions as of the date of the decedent’s death and the effect on the land’s value.
Note: Property valuation is also important during the landowner’s life for purposes of gift taxes, property taxes, or to establish a selling price. The issue is complicated by the fact that the effect of contamination on value, like other elements influencing valuation is frequently more subjective than it is tangible and quantifiable.
Two of the big ways that environmental constraints can impact the value of agricultural land involve hazardous materials and wetlands.
Hazardous chemicals/waste. Farms and ranches use various chemicals in the process of raising crops and livestock and operating machinery and equipment. It was not uncommon in the past for a farm or ranch to have a dump site on the premises. Various hazardous substances could be present at those sites. When hazardous chemicals are present, they will increase the cost of owning the property in terms of monitoring and cleanup costs as well as potential legal liability.
In recent years, the IRS has been all over the board on whether cleanup costs are currently deductible or must be capitalized. In short, the answer depends on whether the taxpayer created the mess that is being cleaned up or is cleaning up someone else’s mess. In a 2004 ruling, a corporation in the business of manufacturing products that it placed in inventory was required by state and federal law to clean up the soil and water contaminated by hazardous waste that the corporation had disposed of at the site. The IRS ruled that the soil and groundwater mediation costs had to be capitalized into the costs of the products that the corporation produced. Rev. Rul. 2004-18, 2004-1 C.B. 509. In 2005, the IRS extended the ruling by concluding that environmental remediation costs are more in the nature of repairs than capital improvements and are allocable to the inventory produced in the tax year during which the costs are incurred. Rev. Rul. 2005-42, 2005-2 C.B. 67.
Note: Because costs incurred to clean up environmentally contaminated property may involve a pre-existing material condition or defect, the tangible property regulations could come into play. In such event, remediation costs may be treated as a betterment because they ameliorated a material condition or defect in existence before the taxpayer bought the property, which would require the costs to be capitalized. Capitalization could have a particularly harsh effect on individual landowners, who may be less capable of sustaining a large outlay for cleanup costs without an offsetting deduction. Also, if the property is held merely as an investment and not as part of the landowner’s trade or business, the landowner will be subject to the passive loss rules. Thus, even if the remediation costs are deductible, costs in excess of income from the property may offset only other passive income that the landowner may have. See I.R.C. §469.
The presence of hazardous chemicals/waste will also make the property less desirable in the marketplace.
Wetlands. Wetland laws and regulations restrict land use and may cause the land to be unmarketable and, perhaps, worthless because of the loss of value to the particular property owner. If the restriction eliminates all of the economic value of the property without a federal permit, some court’s have held that a governmental taking has occurred. For example, in 2014, the United States Court of Federal Claims held that the denial of a CWA §404 permit constituted a taking. Lost Tree Village Corporation v. United States, 115 Fed. Cl. 219 (2014), aff’d., 787 F.3d 1111 (Fed. Cir. 2015). Under the facts of the case, the landowner bought the tract at issue as part of a transaction in which the landowner purchased an entire peninsula on which the tract was located. The landowner developed the other land into a gated community and did not treat the tract as part of the same economic unit, but later decided to develop the tract. In order to develop the tract, the landowner needed to acquire a Clean Water Act Section 404 permit. The permit was denied, and the landowner sued for a constitutional taking. Initially, the U.S. Court of Federal Claims determined that a constitutional taking had occurred and that the relevant parcel against which to measure the impact of the permit denial was the tract plus a nearby lot and scattered wetlands located nearby that the landowner owned. On appeal, the U.S. Court of Appeals for the Federal Circuit held that the tract was the relevant parcel. On remand, the Court of Federal Claims, held that the loss of value caused by the permit denial was 99.4 percent of the tract's value, or $4,217,888 based on the difference in the tract's value before and after the permit denial. The court rejected the government's argument that the "before valuation" must account for the permit denial. The court said that the government cannot lower the tract's value by arguing the possibility of the permit denial.
The presence of a wetland on tract can also trigger a reduction in the land’s assessed value for property tax purposes. In a significant case from New Jersey, the New Jersey Superior Court upheld a state tax court decision that reduced a property tax assessment from nearly $20 million to $976,500. Bergen County Associates v. Borough of East Rutherford, 265 N.J. Super. 1, 625 A.2d 524 (1993), certification den., 134 N.J. 482, 634 A.2d 528 (1993). The court found persuasive testimony that indicated that the application process for permits to dredge and fill wetlands had become “much stricter” in the late 1980s, and were “virtually impossible to obtain.” It is important to note that the taxpayer was not denied a permit to fill the property. Instead, the taxpayer went directly to court to argue for a substantial assessed valuation reduction based on the land use restrictions.
On the property tax valuation issue, as long as the property has a value in use (e.g., it is producing income), a lack of marketability will not support a claim for lack of value. However, the IRS Examination Technique Handbook for Estate Tax Examiners instructs IRS estate and gift tax examiners to consult assessment records as good sources of information for estate and gift tax values.
IRS test. The IRS test for valuation is the “willing-buyer/willing-seller” test. Treas. Reg. §§20.2031-1(b); 25.2512-1. For estate (and gift) tax purposes, property must be valued at its fair market value as of the valuation date in accordance with the IRS test. The test necessarily focuses on the marketability of any particular property. But, there is value in use that is separate from marketability. Value in use focuses on value to the particular owner of the property.
Consider the following example:
Kenny Dewitt owns a farm that produces an income stream (net of expenses) of $350,000 per year in harvested crops. Assume that the farm normally would has a capitalization rate of four percent (typical for cropland), producing a “clean” value of $875,000. Due to contamination from leaking underground storage tanks and nitrate contamination of groundwater, the property is neither marketable nor mortgageable, leaving the equity yield (which is generally higher than the cost of debt financing) the primary component of the capitalization rate. In addition, a higher return on equity will be demanded to reflect the additional risk of holding contaminated property and its lack of marketability. As a result, the capitalization rate could easily become eight percent, which decreases the value of the property by 50 percent to $437,500. After this value is calculated, the costs of cleaning up the property still will have to be taken into account.
Note: It’s probably overly simplistic to determine the “clean value” of a property and then subtract the cost of cleanup. Additional factors such as contingent liabilities to the public and stigmatization may affect value to at least the same extent as the actual remediation costs.
Stigma. A physical cleanup of a tract does not eliminate the loss of value resulting from stigmatization. Even when property has been cleaned up to the satisfaction of the state and federal government, potential buyers tend to remain reluctant, making the property less desirable in the marketplace. Additionally, if interested buyers can be found, lenders may be reluctant to finance the acquisition of contaminated or potentially contaminated property. That could make financing the property more costly. That, in turn, can impact market value. Thus, it’s safe to say that external environmental factors can influence market value.
Buying agricultural land often is fairly straightforward. However, when environmental factors are present determining fair market value takes on a completely different twist.
Friday, May 21, 2021
The first of two summer conferences focusing on agricultural taxation and farm/ranch estate and business planning sponsored by Washburn Law School is coming up soon on June7-8. The live presentation will be at the Shawnee Lodge and Conference Center near West Portsmouth, Ohio. Attendance may also be online because we will be broadcasting the conference live.
This year’s conference includes a component focusing on the farm economy. I want to focus on that presentation for today’s article. Understanding ag economics is critical to a complete ability to represent a farmer or rancher in tax as well as estate/business planning.
The farm economy and the upcoming Ohio conference – it’s the focus of today’s post.
The Ag Economy
As is well known the general economy is struggling. Of course, the struggles are related to the economy trying to recover from the various state-level shut-downs. But what about the ag economy? Understanding the economics that farm and ranch clients are dealing is critical for tax practitioners and those that advise farmers and ranchers on estate and business planning matters.
So, what are the key points concerning the farm economy right now that planners must understand?
Net farm income. For starters U.S. net farm income was higher in 2020 than it was in 2019. When government payments are included, net farm income was 46 percent higher than in 2019 representing the fourth highest amount for any year since 1970. That’s good news for ag producers, rural communities and the practitioners that represent them. However, it’s also important to understand that 38 percent of the total amount was from government payments and not the private marketplace. That’s also a record – and not a good one. What government giveth, government can taketh away.
Earlier this year, USDA projected net farm income to drop eight percent compared to 2020. But, even with that drop, net farm income would still be 21 percent higher than the 2000-2019 average. So far this year grain prices for the major row-crop commodities (corn, soybeans and wheat) have been soaring. These prices have been driven by strong export demand, tight stocks, weather concerns in South America and the U.S. economy coming out of the various state-level shutdowns.
Cattle market. So far this year, the cattle market has shown improved beef demand as restaurants reopen and exports have been strong. There is also a smaller 2021 calf crop. However, there are challenges on the processing side of the equation with capacity issues and higher feed prices presenting difficulties. In addition, drought in cattle country will always be a concern.
Dairy. As for the dairy industry, demand is showing greater strength and dairy prices are increasing. This can also be a resulting impact of the loss of numerous dairy farms in recent years that lowers production. However, feed cost is wiping out all of the impact of higher dairy prices.
Exports. In 2020, total ag exports were also seven percent higher than they were in 2019. U.S. ag exports to China alone were 91 percent higher in 2020 than they were in 2019, with total ag exports to China being higher in 2020 than at any point during the Obama Administration (or any prior Administration). China is a critically important market for U.S. ag producers. China has approximately 20 percent of global population but only seven percent of the world’s arable land. China must import food from elsewhere. The Trump Administration got serious with China’s global trade conduct, imposed tariffs and other sanctions against it to the benefit of U.S. agriculture. Whether this pattern continues is an open question.
So far in 2021, total U.S. ag exports are up 24 percent compared to last year. A large part of that is due to the increased level of exports to China. But, there are numerous other ag export markets around the world to keep an eye on.
Accounting. What about the farm balance sheet? How is it looking. For starters, U.S. farmland values continue to hold steady if not slightly higher. The primary influencers of land values are commodity prices, government support programs, the supply of land, interest rates and inflation in the general economy. Shocks to one or more of those factors could impact land values significantly.
Farm working capital has seen four straight years of increases after reaching a low point in 2016. However, total farm debt continues to inch upward the U.S. farm debt to asset ratio is at its highest point in about 12 years (though still far below where it was during the height of the farm debt crisis of the 1980s. Overall, farm balance sheets (especially for crop producers) have improved primarily because of higher government payments, higher commodity prices and strong land values.
Prognosticating the Future
What does the future hold for the agricultural sector in the U.S.? For starters, there is a different administration consisting largely of retreads that have been in the bureaucratic swamp for decades. They love to regulate economic activity. While taxpayer dollars may still flow to the sector, that doesn’t mean it will be to support traditional and “ad hoc” farm programs. It’s more likely that taxpayer dollars will flow to support “food stamps” (remember, a record number of people were on food stamps the last time the current USDA Secretary held the position) and “rural development” and conservation programs. Of course, with taxpayer dollars flowing to support conservation activities on farms and ranches comes regulation of private property.
The next Farm Bill comes up in 2023. What will be the focus of the debate? Of course, much depends on the outcome of the 2022 mid-term elections. Will there be an examination of the existing farm programs and how they apply to large farms compared to smaller ones? Will there be an even greater focus on the environment? Will the “waters of the United States” (WOTUS) rule be revisited yet again? What about efforts to regulate carbon? What about the illegal immigration issue and the current policy fostering a wide-open border? What about ethanol production? Recently, the Iowa Governor was quoted as saying, “Every day under normal circumstances hunger is a reality for one in nine Iowans.” Iowa prides itself is being the nation’s leader in ethanol production. In light of that, let the Governor’s quote sink-in. Also, recall where the current USDA Ag Secretary is from.
As noted above, ag trade and exports is in a rather good spot right now. There was an emphasis on bilateral rather than multilateral trade agreements. Will that continue? Probably not. It’s likely that there will be an emphasis on rejoining various multilateral trade agreements. What will be the impact on U.S. ag? What about China? It now has more leverage on trade deals with the U.S.
There are always external factors and policies that bear on the bottom-line of agricultural producers. What are those going to be? In 2015, the Congress passed, and the President signed into law, a $305 billion infrastructure bill. Now, the present (old) Administration is at it again wanting to spend taxpayer dollars on “infrastructure.” I guess that’s an admission that the 2015 bill didn’t work – or maybe the new push for another bill is just an attempt to throw money around to potential voters.
Another factor influencing farmers and ranchers is tax policy. The potential for increased income and capital gain rates, the removal of “stepped-up” basis at death, higher estate and gift tax rates coupled with lower exemptions, and a higher corporate tax rate is significant.
In the general economy, inflation and unemployment are lurking. Fuel (and other input) prices are up in some places by 50 percent since the beginning of the year – a significant input cost for ag producers. That, coupled with record taxpayer dollars flowing into the sector are being capitalized into higher food prices. Providing lower-income people with non-taxable cash has caused them not to seek jobs and has caused unemployment to be higher than what it otherwise would be. The economy is presently characterized by a high level of job openings and high unemployment at the same time. Let that sink in.
As the Congress tosses around trillion-dollar spending bills, it represents spending money that the government doesn’t have. So, the government just makes more by printing it (or borrowing it). The influx of money in the economy makes the dollars that are already there worth less. Remember, the promise was that “no one making less than $400,000 would have their taxes go up.” Ok, but the money you have in your pocket is worth less. Same difference? Not quite. Inflation deals more harshly with lower-income persons than it does with someone of greater wealth and with higher income. Even without factoring in the rise in fuel and food prices, inflation was at 4.2 percent in April, the sharpest spike since 2008.
What do these external factors mean for agriculture? Any one of them can be bad. A combination of them can be really bad. Now is not the time to be buying more things on credit. It’s time to be prudent with the income that is presently there. Pay-off debt. Tidy-up estate plans. Righten the “ship” and get ready. The ride could get rough.
Join us at the Ohio conference either in person or via the online simulcast and join in the discussion. You don’t want to miss this one. For more information and to register, you can click here: https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html
Tuesday, May 18, 2021
Sometimes errors are made in real estate deeds involving conveyances of farm and ranch land. The mistake might be a minor one that goes uncorrected, or it could be significant one that means potentially thousands of dollars in lost acres or access rights or something similar. Is there a way to fix the error after it has occurred? Maybe.
The doctrine of reformation – it’s the topic of today’s post.
One of the core principles of contract law is that of equity. Sometimes the common law cannot adequately provide a remedy to a particular situation. That could mean that the law would be of no import to a well-deserving plaintiff. In the Earl of Oxford’s case in 1615, King James is quoted as saying, “Where common law and equity conflict, equity should prevail.” 21 ER 485 (1615). In essence, what the King was saying is that when an agreement has been entered into, but the contract, deed, or other instrument in its written form does not express what the parties actually intended, a court has equitable jurisdiction to reform the written instrument so as to conform to the parties’ intent. The court doesn’t rewrite the parties’ deal, it simply corrects the language to square it with the parties’ intent where there is no other adequate remedy at law. Of course, the evidence must sufficiently disclose the parties’ intent, and that the instrument, as written, doesn’t carry out that intent. And, there are some situations where reformation is not available. One of those includes governmental errors on the theory that there is no mutuality with individual members of the public.
For a court to reform a document, courts generally require that the document is the only document illustrating the parties’ intent and that there was a mutual mistake (including a mistake of law) at the time the document was executed. If there was a unilateral mistake with respect to a contract, it’s possible that the court could order the contract to be rescinded. Rescission doesn’t occur often, but it can apply if the unilateral mistake is coupled with fraud, misrepresentation or some sort of inequitable conduct on the defendant’s part. See, e.g., Boyle, et al. v. McGlynn, et al., 845 N.Y.S.2d 312 (2006).
In a recent court decision from Iowa, Midstates Bank, N.A. v. LBR Enterprises, LLC, No. 20-0336, 2021 Iowa App. LEXIS 391 (Iowa Ct. App. May 12, 2021), the court reformed a clerical error in a deed to reflect the legal description in the purchase agreement. The defendants owned two tracts of land, consisting of a 202-acre farm and a 32-acre homestead. The defendants had previously leased the farmland for rental income before deciding to sell the farmland to a cattle-feeding business run by their son and three other partners. After negotiating a purchase price, the defendants retained a life estate so that they could live in their house on the property for the remainder of their lives. The cattle-feeding business obtained a loan from the plaintiff bank to pay off the defendants’ mortgage on the property.
After the bank approved the loan, it hired a title company to prepare a warranty deed. Due to an error caused by the title company, the warranty deed did not match the life estate description in the purchase agreement. Rather than granting the defendants a life estate in the house on the property, the deed granted the defendants a life estate in the entire 234 acres. When the cattle-feeding business defaulted on payments two years later, the title company blocked a proposed sale, noting the deed named the defendants as life estate holders of the entire property. The plaintiff petitioned for reformation and claimed that the deed did not reflect the true intent of the parties because of the clerical error. The defendants argued that the plaintiff lacked standing to seek reformation of the deed.
The trial court reformed the deed to reflect that the defendants’ life estate was only in the house in which they currently resided. On appeal, the defendants maintained their argument that the bank lacked standing to seek reformation of the deed. The plaintiff argued that because it had a mortgage on the real estate, it had standing to bring the reformation action. The appellate court noted that the plaintiff would be required to allege some specific injury and injury in fact. The appellate court held that because the plaintiff paid off the existing mortgage and attached its security interest to the real estate, it had first priority upon default. Further, the appellate court held that the plaintiff’s security interest under the mortgage instrument was diminished, therefore injury in fact had been established.
The defendants also claimed that the plaintiff failed to prove that a clerical error created a mistake in the deed. The appellate court disagreed, noting that reformation is an equitable remedy when it can be proven that the instrument does not reflect the parties’ true agreement. On this point, the court concluded that the bank offered clear and convincing proof that the deed contained an error through a disinterested witness - the clerk at the title company. The facts also showed, the appellate court noted, that the defendants did not act as though they had a life estate in all 234 acres after the purchase agreement. Related to that fact, the appellate court determined that the purchase agreement did not merge into the deed because the parties did not agree to modify the life estate from the house in which the defendants resided to the entire property.
Consequently, the appellate court that the error in the deed could be reformed to reflect the life estate as described in the purchase agreement – it only applied to the house on the property and not the entire farm.
There are many court decisions where reformation of written instruments has been allowed as a remedy on the ground of mutual mistake. Reformation may occur to include land that was erroneously omitted or delete land that had been incorrectly included. It can also be allowed when the signature of a witness is required, or a seal is required that has been left out inadvertently. It’s an old legal doctrine that is still good law today.