Tuesday, May 18, 2021

Deed Reformation – Correcting Mistakes After the Fact

Overview

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.

In General

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there was a unilateral mistake with respect to a contract, it’s possible that the court could order the contract to be rescinded.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). 

Recent Case

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.

Conclusion

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. 

May 18, 2021 in Contracts, Real Property | Permalink | Comments (0)

Sunday, May 16, 2021

Intergenerational Transfer of Family Businesses with Split-Dollar Life Insurance

Overview

Last week, the U.S. Tax Court, in Morrissette v. Comr., T.C. Memo. 2021-60, decided a case involving an intergenerational transfer of a closely-held family business and the “split-dollar” life insurance technique.  There are some good “take-home” points from the case that show how the use of the technique can work in a complicated estate plan involving a family business where the intent is to keep the business in the family for multiple generations.

Estate Planning with the split-dollar life insurance technique – it’s the topic of today’s post.

Split-Dollar (In General)

In general, a split-dollar life insurance plans exists when two persons enter into an agreement to share both the premiums due and the proceeds receivable on a whole life policy.  See, e.g., Treas. Reg. 1.61-22(B)(1).  This is usually accomplished is by an employer entity splitting premiums and proceeds with an employee.  The employee either pays premiums for his portion (via a loan from the employer) based on the one-year cost of term insurance or pays income tax on the employer’s payment of such amount.  See Rev. Rul. 64-328, 1964-2 C.B. 11.  The advantage is that the employee is responsible for only the cost of pure life insurance protection.  That cost is either determined by the PS58 Cost Table that is published in Rev. Rul. 55-747, 1955-2 C.B. 228, or if it is less, by the insurance company’s premium tables for one-year term insurance of standard risks.  Rev. Rul. 66-110, 1966-1 C.B. 12.   Often, the employee has the option to continue the policy when the agreement terminates.  If the employee dies, the named beneficiary receives a tax-advantaged death benefit.   

The split-dollar technique is sometimes used by large estates in an attempt to minimize taxes at death, often in conjunction with an irrevocable life insurance trust (ILIT).  It can also be used as a funding mechanism for a buy-sell agreement in a closely-held family business where the goal is to maintain family ownership of the business over multiple generations.  But split-dollar arrangements are heavily regulated and specific rules must be followed precisely. 

The Morrissette Estate Plan

Arthur Morrissette founded International Moving Company (Interstate Van Lines) in 1943. He and his wife established revocable trusts in 1994 and funded the trusts, at least in part, with company stock.  The trusts directed that the company stock pass to qualified subchapter S trusts (QSSTs) for the benefit of their sons, and then to trusts for the benefit of their grandchildren. 

After Arthur’s death, his surviving spouse established a plan to secure the funds to pay the estate taxes imposed on the stock passing via the QSST trusts to her sons and grandchildren. She first created three” dynasty” insurance trusts (irrevocable life insurance trusts (ILITs)) – one for each of her sons and their families.  The ILITs and the sons entered into shareholder agreements which set forth arrangements whereby the ILITs would purchase the stock held by a son’s QSST upon the son’s death.   To fund the buyouts, each ILIT secured a life insurance policy on the lives of the two other sons via a cross-purchase buy-sell arrangement.  Ultimately, the three ILITs purchased a total of six policies.

The surviving spouse arranged to pay all the premiums for the policies in lump sums out of her revocable trust. The lump-sum amounts that she advanced to pay premiums on the policies were designed to be sufficient to maintain the policies for her sons' projected life expectancies (which at the time ranged from approximately 15 to 19 years).  The ILITs would ultimately acquire the stock of QSST trusts for the benefit of her grandchildren and subsequent generations, and were designed to not be subject to federal estate tax.

The surviving spouse advanced approximately $29.9 million to make lump sum premium payments on policies insuring the lives of her three sons. The financing for these life insurance policies was structured as “split-dollar arrangements,” meaning that the cost and benefits would be split between the trusts. When she paid a lump sum amount to cover the premiums on the policies, the policies themselves were designed to pay out varying amounts to the trusts for both herself and her sons.

Specifically, upon the death of each of her sons, her revocable trust would receive (attributable to her “split-dollar receivables”) the greater of either (i) the cash surrender value of that policy, or (ii) the aggregate premium payments on that policy. Each ILIT would receive the balance of the policy death benefit.  Such arrangements are commonly structured so that the company advances funds to an ILIT to pay premiums on insurance on the life of the owner of the company, and the split-dollar receivable is payable upon the death of that owner. However, the surviving spouse’s plan was structured such that the receivable wasn’t payable until the death of one of the sons. Also, the company did not own the split-dollar receivable and it would become an asset of her taxable estate.  Given her sons’ life expectancies, the estate was not likely to collect the amounts payable with respect to the split-dollar receivables for 15 to 19 years.

From 2006 until her death in 2009, the surviving spouse made (and reported) gifts to the ILITs out of her revocable trust based upon the cost of the current life insurance protection in accordance with the IRS tables corresponding to the “economic benefit regime.” The total amount of the gifts was $29.9 million, but the economic benefit of the gifts was far less than that.  Accordingly, the surviving spouse reported the payment of the premiums as gifts to her sons for gift tax purposes to the extent of the economic benefit specified by Treas. Reg. §1.61-22. 

IRS gift tax challenge. 

The IRS issued two Notices of Deficiency to the estate. One Notice determined a gift tax liability for the tax year ending December 31, 2006, which concluded the surviving spouse’s estate had failed to report total gifts in the amount that the surviving spouse’s revocable trust advanced to the ILITs to make lump-sum payments of policy premiums. The second Notice grossed-up the surviving spouse’s lifetime gifts by the $29.9 million gifted to the ILITs.  

The surviving spouse’s estate moved for partial summary judgment on the threshold legal question of whether the split-dollar arrangements should be governed under the economic benefit regime of Treas. Reg. §1.61-22.  If so, the surviving spouse didn’t make any significant gift in 2006, and the total value reported for the split-dollar receivables should be based on the present value of the right to collect the split-dollar receivables in 15 to 19 years.  The IRS asserted that it was factually unclear as to whether or not the revocable trust had conferred upon the ILITs an economic benefit in addition to the current cost of life insurance protection.  The IRS claimed that the revocable trust’s lump-sum premium payments should be treated as loans owed back to the estate and valued under Treasury Regulations finalized in 2003 concerning how to treat split-dollar arrangements for tax purposes.  See Rev. Rul. 2003-105, 2003-2 C.B. 696.  The issue was, in essence, whether the 2003 regulations controlled the outcome, or whether the economic benefit regulation controlled.

Ultimately, the Tax Court disagreed with the IRS position. Estate of Morrissette, 146 T.C. 171 (2016).  The Tax Court held that the split-dollar agreements complied with the economic benefit regulation of Treas. Reg. § 1.61-(1)(ii)(A)(2), and that the surviving spouse made annual gifts only of the cost of current protection for gift tax purposes.  Under the regulation, only the economic benefit provided under the split-dollar life insurance arrangement to the donee is current life insurance protection.  As such, the donor is deemed owner of the life insurance contract, irrespective of actual policy ownership, and the economic benefit regime applies.  Thus, to determine if any additional economic benefit was conferred by the revocable trust to the ILITs, the Tax Court considered whether or not “the dynasty trusts [ILITs] had current access to the cash values of their respective policies under the split-dollar life insurance arrangements or whether any other economic benefit was provided.”  Because the split-dollar arrangements were carefully structured to only pay the ILITs that portion of the death benefit of the policy in excess of the receivables payable to the revocable trust, the Tax Court concluded that the ILITs could not have any current access under the final regulations. The Tax Court also determined that no additional economic benefit was conferred by the revocable trust to the dynasty trusts.  The valuation of the receivables at $7.48 represented an approximate 77 percent valuation discount from the value of the amount advanced to pay the premiums. 

IRS estate tax challenge.  The surviving spouse’s estate valued the receivables at $7.48 million.  The IRS disagreed with the estate’s valuation, claiming instead that the transfer of $29.9 million made by her revocable trust should be included in her estate at death by virtue of I.R.C. §2036 and I.R.C. §2038.  The Tax Court did not agree with the IRS position, determining that the transfers had valid non-tax purposes.  The evidence showed that the decedent desired to keep the business in the family, needed liquidity for estate tax purposes, and also wanted to provide a transition of the business to the next generation of the family while maintaining family harmony.  As such, the Tax Court concluded, the cash surrender value of the policies was not pulled back into the estate at death.  The Tax Court also held that I.R.C. §2703 did not apply because the split-dollar agreements served a business purpose and were not simply a manner in which to transfer property for less than full and adequate consideration.  They were also comparable to arm’s length transactions.  However, the court held that the estate was liable for the 40 percent understatement penalty of I.R.C. §6662 because of an undervaluation of the decedent’s split-dollar rights to the life insurance policies. 

The Tax Court did not determine the estate’s federal estate tax value, but directed the parties to value of the rights associated with the split dollar arrangements based on cash surrender values, life expectancies and discount rates.  The Tax Court said that the split-dollar rights are the rights of the decedent’s trust to payment in exchange for paying the policy premiums.  That payment, the Tax Court said, is either the amount of premiums paid or the cash surrender values of the policies, whichever is greater.

Conclusion

The Tax Court’s 2016 decision is very helpful to high-net-worth individuals and owners of closely held businesses.  Similarly structured split-dollar arrangements will be governed by the economic benefit doctrine and protect from gift tax liability.  The result will be that the value of the split-dollar receivables would be determined based on typical valuation principles (i.e., the amount a third party would pay to purchase the split-dollar receivables).

Last week’s Tax Court decision that I.R.C. §2703(a) does not apply to the split-dollar receivables, because they were not subject to any restriction on the revocable trust’s rights to sell or use them opens the door to intergenerational split-dollar arrangements. 

These two Tax Court opinions, taken together, provide a blueprint for passing family assets (like closely held businesses such as a farm or ranch) throughout subsequent generations, with predictable (and favorable) estate and gift tax consequences for the original owners.  That is particularly important in light of the unfavorable changes the present Congress might make to the laws governing the transfer tax system.

May 16, 2021 in Business Planning, Estate Planning | Permalink | Comments (0)

Wednesday, May 12, 2021

The Revocable Trust – What Happens When the Grantor Dies?

Overview

My article last month on the use of the revocable trust in an estate plan generated many nice comments.  You can read that article here:  https://lawprofessors.typepad.com/agriculturallaw/2021/04/the-revocable-living-trust-is-it-for-you.html.  I also received several questions concerning what happens from an income tax standpoint when the grantor of the trust dies.  After answering those questions, I thought it might be a good idea to write an article on it for the blog.

What are the income tax impacts of a revocable trust when the grantor dies – it’s the topic of today’s post.

Income Tax Issues for the Year of Death

When the grantor of a revocable trust dies, the trust assets are not impacted.  The trust continues according to its terms and, as mentioned in last month’s article, the assets contained in the trust are not included in the decedent’s probate estate.  For income tax purposes, the trust is required to obtain a taxpayer identification number (TIN).  That’s the case even if the trust had obtained a TIN during the grantor’s lifetime.  Treas. Reg. §301.6109-1(3)(i)(A).    That means that the trustee will likely have to establish new accounts for the trust with banks and other financial institutions with which the trust does business.

For the year of the grantor’s death, all tax items must be allocated between the grantor and the trust for the pre-death and post-death periods.  This requires the trustee to establish some type of system to make sure that the proper amounts of income, loss, deduction, credit, etc., are allocated appropriately in accordance with the trust’s method of accounting. 

Returns and Reporting Issues

When the grantor of a revocable trust dies, the trust is no longer a grantor trust.  Thus, all tax-related activity of the trust that occurred before the grantor’s death during the year of death must be reported on the grantor’s final income tax return.  Upon the grantor’s death, the trust becomes a separate taxpayer (from the grantor’s estate) with a calendar year as its tax year.  I.R.C. §644(a).  Because of this separate taxpayer status, the grantor’s estate will also have to obtain a TIN and report tax items separately from those of the trust.   

Note:   If the terms of the trust require all of the trust income to be distributed annually but not trust corpus, the trust is a “simple” trust.  If not, the trust is a “complex” trust. 

Note:   The grantor’s estate can elect either a fiscal year or a calendar year for tax reporting purposes.  When a grantor dies late in the year, it may be beneficial for the executor of the grantor’s estate to elect a fiscal year.  That may provide some ability to use tax-deferral techniques for the estate or the beneficiaries and can allow the executor more time to deal with administrative duties concerning the estate. 

One technique that can help simplify tax filings after the grantor dies is for the trustee to work with the administrator of the grantor’s estate in considering whether to make an I.R.C. §645 election.  The election can be used for certain revocable trusts, and has the effect of treating the trust as part of the decedent’s estate.  I have written about the I.R.C. §645 election here:  https://lawprofessors.typepad.com/agriculturallaw/2020/11/merging-a-revocable-trust-at-death-with-an-estate-tax-consequences.html.  To recap that article, the election can reduce the number of separate income tax returns that will have to be filed after the grantor’s death.  The irrevocable election is made via Form 8855. 

A Sec. 645 election makes available several income tax advantages that would not otherwise be available in a separate trust tax filing.  I detailed those in my article linked above that I wrote last fall, but for our purposes here, while the election is in force (two years if no federal estate tax return is required to be filed; other deadlines apply if a Form 706 is required (See Treas. Reg. §1.645-1(f)) income and deductions are reported on a combined basis – all trust income and expense is reported on the estate’s income tax return.  The one exception is for distributable net income (DNI).  DNI is computed separately.  The combined reporting on the estate’s income tax return might be on a fiscal year instead of the calendar year-end that is required for trusts. 

When the election period terminates, the “electing trust” is deemed to be distributed to a new trust.  That’s a key point to understand.  The new trust must use the calendar year for reporting purposes.  As a result, the trust beneficiaries might receive two Schedule K-1s if the co-electing estate files on a fiscal year. 

If the decedent’s estate was large enough to require the filing of Form 706, the assets in the revocable trust are aggregated and reported on Schedule G.  They are not listed separately.  Part 4 should be answered, “yes.”  In addition, a verified copy of the trust should be attached to Form 706. 

Complexity of Farm Estates

A decedent’s estate is a separate entity for income tax purposes.  In general, an estate’s net income, less deductions for the value of property distributed to heirs, is taxed to the estate.  The distributions are taxed to the heirs in the calendar year which includes the last day of the estate fiscal year during which the distributions were made.  When these principles are applied to the unique aspects of a farmer’s estate, problems (and opportunities) arise.  A farmer’s estate has numerous attributes that require specialized application of the general principles of estate income taxation.  Those include the seasonal nature of the business with bunching of income and expense in different times of the year; a complex mix of land and depreciable property that is subject to recapture; inventory; common use of income tax deferral due techniques; the problem of establishing income tax basis in property; determining accurate property inventories; and unique capital gain holding periods for certain assets.

Conclusion

A revocable trust is a common and often beneficial part of the estate plan of a farmer or rancher.  But, understanding the tax issues when the trust grantor dies is important.  Likewise, fitting the tax aspects a revocable trust that are triggered by the grantor’s death with the overall complexity of an agricultural estate is crucial.    

May 12, 2021 in Estate Planning, Income Tax | Permalink | Comments (0)

Monday, May 10, 2021

The “Mis” STEP Act – What it Means To Your Estate and Income Tax Plan

Overview

In late March, a group of five Democrat Senators from northeastern states introduced the “Sensible Taxation and Equity Promotion (STEP) Act.  Similar legislation has been introduced into the U.S. House, also from an East Coast Democrat.  These bills, combined with S.994 that I wrote about last time, would make vast changes to the federal estate and gift tax system, have a monumental impact on estate planning for many – including farm and ranch families – and would also make significant income tax changes.  The STEP Act also has a retroactive effective date of January 1, 2021. That makes planning to avoid the impacts next to impossible.  Today’s focus will be on the provisions of the STEP Act.

The key components of the STEP Act and its impacts and planning implications – it’s the topic of today’s post.

Income Tax Provisions

Before addressing the STEP Act’s provisions, it’s important to remember other proposals that are on the table.  Those include an income tax rate increase on taxable income exceeding $400,000 (actually about $450,000) by setting the rate at 39.6 percent.  Also, for these taxpayers, the itemized deduction tax benefit is capped at 28 percent.  That makes deductions less valuable.  In addition, the PEASE limitation of three percent would be restored.  This limitation reduces itemized deductions by three percent of adjusted gross income (AGI) over a threshold, up to 80 percent of itemized deductions.  Also, proposed is a phase-out of the qualified business income deduction (QBID) of I.R.C. §199A.  The phaseout of the QBID would impact many taxpayers with AGI less than $400,000. 

Capital Gains 

The STEP Act is largely concerned with capital gains and trusts.  The STEP Act applies the 39.6 percent rate to capital gains exceeding $1,000,000. Passive gains exceeding this threshold would be taxed at 43.4 percent after adding in the additional 3.8 percent net investment income tax of I.R.C. §1411 created by Obamacare.  An additional $500,000 exclusion is provided for the transfer of a personal residence ($250,000 for a taxpayer with single filing status).  Also, outright charitable donations of appreciated property are excluded, but (apparently) not transfers to charitable trusts), and some assets held in retirement accounts.

From an estate planning standpoint, if this provision were to become law a “lock-in” effect would occur to some extent – taxpayers would simply hold assets until death to receive the basis adjustment at death equal to the asset’s fair market value (I.R.C. §1014).  Unless, of course, the “stepped-up” basis rule is eliminated. 

Note:   Planning strategies such as charitable remainder trusts (maybe), appropriate timing of the harvesting of gains and losses and similar techniques can be used to keep income under the $1 million threshold.  Also, especially for high-income taxpayers residing in states with relatively high income tax rates, a tax minimization strategy has been the use of the incomplete non-grantor trust (ING).  An ING is a self-settled, asset protection trust that allows a grantor to fund the trust without incurring gift tax while also achieving non-grantor status for income tax purposes.  The typical structures is to establish the trust is a state without an income tax with the grantor funding the ING with appreciated assets having a low basis. The ultimate sale of the trust assets thereby avoids state income tax.  The IRS has announced that it is studying INGs and will not issue any further rulings concerning them.  Rev. Proc. 2021-3, 2021-1, IRB 140, Sec. 5.

Trusts 

The Step Act also proposes new I.R.C. §1261 which, under certain circumstances, imposes income recognition on gains at the time an asset is transferred to a trust.  Under this provision, gain recognition occurs at the time of a transfer to a non-grantor trust, as well as a grantor trust if the trust assets (corpus) will not be included in the grantor’s estate.  If the corpus will be included in the grantor’s estate at death, there apparently is no gain until a triggering event occurs.  Proposed I.R.C. §1261(b)(1)(A).  

Note:   The lack of clarity of the STEP Act’s language concerning transfers to grantor trusts creates confusion.  Seemingly the relinquishment of all retained powers under I.R.C. §2036 would mean that the trust corpus would not be included in the grantor’s estate, and the transfer to trust would be an income recognition event.  It simply is not clear what the STEP Act’s language, “would not be included” means. 

Apparently, a transfer to a non-grantor marital trust is not an income recognition event. Proposed I.R.C. §1261(c)(2).  Similarly, a transfer qualified disability trust or cemetery trust does not trigger gain recognition.  As noted above, the language is unclear whether a transfer in trust to a charity is excluded from recognition.  However, a transfer to a natural person that is other than the transferor’s spouse is taxed at the time of the transfer. 

Assets that are held in a non-grantor trust would be deemed to be sold every 21 years.  That will trigger gain to the extent of unrealized appreciation every 21 years, with the first of these “trigger dates” occurring in 2026. 

The STEP Act also requires annual reporting for trusts with more than $1 million of corpus or more than $20,000 of gross income.  The reporting requires providing the IRS with a balance sheet and an income statement, and a listing of the trustee(s), grantor(s) and beneficiaries of the trust. 

Note:   The built-in gain on an asset that is transferred during life either outright to a non-spouse or to a type of trust indicated above cannot be spread over 15 years.  However, the transfer of illiquid property (e.g., farmland) to a non-grantor trust that is not otherwise excluded is eligible for installment payments over 15 years, with interest only needing to be paid during the first five years.  If the tax on the appreciated value is caused by death, the tax can be paid over 15 years by virtue of I.R.C. §6166.

Grantor trusts – sales and swaps.  An important estate planning technique for higher wealth individuals in recent years designed to reduce potential estate tax involves the sale or gifting of assets to a grantor trust.  The goal of such a transaction is to make a completed transfer for federal estate and gift tax purposes, but retain enough powers so that the transfer is incomplete for income tax purposes.  This is the “intentionally defective grantor trust” (IDGT) technique. The result of structuring the transaction in this manner is that the future appreciation of the assets that are sold to the trust is removed from the grantor’s estate, and the grantor remains obligated for the annual income tax liability.  Of course, the trust could reimburse the grantor for that tax obligation.  Thus, the grantor ends up with a tax-free “gift” to the trustee of the trust’s income tax liability.  This allows the trust assets to grow without loss of value to pay taxes. 

The IRS blessed the IDGT technique in Rev. Rul. 85-13, 1985-1 C.B. 184.  In the Ruling, the IRs determined that the grantor’s sale of the asset to the trust did not trigger income tax – the grantor was simply “selling” to himself.  The irrevocable, completed nature of the transfer to the trust coupled with grantor trust status for income tax purposes is done by particular trust drafting language.  Also, that language can be drafted to allow the grantor to “swap” low basis assets in the trust with assets having a higher basis.  This allows the “swapped-out” asset to receive a basis increase at the time of the grantor’s death by virtue of inclusion in the grantor’s estate.  I.R.C. §1014

Under the STEP Act, a sale to a grantor trust might be treated as a transfer in trust.  If that is what the language means, then Rev. Rul. 85-13 is effectively repealed.  It also appears that swaps to a grantor trust would be treated that same as a sale.  If this is correct, IDGTs as a planning tool are eliminated. 

GRATs.  One popular estate planning technique for the higher-valued estates has been the use of a grantor-retained annuity trust (GRAT). With this approach, the grantor transfers assets to a trust in return for an annuity. As the trust assets grow in value, any value above the specified annuity amount benefits the grantor’s heir(s) without being subject to federal gift tax.  However, under the STEP Act, a transfer to a grantor trust is taxable if all of the transferred assets are not included in the grantor’s estate.  But, if all of the assets transferred to a grantor trust are included in the grantor’s estate, the transfer to the trust is not a taxable event.

This language raises a couple of questions.  One of the characteristics of a GRAT is that it can be drafted to make a portion taxable.  In that case, it is not completely includible in a decedent’s estate.  Likewise, if property is transferred into a GRAT and the transferor dies during the GRAT’s term and the I.R.C. §7520 rate rises, then less than all of the corpus of the GRAT is included in the decedent’s estate. See Treas. Reg. §20.2036-1, et seq.  This would appear to mean that, under the STEP Act, the transfer to the GRAT would be a taxable event.  It is also unclear whether the use of a disclaimer in the context of a GRAT will eliminate this potential problem. 

Estate Tax Deduction

Income taxes that the STEP Act triggers would be deductible at death as an offset against any estate tax that is due on account of the taxpayer’s death. 

The Constitutional Issue

As noted above, the STEP Act carries a general effective date of January 1, 2021.  It is retroactive.  If that retroactive provision were to hold, many (if not all) planning options that could presently be utilized will be foreclosed.  But is a retroactive tax provision constitutional? 

To be legal, a retroactive tax law change can satisfy the constitutional due process requirement if it is rationally related to a legitimate purpose of government.  Given the enormous amount of spending that the Congress engaged in during 2020 to deal with the economic chaos caused by various state governors shuttering businesses, a "legitimate purpose" could be couched in terms of the “need” to raise revenue.  See, e.g., Pension Benefit Guaranty Corporation v. R.A. Gray & Co., 467 U.S. 717 (1984)United States v. Carlton, 512 U.S. 26 (1994); In re Fifield, No. 04-10867, 2005 Bankr. LEXIS 1210 (Bankr. D. Vt. Jun. 20, 2005).  That’s the case even though historic data indicate that government revenues rarely increase in the long-term from tax increases – particularly the type of tax increases that are presently being proposed. 

Planning Steps

Will the STEP Act become law as proposed?  Probably not.  But, combined with S. 994 the two proposals offer dramatic changes to the rules surrounding income tax, as well as federal estate and gift tax.  With the proposal to basically double the capital gains tax rate, it could be a good idea to intentionally trigger what would be a gain under the STEP Act.  Doing so would at least remove those assets from the transferor’s estate.  In general, “harvesting” gains now before a 39.6 percent rate applies could be a good strategy.  Also, estate plans should be reexamined in light of the possible removal of the fair market value basis rule at death.  Consideration should be given to donating capital gain property to charity, setting up installment sales of property, utilizing the present like-kind exchange rules and making investments in qualified opportunity zones.   

Is all planning basically eliminated for 2021?  I don’t know.  There simply is no assurance whether transfers made to lock in the existing federal estate and gift tax exemption, utilize valuation discounts, etc., will work.  If the STEP Act is enacted, perhaps one strategy that will work would be to gift cash (by borrowing if necessary).  If the STEP Act is not enacted, then utilizing grantor trusts with sales and swaps could be an effective technique to deal with a much lower exemption.

One key to estate planning is to have flexibility.   The use of disclaimer language in wills and trusts is one way to provide flexibility.  Coupled with a rescission provision, disclaimer language included in documents governing transactions completed in 2021 might work…or might not.  It’s also possible that such a strategy could work for estate and gift tax purposes, but not for income tax purposes.

Another technique might be to set up an installment sale of assets to a marital trust for the spouse’s benefit that gives the spouse a power of appointment and entitles the spouse to lifetime income from the entire interest payable at least annually (basically a QTIP trust for the spouse (see I.R.C. §2523(e)).  The STEP Act indicates that such a transfer would not be a gain recognition event – marital trusts are excluded so long as the spouse is a U.S. citizen.  The surviving spouse would be given the power to appoint the entire interest and it could be exercised in favor of the surviving spouse or the estate of the surviving spouse.  No person other than the surviving spouse could have any power to appoint any part of the interest to any person other than the surviving spouse.  With a disclaimer provision the surviving spouse could disclaim all interest in the trust if the STEP Act is not enacted (or is enacted but becomes effective after the transfer by installment sale).  The disclaimer would then shift the assets into a trust for the surviving spouse’s heirs.  There are other techniques that could be combined with this approach to then add back the spouse.  If the STEP Act is enacted, the assets could remain in the marital trust and not trigger gain recognition.  The point is that the disclaimer adds tremendous flexibility (until disclaimers are eliminated – but the drafters of the STEP Act haven’t figured that out yet). 

Also, I haven’t even discussed the proposed American Families Plan yet.  On that one, Secretary Vilsack’s USDA put out an incredibly misleading press release titled, “The American Families Plan Honors America’s Family Farms.”  In it, the USDA claims that the proposed changes to the federal estate tax would apply to only two percent of farms and ranches.  That’s true as long as the family continues to own the farm and is materially participating in the farming operation.  What the USDA didn’t mention is that the American Families Plan eliminates many income tax deductions and will increase the federal income tax bill for practically all farmers and ranchers.

Conclusion

Presently, there is considerable uncertainty in the income tax and estate/business planning environment.  Also, the next shift in the political winds could wipe-out all of these proposed changes (if enacted) and the rules will swing back the other direction. 

There’s never a dull moment.  I can’t emphasize enough how important it is to attend (either in-person or online) this summer’s national conference on farm income tax and estate/business planning.  It’s imperative to get on top of these issues.  For more information on those conferences click here:  https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html and here: https://www.washburnlaw.edu/employers/cle/farmandranchtaxaugust.html 

May 10, 2021 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Friday, May 7, 2021

Planning for Changes to the Federal Estate and Gift Tax System

Overview

I have received many questions recently on what the Congress might do to the federal estate and gift tax laws and the planning steps, if any, that can be taken now to prepare for changes.  It’s an important questions that many have, particularly farm and ranch families.  It’s also a topic that I will spend a good deal of time on during the summer conferences in Ohio and Montana.  You can learn more about those conferences here:   https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html  and https://www.washburnlaw.edu/employers/cle/farmandranchtaxaugust.html

What has been proposed?  Will it pass?  Will valuation discounts be eliminated?  What about the income tax basis rule at death – will it change?

The possible changing estate and gift tax (and income tax basis at death) landscape – it’s the topic of today’s post.

The Current Situation

The Tax Cuts and Jobs Act (TCJA) doubled the basic exclusion amount as well as the generation-skipping transfer tax (GSTT) exemption for years 2018-2025 to $10 million (in 2011 dollars).  Starting in 2026, the exemptions revert to pre-TCJA law - $5 million in 2011 dollars.  In other words, beginning in 2026, the exemptions will fall to $5 million but will be adjusted for inflation since then.  But will we get to 2026 without the current exemptions being reduced before then?  That’s a good question that depends entirely on politics.

What if the exemption decreases?  If the current Congress decreases the exemption, it’s important to understand the “math” behind the computation of a decrease.  Presently, the exemption equivalent of the unified credit for federal estate and gift tax purposes is $11.7 million.  It was $5.49 million in 2017, before TCJA increased it to $11.18 million in 2018.  One strategy to address a drop in the exemption might be to make gifts now while the exemption is at $11.7 million and use exemption to cover the taxes on the gifts.  However, the way the IRS views the $11.7 million exemption is in two separate pieces.  One piece is $5.85 million and represents the “old” exemption.  According to the IRS, gifts made in 2021 use this part of the current $11.7 million exemption first.  Then, for taxable gifts beyond $5.85 million in 2021, the other “piece” of the exemption (also equal to $5.85 million) is utilized.  This piece represents the 2018 exemption increase.  It is this piece that is lost if it is not used before the law changes that decreases the exemption.  This assumes, of course, that any reduction in the exemption would take effect after 2021.  A retroactive change would wipe out this planning strategy of making gifts now to use up the higher exemption. 

Proposed Legislation – S. 994 

Exemption and rates.  Earlier this year, Senator Bernie Sanders proposed the “For the 99.5% Act.”  S. 994.  The bill is currently in the Senate Finance Committee.  A similar proposal was proffered in 2019 but didn’t’ go anywhere.  Basically, the same proposal was made in the President’s final proposed budget in 2016.  The proposals all do essentially the same thing – set the federal gift tax exemption at $1 million without indexing for inflation; set the federal estate tax and GSTT exemption at $3.5 million; and retain portability of any unused exclusion amount.  S. 994, Sec. 2(b).  In terms of the tax rate structure, taxable estates exceeding $3.5 million up to $10 million would face a 45 percent rate.  Taxable estates over $10 million up to $50 million would be taxed at a 50 percent rate.  Those over $50 million but not over $1 trillion would be taxed at 55 percent, and those exceeding $1 trillion would be taxed at 65 percent.  If enacted in its present form, the effective date would be for deaths, GSTT transfers and gifts made after December 31, 2021.  S. 994, Sec. 2(c). 

Special use valuation.  For farms and ranches potentially subject to federal estate tax, electing special use valuation can be a viable estate tax planning technique if the elected land will be farmed by a family member (or members) for 10 years after the decedent dies.  I.R.C. §2023A.  For deaths in 2021, the maximum reduction in value of farmland subject to the election is $1.18 million.  The proposal is to increase that amount to $3 million, effective for deaths after 2021.  S. 994, Sec. 3. 

Conservation easement.  Under current law, land subject to a conservation easement can be excluded from estate tax up to $500,000 in value.  S. 994 increases that amount to $2 million.  It also increases the maximum percentage of the land which can be excluded from 40 percent to 60 percent.  S. 994, Sec. 4.  This provision would be effective for deaths and gifts after 2021.

Grantor trusts.  S. 994 eliminates the current income tax basis step-up rule at death for property contained in certain types of grantor trusts.  The provision applies to property held in a trust of which the transferor is considered to be the owner, and the property transferred to the trust is not included in the transferor’s gross estate at death.  S. 994, Sec. 5. 

Valuation discounts.  As for valuation discounts for such things as lack of marketability, minority interests, blockage, and built-in gain taxes, S.994 specifies that any assets of an entity that are not used in the active conduct of the trade or business that are transferred are to be valued as if the assets were transferred directly (i.e., non-actively traded interests).  Likewise, “passive assets” are not treated as used in the active conduct of a trade or business.  S. 994, Sec. 6.  In addition, no discount for minority interest is allowed if the transferee and family members have control or majority ownership (for non-actively traded interests).  Id.  These assets are to be valued as if the transferor had transferred the assets directly to the transferee.  Id. 

Excluded from the definition of non-business assets are inventory and real estate rental activities involving a real estate professional where the 750-hour requirement has been satisfied.  See, I.R.C. §469(c)(7).  There is also an exception for working capital.  Id.  A “look-through” rule also applies with respect to non-business assets.  This rule is designed to prevent any discount for non-business assets that are held in a lower-tier entity.  A 10 percent ownership interest threshold applies for this purpose.  If the rule applies, the upper-tier entity is treated as if it directly owns its ratable share of the lower-tier entity’s assets.  Id. 

As for minority discounts, S.994 disallows them when the transferor, transferee and family members together have either control or majority ownership after the transfer of entity interests.  “Member of the family” is defined in accordance with I.R.C. §2032A(e)(2).  There the definition includes an individual’s spouse and siblings, ancestors and descendants (including lineal descendants of the decedent’s spouse or parent of the decedent), spouses of descendants, and lineal descendants and spouses of the decedent’s spouse.  For these purposes, a legally adopted child of an individual is treated as blood relation. 

As a distinction from other parts of the legislation, the valuation rules would be effective upon date of enactment.  Id. 

Consider the following example illustrating the impact of eliminating (or severely restricting) valuation discounts:

Example:  Snarkfeltcher Valley Farms (SVF) is a closely-held family farming operation owned by family members.  The parents would like to transfer controlling interests to their son and daughter so that they can manage and control the family business after the parents retire and ultimately pass away.  Presently, SVF has a fair market value of $12 million.  With appropriate estate planning, upon the last of the parents to die with transfer of full operational control to the children, valuation discounts could be achieved.  Under current law, the federal estate tax would be computed as follows (assume that all of the assets are used in SVF’s trade or business):

            Gross Value:                                       $12,000,000

            Lack of marketability discount           $3,000,000

            Minority interest discount:                   $1,800,000

            Net taxable value:                                 $7,200,000

            Available exemption:                         $11,000,000

            Estate tax due:                                    $0

Now assume that S.994 becomes law and the transfer of control of SVF occurs after the law become effective.  Here’s how the federal estate tax would be computed:

Gross Value:                                       $12,000,000

Lack of marketability discount:         $3,000,000

            Minority interest discount:                 $0

            Net taxable value:                               $9,000,000

            Tentative estate tax:                            $3,795,800 ($1,320,800 + .45 x $5.5 mil.)

            Less available credit:                          $1.455,800 (credit that offsets first $3.5 mil.)

            Estate tax due:                                    $2,340,000

Grantor-retained annuity trusts.  An important business succession planning concept for some families is that of the grantor-retained annuity trust (GRAT).  A GRAT is a technique that can allow the grantor to “freeze” the value of the transferred assets while simultaneously providing the grantor with a cash flow stream for a specified time-period.  I have written about the use of the GRAT here:  https://lawprofessors.typepad.com/agriculturallaw/2018/09/farm-wealth-transfer-and-business-succession-the-grat.html

S. 994 essentially eliminates GRATs as a planning strategy by imposing a minimum 10-year term, and a maximum term tied to the life expectancy of the annuitant plus 10 years. In addition, the remainder interest must have a value (as determined at the time of the transfer) that is not less than an amount that is equal to the greater of 25 percent of the GRAT’s fair market value or $500,000, and not be greater than the fair market value of the property in the trust.  S. 994, Sec. 7.  These rules would be effective to transfer made after the date of enactment.  Id. 

Grantor trusts.  S. 994 also makes changes to the rules governing grantor trusts.  While assets in a grantor trusts are included in the grantor’s estate for federal tax purposes, distributions from grantor trusts during the grantor’s life are treated as taxable gifts.  S. 994, Sec. 8.  In addition, if at anytime during the life of the owner, the owner ceases to be treated as the owner of any of the trust assets, those assets are deemed to be a gift.  Id.  These changes would apply to trusts created after the date of enactment as well as to transfers made to pre-existing trusts after date of enactment and sales to pre-existing trusts.  Apparently existing grantor trusts would be grandfathered. 

GSTT.  The proposed legislation specifies that the inclusion ratio of any trust other than a qualifying trust is pegged at 1.  In addition, a qualifying trust must terminate not greater than 50 years after the trust is created.  Also, pre-existing trusts must terminate within 50 years of enactment.  S. 994, Sec. 9.  Also, S. 994 eliminates the GSTT exemption for certain long-term trusts.  Id. 

Gift tax rule changes.  S. 994 specifies that the first $10,000 of gifts made to a person during the calendar year are not to be included in the amount of gifts made during the year.  S. 994, Sec. 10.  The limit is $20,000 per donor.  The transfers subject to this limitation include transfers in trust, a transfer of an interest in a pass-through entity, a transfer of an interest subject to a prohibition on sale, and any other transfer of property that, without regard to withdrawal, put, or other such rights in the done, cannot immediately be liquidated by the donee.  S. 994, Sec. 10. 

Client Relations

Given these proposed changes in federal estate and gift tax law, how should practitioners advise clients?  For starters, the possible impacts on a client’s estate plan of the proposed changes should be discussed.  Perhaps a projection should be done of a client’s estate value particularly in light of the changes in the valuation discount rules.  Also, consideration should be made of the benefits of accelerating the funding of GRATs and other grantor trusts.  In that vein, sales to an intentionally defective grantor trust (IDGT) may also need to be accelerated.  I have discussed IDGTs here:  https://lawprofessors.typepad.com/agriculturallaw/2017/07/using-an-idgt-for-wealth-transfer-and-business-succession.html and here: https://lawprofessors.typepad.com/agriculturallaw/2018/08/intentionally-defective-grantor-trust-what-is-it-and-how-does-it-work.html

Also, give consideration to using the lifetime federal estate/gift tax exclusion prior to the law’s enactment (assuming that it does get enacted).  That also means being prepared to make taxable gifts.  Other thoughts should be given to the ordering rules surrounding the ordering rules for the deceased spouse unused exclusion (DSUE) amount. 

Conclusion

The proposed changes in the rules governing federal estate and gift tax are creating many questions and concern.  Knowing what the proposed changes might be is useful for purposes of evaluating the steps that can be taken to best handle the changes if they are enacted, and ensure that one’s estate/business planning goals can be achieved.  Again, I will spend a significant amount of time at the summer events in Ohio and Montana discussing these matters.  Don’t miss out.  Attendance online is also possible. 

May 7, 2021 in Business Planning, Estate Planning | Permalink | Comments (0)

Saturday, May 1, 2021

The Agricultural Law and Tax Report

Overview
 
Starting Monday May 3, I am hosting a daily 2-minute program, The Agricultural Law and Tax Report on farm radio stations nationwide and on SiriusXM 147.  The purpose of each report is to educate farmers and ranchers and rural landowners on the unique legal and tax issues that they are often faced with.  Each program explains what the law is on a particular topic, and how actual court cases and IRS rulings have been decided based on that law, and what the application is to a farming or ranching operation.
 
Topical Coverage
 
Some of the topics that I will address include:
 
Contract Issues - (auction sales; farm leases; hunting leases; grain and livestock sale contracts; types of clauses to protect the farmer-seller; remedies if there is a breach).
 
Ag Financing Issues - (collateral issues; rules governing lenders and farm borrowers; foreclosure issues and Farmers’ Home (FSA); redemption rights for farmland; agricultural liens).
 
Agricultural Bankruptcy - (Chapter 12 farm bankruptcy issues).
 
Farm Income Tax - (handling USDA/CCC loans; government payments; crop insurance proceeds; pre-paying expenses; deferred payment contracts; commodity trading income; easement payments; crop and livestock share rental income).
 
Real Property Issues - (fences and boundaries; buying and selling farmland; recoveries from settlements and court judgments (such as the Roundup litigation, etc.)).
 
Farm Estate Planning - (types of title ownership; disruption of family farm if there is no will or trust; planning approaches to facilitate keeping the farm in the family; federal estate tax planning; gifting of farm assets; treating off-farm and on-farm heirs fairly).
 
Liability Issues - (food product liability issues (labeling and disparagement laws); liability for trespassers and others on the property; trespassing dog laws; nuisance law; employer's responsibility for farm employees; animal diseases; fence laws).
 
Criminal Law Issues - (what can the government search without a warrant; cruelty to animal laws; government programs and criminal liability; environmental liability for farmers and ranchers).
 
Water Law Issues - (types of water law systems; use of surface water for crops and livestock; use of subsurface water; boundary disputes).
 
The initial sponsor is First State Bank headquartered in Lincoln, NE.  If you are interested in also becoming a sponsor, please let me know.
 
Many thanks to John Mellencamp and Sony Music Publishing Co. for the "bumper" music that accompanies each show. And...special thanks to Donn Teske.
 
Check with your local farm radio station to see if they are carrying The Agricultural Law and Tax Report. If not, please call your local station and request it, and let me know
 
My hope is that you find the show profitable for your farming business, rural practice, and your local rural community.

May 1, 2021 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Friday, April 30, 2021

Court Developments of Interest

Overview

Periodically on this blog, I summarize recent cases of interest to those involved in agriculture and tax practitioners in general.  Today is one of those days. 

Recent court developments of interest – it’s the topic of today’s post.

Defendant’s Removal of Trees Within Conservation Easement Not a Nuisance

Cergnul v. Bradfield, 2021 Ind. App. Unpub. LEXIS 295 (Ind. Ct. App. Apr. 9, 2021)

The developers of a subdivision agreed to record a conservation easement twenty feet wide along two boundaries of the subdivision after complaints by local farmers. The conservation easement’s purpose was to preserve the visual aesthetic for residents who enjoyed the rural setting. Although the restrictive covenants that were recorded did not reference the conservation easement, the developer recorded a final plat that explicitly referred to the conservation easement. The defendant purchased a lot in the subdivision and proceeded to remove some trees and brush from within the conservation easement. The defendant had reviewed the restrictive covenants, which had not been updated after the final plat was recorded. The defendant also had met with a representative of the subdivision’s homeowner’s association, who advised the defendant that he could clear the trees and brush so long as he did not change the grade of the land. The plaintiff was an adjoining neighbor outside the subdivision who sought damages for the loss of quiet enjoyment of his property.

The trial court found that the plaintiff lacked standing to challenge the activity within the conservation easement. Further, the trial court noted that the plaintiff failed to demonstrate that he had been denied a property right. On appeal, the plaintiff argued that although he lacked standing to enforce the conservation easement, he was entitled to damages to address a nuisance. The plaintiff noted that the developers had set aside a conservation easement pursuant to state law and that the defendant’s conduct amounted to nuisance per se. The appellate court noted that the conservation easement enabling statute did not provide the plaintiff with a private right of enforcement. Alternatively, the plaintiff argued that the defendant’s conduct created a nuisance per accidens as the right to the quiet enjoyment of his property had been destroyed. The appellate court noted that whether the defendant’s conduct qualified as a nuisance per accidens depended on whether his conduct would cause actual physical discomfort to a person of ordinary sensibilities. The appellate court found that the plaintiff failed to show any such evidence, and as a result, affirmed the trial court’s decision and denied the nuisance damages sought by the plaintiff. 

No Attorney-Client Privilege For Communications Between Trustee and Attorney

In re Estate of McAleer, No. 6 WAP 2019, 2021 Pa. LEXIS 1524 (Pa. Sup. Ct. Apr. 7, 2021)

The decedent created a revocable trust and named his son as the sole trustee. The trust named the son and his two step-brothers as beneficiaries. In 2014, the trustee filed a first and partial accounting of the trust. A step-brother objected and the trustee hired two separate law firms to respond to the step-brother’s objections. After an evidentiary hearing, the probate court dismissed the objections. During the court process, additional filings indicated that about $124,000 of trust funds had been expended from the trust for attorney’s fees and costs through 2015. The step-brothers then filed a petition to determine the reasonableness of the fees. In early 2016, the trustee filed a second and final accounting to which the step-brothers also objected. The trustee claimed that he had no obligation to provide the step-brothers with copies of billing invoices because they were protected by attorney-client privilege. The probate court disagreed and ordered the trustee to forward the unredacted invoices to the step-brothers withing 30 days. The trustee disclosed the invoices, but filed an interlocutory appeal on the issue of the attorney invoices.

The state Supreme Court upheld the probate court’s ruling, noting that the assertion of privilege requires sufficient facts be established to show that the privilege has been properly invoked. According to the state Supreme Court, the trustee had not established those facts. The state Supreme Court also held that the privilege didn’t apply because the interests the privilege protected conflicted with “weightier obligations” – the fiduciary duty of the trustee to provide information to the beneficiaries outweighed the privilege. This was especially the case because the attorney fees were paid from the trust.

Will Authorized Court To Review Sale/Transfer of Farmland

In re Estate of Burge, No. 19-1881, 2021 Iowa App. LEXIS 214 (Iowa Ct. App. Mar. 17, 2021)

The decedent left her estate to her three children and six grandchildren. Two of her children sought to probate the will as executors. One of the executors died shortly after, and his wife participated in the proceedings as the executor and sole beneficiary of his estate. The will distributed a lump sum to the now deceased son if he “is surviving on the death of the survivor” of the decedent. The will distributed half of the remainder to the three children in equal shares and the other half to the six grandchildren in equal shares. The decedent’s will also granted four grandchildren an option to purchase all of her farmland. If they chose to exercise this option, the will directed them to pay a penalty if they sold the farmland within 15 years. The will also had a provision that offered one of the decedent’s children, the remaining executor, to receive his share of the estate in farmland, provided that he could agree upon a division with the grandchildren. Both the grandchildren and the executor exercised their option to purchase the farmland.

The first proposed contract filed by the executor to purchase the farmland was rejected by the trial court because some of the beneficiaries did not participate in negotiations or agree to the terms. The executor filed a second proposed contract to transfer the decedent’s farmland to himself and the four grandchildren. The trial court approved this contract but included direction that if the executor continued with the exercise of his option, he would not be entitled to his residuary share of the estate. Two of the four grandchildren and the executor appealed, and argued that the trial court should not have removed them as residue beneficiaries. The executor also argued that the trial court should have excluded his deceased brother’s wife as a beneficiary.

The appellate court held that since the deceased son survived the decedent, the deceased son’s wife was entitled to his share of the estate as the sole beneficiary. The two grandchildren argued that the executor had the sole right to sell the real estate without court oversight, because the will provided an unrestricted power of sale. The appellate court disagreed and noted that the decedent’s will contained numerous provisions on the sale in her will, namely that the court could resolve any dispute as to the reasonableness of the terms and conditions of the sale. The two grandchildren also argued that the first proposed contract was binding and that the trial court was bound to accept it without modification. The appellate court noted that the first proposed contract did not provide for the executor’s share of the farmland, and the farmland sale/transfer was subject to the terms and conditions in the will and court review for reasonableness.

FBAR Penalties Not Subject to “Full Payment” Rule

Mendu v. United States, No. 17-cv-738-T, 2021 U.S. Claims LEXIS 537 (Fed. Cl. Apr. 7 2021)

The plaintiff was assessed approximately $750,000 of “willful” Foreign Bank and Financial Account (FBAR) penalties. Such penalties can reach up to 50 percent of the highest account balance of the foreign account. He paid $1,000 of the penalty amount and then sued in the U.S. Court of Federal Claims under the Tucker Act to recover the $1,000 as an illegal exaction. The IRS counterclaimed, seeking the entire judgment of $750,000 plus interest. The plaintiff moved to dismiss his complaint on the basis that the court lacked jurisdiction over the illegal exaction claim on the basis of Flora v. United States, 362 U.S. 145 (1960). Such dismissal would nullify the court’s jurisdiction over the counterclaim of the IRS. Under Flora, in accordance with 28 U.S.C. §1346(a)(1), a taxpayer seeking to file a federal tax claim in federal court (other than the U.S. Tax Court) must pay the full amount of the tax before filing suit. However, the plaintiff claimed that 28 U.S.C. §1346(a)(1) only applied to “internal revenue taxes” and claims related to “internal revenue laws.” The petitioner noted that Bedrosian v. United States, 912 F.3d 144 (3d Cir. 2018) hinted that FBAR penalties may fall within the reach of 28 U.S.C. §1346(a).

The court, in ruling for the plaintiff, flatly rejected the Bedrosian decision in holding that FBAR penalties are not subject to the Flora rule because they are not internal revenue laws or internal revenue taxes. The court noted that FBAR penalties are contained in Title 31 of the U.S. Code rather than Title 26 (the Internal Revenue Code), and that this placement was intentional. Title 31, the court noted, has as its purpose, the regulation of private behavior rather than the purpose of being a charge imposed for the purpose of raising general revenue. In addition, the court concluded that FBAR penalties are unlike civil penalties in that they contain no statutory cross-reference that equate “penalties” with “taxes.” The court also reasoned that the if the full payment rule didn’t apply to FBAR penalties there wouldn’t be any concern that the collection of FBAR penalties would be seriously impaired because they are enforced via a civil action to recover a civil penalty. That meant that there were no administrative collection procedures for FBAR penalties with which a partial payment illegal exaction claim would interfere. Thus, the court concluded that the Congress did not intend to subject FBAR penalty suits to the full payment rule. 

Conclusion

There’s always action in the courts and with the IRS.  That’s especially true this tax season which continues…

April 30, 2021 in Estate Planning, Income Tax, Real Property | Permalink | Comments (0)

Wednesday, April 28, 2021

Summer Conferences – NASBA Certification! (and Some Really Big Estate Planning Issues - Including Basis)

Overview

This summer Washburn Law School is sponsoring along with other co-sponsor two conferences on farm income tax and farm/ranch estate and business planning.  The conferences, while primarily directed to practitioners that advise farmers and ranchers, is also for agricultural producers and others interested in learning about tax and estate/business planning issues.  Now, Washburn Law School has been certified by the National Association of State Boards of Accountancy (NASBA) as a provider of continuing professional education (CPE).  That means that CPAs and accountants can receive CPE credit for attending online or in person.

Summer conferences – the topic of today’s post.

Ohio and Montana

The first summer conference is on June 7-8 at the Shawnee State Park Lodge and Conference Center near West Portsmouth, Ohio.  The second summer conference is slated for August 2-3 at the Hilton Garden Inn located in Missoula, MT. 

For more information, here is the link to the Ohio seminar:  https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html.

The co-sponsors for the Ohio event are as follows:

The Wright and Moore Law Company of Delaware, OH; AgriLegacy; and BASE.   

You may learn more about each one here: 

https://www.ohiofarmlaw.com/

https://agrilegacy.com/

https://www.baseonline.com/

For more information about the Montana seminar, click on the following link:  https://www.washburnlaw.edu/employers/cle/farmandranchtaxaugust.html.

In addition to the sponsors of the Ohio seminar, an addition sponsor is the Budd-Falen Law Firm in Cheyenne, Wyoming.  More information about the firm can be found here:  https://buddfalen.com/.

Critical Issues for 2021 (and Potentially Beyond)

The political power advantage in Washington, D.C. is razor thin but proposed legislation, if it were to become law would make significant impacts on tax and estate planning for many farmers and ranchers.  The mindset of the current administration is generally opposed to people that work for themselves – such people can’t be as easily controlled.  That means that many in agriculture are in the crosshairs of policy. 

So what will we be talking about at the summer conferences?   A major emphasis will be on how to plan for proposed changes in the law, and how the changes will impact farming and ranching operations.   

Here’s just a few of the things we will address:

  • The current proposal to tax any transfer of property (after an exclusion amount) either during lifetime or at death that has a net gain associated with the transfer.  What are the implications of this for certain types of trusts?
  • The proposal to require all non-grantor trusts to report gain on appreciated assets contained in the trust every 21 years, and provide to the IRS a balance sheet, income statement and a list of the trustees, grantors and beneficiaries.
  • The impact of proposed legislation on installment payment of federal estate tax and special use valuation.
  • Potential changes in the level of the present interest annual exclusion and the establishment of a lifetime ceiling on gifts.
  • The proposed reduction in the federal estate tax applicable exclusion to an amount significantly less than the current $11.7 million amount, and an increase in the tax rate applicable to taxable estates.
  • The proposed change to the current “coupling” of the federal estate and gift tax systems.
  • The proposed elimination of “Dynasty Trusts” and “Intentionally Defective Grantor Trusts.”
  • The proposed changes to Grantor-Retained Annuity Trusts that would basically eliminate them as a planning concept.
  • The proposed elimination of valuation discounting as planning strategy.
  • The proposed increase in the capital gains tax rate
  • The proposed increase in the corporate tax rate

What About the Estate Tax and Income Tax Basis?

While it now looks as if the federal estate tax exemption will not be reduced, as I wrote here, https://lawprofessors.typepad.com/agriculturallaw/2021/02/what-now-part-two.html, the really big issue is income tax basis.  Currently, an asset that is included in a decedent’s estate at death for tax purposes receives an income tax basis in the hands of the heir(s) equal to the fair market value of the asset at the time of death.   I.R.C. §1014. This is commonly referred to as “stepped-up” basis.  Thus, if the heir were to sell the asset capital gains tax for the heir would be computed as the difference between the selling price of the asset and the value at the time of the heir inherited the asset.  For an asset that is sold shortly after inheritance, the capital gains tax is likely to be minimal to none. 

If the stepped-up basis rule were to be eliminated, the heir would receive the decedent’s income tax basis. For farmland that the decedent owned for many years, for example, that basis could be much lower than the date-of-death value.  That would be particularly the case if the decedent had received the farmland by gift, receiving the donor’s income tax basis in the farmland at the time of the gift.  The result would be heir’s being hit with large capital gains tax, or simply refusing to sell the land (if possible) and creating a “lock-in” effect with respect to certain assets.  

What would be particularly troubling is if the income tax basis rule were changed such that the appreciation in a property’s value would be taxed at the decedent’s death rather than waiting for the heir to sell the property. 

A change in the income tax basis rule would substantially impact estate and business planning.  This is particularly true with respect to farm and ranch estates where many assets have a low basis – either from being owned for many years or because of income tax planning strategies that have substantially diminished or eliminated the basis in assets.  Changing to a “carry-over” basis rule at death would also be an absolute nightmare for tax professionals.  That was certainly the case the last time a carry-over basis rule was tried during the Carter administration.  The protests from the practitioner community (and others) were so substantial that the Congress repealed the rule before it took effect.

Retroactivity

This basis issue will be a significant topic of discussion at the summer seminars.  What planning steps can be taken to plan to avoid this proposed rule change?  The answer to that question depends on whether the change in the rule will be retroactively effective.  If retroactive, then that will foreclose many (if not all) planning options that could be utilized now. 

To be legal, a retroactive tax law change can satisfy the constitutional due process requirement if it is rationally related to a legitimate purpose of government.  Given the enormous amount of spending that the Congress engaged in during 2020 to deal with the economic chaos, a "legitimate purpose" could be couched in terms of the “need” to raise revenue.  See, e.g., Pension Benefit Guaranty Corporation v. R.A. Gray & Co., 467 U.S. 717 (1984)United States v. Carlton, 512 U.S. 26 (1994); In re Fifield, No. 04-10867, 2005 Bankr. LEXIS 1210 (Bankr. D. Vt. Jun. 20, 2005).  That’s even though historic data indicate that government revenues don’t necessarily increase in the long-term from tax increases.

Conclusion

This is definitely the summer to attend one of these events.  The planning issues loom large.  The economic impacts of the proposed changes can be substantial and ripple throughout the entire economy.  In addition to income tax, these critically important estate planning issues will be unraveled and open for discussion at the summer seminars.  I encourage anyone interested in agriculture, sustainability and transition of the family farm and food production to attend – either online or in-person.  These will be vitally important conferences.  NASBA certification will allow those needing CPE to attend online and receive credit.  That’s a big plus!

April 28, 2021 in Estate Planning, Income Tax | Permalink | Comments (2)

Sunday, April 25, 2021

What’s an “Asset” For Purposes of a Debtor’s Insolvency Computation?

Overview

The general rule is that discharge of indebtedness produces ordinary income – known as cancellation of debt income (CODI).  I.R.C. § 61(a)(12).  However, there are exceptions to the general rule.  One of those exceptions concerns a debtor that is “insolvent” but not in bankruptcy. An insolvent debtor that’s not in bankruptcy doesn’t have CODI to report.  But how is insolvency to be measured?    In 2017, the U.S. Tax Court clarified the issue.  Unfortunately, just recently the IRS voiced its disagreement with the Tax Court’s 2017 opinion.

The definition of “insolvency” for purposes of the exclusion from income of CODI – it’s the topic of today’s post.

In General

An important part of debt resolution is the income tax consequences to the debtor.  Actually, there are two major categories of income tax consequences--(1) gain or loss if property is transferred to the lender in satisfaction of indebtedness and (2) possible CODI to the extent debt discharged exceeds the fair market value of property given up by the debtor.

Recourse debt. The handling of discharge of indebtedness income depends upon whether the debt was recourse or nonrecourse.  With recourse debt, the collateral stands as security on the loan.  If the collateral is insufficient, the debtor is personally liable on the obligation and the debtor's non-exempt assets are reachable to satisfy any deficiency.  The bulk of farm and ranch debt is recourse debt.

For recourse debt, when property is given up by the debtor, the income tax consequences involve a two-step process.   Basically, it is as if the property is sold to the creditor, and the sale proceeds are applied on the debt.  First, there is no gain or loss (and no other income tax consequence) up to the income tax basis on the property.  The difference between fair market value and the income tax basis is gain or loss.  There is no relief from gain--even if the taxpayer is insolvent.  This is the end of the first step in the process--treated as a hypothetical sale on the debt being discharged.  Second, if the indebtedness exceeds the property's fair market value, the difference is discharge of indebtedness income.

Nonrecourse debt.  For nonrecourse debt, the collateral stands as security on the obligation.  But if the collateral is worth less than the balance on the debt, the debtor does not bear personal liability on the obligation.  Therefore, the creditor must look solely to the collateral in the event of default.  Very little farm and ranch debt is nonrecourse, except perhaps for some installment land contracts and commodity loans from the Commodity Credit Corporation to the extent that the debtor may pay off the loan with a sufficient amount of an eligible commodity having a price support value equal to the outstanding value of the loan (or less than the value of the loan in the case of a “marketing assistance loan”). 

Handling nonrecourse debt involves a simpler one-step process. See, e.g., Comr. v. Tufts, 461 U.S. 300 (1983).  Fair market value is ignored, and the entire difference between the income tax basis of any property involved (and transferred to the creditor) and the amount of debt discharged is gain (or loss).  There is no CODI.

Exceptions

There are several relief provisions that a debtor may be able to use to avoid the general rule that CODI constitutes income.

Bankruptcy.  A debtor in bankruptcy does not report CODI as income.  I.R.C. §108(a)(1)(A).  However, the debtor must reduce tax attributes (including operating losses and investment tax credits carried forward) and reduce the income tax basis of their property. Losses are reduced dollar for dollar; credits are reduced one dollar for three dollars (one dollar of credit offsets three dollars of CODI).  To preserve net operating losses and tax credit carryovers, a debtor may elect to reduce the basis of depreciable property before reducing other tax attributes.

Real property business debt.  Taxpayers other than C corporations can elect to exclude from gross income amounts realized from the discharge of “qualified real property business indebtedness.”  I.R.C. §108(a)(1)(D).  Instead, the income tax basis of the property is reduced.

Note:   The provision does not apply to farm indebtedness.

Solvent farmers.  For all debtors other than farmers, once solvency is reached there is CODI.  For solvent farm debtors, however, the discharge of indebtedness arising from an agreement between a person engaged in the trade or business of farming and a “qualified person” to discharge “qualified farm indebtedness” is eligible for special treatment.  I.R.C. §108(a)(1(C).  A special procedure for reducing tax attributes and reducing the basis of property is available to the debtor.

A “qualified person” is someone who is “actively and regularly engaged in the business of lending money and who is not somehow related to or connected with the debtor.”  “Qualified farm indebtedness” means indebtedness incurred directly in connection with the operation by the taxpayer of the trade or business of farming and 50 percent or more of the average annual gross receipts of the taxpayer for the three proceeding taxable years (in the aggregate) must be attributable to the trade or business of farming.  In many instances, the presence of off farm income can make qualifying for the solvent farm debtor rule difficult.  Also, a cash rent landlord is likely to be deemed to not be engaged in the trade or business of farming such that discharge of indebtedness is not discharge of qualified farm indebtedness.  See, e.g., Lawinger v. Comr., 103 T.C. 428 (1994). 

If the requirements are met, a solvent farm debtor first reduces tax attributes in the following order:

  • Net operating loss of the taxable year and any carryover losses to that year.
  • General business credits (including investment tax credits carried over to that year).
  • Minimum tax credit
  • Capital losses for the year and capital losses carried over to that year.
  • Passive activity loss and credit carryovers.
  • Foreign tax credits

Again, losses reduce CODI dollar for dollar.  One dollar of credits reduces three dollars of CODI.

After the reduction of tax attributes, solvent farm debtors reduce the income tax basis of property used in a trade or business or held for the production of income in the following order:

  • Depreciable property.
  • Land used or held for use in the trade or business of farming.
  • Other qualified property.

Note:   An election can be made to reduce the basis of depreciable property first, before reducing the tax attributes.  This may help to preserve the tax attributes for later use.

If, after tax attributes and property basis is reduced, discharge of indebtedness remains, the remainder is income.

Purchase price adjustment.  For solvent taxpayers who are not in bankruptcy, any negotiated reduction in the selling price of assets does not have to be reported as discharge of indebtedness income.  I.R.C. §108(e)(5).  To be eligible, the debt reduction must involve the original buyer and the original seller.

Insolvent debtors.  Debtors who are insolvent but not in bankruptcy likewise do not have CODI.  I.R.C. §108(a)(1)(B).  But, again, insolvent debtors must reduce tax attributes and reduce the income tax basis of property.  It is handled much like debtors in bankruptcy make the calculations.  However, the amount of income from discharge of indebtedness that can be excluded from income is limited to the extent of the debtor's insolvency.  If the amount of debt discharged exceeds the amount of the insolvency, income is triggered as to the excess.  Thus, for the rule of insolvent taxpayers to apply, the taxpayer must be insolvent both before and after the transfer of property and transfer of indebtedness.

Determining Insolvency

The determination of the taxpayer’s solvency is made immediately before the discharge of indebtedness. “Insolvency” is defined as the excess of liabilities over the fair market value of the debtor’s assets. Both tangible and intangible assets are included in the calculation. Likewise, both recourse and nonrecourse liabilities are included in the calculation, but contingent liabilities are not. The separate assets of the debtor’s spouse are not included in determining the extent of the taxpayer’s insolvency.

Historically, the courts have held that property exempt from creditors under state law is not included in the insolvency calculation. However, the IRS ruled in mid-1999 that property exempt from creditors under state law is included in the insolvency calculation. Priv. Ltr. Rul. 9932013 (May 4, 1999), revoking Priv. Ltr. Rul. 9125010 (Mar. 10, 1991); Tech. Adv. Memo. 9935002 (May 3, 1999).  In 2001, in Carlson v. Comr., 116 T.C. 87 (2001), the Tax agreed with the IRS position. The Tax Court held that a commercial fishing license was an “asset” because the license could be used, in combination with other assets, to immediately pay the income tax on canceled-debt income.

Recent Tax Court clarification.  In Schieber v. Comr., T.C. Memo. 2017-32, the petitioner retired from a police force in 2005 and began receiving monthly distributions from his pension plan. The plan withheld federal income tax from the payments. The plan specified that the petitioner could not convert his interest in the plan into a lump-sum cash amount, assign the interest, sell the interest, borrow against the interest, or borrow from the plan. Upon the petitioner’s death, his surviving wife would receive payments for her life. In 2009, GMAC canceled approximately $450,000 of the petitioner’s mortgage debt that was secured by some of the petitioner’s non-residential real estate. The petitioner was not in bankruptcy in 2009. The canceled debt included $30,076 of interest. The petitioner excluded the forgiven interest from income because he had not deducted it on his Form 1040.  See I.R.C. §108(e)(2).  That provision specifies that “no income shall be realized from the discharge of indebtedness to the extent that payment of the liability would have given rise to a deduction.”

While the IRS conceded this point concerning the interest exclusion, the IRS claimed that the petitioner’s interest in the principal amount of $418,596 that was canceled should be included in income. The petitioner claimed that the pension plan should not be considered an asset for purposes of the insolvency computation of I.R.C. §108(d)(3). Under that provision a taxpayer may exclude canceled debt from income to the extent of the taxpayer’s insolvency, defined as the extent to which the taxpayer’s liabilities exceed the fair market value of the taxpayer’s assets.

I.R.C. §108(d)(3) does not define the term “assets.”  As noted above, in Carlson v. Comr., 116 T.C. 87 (2001), the full Tax Court determined that the value of an exempt asset could be included in the insolvency calculation if it gives the taxpayer “the ability to pay an immediate tax on income” from the canceled debt. In Schieber, the petitioner claimed that he couldn’t access the pension funds by its terms. The IRS did not challenge that point, instead claiming that the point was irrelevant. Instead, the IRS claimed that the petitioner’s right to receive monthly payments caused the plan to be considered an “asset.” The Tax Court disagreed, clarifying that its prior decision in Carlson only extended to assets that gave the taxpayer the “ability to pay an immediate tax on income” from the canceled debt, not the ability to pay the tax gradually over time. 

Just recently, the IRS announced its disagreement with the Tax Court’s opinion in Schieber. A.O.D. 2021-1, IRB 2021-15.

Conclusion

The Tax Court’s Schieber decision provided clarity concerning the definition of “assets” for purposes of the insolvency calculation of I.R.C. § 108(d)(3). If an asset doesn’t provide the debtor with the ability to pay an immediate tax on income, the asset’s value is excluded from the insolvency computation. Schieber cites back to the full Tax Court opinion in Carlson for its rationale.  Unfortunately, the IRS audit and litigation position appears to be unchanged. 

April 25, 2021 in Bankruptcy, Income Tax | Permalink | Comments (0)

Thursday, April 22, 2021

The Revocable Living Trust – Is it For You?

Overview

A common question that I receive from individuals interested in creating an estate plan is whether a trust should be a part of the plan.  More specifically, the question typically is whether a revocable living trust should be used.  That’s a difficult question to answer because there are many factors to consider when determining whether to include a revocable living trust as part of an estate plan.  Clearly, one valuable use of a revocable trust is to provide a management vehicle for property of older individuals at a time when they may not be capable of providing active management effort.  But are there others? 

A revocable living trust – what is it?  How does it work?  What are the pros and cons of utilizing it as part of an estate plan.  These matters are the focus of today post.

In General

The revocable trust can be valuable as a basic instrument in an estate plan for some persons, particularly where management of an individual's assets is needed.  The passage of property to one's beneficiaries at death requires the same detailed and careful planning as does the accumulation of the property during lifetime.  There is no legal device which will solve this problem on a "one size fits all" basis.  As with all estate planning tools available, the use of a revocable trust should be done only after a complete analysis of the individual's assets, stated desires and overall family goals.

The grantor creates the trust by executing a trust agreement and funds the trust by transferring property to the trust during life. Asset titles must be changed into the name of the trustee of the trust.  The grantor retains the power to amend, modify or revoke the trust.  Frequently, the grantor retains the right to receive the income for the grantor's life.

Estate and gift tax aspects.  Because the grantor reserves the power to revoke the trust, the transfer of property to the trust does not constitute a gift.  Treas. Reg. §25.2511-2(c).  However, whenever income or principal is applied to the benefit of a third party, the grantor may be deemed to have made a gift to the beneficiary.  Treas. Reg. §25.2511-2(f).  Subsequent termination of the power to revoke, other than by death, completes the gift for federal gift tax purposes.  Id.

Because of the powers the grantor retains over the trust, the property in the trust is subject to federal estate tax.  I.R.C. §§2036-2038.  See, e.g., Estate of Bell, 66 T.C. 729 (1976); Treas. Reg § 20-2038-1(a).  There is also a “three-year within death” rule that pulls some transfers that a decedent makes within three years of death.  Indeed, for deaths before August 6, 1997, the position of the courts had been that gifts of trust income or principal within three years of the grantor's death were included in the grantor's estate if the donees were potential trust beneficiaries.  I.R.C. § 2035(d)(2).  See also Estate of Collins v. United States, 94-1 U.S.T.C. ¶60,161 (E.D. Mich. 1994); Estate of Jalkut v. Commissioner, 96 T.C. 675 (1991), acq., 1991-2 C.B. 1. However, for deaths after August 5, 1997, any transfer from a grantor (e.g., revocable) trust is treated as a transfer by the grantor.  I.R.C. § 2035(e), added by TRA-97, Sec. 1310.

Claims against a decedent’s estate give rise to a deduction for the estate.  But, are those claims limited to the value of assets included in the decedent’s probate estate?  If so, then claims arising from assets in a decedent’s revocable trust would not create a deduction because the assets in the trust are not included in the decedent’s probate estate.  However, the U.S. Tax Court has held that a deduction for claims against the estate under I.R.C. § 2053 is not limited to the value of assets in probate estate.  Estate of Snyder v. United States, 99-2 U.S. Tax Cas. (CCH) ¶ 60,357 (Fed. Cl. 1999).  The Tax Court noted that the statute makes no distinction between probate and non-probate assets).

Income tax aspects.  A revocable living trust is disregarded as a taxable entity because it is treated as a "grantor trust" with all trust income taxable to the grantor.  I.R.C. § 676(a).  Form 1041 is required to be filed with a separate statement attached showing income, deductions and credits attributable to the grantor from the trust.  Treas. Reg. § 1.671-4.  But, if an individual is both the grantor and the trustee and all items of income, deduction and credit are treated as owned by the grantor, it is not necessary for the individual to file a Form 1041.  The information is reported on the grantor's individual return.  Treas. Reg. § 1.671-4(b).  Generally, the trust is to obtain a taxpayer identification number.  I.R.C. § 6109.  But, if the grantor is also the trustee and is treated as the owner of all assets held by the trust, there is no requirement to obtain a taxpayer identification number.  Treas. Reg. § 301.6109-1(a)(2).

Also, a qualified revocable trust may elect under I.R.C. §645 to be treated and taxed as part of an estate, and not as a separate trust, for all tax years of the estate ending after the date of the decedent’s death and before the applicable date that terminates the election period.  The applicable date for decedents dying on or after December 24, 2002, is set by Treas. Reg. §1.645-1(f)(2)(ii), effective on that date, where an estate tax return must be filed.  The IRS has announced that qualified revocable trusts for decedents dying before December 24, 2002, may use the Treas. Reg. §1.645-1(f)(2)(ii) dates if Form 1041, U.S. Income Tax Return for Estates and Trusts, has not been filed treating the Section 645 election period as terminated.  Notice 2003-33, C.B. 990.

Note:  Because transfers to a revocable living trusts rarely include all of the transferor’s assets, the plan often includes a "pour over will."  This will assures that property not needed in estate settlement for payment of debts and taxes would be transferred following estate settlement into the trust.

Other Particular Issues

The residence.  Transferring the principal residence to a revocable living trust does not make the residence ineligible for exclusion gain on sale under I.R.C. § 121, See Ltr. Rul. 8007050, Nov. 23, 1979.  The principal residence is eligible for the exclusion to the extent the owner is treated as the owner of the trust under I.R.C. §§ 671-677.  See, e.g., Priv. Ltr. Rul. 8239055 (Jun. 29, 1982).  But, the residence may be ineligible for preferential credit or exemption from property tax under state law.

Depreciation.  Expense method depreciation does not apply to trusts.  I.R.C. § 179(d)(4). But, the IRS acknowledges that this rule only applies to non-grantor trusts, such as irrevocable trusts.  Because a revocable trust is a grantor trust, property transferred to the trust that is eligible I.R.C. §179 property remains eligible.  Depreciation deductions, in general, are apportioned between the trustee and income beneficiaries as trust income is allocated.  Treas. Reg. §§ 1.611-1(c)(4)(1973), 1.167(h)-1(b).

Estate planning.  From an estate planning standpoint, the transfer of closely-held business assets to the trust could terminate installment payment of federal estate tax unless the transfer is merely a change in organizational form.  But, if that hurdle is cleared, property interests contained in the trust at death are not made ineligible for installment payment of federal estate tax simply by virtue of being held in trust.  See, e.g., Priv. Ltr. Rul. 7747007 (Aug. 19, 1977); Priv. Ltr. Rul. 8132027 (May 1, 1981); Priv. Ltr. Rul. 200529006 (Apr. 11, 2005).

Recapture of special use valuation (I.R.C. §2032A) benefits could occur unless all beneficiaries are qualified heirs and consent to personal liability for recapture tax.

Conveyance of joint tenancy property to a revocable living trust could result in a severance of the joint tenancy characteristic.  Black v. Commissioner, 765 F.2d 862 (9th Cir. 1985).  But the Tax Court has held that the transfer of jointly owned property to trust with retained right to jointly revoke transfer does not constitute severance, and §I.R.C. 2040 remains applicable to tax a decedent's estate to the extent of the decedent's proportionate contributions. Estate of May, T.C. Memo, 1978-20.

Pros and Cons of Revocable Living Trusts

There is a lot of information available about the supposed benefits of a revocable living trust.  Much of this information is peddled by those desiring to profit from the selling of the trust.  That doesn’t mean that the information is inaccurate.  It does mean that a person considering the use of a revocable trust needs to do their “homework” and discern carefully the information that is provided.

The following is a straightforward discussion of the go things and not-so-good things about a revocable trust with comparison to the probate process when a decedent dies with a will.

Probate avoidance.  Avoiding probate is a reason often cited for the use of a revocable trust.  But, what is "probate"?  The answer to that question is tied to state law.  Probate can be more complex, and costly, in some states as compared to others.  It is not costless to create a revocable trust, and it is not costless to administer a revocable trust at death.  There simply is no clear-cut answer as to whether a revocable trust is better than a properly drafted will from an economic standpoint.  However, probate is a public process and trust administration is not.  Privacy may be an important aspect of a trust that some place a high priority on.  But, the public nature of the probate process also puts in place a judge to administer the process, deal with creditor claims and handle disputes that might arise.  That administrative supervision is not there to the same degree with a trust. 

Estate tax savings.  Many times, the impression is erroneously given that a revocable trust is the only way to avoid estate taxes.  A revocable trust does not avoid more taxes associated with death than does a properly drafted will.  Avoiding probate by using a trust does not mean that taxes are avoided.  The tax results for an estate where the decedent has a revocable trust should be the same as for an estate where the decedent had a will.

Distribution of assets.  Assets are generally not tied up in probate for a long period of time.  With most state probate systems, assets are available to a personal representative five days following the decedent's death.  Any delay in distributing assets to the beneficiaries should be no greater in probate administration than when a revocable trust is used.  A trustee as well as a personal representative must make sure that the creditors are paid, taxes are computed and properly paid and all other distributions are proper.  Partial distributions can be made for those beneficiaries in need of assets.

Fees and costs. The cost of preparing and funding a revocable trust is greater than the cost of having a will prepared that accomplishes the same testamentary disposition.  Upon death, estate settlement costs are either hourly or a percentage of the estate.  The settlement process (administration of assets, payment of debts, tax filings and asset distributions) is virtually the same regardless of whether a trust or a will is used.  A bank, if named as trustee, will most likely have a settlement fee for closing a trust estate.  Fees for settling the estate through a trust, whether legal or administrative, just do not disappear.

Privacy.  As noted above, a revocable trust does maintain family privacy to some degree.  This is a desirable feature of the revocable trust to many people, although some limited disclosure must be made for inheritance tax purposes in states that have an inheritance tax.

Creditors rights.  Present and future creditors of the grantor can reach trust assets.  Transfers to a revocable trust to avoid creditors will not, typically, be allowed.  Probate proceedings statutorily provide for the elimination of some claims when the statutory notice provisions are followed.  However, in most instances, legitimate claims are allowed against the estate and probate should not be viewed as a method of avoiding all creditors.  The probate process, however, does provide an ability to terminate creditors' rights in the probate assets.

Note:  Assets held in a revocable trust that was created by a deceased spouse for the discretionary use and benefit of a surviving spouse can be counted as available resources (as can the income from the trust) for Medicaid eligibility purposes.  On the other hand, a trust created by the deceased spouse's will (a testamentary trust) for the benefit of the institutionalized spouse, if drafted property, may possibly not be treated as an available resource. 

Disinheriting a spouse.  While it has been possible in some states in the past, to my knowledge, no state remains where assets can be transferred to a revocable trust, with the grantor’s spouse not being named as a beneficiary, and effectively disinherit the spouse. The rights of a surviving spouse to a statutory elective share of a deceased spouse's property are not avoided by using a revocable trust rather than a Will.

Challenges.  Both revocable trusts and wills are susceptible to challenge by unhappy heirs.  Precedent is perhaps better established in the probate format.  A revocable trust may create greater suspicion on the part of the heirs.  This could mean that challenges are more likely in the context of a revocable trust as compared to a will administered through the probate process. 

Trust language interpretation.  There is a large body of caselaw that has developed around interpretation questions for wills.  This law does not automatically apply to the interpretation of a revocable trust when there may be uncertainty as to the actual intent of the grantor.  Even though the considerations might appear to be the same, that has not always been the case when applied by the Courts.

Conclusion

A revocable trust is clearly not advised for everyone.  Each person has unique goals and needs that must be considered in light of the benefits and burdens inherent in any type of estate planning arrangement that might be utilized.  There is no legal device which will make the basic personal decisions which must be faced for constructive estate planning, and there is no substitute for good counseling in the preparation and implementation of one's estate plan.

April 22, 2021 in Estate Planning | Permalink | Comments (0)

Monday, April 19, 2021

Ag Law and Taxation - 2016 Bibliography

Overview

Today's post is a bibliography of my ag law and tax blog articles of 2016.  Earlier this year I have provided bibliographies for you of my blog articles for 2020, 2019, 2018 and 2017.  This now completes the bibliographies since I began the blog in July of 2016.  At the end of 2021, I will post a lengthy blog article of all of the articles published through that timeframe. 

The 2016 bibliography of articles – it’s the subject matter of today’s post.

BUSINESS PLANNING

Treasury Attacks Estate and Entity Planning Techniques With Proposed Valuation Regulations

https://lawprofessors.typepad.com/agriculturallaw/2016/08/treasury-attacks-estate-and-entity-planning-techniques-with-proposed-valuation-regulations.html

Using an LLC to Reduce S.E Tax and the NIIT

https://lawprofessors.typepad.com/agriculturallaw/2016/09/using-an-llc-to-reduce-se-tax-and-the-niit.html

IRS Audit Issue – S Corporation Reasonable Compensation

https://lawprofessors.typepad.com/agriculturallaw/2016/10/irs-audit-issue-s-corporation-reasonable-compensation.html

Rents Are Passive, But They Can Be Recharacterized - And Grouped (Sometimes)

https://lawprofessors.typepad.com/agriculturallaw/2016/11/rents-are-passive-but-they-can-be-recharacterized-and-grouped-sometimes.html

Tribute To Orville Bloethe

https://lawprofessors.typepad.com/agriculturallaw/2016/12/tribute-to-orville-bloethe.html

CIVIL LIABILITIES

Registration of a Pesticide Doesn't Mean It Might Not Be Misbranded

https://lawprofessors.typepad.com/agriculturallaw/2016/07/registration-of-a-pesticide-doesnt-mean-it-might-not-be-misbranded-.html

Death of Livestock In Blizzard Was a Covered Loss by “Drowning”

https://lawprofessors.typepad.com/agriculturallaw/2016/08/death-of-livestock-in-blizzard-was-a-covered-loss-by-drowning.html

FIFRA Pre-Emption of Pesticide Damage Claims

https://lawprofessors.typepad.com/agriculturallaw/2016/08/fifra-pre-emption-of-pesticide-damage-claims.html

Agritourism Acts, Zoning Issues and Landowner Liability

https://lawprofessors.typepad.com/agriculturallaw/2016/09/agritourism-acts-zoning-issues-and-landowner-liability.html

The “Agriculture” Exemption From The Requirement To Pay Overtime Wages

https://lawprofessors.typepad.com/agriculturallaw/2016/09/the-agriculture-exemption-from-the-requirement-to-pay-overtime-wages.html

The Scope and Effect of Equine Liability Acts

https://lawprofessors.typepad.com/agriculturallaw/2016/09/the-scope-and-effect-of-equine-liability-acts.html

What’s a Rural Landowner’s Responsibility Concerning Crops, Trees and Vegetation Near an Intersection?

https://lawprofessors.typepad.com/agriculturallaw/2016/12/whats-a-rural-landowners-responsibility-concerning-crops-trees-and-vegetation-near-an-intersection.html

CONTRACTS

Some Thoughts on Production Contracts

https://lawprofessors.typepad.com/agriculturallaw/2016/10/some-thoughts-on-production-contracts.html

CRIMINAL LIABILITIES

Prison Sentences Upheld For Egg Company Executives Even Though Government Conceded They Had No Knowledge of Salmonella Contamination.

https://lawprofessors.typepad.com/agriculturallaw/2016/07/prison-sentences-upheld-for-egg-company-executives-even-though-government-conceded-they-had-no-knowledge-of-salmonella-contam.html

ENVIRONMENTAL LAW

Registration of a Pesticide Doesn't Mean It Might Not Be Misbranded

https://lawprofessors.typepad.com/agriculturallaw/2016/07/registration-of-a-pesticide-doesnt-mean-it-might-not-be-misbranded-.html

FIFRA Pre-Emption of Pesticide Damage Claims

https://lawprofessors.typepad.com/agriculturallaw/2016/08/fifra-pre-emption-of-pesticide-damage-claims.html

Air Emissions, CWA and CERCLA

https://lawprofessors.typepad.com/agriculturallaw/2016/08/air-emissions-cwa-and-cercla.html

Are Seeds Coated With Insecticides Exempt From FIFRA Regulation?

https://lawprofessors.typepad.com/agriculturallaw/2016/12/are-seeds-coated-with-insecticides-exempt-from-fifra-regulation.html

ESTATE PLANNING

The Situs of a Trust Can Make a Tax Difference

https://lawprofessors.typepad.com/agriculturallaw/2016/07/the-situs-of-a-trust-can-make-a-tax-difference.html

Treasury Attacks Estate and Entity Planning Techniques With Proposed Valuation Regulations

https://lawprofessors.typepad.com/agriculturallaw/2016/08/treasury-attacks-estate-and-entity-planning-techniques-with-proposed-valuation-regulations.html

Common Estate Planning Mistakes of Farmers

https://lawprofessors.typepad.com/agriculturallaw/2016/09/common-estate-planning-mistakes-of-farmers.html

Staying on the Farm With the Help of In-Home Care

https://lawprofessors.typepad.com/agriculturallaw/2016/10/staying-on-the-farm-with-the-help-of-in-home-care.html

Including Property in the Gross Estate to Get a Basis Step-Up

https://lawprofessors.typepad.com/agriculturallaw/2016/10/including-property-in-the-gross-estate-to-get-a-basis-step-up.html

Farm Valuation Issues

https://lawprofessors.typepad.com/agriculturallaw/2016/10/farm-valuation-issues.html

The Future of the Federal Estate Tax and Implications for Estate Planning

https://lawprofessors.typepad.com/agriculturallaw/2016/11/the-future-of-the-federal-estate-tax-and-implications-for-estate-planning.html

Tribute To Orville Bloethe

https://lawprofessors.typepad.com/agriculturallaw/2016/12/tribute-to-orville-bloethe.html

INCOME TAX

House Ways and Means Committee Has A Blueprint For Tax Proposals - Implications For Agriculture

https://lawprofessors.typepad.com/agriculturallaw/2016/07/house-ways-and-means-committee-has-a-blueprint-for-tax-proposals-implications-for-agriculture.html

In Attempt To Deny Oil and Gas-Related Deductions, IRS Reads Language Into the Code That Isn’t There – Tax Court Not Biting

https://lawprofessors.typepad.com/agriculturallaw/2016/07/in-attempt-to-deny-oil-and-gas-related-deductions-irs-reads-language-into-the-code-that-isnt-there-tax-court-not-biti.html

IRS Does Double-Back Layout on Self-Employment Tax

https://lawprofessors.typepad.com/agriculturallaw/2016/08/irs-does-double-back-layout-on-self-employment-tax.html

S.E. Tax on Passive Investment Income; Election Out of Subchapter K Doesn’t Change Entity’s Nature; and IRS Can Change Its Mind

https://lawprofessors.typepad.com/agriculturallaw/2016/08/se-tax-on-passive-investment-income-election-out-of-subchapter-k-doesnt-change-entitys-nature-and-irs-can-change-it.html

Handling Depreciation on Asset Trades

https://lawprofessors.typepad.com/agriculturallaw/2016/08/handling-depreciation-on-asset-trades.html

Claiming “Bonus” Depreciation on Plants

https://lawprofessors.typepad.com/agriculturallaw/2016/08/claiming-bonus-depreciation-on-plants.html

Proper Reporting of Crop Insurance Proceeds

https://lawprofessors.typepad.com/agriculturallaw/2016/08/proper-reporting-of-crop-insurance-proceeds.html

Permanent Conservation Easement Donation Opportunities and Perils

https://lawprofessors.typepad.com/agriculturallaw/2016/09/permanent-conservation-easement-donation-opportunities-and-perils.html

Sales By Farmers/Rural Landowners Generate Common Questions

https://lawprofessors.typepad.com/agriculturallaw/2016/09/sales-by-farmersrural-landowners-generate-common-questions-.html

Expense Method Depreciation - Great Tax Planning Opportunities On Amended Returns

https://lawprofessors.typepad.com/agriculturallaw/2016/09/expense-method-depreciation-great-tax-planning-opportunities-on-amended-returns.html

The DPAD and Agriculture

https://lawprofessors.typepad.com/agriculturallaw/2016/10/the-dpad-and-agriculture.html

Donating Food Inventory to a Qualified Charity - New Opportunity for Farmers

https://lawprofessors.typepad.com/agriculturallaw/2016/10/donating-food-inventory-to-a-qualified-charity-new-opportunity-for-farmers.html

Farm Valuation Issues

https://lawprofessors.typepad.com/agriculturallaw/2016/10/farm-valuation-issues.html

Treatment of Farming Casualty and Theft Losses

https://lawprofessors.typepad.com/agriculturallaw/2016/10/treatment-of-farming-casualty-and-theft-losses.html

More on Handling Farm Losses

https://lawprofessors.typepad.com/agriculturallaw/2016/11/more-on-handling-farm-losses.html

Selected Tax Issues For Rural Landowners Associated With Easement Payments

https://lawprofessors.typepad.com/agriculturallaw/2016/11/selected-tax-issues-for-rural-landowners-associated-with-easement-payments.html

Are You A Farmer? It Depends!

https://lawprofessors.typepad.com/agriculturallaw/2016/11/are-you-a-farmer-it-depends.html

Rents Are Passive, But They Can Be Recharacterized - And Grouped (Sometimes)

https://lawprofessors.typepad.com/agriculturallaw/2016/11/rents-are-passive-but-they-can-be-recharacterized-and-grouped-sometimes.html

It’s Fall and Time to “Hoop it Up”!

https://lawprofessors.typepad.com/agriculturallaw/2016/11/its-fall-and-time-to-hoop-it-up.html

Utilizing the Home Sale Exclusion When Selling the Farm

https://lawprofessors.typepad.com/agriculturallaw/2016/12/utilizing-the-home-sale-exclusion-when-selling-the-farm.html

Farmland Acquisition – Allocation of Value to Depreciable Items

https://lawprofessors.typepad.com/agriculturallaw/2016/12/farmland-acquisition-allocation-of-value-to-depreciable-items.html

Tribute To Orville Bloethe

https://lawprofessors.typepad.com/agriculturallaw/2016/12/tribute-to-orville-bloethe.html

IRS Continues (Unsuccessfully) Attack on Cash Accounting By Farmers

https://lawprofessors.typepad.com/agriculturallaw/2016/12/irs-continues-unsuccessfully-attack-on-cash-accounting-by-farmers.html

The Uniform Capitalization Rules and Agriculture

https://lawprofessors.typepad.com/agriculturallaw/2016/12/the-uniform-capitalization-rules-and-agriculture.html

The Non-Corporate Lessor Rule – A Potential Trap In Expense Method Depreciation

https://lawprofessors.typepad.com/agriculturallaw/2016/12/the-non-corporate-lessor-rule-a-potential-trap-in-expense-method-depreciation.html

REAL PROPERTY

Texas Mineral Estates, Groundwater Rights, Surface Usage and the “Accommodation Doctrine”

https://lawprofessors.typepad.com/agriculturallaw/2016/08/texas-mineral-estates-groundwater-rights-surface-usage-and-the-accommodation-doctrine.html

So You Want To Buy Farmland? Things to Consider

https://lawprofessors.typepad.com/agriculturallaw/2016/09/so-you-want-to-buy-farmland-things-to-consider.html

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

https://lawprofessors.typepad.com/agriculturallaw/2016/09/whats-the-character-of-the-gain-from-the-sale-of-farm-or-ranch-land.html

Utilizing the Home Sale Exclusion When Selling the Farm

https://lawprofessors.typepad.com/agriculturallaw/2016/12/utilizing-the-home-sale-exclusion-when-selling-the-farm.html

REGULATORY LAW

New Food Safety Rules Soon to Apply to Farmers and Others In the Food Production Chain

https://lawprofessors.typepad.com/agriculturallaw/2016/10/new-food-safety-rules-soon-to-apply-to-farmers-and-others-in-the-food-production-chain.html

New Regulations on Marketing of Livestock and Poultry

https://lawprofessors.typepad.com/agriculturallaw/2016/11/new-regulations-on-marketing-of-livestock-and-poultry.html

The Future of Ag Policy Under Trump

https://lawprofessors.typepad.com/agriculturallaw/2016/11/the-future-of-ag-policy-under-trump.html

Verifying Employment – New Form I-9; The Requirements and Potential Problem Areas

https://lawprofessors.typepad.com/agriculturallaw/2016/11/verifying-employment-new-form-i-9-the-requirements-and-potential-problem-areas.html

SECURED TRANSACTIONS

Feedlot Has Superior Rights to Cattle Sale Proceeds

https://lawprofessors.typepad.com/agriculturallaw/2016/08/feedlot-has-superior-rights-to-cattle-sale-proceeds.html

WATER LAW

Watercourses and Boundary Lines

https://lawprofessors.typepad.com/agriculturallaw/2016/11/watercourses-and-boundary-lines.html

April 19, 2021 in Business Planning, Civil Liabilities, Contracts, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Saturday, April 17, 2021

Is That Old Fence Really the Boundary?

Overview

For rural properties, fences are generally considered by the landowners to be the boundaries.  But by law, the actual boundary is an imaginary line that is located according to the property description in the deeds to the properties.  It’s this discrepancy between the existing fence and the legal boundary that can create issues between adjacent landowners.  How is this issue resolved?  What factors are relevant in determining where the actual boundary is located. 

I am revisiting a topic I have written about in the past because the questions continue to come up.  There may also be new readers to the blog that haven’t read my prior posts dealing with this topic.  So going over things again can’t hurt.

Old fences and boundaries – it’s the topic of today’s post.

Basic Principles

An existing fence is typically considered to be evidence of where the imaginary line between two properties is located.  It matters little whether the fence is permanent or not.  But, it is also possible (and in many instances, likely) that an old fence has been used as part of the description of the land as the property has changed hands.  It’s not unusual for a farm property to be sold according to the existing fence lines. 

Metes and bounds.   In the eastern one-third of the United States, land descriptions are likely to be “metes and bounds” descriptions.  With this type of description, a tract of land is described by a series of directions that trace the perimeter of the land.  Such tracing might include following an old fence. 

General location.  In some rural areas, I have seen deeds refer to the boundary of a farm by general location, such as “The old Snarkfeltcher place on Highway 47, three miles east of the Dinwiddie junction.”  With a description such as that, the boundary of the farm is the physical boundary where the land abuts an adjoining tract of land.  It might very well be marked by an existing fence, which the parties intend to use as the boundary.   

Note:   In either the situation where a metes and bounds description or a general location description is used, the fence may actually be considered to be the permanent boundary marker.  If the fence later deteriorates, it may be necessary to relocate (recreate) the fence to precisely determined the boundary. 

Survey.  Presently, it is common for a tract of land to be described in a way that requires the mapping out of survey lines.  This is common when the land is such that a survey is easy to conduct.  For some rural properties, however, the topography of the land may be such that there really isn’t a good way to do a survey at an economical price.  In this situation, an existing fence may not be built on the boundary line, but it is treated as the boundary by the adjoining landowners.  Indeed, it is often the case that prior adjoining owners agreed to build the fence to one side of the actual boundary line as a matter of convenience – to get around thick brush or trees or water or some other obstacle.  When this has happened, the fence was not intended to be the boundary line – at least not originally.  But, with the passage of time the fence may come to be thought of as marking the boundary regardless of whether it actually does. 

Existing Fence Line As Actual Boundary

Those fences that are not on the true boundary (perhaps as revealed by a subsequent survey), are what give rise to disputes.  If I were to track the questions that I get by category, I would say that, after tax and estate/business planning questions, issues with fences (and leases) trigger the most questions.  So, based on the above discussion, a key question is whether an old fence line can be substituted for the actual boundary when it is not on the surveyed line.  If it can, how does that happen?

Passage of Time

The mere passage of time will not cause the fence to be substituted for the property description boundary.  So, the fact that the fence has been there for decades doesn’t matter much by itself.  However, patterns of usage of the land on each side of the fence may cause the fence to become fixed as the boundary and have the legal effect of changing the boundary set out in the deed.  This is an important point surveyors and realtors often fail to properly understand.   

Adverse possession.  A party can acquire title to property that isn’t lawfully theirs by making an open and notorious use of the property for a specific period of time.  The timeframe varies from state-to-state as do the specific elements of an adverse possession claim, but in most states the timeframe is somewhere between five and 20 years.  But, for adverse possession to apply, the party trying to claim title via adverse possession must know that the property they are claiming as theirs doesn’t lawfully belong to them.  If it is not known where the actual property boundary is, courts look at the intent of the party trying to claim title by adverse possession.  If the property was occupied merely by mistake with no intent to claim the disputed area such that the claimant intended only to hold up to the true line (wherever it is), adverse possession is not present.  Alternatively, if the occupant takes possession of the property believing the land to be his or her own up to the mistaken line and openly claims title to it (often evidenced by conduct), the possession will be considered adverse. 

Note:   Many adverse possession claims fail because both parties have thought that the fence actually represented the boundary and thus do not intend to claim any additional property than what they are legally entitled to claim. 

Treating An Old Fence at the Boundary

Adjacent landowners may agree that an existing old fence actually constitutes the boundary in several ways.

Written agreement.  Although not common, the parties may settle uncertainty about the boundary on the basis of a written agreement.  In that instance, corrective deeds will be issued, and the property descriptions of the adjoining tracts will be changed to reflect the fence line.  Multiple deeds may be necessary to transfer the disputed area.  It’s important to hire an attorney that practices in real estate matters to get the deeds drafted and filed properly. 

Memo of understanding.  Another way in which the adjacent owners may settle the boundary dispute is to enter into a memorandum of understanding that designates the old fence line as the boundary.  That memo can be recorded in the land records where it will bind not only the present owners of the adjacent tracts, but their successors.  For the memorandum to be enforceable, the boundary must be uncertain or in dispute.  The memo is technically called a “parol agreement.”  It is not subject to state law governing conveyances.  Even so, it’s a good practice for the memo to accurately describe the affected land and that the parties sign it.  The parties should then observe the property line as described in the memo. 

Practical location.  Also, known as “boundary by acquiescence,” the doctrine of practical location may also be used to establish an old fence as the boundary.  This situation arises when one party occupies to the fence line for the statutory timeframe (the same timeframe as that for adverse possession), knowing that the fence is not the true boundary but not knowing where the true boundary is located.  If the parties know that the fence is not the true boundary, but they do know where the true boundary is located, neither a memorandum (parol agreement) nor boundary by acquiescence applies. 

Equitable exchange.  It may be possible in some states for a court to grant an “equitable exchange.”  With an equitable exchange, one party is ordered to “trade” property on one side of the line for property on the other.  However, this remedy is extraordinary, and a court will only grant such an exchange if the parties can show that the true location of the boundary will present an unusual hardship or some other circumstance.   

Recent Case

The farmland boundary cases are voluminous.  That’s unfortunate because it almost always means that neighbors are not getting along and are in a heated dispute about a boundary.  Resolving such a dispute in court can be costly.

An example of a boundary dispute that involved several of the concepts discussed in today’s article is the Iowa case of Liddiard v. Mikesh, 947 N.W.2d 231 (Iowa Ct. App. 2020).  In the case, the plaintiff failed to establish an existing fence as the boundary line either by adverse possession or under the boundary by acquiescence theory.  The facts revealed that the plaintiff and his family had owned their property for 75 years. The property description in the original deed noted that plaintiff’s property included forty acres, containing five acres “more or less” bounded by the brink of a bluff. The “more or less” language was not included when the plaintiff’s family purchased the land. The defendant hired a surveyor to complete a survey when he purchased property next to the plaintiff’s property. The survey was recorded and included a five-acre square cut-out in the northeast corner of the plaintiff’s property. In a dispute over logging timber, the defendant prevailed in small claims court, where the small claims court found that the defendant owned the five-acres. The small claims court noted it had no jurisdiction to establish property lines. Six years later, the plaintiff sought to quiet title for approximately eight acres, including the five-acre square. The plaintiff argued that the true boundary line was the fence line, and that he was the owner of the disputed property under theories of adverse possession and boundary by acquiescence.

The trial court held that the plaintiff failed to establish either possession by adverse possession or boundary by acquiescence. On appeal, the plaintiff argued that the trial court erred in ruling that he did not establish possession under either claim. The appellate court held that the plaintiff did not prove adverse possession by establishing hostile, actual, open, exclusive and continuous possession, under a claim of right for at least ten years. The appellate court noted that both parties had used the land, therefore the plaintiff’s use was not exclusive. While the plaintiff maintained the fence, the appellate court noted that a claim of right must be established by substantial maintenance and improvement to establish adverse possession. Additionally, the appellate court noted that the plaintiff did not openly claim ownership until the logging dispute six years prior. The appellate court also held that there was no boundary by acquiescence because both parties did not acknowledge and treat the fence line as the boundary. The appellate court noted that the defendant was able to show that the fence was a courtesy fence constructed to keep livestock contained. 

Conclusion

Fences and boundary matters can create headaches for rural landowners.  It’s best to know the rules so that you can get a dispute resolved quickly and efficiently, or not get into a dispute in the first place. 

April 17, 2021 in Real Property | Permalink | Comments (0)

Thursday, April 15, 2021

Regulation of Agriculture – Food Products, Slaughterhouse Line Speeds and CAFOs

Overview

Agriculture is one of the most heavily regulated industries in the United States.  Almost every activity of a farmer or rancher is somehow regulated by federal or state government.  For example, federal and state governments regulate the marketing and quality standards of various ag products; animal and plant health is regulated; farm programs are numerous and are often tied to crop insurance and/or soil conservation; water use is regulated; and ag products are subject to various export and import programs.  This just names a few ways that ag is regulated.  Such regulation can also lead a producer into tangled administrative battles with various regulatory agencies and which can end up in court.

In today’s post, I take a look at some recent examples of court cases involving the regulation of agriculture and food production.  It’s just a sample of what a farmer or rancher often encounters.

Recent cases involving the regulation of agriculture – it’s the topic of today’ post.

Background – The Government’s Regulatory Power Authority

Every level of government has certain basic powers. For example, the federal government's power includes the commerce power, exercise of eminent domain, the power to tax, and the power to spend.  The commerce power is the constitutionally-based power to regulate commerce between and among the states and with other countries and regulates goods and transactions “affecting” interstate commerce.  The power of eminent domain is the power to acquire property for the public good.  The power to tax is the power to generate revenue.  While the constitution limits the federal government's exercise of these powers, much of the regulation of agricultural activities occurs in accordance with the Congress' ability to regulate commerce among the states in accordance with the Commerce Clause of Article I, Section 8 of the Constitution.

State-level governmental power to regulate agricultural activities derives largely from the police power.  The states, in accordance with their police power, may regulate activities in order to promote the health, safety, and welfare of its citizens. The police power is limited only by the extent to which the regulations infringe upon constitutional guarantees, such as equal protection of the laws and by the limits on the “taking” of property value through the heavy hand of regulation.  In general, a state's exercise of its police power will only be found improper if it is utilized in an arbitrary, capricious, discriminatory or confiscatory manner or results in a “taking.”  But, of course, the power can be abused, as was evidenced clearly in some states during 2020. 

Thus, the extent and validity of much of federal regulation of agricultural activities is measured by the Commerce Clause while state regulation is made possible by the police power.

Recent Court Decisions

In recent weeks, the courts have decided numerous cases involving the regulation of food and agriculture concerning various matters.  The following is just a sampling of three cases:

Missouri Food Labeling Law Upheld

Turtle Islands Foods, SPC v. Thompson, No. 19-3154, 2021 U.S. App. LEXIS 9037 (8th Cir. Mar. 29, 2021)

 Missouri law (Mo. Rev. Stat. §265.494(7)) makes it a criminal offense to misrepresent a product as meat that is not derived from the harvested production of livestock or poultry. A violation of the law could result in up to a year in prison plus up to a $1,000 fine. The law is directed at businesses that sell “alternative” protein sources such as those that are plant-based or cell-cultured and market such products as a meat-based product. The plaintiff, a maker of a vegetarian turkey substitute, challenged the law as an unconstitutional violation of free speech, due process and the Dormant Commerce Clause. The plaintiff sought a preliminary injunction preventing the state from enforcing the law. The state submitted evidence showing how the plaintiff could comply with the law, noting that a label clearly stating that the product was “plant-based,” “veggie,” “lab grown,” or something similar.

The trial court denied the plaintiff’s request for an injunction on the basis that the law only barred a company from misleading consumers into believing that a product is meat from livestock when it is not. The trial court also determined that the plaintiff had failed to prove an irreparable injury by risk of prosecution because its packaging already contained the necessary disclaimers.

On further review, the appellate court affirmed. The appellate court noted that the plaintiff admitted that its products were labeled in such a way to clearly indicate that the products did not contain meat from slaughtered animals and denoted that they were plant-based, vegan or vegetarian. The appellate court noted that, on remand at the trial court, facts could be discovered that could possibly lead to a different result on appeal. 

USDA Rule Eliminating Line Speeds Vacated

United Food & Commercial Workers Union, Local No. 663 v. United States Department of Agriculture, No. 19-cv-2660, 2021 U.S. Dist. LEXIS 62656 (D. Minn. Mar. 31, 2021)

USDA inspectors, under the Federal Meat Inspection Act (FMIA), monitor port slaughter plants to ensure the safety and wholesomeness of pork products that are sold to the public. To ensure that post-mortem inspections are adequate, the Food Safety Inspection Service (FSIS) regulates the speed of evisceration lines. 9 C.F.R. §310.1(b)(3). In late 2019 the FSIS adopted as a final rule the New Swine Inspection System ("NSIS"), an optional program that implemented several reforms, including the elimination of evisceration line speed limits at pork processing plants. A labor union sued, claiming that the final rule was not properly promulgated under the Administrative Procedure Act (APA). When FSIS proposed the NSIS, it expressly identified worker safety as an important consideration and requested public comment on whether increasing line speeds would harm workers. The FSIS received many comments raising worker safety concerns before finalizing the optional rule. The court vacated the portion of the final rule pertaining to line speed limits concluding that the rule didn’t contain any discussion, analysis or evaluation of the submitted worker safety comments. The court reasoned that such failure violated the APA because worker safety was a key aspect of the rule. Thus, this part of the rule was remanded to the FSIS for review. The balance of the rule was not vacated and remains in effect. The court also stayed its order and entry of judgment for 90 days to give the FSIS time to address the issue. 

Zoning Ordinance Allows for CAFO

Chambers v. Delaware-Muncie Metropolitan Board of Zoning Appeals, 150 N.E.3d 603 (Ind. Ct. App. 2020)

The petitioners owned property located in an area that was zoned as “agricultural.” The petitioners sought and eventually obtained a permit from the county building commissioner to build several hog barns configured as a concentrated animal feeding operation (CAFO) on their property. Neighbors of the petitioners asked the zoning board to review the building commissioner’s decision to issue the permit. The zoning board voided the permit and determined that the farming zone did not recognize industrial agricultural uses, such as the petitioners’ proposed CAFO. The petitioners sought a review of the zoning board’s decision. The trial court noted that the zoning ordinance specifically permitted animal husbandry, as well as raising and selling hogs and the erection of barns and similar farming building. The trial court determined that the zoning ordinance clearly indicated that hog raising operations were a permitted use. The trial court noted that the county could have excluded CAFOs or put other restrictions in place to maintain more traditional farming operations. Additionally, the trial court noted that several CAFOs were located and permitted in other agricultural zones in the county. Thus, the trial court held that the zoning board’s decision was reversed and the building commissioner’s decision to issue the permit to the petitioners was reinstated. On appeal, the neighbors of the petitioners argued that the zoning ordinance was ambiguous because it did not mention CAFOs. The appellate court agreed with the trial court and noted that the zoning ordinance set no limit on the scale of permitted uses in the agricultural zone. The appellate court determined that the plain language of the zoning ordinance was not ambiguous, and the petitioners were permitted to raise any number of hogs, subject to state and federal limitations. 

Conclusion

The federal and state government regulation of agricultural activities seems to grow as the years go on.  The government becomes more and more entangled in the daily life of a farmer or rancher.  Do the benefits outweigh the costs?  Probably not?  Is there hope on the horizon for less governmental regulation?  That tide recently changed.  In any event the matter is just another reason that an experienced ag lawyer is needed more now than ever before.

April 15, 2021 in Regulatory Law | Permalink | Comments (0)

Monday, April 12, 2021

Tax Potpourri

Overview

Income tax (as well as other forms of taxes) has been an element of life for over a century in the United States.  Tax issues seemingly permeate just about everything a person does and shapes one’s behavior.  In today’s article I summarize several recent tax-related cases to illustrate my point of how pervasive tax issues are. 

Tax issues in various contexts in recent court cases – it’s the topic of today’s post.

Taxpayer Unable to Establish Funds Used to Cover Expenses as Loans or Gifts

Oss v. Dep’t. of Revenue, No. TC-MD 190304N, 2020 Ore. Tax LEXIS 47 (Ore. T.C. Jul. 30, 2020)

An issue that presents itself more than we would like to admit is the proper characterization of financial assistance provided to a child by a parent or parents.  The issue sometimes comes up when a parent dies without clear specification in a will or a trust of the nature of the transfer.  This often flares up when other children are present, and their inheritance would be diminished if the transfer were considered to be a gift.   

This matter came up in a recent Oregon case.  In the case, the plaintiff operated a recreational marijuana business as a single-member limited liability company. The plaintiff’s business and personal expenses were largely cash-based. Under the cash accounting method, the plaintiff reported on his 2015 Schedule C: gross receipts of $1,153,466; cost of goods sold of $1,100,217; and gross income of $53,249. After reviewing the plaintiff’s 2015 tax return and analyzing the plaintiff’s gross receipts using an indirect analysis, the defendant determined the plaintiff had $1,144,181 in purchases and had substantiated $287,414 in nondeductible expenses, resulting in $1,431,595 in outgoing cash. As a result, the defendant increased the plaintiff’s 2015 gross receipts by $278,129, which was the amount outgoing cash exceeded the plaintiff’s gross receipts.

The plaintiff argued that the additional funds used to cover expenses were attributable to a combination of loans, gifts, and savings. Specifically, the plaintiff claimed that he received $120,000 from his father as a result of four nontaxable loans and $150,000 in nontaxable gifts from his grandfather over six years. The plaintiff also claimed to have built up a reserve of cash savings by spending less on living expenses than the defendant had determined in its indirect income analysis.

The state tax court noted that taxpayers are required to keep adequate records in order to determine their correct tax liability. The court determined that the plaintiff was unable to establish that he received a loan from his father, gifts from inheritance funds, or cash savings. The plaintiff only had a handwritten note from his father and no bank statements or testimony to establish the loans or gifts existed. The court also noted that the plaintiff likely understated his annual living expenses by relying on bankruptcy standards to estimate living expenses. As a result, the court held that the defendant had properly adjusted the plaintiff’s gross receipts for 2015. 

Settlement Proceeds Are Taxable Income

Blum v. Comr., T.C. Memo. 2021-18

On this blog, I have published a couple of detailed articles on the tax treatment of court settlements and judgments.  You may read those here:https://lawprofessors.typepad.com/agriculturallaw/2019/07/tax-treatment-of-settlements-and-court-judgments.html and here https://lawprofessors.typepad.com/agriculturallaw/2020/12/taxation-of-settlements-and-court-judgments.html The issue came up again in a recent case involving a lawsuit against a law firm for malpractice. 

In the case, 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. 

IRS Listing of Taxpayers With Significant Tax Debt Constitutional

Rowen v. Comr., 156 T.C. No. 8 (2021)

Currently, a push is being made in D.C. for an “infrastructure” bill.  I guess the massive one in 2015 didn’t do the trick. The current proposal, just like the one in 2015, has a bunch of “stuff” in it that has little to nothing to do with infrastructure.  In the 2015 legislation, one of those non-infrastructure provisions was an IRS “travel ban.”  That “travel ban” provision came up in a recent case when a taxpayer claimed it was unconstitutional.

Section 32101, subsection (a) of the “Fixing America’s Surface Transportation” (FAST) Act created I.R.C. §7345 which authorizes the IRS to certify lists of seriously delinquent taxpayers to the Treasury Department that will then send those lists to the State Department for denial or revocation of a listed taxpayer’s passport.  In the recent case, the petitioner had unpaid tax debt of nearly $500,000 and the IRS certified to the Treasury Department that the petitioner had a “seriously delinquent tax debt” within the meaning of I.R.C. §7345(b), giving the U.S. Secretary of State the ability to deny or revoke the petitioner’s passport. The petitioner sued for a determination that the certification was erroneous under I.R.C. §7345(e)(1) and moved for summary judgment on the basis that I.RC. §7345 violated the Due Process Clause of the Constitution and illegally infringed his right to travel internationally. The petitioner also claimed that I.R.C. §7345 violated his human rights under the Universal Declaration of Human Rights.

The Tax Court held that I.R.C. §7345 is not constitutionally defective because it doesn’t restrict the right to international travel and that the IRS was entitled to judgment as a matter of law. The Tax Court noted that all passport-related decisions are left to the Secretary of State and that the authority of the Secretary of State to revoke a passport doesn’t derive from I.R.C. §7345. The Tax Court noted that the constitutionality of the authority granted to the Secretary of State by FAST Act section 32101(e) was not an issue in the case and, therefore, the Court expressed no view on that issue. 

Failure to Substantiate Eliminates Charitable Deduction

Chiarelli v. Comr., T.C. Memo. 2021-27

If there is one thing that is certain about tax law, it is that deductions are a matter of “legislative grace” and a taxpayer must be able to substantiate them if challenged.  Recently, the U.S. Tax Court dealt with yet another case involving the substantiation of deductions.

Under the facts of this case, the petitioner made numerous charitable donations of clothing, furniture and antiques that he inherited. However, the petitioner didn’t maintain any proper receipts from the charitable donees, he didn’t keep reliable records in lieu of receipts. The petitioner also didn’t have contemporaneous written acknowledgements for his contributions exceeding $250, and didn’t satisfy the heightened record keeping and return statement requirements for contribution exceeding $5,000. Appraisals of the donated items didn’t account for the items’ physical condition and age, and didn’t include any mention of the appraiser’s qualifications or a statement that the each appraisal was prepared for income tax purposes. The petitioner also did not complete the appraisal summary on Form 8283.

The Tax Court rejected the petitioner’s substantial compliance argument noting that while the petitioner provided supplemental information, the supplemental information was also incomplete. The Tax Court also rejected the petitioner’s claim that he cured his defective submissions by responding to IRS's request for additional documentation within 90 days in accord with Treas. Reg. §1.170A-13(c)(4). 

Conservation Easement Deduction Allowed for Donated Façade Easement

C.C.M. AM 2021-001 (Mar. 8, 2021)

Conservation easement deduction cases are everywhere.  The IRS is all over taxpayers engaged in donating permanent conservation easement to a qualified charity and claiming a charitable deduction for the loss of value to their land caused by the easement.  Recently the IRS put out more guidance on donated conservation easements in the form of a Memo from the IRS Chief Counsel’s Office.

The taxpayer in the Memo donated an easement on a building in a registered historic district on which the taxpayer had installed an accessibility ramp to comply with the Americans With Disabilities Act (ADA). The IRS determined that the installation of the ramp would not disqualify the taxpayer’s deduction. The IRS viewer the ramp as “upkeep” essential to the preservation of the structure. Such upkeep, if required to comply with the ADA, does not jeopardize the donor’s eligibility for a charitable deduction under I.R.C. §170(h)(4)(B) with respect to a building in a registered historic district. 

Conclusion

The manner in which taxation impacts daily life is staggering.  The cases discussed in today’s post illustrate just some of the ways that a taxpayer can get crosswise with the IRS.  Take heed!

April 12, 2021 in Income Tax | Permalink | Comments (0)

Saturday, April 10, 2021

Federal Farm Programs and the AGI Computation

Overview

Many farmers participate in federal farm programs and receive subsidies on a per-person basis.  There are limits to the amount of subsidies that can be received.  However, to be eligible to participate in most federal farm programs the applicant (individual or entity) must have an average adjusted gross income (AGI) of $900,000 or less. 

What is AGI for farm program eligibility purposes?  How is it computed?  Does it matter if the applicant is an individual or an entity? 

The computation of AGI for farm program eligibility purposes – it’s the topic of today’ post.

In General

A prerequisite to participating in many federal farm programs is annually certifying that average AGI doesn’t exceed a $900,000 threshold. The measuring period is the prior three years, skipping the immediately prior year.  The $900,000 limit applies to most USDA farm programs, but there are some exceptions – particularly those concerning conservation or disasters.  An applicant must provide the IRS with written consent to allow the USDA to verify AGI.  The consent (via USDA Form CCC-941) allows the IRS to verify to the FSA, based on a farm program applicant’s tax return information, whether (for most farm programs) the $900,000 limit is not exceeded.  The consent covers the three tax years that precede the immediately preceding tax year for which farm program benefits are being sought.  Thus, for 2021, the relevant tax years are 2019, 2018 and 2017.  For a farmer or a farming operation that has not been operating for the three-year period before the immediately preceding year, the FSA uses an average of income for the years of operation. FSA 5-PL, Para. 312, subparagraph F

Note:  Worksheets used in determining AGI calculations should be retained for at least three years.

Defining AGI – The FSA Way

As noted, average AGI is measured over the three taxable years preceding the most immediately preceding complete taxable year for which benefits are requested.  FSA 5-PL, Para. 293.  The FSA, in its 5-PL at Paragraph 296, subparagraph B, sets forth the following Table for guidance on AGI determinations using a producer/applicant’s data that has been reported to the IRS:

If determining AGI for….

Then see IRS Form….

AND use the amount entered on….

Corporations

1120 or 1120-S

Either of the following:

·       Line 30 (total taxable income) plus line 19 (charitable contributions)

·       For S corporations, use only Form 1120-S, line 21 (ordinary business income).

Estates or trusts

1041

Line 23 (taxable income) plus line 13 (charitable deductions)

LLCs, LLPs, LP or similar type organization taxed as partnership

1065

Line 22 (total income from trade or business) plus line 10 (guaranteed payments to partners).

Persons

1040

Line 8b (AGI)

Tax-exempt or charitable organizations

990-T

Line 31 (unrelated business taxable income) minus income that CCC determines to be from noncommercial activity.

For a sole proprietor filing a joint return, an exception exists from the need to report the full amount reported as AGI on the final IRS tax return for the applicable year.  Under the exception, a certification may be provided by a CPA or an attorney that specifies what the amounts would have been if separate tax returns would have been filed for the applicable year.  FSA 5-PL, Para. 296, subparagraph A. 

Schedule K Issues

IRS Form 1120-S and Form 1065 do not refer to income or deductions reported on Schedule K-1. A Schedule K-1 is the IRS Form that is used to report amounts that are passed through to each taxpayer that has an interest in a “flow-through” entity such as an S corporation, partnership, trust or an estate.  Consequently, any I.R.C. §179 deduction (i.e., expense method depreciation) would not be factored into the average AGI computation for a farming operation that is a flow-through entity seeking farm program benefits.  But it would be taken into account for a C corporation. Thus, a C corporation and an S corporation with identical taxable incomes may not be treated similarly for farm program eligibility purposes.  This is particularly true for an S corporation farming entity, for example, that has AGI over the $900,000 threshold without factoring in any I.R.C. §179 amount but is under the limitation when the I.R.C. §179 deduction is taken into account. 

Threatened with litigation on this disparate treatment, the FSA backed down and the 5-PL was later amended to reflect the rule change allowing the I.R.C. §179 deduction for flow-through entities as well as sole proprietorships and C corporations.  However, FSA still ignores other K-1 items in the computation of AGI for purposes of the $900,000 AGI computation.  At least this is the position of the national FSA.  There may be variations at the local and state level.  Consistent application of the regulations has never been a staple of the FSA. 

Certifying Income – Form CCC-941

A producer seeking farm program benefits, as noted above, must annually certify income to the FSA to ensure that the $900,000 threshold (in most instances) is not exceeded. The verification process starts with the FSA’s referral of the applicant’s AGI certification and written consent to the IRS to use the applicant’s tax information on file and disclose certain information to the FSA for AGI verification purposes.  FSA 5-PL, Para. 301, Subparagraph A.  Consent for disclosure of tax information is valid only if the IRS receives it within 120 calendar days of the date the Form CCC-941 was signed.  FSA 5-PL, Para. 301, Subparagraph E. 

If an attorney or CPA statement is provided, both the statement and the completed Form CCC-941 must be submitted to the local FSA office before the Form CCC-941 is considered to be complete and AGI is updated in the producer’s file.  The submitted Form CCC-941 is then sent to the IRS and the statement of the attorney/CPA is attached to a copy of the Form that FSA retains.  FSA 5-PL, Para. 302, Subparagraph A.

Form CCC-941 is required to determine payment eligibility for all persons; legal entities; interest holders in a legal entity, including embedded entities to the fourth level of ownership interest, regardless of the level of interest held; and, members of a general partnership or joint venture, regardless of the number of members.  FSA 5-PL, Par. 294.  It is submitted under the same name and TIN as is used for tax filing purposes.  For example, for farm assets and land that have been transferred to a revocable trust, the identification on Form CCC-941 is the grantor’s name and Social Security number.

If Form CCC-941 is not filed for a program year, the producer is not eligible for farm program payments for that year.  Any program payments erroneously paid will have to be returned, with interest. 

Note:  Technically, the FSA rules state that to comply with the AGI requirement for the applicable crop, program or fiscal year, a person or legal entity must provide either a completed Form CCC-941 for that year or a statement from a CPA or attorney that the average AGI does not exceed the applicable limitation.  But, in all cases, the portions of Form CCC-941 pertaining to consent of disclosure of tax information must be completed and signed by the person (or entity) subject to AGI compliance.  FSA 5-PL, Par. 294, subparagraph B.

The form must be personally signed by the applicant – either in their own name or, if the application is on behalf of an entity, by the designated officer(s).  If the applicant is a minor, the Form can be signed by a parent or guardian.  One spouse cannot sign for the other spouse, however, absent a duly executed power-of-attorney (POA).  Likewise, neither IRS Form 2848 nor an FSA POA (Form 211) is acceptable.  FSA 5-PL, Para. 302, Subparagraph C. 

Note:  A Table contained in the FSA 5-PL, Amendment 4, page 6-34 at Para. 302, subparagraph C, sets forth the signature authority for Form CCC-941. 

If the applicant is a grantor trust, the Form must denote the grantor’s name.  For a deceased person, Form CCC-941 may be filed by the surviving spouse, an authorized representative or an entity that is responsible for filing the final Federal income tax return for the decedent.  FSA 5-PL, Para. 302, subparagraph D.  If filing is by an authorized representative, proof of such authorization must be provided by attachment to Form CCC-941. 

If a Form CCC-941, as submitted to the IRS, is incomplete or illegible it will be returned to the FSA along with IRS Notice 1398 containing the reason(s) for the rejection.  FSA 5-PL, Para. 301, Subparagraph H.  The FSA will then contact the person or entity that submitted the Form and explain the reason(s) for the rejection as well as provide assistance to get the Form corrected.  Id., Subparagraph H. 

Form CCC-941 authorizes the FSA to obtain AGI data from the IRS.  When the IRS receives the Form, it matches the identity of the name on the Form with the tax records associated with the name.  The IRS then calculates AGI according to the FSA’s definition of the term and reports to the FSA whether the applicant is within the $900,000 threshold.  If the IRS reports to the FSA that a producer is over the AGI limit, FSA then sends the producer a letter informing them that they have 30 days to provide a third-party verification by a CPA or an attorney that the producer’s average AGI is within the threshold along with associated tax records. If an entity is the farmer, this letter will be required for both the entity and the individual. If, upon review, the FSA still deems the producer to not be eligible for benefits, the producer may file an administrative appeal within 30 days of the determination.

Note:   It’s important for a producer/applicant to respond to the FSA within the 30-day timeframe so as to preserver administrative appeal rights.  However, the FSA 5-PL does state that appeal rights exist even if requested information is not timely provided.  FSA 5-PL, Para. 297, Subparagraph E.

The failure to provide the FSA with correct and accurate information to establish AGI compliance can result in ineligibility for all program payments and benefits that are subject to the AGI limitation for the applicable years.  In addition, the producer/entity will have to refund any benefits already paid due to the incorrect information and face possible civil or criminal prosecution.  FSA 5-PL, Para. 297, Subparagraph D.

A person or entity that lacks tax records or is not required to file tax returns may document AGI by providing to FSA annual budgets and a statement of operations; annual public financial disclosures; financial statements; or any other documentation as FSA deems acceptable. 

Note:  Some farmers have expressed concern about the information the IRS shares with the FSA.  However, the IRS does not report the applicant’s income, AGI (or average AGI), or any determination on the applicant’s eligibility or ineligibility for farm program payments.  The IRS merely computes AGI according to the FSA approach and reports to the FSA whether the producer/applicant is over or under the applicable threshold.  FSA 5-PL, Para. 303, subparagraph B.  FSA maintains the information that the IRS provides to it in a secure database, and the information  is not subject to a Freedom of Information Act request.  Id., subparagraph C. 

Exception for Exceeding the AGI Threshold

The 75 percent test.  There are some farm programs for which the $900,000 AGI limit does not apply if at least 75 percent of AGI is derived from farming, ranching or forestry activities.  For this purpose, “farm AGI” is comparable to net income from farming and may be identical to net farm profit (or loss) on Schedule F.  The FSA definition of “farm AGI” also includes income from the sale of farmland, breeding livestock and ag conservation easements, for example.  However, the term does not include income derived from the sale of farm equipment as well as income derived from the sale of production inputs and services.  However, if at least two-thirds of total AGI from all sources is from farming, the income from the sale of farm equipment and production inputs and services counts as farm AGI.  FSA 5-PL, Para. 312, subparagraph F.    

In recent years, the market facilitation program (MFP) and the Coronavirus Food Assistance Program (CFAP) are examples of farm programs that don’t subject the applicant to a $900,000 AGI limitation.  A producer applying for benefits from such a program must certify that the 75 percent test is satisfied.  For this purpose, the FSA might require the producer to sign Form CCC-942.  Alternatively, a letter from the producer’s professional tax preparer (an attorney of a CPA) can suffice.  For entities that are applying for benefits, a certification letter is required for the entity and for the individual producer. 

Note:  The FSA cannot send certifications with respect to the 75 percent farm AGI test to the IRS for verification.

For purposes of the 75 percent test, the FSA, in a Table in the FSA 5-PL, Amendment 6, Para. 312, subparagraph B, defines income from farming, ranching and forestry.  The Table illustrates that the term is defined broadly.  

Wages paid by a farm employer do not constitute farm income.  Thus, if an applicant’s only income is from wages earned via employment with, for example, a farming C corporation, the wages do not count as farm income for purposes of the 75 percent test.  But, of course, this is only an issue if the producer/applicant’s income is over the $900,000 threshold. 

The FSA regulations and associated guidance do not address whether income from a farmer’s foreign sales that are funneled through an IC-DISC counts as farm income for purposes of the 75 percent test.  An IC-DISC allows a farmer that will be selling into an export market to essentially transfer income from the farmer to the tax-exempt IC-DISC via an export sales commission.  An IC-DISC can be formed and utilized by any taxpayer that manufactures, produces, grows or extracts (MPGE) property in the U.S. that is held primarily for sale, lease or rental in the ordinary course of the taxpayer’s trade or business.  That definition certainly includes farmers.  The property to be exported is transferred to the IC-DISC which then sells the assets into an export market.  While there is no “official” guidance on the issue, it would seem reasonable that such income counts as farm income. 

Conclusion

Farmers participating in federal farm programs are subject to many detailed rules.  In recent years, such payments have made up a substantial portion of total farm income.  That makes compliance with the rules and staying within the average AGI limit critical. 

April 10, 2021 in Income Tax, Regulatory Law | Permalink | Comments (0)

Monday, April 5, 2021

Tax Considerations When Leasing Farmland

Overview

 

A lot of farmland is leased.  Farmers (and landlords) are often good at understanding the components of economic risk associated with a farm lease and utilize the best type of lease accordingly.  But what about tax issues?  There are numerous income tax issues associated with leasing farmland.  Sometimes the tax issues of leasing also impact estate and business planning issues for the farm landlord.  These can be very important issues that shouldn’t be overlooked when deciding the type of lease to utilize. 

Tax and planning considerations when leasing farmland – it’s the topic of today’s post.

Types of Leases

Different types of agricultural land leasing arrangements exist.  The differences are generally best understood from a risk/return standpoint. 

  • Cash leases involve the periodic payment of a rental amount that is either a fixed number of dollars per acre, or a fixed amount for the entire farm. Typically, such amounts are payable in installments or in a lump sum. 
  • A flexible cash lease specifies that the amount of cash rent fluctuates with production conditions and/or crop or livestock prices.
  • A hybrid cash/guaranteed bushel lease contains elements similar to those found in crop-share leases. For example, a hybrid cash lease usually specifies that the rental amount is to be determined by multiplying a set number of bushels by a price determined according to terms of the lease, but at a later date.  The tenant will market the entire crop.  The landlord benefits from price increases, while requiring no management or selling decisions or capital outlay.  However, the rental amount is adversely affected by a decline in price.  The tenant, conversely, will not bear the entire risk of low commodity prices, as would be the case if a straight-cash lease were used, but does bear all of the production risk and must pay all of the production costs.  The tenant delivers a set amount of a certain type of grain to a buyer by a specified date.  The landlord determines when to sell the grain, and is given an opportunity to take advantage of price rises and to make his or her own marketing decisions.  However, the landlord must make marketing decisions, and also is subject to price decreases and the risk of crop failure.  For the tenant, the required capital outlay will likely be less, and the tenant should have greater flexibility as to cropping patterns.  While the rental amount may be less than under a straight-cash lease, the tenant will continue to bear the risk of crop failure. 
  • A minimum cash or crop share lease, involves a guaranteed cash minimum. However, the landlord has the opportunity to share in crop production from a good year (high price or high yield) without incurring out-of-pocket costs.  For a tenant, the minimum cash payment likely will be less than under a straight-cash lease because the landlord will receive a share of production in good years.  The tenant, however, still retains much of the production risk.  In addition, the tenant typically does not know until harvest whether the tenant will receive all or only part of the crop.  This may make forward cash contracting more difficult.
  • Under a crop-share leasing arrangement, the rent is paid on the basis of a specified proportion of the crops. The landlord may or may not agree to pay part of certain expenses.  There are several variations to the traditional crop-share arrangement.  For example, with a crop share/cash lease, rent is paid with a certain proportion of the crops, but a fixed sum is charged for selected acreage such as pasture or buildings, or both.  Under a livestock-share leasing arrangement, specified shares of livestock, livestock products and crops are paid as rent, with the landlord normally sharing in the expenses.  For irrigation crop-share leases, rent is a certain proportion of the crops produced, but the landlord shares part of the irrigation expenses.  Under labor-share leases, family members are typically involved and the family member owning the assets has most of the managerial responsibility and bears most of the expenses and receives most of the crops.  The other family members receive a share of yield proportionate to their respective labor and management inputs.

Self-Employment Tax 

Type of lease matters.  Self-employment tax is imposed on net earnings derived from self-employment. I.R.C. §1402. That phrase is defined as gross income derived by an individual from a trade or business that the taxpayer conducts.  Id.  However, rents from real estate and from personal property leased with real estate are excluded from the definition of net earnings from self-employment.  I.R.C. §1402(a)(1).  Likewise, income from crop-share and/or livestock-share rental arrangements for landlords who are not materially participating in the farming operation are not classified as self-employment income subject to Social Security tax (and, thus, do not count toward eligibility for Social Security benefits in retirement).  I.R.C. §1402(a)(1)(A).  Only if the rental income is produced under a crop or livestock-share lease where the individual is materially participating under the lease does the taxpayer generate self-employment income.  Id.

Avoiding self-employment tax.  Income received under a cash rental arrangement is not subject to self-employment tax, nor does such income count toward eligibility for Social Security benefits in retirement.  An exception to this rule exists if the lessor leases land to an entity in which the lessor is materially participating. I.R.C. §1402(a)(1)(A). IRS has won several cases in which they have successfully attributed the lessor’s material participation in the entity to the leasing arrangement with the result that passive cash rent income is transformed into material participation income subject to self-employment tax.  But, if the rental income represents a fair market rate of rate, the rental income is not subject to self-employment tax.  Martin v. Comr., 149 T.C. 293 (2017).  So, the key to avoiding self-employment tax on “self-rentals” is to make sure that the lease is a “passive” lease (i.e., a cash lease) and that the rental rate is set at a fair market rate of rent (or very closely to it). 

Material participation leases.  The key concept for farm landlords attempting to qualify rental income as self-employment subject to Social Security tax is material participation.  Rental income is self-employment income if it results from a material participation lease.  If the lease is a material participation lease, the income is subject to self-employment tax.  If it is not such a lease, the income is not subject to the tax.  A lease is a material participation lease if (1) it provides for material participation in the production or in the management of the production of agricultural or horticultural products, and (2) there is material participation by the landlord.  Both requirements must be satisfied.  While a written lease is not required, a written lease does make a material participation arrangement easier to establish.  In addition, agricultural program payments that are received under a crop-share or livestock-share lease are considered to be self-employment income for Social Security purposes if the landlord materially participates under the lease.

Observation:  Managing earned income in retirement years is important and can influence the type of lease that is utilized.  Once full retirement age is reached, a taxpayer can receive an unlimited amount of income without the loss of Social Security benefits.  Full retirement age is either 66, 67, or 66 and a certain number of months, depending on your year of birth.  For persons age 62 to 65, the earnings limit in 2021 is $18,240.  For excess amounts, benefits are reduced $1 for every $2 over the limit.   For a person reaching full retirement age in 2021, the limit increases to $50,520. Above that level, $1 in Social Security benefits are lost for every $3 of earnings.  A key point in all of this is that, for retired farm landlords under full retirement age, they may not be able to receive full Social Security benefits if they are materially participating under a lease.

Income Tax Considerations

USDA cost-sharing payments.  Under certain federal farm programs, especially those programs designed to provide environmental benefits, the USDA shares in part of the expense associated with complying with the program.  If certain requirements are satisfied, the farmer that receives cost-share payments can exclude them from income.  I.R.C. §126.  Crop-share and livestock-share landlords are eligible to exclude cost-share payments from income.

Soil and water conservation expenses.  Taxpayers engaged in farming can (upon satisfying several requirements) deduct soil and water conservation expenses in the year incurred under a one-time election, rather than capitalizing the expenditures.  I.R.C §175.  One of those requirements is that the taxpayer be engaged in the business of farming.  A farm operator or landowner receiving rental income under a crop-share or livestock-share lease satisfies the test.  But, a landlord collecting rental income on a cash rent basis is not eligible to deduct soil and water conservation expenses on the associated real estate.  The landlord must materially participate in the farming operation.    

Fertilizer and lime.  A taxpayer can deduct fertilizer and lime costs by making an election on the tax return, if the taxpayer is in the trade or business of farming. I.R.C. §180.  For farm landlords, the lease must be a crop-share or livestock-share lease.  A landlord under a cash rent lease cannot deduct the cost of fertilizer and lime.  A farm landlord must be materially participating under the lease. 

Interest.  Most farm interest is fully deductible as business interest.  Crop-share and livestock-share leases with substantial involvement in decisionmaking by the landlord are deemed to be “businesses” for this purpose.  

Farm income averaging.  Income averaging is available for farmers and fishermen, and allows current farm income to be averaged over three prior base years. I.R.C. §1301.  The provision is available by election (by filing Schedule J) and provides the benefit of applying lower income tax rates from the prior base years.  A “farming business” for purposes of income averaging is defined as the trade or business of farming involving the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity and includes operating a nursery or sod farm or the raising or harvesting of trees bearing fruit, nuts, or other crop or ornamental trees (but not evergreen trees more than six years old when severed from the roots).  Also included in the definition is the raising, shearing, feeding, caring for, training and managing animals.  Crop-share landlords are deemed to be engaged in the business of farming if the lease is in writing and is entered into with the tenant before the tenant begins significant activities on the land. 

Special Use Valuation

As I wrote in a recent post, a special use valuation election can be made in an estate to value the farmland used in farming at its agricultural value rather than fair market value.  That eliminates factors that put upward price pressure on the land and helps the land stay in farming by the family be reducing or eliminating the federal estate tax on the decedent’s estate.  However, many tests have to be satisfied to make the election, one of which requires the decedent (if the decedent was a landlord) to have had material participation under a lease for five of the last eight years before the earlier of retirement, disability or death if a special use valuation election is going to be made for the agricultural real estate included in the decedent-to-be’s estate.  I.R.C. §2032A(b)(1)(A)

The solution, if a family member is present, may be to have a non-retired landlord not materially participate, but rent the land that is to be elected in the landlord’s estate upon death to a materially participating family member or to hire a family member as a farm manager.  Cash leasing of elected land to family members is permitted before the landlord dies, but generally not after death.  The solution, if a family member is not present, is to have the landlord retire at full retirement age or older, materially participate during five of the eight years immediately preceding retirement, and then during retirement rent out the farm via a non-material participation crop-share or livestock-share lease.

Leases and Farm Program Benefits

Leases can also have an impact on a producer’s eligibility for farm program payments.  In general, to qualify for farm program payments, an individual must be “actively engaged in farming.”  Each “person” who is actively engaged in farming is eligible for one payment limit of federal farm program payments.  A tenant qualifies as actively engaged in farming through the contribution of capital, equipment, active personal labor or active personal management.  Likewise, a landlord qualifies as actively engaged in farming by the contribution of the owned land if the rent or income for the operation’s use of the land is based on the land’s production or the operation’s results (not cash rent based on a guaranteed share of the crop).  In addition, the landlord’s contribution must be “significant,” must be “at risk,” and must be commensurate with the landlord’s share of the profits and losses from the farming operation. 

A landlord who cash leases land is considered a landlord under the payment limitation rules and may not be considered actively engaged in farming.  In this situation, only the tenant is considered eligible.  Under the payment limitation rules, there are technical requirements that restrict the cash-rent tenant’s eligibility to receive payments to situations in which the tenant makes a “significant contribution” of (1) active personal labor and capital, land or equipment; or (2) active personal management and equipment.

Conclusion

Utilizing the “correct” farm lease for your farming operation involves more than just the economics of the relationship.  Taxes and planning considerations also play an important role.  Properly consideration should be made.  Do your “due diligence.”

April 5, 2021 in Income Tax | Permalink | Comments (0)

Friday, April 2, 2021

Ag Law and Taxation - 2017 Bibliography

Overview

Today's post is a bibliography of my ag law and tax blog articles of 2017.  This will make it easier to find the articles you are looking for in your research.  In late January I posted the 2020 bibliography of articles.  In late February I posted the bibliography of the 2019 articles.  Last month, I posted the 2018 bibliography of articles.  Today’s posting is the bibliography of my 2017 articles.  Later this month I will post the 2016 bibliography. 

The library of content continues to grow with relevant information for you practice or your farming/ranching business.

The 2017 bibliography of articles – it’s the subject matter of today’s post.

BANKRUPTCY

The Most Important Agricultural Law and Tax Developments of 2016

https://lawprofessors.typepad.com/agriculturallaw/2017/01/the-most-important-agricultural-law-and-tax-developments-of-2016.html  

Top Ten Agricultural Law and Tax Developments of 2016 (Ten Through Six)

https://lawprofessors.typepad.com/agriculturallaw/2017/01/top-ten-agricultural-law-and-tax-developments-of-2016-ten-through-six.html

Top Ten Agricultural Law Developments of 2016 (Five Through One)

https://lawprofessors.typepad.com/agriculturallaw/2017/01/top-ten-agricultural-law-developments-of-2016-five-through-one.html

Farm Financial Stress – Debt Restructuring

https://lawprofessors.typepad.com/agriculturallaw/2017/01/farm-financial-stress-debt-restructuring.html

Qualified Farm Indebtedness – A Special Rule for Income Exclusion of Forgiven Debt

https://lawprofessors.typepad.com/agriculturallaw/2017/03/qualified-farm-indebtedness-a-special-rule-for-income-exclusion-of-forgiven-debt.html

What Are a Farmer’s Rights When a Grain Elevator Fails?

https://lawprofessors.typepad.com/agriculturallaw/2017/07/what-are-a-farmers-rights-when-a-grain-elevator-fails.html

Agricultural Law in a Nutshell

https://lawprofessors.typepad.com/agriculturallaw/2017/07/agricultural-law-in-a-nutshell.html

The Business of Agriculture – Upcoming CLE Symposium

https://lawprofessors.typepad.com/agriculturallaw/2017/08/the-business-of-agriculture-upcoming-cle-symposium.html

Tough Financial Times in Agriculture and Lending Clauses – Peril for the Unwary

https://lawprofessors.typepad.com/agriculturallaw/2017/10/tough-financial-times-in-agriculture-and-lending-clauses-peril-for-the-unwary.html

What Interest Rate Applies to a Secured Creditor’s Claim in a Reorganization Bankruptcy?

https://lawprofessors.typepad.com/agriculturallaw/2017/11/what-interest-rate-applies-to-a-secured-creditors-claim-in-a-reorganization-bankruptcy.html

PACA Trust Does Not Prevent Chapter 11 DIP’s Use of Cash Collateral

https://lawprofessors.typepad.com/agriculturallaw/2017/11/paca-trust-does-not-prevent-chapter-11-dips-use-of-cash-collateral.html

Are Taxes Dischargeable in Bankruptcy?

https://lawprofessors.typepad.com/agriculturallaw/2017/12/are-taxes-dischargeable-in-bankruptcy.html

Christmas Shopping Season Curtailed? – Bankruptcy Venue Shopping, That Is!

https://lawprofessors.typepad.com/agriculturallaw/2017/12/christmas-shopping-season-curtailed-bankruptcy-venue-shopping-that-is.html

BUSINESS PLANNING

The Most Important Agricultural Law and Tax Developments of 2016

https://lawprofessors.typepad.com/agriculturallaw/2017/01/the-most-important-agricultural-law-and-tax-developments-of-2016.html

Top Ten Agricultural Law and Tax Developments of 2016 (Ten Through Six)

https://lawprofessors.typepad.com/agriculturallaw/2017/01/top-ten-agricultural-law-and-tax-developments-of-2016-ten-through-six.html

Top Ten Agricultural Law Developments of 2016 (Five Through One)

https://lawprofessors.typepad.com/agriculturallaw/2017/01/top-ten-agricultural-law-developments-of-2016-five-through-one.html

C Corporation Penalty Taxes – Time to Dust-Off and Review?

https://lawprofessors.typepad.com/agriculturallaw/2017/01/c-corporation-penalty-taxes-time-to-dust-off-and-review.html

Divisive Reorganizations of Farming and Ranching Corporations

https://lawprofessors.typepad.com/agriculturallaw/2017/01/divisive-reorganizations-of-farming-and-ranching-corporations.html

The Scope and Effect of the “Small Partnership Exception”

https://lawprofessors.typepad.com/agriculturallaw/2017/02/the-scope-and-effect-of-the-small-partnership-exception.html

Using the Right Kind of an Entity to Reduce Self-Employment Tax

https://lawprofessors.typepad.com/agriculturallaw/2017/04/using-the-right-kind-of-an-entity-to-reduce-self-employment-tax.html

Employer-Provided Meals and Lodging

https://lawprofessors.typepad.com/agriculturallaw/2017/05/employer-provided-meals-and-lodging.html

Self-Employment Tax on Farming Activity of Trusts

https://lawprofessors.typepad.com/agriculturallaw/2017/05/self-employment-tax-on-farming-activity-of-trusts.html

Minority Shareholder Oppression Case Raises Several Tax Questions

https://lawprofessors.typepad.com/agriculturallaw/2017/05/minority-shareholder-oppression-case-raises-several-tax-questions.html

Farm Program Payment Limitations and Entity Planning – Part One

https://lawprofessors.typepad.com/agriculturallaw/2017/06/farm-program-payment-limitations-and-entity-planning-part-one.html

Farm Program Payment Limitations and Entity Planning – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2017/06/farm-program-payment-limitations-and-entity-planning-part-two.html

Summer Ag Tax/Estate and Business Planning Conference

https://lawprofessors.typepad.com/agriculturallaw/2017/06/summer-ag-taxestate-and-business-planning-conference.html

An Installment Sale as Part of an Estate Plan

https://lawprofessors.typepad.com/agriculturallaw/2017/07/an-installment-sale-as-part-of-an-estate-plan.html

The Use of a Buy-Sell Agreement for Transitioning a Business

https://lawprofessors.typepad.com/agriculturallaw/2017/08/the-use-of-a-buy-sell-agreement-for-transitioning-a-business.html

The Business of Agriculture – Upcoming CLE Symposium

https://lawprofessors.typepad.com/agriculturallaw/2017/08/the-business-of-agriculture-upcoming-cle-symposium.html

Forming a Farming/Ranching Corporation Tax-Free

https://lawprofessors.typepad.com/agriculturallaw/2017/08/forming-a-farmingranching-corporation-tax-free.html

Farmers Renting Equipment – Does it Trigger A Self-Employment Tax Liability?

https://lawprofessors.typepad.com/agriculturallaw/2017/08/farmers-renting-equipment-does-it-trigger-a-self-employment-tax-liability.html

New Partnership Audit Rules

https://lawprofessors.typepad.com/agriculturallaw/2017/09/new-partnership-audit-rules.html

Self-Employment Tax on Farm Rental Income – Is the Mizell Veneer Cracking?

https://lawprofessors.typepad.com/agriculturallaw/2017/09/self-employment-tax-on-farm-rental-income-is-the-mizell-veneer-cracking.html

IRS To Finalize Regulations on Tax Status of LLC and LLP Members?

https://lawprofessors.typepad.com/agriculturallaw/2017/10/irs-to-finalize-regulations-on-tax-status-of-llc-and-llp-members.html

H.R. 1 – Farmers, Self-Employment Tax and Business Arrangement Structures

https://lawprofessors.typepad.com/agriculturallaw/2017/11/hr-1-farmers-self-employment-tax-and-business-arrangement-structures.html

Summer 2018 – Farm Tax and Farm Business Education

https://lawprofessors.typepad.com/agriculturallaw/2017/11/summer-2018-farm-tax-and-farm-business-education.html

Partnerships and Tax Law – Details Matter

https://lawprofessors.typepad.com/agriculturallaw/2017/11/partnership-and-tax-law-details-matter.html   

CIVIL LIABILITIES

The Most Important Agricultural Law and Tax Developments of 2016

https://lawprofessors.typepad.com/agriculturallaw/2017/01/the-most-important-agricultural-law-and-tax-developments-of-2016.html

Top Ten Agricultural Law and Tax Developments of 2016 (Ten Through Six)

https://lawprofessors.typepad.com/agriculturallaw/2017/01/top-ten-agricultural-law-and-tax-developments-of-2016-ten-through-six.html

Top Ten Agricultural Law and Developments of 2016 (Five Through One)

https://lawprofessors.typepad.com/agriculturallaw/2017/01/top-ten-agricultural-law-developments-of-2016-five-through-one.html

Recreational Use Statutes – What is Covered?

https://lawprofessors.typepad.com/agriculturallaw/2017/02/recreational-use-statutes-what-is-covered.html

Is Aesthetic Damage Enough to Make Out a Nuisance Claim?

https://lawprofessors.typepad.com/agriculturallaw/2017/04/is-aesthetic-damage-enough-to-make-out-a-nuisance-claim.html

Liability Associated with a Range of Fires and Controlled Burns

https://lawprofessors.typepad.com/agriculturallaw/2017/04/liability-associated-with-a-range-fires-and-controlled-burns.html

What’s My Liability for Spread of Animal Disease

https://lawprofessors.typepad.com/agriculturallaw/2017/06/whats-my-liability-for-spread-of-animal-disease.html

Dicamba Spray-Drift Issues

https://lawprofessors.typepad.com/agriculturallaw/2017/07/dicamba-spray-drift-issues.html

Agricultural Law in a Nutshell

https://lawprofessors.typepad.com/agriculturallaw/2017/07/agricultural-law-in-a-nutshell.html

The Business of Agriculture – Upcoming CLE Symposium

https://lawprofessors.typepad.com/agriculturallaw/2017/08/the-business-of-agriculture-upcoming-cle-symposium.html

Right-to-Farm Laws

            https://lawprofessors.typepad.com/agriculturallaw/2017/09/right-to-farm-laws.html

CONTRACTS

The Most Important Agricultural Law and Tax Developments of 2016

https://lawprofessors.typepad.com/agriculturallaw/2017/01/the-most-important-agricultural-law-and-tax-developments-of-2016.html

Top Ten Agricultural Law and Tax Developments of 2016 (Ten Through Six)

https://lawprofessors.typepad.com/agriculturallaw/2017/01/top-ten-agricultural-law-and-tax-developments-of-2016-ten-through-six.html

Top Ten Agricultural Law Developments of 2016 (Five Through One)

https://lawprofessors.typepad.com/agriculturallaw/2017/01/top-ten-agricultural-law-developments-of-2016-five-through-one.html

Another Issue With Producing Livestock on Contract – Insurance

https://lawprofessors.typepad.com/agriculturallaw/2017/01/another-issue-with-producing-livestock-on-contract-insurance.html

The Ability of Tenants-in-Common To Bind Co-Tenants to a Farm Lease – and Related Issues

https://lawprofessors.typepad.com/agriculturallaw/2017/02/the-ability-of-tenants-in-common-to-bind-co-tenants-to-a-farm-lease-and-related-issues.html

Ag Goods Sold at Auction – When is a Contract Formed?

https://lawprofessors.typepad.com/agriculturallaw/2017/05/ag-goods-sold-at-auction-when-is-a-contract-formed.html

Agricultural Law in a Nutshell

https://lawprofessors.typepad.com/agriculturallaw/2017/07/agricultural-law-in-a-nutshell.html

The Business of Agriculture – Upcoming CLE Symposium

https://lawprofessors.typepad.com/agriculturallaw/2017/08/the-business-of-agriculture-upcoming-cle-symposium.html

Ag Contracts and Express Warranties

https://lawprofessors.typepad.com/agriculturallaw/2017/09/ag-contracts-and-express-warranties.html

What Remedies Does a Buyer Have When a Seller of Ag Goods Breaches the Contract?           

https://lawprofessors.typepad.com/agriculturallaw/2017/10/what-remedies-does-a-buyer-have-when-a-seller-of-ag-goods-breaches-the-contract.html  

COOPERATIVES

The Most Important Agricultural Law and Tax Developments of 2016

https://lawprofessors.typepad.com/agriculturallaw/2017/01/the-most-important-agricultural-law-and-tax-developments-of-2016.html

Top Ten Agricultural Law Developments of 2016 (Five Through One)

https://lawprofessors.typepad.com/agriculturallaw/2017/01/top-ten-agricultural-law-and-tax-developments-of-2016-ten-through-six.html

What Is a Cooperative Director’s Liability to Member-Shareholders and Others?

https://lawprofessors.typepad.com/agriculturallaw/2017/07/what-is-a-cooperative-directors-liability-to-member-shareholders-and-others.html

CRIMINAL LIABILITIES

The Necessity Defense to Criminal Liability

https://lawprofessors.typepad.com/agriculturallaw/2017/05/the-necessity-defense-to-criminal-liability.html

The Business of Agriculture – Upcoming CLE Symposium

https://lawprofessors.typepad.com/agriculturallaw/2017/08/the-business-of-agriculture-upcoming-cle-symposium.html

What Problems Does The Migratory Bird Treaty Act Pose For Farmers, Ranchers and Rural Landowners?

https://lawprofessors.typepad.com/agriculturallaw/2017/08/what-problems-does-the-migratory-bird-treaty-act-pose-for-farmers-ranchers-and-rural-landowners.html

ENVIRONMENTAL LAW

Drainage Activities on Farmland and the USDA

https://lawprofessors.typepad.com/agriculturallaw/2017/03/drainage-activities-on-farmland-and-the-usda.html

The Application of the Endangered Species Act to Activities on Private Land

https://lawprofessors.typepad.com/agriculturallaw/2017/04/the-application-of-the-endangered-species-act-to-activities-on-private-land.html

Eminent Domain – The Government’s Power to “Take” Private Property

https://lawprofessors.typepad.com/agriculturallaw/2017/06/eminent-domain-the-governments-power-to-take-private-property.html

Spray Drift As Hazardous Waste?

https://lawprofessors.typepad.com/agriculturallaw/2017/07/spray-drift-as-hazardous-waste.html

What Problems Does The Migratory Bird Treaty Act Pose For Farmers, Ranchers and Rural Landowners?

https://lawprofessors.typepad.com/agriculturallaw/2017/08/what-problems-does-the-migratory-bird-treaty-act-pose-for-farmers-ranchers-and-rural-landowners.html

The Prior Converted Cropland Exception From Clean Water Act Jurisdiction

https://lawprofessors.typepad.com/agriculturallaw/2017/09/the-prior-converted-cropland-exception-from-clean-water-act-jurisdiction.html

Air Emission Reporting Requirement For Livestock Operations

https://lawprofessors.typepad.com/agriculturallaw/2017/11/air-emission-reporting-requirement-for-livestock-operations.html

ESTATE PLANNING

Rights of Refusal and the Rule Against Perpetuities

https://lawprofessors.typepad.com/agriculturallaw/2017/01/rights-of-refusal-and-the-rule-against-perpetuities.html

Some Thoughts On Long-Term Care Insurance

https://lawprofessors.typepad.com/agriculturallaw/2017/02/some-thoughts-on-long-term-care-insurance.html

Overview of Gifting Rules and Strategies                                                                 

https://lawprofessors.typepad.com/agriculturallaw/2017/04/overview-of-gifting-rules-and-strategies.html

Disinheriting a Spouse – Can It Be Done?

https://lawprofessors.typepad.com/agriculturallaw/2017/04/disinheriting-a-spouse-can-it-be-done.html

Specific Property Devised in Will (or Trust) That Doesn’t Exist At Death – What Happens?

https://lawprofessors.typepad.com/agriculturallaw/2017/05/specific-property-devised-in-will-that-doesnt-exist-at-death-what-happens.html

Discounting IRAs for Income Tax Liability?

https://lawprofessors.typepad.com/agriculturallaw/2017/05/discounting-iras-for-income-tax-liability.html

Special Use Valuation and Cash Leasing

https://lawprofessors.typepad.com/agriculturallaw/2017/05/special-use-valuation-and-cash-leasing.html

Self-Employment Tax On Farming Activity Of Trusts

https://lawprofessors.typepad.com/agriculturallaw/2017/05/self-employment-tax-on-farming-activity-of-trusts.html

Would an Interest Charge Domestic International Sales Corporation Benefit a Farming Business?

https://lawprofessors.typepad.com/agriculturallaw/2017/07/would-an-interest-charge-domestic-international-sales-corporation-benefit-a-farming-business.html

An Installment Sale as Part of An Estate Plan

https://lawprofessors.typepad.com/agriculturallaw/2017/07/an-installment-sale-as-part-of-an-estate-plan.html

Using An IDGT For Wealth Transfer and Business Succession

https://lawprofessors.typepad.com/agriculturallaw/2017/07/using-an-idgt-for-wealth-transfer-and-business-succession.html

Federal Tax Claims in Decedent’s Estates – What’s the Liability and Priority?

https://lawprofessors.typepad.com/agriculturallaw/2017/08/federal-tax-claims-in-decedents-estates-whats-the-liability-and-priority.html

Estate Tax Portability – The Authority of the IRS To Audit

https://lawprofessors.typepad.com/agriculturallaw/2017/10/estate-tax-portability-the-authority-of-the-irs-to-audit.html

Digital Assets and Estate Planning       

https://lawprofessors.typepad.com/agriculturallaw/2017/10/digital-assets-and-estate-planning.html

INCOME TAX

The Burden of Proof in Tax Cases – What are the Rules?

https://lawprofessors.typepad.com/agriculturallaw/2017/02/the-burden-of-proof-in-tax-cases-what-are-the-rules.html

The Home Office Deduction

https://lawprofessors.typepad.com/agriculturallaw/2017/02/the-home-office-deduction.html

IRS To Continue Attacking Cash Method For Farmers Via the “Farming Syndicate Rule”

https://lawprofessors.typepad.com/agriculturallaw/2017/02/irs-to-continue-attacking-cash-method-for-farmers-via-the-farming-syndicate-rule.html

Using Schedule J As A Planning Tool For Clients With Farm Income

https://lawprofessors.typepad.com/agriculturallaw/2017/03/using-schedule-j-as-a-planning-tool-for-clients-with-farm-income.html

Deductibility of Soil and Water Conservation Expenses

https://lawprofessors.typepad.com/agriculturallaw/2017/03/deductibility-of-soil-and-water-conservation-expenses.html

Should Purchased Livestock Be Depreciated or Inventoried?

https://lawprofessors.typepad.com/agriculturallaw/2017/03/should-purchased-livestock-be-depreciated-or-inventoried.html

The Changing Structure of Agricultural Production and…the IRS

https://lawprofessors.typepad.com/agriculturallaw/2017/03/the-changing-structure-of-agricultural-production-andthe-irs.html

Farm-Related Casualty Losses and Involuntary Conversions – Helpful Tax Rules in Times of Distress

https://lawprofessors.typepad.com/agriculturallaw/2017/03/farm-related-casualty-losses-and-involuntary-conversions-helpful-tax-rules-in-times-of-distress.html

Charitable Contributions Via Trust

https://lawprofessors.typepad.com/agriculturallaw/2017/03/charitable-contributions-via-trust.html

Ag Tax Policy The Focus in D.C.

https://lawprofessors.typepad.com/agriculturallaw/2017/04/ag-tax-policy-the-focus-in-dc-.html

For Depreciation Purposes, What Does Placed in Service Mean?

https://lawprofessors.typepad.com/agriculturallaw/2017/04/for-depreciation-purposes-what-does-placed-in-service-mean.html

Tax Treatment of Commodity Futures and Options

https://lawprofessors.typepad.com/agriculturallaw/2017/04/tax-treatment-of-commodity-futures-and-options.html

Discounting IRAs for Income Tax Liability?

https://lawprofessors.typepad.com/agriculturallaw/2017/05/discounting-iras-for-income-tax-liability.html

Like-Kind Exchanges, Reverse Exchanges, and the Safe Harbor

https://lawprofessors.typepad.com/agriculturallaw/2017/05/like-kind-exchanges-reverse-exchanges-and-the-safe-harbor.html

Insights Into Handling IRS Disputes

https://lawprofessors.typepad.com/agriculturallaw/2017/05/insights-into-handling-irs-disputes.html

Employer-Provided Meals and Lodging

https://lawprofessors.typepad.com/agriculturallaw/2017/05/employer-provided-meals-and-lodging.html

Self-Employment Tax On Farming Activity Of Trusts

https://lawprofessors.typepad.com/agriculturallaw/2017/05/self-employment-tax-on-farming-activity-of-trusts.html

Minority Shareholder Oppression Case Raises Several Tax Questions

https://lawprofessors.typepad.com/agriculturallaw/2017/05/minority-shareholder-oppression-case-raises-several-tax-questions.html

Input Costs – When Can a Deduction Be Claimed?

https://lawprofessors.typepad.com/agriculturallaw/2017/06/input-costs-when-can-a-deduction-be-claimed.html

Like-Kind Exchange Issues

https://lawprofessors.typepad.com/agriculturallaw/2017/06/like-kind-exchange-issues.html

Tax Issues With Bad Debt Deductions

https://lawprofessors.typepad.com/agriculturallaw/2017/06/tax-issues-with-bad-debt-deductions.html

Like-Kind Exchanges – The Related Party Rule and a Planning Opportunity

https://lawprofessors.typepad.com/agriculturallaw/2017/06/like-kind-exchanges-the-related-party-rule-and-a-planning-opportunity.html

Tax Treatment of Cooperative Value-Added Payments

https://lawprofessors.typepad.com/agriculturallaw/2017/06/tax-treatment-of-cooperative-value-added-payments.html

Would an Interest Charge Domestic International Sales Corporation Benefit a Farming Business?

https://lawprofessors.typepad.com/agriculturallaw/2017/07/would-an-interest-charge-domestic-international-sales-corporation-benefit-a-farming-business.html

Timber Tax Issues – Part One

https://lawprofessors.typepad.com/agriculturallaw/2017/07/timber-tax-issues-part-one.html

Timber Tax Issues – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2017/07/timber-tax-issues-part-two.html

An Installment Sale as Part of An Estate Plan

https://lawprofessors.typepad.com/agriculturallaw/2017/07/an-installment-sale-as-part-of-an-estate-plan.html

Using An IDGT For Wealth Transfer and Business Succession

https://lawprofessors.typepad.com/agriculturallaw/2017/07/using-an-idgt-for-wealth-transfer-and-business-succession.html

Prospects for Tax Legislation

https://lawprofessors.typepad.com/agriculturallaw/2017/08/prospects-for-tax-legislation.html

Deferred Payment Contracts

https://lawprofessors.typepad.com/agriculturallaw/2017/08/deferred-payment-contracts.html

When Is A Farmer Not A “Qualified Farmer” For Conservation Easement Donation Purposes?

https://lawprofessors.typepad.com/agriculturallaw/2017/08/when-is-a-farmer-not-a-qualified-farmer-for-conservation-easement-donation-purposes.html

Substantiating Charitable Contributions

https://lawprofessors.typepad.com/agriculturallaw/2017/08/substantiating-charitable-contributions.html

Forming a Farming/Ranching Corporation Tax-Free

https://lawprofessors.typepad.com/agriculturallaw/2017/08/forming-a-farmingranching-corporation-tax-free.html

Farmers Renting Equipment – Does It Trigger A Self-Employment Tax Liability?

https://lawprofessors.typepad.com/agriculturallaw/2017/08/farmers-renting-equipment-does-it-trigger-a-self-employment-tax-liability.html

Commodity Credit Corporation Loans and Elections

https://lawprofessors.typepad.com/agriculturallaw/2017/09/commodity-credit-corporation-loans-and-elections.html

New Partnership Audit Rules

https://lawprofessors.typepad.com/agriculturallaw/2017/09/new-partnership-audit-rules.html

Alternatives to Like-Kind Exchanges of Farmland

https://lawprofessors.typepad.com/agriculturallaw/2017/09/alternatives-to-like-kind-exchanges-of-farmland.html

South Dakota Attempts To Change Internet Sales Taxation – What Might Be The Impact On Small Businesses?

https://lawprofessors.typepad.com/agriculturallaw/2017/09/south-dakota-attempts-to-change-internet-sales-taxation-what-might-be-the-impact-on-small-businesses.html

Fall Tax Schools

https://lawprofessors.typepad.com/agriculturallaw/2017/09/fall-tax-schools.html

Self-Employment Tax on Farm Rental Income – Is the Mizell Veneer Cracking?

https://lawprofessors.typepad.com/agriculturallaw/2017/09/self-employment-tax-on-farm-rental-income-is-the-mizell-veneer-cracking.html

Tax Treatment of Settlements and Court Judgments

https://lawprofessors.typepad.com/agriculturallaw/2017/10/tax-treatment-of-settlements-and-court-judgments.html

The “Perpetuity” Requirement For Donated Easements

https://lawprofessors.typepad.com/agriculturallaw/2017/10/the-perpetuity-requirement-for-donated-easements.html

The Tax Rules Involving Prepaid Farm Expenses

https://lawprofessors.typepad.com/agriculturallaw/2017/10/the-tax-rules-involving-prepaid-farm-expenses.html

It’s Just About Tax School Time

https://lawprofessors.typepad.com/agriculturallaw/2017/10/its-just-about-tax-school-time.html

IRS To Finalize Regulations On Tax Status of LLC and LLP Members?

https://lawprofessors.typepad.com/agriculturallaw/2017/10/irs-to-finalize-regulations-on-tax-status-of-llc-and-llp-members.html

The Deductibility (Or Non-Deductibility) of Interest

https://lawprofessors.typepad.com/agriculturallaw/2017/10/the-deductibility-or-non-deductibility-of-interest.html

H.R. 1 - Farmers, Self-Employment Tax and Business Arrangement Structures

https://lawprofessors.typepad.com/agriculturallaw/2017/11/hr-1-farmers-self-employment-tax-and-business-arrangement-structures.html

The Broad Reach of the Wash-Sale Rule

https://lawprofessors.typepad.com/agriculturallaw/2017/11/the-broad-reach-of-the-wash-sale-rule.html

Comparison of the House and Senate Tax Bills – Implications for Agriculture

https://lawprofessors.typepad.com/agriculturallaw/2017/11/comparison-of-the-house-and-senate-tax-bills-implications-for-agriculture.html

Partnerships and Tax Law – Details Matter

https://lawprofessors.typepad.com/agriculturallaw/2017/11/partnership-and-tax-law-details-matter.html

Senate Clears Tax Bill - On To Conference

https://lawprofessors.typepad.com/agriculturallaw/2017/12/senate-clears-tax-bill-on-to-conference-committee.html

Are Taxes Dischargeable in Bankruptcy?

https://lawprofessors.typepad.com/agriculturallaw/2017/12/are-taxes-dischargeable-in-bankruptcy.html

Bitcoin Fever and the Tax Man

https://lawprofessors.typepad.com/agriculturallaw/2017/12/bitcoin-fever-and-the-tax-man.html

House and Senate to Vote on Conference Tax Bill This Week

https://lawprofessors.typepad.com/agriculturallaw/2017/12/house-and-senate-to-vote-on-conference-tax-bill-this-week.html

Another Tax Bill Introduced, Year-End Planning, and Jan. 10 Seminar/Webinar

https://lawprofessors.typepad.com/agriculturallaw/2017/12/another-tax-bill-introduced-year-end-planning-and-jan-10-seminarwebinar.html

PUBLICATIONS

Agricultural Law in a Nutshell

https://lawprofessors.typepad.com/agriculturallaw/2017/07/agricultural-law-in-a-nutshell.html

REAL PROPERTY

Another Issue When the Definition of “Agriculture” Matters – Property Tax

https://lawprofessors.typepad.com/agriculturallaw/2017/01/another-issue-when-the-definition-of-agriculture-matters-property-tax.html

The Ability of Tenants-in-Common To Bind Co-Tenants to a Farm Lease – and Related Issues

https://lawprofessors.typepad.com/agriculturallaw/2017/02/the-ability-of-tenants-in-common-to-bind-co-tenants-to-a-farm-lease-and-related-issues.html

Like-Kind Exchanges, Reverse Exchanges, and the Safe Harbor

https://lawprofessors.typepad.com/agriculturallaw/2017/05/like-kind-exchanges-reverse-exchanges-and-the-safe-harbor.html

Like-Kind Exchange Issues

https://lawprofessors.typepad.com/agriculturallaw/2017/06/like-kind-exchange-issues.html

Easements on Agricultural Land – Classification and Legal Issues

https://lawprofessors.typepad.com/agriculturallaw/2017/08/easements-on-agricultural-land-classification-and-legal-issues.html

Should I Enter Into An Oil and Gas Lease?

https://lawprofessors.typepad.com/agriculturallaw/2017/12/should-i-enter-into-an-oil-and-gas-lease.html

REGULATORY LAW

Checkoffs, The Courts and Free Speech

https://lawprofessors.typepad.com/agriculturallaw/2017/01/checkoffs-the-courts-and-free-speech.html

Joint Employment Situations In Agriculture – What’s the FLSA Test?

https://lawprofessors.typepad.com/agriculturallaw/2017/02/joint-employment-situations-in-agriculture-whats-the-flsa-test.html

Farmers, Ranchers and Government Administrative Agencies

https://lawprofessors.typepad.com/agriculturallaw/2017/03/farmers-ranchers-and-government-administrative-agencies.html

IRS To Target “Hobby” Farmers

https://lawprofessors.typepad.com/agriculturallaw/2017/03/irs-to-target-hobby-farmers.html

Drainage Activities on Farmland and the USDA

https://lawprofessors.typepad.com/agriculturallaw/2017/03/drainage-activities-on-farmland-and-the-usda.html

What is a “Separate Person” For Payment Limitation Purposes?

https://lawprofessors.typepad.com/agriculturallaw/2017/03/what-is-a-separate-person-for-payment-limitation-purposes.html

Livestock Indemnity Payments – What They Are and Tax Reporting Options

https://lawprofessors.typepad.com/agriculturallaw/2017/03/livestock-indemnity-payments-what-they-are-and-tax-reporting-options.html

Can One State Regulate Agricultural Production Activities in Other States?

https://lawprofessors.typepad.com/agriculturallaw/2017/06/can-one-state-regulate-agricultural-production-activities-in-other-states.html

Farm Program Payment Limitations and Entity Planning – Part One

https://lawprofessors.typepad.com/agriculturallaw/2017/06/farm-program-payment-limitations-and-entity-planning-part-one.html

Farm Program Payment Limitations and Entity Planning – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2017/06/farm-program-payment-limitations-and-entity-planning-part-two.html

Eminent Domain – The Government’s Power to “Take” Private Property

https://lawprofessors.typepad.com/agriculturallaw/2017/06/eminent-domain-the-governments-power-to-take-private-property.html

Department of Labor Overtime Rules Struck Down – What’s the Impact on Ag?

https://lawprofessors.typepad.com/agriculturallaw/2017/09/department-of-labor-overtime-rules-struck-down-whats-the-impact-on-ag.html

The Prior Converted Cropland Exception From Clean Water Act Jurisdiction

https://lawprofessors.typepad.com/agriculturallaw/2017/09/the-prior-converted-cropland-exception-from-clean-water-act-jurisdiction.html

Air Emission Reporting Requirement For Livestock Operations

https://lawprofessors.typepad.com/agriculturallaw/2017/11/air-emission-reporting-requirement-for-livestock-operations.html

Federal Labor Law and Agriculture

https://lawprofessors.typepad.com/agriculturallaw/2017/11/federal-labor-law-and-agriculture.html

 Electronic Logs For Truckers and Implications for Agriculture

https://lawprofessors.typepad.com/agriculturallaw/2017/12/electronic-logs-for-truckers-and-implications-for-agriculture.html

SECURED TRANSACTIONS

Ag Supply Dealer Liens – Important Tool in Tough Financial Times

https://lawprofessors.typepad.com/agriculturallaw/2017/01/ag-supply-dealer-liens-important-tool-in-tough-financial-times.html

“Commercial Reasonableness” of Collateral Sales

https://lawprofessors.typepad.com/agriculturallaw/2017/07/commercial-reasonableness-of-collateral-sales.html

What Are A Farmer’s Rights When a Grain Elevator Fails?

https://lawprofessors.typepad.com/agriculturallaw/2017/07/what-are-a-farmers-rights-when-a-grain-elevator-fails.html

Selling Collateralized Ag Products – The “Farm Products” Rule

https://lawprofessors.typepad.com/agriculturallaw/2017/09/selling-collateralized-ag-products-the-farm-products-rule.html

SEMINARS AND CONFERENCES

Fall Tax Schools

https://lawprofessors.typepad.com/agriculturallaw/2017/09/fall-tax-schools.html

Another Tax Bill Introduced, Year-End Planning, and Jan. 10 Seminar/Webinar

https://lawprofessors.typepad.com/agriculturallaw/2017/12/another-tax-bill-introduced-year-end-planning-and-jan-10-seminarwebinar.html

Summer 2018 - Farm Tax and Farm Business Education

https://lawprofessors.typepad.com/agriculturallaw/2017/11/summer-2018-farm-tax-and-farm-business-education.html

The Business of Agriculture – Upcoming CLE Symposium

https://lawprofessors.typepad.com/agriculturallaw/2017/08/the-business-of-agriculture-upcoming-cle-symposium.html

Summer Ag Tax/Estate and Business Planning Conference

https://lawprofessors.typepad.com/agriculturallaw/2017/06/summer-ag-taxestate-and-business-planning-conference.html

WATER LAW

Prior Appropriation – First in Time, First in Right

https://lawprofessors.typepad.com/agriculturallaw/2017/02/prior-appropriation-first-in-time-first-in-right.html

Kansas Water Law - Reactions to and Potential Consequences of the Garetson decision

https://lawprofessors.typepad.com/agriculturallaw/2017/02/kansas-water-law-reactions-to-and-potential-consequences-of-the-garetson-decision.html

Public Access To Private Land Via Water

https://lawprofessors.typepad.com/agriculturallaw/2017/04/public-access-to-private-land-via-water.html

Big Development for Water in the West - Federal Implied Reserved Water Rights Doctrine Applies to Groundwater

https://lawprofessors.typepad.com/agriculturallaw/2017/12/big-development-for-water-in-the-west-federal-implied-reserved-water-rights-doctrine-applies-to-grou.html

April 2, 2021 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Wednesday, March 31, 2021

Farmland in an Estate – Special Use Valuation and the 25 Percent Test

Overview

Fifty years ago, concerns began to arise in the farm sector about farmland being valued in decedents’ estates at values reflecting commercial development potential rather than values reflecting agricultural purposes.   The concern was particularly acute if the family desired to continue the farming operation after their family member died.  At the time, the federal estate tax exemption was $60,000 and the top rate was 77 percent on gross estate values exceeding $10 million.

The Congress responded by enacting I.R.C. §2032A – special use valuation.  This allows, by election, farmland to be valued in a decedent’s estate for federal estate tax purposes at its value for farming purposes.  But it’s a very complex provision.  One of those complexities, the “25 percent test,” is a key component with an interesting history.

Special use valuation’s 25 percent test – it’s the topic of today’s post.

 Special Use Valuation – Background and Basic Qualification Requirements

The Tax Reform Act of 1976 provided a legislative solution to the perceived problem facing rural landowners of having the farmland in their estates taxed at fair market value (based on a “willing buyer/willing seller” test) reflective of commercial development potential, and based the ability of the IRS to use fluctuating values in agricultural land markets to its advantage.  That solution, in the form of the enactment of I.R.C. §2032A, allows the executor of a decedent’s estate to value farmland in the estate at its value for agricultural purposes rather than fair market value.  The basic idea of the provision is to relieve farm families from having to sell an eligible family farm or business when the income from its present use is insufficient to pay the tax calculated upon its highest and best use.  In recent months, the heightened uncertainty over the future level of the federal estate tax exemption (as well as federal estate tax rate(s)) has increased interest in the utilization of special use valuation. 

Because of the significant tax benefits that can be derived by a decedent’s estate making an election to value qualified elected land under a special use valuation election, numerous requirements must be satisfied.  The following is a listing of the pre-death requirements that an estate must satisfy to make an I.R.C. §2032A election:  

  • The real estate used in farming together with the farm personal property must make up at least 50 percent of the adjusted value of the decedent’s gross estate, using fair market value figures, and that amount or more must pass to qualified heirs. I.R.C. § 2032A(b)(1)(A)
  • The decedent or a member of the decedent’s family must have had an equity interest in the farm operation at the time of death and for five or more of the last eight years before death. I.R.C. §2032A(a)(1), (b)(1)(C)(i).
  • The real estate must have been owned by the decedent or a member of the family and held for a qualified use during five or more years in the eight-year period ending with the decedent’s death. I.R.C. §2032A(b)(1)(C)(i). 
  • The decedent or a member of the decedent’s family must have materially participated in the farming operation for at least five out of the eight years immediately preceding the earlier of the decedent’s death, disability or retirement. I.R.C. §2032A(b)(1)(C)(ii). 
  • The farmland and personal property used in farming must have been “acquired from the decedent to a qualified heir or passed from the decedent” to a qualified heir. I.R.C. 2032A(e)(9). 
  • For land owned by a partnership, the decedent must have had an interest in a closely-held business. I.R.C. § 2032A(g); 6166(b)(1)(B).

The 25 Percent Test

An additional test requirement that must be satisfied for a decedent’s estate to be eligible to make a special use valuation election is that the farmland that is eligible for a special use valuation election must also make up at least 25 percent of the adjusted value of the decedent’s gross estate. I.R.C. §2032A(b)(1)(B).  That requirement sounds simple enough.  However, a question has been raised whether the 25 percent test be satisfied only with property that is subject to a special use valuation election?  Historically, the IRS thought that it did, and adopted a regulation specifying just that.  See Priv. Ltr. Rul. 8042009 (Jun. 30, 1980); Treas. Reg. §20.2032A-8(a)(2).  In 1988, however, the Federal District Court for the Central District of Illinois invalidated the regulation. Miller v. United States, 680 F. Supp. 1269 (C.D. Ill. 1988).  But, the IRS kept auditing and re-litigated the issue, culminating in another court opinion on the matter in 2012.  The IRS lost again. 

The 2012 Case -Finfrock v. United States

In Finfrock v. United States, 860 F. Supp. 2d 651 (C.D. Ill. 2012), the decedent owned 61.05 percent of the stock of Finfrock Farms, Inc. The corporation owned four tracts of real estate – tracts of 40 acres, 122.5 acres, 377.21 acres and 165 acres.  There was no question that the ownership test was satisfied, or that the 50 percent or 25 percent tests were satisfied.  Indeed, the adjusted value of the gross estate was $2,608,848 including the farmland which was valued at 1,775,000.  For the entire eight-year period preceding the decedent’s death, a son farmed the land, and upon the decedent’s death the ownership of the corporation passed to qualified members of the decedent’s family.  The estate elected special use valuation as to the fourth tract of farmland because that was the only tract that the family wished to continue to farm.  The other tracts were sold to unrelated persons shortly after the decedent died.  The fair market value of the fourth tract was $402,930, or about 15 percent of the estate’s adjusted value. The special use value election on that tract dropped its value reported on the estate tax return to $227,233.00.  On audit, the IRS denied the election because the land subject to the election did not exceed 25 percent of the adjusted value of the gross estate. 

The IRS position.  The position of the IRS in Finfrock was that not only must the estate satisfy the 25 percent test to be eligible to make a special use valuation election, the election must be made applicable to at least 25 percent of the value of farmland that is included in the estate (using fair market value figures). 

As noted, the Treasury Regulation at issue in Finfrock had previously been invalidated in 1988 by the same court. Miller v. United States, 680 F. Supp. 1269 (C.D. Ill. 1988).  In Miller, the court held Treas. Reg. §20.2032A-8(a)(2) invalid insofar as it attempted to impose a non-statutory requirement that 25 percent of the adjusted value of the gross estate must consist of farmland subject to the special use valuation election.  The court determined that the regulation was not simply interpretative of the statute, but was legislative in nature because it imposed a requirement that the statute did not contain.  So, the regulation was invalid to the extent it went beyond merely procedural matters (e.g., the proper form to file or information to include on prescribed forms).

After Miller, it was believed that the IRS no longer enforced the regulation against estates.  Obviously, that wasn’t the case in Finfrock, where the IRS again asserted the application of the regulation.  The estate pointed to the 1988 Miller decision, arguing that the statute was clear and unambiguous in that the 25 percent requirement only meant that 25 percent of the adjusted value of the gross estate had to be comprised of farmland.  It did not mean that the election must also be on at least 25 percent of the farmland in the estate.  The IRS argued that the statute was silent on the matter, and that the regulation merely clarified the statutory ambiguity.  But, the court disagreed, noting that the statute’s plain language did not require that the property constituting 25 percent or more of the adjusted value of the gross estate also be subject to the election.  The court held that the statute unambiguously allows an executor to make the election on land comprising less than 25 percent of the adjusted value of the gross estate, and that the regulation impermissibly imposed a requirement in addition to the statute’s plain meaning.  Because the statute was neither silent nor ambiguous, the issue of whether the regulation was a reasonable interpretation of the statute was not in issue. 

Planning Implications

Finfrock reasserts the point that any attempt by the Treasury to limit the scope of a special use valuation election beyond the statute is impermissible.  That’s a key point, particularly when the issue involves the amount of land that must be subjected to a special use value election.   When an election is made, an amount equal to the adjusted tax difference becomes a lien in favor of the United States. I.R.C. §6324B(a). The lien applies “on the property in which such interest exists.”  The lien arises at the time the election is filed and continues until liability for the tax ceases, or the recapture tax has been paid.  I.R.C. §6324B(b).   

The ability to limit the amount of property subject to the lien allows for tailoring of the special use valuation election.  Such tailoring can aid in minimizing the potential for recapture tax being triggered during the ten-year period following the date of the decedent’s death by restricting the election to the land most likely to be continued in farm use during the recapture period.

Conclusion

The present concerns about a potential reduction in the amount that can be excluded from federal estate tax is real in the agricultural sector.  That concern is separate from that over a possible change in the income tax basis rule for property included in a decedent’s estate at death.  Consequently, it may be time to “dust off” the special use valuation provisions and refamiliarize ourselves with its detailed rules.  The 25 percent test is an important one of those.

March 31, 2021 in Estate Planning | Permalink | Comments (0)

Monday, March 29, 2021

Damaged and/or Destroyed Trees and Crops – How is the Loss Measured?

Overview

Sometimes a farmer, rancher or other rural landowner experiences damages to trees as a result of someone else’s conduct.  Maybe the damage occurs from aerial spry drift or excess (and wrongful) water drainage from an adjacent tract, or from some other occurrence.  The trees could be a producing orchard; or a windbreak designed to minimize soil loss and protect buildings; or ornamental trees and bushes providing an aesthetic benefit.  Often, trees are planted to become mature trees with an eye toward materially benefitting the property – whether monetarily or not.  

No matter whether the damage was intentional or a result of negligence, the computation of the amount of damages the landowner is entitled to can be difficult to determine. 

Computing tree damage - it’s the topic of today’s post. 

Negligence – Determining Liability

The negligence concept is the great workhorse of tort law.  More than 90 percent of all civil liability problems are those relating to negligence.  The negligence system is designed to provide compensation to those who suffer personal injury or property damage.  The negligence system is a fault-based system.  The vast majority of situations involving damage to trees are the result of negligent conduct with liability determined under the negligence, fault-based approach

For a person to be deemed legally negligent, certain conditions must exist. These conditions can be thought of as links in a chain. Each condition must be present before a finding of negligence can be obtained.  The first condition is that of a legal duty giving rise to a standard of care.  To be liable for a negligent tort, the defendant's conduct must have fallen below that of a “reasonable and prudent person” under the circumstances.  If a legal duty exists, it is necessary to determine whether the defendant's conduct fell short of the conduct of a “reasonable and prudent person (or professional) under the circumstances.”  This is called a breach, and it is the second element of a negligent tort case.  Once a legal duty and breach of that duty are shown to exist, a causal connection (the third element) must be established between the defendant's act and (the fourth element) the plaintiff's injuries (whether to person or property.  In other words, the resulting harm to the plaintiff must have been a reasonably foreseeable result of the defendant's conduct at the time the conduct occurred. Reasonable foreseeability is the essence of causality (also known as proximate cause).

Computing Damages

The fourth element of a tort claim, damages, when occurring to an annual crop (such as corn, soybeans and wheat, for example), are pegged by the lost value of the crop pegs.  That’s the starting point for determining the amount that can be recovered.  Of course, the party suffering the loss must establish the extent of the monetary damage, often by market data or by establishing the existence of a contract that specified the amount to be received on harvest and sale, discounted for risk of loss due to weather and/or insects. 

But, when the damage occurs to a plant, such as a tree, there is an additional component to the damage calculation – restoration.  Restoration involves calculating the cost of returning the disaffected landowner’s property to its condition before the damage occurred.  Sometimes courts compute the restorative cost as the difference in the value of the land before and after the damage.  But, the cases also demonstrate that the computation is not easy. See, e.g., B. & B. Farms, Inc. v. Matlock’s Fruit Farms, Inc., 73 Wash. 2d 146, 437 P.2d 178 (1968); Reeder Flying Service v. Crompton, 470 P.2d 281(Wyo. 1970).  The courts use various measures to assess the loss, but the goal is to provide adequate compensation so that the injured party is restored as closely as possible to pre-damage status.

Note:  A lawsuit to recover damages to trees (as well as crops), under the common law, is considered to be an action to recover for injuries to real estate.  Thus, the lawsuit is to be filed in the county where the trees are/were standing. 

For trees and vines that produce nuts and fruits, the measure of damages is generally the difference in land value immediately before and after the damage or destruction.  See, e.g., Rowe v. Chicago & North Western Railway Co., 102 Iowa 286 (1897); Collins v. Morris, 97 Kan. 264 (1916).  But, it might also be possible for the plaintiff to recover the value of the crop before the damage occurred.  So, the plaintiff should provide evidence of the cost of harvesting and marketing the crop in addition to the value of the crop itself.  Damages are a net computation.  See, e.g., Peterson v. Hager, 714 F.2d 1035 (10th Cir. 1983)But, one court has held that damages to a fruit crop itself could not be awarded because the value of the fruit-producing trees was an element of the damages.  If the value of the crop were to be included in the damage calculation, the court reasoned, the result would be double damages.  Hill v. Morrison, 88 Cal. App. 405, 263 P. 573 (1928). 

Recent Case

A Kansas case last year illustrates how courts handle claims involving alleged damages to trees.  In Ringneck Farms, LLC v. Steuwe, 471 P.3d 33 (Kan. Ct. App. 2020), the plaintiff owned a ranch used for commercial hunting purposes that was adjacent to the defendant’s property. The ranch had a row of hedge trees approximately 20 yards wide and 300 yards long adjacent to the defendant’s property. The hedge trees were mature trees. The defendant’s tenant contacted the plaintiff requesting permission to cut down the hedgerow and install a fence. The plaintiff told the tenant to not cut down the trees or disturb the vegetation. However, the tenant proceeded to cut down the hedgerow and installed the fence. In the process about 156 mature trees were destroyed. The plaintiff sued alleging negligence, conversion and trespass claiming that that the loss of the trees decreased the value of the property for hunting purposes. The defendant filed a motion in limine seeking to bar the plaintiff from presenting evidence about the trees’ replacement value, claiming that Kansas law did not recognize replacement value as a proper measure of damages for tree destruction. The defendant specifically referred to the plaintiff’s two experts, arborists that were prepared to testify that the replacement cost of the trees was $1,092,361.

The trial court granted the defendant’s motion. The defendant then moved for summary judgment, claiming that the trial court’s grant of the motion in limine established that the plaintiff could not establish that damages existed and, thus, had no claim. The trial court granted the summary judgment motion on the negligence issue, finding that the plaintiff did not know the market value of the ranch before and after the trees were removed and, thus, could not prove damages. In its response to the summary judgment motion, the plaintiff claimed that the ranch was damaged by virtue of the tree removal reducing the quality of hunting on the ranch. However, the trial court viewed this assertion did not convert any of the defendant’s statement of facts.

On appeal, the issue was whether the plaintiff had presented sufficient evidence of damages to present its case to a jury. The appellate court first determined that the plaintiff had not abandoned its claims for conversion and trespass because the defendant didn’t specifically address the conversion and trespass claims in the defendant’s trial court motions focusing solely on negligence. The appellate court also determined that the trial court did not err in granting the defendant’s motion in limine. The appellate court noted that damages had to be calculated in a reasonable manner, citing the fact that replacement cost of the trees with mature trees would exceed three times the value of the ranch. Thus, it was proper for the trial court to exclude the plaintiff’s proposed evidence on replacement cost of the hedgerow with mature trees.

On review of the grant of summary judgment on the negligence claims, the appellate court noted that the general rule that the measure of damages for negligent destruction of trees is the difference in market value of the land immediately before and after the damage. However, the appellate court noted that this rule is flexible, and the parties may present evidence supporting alternative measures of damages – trees having value independent of the land; loss of income from fruit trees; sentimental value of a tree, etc.  See, e.g., Evenson v. Lilley, 295 Kan. 43, 282 P.3d 610 (2012). On this point, the appellate court concluded that the plaintiff had submitted sufficient evidence of damages to overcome the defendant’s summary judgment motion. The appellate court noted that the plaintiff had provided sufficient evidence to overcome the motion by showing that the removal of the trees impacted the quality of hunting on the ranch which justified reasonable replacement costs as a measure of damages. The appellate court also determined that the plaintiff had provided sufficient evidence of damages on the conversion and trespass claims. The case was remanded to the trial court for further proceedings. 

Conclusion

When tree damage occurs on a farm, ranch or rural property the computation of damages is a key focus.  The damage calculation can differ based on whether the trees are income producing, soil preservation, or simply provide aesthetic beauty.  However, in general, the courts try to make the damaged party whole by returning them to the place they were in before the damage occurred.  Preserving evidence and substantiating the loss is key to recovery.

March 29, 2021 in Civil Liabilities | Permalink | Comments (0)

Friday, March 26, 2021

C Corporation Compensation Issues

Overview

A “hot-button” audit issue for S corporations involves the issue of “reasonable compensation” for shareholders.  Compensation is also an important issue in the C corporate context.  While in the S corporate context the temptation is to set compensation too low, the concern is just the opposite when a C corporation is involved. 

But, what is “reasonable compensation”?  Why does it matter?

Compensation issues in the C corporation context – it’s the topic of today’s post.

The Basic Problem

A corporate-level deduction is allowed for “reasonable” salaries and compensation paid to employees for their personal services.  Because of the dual-level taxation associated with C corporations (on corporate income when earned and again when paid as dividends) C corporations have an incentive to pay larger than normal salaries so as to reduce their taxable income and get corporate earnings to owners with only one level of tax.  But, the IRS can challenge what it deems to be “excessive” salaries as disguised dividends resulting in a loss of a corporate deduction from taxable income and the addition of the “excessive” amount to the corporation’s net taxable income.  Conversely, in certain situations, corporate employees may receive only a nominal salary in an attempt to minimize FICA and Medicare taxes.  Upon audit, IRS may increase the salary with the result that FICA and Medicare tax will be due, plus interest and penalties.  Another problem associated with setting salaries too low is that the corporation could be assessed for payroll taxes on the unreported compensation.  The penalties and interest associated with unreported compensation are often greater than an income tax deficiency assessment.  The quarterly payroll deposit rules will typically have been violated, resulting in cascading penalties that include the failure to timely deposit and failure to properly report.

What is a “Reasonable” Salary?

Corporate salaries must be “reasonable” in light of the personal services that are actually rendered.  I.R.C. §162(a)(1).  However, “reasonable” is not defined in the Code, and the Regulations provide only that “reasonable compensation is an amount paid for like service by like enterprises under like circumstances.” Treas. Regs. §§1.162-7(b)(3) and 1.1366-3(a). Thus, the facts and circumstances of each particular situation are determinative of the outcome.  The courts, in numerous cases involving the issue, have set forth several factors to be used in determining the reasonableness of salaries, including.  Likewise the IRS Audit Manual utilizes the same factors. 

The factors are as follows: 

  • The level of the salary in light of the employee’s qualifications
  • The compensation paid in light of the nature and extent of the employee’s work, with consideration paid to the role that the shareholder plays in the corporation (e.g., the employee’s position, number of hours worked and duties performed)
  • How the compensation compares to compensation paid for similar services by similar entities
  • Whether the compensation is reasonable in relation to the salary history of the corporation
  • Whether the compensation is reasonable in light of the character and financial condition of the corporation
  • Whether a hypothetical, independent investor would conclude that there is an adequate return on investment after considering the shareholder’s compensation
  • The size and complexity of the business
  • How the amount of salaries paid compares to corporate sales and net income
  • General economic conditions
  • How the amount of salaries compare to shareholder distributions and retained earnings
  • The corporation’s dividend history
  • Whether the employee and employer dealt at arm’s length
  • Whether the employee guaranteed the employer’s debt
  • Whether there has been a “catch-up” element involved where the corporation is making up for years when the employee was under paid
  • Whether the corporation has developed compensation policy for employees allowing them to participate in the company’s success

The cases confirm that no single factor controls.  Instead, a combination of the factors must be considered.  In addition, the factors are not all inclusive and may not be given equal weight.  Fewer or additional factors may be appropriate, depending on the surrounding facts and circumstances.

What’s “reasonable compensation” for an owner of a closely-held farming or ranching operation?  The answer to that question depends on how the factors listed above apply to the facts and circumstances of the particular situation. 

Tax Planning Strategy

As a tax planning strategy, before year-end, each shareholder/employee’s compensation should be reviewed for reasonableness and increased by payment of a year-end bonus if needed.  While reasonableness is based on the facts and circumstances, compensation can often be set at the low end of a wide salary range that is both reasonable and supportable.  The better the documentation explaining why wages and bonuses are appropriate, the more likely that the payments can withstand IRS attack.

Consider the following example:

Joe starts up an accounting practice, and employs Blake and Terry.  Joe operates as a personal service corporation.  The firm has a successful first year, generating an extra $300,000 in corporate net income.  Joe declares a bonus for himself in the amount of $300,000, which eliminates the corporation’s taxable income.  However, $200,000 of the $300,000 in additional income was generated by the efforts of Blake and Terry. Joe actually spent a couple of months of the year taking a sabbatical in the north woods of Minnesota playing his ukulele for the animals that would listen and giving a break to Blake and Terry from his dry humor. Joe claimed he continued to “manage’ the practice from his remote location.

The IRS would likely take the position that the extra time and effort expended by Joe in managing the accounting practice is, at best, a nominal factor to be taken into account when a large portion of the income is based on the services rendered by other employees.  So, IRS would likely conclude that $200,000 of net income paid to Joe is actually a non-deductible dividend to Joe.  The resulting additional corporate income is taxed at the 21 percent rate applicable to personal service corporations.  The result would be an added tax liability of $42,000. 

Joe could elect to have the company taxed as an S corporation.  Joe would then refrain from declaring and paying the $300,000 bonus to himself, instead picking it up as an S corporation distribution which is taxed to the shareholders on a pro rata basis.  But, if Joe does this, IRS could examine the $300,000 paid as an S corporation distribution to determine whether it actually should be treated as compensation to Joe.  If all or a portion of the $300,000 is deemed to be compensation, Social Security and Medicare tax will be assessed on the amount deemed to be compensation.  Also, with an S election, if Joe were to set his compensation at the amount of the maximum for qualified retirement plan funding, with the balance of corporate net income structured as an S corporation distribution, that would avoid Medicare tax on the amount of the S corporation distribution.  IRS, however, would likely examine that scenario to determine whether the compensation amount is too low.

Prominent Case

There have been numerous prominent cases on the issue of reasonable compensation.  A particularly high-profile one involved the founder and CEO of Menards, a chain of “home improvement” stores located in the Midwest.

In Menard, Inc. v. Commissioner, 560 F.3d 620 (7th Cir. 2009), the IRS challenged the $20 million salary of a corporate CEO (who was also a shareholder/employee that worked full time and owned all of the voting stock and 56 percent of the non-voting stock) as unreasonable. The compensation plan for the CEO included a base salary, a profit-sharing plan and a bonus plan that had been in place since 1973.  Over $17 million of the total amount was paid in accordance with a bonus plan that had been in place since 1973.   The bonus was tied to 5 percent of the corporation’s net income before taxes.  The Tax Court disallowed all but $7 million of the salary (after comparisons to CEO salaries of competing businesses – Home Depot and Lowe’s) determining it to be a disguised dividend.  On further review, the appellate court reversed.  The appellate court determined that, the under the CEO’s management, corporate revenues grew from $788 million in 1991 to $3.4 billion in 1998 (the year at issue) and the corporation’s taxable income grew from $59 million to $315 million during the same timeframe.  The corporation’s rate of return on shareholder’s equity in 1998 was higher than that of either company the Tax Court used for comparison purposes.  The appellate court noted that the CEO handled a large part of the duties which were normally delegated in other companies to subordinates.  In addition, the fact that there was no independent Board of Directors for the corporation required the CEO to accept greater responsibility and duties that normally don’t apply to comparable CEOs.  Thus, to the appellate court, the 5 percent of net corporate income did not look at all like a dividend and the appellate court held that the Tax Court committed clear error in holding that the salary was excessive.  That was particularly the case, the court noted because the compensation that the Tax Court determined to be a disguised dividend was paid before a determination of the corporation’s net income for the year, and was paid on an annual basis.  That meant that it was not a set dollar amount that constituted a dividend.   

The appellate court was also highly skeptical of the Tax Court’s remark that the owner of a business has no need for incentive compensation because ownership is incentive enough. The appellate court reasoned that owners should not be treated differently from other managers and also stated that the Tax Court had established itself as the “super-personnel department for closely-held corporations.” 

Recent Case

In Aspro, Inc. v. Comr., T.C. Memo. 2021-8, the petitioner was a C corporation in the asphalt paving business incorporated under Iowa law with its principal place of business in Iowa.  The petitioner had three shareholders and did not declare or distribute any dividends to them during the tax years in issue (2012-2014) or in any prior year.  This was despite the petitioner having significant profits before setting management fees.  Thus, the shareholders didn’t receive any return on their equity investment.  The petitioner did not enter into any written management or consulting services agreements with any of its shareholders. Also, there was no management fee rate or billing structure negotiated or agreed to between the shareholders and petitioner at the beginning of any of the years in issue.  In addition, none of the shareholders invoiced or billed the petitioner for any services provided indirectly via other legal entities that the shareholders controlled. Instead, the petitioner’s board of directors would approve the management fees to be paid to the shareholders at a board meeting later in the tax year, when the board had a better idea how the company was going to perform and how much earnings the company should retain.  But, the board minutes did not reflect how the determinations were made.  The petitioner’s board did not attempt to value or quantify any of the services performed on its behalf and simply approved a lump-sum management fee for each shareholder for each year. The amounts were not determined after considering the services performed and their values. There was no correlation between management fees paid and services rendered. In total, the shareholders received management fees exceeding $1 million every year for the years in issue. The management fees were simply paid after-the-fact in an attempt to zero-out the petitioner’s taxable income.

The IRS completely denied the petitioner’s claimed deductions for management fees and amounts the petitioner claimed for the domestic production activities deduction for the years in issue.  The Tax Court upheld the IRS position denying the deduction.  The Tax Court determined that the petitioner failed to prove that the management fees were neither ordinary and necessary business expenses or reasonable in accordance with Treas. Reg. §1.162-7.  Based on the facts and circumstances, the Tax Court concluded that the absence of the dividend payments where the petitioner had available profits created an inference that at least some of the compensation represented a distribution with respect to corporate stock.  While the management fees loosely corresponded to each shareholder’s percentage interest, the Tax Court inferred that the shareholders were receiving disguised distributions based on each shareholder’s equity interest. 

As for the services rendered to the petitioner via the shareholders’ controlled entities, the Tax Court noted that if the services were to be compensated, the petitioner should have invoiced directly for the services.  The services, as a result, did not provide even indirect support for the management fees the petitioner paid to its shareholders.  The Tax Court also noted that the management fees were not set in advance for services to be provided and there was no management agreement that supported any objective pricing that the parties bargained for.  The shareholders also could not explain how the management fees were determined, and the corporate president (and one of petitioner’s board members) displayed a misunderstanding of the nature of deductible management fees and stock distributions.  The Tax Court also noted that the effect of the deduction for management fees was to create little taxable income to the petitioner, indicating that the fees were disguised distributions.  The Tax Court further determined that the petitioner’s president rendered no services to the petitioner other than being the president and, as such was already overcompensated by his base salary and annual bonus totaling approximately $500,000 annually.  Thus, the additional management fee was completely unreasonable as to him.  

Conclusion

Paying “reasonable compensation” in the context of closely-held corporations is critical. 

March 26, 2021 in Business Planning, Income Tax | Permalink | Comments (0)