Sunday, February 21, 2021
The Packers and Stockyards Act (PSA) of 1921 provides protection for cash sellers of livestock to parties that the PSA covers. However, many times a livestock seller may sell to a buyer that the PSA does not apply to. A new law enacted in late 2020 as part of a massive spending bill addresses the issue by amending the PSA to provide a statutory trust for unpaid cash sellers of livestock to a livestock “dealer.”
The recent creation of a livestock dealer trust – it’s the topic of today’s post.
The PSA was enacted with the purpose of ensuring fair competition in and trade practices involving livestock marketing, meat and poultry. 7 U.S.C. §§181-229. See also Armour & Company v. United States, 402 F.2d 712 (7th Cir. 1968). The scope of the PSA is quite broad, vesting in the U.S. Secretary of Agriculture (Secretary) wide discretion to investigate and regulate all activities connected with livestock marketing. See, e.g., Rice v. Wilcox, 630 F.2d 586 (8th Cir. 1980).
What happens when a livestock packer, market agency or a livestock dealer fails to pay for livestock that it buys from a livestock seller? Under the PSA, two provisions come into play - the “prompt payment rule and the creation of a statutory trust.
PSA Rules Governing Payment For Livestock – Longstanding Rules
Prompt payment rule. The PSA provides for failure to make prompt and full payment for “livestock.” Livestock is defined to include “cattle, sheep, swine, horses, mules, or goats—whether live or dead.” 7 U.S.C. § 182(4). Generally, to not be deemed to be engaged in an “unfair practice” under the PSA, a packer must make full payment of the livestock’s purchase price “before the close of the next business day following the purchase of livestock and transfer of possession thereof.” 7 U.S.C. §§228b(a) and (c). A packer subject to the prompt payment rule is defined as “any person engaged in the business (a) of buying livestock in commerce for purposes of slaughter, or (b) of manufacturing or preparing meats or meat food products for sale or shipment in commerce, or (c) of marketing meats, meat food products, or livestock products in an unmanufactured form acting as a wholesale broker, dealer, or distributor in commerce.” 7 U.S.C. §191. When livestock is purchased for slaughter, payment must be made to the seller or the seller’s representative at the point of transfer or the funds must be wired to the seller’s account by the close of the next business day. Id. If the sale is based on carcass weight, or is a grade/yield sale, the same rule applies once the purchase amount has been determined. Id. If the seller (or the seller’s agent) is not present to receive payment at the point of sale, the packer is to either wire the funds to the seller and put a check in the mail for the full amount by the close of the next business day. Id.
The prompt payment requirement can be waived by written agreement that is entered into before the purchase or sale of livestock. 7 U.S.C. §228(b)(b). The regulations provide a format for the waiver. 9 C.F.R. §201.200(a). The agreement must be disclosed in the business records of the buyer and the seller, and on the accounts or other documents that the buyer issues relating to the transaction. 7 U.S.C. §228b(b). But, if the prompt payment requirement is waived, the seller will lose any interest the seller has in the statutory trust (discussed below). 7 U.S.C. §196(c).
The prompt payment rule also applies to “market agencies” and “dealers” in addition to packers (as defined above). A “market agency” is any person “engaged in the business of (1) buying or selling in commerce livestock on a commission basis or (2) furnishing stockyard services.” 7 U.S.C. §201(c). Simply denoting “commission” on an invoice does not, by itself, indicate that the sale was on a commission basis. It’s the nature of the business relationship of the parties and the surrounding facts and circumstances that are determinative. See, e.g., Ferguson v. United States Department of Agriculture, 911 F.2d 1273 (8th Cir. 1990). A “dealer” is “any person, not a market agency, engaged in the business of buying or selling in commerce livestock, either on his own account or as the employee or agent of the vendor or purchaser.” 7 U.S.C. §201(d). In Kelly v. United States, 202 F.2d 838 (10th Cir. 1953), the court said that a person can be a “dealer” even if the buying and selling of livestock is not the person’s only business.
A violation of the prompt payment rule constitutes an “unfair practice” under the PSA. 7 U.S.C. §228b(c). The same is true for the issuance of an insufficient funds check and the failure to pay when due. 7 U.S.C. §213(a); 7 U.S.C. §228(b).
The inability to make prompt payment is sometimes tied to the financial condition of the buyer. Consequently, all market agencies are prohibited from operating while insolvent – when current liabilities exceed current assets. 7 U.S.C. §204. See also United States v. Ocala Livestock Market, Inc., 861 F. Supp. 2d 1328 (M.D. Fla. 2012).
Statutory packer trust. For packers with average annual purchases of livestock exceeding $500,000, the PSA establishes a statutory trust for the benefit of unpaid cash sellers. A “cash sale” is any sale where the seller does not expressly extend credit to the packer. 7 U.S.C. §196(a); Kunkel v. Sprague National Bank, 128 F.3d 636 (8th Cir. 1997). The provision extends to “all inventories of, or receivables or proceeds from meat, meat food products, or livestock products derived therefrom….” 7 U.S.C. §196(b). The funds must be held in the trust for the benefit of al unpaid cash sellers of livestock until full payment has been received by the unpaid seller. Id.
If a packer files bankruptcy, assets contained in the statutory trust are not part of the bankruptcy estate. 11 U.S.C. §541(d). This means that the unpaid cash sellers of livestock do not have to compete with the bankrupt debtor’s secured creditors for the assets contained in the trust. See, e.g., Rogers and King, Collier Farm Bankruptcy Guide §105. Claims for payment from the statutory trust will defeat a properly perfected Uniform Commercial Code lien. See, e.g., In re Gotham Provision Company, 669 F.2d 1000 (5th Cir. 1982). Likewise, a bank creditor of a packer is not able to setoff funds held in the statutory trust. See, e.g., In re Jack-Rich, Inc., 176 B.R. 476 (Bankr. C.D. Ill. 1994). Also, payment from a statutory trust to livestock sellers are not recoverable as a preference item in bankruptcy. But, what constitutes cash collateral can present issues.
An unpaid cash seller can make a claim against trust assets by providing notice to the Secretary within 30 days of the final date for making prompt payment under 7 U.S.C. §228(b) or within 15 business days of being notified that the seller’s check has been dishonored, whichever is later. 7 U.S.C. §196(b); see also 9 C.F.R. §203.15.
The statutory trust requirement does not apply to livestock purchases by market agencies and dealers. However, payments that a livestock buyer makes to a market agency for sales on commission are considered to be trust funds that must be deposited into a custodial account. 9 C.F.R.§201.42(a), (b). In other words, a market agency or a dealer must maintain a custodial account for trust funds. By close of the next business day after an auction, market agencies must deposit into the custodial account: (1) all proceeds collected from the auction, and (2) an amount equal to the proceeds receivable from the livestock sale that are due from the market agency; any owner, employee, or officer of the market agency; and any buyer to whom the market agency has extended credit. 7 U.S.C. §201.42(c)-(d); 9 C.F.R. §201.42(c). In addition, a market agency must deposit an amount equal to all of the remaining proceeds receivable into the custodial account within seven days of the auction, even if some of the proceeds remain uncollected. Id. Funds in the custodial account can only be withdrawn to remit the net proceeds due a seller, to pay lawful charges which the market agency is required to pay, and to obtain sums due the market agency as compensation for its services. 9 C.F.R. §201.42(d). A market agency must transmit or deliver the net proceeds received from the sale to the seller by the close of business on the day after the sale. 7 U.S.C. §228b(a); 9 C.F.R. §201.43(a).
To make a statutory trust claim, written notice must be given to the buyer and the Grain Inspection Packers and Stockyards Administration (GIPSA). The livestock not paid for must be identified along with the date of delivery. The applicable “look-back” period is 30 days before receipt by the buyer and the Secretary.
Note: Effective November 29, 2018, GIPSA is no longer a standalone agency within the United States Department of Agriculture (USDA), but is contained within the USDA’s Agricultural Marketing Service (AMS). The USDA final rule detailing the reorganization is found at 83 FR 61309 (Nov. 29, 2018).
Amended PSA - Statutory Dealer Trust
Origin. H.R. 133, The Consolidated Appropriations Act, 2021, was signed into law in late 2020. Title VII, Subtitle B, Chapter 2, §763 of the legislation amends the PSA by creating a statutory trust for the benefit of unpaid cash sellers of livestock to a dealer. Examples of “unpaid cash sellers” that may receive protection from the statutory trust include livestock producers, auction markets, and livestock dealers selling to another livestock dealer. The PSA says a dealer is “any person, not a market agency, engaged in the business of buying or selling in commerce livestock, either on his own account or as the employee or agent of the vendor or purchaser.” 7 U.S.C. § 201(d). Thus, a “dealer” that buys or sells livestock with their own funds, or the funds of their employer, or is acting as an agent in such a transaction is covered.
Covered transactions. Under the new provision, all cash purchases (any sale where the seller doesn’t extend credit to the buyer) of livestock by a dealer with average annual purchases of $100,000 or more, and all inventories of, or receivables or proceeds from the livestock purchased in a cash sale transaction must be held by the dealer in trust until the unpaid cash sellers have been paid in full. “Payment in full” does not include an unpaid cash seller that receives a payment instrument that is dishonored. Indeed, payment is not considered to have been made if a payment instrument that is given in exchange for the livestock is dishonored. Thus, if the dealer does not pay for livestock at the time of delivery, the dealer must maintain a trust with certain assets until they satisfy the unpaid purchase of livestock.
What’s in the trust? Generally, the trust assets include the livestock that the dealer purchases as well as any earnings from the resale of the livestock. But a dealer need not segregate trust assets for each seller. Instead, the trust consists of commingled livestock-related assets, and all of the trust assets are subject to claims of an unpaid cash seller to the extent of the seller’s claim.
Priority rule. Unpaid cash sellers have first priority as to trust assets. If the dealer files bankruptcy, the trust assets are not included in the dealer’s bankruptcy estate. A buyer of livestock subject to the dealer trust receives good title to the livestock if the livestock are received in exchange for the payment of new value, and the livestock are received in good faith without notice that the transfer is a breach of trust. Also, a transfer of livestock that is subject to a dealer trust is not “for value” if the transfer is in satisfaction of an antecedent debt or to a secured party in accordance with a security agreement. Presumably, payment from a dealer trust to livestock sellers is also not recoverable as a preference item in bankruptcy. But what constitutes cash collateral can present issues.
Securing the trust’s benefit. An unpaid cash seller can lose the benefit of the trust by not giving notice to the dealer in writing of the seller’s claim on the trust and properly filing the notice with the USDA Secretary within 30 days after payment was due if a payment instrument has not been received, or within 15 business days after the date on which the seller receives the notice that the payment instrument promptly presented for payment has been dishonored. Generally, a dealer’s payment is due before the close of the next business day after the purchase and transfer of possession of livestock. 7 U.S.C. §228b. When a dealer receives the notice of the seller’s intent to preserve the trust’s benefits, the dealer has 15 business days to give notice to all persons who have a recorded security interest in or lien on the livestock held in the trust.
Enforcement. Enforcement of a dealer trust lies with the U.S. Secretary of Agriculture. Whenever the Secretary believes that a dealer has failed to comply with the dealer trust provisions or that action would otherwise be in the best interest of an unpaid cash seller, the Secretary is to either appoint an independent trustee to preserve the trust assets and enforce the trust or file suit in the federal district court in the jurisdiction of the dealer’s location. In the alternative, an unpaid cash seller can sue to enforce the trust.
The PSA is a major piece of legislation significantly regulating livestock sales involving covered entities. It provides a level of protection for livestock sellers in terms of ensuring payment. In addition, it is a good practice for lenders that finance PSA-covered entities to ensure that these entities promptly pay for all livestock purchased. Now, the PSA statutory trust rules cover “dealers” in livestock and provide additional protection for unpaid cash sellers of livestock. The dealer statutory trust provision is applicable to covered transactions occurring on and after date of enactment. Lenders should take note.
Thursday, February 18, 2021
Over the past few decades, valuation discounting through the use of family-owned business entities has become a popular estate and gift tax planning technique. If structured properly, the courts have routinely validated discounts ranging from 10 to 40 percent. Valuation discounting has proven to be a very effective strategy for transferring wealth to subsequent generations. It is a particularly useful technique with respect to the transfer of small family businesses and farming/ranching operations. Similar, but lower, valuation discounts can also be achieved with respect to the transfer of fractional interests in real estate.
With the new Administration and Congress in place, will estate tax valuation regulations be put in place that diminish or eliminate the valuation discounting technique? It’s a distinct possibility. If it happens, it will remove a significant planning tool for higher wealth estates and will increase the transfer tax cost of transitioning certain farms and ranches to the next generation.
Estate tax valuation discounts – it’s the topic of today’s post.
Valuation and The Concept of Discounting
The value of an asset for federal estate and gift tax purposes is “fair market value.” For assets traded on an established market or that have a readily ascertainable value, the value for gift and estate tax purposes is their fair market value on the date of the transfer or death as determined by the established market or the otherwise readily ascertainable value. For other assets, such as interests in a closely-held (non-publicly trade) farm or ranch. Fair market value is more difficult to determine. For this type of property, fair market value is defined as “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell, and both having reasonable knowledge of relevant facts.” Treas. Reg. §§20.2031-1(b); 25.2512-1; Rev. Rul. 59-60, 1959-1 C.B. 237. State law controls the determination of what has been transferred in the valuation process.
The concept of “fair market value” under the “willing buyer-willing seller” test must necessarily take into account a value reduction to reflect either non-marketability of an interest in a closely-held business as well as any lack of control (minority position) that the interest has. A willing buyer simply would not pay a pro-rata portion of an entity’s value for an interest that is not a controlling interest or is not marketable because it is not publicly traded. Under this standard, it is immaterial whether the buyer and seller are related – the test is based on a hypothetical buyer and seller. Thus, there is no attribution of ownership between family members that would change a minority interest into a majority interest.
Background. The two primary tax Code provisions that bear on the valuation issue are I.R.C. §2036 and I.R.C. §2704. I.R.C. §2036 states that, “[t]he value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death— (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom.” I.R.C. §2704 address how to value intra-family transfers of interests in corporations and partnerships subject to lapsing voting or liquidation rights and restrictions on liquidation. I.R.C. §2704(a)(1) generally provides that, if there is a lapse of any voting or liquidation right in a corporation or a partnership and the individual holding the right immediately before the lapse and members of the individual’s family hold, both before and after the lapse, control of the entity, the lapse will be treated as a transfer by the individual by gift, or a transfer which is includible in the gross estate, whichever is applicable. Combined, these two Code sections govern transfers of property where the transferor retains certain rights over the property where a bona fide sale for adequate consideration wasn’t received, and the intra-family transfers. Both of those types of transactions are often a part of estate and business planning for farming and ranching operations.
2016 proposal. Near the tail-end of the Obama/Biden administration, the Treasury issued proposed regulations (REG-163113-02) that would have significantly curtailed the ability to take valuation discounts on intrafamily transfers of business interests (e.g., discounts for lack of marketability and minority interests) involving both I.R.C. §2036 and I.R.C. §2704. Specifically, the proposed regulations would treat certain transfers occurring within three years of death that result in the lapse of a liquidation right as transfers occurring at death for purposes of I.R.C. §2704(a). At that time, the IRS explained that the regulations were intended to address estate planning strategies that avoid the application of I.R.C. §2704. The proposed regulations added a three-year rule to narrow the exception to the definition of a lapse of a liquidation right to transfers that occur three or more years prior to the transferor’s death and that do not restrict or eliminate the rights associated with the ownership of the transferred interest. The proposed regulation was issued by itself, and not also as a temporary regulation, and did not have any provision stating that a taxpayer could rely on it before it is issued as a final regulation.
The effective date of the proposed regulation reaches back to include valuations associated with any lapse of any right created on or after October 8, 1990 occurring on or after the date the proposed regulations is published in the Federal Register as a final regulation. This would make it nearly impossible to avoid the application of the final regulation by various estate planning techniques.
IRS concern. So, why proposed regulations? What is the IRS concerned about? While the IRS has won a number of court cases involving discounting in the context of family limited partnerships (FLPs), it has lost some very significant ones. The courts have validated discounts associated with FLPs where the FLP was formed for legitimate business purposes and state law formalities have been followed closely. From my sources both inside and outside of the IRS, the IRS is apparently still encountering situations involving FLPs that are not established in accordance with state law, don’t adequately document the business reasons for forming the FLP and have inaccurate or incomplete asset appraisals. They think that the revenue loss is large as a result of the technical non-compliance with I.R.C. §§2036 and 2704. Consequently, the new proposed regulations eliminate the ability to value an interest in an entity (in the aggregate) at an amount less than the value of the value of the property had it not been contributed to the entity. The IRS view is that the lower value of the property as contained in the entity is an inappropriate way to avoid transfer taxes.
Elimination of the proposed regulations. Before the proposed regulations were finalized, President Trump issued Executive Order (EO) 13789. In that EO, President Trump directed the Treasury Department to review all significant tax regulations issued since January 1, 2016. The Treasury Department was directed to identify regulations that may be “unduly burdensome or complex,” and propose actions to mitigate those burdens. The Treasury Department identified the proposed valuation regulations as unduly burdensome or complex, and “would have hurt family-owned and operated businesses by limiting valuation discounts.” Additionally, the regulations “would have made it difficult and costly for a family to transfer their businesses to the next generation.” The Treasury Department also noted stakeholders’ concerns that the regulations were vague and would be burdensome to administer.
In withdrawing the proposed regulations, (NPRM REG-163113-02), the Treasury commented that the regulations were “unworkable” and stated that, “it is unclear whether the valuation rules of the proposed regulations would have even succeeded in curtailing artificial valuation discounts.”
The Biden Treasury Department could revive the withdrawn proposed regulations and potentially finalize them sometime in 2021. If that happens, the ability to generate valuation discounts for the transfer of family-owned entities such as farm and ranches would be seriously impacted.
Clearly, the Treasury can write regulations that specify that certain restrictions on transfer can be disregarded when determining the value of an interest in an entity to a family member of the transferor. However, without legislation allowing it, the IRS cannot simply ignore discounts for lack of marketability or lack of control (minority interest). Long-standing interpretations of I.R.C. §2704 (and I.R.C. §2036) by the Tax Court and the Circuit Courts support valuation discounts when the transaction is done properly. As a result, the Courts may have a different view than the IRS/Treasury with respect to the proposed regulations based on the longstanding Congressional intent to allow discounts in a family context. Having discretion does not mean that Treasury has discretion to determine value as it pleases.
The possibility of the valuation regulations returning puts an emphasis on examining estate and transition plans now. It’s a good idea to have a wealth transfer strategy in place. While the political margins are close in the House and Senate, the Treasury and IRS could significantly alter the planning landscape without any need for congressional approval.
The valuation discounting issue merits close attention.
Monday, February 15, 2021
The calendar indicates that the time for conducting open burns of agricultural land is approaching. In the Great Plains (and also some areas of eastern Washington and Oregon), prescribed burning of pasture grass is a critical component of rangeland management. It is an effective and affordable means of reversing and controlling the negative impacts of woody plant growth and its expansion that damages native grasslands. It can also play a role in limiting wildfire risk. But some landowners are reluctant to engage in prescribed (controlled) burns out of a concern for liability and casualty risks associated with escaped fire and smoke. While some states in the Great Plains have “burn bans,” agricultural-related burns are typically not prohibited during such bans.
The legal rules, regulations and liability risks associated with prescribed burning of agricultural lands – it’s the topic of today’s post.
Regulations – The Kansas Approach
The states that comprise the Great Plains have regulations governing the conduct of prescribed burns. The regulations among the states have commonalities, but there are distinctions from state-to-state. In addition, in some states, open burning bans can be imposed in the interest of public safety but exempt agricultural-related burns. For purposes of this article, I will look at the Kansas regulations.
Kansas administrative regulations set forth the rules for conducting prescribed burns. K.A.R. §28-19-645 et seq. In general, open burning is prohibited unless an exception applies. K.A.R. §645. One of those exceptions is for open burning of agricultural lands that is done in accordance with the regulations. K.A.R. §28-19-647(a)(3). Under that exception, open burning of vegetation such as grass, woody species, crop residue, and other dry plant growth for the purpose of crop, range, pasture, wildlife or watershed management is exempt from the general prohibition on open burning. K.A.R. §28-19-648(a). However, a prescribed burn of agricultural land must be conducted within certain guidelines. For instance, before a burn is started the local fire control authority with jurisdiction in the area must be notified unless local government has specified that notification is not required. K.A.R. §28-19-648(a)(1). Also, the burn cannot create a traffic hazard. If wind conditions might result in smoke blowing toward a public roadway, notice must be given to the highway patrol, county sheriff or local traffic officials before the burn is started. K.A.R. §28-19-648(a)(2). Likewise, a burn cannot create a visibility safety hazard for airplanes that utilize a nearby airport. K.A.R. §28-19-648(a)(3). If such a problem could potentially result, notice must be given to the airport officials before the burn begins. Id. In all situations, the burn must be supervised until the fire is extinguished. K.A.R. §28-19-648(a)(4). Also, the Kansas burn regulations allow local jurisdictions to adopt more restrictive ordinance or resolutions governing prescribed burns of agricultural land. K.A.R. §28-19-648(b).
Kansas regulations also specify that the open burning of vegetation and wood waste, structures, or any other materials on any premises during the month of April is prohibited in the counties of Butler, Chase, Chautauqua, Cowley, Elk, Geary, Greenwood, Johnson, Lyon, Marion, Morris, Pottawatomie, Riley, Sedgwick, Wabaunsee, and Wyandotte counties. K.A.R. §28-19-645a(a). This is the Flint Hills region of Kansas – some of the most abundant pasture ground in the United States. However, certain activities are allowed in these counties during April. For instance, the prescribed burning of agricultural land for the purposes of range or pasture management is allowed, as is the burning of Conservation Reserve Program (CRP) land that is conducted in accordance with the requirements for a prescribed burn of agricultural land. K.A.R. §28-19-645a(b)(1). Open burning during April is also allowed in these counties if it is carried out on a residential premise containing five or less dwelling units and incidental to the normal habitation of the dwelling units, unless prohibited by any local authority with jurisdiction over the premises. K.A.R. §28-19-645a(b)(2). Also, open burning is allowed for cooking or ceremonial purposes, on public or private lands regularly used for recreational purposes. Id.
Non-agricultural open burning activities must meet certain other requirements including a showing that the open burning is necessary, in the public interest and not otherwise prohibit by any local government or fire authority. K.A.R. §28-19-647(b). These types of open burning activities must also be conducted pursuant to an approved written request to the Kansas Department of Health and Environment that details how the burn will be conducted, the parameters of the activity, and the location of public roadways within 1,000 feet as well as occupied dwelling within that same distance. K.A.R. §§28-19-647(d)(2)(E-F). The open burning of heavy oils, tires and tarpaper and other heavy smoke-producing material is not permitted. K.A.R. §28-19-647(e)(2). A burn is not to be started at night (two hours before sunset until one hour after sunrise) and material is not to be added to a fire after two hours before sunset. A burn is not to be conducted during foggy conditions or when wind speed is less than five miles-per-hour or greater than 15 miles-per-hour. K.A.R. §§28-19-647(e)(3-5).
Legal Liability Principles
As noted above, Kansas regulations require that an agricultural prescribed burn is to be supervised until the fire is extinguished. But sometimes a fire will get out of control even after it is believed to be extinguished and burn an adjacent property resulting in property damage. How does the law sort out liability in such a situation?
Negligence. In general, as applied to agricultural burning activities, the law applies one of three possible principles. One principle is that of negligence and the other is that of strict liability. The negligence system is a fault system. 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. How is duty measured? To be liable for a negligent tort, the defendant's conduct must have fallen below that of a “reasonable and prudent person” under the circumstances. A reasonable and prudent person is what a jury has in mind when they measure an individual's conduct in retrospect - after the fact, when the case is in court. The conduct of a particular tortfeasor (the one causing the tort) who is not held out as a professional is compared with the mythical standard of conduct of the reasonable and prudent person in terms of judgment, knowledge, perception, experience, skill, physical, mental and emotional characteristics as well as age and sanity. For those held out as having the knowledge, skill, experience or education of a professional, the standard of care reflects those factors. For example, the standard applicable to a professional veterinarian in diagnosing or treating animals is what a reasonable and prudent veterinarian would have done under the circumstances, not what a reasonable and prudent person would do.
If a legal duty exists, it is necessary to determine whether the defendant's conduct fell short of the conduct of a “reasonable and prudent person (or professional) under the circumstances.” This is called a breach, and is the second element of a negligent tort case.
Once a legal duty and breach of that duty are shown to exist, a causal connection (the third element) must be established between the defendant's act and (the fourth element) the plaintiff's injuries (whether to person or property). In other words, the resulting harm to the plaintiff must have been a reasonably foreseeable result of the defendant's conduct at the time the conduct occurred. Reasonable foreseeability is the essence of causality (also known as proximate cause). For example, assume that a Kansas rancher has followed all of the rules to prepare for and conduct a prescribed pasture burn. After conducting the burn, the rancher banks the fire up and leaves it in what he thinks is a fairly safe condition before heading to the house for lunch. Over lunch, the wind picks up and spreads the fire to an adjoining tract of real estate. If the burning of the neighbor's property was not reasonably foreseeable, an action for negligence will likely not be successful. However, if the wind was at a high velocity before lunch and all adjoining property was extremely dry, it probably was foreseeable that the fire would escape and burn a neighboring landowner's tract.
Note: For a plaintiff to prevail in a negligence-type tort case, the plaintiff bears the burden of proof to all of the elements by a preponderance of the evidence (just over 50 percent).
Intentional interference with real property. Another legal principle that can apply in to open burning activities, is intentional interference with real property. This principle is closely related to trespass. Trespass is the unlawful or unauthorized entry upon another person's land that interferes with that person's exclusive possession or ownership of the land. At its most basic level, an intentional trespass is the intrusion on to another person's land without the owner's consent. However, many other types of physical invasions that cause injury to an owner's possessory rights abound in agriculture. These types of trespass include dynamite blasting, flooding with water or residue from oil and gas drilling operations, erection of an encroaching fence, unauthorized grazing of cattle, raising of crops and cutting timber on another's land without authorization, and prescribed agricultural burning activities, among other things.
In general, the privilege of an owner or possessor of land to utilize the land and exploit its potential natural resources is only a qualified privilege. The owner or possessor must exercise reasonable care in conducting operations on the land so as to avoid injury to the possessory rights of neighboring landowners. The owner or possessor must exercise reasonable care in conducting operations on the land so as to avoid injury to the possessory rights of neighboring landowners. For example, if a prescribed burn of a pasture results in heavy smoke passing onto an adjoining property accompanied with a long-term residual smoke odor, the party conducting the burn could be held legally responsible for damages under the theory of intentional interference with real property even if the burn was conducted in accordance with applicable state regulations. See, e.g., Ream v. Keen, 112 Ore. App. 197, 828 P.2d 1038 (1992), aff’d, 314 Ore. 370, 838 P.2d 1073 (Ore. 1992).
Strict liability. Some activities are deemed to be so dangerous that a showing of negligence is not required to obtain a recovery. Under a strict liability approach, the defendant is liable for injuries caused by the defendant's actions, even if the defendant was not negligent in any way or did not intend to injure the plaintiff. In general, those situations reserved for resolution under a strict liability approach involve those activities that are highly dangerous. When these activities are engaged in, the defendant must be prepared to pay for all resulting consequences, regardless of the legal fault.
Kansas liability rule for prescribed burning. A strict liability rule could apply to a prescribed burn of agricultural land if the activity were to be construed as an inherently (e.g., extremely) dangerous activity. In Kansas, however, farmers and ranchers have a right to set controlled fires on their property for agricultural purposes and will not be liable for damages resulting if the fire is set and managed with ordinary care and prudence, depending on the conditions present. See, e.g., Koger v. Ferrin, 23 Kan. App. 2d 47, 926 P.2d 680 (Kan. Ct. App. 1996). In Kansas, at least at the present time, the courts have determined that there is no compelling argument for imposing strict liability on a property owner for damages resulting from a prescribed burn of agricultural land. Id.
Note: The liability rule applied in Texas and Oklahoma is also negligence and not strict liability. In these states, carefully following applicable prescribed burning regulations goes along way to defeating a lawsuit claiming that damages from a prescribed burn were the result of negligence.
Certainly, for prescribed burns of agricultural land in Kansas, the regulations applicable to non-agricultural burns establish a good roadmap for establishing that a burn was conducted in a non-negligent manner. Following those requirements could prove valuable in protecting against a damage liability claim if the fire gets out of control and damages adjacent property.
Prescribed burning of agricultural land in Kansas and elsewhere in the Great Plains is an excellent range management tool. Practiced properly the ecological and economic benefits to the landowner can be substantial. But a burn must be conducted within the framework of existing regulations with an eye toward the legal rule governing any potential liability.
Wednesday, February 10, 2021
January 27’s article dealt with the deductibility of start-up costs. You may read the post here: https://lawprofessors.typepad.com/agriculturallaw/2021/01/deducting-start-up-costs-when-does-the-business-activity-begin.html In that article, I noted that start -up costs can be deducted by election in the year the business begins – at least to an extent. Of course, businesses that are starting out often incur tax losses. The business activity may eventually turn a profit, but how long can a business activity incur losses before the IRS says the business activity is really a hobby and denies loss deductibility. Start-up expenses; whether a trade or business activity is involved; when when a business activity begins; and how long losses can be sustained and not be deemed to be a hobby – these are all intertwined issues for new business activities. In addition, if an activity is deemed to be a hobby, the impact of the Tax Cuts and Jobs Act TCJA) for tax years beginning after 2017 is harsh.
Taking another look at tax issues encountered by many new business activities – it’s the topic of today’s post.
Tax Code Rules
For a business expense to be deductible, it generally must be “ordinary and necessary” or be an investment expense. I.R.C. §§162; 212. Investment-related deductions under I.R.C. §212 have largely been eliminated by the TCJA. That puts the emphasis on deductions to be tied to a trade or business activity so that they can be deducted under I.R.C. §162. The trade or business must be conducted with a profit intent. If not, the activity is deemed to be a hobby and associated losses are “hobby losses.”
What is a “hobby”? A “hobby” under the Code is defined in terms of what it is not. I.R.C. §183. A hobby activity is essentially defined as any activity that a taxpayer conducts other than those for which deductions are allowed for expenses incurred in carrying on a trade or business or producing income. I.R.C. §§162; 212. The determination of whether any particular activity is a hobby activity or not is based on the facts and circumstances of each situation. It’s a highly subjective determination.
But the Code provides a safe harbor. I.R.C. §183(d). Under the safe harbor, an activity that doesn’t involve horse racing, breeding or showing must show a profit for three of the last five years, ending with the tax year in question. It’s two out of the last seven years for horse-related activities. If the safe harbor is satisfied (either for horse activities or other activities, a presumption arises that the activity is not a hobby. The safe harbor applies only for the third (or second) profitable year and all subsequent years within a five-year (or seven-year) safe-harbor period that begins with the first profitable year. Treas. Reg. §1.183-1(c).
What about losses in early years? As noted above, the safe harbor applies only after a taxpayer incurs a third profitable year within the five-year testing period. That means that only loss years arising after that time (and within the five-year period) are protected. Losses incurred in the first several years are not protected under the safe harbor. It makes no difference whether the activity turns a profit in later years.
Postponing the safe harbor. It is possible to postpone the application of the safe harbor until the close of the fourth tax year (or sixth (for horse activities) after the tax year the activity begins. I.R.C. §183(e). This is accomplished by making an election via Form 5213 to allow losses incurred during the five-year period to be reported on Schedule C. Thus, if the activity shows a profit for three or more of the five years, the activity is presumed to not be a hobby for the full five-year period. The downside risk of the election occurs if the taxpayer fails to show a profit for at least three of the five years. If that happens, a major tax deficiency could occur for all of the years involved. Thus, filing Form 5213 should not be made without thoughtful consideration. For example, while the election provides more time to establish that an activity is conducted with a profit intent, it will also put the IRS on notice that an activity may be conducted without a profit intent. It also extends the statute of limitations for a tax deficiency (and refund claims) associated with the activity. See, e.g., Wadlow v. Comr., 112 T.C. 247 (1999).
The burden of proof. Satisfaction of the safe harbor shifts the burden to prove that the activity is a hobby (i.e., lacks a profit motive) to the IRS. That means that the IRS can rebut the for-profit presumption even if the safe harbor is satisfied – although it doesn’t tend to do so without extenuating circumstances. If the presumption does not resolve the issue of whether a farm is being operated for pleasure or recreation and not as a commercial enterprise, a determination must be made as to whether the taxpayer was conducting the activity with the primary purpose and intention of realizing a profit. The expectation of profit need not be reasonable, but there must be an actual and honest profit objective. Whether the requisite intention to make a profit is present is determined by the facts and circumstances of each case with the burden of proof on the farmer or rancher attempting to deduct the losses. See, e.g., Ryberg v. Comm’r, T.C. Sum. Op. 2012-24.
To assist in making this determination, the IRS has developed nine factors (which are contained in the Treasury Regulations) to be examined in determining whether the requisite profit motive exists. Treas. Reg. § 1.183-2(b). Those factors are: 1) the manner in which the taxpayer carries on the activity; 2) the taxpayer’s own expertise or the expertise of the taxpayer’s adviser(s); 3) the time and effort the taxpayer expends on the activity; 4) the expectation that assets used in the activity may appreciate in value; 5) the taxpayer’s success in carrying on similar activities; 6) the taxpayer’s history of income or loss with respect to the activity; 7) the amount of occasional profits, if any, from the activity; 8) the taxpayer’s financial status; and 9) whether there were any elements of personal pleasure or recreation that the taxpayer derived from the activity.
Showing a Profit Intent - Recent Case
While the IRS is presently not aggressively auditing farming activities that it believes are not conducted with the requisite profit intent. Just a few days ago, the Tax Court decided a hobby loss case where the taxpayer failed to clear the bar on showing a profit intent for the farming activity that he was attempting to start.
In Whatley v. Comr., T.C. Memo. 2021-11, the petitioner had retired from the banking industry. Before he retired, in 2003 he purchased a 156-acre tract that had been a timber farm and cattle operation for 350,000. 134 acres of the tract was timber. It was not an active timber or farming operation when he bought it, but was in the Conservation Reserve Program (CRP). In 2004, he bought an additional 26 contiguous acres. That tract had a new (built in 2000) home on it along with a barn and a small caretaker’s house. On the advice of his long-time CPA, the petitioner created an LLC in 2004. He owned 97 percent of the LLC, his wife was a one percent owner, and their children owned the balance. He never transferred the land to the LLC.
For several years, he spent about 700 hours annually maintaining the property without any formal business plan. There was no timber harvesting because of the land being in the CRP. The petitioner would occasionally “thin” the trees to allow sunlight to get through to aid the growth of pine trees which would be harvested after many years of growth. The petitioner testified that he had wanted to introduce cattle “from day one.” He had consulted with two cattle experts for advice, but he couldn’t remember when the consultations had occurred or what he had learned from those experts. In reality, however, the petitioner didn’t actually have cattle on the property until at least 2008 – soon after he learned that he was going to be audited. He also testified that many of what he claimed to be cattle-related activities were really preparatory activities so that cattle could be on the property at some future date. Those preparatory activities included the installation of fencing and barn repairs.
He ran the LLC very informally, keeping no traditional accounting records such as ledgers, balance sheets, income statements, or cashflow statements. He didn’t expense the cost of insurance for the property and didn’t maintain a separate bank account or any separate banking records during the years at issue. For those years, the petitioner filed Form 1065 (partnership return) stating that the LLC’s principal business activity was a “Farm” and the principal product or service was “Cattle.” This was also how the activity was characterized on the petitioner’s Schedule F. The petitioner’s tax returns were professionally prepared by the petitioner’s CPA even though the petitioner had a “cattle farm” with no cattle, and a “tree farm” with no timber. He showed a tax loss from the property for tax years 2004-2008 on Schedule F, with the losses stemming largely from depreciation claimed on two buildings on the property.
The IRS notified the petitioner in early 2008 that it was going to audit the LLC for tax year 2005. Upon receiving the audit notice, the petitioner put together a forest management plan and brought cattle to the property. The IRS later expanded the audit to include tax years 2004 and 2006-2008. The IRS disallowed the losses on the basis that the petitioner’s activity on the land was not engaged in with a profit intent. The IRS also disallowed a large charitable deduction for the petitioner’s deduction of a permanent conservation easement.
The Tax Court agreed with the IRS, finding that all nine factors of the I.R.C. §183 regulations favored the IRS. This was despite the Tax Court’s recognition that the facts suggested that the petitioner was attempting to transform the property into a viable farming business.
The TCJA suspends miscellaneous itemized deductions for years 2018-2025. Thus, deductions for expenses from an activity that is determined to be a hobby are not allowed in any amount for that timeframe. I.R.C. §67(g). But all of the income from the activity must be recognized in adjusted gross income. That’s painful, and it points out the importance of establishing the requisite profit intent.
Hobby activities involving agricultural activities (especially those involving horses) have been on the IRS radar for quite some time. That’s not expected to change. It’s also an issue that some states are rather aggressive in policing. See, e.g., Howard v. Department of Revenue, No. TC-MD 160377R, 2018 Ore. Tax LEXIS 35 (Ore. Tax Ct. Mar. 16, 2018); Feola v. Oregon Department of Revenue, No. TC-MD 160081N, 2018 Ore. Tax. LEXIS 48 (Ore. Tax. Ct. Mar. 27, 2018). It’s also not an issue that the U.S. Supreme Court is likely to review if the taxpayer receives an unfavorable opinion at the U.S. Circuit Court of Appeals level. See, e.g., Hylton v. Comr., T.C. Memo. 2016-234, aff’d., No. 17-1776, 2018 U.S. App. LEXIS 35001 (4th Cir. 2018), cert. den., No. 18-789, 2019 U.S. LEXIS 966 (U.S. Sup. Ct. Feb. 19, 2019).
Clearly, the petitioner’s CPA did Whatley did him no favors. The tax planning and counsel was egregious. Equally clear, however, was that the petitioner in Whatley was engaged in activities with the intent of ultimately conducting an operating farm. But does that ultimate end-goal of an activity matter? Given the nine-factor approach of the regulations, it appears that the IRS could swoop in with a well-timed audit and wipe out what would otherwise be legitimate business expenses. Should a broader, more long-term view of new business activities be undertaken to evaluate whether a profit intent is present? In other words, is there a better way to evaluate alleged hobby activities than the present nine-factor approach? The U.S. Court of Appeals for the Seventh Circuit certainly thinks so. In Roberts v. Comr., 820 F.3d 247 (7th Cir. 2016), the court called the nine-factor text “goofy” and took issue with start-up expenses being denied as hobby loss expenses. The Whatley case is appealable to the Eleventh Circuit.
For now, the nine-factor test of the regulations is what is used to determined profit intent and whether the hobby loss rules apply. As noted, at least one U.S. Circuit Court of Appeals is dissatisfied with the nine-factors. Will another Circuit follow suit? Only time will tell whether the nine-factor test has outlived its usefulness.
Monday, February 8, 2021
A recent U.S. Tax Court decision is instructive on how carelessness in tax planning with respect to a C corporation can prove to be costly. Maintaining detailed books and records; properly invoicing for services rendered to the corporation; carefully planning for and specifying how management fees are to be set and compensated; and paying reasonable compensation are all key components to how a C corporation should be operated. But, when those aspects of C corporate operational life are not observed, a bad tax outcome is the result. A recent U.S. Tax Court opinion makes that point clear.
Key aspects of operating a C corporation and the perils of sloppiness – it’s the focus of today’s post.
Treas. Reg. §1.162-7(a) allows a deduction for ordinary and necessary business expenses that are paid or incurred in carrying on a trade or business. See also I.R.C. §162(a)(1). This includes a reasonable allowance for salaries or other compensation for personal services that are actually rendered to the corporation. Treas. Reg. §1.162-7(a). That’s a key point in the C (and S) corporation context – compensation must be “reasonable” to be deductible. Management fees must meet also meet the ordinary and necessary test. They are part of overall compensation and, overall, compensation must be reasonable – an amount that would typically be paid for similar services by similar businesses under similar circumstances. The reasonableness test is applied on an individual-by-individual basis rather than whether, for instance, the total compensation to a group of shareholders is reasonable. In addition, payment must be for actual services. It must not be a distribution to the shareholders that is disguised as deductible compensation.
Deducting management fees. The issue of whether compensation is deductible as payment for services rendered to the corporation is a particular sticky one when the corporation doesn’t have very many shareholders. In that instance, the courts tend to view the situation lending itself to a greater probability that there is a lack of bargaining at arms’ length between the employees (e.g., shareholders) and the corporate board. The tendency, at least in the view of the IRS is that “management fees” are not really paid purely for services rendered to the corporation. But, the analysis is based on a facts and circumstances test containing multiple factors – the corporation’s history of distributions to the holders of the corporate equity; whether the management fee paid to a shareholder is proportional to that shareholder’s percentage interest in the corporation; whether the services performed were via the shareholder’s controlled entity and the fee was paid to the shareholder; whether the management fee was negotiated at the beginning of the tax year and paid throughout the year as services were performed; the level of corporate taxable income after deducting management fees that were paid out; whether there was a structure in place for determining the level of management fees.
Recent Tax Court 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 the petitioner at the beginning of any of the years in issue.
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. However, the Board minutes did not reflect how the determinations were made. The 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 deductions.
The Tax Court determined that the petitioner failed to prove that the management fees were ordinary and necessary business expenses and 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 corporation 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 established in advance for services to be provided and there was no management agreement that evidenced any type of arms’ length negotiation to support a fee structure 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 pointed out that the effect of the deduction for management fees was to create little taxable income to the petitioner. That, the Tax Court believed, indicated 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 bonus totaling approximately $500,000 annually. Thus, the additional management fee was completely unreasonable as to him.
As noted above, to be deductible, compensation in the corporate context must be “reasonable.” For starters, that means that the corporation must establish the connection between the services that are performed and the compensation (including management fees) that are paid. In AsPro, Inc., the corporation didn’t meet that burden. In Aspro, Inc., the Tax Court looked at numerous factors to determine reasonableness – the employee’s qualifications; the work performed for the corporation; the size of the corporation and the complexity of business operations; how salaries compare to corporate gross and net income; general economic conditions in the corporation’s industry; how compensation to the shareholders stacked-up against corporate distributions to those same shareholders; whether the compensation packages for the shareholders was comparable positions in similar businesses; overall salary policy; and past compensation history.
The Tax Court also noted that some of the U.S. Circuit Courts of Appeal don’t analyze the issue of reasonable compensation based on multiple factors, but rather the amount of compensation an independent investor would pay. The Circuit Court to which Aspro Inc. would be appealable has not settled on the approach it would use to determine reasonable compensation in the corporate context.
The Aspro, Inc. case is a textbook roadmap case of how to screw up C corporate tax planning. There was no detailed, thought-out plan backing up the management fees, no clarity or documentation of what services were rendered and how frequently they were rendered, and no substantiation of whether the services were necessary to be paid for in the petitioner’s industry. There was no management agreement that listed the services to be provided by each contracting party, and no documentation of the level of pay for those services.
The complete lack of planning and associated documentation in Aspro, Inc. resulted in a tax bill exceeding $1.5 million, plus interest.
Truly a roadmap for disaster.
Saturday, February 6, 2021
In Part One earlier this week, I took a look at the possible income tax-related changes that might be on the horizon and the planning implications of such changes. In today’s post I turn the spotlight to potential changes that could impact estate and business planning. Will estate and gift tax rates change? What about the level of the federal estate and gift tax exemption? Will the income tax basis rule change when a person dies? Will valuation discounts be available? These are all important questions that bear on how the farming or ranching business should be structured to facilitate an intergenerational transfer. These are all questions that are on the minds of many farm and ranch families.
Potential law changes that could impact farm and ranch estate and business planning – it’s the topic of today’s post.
Estate and Gift Tax Exemption
When I first started practicing, the federal estate and gift tax exemption sheltered $600,000 of wealth. That seems like a pittance now with the current level set at $11.7 million for deaths in and taxable gifts made in 2021. Indeed, the farm and ranch estate and business planning practice was robust at the time. Even 30 years ago, it was quite easy for a modest-sized farming operation to reach the $600,000 net worth level. That meant that proper structuring of entities, leases, asset ownership and coordinated provisions in wills and trusts were very important. In addition, in situations where it was clear that the family would continue farming after the death(s) of the senior generation, it was necessary to coordinate the planning with an eye toward a possible special use valuation election in the first spouse’s (and sometimes also the second spouse’s) estate. With the possible reduction of the exemption being discussed those planning techniques and concepts will be back in vogue.
USDA data indicates that the present average U.S. farmland value for all classes of land averaged $3,160 per acre in 2020. Nationwide, the average farm size is 445 acres. Thus, the typical U.S. farming operation has land worth $1,406,200. Add in livestock, farm machinery and equipment, grain inventory, the home and outbuildings, retirement savings, life insurance and other miscellaneous assets, the typical farm estate will routinely have an asset value totaling anywhere from three million to five million dollars. Of course, these are averages and the federal estate tax is based on net worth (asset value less debt), but the point is that a reduction in the exemption to under at or under the $5 million level would be of considerable concern to many farm and ranch families (and other small business owners).
Some proposals that I have seen would lower the exemption anywhere in a range from $3.5 million $5 million. If that happens, a key question is whether it would be indexed for inflation and whether the reduction would apply retroactively to January 1, 2021. Any retroactive change could make some prior tax-free gifts taxable. There is also talk about increasing the top federal estate and gift tax rate to at least 45%.
While no estate plan can accurately anticipate all potential changes in the law, clearly delaying estate planning now increases the potential that a detrimental change in the law would be in effect before the estate/business plan could be finished.
Planning strategies. So, what might be some strategies that could be employed right now? What’s the most efficient way to use the current exemption amount?
- Various types of trusts. Gifting property to an irrevocable trust containing a disclaimer provision provides needed flexibility to adjust for changes in the exemption level. It can also be used to shift income among beneficiaries. The trust can be carefully drafted to give the grantor limited access to trust assets while simultaneously protecting trust assets from creditor claims and/or and IRS claim that the trust assets should be included in the grantor’s estate.
For some assets, a better approach may be to have the owner borrow against them and gift the cash to a trust. This was an approach that was used in prior years when the exemption was much lower. The loaned funds are then gifted to a trust and covered by the exemption so that no gift tax occurs. The leveraged asset remains in the estate but with debt against it. The result is that the taxable value of the decedent’s estate is reduced.
- Valuation discounting. A common estate/business planning technique when the exemption was much lower than its present level was to utilize various valuation discounting approaches with respect to interests in entities. Such discounts from fairy market value can be achieved to reflect the owner’s minority interest in an entity as well as the fact that the interest is in an entity that is not publicly traded and, as a result, lacks marketability. A $10 million interest, therefore, may be able to be valued in the decedent’s estate with a discounted value of $8 million, for example, to reflect that the decedent only owned 30% (as an example) of a small, closely-held farming or ranching operation. The IRS has routinely attacked valuation discounting, and the regulations on the matter that were frozen during the Trump Administration now will likely come back. If so, valuation discount planning may become unavailable.
- GRAT. 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. Of course, if the exemption is lowered, more estates will be in the “high-value” category and the GRAT technique could be even more widespread in use. Unfortunately, there are discussions that up to 25 percent of the value of assets transferred to a GRAT would be taxed. If that occurs, the GRAT technique would go by the wayside.
- Gifting. A longstanding strategy for large estates that will potentially exceed the exemption amount at death is to use annual exclusion gifts (either outright or via interests in closely-held family entities) to ultimately reduce the size of the taxable estate to an amount that would be fully covered by the exemption amount. The strategy has become less popular in recent years given the substantial increase in the exclusion amount to its present level of $11.7 million for deaths and gifts made in 2021. However, current law causes the exclusion amount to decrease to $5 million (plus an adjustment for inflation from 2018) beginning in 2026. If the exemption were to be reduced to the $3.5 million to $5 million range before then that could place an emphasis for some estates to make gifts now and cover it with the currently higher exemption amount.
- One thing to keep in mind with this strategy is a concern that was first raised when the Tax Cuts and Jobs Act was enacted in late 2017. That is the issue of “clawback” – whether gifts made between 2018 and 2025 that utilized the larger exemption amount will trigger additional estate tax. In late 2019, the Treasury issued Final Regulations taking the position that clawback will not be imposed when the exclusion drops to the $5 million amount (with an inflation adjustment) at the start of 2026. T.D. 9884. Thus, in accordance with the Final Regulation, and estate can compute its estate tax liability using the higher exemption amount that was in effect at the time the gift(s). Of course, if the law changes the exemption amount before 2026, the Final Regulation wouldn’t apply. It would then be up to the Treasury whether to utilize clawback on an estate with a lower exemption amount that at the time the decedent made gifts.
Under the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97,the basic exclusion amount (BEA) was increased from $5 million to $10 million, indexed for inflation. In 2020, the inflation-indexed BEA is $11.58 million. The TCJA states that the increased $10 million BEA will be in place only until the end of 2025, after which it will revert to the previous $5 million BEA, indexed for inflation. Those in a position to make larger gifts have an opportunity to seize the increased BEA before it is lost; but, in doing so, one should not forget some long-standing gift planning considerations. Before discussing potential planning that may make use of the increased BEA, it is important to address one concern raised after the enactment of the TCJA regarding whether larger gifts made between 2018 and 2025 that used the increased BEA would give rise to additional estate tax once the exclusion returns to its reduced amount as scheduled under current law. On Nov. 26, 2019, Treasury and the IRS released final regulations (T.D. 9884), clarifying that there will be no "clawback" when the exclusion amount reverts to $5 million (inflation indexed) at the beginning of 2026. Instead, an estate will be allowed to compute its estate tax using the increased BEA that was in effect when the gifts from 2018 to 2025 were made.
- Retroactive change. A retroactive change in the estate/gift tax exemption would pose special problems. One effect could be that a taxable gift covered by the current $11.7 million exemption would now be taxable to the extent it exceeds the new, lowered exemption level. This effect can be avoided with a special type of marital trust (assuming that the transferor is married) coupled with an election (known as a “QTIP” election). This would involve some guessing as to what the new (lower) exemption level would be. The election ideally would be made on only with respect to the value of enough property such that the balance could remain exempt from estate tax as covered by the new (lower) exemption amount. For large estates where both spouses utilize this technique, the “reciprocal trust doctrine” would need to be avoided.
Another way to potentially combat a retroactive reduction in the exemption is to incorporate formula language in a trust that sets forth the value of property gifted to the trust. Often this approach is used when gifting fractional interests in an entity (such as a limited liability company) to the trust. The formula language must be drafted with precision. For example, in Wandry v. Comr., T.C. Memo. 2012-88, formula clause language was upheld as valid because it caused the transfer of percentage interests to the donees equal in value to the amounts set forth in the associated gift documents (i.e., dollar amounts) rather than fixed percentage interests. But, in Nelson v. Comr., T.C. Memo. 2020-81, the tax court determined that the formula clause language was ineffective because it resulted in the transfer of fixed dollar amounts resulting in a substantial gift tax deficiency.
Disclaimer language in trust instruments can also be used to allow flexibility to deal with a retroactive change in the exemption level. I.R.C. §2518. A disclaimer is a renunciation of rights to property that would otherwise pass to the person if they didn’t exercise their right to disclaim receiving the property. There are also ways to create what I would call a “defective” disclaimer to deal with the issue of retroactivity. Again, it’s a very complex matter that requires clear and precise drafting.
Other Potential Changes
GSTT. There is additional buzz about imposing the current generation-skipping transfer tax (GSTT) on certain “perpetual” or long-term trusts periodically. For most people, this would be a minor issue.
Present interest gifts. One proposal is to cap the present interest exclusion for gift tax purposes to $20,000 per donor. Presently, a person can give up to $15,000 to a donee annually (on a cumulative basis) and incur no gift tax. There is no limit on the number of donees under current law. Restricting the provision to $20,000 per donor annually would be a substantial restriction on the ability to make non-taxable gifts. This would be a significant change by itself, but when combined with a lower estate tax exemption, such a change would be monumental. Tax-free gifting techniques have long been used as an estate tax minimization strategy. That would change if this provision were to become law.
Income tax basis. This is the “monster” in the room. 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. To make matters worse, there is even talk of imposing a capital gains tax on the appreciated value at the time of death, rather than at the time the heir sells the inherited property that has appreciated in value.
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.
Now is certainly the time to engage tax and estate/business planning professionals in discussion about income tax planning, estate planning and entity structuring. The legislation that has been discussed as potentially coming in the near future has important implications for farming and ranching operations (and other small businesses) that desire to continue into the next generation. I will be addressing these issues and providing planning suggestions at my two national event this summer. Shawnee State Park in Ohio on in early June and Missoula, Montana in early August. Registration details will be available soon. Maybe we will have more details by then and can craft plans forward.
Monday, February 1, 2021
The title of today’s article seems to be on the minds of many farmers and ranchers in recent days with the beginning of a new Congress and the inauguration of Joe Biden. I have had many emails, phone calls and conferences with farm families recently that are asking what the impact of tax changes on their businesses and livelihoods might be. Are structural changes in the form of the farming business required? Should existing estate plans be reviewed? What income tax moves should be made? Should capital assets be sold now? These are important questions.
Today’s article is Part One of a two-part series on tax changes that might be forthcoming soon and what the changes could mean. Today, I take a look at possible changes in the income tax world. In Part Two later this week, I will examine what might happen on the estate planning side of the equation.
Federal Income Taxation Possible Changes
While there is no definite proposed tax bill(s) yet, and no detailed articulation of possible tax legislation has clearly been offered, there were things that candidate-Biden’s people placed on his website before the election.
Increase in the maximum ordinary and capital gain tax rates. It now appears possible that the top individual federal income tax rate on ordinary income (as well as net short-term capital gains) could return to a 39.6 percent rate, up from the present 37 percent rate. Comments were also made that rates on individuals with income (taxable?) above $400,000 would also be increased. If true, then a married couple filing jointly that is presently in the 32 percent bracket could see a rate increase. But, again, it’s not clear whether the $400,000 figure is for a married couple filing jointly or for a single person, or whether the threshold refers to gross or taxable income.
Itemized deductions. There are a couple of key possibilities to watch with respect to itemized deductions. Starting in 2018, many itemized deductions were eliminated but, in return, the standard deduction was essentially doubled. For lower-income individuals this represented a major tax break and tax simplification. Now, a new policy may reduce the standard deduction to prior levels with a restoration of itemized deductions (for taxpayers that itemize deductions). The tax benefit of itemized deductions (including charitable deductions and those stemming from a contribution to a pension plan) would appear to be limited to 28 percent for higher-income taxpayers (however that is defined). Thus, a dollar of itemized deduction would only cut the tax bill by $.28. A taxpayer in a tax bracket higher than 28 percent would not see a benefit of an itemized deduction any greater than 28 percent on the dollar.
The so-called “Pease limitation” was repealed for tax years beginning after 2017. It operated as a “stealth” tax on higher-income taxpayers. Before it was repealed, it reduced the value of a taxpayer’s itemized deductions by three percent for every dollar of taxable income above a certain threshold – effectively increasing the taxpayer’s marginal tax rate. The “buzz” is that the Pease limitation would be put back in place.
As a hat-tip to taxpayers (e.g., voters) in the high-tax states such as California, Illinois and New York, a pre-election policy position indicates that the limit on the deduction for state and local taxes would be removed. This would be a significant benefit for higher income taxpayers.
Capital gains. It is likely that a legislative push will be made to increase the capital gain rates on higher-income individuals. The present top rate on long-term capital gains is 20 percent. Thanks to a provision included in Obamacare (adding I.R.C. §1411) that 20 percent rate jumps to 23.8 percent if the gain is passive for married taxpayers filing jointly with modified adjusted gross income exceeding $250,000 ($200,000 for a single filer). It appears likely that a legislative proposal will include a provision taxing net long-term gains and dividends at the ordinary income rate for taxpayers with income (taxable?) over $1 million. If the gain is passive, the effective rate would jump to a combined 43.4 percent. That would amount to a tax increase of 82.4 percent on such gains.
Observation. Coupled with state-level taxation of capital gains, the effective rate could exceed 50 percent.
If capital gain rates increase, that could create a greater incentive to use charitable remainder trusts (CRT). A CRT is funded by the transfer of property from the donor. There is no tax on the transfer of the property to the CRT. The CRT then sells the property tax-free and uses the proceeds to annually pay the beneficiary (typically the donor) a percentage of the market value of the trust. The annual distribution comes first from the trust’s net income and then from principal. The distributions to a non-charitable beneficiary are taxable annually as ordinary income to the extent there is net income to the CRT. The remainder of the distribution is taxable as capital gain to the extent there is accumulated short and long-term capital gain to the CRT calculated using the donor’s carryover tax basis. If the distributions to the beneficiary are larger than the net income and accumulated capital gain of the CRT, the difference is not taxable to the beneficiary. If a “net income with make-up provisions” CRT is used, it might be possible to delay distributions to a time (up to 20 years) when capital gain and ordinary tax rates are lower. But, of course, future rates are unknown.
An intentionally non-grantor trust might also be advisable to avoid an increase in the capital gains tax as well as state income tax (except for New York). These trusts are very complex and usually work well for large estates in tandem with the high-level (currently) of the federal estate tax exemption. They became popular after the tax changes that went into effect for tax years beginning after 2017, but could still have merit to avoid a higher capital gains rate and state income tax.
Self-employment tax. Presently, for 2021, an employee pays a combined rate of 7.65 percent for Social Security and Medicare. The OASDI portion is 6.2 percent on earnings up to $142,800. The Medicare portion (hospitalization insurance) is 1.45 percent on all earnings. The rate for self-employed persons is the full combined 15.3 percent up to the $142,800 base. Also, persons with earned income over $200,000 ($250,000 for MFJ) pay an additional 0.9 percent in Medicare taxes due to another provision in included in Obamacare. Thus, for a self-employed person, the rate is 2.9 percent from $142,800 to $200,000 ($250,000 mfj) and then 3.8 percent above those thresholds.
What looks likely to be proposed is that the 12.4 percent OASDI portion would apply to wages and net self-employment income in excess of $400,000. Whether this is in addition to the existing 3.8 percent tax on incomes at this level or would be the total percentage amount is not clear.
Observation. Clearly, if these self-employment tax changes occur, it will incentivize the creation of or conversion of existing entities to S corporations. Doing so will allow some of the earnings to be received in the form of a salary (subject to self-employment tax) with the balance taken as S corporation dividends (not subject to self-employment tax). The salary must approximate “reasonable compensation” (I have written a blog article on that issue in the past), but utilizing an S corporation is a good technique (as a rule of thumb) when at least $10,000 of self-employment tax savings can be achieved over other entity forms (including a sole proprietorship). One concern, of course, would be if the Congress were to eliminate the self-employment tax savings of an S corporation for businesses that provide personal services.
Credits. One possible proposal is an increase in the child tax credit to $4,000 for a qualifying child ($8,000 for two or more qualifying children). Apparently, the credit would remain refundable and would start phasing out at income levels above $125,000. A new credit (refundable?) could be proposed for certain caregivers.
Eligible first-time homebuyers might receive a refundable tax credit of up to $15,000 upon the purchase of a home. Low-income renters could see a refundable tax credit designed to reduce the cost of rent and associated utilities to no more than 30 percent of monthly income. Such a provision would be a variation of state-level tax credits for tenants of residential properties that exist in about half of the states.
Other credits can be anticipated to benefit less efficient and more costly forms of energy, while simultaneously reducing or eliminating standard business deductions for the oil and gas industry.
Real estate-related activities. What I have seen are discussions about: (1) eliminating the $25,000 deduction for losses related to real estate activities where the taxpayer actively participates in the activity but falls short of material participation (I.R.C. §469(i)): (2) eliminating the like-kind exchange rules for real estate trades; slowing down depreciation for certain types of business property; and eliminating the 20 percent qualified business income deduction of I.R.C. §199A for rental real estate activities. Related to this last point, there are rumblings that the I.R.C. §199A deduction could be eliminated in its entirety. For many small businesses, that would amount to a effective tax rate increase ranging between three and five percent.
Convert to a Roth? Should a taxpayer move funds from a traditional IRA to a Roth? The answer, as is the case with many tax-related questions, is that it “depends.” If tax rates are expected to be higher in the future, it may make tax-sense to make the conversion and pay the tax on the conversion at what is anticipated to be now-lower rates. But other considerations should be made. What about the impact of state-level taxes? What about the impact of the loss of ability to stretch the payout with respect to certain beneficiaries? Will there be an impact on various ways to offset income with a Roth, such as charitable donations? Will Medicare premiums be impacted? What happens if Social Security benefits have already started to be received? These are some of the considerations that need to be made when considering converting a traditional IRA to a Roth.
Corporate tax. It is likely that a legislative tax proposal will increase the corporate tax rate by 33 percent, from its present 21 percent to 28 percent, and restore the alternative minimum tax on corporations above a threshold of annual income.
Retroactive Tax Increase?
If and when tax changes occur, when will they be effective? Retroactive tax changes create complexity, but can be legal. As for complexity, estimated taxes and withholding are based on the law in existence at the time of payment. If the law changes retroactively, those “pre-paid” taxes now must be recomputed. 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.
Of course, tax changes that occur on either a retroactive or date of enactment basis make planning impossible.
In Part Two, I will turn my attention to what might happen on the estate planning front.
Wednesday, January 27, 2021
One effect of the virus of 2020 is that it has spurred business start-ups by people attempting to generate income in new ways and with new methods. That raises an important tax question - when beginning a business, what expenses are deductible? That’s an interesting question not unlike the “chicken and the egg” dilemma. Which came first – the business or the expense? To have deductible business expenses, there must be a business. When did the business begin? That’s a key determination in properly deducting business-related expenses.
Deducting costs associated with starting a business – it's the topic of today’s post.
Categorization – In General
The Code allows deductions for various expenses that are related to a taxpayer’s investments that don’t amount to a business if the expenses are ordinary and necessary for the production or collection of income or are for the management, conservation or maintenance of property held for the production of income. I.R.C. §212.
Once the business begins, all of the ordinary and necessary expenses of operating the business (on a basis that is regular, continuous and substantial) that are paid or incurred during the tax year are deductible. I.R.C. §162. But, business start-up costs are handled differently. I.R.C. §195.
I.R.C. §195(a) generally precludes taxpayers from deducting startup expenditures. However, by election, a taxpayer can deduct business start-up expenses on the return for the year that the business begins. I.R.C. §195(b). The election is irrevocable. Treas. Reg. §1.195-1(b). The deduction is the lesser of the amount of start-up expenses for the active trade or business, or $5,000 reduced (but not below zero) by the amount by which the start-up expenses exceed $50,000. I.R.C. §195(b)(1)(A); I.R.C. §195(b)(1)(A)(i). Once the election is made, the balance of start-up expenses is deducted ratably over 180 months beginning with the month in which the active trade or business begins. I.R.C. §195(b)(1)(B); Treas. Reg. §1.195-1(a). This all means that in the tax year in which the taxpayer’s active trade or business begins, the taxpayer can deduct the $5,000 amount (if that’s the lesser of, etc.) and the ratable portion of any excess start-up costs.
The election is normally made on a timely filed return for the tax year in which the active trade or business begins. However, if the return that year was timely filed without the election, the election can be made on an amended return that is filed within six months of the due date for the return (excluding extensions). The amended return should clearly indicate that the election is being made and should state, “Filed pursuant to section 301.9100-2” at the top of the amended return. Without the election, the start-up costs should be capitalized.
What are start-up expenses? Amounts paid or incurred in connection with creating an active trade or business are startup expenditures. I.R.C. §195(c). More specifically, start-up costs are amounts that the taxpayer pays or incurs for: investigating the creation or acquisition of an active trade or business; creating an active trade or business; or activities that the taxpayer engages in for profit and for the production of income before that day on which the active trade or business begins, in anticipation of the activities becoming an active trade or business, and which would be deductible in the year paid or incurred if in connection with an active trade or business. I.R.C. §§195(c)(1)(A)(i-iii); 195(c)(1)(B). Common types of start-up expenses include advertising costs; salaries and wages; and expenses related to travel. See, e.g., IRS Field Service Advice 789 (1993). But, interest expense, state and local taxes, and research and experimental expenses are not start-up expenses. I.R.C. §195(c)(1).
Start-up expenses are limited to expenses that are capital in nature rather than ordinary. That’s an important point because it means that I.R.C. §195 does not bar the deductibility of ordinary and necessary expenses a taxpayer incurs in an ongoing activity for the production of income under I.R.C. §212. In addition, it makes no difference that the activity is later transformed into a trade or business activity under I.R.C. §162. For example, in Toth v. Comr., 128 T.C. 1 (2007), the taxpayer started operating a horse boarding and training facility for profit in 1998. The activity showed modest profit the first few years, but had really taken off by 2004. For 1998 and 2001, the taxpayer claimed expenses from the activity on Schedule C as ordinary and necessary business expenses deductible in accordance with I.R.C. §162, but she later determined that the expenses should be deducted in accordance with I.R.C. §212 as miscellaneous itemized deduction on Schedule A (which are presently suspended through 2025). However, the IRS took the position that the taxpayer anticipated that the horse activity would become an active trade or business and, as such, her expenses had to be capitalized under I.R.C. §195. The Tax Court agreed with the taxpayer. Start-up expenses, the Tax Court said, were capital in nature rather than ordinary. Thus, once her income producing activity began her expense deductions were not barred by I.R.C. §195. It didn’t matter that the activity later became a trade or business activity under I.R.C. §162.
When does the business begin? A taxpayer cannot deduct or amortize startup expenditures if the activities to which the expenditures relate fail to become an “active trade or business.” See I.R.C. §§195(a), (c). There are no regulations that help define when a trade or business begins, so the question is answered based on the facts and circumstances of a particular situation. To be engaged in a trade or business, a taxpayer must: (1) undertake an activity intending to make a profit, (2) be regularly and actively involved in the activity, and (3) actually have commenced business operations. See, e.g., McManus v. Comr., T.C. Memo. 1987-457, aff’d., 865 F.2d 255 (4th Cir. 1988). In addition, the courts have held that a taxpayer is not engaged in a trade or business “until such time as the business has begun to function as a going concern and performed those activities for which it was organized.” Richmond Television Corp. v. United States, 345 F.2d 901, 907 (4th Cir. 1965), vacated and remanded on other grounds, 382 U.S. 68 (1965). Likewise, an activity doesn’t have to generate sales or other revenue for the business to be deemed to have begun. Cabintaxi Corp. v. Commissioner, 63 F.3d 614, 620 (7th Cir. 1995), aff’g., in part, rev’g. in part, and remanding T.C. Memo. 1994-316; Jackson v. Commissioner, 864 F.2d 1521, 1526 (10th Cir. 1989), aff’g., 86 T.C. 492 (1986). However, merely researching or investigating a potential business is not enough. Dean v. Commissioner, 56 T.C. 895, 902-903 (1971).
Two Tax Court Cases
Recently, the U.S. Tax Court has decided two cases involving the deductibility of start-up costs. In Smith v. Comr., T.C. Sum. Op 2019-12, the Tax Court dealt with I.R.C. §195 and the issue of when the taxpayer’s business began. The Tax Court was convinced that the petitioner had started his vegan food exporting business, noting that the petitioner had been peddling his vegan food products in Jamaica, the Dominican Republic, Brazil Argentina and Columbia. However, he was having trouble getting shelf space. Thus, for the tax year at issue, he showed expenses associated with the activity of about $41,000 and gross sales of slightly over $2,000. The IRS largely disallowed the Schedule C expenses due to lack of documentation and tacked on an accuracy-related penalty. After issuing the statutory notice of deficiency, the IRS said the expenses were not deductible because they were start-up expenditures. Because IRS raised the I.R.C. §195 issue at trial, the IRS bore the burden of proof on the issue. The Tax Court determined that the taxpayer was, based on the facts, engaged in a trade or business. He had secured products to sell, actively marketed those products, attended food shows and other meetings around the Caribbean and South America and had established a network to find potential customers. Thus, I.R.C. §195 did not apply to limit the deduction of the expenses – they would be deductible under I.R.C. §162. Or would they?
To be deductible under I.R.C. §162 as an ordinary and necessary business expense on Schedule C (or Schedule F), the taxpayer must substantiate the expenses. Here’s where the IRS largely prevailed in Smith. The Tax Court determined that the taxpayer had not substantiated his expenses. Thus, the expenses were not deductible beyond (with a small exception) what the IRS allowed. The Tax Court also upheld the accuracy-related penalty.
Earlier this week, in Costello v. Comr., T.C. Memo. 2021-9, the Tax Court addressed the deductibility of start-up costs associated with various farming activities. In the case, the petitioners, a married couple, were residents of California but the wife conducted a farming operation in Mexico for which she reported a net loss on Schedule F for every year from 2007 to 2014. She began raising chickens to sell for meat in 2007, but couldn’t recall selling any of the chickens through 2011 and only had one sale of anything during that timeframe – a $264 loss on the resale of livestock. She then switched to raising chickens for egg production, but soon determined that the venture wouldn’t be profitable due to an increased cost of feed. She then sold what eggs had been produced for $1,068 and switched back to selling chickens for meat in 2012. She didn’t sell any chickens in 2012 or 2013 and her plan to begin selling chickens in 2014 was thwarted when the flock was destroyed by wild dogs. Also, during 2007-2011, she attempted to grow various fruits and vegetables, but the activity was discontinued because the soil was not capable of production due to a nearby salt flat. As a result, she had no sales revenue, only expenses that she deducted. She then tried to grow peppers in 2012, but insects destroyed the crop and there was no marketable production. Later that year, she acquired three cows and three calves in hopes to “make the calves big, sell them, impregnate the mothers…repeat.” She had to sell the cows in 2013 for $4,800 because there was insufficient forage on the 6,500-acre tract. The $4,800 was the only farm activity income reported for 2013. In 2012 and 2013, the taxpayers reported deductible business expenses on their Schedules C and Schedule F, later reaching an agreement with the IRS that the Schedule C expenses should have been reported on Schedule F.
The IRS disallowed the deductions, determining that the wife didn’t conduct a trade or business activity for profit and because the business had not yet started during either 2012 or 2013. The Tax Court agreed with the IRS, concluding that the farming activities never moved beyond experimentation and investigation into an operating business. The Tax Court determined that the overall evidence showed that her activities were still largely pre-operational because she was still planting research crops and the money from the sale of eggs was merely incidental after she had decided to abandon her egg production activity and get into livestock production Accordingly, the expenses were nondeductible startup expenses for the years at issue. In addition, although the Tax Court reasoned that some of the wife’s farming activities could have constituted an active trade or business, costs were not segregated by activity. Also, the there was no itemization of costs or basis in the cattle activity to allow for an estimation of any deductible loss.
When a business is in its early phase, it’s important to determine the proper tax treatment of expenses. It’s also important to determine if and when the business begins. The Tax Cuts and Jobs Act makes this determination even more important. As the recent Tax Court cases indicate, proper documentation and substantiation of expenses is critical to preserve deductibility.
Sunday, January 24, 2021
The world of agricultural law and taxation is certainly pertinent in the daily lives of farmers and ranchers. In recent days and weeks, the courts have addressed more issues that can make a difference for ag producers. In today’s post, I examine a few of those. Those discussed today involve individual and entity taxation as well as environmental and regulatory issues.
More recent developments in ag law and tax - it’s the topic of today’s post.
Flow-Through Entities Can Deduct State and Local Taxes
IRS Notice 2020-75, applicable to specified income tax payments made on or after November 9, 2020
In a Notice, the IRS has said that taxes that are imposed on and paid by a partnership (or an S corporation) on its income are allowed as a deduction by the partnership (or S corporation) in computing its non-separately stated taxable income or loss for the tax year of payment. They are not passed through to the partners or shareholders, where they would be subject to the $10,000 limitation on state and local tax deductions imposed by the Tax Cuts and Jobs Act effective for tax years beginning after 2017.
The IRS did not set a timetable for the issuance of proposed regulations. The IRS issued the Notice in response to some states enacting laws to allow this type of treatment for partnerships and S corporations. Thus, for a flow-through entity to be able to do this for a partnership or S corporation, state law must provide for pass-through entity level taxation. The Notice won't apply unless state law allows this. Merely allowing a pass-through entity to make withholding tax payments on behalf of the owners will not qualify because those withholding tax payments are treated as payments made by the owners and not as payments in satisfaction of the pass -through entity's tax liability. In addition, entities taking advantage of the Notice will reduce allocable taxable income which will, in turn reduce allocable qualified business income for purposes of I.R.C. §199A and, therefore, the qualified business income deduction.
IRA Distributions Included in Income and Subject to Early Withdrawal Penalty
Ball v. Comr., T.C. Memo. 2020-152
During 2012 and 2013 the petitioner participated in a SEP-IRA. Chase Bank (Chase) was the custodian. In 2012, he took two distributions from the account totaling over $200,000. He had the bank deposit the distributions into a Chase business checking account that he had opened in the name of The Ball Investment Account LLC (Ball LLC), of which he was the sole owner and only member. Importantly, Ball LLC was not a retirement account. The petitioner informed Chase that the distributions were early distributions that were not exempt from tax. The petitioner made real estate loans with the distributed funds. The first loan was repaid in April 2013 with a check payable to "the Ball SEP Account." The funds were deposited into the SEP-IRA account. He paid off the second loan in installments in 2012 and 2013. The payments were made with checks made payable to "the Ball SEP Account.” Chase, as custodian, had no knowledge of or control over the use that Ball LLC made of the distributions that were deposited in the Ball LLC business checking account. Chase also didn’t hold or control any documents related to the loans Ball LLC made. Chase issued the petitioner a Form 1099-R for the 2012 tax year reporting that the petitioner had received taxable distributions from the SEP-IRA of $209,600. While the petitioner reported the distributions on his Form 1040, he did not include them in gross income and reported no tax and no tax liability. The IRS issued a CP2000 Notice stating that the petitioner had failed to report the distributions from Chase Bank and that he therefore owed $67,031 in tax and a substantial-understatement penalty of $13,406. The petitioner did not respond to the Notice, and the IRS then sent him a notice of deficiency that determined the deficiency, additional tax, and penalty due. The Tax Court determined that the petitioner had unfettered control over the distributions, rejecting the petitioner’s “conduit agency arrangement” argument. The Tax Court determined that Ball LLC was not acting as an agent or conduit on behalf of Chase when Ball LLC received and made use of the distributions. The Tax Court noted that Chase had no knowledge of how the distributed funds were used after they were deposited in the Ball LLC account at the petitioner’s direction and that nothing in the record showed that petitioner, who controlled Ball LLC, did not have unfettered control over the distributions. The Tax Court determined that the facts of his case were analogous to those in Vandenbosch v. Comr., T.C. Memo. 2016-29 and, as a result, Ball LLC was not a conduit for Chase. As a result, the IRS position that the distributions should be included in the petitioner’s income was upheld. In addition, the petitioner had not yet reached age 59.5 which meant that he was liable for the 10 percent early distribution penalty. The Tax Court also upheld the accuracy-related penalty.
New ESA Definition of “Habitat”
85 Fed. Reg. 81411 (Dec. 16, 2020), effective, Jan. 15, 2021
In response to the U.S. Supreme Court decision in Weyerhaeuser Co. v. United States Fish and Wildlife Service, 139 S. Ct. 361 (2018), the United States Fish and Wildlife Service (USFWS) has modified the definition of “habitat” for listed species under the Endangered Species Act (ESA). The modification is the first change in the definition since the Endangered Species Act’s (ESA) enactment in 1973. Under Weyerhaeuser, the U.S. Supreme Court held that an area being designated as habitat is a prerequisite for a designation as “critical habitat.” The regulation defines “habitat” as “the abiotic and biotic setting that currently or periodically contains the resources and conditions necessary to support one or more life processes of a species.” Thus, to be “habitat” an area must already contain the conditions necessary to support the species it is intended to be habitat for. Thus, only those areas which include the environmental conditions that can provide benefits to the species at issue (one seeking either a listed or endangered species) will be eligible for critical habitat designation.
Federal Government Must Pay Farmers Millions For Army Corps of Engineers' Mismanagement of Missouri River.
Ideker Farms, Inc. v. United States, No. 14-183L, 2020 U.S. Claims LEXIS 2548 (Fed. Cl. Dec. 14, 2020)
In 2014, 400 farmers along the Missouri River from Kansas to North Dakota sued the federal government claiming that the actions of the U.S. Army Corps of Engineers (COE) led to and caused repeated flooding of their farmland along the Missouri River. The farmers alleged that flooding in 2007-2008, 2010-2011, and 2013-2014 constituted a taking requiring that “just compensation” be paid to them under the Fifth Amendment. The litigation was divided into two phases – liability and just compensation. The liability phase was decided in early 2018 when the court determined that some of the 44 landowners selected as bellwether plaintiffs had established the COE’s liability. In that decision, the court held that the COE, in its attempt to balance flood control and its responsibilities under the Endangered Species Act, had released water from reservoirs “during periods of high river flows with the knowledge that flooding was taking place or likely to soon occur.” The court, in that case, noted that the COE had made other changes after 2004 to reengineer the Missouri River and reestablish more natural environments to facilitate species recovery that caused riverbank destabilization which led to flooding. Ultimately, the court, in the earlier litigation, determined that 28 of the 44 landowners had proven the elements of a takings claim – causation, foreseeability and severity. The claims of the other 16 landowners were dismissed for failure to prove causation. The court also determined that flooding in 2011 could not be tied to the COE’s actions and dismissed the claims for that year.
The present case involved a determination of the plaintiffs’ losses and whether the federal government had a viable defense against the plaintiffs’ claims. The court found that the “increased frequency, severity, and duration of flooding post MRRP [Missouri River Recovery Program] changed the character of the representative tracts of land.” The court also stated that, “ [i]t cannot be the case that land that experiences a new and ongoing pattern of increased flooding does not undergo a change in character.” The court determined that three representative plaintiffs, farming operations in northwest Missouri, southwest Iowa and northeast Kansas, were collectively owed more than $7 million for the devaluation of their land due to the establishment of a “permanent flowage easement” that the COE created which constituted a compensable taking under the Fifth Amendment.
The impact of the court’s ruling means that hundreds of landowners affected by flooding in six states are likely entitled to just compensation for the loss of property value due to the new flood patterns that the COE created as part of its MRRP.
As 2021 unwinds, more issues will occur, many of which will likely involve estate and business entity planning along with income tax planning.
Wednesday, January 20, 2021
Today's post is a bibliography of my ag law and tax blog articles of 2020. Many of you have requested that I provide something like this to make it easier to find the articles. If possible, I will do the same for articles from prior years. The library of content is piling up - I have written more than 500 detailed articles for the blog over the last four and one-half years.
Cataloging the 2020 ag law and tax blog articles - it's the topic of today's post.
Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech
Unique, But Important Tax Issues – “Claim of Right;” Passive Loss Grouping; and Bankruptcy Taxation
Disaster/Emergency Legislation – Summary of Provisions Related to Loan Relief; Small Business and Bankruptcy
Retirement-Related Provisions of the CARES Act
Farm Bankruptcy – “Stripping, “Claw-Black,” and the Tax Collecting Authorities
SBA Says Farmers in Chapter 12 Ineligible for PPP Loans
The “Cramdown” Interest Rate in Chapter 12 Bankruptcy
Bankruptcy and the Preferential Payment Rule
Partnership Tax Ponderings – Flow-Through and Basis
Farm and Ranch Estate and Business Planning in 2020 (Through 2025)
Transitioning the Farm or Ranch – Stock Redemption
Estate and Business Planning for the Farm and Ranch Family – Use of the LLC (Part 1)
Estate and Business Planning for the Farm and Ranch Family – Use of the LLC (Part 2)
The Use of the LLC for the Farm or Ranch Business – Practical Application
Top Ten Agricultural Law and Tax Developments from 2019 (Numbers 10 and 9)
Ag Law in the Courts – Feedlots; Dicamba Drift; and Inadvertent Disinheritance
Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech
Dicamba, Peaches and a Defective Ferrari; What’s the Connection?
Liability for Injuries Associated with Horses (and Other Farm Animals)
Issues with Noxious (and Other) Weeds and Seeds
Of Nuisance, Overtime and Firearms – Potpourri of Ag Law Developments
The Statute of Frauds and Sales of Goods
Disrupted Economic Activity and Force Majeure – Avoiding Contractual Obligations in Time of Pandemic
Is it a Farm Lease or Not? – And Why it Might Matter
Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 2 and 1)
Concentrated Ag Markets – Possible Producer Response?
Is an Abandoned Farmhouse a “Dwelling”?
Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 8 and 7)
Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 6 and 5)
Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 4 and 3)
Clean Water Act – Compliance Orders and “Normal Farming Activities”
Groundwater Discharges of “Pollutants” and “Functional Equivalency”
NRCS Highly Erodible Land and Wetlands Conservation Final Rule – Clearer Guidance for Farmers or Erosion of Property Rights? – Part One
NRCS Highly Erodible Land and Wetlands Conservation Final Rule – Clearer Guidance for Farmers or Erosion of Property Rights? – Part Two
NRCS Highly Erodible Land and Wetlands Conservation Final Rule – Clearer Guidance for Farmers or Erosion of Property Rights? – Part Three
The Prior Converted Cropland Exception – More Troubles Ahead?
TMDL Requirements – The EPA’s Federalization of Agriculture
Eminent Domain and “Seriously Misleading” Financing Statements
Ag Law in the Courts – Feedlots; Dicamba Drift; and Inadvertent Disinheritance
Recent Developments Involving Estates and Trusts
What is a “Trade or Business” For Purposes of Installment Payment of Federal Estate Tax?
Alternate Valuation – Useful Estate Tax Valuation Provision
Farm and Ranch Estate and Business Planning in 2020 (Through 2025)
Retirement-Related Provisions of the CARES Act
Are Advances to Children Loans or Gifts?
Tax Issues Associated with Options in Wills and Trusts
Valuing Farm Chattels and Marketing Rights of Farmers
Is it a Gift or Not a Gift? That is the Question
Does a Discretionary Trust Remove Fiduciary Duties a Trustee Owes Beneficiaries?
Can I Write my Own Will? Should I?
Income Taxation of Trusts – New Regulations
Merging a Revocable Trust at Death with an Estate – Tax Consequences
When is Transferred Property Pulled Back into the Estate at Death? Be on Your Bongard!
‘Tis the Season for Giving, But When is a Transfer a Gift?
Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 2 and 1)
Does the Penalty Relief for a “Small Partnership” Still Apply?
Substantiation – The Key to Tax Deductions
Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech
Unique, But Important Tax Issues – “Claim of Right;” Passive Loss Grouping; and Bankruptcy Taxation
Conservation Easements and the Perpetuity Requirement
Tax Treatment Upon Death of Livestock
What is a “Trade or Business” For Purposes of I.R.C. §199A?
Tax Treatment of Meals and Entertainment
Farm NOLs Post-2017
Disaster/Emergency Legislation – Summary of Provisions Related to Loan Relief; Small Business and Bankruptcy
Retirement-Related Provisions of the CARES Act
Income Tax-Related Provisions of Emergency Relief Legislation
The Paycheck Protection Program – Still in Need of Clarity
Solar “Farms” and The Associated Tax Credit
Obtaining Deferral for Non-Deferred Aspects of an I.R.C. §1031 Exchange
Conservation Easements – The Perpetuity Requirement and Extinguishment
PPP and PATC Developments
How Many Audit “Bites” of the Same Apple Does IRS Get?
More Developments Concerning Conservation Easements
Imputation – When Can an Agent’s Activity Count?
Exotic Game Activities and the Tax Code
Demolishing Farm Buildings and Structures – Any Tax Benefit?
Tax Incentives for Exported Ag Products
Deducting Business Interest
Recent Tax Court Opinions Make Key Point on S Corporations and Meals/Entertainment Deductions
Income Taxation of Trusts – New Regulations
Accrual Accounting – When Can a Deduction Be Claimed?
Farmland Lease Income – Proper Tax Reporting
Merging a Revocable Trust at Death with an Estate – Tax Consequences
The Use of Deferred Payment Contracts – Specifics Matter
Is Real Estate Held in Trust Eligible for I.R.C. §1031 Exchange Treatment?
Recent Court Developments of Interest
Principles of Agricultural Law
Signing and Delivery
Abandoned Railways and Issues for Adjacent Landowners
Obtaining Deferral for Non-Deferred Aspects of an I.R.C. §1031 Exchange
Are Dinosaur Fossils Minerals?
Real Estate Concepts Involved in Recent Cases
Is it a Farm Lease or Not? – And Why it Might Matter
Top Ten Agricultural Law and Tax Developments from 2019 (Numbers 10 and 9)
Top Ten Agricultural Law and Tax Developments from 2019 (Number 8 and 7)
Hemp Production – Regulation and Economics
DOJ to Investigate Meatpackers – What’s it All About?
Dicamba Registrations Cancelled – Or Are They?
What Does a County Commissioner (Supervisor) Need to Know?
The Supreme Court’s DACA Opinion and the Impact on Agriculture
Right-to-Farm Law Headed to the SCOTUS?
The Public Trust Doctrine – A Camel’s Nose Under Agriculture’s Tent?
Roadkill – It’s What’s for Dinner (Reprise)
Beef May be for Dinner, but Where’s It From?
Of Nuisance, Overtime and Firearms – Potpourri of Ag Law Developments
What Farm Records and Information Are Protected from a FOIA Request?
Can One State Dictate Agricultural Practices in Other States?
Family Farming Arrangements and Liens; And, What’s a Name Worth?
Conflicting Interests in Stored Grain
Eminent Domain and “Seriously Misleading” Financing Statement
Summer 2020 Farm Income Tax/Estate and Business Planning Conference
Registration Open for Summer Ag Income Tax/Estate and Business Planning Seminar
Summer 2020 – National Farm Income Tax/Estate and Business Planning Conference
Year-End CPE/CLE – Six More to Go
2021 Summer National Farm and Ranch Income Tax/Estate and Business Planning Conference
Principles of Agricultural Law
More “Happenings” in Ag Law and Tax
Recent Cases of Interest
More Selected Caselaw Developments of Relevance to Ag Producers
Court Developments of Interest
Ag Law and Tax Developments
Recent Court Developments of Interest
Court Developments in Agricultural Law and Taxation
Ag Law and Tax in the Courtroom
Recent Tax Cases of Interest
Ag and Tax in the Courts
Of Nuisance, Overtime and Firearms – Potpourri of Ag Law Developments
January 20, 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)
Sunday, January 17, 2021
For the Spring 2021 academic semester, Kansas State University will be offering my Agricultural Law and Economics course online. No matter where you are located, you can enroll in the course and participate in it as if you were present with the students in the on-campus classroom.
Details of this spring semester’s online Ag Law course – that’s the topic of today’s post.
The course provides a broad overview of many of the issues that a farmer, rancher, rural landowner, ag lender or other agribusiness will encounter on a daily basis. As a result, the course looks at contract issues for the purchase and sale of agricultural goods; the peril of oral contracts; the distinction between a lease and a contract (and why the distinction matters); and the key components of a farm lease, hunting lease, wind energy lease, oil and gas lease, and other types of common agricultural contractual matters. What are the rules surrounding ag goods purchased at auction?
Ag financing situations are also covered – what it takes to provide security to a lender when financing the purchase of personal property to be used in the farming business. In addition, the unique rules surrounding farm bankruptcy is covered, including the unique tax treatment provided to a farmer in Chapter 12 bankruptcy.
Of course, farm income tax is an important part of the course. Tax planning is perhaps the most important aspect of the farming business that every-day decisions have an impact on and are influenced by. As readers of this blog know well, farm tax issues are numerous and special rules apply in many instances. The new tax law impacts many areas of farm income tax.
Real property legal issues are also prevalent and are addressed in the course. The key elements of an installment land contract are covered, as well as legal issues associated with farm leases. Various types of interests in real estate are explained – easements; licenses; profits, fee simples, remainders, etc. Like-kind exchange rules are also covered as are the special tax rules (at the state level) that apply to farm real estate.
A big issue for some farmers and ranchers concerns abandoned railways, and those issues are covered in the course. What if an existing fence is not on the property line?
Farm estate and business planning is also a significant emphasis of the course. What’s the appropriate estate plan for a farm and ranch family? How should the farming business be structured? Should multiple entities be used? Why does it matter? These questions, and more, are addressed.
Agricultural cooperatives are important for the marketing of agricultural commodities. How a cooperative is structured and works and the special rules that apply are also discussed.
Because much agricultural property is out in the open, that means that personal liability rules come into play with respect to people that come onto the property or use farm property in the scope of their employment. What are the rules that apply in those situations? What about liability rules associated with genetically modified products? Ag chemicals also pose potential liability issues, as do improperly maintained fences? What about defective ag seed or purchased livestock that turns out to not live up to representations? These issues, and more, are covered in the scope of discussing civil liabilities.
Sometimes farmers and ranchers find themselves in violation of criminal laws. What are those common situations? What are the rules that apply? We will get into those issue too.
Water law is a very big issue, especially in the western two-thirds of the United States. We will survey the rules surrounding the allocation of surface water and ground water to agricultural operations.
Ag seems to always be in the midst of many environmental laws – the “Clean Water Rule” is just one of those that has been high-profile in recent years. We will talk about the environmental rules governing air, land, and water quality as they apply to farmers, ranchers and rural landowners.
Finally, we will address the federal (and state) administrative state and its rules that apply to farming operations. Not only will federal farm programs be addressed, but we will also look at other major federal regulations that apply to farmers and ranchers.
Further Information and How to Register
Information about the course and how to register is available here: https://www.enrole.com/ksu/jsp/session.jsp?sessionId=442107&courseId=AGLAW&categoryId=ROOT
You can also find information about the text for the course at the following link: https://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/principlesofagriculturallaw/index.html
If you are an undergraduate student at an institution other than Kansas State, you should be able to enroll in this course and have it count as credit towards your degree at your institution. Consult with your academic advisor to see how Ag Law and Economics will transfer and align with your degree completion goals.
If you have questions, you can contact me directly, or submit your questions to the KSU Global Campus staff at the link provided above.
I hope to see you in class beginning on January 26!
January 17, 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, January 15, 2021
After many months of delay, the IRS has finally issued final regulations providing guidance to agricultural/horticultural cooperatives and patrons on the I.R.C. §199A(a) and I.R.C. §199A(g) deduction for qualified business income (QBI). The final regulations make several changes to the Proposed Regulations, and are important to patrons of ag cooperatives and return preparers.
The QBI Final Regulations applicable to agricultural/horticultural cooperatives – it’s the topic of today’s post.
The Consolidated Appropriations Act of 2018, H.R. 1625 (Act) became law. The Act contained a provision modifying I.R.C. §199A that was included in the Tax Cuts and Jobs Act (TCJA) enacted in late 2017. I.R.C. §199A created a 20 percent QBI deduction for sole proprietorships and pass-through businesses. However, the provision created a tax advantage for sellers of agricultural products sold to agricultural cooperatives. Before the technical correction, those sales generated a tax deduction from gross sales for the seller. But if those same ag goods were sold to a company that was not an agricultural cooperative, the deduction could only be taken from net business income. That tax advantage for sales to cooperatives was deemed to be a drafting error and has now been technically corrected.
The modified provision removes the TCJA’s QBI deduction provision for ag cooperatives and replaced it with the former (pre-2018) domestic production activities deduction (DPAD) of I.R.C. §199 for cooperatives. In addition, the TCJA provision creating a 20 percent deduction for patronage dividends also was eliminated. Also, the modified language limits the deduction to 20 percent of farmers’ net income, excluding capital gains.
The Modification: New I.R.C. §199A(g)
The provision in the Act removes the QBI deduction for agricultural or horticultural cooperatives. In its place, the former DPAD provision (in all practical essence) is restored for such cooperatives. Thus, an ag cooperative can claim a deduction from taxable income that is equal to nine percent of the lesser of the cooperative’s qualified production activities income or taxable income (determined without regard to the cooperative’s I.R.C. § 199A(g) deduction and any deduction allowable under section 1382(b) and (c) (relating to patronage dividends, per-unit retain allocations, and nonpatronage distributions)) for the taxable year. The amount of the deduction for a taxable year is limited to 50 percent of the W-2 wages paid by the cooperative during the calendar year that ends in such taxable year. For this purpose, W-2 wages are determined in the same manner as under the other provisions of section 199A (which is not repealed as applied to non-cooperatives), except that “wages” do not include any amount that is not properly allocable to domestic production gross receipts. A cooperative’s DPAD is reduced by any amount passed through to patrons.
Under the technical correction, the definition of a “specified agricultural or horticultural cooperative” is limited to organizations to which part I of subchapter T applies that either manufacture, produce, grow, or extract in whole or significant part any agricultural or horticultural product; or market any agricultural or horticultural product that their patrons have manufactured, produced, grown, or extracted in whole or significant part. The technical correction notes that Treas Reg. §1.199-6(f) is to apply such that agricultural or horticultural products also include fertilizer, diesel fuel, and other supplies used in agricultural or horticultural production that are manufactured, produced, grown, or extracted by the cooperative.
Note: As modified, a “specified agricultural or horticultural cooperative” does not include a cooperative solely engaged in the provision of supplies, equipment, or services to farmers or other specified agricultural or horticultural cooperatives.
Impact on patrons. Under the new language, an eligible patron that receives a qualified payment from a specified agricultural or horticultural cooperative can claim a deduction in the tax year of receipt in an amount equal to the portion of the cooperative’s deduction for qualified production activities income that is: 1) allowed with respect to the portion of the qualified production activities income to which such payment is attributable; and 2) identified by the cooperative in a written notice mailed to the patron during the payment period described in I.R.C. §1382(d).
Note: The cooperative’s I.R.C. §199A(g) deduction is allocated among its patrons on the basis of the quantity or value of business done with or for the patron by the cooperative.
The patron’s deduction may not exceed the patron’s taxable income for the taxable year (determined without regard to the deduction, but after accounting for the patron’s other deductions under I.R.C. §199A(a)).
What is a qualified payment? It’s any amount that meets three tests:
1) the payment must be either a patronage dividend or a per-unit retain allocations;
2) the payment, must be received by an eligible patron from a qualified agricultural or horticultural cooperative; and
3) the payment must be attributable to qualified production activities income with respect to which a deduction is allowed to the cooperative.
An eligible patron cannot be a corporation and cannot be another ag cooperative. In addition, a cooperative cannot reduce its income under I.R.C. §1382 for any deduction allowable to its patrons by virtue of I.R.C. §199A(g). Thus, the cooperative must reduce its deductions that are allowed for certain payments to its patrons in an amount equal to the I.R.C. §199A(g) deduction allocated to its patrons.
Transition rule. A transition rule applied such that the repeal of the DPAD did not apply to a qualified payment that a patron receives from an ag cooperative in a tax year beginning after 2017 to the extent that the payment is attributable to qualified production activities income with respect to which the deduction is allowed to the cooperative under the former DPAD provision for the cooperative’s tax year that began before 2018. That type of qualified payment is subject to the pre-2018 DPAD provision, and any deduction allocated by a cooperative to patrons related to that type of payment can be deducted by patrons in accordance with the pre-2018 DPAD rules. In that event, no post-2017 QBI deduction was allowed for those type of qualified payments. This simple statement created surprising results and added complexity to the computations for determining the proper 2018 QBID. Taxpayers needed to identify sales to non-cooperatives, sales to cooperatives during the year that began in 2017, and sales to cooperatives during the year that began in 2018 to properly compute their 2018 QBID.
Status of Ag Cooperatives and Patrons After the Act
With the technical correction to I.R.C. §199A, where did things stand for farmers?
- The overall QBI deduction cannot exceed 20 percent of taxable income less capital gain. That restriction applies to all taxpayers regardless of income. When income exceeds the taxable income threshold , the 50 percent of W-2 wages limitation and qualified property limit are phased-in.
- The prior I.R.C. 199 DPAD no longer exists, except as resurrected for agricultural and horticultural cooperatives as noted above. The 20 percent QBI deduction of I.R.C. §199A is available for sole proprietorships and pass-through businesses. For farming businesses structured in this manner, the tax benefit of the 20 percent QBI deduction will likely outweigh what the DPAD would have produced.
- While those operating in the C corporate form can’t claim a QBI deduction, the corporate tax rate is now a flat 21 percent. That represents a tax increase for those corporations that would have otherwise triggered a 15 percent rate under prior law and benefitted from DPAD in prior years.
- For C corporations that are also patrons of an agricultural cooperative, the cooperative’s DPAD does not pass through to the patron.
- For a Schedule F farmer that is a patron of an agricultural cooperative and pays no wages, there are two steps to calculate the tax benefits. First, the cooperative’s DPAD that is passed through to the patron can be applied to offset the patron’s taxable income regardless of source. Second, the farmer/patron is entitled to a QBI deduction equal to 20 percent of net farm income derived from qualified non-cooperative sales, subject to the taxable income limitation (presently $329,800 (mfj); $164,900 (single, MFS and HH for 2021).
- For farmers that pay W-2 wages and sell to ag cooperatives , the QBI deduction is calculated on the sales to cooperatives by applying the lesser of 50 percent of W-2 wages or 9 percent reduction limitation. Thus, for a farmer that has farm income beneath the taxable income limitation , the QBI deduction will never be less than 11 percent (i.e., 20 percent less 9 percent). If the farmer is above the taxable income limitation the 50 percent of W-2 wages limitation will be applied before the 9 percent limitation. This will result in the farmer’s QBI deduction, which cannot exceed 20 percent of taxable income. To this amount is added any pass-through DPAD from the cooperative to produce the total deductible amount.
- For farmers that sell ag products to non-cooperatives and pay W-2 wages, a deduction of 20 percent of net farm income is available. If taxable income is less than net farm income, the deduction is 20 percent of taxable income less capital gains. If net farm income exceeds the taxable income limitation the deduction may be reduced on a phased-in basis.
- The newly re-tooled cooperative DPAD of I.R.C. 199A may incentivize more cooperatives to pass the DPAD through to their patrons.
After a frustrating 2018 tax season experience with respect to associated IRS Forms and IRS computers not recognizing Forms as submitted in accordance with the instructions for the I.R.C. §199A(g) amount, the IRS issued Proposed Regulations concerning the computation of the I.R.C. §199A(g) amount. REG-118425-18. The Proposed Regulations clarified that patronage dividends include money, property, qualified written notices of allocations, qualified per-unit retain certificates for which a cooperative receives a deduction under I.R.C. §1382(b), nonpatronage distributions paid in money, property, qualified written notices of allocation, as well as money or property paid in redemption of a nonqualified written notice of allocation for which an exempt cooperative receives a deduction under I.R.C. §1382(c)(2). But, dividends on capital stock are not included in QBI. Prop. Treas. Reg. §1.199A-7(c)(1).
Under Prop. Treas. Reg. §1.199A-7(c), patronage dividends or similar payments may be included in the patron’s QBI to the extent that these payments: (i) are related to the patron’s trade or business; (ii) are qualified items of income, gain, deduction, or loss at the cooperative’s trade or business level; and (iii) are not income from a specified service trade or business (SSTB) (as defined in I.R.C. §199A(d)(2)) at the cooperative level. But, they are only included in the patron’s income if the cooperative provides the required information to the patron concerning the payments. Prop. Treas. Reg. §1.199A-7(c)(2). The transition DPAD rules were reaffirmed in Prop. Treas. Reg. §1.199A-7(h)(2) thus validating the related complex calculations on 2018 tax returns.
The patron’s QBID. The amount of a patron’s deduction that can be passed through to the patron is limited to the portion of the patron’s deduction that is allowed with respect to qualified production activities income (QPAI) to which the qualified payments (patronage dividends and per unit retains) made to the patron are attributable. I.R.C. §199A(g)(2)(E). In other words, the distribution must be of tax items that are allocable to the cooperative’s trade or business on behalf of or with a patron. The cooperative makes this determination in accordance with Treas. Reg. §1.199A-3(b). This is, essentially, the former DPAD computation except that account is taken for non-patronage income not being part of the computation.
There is a four-step process for computing the patron’s QBID: 1) separate patronage and non-patronage gross receipts (and associated deductions); 2) limit the patronage gross receipts to those that are domestic production gross receipts (likely no reduction here); 3) determine qualified production activities income from the domestic, patronage-sourced gross receipts; 4) apply a formula reduction (explained below). Prop. Treas. Reg. §1.199A-8(b).
The ”wages” issue. As noted, the farmer-patron must reduce the “patron’s QBID” by a formula that is the lesser of 9 percent of QBI that relates to qualified payments from the cooperative, or 50 percent of the patron’s W-2 wages paid that are allocable to the qualified payments from the cooperative. I.R.C. §199A(b)(7)(A)-(B). In Notice 2019-27, 2019-16 IRB, the IRS set forth various methods for calculating W-2 wages for purposes of computing the patron’s QBID. See also Prop. Treas. Reg. §1.199A-11. Because the test is the “lesser of,” a patron that pays no qualified W-2 wages has no reduction. Remember, however, under I.R.C. §199A(b)(4) and Prop. Treas. Reg. §1.199A-11(b)(1), wages paid in-kind to agricultural labor are not “qualified wages” but wages paid to children under age 18 by their parents are.
I.R.C. §199A(b)(7) requires the formula reduction even if the cooperative doesn’t pass through any of the I.R.C. §199A(g) deduction (the deduction for a patron) to the patron for a particular tax year. If the patron has more than a single business, QBI must be allocated among those businesses. Treas. Reg. §1.199A-3(b)(5). The Proposed Regulations do not mention how the formula reduction functions in the context of an aggregation election. For example, if an aggregation election is made to aggregate rental income with income from the farming operation, must an allocation be made of a portion of the rental income as part of the formula reduction?
The formula reduction applies to the portion of a patron’s QBI that relates to qualified payments from a cooperative. If the patron has negative QBI that is associated with business done with the cooperative, the 9 percent amount will always be lower than the W-2 wage amount.
An optional safe harbor allocation method exists for patrons with taxable income under the applicable threshold of I.R.C. §199A(e)(2) to determine the reduction. Under the safe harbor, a patron must allocate the aggregate business expenses and W-2 wages ratably between income from qualified payments and income from other than qualified payments to determine QBI. Prop. Treas. Reg. §1.199A-7(f)(2)(ii). Unfortunately, the example contained in the Proposed Regulations not only utilized an apparently unstated “reasonable method of allocation,” but also an allocation of W-2 wage expense that doesn’t match the total expense allocation.
The amount of deductions apportioned to determine QBI allocable to qualified payments must be equal to the proportion of the total deductions that the amount of qualified payments bears to total gross receipts used to determine QBI. The same proportion applies to determine the amount of W-2 wages allocable to the portion of the trade or business that received qualified payments.
The part of the Proposed Regulations attempting to illustrate the calculation only mentions gross receipts from grain sales. There is no mention of gross receipts from farm equipment, for example. Based on the language of Prop. Treas. Reg. §1.199A-7(f)(2)(ii), gross receipts from the sale of equipment and machinery should be included in the calculation and the farmer would have to allocate gross receipts from equipment sales between patronage and non-patronage income. Indeed, in prior years, depreciation may have been allocated between patronage and non-patronage income. Likewise, the example didn’t address how government payments, custom work, crop insurance proceeds or other gross receipts are to be allocated.
This meant that the patron must know the qualified payments from the cooperative that were allocable to the patron that were used in computing the deduction for the patron at the cooperative level that could be passed through to the patron. This information is contained on Form 1099-PATR Box 7.
A patron with taxable income above the threshold levels that receives patronage dividends (or similar payments) from a cooperative and is conducting a trade or business might be subject to the W-2 wages and “unadjusted basis immediately after acquisition” (UBIA) limitation. In that instance, the patron is to calculate the W-2 wage and UBIA limitations without regard to the cooperative’s W-2 or UBIA amounts. Prop. Treas. Reg. §1.199A-7(e)(2). That means the cooperative (unlike a RPE) does not allocate its W-2 wages or UBIA to patrons. Instead, a patron allocates (by election) W-2 wages and UBIA between patronage and non-patronage income using any reasonable method based on all the facts and circumstances that clearly reflects the income and expense of each trade or business. Prop. Treas. Reg. §1.199A-7(f)(2)(i).
The patron’s QBID that is passed through from the cooperative (which is not limited by W-2 wages at the patron level) is limited to the patron’s taxable income taking into account the non-patron QBID which is limited to 20 percent of taxable income not counting net capital gains. Any unused patron-QBID is simply lost – there is not carryover or carryback provision that applies.
Identification by the cooperative. A cooperative must identify the amount of a patron’s deduction that it is passing through to a patron in a notice that is mailed to the patron via Form 1099-PATR during the “applicable payment period” – no later than the 15th day of the ninth month following the close of the cooperative’s tax year. I.R.C. §199A(g)(2)(A); Prop. Treas. Reg. §1.199A-8(d)(3); I.R.C. §1382(d).
A patron uses the information that the cooperative reports to determine the patron’s QBID. If the information isn’t received on or before the Form 1099-PATR due date, no distributions from the cooperative will count towards the patron’s QBI if the lack of reporting occurs after June 19, 2019. Prop. Treas. Reg. §1.199A-7(c)(3); Prop. Treas. Reg. §1.199A-7(d)(3).
Final Regulations (TD 9947)
On January 14, 2021 the IRS issued Final Regulations on the cooperative QBI issue. The Final Regulations make several changes to the Proposed Regulations. One clarification that likely won’t impact many farmers requires a cooperative to separately determine the amounts of qualified items that relate to non-specified service trades or business (SSTBs) and those that relate to SSTBs when making distributions to patrons. Treas. Reg. §§1.199A-7(c)(3) and (d)(3). The cooperative is to report the net amount of qualified items from non-SSTBs in distributions to patrons without delineating on a business-by-business basis. Once a patron receives the information from the cooperative, the patron will have to determine if the qualified item is includible in the patron’s QBI under Treas. Reg. §1.199A-7(c)(2) and whether the qualified item from the SSTB is includible in the patron’s QBI based on the threshold rules of I.R.C. §199A(d)(3). Treas. Reg. §1.199A-7(d)(3)(i).
Under the Proposed Regulations, a question existed whether a patron needed to include gain on selling farm equipment, farm program payments, self-rentals, or other similar income sources in calculation of the I.R.C. §199A(g) amount. The Final Regulations didn’t answer the question. Under the Final Regulations, when calculating the I.R.C. §199A(b)(7) reduction, a patron is to use a “reasonable method” to allocated income between that from qualified payments and that not coming from qualified payments, based on all of the facts and circumstances. Treas. Reg. §1.199A-7(f)(2)(i). Basically, that means that a farmer/patron can make their own decision with respect to including or excluding such items. The only requirement is that a “reasonable method” be utilized.
The final regulations specify that a farmer/patron that aggregates a rental real estate busines and a farming business that does business with a cooperative is to exclude the rental income when calculating the I.R.C. §199A(b)(7) reduction for the patron’s aggregated trade or business. Similarly, the patron is to allocate rental expense against qualified payments when computing the reduction only to the extent rental expense is related to the qualified payments from the cooperative. Preamble to TD 9947.
On the wage issue, qualified payments need not be reduced if the cooperative was limited by the 50 percent of wage limitation.
The Final Regulations provide an example of the effect of negative QBI on the I.R.C. §199A(b)(7) reduction, pointing out that negative QBI from a cooperative results in no adjustment to the reduction computation:
“A farmer conducts two types of agricultural businesses (A and B). Assume the farmer treats A and B as one trade or business for purposes of the [I.R.C. §199A(a)] deduction. The farmer conducts A with non-Specified Cooperatives and B through a Specified Cooperative. The farmer generates $100 of qualifying income through A and receives $100 of qualifying income from a Specified Cooperative in B, all of which is also a qualified payment. The farmer has $180 of qualified expenses. For purposes of the [I.R.C. §199A(a)] deduction, the farmer’s QBI ($20) from the trade or business is used to calculate the deduction, resulting in a $4 deduction. The farmer then must determine if there is any [I.R.C. §199A(b)(7)] reduction to this amount. The farmer reasonably allocates its qualified expenses for purposes of calculating the I.R.C. §199A(b)(7)] reduction and determines $110 of the qualified expenses are allocable to B (and $70 to A). The farmer will use only QBI from B to calculate the [I.R.C. §199A(b)(7)] reduction because that is the only QBI properly allocable to qualified payments. Farmer’s QBI for purposes of [I.R.C. §199A(b)(7)(A)] is negative $10, resulting in a $0 [I.R.C. §199A(b)(7)] reduction (regardless of W-2 wages under [I.R.C. §199A(b)(7)(B)]). ((Preamble to TD 9947)).”
The IRS, in the Final Regulations, maintained its position that cooperatives must calculate two separate deductions – one for patronage and another for nonpatronage activities. The IRS takes the position in the Final Regulations that nonpatronage income is excluded from the calculation of the deduction, which reduces the overall value of the deduction for cooperatives and patrons. Income or deductions is from patronage sources if it comes from a transaction that facilitates the cooperative’s marketing, purchasing or services. If a transaction is merely incidental to the cooperative’s operation, the income or deduction is from nonpatronage sources.
The IRS claims that the Form 8903 instructions make it clear that separate calculations are necessary for the patronage section of I.R.C. §199A(g) deductions and nonpatronage I.R.C. §199A(g) deductions. However, there is no support for the IRS position in the statute’s legislative history for the disparate treatment of patronage and nonpatronage source income. Likewise, the Tax Court (in both Memorandum and Full opinions) has rejected the IRS approach for computing the former domestic production activities deduction of I.R.C. §199 on which I.R.C. §199A is based. Growmark, Inc. v. Comr., T.C. Memo. 2019-161; Ag Processing, Inc. v. Comr., 153 T.C. 34 (2019).
The Final Regulations are generally applicable to tax years beginning after January 19, 2021, but can be used for earlier tax years. Otherwise, for tax years beginning on or before January 19, 2021, the Proposed Regulations apply.
The Final Regulations do clarify a couple of issues that were unclear in the Proposed Regulations. However, the Final Regulations do not answer the question of whether gain from certain various sources of income for a farmer/patron in the I.R.C. §199A(g) computation.
Wednesday, January 13, 2021
The biggest three developments of 2020 in ag law and tax are up for discussion today. 2020 was a year of many important developments of relevance to the agricultural industry, but the top three stand out in particular.
The three most important developments of 2020 – it’s the topic of today’s post.
No. 3 – SCOTUS DACA Opinion
Background. In mid-2020, the U.S. Supreme Court issued its opinion in Department of Homeland Security, et al. v. Regents of the University of California, et al., 140 S. Ct. 1891 (2020) where the Court denied the U.S. Department of Homeland Security’s (DHS) revocation of the Deferred Action for Childhood Arrivals (DACA). The Court’s decision is of prime importance to agriculture because the case involved the ability of a federal government agency to create rules that are applied with the force of law without following the notice and comment requirements of the Administrative Procedure Act. Agricultural activities are often subjected to the rules developed by federal government agencies, making it critical that agency rules are subjected to public input before being finalized.
The DHS started the DACA program by issuing an internal agency memorandum in 2012. The DHS took this action after numerous bills in the Congress addressing the issue failed to pass over a number of years. The DACA program illegal aliens that were minors at the time they illegally entered the United States to apply for a renewable, two-year reprieve from deportation. The DACA program also gave these illegal immigrants work authorizations and access to taxpayer-funded benefits such as Social Security and Medicare. Current estimates are that between one million and two million DACA-protected illegal immigrants are eligible for benefits In 2014, the DHS attempted to expand DACA to provide amnesty and taxpayer benefits for over four million illegal aliens, but the expansion was foreclosed by a federal courts in 2015 for providing benefits to illegal aliens without following the procedural requirements of the Administrative Procedure Act as a substantive rule and for violating the Immigration and Naturalization Act. Texas v. United States, 809 F.3d 134 (5th Cir. 2015), aff’g., 86 F. Supp. 3d 591 (S.D. Tex. 2015). In 2016, the U.S. Supreme Court affirmed the lower court decisions. United States v. Texas, 136 S. Ct. 2271 (2016). Based on these court holdings and because DACA was structured similarly, the U.S. Attorney General issued an opinion that the DACA was also legally defective. Accordingly, in June of 2017, the DHS announced via an internal agency memorandum that it would end the illegal program by no longer accepting new applications or approving renewals other than for those whose benefits would expire in the next six months. Activist groups sued and the Supreme Court ultimately determined that the action of the DHS was improper for failing to provide sufficient policy reasons for ending DACA. In other words, what was created with the stroke of a pen couldn’t be eliminated with a stroke of a pen.
Administrative Procedure Act (APA). The APA was enacted in 1946. Pub. L. No. 79-404, 60 Stat. 237 (Jun. 11, 1946). The APA sets forth the rules governing how federal administrative agencies are to go about developing regulations. It also gives the federal courts oversight authority over all agency actions. The APA has been referred to as the “Constitution” for administrative law in the United States. A key aspect of the APA is that any substantive agency rule that will be applied against an individual or business with the force of law (e.g., affecting rights of the regulated) must be submitted for public notice and comment. 5 U.S.C. §553. The lack of DACA being subjected to public notice and comment when it was created and the Court’s requirement that it couldn’t be removed in like fashion struck a chord with the most senior member of the Court. Justice Thomas authored a biting dissent that directly addressed this issue. He wrote, “Without grounding its position in either the APA or precedent, the majority declares that DHS was required to overlook DACA’s obvious legal deficiencies and provide additional policy reasons and justifications before restoring the rule of law. This holding is incorrect, and it will hamstring all future agency attempts to undo actions that exceed statutory authority.”
Farmers and ranchers often deal with the rules developed by federal (and state) administrative agencies. Those agency rules often involve substantive rights and, as such, are subject to the notice and comment requirements of the APA. Failure to follow the APA often results in the restriction (or outright elimination) of property rights without the necessary procedural protections the APA affords. It’s also important that when administrative agencies overstep their bounds, a change in agency leadership has the ability to swiftly rescind prior illegal actions – a point Justice Thomas made clear in his dissent.
No. 2 - Public Trust Doctrine
Background. Centuries ago, the seas were viewed as the common property of everyone - they weren’t subject to private use and ownership. Instead, they were held in what was known as the “public trust.” This concept was later adopted in English law, the Magna Carta, and became part of the common (non-statutory) law of individual states in the United States after the Revolution. Over the years, this “public trust doctrine” has been primarily applied to access to the seashore and intertidal waters, although recently some courts have expanded its reach beyond its historical application.
But, any judicial expansion of the public trust doctrine results in curtailing vested property rights. That’s a very important concern for agriculture because of agriculture’s necessary use of natural resources such as land, air, water, minerals and the like. Restricting or eliminating property rights materially impacts agricultural operations in a negative manner. It also creates an economic disincentive to use property in an economically (and socially) efficient manner.
How could an expanded public trust doctrine apply? For farmers and ranchers, it could make a material detrimental impact on the farming operation. For instance, many endangered species have habitat on privately owned land. If wildlife and their habitat are deemed to be covered by the doctrine, farming and ranching practices could be effectively curtailed. What about vested water rights? A farming or ranching operation that has a vested water right to use water from a watercourse for crop irrigation or livestock watering purposes could find itself having those rights limited or eliminated if, under the public trust doctrine, a certain amount of water needed to be retained in the stream for a species of fish.
One might argue that the government already has the ability to place those restrictions on farming operations, and that argument would be correct. But, such restrictions exist via the legislative and regulatory process and are subject to constitutional due process, equal protection and just compensation protections. Conversely, land-use restrictions via the public trust doctrine bypass those constitutional protections. No compensation would need to be paid, because there was no governmental taking – a water right, for example, could be deemed to be subject to the “public trust” and enforced without the government paying for taking the right.
Nevada Case. Mineral County v. Lyon County, No. 75917, 2020 Nev. LEXIS 56 (Nev. Sup. Ct. Sept. 17, 2020), involved the state of Nevada’s water law system for allocating water rights and an attempt to take those rights without compensation via an expansion of the public use doctrine. The state of Nevada appropriates water to users via the prior appropriation system – a “first-in-time, first-in-right” system. Over 100 years ago, litigation over the Walker River Basin began between competing water users in the Walker River Basin. The Basin covers approximately 4,000 square miles, beginning in the Sierra Nevada mountain range and ending in a lake in Nevada. In 1936, a federal court issued a decree adjudicating water rights of various claimants to water in the basin via the prior appropriation doctrine.
In 1987, an Indian Tribe intervened in the ongoing litigation to establish procedures to change the allocations of water rights subject to the decree. Since that time, the state reviews all changes to applications under the decree. In 1994, the plaintiff sought to modify the decree to ensure minimum stream flows into the lake under the “doctrine of maintenance of the public trust.” The federal district (trial) court granted the plaintiff’s motion to intervene in 2013. In 2015, the trial court dismissed the plaintiff’s amended complaint in intervention on the basis that the plaintiff lacked standing; that the public trust doctrine could only apply prospectively to bar granting appropriative rights; any retroactive application of the doctrine could constitute a taking requiring compensation; that the court lacked the authority to effectuate a taking; and that the lake was not part of the basin.
On appeal, the federal appellate court determined that the plaintiff had standing, and that the lake was part of the basin. The appellate court also held that whether the plaintiff could seek minimum flows depended on whether the public trust doctrine allowed the reallocation of rights that had been previously settled under the prior appropriation doctrine. Thus, the appellate court certified two questions to the Nevada Supreme Court: 1) whether the public trust doctrine allowed such reallocation of rights; and 2) if so, whether doing so amounted to a “taking” of private property requiring “just compensation” under the Constitution.
The state Supreme Court held that that public trust doctrine had already been implemented via the state’s prior appropriation system for allocating water rights and that the state’s statutory water laws is consistent with the public trust doctrine by requiring the state to consider the public interest when making allocating and administering water rights. The state Supreme Court also determined that the legislature had expressly prohibited the reallocation of water rights that have not otherwise been abandoned or forfeited in accordance with state water law.
The state Supreme Court limited the scope of its ruling to private water use of surface streams, lakes and groundwater such as uses for crops and livestock. The plaintiff has indicated that it will ask the federal appellate court for a determination of whether the public trust doctrine could be used to mandate water management methods. If the court would rule that it does, the result would be an unfortunate disincentive to use water resources in an economically efficient manner (an application of the “tragedy of the commons”). It would also provide a current example (in a negative way) of the application of the Coase Theorem (well-defined property rights overcome the problem of externalities). See Coase, “The Problem of Social Cost,” Journal of Law and Economics, Vol. 3, October 1960.
Oregon Case. In Chernaik v. Brown, 367 Or. 143 (2020), the plaintiffs claimed that the public trust doctrine required the State of Oregon to protect various natural resources in the state from harm due to greenhouse gas emissions, “climate change,” and ocean acidification. The public trust doctrine has historically only applied to submerged and submersible lands underlying navigable waters as well as the navigable waters. The trial court rejected the plaintiffs’ arguments. On appeal the state Supreme Court affirmed, rejecting the test for expanding the doctrine the plaintiffs proposed. Under that test, the doctrine would extend to any resource that is not easily held or improved and is of great value to the public. The state Supreme Court held that the plaintiffs’ test was too broad to be adopted and remanded the case to the lower court.
No. 1 – CARES Act, CFAP Programs and Disaster Legislations and CAA, 2021
Quite clearly, the biggest development of 2020 involved the numerous tax and loan provisions enacted in an attempt to offset the loss of income and closure of business resulting from the actions of various state governors as a result of the virus. Also, the various pieces of legislation made some of the most significant changes to the retirement planning rules in about 15 years. In addition, tax provisions were contained in disaster legislation that took effect in 2020. In late December of 2020, the Consolidated Appropriations Act of 2021 (CAA, 2021) was signed into law. This law made significant changes to the existing Paycheck Protection Program (PPP), and provided another round of payments to farmers and ranchers under the Coronavirus Food Assistance Program (CFAP). The CAA, 2021 also extended numerous tax provisions that were set to expire at the end of 2020.
2020 was another big year in the ag law and tax world. There’s never a dull moment.
Monday, January 11, 2021
No. 5 – Dicamba Drift Damages
Numerous cases have been filed in recent years alleging damage to soybean crops as a result of dicamba drift. However, one significant case has involved alleged dicamba drift damage to a peach crop. In 2019, the federal trial court judge hearing the case allowed much of the case to go to the jury. In early 2020, the jury returned a $265 million judgment against Monsanto/Bayer and BASF. $15 million of that amount was to compensate the peach farmer. $250 million was punitive damages. Throughout 2020, the litigation continued with the courts addressing the whether the allocation of damages was proper and reasonable.
Dicamba Drift, Peaches and Calculation of Damages
The plaintiff claimed that his peach orchard was destroyed after the defendants (Monsanto and BASF) conspired to develop and market dicamba-tolerant seeds and dicamba-based herbicides. The plaintiff claimed that the damage to the peaches occurred when dicamba drifted from application to neighboring fields. The plaintiff claimed that the defendants released its dicamba-tolerant seed with no corresponding dicamba herbicide that could be safely applied. As a result, farmers illegally sprayed an old formulation of dicamba herbicide that was unapproved for in-crop, over-the-top, use and was "volatile," or prone to drift.
While many cases had previously been filed on the dicamba drift issue, the plaintiff did not join the other litigation because it focused on damages to soybean crops. Monsanto moved to dismiss the claims for failure to warn; negligent training; violation of the Missouri Crop Protection Act; civil conspiracy; and joint liability for punitive damages. BASF moved to dismiss those same counts except the claims for failure to warn. The trial court granted the motion to dismiss in part. Monsanto argued that the failure to warn claims were preempted by the Federal Insecticide, Fungicide, and Rodenticide Act ("FIFRA"), but the plaintiff claimed that no warning would have prevented the damage to the peaches. The trial court determined that the plaintiff had adequately plead the claim and denied the motion to dismiss this claim. Both Monsanto and BASF moved to dismiss the negligent training claim, but the trial court refused to do so. However, the trial court did dismiss the claims based on the Missouri Crop Protection Act, noting that civil actions under this act are limited to “field crops” which did not include peaches. The trial court did not dismiss the civil conspiracy claim based on concerted action by agreement, but did dismiss the aiding and abetting portion of the claim because that cause of action is no recognized under Missouri tort law.
The parties agreed to a separate jury determination of punitive damages for each defendant. Bader Farms, Inc. v. Monsanto Co., et al., No. MDL No. 1:18md2820-SNLJ, 2019 U.S. Dist. LEXIS 114302 (E.D. Mo. July 10, 2019). At the jury trial, the jury found that Monsanto had negligently designed or failed to warn for 2015 and 2016 and that both defendants had done so for 2017 to the present. The jury awarded the plaintiff $15 million in compensatory damages and $250 million in punitive damages against Monsanto for 2015 and 2016. The jury also found that the defendants were acting in a joint venture and in a conspiracy. The plaintiff submitted a proposed judgment that both defendants are responsible for the $250 million punitive damages award. BASF objected, but the trial court found the defendants jointly liable for the full verdict in light of the jury’s finding that the defendants were in a joint venture. Bader Farms, Inc. v. Monsanto Co., et al., MDL No. 1:18-md-02820-SNJL, 2020 U.S. Dist. LEXIS 34340 (E.D. Mo. Feb. 28, 2020). BASF then moved for a judgment as a matter of law on punitive damages or motion for a new trial or remittitur (e.g., asking the court to reduce the damage award), and Monsanto moved for a judgment as a matter of law or a new trial. The trial court, however, found both defendants jointly liable, although the court lowered the punitive damages to $60 million after determining a lack of actual malice.
The trial court did uphold the $15 million compensatory damage award upon finding that the correct standard under Missouri law was applied to the farm’s damages. Bader Farms, Inc. v. Monsanto Co, et al., MDL No. 1:18md2820-SNLJ, 2020 U.S. Dist. LEXIS 221420 (E.D. Mo. Nov. 25, 2020). The defendants filed a notice of appeal on December 22, 2020.
No. 4 – Groundwater Discharges and Functional Equivalency
Under the Clean Water Act (CWA), a National Pollution Discharge Elimination System (NPDES) permit is required for an “addition” of any “pollutant” from a “point source” into the “navigable waters of the United States” (WOTUS). 33 U.S.C. §1362(12). Excluded are agricultural stormwater discharges and return flows from irrigated agriculture. 33 U.S.C. §1362(14). Clearly, a discharge directly into a WOTUS is covered. A point source of pollution is that which comes from a discernible, confined and discrete conveyance such as a pipe, ditch or well.
But, is an NPDES permit necessary if the discharge is directly into groundwater which then seeps its way to a WOTUS in a diffused manner? Are indirect discharges from groundwater into a WOTUS covered? If so, does that mean that farmland drainage tile is subject to the CWA and an NPDES discharge permit is required? 1n the 48 years of the CWA, the federal government has never formally taken that position, instead leaving the matter up to the states. The issue is a big one for agriculture. In 2020, the U.S. Supreme Court addressed the issue.
Ninth Circuit Decision
In 2018, three different U.S. Circuit Courts of Appeal decided cases on the discharge from groundwater issue. One of those cases was heard by the U.S. Circuit Court of Appeals for the Ninth Circuit. In Hawai’i Wildlife Fund v. County of Maui, 881 F.3d 754 (9th Cir. 2018), the defendant owned and operated four wells at the Lahaina Wastewater Reclamation Facility (LWRF). Although constructed initially to serve as a backup disposal method for water reclamation, the wells became the defendant’s primary means of effluent disposal into groundwater and, ultimately, the Pacific Ocean. The defendant injected approximately 3 to 5 million gallons of treated wastewater per day into the groundwater via its wells. The wastewater seeped through the groundwater for about one-half of a mile until it reached the Pacific Ocean. The U.S. Court of Appeals for the Ninth Circuit held that the seepage into the Pacific from the point-source wells one-half mile away was “functionally one into navigable water,” and that a permit was required because the “pollutants are fairly traceable from the point source to a navigable water.”
After the Ninth Circuit issued its opinion, the EPA, on February 20, 2018, requested comment on whether pollutant discharges from point sources that reach jurisdictional surface waters via groundwater may be subject to Clean Water Act (“CWA”) regulation. Specifically, the EPA sought comment on whether the EPA should consider clarification or revision of previous EPA statements regarding the Agency’s mandate to regulate discharges to surface waters via groundwater under the CWA. In particular, the EPA sought comment on whether it is consistent with the CWA to require a CWA permit for indirect discharges into jurisdictional surface waters via groundwater. The EPA also sought comment on whether some or all of such discharges are addressed adequately through other federal authorities, existing state statutory or regulatory programs or through other existing federal regulations and permit programs.
After receiving over 50,000 comments, on April 15, 2019, the EPA issued an interpretive statement concluding that the releases of pollutants to groundwater are categorically excluded from the NPDES regardless of whether the groundwater is hydrologically connected to surface water. The EPA reasoned that the Congress explicitly left regulation of groundwater discharges to the states and that the EPA had other statutory authorities through which to regulate groundwater other than the NPDES. The EPA, in its statement, noted that its interpretation would apply in areas not within the jurisdiction of the U.S. Circuit Courts of Appeal for the Ninth and Fourth Circuits.
The Supreme Court and the Hawaii Case
In 2019, the U.S. Supreme Court agreed to hear the Ninth Circuit opinion. Hawaii Wildlife Fund v. County of Maui, 881 F.3d 754 (9th Cir. 2018), pet. for cert. granted, County of Maui v. Hawaii Wildlife Fund, 139 S. Ct. 1164 (2019). Boiled down to its essence, the case turns on the meaning of “from.” As noted above, an NPDES permit is required for point source pollutants that originate “from” a point source that are discharged into a navigable water. The NPDES system only applies to discharges of “any addition” of any pollutant from “any point source” to “navigable waters.” Thus, by the statutory text, there must be an “addition” of a pollutant to a navigable water of the U.S. “from” a point source. Discharges of pollutants into groundwater are not subject to the NPDES permit requirement even if the groundwater is hydrologically connected to surface water. The legislative history of the CWA indicates that the Congress intentionally chose not to regulate hydrologically-connected groundwater, instead leaving such regulation up to the states. See, e.g., Umatilla Water Quality Protective Association v. Smith Frozen Foods, 962 F. Supp. 1312 (D. Or. 1997).
As noted, the case involved pollutants that originated from a point source, traveled through groundwater, and then a half-mile later reached a WOTUS. Does the permit requirement turn on a direct discharge into a WOTUS (an addition of a pollutant from a point source), or simply a discharge that originated at a point source that ultimately ends up in a WOTUS? Clearly, the wells at issue in the case are point sources – on that point all parties agreed. But, are indirect discharges into a WOTUS via groundwater (which is otherwise exempt from the NPDES) subject to the permit requirement?
On April 23, 2020, in County of Maui v. Hawaii Wildlife Fund, 140 S. Ct. 1462 (2020), issued a 6-3 opinion written by Justice Breyer holding that an NPDES permit is required not only when there is a direct discharge of a pollutant from a point source into a WOTUS, but also when there is the “functional equivalent” of a direct discharge. This conclusion, the Court noted, was somewhat of a middle ground between the Ninth Circuit’s “fairly traceable” test and the position that a permit is required only if a point source ultimately delivered the pollutant to a WOTUS. The Court determined that because the Congress coupled the words “from” and “to” in the statutory language that the Congress was referring to the destination of a WOTUS rather than the origin of a point source. Thus, the Court determined that a permit is required when there is a direct discharge of a point source pollutant to a WOTUS or when, in effect, that is what occurred. The Court believed that the EPA’s recent Interpretive Statement excluding all releases of pollutants to groundwater from the permit requirement was too broad and would create a loophole that would defeat the purpose of the CWA. The Court noted that many factors could be relevant in determining whether a particular discharge is the functional equivalent of a direct discharge into a WOTUS, but that time and distance would be the most important factors in most cases. The Court also indicated that other factors could include the nature of the material through which a pollutant traveled and the extent of its dilution or chemical change while doing so, and noted that the lower courts would provide additional guidance as they decided subsequent cases.
Justice Thomas dissented (joined by Justice Gorsuch), pointing out that the use of the word “addition” in the statute requires an augmentation or increase of a WOTUS by a pollutant and that, as a result, anything other than a direct discharge is statutorily excluded. Indeed, in 2010, the Court declined to hear a case where the lower court held that an NPDES permit is not required unless there is an “addition” of a pollutant to a WOTUS. See e.g., Friends of the Everglades, et al. v. South Florida Water Management District, et al., 570 F.3d 1210 (11th Cir. 2009) reh’g., den., 605 F.3d 962 (11th Cir. 2010), cert. den., 131 S. Ct. 643 (2010). Justice Thomas also noted that the Court’s opinion provided practically zero guidance on the question of when a permit is necessary when a direct discharge is not involved, except for the Court’s provision of a list of non-exhaustive factors. Justice Thomas stated, “[The] Court does not commit to whether those factors are the only relevant ones, whether [they] are always relevant, or which [ones] are the most important.”
Justice Alito also dissented, similarly disenchanted with the nebulous standard and “buck-passing” of the Court to lower courts on the issue. Justice Alito wrote that, “If the Court is going to devise its own legal rules, instead of interpreting those enacted by Congress, it might at least adopt rules that can be applied with a modicum of consistency.”
Ultimately, the Court’s “functional equivalency” test was narrower than the “fairly traceable” test that the Ninth Circuit utilized, and the Court vacated the Ninth Circuit’s opinion and remanded the case for a decision based on the Court’s standard.
Implications for agriculture. The Court’s opinion is significant for agriculture. From a hydrological standpoint, surface water and groundwater systems are often connected. Groundwater is what often maintains a presence of surface water in a stream. From agriculture’s perspective, the case is important because of the ways that a pollutant can be discharged from an initial point and ultimately reach a WOTUS. For example, the application of manure or commercial fertilizer to a farm field either via surface application or via injection could result in eventual runoff of excess via the surface or groundwater into a WOTUS. Certainly, when manure collects and channelizes through a ditch or depression and enters a WOTUS a direct discharge requiring an NPDES permit is required. See, e.g., Concerned Area Residents for the Environment v. Southview Farm, 34 F.3d 114 (2d Cir. 1994). But, that’s a different situation from seepage of manure (or other “pollutants”) through groundwater. No farmer can guarantee that 100 percent of a manure or fertilizer application is used by the crop to which it is applied and that there are no traces of the unused application remaining in the soil. Likewise, while organic matter decays and returns to the soil, it contains nutrients that can be conveyed via stormwater into surface water. The CWA recognizes this and contains an NPDES exemption for agricultural stormwater discharges. But, if the Supreme Court decides in favor of the environmental group, the exemption would be removed, subjecting farmers (and others) to onerous CWA penalties unless a discharge permit were obtained - at a cost estimated to exceed $250,000 (not to mention time delays).
What about farm field tile drainage systems? Seemingly, such systems would make it easier for “pollutants” to enter a WOTUS. Such drainage systems are prevalent in the Midwest and other places, including California’s Central Valley. Groundwater, by some standards, is polluted or includes pollutants. Farm field drainage tile is deliberately installed to deliver that polluted groundwater to a WOTUS. That is a significant reason that groundwater discharges have always been exempt from the NPDES permit requirement along with agricultural stormwater discharges and agricultural irrigation return flows. Should the law now discourage agricultural drainage activities?
Pesticide drift and groundwater discharges of “pollutants” - two big issues for agricultural producers. Next time I look at the three biggest developments of 2020.
Saturday, January 9, 2021
There were many major legal and tax developments during 2020 that impacted agriculture and will continue to do so into the future. Today, I continue my journey through the biggest developments of 2020.
The seventh and six most impactful developments of 2020 – it’s the topic of today’s post.
No. 7 – NRCS Final Rule on Conservation Provisions of the 1985 Farm Bill
85 Fed. Reg. 53137 (Aug. 28, 2020)
The federal government’s regulation of farm and ranch land is critical to all agricultural producers. As a result, a significant regulatory development in 2020 involving farming practices on land makes the list as No. 7.
In late 2018, the USDA published a new interim rule concerning the conservation provisions that originated with the 1985 Farm Bill. On August 28, 2020, a Final Rule was published. The Final Rule adds definitions for “wetland hydrology,” “normal climatic conditions,” and “best drained condition.” The Final Rule also modifies the manner in which the Natural Resources Conservation Service (NRCS) is to delineate the various types of wetland and states that wetland determinations made between 1990 and 1996 are to be “certified” such that USDA benefits will not be denied if a farmer conducts farming activities on land that is covered by such a certification. 7 C.F.R. §12.5(b)(6)(i).
Delineations. The NRCS claims that the Final Rule was prepared to clarify how the USDA “delineates, determines” and certifies wetlands located on subject land in a manner sufficient for making determinations of ineligibility for certain USDA program benefits. However, the Final Rule does not clarify as much as it alters how the NRCS makes these determinations so as to make the process more convenient for the NRCS, and making appeals from that convenient, simplified process more difficult. The Final Rule also represents a step away from the possible (but often inconvenient) scientific determination of wetland hydrology in regularly cropped farmed wetland across the prairie pothole region (a significant portion of the northern Great Plains and north-central Iowa and south-western Minnesota).
“Best drained condition.” The NRCS claims that allowing the “best drained condition” of a tract is intended…” to provide clarity regarding a long-standing and practiced statutory concept that is fundamental to the identification of…” hydrologically altered farmed wetlands. Calling this assertion a “stretch” is an understatement of substantial degree. The phrase “best drained condition” is derived from Barthel v. United States Department of Agriculture, 181 F.3d 984 (8th Cir. 1999). In that case, the U.S. Court of Appeals for the Eighth Circuit held that the plaintiff landowners were entitled to the historic “wetland and farming regime” of a 450-acre hay meadow irrespective of the degree of manipulation of a ditch drainage device. After more than 15 years and multiple contempt actions brought against the U.S. Secretary of Agriculture in the Barthel litigation, the NRCS finally recognized that the Barthel decision meant that it had to apply a historic drainage (i.e., “best drained condition”) test to wetland determinations, and that the focus of the analysis was not to be on the manipulation of the drainage device, but rather on the effect of the manipulation of the drainage device on the subject property.
Under the Final Rule, the NRCS explains how “best drained condition” is to be identified. The NRCS asserts that the decision is to be made based upon the best available evidence. That could include remote resources such as historical aerial imagery or other historical evidence. Indeed, this is what the NRCS does in practice. NRCS personnel make a decide whether or not the drainage outlet (device) is in good condition by examining the available historic aerial photographs and identifying one as providing the best historic drainage. If the existing drainage matches that historic drainage, then aerial imagery may be used. That’s what constitutes “best available evidence.” One of a handful of aerial photographs taken between 1935 and 1985 is picked as the best by the agency expert. Then it is set aside never to be used again. The agency expert then judges if the outlet is compromised.
Since 1990, many landowners have been told that their wetland determinations made before 1996 were invalid and they requested new ones. The new determinations resulted in more acres being determined as wetland than were designated in the original determinations. This resulted in the loss of land use rights and the payment of penalties. In one instance, an Iowa farmer was forced through a myriad of appeals as a result of wetland conversions done by his drainage district in the 1990s. Following administrative appeals and court challenges (see Gunn v. United States, 118 F.3d 1233 (8th Cir. 1997), cert. den., 522 U.S. 1111 (1998)), and after the farmer and the drainage district were forced to mitigate, an old determination surfaced showing that there actually was no wetland on his farm. The initial determination of no wetland should have been considered certified. Will compensation be paid for the farmer’s loss of property rights? Hardly.
The NRCS responded to a comment about changing determinations based on new technology by stating that the limited circumstances where certified wetland determinations are subject to revision are: “if the land in question has been removed from agricultural use, upon request of the USDA program participant, or when a violation of the wetland conservation provisions has occurred.” In actual practice, this statement is incorrect. NRCS states in its policy manual, The Food Security Act Manual, 5th Edition, that it will not make a review upon request unless it determines that there was an error. Will the policy manual be amended to account for this statement in the Final Rule? That’s a significantly important question for agricultural producers
There are numerous other aspects to the Final Rule. In general, the Final Rule is troubling for farmers in many respects. Perhaps the biggest is the NRCS position concerning wetland hydrology indicators for hydrologically altered wetland. Millions of acres of these types of wetland are present in the prairie pothole states. Also, of primary concern is the NRCS’ intent to triple the tile set-back requirements from the edge of farmed wetlands if the adjoining soil has groundwater discharge potential.
It is difficult to believe that NRCS hydrologists, botanists and soil scientists were meaningfully involved in the writing of the Final Rule.
No. 6 – Dormant Commerce Clause
National Animal Meat Institute v. Becerra, 825 Fed. Appx. 518 (9th Cir. 2020).
Article I, section 8, clause 3 of the United States Constitution (the “Commerce Clause”) grants Congress the power to “regulate commerce” among the states. Although the Constitution does not specifically limit a state’s power to regulate commerce, the United States Supreme Court has long interpreted the clause as an “implicit restraint on state authority, even in the absence of a conflicting federal statute.” Gibbons v. Ogden, 22 U.S. 1 (1824) The basic precept was that when the Constitution was ratified the country was a single economic union, and the states surrendered their sovereign power to impose tariffs and restrain interstate trade. See, e.g., THE FEDERALIST No. 7, 39–41 (Hamilton). Instead, it is the Congress that can impose economic regulation (consistent with constitutional limits) on interstate commerce. Thus, under the “Dormant Commerce Clause” a state cannot enact any rules or regulations that affirmatively discriminate against the economic production of goods in another state without a legitimate local justification for doing so.
Clearly, a law that expressly mandates different treatment of in-state and out-of-state competing economic interests is unconstitutional on its face if that treatment favors in-state interests and burdens out-of-state interests. But, when a law is facially neutral, courts determine whether a Dormant Commerce Clause violation exists on the basis of whether the law imposes burdens on interstate commerce that are "clearly excessive in relation to the putative local benefits.” See, e.g., Minnesota v. Barber, 136 U.S. 313 (1890); Gratiot Sanitary Landfill v. Michigan Department of Natural Resources, 504 U.S. 353 (1992).
State Regulation of Out-of-State Ag Production Activities
Eggs. In 2014, a California federal court dismissed for lack of standing a challenge brought by major egg producing states to a California law (AB1437) dictating methods of production for all eggs sold in California. Missouri, et al. v. Harris, 58 F. Supp. 3d 1059 (E.D. Cal. 2014). The legislation bans the sale of shell eggs within California by producers or handlers if the eggs are the product of an egg-laying hen that was confined in an enclosure that fails to comply with certain animal care standards.
The lawsuit claimed that the law (which amended the state’s Health and Safety Code) and its implementing regulations, violated the Commerce Clause of the United States Constitution and was preempted by the Federal Egg Products Inspection Act. 21 U.S.C. §1031 et seq. Effective January 1, 2015, the law criminalized the sale of eggs for human consumption in California if the eggs were the product of egg-laying hens confined in a manner not in compliance with the law no matter where they were produced. A violation of the law constitutes a misdemeanor and is punishable with a fine of not more than $1,000 or imprisonment in the county jail for not more than 180 days or both. Cal. Health & Safety Code §25997.
The implementing regulations require enclosures containing nine or more egg-laying hens to provide a minimum of 116 square inches of floor space per bird. 3 C.C.R. 1350. Enclosures containing eight or fewer birds are also regulated. Id. Purportedly, the law was enacted to “protect California consumers from the deleterious, health, safety, and welfare effects of the sale and consumption of eggs derived from egg-laying hens that are exposed to significant stress and may result in increased exposure to disease pathogens including salmonella.” The plaintiffs, however, alleged that the California legislature’s real intent was to “level the playing field” for California producers faced with a costly California regulatory regime. It was not enacted, the plaintiffs claimed, with the primary concern of protecting the health of California citizens.
The trial court dismissed the case for lack of standing. The court asserted that the plaintiffs were claiming injury-in-fact to all of the citizens in their respective states, and reasoned that the increased cost of egg production in the non-California states challenging the law did not affect the general citizenry of those states. Instead, the court determined that the California legislation would only impact egg producers that failed to conform their farming procedures to comply with the California rules. Thus, according to the court, the plaintiffs did not bring the case on behalf of “a substantial segment of their populations.” While the court accepted as true the claim that the California legislation would impose a substantial cost on the plaintiff-states, that cost wouldn’t be borne on the citizenry of the states as a whole, but rather just the subset of egg farmers that wished to continue selling eggs in California.
The court also dismissed as without merit and speculative the plaintiffs’ argument that any resulting increase in the cost of eggs would injure all egg consumers. The plaintiffs also alleged that they were disadvantaged compared to other states that were not impacted by the California legislation. The court also dismissed this allegation as a basis for standing because the plaintiff states would not have to completely withdraw from egg production but would only incur “price fluctuations.”
The court also determined that the threat of prosecution by California was merely speculative and was not imminent. The court noted that the plaintiffs didn’t “articulate any concrete plan by their egg farmers to violate California’s shell egg laws.” Merely preferring to continue to market eggs to California, the court said, was not a specific harm. Unfortunately, the trial court failed to cite any cases to support its position on the standing issue where a state threatened to impose or did impose criminal penalties on conduct occurring in other states.
The trial court’s opinion was affirmed on appeal. Missouri v. Harris, 842 F.3d 658 (9th Cir. 2016). The U.S. Supreme Court declined to hear the case. Missouri v. Becerra, 198 L. Ed. 2d 255 (2017).
Calves, pigs and hens. In the fall 2018 election, California voters passed Proposition 12 (“The Farm Animal Confinement Initiative”) that establishes minimum requirements on farmers to provide more space for egg-laying hens, breeding pigs, and caves raised for veal. Specifically, the law requires that covered animals be housed in confinement systems that comply with specific standards for freedom of movement, cage-free design and minimum floor space. The law identifies covered animals to include veal calves, breeding pigs and egg-laying hens. The implementing regulations prohibit a farm owner or operator from knowingly causing any covered animal to be confined in a cruel manner, as specified, and prohibits a business owner or operator from knowingly engaging in the sale within the state of shell eggs, liquid eggs, whole pork meat or whole veal meat, as defined, from animals housed in a cruel manner.
In addition to general requirements that prohibit animals from being confined in a manner that prevents lying down, standing up, fully extending limbs or turning around freely, the measure added detailed confinement space standards for farms subject to the law.
Under Proposition 12, effective January 1, 2022, all pork producers selling in the California market must raise sows in conditions where the sow has 24 square feet per sow. The law also applies to meat processors – whole cuts of veal and pork must be from animals that were housed in accordance with the space requirements of Proposition 12.
The National Animal Meat Institute (NAMI) challenged Proposition 12 as an unconstitutional violation of the Dormant Commerce Clause by imposing substantial burdens on interstate commerce “that clearly outweigh any valid state interest.” The trial court rejected the challenge, finding that the plaintiff failed to establish that the law discriminated against out-of-state commerce for the purpose of economic protectionism. National Animal Meat Institute v. Becerra, 420 F. Supp. 3d 1014 (C.D. Cal. 2019). On appeal, the appellate court affirmed. National Animal Meat Institute v. Becerra, 825 Fed. Appx. 518 (9th Cir. 2020). The appellate court determined that the trial court did not abuse its discretion in finding that the plaintiff was not likely to succeed on the merits of its Dormant Commerce Clause claim. The appellate court also stated that the plaintiff acknowledged that Proposition 12 was not facially discriminatory, and had failed to produce sufficient evidence that California had a protectionist intent in enacting the law. The appellate court noted the trial court’s finding that the law was not a price control or price affirmation statute. Similarly, the appellate court held that the trial court did not abuse its discretion in holding that Proposition 12 did not substantially burden interstate commerce because it did not impact an industry that is inherently national or requires a uniform system of regulation. The appellate court noted that the law merely precluded the sale of meat products produced by a specific method rather than burdening producers based on their geographic location.
A separate legal action has been filed in a different California court against Proposition 12 and it continues.
The regulation of activities on agricultural land, and the regulation of ag productions activities - two big developments in 2020. Next time I start to examine the five most important ag law and tax developments of 2020.
Friday, January 8, 2021
There are a couple of online continuing education events that I will be conducting soon, and the dates are set for two summer national conferences in 2021.
Upcoming continuing education events – it’s the topic of today’s post.
Top Developments in Agricultural Law and Tax
On Monday, January 11, beginning at 11:00 a.m. (cst), I will be hosting a two-hour CLE/CPE webinar on the top developments in agricultural law and agricultural taxation of 2020. I will not only discuss the developments, but project how the developments will impact producers and others in the agricultural sector and what steps need to be taken as a result of the developments in the law and tax realm. This is an event that is not only for practitioners, but producers also. It’s an opportunity to hear the developments and provide input and discussion. A special lower rate is provided for those not claiming continuing education credit.
You may learn more about the January 11 event and register here: https://washburnlaw.edu/employers/cle/taxseasonupdate.html
Tax Update Webinar – CAA of 2021
On January 21, I will be hosting a two-hour webinar on the Consolidated Appropriations Act, 2021. This event will begin at 10:00 a.m. (cst) and run until noon. The new law makes significant changes to the existing PPP and other SBA loan programs, CFAP, and contains many other provisions that apply to businesses and individuals. Also, included in the new law are provisions that extend numerous provisions that were set to expire at the end of 2020. The PPP discussion is of critical importance to many taxpayers at the present moment, especially the impact of PPP loans not being included in income and simultaneously being deductible if used to pay for qualified business expenses. Associated income tax basis issues loom large and vary by entity type.
You may learn more about the January 21 event and register here: https://agmanager.info/events/kansas-income-tax-institute
Summer National Conferences
Mark your calendars now for the law school’s two summer 2021 events that I conduct on farm income tax and farm estate and business planning. Yes, there are two locations for 2021 – one east and one west. Each event will be simulcast live over the web if you aren’t able to attend in-person. The eastern conference is first and is set for June 7-8 at Shawnee Lodge and Conference Center near West Portsmouth, Ohio. The location is about two hours east of Cincinnati, 90 minutes south of Columbus, Ohio, and just over two hours from Lexington, KY. I am presently in the process of putting the agenda together. A room block will be established for those interested in staying at the Lodge. For more information about Shawnee Lodge and Conference Center, you made click here: https://www.shawneeparklodge.com/
The second summer event will be held on August 2-3 in Missoula, Montana at the Hilton Garden Inn. Missoula is beautifully situated on three rivers and in the midst of five mountain ranges. It is also within three driving hours of Glacier National Park, and many other scenic and historic places. The agenda will soon be available, and a room block will also be established at the hotel. You may learn more about the location here: https://www.hilton.com/en/hotels/msogigi-hilton-garden-inn-missoula/
Take advantage of the upcoming webinars and mark you calendars for the summer national events. I look for to seeing you at one or more of the events.
January 8, 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)
Thursday, January 7, 2021
After working through the “Almost Top Ten” agricultural law and tax developments of 2020, I have now reached what I consider to be the ten biggest developments of 2020 in terms of their significance to the agricultural sector as a whole. Agricultural law and agricultural tax intersects with everyday life of farmers and ranchers in many ways. Some of those areas of intersection of good, but some are quite troubling. In any event, it points the need for being educated and having good legal and tax counsel that is well-trained in the special rules that apply agriculture.
Developments 10 through 8 of the “Top Ten” agricultural law and tax developments of 2020 – it’s the topic of today’s post.
No. 10 – Department of Justice Announces Investigation of Meatpackers
In May of 2020, President Trump asked the U.S. Department of Justice (DOJ) to investigate the pricing practices of the major meatpackers. In addition, 11 state Attorneys General have asked the DOJ to do the same. They pointed out in the DOJ request that the four largest beef processors control 80 percent of U.S. beef processing. According to USDA data, boxed beef prices have recently more than doubled while live cattle prices dropped approximately 20 percent over the same timeframe. The concern is that the meatpackers are engaged in price manipulation and other practices deemed unfair under federal law.
Questions about the practices of the meatpacking industry are not new – they have been raised for well over a century. Indeed, a very significant federal law was enacted a century ago primarily because of the practices of the major meatpackers. So, why is there still talk about investigations? Is existing law ineffective?
Much of the matter is grounded in concerns about price manipulation by meatpackers. Section 2020 of the Packers and Stockyards Act (PSA), 7 U.S.C. §§192(a) and (e) makes it unlawful for any packer who inspects livestock, meat products or livestock products to engage in or use any unfair, unjustly discriminatory or deceptive practice or device, or engage in any course of business or do any act for the purpose or with the effect of manipulating or controlling prices or creating a monopoly in the buying, selling or dealing any article in restraint of commerce. This is a distinct concern in the livestock industry.
In June of 2010, the USDA issued proposed regulations providing guidance on the handling of antitrust-related issues under the PSA. 75 Fed. Reg. No. 119, 75 FR 35338 (Jun. 22, 2010). Under the proposed regulations, "likelihood of competitive injury" was defined as "a reasonable basis to believe that a competitive injury is likely to occur in the market channel or marketplace.” It includes, but is not limited to, situations in which a packer swine contractor, or live poultry dealer raises rivals' costs, improperly forecloses competition in a large share of the market through exclusive dealing, restrains competition, or represents a misuse of market power to distort competition among other packers, swine contractors, or live poultry dealers. It also includes situations “in which a packer, swine contractor, or live poultry dealer wrongfully depresses prices paid to a producer or grower below market value, or impairs a producer's or grower's ability to compete with other producers or growers or to impair a producer's or grower's ability to receive the reasonably expected full economic value from a transaction in the market channel or marketplace." According to the proposed regulations, a “competitive injury” under the PSA occurs when conduct distorts competition in the market channel or marketplace. The scope of PSA §202(a) and (b) is stated to depend on the nature and circumstances of the challenged conduct. The regulations specifically note that a finding that a challenged act or practice adversely affects or is likely to affect competition is not necessary in all cases. The proposed regulations note that a PSA violation can occur without a finding of harm or likely harm to competition, but as noted above, that is contrary to numerous court opinions that have decided the issue. The regulations eventually made it into the form of an Interim Final Rule but were later withdrawn. 82 FR 48594 (Oct. 18, 2017).
If the investigation is actually conducted, results could occur that would be very positive to livestock producers (and consumers) throughout the nation.
No. 9 – Conservation Easements
During 2020, the U.S. Tax Court and the appellate courts continued to issue numerous opinions involving the donation of permanent conservation easements to qualified organizations and the donor claiming an associated charitable deduction. Presently, the U.S. Tax Court has over 100 cases on its docket involving donated conservation easements. A donated conservation easement involves a legal agreement between a landowner and either a government agency or a land trust specifying that the donated land must be used in ways that preserve specified conservation/preservation goals.
Very specific requirements contained in the Internal Revenue Code must be satisfied to secure a charitable deduction for the donor. Those rules include a requirement that the donated easement be perpetual in nature and that any proceeds received upon judicial extinguishment of the easement be split between the donor and the donee in a prescribed manner. The easement must also be valued very carefully and meet IRS guidelines. In addition, syndicated easement transactions receive heightened scrutiny by the IRS. A syndicated conservation easement transaction is one where the tax benefit is split among various investors. It is a transaction that the IRS has identified as “abusive” when an appraisal is used to value the donated land that overvalues the land at issue and, thus, inflates the donor’s charitable deduction.
During 2020, the IRS offered a settlement program for persons and entities engaging in transactions that the IRS viewed as improper by allowed such taxpayers to avoid litigation by paying penalties and surrendering any tax benefits already received. Relatedly, in 2020, the U.S. Senate started investigations into potential abuses involving conservation easements. In August, the Senate published its findings, concluding the promoters of syndicated conservation easements and those participating in the transactions had avoided paying billions in taxes improperly. The Senate report termed syndicated conservation easement transactions as an “abusive tax shelter,” and that allowing such deals to continue “could undermine the U.S. Tax system.”
The heightened IRS scrutiny of conservation easement transactions, coupled with the very high rate of success in court challenging the claimed charitable deductions makes it critical that attorneys, other tax advisors and appraisers follow every rule. Deeds conveying the easement must be very carefully drafted. The IRS has indicated that it will examine every transaction and litigate all cases where it deems an inappropriate charitable deduction has been claimed.
No. 8 – Farm Records and FOIA
Telematch, Inc. v. United States Department of Agriculture., No. 19-2372, 2020 U.S. Dist. LEXIS 223112 (D.D.C. Nov. 27, 2020)
Farmers disclose a great deal of information and data to the USDA (federal government) to be able to participate in federal farm programs. The information/data is often tied to the particular farmer and farm location, thus raising privacy concerns over what persons and/or entities have access to it. Indeed, in recent years some animal activists opposed to large-scale confinement livestock production have committed acts of vandalism (and worse) against targeted facilities.
Because the information about farmers, their operations, and the locations of fields and facilities is in the hands of the USDA it is generally subject to disclosure to the public. In 1967, the Congress enacted the Freedom of Information Act (FOIA). 5 U.S.C. §552. The FOIA requires the disclosure of federal government documents upon request. The idea behind the law is to make federal agencies more transparent. But can a FOIA request reach private information of farmers that is in the USDA’s hands? Isn’t this personal information private? It’s an important concern for farmers. In 2020, a federal court issued an opinion that could prove to be very helpful toward easing the concerns of agricultural producers wanting to ensure that their private information is protected from public exposure.
In Telematch, the plaintiff was in the business of collecting and analyzing agricultural data from various sources, including the federal government. The plaintiff submitted seven FOIA requests to the USDA for specific records. The records sought included farm, tract, and customer numbers created by the USDA. The USDA created these numbers to assign them to land enrolled in USDA programs and to identify program participants. The USDA denied the plaintiff’s FOIA requests either in part or fully on the basis that the records at issue were geospatial information exempt from disclosure as relating to specific farm locations and specific farmers, and on the basis that the information sought would result in an unwarranted invasion of personal privacy.
The plaintiff administratively appealed the FOIA requests, and then sued in federal court three months later after being unsatisfied with the USDA’s failure to adjudicate the appeal. The plaintiff alleged that the USDA violated the FOIA by withholding the customer, farm, and tract numbers. Additionally, the plaintiff alleged the USDA violated the FOIA by following an unlawful practice of systematically failing to adhere to FOIA deadlines. The plaintiff claimed that no substantial privacy interest was at stake, and the public interest in obtaining the requested information outweighed any privacy concerns.
As a starting point, the trial court noted that the FOIA mandates that an agency disclose records on request, unless the records fall within an exclusion. As to the farm and tract numbers, the trial court held that the USDA properly withheld the information as geospatial information. The trial court held that the farm and tract numbers are geospatial information, as they refer to specific physical locations. Thus, USDA had properly not disclosed them to the plaintiff.
The trial court also held that the USDA also properly withheld the customer numbers from disclosure. Disclosing them, the trial court determined, would have been an invasion of personal privacy. The court noted that while the customer numbers alone did not reveal information about landowners, they could be combined with other public data to identify individual farmers and reveal information about their farms and financial status. The plaintiff claimed that disclosing the customer, farm, and tract numbers would allow the public to monitor how the USDA was administering its farm programs. Likewise, the plaintiff argued that the disclosure of the information would let the public determine whether the USDA was overpaying program participants and allow the public to determine whether farmers are complying with the USDA program. However, the trial court concluded that neither of the plaintiff’s arguments warranted the disclosure of the numbered information because the plaintiff showed no evidence to support its claim of fraud and because the FOIA’s purpose is to shed light on what the government is doing rather than the conduct of USDA program participants. As a result, the court held that the USDA also properly withheld the customer numbers.
As for the plaintiff’s claim that the USDA systematically failed to adhere to FOIA deadlines, the court held that the plaintiff lacked standing for failing to establish the existence of an unlawful policy or practice. The court noted that the USDA responded to the FOIA requests according to then-existing USDA regulations. The regulations stated that FOIA requests served on USDA required prepayments for the request to commence. The plaintiff failed to prepay on some of the requests, and the USDA completed the remainder of the requests within FOIA deadlines. Finally, the court held that the USDA’s failure to adhere to statutory deadlines to process the plaintiff’s administrative appeals did not rise to the level of systematically ignoring FOIA requests.
An appeal was filed in the case on December 21, 2020.
The DOJ investigating meatpackers; tax issues with donated conservation easements; and the privacy of farm data – developments ten through eight. Next time, I continue working my way toward the most significant ag law and ag tax development of 2020.
Tuesday, January 5, 2021
Today’s post continues my trek through the “Almost Top 10” ag law and tax developments of 2020. 2020 was another big year for many illustrations of the law intersecting with agriculture. In today’s final installation of the “Almost Top 10” I look at an Indiana case involving the state’s right-to-farm law; a Montana case involving the issue of whether dinosaur fossils are minerals and, thus, belong to the mineral estate owner; and force majeure clauses in contracts and their application to events that make contract performance impossible.
The final installment of the “Almost Top Ten” of 2020 – it’s the topic of today’s post.
Himsel v. Himsel, 122 N.E. 3d 395 (Ind. Ct. App. 2019); reh’g. den., No. 18A-PL-645, 2019 Ind App. LEXIS 314 (Ind. Ct. App. Jul. 12, 2019); rev. den., 143 N.E.3d 950 (Ind. 2020).
Every state has enacted a right-to-farm (RTF) law that is designed to protect existing agricultural operations by giving farmers and ranchers who meet the legal requirements a defense in nuisance suits. It may not be only traditional row crop or livestock operations that are protected. But, the RTF laws vary widely from state-to-state. One such law, the Indiana version (Ind. Code §32-30-6-9), was at issue in 2019 and 2020.
The Himsel Litigation
The Indiana Court of Appeals determined that the Indiana RTF law applied to protect the defendant because the change in the nature of the defendant’s hog operation from row crop farming to a large-scale confined animal feeding operation (CAFO) involving 8,000 hogs was “not a significant change” that would make the RTF law inapplicable. In other words, 8,000 hogs in a confinement building raised by a contracting party that likely doesn’t make management decisions concerning the hogs, doesn’t report some the associated contract income as farm income on Schedule F, and cannot pledge the hogs as loan collateral due to a lack of an ownership interest in the hogs, was somehow not significantly different from a farmer raising 200 hogs and 200 head of cattle with associated crop ground who manages the diversified operation. Just the sheer number of hogs alone stands out in stark contrast. Indeed, the hog operation required a change in the existing zoning of the tract.
The plaintiffs in Himsel, members of the same family as the defendants, were found to have essentially come to the nuisance because one of them chose to retire from farming and remain on the land that he had lived on for nearly 80 years, and the other didn’t move from the rural home he built in 1971. An 8,000-head hog confinement operation and the presence of 3.9 million gallons of untreated hog manure was deemed to be comparable to farming in this area in 1941.
The court also determined that a “taking” had not occurred because the plaintiff had not sold his home and moved away from the place where he grew up and lived all of his life, and the RTF law did not take the entire value of the plaintiffs’ property away. The appellate court, however, did not address the implications of whether its opinion essentially granted the CAFO an easement to produce odors across the plaintiffs’ property.
The appellate court declined to rehear the case and the Indiana Supreme Court declined to review the appellate court’s decision by a single vote. On July 17, 2020, a petition for certiorari was filed with the U.S. Supreme Court. On October 5, 2020, the U.S. Supreme Court declined to hear the case.
Following Indiana’s lead, several states have modified their state RTF laws to more closely align with the Indiana provision.
Dinosaur Fossils Are Not Minerals
A common granting clause in a mineral deed specifies that the grantor either conveys or reserves “the oil, gas and other minerals.” That language can raise an issue concerning what “other minerals” means. Does it include such things as gravel, clay granite, sandstone, limestone, coal, carbon dioxide, hot water and steam? The courts have struggled with this issue and have reached differing conclusions. Does the phrase mean anything that is in the soil that the surface estate owner doesn’t use for agricultural purposes? Does is matter how the substance is extracted? Does it matter if the material is located in the subsoil rather than the topsoil? Is it material if the substance can be extracted without significant damage to the surface estate?
The issue of whether dinosaur fossils are “minerals” for the purposes of a mineral reservation clause in a mineral deed was an issue in a recent Montana case. In Murray, court dealt with the issue in a case with millions of dollars on the line. Under the facts of the case, the plaintiffs (a married couple), leased farm and ranch land beginning in 1983. Over a period of years, the owner of the land transferred portions of his interest in the property to his two sons and sold the balance to the plaintiffs. From 1991 to 2005, the plaintiffs and the sons operated the property as a partnership. In 2005, the sons severed the surface estate from the mineral estate and sold their remaining interests in the surface estate to the plaintiffs. A mineral deed was to be executed at closing that apportioned one-third of the mineral rights to each son and one-third to the plaintiffs. After the transactions were completed, the plaintiffs owned all of the surface estate of the 27,000-acre property and one-third of the mineral (subsurface) estate. At the time, none of the parties suspected there were valuable dinosaur fossils on the property, and none of them gave any thought to whether dinosaur fossils were part of the mineral estate as defined in the mineral deed. Likewise, none of the parties expressed any intent about who might own dinosaur fossils that might be found on the property.
Specifically, the mineral deed stated that the parties would own, as tenants in common, “all right, title and interest in and to all of the oil, gas, hydrocarbons, and minerals in, on and under, and that may be produced from the [Ranch].” The purchase agreement required the parties “to inform all of the other parties of any material event which may [affect] the mineral interests and [to] share all communications and contracts with all other Parties.”
In 2006, the plaintiffs gave permission to a trio of fossil hunters to search (and later dig) for fossils on the property. The hunters ultimately uncovered dinosaur fossils of great value including a nearly intact Tyrannosaurus rex skeleton and two separate dinosaurs that died locked in battle. The fossils turned out to be extremely rare and quite valuable, with the “Dueling Dinosaurs” valued at between $7 million and $9 million. In 2014, the plaintiffs sold the Tyrannosaurus rex skeleton to a Dutch museum for several million dollars. A Triceratops foot was sold for $20,000 and a Triceratops skull was offered for sale for over $200,000. The proceeds of sale were placed in an escrow account pending the outcome of a lawsuit that the sons filed. The sons (the defendants in the present action) sued claiming that the fossils were “minerals” and that they were entitled to a portion of any sale proceeds. The plaintiffs brought a declaratory judgment action in state court claiming that the fossils were theirs as owners of the surface estate. The defendants removed the action to federal court and asserted a counterclaim on the basis that the fossils should be included in the mineral estate. The trial court granted summary judgment for the plaintiffs on the basis that, under Montana law, fossils are not included in the ordinary and natural meaning of “mineral” and are thus not part of the mineral estate.
On appeal, the appellate court reversed. The appellate court determined that the term “fossil” fit within the dictionary definition of “mineral.” Specifically, the appellate court noted that Black’s Law Dictionary defined “mineral” in terms of the “use” of a substance, but that defining “mineral” in that fashion did not exclude fossils. The appellate court also noted that an earlier version of Black’s Law Dictionary defined “mineral” as including “all fossil bodies or matters dug out of mines or quarries, whence anything may be dug, such as beds of stone which may be quarried.” Thus, the appellate court disagreed with the trial court that the deed did not encompass dinosaur fossils. Turning to state court interpretations of the term “mineral”, the appellate court noted that the Montana Supreme Court had held certain substances other than oil and gas can be minerals if they are rare and exceptional. Thus, the appellate court determined that to be a mineral under Montana law, the substance would have to meet the scientific definition of a “mineral” and be rare and exceptional. The appellate court held that those standards had been met. The plaintiffs sought a rehearing by the full Ninth Circuit and their request was granted. The appellate court then determined that the issue was one of first impression under Montana law and certified the question of whether dinosaur fossils constitute “minerals” for the purpose of a mineral reservation under Montana law to the Montana Supreme Court.
The Montana Supreme Court answered the certified question in the negative – dinosaur fossils are not “minerals” for the purpose of the mineral reservation at issue because they were not included in the expression, “oil, gas and hydrocarbons,” and could not be implied in the deed’s general grant of all other minerals. “Fossils” and “minerals” were mutually exclusive terms as the parties used those terms in the mineral deed. In making its determination, the Montana Supreme Court reasoned that whether a substance or material is a “mineral” is based on whether it is rare and valuable for its mineral properties, whether the conveying instrument expressed an intent to use the scientific definition of the term, and the relation of the substance or material to the land’s surface and the method and effect of its removal. The Court also noted that deeds are like contracts and should be interpreted in accordance with their plain and ordinary meaning to give effect to the parties’ mutual intent at the time of execution.
The Court noted that the term “minerals” is defined in various areas of Montana statutory law (including tax provisions) and none include “fossils,” and that the only statutory provision mentioning fossils and minerals in the same statute referred to them separately. The Court also noted that the U.S. Department of Interior (for purposes of federal law) had made an administrative decision in 1915 that dinosaur fossils are not “minerals.” As such, the terms were mutually exclusive as used in the mineral deed between the parties, and the plaintiffs maintained ownership of any interests that the two sons had not specifically reserved in the mineral deed. The deed simply did not contemplate including “fossils” under the mineral reservation clause. Instead, the Court concluded that “minerals” under Montana law are a resource that is mined as a raw material for further processing, refinement and eventual economic exploitation. Fossils are not mined, they are excavated, and they are not rare and valuable due to their mineral properties. Therefore, unless specifically mentioned in the mineral deed, language identifying “minerals” would not “ordinarily and naturally” include fossils.
Based on the Montana Supreme Court’s answer to the certified question, the U.S. Court of Appeals for the Ninth Circuit affirmed the federal district court’s order granting summary judgment to the plaintiffs and declaring them the sole owners of the dinosaur fossils.
Force Majeure Clauses in Contracts
Governmental reaction to the China-originated virus in 2020 created legal and economic issues for many persons and businesses. One of those legal issues involves existing contracts. The issuance of various Executive Orders by state governors as a result of the anticipated impact of the virus shut down significant economic activity in those states and triggered problems up and down the food supply chain. That raised numerous questions. What happens when a supply chain is disrupted? What recourse exists for a farmer that entered into a contract to sell corn to an ethanol plant, and now the ethanol price has collapsed and the plant refuses to pay? What if a hog buyer won’t buy hogs because the processing plant is shut-down? What if a milk buyer backs out of a milk contract because the milk market has disintegrated? Grain can be stored and milk can be dumped, but what do you do with a 300-lb. fat hog?
A common provision in some agricultural contracts (particularly hog production contracts) is known as a “force majeure” provision. Under such a provision, a contracting party is not liable for damages due to the delay or failure to perform under the contract because of an event that is beyond the party’s control. Performance is excused until it becomes possible for the party to perform under the contract.
Force Majeure means “superior force” or “unavoidable accident.” It applies when there are circumstances beyond a party’s control that excuses the party from performing, such as an extraordinary event like war, riot, crime, pandemic, etc. Most often, a “force majeure” event involves an “act of God” (i.e. flooding, earthquakes, or volcanoes) or the failure of third parties (such as suppliers and subcontractors) to perform their obligations to a contracting party. However, sometimes a contracting party will attempt to use the clause to extract themselves from a contract that has turned out to not be profitable for them.
A force majeure clause is not uncommon in contracts. It concerns how the parties allocate risk and, in essence, frees the contracting parties from liability or obligation when an extraordinary event or circumstance beyond their control prevents at least one party from fulfilling their contractual obligations. The event or circumstance must be one that the parties couldn’t have anticipated at the time the contract was entered into; the party seeking to remove themselves from the contract must not have caused the problem; and the event or circumstance makes it impossible or impractical to perform the contract.
The wording of a force majeure clause is critical and should be negotiated by the contracting parties so that it applies equally to all parties to the contract. Often, it is helpful if the clause includes examples of acts that will excuse performance under the provision.
A contract may distinguish between “acts of God” and force majeure, and a contract may include an “act of God” clause rather than a force majeure clause. Many contracts contain language specifying that if a particular event occurs, then no performance is required. That type of language tends to deal with “acts of God.” Again, it’s a matter of how the parties allocated risk. Perhaps the virus is such an event that is comparable to those that fall under the category of an “act of God.”
In the next post, I will start the journey through the “Top Ten” of 2020 in ag law and ag tax.
Sunday, January 3, 2021
I continue today with my perusal of the biggest developments in agricultural law and taxation from 2020 with the second installment of the “almost top 10” of 2020. In part one, I covered deprioritization (or the lack thereof) of withheld taxes in a Chapter 12 bankruptcy; the preferential payment rule in bankruptcy involving the Dean Foods matter; the significant ag nuisance jury verdict in North Carolina involving Murphy Brown; and a recent federal court opinion holding that filing a tax return with false information on
Part two of the “almost top ten of 2020” (in no particular order) – that’s the topic of today’s post.
“Renewable” Energy Cash Grants
Section 1603 of the American Recovery and Reinvestment Tax Act (ARRTA) was a green energy subsidy program created by the Congress and signed into law as a part of the 2009 economic “stimulus” package. The program created a system of cash grants in lieu of investment tax credits for entities that installed various types of alternative energy property such as solar, wind, geothermal, biomass, and hydropower. The purpose of payments (which were made after a qualified energy system was installed) was to reimburse grant recipients for a portion of the cost they incurred to install the energy systems at business locations. The program started in 2009 and ended in 2012.
The program is not without criticism and IRS scrutiny. The IRS rigorously audits companies utilizing the grants and, in some instances, the courts have ruled for the companies when the IRS partially denied the grants. Those cases primarily involved indemnity agreements that allowed the financiers of the projects to recover their funds elsewhere if the grant was improperly disallowed. In such “tax equity” deals it is common for the developer that finances a project to indemnify the tax equity investors if the tax benefits are less than expected. See, e.g., Alta Wind I Owner Lessor C v. United States, No. 13-402, 2020 U.S. Claims LEXIS 2071 (Fed. Cl. Oct. 21, 2020). In Alta, the wind energy company plaintiff claimed that the government underpaid on the Sec. 1603 grant. The court ruled that the company had alleged sufficient facts and injury to satisfy the constitutional standing requirement for the court to hear the case because the company had purchased the energy facilities at issue via a negotiated business transaction and alleged it had not been paid in full under Sec. 1603.
The IRS also won a significant case in 2020. In early 2012, the plaintiff placed a qualified wind facility into service at a cost of $433,077,031. The plaintiff applied for a Section 1603 grant (in lieu of tax credits) of $129,923,109. As part of the grant application, the plaintiff submitted a development agreement that claimed to show a “proof of payment” in support of a $60 million development fee. The plaintiff, a “project company,” paid the development fee to its parent company, Invenergy, LLC. The U.S. Treasury awarded the plaintiff a grant of $117,216,098. The Treasury explained that the reason for the $12.7 million shortfall was based on the plaintiff’s excessive cost basis in the facility based on the inclusion of the development fee in the cost basis calculation. The Treasury asserted that the development fee transaction was a sham lacking economic substance shaped solely by tax avoidance motives.
The court agreed. Bank records showed that money passed through the bank accounts of several entities related to the plaintiff by wire transfer and then back into the original account. The court determined that the plaintiff could not establish any business purpose or economic substance to the banking transactions. A CPA from a national firm, as the result of an audit, testified that the development agreement contained no quantifiable services. Invenergy, LLC, was not able to produce any accounting journal entries showing a business purpose for the banking transactions. Thus, the court determined that the evidence showed a development fee with no quantifiable services, circular wire transfers that started and ended in the same bank account on the same day, none of which were corroborated by independent testimony. The court denied the plaintiff reimbursement of the $12,707,011 cash grant, and the U.S. Treasury was entitled to recover an overpayment of $4,380,039. Bishop Hill Energy, LLC, et al. v. United States, 143 Fed. Cl. 540 (2019). The court also reached the same conclusion in California Ridge Wind Energy, LLC v. United States, 143 Fed. Cl. 757 (2019).
The appellate court affirmed, upholding the trial court’s finding that amounts stated by the plaintiff in development agreements pertaining to the wind farms did not reliably indicate the development costs. The appellate court, on a consolidated appeal of the two cases, noted the “round-trip” nature of the payments; the absence in the agreements of any meaningful description of the development services to be provided, and the fact that all, or nearly all, of the development services had been completed by the time the agreements were executed. The appellate court also determined that the services were not quantifiable. As a result, the government could recover $10 million in cash grants from the two companies. California Ridge Wind Energy, LLC v. United States, 959 F.3d 145 (Fed. Cir. 2020).
The case is significant because it could impact the computation of tax credits for future projects.
Trust Income Tax Regulations
On May 7, 2020, the IRS issued proposed regulations providing guidance on the deductibility of expenses that estates and non-grantor trusts incur. REG-113295-18. The reason for the proposed regulations is that the Tax Cuts and Jobs Act (TCJA), effective for tax years beginning after 2017 and before 2026, bars individual taxpayers from claiming miscellaneous itemized deductions. I.R.C. §67(g). This TCJA suspension of miscellaneous itemized deductions for individuals raised questions as to whether and/or how estates and non-grantor trusts are impacted. In late September, the IRS finalized the regulations. TD 9918 (Sept. 21, 2020).
The Final Regulations affirm that deductions for costs which are paid or incurred in connection with the administration of an estate or trust and which would not have been incurred if the property were not held in such trust or estate remain deductible in computing AGI. In other words, I.R.C. §67(e) overrides I.R.C. §67(g). However, the Final Regulations do not provide any guidance on whether these deductions (including those under I.R.C. §§642(b), 651 and 661) are deductible in computing alternative minimum tax for an estate or trust. That point was deemed to be outside the scope of the Final Regulations.
As for excess deductions, the Final Regulations confirm the position of the Proposed Regulations that excess deductions retain their nature in the hands of the beneficiary. Treas. Reg. §1.642(h)-2(a)(2). Excess deductions passing from a trust or an estate have their nature pegged by Treas. Reg. §1.652(b)-3. The nature of excess deductions of a trust or an estate is determined by a three-step process: 1) direct expenses are allocated first (e.g., real estate taxes offset real estate rental income); 2) the trustee can exercise discretion when allocating remaining deductions – in essence, offsetting less favored deductions for individuals by using them against remaining trust/estate income (also, if direct expenses exceed the associated income, the excess can be offset at this step); 3) once all of the trust/estate income has been offset any remaining deductions constitute excess deductions when the trust/estate is terminated that are allocated to the beneficiaries in accordance with Treas. Reg. §1.642(h)-4. Treas. Reg. 1.642(h)-2(b)(2).
Lying With Purpose of Harming Livestock Facility is Protected Speech
Animal Legal Defense Fund v. Schmidt, 434 F. Supp. 3d 974 (D. Kan. 2020)
Beginning with Kansas in 1990, several states have enacted legislation designed to protect confined animal production facilities from sabotage activity from groups and individuals opposed to animal agriculture. The laws generally forbid undercover filming or photography of activity on farms without the owner's consent. They have been challenged as unconstitutional on numerous occasions.
In this federal case involving Kansas law, the plaintiffs are a consortium of activist groups regularly conduct undercover investigations of livestock production facilities. Some of the plaintiffs gain access to farms through employment without disclosing the real purpose for which they seek employment (and lie about their ill motives if asked) and wear body cameras while working. For those hired into managerial and/or supervisory positions, they gain the ability to close off parts of the facility to avoid detection when filming and videoing. The film and photos obtained are circulated through the media and with the intent of encouraging public officials, including law enforcement, to take action against the facilities. The employee making the clandestine video or taking pictures, is on notice that the facility owner forbids such conduct via posted notices at the facility. The other plaintiffs utilize the data collected to cast the facilities in a negative public light but do no “investigation.”
In 1990, Kansas enacted the Kansas Farm Animal and Field Crop and Research Facilities Protect Act (Act). K.S.A. §§ 47-1825 et seq. The Act makes it a crime to commit certain acts without the facility owner’s consent where the plaintiff commits the act with the intent to damage an animal facility. Included among the prohibited acts are damaging or destroying an animal facility or an animal or other property at an animal facility; exercising control over an animal facility, an animal from an animal facility or animal facility property with the intent to deprive the owner of it; entering an animal facility that is not open to the public to take photographs or recordings; and remaining at an animal facility against the owner's wishes. K.S.A. § 47-1827(a)-(d). In addition, K.S.A. § 47-1828 provides a private right of action for "[a]ny person who has been damaged by reason of a violation of K.S.A. § 47-1827 against the person who caused the damage." For purposes of the Act, a facility owner’s consent is not effective if it is induced by force, fraud, deception duress or threat. K.S.A. § 47-1826(e). The plaintiff challenged the constitutionality of the Act, and filed a motion for summary judgment. The defendant also motioned for summary judgment on the basis that the plaintiffs lacked standing or, in the alternative, the Act barred trespass rather than speech.
On the standing issue, the trial court held that the plaintiffs lacked standing to challenge the portions of the Act governing physical damage to an animal facility (for lack of expressed intent to cause harm) and the private right of action provision, However, the trial court determined that the plaintiffs did have standing to challenge the exercise of control provision, entering a facility to take photographs, etc., and remaining at a facility against the owner’s wishes to take pictures, etc. The plaintiffs that did no investigations but received the information from the investigations also were deemed to have standing on the same grounds. On the merits, the trial court determined that the Act regulates speech by limiting what the plaintiffs could say and by barring pictures/videos. The trial court determined that the provisions of the Act at issue were content-based and restricted speech based on viewpoint – barring only that speech that would harm an animal facility. The trial court determined that barring lying is only constitutionally protected when it is associated with a legally recognizable harm, and the Act is unconstitutional to the extent it bars false speech intended to damage livestock facilities. Because the provisions of the Act at issue restrict content-based speech, its constitutionality is measured under a strict scrutiny standard. As such, a compelling state interest in protecting legally recognizable rights must exist. The trial court concluded that even if privacy and property rights involved a compelling state interest, the Act must be narrowly tailored to protect those rights. By focusing only on those intending to harm owners of a livestock facility, the Act did not bar all violations of property and privacy rights. The trial court also determined that the Governor was a proper defendant.
In a later action, the court entered a permanent injunction against enforcement of Kan. Stat. Ann. §§47-1827(b)-(d). Animal Legal Defense Fund v. Kelly, No. 18-2657-KHV, 2020 U.S. Dist. LEXIS 58909 (D. Kan. Apr. 3, 2020). A notice of appeal of the court’s decision was filed on May 1, 2020. In July, the court trimmed-down the plaintiff’s request of attorney fees and costs from almost $250,000 to slightly over $176,000. Animal Legal Defense Fund v. Kelly, No. 18-2657-KHV, 2020 U.S. Dist. LEXIS 124,480 (D. Kan. Jul. 15, 2020).
In the next post, I will continue the look at the “almost Top 10” of 2020 with Part 3.
Friday, January 1, 2021
It’s the time of year again where I sift through the legal and tax developments impacting U.S. agriculture from the past year, and rank them in terms of their importance to farmers, ranchers, agribusinesses, rural landowners and the ag sector in general.
As usual, 2020 contained many legal and tax developments of importance to the agricultural sector. Of course, there were major tax law changes that occurred as a result of the federal government’s response to various state governors shutting down businesses in their states and locking down their economies with resulting economic harm. The other issues continued their natural ebb and flow in reaction to the economics governing the sector and policy and regulatory implementations.
It’s also difficult to pair things down to ten significant developments. There are other developments that are also significant, but perhaps less so on a national scale. So, today’s post is the first installment in a series devoted to those developments that were left on the cutting table and didn’t quite make the “Top Ten” for 2020.
The “almost top ten of 2020” (in no particular order) – that’s the topic of today’s post.
Withheld Tax Not Deprioritized in Bankruptcy
In In re DeVries, 621 B.R. 445 (8th Cir. B.A.P. 2020), rev’g., No. 19-0018, 2020 U.S. Bankr. LEXIS 1154 (Bankr. N.D. Iowa Apr. 28, 2020)
A major aspect of Chapter 12 bankruptcy is the ability to deprioritize governmental claims (e.g., taxes). But, does the provision cover withheld taxes? Is so, Chapter 12 is even more valuable to farm debtors.
In this case, the debtors filed Chapter 12 and sold a significant amount of farmland and farming machinery in 2017, triggering almost $1 million of capital gain income and increasing their 2017 tax liability significantly. The tax liability was offset to a degree by income tax withholding from the wife’s off-farm job. Their amended Chapter 12 plan called for a refund to the estate of withheld federal and state income taxes. The taxing authorities objected, claiming that the withheld amounts had already been applied against the debtor’s tax debt as 11 U.S.C. §553(a) allowed. The debtors claimed that 2017 legislation barred tax debt arising from the sale of assets used in farming from being offset against previously collected tax. Instead, the debtors argued, the withheld taxes should be returned to the bankruptcy estate. If withheld taxes weren’t returned to the bankruptcy estate, the debtors argued, similarly situated debtors would be treated differently.
The bankruptcy court was faced with the issue of whether 11 U.S.C. §1232(a) entitled the bankruptcy estate to a refund of the withheld tax. Largely based on legislative history, the trial court concluded that 11 U.S.C. §1232(a) overrode a creditor’s set-off rights under 11 U.S.C. §553(a) in the context of Chapter 12. The debtors’ bankruptcy estate was entitled to a refund of the withheld income taxes.
On appeal, the bankruptcy appellate panel for the Eighth Circuit reversed. The appellate panel determined that 11 U.S.C. §1232(a) is a priority-stripping provision and not a tax provision and only addresses the priority of a claim and does not establish any right to or amount of a refund. As such, nothing in the statue authorized a debtor’s Chapter 12 plan to require a taxing authority to disgorge, refund or turn-over pre-petition withholdings for the benefit of the bankruptcy estate. The statutory term “claim,” The court reasoned, cannot be read to include withheld tax as of the petition date. Accordingly, the statute was clear and legislative history purporting to support the debtor’s position was rejected.
Bankruptcy and the Preferential Payment Rule – The Dean Foods Matter
A decade ago, the preferential payment rule arose in the context of the VeraSun bankruptcy. In late 2020, the issue back in relation to bankruptcy filing of Dean Foods, the largest dairy subsidiary company in the United States. Dean Foods and its forty-three affiliates filed Chapter 11 bankruptcy on November 12, 2019 in the United States Bankruptcy Court for the Southern District of Texas, which is being jointly administered under case no. 19-36313. In the fall of 2020, Dean Foods and its affiliates filed a joint Chapter 11 plan of liquidation. Dairy farmers that sold milk to Dean Farms shortly before the bankruptcy filing then started receiving letters demanding repayment of the amount paid for those milks sales.
The preferential payment rule does come with some exceptions. The exceptions basically comport with usual business operations. In other words, if the transaction between the debtor and the creditor occurred in the normal course of the parties doing business with each other, then the trustee’s “avoidance” claim will likely fail.
Exchange for new value. The bankruptcy trustee cannot avoid a transfer to the extent the transfer was intended by the debtor and the creditor (to or for whose benefit such transfer was made) to be a contemporaneous exchange for new value given to the debtor, and occurred in a substantially contemporaneous exchange. 11 U.S.C. §547(c)(1)(A-B). A contemporaneous exchange for new value is not preferential because it encourages the creditor to deal with troubled debtors and because other creditors are not adversely affected if the debtor’s estate receives new value. See, e.g., In re Jones Truck Lines, 130 F.3d 323 (8th Cir. 1997). “New value” as used in Section 547(c) means “money or money’s worth in goods, services, or new credit.” 11 U.S.C. § 547(a)(2). An exchange for new value is presumed substantially contemporaneous if the transfer of estate property is made within seven days of the transfer of the new value. See, e.g., In re Mason, 189 B.R. 932 (Bankr. N.D. Iowa 1995).
Ordinary course of business. The bankruptcy trustee also cannot avoid a transfer to the extent that the transfer was in payment of a debt that the debtor incurred in the ordinary course of the debtor’s business (or financial affairs) with the creditor, and the transfer was made in the ordinary course of business or financial affairs of the debtor and the creditor; or was made according to ordinary business terms. 11 U.S.C. §547(c)(2)(A)-(B). If the transaction at is the first between the parties, “the transaction must be typical compared to both parties’ past dealings with similarly-situated parties. In re Pickens, No. 06-01120, 2008 Bankr. LEXIS 6 (Bankr. N.D. Iowa Jan. 3, 2008).
The vast majority of dairy farmers receiving the demand letters should be able to demonstrate that the milk sales were in the ordinary course of business. But, just knowing the exceptions to the rule is vitally important.
Appellate Court Upholds $750,000 Compensatory Damage Award in Hog Nuisance Suit
Here, the plaintiffs were pre-existing neighbors to the defendant’s large-scale confinement hog feeding facility conducted by a third-party farming operation via contract. The facility annually maintained nearly 15,000 of the defendant’s hogs that generated about 153,000 pounds of feces and urine every day. The waste was disposed of via lagoons and by spreading it over open “sprayfields” on the farm. The plaintiffs sued in state court in 2013 for nuisance violations, but later dismissed that action and refiled in federal court after learning of the defendant’s control over the hog feeding facility naming the defendant as the sole defendant.
The federal trial court coordinated 26 related cases against similar hog production operations brought by nearly 500 plaintiffs into a master case docket and proceeded with trials in 2017. In this case, the jury awarded $75,000 in compensatory damages to each of 10 plaintiffs and $5 million in punitive damages to each plaintiff. The punitive damage award was later reduced to $2.5 million per plaintiff after applying a state law cap on punitive damages.
On appeal, the appellate court determined that the trial court had properly allowed the plaintiffs’ expert testimony to establish the presence of fecal material on the plaintiffs’ homes and had properly limited the expert witness testimony of the defendant concerning odor monitoring she conducted at the hog facility. The appellate court also rejected the defendant’s claim that the third party farming operation should be included in the case as a necessary and indispensable party. The appellate court also affirmed the trial court’s holding concerning the availability of compensatory damages beyond the rental value of the property and the jury instruction on nuisance. The appellate court also concluded that the trial court properly submitted the question of punitive damages to the jury. The appellate court reversed the trial court’s admission of financial information of the defendant’s corporate grandfather and combining the punitive damages portion of the trial with the liability portion, but held that such errors did not require a new trial. However, the appellate court remanded the case for a consideration of the proper award of punitive damages without consideration of the grandparent’s company’s financial information (such as compensation amounts to corporate executives).
It’s also important to note that while North Carolina law was involved in this case, as a result of this litigation several states, including Nebraska and Oklahoma, have recently amended their state right-to-farm laws with the intent of strengthening the protections afforded farming operations.
Shortly after the appellate court reached its decision, the defendant's parent company (China-based WH Group Ltd and its U.S.-based pork producer Smithfield Foods, Inc.) announced that it settled the nuisance suits brought by hundreds of plaintiffs. Smithfield Foods, Inc. said that the settlement, "takes into account the divided decision of the court."
Lifetime Ban on Owning Firearms For Filing Tax Returns With False Statement
Folajtar v. The Attorney General of the United States, 980 F.3d 897(3rd Cir. 2020)
Any law that impairs a fundamental constitutional right (any of the first ten amendments to the Constitution) is subject to strict scrutiny – or at least it’s supposed to be. The right to bear arms, as the Second Amendment, is a fundamental constitutional right. Thus, any law restricting that right is to be strictly scrutinized. But, does a convicted felon always permanently lose the right to own a firearm. What if the felony is a non-violent one? These questions were at issue in this case.
The plaintiff pleaded guilty in 2011 to willfully making a materially false statement on her federal tax returns. She was sentenced to three-years’ probation, including three months of home confinement, a $10,000 fine, and a $100 assessment. She also paid back taxes exceeding $250,000, penalties and interest. Her conviction triggered 18 U.S.C. §922(g)(1), which prohibits those convicted of a crime punishable by more than one year in prison from possessing firearms. The plaintiff’s crime was punishable by up to three years’ imprisonment and a fine of up to $100,000.
As originally enacted in 1938, 18 U.S.C. §922(g)(1) denied gun ownership to those convicted of violent crimes (e.g., murder, kidnapping, burglary, etc.). However, the statute was expanded in the 1968. Later, the U.S. Supreme Court recognized gun ownership as an individual constitutional right in 2008. District of Columbia v. Heller, 554 U.S. 570 (2008). In a split decision, the majority reasoned that any felony is a “serious” crime and, as such, results in a blanket exclusion from Second Amendment protections for life. The majority disregarded the fact that the offense was non-violent, was the plaintiff’s first-ever felony offense, and was an offense for which she received no prison sentence. The majority claimed it had to rule this way because of deference to Congressional will that, the majority claimed, created a blanket, categorical rule.
The dissent rejected the majority’s categorical rule, pointing out that the plaintiff’s offense was nonviolent, and no evidence of the plaintiff’s dangerousness was presented. The dissent also noted that the majority’s “extreme deference” gave legislatures the power to manipulate the Second Amendment by simply choosing a label. Instead, the dissent reasoned, when the fundamental right to bear arms is involved, narrow tailoring to public safety is required. Because the plaintiff posed no danger to anyone, the dissent’s position was that her Second Amendment rights should not be curtailed. Likewise, because gun ownership is an individual constitutional right, the dissent pointed out that the Congress bears a high burden before extinguishing it. Post-2008, making a categorical declaration is insufficient to satisfy that burden, according to the dissent.
Expect this case to be headed to the U.S. Supreme Court.
That’s the first part of the trip through the “almost Top 10” of 2020. I will continue the trek through the list next time.