Friday, January 18, 2019
Presently, over 300,000 cell/wireless towers have been erected in the United States. Some of those are on farm and ranch land with the landowners having been presented an agreement to sign allowing the wireless carrier to use of some of the land. But, not all agreements are created equally.
What makes a cell/wireless tower agreement a good one? What are the key elements of a good agreement? What should or should not be included in an agreement from the landowner’s perspective? These questions are the topic of today’s post.
The Battle of the Forms
A key point for a landowner to understand is that when presented with an agreement to sign, the standard form of the wireless carrier is one-sided. It is one-sided in the favor of the wireless carrier. That’s to be expected. After all, a maxim of contract law is that the party who drafts a contract drafts the contract in their favor. So, a wireless carrier, via a landowner agreement, will attempt to take as much advantage of a naïve landowner as possible. That means a landowner presented with a wireless carrier’s boilerplate form could incur substantial legal fees to have the form edited in the negotiation process to reach a more balanced agreement that protects the landowner’s property rights.
A better approach might be for attorneys that represent landowners to develop their own standard form that thoroughly protects a landowner’s property rights while also ensuring that the wireless carrier can still experience an economic benefit from the placement of the tower on the landowner’s property.
There are a couple of basic points to be made when drafting a cell/wireless tower agreement. These are: 1) clearly identify the premises that is subject to the agreement; and 2) clearly identify the grant of authority. An exhibit should be included with the agreement that contains the legal description of the subject property along with drawings and/or photos. The more detail that is provided, the easier it will be to police the agreement. That’s particularly true with respect to unauthorized collocations (the placement of additional electronic devices on a tower) and subleases. In addition, any standard agreement should address the usage of common areas and access points. Similarly, the landowner will want the retained right to control signage, conduct and look. Nobody wants an eyesore on their property.
The grant of authority to the carrier involves the property rights that are given to the company. The grant of authority should be either a license or a lease. An easement should not be granted. The grant of an easement may result in granting others access to the same property. Instead, a license is all the legal authority that a wireless company needs. A license simply gives the wireless company exclusive permission to enter the property to establish the tower and perform necessary maintenance activities. A lease can also be utilized if it grants exclusive use to the wireless company and not shared use. In addition, a lease may provide more protection to the landowner in the event of the bankruptcy of the wireless company.
Whether a license or a lease is utilized, some basic elements should be included in the document.
Term. The term of the agreement and any renewal options should be clearly specified. For larger installations of wireless towers, the term is typically a series of five-year terms totaling somewhere between 20 and 30 years. For smaller installations that are placed in a right-of-way, a shorter term is generally better because of uncertainly that may exist due to governmental regulatory authority. Each particular situation will be different in terms of that the optimal term will be, whether an automatic renewal clause should be included and whether actual affirmative notice should be required of renewals.
Care should be given, however, to the use of a clause that gives the wireless company the “option to lease” or a clause that provides for a long “due diligence” period. The problem with those clauses are that they can tie up the site for a set amount of time with no guarantee of rent flowing to the landowner. Relatedly, a landowner should not allow the wireless company to have a long delivery or construction period for obtaining the necessary permits without requiring additional compensation. Ideally, the term of the agreement should begin immediately with a construction period of 30-60 days being added to the overall term.
If the wireless company desires either an option to lease or a due diligence clause, such a clause should be negotiated as an addition to the basic agreement for additional compensation. For instance, a “due diligence” period is a timeframe that the wireless company is given to obtain the necessary legal clearances and ensure that the location works for the company. This landowner should not give this time period away without additional compensation, even if the underlying agreement is not yet in force. Likewise, during this due diligence period, the landowner should consider requiring the wireless to carry insurance for any activities on the site by the company or consultants (and require copies of consultant reports be provided to the landowner), require prior written consent for any borings, and require the wireless company to indemnify the landowner for liability arising from the conduct of the company or consultants, etc.
Rent. The amount of rent or license fee paid to the landowner will depend on whether the installation is inside or outside the existing right-of-way. If it is inside the right-of way, the amount should be a reasonable approximation of cost. If it is outside the right-of-way, it will likely be tied to the market rate. In either event, a landowner should do the necessary “homework” to determine what an appropriate level of compensation should be, but the landowner’s compensation should be comprised of a base amount with additional compensation for collocation (additional devices added to the existing structure). In addition, a provision for late fees, interest and the possibility of holdover should be included in the agreement. Late fees are essentially whatever the landowner is able to negotiate, with interest on late fees typically limited by state law. A “savings” clause should be included to ensure that a state law barring usury won’t be violated. The hold-over rent amount will likely be in the range of 125 percent to 150 percent of the rent amount at the time the hold-over began.
Assignment. Often, the wireless company will desire to assign the lease to another related (affiliate) company, such as a “tower operating company.” Any assignment should require the landowner’s written approval. One option for a landowner to consider is to execute a property management agreement. But, in no event should the landowner agree to release the original wireless company from responsibility for liability associated with hazardous chemicals (battery leakage, etc.) and insurance.
Relatedly, a landowner should not allow the wireless company to sublicense or sublease without the landowner’s prior written approval. In addition, the landowner should retain the ability to consent to any proposed sublicense or sublease involving the placement of another carrier’s equipment (“facilities”) on the existing tower (or other structure). If additional equipment is desired to be placed on the existing tower or structure, additional rent or fees should be paid to the landowner.
Interference. The landowner is legally obligated to provide the tenant with “peaceable possession” of the premises. “Peaceable possession” means that the landowner will provide the premises to the tenant in a condition that will serve the intended purpose(s) of the tenant’s use. As applied to cell/wireless tower license or lease situations, that means that the landowner should not cause any interference problems for the existing tenant or licensee. For facilities and structures that are outside of a right-of-way and entirely on the landowner’s property, the landowner should ensure that subsequent tenants/licensees (collocators) do not cause interference. While the legal burden is on a newcomer to cure interference issues that are caused by the subsequent placement of a facility on an existing tower/structure, the landlord should take steps to ensure the landlord’s non-responsibility for interference or curing the problem. Also, the landlord should ensure that no rights have been granted that could lead to an interference.
Improvements. A significant area of concern for landowners is how to deal with improvements that the wireless company may desire to place on the tower/structure after the initial installation. Any proposed improvement should require detailed plans with prior approval and, of course, additional compensation for the landowner. The landowner should not agree to clause language such as, “approval not to be unreasonably withheld, delayed or conditioned…”. Also, the landowner should control the appearance of any improvements, and require that any improvement by the licensee/tenant be performed in compliance with applicable laws, codes and ordinances. In addition, the licensee/landlord should not be authorized to contract for or on behalf of the licensor or impose any additional expense (such as utilities) on the landowner.
The landowner should ensure that improvements will be maintained and upgraded to continuously be in compliance with applicable laws, and that any new installations will not be heavier, or exceed capacity or space than the original grant permitted. Similarly, the agreement should specify that the wireless company pay for utilities and that the landlord is not responsible for any interruptions in cell/wireless service. Concerning an operational issue, the landowner should not allow the wireless company to use the landowner’s electric connection with a submeter.
Access. The landowner should make sure that the agreement provides sufficient protection related to access to the property. In general, it is advisable to require the landowner to be given 24-hour notice when access to the property is desired or will be occurring. In addition, access to the property should be limited to just what is necessary to accomplish the purpose of gaining access. Also, some provision should be included in the agreement for emergency access to the property. If the wireless facilities are installed on the roof of a building, access to the facilities should be limited to just those areas that the wireless company needs. In addition, if the facility is placed on the top of a commercial building the roof contractor should approve of the access and roof penetrations should be avoided that could possibility invalidate roof warranties. Relatedly, the size, weight and frequency of roof access should be limited. If the installation of the cell/wireless facility is on private land (such as farmland), access should similarly be limited, and provisions included to protect fencing and animals, for example. The burden of maintaining secure fencing should be on the wireless company.
Default. The agreement should provide for events of default and termination by the landlord. Common events of default would be the non-payment of rent by the wireless company or habitual late payments. Likewise, default could be triggered on the violation of any term of the agreement, including non-permitted collocations and the bankruptcy of the wireless company. Consideration may need to be given as to whether a clause should be included that allows default to be cured by a monetary payment provision.
Care should be taken to clearly specify how and when the wireless company can terminate the agreement. Commonly, wireless carriers want a provision included in the agreement that allows them to terminate the agreement for “technological, economic, or environmental” reasons. A landowner should not accept this clause. It is a “get out of jail free” clause for the wireless company. From the landowner’s perspective, the agreement should either bar terminations by the wireless company or allow it for an additional payment (such as rent for the balance of the then-existing term or an amount of rent equal to a year or two).
Decommissioning. Thought should be given in the agreement concerning the ultimate removal of the tower and related improvements. Removal should also apply to improvements that have been made beneath the surface of the property. The manner of removal may depend on the type of facility that has been erected. If possible, the agreement should provide for immediate ownership of the facility/improvement in the landowner (although this likely won’t work if the structure has been added to a light pole that is on the landowner’s property located in a right-of-way). Alternatively, an option can be included in the agreement for the landowner to retain improvements or require removal of structures, footings and foundations.
Miscellaneous provisions. A well-drafted agreement should contain provisions dealing with numerous other issues. The following is a breakdown of the major “miscellaneous” provisions:
- Insurance provisions should apply to contractors and subsidiaries without reciprocal indemnity (which may be banned by state and/or local law). It’s a good idea to have insurance professionals review the insurance provisions.
- A tax provision should clearly state that taxes due are in addition to the rent amount due under the agreement. Likewise, the agreement should make the wireless company pay any increase in any property tax or insurance as a result of the installation and associated improvements.
- A “notice” provision should require that all notices, requests, demands and other communications be in writing and delivered to a specific address, and have multiple government entities copied (such as the city/county clerk; county/township/city engineer, etc.).
- Clause language should be included to limit the ability of the wireless company to store items on the property. This is an environmental concern. Stored batteries and generators can leach, and diesel fuel can leak.
- A provision should be included for attorney fees.
- Give thought as to whether a severability provision should be included as well as a clause providing that the landlord is not liable for brokerage or agent fees.
- A governing law provision should specify that the governing law is where the premises subject to the agreement is located and that jurisdiction is in the state rather than federal court.
- Other clauses to consider include a mortgage subordination provision; a clause providing for the limitation of liability; no relocation assistance (condemnation payments need to go to the landlord); and that time is of the essence.
- A provision addressing the sale of the agreement.
- It might be a good idea to include a provision addressing the possible sale of the agreement.
Perhaps the biggest key for a landowner in achieving a good agreement with a cell/wireless company is to control the drafting process. A good agreement can produce a good economic result for a landowner. A bad agreement that is not put together well can result in undesireable situations for the landowner. Good legal counsel is a must in getting a good agreement that will provide long-term benefits.
Wednesday, January 16, 2019
An important issue for many farmers and ranchers concerns potential liability for injury or damage caused by persons that work on behalf of the farming or ranching business. This is a real concern because of the many potentially dangerous situations that farming or ranching can present with respect to, for example, machinery and equipment, livestock, and a work environment that is subject to weather conditions that can often be less than favorable.
Farm/ranch businesses and liability for the acts of workers – that’s the topic of today’s post.
Employee or Independent Contractor?
In certain situations, one person may be held liable for the tortious acts of another person based on a special relationship between the two even without having personally committed the act that caused liability. This is known as “vicarious liability,” and it can mean that an employer can be liable for the acts of an employee. But, for the employer to be jointly liable with the employee, the employee must have committed the act leading to liability while acting in the “scope of employment.” This rule is often described as the doctrine of “respondeat superior,” which means “let the person higher up answer.” It’s the control by the employer over an employee that justifies joint liability.
Factors for making the distinction. The control issue is a key point. Vicarious liability generally does not apply to conduct of independent contractors. How is that determination made? While no single factor is dispositive in all cases, an employee is generally one who works subject to the control of the employer. See, e.g., Coates v. Anderson, 84 P.3d 953 (Wyo. 2004). This usually requires control both with respect to the manner and means of performing the particular job task. In these situations, the employer is responsible for the acts of the employee committed in the scope of the employee's employment. The “control” required to make a person an employee rather than an independent contractor is usually held to be control over the physical details of the work. It is not enough that the employer exercise control over the general manner in which the work is carried out, there must be control over the physical details of the work in order for an employer-employee relationship to be established. Therefore, if the employer retains control over the manner of performance by specifying how the work is to be accomplished, the time the individual will start working, the lunch break and other breaks, the employer is retaining control over the manner of performance. Likewise, the employer retains control over the means of performance if the employer provides the tools and equipment necessary to complete the job. An employer may also be directly liable to a customer for breaching a duty of care owed to the customer to supervise its employees involved in service for hire or to supply its employees with safe and proper equipment. See, e.g., Eischen, et al. v. Crystal Valley Cooperative, 835 N.W.2d 629 (Minn. Ct. App. 2013). An independent contractor, on the other hand, although hired to produce a certain result, is not subject to the control of the employer while the work is performed.
In any given situation, there may not be any control over the manner of performance, but there may be control over the means of performance. Thus, individuals hiring other persons to accomplish certain tasks should clearly specify whether an employer-employee relationship is to result. This clarity is often lacking in ag settings.
If the subordinate is free to execute the work without being subject to the direction of the principal as to details, that person is usually an independent contractor. A person engaging an independent contractor is generally not liable to third persons for the independent contractor's acts. However, if the work is such that, unless special precautions are taken, there will be a high degree of danger to others, the person hiring the independent contractor will be liable. This is an exception for “inherently dangerous”activities. This rule first applied principally to work which was highly dangerous even if every possible precaution was taken such as might occur with the use of dynamite. More recently, employer liability has been applied where the work to be done by the independent contractor is not “ultra-hazardous” if it is performed without adequate precautions. In this situation, if the independent contractor omits the precautions, the independent contractor's negligence is attributed to the employer. An example could be aerial crop spraying in some states.
“Scope of employment.” A difficult question in the area of respondeat superior is whether, in a particular case, the employee was acting “within the scope of his employment” when the tort occurred. In general, the tort is within the scope of employment if the individual acted with the intent to further the employer's business, even if the means chosen were indirect, unwise, and perhaps even forbidden. Most courts hold that an employee will be deemed to be within the scope of employment even though the employee's intent to serve the employer is coupled with a separate personal purpose.
Most courts hold that if an accident occurs when the employee is traveling from home to work, the employee is not acting within the scope of employment. This seems correct because the employer usually has no “control” over the employee at that time. The result should be the same even if the employer pays the employee a mileage allowance for the trip, and also agrees to pay the employee's hotel expenses for an overnight stay. Likewise, where the employee is returning home after the day's business activities, most courts do not hold an employer liable if the employee commits a negligent act. In one case, the defendant was not liable for the plaintiff's injuries sustained in an auto accident with the defendant's farm tenant while the tenant traveling from the farm to the defendant's home to help mow the defendant's law. The tenant not acting within scope of his job duties as a farm tenant at the time of accident and no evidence was presented that the defendant was in partnership or acting in a joint enterprise with the tenant. Granillo, et al. v. McKinzie, No. 11-07-00241-CV, 2009 Tex. App. LEXIS 728 (Tex. Ct. App. Feb. 5, 2009).
Interesting cases arise in situations involving an employee on a business trip who makes a short “side trip”, or “detour”, for the employee's own purposes. The traditional view has been that while the employee is on the first leg of a side trip, the employee is engaging in what is often called a “frolic and detour” and is thus not within the scope of employment. But, as soon as the employee begins to return towards the path of the original business trip, the employee is once again within the scope of employment, no matter how far afield the employee may be at that point. The recent trend, however, has been to take a less “mechanical” view of the “frolic and detour” problem. Most courts today hold that the employee is within the scope of business if the deviation is “reasonably foreseeable”. Under this approach, the employee might be within the scope of employment even while heading toward the object of a personal errand, if the deviation was slight in terms of distance. But, if the deviation was large and unforeseeable, in terms of miles, then the employee is not within the scope of business even while heading back towards the business goal, at least until returning reasonably near to the original route the employee was supposed to take.
Recent case. In Moreno v. Visser Ranch, Inc., No. F075822, 2018 Cal. App. LEXIS 1194 (Cal. Ct. App. Dec. 20, 2018), the defendant dairy employed a worker to be on call around the clock to repair equipment on the defendant’s various farms as needed. The worker was in his work vehicle when he was involved in a single vehicle accident. The plaintiff was riding with the worker at the time of the accident. The plaintiff was employed by a third party to perform various services at the dairy and other local farms. On the night of the accident, the worker and third party attended a family function (they were related) not located on farm property. On the way home after the function, the vehicle they were in left the road and rolled over. The plaintiff was not wearing a seat belt and was seriously injured. The plaintiff sued the driver, dairy farm and the auto manufacturer for negligence. The plaintiff also sued the State and the County based on the dangerous condition of the road where the accident occurred (the road was under construction). The dairy moved for summary judgment on the plaintiff’s respondeat superior claim on the basis that the driver was not acting within the scope of employment when the accident occurred. The trial court granted the motion. The trial court also granted summary judgment for the dairy on the issue of liability arising from ownership of the vehicle. The plaintiff was, however, able to recover statutory damages from the driver. On appeal, the appellate court determined that fact issues remained on the respondeat superior claim. Though the worker and the plaintiff were returning from a family function, the driver was on call 24/7 to respond to issues at the dairy farm. In addition, the appellate court determined that a fact issue remained as to whether the worker, was acting within the scope of his employment and benefiting the dairy farm at the time of the accident. The appellate court remanded the case.
The potential liability of a farm or ranch business for the conduct of persons working for it is an important issue. Liability often turns on how much control the business exercises over the job tasks. The liability issue and the ways it can occur for any particular farm or ranch business is a good conversation to have with legal counsel.
Monday, January 14, 2019
I will be doing an early tax season 2-hour continuing education event in February, and the date is set for Washburn Law School’s summer ag tax and estate/business planning conference. These events are the topic of today’s post – tax season CLE/CPE and summer seminar.
Tax Season Seminar/Webinar
The Tax Cuts and Jobs Act (TCJA) enacted in late 2017, has dramatically changed the computation of taxable income and tax liability. One result of this tax reform is that practically all farmers and ranchers will see a lower tax liability. One of the primary reasons for this, at least for sole proprietorships and pass-through entities is the 20 percent qualified business income deduction (QBID). Depreciation rules also have changed significantly as have the rules surrounding like-kind exchanges. Indeed, the disallowance of like-kind exchange treatment for post-2017 trades of personal property also has self-employment tax implications that must be accounted for. There are also numerous other provisions that can impact the tax return including changes in various credits, the doubling of the standard deduction, the elimination of many itemized deductions, changes to loss limitation rules and changes to methods of accounting.
On February 8, 2019, I will be conducting a 2-hour CLE/CPE from noon to 2 p.m. (cst). The seminar will be held live at the law school and will also be simulcast over the web. I will cover the latest changes to IRS forms, Treasury Regulations, and any other last-minute developments impacting the filing of returns during the 2019 filing season. Hopefully, the QBID final regulations will be released before the seminar in time to allow analysis and comment. They are due to be released by January 28 but could be released before then unless the partial government shut-down causes a delay. In any event, attendees will get the latest update of what is necessary to know for filing 2018 returns.
For more information about the February 8 event, click here: http://washburnlaw.edu/employers/cle/taxseasonupdate.html
To register click here: http://washburnlaw.edu/employers/cle/taxseasonupdateregister.html
2019 Summer Seminar
Washburn Law School’s rural law program in conjunction with the Department of Agricultural Economics at Kansas State University will be hold it’s 2019 summer farm income tax and estate/business planning seminar in Steamboat Springs, Colorado on August 13 and 14 at the Grand Hotel. On August 13 myself and Paul Neiffer will be addressing key farm income tax planning concepts, particularly how the final regulations under I.R.C. §199A apply in the farm/ranch context. On August 14, myself and others will be addressing important estate and business planning principles that can be applied to farm and ranch estates.
The summer seminar is also being co-sponsored by WealthCounsel, a network of estate and business planning attorneys that provide educational seminars and an automated drafting system, among other things.
Hold the date for the summer seminar and be watching for further details. If you aren’t able to attend in person, the seminar will be live simulcast over the web.
2019 will be another very busy year on the ag tax and estate/business planning front. I hope to see you at any event somewhere along the road.
Thursday, January 10, 2019
Since the blog post on December 31, I have been surveying the biggest developments in agricultural law and taxation of 2018. The first post looked at those developments that were not quite big enough to make the Top 10. Subsequent posts have examined developments 10 through 4. That brings us to today – the biggest three developments of 2018 in agricultural law and taxation.
Number 3 – The 2018 Farm Bill
In general. In late 2018, a new Farm Bill passed the Congress and was signed into law. As for cost, the total estimated price tag for the Farm Bill is $867 billion (a large portion of that total is devoted to Food Stamps) and it didn’t address the estimated $32 billion in in cost overruns on price loss coverage (PLC) and agriculture risk coverage (ARC) of the prior Farm Bill.
The Farm Bill, like prior law, doesn’t treat all entities that are similarly taxed the same under the attribution rules. In other words, an entity must either be a general partnership or a joint venture to not be limited in payment limits at the entity level. Also remaining the same is the $900,000 AGI limitation to be eligible to participate in federal farm programs. The general $125,000 payment limit also remains the same.
Crop reference prices. Reference prices (for PLC) will be the greater of the current reference price; or 85 percent of the average of the marketing year average price for the most recent five-year period, excluding the high and low prices. If base acres were not planted to a covered crop from 2009-2017, the base acres will be maintained but won’t be eligible for any PLC or ARC payments. The old reference price will be used or the “effective reference price” (ERP). The ERP is used each year and used in determining if there will be a PLC payment. The ERP will never be lower than the current reference price and can never be higher than 115% of the current reference price (from the 2014 Farm Bill). That means that it is possible for the reference price to increase when prices decrease. The ERP will be calculated annually based on 85 percent of the Olympic Average of the mid-year average prices for the last five crop years (eliminating the highest and lowest prices). If this number is higher, it is then compared to 115 percent of the current reference price. If it is lower, it will be the effective reference price for that crop year. If it is higher than the 115 percent, it will be limited to 115 percent. Presently, most major crops are not close to any adjustment to the reference price for at least the next couple of years.
The Farm Bill give participating producers a one-time opportunity to update program yields. The update is accomplished by means of a formula. The formula takes 90 percent of the average yield for crops from 2013-2017 and reduces it by a ratio that compares the 2013-2017 national average yields with the average for 2008-2012 crops. That producers a “yield update factor” that determines the portion of the initial 90 percent that can be used to update program yields. The update factor will vary from crop to crop.
As for ARC, it will be based on physical location of the farm and RMA data will have priority. If a farm crosses county lines, ARC payments will be computed on a pro-rata basis in accordance with the acres in each county with irrigated and non-irrigated payments being calculated for each county. Also, the USDA, with respect to ARC, will use a yield plug of 80 percent of the “transitional yield” and will calculate a trend-adjusted yield that will be used in benchmark calculations.
Other features. The Farm Bill contains numerous other provision of importance. The following is a bullet-point list of a few of the more significant ones:
- While a producer is locked into either PLC or ARC for 2019-2020, an annual election can be made to change the election beginning in 2021.
- The dairy margin program has been enhanced significantly such that smaller scale dairy producers are major beneficiaries under the Farm Bill.
- The CRP acreage cap is increased from 24 million acres to 27 million acres by 2023 (with CRP rental rates limited to 90 percent of the county average rental rate for land enrolled via the continuous enrollment option, and 85 percent of the county average for general enrollments). Two million acres are reserved for grasslands.
- The Conservation Stewardship Program (CSP) is reauthorized, but eliminated is the acre-based funding cap and the $18/acre national average payment rate. Spending is also capped at $1 billion annually.
- The Environmental Quality Incentives Program (EQIP) gets enhanced funding (by $.25 billion) with half of the increase pegged for livestock.
- Farm direct ownership loans are increased from $300,000 to $600,000, and guarantees are enhanced from $700,000 to $1,750,000.
- The Farm Bill increases loan rates by 13-24 percent for grains and soybeans. The new loan rates are$2.20 for corn; $6.20 for soybeans; $3.38 for wheat; $2.20 for sorghum; $2.50 for barley; $2.00 for oats.
- Base acres that were planted entirely to grass and pasture from 2009-2017 will not be eligible for farm program payments, but will be eligible for a five-year grassland incentive contract with the “rental amount” set at $18/acre.
- Crop insurance is not significantly changed, but modifications to crop insurance are designed to incentivize the use of cover crops.
- Hemp is added as an “agricultural commodity” eligible for taxpayer subsidies and it is removed from the federal list of controlled substances.
- Nieces nephews and first cousins can qualify for payments without farming;
- Work is not required to get food stamps;
- New taxpayer subsidies are proved for hops and barley.
- The Farm Bill codifies many changes to the National Organic Standards Board and how the Board represents the public and the USDA on matters concerning organic crops.
Number Two - Waters of the United States (“WOTUS”) Developments
In general. The Clean Water Act (CWA) makes illegal the discharging of dredge or fill material into the “navigable waters of the United States” (WOTUS) without first obtaining a permit from the Secretary of the Army acting through the Corps of Engineers (COE). Unfortunately, just exactly what is a WOTUS that is subject to federal regulation has been less than clear for many years and that uncertainty has resulted in a great deal of litigation. In 2006, the U.S. Supreme Court had a chance to clarify the matter but failed. Rapanos v. United States, 547 U.S. 715 (2006). In subsequent years, the Environmental Protection Agency (EPA) attempted to exploit that lack of clarity by expanding the regulatory definition of a WOTUS.
2014 proposed regulation. In March of 2014, the EPA and the COE released a proposed rule defining “waters of the United States” (WOTUS) in a manner that would significantly expand the agencies’ regulatory jurisdiction under the CWA. Under the proposed rule, the CWA would apply to all waters which have been or ever could be used in interstate commerce as well as all interstate waters and wetlands. In addition, the proposed WOTUS rule specifies that the agencies’ jurisdiction would apply to all “tributaries” of interstate waters and all waters and wetlands “adjacent” to such interstate waters. The agencies also asserted in the proposed rule that their jurisdiction applies to all waters or wetlands with a “significant nexus” to interstate waters.
Under the proposed rule, “tributaries” is broadly defined to include natural or man-made waters, wetlands, lakes, ponds, canals, streams and ditches if they contribute flow directly or indirectly to interstate waters irrespective of whether these waterways continuously exist or have any nexus to traditional “waters of the United States.” The proposed rule defines “adjacent” expansively to include “bordering, contiguous or neighboring waters.” Thus, all waters and wetlands within the same riparian area of flood plain of interstate waters would be “adjacent” waters subject to CWA regulation. “Similarly situated” waters are evaluated as a “single landscape unit” allowing the agencies to regulate an entire watershed if one body of water within it has a “significant nexus” to interstate waters.
The proposed rule became effective as a final rule on August 28, 2015 in 37 states and became known as the “2015 WOTUS rule.”
2015 court injunction and 2016 Sixth Circuit ruling. On October 9, 2015, the U.S. Court of Appeals for the Sixth Circuit issued a nationwide injunction barring the rule from being enforced anywhere in the U.S. Ohio, et al. v. United States Army Corps of Engineers, et al., 803 F.3d 804 (6th Cir. 2015). Over 20 lawsuits had been filed at the federal district court level. On February 22, 2016, the U.S. Court of Appeals for the Sixth Circuit ruled that it had jurisdiction to hear the challenges to the final rule, siding with the EPA and the U.S. Army Corps of Engineers that the CWA gives the circuit courts exclusive jurisdiction on the matter. The court determined that the final rule is a limitation on the manner in which the EPA regulates pollutant discharges under CWA Sec. 509(b)(1)(E), the provision addressing the issuance of denial of CWA permits (codified at 33 U.S.C. §1369(b)(1)(E)). That statute, the court reasoned, has been expansively interpreted by numerous courts and the practical application of the final rule, the court noted, is that it impacts permitting requirements. As such, the court had jurisdiction to hear the dispute. The court also cited the Sixth Circuit’s own precedent on the matter in National Cotton Council of America v. United States Environmental Protection Agency, 553 F.3d 927 (6th Cir. 2009) for supporting its holding that it had jurisdiction to decide the dispute. Murray Energy Corp. v. United States, Department of Defense, No. 15-3751, 2016 U.S. App. LEXIS 3031 (6th Cir Feb. 22, 2016).
2017 – The U.S. Supreme Court jumps in and the “suspension rule.” In January of 2017, the U.S. Supreme Court agreed to review the Sixth Circuit’s decision. National Association of Manufacturers v. Department of Defense, et al., 137 S. Ct. 811 (2017). About a month later, President Trump issued an Executive Order directing the EPA and the COE to revisit the Clean Water Rule and change their interpretation of waters subject to federal jurisdiction such that it only applied to waters that were truly navigable – the approach taken by Justice Scalia in Rapanos v. United States, 547 U.S. 715 (2006). The EPA and Corps later indicated they would follow the President’s suggested approach, and would push the effective date of the revised Clean Water Rule to two years after its finalization and publication in the Federal Register. In November of 2017, the EPA issued a proposed rule (the “suspension rule”) delaying the effective date of the WOTUS rule until 2020.
2018 developments. In January of 2018, the U.S. Supreme Court ruled unanimously that jurisdiction over challenges to the WOTUS rule was in the federal district courts, reversing the Sixth Circuit’s opinion. National Association of Manufacturer’s v. Department of Defense, No. 16-299, 2018 U.S. LEXIS 761 (U.S. Sup. Ct. Jan. 22, 2018). The Court determined that the plain language of the Clean Water Act (CWA) gives authority over CWA challenges to the federal district courts, with seven exceptions none of which applied to the WOTUS rule. In particular, the WOTUS rule neither established an “effluent limitation” nor resulted in the issuance of a permit denial. While the Court noted that it would be more efficient to have the appellate courts hear challenges to the rule, the court held that the statute would have to be rewritten to achieve that result. Consequently, the Supreme Court remanded the case to the Sixth Circuit, with instructions to dismiss all of the WOTUS petitioners currently before the court. Once the case was dismissed, the nationwide stay of the WOTUS rule that the court entered in 2015 was removed, and the injunction against the implementation of the WOTUS rule entered by the North Dakota court was reinstated in those 13 states.
This “suspension” rule that was issued in November of 2017 was published in the Federal Register on February 6, 2018, and had the effect of delaying the 2015 WOTUS rule for two years. In the interim period, the controlling interpretation of WOTUS was to be the 1980s regulation that had been in place before the 2015 WOTUS rule became effective. The “suspension rule” was challenged in court by a consortium of environmental and conservation activist groups. They claimed that the rule violated the Administrative Procedures Act (APA) due to inadequate public notice and comment, and that the substantive implications of the suspension were not considered which was arbitrary and capricious, and improperly restored the 1980s regulation.
In June of 2018, the federal district court for the southern district of Georgia entered a preliminary injunction barring the WOTUS rule from being implemented in 11 states - Alabama, Florida, Georgia, Indiana, Kansas, Kentucky, North Carolina, South Carolina, Utah, West Virginia and Wisconsin. Georgia v. Pruitt, No. 2:15-cv-79, 2018 U.S. Dist. LEXIS 97223 (S.D. Ga. Jun. 8, 2018). A prior decision by the North Dakota federal district court had blocked the rule from taking effect in 13 states – AK, AZ, AR, CO, ID, MO, MT, NE, NV, NM, ND, SD and WY. North Dakota v. United States Environmental Protection Agency, No. 3:15-cv-59 (D. N.D. May 24, 2016).
In July of 2018, the COE and the EPA issued a supplemental notice of proposed rulemaking. The proposed rule seeks to “clarify, supplement and seek additional comment on” the 2017 congressional attempt to repeal the Obama Administration’s 2015 WOTUS rule. Repeal would mean that the prior regulations defining a WOTUS would become the law again. The agencies are seeking additional comments on the proposed rulemaking via the supplemental notice. The comment period was open through August 13, 2018.
In August of 2018, the court issued its opinion in the “suspension rule” case. The court agreed with the plaintiffs, determining that the content restriction on the scope of the public comments that the agencies levied during the rulemaking process violated the APA, and enjoined the suspension rule on a nationwide basis. South Carolina Conservation League, et al. v. Pruitt, No. 2-18-cv-330-DCN, 2018 U.S. Dist. LEXIS 138595 (D. S.C. Aug. 16, 2018).
In September of 2018, another federal court entered a preliminary injunction against the implementation of the Obama-era WOTUS rule. This time the injunction applied in Texas, Louisiana and Mississippi, and applied until the court resolved the case on the issue pending before it. The court specifically noted that the public’s interest in having the Obama-era WOTUS rule preliminarily enjoined was “overwhelming.” Texas v. United States Environmental Protection Agency, et al., No. 3:15-CV-00162 (S.D. Tex. Sept. 12, 2018).
On December 11, 2018, the EPA and the COE proposed a new WOTUS definition that is narrower than the 2015 WOTUS definition, particularly with respect to streams that have water in them only for short periods of time. Once the new proposed rule is published in the Federal Register, a 60-day comment period will be triggered. That publication date (and comment period and subsequent hearing) has now been delayed by the partial government shutdown.
Whew! What a trek through the WOTUS landscape!
Number 1 - I.R.C. §199A (and the proposed regulations)
In general. At the top of the list for 2018 stands the qualified business income deduction (QBID) of new I.R.C. §199A as created by the Tax Cuts and Jobs Act (TCJA). The QBID is a 20 percent deduction for sole proprietorships and pass-through businesses on qualified business income effective for years 2018-2025. The new deduction makes tax planning and preparation more complex - much more complex and it impacts all farm and ranch businesses in terms of how to structure the business and tax planning to take advantage of the deduction. In addition, a complex formula applies to taxpayers that are deemed “high income” under the provision. The formula causes a re-computation of the deduction and injects additional planning concerns. In addition, a separate computation applies to agricultural cooperatives and their patrons. The wide application of the new provision throughout the economy and the agricultural sector cannot be understated.
Proposed regulations. On August 8, 2018, the Treasury issued proposed regulations concerning the QBID. While some aspects of the proposed regulations are favorable to agriculture, other aspects create additional confusion, and some issues are not addressed at all. One favorable aspect is an aggregation provision that allows a farming operation with multiple businesses (e.g., row-crop; livestock; etc.) and common ownership to aggregate the businesses for purposes of the QBID. This is, perhaps, the most important feature of the proposed regulations with respect to agricultural businesses because it allows a higher income farming or ranching business to make an election to aggregate their common controlled entities into a single entity for purposes of the QBID.
Similar to the benefit of aggregation, farms with multiple entities can allocate qualified W-2 wages to the appropriate entity that employs the employee under common law principles. This avoids the taxpayer being required to start payroll in each entity. Likewise, carryover losses that were incurred before 2018 and that are now allowed in years 2018-2025 will be ignored in calculating qualified business income (QBI) for purposes of the QBID. This is an important issue for taxpayers that have had passive losses that have been suspended under the passive loss rules.
Other areas of the proposed regulations need clarification in final regulations. As for aggregation and common ownership of the entities to be aggregated, the proposed regulations limit family attribution to just the spouse, children, grandchildren and parents. In other words, common ownership is limited to lineal ancestors and descendants. It would be helpful if the final regulations included siblings in the relationship test. Also, one of the big issues for farmers and ranchers operating as sole proprietorships or as a pass-through entity is whether land rental income constitutes QBI. One of the unclear issues under the proposed regulations is whether income that a landlord receives from leasing land to an unrelated party (or parties) under a cash lease or non-material participation share lease may qualifies for the QBID. It may not. Clarity is needed.
The proposed regulations appear to take the position that gain that is “treated” as capital gain is not QBI. This would appear to exclude I.R.C. §1231 gain (such as is incurred on the sale of breeding livestock) from being QBI-eligible. Clarity is needed on this point also. Other areas needing clarification include the treatment of losses and how to treat income from the trading in commodities. In addition, clarification is needed with respect to various issues associated with a trusts and estates.
2018 was another incredibly active year on the ag law and tax front. 2019 looks like it will continue the pace. Stay dialed in to the blog, website, seminars, TV and radio programs to keep up with the developments as they occur.
Tuesday, January 8, 2019
This week I continue the trek through the Top Ten ag law and tax developments of 2018 with the top six developments. Today’s post goes through numbers six, five and four. On Thursday I will turn attention to the remaining top three developments
Number 6 – U.S. Supreme Court Says States Can Collect Sales Tax on Remote Sellers
South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018)
In 2018, the U.S. Supreme Court handed South Dakota a narrow 5-4 win in its quest to collect taxes from online sales. The Court held that the Constitution’s Commerce Clause did not bar South Dakota from statutorily requiring remote sellers without a physical presence in the state to collect and remit sales tax on goods and services that are sold to buyers for delivery inside the state of South Dakota. In so doing, the Court overruled 50 years of Court precedent on the issue.
Historical precedence. In 1967, the U.S. Supreme Court determined that the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States” in holding that Illinois could not subject a mail order seller located in Missouri to use tax where the seller had no physical presence in Illinois. National Bellas Hess, Inc. v. Illinois Department of Revenue, 386 U.S. 753 (1967). In holding the law unconstitutional, the Court reasoned that subjecting the seller’s interstate business to local “variations in rates of tax…and record-keeping requirements” would violate the purpose of the Commerce Clause “to ensure a national economy free from…unjustifiable local entanglements.”
Twenty-five years later, the Court reaffirmed the limitations of the Commerce Clause on state regulatory authority in Quill Corporation v. North Dakota, 504, U.S. 298 (1992). In Quill, the Court held that a mail order house with no physical presence in North Dakota was not subject to North Dakota use tax for “property purchased for storage, use, or consumption within the State.” The Court followed closely its holding in National Bellas Hess, Inc. because doing so “encourage[d] settled expectations and …foster[ed] investment by businesses and individuals.” As applied to internet sales, Quill (which predated the internet) does not exempt all internet sales from state sales taxes – just sales by sellers who don’t have a physical presence in a particular state. National retailers have a presence in many states.
More recently, the Court examined a Colorado “tattletale” law that required out-of-state sellers with no physical presence in the state “to notify…customers of their use tax liability and to report” sales information back to Colorado. Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2013). The trial court enjoined enforcement of the law on Commerce Clause grounds. On appeal, the Tenth Circuit held that it couldn’t hear the challenge to the law because the Tax Injunction Act (28 U.S.C. §1341) divested it of jurisdiction and the matter belonged in state court and, ultimately, the U.S. Supreme Court. The Tenth Circuit remanded the case for dismissal of the Commerce Clause claims and dissolution of the permanent injunction. The U.S. Supreme Court reversed and remanded the decision of the Tenth Circuit on the jurisdiction issue and, on remand, the Tenth Circuit, invalidated the Colorado law on Commerce Clause grounds. Direct Marketing Association v. Brohl, 814 F.3d 1129 (10th Cir. 2016).
South Dakota Legislation. S.B. 106 was introduced in the 2016 South Dakota legislative session. It requires the collection of sales taxes from certain remote sellers – those with “gross revenue” from sales in South Dakota of over $100,000 per calendar year or with 200 or more “separate transactions” in the state within the same timeframe. After S.B. 106 was signed into law, the state Department of Revenue soon thereafter began issuing notices to sellers that it thought were in violation of the law. Several out-of-state sellers that received notices did not register for sale tax licenses as the law required, and the state took legal action against them. The result was that the South Dakota Supreme Court invalidated S.B. 106 on Commerce Clause grounds based on the U.S. Supreme Court precedent referenced above. The U.S. Supreme Court agreed to hear the case.
U.S. Supreme Court decision. Article I, Section 8 of the U.S. Constitution says that, “The Congress shall have the power...to regulate commerce…among the several states…”. That was the key point of the Court’s 1967 Bellas Hess, Inc. decision. As noted above, in that case the Court stated that the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States.” Apparently, that is not the case anymore, at least according to the majority in Wayfair – Justices Kennedy, Thomas, Ginsburg, Alito and Gorsuch. Under the new interpretation of the Commerce Clause, states can impose sale tax obligations on businesses that have no physical presence in the state. But is that completely true? Can the Court’s opinion be construed as giving the states a “blank check” to tax out-of-state businesses? Maybe not.
In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), the Court ruled that a state tax would be upheld if it applied to an activity having a substantial nexus with the state; was fairly apportioned; did not discriminate against interstate commerce; and, was fairly related to the services that the state provided. Later, in the Quill case, the Court determined that a physical presence in the taxing jurisdiction was what satisfied the Brady “substantial nexus” requirement.
In Wayfair, the Court determined that a “substantial nexus” could be present without the party subjected to tax having a physical presence in the taxing jurisdiction. But, the key point is that the “substantial nexus” test of Brady remains. Likewise, the other three requirements of Brady remain – fair apportionment; no discrimination against interstate commerce, and; fairly related to services that the state provides. In other words, taxing a business without a physical presence in the state cannot unduly burden interstate commerce. The Wayfair majority determined that the South Dakota law satisfied these tests because of the way it was structured – limited application (based on transactions or dollars of sales); not retroactive; the state was a member of the Streamlined Sales and Use Tax Agreement; the sellers at issue were national businesses with a large online presence; and South Dakota provided tax software to ease the administrative burden.
Implications. Presently, 23 states are “full members” of the Streamlined Sales and Use Tax Agreement. For those states, the Wayfair majority seemed to believe that had the effect of minimizing the impact on interstate commerce. Also, it would appear that any state legislation would have to have exceptions for small businesses with low volume transactions and sales revenue. That’s an important point for many rural businesses that are selling online. Whether a series LLC (in some states such as Iowa) or subsidiaries of a business could be created, each with sales below the applicable threshold, remains to be seen.
Post Wayfair, where will the line be drawn? Wayfair involved state sales tax. Will states attempt to go after a portion of business income of the out-of-state business via income tax? That seems plausible. However, the Interstate Income Act of 1959 (15 U.S.C. §381-384), requires that a business (or individual) have some sort of connection with a state before its income can be taxed (at least with respect to the solicitation of orders for tangible personal property). Is that legislation now unconstitutional too? Or, is there a distinction remaining between taxing receipts as opposed to income? Only time will tell.
Number 5 - Discharges of “Pollutants” To Groundwater
Hawai’i Wildlife Fund v. Cty. of Maui, 881 F.3d 754 (9th Cir. 2018); Upstate Forever, et al. v. Kinder Morgan Energy Partners, LP, et al., 887 F.3d 637 (4th Cir. 2018); Tennessee Clean Water Network v. Tennessee Valley Authority, 905 F.3d 436 (6th Cir. 2018),
Background. 2018 saw a great deal of litigation on the issue of whether the discharge of a “pollutant” into groundwater requires a discharge permit under the Clean Water Act (CWA). Often, the courts have deferred to the EPA position that a point source discharge of a pollutant to groundwater that is hydrologically connected to a “Water of the United States” (WOTUS) is subject to the CWA. However, some courts take the position that a discharge, to be subject to the CWA, must be directed from a point source to a WOTUS. It’s a big issue for agriculture, particularly irrigation crop agriculture.
Ninth Circuit opinion. Early in the year, the U.S. Court of Appeals for the Ninth Circuit said that at least some discharges into groundwater are a CWA-covered event. In the case, the defendant owned and operated four wells at the Lahaina Wastewater Reclamation Facility (LWRF), which is the principal municipal wastewater treatment plant for a city. Although constructed initially to serve as a backup disposal method for water reclamation, the wells have since become the defendant’s primary means of effluent disposal into groundwater and, ultimately, the Pacific Ocean. The LWRF receives approximately 4 million gallons of sewage per day from a collection system serving approximately 40,000 people. That sewage is treated at LWRF and then either sold to customers for irrigation purposes or injected into the wells for disposal. The defendant injects approximately 3 to 5 million gallons of treated wastewater per day into the groundwater via its wells. The defendant conceded, and its expert, confirmed that wastewater injected into wells 1 and 2 enters the Pacific Ocean. In addition, in June 2013 the EPA, the Hawaii Department of Health, the U.S. Army Engineer Research and Development Center, and researchers from the University of Hawaii conducted a study on wells 2, 3 and 4. The study involved placing tracer dye into Wells 2, 3, and 4, and monitoring the submarine seeps off Kahekili Beach to see if and when the dye would appear in the Pacific Ocean. This study, known as the Tracer Dye Study, found that 64% of the treated wastewater from wells 3 and 4 discharged into the ocean.
The plaintiff sued, claiming that the defendant was in violation of the Clean Water Act (CWA) by discharging pollutants into navigable waters of the United States without a CWA National Pollution Discharge Elimination System (NPDES) permit. The trial court agreed, holding that an NPDES permit was required for effluent discharges into navigable waters via groundwater.
On appeal, the appellate court held that the wells were point sources that could be regulated through CWA permits despite the defendant’s claim that an NPDES permit was not required because the wells discharged only indirectly into the Pacific Ocean via groundwater. Specifically, the appellate court held that “a point source discharge to groundwater of “more than [a] de minimis” amount of pollutants that is “fairly traceable from the point source . . . such that the discharge is the functional equivalent of a discharge into a navigable water” is regulated under the CWA.” The appellate court reached this conclusion by citing cases from other jurisdictions that determed that an indirect discharge from a point source into a navigable water requires an NPDES discharge permit. The defendant also claimed its effluent injections are not discharges into navigable waters, but rather were disposals of pollutants into wells, and that the CWA categorically excludes well disposals from the permitting requirements. However, the appellate court held that the CWA does not categorically exempt all well disposals from the NPDES requirements because doing so would undermine the integrity of the CWA’s provisions. Lastly, the plaintiff claimed that it did not have fair notice because the state agency tasked with administering the NPDES permit program maintained that an NPDES permit was unnecessary for the wells. However, the court held that the agency was actually still in the process of determining if an NPDES permit was applicable. Thus, the court found the lack of solidification of the agency’s position on the issue did not affirmatively demonstrate that it believed the permit was unnecessary as the defendant claimed. Furthermore, the court held that a reasonable person would have understood the CWA as prohibiting the discharges, thus the defendant’s due process rights were not violated.
EPA action. 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, EPA seeks comment on whether 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. A number of courts have taken the view that Congress intended the CWA to regulate the release of pollutants that reach “waters of the United States” regardless of whether those pollutants were first discharged into groundwater. However, other courts, have taken the view that neither the CWA nor the EPA’s definition of waters of the United States asserts authority over ground waters, based solely on a hydrological connection with surface waters. EPA has not stated that CWA permits are required for pollutant discharges to groundwater in all cases. Rather, EPA’s position has been that pollutants discharged from point sources that reach jurisdictional surface waters via groundwater or other subsurface flow that has a direct hydrologic connection to the jurisdictional water may be subject to CWA permitting requirements. As part of its request, EPA sought comments on whether it should review and potentially revise its previous positions. 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 seeks 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.
Fourth Circuit opinion. Later in 2018, the U.S. Court of Appeals for the Fourth Circuit largely followed the Ninth Circuit’s approach in a case involving somewhat similar facts. The court held that an ongoing addition of pollutants to navigable waters was sufficient for CWA citizen -suit cases. The plaintiffs, a consortium of environmental and conservation groups, brought a citizen suit under the Clean Water Act (CWA) claiming that the defendant violated the CWA by discharging “pollutants” into the navigable waters of the United States without a required discharge permit via an underground ruptured gasoline pipeline owned by the defendant’s subsidiary. The plaintiff claimed that a discharge permit was needed because the CWA defines “point source pollutant” (which requires a discharge permit) as “any discernible, confined and discrete conveyance, included but not limited to any…well…from which pollutants are or may be discharged.” The trial court dismissed the plaintiffs’ claim.
On appeal, the appellate court held that the court had subject matter jurisdiction under the CWA’s citizen suit provision because the provision covered the discharge of “pollutants that derive from a ‘point source’ and continue to be ‘added’ to navigable waters.” Thus, even though the pipeline was no longer releasing gasoline, it continues to be passing through the earth via groundwater and continued to be discharged into regulable surface waters. This finding was contrary to the trial court’s determination that the court lacked jurisdiction because the pipeline had been repaired and because the pollutants had first passed through groundwater. As such, the appellate court determined that, in accord with the Second and Ninth Circuits, that a pollutant can first move through groundwater before reaching navigable waters and still constitute a “discharge of a pollutant” under the CWA that requires a federal discharge permit. The discharge need not be channeled by a point source until reaching navigable waters that are subject to the CWA. The appellate court did, however, point out that a discharge into groundwater does not always mean that a CWA discharge permit is required. A permit in such situations is only required if there is a direct hydrological connection between groundwater and navigable waters. In the present case, however, the appellate court noted that the pipeline rupture occurred within 1,000 feet of the navigable waters. The court noted that the defendant had not established any independent or contributing cause of pollution.
Sixth Circuit opinion. After the Ninth Circuit and Fourth Circuit decisions, the U.S. Court of Appeals for the Sixth Circuit issued another opinion in 2018 on the groundwater/CWA issue. The Sixth Circuit, in concluded that groundwater is not a point source of pollution under the CWA. The defendant in the case was a utility that burns coal to produce energy. It also produced coal ash as a byproduct. The coal ash was discharged into man-made ponds. The plaintiffs, environmental activist groups, claimed that the chemicals from the coal ash in the ponds leaked into surrounding groundwater where it was then carried to a nearby lake that was subject to regulation under the Clean Water Act (CWA). The plaintiffs claimed that the contamination of the lake without a discharge permit violated the CWA and the Resource Conservation and Recovery Act (RCRA).
The trial court had dismissed the RCRA claim, but the appellate court reversed that determination and remanded the case on that issue. On the CWA claim, the trial court ruled as a matter of law that the CWA applies to discharges of pollutants from a point source through hydrologically connected groundwater to navigable waters where the connection is "direct, immediate, and can generally be traced." The trial court held that the defendant’s facility was a point source because it "channel[s] the flow of pollutants . . . by forming a discrete, unlined concentration of coal ash," and that the Complex is also a point source because it is "a series of discernible, confined, and discrete ponds that receive wastewater, treat that wastewater, and ultimately convey it to the Cumberland River." The trial court also determined that the defendant’s facility and the ponds were hydrologically connected to the Cumberland River by groundwater. As for the defendant’s facility, the trial court held that "[f]aced with an impoundment that has leaked in the past and no evidence of any reason that it would have stopped leaking, the Court has no choice but to conclude that the [defendant’s facility] has continued to and will continue to leak coal ash waste into the Cumberland River, through rainwater vertically penetrating the Site, groundwater laterally penetrating the Site, or both." The trial court determined that the physical properties of the terrain made the area “prone to the continued development of ever newer sinkholes or other karst features." Thus, based on the contaminants flowing from the ponds, the court found defendant to be in violation of the CWA. The trial court also determined that the leakage was in violation of the defendant “removed-substances” and “sanitary-sewer” overflow provisions. The trial court ordered the defendant to "fully excavate" the coal ash in the ponds (13.8 million cubic yards in total) and relocate it to a lined facility.
On further review, the appellate court reversed. The appellate court held that the CWA does not apply to point source pollution that reaches surface water by means of groundwater movement. The appellate court rejected the plaintiffs’ assertion that mere groundwater is equivalent to a discernable point source through which pollutants travel to a CWA-regulated body of water. The appellate court noted that, to constitute a “conveyance” of groundwater governed by the CWA, the conveyance must be discernible, confined and discrete. While groundwater may constitute a conveyance, the appellate court reasoned that it is neither discernible, confined, nor discrete. Rather, the court noted that groundwater is a “diffuse” medium that “travels in all directions, guided only by the general pull of gravity.” In addition, the appellate court noted that the CWA regulates only “the discharge of pollutants ‘to navigable waters from any point source.’” In so holding, the court rejected the holdings of the Ninth Circuit and the Fourth Circuit.
That different conclusion by the Sixth Circuit could prove to be very important for irrigation crop agriculture. It may also mean that the U.S. Supreme Court could be asked to clear up the discrepancy.
Number 4 - Air Emission Reporting for Livestock Operations
Fair Agricultural Reporting Method Act (Farm Act) and Subsequent Litigation
Background. Under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) and the Emergency Planning and Community Right-to-Know Act (EPCRA), the federal government is to be notified when large quantities of hazardous materials are released into the environment. Once notified, the Environmental Protection Agency (EPA) has discretion to take remedial actions or order further monitoring or investigation of the situation. In 2008, the EPA issued a final regulation exempting farms from the reporting/notification requirement for air releases from animal waste on the basis that a federal response would most often be impractical and unlikely. However, the EPA retained the reporting/notification requirement for Confined Animal Feeding Operations (CAFOs) under EPCRAs public disclosure rule.
Various environmental groups sued, challenging the exemption on the basis that the EPA acted outside of its delegated authority to create the exemption. On the other hand, agricultural groups claimed that the retained reporting requirement for CAFOs was also impermissible. The environmental groups claimed that emissions of ammonia and hydrogen sulfide (both hazardous substances under CERCLA) should be reported as part of furthering the overall regulatory objective. The court noted that there was no clear way to best measure the release of ammonia and hydrogen sulfide, but determined that continuous releases are subject to annual notice requirements. The court held that the EPA’s final regulation should be vacated as an unreasonable interpretation of the de minimis exception in the statute. As such, the challenge brought by the agriculture groups to the CAFO carve out was mooted and dismissed. Waterkeeper Alliance, et al. v. Environmental Protection Agency, 853 F.3d 527 (D.C. Cir. 2017).
The court’s order potentially subjected almost 50,000 farms to the additional reporting requirement. As such, the court delayed enforcement of its ruling by issuing multiple stays, giving the EPA additional time to write a new rule. However, on March 23, 2018, President Trump signed into law the Consolidated Appropriations Act of 2018, H.R. 1625. Division S, Title XI, Section 1102 of that law, entitled the Fair Agricultural Reporting Method Act (FARM Act), modifies 42 U.S.C. §9603 to include the EPA exemption for farms that have animal waste air releases. Specifically, 42 U.S.C. §9603(e) is modified to specify that “air emissions from animal waste (including decomposing animal waste) at a farm” are exempt from the CERCLA Sec. 103 notice and reporting requirements. “Animal waste” is defined to mean “feces, urine, or other excrement, digestive emission, urea, or similar substances emitted by animals (including any form of livestock, poultry, or fish). The term animal waste “includes animal waste that is mixed or commingled with bedding, compost, feed, soil or any other material typically found with such waste.” A “farm” is defined as a site or area (including associated structures) that is used for “the production of a crop; or the raising or selling of animals (including any form of livestock, poultry or fish); and under normal conditions, produces during a farm year any agricultural products with a total value equal to not less than $1,000.”
2018 litigation. Relatedly, in late 2018, various environmental groups filed suit in the Federal District Court for the District of Columbia to overturn a USDA/FSA regulation that was issued in 2016 that exempts medium-sized (as redefined) CAFOs from environmental review under the National Environmental Policy Act (NEPA) before receiving FSA loans or loan guarantees. The groups claim that proper procedures were not followed when the rule was developed, and seek to have the rule rescinded and reissued after a determination of the potential impacts of the exemption is made with the reissued rule made subject to a public comment period.
Before the regulation was issued in 2016, the FSA performed Environmental Impact Statement (EIS) reviews to assess the impact of a government loan or loan guarantee to a medium-sized CAFO – defined as a facility holding 350 dairy cows, 500 feedlot cattle, 1250 hogs, 27,500 turkeys, and 50,000 chickens. For those facilities meeting the definition of a medium-sized CAFO, the FSA would undertake an EIS before loans or loan guarantees were approved. The results of the EIS were provided to the public before the USDA/FSA dispersed funds. The EIS process could take many months. Under the 2016 regulation, an EIS is not required unless a particular farm/facility has more than 699 dairy cows, 999 fat cattle, 2,499 hogs, 54,999 turkeys, and 124,999 chickens.
Next time I will go through the biggest three developments in ag law and tax. What do you think they might be?
Friday, January 4, 2019
The journey continues through the biggest developments in agricultural law and taxation for 2018. As I mentioned in Wednesday’s post, these developments are selected based on their impact to ag producers, agribusinesses and associated professional service businesses on a nationwide basis. Today I look at what I view as the Eighth and Seventh most important developments of 2018.
Number 8 – COE Wetland Manuals and Congressional Budget Acts Result in Frozen Dirt Being a “Navigable Wetland”
Tin Cup, LLC v. United States Army Corps of Engineers, 904 F.3d 1068 (9th Cir. 2018).
According to its 1987 Manual for delineating wetlands, before the U.S. Army Corps of Engineers (COE) may assert jurisdiction over an alleged wetland, it must find that the area satisfies the three wetland criteria of hydric soil; predominance of hydrophytic vegetation; and wetland hydrology (soil saturation/inundation). Wetland hydrology under the 1987 Manual requires either the appropriate inundation during the growing season or the presence of a primary indicator. Table 5 of the 1987 Manual indicates a nontidal area is not considered to evidence wetland hydrology unless the soil is seasonally inundated or saturated for 12.5 percent to 25 percent of the growing season. A “growing season” is defined as a season in which soil temperature at 19.7 inches below the surface is above 41 degrees Fahrenheit. The 1987 Manual lists six field hydrologic indicators, in order of decreasing reliability, as evidence that inundation and/or soil saturation has occurred: (1) visual observation of inundation; (2) visual observation of soil saturation; (3) watermarks; (4) drift lines; (5) sediment deposits; and (6) drainage patterns within wetlands.
In 1989, the COE adopted a new manual. The 1989 Manual superseded the 1987 Manual. The delineation procedures contained in the 1989 manual were less stringent. Thus, it became more likely that the COE could determine that a particular tract contained a regulable wetland. This change in delineation techniques caught the attention of the Congress which barred the use of the 1989 Manual via the 1992 Budget Act. Pub. L. No. 102-104, 105 Stat. 510 (Aug. 17, 1991). Specifically, the 1992 Budget Act prohibited the use of funds to delineate wetlands under the 1989 Manual "or any subsequent manual not adopted in accordance with the requirements for notice and public comment of the rulemaking process of the Administrative Procedure Act."
The 1992 Budget Act also required the COE to use the 1987 Manual to delineate any wetlands in ongoing enforcement actions or permit application reviews. In the 1993 Budget Act, the Congress again addressed the issue by stating that, “None of the funds in this Act shall be used to identify or delineate any land as a "water of the United States" under the Federal Manual for Identifying and Delineating Jurisdictional Wetlands that was adopted in January 1989 or any subsequent manual adopted without notice and public comment. Furthermore, the Corps of Engineers will continue to use the Corps of Engineers 1987 Manual, as it has since August 17, 1991, until a final wetlands delineation manual is adopted.” Thus, it was clear that Congress mandated that the COE continue to use the 1987 Manual to delineate wetlands unless and until the COE utilized the formal rulemaking process to change the delineation procedure. While the Congress mandated the use of the 1987 Manual to delineate wetlands, it also appropriated funds to the U.S. Environmental Protection Agency (EPA) to contract with the National Academy of Sciences for a review and analysis of wetland regulation at the federal level. See Department of Veterans Affairs and Housing and Urban Development and Independent Agencies Appropriations Act of 1993, Pub. L. 102-389, 106 Stat. 1571 (Oct. 6, 1992); H.R. Rep. No. 102-710, at 51 (1992); H.R. Conf. Rep. No. 102-902 at 41.
This resulted in a report being published in 1995 containing a suggestion that the 1987 Manual either eliminate the requirement of a “growing season” approach to wetland hydrology or move to a region-specific set of criteria for delineating wetlands. Consequently, the COE began issuing regional “supplements” to the 1987 Manual that provided criteria for wetland delineation that varied across the country. For instance, in the COE’s 2007 Alaska Supplement, the COE eliminated the measure of soil temperature contained in the 1987 Manual and replaced it with “vegetation green-up, growth, and maintenance as an indicator of biological activity occurring both above and below ground.”
In this case, the plaintiff was a closely-held family pipe fabrication company in Alaska that sought to relocate its business for expansion purposes. The plaintiff found a suitable location (a 455-acre tract in North Pole) where it would need to lay gravel and construct buildings as well as a railroad spur. Because gravel is contained within the regulatory definition of “pollutant” under the Clean Water Act (CWA) and because the tract was purportedly a “wetland,” the plaintiff had to obtain a discharge permit so that it could place gravel fill on the property before starting construction. The plaintiff received a permit in 2004 and, pursuant to that permit, cleared about 130 acres from the site. In 2008, the plaintiff submitted another permit application to place gravel fill on the site. The COE issued a new jurisdictional determination in 2010, concluding that wetlands were present on 351 acres, including about 200 acres of permafrost – frozen soil. The COE granted the plaintiff a discharge permit to place gravel fill on 118 acres, but included mitigation conditions that the plaintiff objected to.
The plaintiff sued on the basis that the COE’s delineation of permafrost as a wetland was improper and, thus, a discharge permit was not necessary. The COE delineated the permafrost on the tract as wetland based on its 2008 Alaska Supplement. U.S. Army Corps of Engineers, Regional Supplement to the Corps of Engineers Wetland Delineation Manual: Alaska Region (Version 2.0) (Sept. 2007). However, the COE’s 1987 Manual specifically excludes permafrost from the definition of a wetland. The plaintiff argued that the Congress had instructed the COE to continue to use the wetland delineation standards in the 1987 Manual until the COE adopted a “final wetland delineation manual” as set forth in the 1992 and 1993 Budget Acts, as noted above. Thus, because permafrost does not have the required “growing season” (it never reached 41 degrees Fahrenheit at a soil depth of 19.7 inches) it cannot be a wetland. The plaintiff pointed out that by virtue of the issuance of regional supplements to the 1987 Manual, the COE had expanded its jurisdiction over private property by modifying the definition of a “wetland.” Key to the plaintiff’s argument was the point that the Supplement was not a new manual that had been developed in accordance with the formal rulemaking process (e.g., notice, comment, and public hearing). It also was never submitted to the Congress and the Government Accountability Office which, the plaintiff noted, the Congressional Review Act requires before any federal governmental agency rule can become effective. 5 U.S.C. Ch. 8, Pub. L. No. 104-121, §201.
The trial court ruled against the plaintiff, holding that the COE could rely on the 2008 Supplement when delineating a wetland and determining its jurisdiction. The trial court determined that the Budget Acts have no force beyond the funds that they appropriate. That meant that the COE could delineate wetlands in accordance in whatever manner it determined – the 1987 Manual or any subsequent Manual or supplemental guidance that it issued. On appeal, the appellate court affirmed, holding that the 1993 Budget Act did not require the COE to continue using the 1987 Manual to delineate wetlands. The appellate court stated that there is a “very strong presumption” that if an appropriations act changes substantive law, it does so only for the fiscal year for which the bill is passed” unless there is a clear statement of futurity. Because the 1993 Budget Act contained no such statement, the Court held that the requirement for use of the definition of a growing season in accordance with the 1987 Manual expired at the end of the 1993 fiscal year.
The appellate court allowed the COE to expand its jurisdiction over wetlands. That inserts more uncertainty into the already murky legal status of WOTUS. Perhaps in 2019, the U.S. Supreme Court will hear the case. It’s an important one in terms of holding government agencies accountable to the will of the Congress.
Number 7 – To Be “Critical Habitat” Under the ESA, the Habitat Must Be Habitable
Weyerhaeuser Co. v. United States Fish & Wildlife Service, 139 S. Ct. 361 (2018), rev’g., Markle Interests, L.L.C. v. United States Fish & Wildlife Service, 827 F.3d 452 (5th Cir. 2016)
Under the Endangered Species Act (ESA), when a species of plant or animal is listed as endangered or threatened, the Secretary of the Interior must consider whether to designate critical habitat for the species. “Critical habitat” is the specific area within the geographical range occupied by the species at the time of listing that is essential to the conservation of the species. Critical habitat may also include specific areas outside the geographical area occupied by the species at the time it is listed if the USFWS determines that such areas are essential for conservation of the species. It can also include presently “unoccupied critical habitat.” But, must a designated habitat area be an area where the endangered or threatened species can survive? If not, then even more private land could be subjected to regulation under the ESA. The issue made it all the way to the U.S. Supreme Court in 2018.
In 2001, the U.S. Fish and Wildlife Service (USFWS) listed the dusky gopher frog as an endangered species. Among the areas designated as critical habitat was a 1,544-acre site in Louisiana where the frog species had last been seen in 1965. While that acreage was largely comprised of closed-canopy timber, it contained five ephemeral ponds and the USFWS believed that the tract met the statutory definition of “unoccupied critical habitat” because it could be a prime breeding ground for the frog.
The plaintiff owned part of the 1,544-acre tract and leased the balance from a group of landowners that had plans for development of the portion of the tract that they owned. Those development improvements could amount to over $30 million (in timber farming and development) if the USFWS barred all development on the tract. But, according the USFWS, that potential lost economic value would not be “disproportionate” to the conservation benefits of the designation. Consequently, the USFWS decided to not exclude the 1,544-acre tract from the frog’s critical habitat.
The plaintiff and the landowners sued to vacate the designation on the basis that the tract couldn’t be designated as critical habitat because it hadn’t been habitat for the frog since 1965 and couldn’t be habitat without significant modification. The plaintiff also challenged the USFWS decision baes on the cost/benefit calculation. However, the trial court upheld the designation on the basis that the tract fit the definition of “unoccupied critical habitat” essential for the frog’s conservation.
On appeal, the U.S. Court of Appeals for the Fifth Circuit affirmed on the basis that that definition of “critical habitat” did not require “habitability.” The appellate court also determined that the decision of the USFWS was not subject to judicial review. On further review, the Supreme Court unanimously reversed 8-0 (Justice Kavanaugh did not participate). The Court pointed out that to be “critical habitat,” the designated area must first be “habitat.” Indeed, the Court pointed out that once a species is designated as endangered, the Secretary must designate the habitat of the species which is then considered to be critical habitat. 16 U.S.C. §1533(a)(3)(A)(i). That also applied in the context of unoccupied critical habitat that is determined to be essential for conservation of the species – the area must be “habitat.”
Because the appellate court did not interpret the term “habitat” (the appellate court simply concluded that “critical habitat” was not limited to areas that were “habitat”), the Supreme Court vacated the appellate court’s opinion and remanded on this issue. The Supreme Court also disagreed with the appellate court’s holding that the determination of the USFWS to not exclude the tract as critical habitat was not subject to judicial review. The Supreme Court noted that the plaintiff’s claim involving the alleged improper weighing of costs and benefits of the designation as critical habitat was the type of claim that the federal court’s routinely review when determining whether to set aside an agency decision as an abuse of discretion. Thus, the Supreme Court also vacated this part of the appellate court’s decision and remanded on the issue.
The Court’s decision is a big “win” for agriculture and private landowners in general.
We will continue the journey through the remainder of the “Top Ten of 2018” next week. Six more developments to go.
Wednesday, January 2, 2019
In today’s post I continue the series of the biggest developments in agricultural law and taxation for 2018. These developments are selected based on their impact to ag producers, agribusinesses and associated professional service businesses on a nationwide basis. Today I look at what I view as the Tenth and Ninth most important developments of 2018.
Number 10 - Management Activities and the Passive Loss Rules
Robison v. Comr., T.C. Memo. 2018-88
In recent years, the IRS has shown an increased focus on business activities that it believes are being engaged in without an intent to make a profit. Absent a profit intent, the “hobby loss” rules apply and limit deductions to the amount of income from the activity. But, engaging in an activity with a profit intent may not be enough to fully deduct losses from the activity. That’s particularly the case if the taxpayer hires a paid manager to run the operation. In that situation, the IRS may claim that the taxpayer is not materially participating in the activity under the passive loss rules. If the IRS prevails on that argument, loss deductions are severely limited, if not eliminated.
Robison v. Comr., T.C. Memo. 2018-88 involved both the hobby loss rules and the passive loss rules. While the petitioners’ ranching activity was deemed not to be a hobby, the court believed that the taxpayer was not materially participating in the activity. That triggered the application of the passive loss rules.
The petitioners deducted their losses from their ranching activity annually starting in 1999 and were audited by the IRS in 2004 and 2008. Each of those audits concluded with an IRS determination that the petitioners were conducting a trade or business with profit intent (e.g., the activity was not a hobby). In 2010, the petitioners shifted the ranch business activity from horses to cattle. The cattle operation was strictly grass-fed, with the cattle grazing upper-elevation Bureau of Land Management (BLM) land during the summer months. The petitioners negotiated the lease contracts with the BLM. They also hired a full-time ranch manager to manage the cattle. However, the petitioners managed the overall business of the ranch. From 2013-2015, the losses from the ranch declined each year.
The IRS initiated a third audit and claimed that the ranching activity was a “hobby,” and also raised the alternative argument that the petitioners failed to satisfy the material participation test of the passive loss rules. The Tax Court determined that the ranching activity was not a hobby based on the nine factors set forth in Treas. Reg. §1.183-2. However, the court determined that the petitioners had failed to satisfy the material participation test of the passive loss rule. The losses were, therefore, passive and only deductible in accordance with those rules. The court determined that only two of the seven tests for material participation were relevant – the 500-hour test (Treas. Reg. §1.469-5T(a)(1) and the facts and circumstances test (Treas. Reg. §1.469-5T(a)(7)). As for the 500-hour test, the court took issue with the manner in which the petitioners documented their time spent on the ranching activity. The court opined that their logs were merely estimates of time spent on ranch activities that were created in preparation for trial and didn’t substantiate their hours of involvement.
As for the facts and circumstances test, the court determined that the petitioners could not satisfy the test because of the presence of the paid ranch manager. The court made no distinction between the cattle grazing activity which the ranch manager was responsible for and the overall business operations for which the petitioners were responsible. Indeed, on the material participation issue, due to the presence of the ranch manager, all of the personal actions and involvement of the petitioners on which the court based its determination of their profit motive were dismissed as “investor” hours. Treas. Reg. §1.469-5T(b)(2)(ii)(A).
Combining the passive loss rules with a hobby loss argument is not a new tactic for the IRS (it was recently utilized with respect to a Kansas ranch), but the Robison decision certainly indicates that it can be expected to be used more frequently.
The result in Robison is that the losses will only be deductible to the extent of passive income from the activity. Otherwise, the losses remain suspended until the petitioners dispose of their entire interest in the activity in a fully taxable transaction to an unrelated party. I.R.C. §469(g).
Number 9 - Court Orders Chlorpyrifos Registrations Canceled
In August, a federal appellate court ordered the EPA to revoke all tolerances and cancel all registrations for chlorpyrifos. League of United Latin American. Citizens v. Wheeler, 899 F.3d 814 (9th Cir. 2018). The revocation and cancellation was to occur within 60-days of the court’s decision. Chlorpyrifos is sold under many brand names but is most readily recognized as the primary ingredient in Lorsban insecticide (Dow AgroScience). It targets pests such as soybean aphids and spider mites and corn rootworm. Chlorpyrifos is presently used on approximately 8 million soybean acres in the U.S. (approximately 10 percent of the entire U.S. planted soybean acreage). The EPA has established chlorpyrifos tolerances for 80 food crops in the United States. Those crops include fruits, nuts and vegetables. Chlorpyrifos is the only effective option for control of borers in cherry and peach trees. It is also the only control for ants that affect citrus crops. It is used on approximately 40,000 farms in the U.S.
Certain environmental and activist groups filed a petition in 2007 to force the Environmental Protection Agency (EPA) to revoke food tolerances for chlorpyrifos based on the activists’ concerns over its impact on drinking water and alleged neurological impacts on children. The Federal Food, Drug, and Cosmetic Act authorizes the EPA to regulate the use of pesticides on foods according to specific statutory standards, and grants the EPA a limited authority to establish tolerances for pesticides meeting statutory qualifications. The EPA is also subject to safety standards in exercising its authority to register pesticides under the Federal Insecticide, Fungicide, Rodenticide Act (FIFRA). The EPA took no action.
In 2015, the court issued a ruling regarding a 2015 petition that required the EPA to make a decision by October 31, 2015 on whether or not it would establish food tolerances for chlorpyrifos. The EPA replied that it did not have sufficient data to make a decision and, as a result, would seek to ban chlorpyrifos. In late 2015, the EPA issued a proposed rule to revoke the tolerances. However, the EPA reversed course in 2017 and left the tolerances in place citing inconsistent scientific research findings on neurodevelopmental impacts. The EPA sought more time to make a decision which would allow continued scientific research, and sought a deadline of October of 2022 as a deadline to review the registration status. However, the court denied the request and ordered the EPA to take action by March 31, 2017.
In early 2017, the USDA wrote to the EPA and commented on the EPA’s plan to revoke chlorpyrifos tolerances and the EPA’s underlying risk assessment that was issued in late 2016. In its letter, the expressed grave concerns about the EPA process that led the EPA to publish three wildly different human health risk assessments for chlorpyrifos within two years. The USDA also expressed severe doubts about the validity of the scientific conclusions underpinning EPA’s latest chlorpyrifos risk assessment. Even though use of the activists’ study to derive a point of departure was criticized by the Federal Insecticide Fungicide Rodenticide Act Scientific Advisory Panel, the EPA continued to rely on the activists’ study and paired it with an inadequate dose reconstruction approach. Consequently, the USDA called on the EPA to deny the activists’ petition to revoke chlorpyrifos tolerances. According to the USDA, such a denial would allow the EPA to ensure the validity of its scientific approach as part of the ongoing registration review process, without the excessive pressure caused by arbitrary, litigation-related deadlines.
The activist groups then sought review of the EPA’s administrative review process and the court granted review. The court also vacated its earlier order that EPA take action by March 31, 2017, and instructed the EPA to revoke all tolerances and cancel all registrations of chlorpyrifos within 60 days.
The EPA, however, challenged the court’s jurisdiction on the basis that the administrative process had not been completed. The EPA claimed that §346a(h)(1) of the FFDCA did not clearly state that obtaining a 24 U.S.C. §346a(g)(2)(c) order in response to administrative objections is a jurisdictional requirement. As such the 24 U.S.C. §346(g)(2)(C) administrative process deprived the court of jurisdiction until the EPA issued a response (final determinations) to activist groups’ administrative objections under 24 U.S.C. §346a(g)(2)(C). The court held that 24 U.S.C. §346a(g)(2)(C) was not jurisdictional, but was structured as a limitation on the parties rather than the court. The court also held that this case presented “strong individual interests against requiring exhaustion and weak institutional interests in favor of it.” Accordingly, the activist groups did not need to exhaust their administrative remedies. On the merits, the court held that there was no justification for the EPA's decision in its 2017 order to maintain a tolerance for chlorpyrifos in the face of scientific evidence that its residue on food causes neurodevelopmental damage to children. The court held that the EPA was in direct contravention of the FFDCA and the FIFRA. Apparently, none of the evidence concerning the USDA’s doubts about the validity of the EPA’s health risk assessments and conclusions was before the court.
A biting dissent argued that the appellate courts have no jurisdiction in cases such as this one until the EPA makes a final determination.
The EPA has petitioned for a rehearing with the full Ninth Circuit. The 60-day timeframe for revocation and cancellation is suspended pending the court deciding whether to rehear the case. If a rehearing is not granted, it is anticipated that Trump Administration will ask the U.S. Supreme Court to hear the case. In any event, it appears that Lorsban will be available to producers in 2019 as the legal proceedings continue.
In Friday’s post we will continue our journey through a few more of the Top Ten ag law and tax developments of 2018. What do you think might be coming up next in the list?
Monday, December 31, 2018
2018 was a big year for developments in law and tax that impact farmers, ranchers, agribusinesses and the professionals that provide professional services to them. It was also a big year in other key areas which are important to agricultural production and the provision of food and energy to the public. For example, carbon emissions in the U.S. fell to the lowest point since WWII while they rose in the European Union. Poverty in the U.S. dropped to the lowest point in the past decade, and the unemployment rate became the lowest since 1969 with some sectors reporting the lowest unemployment rate ever. The Tax Cuts and Jobs Act (TCJA) doubles the standard deduction in 2018 compared to 2017, which will result additional persons having no federal income tax liability and other taxpayers (those without a Schedule C or F business, in particular) having a simplified return. Wages continued to rise through 2018, increasing over three percent during the third quarter of 2018. This all bodes well for the ability of more people to buy food products and, in turn, increase demand for agricultural crop and livestock products. That’s good news to U.S. agriculture after another difficult year for many commodity prices.
On the worldwide front, China made trade concessions and pledged to eliminate its “Made in China 2025” program that was intended to put China in a position of dominating world economic production. The North-Korea/South Korea relationship also appears to be improving, and during 2018 the U.S. became a net exporter of oil for the first time since WWII. While trade issues with China remain, they did appear to improve as 2018 progressed, and the USDA issued market facilitation payments (yes, they are taxed in the year of receipt and, no, they are not deferable as is crop insurance) to producers to provide relief from commodity price drops as a result of the tariff battle.
So, on an economic and policy front, 2019 appears to bode well for agriculture. But, looking back on 2018, of the many ag law and tax developments of 2018, which ones were important to the ag sector but just not quite of big enough significance nationally to make the “Top Ten”? The almost Top Ten – that’s the topic of today’s post.
The “Almost Top Ten” - No Particular Order
Syngenta litigation settles. Of importance to many corn farmers, during 2018 the class action litigation that had been filed a few years ago against Syngenta settled. The litigation generally related to Syngenta's commercialization of genetically-modified corn seed products known as Viptera and Duracade (containing the trait MIR 162) without approval of such corn by China, an export market. The farmer plaintiffs (corn producers), who did not use Syngenta's products, claimed that Syngenta's commercialization of its products caused the genetically-modified corn to be commingled throughout the corn supply in the United States; that China rejected imports of all corn from the United States because of the presence of MIR 162; that the rejection caused corn prices to drop in the United States; and that corn farmers were harmed by that market effect. In April of 2018, the Kansas federal judge handling the multi-district litigation preliminarily approved a nationwide settlement of claims for farmers, grain elevators and ethanol plants. The proposed settlement involved Syngenta paying $1.5 billion to the class. The class included, in addition to corn farmers selling corn between September of 2013 and April of 2018, grain elevators and ethanol plants that met certain definition requirements. Those not opting out of the class at that point are barred from filing any future claims against Syngenta arising from the presence of the MIR 162 trait in the corn supply. Parties opting out of the class can't receive any settlement proceeds, but can still file private actions against Syngenta. Parties remaining in the class had to file claim forms by October of 2018. The court approved the settlement in December of 2018, and payments to the class members could begin as early as April of 2019.
Checkoff programs. In 2018, legal challenges to ag “checkoff” programs continued. In 2017, a federal court in Montana enjoined the Montana Beef Checkoff. In that case, Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, No. CV-16-41-GF-BMM, 2017 U.S. Dist. LEXIS 95861 (D. Mont. Jun. 21, 2017), the plaintiff claimed that the federal law requiring funding of the Montana Beef Council (MBC) via funds from the federal beef checkoff was unconstitutional. The Beef Checkoff imposes a $1.00/head fee at the time cattle are sold. The money generated funds promotional campaigns and research, and state beef councils can collect the funds and retain half of the collected amount with the balance going to the Cattleman’s Beef Production and Research Board (Beef Board). But, a producer can direct that all of the producer’s assessment go to the Beef Board. The plaintiff claimed that the use of the collected funds violated their First Amendment rights by forcing them to pay for “speech” with which they did not agree. The defendant (USDA) motioned to dismiss, but the Magistrate Judge denied the motion. The court determined that the plaintiffs had standing, and that the U.S. Supreme Court had held in prior cases that forcing an individual to fund a private message that they did not agree with violated the First Amendment. Any legal effect of an existing “opt-out” provision was not evaluated. The court also rejected the defendant’s claim that the case should be delayed until federal regulations with respect to the opt-out provision was finalized because the defendant was needlessly dragging its heels on developing those rules and had no timeline for finalization. The court entered a preliminary injunction barring the MBC from spending funds received from the checkoff. On further review by the federal trial court, the court adopted the magistrate judge’s decision in full. The trial court determined that the plaintiff had standing on the basis that the plaintiff would have a viable First Amendment claim if the Montana Beef Council’s advertising involves private speech, and the plaintiff did not have the ability to influence the advertising of the Montana Beef Council. The trial court rejected the defendant’s motion to dismiss for failure to state a claim on the basis that the court could not conclude, as a matter of law, that the Montana Beef Council’s advertisements qualify as government speech. The trial court also determined that the plaintiff satisfied its burden to show that a preliminary injunction would be appropriate.
The USDA appealed the trial court’s decision, but the U.S. Court of Appeals for the Ninth Circuit affirmed the trial court in 2018. Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, 718 Fed. Appx. 541 (9th Cir. 2018). Later in 2018, as part of the 2018 Farm Bill debate, a provision was proposed that would have changed the structure of federal ag checkoff programs. It did not pass, but did receive forty percent favorable votes.
GIPSA rules withdrawn. In the fall of 2016, the USDA sent to the Office of Management and Budget (OMB) an interim final rule and two proposed regulations setting forth the agency’s interpretation of certain aspects of the Packers and Stockyards Act (PSA) involving the buying and selling of livestock and poultry. The proposals generated thousands of comments, with ag groups and producers split in their support. The proposals concern Section 202 of the PSA (7 U.S.C. §§ 192 (a) and (e)) which 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. The “effect” language of the statute would seem to eliminate any requirement that the producer show that the packer acted with the intent to control or manipulate prices. However, the federal courts have largely interpreted the provision to require a plaintiff to show an anti-competitive effect in order to have an actionable claim.
The interim final rule and the two proposed regulations stemmed from 2010. In that year, the Obama administration’s 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 included, but was 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) was stated to depend on the nature and circumstances of the challenged conduct. The proposed regulations specifically noted 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 also specified that a PSA violation could occur without a finding of harm or likely harm to competition, contrary to numerous court opinions on the issue.
On April 11, 2017, the USDA announced that it was delaying the effective date of the interim final rule for 180 days, until October 19, 2017, with the due date for public comment set at June 12, 2017. However, on October 17, 2017, the USDA withdrew the interim rule. The withdrawal of the interim final rule and two proposed regulations was challenged in court. On December 21, 2018, the U.S. Court of Appeals for the Eighth Circuit denied review of the USDA decision. In Organization for Competitive Markets v. United States Department of Agriculture, No. 17-3723, 2018 U.S. App. LEXIS 36093 (8th Cir. Dec. 21, 2018), the court noted that the USDA had declined to withdraw the rule and regulations because the proposal would have generated protracted litigation, adopted vague and ambiguous terms, and potentially bar innovation and stimulate vertical integration in the livestock industry that would disincentivize market entrants. Those concerns, the court determined, were legitimate and substantive. The court also rejected the plaintiff’s argument that the court had to compel agency action. The matter, the court concluded, was not an extraordinary situation. Thus, the USDA did not unlawfully withhold action.
No ”clawback.” In a notice of proposed rulemaking, the U.S Treasury Department eliminated concerns about the imposition of an increase in federal estate tax for decedents dying in the future at a time when the unified credit applicable exclusion amount is lower than its present level and some (or all) of the higher exclusion amount had been previously used. The Treasury addressed four primary questions. On the question of whether pre-2018 gifts on which gift tax was paid will absorb some or all of the 2018-2025 increase in the applicable exclusion amount (and thereby decrease the amount of the credit available for offsetting gift taxes on 2018-2025 gifts), the Treasury indicated that it does not. As such, the Treasury indicated that no regulations were necessary to address the issue. Similarly, the Treasury said that pre-2018 gift taxes will not reduce the applicable exclusion amount for estates of decedents dying in years 2018-2025.
The Treasury also stated that federal gift tax on gifts made after 2025 will not be increased by inclusion in the tax computation a tax on gifts made between 2018 and 2015 that were sheltered from tax by the increased applicable exclusion amount under the TCJA. The Treasury concluded that this is the outcome under current law and needed no regulatory “fix.” As for gifts that are made between 2018-2025 that are sheltered by the applicable exclusion amount, the Treasury said that those amounts will not be subject to federal estate tax in estates of decedents dying in 2026 and later if the applicable exclusion amount is lower than the level it was at when the gifts were made. To accomplish this result, the Treasury will amend Treas. Reg. §20.2010-1 to allow for a basic exclusion amount at death that can be applied against the hypothetical gift tax portion of the estate tax computation that is equal to the higher of the otherwise applicable basic exclusion amount and the basic exclusion amount applied against prior gifts.
The Treasury stated that it had the authority to draft regulations governing these questions based on I.R.C. §2001(g)(2). The Treasury, in the Notice, did not address the generation-skipping tax exemption and its temporary increase under the TCJA through 2025 and whether there would be any adverse consequences from a possible small exemption post-2025. Written and electronic comments must be received by February 21, 2019. A public hearing on the proposed regulations is scheduled for March 13, 2019. IRS Notice of Proposed Rulemaking, REG-106706-18, 83 FR 59343 (Nov. 23, 2018).
These were significant developments in the ag law and tax arena in 2018, but just not quite big enough in terms of their impact sector-wide to make the “Top Ten” list. Wednesday’s post this week will examine the “bottom five” of the “Top Ten” developments for 2018.
December 31, 2018 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, December 21, 2018
Depreciation is a familiar concept to a farmer or rancher. It’s an allowance for the wear-and-tear over the life of an asset that is used (for a farmer) in the business of farming. But what is depletion? It’s conceptually similar to depreciation. In tax “lingo” it’s a deductible allowance for the exhaustion of mineral deposits, timber and other natural resources. If a taxpayer has an economic interest in the resource, the cost of the diminishing resource can be recovered through the depletion allowance.
Depletion – it’s the topic of today’s blog post.
The depletion allowance is claimed either on a cost-per-unit basis or as a percentage of gross income from the disposal of the resource. I.R.C. §611. Cost depletion allocates to each unit of production a pro rata portion of the original cost or investment in the resource. In general, the total projected number of units in the deposit or timber tract (tons, barrels, boardfeet, etc.) is divided into the cost of the resource to obtain the amount of cost which should be deducted for each unit of production sold. I.R.C. §612. Cost depletion is required for timber. See IRS Pub. 535.
Percentage depletion is applicable to all minerals. With percentage depletion, a flat percentage of the gross income from the property each year is treated as the depletion deduction to allow the taxpayer to recover the cost of the minerals/resources. The percentage depletion rates are set forth in the statute. I.R.C. §613(b). The percentage figures range from a top of 22 percent for deposits in the United States of sulphur and uranium (and other specified elements such as bauxite and nickel), to 5 percent for clay that is used or sold for use in the manufacture of drainage and roofing tile, flower pots, and kindred products. Id.
The taxpayer has the choice of using the higher of cost depletion or percentage depletion and may make the choice each year. However, special rules apply when the predominant property (by value) is hydrocarbon gas. Another point to remember is that the depletion deduction under the percentage depletion method cannot exceed 100 percent of the taxable income from the property computed without the deduction for depletion.
As noted above, percentage depletion is allowed to one who has an “economic interest” in the minerals in place. That generally means that it is available to an owner or lessee. But what if the lessor can terminate the lease on short notice? In that situation does the lessee still have an economic interest entitling the lessee to a deduction for percentage depletion? That question was answered in United States v. Swank, 451 U.S. 571 (1981). In that case, the lessor owned a coal mine and leased the unmined coal (e.g., mineral interest) to lessees in exchange for a fixed royalty per ton based on the sale of the mined coal at prices the lessee would determine. The lessee mined the coal over an uninterrupted period of several years and the proceeds of the sale of the coal were the only revenue from which the lessees recovered royalties that were paid to the lessors. The lessor had the right to terminate these leases with 30 days' notice. But, that termination right was never exercised. The lessee sought to claim a percentage depletion deduction for the cost of the mined coal. The IRS claimed that the lessee should not have been allowed to take a percentage depletion allowance because the lessor had the right to terminate the lease on short notice. That termination right, the IRS asserted, deprived the lessee of an economic interest. The trial court disagreed with the IRS and the U.S. Supreme court affirmed. The mere existence of the unexercised right to terminate leases did not destroy the lessee’s economic interest in the leased mineral deposits. A deduction based on percentage depletion of the coal deposit was proper. See also Rev. Rul. 83-160, 1983-2 C.B. 99; and FSA 1999-927 (date redacted).
The impact of the U.S. Supreme Court opinion in Swank, is that a when a farmer leases a mineral deposit to a lessee to extract the minerals, the farmer should have little trouble in being able to claim a deduction for depletion based on an application of a percentage to the gross royalties received. The tax issues get more complex, however, if the farmer become the operator of the mineral deposit.
Depletion of Soil
Soil, sod, dirt, turf, water and mosses are not included within the terms “all other minerals” for purposes of claiming 14 percent percentage depletion. I.R.C. §613(b)(7)(A)-(C). However, soil in place can be subject to depletion under the cost method. Rev. Rul. 78, 1953-1 C.B. 18. While no depletion allowance is generally allowed for sod, a federal district court in Florida has held that sod was a natural deposit and that the removal of the grass resulted in a loss of the soil for which a depletion allowance could be claimed. Flona Corp. v. United States, 218 F. Supp. 354 (S.D. Fla. 1963). Likewise, cost depletion of topsoil is allowed to a taxpayer upon the sale of sod and balled nursery where the taxpayer can establish that each cutting removed some part of the natural deposit. Rev. Rul. 77-12, 1977-1 C.B. 161, revoking Rev. Rul 54-241, 1954-1 C.B. 63.
Other points on soil. Soil presents some interesting depletion questions. Here are a few of the more common ones:
- If a mineral or natural resource deposit is continuously replenished by the decomposition of other plants, no depletion is available. See, e.g., Rul. 79-267, 1979-2 C.B. 243.
- Loam is a natural deposit subject to depletion, but not percentage depletion. Rul. 79-411, 1979-2 C.B. 246.
- “Peat” is eligible for percentage depletion at a 5 percent rate, but various types of “moss” are not. See, e.g., I.R.C. §613(b)(7)(A).
- Peat moss is subject to a percentage depletion allowance of 5%. The question, then, is the point at which moss becomes peat moss.
- Peat moss must actually be extracted rather than merely subside. See, e.g., A. Duda & Sons, Inc. v. United States, 560 F.2d 669 (5th Cir. 1977), rev’g., 383 F. Supp. 1303 (M.D. Fla. 1974).
Depletion of Timber
The sale of standing timber typically triggers capital gain for a farmer-seller. The tax basis in the timber can be recovered either through depletion or by an offset against the selling price. But, if the income from a timber sales is reported as “Other income…” on Schedule F, timber depletion should be claimed in order to preserve the basis. Alternatively, if the income from timber sales is reported as an item purchased for resale, depletion on the timber should be listed as the cost (or other) basis. There is no line on Schedule F for depletion. That means that the taxpayer will have to indicate how the depletion was computed. The taxpayer should complete Form T to show the depletion computation.
Depletion of Groundwater
In some parts of the country, the IRS permits a depletion allowance for water deposits in an aquifer beneath the surface. In portions of the Ogallala formation which runs through Western Nebraska and Kansas, Eastern Colorado, part of New Mexico and the panhandles of Oklahoma and Texas, taxpayers are permitted to claim a depletion deduction for water. In these areas, the water is being pumped at a level exceeding the recharge rate for the underlying aquifer. The IRS permits a depletion allowance on water in these areas where it can be shown that the rate of recharge in the underlying aquifer is extremely low. In 1965, the Fifth Circuit Court of Appeals held that groundwater in the Ogallala formation in the Southern High Plains of Texas and New Mexico was a depletable mineral and natural deposit. United States v. Shurbet, 347 F.2d 103 (5th Cir. 1965).
The IRS stated that it would follow this case, but that it would limit the application of the rule to situations similar to those in the Southern High Plains of Texas and New Mexico where water is extracted from the Ogallala formation. Rev. Rul. 65-296, 1965-2 C.B. 181.
In late 1982, IRS announced a broadening of the rule in Shurbet to areas where it could be demonstrated that the groundwater is being depleted and that the rate of recharge is so low that, once extracted, the “groundwater would be lost to the taxpayer and immediately succeeding generations.” Rev. Rul. 82-214, 1982-2 C.B. 115.
Depletable Property Held by an Estate or Trust
For mineral or timber property held in trust, the allowable deduction for depletion is to be apportioned between the income beneficiaries and the trustee on the basis of trust income from the property allowable to each unless the governing instrument allows the trustee to maintain a reserve for depletion. If the trust instrument or local law requires or permits the trustee to maintain a reserve for depletion, however, the allowance may be allocated first to the trustee to the degree that income is placed in the depletion reserve. Any excess amount is apportioned between the income beneficiaries and the trustee on the basis of the trust income allocable to each. Rev. Rul. 60-47, 1960-1 C.B. 250; Regs. § 1.611-1(c)(4). Rev. Rul. 61-211, 1961-2 C.B. 124, modified by Rev. Rul. 74-71, 1974-1 CB 158, governs the situation if the trust or estate is entitled to a portion of a depletion deduction from a partnership or another estate or trust. See also Rev. Rul. 66-278, 1966-2 C.B. 243.
While depreciation is a commonly understood concept, depletion is less understood in its application. But, the point remains that a tax deduction may be available for the exhaustion of mineral deposits, timber and other natural resources.
Note: There won't be any postings next week in light of the Christmas holiday. To all of the blog post readers, may you and your family have a very Merry Christmas! Postings will resume on Dec. 31.
Wednesday, December 19, 2018
For agriculture, drainage of surface water is a significant legal issue. When surface water is sufficient, problems can arise concerning disposal of rainfall and/or melting snow which water-logs valuable fields and pastures forming bogs and sinkholes, thereby making cultivation difficult or impossible. The drainage of excess surface water can create disputes among rural landowners. While it’s an issue that arises more frequently in the areas of the U.S. that are east of the Missouri River, it sometimes comes up in the more arid parts of the country. When too much surface water is present, how can it be disposed of without creating legal problems with an adjoining property owner?
The rules governing the disposal of excess surface water – that’s the topic of today’s post
In general, it has historically been wrongful for a landowner to disturb the existing pattern of drainage and thereby obstruct the flow of water from another's lands, or cast upon the lands of another more water than would naturally flow thereupon, or cause an usually high concentration of water in the course of drainage. While that’s the general rule, there are exceptions. Indeed, at least three different legal theories may be utilized to resolve surface water drainage conflicts.
The rule of absolute ownership. The rule of absolute ownership, also known as the common enemy rule, is the oldest legal theory applicable to the use of surface water. This rule is based upon the theory that surface water is the enemy of every landowner and a property owner is given complete freedom to discharge surface waters regardless of the harm that might result to others. The owner is allowed to dispose of surface water in any manner that will result in the highest benefit to his or her land. In its original form, the common-enemy doctrine encouraged land development, but also encouraged conflict both between and among landowners.
Today, most courts have modified this rule by importing into it qualifications based on concepts of reasonable use, negligence, and/or nuisance to prohibit discharges of large quantities of water onto adjoining land by artificial means in a concentrated flow, except through natural drainways. For example, in Currens v. Sleek, 138 Wash. 2d 858, 983 P.2d 626 (1999), the court determined that a landowner has an unqualified right to make lawful improvements on their own land, but those improvements must limit the harm caused by changes in the flow of surface water to that which is reasonably necessary. See also Johnson v. Philips, 433 S.E.2d 895 (S.C. Ct. App. 1993). If land clearing activities alter the surface drainage significantly, it may give an adjoining landowner the basis to bring a nuisance suit. For example, in Lucas v. Rawl Family Partnership, 359 S.C. 505, 598 S.E.2d 712 (2004), the evidence showed that after the neighbors cleared their land, the owner's fields flooded in every heavy rain, making it unsuitable for crops. The court held that there was a jury question presented as to whether the neighbors' actions constituted a nuisance per se and were dangerous to the property at all times. Similarly, in Mullins v. Greer, 26 Va. 587, 311 S.E.2d 110 (1984), a landowner had constructed an embankment causing excess water to flow onto a neighbor. The landowner claimed that the embankment was properly constructed and didn’t interfere with the natural channel and flow of a stream. The court ordered the landowner to remove the embankment.
The civil law rule. The civil law rule imposes liability upon one who interferes with the natural flow of surface water and, as a result, invades another's interest in land. This rule is the opposite of the common enemy rule, and is phrased in terms of dominant and servient estates. This rule imposes a servitude upon the lower or servient estate which requires that it receive all waters which flow in the course of nature from the higher or dominant tract. The owner of the dominant tract cannot, however, do anything that would increase the natural drainage burden imposed upon the lower estate. But, the complaining party must prove that they incurred damage. For example, in Mullen v. Natural Gas Line Company of America L.L.C., 801 N.W.2d 627 (Iowa Ct. App. 2011), the plaintiff failed to prove that the defendant’s drainage activity increased the quantity of water or changed the manner of discharge onto the plaintiff’s property. As a result, the plaintiff was denied injunctive relief and damages.
Essentially, the civil law rule involves accepting the natural flow of water. While this rule minimizes conflict between and among landowners, it also discourages land improvement. As a result, some states have modified the civil law rule to accommodate artificial changes in the natural flow of surface water if the change is incidental to the normal use and improvement of land. These changes are most likely to be acceptable when the water empties into an existing natural watercourse. However, substantial changes in natural drainage flows resulting in damages to an adjoining landowner are not permissible. This rule applies even in connection with governmentally approved soil conservation practices that substantially alter the natural flow of surface water. For example, in O’Tool v. Hathaway, 461, N.W.2d 161 (Iowa 1990), a farmer constructed several conservation terraces as part of his soil and water conservation plan for the farm. One of the terraces broke during a heavy rainfall and the resulting flow of the previously ponded water in the terrace damaged the basement of neighboring homeowners. The homeowners sued, alleging liability because the flow of the water from the terrace break had altered the natural flow of water from the dominant to the servient estate. The trial court agreed and awarded them damages for materials to fix their basement. The appellate court tacked on labor expenses, finding that the farmer was liable under the "natural flow" doctrine because the farmer had substantially changed the water drainage method. The appellate court found that the farmer was negligent in constructing a terrace in a location that if it broke, the resulting water flow would cause foreseeable damages to the homeowners.
The strict application of the civil law rule has also been modified by a so-called “husbandry” exception, and interference with natural drainage will be allowed if the interference is limited to that which is incidental to reasonable development of the dominant estate for agricultural purposes. See, e.g., Callahan v. Rickey, 93 Ill. App. 3d 916, 418 N.E.2d 167 (1981).
Reasonable Use Rule. Today, many jurisdictions have adopted the rule of reasonable use which attempts to avoid the rigidities of either the civil-law or common-enemy doctrines. Instead, the reasonable use rule determines the rights of the parties by an assessment of all the relevant factors with respect to interference with the drainage of surface waters. Under the reasonable use rule, a landowner is entitled to make a reasonable use of diffused surface water, with such use being a factual question for a jury. For example, in Kral v. Boesch, 557 N.W.2d 597 (Minn. Ct. App. 1996), a landowner created a channel to drain surface water from his property to a tile intake bordering the parties' properties by lowering the intake in order to allow the channel water to flow into it. The neighbor discovered what the landowner had done and raised the intake to keep the water out and plugged it with cement, which caused surface water to stand in three areas of the landowner’s property and damaged the landowner’s crops. The trial court determined that the granted injunctive relief to the landowner under the reasonable use rule. On appellate court affirmed. It was appropriate for the landowner to drain water into the adjoining owner’s tile drainage system.
Ultimately, in legal disputes over the application of the reasonable use rule, it’s often up to a jury. The jury must determine whether the benefit to the actor's land outweighs the harm that results from the alteration of the flow of surface water onto neighboring lands. A landowner will be liable for damages only to the extent that interference with the flow of surface water is unreasonable. Whether a landowner has acted reasonably in removing excess surface water depends upon such things as the degree or extent of harm, the foreseeability of damage, and the amount of care that was exercised to prevent damage. Is the drainage reasonably necessary? Did the party draining the excess water take reasonable care to avoid unnecessary damage to a neighbor’s property? Is the benefit from diverting the excess water greater than the harm to the neighbor? Does the draining improve the “normal and natural” system of drainage? These are all important questions to ask before diverting excess water on to a neighbor. These are often the questions a jury will weigh.
Drainage codes. Many states have adopted statutory drainage codes. Under those codes, a landowner can institute drainage proceedings for the construction, repair or improvement of agricultural drainage ditches. These codes, if they apply in a particular situation, must be complied with.
Excess surface water can be can be diverted and discharged onto a neighbor. However, care must be taken in doing so.
Monday, December 17, 2018
A fundamental point about tax law is that deductions, especially those associated with a business, must be substantiated. In addition, given the complexity of the tax Code, it is often in the best interest of a small business owner or farmer/rancher to hire a professional tax preparer. Simply relying on tax software will not eliminate penalties that the IRS can impose if the tax liability is understated.
Substantiating deductions and the peril of self-prepared business returns – that’s the topic of today’s post.
A recent Tax Court case illustrates the necessity of properly substantiating business deductions. In Dasent v. Commissioner, T.C. Memo. 2018-202, the taxpayers were a married couple that claimed various business expenses on Schedule C. They self-prepared their return for 2014, the year in issue. Their Schedule C reported no gross receipts and total expenses of $28,173. They also claimed unreimbursed employee expenses of $23,931 on Schedule A. The IRS denied the Schedule C and Schedule A deductions and also asserted that the couple failed to report $25,622 of IRA distributions (and the associated penalty for early withdrawal). The IRS also determined that the couple failed to report $123,168 of cancelled debt income. The IRS also imposed a penalty for underpayment of tax associated with the substantial understatement of tax.
The Tax Court determined that the wife failed to provide sufficient evidence that she was engaged in a business with a profit motive. The Tax Court also concluded that the wife failed to substantiate any of the business expenses associated with the wife’s business and provided no means for the court to estimate those expenses under the Cohan rule.
The Cohan rule. What’s the Cohan rule? The rule comes from a 1930 decision of the U.S. Court of Appeals for the Second Circuit involving George M. Cohan. Cohan was an American entertainer, playwright, composer, lyricist, actor, singer, dancer and producer. He wrote, composed, produced and appeared in about 40 Broadway musicals (which means that I would never have heard of him had he not found himself the subject of a tax case!).
Mr. Cohan might have been a good entertainer, but he wasn’t so hot at keeping good records for his travel and entertainment expenses associated with his business activities. In Cohan v. Comr., 39 F.2d 540 (2nd Cir. 1930), the famous judge Learned Hand ruled for the IRS on numerous points but in the process set forth the principle that when the IRS asserts a tax deficiency in cases where the evidence clearly shows that some deduction should be allowed, the court can estimate those expenses. As a result, the court allowed Mr. Cohan to use estimates to establish his business expenses.
But, it’s not a sure thing when a taxpayer relies on the use of the Cohan rule to get deductions for expenses that haven’t been properly substantiated. There are numerous cases where the court has refused to use the rule. See, e.g., Sam Kong Fashions, Inc. v. Comr., T.C. Memo. 2005-157; Stewart v. Comr., 2005-212; Harlan v. Comr., T.C. Memo. 1995-309. That means that the burden remains on the taxpayer when records substantiating expenses are missing. In addition, under I.R.C. §274(d) (which was enacted after the Cohan decision) substantiation is required for travel, entertainment, business gifts and any expenses associated with “listed property” (a special classification for assets that can be used for both personal and business purposes). Indeed, in the present case, the Tax Court noted that the Cohan rule has no application to I.R.C. §274(d) expenses.
Other points of the case. The petitioners also claimed that they should not be subject to the 10 percent penalty for early withdrawal from their IRA because the withdrawn funds were used to pay for their daughter’s college tuition, The Tax Court, however, upheld the penalty because the petitioners failed to establish that the withdrawn funds were actually used to pay the daughter’s tuition. The Tax Court also upheld the imposition of a 20 percent penalty for substantial understatement of tax. On that issue, the Tax Court noted that the petitioners were college-educated and used a tax software (TurboTax). However, the Tax Court noted, tax software is not the same as relying on professional tax advice. The software only produces a result that is as good as the information that is input. The taxpayer must still understand tax law good enough to properly use the software.
Return Prep – Post TCJA
Given the increased complexity of many parts of the Code that the Tax Cuts and Jobs Act (TCJA) has introduced, self-prepared returns will be even more difficult for those taxpayers with a Schedule C or F business. That’s particularly true with respect to the new I.R.C. §199A, the 20 percent pass-through deduction for non-C corporate businesses. Some taxpayers may assume that they are entitled to a straight-up 20 percent deduction from their taxable income (some may even incorrectly assume it’s taken from gross income). While a full 20 percent deduction is possible, it’s not likely to be the case in many situations due to the presence of capital gain income, other types of non-qualified income, certain deductions, and income level. In addition, what about rental income? Is it business income or not? We won’t know the answer to that question (and numerous others) until the final regulations are issued. I.R.C. §199A is just one area of complexity added by the new law. Many other changes also apply, such as with respect to depreciation, that will make preparation of the return for taxpayers with businesses more difficult for 2018 as compared to prior years.
Properly substantiating business expenses is the key to claiming deductions for them. Don’t assume that the court will estimate them for you under the Cohan rule even if the expenses involved are those for which the rule could apply. The TCJA has ramped-up the complexity of return preparation (and planning) for those with small businesses (including farms and ranches). Relying on tax software will not be enough to eliminate penalties for an understatement of tax. This might be the year, for those that haven’t done so already, to hire a professional return preparer.
Thursday, December 13, 2018
In general, a farmer or rancher that uses the cash method of accounting gets to deduct business-related expenses in the year that they are paid. But, is that always the case? What about livestock that is purchased for resale, or growing crops associated with the purchase of a farm? Are there other special situations in the farm or ranch setting? Does the Tax Cuts and Jobs Act (TCJA) have any impact?
The cash method of accounting and special situations for farmers and ranchers – it’s the topic of today’s blog post.
As stated above, the general rule for taxpayers on the cash method of accounting is that a deduction can be claimed for expenses when those expenses are paid. However, for farmers and ranchers that utilize the cash method of accounting, a deduction can be taken for the cost of livestock and other items that are purchased for resale only when the items are sold. Treas. Regs. §1.61-4(a). For example, in Alexander v. Comr., 22 T.C. 234 (1954), acq., 1954-2 C.B. 3, the petitioner was a cattle feeder that purchased calves and yearlings. He fed them for approximately nine to 18 months and then sold them as beef cattle. He was on the cash method of accounting and deducted the cost of the cattle in the year of purchase as an operating expense rather than deferring the deduction until the year he sold the cattle. The IRS disagreed with that approach and the Tax Court upheld the IRS position and the underlying Treasury Regulation. The cattle feeder’s gain on later sale was to be reduced by the cost of purchase.
Other Ag Products
The rule applied in the Alexander case is widely recognized as the “feeder calf” rule whereby the cost of feeder calves is not deductible until the calves are sold. However, the rule has much broader application beyond the feeder calf scenario. For instance, in Dodds v. Comr., T.C. Memo. 1986-174, the Tax Court held that the rule required the taxpayers to deduct the cost of their Valencia orange tree grove attributable to the growing orange crop when the crop was sold. The Tax Court noted that Treas. Reg. §1.61-4 applies to livestock and produce.
The same tax treatment applies to grain and other items that are purchased for resale. For example, if a farmer pledges grain to the Commodity Credit Corporation (CCC) as collateral for a loan and the grain goes out of condition and is sold, if that grain is replaced with the same quantity of grain (that meets CCC standards for quality) that will be sold, the purchased grain acquires an income tax basis equal to the purchase price. The purchase price amount would then offset (either partially or fully) the amount realized on later sale of the grain. The same rationale applies when a farmer buys a commodity certificate and then uses the certificate to acquire grain for later resale, the purchase price of the grain would establish the farmer’s tax basis in the grain. That tax basis would then be used to offset gain (or create a loss) on later sale.
Inventory Method Application
The IRS also takes the position that a “last-in-first-out” (LIFO) method to account for inventory costs may not be used to determine the cost to be deducted in the year of sale. In Rev. Rul. 88-60, 1988-2 C.B. 30, the taxpayer was engaged in the business of acquiring livestock for the purpose of resale. The taxpayer, a corporation, utilized the cash method and computed the profits from the sale of the livestock by determining the cost of the livestock sold as if the latest cattle acquired were the first sold. The cost basis of the remaining unsold cattle at the end of the year reflected the cost of the earliest cattle that the taxpayer had acquired. The IRS took the position that this method did not reflect the actual cost of the livestock sold, and was not permitted by Treas. Reg. §1.61-4 because it reflected the cost of the latest purchases of calves and yearlings. That wasn’t, the IRS determined, consistent with the cash method of accounting. Instead, the cost was to be subtracted from the particular item sold and cannot be deducted from other similar items sold. Allowing the use of the LIFO method would allow the taxpayer to deduct part of the cost of the feeder cattle in the year in the year of purchase rather than deferring the deduction until the year of sale. In other words, “cost” in Treas. Reg. §1.61-4 meant the actual cost of the livestock rather than the base year cost as determined under LIFO. See also, Priv. Ltr. Rul. 8406003 (Oct. 18, 1983); Peterson v. Vinal, 225 F. Supp. 478 (D. Neb. 1964).
Farmland With Growing Crop
When a farm is purchased that has a growing crop (or crops) on it, the IRS position is that the portion of the purchase price allocated to the growing crop does not produce a current income tax deduction. Instead, the amount allocated to the growing crop is to be capitalized and taken into account when determining net profit or loss in the year that the crop is sold. Rev. Rul. 85-82, 1985-1 C.B. 57. See also Priv. Ltr. Rul. 8350002 (Aug. 8, 1983); GCM 39096 (Dec. 21, 1983). It is not deductible on purchase of the farm as a purchase of “feed” unless the taxpayer intends to feed the crop to livestock. In that case, current deduction would seem to be permissible as to a reasonable amount of the acquired crop that is necessary to feed the taxpayer’s livestock.
What About Poultry?
A current deduction is allowed for the cost of purchasing baby chick and egg-laying hens by a farmer that uses the cash method of accounting as long as the method is consistently followed and clearly reflects income. The same is true if they are purchased for the purpose of raising and later resale. In Rev. Rul. 60-191, 1960-1 C.B. 78, the IRS took this position because it determined that the cost of the chicks was nominal compared to the cost of raising them, and because cost identification would be difficult. See also Priv. Ltr. Rul. 8528027 (Apr. 15, 1985). Whether that same rationale applies to other types of poultry, such as ostriches and emus, is an open question.
Impact of the TCJA
Section 13102 of the TCJA makes several amendments to the accounting rules for “small” businesses. In a significant change from prior law, for tax years beginning after 2017, a farming business (including a farm C corporation or a farming partnership with a C corporation partner) can qualify for the cash method of accounting if average gross receipts over the prior three years immediately before the tax year at issue do not exceed $25 million ($26 million for 2019). I.R.C. §448. The TCJA also contains a provision that exempts taxpayers that meet the gross receipts test from the requirement to account for inventories so as to clearly reflect income. However, the taxpayer’s method of accounting for inventory must either treat the inventory as non-incidental materials and supplies, or conform to the taxpayer’s method of accounting reflected in an applicable financial statement (AFS) for the tax year. If the taxpayer doesn’t have an AFS, the taxpayer’s method of accounting must conform to the taxpayer’s books and records “prepared in accordance with the taxpayer’s accounting procedures.” I.R.C. §471(c).
So what does this mean for farmers? For starters, if inventory is accounted for as incidental materials and supplies, inventory accounting methods don’t apply. As noted above, the IRS will not allow the use of LIFO, but FIFO or average cost method could be used. See, Rev. Proc. 2002-28, 2002-1 C.B. 815. But, does this mean that a farmer can claim a deduction in the year of purchase for livestock and other items that will be resold in a later year? That may be the case if the items fit within the definition of incidental supplies, and the farmer’s books and records consistently expense the items, and the farmer does not have an AFS (very few will).
Under the tangible property regulations, the IRS provided a de minimis safe harbor limit for those without an AFS. See Treas. Reg. §1.263(a)-1(f)(1)(ii)(D). In Notice 2015-82,2015-50 IRB, the IRS set that safe harbor at $2,500 (effective beginning with tax year 2016) for purposes of administrative convenience to allow a taxpayer to deduct amounts within the safe harbor limit that are expended for the acquisition or production of new property or for the improvement of existing property which would otherwise have to be capitalized under I.R.C. §263(a). To use the safe harbor, the item must be substantiated by an invoice. The $2,500 safe harbor should apply for feeder pigs. Cattle, however, may not as easily fit within the safe harbor.
Thus, for a farmer eligible for the cash method of accounting, the prior law current write-off rule for baby chicks and hens still applies. In addition, a current deduction is allowed (under the tangible property regulations) for the cost of tangible property that has an acquisition cost (or production cost) of $200 (per unit or per item) or less. That $200 amount should cover the cost of feeder pigs. The acquisition cost of other livestock purchased for resale, such as cattle, would also be currently deductible if the acquisition cost is within the $2,500 safe harbor.
Currently deducting the cost of livestock purchased for resale, if this is not an approach the taxpayer has previously taken, amounts to an accounting change requiring the filing of Form 3115. A full I.R.C. §481(a) adjustment will occur. I.R.C. §471(c)(4). The automatic change number is 235. However, this does not mean that IRS will grant audit protection for the change and even though the IRS grants consent to the change in how to account for livestock purchased for resale, that doesn’t mean it’s permissible and creates no presumption that it's a permissible method of accounting under a provision of the Code. See Rev. Proc. 2018-40, 2018-34 IRB 320.
The cash method of accounting allows the taxpayer to claim a deduction in the year the expense in incurred. However, there are some special situations in agriculture where the deduction is deferred. In addition, it is not presently known how the IRS will view the TCJA changes on this issue. Clearly, a farm taxpayer need not currently deduct the acquisition cost of items purchased for resale. The old rules can still be followed. But, if a current deduction is desired, there may be a way to accomplish that result.
Tuesday, December 11, 2018
For tangible depreciable personal property, all or part of the income tax basis can be deducted currently in the year in which the property is placed in service (defined as when property is in a state of readiness for use in the taxpayer's trade or business) under I.R.C. §179, regardless of the time of year the asset was placed in service. See, e.g., Brown v. Comm’r., T.C. Sum. Op. 2009-171. This expense method depreciation amount is an off-the-top depreciation allowance that may be taken at the taxpayer's election each year.
The Tax Cuts and Jobs Act (TCJA) increased the maximum amount a taxpayer may expense under I.R.C. §179 to $1 million. The TCJA also increased the phase-out threshold amount to $2.5 million for tax years beginning after 2017. The $1 million and $2.5 million amounts are indexed for inflation for tax years beginning after 2018. For 2019, the maximum amount that can be expenses under the provision increases to $1,020,000 and the phase-out threshold will be $2,550,000.
But, farm structures present an interesting issue as to whether they qualify for expense method depreciation. Farm buildings don’t count, but what about other types of structures? Where is the line drawn? The eligibility for I.R.C. §179 of certain farm structures – that’s the topic of today’s post.
As noted, for the farmer or rancher, expense method depreciation is potentially available for a wide array of assets. For example, not only can expense method depreciation be claimed on machinery and equipment, as well as purchased breeding stock, pickup trucks and business automobiles, it can also be claimed on tile lines, fences, feeding floors, grain bins, silos and similar “structures” because these structures are not “buildings.”
Eligibility of Farm “Structures”
In general, tangible property is eligible for expense method depreciation if it is I.R.C. §1245 property and is used as an integral part of manufacturing, production or extraction, or constitutes a facility used in connection with manufacturing, production or extraction for the bulk storage of fungible commodities, or is a single purpose agricultural or horticultural structure as defined in I.R.C. §168(i)(13). I.R.C. §1245(a)(3). But, a “building” (or its structural components) is not eligible. I.R.C. §1245(a)(3)(B).
Unfortunately, the term “building” is not defined in I.R.C. §179. The regulations under I.R.C. §1245 specify that language used to describe property in I.R.C. §1245(a)(3)(B) (which includes “a building or structural components”) is to have the same meaning as utilized for the (now repealed) investment tax credit (ITC) and associated regulations. Treas. Reg. §1.48-1(a). The term “building” was defined for investment tax credit purposes (“buildings” were not eligible for investment tax credit) as follows: “The term building generally means any structure or edifice enclosing a space within its walls, and usually covered by a roof, the purpose of which is, for example, to provide shelter or housing, or to provide working, office, packing, display, or sales space.” Treas. Reg. §§1.48-1(e)(1)-(2).
Also, I.R.C. §48(p), even though it has been repealed, contains the current, valid definition of a single purpose agricultural or horticultural structure. That provision (and subsections thereunder) defined property which qualified for the ITC. Tax legislation in 1986 moved that language into I.R.C. §1245 for depreciation recapture purposes. Under that definition, a single purpose ag structure (which is not a farm “building”) is used for housing, raising and feeding a particular type of livestock and their produce and the housing of the necessary equipment. Structures that fit this definition include hog houses, poultry barns, livestock sheds, milking parlors and similar structures. Also included within the definition are greenhouses that are constructed and designed for the commercial production of plants and a structure specifically designed and used for the production of mushrooms. Thus, only livestock structures and greenhouses qualify under this category.
IRS and court guidance. In the context of the ITC, certain the IRS and the courts have provided guidance. This guidance remains instructive on where the line is drawn between a “building” (not eligible for I.R.C. §179) and other structures that are eligible for I.R.C. §179 because they don’t meet the definition of a “building.”
- As to whether ag commodity storage facilities are “buildings,” in Rev. Rul. 66-89, 1966-1 C.B. 7, the IRS set forth two basic criteria for determining what improvements qualify as storage facilities, rather than buildings (for investment credit purposes): (1) the facility must provide storage space but not work space; and (2) the facility must not be reasonably adaptable to other uses.
- Catron v. Comr., 50 T.C. 306 (1968), acq., 1972-2 C.B. 1, involved a pre-fabricated Quonset-type structure used in the taxpayers’ apple farming business. Two-thirds of the structure was devoted to the selecting, grading and boxing of apples. The other one-third of the structure was refrigerated. The refrigerated area was held to not be a building as “other tangible property” that the taxpayer used in connection with agricultural production.
- Similar to the rationale applied in Catron, the Tax Court, in Palmer Olson v. Comr., T.C. Memo. 1970-296, determined that property constitutes a storage facility if it does not include working space.
- In Rul. 68-132, 1968-1 C.B. 14, modified by Rev. Rul. 71-359, 1971-2 C.B. 61, the IRS determined that a controlled temperature facility that provided specialized storage for potatoes for a potato farmer was not “building” despite its outward appearance. It, thus, qualified for investment tax credit. The IRS noted that the cleaning, processing, grading and packaging of the potatoes was carried on in an adjacent building.
- In Rul. 71-359, 1971-2 C.B. 6, the IRS ruled that a structure that was used for the storage of raw peanuts in the course of the taxpayer’s business of buying peanuts from growers and selling peanuts to manufacturers was not a “building.”
- In Merchants Refrigeration Co. of California v. Comr., 60 T.C. 856 (1973), acq., 1974-2 C.B. 3, a large freezer room in which frozen food stuffs were stored in cartons or bags was a storage facility and not a building.
- The Tax Court, in Central Citrus Co. v. Comr., 58 T.C. 365 (1972), determined that “sweet rooms” that occupied approximately one-sixth of a facility and where fruit was stored subject to controlled atmospheric conditions were not buildings. The Tax Court noted that the “sweet rooms” were not reasonably adaptable for other uses.
- In Giannini Packing Corp. v. Comr., 83 T.C. 526 (1984), the Tax Court held that rooms built to cool and preserve fruit were integral parts of production process of the fresh fruit and were not “buildings.”
- In Ltr. Rul. 8227012 (Mar. 30, 1982), the IRS determined that a freezer storage facility for pre-packaged food products was a building because it was similar to a warehouse. It was built on a concrete slab, had roof constructing consisting of structural steel and decking, and was constructed with steel racks from the floor to the ceiling located throughout. It also wasn’t used, the IRS noted, for the bulk storage of fungible commodities.
Hoop structures. There really isn’t any good guidance on the eligibility of “hoop” structures for I.R.C. §179. “Hoop” structures generally fit in the category of a general purpose farm building. At least that’s the likely IRS position. Granted, a fact-dependent argument can be made that a hoop structure is used as an integral part of production or is akin to a bulk storage facility used in connection with production. If that argument prevails, a hoop structure is I.R.C. §1245 property with no class life and a seven-year recovery period. In that case, a hoop structure would be eligible for I.R.C. §179 depreciation (and potentially be eligible for first-year “bonus” depreciation). The key to the determination of a hoop structure’s status is determining whether it is easily adaptable to other uses. If it is, it is properly classified as a “building.” If it is a general purpose ag building, it would not qualify for I.R.C. §179 depreciation.
Significant case. In Hart v. Comr., T.C. Memo. 1999-236, the taxpayers grew and processed tobacco on their Kentucky farm. After harvesting the tobacco in the summer, the taxpayers placed the plants over sticks in the field to cure. After the tobacco cured, the taxpayers transported the plants to a tobacco barn where the plants were hung to cure for several months. The taxpayers acquired a new tobacco barn in 1994. The barn was an enclosed “A-frame” structure with wooden walls and a dirt floor. The structure had three doors that were big enough to allow farm machinery to enter and exit. While the structure did not have a strong foundation, the foundation could be strengthened easily. It wasn’t suitable for the storage of grain because of ventilation and cracks. It also had minimal electrical wiring and fixtures, no insulation and no heating or plumbing. The structure contained a “stripping room” where the taxpayers cured, stripped, graded, baled and boxed tobacco leaves. The stripping room was enclosed only if the weather was cold.
On their tax return, the taxpayers reported the cost of the tobacco barn as $16,730 and elected to deduct $6,750 as expense method depreciation under I.R.C. §179 and depreciate the balance of the structure’s cost over 10 years under the 150 percent declining balance method (as a single-purpose agricultural/horticultural structure). The taxpayers’ position was that the structure was a structure other than a building used either as “an integral part of manufacturing or production” of tobacco or as “a facility used in connection with manufacturing or production.” The IRS, however, claimed that the structure was not entitled to I.R.C. §179 treatment and that its recovery period was 20 years.
The Tax Court upheld the IRS position, determining that the tobacco barn was a “building” rather than a “structure.” The Tax Court noted that the barn looked like a building and it provided working space for employees beyond what was required to cure tobacco. On that latter point, the Tax Court noted that the barn was used for five months out of the year to strip, grade, bale and box tobacco. The employees did more in the barn than simply hanging tobacco plants for curing. The barn also wasn’t a single purpose agricultural/horticultural structure as defined in I.R.C. §1245(a)(3)(D) because the taxpayers didn’t use it exclusively for the commercial production of plants in a greenhouse, or for the commercial production of mushrooms. See, e.g., I.R.C. §168(i)(13). Instead, it was a general-purpose structure that didn’t satisfy the “specific design” or “exclusive use” tests of Treas. Reg. §1.48-10(c)(1) or the “actual use” test of Treas. Reg. §1.48-10(e)(2). Thus, the barn was a “farm building” with a 20-year recovery life. It was also not a land improvement that could be depreciated over 15 years.
The significant increase in the I.R.C. §179 amount in recent years, and particularly as a result of the TCJA, makes the determination of qualified assets very important. On the farm or ranch, “buildings” aren’t eligible, but if a structure provides storage space for ag commodities and can’t easily be adapted to other uses, it just might be eligible property.
Friday, December 7, 2018
The Endangered Species Act (ESA) has the potential to restrict substantially agricultural activities because many of the protections provided for threatened and endangered species under the ESA extend to individual members of the species when they are on private land. Many endangered species have some habitat on private land. Current estimates are that half of the species listed as endangered or threatened have about 80 percent of their habitat on privately owned land.
When a species is listed as endangered or threatened, the Secretary of the Interior (Secretary) must consider whether to designate critical habitat for the species. Once a critical habitat designation is made, activities on the designated land are severely restricted. But how is that designation made, and can a court review the decision to list an area as critical habitat? Those are important questions for landowners, both rural and otherwise. Those questions are also the topic of today’s post – critical habitat designations under the ESA and judicial review.
The ESA establishes a regulatory framework for the protection and recovery of endangered and threatened species of plants, fish and wildlife. 16 U.S.C. § 1531 et seq. The U.S. Fish and Wildlife Service (USFWS), within the Department of the Interior, is the lead administrative agency for most threatened or endangered species, but the National Marine Fisheries Service (NMFS), within the Department of Commerce administers the ESA for certain endangered or threatened marine or anadromous species.
Under the ESA, an “endangered species” is a species which is in danger of extinction throughout all or a significant part of its range other than a species determined by the USFWS to constitute a pest whose protection under the provisions of the Act would present an overwhelming and overriding risk to humans. 16 U.S.C. § 1532(6). A “threatened species” is a species which is likely to become endangered within the foreseeable future throughout all or a significant portion of its range. 16 U.S.C. § 1532(20). The term “species” includes any subspecies of fish or wildlife or plants and any distinct population segment of any species of vertebrate fish or wildlife which interbreeds when mature. 16 U.S.C. § 1532(16).
The Listing Process. Secretary determines when a species is to be listed as either threatened or endangered, and other federal agencies have a duty to conserve listed species by consulting with the FWS when developing their own programs. See, e.g., Sierra Club v. Glickman, 156 F.3d 606 (5th Cir. 1998). As of December 6, 2018, 1,661 species in the United States had been listed under the ESA, with 1,275 species listed as endangered and 386 listed as threatened. Presently, the states with the greatest number of species listed as endangered or threatened are: Hawaii, California, Florida, Alabama and Texas.
An endangered or threatened listing is to be made on the basis of the best available scientific and commercial data without reference to possible economic or other impacts after the USFWS conducts a review of the status of the species. 16 U.S.C. § 1533(b)(1)(A) (2002); 50 C.F.R. 424.11 (20). There is, however, no statutory threshold definition or quantification of the level of data necessary to support a listing decision. Indeed, the information supporting a listing decision need not be credible; only the “best available.”
The Secretary's decision to list a species as endangered or threatened is based upon the presence of at least one of the following factors; (1) the present or threatened destruction, modification, or curtailment of a species' habitat or range; (2) the over-utilization for commercial, sporting, scientific or educational purposes; (3) disease or predation; (4) the inadequacy of existing regulatory mechanisms; or (5) other natural or manmade factors affecting a species' continued existence. 16 U.S.C. § 1533(a)(1). The USFWS may decline to list a species upon publishing a written finding either that listing is unwarranted or that listing is warranted, but that the USFWS lacks the resources to proceed immediately with the proposal. 16 U.S.C. § 1533(b)(3)(C)(ii).
Ever since the effective date of the 1982 amendments to the ESA, when a species is listed as endangered or threatened, the Secretary must designate critical habitat for the species. See Center for Biological Diversity v. United States Fish & Wildlife Service, 450 F.3d 930 (9th Cir. 2006). “Critical habitat” is the specific area within the geographical range occupied by the species at the time of listing that is essential to the conservation of the species. Critical habitat may also include specific areas outside the geographical area occupied by the species at the time it is listed if the USFWS determines that such areas are essential for conservation of the species. 16 U.S.C. §1532(5)(A). However, critical habitat need not include the entire geographical range which the species could potentially occupy. 16 U.S.C. § 1532(5). In making a critical habitat determination, the USFWS must consider economic impacts and other relevant impacts, as well as best scientific data. See, e.g., New Mexico Cattle Growers Association v. United States Fish and Wildlife Service, 248 F.3d 1277 (10th Cir. 2001). The failure to consider the economic and social impacts of a critical habitat designation at the time of the designation can be cause to set aside the designation. Home Builders Association of Northern California, et al. v. United States Fish and Wildlife Service, 268 F. Supp. 2d 1197 (E.D. Cal. 2003). The USFWS may exclude any area from critical habitat if the benefits of the exclusion outweigh the benefits of specifying the area as critical habitat, unless the USFWS determines on the basis of best scientific and commercial data available that the failure to designate an area as critical habitat will result in the extinction of the species. 16 U.S.C. § 1533(b)(2).
Under the facts of Weyerhaeuser Co. v. United States Fish & Wildlife Service, No. 17-71, 2018 U.S. LEXIS 6932 (U.S. Sup. Ct. Nov. 27, 2018), the USFWS, in 2001, listed the dusky gopher frog as an endangered species after determining that its wild population had dwindled to about 100 that were found at a single pond in Mississippi. It’s habitat had covered coastal areas of Alabama, Louisiana and Mississippi in certain open-canopy pine forests that have since been almost entirely replaced with urban development, agricultural operations and closed-forest timber farming enterprises. Upon making the designation, the Secretary had to designate the critical habitat for the frog. It did so in 2010. Among the areas designated as critical habitat was a 1,544-acre site in Louisiana where the frog species had last been seen in 1965. While that acreage was largely comprised of closed-canopy timber, it contained five ephemeral ponds and the USFWS believed that the tract met the statutory definition of “unoccupied critical habitat” because it could be a prime breeding ground for the frog. The USFWS then issued a report on the probable economic impact of designating the tract (and the other areas) as critical habitat.
The plaintiff owns part of the 1,544-acre tract and leased the balance from a group of landowners that had plans for development of the portion of the tract that they owned. Those development costs could amount to over $30 million (in timber farming and development) if the USFWS barred all development on the tract. But, according the USFWS, those potential costs would not be “disproportionate” to the conservation benefits of the designation. Consequently, the USFWS decided to not exclude the 1,544-acre tract from the frog’s critical habitat.
The plaintiff and the landowners sued to vacate the designation on the basis that the tract couldn’t be designated as critical habitat because it hadn’t been habitat for the frog since 1965 and couldn’t be habitat without significant modification. The plaintiff also challenged the decision of the USFWS not to exclude the tract from the frog’s critical habitat on the basis that the USFWS had failed to adequately weigh the benefits of designating the tract against the economic impact of the designation. The claim was that the USFWS used an unreasonable methodology for estimating economic impact and failed to consider certain categories of costs.
The trial court upheld the designation on the basis that the tract fit the definition of “unoccupied critical habitat” which only required the USFWS to decide that the tract was essential for the frog’s conservation. On appeal, the U.S. Court of Appeals for the Fifth Circuit affirmed on the basis that that definition of “critical habitat” required a “habitability” requirement. The appellate court also determined that the decision of the USFWS was not subject to judicial review.
On further review, the Supreme Court unanimously reversed 8-0 (Justice Kavanaugh did not participate). Chief Justice Roberts wrote the Court’s opinion, and pointed out that to be “critical habitat,” the designated area must first be “habitat.” Indeed, the Court pointed out that once a species is designated as endangered, the Secretary must designate the habitat of the species which is then considered to be critical habitat. 16 U.S.C. §1533(a)(3)(A)(i). That also applied in the context of unoccupied critical habitat that is determined to be essential for conservation of the species – the area must be “habitat.” Because the appellate court did not interpret the term “habitat” (the appellate court simply concluded that “critical habitat” was not limited to areas that were “habitat”), the Supreme Court vacated the appellate court’s opinion and remanded on this issue.
The Supreme Court also disagreed with the appellate court’s holding that the determination of the USFWS to not exclude the tract as critical habitat was not subject to judicial review. The Supreme Court noted that the plaintiff’s claim involving the alleged improper weighing of costs and benefits of the designation as critical habitat was the type of claim that the federal court’s routinely review when determining whether to set aside an agency decision as an abuse of discretion. Thus, the Supreme Court also vacated this part of the appellate court’s decision and remanded on the issue.
The case is important to private landowners for a couple of reasons. First, on remand the appellate court will have to redetermine the designation of the frog’s critical habitat on the basis that it first must actually be habitat for the frog. There is a “habitability” requirement when the Secretary designates an area as “critical habitat.” Second, the USFWS doesn’t get a free pass when designating an area as critical habitat. That designation is subject to judicial review (as are all USFWS decisions to decline to list a species).
Tuesday, December 4, 2018
Next week, on December 12-13 the final KSU Tax Institute will be held live from the Memorial Union at Pittsburg State University. The two-day event will be simulcast live over the web. It’s a chance to get more education on the new tax law and pick up on some of the important year-end tax planning opportunities under the Tax Cuts and Jobs Act (TCJA).
The KSU Tax Institutes started in late October and finish up at PSU next week. During this timeframe, we have continued to get dribs and drabs of additional information from the IRS and the Treasury about certain aspects of the TCJA. While we don’t have final regulations on the new pass-through business deduction for non-C corporate businesses, the final regulations might be issued by the time of the seminar next week. If that happens, I would especially encourage you to take part either in the live presentation or the webinar. I will cover the QBID in detail on Day 2 – December 13. I will go through many examples and show the practical application of how the deduction works and the best way to structure the business to best take advantage of the new provision. As a web participant, you will be able to interact and have your questions heard and answered.
While the seminar is not exclusively (or even primarily) devoted to ag-related tax issues, I will spend a good deal of time on Day 2 addressing planning concepts for farmers and ranchers as well as other small businesses.
You can register for next week’s seminar/webinar here: https://www.agmanager.info/events/kansas-income-tax-institute
If you are looking to fulfill an ethics requirement. I will be offering a 2-hour ethics session along with Prof. Lori McMillan, my tax colleague at Washburn Law school. The event will be the afternoon of Dec. 14 live from the law school in Topeka and will also be simulcast over the web. You can register for the ethics session here: http://washburnlaw.edu/employers/cle/taxethicsregister.html
Monday, December 3, 2018
Partnerships are a common entity form for farming operations. This is particularly true when the farming operation participates in federal farm programs. A general partnership is the entity form for a farming operation that can result in the maximization of federal farm program payments. But, tax issues can get complex when a partner sells or exchanges a partnership interest. In addition, the 20 percent deduction for non-C corporate businesses may also come into play.
The tax issues surrounding the sale or exchange of a partnership interest – that’s the topic of today’s post.
When a partner sells or exchange a partnership interest to anyone other than the partnership itself, the partner generally recognizes a capital gain or loss on the sale. I.R.C. §741. That’s a good tax result for capital gain because of the favorable tax rates that apply to capital gain income, but not a good tax result if a loss is involved because of the limited ability to deduct capital losses (e.g., they offset capital gain plus $3,000 of other income for the year). When a partner sells his interest in the partnership to the partnership in liquidation of the partner’s interest, the liquidating partner generally does not recognize gain (except to the extent money is received that exceeds the partner’s basis in the partnership interest or the partner is relieved of indebtedness). The liquidating partner receives a basis in the distributed property equal to what his basis had been in the partnership interest.
The general rule that a partner’s sale or exchange of his partnership interest triggers capital gain doesn’t apply to the extent the gain realized on the transaction is attributable to “hot assets.” “Hot assets” (as defined under I.R.C. §751) are unrealized receivables or inventory items of the partnership. In essence, “hot assets” are ordinary income producing assets that have not already been recognized as income, but eventually would have been recognized by the partnership and allocated to the partner in the ordinary course of partnership business and taxed at ordinary income rates. The partner’s sale or exchange of their interest merely accelerates the recognition of the income (such as with depreciation recapture). Thus, the income on the transaction is recharacterized from capital to ordinary. I.R.C. §751(a). The rationale for the recharacterization is that if the partnership were to sell such “hot assets,” ordinary income or loss would be recognized on the sale. Thus, when a partner sells or exchanges a partnership interest, the partner should recognize ordinary income on the portion of the income from the sale of the partnership interest that is attributable to the “hot assets.” If this recharacterization rule didn’t apply, a partner would be able to transform what would have been ordinary income into capital gain by selling or exchanging their partnership interest.
Similarly, when a partnership distributes property to a partner in exchange for the partner’s interest in the “hot assets” of the partnership, the transaction may be treated as sale or exchange of the hot assets between the partner and the partnership that generates ordinary income. It is possible, and perhaps frequent, for a partner involved in farming to recognize ordinary income and a capital loss, even though the partner had an overall gain on the sale. The ordinary income is taxed immediately, but the capital loss is limited as described above.
Types of “Hot Assets”
Unrealized receivables. There are three categories of unrealized receivables: (1) goods; (2) services; and (3) recapture items. I.R.C §751(c) defines the term “unrealized receivables” as including, “to the extent not previously includible in income under the method of accounting used by the partnership, any rights (contractual or otherwise) to payment for (1) goods delivered, or to be delivered, to the extent the proceeds therefrom would be treated as amounts received from the sale or exchange of property other than a capital asset, or (2) services rendered, or to be rendered.” In addition, the term “unrealized receivables” includes not only receivables, but also depreciation recapture. See, e.g., Treas. Reg. §§1.751-1(c)(4)(iii) and (v).
In the farming context, the “goods” terminology contained in the definition of “unrealized receivables” would include property used in the trade or business of farming that is subject to depreciation or amortization as defined by I.R.C. §1245. Included in the definition of I.R.C. §1245 property is personal property (I.R.C. §1245(a)(3)(A)) such as farm equipment and machinery. Also included in this definition are horses, cattle, hogs, sheep, goats, and mink and other furbearing animals, irrespective of the use to which they are put or the purpose for which they are held. Treas. Reg §1.1245-3(a)(4). The definition also includes certain real property that has an adjusted basis reflective of accelerated depreciation adjustments. I.R.C. §1245(a)(3)(C). That would include such assets as farm fences and farm field drainage tile. It also includes grain bins and silos by virtue of a definitional provision including a facility that is used for the bulk storage of fungible commodities. I.R.C. §1245(a)(3)(B)(iii). In addition, the definition includes single purpose agricultural or horticultural structures as defined in I.R.C. §168(i)(13). I.R.C. §1245(a)(3)(D).
The “goods” terminology also includes real property defined by I.R.C. §1250 that has been depreciated to the extent that accelerated depreciation incurred to the date of sale is in excess of straight-line depreciation. Farm property that falls in the category of I.R.C. §1250 property includes barns, storage sheds and work sheds. If these properties are sold after the end of their recovery period, there is no ordinary income. Also, included in this definition is farmland on which soil and water conservation expenses have been recaptured. I.R.C. §751(c); IRC §1252(a).
The “unrealized receivables” definition also includes rights (contractual or otherwise) to payment for goods delivered or to be delivered to the extent that the payment would be treated as received for property other than a capital asset, or services rendered or to be rendered to the extent that the income from such rights to payment was not previously included in income under the partnership’s method of accounting. The rights must have arisen under contracts or agreements that were in existence at the time of the sale or distribution, although the partnership may not be able to enforce payment until a later time. Treas. Reg. §1.751-1(c)(1). Thus, in the ag realm, the definition includes the present value of ordinary income attributable to deferred payment contracts for grain and livestock, installment notes for assets sold under the installment method, cash rent lease income, and ag commodity production contracts.
Inventory. The other category of “hot assets,” inventory items, includes stock in trade or other property of a kind which would properly be included in the inventory of the taxpayer if on hand at the close of the tax year, and property the taxpayer holds primarily for sale to customers in the ordinary course of business. I.R.C. §751(d) referencing I.R.C. §1221(a)(1). Whether a taxpayer holds property as a capital asset or for use in the ordinary course of business is a dependent on the facts. See, e.g. United States v. Winthrop, 417 F.2d 905 (9th Cir. 1969). For many farm partnerships, inventory items that constitute “hot assets” might include harvested crops, livestock that are being fed-out, poultry, tools and supplies, repair parts, as well as crop inputs (e.g., seed, feed and fertilizer) not yet applied to the land. On the other hand, an unharvested crop is not included in the definition of “inventory” if the unharvested crop is on land that the taxpayer uses in the trade or business that has been held for more than a year, if the land and the crop are sold or exchanged (or are the subject of an involuntary conversion) at the same time and to the same person. I.R.C. §1231(b)(4).
Inventory also includes any other property that, if sold by the partnership, would neither be considered a capital asset nor I.R.C. §1231 property. I.R.C. §751(d)(2). I.R.C. §1231 property is real or depreciable business property held for over a year (two years for some livestock). Thus, for a farm partnership, included in the definition of “inventory” by virtue of not being I.R.C. §1231 property would be single purpose agricultural or horticultural structures, grain bins, or farm buildings held for one year or less from the date of acquisition (I.R.C. §1231(b)(1); personal property (other than livestock) held for one year or less from the date of acquisition (Id.); cows and horses held for less than 24 months from the date of acquisition (I.R.C. §1231(b)(3)(A)); and other livestock (regardless of age, but not including poultry) held by the taxpayer for less than 12 months from the date of acquisition (I.R.C. §1231(b)(3)(B)).
Qualified Business Income Deduction
The Tax Cuts and Jobs Act (TCJA) creates new I.R.C. §199A effective for tax years beginning after 2017 and before 2026. The provision creates an up to 20 percent deduction from taxable income for qualified business income (QBI) of a business other than a C corporation. To be QBI, only ordinary income is eligible. Income taxed as capital gain is not. If gain on the sale or exchange of a partnership interest involves “hot assets,” the gain is taxed as ordinary income. Is it, therefore, QBI-eligible?
Under Prop. Treas. Reg. §1.199A-3, any gain that is attributable to a partnership’s hot assets is considered attributed to the partnership’s trade or business and may constitute QBI in the hands of the partner. Thus, if I.R.C. §751(a) or (b) applies on the sale or exchange of a partnership interest, the gain or loss attributable to the partnership assets that gave rise to ordinary income is QBI. Given the potentially high amount of “hot assets” that a farm partnership might contain (particularly when depreciation recapture is considered), the QBI deduction could play an important role in minimizing the tax bite on sale or exchange of a partnership interest.
When a partnership interest is sold or exchanged, the resulting tax issues have to be sorted out. An understanding of what qualifies as a “hot asset” helps in properly sorting out the tax consequences. In addition, the new QBI deduction can help soften the tax blow.
Thursday, November 29, 2018
The tax law is structured to tax income less the cost of producing the income. Over time, assets wear out or cease to be useful with their cost, in effect, being consumed during their period of usefulness in the farming or ranching business. In recognition of this cost, the tax law allows an annual deduction for depreciation. In addition, in some instances the total allowable depreciation for the asset can be claimed entirely in the first year that the taxpayer places the asset in service.
In general, depreciation is allowable on all tangible and intangible property with a limited useful life of more than one year that is used in the trade or business of farming or ranching or held for the production of income. Property that is depreciable includes business machinery and equipment, buildings, patents, purchased livestock and property held for rental. Property that is generally not depreciable includes inventories or stock in trade, a building used only as a residence and an automobile used only for pleasure. Land is not depreciable because it doesn’t have a determinable useful life.
Farmers and ranchers do encounter some unique situations that raise the question of whether an allowance for depreciation is available. Assets that are sufficiently similar to land may be non-depreciable because they don’t have a determinable useful life.
Non-depreciable farm assets due to the lack of a determinable useful life – that’s the topic of today’s post.
Agricultural operations can have several unique assets that aren’t depreciable because they don’t have a determinable useful life.
Grazing preferences. In general, grazing preferences are not be depreciable or amortizable. In Uecker v. Comr., 81 T.C. 783 (1983), aff’d, 766 F.2d 909 (5th Cir. 1985), the court held that grazing privileges had an indeterminant life because the taxpayers had preferential application and renewal privileges under state and federal law. They weren’t depreciable under I.R.C. §178 because of the taxpayers' ability to renew them indefinitely.
The same result was reached in Shufflebarger v. Comr., 24 T.C. No. 90 (1955). Under the facts of the case, the taxpayers acquired a portion of a summer allotment of grazing privileges in a national forest. They amortized the cost of acquiring the grazing privileges deducted it. The IRS disallowed the deduction on the basis that the rights had an indefinite duration. The Tax Court agreed. The same result was reached in Central Arizona Ranching Company v. Comr., T.C. Memo. 1964-217, a case involving state and federal land leases. Also, in Priv. Ltr. Rul. 8327003 (Mar. 17, 1983), the IRS determined that a taxpayer’s interest in a state grazing rights lease did not qualify as real property for purposes of a tax deferred exchange under I.R.C. §1031, but it was not subject to depreciation or amortization deductions under I.R.C. 167. The IRS noted that the terms of the lease were of indefinite duration.
But, a change in the facts could lead to a different conclusion if those facts reveal that the life of the grazing privilege has a certain end point, such as when the rights are dependent on the supply of a natural resource that will eventually be depleted.
Earthen irrigation ditches and levees. In Rev. Rul. 69-606, 1969-2 C.B. 33, the IRS ruled that the cost allocated to earthen watering tanks or "ponds" that were constructed by a prior owner on land that the buyer leased to ranchers was not recoverable through depreciation because it didn’t have a determinable useful life. The IRS also ruled that the buyer couldn’t recover the allocated cost as a soil and water conservation expense. The Tax Court concluded similarly in Wolfsen Land & Cattle Co. v. Comr., 72 T.C. 1(1979). In that case, the taxpayer bought a ranch that had an extensive irrigation system on over 17,000 acres. The Tax Court upheld the IRS determination that the system was not depreciable because it had an indeterminant useful life. The Tax Court noted that the evidence revealed that consistently repairing the system would result in the system lasting indefinitely.
However, some cases have held dams and ponds to be depreciable if a definite useful life can be demonstrated. For example, In Rudolph Investment Corp. v. Comr., T.C. Memo. 1972-129, earthen water tanks and dams were determined to have a ten-year useful life. In Rev. Rul. 75-151, 1975-1 C.B. 88, the IRS pointed out that the question of whether dams, ponds, canals and similar structures are depreciable depends on a factual determination that the asset is actually exhausting and that such exhaustion is susceptible of measurement. But, for farmers and ranchers, a current deduction under I.R.C. §175 is available for expenditures incurred for earthen terraces and dams which are non-depreciable. Of course, the qualifications for I.R.C. §175 must be satisfied.
Permanent Pastures. Permanent pasture is generally defined as land that is used to grow grasses or other forage naturally or through cultivation and is not included in a crop rotation for five years or longer. Permanent pastures have been held to be depreciable. For example, in Johnson v. Westover, 55-1 USTC ¶9,421 (S.D. Cal. 1955), the taxpayer purchased a ranch that included 200 acres of permanent pasture that had been planted with various grasses about five years earlier. The court determined, based on the evidence, that the pasture should be replanted at the end of 10 years to maintain its economic usefulness. At the time of purchase, the evidence showed that the pasture had a remaining life of five years.
Government Allotments or Quotas. Many farmers participate in federal farm programs. Particularly under prior farm bills, farmers were required to participate in acreage allotments. An acreage allotment is a particular farm’s share, based on its historic production, of the national acreage needed to produce sufficient supplies of a particular crop. In essence, an allotment represents the federal government’s attempt to micro-manage production of certain types of crops. These allotments have been held to not be depreciable due to a lack of a determinable useful life. For example, in Wenzel v. Comr., T.C. Memo. 1991-166, the Tax Court addressed the peanut base acreage allotment as part of the federal farm programs was depreciable. The Tax Court noted that wule the program had been controversial for some time, it continued to be reauthorized by subsequent farm bills. Thus, the Tax Court determined that the peanut program was a stable program that would continue unless the Congress took action to terminate it. Because the actions of Congress were completely unpredictable, the Tax Court held that the peanut program base acreage allotment was indeterminant and the associated cost to the taxpayer was not depreciable. Later, in C.C.A. 200429001 (Jul. 16, 2004), the IRS noted that three additional farm bills had become law since the Tax Court’s ruling in Wenzel and the peanut program continued. That lead the IRS to conclude that the duration of the peanut program could not be determined with reasonable certainty or accuracy. Consequently, the IRS determined, the peanut base acreage allotment did not have a determinable useful life and could not be depreciated.
But a transferable right to receive a premium price for a fixed quantity of milk in accordance with a regional milk marketing order has been held to be amortizable (e.g., the cost could be spread over the useful life – 15 years) when it has a statutory expiration date and is not expected to be renewed. For example, in Van de Steeg v. Comr., 60 T.C. 17 (1973), aff’d., 510 F2d 961 (9th Cir. 1975), the taxpayers were dairy farmers who marketed their milk production subject to a Federal Milk Marketing Order. On several occasions they purchased an intangible asset (referred to as a "class I milk base") which they used in their dairy business. They claimed depreciation for the milk base and IRS disallowed the deduction on the basis that the asset had an indeterminable useful life – it depended on the will of the Congress whether or not to extend the program. The Tax Court (affirmed by the Ninth Circuit) held that the program that created the class I milk base always contained an express termination date and the existence of two extensions did not change the fact that a termination date always existed, even though the date had changed. While the IRS disagrees with the Van de Steeg opinion, it did announce that it would follow it. Rev. Rul. 75-466, 1975-2 C.B. 74.
Drilling Costs for Wells. Drilling costs for wells are not depreciable, but parts of wells, such as piping and casings are. See, e.g., Rev. Rul. 56-599, 1956-2 C.B. 122. However, there is language in a Treasury Regulation that indicates that wells might be depreciable. See, e.g., Treas. Reg. §1.175-2(b)(1). In addition, the fact that the IRS has previously ruled that water wells were eligible for the investment tax credit (when it was available), bolsters the argument that water wells are depreciable. To be eligible for the investment tax credit, the property at issue had to be depreciable property. See, e.g., Rev. Rul. 72-222, 1972-1 C.B. 17; Rev. Rul. 81-120, 1981-1 C.B. 20.
Landscaping and Land Modification Costs. If a farmer or rancher incurs costs associated with landscaping or modifying the land (dirt moving) to construct a building that will be used in the farming business, the costs are likely depreciable. Support for this position can be found in Rev. Rul. 74-265, 1974-1 C.B. 56. Under the facts of the ruling, the taxpayer constructed and operated a garden-type apartment complex on several acres. The surrounding area was landscaped according to an architect's plan to conform it to the general design of the apartment complex. The expenditures for landscaping included the cost of top soil, seeding, clearing and grading, and planting of perennial shrubbery and ornamental trees around the perimeter of the tract of land and immediately adjacent to the buildings. The replacement of the apartment buildings after the expiration of their useful lives would destroy the immediately adjacent landscaping, consisting of perennial shrubbery and ornamental trees. The IRS ruled that the perennial shrubbery and ornamental trees immediately adjacent to the apartment buildings were depreciable because the replacement of the buildings would destroy the landscaping. That meant that the land preparatory costs could be recovered through depreciation deductions over the established useful life of the apartment buildings.
Logging Roads, Bridges and Culverts. Logging roads, bridges and culverts are depreciable if the taxpayer can establish that the roads have a determinable life. In one instance, the IRS ruled that a road did have a determinable useful life that could be determined by the amount of time it took to harvest trees that were reachable by the road. Rev. Rul. 88-99, 1988-2 C.B. 33. Under the facts of the ruling, the taxpayer built roads in order to harvest timber, to transport the logs cut from the timber to its facilities for processing, and to carry out general management activities. The taxpayer wanted to depreciate two of the roads. One road was to be maintained so that the taxpayer could use it for an indefinite period of time to manage and harvest timber. The IRS ruled that the roadbed could not be depreciated, but that the associated surface, bridges and culverts could be because they each had determinable useful lives. The other road was to be abandoned after four years, and the useful lives of all parts of the road (roadbed, surface, bridges, culverts, etc.) would terminate when the timber harvest and reforestation work was completed that the road was associated with. Thus, this road could be depreciated.
In a Tax Court case, the taxpayers were allowed to depreciate paved lots that were used in a cattle operation. Eldridge v. Comr., T.C. Memo. 1995-384. The court based its determination on the fact that the taxpayers maintained the horse barn and associated paved areas primarily for use in their cattle-raising activity. The horses housed in the barn were used by the taxpayers to move cattle from one pasture to another, and the Tax Court determined that the horse barn was maintained primarily for use in the cattle-raising activity which was engaged in for profit.
There are many unique items on a farm or ranch that present tricky issues with respect to depreciation because they don’t clearly have a determinable useful life. But, if a determinable useful life can be determined, a deduction for depreciation is available if the asset is used in the taxpayer’s trade or business or for the production of income.
Tuesday, November 27, 2018
Easements are a commonly encountered in agricultural settings. An easement does not give the holder of the easement a right of possession, but a right to use or to take something from someone else's land. To the holder of the easement, the easement is a right or interest in land, but to the owner of the real estate subject to the easement, the easement is an encumbrance upon that person's estate.
Easements may take several forms. Most easements are affirmative that entitle the holder to do certain things upon the land subject to the easement. A negative easement gives its holder a right to require the owner of the land subject to the easement to do or not to do specified things with respect to that land. For example, a negative easement could be a right-of-way, a riparian right, a right to lateral and subjacent support (see, e.g., Ohio Rev. Code. §§723.49-.50), a surface water flowage easement, a manure easement, a soil retention easement or an easement to be free from nuisances, just to name a few.
But, does the law recognize a negative easement for light, air or view? It’s an interesting question, and the issue comes up in ag settings more often than would be suspected. It’s also the topic of today’s post – whether the law recognizes a negative easement for light, air or view.
General rule. Negative easements are synonymous with covenantal land restrictions and are similar to certain “natural rights” that are incidents of land ownership. However, most American courts reject the English “ancient lights” doctrine. That means that American courts typically refuse to recognize a negative easement for light, air and view. This was the result, for example, in Fontainebleau Hotel Corp. v. Forty-Five Twenty-Five, Inc., 114 So.2d 357 (Fla. App. 1959). In the case, a hotel’s additional floors added to the top of the existing building cast a shadow over an adjacent hotel’s beach frontage. The complaining hotel asserted that the other hotel couldn’t add the additional floors to its building because the adjacent hotel had a negative easement over the other hotel’s property for light, air and view. The court rejected the claim on the basis that American law does not recognize a negative easement for light, air or view.
Exception. However, if light, air or view is obstructed out of spite or malice, an American court might determine that a negative easement exists. In other words, if a property owner's interference with a neighboring owner's light, air or view is done maliciously, the court may enjoin the activity as a nuisance. For example, in Coty v. Ramsey Associates, Inc., 149 Vt. 451, 546 A.2d 196 (1988), the court enjoined the defendant's “spite farm” on the basis that it constituted a nuisance. There was no question that the hog “farm” at issue was created purely out of maliciousness against an adjoining landowner. Thus, the court held that the adjoining landowner that had been harmed held a negative easement over the hog “farm” for light, air and view. In addition to the actual damages that the hog farm created, the court imposed substantial punitive damages. The conduct of the hog farm owner was incredibly egregious.
In Rattigan v. Wile, 445 Mass. 850, 841 N.E.2d 680 (2006), the parties were adjoining property owners. The defendant had outbid the plaintiff for the tract that the defendant purchased. That fact upset the plaintiff and the plaintiff then successfully challenged the defendant’s building permit. The result was that the defendant could not build on his tract as desired without being in violation of applicable zoning bylaws. The defendant retaliated against the plaintiff by flying his helicopter near the plaintiff’s property and otherwise harassing the plaintiff. The plaintiff sued, and the court entered an injunction against the defendant that also barred the defendant from putting portable toilets on the property line between the parties. The defendant appealed, claiming (in essence) that the plaintiff did not have any negative easement for light, air or view over the defendant’s property. However, the appellate court affirmed the trial court’s order of injunctive relief on the basis that the defendant’s conduct constituted a nuisance. The appellate court also determined that the proper measure of damages was the loss of rental value ($318,000 plus some additional out-of-pocket costs) attributable to the plaintiff’s property. The appellate court, however, modified the trial court’s permanent injunction so as to not limit the defendant’s legitimate uses of his property.
The issue of maliciousness or “spite” often arises with respect to fences. In 1887, Massachusetts enacted one of the earliest “spite fence” statutes in the United States which declared such a fence to be a private nuisance. Mass. Gen. Laws Ch. 348, §1 (1887); presently codified as Mass. Ann. Laws Ch. 49, §21. A “spite” fence is one that is an overly tall structure that is constructed with no legitimate purpose other than to obstruct an adjoining landowner’s light, air or view. For example, in Rice v. Cook, 115 A.3d 86 (Maine 2015), the parties disagreed over the boundary to their adjoining tracts. Neither party knew where the actual boundary was until a survey was completed in 2008, but the survey result upset the defendant and he erected what the court deemed to be a “spite fence” under Maine law which specifies that “[a]ny fence or other structure in the nature of a fence, unnecessarily exceeding 6 feet in height, maliciously kept and maintained for the purpose of annoying the owners or occupants of adjoining property, shall be deemed a private nuisance.” Me. Rev. Stat. Ann. Tit. 17, §2801. The court noted that the evidence clearly demonstrated that the defendant built the fence with the intent to annoy the plaintiff and interfere with the plaintiffs’ use of their property.
A row of trees can also be a “spite fence.” Unless there is some good reason to plant tall trees on a property line with the knowledge that the trees will block a neighbor’s view, the trees could be deemed to be a malicious spite fence and the trees ordered removed. For example, in Wilson v. Handley, 97 Cal. App. 4th 1301 (2002), the plaintiff built a second story addition to her log cabin. The defendant, a neighbor, then planted a row of evergreen trees parallel with the property line. When the trees became mature in the future, they would block the plaintiff’s mountain view from the second story addition. Because the evidence disclosed that the trees were planted to purposely block the view, they were deemed to be a “spite fence” and a private nuisance in violation of California law. Under California law, any fence or other structure in the nature of a fence (such as trees) that exceeds 10 feet in height and is maliciously erected or maintained for the purpose of annoying the owner or occupant of adjoining property is a private nuisance. See, Cal. Civ. Code §6-10 841.4. See also Vanderpol v. Starr, 194 Cal. App. 4th 385 (2011).
The California case is interesting for the fact that the court determined a “spite fence” existed even though the trees at issue would not obscure the view until some future date, if at all. The court noted that some varieties of trees can grow quickly Normally there can be no claim for an “anticipatory nuisance.” In other words, the law does not recognize an action for a nuisance until the nuisance actually occurs. For example, in Blackwell v. Lucas, No. 2017-CA-01492-COA, 2018 Miss. App. LEXIS 582 (Miss. Ct. App. Nov. 20, 2018), the defendants planted some plants and shrubs in the front yard of their home. Their neighbors, the plaintiffs, sued on the basis that the plants and shrubs caused them “mental pain and suffering.” Their complaint sought damages and preliminary and permanent injunctive relief requiring the removal of the plants and shrubs or to restrict their growth and height so that the plaintiffs’ view of the ocean and surrounding areas was not blocked. The defendants motioned to dismiss the case on the basis that the complaint failed to allege a violation of any legally cognizable right. The trial court dismissed the case.
On appeal, the appellate court noted that the plaintiffs’ only allegation of harm was that, if allowed to grow, the plants and shrubs would obstruct their view across the defendants’ property at some undetermined future date. The plaintiffs claimed that this potential future “harm” gave them a viable cause of action for a “spite fence” or nuisance. The appellate court stated that the plaintiffs had no common law or statutory right to an unobstructed view across their neighbors’ property. Nor did they have a right to dictate the type or placement of the defendants’ shrubs. In support of their claim, the plaintiffs cited the only reported Mississippi case concerning a “spite fence.” In that case, the court ordered the removal of a fourteen-foot-high "spite fence." That court relied on a treatise that defined a "spite fence" as "a structure of no beneficial use to the erecting owner or occupant of the premises but erected or maintained by him solely for the purpose of annoying the owner or occupier of adjoining property.” In this case, however, the appellate court pointed out that because the prior opinion was a 5-5 decision there remained no precedent for a “spite fence” claim under Mississippi law. Moreover, the appellate court declined to recognize a new cause of action for a “spite fence” in a case that did not even involve a traditional fence. The appellate court also pointed out that the plaintiffs’ complaint failed to state a claim for the additional reason that it failed to allege that the “plants and shrubs” actually obstructed their view. The complaint merely asserted that, if allowed to grow, the shrubbery would obstruct their view at some unspecified point in the future. Thus, the appellate court held that the plaintiffs’ complaint failed to state a claim upon which relief could be granted and affirmed the trial court’s decision.
American law generally does not recognize a negative easement for light, air or view. But, if the facts of a situation reveal that light, air or view has been obstructed with the intent to cause harm to an adjoining landowner, then a legal right may be impacted. The obstruction can take the form of a traditional fence, trees and shrubs, or the deliberately improper operation of a farm. If whatever is done, is done with malicious intent, a negative easement may be found to exist.
Wednesday, November 21, 2018
An issue for all motorists, but one of particular interest to motorists using rural roadways is the length of time that a train can block a crossing. In rural areas, there may be few (if any) options for detouring around a blocked crossing.
Many states (and some towns and municipalities) have statutes the denote the maximum length of time that a train can block a crossing. But, can state law regulate the length of time a train blocks a crossing? Is the issue a matter of federal law? That’s the topic of today’s post – train blockage of crossings and how state and federal law deals with the issue.
Many states have statutes that specify the maximum length of time that a train can block a public roadway grade crossing. The state laws vary, but a general rule of thumb is that a blockage cannot exist for more than 20 minutes. There are numerous exceptions, of course, that concern such things as emergencies and when the blockage is a result of something beyond the control of the railroad. In addition, in states that don’t have a state law addressing the issue, there may be restrictions at the local level – cities, towns, villages and municipalities.
Here's a sample of a few state rules on the issue:
In Arizona, if an engineer, conductor or other employee of a railroad permits a locomotive or railcars to be or remain on a crossing of a public highway or over the railway in a manner that obstructs travel over the crossing for longer than 15 minutes is guilty of a class 2 misdemeanor. Ariz. Rev. Stat. §40-852. An exception is provided for an “unavoidable accident.” See also Terranova v. Southern Pacific Transportation Company, 158 Ariz. 125, 761 P.2d 1029 (1988).
Under Iowa law, a ten-minute maximum is the rule. Iowa Code §327G.32. Exceptions are provided when a blockage longer than ten minutes is required for the railroad to comply with signals affecting the safety of the movement of the train; when the train is disabled; or when it is necessary to comply with governmental safety regulations including but not limited to speed ordinances and speed regulations. Interestingly, a railroad employee is not subject to penalty under the provision if they were acting on orders of a supervisor or the railroad in general. In that case, the penalty for violating the law applies to the railroad. The Iowa provision also says that a political subdivision of the state may pass an ordinance dealing with the matter if it for a public safety purpose.
The Indiana law is similar to the Iowa law. In Indiana, public travel cannot be blocked for more than 10 minutes by any train, railroad car, or engine. Indiana Code §8-6-7.5-1. There are exceptions from the 10-minute rule in situations where the train, railroad car or engine cannot be moved by reason of uncontrollable circumstances. In addition, a railroad cannot permit successive train movements to obstruct vehicular traffic at a highway grade crossing until all vehicular traffic that has already been delayed by a train has been allowed at least five minutes to clear. Violations of the law constitutes a “Class C infraction.” The penalty is generally imposed on the railroad corporation.
Nebraska, the home of Union Pacific Railroad, has a very detailed, lengthy statute dealing with the issue. A train obstruction of a public highway, street or alley in any unincorporated town or village in the state is prohibited beyond 10 minutes. Neb. Rev. Stat. §17-225. The penalty for violation is a fine of $10 to $100. In addition, any members of a train crew, yard crew, or engine crew cannot be held personally responsible for any violation if they were acting on orders by their employer. It is the railroad that bears the responsibility to comply with the law. Neb. Rev. Stat. §17-594. Nebraska law also states that at crossings, a train cannot be stored or parked in a manner that obstructs the motoring public’s view of an oncoming train. Neb. Rev. Stat. §74-1323. Violation of the Nebraska provision is coupled with a minimal penalty – Class IV misdemeanor with a maximum fine of $200 for each offense (every day constitutes a separate offense).
Does Federal or State Law Control?
An interesting question involves the extent to which the state laws on public roadway grade crossing blockage laws are valid. Railroads are subject to an interesting mix of federal and state law. Does federal law preempt state law on this issue? That was the question presented in a recent Kansas case.
In State of Kansas v. Burlington Northern Santa Fe Railway Company, No. 118,095, 2018 Kan. App. LEXIS 63 (Kan. Ct. App. Nov. 2, 2018). Burlington Northern Santa Fe Railway (BNSF) operates trains through Bazaar (an unincorporated community) in Chase County, Kansas. At issue were two railroad crossings where the main line and the side lines crossed county and town roads. The side line is used to change crews or let other trains by on the main line. Early one morning, the Chase County Sherriff received a call that a train was blocking both intersections. The Sherriff arrived on scene two hours later and spoke with a BNSF employee. This employee said that he was checking the train but did not state when the train would move. The Sherriff then called BNSF three times. The train remained stopped on both crossings for approximately four hours. The Sherriff issued two citations (one for each engine) under K.S.A. 66-273 for blocking the crossings for four hours and six minutes.
K.S.A. 66-273 prohibits railroad companies and corporations operating a railroad in Kansas from allowing trains to stand upon any public roadway near any incorporated or unincorporated city or town in excess of 10 minutes at any one time without leaving an opening on the roadway of at least 30 feet in width. BNSF moved to dismiss the citation, but the trial court rejected the motion. During the trial, many citizens presented evidence that they could not get to work that day and a service technician could not reach a home that did not have hot water and was having heating problems. BNSF presented train logs for one of the engines. These logs showed that one engine was only stopped in Bazaar for 8 minutes to change crews and was not in Bazaar at 9:54 a.m. The Sheriff later conceded that he might have mistaken the numbers on the engines for the citations. There were no train logs for the other engine. BNSF also stated there could be other alternatives from blocking the crossings but uncoupling the middle of the train would be time consuming and unsafe. The trial court ruled against BNSF and entered a fine of $4,200 plus court costs.
On appeal, BNSF claimed that the Interstate Commerce Commission Termination Act (ICCTA) and Federal Railroad Safety Act (FRSA) preempted Kansas law, and that the evidence presented was not sufficient to prove a violation of Kansas Law. The appellate court agreed, holding that the ICCTA, by its express terms contained in 49 U.S.C. 10501(b), preempted Kansas law. While the appellate court noted that the Kansas statute served an “admirable purpose,” it was too specific in that it applied only to railroad companies rather than the public at large. Also, the statute had more than a remote or incidental effect on railway transportation. As a result, the Kansas law infringed on the Surface Transportation Board’s exclusive jurisdiction to regulate the railways in the United States. The court noted that the Surface Transportation Board was created by the ICCTA and given exclusive jurisdiction over the construction, acquisition, operation, abandonment, or discontinuance of railroad tracks and facilities. In addition, the appellate court noted that the Congress expressly stated that the remedies with respect to regulation of rail transportation set forth in the ICCTA are exclusive and preempt other remedies provided under federal or state law The appellate court did not consider BNSF’s other arguments.
The Kansas case indicates that state law may have to be carefully tailored to apply broadly to roadway obstructions generally, and not have anything more than a slight impact on railway transportation. If those requirements are not satisfied, federal law may control.
Have a blessed Thanksgiving. I will not be posting on Friday this week. The next post will be on Tuesday Nov. 27.
Monday, November 19, 2018
Liability issues abound for farmers and ranchers. Many farmers have a comprehensive farm liability policy to cover potential liability events associated with the farming operation. But, a comprehensive farm liability policy is a hybrid policy that contains both homeowners and commercial insurance elements. That’s because the home is on a part of the same premises where the farm and ranch business is conducted. and live on the same property.
One of the unique aspects of farming and ranching is that it’s not uncommon for a farmer or rancher to conduct some other type of business activity on the farm or ranch premises. That other activity may or may not be related to the business of farming. It is these other activities (such as a road-side stand, corn maize or U-Pick operation) that can raise questions about whether there is insurance coverage for them under the farm’s comprehensive insurance policy. That’s because those policies often exclude “non-farm business pursuits” of the insured.
The scope and application of non-business pursuits of the insured as applied in the context of farming/ranching operations – that’s the focus of today’s post.
The issue is often straightforward for farming operations that don’t conduct a separate business on the premises. The comprehensive liability policy should cover the risks associated with the farming business because of it being tailored to the activities that the insured conducts as part of the farming operation. But, for those that have a smaller farming operation or a hobby farm, the insurance coverage issue can be a big one. Often the insurance coverage for these activities is provided by means of a traditional homeowner’s policy. But, that can mean situations of non-coverage can arise as additional activities occur.
Excluded activities. Homeowner policies exclude business or farming activities. Thus, any activity that is deemed to be “business” or “farming” is excluded from liability or property coverage. That means that liability coverage would need to be broadened by adding an endorsement (subject to the carrier’s guidelines) to the policy that details all of the business or farming activities that are occurring on the premises. Alternatively, a traditional homeowner policy might be able to be modified by adding a “farm liability” endorsement. This additional endorsement would be appropriate when there are farm “hobby” activities on the premises. This endorsement will essentially blend the personal and business coverages by making no distinction between the two general types of activities.
What should be covered? All dwellings on the premises should be covered including all buildings and appurtenant structures, equipment and coverage for livestock. Many homeowner policies will cover a limited amount of animals for personal use such as horses and cows and goats, but if the animal is part of a business activity, a homeowner policy won’t provide coverage. That would mean, for example, that the typical homeowner policy won’t cover liability situations arising from boarding horses whether a fee is charged or not. If a fee is charged, the activity is an excluded business pursuit. If a fee is not charged, coverage may not be available because the horses owned by someone other than the insured.
Hanover American Insurance Company v. White, No. CIV-14-0726-HE, (W.D. Okla. Aug. 3, 2015), is a good illustration of the application of the “business pursuits of the insured.” The insured’s primary business was an aviation-related rental and repair business. He also co-owned an oilfield service company. The premises where the oilfield service company business was conducted was comprised of 150 acres. It was not adjacent to either of the insured’s other properties. The property was fenced, and the insured kept a bull and about 50 head of cattle on the property. The bull was purchased for the purpose of breeding the cows and produce calves. Some of the resulting calf crop was sold and the balance used for team roping. An employee of the oilfield service company cared for the cattle and bought supplies for them by charging the cost to the company’s account.
The bull escaped its enclosure and attacked another person who died as a result of the injuries. The decedent’s estate sued the insured. The insured was covered by a homeowner policy on his residence and a dwelling policy for a dwelling on another property the insured owned. Both policies contained identical language that excluded bodily injury “[a]rising out of or in connection with a ‘business’ engaged in by an ‘insured.’” Both policies also defined “business” to “include…trade, profession or occupation.”
The insurance companies claimed that they had no duty to defend or indemnify the insured. Both companies claimed that the liability event fell within the “business exclusion” of the companies’ respective policies. The insured claimed he wasn’t engaged in a cattle business, but merely a hobby activity and had coverage under the policies. The court disagreed with the insured on the basis that the evidence showed that he engaged in the cattle activity with the intent (at least in part) to make a profit. The court also pointed out that the insured treated the cattle activity as a Schedule F business on his tax returns. That meant that the resulting losses from the cattle activity offset the income of the insured’s wife. Thus, the court was persuaded that the cattle activity was not purely a hobby. It was a business activity not covered by his insurance policies.
In Western National Assurance Company v. Robel, No. 35394-0-III, 2018 Wash. App. LEXIS 2387 (Wash. Ct. App. Oct. 23, 2018), the defendants owned a farm and orchard. The orchard was listed in the area brochure as one of the “U-Pick” orchards. The orchard also sold pre-picked cherries. The plaintiff called the defendants to ensure that they were open before visiting. The plaintiff and her friend arrived at the orchard, and each of them were given a basket to strap on and were directed to the orchard where the 10-foot tall, three-legged ladders were located. While picking cherries on a ladder, the plaintiff ‘s basket filled and caused her to become top-heavy. She lost her balance and fell off the ladder. As a result of the fall, the plaintiff broke her hand and foot, and injured her neck, back and shoulder. The defendants were not at the orchard that day. The plaintiff sued alleging that the defendants, doing business as an orchard, failed to maintain the orchard in a safe manner and failed to properly instruct her on use of the ladder.
The defendants’ insurance company with whom they held a homeowners’ policy defended the suit which was dismissed by the trial court for improper service. The appellate court reversed as to the dismissal and the insurance company brought a declaratory judgment action claiming that the homeowners’ policy did not provide liability coverage for the defendant’s orchard business due to an exclusion for business pursuits of the insured. The trial court agreed and denied coverage under the policy for the plaintiff’s injuries. The appellate court affirmed, finding that the accident arose from a separate business pursuit of the insured that was within the policy exclusion. The appellate court determined that it was immaterial that the defendants did not make much profit from the U-Pick business as a part of their overall farming operation. What mattered, the appellate court determined, was that the defendants sold produce to the public that were invited as business guests to the premises. In addition, the appellate court determined that the use of a ladder was within the scope of the U-Pick business.
The non-farm “business pursuits” exclusion is an important exclusion that rural landowners need to be aware of. It’s a particular issue for smaller, hobby-type operations and those growing or organic or specialty or niche crops. Clearly, each rural/farming enterprise is different. That means that a good comprehensive farm liability policy should be customized to fit each particular situation. Start with the basic coverage and then add on coverage based on your own unique set of facts. Also, give careful thought to the amount of coverage needed. The insurance agent is a key person in making sure that coverage is provided for the needs of the insured. In farm settings, it’s almost always recommended that the insurance agent visit the premises to ensure that the agent has a full understanding of your needs.