Thursday, March 21, 2019

Packers and Stockyards Act Provisions For Unpaid Cash Sellers of Livestock


The Packers and Stockyards Act (PSA) of 1921 was enacted with the purpose of ensuring fair competition in and trade practices involving livestock marketing, meat and poultry.  7 U.S.C. §§181-229.  See also Armour & Company v. United States, 402 F.2d 712 (7th Cir. 1968).  The scope of the PSA is quite broad, vesting in the U.S. Secretary of Agriculture (Secretary) wide discretion to investigate and regulate all activities connected with livestock marketing.  See, e.g., Rice v. Wilcox, 630 F.2d 586 (8th Cir. 1980)

What happens when a livestock packer, market agency or a livestock dealer fails to pay for livestock that it buys from a livestock seller?  The “prompt payment rule and the statutory trust of the PSA – that’s the topic of today’s post.

Rules Governing Payment For Livestock

Prompt payment rule.  The PSA provides for failure to make prompt and full payment for livestock.  Generally, to not be deemed to be engaged in an “unfair practice” under the PSA, a packer must make full payment of the livestock’s purchase price “before the close of the next business day following the purchase of livestock and transfer of possession thereof.”  7 U.S.C. §§228b(a) and (c).  A packer subject to the prompt payment rule is defined as “any person engaged in the business (a) of buying livestock in commerce for purposes of slaughter, or (b) of manufacturing or preparing meats or meat food products for sale or shipment in commerce, or (c) of marketing meats, meat food products, or livestock products in an unmanufactured form acting as a wholesale broker, dealer, or distributor in commerce.”  7 U.S.C. §191.  When livestock is purchased for slaughter, payment must be made to the seller or the seller’s representative at the point of transfer or the funds must be wired to the seller’s account by the close of the next business day.  Id.  If the sale is based on carcass weight, or is a grade/yield sale, the same rule applies once the purchase amount has been determined.  Id.  If the seller (or the seller’s agent) is not present to receive payment at the point of sale, the packer is to either wire the funds to the seller and put a check in the mail for the full amount by the close of the next business day.  Id. 

The prompt payment requirement can be waived by written agreement that is entered into before the purchase or sale of livestock.  7 U.S.C. §228(b)(b)The regulations provide a format for the waiver.  9 C.F.R. §201.200(a)The agreement must be disclosed in the business records of the buyer and the seller, and on the accounts or other documents that the buyer issues relating to the transaction.  7 U.S.C. §228b(b).  But, if the prompt payment requirement is waived, the seller will lose any interest the seller has in the statutory trust (discussed below).  7 U.S.C. §196(c)

The prompt payment rule also applies to “market agencies” and “dealers” in addition to packers (as defined above).  A “market agency” is any person “engaged in the business of (1) buying or selling in commerce livestock on a commission basis or (2) furnishing stockyard services.” 7 U.S.C. §201(c).  Simply denoting “commission” on an invoice does not, by itself, indicate that the sale was on a commission basis.  It’s the nature of the business relationship of the parties and the surrounding facts and circumstances that are determinative.  See, e.g., Ferguson v. United States Department of Agriculture, 911 F.2d 1273 (8th Cir. 1990).  A “dealer” is “any person, not a market agency, engaged in the business of buying or selling in commerce livestock, either on his own account or as the employee or agent of the vendor or purchaser.”  7 U.S.C. §201(d).  In Kelly v. United States, 202 F.2d 838 (10th Cir. 1953), the court said that a person can be a “dealer” even if the buying and selling of livestock is not the person’s only business. 

A violation of the prompt payment rule constitutes an “unfair practice” under the PSA.  7 U.S.C. §228b(c).  The same is true for the issuance of an insufficient funds check and the failure to pay when due.  7 U.S.C. §213(a); 7 U.S.C. §228(b). 

The inability to make prompt payment is sometimes tied to the financial condition of the buyer. Consequently, all market agencies are prohibited from operating while insolvent – when current liabilities exceed current assets.  7 U.S.C. §204.  See also United States v. Ocala Livestock Market, Inc., 861 F. Supp. 2d 1328 (M.D. Fla. 2012). 

Statutory Trust.  For packers with average annual purchases of livestock exceeding $500,000, the PSA establishes a statutory trust for the benefit of unpaid cash sellers.  A “cash sale” is any sale where the seller does not expressly extend credit to the packer.  7 U.S.C. §196(a); Kunkel v. Sprague National Bank, 128 F.3d 636 (8th Cir. 1997)The provision extends to “all inventories of, or receivables or proceeds from meat, meat food products, or livestock products derived therefrom….”  7 U.S.C. §196(b).  The funds must be held in the trust for the benefit of al unpaid cash sellers of livestock until full payment has been received by the unpaid seller.  Id. 

If a packer files bankruptcy, assets contained in the statutory trust are not part of the bankruptcy estate.  11 U.S.C. §541(d).  This means that the unpaid cash sellers of livestock do not have to compete with the bankrupt debtor’s secured creditors for the assets contained in the trust.  See, e.g., Rogers and King, Collier Farm Bankruptcy Guide §105[1].  Claims for payment from the statutory trust will defeat a properly perfected Uniform Commercial Code lien.  See, e.g., In re Gotham Provision Company, 669 F.2d 1000 (5th Cir. 1982).  Likewise, a bank creditor of a packer is not able to setoff funds held in the statutory trust.  See, e.g., In re Jack-Rich, Inc., 176 B.R. 476 (Bankr. C.D. Ill. 1994).  Also, payment from a statutory trust to livestock sellers are not recoverable as a preference item in bankruptcy.  But, what constitutes cash collateral can present issues. 

An unpaid cash seller can make a claim against trust assets by providing notice to the Secretary within 30 days of the final date for making prompt payment under 7 U.S.C. §228(b) or within 15 business days of being notified that the seller’s check has been dishonored, whichever is later.  7 U.S.C. §196(b); see also 9 C.F.R. §203.15.

The statutory trust requirement does not apply to livestock purchases by market agencies and dealers.  However, payments that a livestock buyer makes to a market agency for sales on commission are considered to be trust funds that must be deposited into a custodial account.  9 C.F.R.§201.42(a), (b).  In other words, a market agency or a dealer must maintain a custodial account for trust funds.    By close of the next business day after an auction, market agencies must deposit into the custodial account:  (1) all proceeds collected from the auction, and (2) an amount equal to the proceeds receivable from the livestock sale that are due from the market agency; any owner, employee, or officer of the market agency; and any buyer to whom the market agency has extended credit. 7 U.S.C. §201.42(c)-(d); 9 C.F.R. §201.42(c)In addition, a market agency must deposit an amount equal to all of the remaining proceeds receivable into the custodial account within seven days of the auction, even if some of the proceeds remain uncollected.  Id.  Funds in the custodial account can only be withdrawn to remit the net proceeds due a seller, to pay lawful charges which the market agency is required to pay, and to obtain sums due the market agency as compensation for its services.  9 C.F.R. §201.42(d).  A market agency must transmit or deliver the net proceeds received from the sale to the seller by the close of business on the day after the sale.  7 U.S.C. §228b(a); 9 C.F.R. §201.43(a). 

To make a statutory trust claim, written notice must be given to the buyer and the Grain Inspection Packers and Stockyards Administration (GIPSA).    The livestock not paid for must be identified along with the date of delivery.  The applicable “look-back” period is 30 days before receipt by the buyer and the Secretary. 

Note:  Effective November 29, 2018, GIPSA is no longer a standalone agency within the United States Department of Agriculture (USDA), but is contained within the USDA’s Agricultural Marketing Service (AMS).  The USDA final rule detailing the reorganization is found at 83 FR 61309 (Nov. 29, 2018).   


Reparation.  A livestock seller that has sustained a PSA “injury” at the hands of a market agency or a dealer can sue in federal district court “for the full amount of damages sustained in consequence of such violation.”  7 U.S.C. §209(a), (b).  Another option for a disaffected livestock seller is to begin a reparation proceeding for money damages.  7 U.S.C. §§209(b); 210.  A filing for a reparation proceeding must be made within 90 days after the cause of action accrues.  7 U.S.C. §210(a).  See also 9 C.F.R. §§202.101-.123.  The filing is made with the Secretary at the AMS/GIPSA Regional Office.  The complaint must state the cause of the action; the date of the transaction; amount of damages; method of computation; place where the transaction occurred; and the name of the parties.  No particular Form is needed to file the complaint, however the P&SP Form 5000 is recommended. The Form is available here: 

Once the complaint is processed and investigated, AMS/GIPSA will serve the complaint on the defendant.  The defendant will then have 20 days upon receipt to file an answer to the complaint.  Once an answer is received, or the time for responding has expired, the complaint is filed with a GIPS hearing clerk.  A hearing will be scheduled will be in writing unless an oral hearing is requested and claimed damages exceed $10,000.  An oral hearing can also occur if necessary to establish the facts and circumstances that gave rise to the controversy.  If AMS/GIPSA determines that a hearing should be in writing, each party will be given notice and 20 days to file objections.  Written hearings allow for additional evidence to be given, and have additional procedures that must be followed.   

If the Secretary determines that the livestock seller is entitled to damages, the Secretary will order the defendant “to pay to the complainant the sum to which he is entitled on or before a day named.”  7 U.S.C. §210(b).  AMS/GIPSA cannot enforce payment of any award, but the order can be enforced by the applicable federal district court (or any state court having general jurisdiction of the parties) upon an enforcement action being filed with the court within one year of the date of the order.  The order is deemed to be prima facie evidence of the facts stated in the order, and a prevailing livestock seller is entitled to reasonable attorney fees.  Id. 

A complaint can be withdrawn at any time to terminate the reparation unless there is a counterclaim. 

Injunction.  7 U.S.C. §228a authorizes a statutory injunction and allows the United States to apply for a temporary injunction or restraining order when it has reason to believe that any person governed by the PSA has “(a) failed to pay or is unable to pay for livestock, meats, meat food products, or livestock products in unmanufactured form, … or has failed to remit to the person entitled thereto the net proceeds from the sale of any such commodity sold on a commission basis; or (b) has operated while insolvent, or otherwise in violation of [the PSA] in a manner which may reasonably be expected to cause irreparable damage to another person; or (c) does not have the required bond; and that it would be in the public interest to enjoin such person from operating subject to this chapter or enjoin him from operating subject to this chapter except under such conditions as would protect vendors or consignors of such commodities or other affected persons.”  When the United States makes such a “proper showing,” the court “shall…issue a temporary injunction or restraining order.”  Id. 


The PSA is a major piece of legislation significantly regulating livestock sales involving covered entities.  It provides a level of protection for livestock sellers in terms of ensuring payment.  In addition, it is a good practice for lenders that finance PSA-covered entities to ensure that these entities promptly pay for all livestock purchased. 

March 21, 2019 in Regulatory Law | Permalink | Comments (0)

Tuesday, March 19, 2019

Packers and Stockyards Act – Basic Provisions


This week’s two posts will be devoted to the Packers and Stockyards Act (PSA). 7 U.S.C. §181 et seq.  Recent news of a sale barn bankruptcy in Kansas has brought renewed attention to how the PSA works and its various provisions.  In today’s post, I will detail a bit of the history of the PSA and several of the basic provisions of the law.  In Thursday’s post, I will deal specifically with the PSA trust that is created to protect unpaid cash sellers of livestock when a buyer files bankruptcy – the problem facing some Kansas cattlemen at the present time.

The PSA – it’s history and basic provisions, that’s the topic of today’s post.

History of the PSA

The PSA is enforced by the USDA’s Packers and Stockyards Administration which regulates the livestock and poultry marketing system in the U.S.  The stated purpose of the PSA is to assure the free flow of livestock from livestock farms and ranches to the marketplace.  See, e.g., Stafford v. Wallace, 258 U.S. 495 (1922). The PSA regulates both packers and stockyards.

The genesis of the PSA dates back to 1888.  That’s when the U.S. Senate authorized an investigation of the buying and selling of livestock to determine if anti-competitive practices were present.  The investigation revealed that major meatpackers were engaging in unfair, discriminatory and anti-competitive practices by means of price fixing, agreements not to compete, refusals to deal and similar arrangements.  The Senate report contributed to the political support for the Sherman Act of 1890. 

In 1902, an injunction was sought against the major meatpackers alleging antitrust violations.  The injunction was issued in 1903 and the Supreme Court sustained it in 1905. Swift & Company v. United States, 196 U.S. 375 (1905). The injunction, however, was not successful in correcting the situations deemed anti-competitive. The same defendants or their successors were indicted and tried for alleged violations of the antitrust laws but were acquitted after trial in 1912.  The dominance and anti-competitive activities of the packers continued, and in 1917, President Wilson directed the Federal Trade Commission (FTC) to investigate the packing industry.  The FTC report documented widespread anti-competitive practices involving operations of stockyards, actions of commission persons, operation of weighing facilities, disposal of dead animals and control of packing plants.

During congressional debate of the PSA, the major packers signed a consent decree in an attempt to ward off the new legislation.  The consent decree was entered into on February 27, 1920, and it enjoined the “Big Five” meatpackers (Swift & Co., Armour & Co., Cudahy Packing Co., Wilson & Co., and Morris & Co.) from certain activities.  The Big Five were prohibited from maintaining or entering into any contract, combination or conspiracy, in restraint of trade or commerce, or monopolizing or attempting to monopolize trade or commerce.  The consent decree also prohibited the Big Five from engaging in any illegal trade practice as well as owning an interest in any public stockyard company, any stockyard terminal railroad or any stockyard market newspaper or journal.  The injunction also prohibited the Big Five from having an interest in the business of manufacturing, selling or transporting, distributing or otherwise dealing in any of numerous food products, mainly fish, vegetables, fruits, and groceries and many other commodities not related to the meatpacking industry.  Similarly, the injunction prohibited the Big Five from using or permitting others to use their distribution systems or facilities for the purchase, sale, handling, transporting or dealing in any of the enumerated articles or commodities.  The injunction also prevented the owning or operating of any retail meat markets except in-plant sales to accommodate employees.  Because the Big Five controlled all the warehousing in their exercise of monopoly power, the injunction prevented them from having an interest in any public cold storage warehouse or engaging in the business of selling or dealing in fresh milk or cream.

Even though the Attorney General of the United States personally appeared before the House Committee on Agriculture and recommended against the proposed legislation on the ground that the consent decree would eliminate the evils in the packing industry and make legislation unnecessary, President Harding signed the PSA into law on April 15, 1921.  Consequently, some of the “Big Five” filed suit seeking to have the consent decree either vacated or declared void.  However, in 1928, the United States Supreme Court upheld the consent decree.  Swift & Co. v. United States, 276 U.S. 311 (1928). Similarly, the Supreme Court turned down requests to modify the decree in 1932 (Swift & Co. v. United States, 286 U.S. 106 (1932)) and 1961. Swift & Co. v. United States, 367 U.S. 909 (1961).  The decree, however, was terminated on November 23, 1981. United States v. Swift & Co., 1982-1 Trade Cas. (CCH) ¶64,464 (N.D. Ill. 1981).

While the PSA was “the most far-reaching measure and extend[ed] further than any previous law into the regulation of private business with few exceptions,” (61 Cong. Rec. 1872 (1921) and the powers given to the Secretary of Agriculture were more “wide-ranging” than the powers granted to the FTC, the Act was upheld as constitutional in several court cases from 1922 to 1934.  Unquestionably, the PSA extends well beyond the scope of other antitrust law.

Selected Provisions of the Act

Registration Requirement.  The PSA requires all marketing agencies that handle livestock to register with the USDA which has the authority to suspend registration for violations of the Act for insolvency. 7 U.S.C. Sec. 181 et seq.

Bonding. Packer bonding is required except for those with average annual purchases of $500,000 or less.  Thus, there is a danger posed to persons or entities selling livestock to relatively small buyers.  Selling to a local locker does not provide the protection that the PSA affords had the sale been to a packer purchasing at least $500,000 worth of livestock per year.

False Weighing.  False weighing of livestock is also prohibited.  False weighing of livestock had been a serious longstanding problem.  “Back balancing” had been a relatively common practice (failure to empty the scales to show a balanced condition).  False weighing is viewed as a serious offense and the regulations impose several detailed requirements to discourage false weighing. See 9 C.F.R. §§ 201.49-201.99.  For example, whenever livestock is weighed for the purpose of sale, a scale ticket must be issued which must be serially numbered and used in sequential order.  9 C.F.R. §201.49(a)The scale tickets must be retained as part of the market agency's or dealer's business records to substantiate each transaction, and must include: 1) the name and location of the weighing; 2) the date of the weighing; 3) the name of the buyer and seller or consigned, or a readily identifiable designation thereof; 4) the number of livestock; 5) the kind of livestock; 6) the actual weight of each draft of livestock; and 7) the identity of the person who weighed the livestock, or their signature if required by State law.  9 C.F.R. §201.49(b).

Gratuities. The Packers and Stockyards Act also prohibits the practice of a stockyard owner or market agency giving gratuities to truckers, consignors or shippers.  Providing free trucking to consignors as an inducement to consign livestock to a particular market is an unfair practice and a willful violation of the PSA that discriminates against those consignors not given free trucking. The practice also constitutes an unfair and unjust practice against competing markets, forcing them to give free trucking in order to remain in business.

Coordinated Buying.  The “turn system” of selling livestock has been held to violate the PSA. Berigan v. United States, 257 F.2d 852 (8th Cir. 1958).  Under the “turn system” of selling livestock, livestock dealers engage in the practice of flipping coins to establish the “order” or “turn” in which they would look at, bid on and have the opportunity to buy stocker and feeder cattle consigned for sale to a market agency.  This method of selling livestock limits the number of buyers or prospective buyers which increases the value of the position or turn of those not eliminated with the effect of restricting competition and depressing the market.

Bribery.  The PSA also prohibits the bribery of weighmasters.  Likewise, bribing employees of a market agency by a dealer to obtain favored treatment in sale of livestock has been held to violate the PSA.   See, e.g., In re McNulty, 13 Agric. Dec. 345 (1954).  Other violations of the PSA include market agencies purchasing animals from consignments for resale, price discounts being offered to some purchasers of meat products, and the use of “bait and switch” tactics in selling meat.

Recordkeeping.  The PSA requires that books and records be kept.  Penalties for failure to do so include a $5,000 fine or three years in prison or both.  Private actions may be brought for “reparations” under the Act by filing a complaint with the USDA within 90 days after the cause of action accrues.  USDA issues the order requiring payment.

Other Prohibited Practices.  The Act prohibits any “unfair, unjustly discriminatory, or deceptive practice or device7 U.S.C. §192(a).  But, in Kinkaid v. John Morrell & Co., 321 F. Supp. 2d 1090 (N.D. Iowa 2004), the court held that hog contracts containing a deduction charge for hogs dying in transit was not an unfair or deceptive practice and did not constitute an unauthorized sale of insurance under state (Iowa) law because the primary purpose of contracts was the sale of hogs.

Enforcement.  Enforcement of the PSA is either by a civil action, initiated by the person aggrieved by the violation of the PSA, or by an action taken by the U.S. Attorney upon request of the Secretary of Agriculture.  Jurisdiction is in the federal district court.


In part two on Thursday, I will dig into the PSA trust provision and the protection it provides for unpaid cash sellers of livestock.  That’s a provision that is of particular importance when a livestock buyer files bankruptcy after buying livestock but before making payment for them.  I will also look at some PSA market competition issues.  Stay tuned. 

March 19, 2019 in Regulatory Law | Permalink | Comments (0)

Friday, March 15, 2019

Can The IRS Collect Unpaid Estate Tax From The Beneficiaries?


If the federal estate tax isn’t paid when due nine months after the date of the decedent’s death, is a person that receives property from the decedent’s estate personally liable for the unpaid tax? Does it matter how the person received the property - either by gift, as a surviving joint tenant or as a beneficiary of the estate?  How long does the IRS have to collect the tax?  These are all important questions, especially with respect to a farmer’s estate where present economic and financial conditions may have dissipated estate property such that the estate no longer has assets and funds with which to pay the tax, or where the assets have already been distributed.

The personal liability of estate beneficiaries for federal estate tax – that’s the topic of today’s post.

Establishing Liability

With the present level of the exemption from federal estate tax pegged at $11.4 million for deaths in 2019, it’s very unlikely that any particular estate will have to worry about federal estate tax.  But, this enhanced level of exemption (it was, in essence, doubled by the late 2017 tax legislation) is set to expire at the end of 2025 and go back to the pre-2018 level of $5 million (adjusted for inflation).  Also, it is possible that a change in the political winds come 2020, could reduce the exemption below $5 million.  That would make it far more relevant again for many farm and ranch families.

When a decedent’s estate has a federal estate tax liability, it is due nine-months after the date of death.  I.R.C. §6075(a).  A six-month extension is available.  But, if the tax is not paid when it is due, any transferee, surviving tenant or beneficiary of the estate is personally liable for the unpaid estate tax to the extent the property they received was included in the decedent’s gross estate under I.R.C. §2034 through I.R.C. §2042I.R.C. §6324(a)(2). The IRS also has a special lien for any unpaid gift tax.  I.R.C. §6324(b).  These liens arise automatically – no assessment, notice or demand for payment or filing is required.  The lien attaches to the gross estate and lasts for the earlier of ten years from the date of the decedent’s death or until the tax is paid. I.R.C. §6324(a).  The lien attaches to the extent of tax shown to be due by the return and of any deficiency in tax found to be due.  Treas. Reg. §301.6324-1(a)(1). 

The IRS must prove that an unpaid tax exists at the time of death and that a beneficiary received property that was included in the decedent’s gross estate at death.  I.R.C. §§ 2035-2042 list the various types of property and the rules governing how those types of property are included in the decedent’s gross estate for estate tax purposes.  Each beneficiary of estate property is personally liable for any unpaid estate tax based on the property they received from the estate and to the extent of the property’s value at the time of the decedent’s death.  I.R.C. 6324(a)(2).  See also Baptiste v. Comr., 29 F.3d 433 (8th Cir. 1994), aff’g. in part and rev’g. in part 100 T.C. 52 (1993); Baptiste v. Comr., 29 F.3d 1533 (11th Cir. 1194), aff’g., 100 T.C. 252 (1993).

Procedurally, the IRS is not required to follow the normal process for collecting a deficiency when it moves to assert the lien against a transferee of estate property.  See, e.g., United States v. Geniviva, 16 F.3d 522 (3rd Cir. 1994).  The special estate tax lien is also not subject to the filing and notice requirements of the general IRS lien of I.R.C. §6321I.R.C. §6323(a).  Thus, buyers, holders of security interests, other lien holders and judgment lien creditors may not be protected unless I.R.C. §6324 provides protection.  Rev. Rul. 69-23, 1969-1 CB 302.

Some property is exempt from the IRS lien.  Included in the exempt list is any part of the decedent’s gross estate that is used to pay charges against the estate or pay administrative costs.  I.R.C. §6324(a)(1).  The lien also doesn’t apply to any part of the decedent’s property that is transferred to a bona fide buyer or holder of a security interest, except that the lien attaches to any consideration received. I.R.C. §§6324(a)(2)-(3).  Also, any property that is released via certificate is exempt.  I.R.C. §6325; Treas. Reg. §301.6324-1(a)(2)(iv). 

Recent Case

The issue of liability of estate beneficiaries for unpaid estate tax came up in a recent case from South Dakota.  In United States v. Ringling, No. 4:17-cv-04006-KES, 2019 U.S. Dist. LEXIS 28146 (D. S.D. Feb. 21, 2019), the defendants were the daughters and one grandson of the decedent. The decedent died in late 1999 leaving his estate equally to his daughters and providing a specific bequest of farmland to one of the daughters as part of her co-equal share of the estate.  The will named the daughters as co-personal representatives of his estate. The estate included farmland and crops among other assets.  In 1999, the federal estate tax exemption equivalent of the unified credit was $650,000 and the top rate was 55 percent.

In 1996, the decedent entered into an agreement with his grandson to buy additional farmland. Under that agreement, the decedent bought the land and the grandson was to pay the decedent $32,000 via an installment contract. Ten days before his death in 1999, the decedent forgave the remaining balance due on the contract of $27,600.96. Also, in 1996 the decedent conveyed a warranty deed to his grandson for the family farm along with irrigation equipment and permits, retaining a life estate and the right to receive the rent income and profits from the farm during his life. After death, the farm was appraised at $345,700. Six days before death, the decedent and his grandson entered into a contract for deed of additional farmland. This contract called for the grandson to pay $90,000 to the decedent, with $10,000 to be paid before or at the time of deed execution and the balance to be paid in 20 equal installments. The grandson would not take possession until March 1, 2000. At the time of the decedent’s death in late 1999, the unpaid balance on the contract was $80,093.30.

In early 2008, the estate filed Form 706 reporting a gross estate of $834,336 and a net estate tax due of $28,939. No payment accompanied the filing. On Form 706, the estate reported assets as three pieces of farmland; co-op shares; stocks; bonds; two contracts for deed; cash; bank accounts; certificates of deposit (CDs); two life insurance policies; a corn crop that had been gifted to the grandson; the decedent’s pickup truck; a van; and other miscellaneous property.  The Form 706 reported that each of the daughters received $121,988 and that the grandson received $416,116. Later in 2008, the IRS agreed that the estate tax was $28,939, but that a late filing penalty of $6,511.27 and a failure to pay penalty of $7,234.75 should be added on. In addition, the IRS assessed interest of $23,189.78. The total amount the IRS asserted due was $65,874.80. In 2010, the estate requested an abatement of the penalties and interest. The IRS denied the request. In 2013, the IRS sent the defendants Form 10492 Notice of Federal Taxes Due with respect to the estate. Later in 2013, the IRS filed a Notice of Federal Tax Lien on the farmland.  The Notice was also sent to the estate. A hearing was not requested. Beginning in 2010, the defendants had made some payments on the estate tax liability, but as of mid-2018 over $63,000 remained due. The IRS then sued seeking payment from the daughters and the grandson personally via I.R.C. §6324(a)(2) and sought summary judgment. Only one daughter filed a response in opposition to summary judgment. 

The court noted that each of the daughters and the grandson jointly owned property with the decedent at the time of his death.  The jointly owned property also included a checking account on which one of the daughters continued to write checks after the decedent’s death.  Under I.R.C. §2040, the court noted, the decedent’s gross estate included all property that he and any other person held as joint tenants with rights of survivorship.   The two life insurance policies were included in the estate by virtue of I.R.C. §2042.  Various gifts were also included in the gross estate under I.R.C. §2035.  These included the decedent’s transfer of the corn crop and CDs to the grandson, as well as the forgiveness of the balance due on the contract for deed.  These were all included in the estate because they had been transferred within three years of death.  Also included in the decedent’s gross estate was the decedent’s retained life estate in the family farm that he had transferred to his grandson.  The retained life estate caused the farm to be included in the gross estate and made it subject to the special estate tax lien as I.R.C. §6324(a)(2) property. 

The court held that the defendants were personally liable for the unpaid federal estate tax as transferees of estate property and that they did not receive the property free and clear of estate tax liabilities. The court noted that transferee liability is not limited to those receiving a gift or bequest under a decedent’s will or via the administration of a revocable trust. Rather, liability extends to recipients of all property included in the gross estate including transferees who received lifetime gifts that are included in the gross estate under I.R.C. §2035 because they were made within three years of death; gift recipients whose gift was a discharge of indebtedness to the decedent; transferees who receive the property as surviving join tenants; property passing to remaindermen when the decedent had a life tenancy in the property; and life insurance proceeds on the life of the decedent.

The one daughter that filed a response to the IRS summary judgment motion asserted that the government was barred by the statute of limitations.  After all, she noted, the decedent died in 1999 and the IRS didn’t file suit to collect the tax until early 2017.  However, under I.R.C. §6324(a)(2), personal liability for unpaid estate tax can be asserted by the IRS ten years from the date the assessment is made against the estate.  I.R.C. §6502(a)(1).  See also United States v. Botefuhr, 309 F.3d 1263 (10th Cir. 2002).  The assessment was made in 2008 (remember the estate didn’t file Form 706 until 2008) and the IRS sued in 2017, nine years into the 10-year timeframe for doing so and 18 years after the decedent’s death.  The daughter challenging the government’s motion didn’t dispute these facts.  Now, the court’s decision finding the daughters and grandson personally liable for the unpaid estate tax comes just over 19 years after the decedent’s death.   


The clear lesson of the case is that federal estate tax liability just doesn’t go away if the estate doesn’t pay it.  In addition, the IRS has a lengthy timeframe to collect the tax.  Proper pre-death planning can, of course, help to either minimize or eliminate the tax.  Also, if the exemption from federal estate tax were to drop in the future, more farms, ranches and small businesses would get caught in its snare.  That was certainly the result for the South Dakota farming operation in the recent case.

March 15, 2019 in Estate Planning | Permalink | Comments (0)

Wednesday, March 13, 2019

Real Estate Professionals and Aggregation – The Passive Loss Rules


Last April I devoted a post to the general grouping rules under I.R.C. §469   Those rules allow the grouping of passive investment activities with other activities in which the taxpayer materially participates.   Thus, for example, an investor in an ethanol plant might be able to group the losses from that investment with the taxpayer’s farming activity. Grouping may make it more likely that the taxpayer can avoid the passive loss rules and fully deduct any resulting losses.

But, there’s another grouping rule – one that applies to a taxpayer that has satisfied the tests to be a real estate professional and it’s only for purposes of determining material participation in rental activities.  This election is an all-or-nothing election – either all of the taxpayer’s rental activities are aggregated or none of them are. 

The aggregation election for real estate professionals – that’s the focus of today’s post.

Real Estate Professional

In last Thursday’s post,  I detailed the rules under I.R.C. §469 pertaining to a real estate professional.  To qualify as a “real estate professional” two test must be satisfied:  (1) more than 50 percent of the personal services that the taxpayer performs in trades or business for the tax year must be performed in real property trades or businesses in which the taxpayer materially participates; and (2) the taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates.  I.R.C. §469(c)(7).  If the two tests are satisfied, as noted above, the rental activity is no longer presumed to be passive and, if material participation is present, the rental activity is non-passive.  I.R.C. §469(c)(7)(A)(i).Another way of putting is that once the tests of I.R.C. §469(c)(7) are satisfied it doesn’t necessarily mean that rental losses are non-passive and deductible, it just means that the rental losses aren’t per se as passive under I.R.C. §469(c)(2) See, e.g., Gragg v. United States, 831 F.3d 1189 (9th Cir. 2016); Perez v. Comr., T.C. Memo. 2010-232.  An additional step remains – the taxpayer must materially participate in each separate rental activity (if there are multiple activities). 

Note:  The issue of whether a taxpayer is a real estate professional is determined on an annual basis.  See, e.g., Bailey v. Comr., T.C. Memo. 2001-296.  In addition, when a joint return is filed, the requirements to qualify as a real estate professional are satisfied if either spouse separately satisfies the requirements.  I.R.C. §469(c)(7)(B). 

Is Separate Really the Rule?

As noted above, if a taxpayer has multiple rental activities, the taxpayer must materially participate in each activity.  That can be a rather harsh rule.  But, there is an exception.  Actually, there are two.  If material participation test cannot be satisfied, the taxpayer can use a relaxed rule of active participation.  I.R.C. §469(i).  That rule allows the deduction of up to $25,000 of losses (subject to an income phase-out).  In addition, the taxpayer can make an election to aggregate all of the rental activities that the taxpayer is involved in for purposes of meeting the material participation test.  Treas. Reg. §1.469-9(g)(1).  This aggregation election is available to a taxpayer that has satisfied the requirements to be a qualified real estate professional under I.R.C. §469(c)(7).  See, e.g., C.C.A. 201427016 (Jul 3, 2014).

Points on aggregation.  Aggregation only applies to the taxpayer’s rental activities.  Activities that aren’t rental activities can’t be grouped with rental activities. In addition, it’s only for purposes of determining whether the material participation test has been met.  Because the election only applies to rental activities, time spent on non-rental activities won’t help the taxpayer meet the material participation test for the rental activities.  This makes the definition of a “rental activity” important.  I highlighted the designated rental activities in last Thursday’s post.  One of them is that the real estate must be used in a rental activity rather be realty that is held in the taxpayer’s trade or business where the average period of customer use for the property is seven days or less.  Temp. Treas. Reg. §1.469-1T(e)(3)(ii); see also Bailey v. Comr., T.C. Memo. 2001-296.   

By election only.  Aggregation is accomplished only by election.  Treas. Reg. §1.469-9(g)(3).  It’s not enough to simply list all of the rental activities of the taxpayer in a single column on Schedule E.  In Kosonen v. Comr., T.C. Memo. 2000-107, the petitioner owned seven residential rental properties.  As of the beginning of 1994, he had non-deductible suspended losses of $215,860 from his properties.  He put in almost 1,000 hours in rental activities in each of 1994 and 1995.  On this 1994 return, he listed each rental property and loss separately on Schedule E and reported a combined loss of $56,954 on line 42 of Schedule E – the line where a taxpayer that is materially participating in rental activities reports net income or loss from all rental activities.  He also reported the loss on line 17 of Form 1040 and subtracted it from other income to compute his adjusted gross income.  He also filed Form 8582 to report the $56,954 loss.  However, he didn’t attach an aggregation statement to the return noting that he was electing to treat his rental real estate activities as a single activity.  He also didn’t combine his 1994 Schedule E rental real estate losses with his previously suspended losses.  The IRS noted that had a proper election been made that the petitioner would have satisfied the material participation requirement.  But, the IRS took the position that an election had not been made and as a result the material participation requirement had to be satisfied with respect to each separate activity.  Because he could meet the material participation test in any single activity by itself, the IRS asserted, the resulting losses were suspended and couldn’t offset active income.  The Tax Court agreed with the IRS.  While the form of his entries on the return were consistent with an aggregation election, the Tax Court held that his method of reporting net losses as active income was not clear notice of an aggregation election.  The fact that the IRS had not yet issued guidance on how to make an aggregation election didn’t eliminate the statutory requirement to aggregate, the Tax Court concluded.     

Attached statement.  To satisfy the statutory election requirement, the election statement attached to the return should clearly state that an election to aggregate rental activities is being made via I.R.C. §469(c)(7)(A) and that the taxpayer is a qualifying taxpayer in accordance with I.R.C. §469(c)(7)(B).   

Late election relief.  It is possible to make a late election via an amended return.  In Rev. Proc. 2011-34, 2011-24 I.R.B. 875, the IRS said a late election can be made in situations where the taxpayer has filed returns that are consistent with having made the election.  In that event, the late election applies to all tax years for which the taxpayer is seeking relief.  The late election is made by making the election in the proper manner as indicated above as an attachment to the amended return for the current tax year.  The attachment must identify the tax year(s) for which the late election is to apply, and explain why a timely election wasn’t initially made.  The opportunity to make a late election is important.  See, e.g., Estate of Ramirez, et al. v. Comr., T.C. Memo. 2018-196. 

Binding election.  The aggregation election cannot be revoked once it is made – it is binding for the tax year in which it is made and for all future years in which the taxpayer is a qualifying real estate professional.  If intervening years exist in which the taxpayer was not a qualified real estate professional, the election has no effect in those years and the taxpayer’s activities will be evaluated under the general grouping rule of Treas. Reg. §1.469-4.  Treas. Reg. §1.469-9(g)(1). 

Years applicable.  If the election hasn’t been made in a year during which the taxpayer was a qualified real estate professional, it can still be made in a later year.  But, the election is of no effect if it is made in a year that the taxpayer doesn’t satisfy the requirements to be a real estate professional.  Treas. Reg. §1.469-9(g)(1).  In other words, the election may be made in any year in which the taxpayer is a qualifying taxpayer for any tax year in which the taxpayer is a qualifying taxpayer. In addition, the failure to make the election in one year doesn't bar the taxpayer from making the election in a later year.  Treas. Regs. §§1.469-9(g)(1) and (3).  

Revocation.  While the aggregation election is normally binding, the aggregation election can be revoked for a year during which the taxpayer’s facts and circumstances change in a material way.  If that happens, the election can be revoked by filing a statement with the original tax return for that year.  According to the regulations, the statement must provide that the I.R.C. §469(c)(7)(A) election is being revoked and describe the material change in the taxpayer’s factual situation that justifies the revocation.  Treas. Reg. §1.469-9(g)(3). 

Rental real estate activities held in limited partnerships.  What happens if the taxpayer makes the election to aggregate all real estate rental activities but not all of the taxpayer’s interests in real estate activities are held individually by the taxpayer?  The regulations address this possibility and use an example of an interest in a rental real estate activity held by the taxpayer as a limited partnership interest.  Treas. Reg. §1.469-9(f)(1). The result is that the effect of the aggregation election doesn’t necessarily apply in this situation.   Instead, the taxpayer’s combined rental activities are deemed to be a limited partnership interest when determining material participation and the taxpayer must establish material participation under one of the tests that apply to determine the material participation of a limited partner contained in Treas. Reg. 1.469-5T(e)(2).  Treas. Reg. §1.469-9(f)(1). But, there is a de minimis exception that applies if the taxpayer’s share of gross rental income from all limited partnership interests in rental real estate is less than 10 percent of the taxpayer’s share of gross rental income from all of the taxpayer’s interests in rental real estate for the tax year.  In this situation, the taxpayer can determine material participation by using any of the tests for material participation in Treas. Reg. §1.469-5T(a) that apply to rental real estate activities.  Treas. Reg. §1.469-9(f)(2).  This is also the rule if the taxpayer has an interest in a rental real estate activity via an LLC.  An LLC interest is not treated as a limited partnership interest for this purpose.  Thus, the taxpayer can use any of the seven tests for material participation contained in Treas. Reg. §1.469-5T(a).  See, e.g., Garnett v. Comr., 132 T.C. 368 (2009); Hegarty v. Comr., T.C. Sum. Op. 2009-153; Newell v. Comr., T.C. Memo. 2010-23; Thompson v. Comr., 87 Fed. Cl. 728 (2009), acq. in result only, A.O.D. 2010-002 (Apr. 5, 2010); Chambers v. Comr., T.C. Sum. Op. 2012-91. 

It should be noted that in its 2017-2018 Priority Guidance Plan, the IRS stated that it planned to finalize regulations under I.R.C. §469(h)(2).  That provision creates a per se rule of non-material participation for limited partner interests in a limited partnership unless the Treasury specifies differently in regulations.  Those regulations were initially issued in temporary form and became proposed regulations in 2011.  Until the IRS takes action to effectively overturn the Tax Court decisions via regulation, the issue will boil down (as it has in the Tax Court cases referenced above) to an analysis of a particular state’s LLC statute and whether there are sufficient factors under the state statute that distinguish an LLC from a limited partnership.

Effect on losses.  The aggregation election also impacts the handling of losses.  Once the aggregation election is made, prior year disallowed passive losses from any of the aggregated real estate rental activities can be used to offset current net income from the aggregated activities regardless of which activity produces the income or prior year loss.  At least this is the position take in the preamble to the regulations.  See Preamble to T.D. 8645 (Dec. 21, 1995).  This is the result even if the disallowed prior year losses occurred in tax years before the aggregation election was made.  Treas. Reg. §1.469-9(e)(4).   

Any suspended losses remain suspended until substantially all of the combined activities (by virtue of the election) are disposed of in a fully taxable transaction. This would be an issue if a rental real estate activity with a suspended loss is aggregated with other rental real estate activities.  Those suspended losses would not be deductible until the entire aggregated activity (now treated as a single activity) is disposed of.  Thus, depending on the amount of the suspended losses at issue, it may not be a good idea to make the aggregation election in this situation.  Likewise, it also may not be a good idea to make the aggregation election if the taxpayer has positive net income from rental real estate activities and passive losses from activities other than rental real estate activities.  If the election is made in this situation, the rental activities won’t be passive, and the taxpayer won’t be able to use the losses from the other passive activities to offset the income from the rental real estate activities.  The losses could then end up being suspended and non-deductible until the entire (combined) activity is disposed of. 


The aggregation election is an election that is available only for real estate professionals and can make satisfying the material participation test easier.  That can allow for full deductibility of losses from rental real estate activities.  But, the terrain is rocky.  Good tax advice and planning is essential.

March 13, 2019 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Monday, March 11, 2019

Developments in Agricultural Law and Taxation


Earlier in the year I devoted a blog post to a few current developments in the realm of agricultural law and taxation.  That post was quite popular with numerous requests to devote a post to recent developments periodically.  As a result, I take a break from my series of posts on the passive loss rules to feature some current developments.

Selected recent developments in agricultural law and taxation – that’s the topic of today’s post. 


While economic matters remain tough in Midwest crop agriculture and dairy operations all over the country and the projection is for the third-lowest net farm income in the past 10 years, it hasn’t resulted in an increase in Chapter 12 bankruptcy filings.  For the fiscal year ended September 30, 2018, filings nationwide were down 8 percent from the prior fiscal year.  However, the number of filing is still about 25 percent higher than it was in 2014.  The filings, however, are concentrated in the parts of the country where traditional row crops are grown and livestock and dairy operations predominate.  For example, according to the U.S. Courts and reports filed by the Chapter 12 trustees, the states comprising the U.S. Circuit Court of Appeals for the Eighth Circuit (Midwest and northern Central Plains) show a 45 percent increase in Chapter 12 filings when fiscal year 2018 is compared to fiscal year 2017.  The Second Circuit (parts of the Northeast) is up 38 percent during the same timeframe.  Offsetting these numbers are the Eleventh Circuit (Southeast) which showed a 47 percent decline in filings during fiscal year 2018 compared to fiscal year 2017.  The far West and Northwest also showed a 41 percent decline in filings during the same timeframe. 

USDA data indicates some rough economic/financial data.  Debt-to-asset ratios are on the rise and the debt-service ratio (the share of ag production that is used for ag payments) is projected to reach an all-time high.  The current ratio for farming operations is projected to reach an all-time low (but this data has only been kept since 2009).  Unfortunately, the U.S. is very good at infusing agriculture with debt capital.  In addition, there are numerous tax incentives for the seller financing of farmland.  In addition, federal farm programs encourage higher debt levels to the extent they artificially reduce farming risk.  This accelerates economic vulnerability when farm asset values decline.

Recent case.  A recent Virginia case illustrates how important it is for a farmer to comply with all of the Chapter 12 rules when trying to get a Chapter 12 reorganization plan confirmed.  In In re Akers, 594 B.R. 362 (Bankr. W.D. Va. 2019), the debtor owed three secured creditors approximately $350,000 in addition to other unsecured creditors. Two of the secured creditors and the trustee objected to the debtor’s proposed reorganization plan. At the hearing on the confirmation of the reorganization plan, it was revealed that the debtor had not provided any of the required monthly reports. As a result, the court denied plan confirmation and required the debtor to put together an amended plan. The debtor subsequently submitted multiple amended plans, and all were denied confirmation because of the debtor’s inaccurate financial reporting and miscalculation of income and expense. In addition, the current proposed plan was not clear as to how much the largest creditor was to be paid. The creditor had foreclosed, and some payments had been made but the payments were not detailed in the plan. The court denied plan confirmation and denied the debtor’s request to file another amended plan and dismissed the case. The court was not convinced that the debtor would ever be able to put together an accurate and manageable plan that he could comply with, having already had five opportunities to do so. 


A recent Iowa case illustrates the need for ag producers to put business agreements in writing.  In Quality Egg, LLC v. Hickmans’s Egg Ranch, Inc., No 17-1690, 2019 Iowa App. LEXIS 158 (Iowa App. Ct. Feb. 20, 2019), the plaintiff, in 2002, entered into an oral contract to sell eggs to the defendant via a formula to determine the price paid for the eggs. The business relationship continued smoothly until 2008, when the plaintiff received a check from the defendant that it determined to be far short of the amount due on the account. Notwithstanding the discrepancy, the parties continued doing business until 2011. In 2014, the plaintiff filed sued to recover the amount due, claiming that the defendant purchased eggs on an open account, and still owed about $1.2 million on that account. The defendant counter-claimed, asserting that the transaction did not involve an open account but simply an oral contract to purchase eggs that had been modified in 2008. Consequently, the defendant claimed that the disputed amount was roughly $580,000, based on the modified oral contract.

The trial court jury found that the ongoing series of transactions for the sale and purchase of eggs was an “open and continuous account” at the time of the short pay, yet still found for the defendant. The plaintiff appealed, asserting that the trial court had erred by allowing oral testimony used to prove the existence of a modified oral contract in violation of the statute of frauds. The appellate court remanded for a new trial on the issue, and the second jury trial in 2017 again found for the defendant. The plaintiff again appealed, asserting the statute of frauds as a defense. The plaintiff also asserted that the trial court had failed to instruct the jury on an open account, depriving the jury of the ability to decide the specific elements of its open account claim. The trial court provided only jury instructions on the elements of the breach of contract counter-claim brought by the defendant. On the statute of frauds issue, the appellate court noted that the defendant had admitted written correspondence, checks, and credit statements to support the oral testimony at trial in support of the oral testimony. Thus, the statute of frauds was not violated. However, on the open account jury instruction issue, the appellate court found that the instructions given were improper because the plaintiff’s burden was to prove its claim of money due on an open account, not to disprove an assertion from the defendant of an amended oral contract. The appellate court found that the instructions never mentioned an open account or discussed an open account in any way, and because of that, the jury was never able to render a proper verdict on the plaintiff’s claim. Accordingly, the appellate court concluded that the jury instructions were insufficient and reversed and remanded for a new trial limited to the open-account claim.

Get it in writing! 


The qualified business income deduction (QBID) continues to bedevil the tax software programs.  It’s the primary reason that the IRS extended the March 1 filing deadline to April 15.  The IRS also released a draft Form 8995 to use in calculating the QBID for 2019 returns.  But, the actual calculation of the QBID is not that complicated.  The difficult part is knowing what is QBI and whether the specified service trade or business limits apply.  No worksheet is going to help with that.  Understand the concepts!  Also, the IRS now says that a PDF attachment of the safe harbor election for rental activities must be combined with the e-filed return.  In addition, the election must be signed under penalty of perjury.  As I see it, this is just another reason to not use the QBID safe harbor election if you don’t have to.   

The U.S. Senate is finally working on tax extender legislation that will extend provisions that expired at the end of 2017.  The legislation would extend those expired provisions for two years, 2018-2019.  The Senate Finance Committee has released a summary of the proposed bill language:

Court says that “Roberts tax” is a non-dischargeable priority claim in bankruptcy.  United States v. Chesteen, No. 18-2077, 2019 U.S. Dist. LEXIS 29346 (E.D. La. Feb. 25, 2019). The debtor filed Chapter 13 bankruptcy. The IRS filed a proof of priority claim for $5,100.10, later amending the claim to $5,795.10 with $695 of that amount being an excise tax under I.R.C. §5000A as a result of the debtor’s failure to maintain government mandated health insurance under Obamacare. The debtor object to the $695 amount being a priority claim that could not be discharged, and the bankruptcy court agreed, finding that the “Roberts Tax” under Obamacare was not a priority claim, but rather a dischargeable penalty in a Chapter 13 case. On appeal, the appellate court reversed. The appellate court noted that the creditor bore the burden to establish that the Roberts Tax was a priority claim and noted that it was the purpose and substance of the statute creating the tax that controlled whether the tax was a tax or a penalty. The appellate court noted that a tax is a pecuniary burden levied for the purpose of supporting government while a monetary penalty is a punishment for an unlawful act or omission. On this point, the appellate court noted that Chief Justice Roberts, in National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), upheld the constitutionality of Obamacare on the basis that the “shared responsibility payment” was a tax paid via a federal income tax return and had no application to persons who did not pay federal income tax. The appellate court noted that the amount was collected by the IRS and produced revenue for the government. It also did not punish an individual for any unlawful activity and, the appellate court noted, the IRS has no criminal enforcement authority if a taxpayer failed to pay the amount. 

Court says that the IRS can charge for PTINs.In 2010 and 2011, the Treasury Department developed regulations that imposed certain requirements that an individual had to comply with to be able to prepare tax returns for a fee - a person had to become a “registered tax return preparer.” These previously unregulated persons had to pass a one-time competency exam and a suitability check. They also had to (along with all other preparers) obtain a Preparer Tax Identification Number (PTIN) and paying a user fee to obtain the PTIN. The plaintiff class challenged the authority of the government to require a PTIN and charge a fee for obtaining it. The IRS claimed that the regulations were necessary for the need to oversee tax return preparers to ensure good service. I.R.C. §6109(a)(4), in existence prior to the regulations at issue, requires a preparer to provide identification and state that the preparer’s social security number shall be used as the required identification. The regulations at issue, however, required preparers to obtain (at a fee paid to the Treasury) a PTIN as the identifying number. Preparers without a PTIN could no longer prepare returns for a fee. The IRS argued that by creating the PTIN requirement, it had created a “thing of value” which allowed it to charge a fee, citing 31 U.S.C. §9701(b). However, the plaintiffs claimed that the PTIN requirements are arbitrary and capricious under the Administrative Procedure Act or, alternatively is unlawful as an unauthorized exercise of licensing authority over tax return preparers because the fee does not confer a “service or thing of value.”

The trial court determined that the IRS can require the exclusive use of a PTIN because it aids in the identification and oversight of preparers and their administration. However, the trial court held that the IRS cannot impose user fees for PTINs. The trial court determined that PTINs are not a “service or thing of value” because they are interrelated to testing and eligibility requirements and the accuracy of tax returns is unrelated to paying a PTIN fee.  Steele v. United States, 260 F. Supp. 3d 52 (D. D.C. 2017).  A prior federal court decision held that the IRS cannot regulate tax return preparers (Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014), thus charging a fee for a PTIN would be the equivalent of imposing a regulatory licensing scheme which IRS cannot do. The trial court determined that prior caselaw holding that the IRS can charge a fee for a PTIN were issued before the Loving decision and are no longer good law.

On appeal, the appellate court vacated the trial court’s decision and remanded the case. The appellate court determined that the IRS does provide a service in exchange for the PTIN fee which the court defined as the service of providing preparers a PTIN and enabling preparers to place the PTIN on a return rather than their Social Security number and generating and maintaining a PTIN database. Thus, according to the appellate court, the PTIN fee was associated with an “identifiable group” rather than the public at large and the fee was justified on that ground under the Independent Offices Appropriations Act. The appellate court also believed the IRS claim that the PTIN fee improves tax compliance and administration. The appellate court remanded the case for further proceeding, including an assessment of whether the amount of the PTIN fee unreasonable exceeds the costs to the IRS to issue and maintain PTINs. Montrois, et al. v. United States, No. 17-5204, 2019 U.S. App. LEXIS 6260 (D.C. Cir. Mar. 1, 2019), vac’g,. and rem’g., Steele v. United States, 260 F. Supp. 3d 52 (D. D.C. 2017).

Sanders (and Democrat) transfer tax proposals.  The Tax Cuts and Jobs Act (TCJA) increased the exemption equivalent of the federal estate and gift tax unified credit to (for 2019) $11.4 million.  Beginning for deaths occurring and for gifts made in 2026, the $11.4 million drops to the pre-TCJA level ($5 million adjusted for inflation).  That will catch more taxpayers.  This is, of course, if the Congress doesn’t change the amount before 2026.  S. 309, recently filed in the Senate by Presidential candidate Bernie Sanders provides insight as to what the tax rules impacting estate and business planning would look like if he (or probably any other Democrat candidate for that matter) were ever to win the White House and have a compliant Congress. The bill drops the unified credit exemption to $3.5 million and raises the maximum tax rate to 77 percent (up from the present 40 percent.  It would also eliminate entity valuation discounts with respect to entity assets that aren’t business assets, and impose a 10-year minimum term for grantor retained annuity trusts.  In addition, the bill would require the inclusion of a grantor trust in the estate of the owner and would limit the generation-skipping transfer tax exemption to a 50-year term.  The present interest gift tax exclusion would also be reduced from its present level of $15,000.


These are just a snippet of the many developments in agricultural taxation and law recently.  Of course, you can find more of these developments on the annotation pages of my website –  I also use Twitter to convey education information.  If you have a twitter account, you can follow me at @WashburnWaltr.  On my website you will also find my CPE calendar.  My national travels for the year start in earnest later this week with a presentation in Milwaukee.  Later this month finds me in Wyoming. Also, forthcoming soon is the agenda and registration information for the ag law and tax seminar in Steamboat Springs, Colorado on August 12-14. Hope to see you at an event this year.

On Wednesday, I resume my perusal of the rental real estate exception of the passive loss rules.  I get a break on the teaching side of things this week – it’s Spring Break week at both the law school and at Kansas State University. 

March 11, 2019 in Bankruptcy, Contracts, Income Tax | Permalink | Comments (0)

Thursday, March 7, 2019

Passive Losses and Real Estate Professionals


Tuesday’s post was the first installment in a series of blog posts on the passive loss rules of I.R.C. §469. In that post, I noted that under I.R.C. §469, a taxpayer is limited in the ability to use losses from passive activities against income from a trade or business that the taxpayer is engaged in.  In that post, I noted that a passive activity includes trades and businesses in which the taxpayer does not materially participate.  Active participation provides a limited ability to deduct losses. 

While a rental activity is normally treated as “per se” passive by presumption, if the taxpayer is deemed to be a “real estate professional” then the presumption is overcome, and the taxpayer will be treated as non-passive if the taxpayer materially participates in the rental activity.

The rule that rents are presumed to be passive is also a concern because of the Net Investment Income Tax (NIIT).  I.R.C. §1411. The NIIT imposes an additional tax of 3.8 percent on passive income, including passive rental income. 

The real estate professional test of the passive loss rules – that’s the topic of today’s post.

History and Basics of the Rule

As noted in Tuesday’s post, the passive loss rules of I.R.C. §469 became effective for tax years beginning after December 31, 1986.  As originally enacted, a passive activity was defined to include any rental activity regardless of much the taxpayer participated in the activity.  This barred rental activities from being used to shelter the taxpayer’s income from other trade or business activity.  Rental activities could often produce a tax loss particularly due to depreciation deductions while the underlying property simultaneously appreciated in value.  The rule was particularly harsh on real estate developers with multiple development projects.   One project would be developed and sold while another project would be rented out.  In this situation, the developer had two activities - one that was the taxpayer’s trade or business activity (non-passive); and one that was a rental activity (passive).  This produced a different result, for example, from what a farmer would achieve if the farmer lost money on the livestock side of the business while making money on the crop portion.  In that situation, the livestock loss would offset the crop income. 

To address this perceived inequity, the Congress amended the passive loss rules to provide a narrow exception to the per se categorization of rental activities as passive.  Under the exception, a “real estate professional” that materially participates in a rental activity is not engaged in a passive activity.  I.R.C. §469(c)(7). Thus, rental activities remain passive activities unless the taxpayer satisfies the requirements to be a real estate professional.

To be a real estate professional two tests must be satisfied:  (1) more that 50 percent of the personal services that the taxpayer performs in trades or business for the tax year must be performed in real property trades or businesses in which the taxpayer materially participates; and (2) the taxpayer performs more than 750 hours of services during the tax year in real property trades or businesses in which the taxpayer materially participates.  I.R.C. §469(c)(7).  If the two tests are satisfied, as noted above, the rental activity is no longer presumed to be passive and, if material participation is present, the rental activity is non-passive.  I.R.C. §469(c)(7)(A)(i).

The issue of whether a taxpayer is a real estate professional is determined on an annual basis.  See, e.g., Bailey v. Comr., T.C. Memo. 2001-296. 

What is a Real Property Trade Or Business?

To qualify for the real estate professional exception, the taxpayer must perform services in a real property trade or business.  Obviously, production agriculture involves farm and ranch land.  This raises a question as to the types of business associated with farming and ranching that could be engaged in a real property trade or business for purposes of the passive loss rules.  Under I.R.C. §469(c)(7)(C), those are: real property development; redevelopment construction; reconstruction; acquisition; conversion; rental; operation; management; leasing; or brokerage. 

Mortgage brokers and real estate agents present an interesting question as to whether they are engaged in a real estate trade or business.  In general, a mortgage broker is not deemed to be engaged in a real property trade or business for purposes of the passive loss rules.  That’s the outcome even if state law considers the taxpayer to be in a real estate business.  What the courts and IRS have determined is that brokerage, to be a real estate business, must involve the bringing together of real estate buyers and sellers.  It doesn’t include brokering financial instruments.  See, e.g., Guarino v. Comr., T.C. Sum. Op. 2016-12; C.C.A. 201504010 (Dec. 17, 2014).  The definition of a real estate trade or business also does not include mortgage brokering.  See, e.g., Hickam v. Comr., T.C. Sum. Op. 2017-66.  But, if a licensed real estate agent negotiates real estate contracts, lists real estate for sale and finds prospective buyers, that is likely enough for the agent to be deemed to be in a real estate trade or business for purposes of the passive loss rules.  See, e.g., Agarwal v. Comr., T.C. Sum. Op. 2009-29.   

A licensed farm real estate appraiser might also be determined to be in a real estate trade or business if the facts are right.  See, e.g., Calvanico v. Comr., T.C. Sum. Op. 2015-64.  A real estate appraisal business involves direct work in the real estate industry.  But, associated services that are only indirectly related to the trade or business of real estate (such as a service business associated with real estate) would not seem to meet the requirements of I.R.C. §469(c)(7).  Indeed, this is the position the IRS has taken in its audit technique guide for passive activities.  See IRS Passive Activity Loss Audit Technique Guide at

What about a taxpayer that works for a farm management company?  The services of a farm management company are a bit different than a real estate management company that is engaged in the real estate business.  See, e.g., Stanley v. United States, No. 5:14-CV-05236, 2015 U.S. Dist. LEXIS 153166 (W.D. Ark. Nov. 12, 2015), nonacq., A.O.D. 2017-07 (Oct. 16, 2017).  But, perhaps services performed that directly relate to the real estate business would count – putting together rental arrangements, managing the leases, dealing with on-farm tenant housing, etc.  Economic related services such as cropping and livestock decisions would seem to not be real estate related.  In any event, the taxpayer would need to be at least a five percent owner of the farm management company for the taxpayer’s hours to count toward the I.R.C. §469(c)(7) tests.  I.R.C. §469(c)(7)(D)(ii); Treas. Reg. §1.469-9(c)(5). 

Importantly, a real property trade or business can be comprised of multiple real estate trade or business activities.  Treas. Reg. §1.469-9(d)(1). This implies that multiple activities can be grouped together into a single activity.  That is, indeed, the case.  Treas. Reg. §1.469-4 allows the grouping of activities that represent an “appropriate economic unit.”  Under that standard, non-rental activities cannot be grouped with rental activities.   Treas. Reg. §1.469-9(g) allows a real estate professional to group all interests in rental activities as a single activity.  If this election is made, the real estate professional can add all of their time spent on all of the rental activities together for purposes of the 750-hour test. 

In Chief Counsel Advice 201427016 (Apr. 28, 2014), the IRS stated that the Treas. Reg. §1.469-9(g) aggregation election “is relevant only after the determination of whether the taxpayer is a qualifying taxpayer.”  Thus, whether a taxpayer is a real estate professional for purposes of the passive loss rules is not affected by an election under Treas. Reg. §1.469-9(g).  In other words, the election under Treas. Reg. 1.469-9(g) has no bearing on the issue of whether a taxpayer qualifies as a real estate professional – puts in more than 750 hours in real estate activities and satisfies the 50 percent test. See also Miller v. Comr., T.C. Memo. 2011-219.  But, grouping can make it easier for the taxpayer to meet the required hours test of I.R.C. §469(c)(7) and be deemed to be materially participating in the activity. 

Regroupings are not allowed in later years unless the facts and circumstances change significantly, or the initial grouping was clearly not appropriate.  Treas. Reg. §1.469-9(d)(2). 


The IRS has taken the position that only an individual can be a real estate professional for purposes of the passive loss rules.  C.C.A. 201244017 (Nov. 2, 2012).  That’s important as applied to trusts.  Much farm and ranch land that is rented out is held in trust.  That would mean that the only way the trust rental income would not be passive is if the trustee, acting in the capacity as trustee, satisfies the tests of I.R.C. §469(c)(7).  The one federal district court that has addressed the issue has rejected the IRS position. Mattie Carter Trust v. U.S., 256 F.Supp.2d 536 (N.D. Tex. 2003).  The Tax Court agrees.

In Frank Aragona Trust v. Comr., 142 T.C. 165 (2014), a trust incurred losses from rental activities which the IRS treated as passive.  The trust had six trustees – the settlor’s five children and an independent trustee.  One of the children handled the daily operation of the trust activities and the other trustees acted as a managing board.  Also, three of the children (including the one handling daily operations) were full-time employees of an LLC that the trust owned.  The LLC was treated as a disregarded entity and operated most of the rental properties.  The trust had essentially no activity other than the rental real estate. The IRS, in treating the losses as passive said that the trustees were acting as LLC employees and not as trustees.  The Tax Court disagreed with the IRS position, finding that the trust materially participated in the rental real estate activities and that the losses were non-passive.  The trustees, the Tax Court noted, managed the trust assets for the beneficiaries, and if the trustees are individuals and work on a trade or business as part of their duties, then their work would be “performed by an individual in connection with a trade or business.”  Thus, a trust, rather than just the trustees, is capable of performing personal services.

The Tax Court’s position in Frank Aragona Trust could be particularly important in agriculture.  A great deal of leased farm ground is held in trust.  The trust will be able to meet the material participation standard via the conduct of the trustees.  That will allow full deductibility of losses.  In addition, the trust income will not be subjected to the additional 3.8 percent tax of I.R.C. §1411.


The real estate professional exception to the per se rule that rental activities are passive is an important one.  The issue may occur quite often in agricultural settings.  In the next post on Monday, we will dig a little further on the passive loss rules. 

March 7, 2019 in Income Tax | Permalink | Comments (0)

Tuesday, March 5, 2019

Passive Losses and Material Participation


The passive loss rules have a substantial impact on farmers and ranchers and investors in farm and ranch land.  Until 1987, it was commonplace for non-farm investors to purchase agricultural real estate and run up losses which were used to offset the investor's wage or other income.  However, the Congress stepped-in and enacted the passive loss rules in 1986.  I.R.C. §469.  Those rules reduce the possibility of offsetting passive losses against active income unless the taxpayer materially participates in the activity. 

A look at the passive loss rules and material participation – that’s the topic of today’s post.

The Basic Concept

The passive loss rules apply to activities that involve the conduct of a trade or business and the taxpayer does not materially participate in the activity or in rental activity on a basis which is regular, continuous and substantial. If the passive loss rules apply, deductions (losses) from passive trade or business activities, to the extent the deductions exceed income from all passive activities, may not be deducted against other income (non-passive activity gains).

For farmers, the passive loss rules are likely to come into play in situations where the farmer is a passive investor in a separate business venture apart from the farming operation.  In that case, the losses from the venture cannot be used to offset the income from the farming operation.  The rules also get invoked when a non-farmer loses money in an activity that is a purported farming activity.

Material Participation 

Unless an investor or other individual can meet one of two critical tests, the passive loss rules apply.  The first of these tests is the test of material participation.  If an individual can satisfy the material participation test, then passive losses can be deducted against active income.  If, for example, a physician is materially participating in a farming or ranching activity, the losses from the farming or ranching activity can be used as a deduction against the physician's income from the practice of medicine.

Does an agent’s activity count?  An investor is treated as materially participating in an activity only if the person “is involved in the operation of the activity on a basis which is regular, continuous, and substantial.” I.R.C. §469(h)(1).  In determining whether an individual taxpayer materially participates (or actively participates), the participation of the taxpayer's spouse is taken into account, whether or not they file a joint income tax return.  In addition, while the statute refers to material participation by the taxpayer, it does not specifically bar imputation of the services of an agent or specifically embrace the rules of the self-employment tax statute (I.R.C. § 1402), which does bar the ability of a taxpayer to impute the  of an agent.  However, a Committee Report and the regulations state that activities of an agent are not attributed to an individual taxpayer and the individual must personally perform sufficient services to establish material participation. Indeed, an individual’s own participation is not taken into account if a paid manager participates in the activity and someone else performs services in connection with management of the activity which exceed the amount of service performed by the taxpayer.  See, e.g., Robison v. Comm’r, T.C. Memo. 2018-88.

Satisfying material participation.  Farm and ranch taxpayers can qualify as materially participating if they materially participated for five or more years in the eight-year period before retirement or disability.  In addition, the material participation test is met by surviving spouses who inherit qualified real property from a deceased spouse if the surviving spouse engages in “active management.”  C corporations are treated as materially participating in an activity with respect to which one or more shareholders, owning a total of more than 50 percent of the outstanding corporate stock, materially participates.  Treas. Reg. §1.469-1T(g)(3)(i)(A).  In other words, the corporation must be organized such that at least one shareholder materially participates, and the materially participating shareholders own more than 50 percent of the corporate stock.  Estates and trusts, except for grantor trusts are treated as materially participating (or as actively participating) if a fiduciary meets the participation test.  See, e.g., Mattie K. Carter Trust v. United States, 256 F. Supp. 2d 536 (N.D. Tex. 2003); Aragona Trust v. Comr., 142 T.C. 165 (2014).

Regulations.  In February 1988, the IRS issued temporary regulations specifying the requirements for the material participation test. Treas. Reg. 1.469-5T. These regulations have great relevance, especially for tenants renting agricultural real estate from the local physician, veterinarian or lawyer or any other non-farm investor.  The temporary regulations lay out seven tests for material participation.

Under the first test, an individual is considered to be materially participating if the individual participates in the activity for more than 500 hours during the year.  Treas. Reg. §1.469-5T(a)(1). This is a substantial amount of time; almost ten hours per week.  In fact, this is more time than some tenants put into the operation on an annual basis.  As a result, this test is exceedingly difficult for most investors to satisfy. 

The second test involves situations where an individual's participation is less than 500 hours, but constitutes “substantially all of the participation” in the activity by all individuals during the year.  Treas. Reg. §1.469-5T(a)(2).  In other words, if the investor puts in less than 500 hours annually in the farming or ranching operation, but substantially all of the involvement comes from the investor, the material participation test will be satisfied.  However, the investor cannot meet this test if there is a tenant involved, because a tenant will probably put more time in than the investor.  Consequently, this test also tends to be difficult to meet.

Under the third test, an individual is considered to be materially participating if the individual puts more than 100 hours per year into the activity and the individual's participation is not less than that of any other individual.  Again, if there is a tenant, this test is nearly impossible to meet because of the likelihood that the tenant will put more hours into the activity than the investor. Treas. Reg. §1.469-5T(a)(3).

The fourth test involves “significant participation.”  An individual is treated as materially participating in significant participation activities if the individual's aggregate participation activities for the year exceed 500 hours.  Treas. Reg. §1.469-5T(a)(4).  A “significant participation activity” is a trade or business activity in which the individual participates for more than 100 hours for the taxable year.  This is an aggregate test. For example, let us assume that an investor owns a farm, two fast food restaurants, and a convenience store.  This rule permits an aggregation of all of those together, provided the investor puts in more than 100 hours in each activity.  If the investor spends more than 100 hours in each activity, then each activity can be aggregated to see if the 500-hour test has been met.  Thus, if an investor puts more than 100 hours into a farm activity, more than 100 hours into, for example, convenience store, and more than 100 hours into each of several restaurants, the total hours may exceed 500. 

Under the fifth test the individual is treated as materially participating if the individual materially participated in the activity for any five of the ten taxable years immediately preceding the taxable year.  Treas. Reg. §1.469-5T(a)(5).  The idea behind this rule is that substantial involvement over a lengthy period indicates that the activity was probably the individual's principal livelihood.  This is a very useful test for a retired farmer who has had several years of involvement.

The sixth test is for individuals involved in personal service activities.  An individual is treated as materially participating in a personal service activity for a taxable year if the taxpayer materially participated in the activity for any three taxable years preceding the taxable year in question.  This is a test solely for personal service activities.  Treas. Reg. §1.469-5T(a)(6).  Thus, it is a rule that can be used by taxpayer’s engaged in accounting, law practice, medicine and other professional services. 

The seventh and final test is a “facts and circumstances” test. Treas. Reg. §1.469-5T(a)(7).  This is the rule under which most farm investors try to qualify, and it requires that the taxpayer participate in the activity during the tax year on a basis that is regular, continuous and substantial.  What a taxpayer does for any other purpose (such as material participation for Social Security purposes), does not count for purposes of the material participation test of I.R.C. §469Treas. Reg. §1.469-5T(b)(2)(i).  In addition, the facts and circumstances test cannot be satisfied unless the taxpayer participates more than 100 hours in the activity during the year as a threshold requirement.  Treas. Reg. §1.469-5T(b)(2)(iii).  Also, as noted above, if the taxpayer is represented by a paid manager, the taxpayer’s own record of involvement does not count.  Treas. Reg. §1.469-5T(b)(2)(ii)(A).  Thus, the involvement of a paid farm manager eliminates the possibility of the investor counting his or her own hours of participation. 

Active participation.  Farm landlords receiving crop share rent will likely have difficulty in satisfying any of the tests for material participation.  However, if a taxpayer fails to meet the material participation test, there is a fallback test of active participation if the taxpayer owns at least 10 percent of the value of the interests in the rental activity and is not a corporation. I.R.C. §469(i).  Active participation requires less than the material participation test, and allows the taxpayer to deduct up to $25,000 each year in losses from a rental real estate activity. 

The IRS position is that a crop-share lease is a joint venture and not a rental real estate activity.  Treas. Reg. § 1.469-1T(e)(3)(viii), Example (8).  Thus, according to the IRS, a crop-share landlord will not qualify under the active participation test. 

The active participation test is unavailable to taxpayers with adjusted gross income in excess of $150,000.  As adjusted income exceeds $100,000, the $25,000 amount is phased-out over a $50,000 adjusted gross income (determined without regard to passive activity losses) range. 



The passive loss rules are important in agriculture.  While they operate to bar passive losses from offsetting passive income, material (or active) participation can suffice to allow full deductibility of losses.  In the next post, we will dig deeper into the passive loss rules.

March 5, 2019 in Income Tax | Permalink | Comments (0)

Friday, March 1, 2019

Valuing Non-Cash Charitable Gifts


Donations to charity can provide a tax deduction for the donor.  Normally, the tax deduction is tied to the value of the property donated to a qualified charity.  That’s an easy determination if the gift is cash.  But what if the gift consists of property other than cash?  How is that valued for charitable deduction purposes?

Valuing non-cash gifts to charity – that’s the topic of today’s post.

Basic Rules

When a charitable contribution of property other than money is made, the amount of the contribution is generally the fair market value (FMV) of the donated property at the time of the donation.  Treas. Reg. §1.170A-1(c)(1).  What is FMV?  It’s “the price at which the property would change hands between a willing buyer and seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.”  Treas. Reg. §1.170A-1(c)(2).  Sometimes FMV is relatively easy to determine under this standard.  Other times, it’s not as easy – especially if the non-cash gift is a unique asset.  In that situation, the IRS has two approaches to arrive at FMV: the comparable sales method; and the replacement value of the donated property.  In a relatively recent Tax Court case, these valuation approaches to a substantial non-cash donation to charity were on display.

Recent Case

In Gardner v. Comr., T.C. Memo. 2017-165, the petitioner was a big-game hunter that had been on numerous safaris and other big-game hunts around the world.  In one two-year period he had been on over 20 safaris.  Like many big-game hunters, he provided the meat from his kills to the local community and then had taxidermists prepare the hide for eventual display in the “trophy room” of his home.  Some of the displays were full body mounts, others were wall hangings or rugs.  These types of displays are the most attractive and desirable in the hunting business.  His trophy room was, at one point, featured in a hunting publication, “Trophy Rooms Around the World.”

Ultimately, the petitioner downsized his collection by donating 177 of the “less desirable” pieces in his collection to a charity (an ecological foundation). None of the donated specimens were of “record book” quality.  Before making the donation, he had the donated specimens appraised.  Based on that FMV appraisal, he claimed a charitable deduction of $1,425,900. That figure was derived from his appraiser’s computation of the replacement cost of each donated item – what it could cost him to replace each item with an item of similar quality.  Replacement cost was computed by projecting the out-of-pocket expenses for the petitioner to travel to a hunting site; take part in a safari; kill the animal; remove and preserve the carcass; ship the carcass to the U.S.; and pay for taxidermy services to prepay the specimen for display.  The petitioner’s appraiser gave every one of the donated items a quality rating of “excellent” for specimen quality and taxidermy quality.  For provenance, the appraiser listed the items as “meager.”  The appraiser, however, did not provide any evidence for the rational of why he utilized the replacement cost approach.  

On audit, the IRS valued the donated specimens at $163,045 based on their expert’s report.  The expert appraiser for the IRS had been a licensed taxidermist for more than 30 years and was a certified appraiser specializing in taxidermy items.  He characterized the donated items as mostly “remnants and scraps” of a trophy collection – what’s left over after mounting an animal or “what’s left over when you’re done mounting an animal.”  He testified that there was an active market among taxidermists for such items to either complete projects or mount them for their own collections.  That market, the IRS expert noted, has been expanded by the internet and allowed a ready determination of market value.  Indeed, the IRS expert found 504 comparable sales transactions via traditional auctions and internet auction sites.  This wasn’t the situation, the IRS expert asserted, where world-class trophy mounts were involved with a thin to non-existent market (which would support the use of the replacement cost approach).  Thus, based on the comparable sale approach, the IRS arrived at the $163,045 value. 

The matter ended up in the Tax Court, and the Tax Court first noted that it had previously determined how to value hunting specimens donated to charity in 1992.  In Epping v. Comr., T.C. Memo. 1992-279, the Tax Court reasoned that if an active market exists, the general rule is to use comparable sales to arrive at a value of the donated property.  The Epping case involved “an assortment of animal mounts, horns, rugs, and antlers.”  The Tax Court in that case determined that there was an active market in hunting specimens with substantial comparable sales.”  However, the Tax Court also noted that replacement cost is appropriate when the donated property is unique, and no evidence of comparable sales exists.  Thus, to be able for a taxpayer to use replacement cost to value the donated items, the taxpayer must show that there is no active market for the comparable items and that there is a correlation between the replacement cost and FMV.  That’s a tough hurdle to clear in many situations.

In the present case, the Tax Court, was persuaded by the IRS expert’s testimony that the 177 donated items were neither of “world-class” nor museum quality.  Instead, the Tax Court agreed that they were mostly “remnants, leftovers, and scraps” of the petitioner’s collection.  In addition, the Tax Court noted that the petitioner’s own testimony indicated that he wanted to “downsize” his collection by getting rid of unwanted items.  The Tax Court also noted that photographs of the specimens provided by his expert indicated that the donated specimens were not high quality, and none were of record-book quality.  In addition, the Tax Court noted that the IRS expert had established an active market for items similar to those the petitioner donated.  Thus, the Tax Court determined that the specimens were commodities rather than collectibles and would be appropriately valued based on the market price for similar items – the IRS approach.  To further support the use of the comparable sales approach, the Tax Court concluded that the petitioner did not really attempt to challenge the IRS expert’s data and didn’t introduce any evidence of market prices for comparable items.  The petitioner failed to prove that the FMV of the 177 donated items exceeded the $163,045 value that the IRS established.         


Valuing non-cash charitable gifts can be tricky.  Establishing FMV of the donated property must be backed up with sufficient evidence that supports the valuation approach.  Truly unique items that lack a ready market may be able to be valued under the replacement cost approach.  A good appraiser goes a long way to making that determination.  As the Tax Court stated, “To paraphrase Ernest Hemingway, there is no hunting like the hunting for tax deductions.”

March 1, 2019 in Estate Planning, Income Tax | Permalink | Comments (0)

Wednesday, February 27, 2019

Ag Nuisances – Basic Principles


Land use conflicts are often present in urban, residential and commercial areas.  However, they also occur in rural areas.  Large-scale livestock agricultural operations, wind “farms” and similar rural land uses present many of the same issues.

How does the law handle rural land-use conflicts?  How can these conflict situations with adjoining landowners best be minimized or avoided? 

Land use conflicts in rural areas, ag nuisances and pointers for minimizes conflict among landowners – this is the discussion of today’s post.

What’s An Ag Nuisance?

A nuisance is an invasion of an individual's interest in the use and enjoyment of land rather than an interference with the exclusive possession or ownership of the land.  See, e.g., Peters, et al. v. Contigroup, et al., 292 S.W.3d 380 (Mo. Ct. App. 2009).  Nuisance law prohibits land uses that unreasonably and substantially interfere with another individual's quiet use and enjoyment.  The doctrine is based on two interrelated concepts: (1) landowners have the right to use and enjoy property free of unreasonable interferences by others; and (2) landowners must use property so as not to injure adjacent owners. In a nuisance action, proof of general damages (diminished quality of life) may be sufficient evidence to support a monetary award.  See, e.g., Stephens, et al. v. Pillen, 681 N.W.2d 59, 12 Neb. App. 600 (2004).

The two primary issues at stake in any agricultural nuisance dispute are whether the use alleged to be a nuisance is reasonable for the area and whether the use alleged to be a nuisance substantially interferes with the use and enjoyment of neighboring land.  See, e.g., Bower v. Hog Builders, Inc., 461 S.W.2d 784 (Mo. 1970)

Are Nuisance and Negligence the Same?

“Nuisance” and “negligence” are not the same thing.  Operating a farming or ranching activity properly and having all requisite permits may still constitute a nuisance if a court or jury determines the activity is “unreasonable” and causes a “substantial interference” with another person's use and enjoyment of property.  Whether a complained of activity, such as spreading manure, results in a “substantial” and “unreasonable” interference with another's property will depend on the facts of each case and the legal rules used in the particular jurisdiction.  See, e.g., Penland v. Redwood Sanitary Sewer Service District, 156 Or. App. 311, 965 P.2d 433 (1998).

Because each claim of nuisance depends on the fact of the case, there are no easy rules to determine when an activity will be considered a nuisance.  In general, a court faced with a particular nuisance claim will consider several factors.  Primary among these factors is whether the use complained of is a reasonable use that is common to the area or whether it is not suitable. See, e.g., May v. Brueshaber, 265 Ga. 889, 466 S.E.2d 196 (1995).  Also important is whether the use complained of is a minor inconvenience which happens very infrequently or whether it is a regular and continuous activity.  The nature of the property use being disturbed is also an important consideration.  If the interference has a significant impact on the complaining party's use of their own property, such as the prevention of living in the complaining party's home, a nuisance will likely be found.  Similarly, if the complained of use is preventing another landowner's use of their property that is a vital part of the local economy, the court will balance the economics of the situation and most likely conclude that the complained of use constituted a nuisance.  An additional important factor, but not conclusive in and of itself of the issue is whether the complained of use was in existence prior to the complaining party's use of their property which is now claimed to be interfered with.  A related concern, if the activity generating the alleged nuisance was in existence prior to the complaining party moving into the vicinity, is whether the nuisance activity was obvious at the time the complaining party moved in.  Many courts also attempt to balance the economic value to society of the uses in question.  If the complained of use adds jobs and income to the local economy, the value to society of continuing the alleged nuisance may outweigh the negative impact it causes.

If A Nuisance Exists, What Then?

If a court determines that a nuisance (just one that is anticipated to occur in the future) exists, it has much discretion in establishing an appropriate remedy for a nuisance.  The most common remedy is for the court to stop (enjoin) the nuisance activity. See, e.g., Moody, et al. v. Wiza, 2007 Ohio 5356 (Ohio Ct. App. 2007); Simpson, v. Kollasch, et. al., 749 N.W.2d 671 (Iowa 2008); Walker, et al. v. Kingfisher Wind, LLC, No. CIV-14-D, 2016 U.S. Dist. LEXIS 141710 (W.D. Okla. Oct. 13, 2016).  However, most courts try to fashion a remedy to fit the particular situation. See, e.g., Valasek v. Baer, 401 N.W.2d 33 (Iowa 1987); Spur Industries, Inc. v. Del E. Webb Development Co., 108 Ariz. 178, 494 P.2d 700 (1972)

Potential Defenses

Priority of location.  If a farmer gets sued for the alleged creation of a nuisance, how does the farmer mount a defense?  While there are no common law defenses that an agricultural operation may use to shield itself from liability arising from a nuisance action, as noted above, the courts do consider a variety of factors to determine if the conduct of a particular farm or ranch operation is a nuisance.  Of primary importance are priority of location and reasonableness of the operation.  Together, these two factors have led courts to develop a “coming to the nuisance” defense.  This means that if people move to an area they know is not suited for their intended use, they should be prohibited from claiming that the existing uses are nuisances.

Right-to-farm laws.  Every state has enacted a right-to-farm law that is designed to protect existing agricultural operations by giving farmers and ranchers who meet the legal requirements a defense in nuisance suits.  The basic thrust of a particular state's right-to-farm law is that it is unfair for a person to move to an agricultural area knowing the conditions which might be present and then ask a court to declare a neighboring farm a nuisance.  Thus, the basic purpose of a right-to-farm law is to create a legal and economic climate in which farm operations can be continued.  Right-to-farm laws can be an important protection for agricultural operations, but, to be protected, an agricultural operation must satisfy the law's requirements.  See, e.g., Alpental Community Club, Inc., v. Seattle Gymnastics Society, 86 P.3d 784 (Wash. Ct. App. 2004); Hood River County v. Mazzara, 89 P.3d 1195 (Or. Ct. App. 2004). 

The most common type of right-to-farm law is nuisance related.  This type of statute requires that an agricultural operation will be protected only if it has been in existence for a specified period of time (usually at least one year) before the change in the surrounding area that gives rise to a nuisance claim. See, e.g., Vicwood Meridian Partnership, et al. v. Skagit Sand and Gravel, 98 P. 3d 1277 (Wash. Ct. App. 2004).  These types of statute essentially codify the “coming to the nuisance defense,” but do not protect agricultural operations which were a nuisance from the beginning or which are negligently or improperly run.  For example, if any state or federal permits are required to properly conduct the agricultural operation, they must be acquired as a prerequisite for protection under the statute.  Another type of right-to-farm statute may be structured to bar local and county governments from enacting regulations or ordinances that impose restrictions on normal agricultural practices.  Still another type exempts (at least in part) agricultural uses from county zoning ordinances.  The major legal issue involving this type of statute is whether a particular activity is an agricultural use or a commercial activity.  In general, “agricultural use” is defined broadly.  See, e.g., Knox County v. The Highlands, L.L.C., 302 Ill. App. 3d 342, 705 N.E.2d 128 (1998), aff’d, 723 N.E.2d 256 (Ill. 1999).

An important point is that while right-to-farm laws try to assure the continuation of farming operations, they do not protect subsequent changes in a farming operation that constitute a nuisance after local development occurs nearby.  See, e.g., Davis, et al. v. Taylor, et al., 132 P.3d 783 (Wash. Ct. App. 2006); Flansburgh v. Coffey, 370 N.W.2d 127 (Neb. 1985).   While a right-to-farm law may not bar an action for a change in operations when a nuisance is present, if a nuisance cannot be established a right-to-farm law can operate to bar an action when the agricultural activity on land changes in nature. See, e.g., Dalzell, et al. v. Country View Family Farms, LLC, No. 1:09-cv-1567-WTL-MJD, 2012 U.S. Dist. LEXIS 130773 (S.D. Ind. Sept. 13, 2012), aff’d., No. 12-3339, 2013 U.S. App. LEXIS 13621 (7th Cir. Jul. 3, 2013). See also Parker v. Obert’s Legacy Dairy, 988 N.E.2d 319 (Ind. Ct. App. 2013).


Land use conflicts in rural areas are not uncommon and have become more prevalent in recent decades as the structure of agriculture had changed and new types of rural land uses have appeared.  To minimize conflict with neighbors and stay out of court defending a nuisance case, attention should be paid to certain key points.  Location of any facility that could give rise to a nuisance claim is key.  Related to location, particularly with respect to odor-related issues is wind direction.  For confinement livestock facilities, proper ventilation is key as is manure storage and field injection practices.  Of course, the overall appearance of farm structures is important - perhaps almost as important as are manure disposal practices. 

Keeping these points in mind just might keep the farming operation out of court.

February 27, 2019 in Civil Liabilities | Permalink | Comments (0)

Monday, February 25, 2019

Estate Planning in Second Marriage Situations


A married couple’s estate planning goals and objectives often dovetail - benefit the surviving spouse for life with the remaining property at the death of the surviving spouse passing to the children.  But, estate planning when a second marriage (either as a result of death or divorce) is involved is more complex, especially when each spouse has children from the prior marriage.  The estate planning techniques of first marriage situations often don’t work when a second marriage is involved.  But, the IRS recently blessed a second marriage estate planning technique.

Estate planning for second marriages – that’s the topic of today’s post.

Second Marriage Estate Plans

Potential problem areas.  Blended families are not uncommon.  When I first started practicing law, I was tasked with developing an estate plan for an older married couple.  Each one of them had outlived their prior spouse and each of them had children from that prior marriage.  They each had a separate farming/ranching operation.  It was imperative to them that their respective children carry on the farming/ranching business that was associated with each of them.  In this situation, the common estate plan for a married couple wouldn’t work.  It was no longer appropriate to balance ownership of all assets equally between the couple and then via reciprocal (i.e., mirror) wills leave a portion of the assets to the surviving spouse outright with the balance in a “credit-shelter” trust and the remainder at the death of the surviving spouse split between all of the kids (from both prior marriages).  This standard approach could have resulted in children of one family eventually owning the other family’s farming/ranching operation.  That would not have been a good result.

It's also common in first marriages for the spouses to own the home and land as joint tenants with right of survivorship. Upon the death of the first spouse, the jointly held asset automatically passes to the surviving spouse.  While that results in the surviving spouse having complete ownership of the asset, that is often not a desirable outcome in a second marriage situation.  The survivor could leave the asset at death to their children of the first marriage. 

Beneficiary designations can also lead to a similar problem as jointly held property.  The spouse is often named as the beneficiary of life insurance, retirement plans/accounts, etc.  But, this can become a problem upon death and the subsequent remarriage of the surviving spouse. 

Potential solution.  One approach that is used in second (and subsequent) situations involves a revocable trust that is funded either during the grantor’s life or at death or via beneficiary designations (or some combination).  The grantor can amend or revoke the trust at any time before death, and on death the trust becomes irrevocable and continues for the surviving spouse’s benefit and the benefit of the children of the first marriage.  The trust income can be paid to the surviving spouse during life and the trust assets remaining at the surviving spouse’s life pass to the grantor’s children of the first marriage.  A “spendthrift” provision can be added to the trust to provide additional assurance that the assets ultimately land in the correct hands, and are not dissipated by creditors, etc.  In addition, the trust allows the grantor to maintain post-death control over the assets of the family from the first marriage.  The assets are not left outright to the surviving spouse of the second marriage, and the surviving spouse cannot change the estate plan to exclusively benefit the survivor’s own children, for example.

Handling Retirement Plans 

In second marriage situations, can an individual retirement account (IRA) also be placed in a trust so that account income benefits the surviving spouse of the second marriage for life with the account balance passing to the children of the pre-deceased spouse’s first marriage?  The tax code complicates matters, but a recent IRS private letter ruling shows how it can be accomplished. 

In general, annual required minimum distributions must be taken from traditional IRAs at the required beginning date (RBD) – April 1 of the year after the year in which the account owner turns 70 ½.  I.R.C. §401(a)(9)(C)(i)(l).  Special rules apply when the IRA owner dies after the RBD.  In that case, any balance remaining in the account is distributed in accordance with certain rules. For example, if the account owner didn’t designate a beneficiary, the post-death payout period is determined by what the deceased owner’s life expectancy was at the time of death.  Treas. Reg. §1.401(a)(9)-(5).  If the IRA owner named a non-spouse as the beneficiary, the account balance is paid out over the longer of the remining life expectancy of the designated beneficiary or the remaining life expectancy of the IRA owner.  Id. 

If the IRA owner designated the spouse as the IRA’s sole designated beneficiary, the required distribution for each year after death is determined by the longer of the remining life expectancy of the surviving spouse or the remaining life expectancy of the deceased spouse based on their age at the time of death.  Id. This can allow payouts to be “stretched.”  But, naming the surviving spouse as the beneficiary of an IRA also gives the surviving spouse the ability to treat the IRA as their own.  That means that the surviving spouse can name their own beneficiaries – not necessarily a good result in second marriage situations where each spouse has children of a prior marriage. 

Trust as a beneficiary.  Can a trust be named the beneficiary of the retirement plan so that the surviving spouse doesn’t have complete control over the account funds?  In general, the answer is “no.”  Treas. Reg. §1.401(a)(9)-4, Q&A 3.  However, a trust beneficiary (with respect to the trust’s interests in the IRA owner’s benefits) is treated as the designated beneficiary of an IRA if certain conditions are satisfied for the period during which the RMDs are being determined by treating the trust beneficiary as the designated beneficiary of the IRA owner.  See Treas. Reg. §1.401(a)(9)-4, Q&A 5(b).

Recent IRS ruling.  In Priv. Ltr. Rul. 201902023 (Oct. 15, 2018), the decedent created a revocable living trust during life.  The trust contained a subtrust to hold the benefits and distributions from his retirement plans (and other assets).  He died after attaining his RBD and after distributions from his IRA had started.  The revocable trust and the subtrust became irrevocable upon his death.  His IRA named the trust as the beneficiary.  The terms of the trust specified that property held by the subtrust were to be “held, administered, and distributed” for the sole benefit of his (younger) surviving spouse.  Upon her death, the trust specified that the retirement plan (along with the remaining assets of the subtrust) were to be divided equally between his children or their descendants.

The IRS noted that the trust identified the surviving spouse as the sole beneficiary of the subtrust in accordance with Treas. Reg. §1.401(a)(9)-4, Q&A 5(b)(3).  In addition, the trust required the trustee to pay the surviving spouse any and all funds in the subtrust that the trustee withdrew, including RMDs, and there could be no accumulation for any other beneficiary.  That satisfied the requirements of Treas. Reg. §1.401(a)(9)-4, Q&A-5 (valid trust under state law; trust is irrevocable or becomes so on death of account owner; the trust identifies the beneficiary; and the plan administrator is given appropriate documentation) and the surviving spouse was treated as the sole designated beneficiary of the IRA.  Thus, the IRS concluded that the payment to the two trusts (first to the revocable trust and then to the subtrust) was permitted by Treas. Reg. §1.401(a)(9)-4. Q&A-5(d) which says that if the trust beneficiary is named as the beneficiary of the account owner’s interest in another trust, that beneficiary will be treated as having been designated as the beneficiary of the first trust and, be deemed to be the IRA account owner for distribution purposes.    

In addition, the IRS determined that because the surviving spouse had a longer life expectancy that did the decedent, the applicable distribution period for the IRA should be based on her life expectancy.   This means that via the trust and the subtrust, the surviving spouse received RMDs as if she were the designated sole beneficiary.  Upon her death, any remaining assets of the subtrust will be distributed to the pre-deceased spouse’s children or their descendants.


Unique estate and business planning issues present themselves in second marriage situations.  Along with a well-drafted marital agreement, other steps should be taken to ensure the continued viability of separate farming/ranching operations that are brought into the subsequent marriage while simultaneously benefiting each spouse’s children of the prior marriages appropriately at the death of their respective parent.  Included in this planning is the treatment of retirement accounts.  The recent IRS ruling illustrates one way to leave an IRA to the spouse of a second marriage and avoid negative consequences.   

February 25, 2019 in Estate Planning | Permalink | Comments (0)

Thursday, February 21, 2019

New Development on Exclusion of Employer-Provided Meals


The Tax Code allows for the exclusion of the value of meals and lodging that an employer provides to an employee.  Of course, certain conditions must be satisfied for the exclusion to apply.  The basic idea is the providing of meals and lodging to an employee must be on the business premises, for the convenience of the employer and as a condition of employment for the value to not be included in the employee’s wages.  For farms and ranches in remote areas, this is a particularly attractive fringe benefit for C corporations.

But, a recent IRS Technical Advice Memorandum puts a new twist on the meals side of the equation.  It involves the presence of meal delivery services.

The exclusion of meals from an employees wages and meal delivery services – that’ s the topic of today’s post.

Meals and Lodging – The Basics

The value of meals and lodging furnished on the business premises for the employer's convenience and as a condition of employment are not taxable income to the employee (and the employee’s spouse and dependents) and are deductible by the employer if they are provided in-kind.  I.R.C. § 119. This tax treatment is available only for meals and lodging furnished to employees, not tenantsSee Weeldreyer v. Comm’r, T.C. Memo. 2003-324; Schmidt v. Comm’r, T.C. Memo. 2003-325; Tschetter v. Comm’r, T.C. Memo. 2003-326; Waterfall Farms, Inc. v. Comm’r, T.C. Memo. 2003-327.  Likewise, the value of meals and lodging furnished on the business premises for the convenience of the employer are not wages for FICA and FUTA purposes. 

As an employer-provided fringe benefit, the meals and lodging arrangement is available only to an individual who is an employee of a C corporation.  Owners of other entities cannot take advantage of this fringe benefit.  For instance, sole proprietors and partners in a partnership do not have the necessary employee status to qualify for the fringe benefit.  Also, I.R.C. §1372 bars S corporation employees who own, directly or indirectly, more than 2 percent of the outstanding stock from receiving tax-free fringe benefits, including the I.R.C. §119 meals and lodging fringe benefit.  In addition, with respect to S corporations, the I.R.C. §318 attribution rules apply in determining who considered to be an S corporation shareholder.

Focus on Meals

Meals that are provided to employees during working hours without the furnishing of lodging must be furnished for substantial non-compensatory business reasons of the employer.  Examples include emergency call situations, employer business activity that permits on a short meal break, and insufficient eating facilities in the vicinity of the employer’s premises. Treas. Reg. §1.119-1(a)(2).

A significant question is whether the value of groceries furnished to an employee that the employee then prepares into meals is eligible for the exclusion. The IRS claims that it is not. Rev. Rul. 77-806.  However, the courts have ruled that either the employer or the employee may prepare the groceries into meals, as long as the arrangement otherwise meets the requirements of I.R.C. §119Jacobs v. Comm’r, 493 F.2d 1294 (3d Cir. 1974); Harrison v. Comm’r, T.C. Memo. 1981-211.  The issue is not settled.  Some courts have held that groceries are included under the definition of meals, but other courts and the IRS have ruled that the value of groceries is not meals and is includible in an employee's gross income.

Under a 1997 provision, the cost of meals furnished on the business premises for the convenience of the employer is fully deductible as a de minimis fringe benefit. Under legislation passed in 1998, if more than one-half of the employees to whom meals are provided on the employer's premises are provided for the convenience of the employer, then all of the meals are treated as furnished for the employer's convenience, and the value of the meals is excludible from the employee's income and is deductible by the employer.  I.R.C. §119(b)(4).  But, there can’t be a cash allowance for meals.  If the allowance constitutes compensation, it’s included in the employee’s gross income.  See, e.g., Priv. Ltr. Rul. 9801023 (Sept. 30, 1997).

Remoteness.  As noted above, for meals to be excluded from an employee’s wages, the meals must be provided as a condition of employment, and be for the employer’s convenience and furnished on the employer’s business premises.  I.R.C. §119(a)(1).  The requirements seem to be easier for remotely located farms and ranches.  In those situations, its often not feasible for employees to go to town for meals.  That makes the argument easier that it’s necessary for the employee to eat on the premises – it’s for the employer’s convenience and as a condition of employment.  

The litigated cases reveal that the remote location of the business is a significant factor in excluding meals from an employee’s wages.  In a 1966 Wyoming case, Wilhelm v. United States, 257 F. Supp. 16 (D. Wyo. 1966), the taxpayers owned a ranch in a remote location several miles from the nearest town.  The taxpayers transferred the ranch, ranch-house and all of the equipment to the corporation and attempted to live in the house tax free.  The corporation also bought the food and treated it as a deductible expense.  The IRS challenged the practice.  The Federal District Court for the District of Wyoming ruled against the IRS and noted that the ranch was a grass ranch that put up very little hay and required constant attention by persons experienced in grass ranch requirements to keep cattle alive.  The court also noted that during snowstorms the cattle needed to be fed daily, needed to be moved, waterholes had to be kept open, and the cattle had to be protected against the hazards of being trapped or falling into ravines.  The court felt that the employees had no other choice but to accept the facilities furnished by the corporate employer, and that the food and lodging were furnished to the employees not only for the convenience of the employer, but that they were indispensable in order to have the employees on the job at all times.

The Wilhelm case was a very important decision, but it also raised the question of how a court would view the situation if the corporation were located in a less remote area. In 1971, the United States Court of Appeals for the 9th Circuit addressed this issue in the context of a grape and crop farming operation in Caratan v. Commissioner, 442 F.2d 606 (9th Cir. 1971).  In Caratan, the corporation was located within a ten-minute drive from a residential area of a nearby town. Company policy required supervisory and management personnel to reside on the farm. Company-owned lodging was supplied free of charge for this purpose. The court, in ruling against the IRS, held that the issue was not the remoteness of the corporation, but whether there was a good business reason to require the employees to remain on the premises. The court indicated that the nature of the farming enterprise would determine the reasonableness of requiring employees to reside on the premises rather than the location of the corporation from the nearest town. Whether corporate business required around the clock work such as is the case with a grain drying operation, a farrow-to-finish operation, a dairy or a cattle ranch with characteristics similar to the ranch involved in the Wilhelm case was the real issue.

Historically, cash grain operations have had the greatest difficulty in successfully excluding the cost of lodging and meals provided by the corporation to employees. The IRS has difficulty in accepting the fact that grain farmers simply cannot lock up their machinery after the fall harvest, return the next spring and expect it to still be there.  The IRS does not put much weight on security, and they think there is no reason why a grain farmer cannot live in town if all that occurs is the planting, cultivating and harvesting of a crop.  On the other hand, livestock ventures or those that are irrigating or drying grain typically have had better success against an IRS challenge. For example, taxpayers were successful in one case involving only a grain operation with the emphasis on grain drying as a reason to be on the premises on a continuing basis.  Johnson v. Comm’r, T.C. Memo. 1985-175; compare with J. Grant Farms, Inc. v. Comm’r, T.C. Memo. 1985-174.

Recent Tech Advice Memo.  If Caratan stands for the proposition that remoteness is not the issue, the most recent IRS development on employer-provided meals supports that position.  In Tech. Adv. Memo. 201903017 (Jan. 18, 2019), an employer provided meals to employees and an IRS examining agent sought guidance on whether the meals were excludible from the employees’ income. The National Office of IRS determined that the value of the meals was not excludible because of the employer’s goals of providing a secure business environment for confidential business discussions; innovation and collaboration; for employee protection due to unsafe conditions surrounding the business premises; and for improvement of employee health; and because of the shortened meal period policy. The National Office determined that the employer’s reasons weren't substantial non-compensatory business reasons as I.R.C. §119 requires. However, the IRS National Office determined that to the extent the taxpayer provided meals so that employees were available to handle emergency outages, the value of those meals were excludible from income under I.R.C. §119. Likewise, snacks provided to employees were excludible as a de minimis fringe.  

But, there’s a new twist to the TAM.  In the TAM, the IRS noted the increasing presence of meal delivery services.  The IRS noted that such services have become more prevalent, and that they tend to undermine the argument that an employee must take their meals on the business premises due to insufficient time to leave the premises for meals.  See, e.g., Treas. Reg. §1.119-1(a)(2)(ii)(c). 


Perhaps the issue of meal delivery services is not that big of an issue for farms and ranches that are truly remotely located in areas that meal delivery services don’t reach.  I.R.C. §119 and the associated Treasury Regulations, of course, don’t mention meal delivery services.  Likewise, there is no caselaw discussing meal delivery services either.    But, in any event, the TAM may be an indication that the IRS will be more likely to raise questions about employer-provided meals in the future.  The availability of a meal delivery service is now a new consideration.  And remember, on the employer side of the equation, beginning in 2018, the 100 percent deduction for amounts incurred and paid for the provision of food and beverages associated with operating a business dropped to 50 percent.  After 2025, the employer deduction is gone.

February 21, 2019 in Income Tax | Permalink | Comments (0)

Tuesday, February 19, 2019

Big EPA Developments – WOTUS and Advisory Committees


In the past few days, two big developments of importance to agriculture have occurred. Both involve the Environmental Protection Agency (EPA).  Last week, the EPA published its proposed rule redefining “waters of the United States” (WOTUS), triggering a 60-day comment period.  In another development, a federal trial court ruled that the EPA has the authority to bar persons currently receiving grant money from the EPA to serve on EPA scientific advisory committees.  Both of these developments are important to agriculture.

Recent EPA developments of importance to agriculture – that’s the topic of today’s post.

WOTUS Redefined

In prior posts over the past couple of years, I have detailed the continuing saga of the WOTUS rule – first as proposed by the Obama Administration’s EPA in 2015; the subsequent court battle; the new proposal by the Trump Administration’s EPA in 2017; more court litigation; and now a revised proposed definition that attempts to clarify what waters are subject to federal jurisdiction under the Clean Water Act (CWA). 

On December 11, 2018, the EPA and the U.S. Army Corps of Engineers (COE) proposed a new WOTUS definition.  That new definition was published in the Federal Register on Feb. 14, 2019.  82 FR 34899 (Feb. 14, 2019).  The proposed definition is subject to a 60-day public comment period that will close on April 15, 2019.  The publication of this new definition is in line with President Trump’s Executive Order of February 28, 2017, that the EPA and the Corps clarify the scope of waters that are federally regulated under the CWA. 

Drainage tile and ephemeral streams.  Under the newly proposed WOTUS definition, groundwater that drains through a farm field tile system is not a point source pollutant subject to federal control under the CWA’s National Pollution Discharge Elimination System  (NPDES).  This specificity shuts the door on the argument set forth in and rejected by the Iowa Supreme Court (construing Iowa law) in a 2017 decision.  See Board of Water Works Trustees of the City of Des Moines v. Sac County Board of Supervisors as Trustees of Drainage Districts 32, 42, 65, 79, 81, 83, 86, et al., No. C15-4020-LTS, 2017 U.S. Dist. LEXIS 39025 (N.D. Iowa Mar. 17, 2017)Also excluded from the WOTUS definition are ephemeral streams (those only temporarily containing water) and diffuse surface runoff that doesn’t enter a WOTUS at a particular discharge point.  

Ditches, PC wetland and farmed wetland.  The proposed rule also excludes ditches from the definition of a WOTUS unless the ditch is connected to a tributary of a WOTUS.  A tributary is defined as “…a river, stream or similar naturally occurring surface water channel that contributes ‘perennial or intermittent’ flow to a traditional navigable water or territorial sea in a typical year…either directly or indirectly through other jurisdictional waters such as tributaries, impoundments, and adjacent wetlands…”.   What is a “typical year”?  For starters, it doesn’t include periods of drought or extreme flooding.  It is one that is within the “normal range of precipitation” over a rolling 30-year period for a “particular geographic area.”  Tributaries “…do not include surface features that flow only in direct response to precipitation, such as ephemeral flows, dry washes, and similar features.”  In other words, dry channels are not “tributaries.”  There must be more than an insubstantial water flow to support federal jurisdiction as a tributary to a WOTUS.

Prior converted (PC) cropland is also not a WOTUS under the proposed WOTUS definition.  A prior converted wetland is a wetland that was totally drained before December 23, 1985.  However, farmed wetland can still be subject to regulation by the USDA.  A “farmed wetland” is a wetland that was manipulated before December 23, 1985, but still exhibits wetland characteristics. Drains affecting these areas can be maintained, but the scope and effect of the original drainage system cannot be exceeded.  See, e.g., Barthel v. United States Department of Agriculture, 181 F.3d 934 (8th Cir. 1999).    

One unanswered question is whether the EPA will accept federal farm program wetland mappings.  It would be nice if the new WOTUS definition would include the same standard as USDA on this issue.  If not, on this issue, farmers will be subject to two distinct federal agencies with two distinct standards.  

Artificial irrigation, lakes and ponds.  The proposed WOTUS definition also would exclude areas that are artificially irrigated.  This is an important exception for rice and cranberry farmers.  See, e.g., United States v. Johnson, 467 F.3d 56 (1st Cir. 2006).  Likewise, excluded are artificial lakes and ponds (a waterbody that doesn’t have a natural outflow) that are constructed in upland areas.  This would include such structures as farm ponds, stock watering ponds, water storage reservoirs, settling basins and log cleaning ponds.  This follows the rationale of a U.S. Supreme Court opinion in 2006.  See Rapanos v. United States, 547 U.S. 715 (2006).  The only catch is if they are covered under other sections of the proposed rule.  For example, a lake or a pond that is “susceptible” to use in interstate or foreign commerce or is subject to a tide’s ebb and flow is deemed to be a WOTUS.  See 33 C.F.R. §328.3.  Likewise, a lake or a pond that contributes “perennial or intermittent flow” to navigable waters of the United States is deemed to be a WOTUS.  What does that mean?  It would appear to mean that only those lakes and ponds that actually have some material influence on navigable waters satisfies the definition of a WOTUS.  Id. If there is no perennial or intermittent flow being contributed by the lake or pond, then the lake or pond is not jurisdictional (at least at the federal level).  But, what about headwater streams that are made artificially perennial by subsurface drainage systems?  Are those to be excluded from the WOTUS definition?  Also, how are ditches that have been excavated into groundwater to be treated if they don't receive perennial surface flows?  Hopefully these two questions will be clarified.

In addition, other water-filled depressions (such as those created by mining or construction activity when fill, sand or gravel is excavated) are excluded from the definition of a WOTUS if they are in uplands.  They are not excluded if they are created in a wetland area to begin with.

Hydrological connections.  The proposed definition says that “[a] mere hydrological connection from a non-navigable, isolated, intrastate lake or pond…may be insufficient to establish jurisdiction under the proposed rule.”  While that seems to be a bit vague, the proposal does state that flooding that occurs once in 100 years into a WOTUS does not trigger federal jurisdiction.  What is clear, however, is that “…ecological connections between physically separated lakes and ponds and otherwise jurisdictional waters” are not under federal control.  This is a major point concerning the proposed WOTUS definition. 

EPA Advisory Committees

A recent federal court decision, Physicians for Social Responsibility v. Wheeler, No. 1:17-cv-02742 (TNM), 2019 U.S. Dist. LEXIS 22276 (D. D.C. Feb. 12, 2019), ended an Obama-era EPA policy of allowing EPA advisory committee members to be in present receipt of EPA grants.  When President Trump took office, he nominated Scott Pruitt to be head of the EPA.  After Senate confirmation, Secretary Pruitt issued a directive regarding membership in its federal advisory committees specifying “that no member of an EPA federal advisory committee be currently in receipt of EPA grants.” The directive reversed an Obama-era rule that allowed scientists in receipt of EPA grants to sit on advisory panels.  That rule was resulting in biased advisory committees stacked with committee members that opposed coal and favored an expansive “Waters of the United States” rule among other matters. The plaintiffs were a group of individuals and organizations who were receiving EPA research grants, and were either serving on an EPA advisory committee or hoped to serve on a committee. They claimed that the new directive illegally barred grant recipients from being members of the advisory committees, and filed suit to invalidate the directive. The EPA claimed that appointment policy was reserved to agency discretion, and that the plaintiffs failed to allege a violation of any specific statutory provision.

The trial court agreed with the EPA’s position, finding that when making appointments to the committees, agency heads have complete discretion “unless otherwise provided by statute, Presidential directive, or other established authority.” One such restriction on their discretion, the trial court noted, is the applicable ethics rules, found in 18 U.S.C. §208, and the accompanying regulation that dictate that a grant recipient can participate on an EPA advisory committee without incurring liability. However, the court reasoned that while someone may serve on an advisory committee without incurring liability under the conflict of interest statute, that does not dictate that an agency must appoint him as a member.  In other words, the conflict of interest rules function as a floor, not a ceiling, for acceptable government service.

The plaintiff also claimed that the EPA failed to adequately explain its change in policy, and challenged it as arbitrary and capricious. However, the trial court determined that the arbitrary and capricious standard cannot be enough, by itself, to provide a meaningful standard for the court. Instead, the court explained that, “When an agency departs from its prior policy, it must display awareness that it is changing position, and it ‘must show that there are good reasons for the new policy.’ But it need not establish ‘that the reasons for the new policy are better than the reason for the old ones; it suffices that the new policy is permissible under the statute, that there are good reasons for it, and that the agency believes it to be better...’” This “reasonable and reasonably explained’ standard is deferential, so long as the agency’s action – and the agency’s explanation for that action – falls within a zone of reasonableness.” In defending its policy change, the EPA explained that “while receipt of grant funds from the EPA may not constitute a financial conflict of interest, receipt of that funding could raise independence concerns depending on the nature of the research conducted and the issues addressed by the committee.” Thus, the change was necessary “to ensure integrity and confidence in its advisory committees.” The trial court found the EPA’s explanation to be within the zone of reasonableness. Based on these findings, the trial court held that the EPA action was rational, considered the relevant factors and within the authority delegated to the agency, and granted the EPA’s motion to dismiss the case. 


The newly proposed WOTUS rule is designed to clarify just exactly what constitutes waters over which the federal government has regulatory authority.  It is a tighter definition in many respects than the 2015 version was.  Public hearings will be held during the 60-day comment period.  For those in the Midwest and Great Plains, public hearing will be held at the EPA building in Kansas City, KS on February 27 and 28.  For those wishing to submit written comments by the April 15 deadline, the comments should be identified by Docket ID No. EPA-HQ-OW-2018-0149 and submitted to the Federal Rulemaking Portal at: 

In addition, removing potential bias from EPA advisory committees is another step in the right direction.  Both developments have big implications for agriculture.

February 19, 2019 in Environmental Law | Permalink | Comments (0)

Friday, February 15, 2019

Tax Matters – Where Are We Now?


If you missed last week’s seminar/webinar, I covered the status of extender legislation, technical corrections, tax software issues and, of course, issues with the qualified business income deduction and the associated transition rule applicable to agricultural cooperatives and their patrons. 

If you’d like to view the video and get my 25-page technical outline, you can click here:

An update on where things sit in the midst of tax season – that’s the topic of today’s post.

Where Art Thou Technical Correction and Extender Legislation?

On January 2, 2019, the House Ways and Means Committee released a draft technical corrections bill that sought to correct “technical and clerical” issues in the Tax Cuts and Jobs Act (TCJA).   However, the newly constituted Ways and Means Committee with a Democratic majority is reported to be unlikely to take up the draft according to a staffer who made the comment at a conference in Washington, D.C. on January 29.

As for extender legislation, nothing has been enacted as of today to extend provisions for 2018 that expired at the end of 2017.  Extender legislation was introduced in early December, but then the bill was revised with the extender provisions stripped-out.  In mid-January Sen. Grassley, the chair of the Senate Finance Committee, said that he wanted to push an extender bill through, but there haven’t been any hearings scheduled yet.  On February 14, he said that he would push for a retroactive extension of expired tax credits that would last for two years (2018 and 2019).

There are numerous individual, business and energy-related provisions that await renewal, including the following:

  • Above-the-line deduction for certain higher-education expenses, including qualified tuition and related expenses, under R.C. §222.
  • The treatment of mortgage insurance premiums as qualified residence interest under I.R.C. §163(h)(3)(E).
  • The exclusion from income of qualified canceled mortgage debt income associated with a primary residence under I.R.C. §108(a)(1)(E)
  • 7-year recovery for motorsport racing facilities under I.R.C. §168(i)(15).
  • Empowerment zone tax incentives under I.R.C. §1391(d)(1)(A).
  • 3-year depreciation for race horses two years or younger under I.R.C. §168(e)(3)(A)(i).  
  • The beginning-of-construction date for non-wind facilities to claim the production tax credit (PTC) or the investment tax credit (ITC) in lieu of the PTC under I.R.C. §45(d) and §48(a)(5). 
  • The credit for construction of energy efficient new homes under I.R.C. §45L.  
  • The energy efficient commercial building deduction under I.R.C. §179D.  
  • Alternative fuel vehicle refueling property credit under I.R.C. §30C(g)
  • Incentives for alternative fuel and alternative fuel mixtures under I.R.C. §6426(d)(5) and §6427(E)(6)(c).  
  • Incentives for biodiesel and renewable diesel under I.R.C. §40A(a); I.R.C. §6426(e)(3); and I.R.C. §6427(e)(6)(B)

New Items for 2019

While the TCJA generally applies beginning with tax years effective after 2017, there are some unique provisions that change for 2019.  These include the following:

  • Medical expenses become more difficult to deduct. For 2018, itemizers could deduct medical expenses to the extent they exceeded 7.5% of the taxpayer’s adjusted gross income (AGI).  For 2019, the "floor" beneath medical expense deductions increases to 10%. R.C. §213(f). 
  • Big shift in the alimony tax rules. For payments required under divorce or separation instruments that are executed after Dec. 31, 2018, the deduction for alimony payments is eliminated, and recipients of affected alimony payments will no longer have to include them in taxable income.  The rules for alimony payments also apply to payments that are required under divorce or separation instruments that are modified after Dec. 31, 2018, if the modification specifically states that the new-for-2019 treatment of alimony payments (not deductible by the payer and not taxable income for the recipient) applies.  R.C. §§215; 71.
  • Shared responsibility payment is history. Obamacare generally provides that individuals must have minimum essential coverage (MEC) for health care, qualify for an exemption from the MEC requirement, or make an individual shared responsibility payment (i.e., pay a penalty) when they file their federal income tax return. The TCJA reduced the individual shared responsibility payment to zero for months beginning after Dec. 31, 2018I.R.C. §5000A(c)However, the I.R.C. §4980H “employer mandate” (also known as an employer shared responsibility payment, or ESRP) remains on the books. The employer mandate general provides that an employer that employed an average of at least 50 full-time employees, including full-time equivalent employees, on business days during the preceding calendar year is required to pay an assessable payment if: (i) it doesn't offer health coverage to its full-time employees; and (ii) at least one full-time employee purchases coverage through the Marketplace and receives an I.R.C. §36B premium tax credit.
  • Liberalized rules for hardship distributions from 401(k) plans. R.C. §401(k) plans may provide that an employee can receive a distribution of elective contributions from the plan on account of hardship (generally, because of an immediate and heavy financial need of the employee; and in an amount necessary to meet the financial need).  Under Treas. Reg.§1.401(k)-1(d)(3)(iv)(E), an employee who receives a hardship distribution cannot make elective contributions or employee contributions to the plan and to all other plans maintained by the employer, for at least six months after receipt of the hardship distribution.  The IRS has modify the regulation to delete the six-month prohibition on contributions and to make “any other modifications necessary to carry out the purposes of” I.R.C. §401(k)(2)(B)(i)(IV).  The revised regs are to apply to plan years beginning after Dec. 31, 2018.
  • There are other tax changes starting in 2019.  For example, the debt-equity documentation regulations apply to issuances in 2019; the accelerated phaseout of the tax credit for wind facilities continues; and many tax-exempt organizations face eased donor disclosure requirements.  Also, while not brand new for 2019, the election out of 100% bonus depreciation into 50 percent bonus is not available unless the tax year includes September 27, 2017.

Final I.R.C. §199A Regulations

Deductions.  While I have addressed the final qualified business income deduction (QBID) regulations in prior posts, software issues remain.  One lingering issue involves how to handle business-related deductions.  The final regulations are consistent with the proposed regulations on the treatment of the self-employed health insurance deduction and retirement plan contributions.  Prop. Treas. Reg. §1.199A-1(b)(4) defines QBI as the net amount of qualified items of income, gain, deduction and loss with respect to a trade or business as determined under the rules of Prop. Treas. Reg. §1.199A-3(b).  The above-the-line adjustments for S.E. tax, self-employed health insurance deduction and the self-employed retirement deduction are examples of such deductions. 

The basic starting point is that QBI is reduced by certain deductions reported on the return that the business doesn’t specifically pay, including the deduction for one-half of the self-employment tax, the self-employed health insurance deduction, and retirement plan contributions.  The self-employed health insurance deduction may only “apply” to Schedule F farmers because, with respect to partnerships and S corporations, it is actually a component of either shareholder wages for an S corporation shareholder or guaranteed payments to a partner and, thus, may not reduce QBI.  The self-employed health insurance deduction should not be removed from an S-corporate owner on their individual return because it has already been removed on Form 1120-S.  Do not deduct it twice. If QBI were reduced by the amount of the I.R.C. §162(l) deduction on the 1040, QBI would be (incorrectly) reduced twice.  In other words, QBI should not be reduced by the self-employed health insurance from the S corporation or the partnership.  The deduction for the S corporation shareholder is allocated to the wage income, and the deduction for the partner is from the guaranteed payment.  The one-half self-employment tax deduction for the partner is allocated between guaranteed payments (if any) and that portion of the K-1 allocated income associated with QBI.  Some tax software programs are not treating this properly.  Watch for updates, such as a box to check on the self-employed health insurance screen.

The final regulations also clarify that the deduction for contributions to qualified retirement plans under I.R.C. §404 is considered to be attributable to a trade or business to the extent that the taxpayer’s gross income from the trade or business is accounted for when calculating the allowable deduction, on a proportionate basis.  See Prop. Treas. Reg. §1.199A-3(b)(vi).  When an S corporation makes an employer contribution to an employer-sponsored retirement plan, that contribution, itself, reduces corporate profits.  Thus, there is less profit on which the QBID can potentially apply.  Thus, for some S corporation owners, a contribution to an employer-sponsored retirement plant will effectively result in a partial deduction, but still subject the entire contribution, plus all future earnings, to income tax upon distribution.  The final regulations make clear that sole proprietors and partners must also “back-out” these amounts from business profits before applying the QBID.  This rule will make 401(k)s with a Roth-style option more valuable. 

The final regulations do not address how deductions for state income tax imposed on the individual’s business income or unreimbursed partnership expenses are to be treated.  The final regulations also don’t mention whether the deduction for interest expense to a partnership interest or an S corporation interest is business related.            

Some tax software is presently reducing QBI passed through from an S corporation or partnership by the I.R.C. §179 amount which is passed through separately.  Other tax software allows the practitioner to either include or exclude the I.R.C. §179 amount.  A suggested approach is to always exclude it at the entity level because it is not known if it can be deducted on the taxpayer’s personal return.  Operating properly, tax software should calculate QBI with a reduction for the I.R.C. §179 deduction at the individual level. 

Fiscal year entities.  The final regulations in January put an earlier report to rest that had surfaced in November of 2018.  The problem that was reported to be the case did not materialize.  Instead, under the final regulations, for purposes of determining QBI, W-2 wages, and the unadjusted basis in assets of qualified property, if an shareholder/partner/member receives any of these items from a passthrough entity having a fiscal year beginning in 2016 and ending before December 31, 2017, the items are treated as having been incurred by the individual during the individual's 2017 taxable year.  No QBID would be available. On the other hand, if an individual receives any of these items from a passthrough entity that has a fiscal year beginning in 2017 and ending in 2018, the items are treated as having been incurred by the taxpayer during the individual’s 2018 tax year.  That means the items may be taken into account in determining the individual’s QBID for 2018. 

Agricultural Cooperatives

During the webinar/seminar on Feb. 8, I also covered the transition rule that bridges the gap between the original QBID cooperative rule and the “fix” that occurred in March of 2018.  My detailed outline associated with the seminar goes through the various computations that might be encountered.  Of course, under the transition rule, a farmer’s calculation of their QBID for 2018 does not include grain sold to a cooperative if the cooperative accounted for those sales when calculating its domestic production activities deduction (DPAD) under former I.R.C. §119 on its 2018 return.  That means that a tax preparer is going to need certain information from the cooperative to prepare the patron’s return properly.  And, yes, in spite of what some tax software companies are saying the 2018 Form 8903 is available via the IRS website (Dec. 2018 version).


For further elaboration on these points and you can read up on my lecture outline and slide presentation associated with the Feb. 8 seminar/webinar.  I also went into detail on how to handle farm rentals with various scenarios.  That issue still seems to bedevil practitioners.  Again, you can access the video (no CE credit for not watching it live), my lecture outline and slides here:

February 15, 2019 in Income Tax | Permalink | Comments (0)

Wednesday, February 13, 2019

Non-Dischargeable Debts in Bankruptcy


Farm financial distress remains a big issue in the ag sector at the present time.  There has been an uptick in farm and ranch bankruptcy filings over the past few years.  This makes bankruptcy law, unfortunately, important to farmers and their legal counsel.

One of the particular rules of bankruptcy concerns the dischargeability of debts.  What debts can be erased?  What debts cannot?  Does a debtor’s conduct during the bankruptcy process matter when it comes to debt discharge?

Bankruptcy debt discharge rules – that’s the topic of today’s post.

Basic Principles of Bankruptcy

The U.S. bankruptcy system is governed by two objectives - (1) a “fresh start” for poor but honest debtors who can obtain a discharge for some (but not all) debts; and (2) a policy of fairness for the unsecured creditors.  The bankruptcy process attempts to provide secured creditors (in most instances) with the value of their collateral, and provides a procedure for unsecured creditors to share in the debtor’s assets on a basis of fairness and equality.

A major feature of bankruptcy in the United States, as noted above, is discharge of indebtedness.  This makes possible the “fresh start” for individual debtors.  While the basic rule is that only debts arising before bankruptcy filing are dischargeable, not all debts can discharged.

Debts Ineligible for Discharge

Categories.  Several categories of debts are not eligible for discharge:

  • Taxes entitled to a preference (normally those within the last three years), for which a return was not filed or was filed late, or for which a fraudulent return was filed or which the debtor tried to evade, are not dischargeable. Penalties on non-dischargeable taxes are likewise not dischargeable.  See, e.g., In re Zuhone, 88 F.3d 469 (7th Cir. 1996).
  • A federal income tax lien against exempt property is not discharged in bankruptcy although the debt for the taxes, penalties and interest secured by the lien may be discharged in bankruptcy. The exempt property may be subject to foreclosure and sale to pay the tax lien.
  • Debt incurred to pay state and local taxes is not discharged.
  • Fines, penalties and forfeitures payable to a governmental unit that are not compensation for pecuniary loss are not dischargeable, nor is debt incurred to pay fines and taxes.
  • Student loans that are insured, guaranteed or funded by a government unit, for-profit entity and non-governmental entity unless the loan was “due and payable” more than five years before the filing of bankruptcy are ineligible for discharge.
  • Claims neither listed nor scheduled by the debtor in time to permit the creditor to file a timely proof of claim cannot be discharged.
  • Alimony and child support is not dischargeable.
  • Nonsupport obligations incurred from divorce or separation is not dischargeable.
  • Claims based on fraud or defalcation while the debtor was acting in a fiduciary capacity or based on embezzlement or larceny are not eligible for discharge.
  • Claims based on willful or malicious injury are not dischargeable. For example, in In re Cantrell, 208 B.R. 498 (B.A.P. 10th Cir. 1997), the debtor's loan agreement required a bank’s prior consent for the sale of secured cattle and that payment for the cattle be by check made out jointly to the debtor and the bank.  The debtor sold much of cattle herd without remitting the sale proceeds to the bank.  This left much of the loan unpaid and unsecured at the time of bankruptcy filing.  The court held that the remaining debt was not dischargeable.
  • Debts that were (or could have been) listed in a prior bankruptcy proceeding and were not discharged in the earlier proceeding because of the debtor’s acts or conduct are not eligible for discharge.
  • Claims owed to a single creditor aggregating more than $600 for luxury goods and services incurred by an individual on or within 90 days of filing the bankruptcy petition cannot be discharged.
  • Cash advances aggregating more than $875 that are consumer credit under an open-end credit plan if incurred on or within 70 days before filing the bankruptcy petition (per line of credit) are not in line for discharge.
  • Claims arising from a judgment entered against the debtor for operating a motor vehicle, vessels or aircraft while legally intoxicated are not eligible for discharge.
  • Homeowner association, condominium and cooperative fees are not discharged.
  • Debt associated with pension and/or profit-sharing plans is not dischargeable.

Fraud.  A debtor in financial distress must be very careful not to engage in fraudulent conduct.  In general, a debtor is denied discharge for fraudulent conduct within one year of filing the bankruptcy petition or during the bankruptcy case or for failure to explain a loss of assets or preserve sufficient recorded information concerning the debtor's financial condition or business transactions.  In general, a creditor doesn’t have to prove that its reliance on the debtor’s misrepresentation was reasonable.  The creditor need only show that its reliance was justifiable.  See, e.g., In re Eccles, 407 B.R. 338 (B.A.P. 8th Cir. 2009).

Relatedly, claims based on the receipt of money, property or services by fraud, false pretenses or a materially false written statement concerning the debtor's (or an insider’s) financial condition intentionally made to deceive creditors are not in line for discharge.  11 U.S.C. §523(a)(2)(B)This point was illustrated recently by a bankruptcy case from Tennessee involving a farmer.

In In re Blankenship, No. 16-10839, 2019 Bankr. LEXIS 7 (Bankr. W.D. Tenn. Jan. 2, 2019), the defendant filed Chapter 11 bankruptcy in 2016. A month after filing, the defendant sought permission to obtain post-petition financing from the plaintiff (an ag lender) in the form of a crop loan to produce and harvest the debtor’s 2016 soybean crop.  To obtain the crop loan, the defendant completed a “Crop Loan Application,” and submitted a “Farm List” to the plaintiff.  The paperwork listed the acreage and yearly rent prices for each parcel of land the defendant planned on farming during that year.

The total acreage listed in the paperwork was well over 8,000 acres. Based on the documentation, the plaintiff approved and made a $1,949,880 crop loan to the defendant.  In 2017, the defendant converted the Chapter 11 case to a Chapter 7 case and subsequently defaulted on the crop loan, at a time when the outstanding balance was $355,012.  The plaintiff sued, claiming that outstanding balance was non-dischargeable under 11 U.S.C. §523(a)(2)(B).  As noted above, under that provision, a creditor seeking to have debt excepted from discharge must establish that the debtor, with intent to deceive, used a materially false written statement to obtain a loan from the creditor and that the creditor reasonably relied on the statement to loan funds to the debtor. 

The bankruptcy court determined that the Crop Loan Application and the Farm List constituted a written statement, and the fact that the Farm List was not attached to the Crop Loan Application was immaterial.  It was more than simply a projection of the acres to be farmed in 2016 - it was a concrete representation of the debtor’s need for $1.9 million.  While the documentation indicated that the debtor planned to farm about 8,000 acres, the debtor actually farmed about 5,000 acres and had profit of approximately $1.5 million less than projected in the documentation.  Consequently, the bankruptcy court regarded the projected acreage and profit numbers as “substantially untruthful” and “materially false.”  The bankruptcy court determined that the there was nothing in the documentation that would have alerted the creditor to the falsity of the information provided, and that the creditor reasonably relied on the information to loan the $1.9 million – an amount necessary for the debtor to plant 8,000 acres.  The bankruptcy court also concluded that the debtor had intent to deceive via the false documentation based on the totality of the circumstances including the fact that the debtor had attested that the Farm List was an accurate representation of the amount of land they were going to farm.  The bankruptcy court pointed out that the debtor knew that the amount of land actually farmed in the prior year was only 5,200 acres.  The bankruptcy court found it inconceivable that the defendant anticipated being able to increase row crop production by almost 50 percent from the previous year based on leasing additional land, while being in an active bankruptcy case. Consequently, the remaining balance of the loan was not dischargeable.   


There is no doubt that times are tough in agriculture.  When finances get strained, it can take an emotional toll on the parties involved.  Even the temptation to engage in conduct that could be construed as fraudulent should be avoided.  Legal, financial and tax counsel should be consulted and allowed to assist throughout the painful process of debt adjustment and, perhaps, reorganization of the farming or ranching operation for long-term success.  In the Tennessee bankruptcy case discussed above, the debtor was not represented by legal counsel.  That was a big mistake.  

February 13, 2019 in Bankruptcy | Permalink | Comments (0)

Monday, February 11, 2019

Is There A Common-Law Right To Hunt (and Fish) Your Own Land?


The Founders understood that governments can often be the biggest obstacle to individual, inalienable rights – those rights that cannot be revoked by some outside (governmental) force.  While a representative form of government can be the best protector of individual rights, it can become the “tyranny of the majority” as noted by John Adams and Alexis De Tocqueville.

The matter of inalienable rights is important to farmers and ranchers.  Land ownership and the rights associated with land ownership is of primary importance to agricultural businesses and families.  One of those rights involves the right to hunt (and fish) the property that an individual owns. 

That’s the topic of today’s post – an individual’s rights to hunt (and fish) their own property.

State Regulation of Hunting Rights

All states have an elaborate set of statutes and regulations governing the hunting of wildlife in that particular state.  The rules govern hunting on state-owned public land as well as privately owned land.  In addition, the hunting rules vary depending on the type of game – big game; small game; fur-bearing or fowl.  The state rules also depend on whether the hunter is a resident of the particular state or a nonresident.  The rules tend to be less restrictive for residents, particularly those in certain age ranges, than they are for nonresidents.  The fees for licenses and/or permits are also much lower for residents than nonresidents, with typical exceptions for full-time students and service members.

As for non-resident landowners, the state rules vary from state-to-state.  Kansas, for example, requires a nonresident “hunt-on-your-own-land” deer permit.  That permit is available to either a resident or nonresident who actively farms a tract of 80-acres or more in the state.  The property must be owned in fee simple.  The name on the deed must be denoted in a particular manner.  

The Iowa approach is different.  Hunting rights in Iowa don’t follow ownership.  A nonresident landowner has no inalienable right to hunt their own property – property for which they pay taxes to the state of Iowa.  The portion of the Iowa hunting laws defining “resident” and “owner” were the subject of a recent case.

Iowa Case

Iowa hunting law allows a resident landowner to obtain annually up to two deer hunting licenses - one antlered or any sex deer hunting license and one antlerless deer free of charge. Iowa Code §483A.  A resident landowner may also buy two antlerless deer hunting licenses. “Owner” is defined as the owner of a farm unit who is a resident of Iowa. Iowa Code §483A.24(2)(a)(3).   A “resident” is defined as including a person with a principle or primary residence or domicile in Iowa, a full-time student, a non-resident under age 18 who has a parent that is an Iowa resident or a member of the military that claims Iowa residency either by filing Iowa taxes or being stationed in Iowa.  Iowa Code  §483A.1A(10).  Nonresident landowners must apply for antlered licensing. The state allots 6,000 antlered or any sex deer hunting licenses to nonresidents via a lottery system for a fee.  If a nonresident landowner does not receive an antlered license through the lottery system, "the landowner shall be given preference for one of the antlerless deer only nonresident deer hunting licenses."

The plaintiff owned 650 acres in southcentral Iowa, but was not domiciled in Iowa.  Over the prior six-year period, the plaintiff received nonresident antlered deer hunting licenses through the lottery four times. The other two years the plaintiff obtained a nonresident antlerless deer hunting license. The plaintiff has been able to hunt every year on his property, but as a nonresident landowner and by paying the higher fees associated with being a “nonresident.” 

In 2016, the plaintiff, in Carter v. Iowa Department of Natural Resources, No. 18-0087, 2019 Iowa App. LEXIS 119 (Iowa Ct. App. Feb. 6, 2019), filed a declaratory action against the state requesting a ruling establishing him as an "owner" under for purposes of Iowa deer hunting laws.  He claimed that not treating him as an “owner” violated his inalienable rights and his equal protection rights under the Iowa Constitution. The state did not respond within 60 days and the action was treated as having been denied.  The plaintiff sought judicial review.

The trial court rules for the state.  On further review, the appellate court affirmed.  While the plaintiff claimed that he had an inalienable right to hunt the property that he owned and paid taxes on to the state of Iowa, the appellate court held that the state’s differential treatment between residents and non-residents for obtaining hunting licenses for antlered deer was reasonable, not arbitrary, and constituted an appropriate use of the state’s police power.  The appellate court also determined that the different treatment of residents and non-residents served a legitimate governmental interest in conserving and protecting wildlife that was rationally related to that legitimate governmental interest.  The court, citing Democko v. Iowa Department of Natural Resources, 840 N.W.2d 281 (Iowa 2013), noted that 2013 decision held that landownership in Iowa does not give the landowner the right to hunt the land because the landowner has no interest in or title to wildlife on the owner’s property.  That wildlife, the Supreme Court had determined in 2013, is owned by the state of Iowa.  Thus, there is no common law right to hunt based on ownership.  The legislature, as the Iowa Supreme Court noted in 2013, established extensive hunting laws (and the subsequent underlying regulations) that had eliminated that right in a manner consistent with the legitimate state interest of wildlife preservation.

What About Private Farm Ponds?

As noted, the Iowa Supreme Court, in 2013, removed from the “bundle of sticks” of private property ownership, the common law right to hunt wildlife on one’s own property.  But what about fish in a pond on privately owned property?  Does the landowner have a right to fish their own pond without going through the state?  The answer may not be as obvious as it seems it should be.  It’s also an issue that is currently being debated in Iowa.  Current Iowa law says that the Iowa Natural Resource Commission (Commission) can’t stock private water unless the owner agrees that the private water is opened to the public for fishing.  Iowa Code §481A.78.  In other words, if the state stocks a private pond, the landowner must make the pond available for public fishing.  However, the law allows the Commission to investigate a private pond to determine if the “living conditions” of the fish in the private pond are suitable and then provide breeding stock on the owner’s request.  In that instance, the private pond need not be opened for public fishing.  Id.

However, this fishing provision of Iowa law has become contentious.  Legislation is presently being worked up in the Iowa legislature that would strike that law entirely and replace it with a new provision specifying that the Commission “shall not stock a private pond or lake.”  SF 203.  The new legislation would allow the Commission to stock a creek or stream flowing through private property.  Id. The legislation also specifies that a fishing license is not required to fish on an entirely land-locked private pond so long as it is not located on a natural stream channel or connected via surface water to waters of Iowa.  Id.


Apparently, there is no “resident” requirement in the law governing the fishing of private ponds in Iowa.  So, a nonresident can fish their own pond even though living out of state, but a nonresident has no common law right to hunt their own property in Iowa.  “Wildlife,” however, belong to the state of Iowa while they are present there.  That is, of course, unless a resident (or nonresident) collides with wildlife on an Iowa public roadway and incurs damage and/or injury in the collision.  Hmmm….  That might be the topic of a future post.        

Do you know the rules in your state?  

February 11, 2019 in Real Property, Regulatory Law | Permalink | Comments (0)

Thursday, February 7, 2019

Defects In Real Estate Deeds – Will Time Cure All?


The law sets forth particular requirements that a real estate deed must satisfy to be effective to convey title in the manner in which the parties to the transaction desire.  Those requirements, for example, might concern particular deed language, recordation, or even the manner in which the deed is executed. 

But, just how technical are those requirements?  Is a failure to precisely follow all of the rules fatal to the conveyance of the property involved?  Can a party to a real estate transaction use a minor “foot-fault” by the other party as a means of getting out of what is discovered to be a bad deal?  What if the “defect” isn’t discovered until several years after the deed is executed and title conveyed?  Does the passage of time matter?

That’s the topic of today’s post – the impact of the passage of time on deed defects.

Curative Statutes

All states have all curative statutes designed to address various types of errors associated with real estate deeds. The statutes vary greatly from state-to-state, and deal with various possible defects.  However, they all have one purpose – to cure defects following the passage of a certain amount of time.   The goal is to allow title examiners to rely upon recorded documents that may have some minor defect once an appropriate length of time has passed.  If execution and recording of the deed is defective, that generally does not impact the validity of the conveyances between the parties to the conveyance. It only impacts whether constructive notice to the world was effective. 

Recent Case.  A recent decision by the U.S Court of Appeals for the Eleventh Circuit dealt with the Florida curative statute and how it applied to a alleged deed defect in a case involving an IRS attempt to foreclose on the real estate.  In Saccullo v. United States, No. 17-14546, 2019 U.S. App. LEXIS 1056 (11th Cir. Jan. 11, 2019), a father executed a deed in 1988 that conveyed a tract of real estate to a trust for the benefit of his son.  But, the deed was witnessed by only one person rather than two as Florida law required.  The father died in 2005, and the IRS asserted that the estate owed $1.4 million in delinquent federal estate tax. In 2015, the IRS filed a tax lien against the property on the basis that it was property that was included in the decedent’s estate.

The son sued, claiming that the lien was inapplicable.  He claimed that the property was not included in the father’s estate because it had been transferred to the trust before the father’s death. The IRS acknowledged that there had been an attempted transfer to the trust before death, but claimed that the properly had not actually been conveyed to the trust because the deed execution was not properly witnessed.  As a result, the IRS claimed, the property was included in the father’s estate at death and was subject to the IRS lien for unpaid taxes. The IRS motioned for summary judgment and the trial court agreed, granting the motion.

On appeal, the appellate court reversed noting that Florida law (Fla. Stat.§95.231) specifies that an improperly executed deed is considered valid five years after recordation. While the IRS claimed that this “curative” statute required “some form of formal adjudication” before it cured a deed and that, even if it did apply automatically, the statute essentially constituted a statute of limitations.  As a statute of limitations, the IRS claimed, it couldn’t apply in a manner that bound the United States.  The IRS cited an old U.S. Supreme Court opinion for that proposition.  See United States v. Summerlin, 310 U.S. 414 (1940). 

The appellate court disagreed with the IRS. The appellate court noted that while the Florida Supreme Court had not squarely addressed this particular issue, the clear weight of Florida authority favored applying the curative statute automatically five years after a deed is recorded and did not require any adjudication. The appellate court also held that Summerlin did not apply because the deed had been cured before the father died (the deed was executed and recorded 17 years before the father died) and, at the time of curing, was deemed to be effectively conveyed to the trust. As a result, there was no statute of limitations issue because the IRS claim failed to accrue. The result was that, upon the father’s death, the real estate was not included in his estate and the IRS lien couldn’t attach to it.  

The “take-home” from the case is that the Florida statute was drafted precisely enough to cure what is probably a commonly-overlooked defect in Florida.  The statute also triggered the running of the five-year period from the date the deed was recorded.  In other words, the act of recording the deed had to occur to start the five-year timeframe running.  Five years was also a long-enough period of time to ensure that no bona fide purchasers would be impacted.  The statute of limitations issue was also not problematic because the IRS lien for unpaid federal estate tax couldn’t arise until after the father had died.  By that time, much more time than five years had passed since the deed had been executed and recorded. 


Where a defect associated with a real estate deed prevents the conveyance from being effective, a curative statute would not help unless it clearly provides that something that was defective because of a statutory requirement is deemed effective with the passage of time.   That’s a lesson for practitioners to keep in mind.  Real estate deeds are often a big part of the business of agriculture.  It’s also a lesson for legislator’s drafting curative statutes to remember to draft carefully.  If drafted carefully, the passage of time will cure defects.

February 7, 2019 in Real Property | Permalink | Comments (0)

Tuesday, February 5, 2019

Can a State Tax a Trust With No Contact With the State?


Last summer, the U.S. Supreme Court decided South Dakota v. Wayfair, 138 S. Ct. 2080 (2018), where the court upheld South Dakota’s ability to collect taxes from online sales by sellers with no physical presence in the state.  That decision was the latest development in the Court’s 50 years of precedent on the issue, and I wrote on the issue here:

Does the Supreme Court’s opinion mean that a state can tax trust income that a beneficiary receives where the only contact with the state is that the beneficiary lives there?  It’s an issue that is presently before the U.S. Supreme Court.  It’s also the topic of today’s post – the ability of a state to tax trust income when the trust itself has no contact with the taxing state.

The “Nexus” Requirement

Article I, Section 8 of the U.S. Constitution says that, “The Congress shall have the regulate commerce…among the several states…”.  That is a rather clear statement – the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States.”  As I pointed out in the blog post on the Wayfair decision last summer, a state tax will be upheld when applied to an activity that meets several requirements:  the activity must have a substantial nexus with the state; must be fairly apportioned; must not discriminate against interstate commerce, and; must be fairly related to the services that the state provided.  Later, the U.S. Supreme Court said that a physical presence was what satisfied the substantial nexus requirement.  

The physical presence requirement to establish nexus was at issue in Wayfair and 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” must be present.  Likewise, the other three requirements of prior U.S. Supreme Court precedent remain – the tax must be fairly apportioned; it must not discriminate against interstate commerce, and; it must be 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. 

Taxing an Out-Of-State Trust?

The U.S. Supreme Court has now decided to hear a case from North Carolina involving that state’s attempt to tax a trust that has no nexus with the state other than the fact that a trust beneficiary is domiciled there.  Kimberley Rice Kaestner Trust 1992 Family Trust v. North Carolina Department of Revenue, 789 S.E.2d 645 (N.C. Ct. App. 2016), aff'd., 814 S.E.2d 43 (N.C. 2018), pet. for cert. granted, No. 18-457, 2019 U.S. LEXIS 574 (U.S. Sup. Ct. Jan. 11, 2019).  The trust at issue, a revocable living trust, was created in 1992 with a situs of New York. The primary beneficiaries were the settlor’s descendants. None of the descendants lived in North Carolina at the time of the trust’s creation. The trust was divided into three separate trusts in 2002, one for each of the settlor’s children. The beneficiary of one of the sub-trusts was a North Carolina resident at that time. The trustee was replaced in 2005 with a successor trustee who resided in Connecticut. North Carolina tax returns were filed for tax years 2005-2008 for the accumulated trust income, that was distributed to the beneficiaries, including the non-North Carolina beneficiaries. In 2009, the trust filed a claim for a refund of North Carolina taxes in an amount slightly exceeding $1.3 million. The trust claimed that N.C. Gen. Stat. §105-160.2, which assesses tax on the amount of taxable income of the estate or trust that is for the benefit of a North Carolina resident, was unconstitutional on due process and Commerce Clause grounds. The defendant denied the claim, and the hearing officer later dismissed the case for lack of jurisdiction.

The trial court dismissed the request for injunctive relief with respect to the refund claim, but denied the defendant’s motion to dismiss the constitutional claims. The trial court then granted summary judgment for the trust on the constitutional claim and ordered the defendant to refund the taxes paid on its accumulated income.

On appeal, the appellate court affirmed. The appellate court determined that the trust failed to have sufficient minimum contacts (as required by the Due Process Clause) with North Carolina to subject the trust to North Carolina income tax. The court cited both International Shoe Co. v. Washington, 326 U.S. 310 (1945) and Quill Corp. v. North Dakota, 504 U.S. 298 (1992) to support its position on this point. The trust did not have any physical presence in the state during the tax years at issue, contained no North Carolina property or investments, had no trust records that were created or kept in North Carolina, and the place of trust administration was not in North Carolina. Basing the imposition of state tax on a beneficiary’s domicile, by itself, did not establish sufficient minimum contacts with the state to satisfy the Due Process Clause and allow North Carolina to tax a non-North Carolina trust. The appellate court held that Brooke v. Norfolk, 277 U.S. 27 (1928) was controlling. In that case, a Maryland resident created a testamentary trust with a Maryland situs for a Virginia beneficiary. Virginia assessed tax on the trust corpus, but the Court held the assessment to be unconstitutional.

On further review, the state Supreme Court affirmed, also noting that a key to the case was that the trust beneficiary did not receive trust distributions during the years at issue. As such, the North Carolina statute violated the Due Process Clause of the U.S. Constitution.

The North Carolina Supreme Court’s decision was delivered 13 days before the U.S. Supreme Wayfair decision, and was based on the controlling U.S. Supreme Court decision at that time – Quill.  Consequently, the North Carolina Department of Revenue, based on Wayfair, sought U.S. Supreme Court review.  On January 11, 2019, the U.S. Supreme Court agreed to hear the case. 


State taxation of trusts varies greatly from state to state in those states that have a state income tax.  A trust’s situs in a state certainly permits that state to subject the trust to the state’s income tax as a resident.  But, a trust may be tied to a state in other ways via a grantor, trustee, assets, or a beneficiary.  In addition, whether a trust is a revocable or irrevocable trust can make a difference. For instance, the Illinois definition of  “resident” includes “an irrevocable trust the grantor of which was domiciled in this State at the time such trust became irrevocable.”  35 ILCS/1501(A)(20)(D); see also, Linn v. Department of Revenue, 2 N.E.3d 1203 (Ill. Ct. App. 2013).  Indeed, a trust may have multiples states asserting tax on the trust’s income. 

However, due process requires that before a state can tax a trust’s income, the trust must have a substantial enough connection (e.g., nexus) with the state.  How the U.S. Supreme Court decides the North Carolina case in light of its Wayfair decision will be interesting.  It’s a similar issue but, income tax is involved rather than sales or use tax.  In my post last summer (noted above) I discussed why that difference could be a key distinction.  In addition, while a trust could be subject to state income tax based on its residency, the trust has grantors and trustees and beneficiaries and assets that can all be located in different states – and can move from state-to-state (at least to a degree). 

The U.S. Supreme Court decision will have implications for trust planning as well as estate and business planning.  Siting a trust in a state without an income tax (and no rule against perpetuities) is looking better each day.

February 5, 2019 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Friday, February 1, 2019

Time to Review of Estate Planning Documents?


The laws surrounding estate planning have changed significantly in recent years and have done so multiple times.  That means that it might be a good idea to review wills, trusts and associated estate planning documents to make sure they still will function as intended at the time of death. 

But, just exactly what should be looked for that might need to be modified?  One item is clause language in a will or trust that is now outdated because of the current federal estate tax exemption that is presently much higher than it has been in prior years. 

That’s the topic of today’s post – the need to review and modifying (when necessary) clause language in a will or trust that no longer will work as anticipated because of the increase in the federal estate tax exemption.

Common Will and Trust Language

Wills and trusts that haven’t been examined in the last five to seven years should be reviewed to determine if pecuniary bequests, percentage allocations and formula clauses will operate as desired upon death. For example, if will or trust  language refers to the “Code” and/or uses Code definitions for transfer tax purposes, or otherwise refers to the Code to carry out bequests, that language may now produce a result that no longer is consistent with the testator’s intent.

Common language used in wills and trust to split out shares to a surviving spouse in “marital deduction” and “credit shelter” amounts often refers to the “Code.”  In other words, the split of the shares is tied to the amount of the federal estate tax exemption at the time of the testator’s death.  This results in an automatic adjustment of the marital deduction portion of the first spouse’s estate (as well as the credit shelter amount) in accordance with the value of the federal estate tax exemption at the time of the decedent’s death. 

Why is such language an issue?  For starters, it could result in nothing being left outright to a surviving spouse.  For example, a clause that leaves a surviving spouse “the minimum amount needed to reduce the federal estate tax to zero” with the balance passing to the spouse in life estate form could result in nothing passing outright to the surviving spouse in marital deduction form.  That would be the case, for example, with respect to an estate that is not large enough to incur federal estate tax.  Presently, the threshold for estate taxability at the federal level is a taxable estate of $11.4 million which means that very few estates will be large enough to incur federal estate tax.  For nontaxable estates, the formula language that was designed to minimize estate tax by splitting the bequests to the surviving spouse between marital property and life estate property no longer works - surviving spouse would receive nothing outright.   

On the other hand, a beneficiary of an estate that is not subject to federal estate tax would receive everything under a provision that provides that the beneficiary receives “the maximum amount that can pass free of federal estate tax.” 

Formula clause language.  As can be surmised from above, a common estate planning approach for a married couple facing the possibility of at least some estate tax upon either the death of the first spouse or the surviving spouse has been for the estate of the first spouse to be split into a marital trust and a credit shelter (bypass) trust.  To implement this estate planning technique, the couple’s property is typically re-titled, if necessary, to roughly balance the estates (in terms of value) so that the order of death of the spouses becomes immaterial from a federal estate tax standpoint.  This necessarily requires the severance of joint tenancy property.  Estate “balancing” between the spouses is critical where combined spousal wealth is between one and two times the amount of the federal estate tax exemption.  For many years that range was between $600,000 and $1.2 million.  Then the ranged ratcheted upward to between $3 million and $6 million.  It then moved upward again to a range of $5 million to $10 million.  Now it is a range of $11.4 million to $22.8 million.  

What formula clause language does is cause the trusts to be split in accordance with a formula that funds the credit shelter trust with the deceased spouse’s unused exemption, and funds the marital trust with the balance of the estate.  As indicated above, the increase in the exemption can cause, a complete “defunding” of the surviving spouse’s marital trust and an “over stuffing” of the credit shelter trust.  That may not be what the decedent had planned to occur.  For instance, here’s a sample of language to be on the lookout for:

“To my Trustee…that fraction of my residuary estate of which the numerator shall be a sum equal to the largest amount, after taking into account all allowable credits and all property passing in a manner resulting in a reduction of the Federal Estate Tax Unified Credit available to my estate, that can pass free of Federal Estate Tax and the denominator of which shall be the total value of my residuary estate

For the purpose of establishing such fraction the values finally fixed in the Federal Estate Tax proceeding in my estate shall control.    

The residue of my estate after the satisfaction of the above devise, I devise to my spouse; provided that, any property otherwise passing under this subparagraph which shall be effectively disclaimed or renounced by my spouse under the provisions of the governing state law or the Internal Revenue Code shall pass under the provisions of paragraph…”.

To reiterate, while the above language typically worked well with federal estate tax exemption levels much lower than the current $11.4 million amount, the language can now result in an “over-stuffed” credit shelter trust (and related de-funding of the marital trust).

Consider the following example:

John and Mary, a married couple, had a combined spousal wealth of $3 million in 2001 at a time when the exclusion from the estate tax was $1 million.  As part of the estate planning process, they re-titled their assets and balanced the value of the assets between them to eliminate problems associated with the order of their deaths.  Assuming John dies first with a taxable estate of $1.5 million, the clause would result in $1 million passing to the bypass trust and $500,000 passing outright to Mary in the marital trust created by the residuary language.  Upon Mary’s subsequent death, her estate would consist of her separate $1.5 million (assuming asset values have not changed) and the $500,000 passing outright to her under the terms of John’s will.  With a $1 million exclusion, only $1 million would be subject to the federal estate tax.

With the present $11.4 million exclusion, the clause would result in John’s entire estate passing to the bypass trust, and nothing passing outright to Mary as part of the marital trust.  While the couple’s estate value is not large enough to trigger an estate tax problem, it would be better to have some of the property that the clause caused to be included in the bypass trust be included in Mary’s estate so that it could receive an income tax basis equal to the date of death value.  With the present $11.4 million exclusion, all of John’s property could be left outright to Mary and added to her separate property with the result that Mary’s estate would still not be subject to federal estate tax.  But, all of the property would be included in her estate at death and the heirs would receive an income tax basis equal to the fair market value at the time of Mary’s death. 

Charitable bequests.  The same problem with formula clause language applies to many charitable bequests that are phrased in terms of a percentage of the “adjusted gross estate” or establish a floor or ceiling based on the extent of the “adjusted gross estate.”


The standard advice has been to routinely revisit existing estate planning documents every couple of years.  Not only does the law change, but family circumstances can change and goals and objectives can change.  But, the rules surrounding estate planning have been modified several times in recent years which means that plan should be revisited even more frequently. 

One final thought.  The current rules sunset at the end of 2025 and then revert back to the rules in play in 2018.  That means that the estate tax exemption would go back to $5 million plus inflation adjustments.  So, just because federal estate tax might not be a problem for a particular estate, that doesn’t mean that estate planning can be ignored.  Reviewing wills and trusts for outdated language is important, but overall objectives should be reviewed and related documents such as financial and health care powers of attorney should be executed or modified as necessary. 

The bottom line - there remain numerous reasons for seeing an estate planning attorney for a review of estate planning documents.  Examining drafting language in older wills and trusts is just one of them.

February 1, 2019 in Estate Planning | Permalink | Comments (0)

Wednesday, January 30, 2019

The Accommodation Doctrine – More Court Action


Over the past three years, I have written on a couple of occasions about the accommodation doctrine – a mineral owner’s right to use the surface estate to drill for and produce minerals.  The doctrine requires a balancing of the interests of the surface and mineral owner.  But, at least one court has also applied the doctrine to groundwater.  Now, a federal appellate court has applied the doctrine to find that vertical drilling on farmland may constitute a trespass.

An update on the accommodation doctrine in the courts – that’s the topic of today’s post.

Accommodation Doctrine

Land ownership includes two separate estates in land – the surface estate and the mineral estate.  The mineral estate can be severed from the surface estate with the result that ownership of the separate estates is in different parties.  In some states, the mineral estate is dominant.  That means that the mineral estate owner can freely use the surface estate to the extent reasonably necessary for the exploration, development and production of the minerals beneath the surface.  If the owner of the mineral estate has only a single method for developing the minerals, many courts will allow that method to be utilized without consideration of its impact on the activities of the surface estate owner.  See., e.g., Merriman v. XTO Energy, Inc., 407 S.W.3d 244 (Tex. 2013). 

But, under the accommodation doctrine, if alternative means of development are reasonably available that would not disrupt existing activities on the surface those alternative means must be utilized.  In other words, the accommodation doctrine applies if the surface owner must establish that the lessee’s surface use precludes (or substantially impairs) the existing surface use, and that the surface owner doesn’t have any reasonable alternative means to continue the current use of the surface estate.  For example, in Getty Oil co. v. Jones, 470 S.W.2d 618 (Tex. 1971), a surface estate owner claimed that the mineral estate owner did not accommodate existing surface use.  To prevail on that claim, the Getty court determined that the surface owner must prove that the mineral estate owner’s use precluded or substantially impaired the existing surface use, that the surface estate owner had no reasonable alternative method for continuing the existing surface use, and that the mineral estate owner has reasonable development alternatives that would not disrupt the surface use. 

Accommodation Doctrine and Water

A question left unanswered in the 1971 decision was whether the accommodation doctrine applied beyond subsurface mineral use to the exercise of groundwater rights.  In 2016, the Texas Supreme Court, in Coyote Lake Ranch, LLC v. City of Lubbock, 498 S.W.3d 53 (Tex. Sup. Ct. 2016), held that it did.  Thus, according to the Court, the doctrine applies in situations where the owner of the groundwater impairs an existing surface use, the surface owner has no reasonable alternative to continue surface use, and the groundwater owner has a reasonable way to access and produce water while simultaneously allowing the surface owner to use the surface.

The Court held that the language of the deed for the land involved in the litigation governed the rights of the parties, but that the deed didn’t address the core issues presented in the case. For example, the Court determined that the deed was silent on the issue of where drilling could occur and the usage of overhead power lines and facilities associated with water development. The Court determined that water and minerals were sufficiently similar such that the accommodation doctrine should also apply to water – both disappear, can be severed, and are subject to the rule of capture, etc. The Court also concluded that a groundwater estate severed from the surface estate enjoys an implied right to use as much of the surface as is reasonably necessary for the production of groundwater. Thus, unless the parties have a written agreement detailing all of the associated rights and responsibilities of the parties, the accommodation doctrine would apply to resolve disputes and sort out rights.

In 2018, however, the Texas Court of Appeals, refused to further expand the accommodation doctrine.  Harrison v. Rosetta Res. Operating, LP, No. 08-15-00318-CV 2018 Tex. App. LEXIS 6208 (Tex Ct. App. Aug. 8, 2018), involved a water-use dispute between an oil and gas lessee and the surface owner. The plaintiff owned the surface of a 320-acre tract. The surface estate had been severed from the mineral estate, with the minerals being owned by the State of Texas.  The plaintiff executed an oil and gas lease on behalf of the State that allowed the lessee to use water from the land necessary for operations except water from wells or tanks of the landowner.

To settle a lawsuit with the plaintiff, the lessee agreed to buy 120,000 barrels of water.  The lessee built a frac pit to store the water that it would use in drilling operations and drilled two wells.  The lessee then assigned the lease to the defendant.  The defendant drilled a third well and had plans to drill additional wells.  However, the defendant did not buy water from the plaintiff as the lessee had.  Instead, the defendant pumped water from a neighbor and brought temporary waterlines onto the plaintiff’s property to fill storage tanks. 

The plaintiff claimed that the defendant (via an employee) orally agreed to continue the existing arrangement that the plaintiff had with lessee and was in violation with an alleged industry custom in Texas – that an oil and gas lessee would only buy water from the surface owner of the tract it was operating.  The plaintiff claimed that it wasn’t necessary for the defendant to bring in hoses and equipment because the defendant should have bought the plaintiff’s water from the plaintiff, Not doing so violated the accommodation doctrine.  The trial court rejected the plaintiff’s arguments.

The appellate court determined that the plaintiff’s accommodation doctrine arguments appeared to rest on his proposition that because a frac pit was built on his land for use by the former lessee, it unified the use of the land with the oil and gas operations, and when the defendant chose not buy his water it substantially interfered with his existing use of the land as a source of water for drilling operations. Thus, the substantial interference complained of was that the frac pit was no longer profitable because the defendant is not using it to supply water for its operations. The appellate court held that categorizing a refusal to buy goods produced from the land as interference with the land for purposes of the accommodation doctrine would stretch the doctrine beyond recognition. Therefore, because the defendant’s use did not impair the plaintiff’s existing surface use in any way, except in the sense that not buying the water had precluded the plaintiff from realizing potential revenue from selling its water to the defendant, the inconvenience to the surface estate was not evidence that the owner had no reasonable alternative to maintain the existing use. Lastly, the court determined that if it were to hold for the plaintiff on these facts they would, in effect, be holding that all mineral lessees must use and purchase water from the surface owner under the accommodation doctrine if his water is available for use. Accordingly, the appellate court affirmed. 

Recent Case

In, Bay v. Anadarko E&P Onshore LLC, No. 17-1374, 2018 U.S. App. LEXIS 36454 (10th Cir. Dec. 26, 2018), the plaintiffs, a married couple, operate a farm in Weld, County, CO. In 1907, the Union Pacific Railroad acquired large swaths of land and sold off surface rights to others, ultimately selling subsurface rights to mineral deposits to the defendant, an oil and gas company. The 1907 deed reserved the following: “First. All coal and other minerals within or underlying said lands. Second. The exclusive right to prospect in and upon said land for coal and other minerals therein, or which may be supposed to be therein, and to mine for and remove, from said land, all coal and other minerals which may be found thereon by anyone. Third. The right of ingress, egress and regress upon said land to prospect for, mine and remove any and all such coal or other minerals; and the right to use so much of said land as may be convenient or necessary for the right-of-way to and from such prospect places or mines, and for the convenient and proper operation of such prospect places, mines, and for roads and approaches thereto or for removal therefrom of coal, mineral, machinery or other material” [emphasis added].

The plaintiffs’ farm was above a large oil and gas deposit. Before 2000, the railroad entered into agreements with surface owners before drilling for oil or gas. Those agreements often included payments to surface owners and provided that the railroad would pay for surface property damages, including crop damages. In 2000, the defendant bought the railroad’s mineral rights in the oil and gas deposit underlying the plaintiffs’ property. In 2004, the defendant leased the mineral rights under the plaintiffs’ farms to an exploration company which drilled three vertical wells on a part of the plaintiffs’ farm. An energy company bought the exploration company in 2006 and drilled four more vertical wells on another part of the plaintiffs’ farm between 2007 and 2011. In an attempt to have fewer wells drilled on their farm and minimize the impact to their farmland, the plaintiffs asked the energy company to drill directionally. The energy company requested $100,000 per directional well. The plaintiffs refused, and the energy company continued to drill vertically. The plaintiffs sued, claiming that the energy company’s surface use constituted a trespass because directional drilling would have resulted in two wells on their property rather than seven.  Directional drilling is the norm in the county with one drill site per pad serving 12-36 wells.

The trial court granted a judgment as a matter of law to the defendant on the basis that the defendant had presented sufficient evidence that vertical drilling was the only commercially reasonable practice; that this practice was afforded in the additional rights granted in the original deed; and that the plaintiffs could not establish trespass. On appeal, the appellate court reversed. The appellate court noted that state law held that deeds containing language identical to the “convenient and necessary” language of the deed at issue does not grant mineral owners more rights than what state common law provides. The appellate court also expressed doubt as to whether a mineral reservation in a deed can expand surface or mineral ownership rights unless those rights are clearly defined in accordance with Gerrity Oil and Gas Corp. v. Magness, 946 P.2d 913 (Colo. 1997). The appellate court concluded that the deed at issue in the case was insufficient to expand mineral or surface rights beyond those recognized in state common law. The appellate court also held that the trial court erred by requiring the plaintiffs to show that vertical drilling wasn’t commercially reasonable. Under Gerrity, the appellate court noted, a surface owner can introduce evidence that "reasonable alternatives were available." Once that evidence is introduced, the appellate court determined that it is then up to a judge or jury to "balance the competing interests of the operator and surface owner and objectively determine whether ... the operator's surface use was both reasonable and necessary." 


The accommodation doctrine sounds reasonable.  But, defining what a reasonable use can be difficult to determine, and if new uses can be asserted the mineral owner’s rights can be diminished.  From an economic standpoint, it would seem that the owner of the surface estate as the accommodated party should pay for the extra expense associated with the accommodation.  In other words, when the mineral estate owner must accommodate, but at the expense of the surface estate owner, both parties benefit and the surface estate owner can’t get rights back for nothing that it sold when the original grant was created.  Some states, such as Kansas, follow this approach.

January 30, 2019 in Real Property, Water Law | Permalink | Comments (0)

Monday, January 28, 2019

Selected Recent Cases Involving Agricultural Law


Last fall, I wrote a blog post where I took a look at a handful of recent court developments involving agricultural law.  Since then I have received numerous requests to do another post surveying more court developments involving legal issues that farmers, ranchers, rural landowners and agribusinesses face. 

Recent court opinions involving ag law issues – that’s the topic of today’s post. 

Adverse Possession

Each state, even though differences exist in state law, recognize that if an individual possesses someone else's land in an open and notorious fashion with an intent to take it away from them, such person (known as an adverse possessor) becomes the true property owner after the statutory time-period (anywhere from 10 to 21 years) has expired.  If use is by permission, the adverse possession statute is never tolled.  See, e.g., Engel v. Carlson, No. A-07-016, 2008 Neb. App. LEXIS 94 (Neb. Ct. App. May 13, 2008).

The requirements that the use of the land must be “adverse” and under a “claim of right” are sometimes combined under the requirement that the use of the land be “hostile” to the true owner’s use.  For example, in Cannon v. Day, 165 N.C. App. 302, 598 S.E.2d 207 (2004), rev. den., 604 S.E.2d 309 (N.C. 2004), the original owners never granted permission to use a lane, and the neighbor had used the lane for more than 20 years adverse to the true owners. The court determined that the neighbor had adversely possessed the lane and the ownership of it passed to the neighbor’s successors in interest. 

The hostility requirement is designed to put the true owner on notice that another party is using the land adversely to the true owner.  See, e.g., Groves v. Applen, No. 31241-7-II, 2005 Wash. App. LEXIS 1460 (Wash. Ct. App. Jun. 14, 2005). However, in Kansas, the adverse possession statute does not contain a “hostility” requirement, and the doctrine can be asserted against an undisclosed co-tenant.  Buchanan v. Rediger, 26 Kan. App.2d 59, 975 P.2d 1235 (1999)

Recent case.  In Collier v. Gilmore, 2018 Ark. App. 549 (Ark. Ct. App. 2018), the Arkansas Court of Appeals held that farming to a cultivation line constituted adverse possession.  The parties each gained title to their respective tracts from the same predecessor. In 1972, the plaintiff purchased his tract and believed that he purchased up to the fence where his predecessor had farmed. However, the deed did not include a strip of land up to the fence. Since the 1980’s, the plaintiff farmed up to where the fence was in 1972 believing that to be the property line. Sometime during the 1980’s the defendant received title to the other portion of the predecessor’s original property. The plaintiff sued claiming adverse possession of the strip of land not in the 1972 deed. The trial court agreed.

On appeal, the appellate court affirmed. The appellate court held that the plaintiff’s farming of the disputed strip for several decades was sufficient to establish an intent to hold against the true owner’s rights. The appellate court also determined that the plaintiff’s possession was also hostile because it was greater than the deed anticipated and was without permission of the true owner. While the strip had never been enclosed by a fence or other enclosure, the property line was the cultivation line which had been clearly identified for decades via the plaintiff’s conduct. 

Vicarious Liability

In certain situations, one person may be held liable for the tortious acts of another person based on a special relationship between the two.  Such liability (called vicarious liability) exists even though the person held liable not have personally committed the act.  Often this issue arises in employment situations.  An employer may be held vicariously liable for the tortious acts (usually negligent ones) committed by an employee.  Thus, if an employee commits a tort during the “scope of employment”, the employer will (jointly with the employee) be liable. 

This rule is often described as the doctrine of “respondeat superior”, which means “let the person higher up answer.”  Vicarious liability applies to torts committed by employees and generally not to those committed by independent contractors.  Therefore, it is critical to determine whether a particular individual was an employee or an independent contractor.  While no single factor is dispositive in all cases, an employee is generally one who works subject to the control of the employer concerning the manner and means of performance. 

Recent case.  In Moreno v. Visser Ranch, Inc., No. F075822, 2018 Cal. App. LEXIS 1194 (Cal. Ct. App. Dec. 20, 2018), at issue was a dairy farm’s liability for a worker involving in an accident.  The dairy employed a worker to be on call around the clock to repair equipment at the dairy.  The worker was involved 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 plaintiff attended a family function (they were related) not located on the dairy’s 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 diary 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. 

Inherently Dangerous Activities

Another aspect of respondeat superior involves activities that the law deems to be inherently dangerous. In this instance, the person making the hire can be held vicariously liable even if the person hired is an independent contractor.  For example, in some states, aerial crop spraying is considered evidence of negligence.  In these situations, a plaintiff only needs to establish that aerial spraying occurred and damage resulted.  A showing of negligence on the part of the individual spraying the crops is not necessary.  However, the majority of states still require a showing of negligence before damages can be recovered.  In the states not requiring a showing of negligence, the practical effect is to apply a strict liability rule.  In these jurisdictions, delegation of the spraying task to an independent contractor does not eliminate a farmer's liability.  This problem is so severe that most farm liability policies do not cover the aerial spraying or dusting of crops.  The damage award in a crop dusting case is calculated on the basis of the difference between the crop yield that would have normally resulted and the yield actually obtained after the damage, adjusted for any reduction in costs, such as drying or hauling costs.  Yield is based on the best evidence available.

Recent case.  In Keller Farms, Inc. v. Stewart, No. 1:16 CV 265 ACL, 2018 U.S. Dist. LEXIS 210209 (E.D. Mo. Dec. 13, 2018), the court held that the aerial application of ag chemicals is not an inherently dangerous activity.  The case involved a dispute involving damage to the plaintiffs’ trees caused by chemicals that allegedly drifted during aerial application. The plaintiffs attempted to hold both the aerial applicator and the landowner that hired the applicator. The plaintiffs claimed the landowner was vicariously liable for the applicator’s actions because aerial spraying of burndown chemicals is an "inherently dangerous activity."

The trial court granted the defendants’ motion for judgment as a matter of law on the plaintiff's trespass claim, but the remaining issues were left for the jury to resolve.  The jury returned a verdict in favor of the defendants on the negligence and negligence per se claims. The plaintiffs filed a motion for a new trial, arguing the verdict was against the weight of the evidence; that the trial court erred in excluding evidence; and that the trial court erred in granting the defendants’ motion for judgment as a matter of law. The trial court, however, denied the plaintiff’s motion for a new trial.

On appeal, the appellate court affirmed. The appellate court determined that the jury’s verdict was not against the weight of the evidence, and that the aerial application of herbicides was commonplace and not inherently dangerous. In addition, the appellate court noted that the defendants’ evidence was that the herbicides did not actually drift onto the plaintiff’s property and that the applicator complied with all label requirements and sprayed during optimal conditions. The appellate court also determined that the trial court had ruled properly on evidentiary matters and that the plaintiff had not proven the alleged monetary damages to the trees properly. The appellate court also upheld the trial court’s denial of the plaintiff’s motion for a new trial. 


The legal issues that farmers and ranchers deal with are potentially very large.  Today’s post examined just a small slice.  It’s always helpful to know what the rules are when the issue arises. 

January 28, 2019 in Civil Liabilities, Real Property | Permalink | Comments (0)