Thursday, February 2, 2023

Failure to Execute a Written Lease Leads to a Lawsuit; and Improper Use of SBA Loan Funds

Overview

One of the most important things that a farmer or rancher can do is to put lease agreements in writing.  The problems that can arise with an oral lease are to innumerable to list or even think of.  The first case below is an example.  The second case involves a farm couple that were struggling financially and were trying to utilize Chapter 12 bankruptcy and SBA COVID relief funds.  But the rules must be followed closely, as the Nebraska bankruptcy court’s decision illustrates.

Problems with oral farming agreements and misuse of SBA loan funds – these are the topics of today’s post.

Document Filed with FSA Not a Valid Lease 

Coniglio v. Woods, No. 06-22-00021-CV, 2022 Tex. App. LEXIS 8926 (Tex. Ct. App. Dec. 7, 2022)

Involved in this case was land in Texas that the landowner’s son managed for his father who lived in Florida. The landowner needed the hay cut on 107 acres of the over 5,100-acre farm and agreed orally that the plaintiff, a neighboring landowner, could cut the hay when necessary.  The hay was cut on an annual basis.  So that he could receive government farm program payments on the land, the plaintiff filed wrote up a “memorialization of a lease agreement” and filed it with the local USDA Farm Service Agency (FSA).  The agreement stated as follows:  “This is to inform you that Michael J. Woods operates my farm [farm number specified], (approximately 107 acres) agriculturally for hay.  This lease agreement began in 2015 and will continue thru December 31, 2020.”  The document was dated September 28, 2016, and was signed by the plaintiff.  The landowner’s son also signed the agreement at the plaintiff’s request, but later testified that he didn’t believe the document to constitute a written lease.  After three years of cutting the hay, the landowner wanted to lease the hay ground for solar development and the plaintiff was told by the landowner and son that the hay no longer needed to be cut and there would be no hay profits to share. 

The plaintiff sued for breach of a farm lease agreement – purportedly a lease for a five-year term.  The plaintiff also claimed that the father and son tortiously interfered with contract for future years, were unjustly enriched by the breach and had also violated the Texas Deceptive Trade Practices Act (DPTA).  The trial court ruled in favor of the plaintiff on the basis that the form submitted to the USDA was sufficient to show the existence of a lease agreement, and entered a judgment for the plaintiff and against the father and son, jointly and severally, for $163,434.68 for breach of the “lease.”  The trial court also awarded triple that amount ($490,304.94) for violation of the DPTA.   The trial court also awarded court costs and attorney fees.  The total award was $601,815.62,   

On appeal, the defendant claimed that the document filed with the FSA did not satisfy the writing requirement of the statute of frauds.  The father testified that he wasn’t aware of any lease agreement and the son testified the arrangement was simply one to have the plaintiff cut the hay when needed and the parties would split the hay.  The son testified that he signed the agreement simply so that the plaintiff could receive the farm subsidies associated with the hay ground.  The appellate court agreed, noting that the document didn’t contain the essential terms of the lease.  It didn’t denote the names of the parties, didn’t describe the property, didn’t note the rental rate, and didn’t list any conditions or any consideration.  Accordingly, the appellate court determined that no valid lease existed and reversed the trial court’s judgment.

Debtors Barred From Further Use of COVID Relief Funds

In re Klein, No. BK 22-40804, 2022 Bankr. LEXIS 3451 (Bankr. D. Neb. Dec. 7, 2022)

This is the debtors’ third Chapter 12 case since 2019. Two banks as creditors filed motions to dismiss, asserting the debtors were not eligible for Chapter 12 bankruptcy because they were not “family farmers” at the time of filing Chapter 12.  The debtors claimed that they did meet the definition of a “family farmer” because they were engaged in farming with 15 cows, 5 calves, a one-half interest in a bull, and cash to operate.  However, the debtors did not know where their cows were or if any of them were pregnant. They also failed to confirm a plan in their previous Chapter 12 cases, did not own any land or equipment and were on the brink of surrendering their livestock.  Their only source of income was Social Security. The debtors obtained a $500,000 COVID hardship loan from the SBA in October of 2021 based on their representation that they were engaged in the business of farming, operating under a confirmed Chapter 12 plan.  When they applied for the loan, the debtors agreed the loan money would only be used as working capital and there was no “substantial adverse change” in their financial condition. The debtors failed to schedule the loan and the debtors claimed they had an approved plan of reorganization for their bankruptcy claim, which they did not. When the debtors received the loan, they paid their attorneys for work on their prior bankruptcy cases, paid themselves for farm work, paid for their own groceries, and paid their daughters as contractors. Within four months of the loan disbursement the debtors had used $275,594.41 of the loan. The SBA sought a preliminary injunction against the debtors to ensure they could not use the remainder of the loan that SBA alleged was obtained by fraud. The bankruptcy court granted the preliminary injunction against the debtors to protect the remainder of the SBA loan.  The court found that without the injunction the SBA would suffer irreparable harm if the loan proceeds were spent, and that the SBA would suffer greater harm if an injunction wasn’t entered than if the debtors’ access to was limited.  The court also determined that the SBA was likely to succeed on its claim to except the debt from discharge and that public policy favored ensuring that the loan process was not abused and that the loan funds were properly used. 

Observation

In Coniglio, the lack of a formal written document memorializing the relationship between the parties and the duties and expectations of both, created a problem that resulted in litigation – litigation that could have been avoided.  Based on the facts as stated by the court, the arrangement appeared to be one of a custom cutter.  That would be the result if the plaintiff supplied the machinery to cut the hay.  In that event, the plaintiff would have simply been an independent contractor and not a tenant.  The other possibility is that the plaintiff was a cropper that was compensated with a share of the crop.  To be a cropper, the plaintiff would have used the landowner’s (or son’s) equipment.  In that instance, the plaintiff would not have any legally enforceable interest in the crop, but would have a contract right to compensation for the provision of his in-kind labor.  A cropper is an employee that is hired to produce a crop.  A cropper has no interest in the real estate is not a tenant operating under a lease agreement.  A cropper is, in essence, an employee.  See, e.g., Henney v. Lambert, 237 Iowa 146, 21 N.W.2d 301 (1946).  The court didn’t get into these distinctions, but that would be the analysis.  In any event, the writing, by itself, was insufficient to constitute a lease. 

Conclusion

The court opinions indicate the problems that can arise when farming agreements aren’t reduced to writing and how financial distress can lead to the snowballing of additional legal issues. 

February 2, 2023 in Bankruptcy, Contracts | Permalink | Comments (0)

Monday, January 30, 2023

Bibliography - July Through December 2022

Overview

 After the first half of 2022, I posted a blog article of a bibliography of my blog articles for the first half of 2022.  You can find that bibliography here:  Bibliography – January through June of 2022

https://lawprofessors.typepad.com/agriculturallaw/2022/09/bibliography-january-through-june-of-2022.html.

Bibliography of articles for that second half of 2022 – you can find it in today’s post.

Alphabetical Topical Listing of Articles (July 2022 – December 2022)

Bankruptcy

More Ag Law Developments – Potpourri of Topics

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

Business Planning

Durango Conference and Recent Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/07/durango-conference-and-recent-developments-in-the-courts.html

Is a C Corporation a Good Entity Choice For the Farm or Ranch Business?

https://lawprofessors.typepad.com/agriculturallaw/2022/07/whats-the-best-entity-structure-for-the-farm-or-ranch-business.html

What is a “Reasonable Compensation”?

https://lawprofessors.typepad.com/agriculturallaw/2022/08/what-is-reasonable-compensation.html

Federal Farm Programs: Organizational Structure Matters – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2022/08/federal-farm-programs-organizational-structure-matters-part-three.html

LLCs and Self-Employment Tax – Part One

https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-one.html

LLCs and Self-Employment Tax – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-two.html

Civil Liabilities

Durango Conference and Recent Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/07/durango-conference-and-recent-developments-in-the-courts.html

Dicamba Spray-Drift Issues and the Bader Farms Litigation

https://lawprofessors.typepad.com/agriculturallaw/2022/07/dicamba-spray-drift-issues-and-the-bader-farms-litigation.html

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

Ag Law and Tax Developments

https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html

More Ag Law Developments – Potpourri of Topics

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

Ag Law Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html

Contracts

Minnesota Farmer Protection Law Upheld

https://lawprofessors.typepad.com/agriculturallaw/2022/09/minnesota-farmer-protection-law-upheld.html

Criminal Liabilities

Durango Conference and Recent Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/20Ag Law Summit

https://lawpr22/07/durango-conference-and-recent-developments-in-the-courts.html

Environmental Law

Constitutional Limit on Government Agency Power – The “Major Questions” Doctrine

https://lawprofessors.typepad.com/agriculturallaw/2022/07/constitutional-limit-on-government-agency-power-the-major-questions-doctrine.html

More Ag Law Developments – Potpourri of Topics

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

Court Says COE Acted Arbitrarily When Declining Jurisdiction Over Farmland

https://lawprofessors.typepad.com/agriculturallaw/2022/10/court-says-coe-acted-arbitrarily-when-declining-jurisdiction-over-farmland.html

Ag Law Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html

Estate Planning

Farm/Ranch Tax, Estate and Business Planning Conference August 1-2 – Durango, Colorado (and Online)

https://lawprofessors.typepad.com/agriculturallaw/2022/07/farmranch-tax-estate-and-business-planning-conference-august-1-2-durango-colorado-and-online.html

IRS Modifies Portability Election Rule

https://lawprofessors.typepad.com/agriculturallaw/2022/07/irs-modifies-portability-election-rule.html

Modifying an Irrevocable Trust – Decanting

https://lawprofessors.typepad.com/agriculturallaw/2022/09/modifying-an-irrevocable-trust-decanting.html

Farm and Ranch Estate Planning in 2022 (and 2023)

https://lawprofessors.typepad.com/agriculturallaw/2022/09/farm-and-ranch-estate-planning-in-2022-and-2023.html

Social Security Planning for Farmers and Ranchers

https://lawprofessors.typepad.com/agriculturallaw/2022/11/social-security-planning-for-farmers-and-ranchers.html

How NOT to Use a Charitable Remainder Trust

https://lawprofessors.typepad.com/agriculturallaw/2022/12/how-not-to-use-a-charitable-remainder-trust.html

Recent Cases Involving Decedents’ Estates

https://lawprofessors.typepad.com/agriculturallaw/2022/12/recent-cases-involving-decedents-estates.html

Medicaid Estate Recovery and Trusts

https://lawprofessors.typepad.com/agriculturallaw/2022/12/medicaid-estate-recovery-and-trusts.html

Income Tax

What is the Character of Land Sale Gain?

https://lawprofessors.typepad.com/agriculturallaw/2022/07/what-is-the-character-of-land-sale-gain.html

Deductible Start-Up Costs and Web-Based Businesses

https://lawprofessors.typepad.com/agriculturallaw/2022/07/deductible-start-up-costs-and-web-based-businesses.html

Using Farm Income Averaging to Deal With Economic Uncertainty and Resulting Income Fluctuations

https://lawprofessors.typepad.com/agriculturallaw/2022/07/using-farm-income-averaging-to-deal-with-economic-uncertainty-and-resulting-income-fluctuations.html

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

What is “Reasonable Compensation”?

https://lawprofessors.typepad.com/agriculturallaw/2022/08/what-is-reasonable-compensation.html

LLCs and Self-Employment Tax – Part One

https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-one.html

LLCs and Self-Employment Tax – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-two.html

USDA’s Emergency Relief Program (Update on Gain from Equipment Sales)

https://lawprofessors.typepad.com/agriculturallaw/2022/08/usdas-emergency-relief-program-update-on-gain-from-equipment-sales.html

Declaring Inflation Reduced and Being Forgiving – Recent Developments in Tax and Law

https://lawprofessors.typepad.com/agriculturallaw/2022/09/declaring-inflation-reduced-and-being-forgiving-recent-developments-in-tax-and-law.html

Ag Law and Tax Developments

https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html

Extended Livestock Replacement Period Applies in Areas of Extended Drought – IRS Updated Drought Areas

https://lawprofessors.typepad.com/agriculturallaw/2022/09/extended-livestock-replacement-period-applies-in-areas-of-extended-drought-irs-updated-drought-areas.html

More Ag Law Developments – Potpourri of Topics

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

IRS Audits and Statutory Protection

https://lawprofessors.typepad.com/agriculturallaw/2022/10/irs-audits-and-statutory-protection.html

Handling Expenses of Crops with Pre-Productive Periods – The Uniform Capitalization Rules

https://lawprofessors.typepad.com/agriculturallaw/2022/10/handling-expenses-of-crops-with-pre-productive-periods-the-uniform-capitalization-rules.html

When Can Depreciation First Be Claimed?

https://lawprofessors.typepad.com/agriculturallaw/2022/10/for-depreciation-purposes-what-does-placed-in-service-mean.html

Tax Treatment of Crops and/or Livestock Sold Post-Death

https://lawprofessors.typepad.com/agriculturallaw/2022/11/tax-treatment-of-crops-andor-livestock-sold-post-death.html

Social Security Planning for Farmers and Ranchers

https://lawprofessors.typepad.com/agriculturallaw/2022/11/social-security-planning-for-farmers-and-ranchers.html

Are Crop Insurance Proceeds Deferrable for Tax Purposes?

https://lawprofessors.typepad.com/agriculturallaw/2022/11/are-crop-insurance-proceeds-deferrable-for-tax-purposes.html

Tax Issues Associated With Easement Payments – Part 1

https://lawprofessors.typepad.com/agriculturallaw/2022/11/tax-issues-associated-with-easement-payments-part-1.html

Tax Issues Associated With Easement Payments – Part 2

https://lawprofessors.typepad.com/agriculturallaw/2022/11/tax-issues-associated-with-easement-payments-part-2.html

How NOT to Use a Charitable Remainder Trust

https://lawprofessors.typepad.com/agriculturallaw/2022/12/how-not-to-use-a-charitable-remainder-trust.html

Does Using Old Tractors Mean You Aren’t a Farmer? And the Wind Energy Production Tax Credit – Is Subject to State Property Tax?

https://lawprofessors.typepad.com/agriculturallaw/2022/12/does-using-old-tractors-mean-you-arent-a-farmer-and-the-wind-energy-production-tax-credit-is-it-subject-to-state-prop.html

Insurance

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

Real Property

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

Ag Law Summit

https://lawprofessors.typepad.com/agriculturallaw/2022/08/ag-law-summit.html

Ag Law and Tax Developments

https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html

More Ag Law Developments – Potpourri of Topics

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

Ag Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html

Regulatory Law

Constitutional Limit on Government Agency Power – The “Major Questions” Doctrine

https://lawprofessors.typepad.com/agriculturallaw/2022/07/constitutional-limit-on-government-agency-power-the-major-questions-doctrine.html

The Complexities of Crop Insurance

https://lawprofessors.typepad.com/agriculturallaw/2022/07/the-complexities-of-crop-insurance.html

Federal Farm Programs – Organizational Structure Matters – Part One

https://lawprofessors.typepad.com/agriculturallaw/2022/08/federal-farm-programs-organizational-structure-matters-part-one.html

Federal Farm Programs – Organizational Structure Matters – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2022/08/federal-farm-programs-organizational-structure-matters-part-two.html

Federal Farm Programs: Organizational Structure Matters – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2022/08/federal-farm-programs-organizational-structure-matters-part-three.html

USDA’s Emergency Relief Program (Update on Gain from Equipment Sales)

https://lawprofessors.typepad.com/agriculturallaw/2022/08/usdas-emergency-relief-program-update-on-gain-from-equipment-sales.html

Minnesota Farmer Protection Law Upheld

https://lawprofessors.typepad.com/agriculturallaw/2022/09/minnesota-farmer-protection-law-upheld.html

Ag Law and Tax Developments

https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html

Animal Ag Facilities and Free Speech – Does the Constitution Protect Saboteurs?

https://lawprofessors.typepad.com/agriculturallaw/2022/10/animal-ag-facilities-and-free-speech-does-the-constitution-protect-saboteurs.html

Court Says COE Acted Arbitrarily When Declining Jurisdiction Over Farmland

https://lawprofessors.typepad.com/agriculturallaw/2022/10/court-says-coe-acted-arbitrarily-when-declining-jurisdiction-over-farmland.html

Ag Law Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html

Water Law

More Ag Law Developments – Potpourri of Topics

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

January 30, 2023 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Friday, January 27, 2023

Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1

Overview

Today’s article concludes my look at the top ag law and tax developments of 2022 with what I view as the top two developments.  I began this series by looking at those developments that were significant, but not quite big enough to make the “Top Ten.”  Then I started through the “Top Ten.”

The top two ag law and tax developments in 2022 – it’s the topic of today’s post.

Recap

Here’s a bullet-point recap of the top developments of 2022 that I have written about:

  • Nuisance law (the continued developments in Iowa) - Garrison v. New Fashion Pork LLP977 N.W.2d 67 (Iowa Sup. Ct. 2022).
  • Minnesota farmer protection law - Pitman Farms v. Kuehl Poultry, LLC, et al., 48 F.4th 866 (8th Cir. 2022).
  • Regulation of ag activities on wildlife refuges - Tulelake Irrigation Dist. v. United States Fish & Wildlife Serv., 40 F.4th 930 (9th Cir. 2022).
  • Corps of Engineers jurisdiction over “wetland” - Hoosier Environmental Council, et al. v. Natural Prairie Indiana Farmland Holdings, LLC, et al., 564 F. Supp. 3d 683 (N.D. Ind. 2021).
  • U. S. Tax Court’s jurisdiction to review collection due process determination - Boechler, P.C. v. Commissioner, 142 S. Ct. 1493 (2022).
  • IRS Failure to Comply with the Administrative Procedure Act - Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022); Green Valley Investors, LLC v. Commissioner, 159 T.C. No. 5 (2022).
  • State law allowing unconstitutional searches unconstitutional - Rainwaters, et al. v. Tennessee Wildlife Resources Agency, No. 20-CV-6 (Benton Co. Ten. Dist. Ct. Mar. 22, 2022).
  • No. 10 USDA’s Emergency Relief Program and the definition of “farm income.”
  • No. 9 - USDA decision not to review wetland determination upheld - Foster v. United States Department of Agriculture, No. 4:21-CV-04081-RAL, 2022 U.S. Dist. LEXIS 117676 (D. S.D. Jul. 1, 2022).
  • No. 8 - Dicamba drift damage litigation - Hahn v. Monsanto Corp., 39 F.4th 954 (8th Cir. 2022), reh’g. den., 2022 U.S. App. LEXIS 25662 (8th Cir. Sept. 2, 2022).
  • No. 7 – The misnamed “Inflation Reduction Act.”
  • No. 6 – Caselaw and legislative developments concerning “ag gag” provisions.
  • No. 5 - WOTUS final rule.
  • No. 4 – Economic issues
  • No. 3 – Endangered Species Act regulations

No. 2 – California Proposition 12

National Pork Producers Council, et al. v. Ross, 6 F.4th 1021 (9th Cir. Jul. 28, 2021), cert. granted, 142 S. Ct. 1413 (2022)

In a huge blow to pork producers (and consumers of pork products) nationwide, the U.S. Court of Appeals for the Ninth Circuit has upheld California’s Proposition 12 in 2021.  Proposition 12 requires any pork sold in California to be raised in accordance with California’s housing requirements for hogs.  This means that any U.S. hog producer, by January 1, 2022, was required to upgrade existing facilities to satisfy California’s requirements if desiring to market pork products in California. In early 2022, the U.S. Supreme Court announced that it would review the Ninth Circuit’s opinion. 

While each state sets its own rules concerning the regulation of agricultural production activities, the legal question presented in this case is whether one state can override other states’ rules. The answer to that question involves an analysis of the Commerce Clause and the “Dormant” Commerce Clause.

The Commerce Clause.  Article I Section 8 of the U.S. Constitution provides in part, “the Congress shall have Power...To regulate Commerce with foreign Nations and among the several states, and with the Indian Tribes.”  The Commerce Clause, on its face, does not impose any restrictions on states in the absence of congressional action.  However, the U.S. Supreme Court has interpreted the Commerce Clause as implicitly preempting state laws that regulate commerce in a manner that disrupts the national economy.  This is the judicially-created doctrine known as the “dormant” Commerce Clause. 

The “Dormant” Commerce Clause.  The dormant Commerce Clause is a constitutional law doctrine that says Congress's power to "regulate Commerce ... among the several States" implicitly restricts state power over the same area.  In general, the Commerce Clause places two main restrictions on state power – (1) Congress can preempt state law merely by exercising its Commerce Clause power by means of the Supremacy Clause of Article VI, Clause 2 of the Constitution; and (2) the Commerce Clause itself--absent action by Congress--restricts state power.  In other words, the grant of federal power implies a corresponding restriction of state power.  This second limitation has come to be known as the "Dormant" Commerce Clause because it restricts state power even though Congress's commerce power lies dormant. Willson v. Black Bird Creek Marsh Co., 27 U.S. 245 (1829).  The label of “Dormant Commerce Clause” is really not accurate – the doctrine applies when the Congress is dormant, not the Commerce Clause itself.

Rationale.  The rationale behind the Commerce Clause is to protect the national economic market from opportunistic behavior by the states - to identify protectionist actions by state governments that are hostile to other states.  Generally, the dormant Commerce Clause doctrine prohibits states from unduly interfering with interstate commerce.  State regulations cannot discriminate against interstate commerce.  If they do, the regulations are per se invalid.  See, e.g., City of Philadelphia v. New Jersey, 437 U.S. 617 (1978).  Also, state regulations cannot impose undue burdens on interstate commerce.  See, e.g., Kassel v. Consolidated Freightways Corp., 450 U.S. 662 (1981).  Under the “undue burden” test, state laws that regulate evenhandedly to effectuate a local public interest are upheld unless the burden imposed on commerce is clearly excessive in relation to the local benefits.     

The Court has never held that discrimination between in-state and out-of-state commerce, without more, violates the dormant Commerce Clause.  Instead, the Court has explained that the dormant Commerce Clause is concerned with state laws that both discriminate between in-state and out-of-state actors that compete with one another, and harm the welfare of the national economy.  Thus, a discriminatory state law that harms the national economy is permissible if in-state and out-of-state commerce do not compete.  See, e.g., General Motors Corp. v. Tracy, 117 S. Ct. 811, 824-26 (1997).  Conversely, a state law that discriminates between in-state and out-of-state competitors is permissible if it does not harm the national economy. H.P. Hood & Sons, Inc. v. Du Mond, 336 U.S. 525 (1949). 

California Proposition 12 Litigation

In 2018, California voters passed Proposition 12.  Proposition 12 bans the sale of whole pork meat (no matter where produced) from animals confined in a manner inconsistent with California’s regulatory standards.  Proposition 12 established minimum requirements on farmers to provide more space for egg-laying hens, breeding pigs, and calves raised for veal. Specifically, the law requires that covered animals be housed in confinement systems that comply with specific standards for freedom of movement, cage-free design and minimum floor space. The law identifies covered animals to include veal calves, breeding pigs and egg-laying hens. The implementing regulations prohibit a farm owner or operator from knowingly causing any covered animal to be confined in a cruel manner, as specified, and prohibits a business owner or operator from knowingly engaging in the sale within the state of shell eggs, liquid eggs, whole pork meat or whole veal meat, as defined, from animals housed in a “cruel manner.”  In addition to general requirements that prohibit animals from being confined in a manner that prevents lying down, standing up, fully extending limbs or turning around freely, the measure added detailed confinement space standards for farms subject to the law. The alleged reason for the law was to protect the health and safety of California consumers and decrease the risk of foodborne illness and the negative fiscal impact on California. 

In late 2019, several national farm organizations challenged Proposition 12 and sought a declaratory judgment that the law was unconstitutional under the dormant Commerce Clause.  The plaintiffs also sought a permanent injunction preventing Proposition 12 from taking effect.  The plaintiffs claimed that Proposition 12 impermissibly regulated out-of-state conduct by compelling non-California producers to change their operations to meet California’s standards.  The plaintiffs also alleged that Proposition 12 imposed excessive burdens on interstate commerce without advancing any legitimate local interest by significantly increasing operation costs without any connection to human health or foodborne illness.  The trial court dismissed the plaintiffs’ complaint.  National Pork Producers Council, et al. v. Ross, No. 3:19-cv-02324-W-AHG (S.D. Cal. Apr. 27, 2020). 

On appeal, the plaintiffs focused their argument on the allegation that Proposition 12 has an impermissible extraterritorial effect of regulating prices in other states and, as such, is per se unconstitutional.  This was a tactical mistake for the plaintiffs.  The appellate court noted that existing Supreme Court precedent on the extraterritorial principle applied only to state laws that are “price control or price affirmation statutes.”  National Pork Producers Council, et al. v. Ross, No. 20-55631, 2021 U.S. App. LEXIS 22337 (9th Cir. Jul. 28, 2021).  Thus, the extraterritorial principle does not apply to a state law that does not dictate the price of a product and does not tie the price of its in-state products to out-of-state prices.  Because Proposition 12 was neither a price control nor a price-affirmation statute (it didn’t dictate the price of pork products or tie the price of pork products sold in California to out-of-state prices) the law didn’t have the extraterritorial effect of regulating prices in other states. 

The appellate court likewise rejected the plaintiffs’ claim that Proposition 12 has an impermissible indirect “practical effect” on how pork is produced and sold outside California.  Id.  Upstream effects (e.g., higher production costs in other states) the appellate court concluded, do not violate the dormant Commerce Clause.   The appellate court pointed out that a state law is not impermissibly extraterritorial unless it regulates conduct that is wholly out of state.  Id.  Because Proposition 12 applied to California and non-California pork production the higher cost of production was not an impermissible effect on interstate commerce.

The appellate court also concluded that inconsistent regulation from state-to-state was permissible because the plaintiffs had failed to show a compelling need for national uniformity in regulation at the state level.  Id.  In addition, the appellate court noted that the plaintiffs had not alleged that Proposition 12 had a discriminatory effect on interstate commerce. 

Simply put, the appellate court rejected the plaintiffs’ challenge to Proposition 12 because a law that increases compliance costs (projected at a 9.2 percent increase in production costs that would e passed on to consumers) is not a substantial burden on interstate commerce in violation of the dormant Commerce Clause. 

As noted above, the U.S. Supreme court decided to review the Ninth Circuit’s opinion.  Unfortunately, the Supreme Court has been careless in applying the anti-discrimination test, and in many cases, neither of the two requirements--interstate competition or harm to the national economy--is ever mentioned.  See, e.g., Hughes v. Oklahoma, 441 U.S. 322 (1979). The reason interstate competition goes unstated is obvious – in most cases the in-state and out-of-state actors compete in the same market.  But, the reason that the second requirement, harm to the national economy, goes unstated is because the Court simply assumes the issue away.  The Supreme Court’s decision in 2023 is a highly anticipated one for agriculture and the dormant Commerce Clause analysis and application in general.

No. 1 – The “Major Questions” Doctrine

West Virginia, et al. v. Environmental Protection Agency, et al., 142 S. Ct. 2587 (2022)

Clearly, the biggest development of 2022 that has the potential to significantly impact agriculture and the economy in general is the Supreme Court’s opinion involving the Environmental Protection Agency’s (EPA’s) regulatory authority under the Clean Air Act (CAA).  The Court invoked the “major question” doctrine to pair back unelected bureaucratic agency authority and return policy-making power to citizens through their elected representatives.  The future impact of the Court’s decision is clear.  When federal regulations amount to setting nationwide policy and when state regulations do the same at the state level, the regulatory bodies may be successfully challenged in court.

The case involved the U.S. Supreme Court’s review of the EPA’s authority to regulate greenhouse gas emissions from existing power plants under the CAA. The case arose from the EPA’s regulatory development of the Clean Power Plan (CPP) in 2015 which, in turn, stemmed from then-President Obama’s 2008 promise to establish policy that would bankrupt the coal industry.  The EPA claimed it had authority to regulate CO2 emissions from coal and natural-gas-fired power plants under Section 111 of the CAA.  Under that provision, the EPA determines emission limits.  But EPA took the position that Section 111 empowered it to shift energy generation at the plants to “renewable” energy sources such as wind and solar.  Under the CPP, existing power plants could meet the emission limits by either reducing electricity production or by shifting to “cleaner” sources of electricity generation.  The EPA admitted that no existing coal plant could satisfy the new emission standards without a wholesale movement away from coal, and that the CPP would impose billions in compliance costs, raise retail electricity prices, require the retirement of dozens of coal plants and eliminate tens of thousands of jobs.  In other words, the CPP would keep President Obama’s 2008 promise by bypassing the Congress through the utilization of regulatory rules set by unelected, unaccountable bureaucrats. 

The U.S. Supreme Court stayed the CPP in 2016 preventing it from taking effect.  The EPA under the Trump Administration repealed the CPP on the basis that the Congress had not clearly delegated regulatory authority “of this breadth to regulate a fundamental sector of the economy.”  The EPA then replaced the CPP with the Affordable Clean Energy (ACE) rule.  Under the ACE rule, the focus was on regulating power plant equipment to require upgrades when necessary to improve operating practices.  Numerous states and private parties challenged the EPA’s replacement of the CPP with the ACE.  The D.C. Circuit Court vacated the EPA’s repeal of the CPP, finding that the CPP was within the EPA’s purview under Section 7411 of the CAA – the part of the CAA that sets standards of performance for new sources of air pollution.  American Lung Association v. Environmental Protection Agency, 985 F.3d 914 (D.C. Cir. 2021).  The Circuit Court also vacated the ACE and purported to resurrect the CPP.  In the fall of 2021, the U.S. Supreme Court agreed to hear the case.

The Supreme Court reversed, framing the issue as whether the EPA had the regulatory authority under Section 111 of the CAA to restructure the mix of electricity generation in the U.S. to transition from 38 percent coal to 27 percent coal by 2030.  The Supreme Court said EPA did not, noting that the case presented one of those “major questions” because under the CPP the EPA would tremendously expand its regulatory authority by enacting a regulatory program that the Congress had declined to enact.  While the EPA could establish emission limits, the Supreme Court held that the EPA could not force a shift in the power grid from one type of energy source to another.  The Supreme Court noted that the EPA admitted that did not have technical expertise in electricity transmission, distribution or storage.  Simply put, the Supreme Court said that devising the “best system of emission reduction” was not within EPA’s regulatory power.

 Clearly, the Congress did not delegate administrative agencies the authority to establish energy policy for the entire country.  While the Supreme Court has never precisely defined the boundaries and scope of the major question doctrine, when the regulation is more in line with what should be legislative policymaking, it will be struck down.  The Supreme Court’s decision is also broad enough to have long-lasting consequences for rulemaking by all federal agencies including the USDA/FSA.  The decision could also impact the Treasury Department’s promulgation of tax regulations. 

The Supreme Court’s decision returns power to the Congress that it has ceded over the years to administrative agencies and the Executive branch concerning matters of “vast economic and political significance.”  But it’s also likely that the Executive branch and the unelected bureaucrats of the administrative state will likely attempt to push the envelope and force the courts to push back.  It’s rare that the Executive branch and administrative agencies voluntarily return power to elected representatives as was done in numerous instances from 2017 through 2020. 

Conclusion

Agricultural law and tax issues were many and varied in 2022.  In 2023, the U.S. Supreme Court will issue opinions in the California Proposition 12 case and the Sackett case involving the scope of the federal government’s jurisdiction over wetlands.  Also, there has been a major development in the Tax Court involving tax issues associated with deferred grain contracts that has resulted in a settlement with IRS, the terms of which cannot be disclosed at this time.  If 2022 showed a trend with USDA it is that the USDA will continue several “hardline” positions against farmers – a narrow definition of farm income; broad regulatory control over wet areas in fields; and ceding regulatory authority to the EPA and the COE.  The U.S. Supreme Court is also anticipated to issue on opinion with potentially significant implications for Medicaid planning. 

Of course, the expanding war against Russia being fought in Ukraine will continue to dominate ag markets throughout 2023.  At home, the general economic data is not good and that will have implications in 2023 for farmers and ranchers.  On January 26, the U.S Bureau of Economic Analysis issued a report (https://www.bea.gov/) showing that the U.S. economy grew by 2.9 percent in the fourth quarter of 2022 and 2.1 percent for all of 2022.  But, the report also showed that economic growth in the economy is slowing.  Business investment grew by a mere 1.4 percent in the fourth quarter of 2022, consisting almost entirely of inventory growth.  That will mean that businesses will be forced to sell off inventories at discounts, which will lower business profits and be a drag on economic growth in 2023.  Nonresidential investment was down 26.7 percent due to the increase in home prices, increased interest rates and a drop in real income.  On that last point, real disposable income dropped $1 trillion in 2022, the largest drop since 1932 - the low point of the Great Depression.  Personal savings also dropped by $1.6 trillion in 2022.  This is a "ticking timebomb" that is not sustainable because it means that consumers are depleting cash reserves.  This indicates that spending will continue to slow in 2023 and further stymie economic growth - about two-thirds of GDP is based on consumer spending.  Relatedly, the Dow was down 8.8 percent for 2022, the worst year since 2008.   2022 also saw a reduction in the pace of international trade.  Imports dropped more than exports which increases GDP, giving the illusion that the economy is better off.  

Certainly, 2023 will be another very busy year for rural practitioners and those dealing with legal and tax issues for farmers and ranchers. 

January 27, 2023 in Civil Liabilities, Environmental Law, Income Tax, Regulatory Law, Water Law | Permalink | Comments (0)

Wednesday, January 25, 2023

Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 4 and 3

Overview

Today’s article is another installment on what I believe to be the Top 10 developments in agricultural law and agricultural taxation of 2022.  Today, I look at developments number four and three.

No. 4– Economic Issues

In general.  Economic issues impact daily decision-making for farmers and ranchers. These issues also impact tax and financial planning.   During 2022, economic issues impacted farms and ranches to a great degree.  Price inflation triggered by economic policies increased the price of fossil fuels which, along with other polices produced wage inflation.  In addition, massive deficit spending resulted in a quintupled the money supply which created excess demand that further increased inflation.  In addition, poor policy past policy choices by the Federal Reserve kept interest rates at artificially low levels further increasing demand and increasing inflation.  Beginning in the first half of 2022, the Federal Reserve started to increase interest rates to decrease demand and reduce inflation.  However, further deficit spending by the Congress enacted into law in August of 2022 will largely offset the impact of the Federal Reserve’s interest rate increases with the result that, as of the end of 2022, inflation was anticipated to continue with the possibility of decreased demand, a scenario not unlike the economic situation of the late 1970s. 

All of these political/economic choices have implications for farmers and ranchers.  Crop production, energy issues, monetary policy, issues in the meat sector, water issues west of the sixth Principal Meridian, and unanticipated outside shocks have farm-level impacts that professional advisors and counselors need to account for when representing farm and ranch clients.

Specific points.  Several specific economic points from 2022 are listed below.

  • The war in Ukraine has had a major impact on global grain trade and created additional issues for U.S. farmers and ranchers. Russia and Ukraine are leading exporters of food grains.  One estimate is that worldwide food and feed prices could rise by 22 percent which could, in turn, cause a surge in malnutrition in developing nations.  Since the war started, total world food output has decreased, resulting in a sharp drop in food exports from exporting countries.  Other food exporting countries have announced new limitations on food exports (or are exploring bans) to preserve domestic supplies.  This will have an impact on international grain markets and will likely have serious implications for the world’s wheat supply.  The extent of such disruptions remained unknown at the end of 2022.
  • The demand for beef remained strong in 2022.  But, a major issue was the disconnect between beef demand and the beef producer.  This fact, along with significant drought in much of the major cattle producing areas signaled producers to decrease herd size.  During 2022, the Congress was considering legislation focused on providing more robust and transparent marketing of live cattle.
  • Pork demand was not as impressive of beef, but improved during 2022.  Export demand dropped primarily due to China which cased U.S. pork production to decline along with pork values.    
  • Poultry, demand remained strong and flock sizes decreased largely because of the presence of Avian Flu.  Toward the latter part of 2022, retail egg prices increased substantially.
  • Water issues. West of the Sixth Principal Meridian, access to water is critical for the success of many farming and ranching operations.  During 2022, a dispute continued to brew between Colorado and Nebraska over water in northeast Colorado that Nebraska lays claim to under a Compact entered into almost 100 years ago.  Water access and availability will continue to be key to profitability of farms and ranches in the Plains and the West.
  • Land values; machinery and input costs. Farm and ranchland values remained strong during 2022, and input, machinery costs and land values continued to outpace inflation.  For those farmers that were able to pre-pay input expenses in 2021 for 2022 crops, much of the price increase of inputs could be blunted until another round of inputs were needed in late 2022 for the 2023 crop.  Also, many short-term loans were locked in before interest rates began rising.  That story will also likely be different in early 2023 when those loans are redone. 

During 2023, the biggest risks to agriculture will continue to be from outside the sector.  Unexpected catastrophic events such as the war in Ukraine, whether (or when) China will invade Taiwan, domestic monetary and fiscal policy, political developments at home and abroad, and government regulation of key segments of the economy that impact agricultural activities remain the biggest unknown variables to the profitability of farming and ranching operations and agribusinesses. 

No. 3 – Endangered Species Act regulations

In early 2022, the Environmental Protection Agency (EPA) announced a new policy regarding its Endangered Species Act (ESA) responsibilities under the Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA).  The ESA requires federal agencies to determine whether an agency action “may affect” any species or habitat protected or designated under the ESA.  If an agency determines that the an action is “likely to adversely affect” protected species or habitat, the agency must consult with the U.S. Fish and Wildlife Service (USFWS) and the National Marine Fisheries Service to determine mitigation measures. The EPA administers the FIFRA, and the EPA now considers practically every decision it makes under FIFRA to require consultation in accordance with the ESA.  In late 2022, the EPA published its policy plan focusing on ESA mitigation for FIFRA pesticide registration reviews.

During 2022, additional ESA regulations were changed or modified, many of which will potentially negatively impact agricultural activities on private land.  For instance, “habitat” is no longer specifically defined, and the Critical Habitat Exclusion Rule was rescinded.  This will make it easier for the USFWS to designate critical habitat for protected species under the ESA.  Much critical habitat is on private property.  The USFWS also continued the process of revising its Listing Rule.

Upon enactment in 1973, the ESA barred the “taking” of endangered species.  The “taking” prohibition only extended to “threatened” species if the Interior Department deemed it necessary and advisable for the conservation of the species.  In 1975, the Interior Department, contrary to the statute, issued a “blanket rule” extending the prohibition to all threatened species, unless it adopted a special rule relaxing the prohibition for a particular species. In essence, the blanket rule provided no meaningful distinction between regulations for species that are listed as threatened or endangered. 

The Trump Administration restored the ESA’s distinction between the regulation of endangered and threatened species by repealing the blanket rule.  The move aligned the practice of the Interior Department with that of the Commerce Department (which manages marines species and never had a blanket rule).  The change applied prospectively only, and no species lost any protection due to the change.  The restoration of regulatory distinctions between endangered and threatened species is designed to better align the incentives of landowners with the interests of rare species. By repealing the blanket rule, burdens imposed on landowners will increase if species decline and relax as they recover.

While the blanket rule remained in effect during 2022, the USFWS is in the process of rescinding the rule.  Expect legal challenges to this action which is contrary to the statute and congressional intent to happen once the rule is formally rescinded. 

Conclusion

Next time I will look at developments two and one.

January 25, 2023 in Environmental Law, Regulatory Law | Permalink | Comments (0)

Monday, January 23, 2023

Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 6 and 5

Overview

Today’s article is another installment on what I believe to be the Top 10 developments in agricultural law and agricultural taxation of 2022.  Today, I look at developments number six and five.

No. 6 – Caselaw and Legislative Developments on “Ag Gag” Provisions

2022 saw further developments in the courts and in state legislatures involving legislative attempts to provide a level of protection to livestock facilities is to bar access to an animal production facility under false pretenses.  At their core, the laws attempt to prohibit a person having the intent to harm a livestock production facility from gaining access to the facility (such as via employment) to then commit illegal acts on the premises.  See, e.g., Iowa Code §717A.3A.  Laws that bar lying and trespass coupled with the intent to do physical harm to an animal production facility should not be constitutionally deficient.  Laws that go beyond those confines may be. 

In Animal Legal Defense Fund, et al. v. Reynolds, et al., No. 4:21-cv-00231-SMR-HCA (S.D. Iowa. Sept. 26, 2022), the plaintiffs (animal rights activist groups) claimed the statute violated their First Amendment rights by hindering them from gaining access to farms and dairies under false pretenses of seeking a job to be able to take pictures and/or videos without the property owner’s consent.  The defendants asserted that the case should be dismissed for lack of standing and lack of ripeness.

The Court (the same judge that ruled earlier in 2022 on another variant of the Iowa laws) held that the plaintiffs had standing because their organizational objectives would be hindered, and that an arrest is not required before a criminal statute can be challenged.  The Court noted that the statute prohibited video recordings (which the court asserted was protected “speech”) while trespassing which the plaintiffs considered important to broadcasting their negative messages about animal agriculture to the public.  More specifically, the court determined that the statute singled out conduct (that the plaintiffs contemplated) by expanding the penalty for conduct already prohibited by law and was not limited to specific uses of a camera.  Accordingly, the court determined that the statute was an unconstitutional restriction on the free speech rights of trespassers apparently on the basis that regulating free speech on private property would create a “slippery slope” for not allowing people to record politicians or express views about the Government.   In addition, any recording, production, editing, and publication of the videos is protected speech.  The court granted summary judgment to the plaintiffs. 

According to the court’s view, it seems practically impossible for farmers to protect their farming operations from those who intend to inflict harm via protected “speech.” Is the court saying that there is a constitutional right to trespass?  If so, that is flatly contrary to the recent U.S. Supreme Court opinion of Cedar Point Nursery, et al. v. Hassid, et al., No. 20-107, 2021 U.S. LEXIS 3394 (U.S. Sup. Ct. Jun. 23, 2021).  

Note:  Interestingly (and hypocritically) the Iowa federal district court’s website contains the following information: “To be admitted into the courthouse, you must present a government issued photo identification.  Please be aware the following items are NOT allowed in the courthouse: cell phones, cameras, other electronic devices (including Apple watches), recording devices,…”.

Note:  Iowa Code §716.7A, the Food Operation Trespass Law, remains in effect.  That law, effective on June 20, 2020, treats as an aggravated misdemeanor a first offense of entering or remaining on the property of a food operation without the consent of a person who has real or apparent authority to allow the person to enter or remain on the property.  A subsequent offense is a Class D felony.  This statutory provision was upheld as constitutional by an Iowa county district court judge in early 2022. 

Tenth Circuit.  In Animal Legal Defense Fund, et al. v. Kelly, 9 F.4th 1219 (10th Cir. 2021), pet. for cert. filed, (U.S. Sup. Ct. Nov. 17, 2021), the court construed the Kansas provision that makes it a crime to take pictures or record videos at a covered facility “without the effective consent of the owner and with the intent to damage the enterprise.”  The plaintiffs claimed that the law violated their First Amendment free speech rights.  The State claimed that what was being barred was conduct rather than speech and that, therefore, the First Amendment didn’t apply.  But, the court tied conduct together with speech to find a constitutional violation – it was necessary to lie to gain access to a covered facility and consent to film activities.  As such, the law regulated protected speech (lying with intent to cause harm to a business) and was unconstitutional.  The court determined that the State failed to prove that the law narrowly tailored to a compelling state interest in suppressing the “speech” involved.  The dissent pointed out (correctly and consistently with the Eighth Circuit) that “lies uttered to obtain consent to enter the premises of an agricultural facility are not protected speech.” The First Amendment does not protect a fraudulently obtained consent to enter someone else’s property. 

Note:  On April 25, 2022, the U.S. Supreme Court declined to hear the case.  Kelly v. Animal Legal Defense Fund, cert. den., 142 S. Ct. 2647 (2022). 

No. 5 – WOTUS Final Rule

On December 30, 2022, the Environmental Protection Agency (EPA) and the U.S. Army Corps of Engineers (COA).  On December 30, 2022, the agencies announced the final "Revised Definition of 'Waters of the United States'" rule which will become effective on March 20, 2023.  It represents a “change of mind” of the agencies from the positions that they held concerning a water of the United States (WOTUS) and wetlands from just over three years ago.  The bottom line is that the new interpretation is extremely unfriendly to agriculture, particularly to farmland owners in the prairie pothole region of the upper Midwest.    

As promised, the Final Rule uses a definition that was in place before 2015 (for purposes of the Clean Water Act) for traditional navigable waters, territorial seas, interstate waters, and upstream water resources that “significantly” affect those waters.

Note:  Two joint memos were published with the final rule to set forth the delineation of the implementation of roles and responsibilities between the agencies.  One is a joint coordination memo to “ensure accuracy and consistency of jurisdictional determinations under the final rule.”  The other is a memo with the USDA to provide “clarity on the agencies’ programs under the Clean Water act and the Food Security Act (Swampbuster).”

Adjacency.  The EPA wants to restore the “significant nexus” via “adjacency.”  This is a big change in the definition of “adjacency.”  It doesn’t mean simply “abutting.”  Instead, “adjacent” includes a “significant nexus” and a “significant nexus” can be established by “shallow hydrologic subsurface connections” to the “waters of the United States.  A “shallow subsurface connection,” the Final Rule states, may be found below the ordinary root zone (below 12 inches), where other wetland delineation factors may not be present.  Frankly, that means farm field drain tile.      

Specifically, the Final Rule sets forth two kinds of adjacency: 1) the traditional “relatively permanent” standard; and 2) the “significant nexus” standard.  The EPA and the COE say the agencies will not assume that all wetlands in a specific geographic area are similarly situated and can be assessed together on a watershed basis in a significant nexus analysis.  But it is clear from the Final Rule that the agencies intend to expand jurisdiction over isolated prairie pothole wetlands using the “significant nexus” standard. 

Note:  The “significant nexus” can be established via a connection to downstream waters by surface water, shallow subsurface water, and groundwater flows and through biological and chemical connections.  The Final Rule states that adjacency can be supported by a “pipe, non-jurisdictional ditch,… or some other factors that connects the wetland directly to the jurisdictional water.”  This appears to be the basis for overturning the NWPR.  Consequently, the prairie pothole region is directly in the “bullseye” of the Final Rule.

Prior converted cropland.  The agencies say the final rule increases “clarity” on which waters are not jurisdictional – including prior converted cropland.  This doesn’t make much sense.  Supposedly, the agencies are “clarifying” that prior converted cropland, (which is not a water), is not a water, but it somehow could be a water if the agencies had not clarified it?  In addition, the burden is placed on the landowner to prove that prior converted cropland is actually prior converted cropland and therefore not a water.

Ditches and drainage devices.  The Final Rule is vague enough to give the government regulatory authority over non-navigable ponds, ditches, and potholes.

The U.S. Supreme Court.  A case is presently pending before the U.S. Supreme Court involving the definition of a WOTUS.  In Sackett v. Environmental Protection Agency, 8 F.4th 1075 (9th Cir. 2021), cert, granted, 142 S. Ct. 896 (2022).  The issue in the case is whether the U.S. Circuit Court of Appeals for the Ninth Circuit used the proper test for determining whether wetlands are “waters of the United States” under the CWA.  Oral argument occurred in early October of 2022.  The Court’s opinion is anticipated sometime before mid-March of 2023, but the issuance of the Final Rule may cause that to be delayed.  In any event, the Supreme Court will have the final say on what a WOTUS rather than the COE or the EPA.

Conclusion

Next time I will look at developments four and three.

January 23, 2023 in Environmental Law, Regulatory Law | Permalink | Comments (0)

Saturday, January 21, 2023

Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 8 and 7

Overview

Today I continue the journey through what I believe to be the Top 10 developments in agricultural law and agricultural taxation of 2022.  Today, I look at developments number eight and seven.

No. 8 – Dicamba Drift Damage Litigation

Hahn v. Monsanto Corp., 39 F.4th 954 (8th Cir. 2022), reh’g. den., 2022 U.S. App. LEXIS 25662 (8th Cir. Sept. 2, 2022)

Damage from the drift of Dicamba has been an issue in certain parts of the country for the past two years.  Over that time, I have written on the technical aspects  of Dicamba and the underlying problems associated with Dicamba application.  In 2022, the Dicamba saga continued with litigation involving Missouri’s largest peach farm. 

In Bader Farms, Inc. v. Monsanto Co., et al., No. MDL No. 1:18md2820-SNLJ, 2019 U.S. Dist. LEXIS 114302 (E.D. Mo. July 10, 2019), the plaintiff is Missouri’s largest peach farming operation and is located in the southeast part of the state.  claimed that his peach orchard was destroyed after the defendants (Monsanto and BASF) allegedly conspired to develop and market Dicamba-tolerant seeds and Dicamba-based herbicides. The suit alleged that the two companies collaborated on Xtend (herbicide resistant cotton seed) that was intended for use with a less volatile form of Dicamba with less drift potential.  But, as of 2015 neither Monsanto nor BASF had produced the new, less volatile, form of Dicamba.  That fact led the plaintiff to claim that the defendants released the Dicamba-tolerant seed with no corresponding Dicamba herbicide that could be safely applied.  As a result, the plaintiff claimed, farmers illegally sprayed an old formulation of Dicamba that was unapproved for in-crop, over-the-top, use and was highly volatile and prone to drift.    The plaintiff claimed its annual peach crop revenue exceeded $2 million before the drift damage, and an expert at trial asserted that the drift caused the plaintiff to lose over $20 million in profits.  While many cases had previously been filed on the dicamba drift issue, the plaintiff did not join the other litigation because it focused on damages to soybean crops.  The plaintiff’s suit also involved claims for failure to warn; negligent training; violation of the Missouri Crop Protection Act (MCPA); civil conspiracy; and joint liability for punitive damages. 

Monsanto moved to dismiss the claims for failure to warn; negligent training; violation of the MCPA; civil conspiracy; and joint liability for punitive damages.  BASF moved to dismiss those same counts except the claims for failure to warn. The trial court granted the motion to dismiss in part.  Monsanto argued that the failure to warn claims were preempted by the Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA), but the plaintiff claimed that no warning would have prevented the damage to the peaches. The trial court determined that the plaintiff had adequately plead the claim and denied the motion to dismiss this claim.  Both Monsanto and BASF moved to dismiss the negligent training claim, but the trial court refused to do so. However, the trial court did dismiss the MCPA claims.  The trial court noted that civil actions under the MCPA are limited to “field crops” which did not include peaches.   The trial court, however, did not dismiss the civil conspiracy claim based on concerted action by agreement, but did dismiss the aiding and abetting portion of the claim because that cause of action is not recognized under Missouri tort law.  The parties agreed to a separate jury determination of punitive damages for each defendant.

Note:  The case went to trial in early 2020 and was one of more than 100 similar Dicamba lawsuits.  Bayer, which acquired Monsanto in 2018 for $63 billion, announced in June of 2020 that it would settle dicamba lawsuits for up to $400 million.

At trial, the jury found that Monsanto had negligently designed or failed to warn for 2015 and 2016 and that both defendants had done so for 2017 to the time of trial.  The jury awarded the plaintiff $15 million in compensatory damages and $250 million in punitive damages against Monsanto for 2015 and 2016.  The jury also found that the defendants were acting in a joint venture and in a conspiracy.  The plaintiff submitted a proposed judgment that both defendants were responsible for the $250 million punitive damages award.  BASF objected, but the trial court found the defendants jointly liable for the full verdict considering the jury’s finding that the defendants were in a joint venture.  Bader Farms, Inc. v. Monsanto Co., et al., MDL No. 1:18-md-02820-SNJL, 2020 U.S. Dist. LEXIS 34340 (E.D. Mo. Feb. 28, 2020). 

BASF then moved for a judgment as a matter of law on punitive damages or motion for a new trial or remittitur (e.g., asking the court to reduce the damage award), and Monsanto moved for a judgment as a matter of law or a new trial.  The trial court, however, found both defendants jointly liable, although the court lowered the punitive damages to $60 million (from $250 million) after determining a lack of actual malice.  The trial court did uphold the $15 million compensatory damage award upon finding that the correct standard under Missouri law was applied to the farm’s damages.  Bader Farms, Inc. v. Monsanto Co, et al., MDL No. 1:18md2820-SNLJ, 2020 U.S. Dist. LEXIS 221420 (E.D. Mo. Nov. 25, 2020).  The defendants filed a notice of appeal on December 22, 2020.     

In Hahn v. Monsanto Corp., 39 F.4th 954 (8th Cir. 2022), reh’g. den., 2022 U.S. App. LEXIS 25662 (8th Cir. Sept. 2, 2022), the appellate court partially affirmed the trial court, partially reversed, and remanded the case.  The appellate court determined that the trial court incorrectly instructed the jury to assess punitive damages for Bayer (i.e., Monsanto) and BASF together, rather than separately, and that a new trial was needed to determine punitive damages for each company.  Indeed, the appellate court vacated the punitive damages award and remanded the case to the trial court with instructions to hold a new trial only on the issue of punitive damages. 

However, the appellate court did not disturb the trial court’s jury verdict of $15 million in compensatory damages.  On the compensatory damages issue, the appellate court held that the trial court properly refused to find intervening cause as a matter of law for the damage to the plaintiff’s peaches.  On that point, the appellate court determined that the spraying of Dicamba on a nearby farm did not interrupt the chain of events which meant that the question of proximate cause of the damage was proper for the jury to determine.  The appellate court also held that the was an adequate basis for the plaintiff’s lost profits because the award was not based on speculation.  The appellate court noted that the peach orchard had been productive for decades, and financial statements along with expert witness testimony calculated approximately $20.9 million in actual damages.  The appellate court also determined that the facts supported the jury’s determination that the defendants engaged in a conspiracy via unlawful means – knowingly enabling the widespread use of Dicamba during growing season to increase seed sales.

No. 7 – The Misnamed “Inflation Reduction Act”

If ever there has been a deceptively misnamed piece of legislation, this is it.  An Act with $750 billion of newly minted money to will not reduce inflation.  Words have no meaning.  I suppose that we are supposed to believe that the following provisions of the bill will reduce inflation:

  • $3 billion for the U.S. Postal Service to buy new electric mail trucks;
  • $3 billion for the EPA to oversee block grants for “environmental justice;”
  • $40 billion total to the EPA which includes $30 billion for “disadvantaged communities” (keep in mind that the total annual budget of the EPA is about $10 billion);
  • $750 million to the Interior Department for new hires;
  • $10 million to the USDA to be spent on “equity commissions” to “combat” racism;
  • $25 million to the Government Accountability Office to determine, “whether the economic, social and environmental impacts of the funds described in this paragraph are equitable;”
  • Via a budget gimmick to keep the amount outside of the Act’s price tag are amounts to the Energy Department for existing “green” energy loan programs and a new energy loan-guarantee program.

Ag Program Spending

The Act contains a great deal of spending on ag conservation-related programs.  Here are the primary provisions:

  • EQIP - $8.45 billion additional funding over Fiscal Years 2023-2026. Prioritizes funding for reduction of methane emissions from cattle (e.g., cattle passing gas) and nutrient management activities (e.g., diets to reduce bloating in cows).
  • CSP - $3.25 billion additional funding over same time frame.
  • Ag Conservation Easement Program (ACEP) - $1.4 billion over same time frame for easements or interests in land that will reduce, capture, avoid or sequester carbon dioxide, or methane oxide emissions with land eligible for the program. ACEP incorporates the Wetlands Reserve Program, the Grasslands Reserve Program and the Farm and Ranch Lands Protection Program. 
  • Regional Conservation Partnership Program - $4.95 billion over same timeframe for cover cropping, nutrient management, and watershed improvement.
  • $4 billion for drought relief that prioritizes the CO basin.
  • The U.S. Forest Service gets $1.8 billion for hazardous fuels reduction projects on USFS land.
  • $14 billion for rural development and lending projects.
  • $3.1 billion to USDA to provide payments to distressed borrowers.
  • $2.2 billion to USDA for farmers, ranchers and forest landowners that have been discriminated against in USDA lending programs (i.e., reparations).
  • $5 billion to USDA for National Forest System to fund forest reforestation and wildfire prevention.

The IRS gets approximately $80 billion in IRS funding (over next 10 years) to hire 87,000 agents.  The IRS currently has 78,000 agents, but 50,000 are set to retire in the next few years.  $46 billion is to be dedicated to enforcement and is anticipated to increase the number of audits by $1.2 million annually.  $25 billion is earmarked for IRS operations, $5 billion for business systems modernization. IRS taxpayer services, which many tax practitioners would say as the most in need of funding, gets the short end of the stick with $4 billion.

Conclusion

I will continue looking at the biggest developments of 2022 in ag law and tax in the next post.

January 21, 2023 in Civil Liabilities, Income Tax, Regulatory Law | Permalink | Comments (0)

Monday, January 16, 2023

Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 10 and 9

Overview

With this post, I begin the trek through what I believe to be the Top 10 developments in agricultural law and agricultural taxation of 2022.  Today, I look at developments No. 10 and nine. 

No. 10 – USDA’s Emergency Relief Program

Background.  The Extending Government Funding and Delivering Emergency Assistance Act was signed into law on September 30, 2021. This legislation includes $10 billion for farmers impacted by weather disasters during calendar years 2020 and 2021. It directs $750 million to assist livestock producers for losses incurred due to drought or wildfires in calendar year 2021 through the Emergency Livestock Relief Program (ELRP). Through the Emergency Relief Program (ERP), the legislation also provides funding for noninsured crop losses incurred.

The United States Department of Agriculture (USDA) released information in August of 2022 involving the question of whether income from the sale of farm equipment counted as farm income for purposes of the ERP.  The issue is an important one because an enhanced payment limit might be at stake.

ERP payments may only be made to a producer with a crop eligible for federal crop insurance or the noninsurance crop disaster assistance program (NAP). The crop for which the recovery is sought must have been subject to a qualifying disaster, which is defined broadly. As a type of qualifying disaster, droughts are rated in accordance with the U.S. Drought Monitor, which publishes a list of qualifying counties.

An ERP payment is not made to any producer that did not receive a crop insurance or NAP payment in 2020 or 2021. Because of this requirement, crop insurance premiums that an ERP recipient has paid are reimbursed by recalculating the ERP payment based on the ERP payment rate of 85% and then backing out the crop insurance payment based on coverage level.

In addition, the ERP requires that the producer receiving a payment obtain either NAP or crop insurance for the next crop years. Also, a producer that received prevented planting payments can qualify for ERP Phase 1 payments based on elected coverage.

Note. ERP payments are for damages occurring in 2020 and 2021, so if they were received in 2022 they are not deferrable to 2023.

Payment limit. The ERP payment limit is $125,000 for specialty crops. For all other crops, ERP imposes a limit of $125,000 combined for ERP Phases 1 and 2. However, for an applicant with “average adjusted gross farm income” (average adjusted gross income (AGI)) based on the immediate three prior years but skipping the first year back (e.g., in 2022, tax years 2018, 2019, and 2020 are used to compute the percentage) that is comprised of more than 75% from farming activities (the “75% test”), the normally applicable $900,000 AGI limit is dropped, and the payment limit goes to $900,000 for specialty crops and $250,000 for all other crops. There are separate payment limits for 2020 and 2021. 

Definition of farm income.  Farm income for ERP purposes includes the following.

  • Net income from Schedule F, Profit or Loss From Farming
  • Pass-through income from farming activities
  • Wages from a farming entity
  • Interest charge domestic international sales corporation (IC-DISC) income from an entity that materially participates in farming (has a majority of gross receipts from farming)
  • Income from packing, storing, processing, transporting and shedding of farm products
  • Gains from the sale of farm equipment, but only if farm income is at least two-thirds of overall AGI (excluding gains from equipment sales and the sale of farm inputs).

Observation. Under the Tax Cuts and Jobs Act (TCJA), for tax years after 2017, a trade-in of farm equipment is treated as a sale that is reported on Form 4797, Sales of Business Property. As a result, many farmers may have little income reported on Schedule F for a tax year that they incurred a large gain from trading in farm equipment reported as having been sold on Form 4797. Thus, sale of farm equipment could cause such a farmer not to receive an additional ERP payment.

The same rule likely applies to income from custom farming or harvesting services and the income derived from providing seed to farmers (offset by allocated expenses).

 No. 9 – Decision to not Review USDA Wetland Certification Upheld  

Foster v. United States Department of Agriculture, No. 4:21-CV-04081-RAL, 2022 U.S. Dist. LEXIS 117676 (D. S.D. Jul. 1, 2022)

The plaintiff owned farmland with a .8-acre portion that USDA certified as a “wetland” in 2011 under the Swampbuster provisions of 16 U.S.C. §§3801, 3821-3824.  The wetland was about 8.5 inches deep at certain times during the year, particularly in the spring after snow melt. The wetland resulted from a tree belt that had been planted in 1936 to prevent soil erosion.  Snow accumulated around the tree belt in the winter and melted in the spring with the water collecting in a low spot in of the field before soaking into the ground or evaporating.  In about one-half of the crop years, the puddle would dry out in time or planting.  In other years it had to be drained to plant crops.  The certification meant that the puddle could not be drained so that it and the surrounding land could not be farmed without the loss of federal farm program benefits. 

The plaintiff sought a review of the certification under 16 U.S.C. §3822(a)(4) which provides for review of a final certification upon request by the person affected by the certification.  The USDA denied review in 2020 citing its own regulation of 7 C.F.R. §12.30(c)(6) which required the plaintiff to show how a natural event changed the topography or hydrology of the wetland that caused the certification to no longer be a reliable indicator of site conditions.  The plaintiff claimed that new evidence existed that would refute the 2011 certification, and also claimed that 16 U.S.C. §3822(a)(4) provided no restriction on the ability to get a review and, as a result, 7 C.F.R. §12.30(c)(6) violated the due process clause by restricting reviews and was arbitrary and capricious under the Administrative Procedure Act.   

The trial court held that 7 C.F.R. §12.30(c)(6) merely restricted when an agency must review a final certification.  The trial court also determined that 7 C.F.R. §12.30(c)(6) did not violate the due process clause as the plaintiff did not show any independent source of authority providing him with a right to certification review on request. The USDA’s denials of review were found not to be arbitrary or capricious and that the plaintiff failed to provide any evidence that the natural conditions of the site had changed, which would require a review of the certification.  The plaintiff also claimed that the Swampbuster provisions were unconstitutional under the Commerce Clause and the Tenth Amendment.  

The trial court rejected the plaintiff’s claims and determined that the statute of limitations on challenging the certification had run.  The trial court also held that the USDA was entitled to summary judgment on the plaintiff’s claim that Swampbuster was unconstitutional, holding that the provisions were within the power of the Congress under the spending clause of Article I, Section 8 of the Constitution.  The trial court also ruled that Swampbuster did not infringe upon state sovereignty by requiring states to implement a federal program, statute or regulation. The trial court further rejected the plaintiff’s claim that a part of Swampbuster violated the Congressional Review Act, finding that the provision at issue was precluded from judicial review.  The court dismissed all the plaintiff’s claims against the USDA and denied the ability for the area to be reviewed again. 

Note:  The trial court’s ruling seems incorrect and the plaintiff docketed an appeal with the U.S. Court of Appeals for the Eighth Circuit on August 16.  No. 22-2729.  The Constitution limits what the government can regulate, including water that doesn’t drain anywhere.  In addition, the U.S. Supreme Court has said the government cannot force people to waive a constitutional right as a condition of getting federal benefits such as federal farm program payments. 

Conclusion

In the next installment I will look at some more of the Top Ten of 2022.

January 16, 2023 in Environmental Law, Regulatory Law | Permalink | Comments (0)

Saturday, January 14, 2023

Top Agricultural Law and Tax Developments of 2022 – Part 4

Overview

Today’s blog article continues the series that began earlier this week reviewing the top ag law and tax developments of 2022.  I am working my way through those developments that were significant, but not quite of national significance to make the “Top Ten” of 2022.

More ag law and tax developments of 2022 – it’s the topic of today’s post.

State Law Allowing Warrantless Searches Unconstitutional

Rainwaters, et al. v. Tennessee Wildlife Resources Agency, No. 20-CV-6 (Benton Co. Ten. Dist. Ct. Mar. 22, 2022) 

The Fourth Amendment protects against illegal searches and seizures.  In general, government officials must secure a search warrant based on probable cause before searching an area unless the owner gives consent.  However, the Fourth Amendment’s protection accorded to “persons, houses, papers and effects,” does not extend to all open areas contiguous to a person’s home, but rather only to the home itself and its surrounding “curtilage” – the area immediately surrounding and associated with the defendant’s home. 

The scope and extent of curtilage is an important issue to farming and ranching operations.  Farming, hunting, recreational and other activity occurs on private land that is not located in the surrounding vicinity of the home.  Indeed, there may not even be a home on the tract.  Does that mean that government agents can conduct a warrantless search on such property?  The ability to do so has become much easier with the new technological developments. 

In addition to the Fourth Amendment protection, in recent years numerous states have enacted legislation designed to provide what is believed to be greater protection from warrantless searches to rural property owners.  Sometimes those laws find themselves at odds with other state laws that allow certain government officials access to property to perform “official” duties.  Other times, those state laws providing access by government officials without a warrant are challenged as unconstitutional.  That is indeed what happened in a Tennessee case in 2022.

In the case, the plaintiffs owned farmland on which they hunted or fished.  They marked fenced portions of their respective tracts where they hunted and also posted the tracts as “No Trespassing.”  Tennessee Wildlife Resources Agency (TWRA) officers entered onto both tracts on several occasions and took photos of the plaintiffs and their guests without permission or a warrant. Tennessee law (Tenn. Code Ann. §70-1-305(1) and (7)) allows TWRA officers to enter onto private property, except buildings, without a warrant “to perform executive duties.”  The TWRA officers installed U.S. Fish & Wildlife Service surveillance cameras on the plaintiffs’ property without first obtaining a warrant to gather information regarding potential violations of state hunting laws.  The plaintiffs challenged the constitutionality of the Tennessee law and sought injunctive and declaratory relief as well as nominal damages. The defendants moved for summary judgment arguing that the plaintiffs lacked standing and that there was no controversy to be adjudicated.

The trial court found the Tennessee law to be facially unconstitutional.  The trial court noted that the statute at issue reached to “any property, outside of buildings” which unconstitutionally allowed for warrantless searches of a home’s curtilage.  The trial court also determined that the officers’ information gathering intrusions were unconstitutional searches rather than reasonable regulations and restrictions, and that the statute was comparable to a constitutionally prohibited general warrant.  It was unreasonable for the TWRA officers to enter onto occupied, fenced, private property without first obtaining consent or a search warrant. The trial court also held the plaintiffs had standing to sue because they experienced multiple unauthorized entries onto their private property, and that declaratory relief was an adequate remedy.  The trial court awarded nominal damages of one dollar. 

Note:  The defendant appealed the trial court’s decision.  Expect more developments in this case in 2023 as well as additional developments in other states on the warrantless search issue.    

IRS Failure to Comply with the Administrative Procedure Act (APA)

Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022); Green Valley Investors, LLC v. Commissioner, 159 T.C. No. 5 (2022)

Several court decisions in 2022 invalidated IRS action for not following federal law in developing regulations that implement the tax code.  For instance, in Mann Construction, the plaintiff challenged IRS Notice 2007–83, which designated certain employee benefit plans featuring cash value life insurance policies as listed transactions.

Note:  A listed transaction is a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has determined to be a tax avoidance transaction. IRS identifies these transactions by notice, regulation, or other form of published guidance as a listed transaction.

Generally, the Code imposes a 20 percent accuracy-related penalty on a taxpayer who has a “reportable transaction” understatement.  The penalty is 30 percent if the taxpayer fails to make certain disclosure requirements that I.R.C. §6011 requires.  That Code section imposes a penalty on a person who fails to include information about a reportable transaction on a return.  A reportable transaction is one that is the same as or “substantially similar to” a tax avoidance transaction (a.k.a. a “listed transaction”) that the IRS has identified by a Notice, Regulation or some other form of published guidance.  Pursuant to IRC §6707A, a failure to report a listed transaction subjects the taxpayer to potential monetary penalties and criminal sanctions.

Note:  The minimum penalty for failure to report a listed transaction is $10,000 ($5,000 for a natural person).  The maximum penalty is $200,000 ($100,000 for a natural person). 

In Mann Construction, the plaintiff had put a cash value life policy plan into effect from the 2013 to 2017 tax years. In 2019, the IRS determined that the plan fit the description identified in Notice 2007–83 and imposed penalties on the plaintiff and its shareholders for failing to disclose their participation. The plaintiff paid the penalties and then sued for a refund alleging that the IRS failed to comply with the notice and comment requirements of the Administrative Procedure Act (APA).

Note:  Under the APA, a federal agency must undertake a Notice of Public Rulemaking when developing a legislative rule.  The Notice is published in the Federal Register and typically provides 60 days for public comment and 30 days for the agency to reply. 

The trial court ruled for the Government. However, the Sixth Circuit reversed, finding that the Notice was invalid because of the APA violation. The IRS argued that it was not required to comply, as the Notice was only an “interpretive rule” and not a “legislative rule.”  However, the Sixth Circuit concluded that the Notice fell on the legislative side. This rulemaking imposed new duties on taxpayers that Congress had not articulated. Congress had delegated the authority to the IRS to determine which transactions will be deemed “a tax avoidance transaction,” and the Notice attempted to do that. The mere fact that the statute permitted some interpretation of the term “tax avoidance transaction” did not remove the Notice from the legislative category. Moreover, Congress did not exempt this from the scope of the APA.

The IRS also argued that Treas. Reg. §1.6011-4(b) allowed the IRS to identify reportable and listed transactions “by notice, regulation, or other form of published guidance.” The Court responded that Congress, not the IRS, gets to amend APA requirements.

In Green Valley Investors, LLC, the petitioner claimed charitable contribution deductions for several syndicated conservation easement transactions.  Effective December 23, 2016, the IRS had identified all syndicated conservation easement transactions from January 1, 2010, forward (and substantially similar transactions) as “listed transactions.”  Notice 2017-10, 2017-4 I.R.B. 544. That designation imposed substantial reporting requirements not only on the participants in such transactions, but also on their material advisors, for as long as the statute of limitations with respect to the transaction remained open.   The IRS denied the deductions and imposed various reportable transaction penalties.  The petitioner challenged the IRS position on the basis that the IRS failed to comply with the notice-and-comment requirements of the APA.  U.S. Tax Court followed the rationale in Mann Construction in holding that Notice 2017-10 was also invalid because of a failure to satisfy the notice and comment requirements of the APA.  The Tax Court determined that Notice 2017-10 was a legislative rule because when the IRS identified syndicated conservation easement transactions as a listed transaction it was not merely providing its interpretation of the law or reminding taxpayers of pre-existing duties.  Instead, the Tax Court determined, the IRS was imposed new duties in the form of reporting and recordkeeping requirements on taxpayers and their material advisors.  These substantive new duties that exposed taxpayer to noncompliance penalties meant that the Notice was a legislative rule subject to the APA’s notice-and-comment requirement.

Note:  Also, in CIC Services, Inc. v. Internal Revenue Service, 2022 U.S. Dist. LEXIS 63545 (E.D. Tenn. Mar. 21, 2022), the court invalidated Notice 2016-66, casting doubt on enforcement against micro captive insurance.  Likewise, in GBX Assoc., LLC v. United States, 2022 U.S. Dist. LEXIS 206500 (N.D. Ohio Nov. 14, 2022), the federal district court followed Green Valley Investors, Inc. in invalidating Notice 2017-10, but it refused to apply a nationwide injunction to enforcement, binding only the parties and leaving this issue for further judicial development.

These cases invalidating IRS Notices for failure of the agency to follow the APA’s notice-and-comment requirements are important to farmers and ranchers.  USDA regulations often shade the line from an interpretive rule into one that is legislative.  The cases provide helpful guidance on where that line is located.

Conclusion

I will continue my journey through the top ag law and tax developments of 2022 in my next post.

January 14, 2023 in Income Tax, Regulatory Law | Permalink | Comments (0)

Monday, January 9, 2023

Top Ag Law and Tax Developments of 2022 – Part 3

Overview

Today’s blog article continues the series that began earlier this week reviewing the top ag law and tax developments of 2022.  I am working my way through those developments that were significant, but not quite of national significance to make the “Top Ten” of 2022.

More ag law and tax developments of 2022 – it’s the topic of today’s post.

Tax Court has Equitable Jurisdiction to Review CDP Determination

Boechler, P.C. v. Commissioner, 142 S. Ct. 1493 (2022)

The petitioner, a two-person North Dakota law firm, was assessed an “intentional disregard” penalty. The IRS notified them of an intent to levy. They requested and received a CDP (Collection Due Process) hearing, in which appeals sustained the proposed levy. I.R.C. §6330(d)(1) requires a Tax Court petition to be filed within 30 days, but the firm filed one day late. The Tax Court dismissed the petition for lack of jurisdiction.  The Eighth Circuit affirmed on the ground that the statutory requirement for filing was jurisdictional and thus could not be waived. In a unanimous decision, the U.S. Supreme Court ruled that the 30-day period was not a jurisdictional requirement largely due to lack of clarity in I.R.C. §6330(d)(1).  Moreover, the Supreme Court reasoned that its decision preserved the possibility for a court to apply equitable tolling to benefit taxpayers in this context, who often acted without counsel. While the application of equitable tolling would depend on further proceedings, the law firm will get the chance to make its case.

Comment: Although the Supreme Court’s decision does not create greater clarity, it may avoid some injustice. Eighth Circuit Judge Kelly wrote a concurring opinion in which he stated that a jurisdictional approach is a “drastic” measure that may impose a disproportionate burden on low-income taxpayers. This concurring opinion may have been what convinced the U.S. Supreme Court to hear the case. 

Additional Note:  In late 2022, the Tax Court addressed the issue of the right to judicial review of an IRS deficiency proceeding in accordance with I.R.C. §6213(a).  In Hallmark Research Collective v. Comr., 159 T.C. No. 6 (2022), the petition was electronically filed one day late.  The Tax Court held that the statute was clear in specifying that the IRS must issue a deficiency notice and that the taxpayer must respond by filing a Tax Court petition within a 90-day time limit.  As such, the 90-day time limit is a prerequisite of jurisdiction.  The court concluded that deficiency proceedings are based in statute and cannot be equitably tolled. 

COE Improperly Declined Jurisdiction

Hoosier Environmental Council, et al. v. Natural Prairie Indiana Farmland Holdings, LLC, et al., 564 F. Supp. 3d 683 (N.D. Ind. 2021)

Note:  I’m reaching back into 2021 to grab this case.  I didn’t see it until early in 2022,  and it should have been on last year’s list.  But, nevertheless, I want to include it as a significant development for 2022 albeit it was a 2021 federal court decision from Indiana. 

This case involved the issue of the U.S. Army Corps of Engineers (COE) deciding not to regulate a wet area on a farm and whether the decision not to exercise jurisdiction was done properly.  The court’s decision is instructive on the procedure for determining the existence of a wetland, what “prior converted cropland is” and how the agency should properly decline to regulate

The defendant acquired farmland to build and operate a concentrated animal feeding operation (CAFO) with over 4,350 dairy cows.  The COE inspected the property and concluded that much of the land was not subject to the Clean Water Act (CWA). The plaintiffs, two environmental groups, sued alleging that the defendant violated the CWA and that the COE’s administrative jurisdictional determination violated the Administrative Procedures Act (APA).  The land at issue was drained in the early 1900's via the creation of several large ditches and drainage canals to move surface water into the Kankakee River 9.5 miles downstream.  The CAFO was constructed on what had been a lakebed over a century ago, and two of the drainage ditches are on the defendant’s land. 

Note:  The lake was totally drained in the early 1990s to make farmland.  Vested with that is the right to maintain the drain.  See, e.g., Barthel v. United States Department of Agriculture, 181 F.3d 934 (8th Cir. 1999).  It is immaterial what the size of the lake was or whether it was where a marsh was at some time in the past.  The land at issue was completely transformed to farmland long before the defendant acquired the land at issue. 

The primary issue before the court was whether the COE’s determination that the land was prior converted wetland (and therefore not subject to COE regulation) was arbitrary and capricious.  The court examined the record to determine if the COE followed its own guidance for delineating wetlands.  The court noted that the administrative record lacked any description of the prior drainage system (the series of medial and lateral ditches transecting the property before defendant’s alterations), the defendant’s new drainage system, how these systems were designed to function, and whether they were effective in removing wetland hydrology from the area. 

Note:  While the plaintiffs made much ado about the COE’s lack of consideration of the hydrology of the land before the farm’s alterations, that is largely an irrelevant point.  Famers are entitled to maintain the “wetland and farming regime” on the land and may engage in whatever drainage activities necessary to keep that historic farming activity and production.  The land in question had been converted to farmland many decades earlier and had been constantly maintained in that status.

The court examined aerial photographs, noting that there was an absence of data identified in the COE’s “Midwest Supplement” to assess the relevant drainage factors, including how the existing and current drainage systems were designed to function, whether they were effective in removing wetland hydrology from the area, and when any conversion occurred.  The absence of these sources, coupled with an absence of any meaningful discussion of the hydrology of the site before the defendant’s alterations, led the court to believe that the COE failed to follow the procedures outlined in its own guidance in deciding the land was prior converted cropland.  The COE also reviewed 14 aerial photographs that spanned from 1938 to 2017.  Those photos showed the presence of row cropping and offered no evidence of potential wetlands.  Relying on aerial photographs, the COE expert’s determination, and a determination of the Natural Resources Conservation Service to conclude that wetlands did not exist, was certainly appropriate. 

Note:  In addition, the court’s analysis on this point seems suspect.  The COE did not need to find and document all three factors.  The hydrology had been materially altered to enable consistent row crop farming.  In that situation wetland hydrology is not present, and the area in question is not a wetland.  As a result, other levees, systems, or dams do not alter area hydrology because there is no wetland hydrology present to alter.  The court referred to the COE’s 1987 Manual for its conclusion that the COE didn’t follow its own procedures.  However, the 1987 Manual was established to evaluate recent alterations to undisturbed wetland.  The court incorrectly applied this standard to materially hydrologically altered wetland where the alteration had occurred a century earlier.  As such, the land in issue was prior converted wetland.  The court incorrectly applied the standards of the 1987 Manual to the facts before it involving alterations that occurred over 100 years ago.   

The court also determined that there was no indication in the record that the aerial photographs were used to assess hydrology characteristics of the defendant’s land before alterations were made, how the drainage systems were designed to function, and how effectively and efficiently they could convert land from wetland to upland.  Further, the court noted there was also no explanation why the COE skipped these steps.  The COE took the position that its review of aerial photographs was sufficient to determine the land’s normal circumstances. The court disagreed, determining that the evidence did not support the COE’s claim that its decision was based on identified relevant factors.  Instead, the court concluded that the COE made impermissible post hoc justifications.  If reliance on its own manuals was not warranted in this situation, the court stated, the COE needed to provide a rationale.  As such, the court determined that the evidence did not support the COE’s argument that its decision was rationally based on the relevant wetland hydrological factors before concluding the land was prior converted cropland.  Absent that rationale, the COE’s determination of wetland status of the defendant’s farmland was arbitrary and capricious. 

Note:  The COE followed its correct procedure in this case contained in the Midwest Supplement and also accepted a prior USDA determination as to the land’s status for federal farm program purposes. The ditches and drains that were legally installed successfully removed wetland hydrology.  The COE did not deviate from its own regulatory guidance and procedures, but the court assumed that it did.  There was no need for the COE to find and document all three wetland characteristic factors. The elimination of wetland hydrology eliminates the possibility that the land was a wetland. 

Concerning the lateral ditch, the plaintiffs claimed that the record did not support the COE’s conclusion that the lateral ditches were irrigation canals that drained uplands and lacked relatively permanent flow.  The plaintiffs pointed to a lack of administrative record and the claimed failure of the COE to follow the relevant factors that it lists in its Approved Jurisdictional Determination Form. The court also held that the COE’s finding of non-jurisdiction over the lateral ditches was arbitrary and capricious. 

The court remanded the case to the COE to conduct a more thorough investigation of the defendant’s tract.

Note:  For farmers, the case is a frustrating one.  At issue was land that had been farmed for over 80 years and the right to continue to farm consistent with the historic drainage of the property was caught up in bureaucratic red tape. The court’s expansive view of standing and lack of understanding of the actual science behind the hydrology and geographic facts of the case created a problem for a dairy operation that should have never happened.  What was involved in the case were shallow ditches dug into prior converted wetland.  That is an activity that the Clean Water Act does not regulate. 

Conclusion

I will continue my journey through the top developments in ag law and tax in a subsequent post.

January 9, 2023 in Environmental Law, Income Tax | Permalink | Comments (0)

Friday, January 6, 2023

Top Ag Law and Developments of 2022 – Part 2

Overview

Today’s blog article continues the series that began earlier this week reviewing the top ag law and tax developments of 2022.  I am working my way through those developments that were significant, but not quite of national significance to make the “Top Ten” of 2022.

More ag law and tax developments of 2022 – it’s the topic of today’s post.

Regulation of Agricultural Activities on Wildlife Refuges

Tulelake Irrigation Dist. v. United States Fish & Wildlife Serv., 40 F.4th 930 (9th Cir. 2022)

This case involves the management of six national wildlife refuges in the Klamath Basin encompassing over 200,000 acres.  The court faced the specific question of whether the federal government can regulate agricultural activities on leased land within the refuges.  The plaintiffs, an irrigation district and associated agricultural groups, sued the defendant, U.S. Fish and Wildlife Service, claiming the defendant violated environmental laws by regulating leased farmland in the Tule Lake and Klamath Refuge. The trial court granted summary judgment in favor of the defendant.  The plaintiffs appealed.  The appellate court noted that the Kuchel Act and the Refuge Act allow the defendant to determine the proper land management practices to protect the waterfowl management of the area.  Under the Refuge Act, the defendant was required to issue an Environmental Impact Statement (EIS) and Comprehensive Conservation Plan (CCP). The defendant did issue an EIS and CCP for the Tule Lake and Klamath Refuge area, which included modifications to the agricultural use on the leased land within the region. The EIS/CCP required the leased lands to be flooded post-harvest, restricted some harvesting methods, and prohibited post-harvest field work, which the plaintiffs claimed violated their right to use the leased land. The plaintiffs argued that the language, “consistent with proper waterfowl management,” within the Kuchel Act was “nonrestrictive” and was not essential to the meaning of the Act. The appellate court held it was improper to read just that portion of the Act without considering the rest of the Act to understand the intent. The appellate court found the Kuchel Act was unambiguous and required the defendant to regulate the leased land to ensure proper waterfowl management. The Refuge Act allows the defendant to regulate the uses of the leased land, but the plaintiffs argued the agricultural practices were a “purpose” rather than a “use” so the defendant could not regulate it under the Refuge Act. The appellate court found the agricultural activity on the leased land was not a “purpose” equal to waterfowl management. The appellate court also held the language of the Act was unambiguous and determined that agricultural activities on the land were to be considered a use that the defendant could regulate.  As such, the conditions needed to benefit waterfowl trumped ag considerations under both the Refuge Act and the Kuchel Act and, as the court stated, if the defendant determined that “an ag use is not consistent with proper waterfowl management, the Service must be allowed to restrict agricultural use.  Accordingly, the appellate court affirmed the trial court’s award of summary judgment for the defendant.

Minnesota Farmer Protection Law Upheld

Pitman Farms v. Kuehl Poultry, LLC, et al., 48 F.4th 866 (8th Cir. 2022)

In early 1988, the Minnesota Legislature directed the Minnesota Department of Agriculture (MDA) to put together a task force to study the issue of agricultural contract production and recommend to the legislature how it might provide additional legal and economic protection to contract growers.  The MDA’s Final Report was issued in February of 1990.  During the 1990 legislative session, the Minnesota legislature approved various economic protections for farmers based on the task force recommendations focusing particularly on parent liability.  As signed into law, MN Stat. §17.93 provides as follows:

“Parent company liability.  If an agricultural contractor is the subsidiary of another corporation, partnership, or association, the parent corporation, partnership or association is liable to a seller for the amount of any unpaid claim or contract performance claim if the contractor fails to pay or perform according to the terms of the contract.” 

In addition, MN Stat. §17.90 specified as follows:

“’Producer” means a person who produces or causes to be produced an agricultural commodity in a quantity beyond the person’s own family use and: (1) is able to transfer title to another; or (2) provides management input for the production of an agricultural commodity.”

The MDA then prepared at “statement of need and reasonableness” (SONAR) to implement the new statutory provision.  The SONAR referred to the legislation as the “Producer Protection Act” (PPA) and the MDA’s implementing rule (MN Rule 1572.0040) for MN Stat §17.93 which went into effect on March 4, 1991, read as follows:

“A corporation, partnership, sole proprietorship, or association that through ownership of capital stock, cumulative voting rights, voting trust agreements, or any other plan, agreement, or device, owns more than 50 percent of the common or preferred stock entitled to vote for directors of a subsidiary corporation or provides more than 50 percent of the management or control of a subsidiary is liable to a seller of agricultural commodities for any unpaid claim or contract performance claim of that subsidiary.”

 During the same 1990 legislative session the Minnesota legislature approved, and the governor signed into law MN Stat. §27.133.  This new law stated as follows:

“Parent company liability.  If a wholesale produce dealer is a subsidiary of another corporation, partnership, or association, the parent corporation, partnership, or association is liable to a seller for the amount of any unpaid claim or contract performance claim if the wholesale produce dealer fails to pay or perform in according to the terms of the contract and this chapter.”

Concerning this provision, the legislature stated, “It is therefore declared to be the policy of the legislature that certain financial protection be afforded those who are producers on the farm….”

Also, under both MN Stat. §17.93 and MN Stat. §27.133, “contractor” and “wholesale produce dealer” were defined as “persons” and “person” was to be applied to corporations, partnerships and other unincorporated associations.”  MN Stat. §665.44, sub. 7. 

In 2017, the defendants entered into chicken production contracts with Prairie’s Best Farm, Inc. to grow chickens in exchange for monthly payments and bi-monthly bonus payments.  In late 2017, Simply Essentials bought the assets of Prairie’s Best and assumed the grower contracts.  Simply Essentials, incorporated in Delaware and headquartered in California, was the subsidiary of the plaintiff, Pitman Farms, which owned more than 50 percent of Simply Essentials.  Shortly thereafter, the plaintiff bought Simply Essentials’ membership interests and became its sole owner.  In 2019, Simply Essentials encountered financial trouble, ceased processing activities and notified the defendants that it was terminating the contracts effective three months later.  The defendants’ demands for payment in excess of $6 million from the plaintiff for breach of contract failed. Both parties sought a declaratory judgment concerning the application of the PPA to the contracts. 

The plaintiff claimed that the PPA did not apply because the defendants were not “sellers” and, even if they were, the PPA didn’t apply because Simply Essentials was an LLC rather than a “corporation, partnership, or association.  The plaintiff also asserted that the PPA’s parent company liability provisions didn’t apply to it because Delaware law applied, and that applying Minnesota law would violate the Dormant Commerce Clause.  The defendant’s counterclaim made the opposite arguments.

The trial court ruled for the plaintiff, finding that the PPA did not apply by its terms because the defendants were not “sellers” and because Simply Essentials was an LLC rather than a “corporation, partnership, or association.”

On appeal, the appellate court unanimously reversed.  The appellate court read the various statutes together to determine the legislature’s purpose and intent.  The appellate court noted that the parent company liability statute of MN Stat. §27.133, the PPA of §§17.90-17.98 and the MDA’s implementing rule all arose from the same legislative session, addressed the same issue, and contained nearly identical language.  Accordingly, the appellate court determined that the trial court should have looked to MN Stat. §27.133 when construing the meaning of “seller” contained in MN Stat. §17.93 and in MDA Rule 1572.0040.  When the various provisions were taken together, the appellate court determined that “seller” can include “producer” under the PPA and the MDA’s implementing regulation. 

The appellate court also concluded that the trial court erred in finding that “seller” was limited to transferors of title.  Because the defendants did not have title to the chickens and could not therefore transfer title, the trial court held that the PPA did not apply.  The appellate court held that such a construction was plainly contrary to the legislature’s intent in creating the PPA which was to provide financial protections to agricultural producers in general and not merely agricultural commodity sellers.  Further, because the appellate court determined that “seller” included “producer,” the defendants were covered by the PPA as providing management services in accordance with MN Stat. §17.90 (2) for the growing of the chickens under contract.  In addition, the appellate court held that the growers were also “sellers” for purposes of the parent company liability provision of MN Stat. §27.133.

The plaintiff also asserted that “subsidiary of another corporation, partnership or association” contained in MN Stat. §17.93 and §27.133 meant that both the parent and the subsidiary had to be either a corporation, partnership or an association.  The trial court agreed with this interpretation.  The appellate court also agreed but pointed out that LLCs (which Simply Essentials was) did not exist in Minnesota when the PPA was enacted and, as such, the legislature had not purposefully excluded them from the statute. The appellate court also noted that an LLC had been found to be a “person” for purposes of the Minnesota Human Rights Act.  That law defined “person” to include a partnership, association, or corporation.  In addition, an unpublished decision of the Minnesota Court of Appeals had previously held that an LLC was an “association” for purposes of a Minnesota oil transportation statute. Thus, there was no apparent reason why the legislature would have singled out LLCs to not be covered under the parent company liability provisions of the PPA. 

The appellate court also noted the strong public policy statement of the Minnesota legislature in enacting the PPA – to protect producers of agricultural commodities from economic harm due to parent business entities using their organizational form to avoid liability for their subsidiaries’ actions. 

Conclusion

I will continue my journey through the top developments in ag law and tax in a subsequent post.

January 6, 2023 in Contracts, Environmental Law, Regulatory Law | Permalink | Comments (0)

Monday, January 2, 2023

Here Come the Feds: EPA Final Rule Defining Waters of the United States – Again

Overview

On December 30, 2022, the Environmental Protection Agency (EPA) and the U.S. Army Corps of Engineers (COA).  On December 30, 2022, the agencies announced the final "Revised Definition of 'Waters of the United States'" rule which will be effective 60 days after it is published in the Federal Register.  It represents a “change of mind” of the agencies from the positions that they held concerning a water of the United States (WOTUS) and wetlands from just over three years ago.  The bottom line is that the new interpretation is extremely unfriendly to agriculture, particularly to farmland owners in the prairie pothole region of the upper Midwest.    

Background

The scope of the federal government’s Clean Water Act (CWA) regulatory authority over wet areas on private land, streams and rivers has been controversial for more than 40 years.  The CWA bars the discharge of a “pollutant” into the “navigable waters of the United States without a federal discharge permit.  A “pollutant” is defined as “dredged spoil, solid waste, incinerator residue, sewage, garbage, sewage sludge, munitions, chemical wastes, biological materials, radioactive materials, heat, wrecked or discarded equipment, rock, sand, cellar dirt and industrial, municipal, and agricultural waste.”

Note:  The legislative history of the CWA reveals that the Congress was not thinking about preserving wetlands when the definition of a “pollutant” was written.  Instead, it blended together (under the umbrella of “pollution”) the COE’s responsibility to protect navigation with the EPA’s responsibility to prevent contamination.  This is the genesis of upstream regulation that environmental groups and numerous courts latched onto.  Routine farming activities were exempted from the discharge permit requirement.       

Many court opinions have been filed attempting to define the scope of the government’s jurisdiction.  On two occasions, the U.S. Supreme Court attempted to clarify matters, but in the process of rejecting the regulatory definitions of a WOTUS proffered by the Environmental Protection Agency (EPA) and the U.S. Army Corps of Engineers (COE) didn’t provide clear direction for the lower courts.  See Solid Waste Agency of Northern Cook County v. United States Army Corps of Engineers, 531 U.S. 159 (2001); Rapanos v. United States, 547 U.S. 175 (2006). 

Particularly with its Rapanos decision, the Court failed to clarify the meaning of the CWA phrase “waters of the United States” and the scope of federal regulation of isolated wetlands. The Court did not render a majority opinion in Rapanos, instead issuing a total of five separate opinions. The plurality opinion, written by Justice Scalia and joined by Justices Thomas, Alito and Chief Justice Roberts, would have construed the phrase “waters of the United States” to include only those relatively permanent, standing or continuously flowing bodies of water that are ordinarily described as “streams,” “oceans,” and “lakes.”  In addition, the plurality opinion also held that a wetland may not be considered “adjacent to” remote “waters of the United States” based merely on a hydrological connection. Thus, in the plurality’s view, only those wetlands with a continuous surface connection to bodies that are “waters of the United States” in their own right, so that there is no clear demarcation between the two, are “adjacent” to such waters and covered by permit requirement of Section 404 of the CWA.

Justice Kennedy authored a concurring opinion, but on much narrower grounds.  In Justice Kennedy’s view, the lower court correctly recognized that a water or wetland constitutes “navigable waters” under the CWA if it possesses a significant nexus to waters that are navigable in fact or that could reasonably be so made. But, in Justice Kennedy’s view, the lower court failed to consider all of the factors necessary to determine that the lands in question had, or did not have, the requisite nexus. Without more specific regulations comporting with the Court’s 2001 SWANCC opinion, Justice Kennedy stated that the COE needed to establish a significant nexus on a case-by-case basis when seeking to regulate wetlands based on adjacency to non-navigable tributaries, in order to avoid unreasonable application of the CWA. In Justice Kennedy’s view, the record in the cases contained evidence pointing to a possible significant nexus, but neither the COE nor the lower court established a significant nexus. As a result, Justice Kennedy concurred that the lower court opinions should be vacated, and the cases remanded for further proceedings.

Justice Kennedy’s opinion was neither a clear victory for the landowners in the cases or the COE. While he rejected the plurality’s narrow reading of the phrase “waters of the United States,” he also rejected the government’s broad interpretation of the phrase. While the “significant nexus” test of the Court’s 2001 SWANCC opinion required regulated parcels to be “inseparably bound up with the ‘waters’ of the United States,” Justice Kennedy would require the nexus to “be assessed in terms of the statute’s goals and purposes” in accordance with the Court’s 1985 opinion in United States v. Riverside Bayview Homes. 474 U.S. 121 (1985). 

The “WOTUS Rule”.  The Obama Administration attempted take advantage of the lack of clear guidance on the scope of federally jurisdictional wetland by dramatically expanding the federal government’s reach by issuing an expansive WOTUS rule.  The EPA/COE regulation was deeply opposed by the farming/ranching and rural landowning communities and triggered many legal challenges.   The rule was challenged by over 30 states and the courts were, in general, highly critical of the regulation and it became a primary target of the Trump Administration.

The “NWPR Rule”.  The Trump Administration essentially rescinded the Obama-era rule with its own rule – the “Navigable Waters Protection Rule” (NWPR). 85 Fed. Reg. 22, 250 (Apr. 21, 2020).  The NWPR redefined the Obama-era WOTUS rule to include only: “traditional navigable waters; perennial and intermittent tributaries that contribute surface water flow to such waters; certain lakes, ponds, and impoundments of jurisdictional waters; and wetlands adjacent to other jurisdictional waters.  In short, the NWPR narrowed the definition of the statutory phrase “waters of the United States” to comport with Justice Scalia’s approach in Rapanos.  Thus, the NWPR excludes from CWA jurisdiction wetlands that have no “continuous surface connection” to jurisdictional waters.  The rule much more closely followed the Supreme Court’s guidance issued in 2001 and 2006 that did the Obama-era rule, but it was challenged by environmental groups.  Indeed, the NWPR has been challenged in 15 cases filed in 11 federal district courts.   

In early 2020, the U.S. Court of Appeals for the Tenth Circuit reversed a Colorado trial court that had entered a preliminary injunction barring the NWPR from taking effect in Colorado as applied to the discharge permit requirement of Section 404 of the CWA.  The result of the appellate court’s decision was that the NWPR became effective in every state.  Colorado v. United States Environmental Protection Agency, 989 F.3d 874 (10th Cir. 2021). 

Later, a federal district court in South Carolina remanded the NWPR to the EPA. South Carolina Coastal Conservation League, et al. v. Regan, No. 2:20-cv-016787-BHH (D. S.C. Jul. 15, 2021).  The NWPR was being challenged on the scope issue.  Even though the NWPR was remanded, the court left the rule intact.  That fit with the strategy of present Administration.  If the court had invalidated the NWPR, then the Administration would have had to defend the indefensible Obama-era rule in court.  That wouldn’t have turned out well for the Administration.  In addition, the opinion not vacating the NWPR allowed the Administration to proceed in trying to write a new rule without bothering to defend the Obama-era rule in court.

Another definition.  On December 7, 2021, the EPA and the COE published a proposed rule redefining a “water of the United States” (WOTUS) in accordance with the pre-2015 definition of the term. 86 FR 69372 (Dec. 7, 2021).   Under the proposed rule, EPA stated its intention to define a WOTUS in accordance with the 1986 regulations as further defined by the courts since that time.  In addition, the agencies said that the proposed rule would base the existence of a WOTUS on the “significant nexus” standard set forth in prior Supreme Court decisions.  As such, a WOTUS would include traditional navigable waters; territorial seas and adjacent wetlands; most impoundments of a WOTUS and wetlands adjacent to impoundments or tributaries that meet either the relatively permanent standard or the significant nexus standard; all waters that are currently used or were used in the past or may be susceptible to use in interstate or foreign commerce, including all waters that are subject to the ebb and flow of the tide. 

The proposed rule defines “interstate waters” as “all rivers, lakes, and other waters that flow across, or form a part of State boundaries” regardless of whether those waters are also traditionally navigable. A “tributary” is also defined as being a WOTUS if it fits in the “other waters” category via a significant nexus with covered waters or if it is relatively permanent. The EPA and COE further define the “relatively permanent standard” as “waters that are relatively permanent, standing or continuously flowing and waters with a continuous surface connection to such waters.” The “significant nexus standard” is defined as “waters that either alone or in combination with similarly situated waters in the region, significantly affect the chemical, physical, or biological integrity of traditional navigable waters, interstate waters, or the territorial seas (the "foundational waters").”

Final Rule

The agencies announced their Final Rule on December 30, 2022.  It will become effective 60 days after it is published in the Federal Register.  As promised, the Final Rule uses a definition that was in place before 2015 (for purposes of the Clean Water Act) for traditional navigable waters, territorial seas, interstate waters, and upstream water resources that “significantly” affect those waters.

Note:  Going back to before 2015 is interesting.  It was in 2015 that the Obama Administration was going to “clarify” everything, and the result was to greatly expand control over private property.  As noted above, this “clarification” resulted in more than 30 states suing the federal government and an injunction was imposed.  Also as noted above, the EPA and the COE under the Trump administration then pursued a long, careful rulemaking procedure which brought actual clarity to the definition.  It’s that clarity that has now been completely overturned, supposedly for “clarity’s” sake.

Two joint memos were published with the final rule to set forth the delineation of the implementation of roles and responsibilities between the agencies.  One is a joint coordination memo to “ensure accuracy and consistency of jurisdictional determinations under the final rule.”  The other is a memo with the USDA to provide “clarity on the agencies’ programs under the Clean Water act and the Food Security Act (Swampbuster).”

Adjacency.  The EPA wants to restore the “significant nexus” via “adjacency.”  This is a big change in the definition of “adjacency.”  It doesn’t mean simply “abutting.”  Instead, “adjacent” includes a “significant nexus” and a “significant nexus” can be established by “shallow hydrologic subsurface connections” to the “waters of the United States.  A “shallow subsurface connection,” the Final Rule states, may be found below the ordinary root zone (below 12 inches), where other wetland delineation factors may not be present.  Frankly, that means farm field drain tile.      

Note:  Farmers needs to pay attention to this, despite what USDA will undoubtedly say about it – the USDA’s Natural Resource Conservation Service (NRCS) is now completely under the thumb of the EPA and the COE (particularly because the practice of mitigation banking under the CWA will cease).  Practically every tile for every tile-drained farmed wetland connects to an open ditch which is a WOTUS.  This effectively disqualifies farmed wetland from being an isolated wetland –[these terms means specific things under the regulations].  The only wetland that will qualify as an isolated wetland (no hydrological connection to a WOTUS) will be those that don’t overflow and don’t have drain tile. 

Specifically, the Final Rule sets forth two kinds of adjacency: 1) the traditional “relatively permanent” standard; and 2) the “significant nexus” standard.  The EPA and the COE say the agencies will not assume that all wetlands in a specific geographic area are similarly situated and can be assessed together on a watershed basis in a significant nexus analysis.  But it is clear from the Final Rule that the agencies intend to expand jurisdiction over isolated prairie pothole wetlands using the “significant nexus” standard. 

Note:  The “significant nexus” can be established via a connection to downstream waters by surface water, shallow subsurface water, and groundwater flows and through biological and chemical connections.  The Final Rule states that adjacency can be supported by a “pipe, non-jurisdictional ditch,… or some other factors that connects the wetland directly to the jurisdictional water.”  This appears to be the basis for overturning the NWPR.  Consequently, the prairie pothole region is directly in the “bullseye” of the Final Rule.

Prior Converted Cropland.  The agencies say the final rule increases “clarity” on which waters are not jurisdictional – including prior converted cropland.  This doesn’t make much sense.  Supposedly, the agencies are “clarifying” that prior converted cropland, (which is not a water), is not a water, but it somehow could be a water if the agencies had not clarified it?  In addition, the burden is placed on the landowner to prove that prior converted cropland is actually prior converted cropland and therefore not a water.

Ditches and drainage devices.  The Final Rule is vague enough to give the government regulatory authority over non-navigable ponds, ditches, and potholes.  On the ditch/drainage device maintenance issue, there is also no recognition that the agencies will follow the opinion of the U.S. Circuit Court of Appeals for the Eighth Circuit in Barthel v. United States Department of Agriculture, 181 F.3d 934 (8th Cir. 1999).  In Barthel, the court ruled that a landowner can do whatever is necessary with respect to an existing drainage device to maintain the “historic wetland and farming regime” for the farm.  While Barthel is a Swampbuster case, it is relevant with respect to the Final Rule given that the USDA is now basically subservient to the EPA and the COE.  

The U.S. Supreme Court

It is rather presumptuous of the CWA and the COE to develop a Final Rule before the U.S. Supreme Court issues its opinion in a case presently pending involving the definition of a WOTUS.  In Sackett v. Environmental Protection Agency, 8 F.4th 1075 (9th Cir. 2021), cert, granted, 142 S. Ct. 896 (2022).  The issue in the case is whether the U.S. Circuit Court of Appeals for the Ninth Circuit used the proper test for determining whether wetlands are “waters of the United States” under the CWA.  The plaintiffs bought a .63-acre lot in 2004 on which they intended to build a home.  The lot is near numerous wetlands the water from which flows from a tributary to a creek, and eventually runs into a lake approximately 100 yards from the lot.  The lake is 19 miles long and is a navigable water subject to the CWA.  The plaintiffs began construction of their home, and the Environmental Protection Agency (EPA) issued a compliance order notifying the plaintiffs that their lot contained wetlands due to adjacency to the lake and that continuing to backfill sand and gravel on the lot would trigger penalties of $40,000 per day.  The plaintiffs sued and the EPA claimed that its administrative orders weren’t subject to judicial review. 

Ultimately the U.S. Supreme Court unanimously rejected the EPA’s argument and remanded the case to the trial court for further proceedings.  The EPA withdrew the initial compliance order and issued an amended compliance order which the trial court held was not arbitrary or capricious.  The plaintiffs appealed and the EPA declined to enforce the order, withdrew it and moved to dismiss the case.  However, the EPA still maintained the lot was a jurisdictional wetland subject to the CWA and reserved the right to bring enforcement actions in the future.  In 2019, the plaintiffs resisted the EPA’s motion and sought a ruling on the motion to bring finality to the matter.  The EPA claimed that the case was moot, but the appellate court disagreed, noting that the withdrawal of the compliance order did not give the plaintiffs final and full relief.  On the merits, the appellate court noted that the lot contained wetlands 30 feet from the tributary, and that under the “significant nexus” test of Rapanos v. United States, 547 U.S. 715 (2006), the lot was a regulable wetland under the CWA as being adjacent to a navigable water of the United States (the lake). 

The U.S. Supreme Court agreed to hear the case and oral argument occurred in early October of 2022.  The Court’s opinion is anticipated sometime before mid-March of 2023, but the issuance of the Final Rule may cause that to be delayed.  In any event, the Supreme Court will have the final say on what a WOTUS rather than the COE or the EPA.

Note:  EPA says the Final Rule reflects prior Supreme Court decisions and will provide “clarity” on which waters are jurisdictional and which ones are not.  How can EPA provide “clarity” when the Supreme Court hasn’t yet said what a WOTUS is?  The role of an administrative agency is to take a statute, or a court decision construing a statute and then write a rule defining the boundaries of the definition - in this instance, that of a WOTUS. 

Conclusion

The definition of a WOTUS has become a political football.  This constant flip-flopping of definitions lends a lack of credibility to the COE and the EPA on the issue.  Didn’t these same agencies believe the 2019 NWPR was good?  The Final Rule represents the agencies’ stealth techniques to extend the government’s reach over wetlands on private property.  There is absolutely no chance that the Final Rule is fair to farmers. 

January 2, 2023 in Environmental Law | Permalink | Comments (0)

Sunday, January 1, 2023

Top Ag Law and Tax Developments of 2022 – Part 1

Overview

At the beginning of each year for about the past 25 years, I have made a point to catalogue the immediately prior year’s top developments in agricultural law and taxation.  It’s important to look back at what the major issues were because they can also provide insight into what might be the big issues in the coming year.  Insight into trends in the law and taxation impacting farmers, ranchers, rural landowners and agribusiness is important because it can aid planning to avoid legal issues in the future.  The law and taxation can have a significant economic impact on a farming operation, or on a family legacy.  While it is very true that issues involving agronomy or animal science or horticulture or other similar disciplines are important and each have their role in the success of a farming business, where “the rubber meets the road” is in the law and taxation.  The law and tax rules set the framework within which all other disciplines must operate.  A deviation outside those boundaries can result in costly litigation, family disputes and an inefficiently run operation that might not survive into the next generation.

With that in mind, today’s article is the beginning of several that highlight the major legal and tax issues of 2022 that were significant for agriculture.  Some are important developments at that state level that could spill over to other states, but the major developments, of course, are those at the federal level – in the federal courts all the way up to the U.S. Supreme Court and with the IRS.

The major developments in ag law and tax from 2022 – the “Almost Top Ten.”  It’s the first in a multi-part series.

Nuisance Law

The first development that was significant in 2022, but not important enough nationally to make the Top Ten, involves a nuisance lawsuit in Iowa that resulted in a significant Iowa Supreme Court decision.  But, first a bit of background on the issue of ag nuisance 

In general.  An issue that is of significance to agriculture is that of nuisance.  Nuisance law prohibits land uses that unreasonably and substantially interfere with another individual's quiet use and enjoyment of property.  It’s 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.  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. 

Defenses.  There are no common law defenses that an agricultural operation may use to shield itself from liability arising from a nuisance action.  However, courts do consider a variety of factors.  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. 

While there are no common law defenses to a nuisance suit, 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. 

The continued Iowa saga of ag nuisance and “right-to-farm” legislation.  Iowa has had a lengthy history of litigation involving animal confinement operations and nuisance suits.  In 2004, the Iowa Supreme Court, in Gacke v. Pork XTRA, L.L.C., 684 N.W.2d 168 (Iowa 2004) addressed the constitutionality of the Iowa right-to-farm law.  Under the facts of the case, the defendant built a confinement hog facility 1,300 feet to the north of the plaintiffs’ farmstead which the plaintiffs had occupied since 1974.  In the summer of 2000, the plaintiffs filed a nuisance action against the defendant claiming damages for personal injury, emotional distress and a decrease in the value of their property, and seeking a permanent injunction, compensatory and punitive damages.  The defendant raised the Iowa right-to-farm statute as a defenseThe pertinent part of the statute provides:

“An animal feeding operation…shall not be found to be a…nuisance under this chapter or under principles of common law, and the animal feeding operation shall not be found to interfere with another person’s comfortable use and enjoyment of the person’s life or property under any other cause of action.”  Iowa Code §657.11.

Importantly, the statutory protection applies regardless of whether the animal feeding operation was established (or expanded) before or after the complaining party was present in the area.  However, the protection of the statute does not apply if the animal feeding operation is not in compliance with all applicable federal and state laws for operation of the facility, or the facility unreasonably and for substantial periods of time interferes with the plaintiff’s comfortable use and enjoyment of the plaintiff’s life or property and failed to use generally accepted best management practices. 

The plaintiffs claimed that the statute was an unconstitutional taking of their private property without just compensation in violation of both the Federal and Iowa constitutions.  The trial court held that the statute did amount to an unconstitutional taking of the plaintiffs’ property, determined that the value of their property had been reduced by $50,000, and that the plaintiffs should be awarded $46,500 to compensate them for their past inconvenience, emotional distress and pain and suffering. However, the court refused to award any future special or punitive damages or injunctive relief. 

On appeal, the Iowa Supreme Court held the right-to-farm law unconstitutional, but only to the extent that it denied the plaintiffs compensation for the decreased value of their property.  In essence, the Court held that the statute gave the defendant an easement to produce odors over the plaintiffs’ property, for which compensation had to be paid.  Importantly, the Court did not opine that right-to-farm laws are not a legitimate purpose of state government. To the contrary, the Court noted the Iowa legislature’s objective of promoting animal agriculture in the state and that the right-to-farm law bore a reasonable relationship to that legitimate objective.  The Court also seemed to indicate that the statute would not be constitutionally defective had the plaintiffs “come to the nuisance” (i.e., moved next door to the defendant’s existing hog operation).

Note:  Post Gacke, the Iowa right-to-farm law could be found to be unconstitutional on a case-by-case basis as determined by a three-part test with the burden on the plaintiff of establishing each element: 1) that the plaintiff personally had not benefitted from the right-to-farm law beyond what the general public enjoyed; 2) that the plaintiff suffered significant hardship; and 3) that the plaintiff lived on their property before the defendant’s operation began and that both the plaintiff and the defendant spent considerable funds in property improvements.

2022 development. In 2022, the Iowa Supreme Court again issued an opinion involving a nuisance suit against a confined animal feeding operation (CAFO).  In Garrison v. New Fashion Pork LLP, 977 N.W.2d 67 (Iowa Sup. Ct. 2022), the plaintiff claimed that the defendant’s neighboring confined animal feeding operation (CAFO) violated both the Clean Water Act and the Resource Conservation Recovery Act due to manure runoff that caused excessive nitrate levels in the plaintiff’s water sources.  The federal court dismissed the suit on summary judgment for lack of expert testimony to establish the plaintiff’s claim, finding that the alleged violations where wholly past violations, and that water test results showed no ongoing violation of either statute, but rather a slight decrease in nitrate levels since the start of the defendant’s confined animal feeding operation (CAFO).  The federal court also declined supplemental jurisdiction over the plaintiff’s state law claims.  The plaintiff then sued the defendant in state court for nuisance, trespass and violation of state drainage law.  The defendant moved for summary judgment based on statutory immunity of Iowa Code § 657.11 and the plaintiff’s lack of evidence or expert testimony. 

The plaintiff, relying on Gacke, claimed that Iowa Code §657.11 as applied to him was unconstitutional under Iowa’s inalienable rights clause.  The trial court, noting that the plaintiff’s own CAFO (raising of 500 ewes, and at times over 1,000 ewes and lambs, on his property for over 40 years, along with a six-foot tall manure pile) had benefited from immunity, rejected the plaintiff’s constitutional challenge for failure to satisfy Gacke’s three-part test.  The trial court then granted the defendant’s summary judgment motion based on the plaintiff’s failure to provide any expert testimony or other evidence to support any exception to the statutory immunity defense or to prove causation or damages. 

On further review, the Iowa Supreme Court affirmed, overruled the three-part test of Gacke and applied rational basis review to reject the plaintiff’s constitutional challenge to Iowa Code §657.11.  The court noted that the statue did not eliminate nuisance claims against CAFOs, but rather established reasonable limitations on recovery rights.  The Iowa Supreme Court concluded that the plaintiff failed to preserve error on his takings claim under article I, section 18 of the Iowa Constitution and failed to generate a question of fact precluding summary judgment on statutory nuisance immunity or causation for his trespass and drainage claims. Specifically, the Iowa Supreme Court noted that without accompanying expert testimony, the plaintiff’s water tests showed neither an increase in nitrate levels nor a spike in nitrate levels that would correlate with manure spreading. The Supreme Court further noted that even assuming an increase in nitrate levels, the plaintiff lacked expert testimony to attribute or correlate any increase in nitrate levels in the stream to the defendants’ actions. Thus, without expert witness testimony that tied the defendant’s alleged misapplication or over-application of manure to the nitrate levels in the plaintiff’s stream, the plaintiff could not, as a matter of law, satisfy his burden of proving that any trespass or drainage violation proximately caused his damages.  Ultimately, the Supreme Court concluded, “balancing the competing interests of CAFO operators and their neighbors is a quintessentially legislative function involving policy choices…[belonging] with the elected branches.” 

Note:   The Iowa Supreme Court’s opinion didn’t explain how the attorneys for the plaintiff failed to preserve error on the plaintiff’s takings claim and failed to provide expert witness testimony on the tort claims for trespass and drainage issues.  However, the Iowa Supreme Court clearly focused on those deficiencies in its opinion. 

Going forward, if a jury finds that a nuisance exists the ag operation can use the nuisance defense if the operation is in full compliance with state and federal regulations, exercises generally accepted management practices, and has for substantial periods of time not interfered with the use and enjoyment of the complaining party’s property. The nuisance defense will apply regardless of the established date or expansion of the operation.  In other words, there is no “first-in-time” requirement. 

Conclusion

There have been several significant developments over the past couple of years either legislatively or in the courts involving ag nuisances in several states.  Expect that to continue and also expect that the 2022 development in Iowa to have an impact on other state legislatures and courts grappling with the ag nuisance issue.   

January 1, 2023 in Civil Liabilities | Permalink | Comments (0)

Thursday, December 29, 2022

Medicaid Estate Recovery and Trusts

Overview

When a Medicaid beneficiary dies, a state might seek recovery of the Medicaid benefits paid during the beneficiary’s life from the deceased beneficiary’s estate.  Part of estate planning to protect assets from being depleted during life and limit or eliminate a state’s right to recover benefits post-death involves transferring property to a trust with the appropriate terms.  Known as a Medicaid Asset Protection Trust (MAPT), it’s a part of estate planning that is very important to many farm and ranch families that desire to keep the farm in the family for multiple generations.  It’s also a topic that I started lecturing on nationally over 30 years ago after I wrote one of the very first law review articles ever published on the topic.  Roger A. McEowen, et al., “Estate Planning for the Elderly and Disabled: Organizing the Estate to Qualify for Federal Medical Extended Care Assistance,” 24 Ind. L. Rev. 1379 (1991).  I then followed that up with another article three years later.  Roger A. McEowen, “Estate Planning for Farm and Ranch Families Facing Long-Term Health Care,” 73 Neb. L. Rev. 104 (1994).

An MAPT was involved in a recent Iowa case.  Unfortunately for the estate, the court’s suspect reasoning resulted in the trust not operating to protect the decedent’s assets from the state seeking reimbursement.  A dissenting opinion, however, pointed out the majority’s flawed rationale.

Medicaid asset protection trusts – it’s the topic of today’s post.

Medicaid Basics

For many persons, estate planning also includes planning for the possibility of long-term health care.  Nursing home care is expensive and can require the liquidation of assets to generate the funds necessary to pay the nursing home bill unless appropriate planning has been taken.  Medicaid is a joint federal/state program that pays for long-term health care in a nursing home.  To be able to receive Medicaid benefits, an individual must meet numerous eligibility requirements but, in short, must have a very minimal level of income and assets.  States set their own asset limits and determine what assets count toward the limit.  Assets exceeding the limit must be spent on the applicant’s nursing home care before Medicaid eligibility can be established. 

There are also rules that can apply to help protect certain assets from being depleted to pay for a long-term care bill, and different rules apply when the Medicaid applicant/beneficiary is married, and the spouse is not applying for or receiving Medicaid.   However, the overriding public policy concern is that private assets are primarily used to pay for care before taxpayer dollars are utilized. 

While some states set different timeframe for the “look-back” period, the general rule is that the value of any non-exempt asset owned by a Medicaid applicant or applicant’s spouse that is disposed of for less than fair market value within five years of an application for Medicaid is treated as an available asset for purposes of Medicaid eligibility. That is the rule for outright transfers as well as transfers to or from a trust.  If such a transfer occurs, a penalty period is triggered that could further delay Medicaid eligibility.  The penalty period is determined by dividing the uncompensated value of the transfer by the average monthly cost of nursing home care in the individual’s state.  The resulting figure is the number of months the individual’s penalty period will last.  The penalty period begins on the date on which the individual has applied and is otherwise eligible for Medicaid. 

Asset Sheltering Trusts

An asset sheltering trust (also known as an MAPT) is a trust designed to enable the grantor to be eligible for public assistance benefits (Medicaid) for long-term health care costs that would be incurred if the grantor entered a nursing facility.  The rules surrounding these types of trusts are quite complex and are constantly changing given the public policy concerns that surround the creation of these types of trusts.

In general, these trusts contain language explicitly evidencing the grantor’s intent to give the trustee complete discretion (a “fully discretionary” trust) to distribute trust income and principal.  Similar language might also be used to assure that the grantor’s intent was to supplement rather than supplant public benefits that might be otherwise available.  The purpose of these types of provisions is that if the beneficiary ever is in need of long-term medical assistance in a nursing facility, then the trustee has the discretion to withhold the payment of funds from the grantor’s property contained in the trust to permit the beneficiary to receive public assistance (Medicaid) benefits at taxpayer expense and preserve the grantor’s assets for the heirs. They also operate to not create any interest in the trust corpus that the state can attach to seek reimbursement from after the beneficiary dies. 

Recent Iowa case.  In In re Trust Under the Will of Riessen, No. 22-0048, 2022 Iowa App. LEXIS 925 (Iowa Ct. App. Dec. 7, 2022), the court faced the issue of whether a trust effectively barred the state from seeking post-death reimbursement for Medicaid benefits paid to a trust beneficiary during life.  The trust grantor died in 1972 with a will that established a trust to hold an equal share of his farm for a daughter, with his son serving as trustee.  The trust authorized the son to pay the net income and principal of the trust to the daughter at his complete discretion – he was not obligated in any way to provide trust funds to his sister as the beneficiary.  The trust also stated that the grantor’s reason for giving the complete discretionary power to the trustee was because it was the grantor’s “hope and desire to keep the entire property in the family.”  The trust specified that the son had the right to rent the land in the trust and farm it as the tenant. The trust also stated that it was the grantor’s intent that the son, as trustee, buy certain adjacent tracts of land to help maintain the family farming operation.

The daughter died in 2020 and during her lifetime the trust didn’t provide any funds for her medical care, but the state did provide Medicaid benefits for her.  After she died, the state sought reimbursement from the trust for the Medicaid benefits provided to the daughter during her life.  The probate court ordered the trust to reimburse the state and the trustee appealed.  The state based its reimbursement claim on Iowa Code §249A.53(2), which provides that when Medicaid funds care for an individual 55 or older that is a resident of a care facility, the debt can be collected from any trust in which the individual had an interest.  However, the trustee asserted that the trust was a fully discretionary trust and that he had the complete discretion to ignore the beneficiary’s medical needs if he so desired – there was no standard set in the trust that he had to follow in providing trust funds for his sister’s care.  As such, the trustee asserted that the beneficiary had no interest in the trust to which the state’s claim could attach. 

The state claimed that the trust language meant that the trust gave the trustee the discretion to use trust funds for his sister’s care for that he deemed “advisable and beneficial” and that discretion meant that the trustee couldn’t completely ignore the beneficiary’s medical needs.  But the trustee pointed out that Iowa Code § 633A.4702 stated that, “in the absence of clear and convincing evidence to the contrary, language in a governing instrument granting a trustee discretion to make or withhold a distribution shall prevail over any language governing instrument indicating that the beneficiary may have a legally enforceable right to distributions or indicating a standard of payments or distributions.”  The appellate court, however, noted that the statute was inapplicable to trusts effective before 2004.  The appellate court also determined (with not much analysis (the entire majority opinion, including a recitation of the facts) is only eight pages (double-spaced)) that the grantor’s intent to maintain the farm in the family did not negate or outweigh the grantor’s desire that his daughter medical needs be met from the trust. 

The appellate court also reasoned that the trust language meant that the trustee could invade the corpus of the trust for the benefit of the sister when necessary and that the grantor preferred for the trust to be used to provide for the sister instead of protect family land.  Consequently, the appellate court determined that the beneficiary had an interest - portions of the trust were to be used for her care and the trustee was instructed to invade the corpus of the trust to make distributions in the sister’s support. This meant that the state had a right to the sister’s interest in the trust for reimbursement of past Medicaid benefits that were paid on her behalf and affirmed the probate court’s determination.

The dissenting judge, a senior judge sitting by designation and who had written a prominent court opinion on the issue in the past, disagreed that the trust language could be interpreted to identify any type of ascertainable or measurable standard that could give the daughter any interest in the trust that would allow the state to have a legitimate reimbursement claim.  Indeed, the trust granted the trustee the “sole and absolute discretion” to invade the trust corpus when the trustee deemed it “necessary for the benefit” of the grantor’s daughter.  That language did not reference any particular standard that could measure the daughter’s interest in the trust.  He noted that the term “benefit,” as used in the trust, is simply not a distributional, ascertainable standard. To read it as one as the majority did, meant that the majority was judicially rewriting the terms of the trust.

Conclusion

Medicaid asset and trust planning can be a complex part of estate planning.  But it can be a very important aspect of protecting farm assets from being depleted paying a long-term health-care bill.  The facts of the Riessen case as stated in the opinion were insufficient to be able to determine whether the trust was drafted with the intent of protecting assets from being depleted to pay for the beneficiary’s long-term health care.  However, as the dissent points out, and as I have written and lectured on this topic for years concerning MAPT language, the trust language at issue comported with that of a properly drafted as a fully discretionary MAPT to accomplish that goal.  The dissent properly pointed out that the majority’s opinion essentially rewrote the trust to give the state a reimbursement claim.   

If the case is appealed, it is likely that the Iowa Supreme Court, based on past precedent, will overturn the appellate court’s judgment.  It’s simply inappropriate for a court to essentially rewrite the terms of a trust to accomplish an outcome it desires.  If the decision is not appealed or is not overturned on appeal, the Iowa legislature will need to determine what it desires from a public policy standpoint concerning the breadth of the state’s ability to be reimbursed from a decedent’s estate for past Medicaid benefits paid. 

December 29, 2022 in Estate Planning | Permalink | Comments (0)

Saturday, December 24, 2022

Recent Cases Involving Decedents' Estates

Overview

Unfortunately, litigation sometimes occurs after death and can involve family members.  The issues can be unique and may also be the result of misunderstandings, the lack memorializing understandings, or simply family members not getting along. 

In today’s post, I highlight three recent cases involving the estate of a decedent.  Hopefully, a review of these cases will provide some insight as to the issues that can arise at deaths in hopes of avoiding them in the future.

A look at recent cases involving estates – it’s the topic of today’s post.

Government Agency’s Interest in Estate Attaches Before Nursing Home’s Judgment Lien. A nursing home sought to recover fees from a decedent’s estate that the decedent incurred while a resident.  The Iowa Department of Health and Human Services (Department) had paid the deceased’s medical fees to the nursing home and filed a claim in probate seeking to recover $395,612.12. The estate executor filed a report and inventory showing the gross value of probate assets as $51,016.20, with $45,000.00 of the value attributed to the decedent’s home. The nursing home claimed it had a right to the value of the home to pay for the debt owed to it via a judicial secured lien, but the Department claimed it had a priority position.  The trial court agreed with the Department.  The nursing home argued on appeal that its secured lien was not subject to the probate code’s classification of debts and charges statutory provision, claiming instead that its judicial lien was on the real estate the decedent owned.  However, the appellate court pointed out that the real estate was a homestead to which the judgment lien did not attach and would not attach upon the decedent’s death merely because the decedent had no heirs.  The appellate court determined that the Department could recover from the decedent’s estate as it existed immediately before death, including her home with the homestead exception still in effect because the nursing’s home judgment would not attach until after the death. The appellate court affirmed the trial court’s grant of summary judgment for the Department.  In re Estate of Rice, No. 21-1868, 2022 Iowa App. LEXIS 936 (Iowa Ct. App. Dec. 7, 2022).

Economic Benefit Not Required for Trust Funds to Pay Attorney’s Fees. The grantor created a trust naming his three daughters as beneficiary.  However, before death, the grantor agreed to give one of his daughters the homestead in return for helping him on the homeplace during his life.  However, this agreement was not memorialized in the trust due to a drafting error.  One of the daughters objected to the alleged pre-death agreement and also objected to part of the trust being used to pay off debts immediately.  The trial court determined that the evidence was sufficient as to the grantor’s intent to respect the pre-death agreement, but did not allow that daughter use funds from the trust to pay attorney fees on the basis that the litigation did not benefit the trust.  On appeal, the appellate court reversed in part.  The appellate court noted that state law allows a court to award “attorney’s fees from trusts administered through the court as well as in probate and guardianship proceedings” when the litigation benefits the decedent’s estate and when the litigation resulted from the executor’s negligence, fraud, or inactivity.  The appellate court determined that an economic benefit was not necessary to award fees, but that other non-economic benefits were sufficient.  Consequently, the appellate court determined that the litigation involving the trust resulted in the trust being administered in the way intended the grantor intended and that this was sufficient to be considered beneficial. In addition, the court found that the fact that the daughter to receive the homestead was a beneficiary of the trust had no bearing on the attorney fee issue.  The appellate court reasoned that to not allow beneficiaries to use trust funds to litigate issues would discourage strong claims from being brought. Ultimately, the appellate court held that the trial court abused its discretion by denying the motion for attorney fees based on its erroneous view that an attorney fees award "required" an economic benefit to the trust and that fulfilling the intent of the settlor was not a basis for awarding attorney fees.  The appellate court held that the trial court should not have discounted the efforts to reform the trust to align with the settlor's undisputed intent simply because the daughter benefitted from the successful outcome of the litigation.  The appellate court, however, determined that the trial court did not err when it determined that the litigation on the issue of mortgage payments did not provide the trust with an economic benefit because the successful litigation did not provide the estate with income it could not have otherwise obtained from a different renter.  In re Petersen Land Trust, No. 29745, 2022 S.D. LEXIS 139 (S.D. Sup. Ct. Nov. 23, 2022).

Surviving Spouse Removed as Co-Trustee. The decedent established a revocable living trust in 2000 to continue his farming operation and benefit his wife as the primary beneficiary and his two sons as the other beneficiaries.  Effective upon the grantor’s death, the trust named the surviving wife as a co-trustee and the decedent’s cousin as an independent co-trustee.  The trust specified that the independent trustee could distribute income and principal to any of the beneficiaries at the independent trustee’s discretion.  Upon the wife’s subsequent death, the trust was to be divided into two separate shares, one for each son, and funded with the remaining trust undistributed income and principal.  Upon the decedent’s death in 2014 the trust contained about $2,385,000 in assets, most of which were nonliquid. Most of the assets had to be liquidated to pay debts that the decedent incurred during life, including part of the decedent’s farm that was sold in 2018.  After payment of debts $112,048.34 remained in the trust. The trust was divided into a marital and a nonmarital share and at the time of the decedent’s death only the nonmarital half was funded.  Without the cousin’s knowledge, the wife withdrew $104,161.34 of the $112,048.34 for her own personal expenses. This amount was more than the wife had a right to receive that year from the trust. In addition, the Farm Service Agency (FSA) deposited farm-related funds directly into the wife’s account instead of the trust account. The cousin requested that the FSA deposit the funds into the trust instead of the wife’s account, but the FSA refused citing the wife’s name as the first named trustee and the only one with the right to change where the funds should be sent. Soon after this, the cousin filed an action to remove the wife as a trustee for mishandling the funds.  The trial court removed the wife as a co-trustee. The wife appealed. The Kansas Uniform Trust Code (KUTC) specifies that a court may remove a trustee if “the trustee has committed breach of trust.” A breach of trust is a violation of the trustee’s duty to the beneficiaries. To determine if the wife committed a breach, the appellate court looked to the decedent's intent for management of the trust. The language of the trust gave the exclusive discretion over distribution of the trust’s income and principal to the cousin as the independent trustee.  The trust stated that, “whenever a power of discretion is granted exclusively to my Independent Trustee, then any Interested Trustee who is then serving as my Trustee is prohibited from participating in the exercise of the power of discretion.” The appellate court found the wife was an interested trustee because she was both a trustee and beneficiary, so she should not have exercised any discretion over the distribution of the funds of the trust. The appellate court agreed with the trial court that the wife repeatedly disregarded the terms of the trust and tried to take advantage of being a co-trustee. The language of the trust agreement was clear that the wife’s discretion should have been restricted and her acts prohibited. The wife failed to show the trial court abused its discretion by removing her as a co-trustee and affirmed the trial court’s decision. In re Link Zweygardt Trust No. 1., No. 124,760, 2022 Kan. App. Unpub. LEXIS 616 (Kan. Ct. App. Dec. 2, 2022).   

Conclusion

The issues that can arise post-death are numerous.  These cases are merely a sample of what can happen. 

December 24, 2022 in Estate Planning | Permalink | Comments (0)

Thursday, December 22, 2022

January Tax Update Webinar and 2023 Summer National Seminars

Overview

Next month, on January 20, I will be doing a two-hour tax update webinar on key tax changes and updates for the 2023 filing season.  As I write this, the Congress is considering yet another massive spending bill that contains important tax provisions.  Indeed the Senate has passed the bill and sent it to the House.  It seems that long gone are the days where the Congress could pass legislation addressing specific tax issues and not have to include technical tax matters in a massive spending bill with all kinds of miscellaneous (i.e., garbage) provisions.  This makes the January 20 webinar important.  This will be (as of now) right before the start of the tax filing season.   Be watching for a link to register.  

Omnibus Legislation – Retirement Provisions

One of the topics that I will address in the 2-hour webinar on January 20 are the tax provisions in the Omnibus legislation (assuming the Congress passes the bill) will be the retirement-related provisions.  As the bill stands as of now, here are just a few of the retirement-related provisions:

  • Increased required minimum distribution (RMD) age. The provision increases the current beginning RMD age from 72 to 73 effective January 1, 2023, and then to age 75 effective January 1, 2033. Act, Sec. 107
  • Excise tax. This provision reduces to 25 percent and, under certain circumstances, practically eliminates the excise tax imposed on failure to take the RMD.  This provision is effective for tax years beginning after the date of enactment.  Act, Sec. 302.
  • Catch-up contributions. While the dollar amount that can be elected to be deferred annually is capped, those who are age 50 and older can defer an additional (“catch-up) amount.  Starting in 2025, this provision increases the current catch-up limit to the greater of $10,000 ($5,000 for SIMPLE plans) or 50 percent more than the regular catch-up amount in 2024 (2025 for SIMPLE plans).  Act, Sec. 109
  • Penalty-free withdrawals. This provision would allow penalty-free withdrawals for “unforeseeable or immediate financial needs relating to necessary personal or family expenses, capped at $1,000 and limited to once every three years (or once annually if the distribution is repaid within three years).  Act, Sec. 115. 

There are numerous other provisions.  In fact, there are over 100 provisions designed to expand coverage, increase retirement savings, and otherwise make the retirement plan rules more streamlined.  I will address the full run-down of what passes at the January 20 webinar. 

Summer 2023 Events

Mark your calendars for the law school’s summer 2023 national ag tax seminars, those will be on June 15-16 in Petosky, Michigan and August 7 and 8 in Coeur ‘d Alene, Idaho.  More information will be coming on those in the next few weeks as the programs get built out.  The Michigan event will be the standard farm income tax, farm estate and business planning seminar.  The August event in Idaho will have the standard farm income tax, farm estate and business planning topical coverage, but there will be a separate concurrent track each day on various agricultural law topics.  Those topics will cover real estate issues, environmental issues, water law, ag torts, leasing arrangements, and other issues facing rural practitioners.  You will be able to pick and choose the sessions that you would like to attend.  Both the Michigan conference and the Idaho conference will be live broadcast online. 

Conclusion

I hope that you will be able to join the online webinar on January 20 as well as one of the summer events.  There are always many legal issues to discuss involving farm and ranch clients.

December 22, 2022 in Income Tax | Permalink | Comments (0)

Sunday, December 11, 2022

Does Using Old Tractors Mean You Aren’t a Farmer? And the Wind Energy Production Tax Credit – Is it Subject to State Property Tax?

Overview

Two recent court opinions highlight how unique tax law can be.  In a recent U.S. Tax Court decision, the court was faced with an IRS challenge of deductions largely because of the manner in which the farming operation was conducted.  In a decision of the Oklahoma Supreme Court, the Court determined that the Federal Production Tax Credit, was not subject to state property tax.

Recent tax cases – it’s the topic of today’s post.

IRS Questions Farming Practices, But Tax Court Allows Most Deductions

Hoakison v. Comr., T.C. Memo. 2022-117

The petitioners, a married couple, farm in southwest Iowa.  The wife worked off-farm at a veterinary clinic, and the husband was a full-time delivery driver for United Parcel Service (UPS).  He purchased his first farm in 1975 four years after graduating high-school and started a cow-calf operation.  The petitioners lived frugally and always avoided incurring debt when possible by purchasing used equipment with cash with the husband doing his own repairs and maintenance.  The petitioners were able to weather the farm crises of the early-mid 1980s by farming in this manner.  Ultimately, the petitioners owned five tracts totaling 482 acres.  The tracts are noncontiguous and range anywhere from six to 14 miles apart.  On the tracts, the petitioners conduct a row-crop and cow-calf operation.  He worked on the farms early in the mornings before his UPS shift and after his shift ended until late into the night. 

Over the years, the petitioners acquired approximately 40 tractors with 17 in use during the years in issue (2013-2015).  The tractors had specific features or used a variety of mounted implements to perform the various tasks needed to operate the various farms.  Certain tractors were dedicated to a particular tract and attached to implements to save time and effort in taking the implements off and reattaching them.  The petitioners also have several used pickup trucks and a machine shed that was used to store farm equipment.  The petitioners’ tax returns for 2013-2015 showed farm losses each year primarily due to depreciation and other farm expenses. 

The IRS disallowed significant amounts of depreciation and other farm expense deductions largely on its claim that the petitioners were not engaged in a farming business, but rather were engaged in a “nostalgic” activity with an excessive and unnecessary amount of old tractors.  The IRS also took the position that the petitioners’ pickups and other vehicles were subject to the strict substantiation requirements of I.R.C. §274(d).  The Tax Court disagreed as to the trucks that had been modified for use on the farm and were only driven a de minimis amount for personal purposes but agreed as to one pickup that was used to travel from farm to farm and to the UPS office.  The Tax Court also pointed out that farm tractors are not listed property. 

Note:  I.R.C. §274(d) excludes from the strict substantiation requirements any "qualified nonpersonal use vehicle." A "qualified nonpersonal use vehicle" is "any vehicle which, by reason of its nature, is not likely to be used more than a de minimis amount for personal purposes." I.R.C. §274(i). The strict substantiation requirements of I.R.C. §274(d) generally apply to any pickup truck or van "unless the truck or van has been specially modified with the result that it is not likely to be used more than a de minimis amount for personal purposes." Treas. Reg. § 1.274-5(k)(7). Other qualified nonpersonal use vehicles not subject to the strict substantiation requirements of I.R.C. §274(d) include any vehicle designed to carry cargo with a loaded gross vehicle weight over 14,000 pounds, combines, flatbed trucks, and tractors and other special purpose farm vehicles. Treas. Reg. §1.274-5(k)(2)(ii)(C), (F), (J) and (Q).

As to the disallowed depreciation on certain tractors, the IRS asserted that the tractors were not used in the petitioners’ farming business because, according to the IRS, the husband was a collector of antique tractors and that the acquisition and maintenance of 40 tractors, most of them more than 40 years old served no business purpose and involved an element of “nostalgia.”  The Tax Court disagreed, noting that the husband had sufficiently detailed his farming practices – avoidance of debt and personally repairing and maintaining the tractors and other farm equipment so as to avoid hiring mechanic work – and that this was an approach that worked well for them.

The Tax Court also noted that the IRS failed to account for petitioners’ noncontiguous tracts which meant that it was necessary to have various tractors and implements located at each farm to save time moving tractors from farm to farm and assembling and disassembling various attachments.   As such, the Tax Court concluded that the items of farm machinery and tractors were used in the petitioners’ farming business and, as such, it was immaterial whether the purchase of the various farm tractors and implements constituted ordinary and necessary expenses.  The Tax Court also determined that the machine shed was a depreciable farm building.  As to various other farming expenses, the Tax Court allowed the petitioners’ claimed deductions for utilities, insurance, gasoline, fuel, oil and repair/maintenance expenses. 

Note:  The Tax Court upheld the accuracy-related penalty with respect to the underpayment related to depreciation on assets that had previously depreciated, but otherwise denied it because the petitioners had reasonably relied on a an experienced professional tax preparer

Federal Production Tax Credits Not Subject to Property Tax  

Kingfisher Wind, LLC v. Wehmuller, No. 119837, 2022 Okla. LEXIS 84 (Okla. Sup. Ct. Oct. 18, 2022)

The plaintiff developed and built two commercial wind energy projects in Oklahoma that included over 100 aerogenerators, electrical equipment, maintenance facility, substation and transmission lines.  The defendant, county assessors, valued the projects at $458 million for property tax purposes.  The plaintiff asserted that the projects were worth only $169 million on the basis that value of the federal Production Tax Credits (PTCs) should be excluded for property tax purposes.  The assessors claimed that the PTCs were tangible personal property subject to tax because they “are of such an economic benefit to owning, operating, and determining the full fair cash value of the wind farm and its real property, they must be included to determine a fair and accurate taxable ad valorem valuation of the wind farm.”  The plaintiff claimed that the PTCs (which have existed since 1992) were intangible personal property that were expressly precluded from property taxation by state law.  The PTC is a federal tax credit that is based on the kilowatt hours of electricity produced by certain types of energy generation, such as that generated by the plaintiff’s projects at issue.  If a taxpayer has insufficient tax liability to use the PTCs that it is entitled to, it may structure a project such that a tax equity investor will contribute cash in exchange for receiving the excess PTCs.  Thus, PTCs are a material economic component of a commercial wind development project and how their value is treated for property tax purposes significantly impacts a project’s return on investment.  Oklahoma law taxes all real and personal property that is not otherwise expressly excluded and classifies intangible property as personal property.  Thus, the question was whether intangible property (such as PTCs) was expressly excluded.  The trial court held that the PTCs were not subject to property tax under Oklahoma law.  On further review, the state Supreme Court noted that it had previously deemed computer software, lease agreements, trademarks, databases, and customer lists to be subject to ad valorem taxation.  After that decision, Oklahoma law was changed to specify that intangible property shall not be subject to ad valorem tax. The Supreme Court determined that PTCs have limited intrinsic value and can only be claimed or enforced by legal action. The court found that even if PTCs had qualities of both tangible and intangible property, the Oklahoma legislature intended for those “in-between” items to be considered intangible and not subject to ad valorem taxation. 

Note:  The Court’s decision only construed Oklahoma law.  Other states have different statutory and constitutional provisions defining items subject to property tax in those respective states.  For instance, the value of the PTC has been held to be subject to property tax in IL, MI, PA, SD and TN.  The opposite result has been reached in AZ, GA, MO, OH, OR and WA. 

Conclusion

From the IRS claiming that a farmer can’t truly be in the farming business by using old tractors to a case illustrating the economic inefficiency of wind energy without a massive taxpayer subsidy, there’s never a dull moment in tax.

December 11, 2022 in Income Tax | Permalink | Comments (0)

Wednesday, December 7, 2022

How NOT to Use a Charitable Remainder Trust

Overview

A charitable remainder trust can be a useful estate planning tool for a farmer or rancher, particularly one that is ready to retire from farming or ranching.  Instead of selling the last crop and reporting the income along with the income from the previous year’s crop that has been deferred to the current year, the crop can be transferred to a charitable remainder trust.  Doing so avoids having to report the sale of the crop and the associated self-employment tax that would be triggered.  But, a charitable remainder trust is a complex estate planning device that should only be utilized by professionals the understand the rules.  A recent Tax Court case involving an Indiana farm couple illustrates how badly things can turn out with a charitable remainder trust if the rules aren’t closely followed.

Charitable remainder trusts – it’s the topic of today’s post.

Background

A charitable remainder trust is an irrevocable trust to which you can donate property, cash or other property.  The trust takes a carryover income tax basis in the transferred asset(s).  The trust then sells the transferred assets (the sale is not taxable because the seller is a charity) and uses the income from the sale to pay the donor (or other designated person(s)).  The payments continue for a specific term of up to 20 years of the life of one or more beneficiaries (typically the transferor).  At the end of the term, the remainder of the trust passes to at least one designated charity.  The remainder donated to the charity must be at least 10 percent of the initial net fair market value of all of the property placed in the trust. 

Types.  There are two types of charitable remainder trusts.  The type of trust is tied to how payment from the trust is made.  A charitable remainder unitrust (CRUT) pays a percentage of the trust value annually to noncharitable beneficiaries.  The payments must be at least five percent and not exceed 50 percent of the fair market value of the trust’s assets, valued annually.  A charitable remainder annuity trust (CRAT) pays a specific dollar amount each year.  The amount is at least 5 percent and no more than 50 percent of the value of the trust’s property, valued as of the date the trust was established. 

Tax on payments.  Payments from a charitable remainder trust are taxed to the non-charitable beneficiaries.  The non-charitable beneficiaries report the income on Schedule K-1 (Form 1041) as distributions of the trust’s income and gains. 

The distributions are reported in a particular order. 

  • Payments are considered to be ordinary income first to the extent the trust had ordinary income for the year and undistributed ordinary income from prior years. This means that if the trust had enough ordinary income to cover all of the payments, all of the payments are taxed as ordinary income.  As a result, it is not advisable to transfer ordinary income property to the trust – particularly not ordinary income property with low or no income tax basis. 
  • Once the trust’s ordinary income is exhausted, payments are taxed as capital gains based on the sale or disposition of the trust’s capital assets. The payments are taxed as capital gain to the extent of the trust’s capital gain for the current year and any undistributed capital gain income from prior years.
  • After all of the trust’s ordinary income and capital gain have been distributed, any additional payments are then characterized as other income to the extent of the trust’s current year and accumulated other income.
  • Finally, after the first three-tiers of distributions have been made, any further payments are considered to be from the “principal” of the trust and are not taxable.

Charitable deduction.  The contribution to a charitable remainder trust will qualify for a partial charitable deduction.  The deduction is partial because it is limited to the present value of the charitable organization’s remainder interest calculated as the value of the donated property minus the present value of the annuity that the trust pays to the non-charitable beneficiary (or beneficiaries).  Treas. Reg. §1.664-2(c).  The deduction is also subject to adjusted gross income and other limits set forth in I.R.C. §170(e). 

Tax filing requirements.  A charitable remainder trust must file Form 5227 every year.  A beneficiary must report any payments received from the trust on Schedule K-1 of Form 1041. 

IRS concerns.  The IRS closely monitors the use of charitable trusts.  It is critical to not inflate the basis of assets transferred to the trust as well as failing to account for the transfer of any assets to the trust.  It’s also important to not mischaracterize the distributions of ordinary or capital gain income as distributions of corpus.  The ordering rules must be closely followed.  There can also be no self-dealing, making an upfront cash payment to a charitable beneficiary in lieu of the remainder interest, or a transfer of the trust’s remainder interest to a non-qualified organization.  Also, personal expenses can’t be paid with trust funds, and funds can’t be borrowed from the trust.  It’s also prohibited to use loans or forward sales of assets or other financial schemes to hid capital gains or income in the trust. 

The Furrer Case

If there ever was a case that provides a roadmap for farmers as to how not to use a charitable remainder, Furrer v. Comr., T.C. Memo. 2022-100 is that case.  Indeed, it is almost inconceivable that the farmer couple involved in the case were represented by legal counsel.  The arguments made on behalf of the Furrers were that bad.    

The Tax Court began its opinion by noted that the Furrers, “after seeing an advertisement in a farm magazine” formed a CRAT.  The opinion goes downhill quickly from there for the Furrers.  The Furrers raised corn and soybeans on their Indiana farm. In July of 2015, they formed the first of two CRATs, naming their son as trustee. The Furrers were the life beneficiaries, and three qualified charities were designated as remaindermen. They transferred 100,000 bushels of corn and 10,000 bushels of soybeans from their farm to the first CRAT, which then sold the grain for $469,003. The CRAT distributed $47,000 to the charities and used the balance to purchase a Single Premium Immediate Annuity (SPIA), which made annual payments to the Furrers of $84,369 in 2015, 2016 and 2017.  The SPIA issued a Form 1099-R to the trustee listing the annuity payments as “gross distributions” and showed a small amount of interest as the “taxable amount.”  The Furrers claimed a $47,000 charitable deduction.

The Furrers created a second CRAT in 2016 naming themselves as the lie beneficiaries and seven qualified charities as the remainder beneficiaries. and also funded that trust with grain that they raised.  The CRAT sold the grain for $691,827 and distributed $69,294 to the charities.  The annuity from this trust was payable over 2016 and 2017 in the amount of $124,921 each year.  The SPIA also issued Form 1099-R to the trustee listing the annuity payments as “gross distributions” and showing a small amount of interest as the “taxable amount.”  They claimed a charitable deduction of $69,294.

On their 2015 and 2016 returns, they did not claim charitable deductions for their transfers to the CRATs, but reported only the interest income from the SPIA, which was reported to them by the life insurance company providing the annuity.  They treated the balance of the annuity distributions that they received as a nontaxable return of corpus under I.R.C. §664(b)(4). They also reported their transfers of crops to the CRATS on Forms 709 for 2015 and 2016, which reflected the fair market value of the crops with a cost basis of zero. The CRATs reported the sales of crops as sales of business property on Form 4797, inexplicably treating the crops as having substantial basis (derived from the purported purchase of the grain at fair market value) that generated a small loss for 2015 and a small gain for 2016. Their son (as trustee) prepared the CRATs’ returns.  

On audit, the Furrers claimed they should be entitled to charitable deductions for the in-kind transfers of the crops that were ultimately destined for the charitable remaindermen, which were not claimed on their return. They made this claim even though they had no income tax basis in the grain that was transferred to the CRATs.  Incredibly, and despite not including the proper documentation, the IRS Revenue Agent allowed the charitable deductions. But the IRS still issued a notice of deficiency for each year because of the omitted income from the annuity and increased their Schedule F income by $83,440 in 2015, and by $206,967 in 2016 and also in 2017.  This resulted in tax deficiencies of $55,040 for 2015, $56,904 for 2016 and $95,907 for 2017.  The IRS also tacked on an accuracy-related penalty for each year.

Note:  For gifts of property (other than publicly traded securities) valued in excess of $5,000, the taxpayer generally must (1) obtain a qualified appraisal of the property and (2) attach to the return on which the deduction is claimed a fully completed appraisal summary on Form 8283.  I.R.C. §170(f)(11)(C). A “qualified appraisal” must be prepared by a “qualified appraiser” no later than the due date of the return, including extensions.  I.R.C. §170(f)(11)(E); Treas. Reg. §1.170A-13(c)(3). The taxpayer must also maintain records substantiating the deduction. Treas. Reg. § 1.170A-13(b)(2)(ii)(D).   At no time did the Furrers secure an appraisal (“qualified” or otherwise) of the crops they transferred to the CRATs. They also did not attach to their 2015 or 2016 return a completed Form 8283 substantiating the gifts, and they did not maintain the written records that the regulations required. But, even had they done so, they would not have been entitled to any charitable deduction because of the lack of an income tax basis in the grain transferred to the trusts.

After the Furrers filed the Tax Court petition, the IRS conceded the accuracy-related penalties for lack of the immediate supervisor’s approval.    But, the IRS attorneys also requested leave to amend its answer to disallow the charitable deductions that the Revenue Agent allowed.  The Tax Court held that the IRS carried its burden of proof on the charitable deduction disallowance issue – the Furrers did not substantiate the in-kind donations and they had no income tax basis in the crops.  Thus, any charitable deduction was limited to zero regardless of whether they would have satisfied the substantiation requirements.  The IRS also maintained that the annuity distributions were fully taxable as ordinary income on the basis that the grain was inventory that the Furrers held for sale to customers in the ordinary course of their farming business.  The Tax Court agreed and noted that the Furrers violated the ordering rules for income tax treatment of distributions from the CRATs.  The Trusts’ sale of the grain involved a sale of ordinary income property (raised grain).  As a result, the annuity was purchased with the proceeds of ordinary income property and any distributions from the trust to the Furrers retained that same ordinary income character.  While the Furrers tried to apply the rules of I.R.C. §72 to the annuity distributions, the Tax Court noted that I.R.C. §664 provides a special rule for annuity distributions from CRATS that was not in their favor. In addition, even if I.R.C. §72 applied, the Tax Court noted that the Furrers would not have been able to use the exclusion rule because they had no “investment in the contract” – the funds used to purchase the contract had never been taxable.

Comment:  I have no answer as to why this case ended up in the Tax Court.  The Furrers were represented by counsel, but there appears to have been some very poor choices made on their behalf.  The counsel of record is from California and the Furreres, as mentioned, farm in Indiana.  I have no explanation as to how that happened. Many aspects of the set-up of the CRATs was wrong, and by not accepting the adjustment made by the IRS Revenue Agent and filing a Tax Court petition, the Furrers ended up losing the charitable deductions that the Revenue Agent had (mistakenly) allowed!  Granted, the Furrers got the accuracy-related penalty to go away, but that was achieved at the price of losing substantial charitable deductions.  I also wonder whether the IRS should have conceded on the penalty issue. The Tax Court’s approach to IRS supervisory approval as a prerequisite to applying penalties has been disregarded by two Circuit Courts of Appeal.  According to the 11th and 9th Circuits, supervisor approval at any time before assessment is enough to satisfy the statute.  See, e.g., Kroner v. Comr., 48 F.4th 1272 (11th Cir. 2022) and Laidlaw’s Harley Davidson Sales, Inc. v. Comr., 29 F.4th 1066 (9th Cir. 2022).  Hopefully the Tax Court’s decision will not be appealed to the Seventh Circuit.  If it is, the prospect for a favorable outcome for the Furrers is slim to none. 

Conclusion

The Furrer case illustrates that the rules surrounding the use of charitable remainder trusts are very complex.  Only competent professionals that are experienced in the rules and use of such trusts should be engaged in utilizing them on behalf of clients.  While the Tax Court said that the Furrers created the trusts after reading an ad in a farm magazine, I do not know the nature and extent of legal and tax advice they received (if any) in advance. If they were guided by tax counsel in setting up the trusts, the counsel was woefully inadequate.  To add insult to injury, as noted, the decision to petition the Tax Court rather than accepting the Revenue Agent’s adjustments put the Furrers in a worse position. 

The Tax Court has not yet officially entered its decision in the Furrer case.  The 90-day timeframe for appeal does not start until the decision document (which is separate from the court’s opinion) has been entered.  Presently, the parties must submit their Tax Court Rule 155 calculations by December 21, 2022.  Those calculations will form the basis of the decision document. 

December 7, 2022 in Estate Planning, Income Tax | Permalink | Comments (0)

Monday, December 5, 2022

Ag Law Developments in the Courts

Overview

It’s been a while since I did a blog article on recent court developments involving farmers, ranchers rural landowners and agribusinesses.  I have been on the road just about continuously for the last couple of months and nine more events remain between now and Christmas.  But, let me take a moment today (and later this week) to provide a summary of some recent court cases involving agriculture.

Recent court opinions involving agriculture – it’s the topic of today’s post.

Jumping Mouse Habitat Designation Upheld

Northern New Mexico Stockman’s Association, et al. v. United States Fish and Wildlife Service, 494 F.Supp.3d 850 (D. N.M. 2020), aff’d., 30 F.4th 1210 (10th Cir. 2022)

In 2014, the U.S. Fish and Wildlife Service (USFWS) listed the New Mexico Meadow Jumping Mouse as an endangered species based on substantial habitat loss and fragmentation from grazing, water management, drought and wildfire.  Accordingly, in 2016, the USFWS designated 14,000 acres along 170 miles of streams and waterways in New Mexico, Arizona and Colorado as critical habitat for the mouse.  The U.S. Forest Service erected fencing around some streams and watering holes in the Santa Fe and Lincoln National Forests that were in the designated area   The plaintiffs, two livestock organizations, with members that graze cattle in those national forests, sued in 2018 claiming that the USFWS failed to sufficiently consider the economic impact of the critical habitat designation.  The trial court dismissed the case, finding that the USFWS was justified in its decision.  The trial court also determined that the USFWS need not compensate the plaintiffs for the reduction in value of the plaintiffs’ water rights.  The trial court reasoned that the USFWS need not consider all of the economic impacts associated with the mouse’s listing when designating critical habitat, only the incremental costs of the designation itself.  The court cited the nine-month annual hibernation period of the mouse giving it only a short time to breed and gain weight for the winter and, as such, the mouse’s habitat needed to remain ideal with tall, dense grass and forage around flowing streams in the designated area.  On appeal, the appellate court affirmed.  The appellate court held that the assessment method of the USFWS for determining the economic impacts of the critical habitat designation on the water rights of the plaintiffs’ members was adequately considered, and that the USFWS had reasonably supported its decision not to exclude certain areas from the critical habitat designation.  

Court Reduces Dicamba Drift Damage Award; Case Continues on Punitive Damages Issue

Hahn v. Monsanto Co., 39 F.4th 954 (8th Cir. 2022)

The plaintiff claimed that his peach orchard was destroyed after the defendants (Monsanto and BASF) conspired to develop and market dicamba-tolerant seeds and dicamba-based herbicides. The plaintiff claimed that the damage to the peaches occurred when dicamba drifted from application to neighboring fields.  The plaintiff claimed that the defendants released the dicamba-tolerant seed with no corresponding dicamba herbicide that could be safely applied.  As a result, farmers illegally sprayed an old formulation of dicamba herbicide that was unapproved for in-crop, over-the-top, use and was "volatile," or prone to drift.  While many cases had previously been filed on the dicamba drift issue, the plaintiff did not join the other litigation because it focused on damages to soybean crops.  Monsanto moved to dismiss the claims for failure to warn; negligent training; violation of the Missouri Crop Protection Act; civil conspiracy; and joint liability for punitive damages.  BASF moved to dismiss those same counts except the claims for failure to warn. The trial court granted the motion to dismiss in part.  Monsanto argued that the failure to warn claims were preempted by the Federal Insecticide, Fungicide, and Rodenticide Act ("FIFRA"), but the plaintiff claimed that no warning would have prevented the damage to the peaches. The trial court determined that the plaintiff had adequately plead the claim and denied the motion to dismiss this claim.  Both Monsanto and BASF moved to dismiss the negligent training claim, but the trial court refused to do so. However, the trial court did dismiss the claims based on the Missouri Crop Protection Act, noting that civil actions under this act are limited to “field crops” which did not include peaches.   The trial court did not dismiss the civil conspiracy claim based on concerted action by agreement but did dismiss the aiding and abetting portion of the claim because that cause of action is no recognized under Missouri tort law.  The parties agreed to a separate jury determination of punitive damages for each defendant.  Bader Farms, Inc. v. Monsanto Co., et al., No. MDL No. 1:18md2820-SNLJ, 2019 U.S. Dist. LEXIS 114302 (E.D. Mo. July 10, 2019).  The jury found that Monsanto had negligently designed or failed to warn for 2015 and 2016 and the both defendants had done so for 2017 to the present.  The jury awarded the plaintiff $15 million in compensatory damages and $250 million in punitive damages against Monsanto for 2015 and 2016.  The jury also found that the defendants were acting in a joint venture and in a conspiracy.  The plaintiff submitted a proposed judgment that both defendants were responsible for the $250 million punitive damages award.  BASF objected, but the trial court found the defendants jointly liable for the full verdict in light of the jury’s finding that the defendants were in a joint venture.  Bader Farms, Inc. v. Monsanto Co., et al., MDL No. 1:18-md-02820-SNJL, 2020 U.S. Dist. LEXIS 34340 (E.D. Mo. Feb. 28, 2020).  BASF then moved for a judgment as a matter of law on punitive damages or motion for a new trial or remittitur (e.g., asking the court to reduce the damage award), and Monsanto moved for a judgment as a matter of law or a new trial.  The trial court, however, found both defendants jointly liable, although the court lowered the punitive damages to $60 million after determining a lack of actual malice.  The trial court did uphold the $15 million compensatory damage award upon finding that the correct standard under Missouri law was applied to the farm’s damages.  Bader Farms, Inc. v. Monsanto Co, et al., MDL No. 1:18md2820-SNLJ, 2020 U.S. Dist. LEXIS 221420 (E.D. Mo. Nov. 25, 2020).  The defendants filed a notice of appeal on December 22, 2020.     

On appeal, the appellate court affirmed the trial court on the causation issue noting that the defendant retained direct contact with the farmers and exercised some degree of control over their actions.  As such, the defendant was aware of the foreseeable consequences that could come from not controlling the farmers’ actions more closely. On the compensatory damage issue, the defendant argued that compensatory damages should be measured by the difference in the value of the orchard before and after the damage.  The appellate court disagreed, noting that such a calculation only applied when the victim is the owner of the land and not a tenant as was the plaintiff.  Thus, compensatory damages were properly measured by lost profits.   The defendant argued the damages were speculative, but the court found that Bader Farms had provided years of financial statements to show the usual costs and profits associated with farming the orchard. The appellate court determined that there was no doubt the defendant had full control over the critical aspects of the project. In 2007, BASF had relinquished their rights to the seed technology to the defendant, so they could not control something they had no rights to. The appellate court also affirmed the finding that BASF and Monsanto had engaged in a civil conspiracy by agreeing to sell products unlawfully and enabling the widespread use of a product that was illegal to spray during the growing season. As members of the civil conspiracy, BASF was correctly found to be severally liable for the damages. The appellate court also found that Bader Farms provided clear and convincing evidence that the companies had acted with reckless indifference, but the two had different degrees of culpability. The trial court should have assessed the punitive damages of the Monsanto and BASF separately. Thus, the appellate court affirmed in part and reversed and remanded the punitive damages judgment to the trial court.

Court Decides to Resolve Property Dispute by Requiring Parties to Use the Existing Property Line

Barlow v. Saxon Holdings Trust, No. SD37361, 2022 Mo. App. LEXIS 657 (Mo. Ct. App. Oct. 21, 2022)

The plaintiff and her husband purchased land in 1987 by warranty deed that included the language, “running thence Southwesterly along the fence 40 rods.” At the time the plaintiff purchased the property, a fence that ran north to south existed and the plaintiff believed and acted like she owned the land up to that fence. The defendant purchased the neighboring land in 2011 and executed a warranty deed that included the language, “beginning at the NE corner of the NE ¼ of said Section 23 and running SW 40 rods.” In the spring of 2020, the defendant hired a surveyor who informed the defendant that his property extended onto the plaintiff’s property to the “40-rod line.” The defendant put up an electric fence on the disputed property to claim it.  In response the plaintiff hired a surveyor who determined the property line was on the original fence line. The plaintiff sued to quiet title. The trial court found ambiguity between the deeds and resolved the ambiguity in favor of the plaintiff and held the plaintiff had adversely possessed the land. The defendant appealed. The appellate court recognized that the deeds individually did not show patent ambiguity, but the difference between the two on the location of property line did create an ambiguity. The appellate court determined that one way to resolve the ambiguity would be to have the parties continue to occupy the land the way they had in accordance with one of the deeds or constructions. This was the trial court’s approach, and the appellate court affirmed the trial court on this point.  The appellate court also noted that the trial court had found the plaintiff’s surveyor credible, and that credibility of a witness was a determination to be left to the trial court’s discretion that the appellate court would not disturb.  The appellate court affirmed the trial court’s resolution of the deed in favor of the plaintiff and determined it need not address the adverse possession claim.

Oil and Gas Lease on Disputed Property Invalidates Adverse Possession

Cottrill v. Quarry Enterprises, LLC, No. 2022 CA 00011, 2022 Ohio App. LEXIS 3191 (Ohio Ct. App. Sept. 27, 2022)

The plaintiff claimed that she had successfully adversely possessed the defendant’s property by receiving title to the property in 1971 from her mother and caring for the land by mowing and maintaining it and using it for recreational events for herself and family. The trial court granted summary judgment for the defendant, finding that the plaintiff failed to establish exclusive possession over the land due to an existing oil and gas lease that the defendant had executed. The plaintiff appealed, claiming that the lease did not invalidate her exclusive use. To show exclusive use, the plaintiff did not have to be the only person who used the land but needed to be the only person who asserted their right to possession over the land. The appellate court found that the oil and gas that existed on the property began in 1958. For the entirety of the time that the plaintiff claimed she had adversely possessed the property, the oil and gas company had the right of possession over the land in dispute, invalidating the plaintiff’s claim.

December 5, 2022 in Civil Liabilities, Environmental Law, Real Property, Regulatory Law | Permalink | Comments (0)

Sunday, November 20, 2022

Tax Issues Associated with Easement Payments – Part 2

Overview

In Part 1 of this series, I noted that an increasingly common issue for rural landowners is that of companies seeking easements across farmland.  Often the easements are sought by energy companies for the placement of pipelines or some form of transmission line.  The easement transaction involves the landowner receiving compensation for the loss of certain property rights.  In Part 1 of this series I focused on the nature of the transaction and the likely tax characterization of the payments a landowner might receive.  In today’s Part 2, I look more in-depth at the type of payments a landowner might receive and how they should be reported for tax purposes.

Tax issues associated with easement payments – Part 2 in a series.  It’s the topic of today’s post.

Types of Payments

“Bonus” payments.  Sometimes a company interested in acquiring an easement will pay an upfront amount to the landowners.  The payment will typically reserve the exclusive right to obtain an easement for a period of time with the landowner retaining the payment regardless of whether the company actually acquires an easement within the specified timeframe.  The landowner properly reports such a “bonus payment” on Schedule E with the amount flowing to Form 1040.  The company would issue a Form 1099-MISC to the landowner, showing the amount of the payment in Box 1. 

Damage payments.  As noted above, an initial payment made to a landowner for acquisition of an easement could result in income to the landowner or a reduction of the landowner’s basis in the land, or both.  That means that a lump sum payment for the right to lay a pipeline across a farm may result in income, a reduction in basis of all or part of the land or both.  An amount for actual, current damage to the property caused by construction activities on the property subject to the easement may be able to be offset by basis in the affected property.  Examples of this type of payment would be payments for damage to the property caused by environmental contamination and soil compaction. A payment for damage to growing crops, however, is treated as a sale of the crop reported either on line 2 of Schedule F or line 1 of Form 4835 for a non-material participation crop-share landlord.  Any payment for future property damage (e.g., liquidated damages), however, is generally treated as rent and reported as ordinary income.

Severance damages.  Involuntary conversion concepts may also come into play in an easement transaction.  “Severance damages” might be paid when only a part of a property is directly impacted by an easement as compensation for loss of value in the portion not directly impacted.  These damages might be paid, for example, when the easement impairs access to the property.  But it is important that the easement transaction (or condemnation proceeding if there is one) refer specifically to such damages as “severance damages.”  If they are not specifically delineated, they will be treated simply as damage payments.  This is an important distinction.  Under the involuntary conversion rules of I.R.C. §1033, it is possible for the landowner to defer gain resulting from the payment of severance damages by using the severance damages to restore the property that the easement impacts or by investing the damages in a timely manner in other qualified property. 

There is no requirement that the landowner apply the severance damages to the portion of the property subject to the easement.  Also, if the easement so impacts the remainder of the property where the pre-easement use of the property is not possible, the sale of the remainder of the property and use of the sale proceeds (plus the severance damages) to acquire other qualified property can be structured as a deferral transaction under I.R.C. §1033.

Temporary easement payments.  Some easements may involve an additional temporary easement to allow the holder to have space for access, equipment and material storage while conduction construction activities on the property subject to the easement.  A separate designation for a temporary easement for these purposes will generate rental income for allocated amounts.  As an alternative, it may be advisable to include the temporary space in the perpetual easement which is then reduced after a set amount of time.  Under this approach, it is possible to apply the payment attributable to the temporary easement to the tract subject to the permanent easement.  Alternatively, it may be possible, based on the facts, to classify any payments for a temporary easement as damage payments.

Negative easements.  A landowner may make a payment to an adjacent or nearby landowner to acquire a negative easement over that other landowner’s tract.  A negative easement is a use restriction placed on the tract to prevent the owner from specified uses of the tract that might diminish the value of the payor’s land.  For instance, a landowner may fear that their property would lose market value if a pipeline, high-power transmission line or wind aerogenerator were to be placed on adjacent property.  Thus, the landowner might seek a negative easement over that adjacent property to prevent that landowner from granting an easement to a utility company for that type of activity from being conducted on the adjacent property.  The IRS has reached the conclusion that a negative easement payment is rental income in the hands of the recipient.  F.S.A. 20152102F (Feb. 25, 2015).  It is not income derived from the taxpayer’s trade or business.  In addition, the IRS position taken in the FSA could have application to situations involving the government’s use of a taxpayer’s property to enhance wildlife and/or conservation. 

Lease Payments

A right of use that is not an easement generates ordinary income to the landowner and is, potentially, net investment income subject to an additional 3.8 percent tax.  I.R.C. §1411.  Thus, transactions that are a lease or a license generate rental income with no basis offset.  For example, when a landowner grants surface rights for oil and gas exploration, the transaction is most likely a lease.  Easements for pipelines, roads, surface sites and similar interests that are for a definite term of years are leases.  Likewise, if the easement is for “as long as oil and gas is produced in paying quantities,” it is lease. 

The IRS has ruled that periodic payments that farmers received under a “lease” agreement that allowed a steel company to discharge fumes without any liability for damage were rent.  In Rev. Rul. 60-170, 1960-1 C.B. 357, the payments from the steel company were to compensate the farmers for damages to livestock, crops, trees and other vegetation because of chemical fumes and gases from a nearby plant.  The IRS determined that the payments were rent and, as such, were not subject to self-employment tax.

Note:  A lease is characterized by periodic payments.  A lease is also indicated when failure to make a payment triggers default procedures and potential forfeiture.    In addition, lease payments are not subject to self-employment tax in the hands of the recipient regardless of the landowner’s participation in the activity.  Accordingly, the annual lease payment income would be reported on Schedule E (Form 1040), with the landowner likely having few or no deductible rental expenses. 

Eminent Domain

Proposed easement acquisitions can be contentious for many landowners.  Often, landowners may not willingly grant a pipeline company or a wind energy company, for example, the right to use the landowners’ property.  In those situations, eminent domain procedures under state law may be invoked which involves a condemnation of the property.  The power of eminent domain is the right of the state government (it’s called the “taking power” for the federal government) to acquire private property for public use, subject to the constitutional requirement that “just compensation” be paid.  While eminent domain is a power of the government, often developers of pipelines and certain other types of energy companies are often delegated the authority to condemn private property.  The condemnation award (the constitutionally required “just compensation”) paid is treated as a sale for tax purposes. 

Note:  The IRS view is that a condemnation award is solely for the property taken.  But, if the condemnation award clearly exceeds the fair market value of the property taken, a court may entertain arguments about the various components of the award.  Thus, it’s important for a landowner to preserve any evidence that might support allocating the award to various types of damages. 

Involuntary conversion.  While a condemnation award that a landowner receives is treated as a sale for tax purposes, it can qualify for non-recognition treatment under the gain deferral rules for involuntary conversions contained in I.R.C. §1033.  Rev. Rul. 76-69, 1976-1 C.B. 219; Rev. Rul. 54-575, 1954-2 C.B. 145.  I.R.C. §1033 allows a taxpayer to elect to defer gain realized from a condemnation (and sales made under threat of condemnation) by reinvesting the proceeds in qualifying property within three years.  See, e.g., Rev. Rul. 72-433, 1972-2 C.B. 470

The election to defer gain under I.R.C. §1033 is made by simply showing details on the return about the involuntary conversion but not reporting the condemnation gain realized on the return for the tax year the award is received.  A disclosure that the taxpayer is deferring gain under I.R.C. §1033, but not disclosing details is treated as a deemed election. 

Note:  If the taxpayer designates qualified replacement real estate on a return within the required period and purchases the property at the anticipated price within three years of the end of the gain year, a valid election is complete. If the purchase price of the replacement property is lower than anticipated, the resulting gain should be reported by amending the return for the election year. If qualified replacement property within the required three-year period, the return for the year of the election must be amended to report the gain.

Conclusion

Rural landowners are facing easement issues not infrequently.  Oil and gas pipelines, wind energy towers, and high voltage power lines are examples of the type of structures that are associated with easements across agricultural land.  Seeking good tax counsel can help produce the best tax result possible in dealing with the various types of payments that might be received.

November 20, 2022 in Income Tax | Permalink | Comments (0)

Friday, November 18, 2022

Tax Issues Associated With Easement Payments - Part 1

Overview

Rural landowners often receive payment from utility companies, oil pipeline companies, wind energy companies and others for rights-of-way or easements over their property.  The rights acquired might include the right to lay pipeline, construct aerogenerators and associated roads, electric lines and similar access rights.  Payments may also be received for the placement of a “negative” easement on adjacent property so that the neighboring landowner is restricted from utilizing their property in a manner that might decrease the value of nearby land.

How are these various types of payment to be reported for tax purposes.  It’s an important issue for many farmers, ranchers and rural landowners.

Tax issues with easement payments Part 1 of a series – it’s the topic of today’s post.

Characterizing the Transaction

The receipt of easement payments raises several tax issues.  The payments may trigger income recognition or could be offset partially or completely by the recipient’s income tax basis in the land that the easement impacts.  Also, a sale of part of the land could be involved.  In addition, a separate payment for crop damage could be involved.

Sale or exchange.  A sale or exchange triggers gain or loss for income tax purposes.  I.R.C. §1001.  Is the grant of an easement a taxable event?  It depends.  In essence, a landowner’s grant of an easement amounts to a sale of the land if after the easement grant the taxpayer has virtually no property right left except bare legal title to the land.  For instance, in one case, the grant of an easement to flood the taxpayer’s land was held to be a sale.  Scales v. Comr., 10 B.T.A. 1024 (1928), acq., 1928-2 C.B. 35.  In another situation, the IRS ruled that the grant of an easement for air rights over property adjoining an air base that caused the property to be rendered useless was a sale.  Rev. Rul. 54-575, 1954-2 C.B. 145.  The grant of a perpetual easement on a part of unimproved land to the state for a highway, as well as the grant of a permanent right-of-way easement for use as a highway have also been held to be a sale.  Rev. Rul. 72-255, 1972-1 C.B. 221; Wickersham v. Comr., T.C. Memo. 2011-178.  Also, the IRS has determined that the grant of a perpetual conservation easement on property in exchange for “mitigation banking credits” was held to be a sale or exchange.  Priv. Ltr. Rul. 201222004 (Nov. 29, 2011).  Under the facts of the ruling, the taxpayer acquired a ranch for development purposes, but did not develop it due to the presence of two endangered species.  The taxpayer negotiated a Mitigation Bank Agreement with a government agency pursuant to which the taxpayer would grant a perpetual conservation easement to the government in return for mitigation banking credits to allow the development of other, similarly situated, land.  The IRS determined that the transaction constituted a sale or exchange. 

Note:  The buyer of mitigation credits is likely to be a dealer that won’t hold the credits long enough to achieve capital gain status on sale.  But, the ultimate answer to the question of the buyer’s tax status is a fact-dependent determination. 

Ordinary income or capital gain?  If the payments for the grant of an easement are, in effect, rents for land use the characterization of the payments in the hands of the landowner is ordinary income.  For example, in Gilbertz v. United States, 574 F. Supp. 177 (D. Wyo. 1983), aff’d., and rev’d. by, 808 F.2d 1374 (10th Cir. 1987), the taxpayers, a married couple, raised cattle on their 6,480-acre ranch.  They held title to the surface rights and a fractional interest in the minerals.  The federal government reserved most of the mineral rights.  In 1976 and 1977, the taxpayers negotiated more than 50 contracts with oil and gas lessees and pipeline companies to receive payments for anticipated drilling activities on the ranch.  The taxpayers reported the payments as non-taxable recovery of basis in the entire ranch with any excess amount reported as capital gain.  The IRS disagreed, asserting that the payments were taxable as ordinary income.  The taxpayers paid the asserted deficiency and sued for a refund.

The trial court dissected the types of payments involved concluding that the “Release and Damage Payments” were not rents taxable as ordinary income.  Instead, the payments from pipeline companies for rights-of-ways and damage to the land involved a sale or exchange and were taxable as capital gain – the pipeline companies had obtained a perpetual right-of-way.  On further review, the appellate court held that the “Release and Damage Payments” were not a return of capital to the taxpayers that qualified for capital gain treatment to the extent the amount received exceeded their basis in the land.  However, the appellate court affirmed the trial court’s holding that the amounts received from the pipeline companies were properly characterized as the sale of a capital asset and constituted a recovery of basis with any excess taxable as capital gain. 

Limited Easements.  The grant of a limited easement is treated as the sale of a portion of the rights in the land impacted by the easement, with the proceeds received first applied to reduce the basis in the land affected.  Thus, if the grant of an easement deprives the taxpayer of practically all of the beneficial interest in the land, except for the retention of mere legal title, the transaction is considered to be a sale of the land that the easement covers.  That means that gain or loss is computed in the same manner as in the case of a sale of the land itself under I.R.C. §1221 or §1231.  In addition, only the basis of the land that is allocable to that portion is reduced by the amount received for the grant of the easement.  Any excess amount received is treated as capital gain.  The allocation of basis does not require proration based on acreage.  Instead, basis allocation is to be “equitably apportioned” based likely on fair market value or assessed value at the time the easement is acquired. 

Location of the easement.  In rare situations where the entire property is impacted by the easement, the entire basis of the property can be used to offset the amount received for the easement.  This might be the situation where severance damage payments are received.  These types of payments may be made when the easement bisects a landowner’s property with the result that the property not subject to the easement can no longer be put to its highest and best use.  This is more likely with commercial property and agricultural land that has the potential to be developed.  Severance damages may be paid to compensate the landowner for the resulting lower value for the non-eased property.  If severance damages exceed the landowner’s basis in the property not subject to the easement, gain is recognized. 

Note:  Whether the easement impacts the entire parcel is a question of fact.  An easement located across a corner of a tract or along a fence line, may be less likely to be found to impact the entire parcel than would an easement down the middle of a tract. 

Conclusion

In Part 2 in this series, I will break down the various types of payments that landowners receive for easements and the proper reporting of those payments.  I will also look at the possibility of eminent domain concepts applying to the easement transaction.

November 18, 2022 in Income Tax | Permalink | Comments (0)