Wednesday, June 29, 2022

S Corporation Dissolution – Part Two; Divisive Reorganization Alternative


In Part One earlier this week, the focus was on the tax issues associated with liquidating an S corporation.  In Part One, I noted that the same general liquidation rules apply to an S corporation as to a C corporation.  However, the tax cost is significantly smaller unless the S corporation is subject to built-in gains taxation.  One other point to note is that an S corporation must be liquidated in the same tax year as the sale/distribution of assets to produce the desired tax result.  If a sale/distribution of assets is accomplished in one tax year and the liquidation of the corporation in the following year, the capital loss produced upon liquidation would not offset the capital gain generated by the sale of assets.  In such a case, the capital loss produced upon liquidation would only offset other long-term capital gains for the tax year of the liquidation, plus $3,000 of ordinary income.  The remaining long-term capital loss would be carried forward to subsequent tax years.

An alternative to liquidating an S corporation is a divisive reorganization – and it’s the topic of today’s post.

Alternative to Liquidation – Divisive Reorganization

An alternative to liquidating an S corporation at the death of the surviving spouse is a divisive reorganization under I.R.C. §355.  This can be an option where heirs exist that are interested in continuing the farming/ranching business.  In a divisive reorganization, part of the assets of a parent corporation are split-off to one or more (former) shareholders through a new corporation.  A divisive reorganization typically involves three major steps:

  • Formation of a new subsidiary corporation;
  • Transfer of part of the parent corporation’s assets to the subsidiary (usually tax-free); and
  • Distribution of the stock in the subsidiary to some of the parent corporation’s shareholders in exchange for their stock in the parent corporation.

A divisive reorganization can be used to divide a single, functionally integrated business (e.g. farming operation) into two separate businesses and will allow surviving shareholders to postpone income recognition that would otherwise occur through corporate liquidation at the death of the first generation shareholders.  Treas. Regs. §§1.355-1(b) & 1.355-3(c), Examples 4 & 5.  See also, Rev. Rul. 75-160, 1975-1 CB 112; Coady v. Com’r., 33 T.C. 771 (1960), acq., 1965-2 C.B. 4, non. acq., 1960-2 C.B. 8 (withdrawn), aff’d., 289 F.2d 490 (6th Cir. 1961); United States v. Marett, 325 F.2d 28 (5th Cir. 1963).

For a divisive reorganization to be tax-free, five tests under IRC §355 must be met:

  • Control test;
  • Active conduct of a business” test;
  • Distribution of “solely stock or securities”;
  • Parent corporation must distribute all of the stock in the subsidiary (or enough for control); and
  • Reorganization must not be used “primarily as a device for distribution of earnings and profits.”

While, technically, these five tests must be satisfied for a divisive reorganization to be tax-free, in reality, only two of the tests generally create issues that could prevent a reorganization from being utilized.  The two problematic requisites/tests are the active conduct of trade or business requirement and the trade or business requirement. 

Active conduct of trade or business.  For purposes of I.R.C. §355, a trade or business must have been actively conducted by the distributing parent corporation throughout the five-year period ending on the date of distribution.  The regulations under I.R.C. §355 expand this requirement and require continued operation of the business or businesses existing before the implementation of the divisive reorganization. Accordingly, a transitory continuation of one of the active businesses would not satisfy the active trade or business test provided by these regulations.  I.R.C. §355(b)(1)(A); Treas. Reg. §1.355-3(a)(1).

Guidance on the active trade or business requirement:

  • The holding of stock and securities for investment purposes will not constitute the active conduct of a trade or business. Also, the ownership and rental of real or personal property (e.g., farm real estate) will not constitute the active conduct of a trade or business unless the owner performs significant services with respect to the operation and management of the property. Treas. Reg. §1.355-3(b)(2)(iv).
  • Rul. 73-234, 1973-1 CB 180 involved a corporate farming operation where the active conduct of a trade or business test was satisfied. The facts involved a livestock share lease with active involvement.  The IRS states, “the fact that a portion of a corporation’s business activities is performed by independent contractors will not preclude the corporation from being engaged in the active conduct of a trade or business if the corporation itself directly performs active and substantial management and operational functions.” 
  • The active conduct of a trade or business test was not met in Rev. Rul. 86-126,1896-2 CB 158. The facts involved a corporation that cash rented farmland.  There was a sharing of expenses.  The tenant planted, raised, harvested and sold the crops using the tenant’s equipment.  The activities of the corporate officers in leasing the land, providing advice and reviewing accounts were determined to not be substantial enough to meet the active trade or business requirement. 

Note.  It does not appear that the use of a farm manager (agent) to perform these services for the corporation necessarily impairs the active conduct of a trade or business requirement.  Webster Corp. v. Comr., 25 T.C. 55 (1955), acq. 1960-2 C.B. 4,.7, aff’d., Comr. v. Webster Corp., 240 F 2d 164 (2d Cir. 1957).  However, the officers and directors must be active in directing the activities of the agent, not mere spectators.

Caution - Tax Planning:  The corporation’s officers and directors’ activities for the pre-distribution (5 yr.) and post-distribution (suggested as 2 years or more) time frames should be well documented before a divisive reorganization is undertaken.  Also, payment of at least nominal officer/director salaries for services performed should be considered.

Trade or business purpose.  Treas. Reg. §1.355-2(b)(2) provides that a corporate business purpose must be a real and substantial non-federal tax purpose germane to the business of the distributing corporation, as well as the controlled corporation.  A shareholder purpose (e.g. accomplishing personal estate planning objectives) by itself, is not a corporate business purpose.  However, the regulations go on to explain that a shareholder purpose may be so nearly co-extensive with a corporate business purpose as to preclude any distinction between them, in which case the transaction meets the corporate business purpose requirement.  A transaction motivated in substantial part by a corporate business purpose will not fail the business purpose requirement merely because it is motivated in part by non-federal tax shareholder purposes.

Note.  According to the Treasury Regulation, the whether the business purpose test has been satisfied is generally readily ascertainable (e.g. shareholder disputes or potential therefore, etc.). 

Examples.  Rev. Rul. 2003-52, 2003-1 C.B. 960 involved a family farming corporation that the parents and their two adult children owned.  The children provided active management.  One child intended to focus on the livestock side of the business while the other child preferred to operate the grain farming operation.  The corporation reorganized into two corporations, with one child receiving the stock of the livestock business and the other child receiving the stock of the grain enterprise.  The IRS approved the reorganization on the basis that it was motivated by a substantial non-tax business purpose even though the reorganization advanced the personal estate planning goals of the parents and promoted family harmony. 

Private Letter Ruling 200323041 (Mar. 11, 2003) involved the separation of a grain farming business between siblings after their father’s death.  The IRS concluded that a corporate split-off that is undertaken to avoid shareholder disputes in a family-owned grain farming corporation (engaged in a single line of business) will constitute a divisive reorganization under I.R.C. §368(a)(1)(D) and the stockholders of the split-off corporation would not recognize gain or loss under I.R.C. §355.  See also Priv. Ltr. Rul. 200425033 (Mar. 4, 2004) and Priv. Ltr. Rul. 200422040 (Feb. 13, 2004)(same).  

Note.  The IRS has ruled that the post-distribution business purpose requirement of I.R.C. Reg. §1.355-2(b) remained satisfied even though the business purpose could not be achieved due to an unexpected change in circumstances following the divisive reorganization. In so ruling, the IRS noted that the “regulations do not require that the corporation in fact succeed in meeting its corporate business purpose, as long as, at the time of the distribution, such a purpose exists and motivates, in whole or substantial part, the distribution.”  Rev. Rul. 2003-55, 2003-1 C.B. 961.

Other considerations.  While I.R.C. §355 requires that the corporation seeking a divisive reorganization be engaged in the active conduct of a trade or business it does not require that all of the assets of the corporation be devoted to or used in an active trade or business.  The corporation may hold non-qualifying assets (generally less than 5% of total) as long as it is engaged in the active conduct of a trade or business. Treas. Reg. §1.355-(3)(a)(ii).

Planning recommendation.  It may be advisable to have all shareholders enter into an agreement providing that any shareholder who violates the post-distribution active trade or business rule agrees to pay all taxes incurred by all shareholders if the divisive reorganization fails to pass IRS scrutiny. 

Note:  In Rev. Proc. 2003-48, 2003-2 C.B. 86, the IRS stated that, for ruling requests after August 8, 2003, it would no longer rule on whether (1) a distribution of stock of a controlled corporation is carried out for business purposes, (2) the transaction is used principally as a device, or (3) a distribution and an acquisition are part of a plan under IRS §355(e).  Rather, taxpayers seeking a ruling under IRS §355 must submit representations on these issues for review and determination by IRS.


Tax issues do arise when an S Corporation is dissolved.  Fortunately, certain planning steps can be taken to avoid the heirs being denied the benefit of a basis increase in the corporate assets to fair market value at death.  A reorganization is one possible tax-efficient planning step that could be utilized.  Other planning options (not discussed in this two-part series) include liquidating the S corporation via a merger, and conversion of the S corporation to a partnership. 

June 29, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Monday, June 27, 2022

S Corporation Dissolution – Part 1


The S corporation as an entity choice for the operating part of a farming or ranching business has waned over the years in favor of the general partnership (for larger operations) or the limited liability company (LLC).  While it can provide self-employment tax savings, those savings may also be achieved by using a different entity form.  Also, an S corporation requires a lot of administrative “maintenance” that some might find too cumbersome.  But, an S corporation does avoid the corporate level tax as a “flow-through” entity and is generally easy to switch to a different entity form (depending on the facts). 

While an S corporation might be an acceptable entity choice for professional service businesses such as law firms and accounting firms, it tends not to work as well as the operating entity for a farm or ranch.  The S corporation can also present some tricky issues upon liquidation.

Part one of a two-part series – tax (and income tax basis) issues upon liquidation of an S corporation.  It’s the topic of today’s post. 

For farm businesses large enough to qualify for more than one government farm program payment limit, a partnership will allow qualification.  An S corporation will be limited to a single payment limit. Another drawback of the S corporation is the adverse impact upon death of a shareholder.  That adverse impact is shown in the fact that the heirs of the deceased shareholder do not get the benefit of a step-up in basis in the underlying corporate assets to fair market value as of the date of the shareholder’s death.  Unlike a partnership where the heirs receive a full income tax basis increase for all of the underlying partnership assets, an heir of an S corporation shareholder only receives a basis increase in the corporate stock equal to the fair market value of the S corporation at death. 

Shareholder Death and Corporate Liquidation

Upon the death of an S corporation shareholder, the decedent’s stock ownership interest receives a step-up in basis to fair market value.  This basis adjustment coupled with the basis increase that results from gain recognition inside the corporation upon liquidation of corporate assets (e.g. sale/distribution of assets, real estate, etc.) and the pass-through of the taxation of this gain to the shareholder (on Schedule K-1), results in only one level of taxation being incurred on liquidation, and that is at the shareholder level. 

Since stock basis has been increased by death and pass-through of income, no gain recognition results when cash or property is distributed to the decedent’s estate/heirs (in exchange for stock) to complete the liquidation, since the pass-through gain (Schedule K-1) to the estate/heirs will be offset by a matching loss from liquidation of the stock.

Property Distributions

Distributions of property (other than cash) are treated as though the corporation sold the property to the shareholder for its fair market value, pursuant to I.R.C. §311(b).  The corporation recognizes gain to the extent the property’s fair market value exceeds its adjusted basis.  When appreciated property is distributed to an “S” corporate shareholder in exchange for stock, the gain recognized at the corporate level passes through to all shareholders (via Schedule K-1) based on their percentage ownership in the corporation. 

If the “S” corporation only had one shareholder whose interest is liquidated at death, gain recognition does not cause taxation problems due to a matching loss offset resulting from the stock basis adjustments discussed above.  In other words, when the S corporation recognizes table gain, that gain increases the estate’s basis in the stock in an amount equal to the taxable gain that the S corporation recognizes.  This taxable gain is reported to the estate on the corporation’s final Schedule K-1 (Form 1120S).  The estate’s tax basis in its S corporation stock is increased to the fair market value of the S corporation’s stock upon the shareholder’s death and is further increased as a result of the deemed sale of the S corporation stock upon liquidation.  Simultaneously, the estate recognizes a taxable loss equal to the gain reported to the estate on the corporation’s final Schedule K-1.  The loss on the deemed sale of the S corporation stock in the liquidation is reported on the estate’s or heir’s Schedule D (Form 1040 or Form 1041).  Typically, the S corporation gain on the Schedule K-1 (Form 1120S) reported on Schedule E (Form 1040 or Form 1041) and the loss on the Schedule D will net out with no tax due by the estate or the heirs for the S corporation gain on liquidation. 

Caution.  In some instances, a farming S corporation may have one spouse as a shareholder and own ordinary income assets such as grain and equipment.  Upon the shareholder’s death with the corporate stock passing to the surviving spouse, the sale of those assets by the surviving spouse will trigger ordinary income to the surviving spouse that will be taxed at the highest rate.  If the surviving spouse then liquidates the S corporation, a capital loss will be triggered in a like amount that will be reported at $3,000 per year (or offset against other capital gains). 

Note.  The business will now have a new step-up in basis in all of its asset which the heirs can contribute tax-free to a new partnership. 

However, if the “S” corporation has more than one shareholder, a distribution of property to a single shareholder (deceased or otherwise) in liquidation of their stock interest will result in a taxation event for all corporate shareholders.

Example:  Assume that Farm Corp. has four equal shareholders.  Mary, a shareholder who owns 25 percent of the S corporation’s stock dies.  The corporation distributes farm real estate to Mary’s estate in liquidation of her stock interest.  Mary’s estate would report 25 percent of any gain at distribution and would be able to offset this taxable gain through a matching capital loss created by the liquidation of her stock in Farm Corp.  Unfortunately, the other shareholders would be responsible for paying tax on the remaining 75 percent of any gain.

Note:  An alternative to avoid this taxation problem when there are multiple shareholders in an S corporation is to simply have the remaining shareholders purchase the stock of the deceased shareholder.  Implementing a corporate buy-sell agreement among the shareholders might be advantageous to accomplish the desired result.

A shareholder’s income tax basis in distributed property distributed by the corporation is the property’s fair market value at the date of distribution.  But the distributee shareholder’s holding period begins when the shareholder actually or constructively receives the property, because the distribution is treated as if the property were sold to the shareholder at its fair market value on that date.  Since the shareholder’s basis in the property is its fair market value (rather than a carryover of the corporation’s basis), the corporation’s holding period does not tack on to the shareholder’s holding period.  Thus, the redeeming shareholder would need to hold distributed property for one year after distribution prior to sale to achieve capital gain income tax treatment on a subsequent sale.


In Part Two, I will take a look at some alternatives for avoiding the negative tax consequences associated with liquidating an S corporation.

June 27, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Saturday, June 25, 2022

Tax Issues with Customer Loyalty Reward Programs


Many companies, including agribusiness retailers, utilize customer loyalty programs as a means of attracting and keeping customers.  Under the typical program, each time a customer or “member” buys a product or service, the customer earns “reward points.”  The reward points accumulate and are computed as a percentage of the customer’s purchases.  When accumulated points reach a designated threshold, they can then be used to buy an item from the retailer or can be used as a discount on a subsequent purchase (e.g., cents per gallon of off a fuel purchase).  Some programs make be structured such that a reward card is given to the customer after purchases have reached the threshold amount.  The reward card typically has no cash value and expires within a year of being issued. 

A “loyalty rewards” program is a cost to the retailer and a benefit to the customer, triggering tax issues for both. 

Tax issues associated with customer “loyalty” programs – it’s the topic of today’s post.

Treasury Regulations – Impact on Retailers

When is economic performance?  Treasury Regulation §1.461-4(g)(3) addresses the treatment of rebates and refunds and specifies that economic performance occurs when payment is made to the person to whom the liability is owed.  The IRS position is that a retailer cannot claim a deduction until the points are actually redeemed because the event fixing the retailer’s liability occurs when a member reaches the minimum number of points for redemption and actually redeems the points. Internal Revenue Manual; Priv. Ltr. Rul. 200849015 (Dec. 5, 2008).   But, for an accrual basis taxpayer, the taxpayer’s liability becomes fixed (and, hence, a deduction can be claimed) when the customers earn the rewards.  Giant Eagle, Inc. v. Comr., 822 F.3d 666 (3d Cir. 2016), rev’g., T.C. Memo. 2014-146. A deduction is not deferred until the customer redeems the rewards. 

Note:   The IRS does not agree on this point and only follows the Third Circuit’s decision in cases appealable to the Third Circuit that cannot be distinguished.  A.O.D. 2016-03 (Oct. 3, 2016).

Two requirements.  Treasury Regulation §1.451-4 addresses trading stamps and premium coupons that are issued with sales and are redeemable in cash, merchandise or “other property.”  Most retailer customer loyalty programs likely satisfy both tests. The National Office of IRS, in a matter involving an accrual basis supermarket chain that had a rewards program that allowed customers to get a certain amount of gas for free depending on purchases of products, said that the supermarket could take a current deduction for the value of the gas rewards. F.S.A. 20180101F (Nov. 7, 2017).   The IRS reached that result by concluding that the gas rewards were being redeemed for “other property.” Treas. Reg. §1,451-4(a)(1).  Clearly, the rewards were issued on the basis of purchases.

Loyalty reward programs that might not satisfy the “redeemable in cash, merchandise or other property test” might be programs that provide customers with cents-off coupons.  With these programs, the IRS could argue that a customer’s right to redeem the coupon is conditioned on a future purchase and, as a result, the coupon liability should be matched to the later sale when the liability becomes fixed and determinable and economic performance occurs.  I.R.C. §461.

Timing of deduction.  The regulation provides that the estimated redemption costs of premium coupons issued in connection with the sale of merchandise is deductible in the year of the merchandise sale, even though the reserves for future estimated redemption costs are not fixed and determinable and don’t otherwise meet the economic performance rules of the all-events test.  Internal Revenue Manual

Retailers with loyalty programs that satisfy the two tests of Treas. Reg. §1.451-4 may find the use of this method preferential from a tax standpoint.  For retailers that can qualify but are not presently using the Treas. Reg. §1.451-4 approach, a method change is required. The method change is achieved by using the advance consent procedures of Rev. Proc. 97-27. 1997-1 C.B. 680. If a loyalty program does not meet the requirements to use Treas. Reg. §451-4, the redemption liability is treated as a deduction and not as an exclusion from income.  Thus, the redemption liability is taken into account in the tax year in which the liability becomes fixed and determinable and economic performance occurs under I.R.C. §461.  That will, in general, be the year in which the customer redeems the loyalty rewards. 

Tax Issues for Customers – The Anikeev case

A recent Tax Court opinion provides guidance on how a taxpayer, as a user of a rewards program is to report the transactions on the taxpayer’s return, and whether the IRS “rebate rule” is applicable.  In Anikeev, et ux. v. Comr., T.C. Memo. 2021-23.   the petitioners, husband and wife, spent over $6 million on their credit card between 2013 and 2014. Nearly all of these purchases were for Visa gift cards, money orders or prepaid debit card reloads that the couple later used to pay the credit card bill.  The credit card earned them five percent cash back on certain purchases after they spent $6,500 in a single calendar year. Before purchases were sufficient for them to reach the five percent level, the card earned one percent cash back on certain purchases.

Rewards were issued in the form of “rewards dollars” that could be redeemed for gift cards and statement credits.  In 2013, the petitioners redeemed $36,200 in rewards dollars from the card as statement credits in 2013 and $277,275 in 2014.  The petitioners did not report these amounts as income for either year.  The IRS audited and took the position that the earnings should have been reported as “other income” as an exception to the IRS “rebate rule.”  Under the rule, when a seller makes a payment to a customer, it’s generally seen as a “price adjustment to the basis of the property.”  It’s a purchase incentive that is not treated as income.  Instead, the incentive is treated as a reduction of the purchase price of what is purchased with the rewards or points. Thus, points and cashback earned on spending are viewed as a non-taxable purchase price adjustment.  The petitioners cited this rule, pointing out that the “manner of purchase of something…does not constitute an accession of wealth.  The IRS, however, claimed that the rewards were taxable upon receipt irrespective of how the gift cards were later used. 

The Tax Court noted that the gift cards were a “product.”  Thus, the portion of their reward dollars associated with gift card purchases weren't taxable.  However, the Tax Court held that the petitioners’ direct purchases of money orders and reloads of cash into the debit cards using their credit card was different in that the petitioners were buying “cash equivalents” rather than a rebate on a purchase.  Thus, the transaction did not involve the purchase of a product subject to a price adjustment.  The purchase of a cash equivalent was different than obtaining a product or service.  Because there was no product or service obtained in connection with direct money order purchases and cash reloads, the reward dollars associated with those purchases were for taxable cash infusions. 

The Tax Court also noted that the petitioners’ practice would most often have been ignored if it had not been for the petitioners’ “manipulation” of the rewards program using cash equivalents.  Thus, the longstanding IRS rule of not taxing credit card points did not apply.  Importantly, the Tax Court held that reward points become taxable when massive amounts of cash equivalents are purchased to generate wealth.  The petitioners did this by buying money orders and funding prepaid debit cards with a credit card for cash back, and then immediately paying the credit card bill. 

Note:  The Tax Court stated that it would like to see some reform in this area that provides guidance on the issue of credit card rewards and the profiting from buying cash equivalents with a credit card. 

June 25, 2022 in Income Tax | Permalink | Comments (0)

Thursday, June 16, 2022

Ag Law-Related Updates: Dog Food Scam; Oil and Gas Issues


Agricultural law touches many aspects of the daily life of a farmer, rancher, or anyone using an ag-related product or service.  In today’s post, I provide a small sample illustrating that very point.

Some additional ag law-related developments – it’s the topic of today’s post.

Claims Against Dog Food Producer Wrongfully Dismissed

Kucharski-Berger v. Hill's Pet Nutrition, Inc., 60 Kan. App. 2d 510, 494 P.3d 283 (Kan, Ct. App. 2021)

A veterinarian prescribed Hill’s Pet Nutrition dog food for the plaintiff’s dog.  The plaintiff sued Hill’s Pet Nutrition upon discovering that the dog food did not contain medicine or drugs, had not been tested and approved for medicinal purposes by the FDA, but was priced higher than “normal” dog food.  The plaintiff claimed the defendant and other pet food manufacturers had conspired to monopolize the prescription pet food market and they had artificially inflated the prices by claiming the food required a prescription.  No federal or state law required pet food to be sold with a prescription from a vet. The plaintiff claimed the defendant had violated the Kansas Restraint of Trade Act (KRTA) and the Kansas Consumers Protection Act (KCPA) and also brought an unjust enrichment claim. The trial court dismissed the case for failure to state a claim under KCPA, the plaintiff had to allege that the defendant was engaged in a deceptive act or practice involving the plaintiff that caused the plaintiff damages.  The plaintiff claimed that the defendant had misrepresented that the dog food required a prescription so as to sell at a premium price.  The appellate court determined that the plaintiff had clearly alleged sufficient facts to put the defendant on notice of the allegations under the KCPA. The defendant claimed that the plaintiff failed to show a causal connection between the prescription practices and the injury, but the appellate court noted that the plaintiff did not need to show she was misled, only that the defendant’s actions were deceptive.  On that point, the appellate court noted that the plaintiff had provided enough detail in the complaint to show that the prescription requirement could be deceptive and was the cause of her spending more money (the injury).  As such, the plaintiff’s KCPA claims should not have been dismissed. With respect to the KRTA claim, the court noted that the plaintiff was required to allege that the defendant was creating a restriction in trade, increasing or reducing the price of merchandise to prevent competition, and had entered into an agreement establishing a set price for a good in the market. The plaintiff alleged the defendant had entered into a contract with other dog food producers to set prices higher for prescription dog food, which violated KRTA. The plaintiff also claimed that the defendant had entered into a conspiracy to monopolize the prescription dog food market.  As such, the appellate court held that the plaintiff had properly presented the KRTA claims.  The appellate court reversed the trial court’s dismissal and remanded the case for furthering proceedings.

Oil and Gas Developments

Fracking Water Not Taxable 

CDOR PLR 22-001 (Apr. 8, 2022)

A Colorado company sold non-potable river water to oil and gas producers for use in hydraulic fracturing and sought guidance from the Colorado Department of Revenue (CDOR) as to its taxability.  The company delivers water by withdrawing it from ditch and reservoir systems, securing rights-of-way, and laying temporary surface lines to the customers’ locations.  The CDOR concluded that the company did not owe sales tax because water in conduits, pipes, ditches and reservoirs is not subject to sales tax. 

Colorado Changes Oil and Gas Severance Tax Credit 

H.B. 1391, signed into law on June 7, 2022. 

Colorado H.B. 1391 was signed into law on June 7, 2022 and changes the calculation of the oil and gas severance tax credit.  Beginning January 1, 2025, the credit will be calculated as 76.56 percent of the gross income attributable to the well in the current tax year, multiplied by the local mill rate of the prior year.  Under prior law, the credit was 87.5 percent of the prior year’s local taxes, which are assessed at 87.5 percent of the gross income of the prior year and are subject to the prior year’s local mill levies.  The change is intended to simplify the credit’s calculation and eliminate the one-year lag in its administration.  Well operators, rather than royalty interest owners will be responsible for the tax. 

Low-Producing Oil and Gas Tax Exemption Tied to Actual Projection. 

Farmer v. Board of Ellis County Commissioners, Nos. 123,488 & 123,489, 2022 Kan. App. LEXIS 19 (Kan. Ct. App. May 6, 2022)

The taxpayer sought a refund for property tax exemptions under state law (K.S.A. 79-201t) for tax year 2018 for several oil and gas leases on his property for low-producing oil and gas wells (less than five barrels per day. The Board of Tax Appeals (BOTA) denied the refund on the basis that it would be retrospective and concluded that the taxpayer should pay the amount of tax based on the predicted production for 2018 rather than actual production. At the trial court, BOTA argued the leases should not be exempt because the 2017 production that was used to find the fair market value for taxes for 2018 was not at the exempt level. BOTA claimed the first time the taxpayers would qualify for the exemption would be in 2019 as the 2018 oil production would be used at that time to predict the value that would meet the exemption level. The trial court held the taxpayers should be granted the exemption as the daily average in 2018 fell below the level required for the exemption.  On appeal, the appellate court concluded that the statute was unclear on when the exemption could take effect and if a refund could be awarded. The appellate court looked at how BOTA honored tax refunds in the past for taxpayers who filed for an exemption retrospectively.  Based on legislative intent, the appellate court held the intent was clearly to allow tax exemptions on the first day an oil well would qualify. The appellate court held that the taxpayer should be refunded property tax if the well actually produced at exempt levels instead of the projected production levels.


There’s never a dull moment in the ag law and tax world. 

June 16, 2022 in Civil Liabilities, Real Property, Regulatory Law | Permalink | Comments (0)

Sunday, June 12, 2022

More Ag Law Court Developments


Three recent court opinions from Kansas illustrate the diverse ways that the law is involved in ag-related activities.  Two of the cases involve ag real estate, with one of those having estate planning implications.  The other case involves rules involving showing animals at the State Fair. 

More ag-related court cases and their implications – it’s the topic of today’s post.

Irrigation System Value Included in Land Valuation in Partition Action 

Claeys v. Claeys, No. 124,032, 2022 Kan. App. LEXIS 16 (Kan. Ct. App. May 6, 2022)

Two brothers each inherited an undivided one-third interest in farmland, and the wife of a deceased brother owned the other one-third interest via a trust created for her benefit.  The brothers obtained a water permit, installed and $83,000 ten-tower irrigation system to convert the dryland to irrigation crop farming, and spent over $10,000 on piping and a water meter.  The irrigation system was one brother’s personal property.  The sister in-law did not contribute to the cost of these improvements. She filed a partition action seeking to sever the co-ownership. The brothers counterclaimed, asserting they improved the value of the land and that her share should be offset to account for the improvements.  Three commissioners were appointed to appraise the land and valued the dryland at $390,000 and the irrigated land at $2,065,000, not including the irrigation equipment.  The sister-in-law chose to buy the smaller, non-irrigated tract.  The commissioners determined that because her tract was less valuable, the brothers owed her $428,333 to account for her one-third interest, with $50,000 of that amount placed in escrow pending the outcome of the brothers’ counterclaim. The trial court determined that the definition of “improvements” should be limited to physical structures and equipment.  The trial court ruled for the sister-in-law on the brothers’ counterclaim, find that the brothers had not shown that they receive a credit for the irrigation-driven value increase.  According to the trial court, the irrigation equipment was personal property of one of the brothers and was not an “improvement.”  Hence, the trial court awarded the $50,000 to the sister-in-law.  On appeal, the appellate court held the trial court erred when it found the brothers did not improve the land.  The appellate court determined that Kansas law requires a “broader inquiry” into possible improvements to the land other than just physical structures and equipment, and that the trial court erred when it found that the brothers did not improve the land when they installed the irrigation system.  Changing the land’s status from dry to irrigated and obtaining a water right improved the value of the land.  “Improvements,” the appellate court determined, are not simply limited to physical additions.  The personal property (irrigation system) improved the property and should have been included in the land valuation.  The water permit was not the sole source of the higher land value for the irrigated ground – the irrigation system was necessary to make the water permit “operative.”  Accordingly, the appellate court held that the trial court erred in denying the brothers’ counterclaim and remanded the case to the trial court to determine whether to award credit for the value of the irrigation equipment based on an assessment of the evidence previously presented at trial. 

Comment:  The case points out the possible peril of leaving property to the children in co-equal undivided interests.  What often happens is that a child (or multiple children) will want to "cash-out" by filing a partition action.  That happened in this case, and then the issue of valuation came up to balance out the economics of the partition.  In determining value, "improvements" had to be dealt with. A change from dryland to irrigation farming increases the value of the land and must be accounted for in a partition action. 

Grand Champion Lamb Properly Stripped of State Fair Title

Gilliam v. Kansas State Fair Board, No. 122, 254, 2022 Kan. App. LEXIS 18 (Kan. Ct. App. May 6, 2022)

The plaintiff’s lamb was crowned grand champion of the market-lamb competition at the 2016 Kansas State Fair. State Fair rules bar exhibitors from treating any part of an animal’s body, internally or externally, with a substance to alter conformation.  Regulations also prohibit changing an animal's natural contours or appearance of an animal’s body or inserting a foreign material under the skin – known as "unethical fitting."   Before the Fair was over, the lamb was removed from display, slaughtered and its meat was sold to market.  After the lamb was processed, a veterinarian analyzed the lamb’s carcass and observed multiple injection marks on the back of both hind legs with associated swelling and discoloration in the muscle and fat and abnormal reddening of the skin over those areas.  The veterinarian concluded that multiple recent injections had likely caused the abnormalities.   Lab tests did not identify any drugs in the lamb’s system leading the veterinarian to conclude that a natural substance had been injected.  These finding led the veterinarian to conclude that injections were used to alter the lamb’s appearance, rather than treat the lamb for any illness. Consequently, the defendant (State Fair Board) determined that the plaintiff had engaged in an “unethical fitting,” and stripped the plaintiff of her title along with her championship belt buckle and her $4,000 cash prize. The plaintiff appealed to two State Fair committees with no success and then filed suit.  The trial court determined that the veterinarian’s findings did not provide “substantial evidence” as to unethical fitting.  While the veterinarian confirmed his findings of injections, the trial court noted that he did not find that the lamb’s appearance had been altered and never used the term “unethical fitting.”  Thus, the trial court held that the plaintiff had sustained her burden of proving the invalidity of the defendant’s action.  On appeal, the defendant asserted that “unethical fitting” was its determination to make, not that of a veterinarian, and that the trial court erred in basing its determination on the veterinarian’s conclusion which it found unsupported by the evidence.  The appellate court noted that state law vested in the defendant the authority to adopt rules and regulations governing the State Fair.  Those rules provided non-exhaustive examples of what could be considered unethical fitting and the appellate court determined that the defendant could consider injections to be an “unethical fitting” even though not listed in the examples.  Thus, the appellate court reversed the trial court and held that substantial evidence supported the defendant’s decision to disqualify the plaintiff’s lamb in accordance with the defendant’s rules and that a finding of “unethical fitting” need not be made nor attested to by a veterinarian.  

Comment:      The facts of the case seem to indicate that the practice of “airing” was engaged in with respect to the lamb.  Airing occurs most frequently with market animals such as steers and lambs and is a practice that injects air into the animal’s muscle.  The fat content of the animal’s feed is increased with the intent of the fat filling the “aired” area. When the practice occurs, it is possible that the animal owner does not know that it has happened.  Many animals are sent to professional “fitters” and the owner merely shows the animal. 

Landowner Establishes Adverse Possession Through “Tacking.”

Shelton v. Chacko, 501 P.3d 909 (Kan. Ct. App. 2022)

The parties owned adjacent tracts. A fence existed between the properties on the assumed boundary.  The plaintiff had a survey completed which indicated that the fence was on the plaintiff’s land inside the surveyed boundary.  The plaintiff sued to have the surveyed line established as the boundary, and the defendant counterclaimed to establish the fence line as the boundary via adverse possession.  The trial court held the appellee had established adverse possession over the property through “tacking.”  While the defendant had only possessed the strip in controversy for eight years, the defendant claimed that the evidence showed that the prior owner of the defendant’s tract had owned it and used it up to the fence for at least seven years which meant that the 15-year requirement for adverse possession was satisfied under Kansas law.  The trial court ruled that the defendant had satisfied the requirements for adverse possession via tacking because there was no interruption in possession and no abandonment for at least 15 years, and the defendant had a continual good-faith belief of ownership.  On appeal, the appellate court affirmed, noting that the defendant provided credible testimony of his belief of ownership up to the fence.  The appellate court noted that the fence was in place when the defendant bought his tract and was not repositioned when it was rebuilt. 

Note:   I often get the question of whether the 15-year requirement (Kansas) for adverse possession “resets” when there is a change in ownership.  The answer is “not necessarily so.”  Here the defendant had a good faith belief of ownership for seven years and his predecessor in interest had also treated it as the boundary, as did the adjacent owner. 

June 12, 2022 in Estate Planning, Real Property, Regulatory Law | Permalink | Comments (0)

Thursday, June 9, 2022

Recent Court Cases of Importance to Agricultural Producers and Rural Landowners


Farmers, ranchers and other rural landowners face many legal and tax issues on a daily basis.  The type of legal issues varies, and some are cyclical.  Others seem to repeat over and over.  In today’s article I discuss two cases from Kansas that illustrate some of the issues that seem to come up frequently with respect to real estate, and one that arises on a cyclical basis. 

Various legal issues associated with agricultural production and rural landownership – it’s the topic of today’s post.

Common Issues Involving Ag Real Estate

Removal of Vegetation Within Easement Proper

Presnell v. Cullen, 2022 Kan. App. Unpub. LEXIS 250 (Kan. Ct. App. May 6, 2022)

Farm and ranch land is often burdened by easements.  Energy-related easements are common in rural areas as are access easements to a landlocked field or home.  One common question is what activities are permissible in the easement area by the easement holder?  Without clear specification in the written easement agreement, the rule is one of reasonability.  That means that the easement holder can use the easement for the purpose(s) for which it was acquired and other associated purposes, within reason. 

In this case, the plaintiff owned land subject to a railroad easement. The Central Kansas Conservancy (Conservancy) acquired the easement from a railroad under the National Trails System Act for the purpose of developing a recreational trail.  The plaintiff sued claiming that the Conservancy did not have a right to cut down vegetation located within the easement.  The trial court disagreed and awarded the Conservancy legal fees.  On appeal, the plaintiff claimed that the Conservancy had a duty to protect and preserve the trees in the easement area, only needed to use 10 to 14 feet of the 66-foot easement, did not control the entire width of the easement, and had actually abandoned the easement. 

The appellate court disagreed, finding that the Conservancy had a right to use the railroad corridor to develop and maintain the trail based either based on title ownership or via the easement.  Thus, the Conservancy was entitled to remove the vegetation, but only to the extent necessary for developing and maintaining the trail.  The appellate court also rejected the plaintiff’s trespass claim.  The appellate court affirmed the trial court’s award of attorney's fees under K.S.A. §61-2709(a). 

Note:  The case points out that reasonable use of the easement is the key when the easement agreement is silent.  Here, the Conservancy could remove vegetation, but only if the removal was related to the trail.  The landowner’s other trees and vegetation were to be left untouched. 

Farmland Adversely Possessed, But No Prescriptive Easement. 

Pyle v. Gall, No. 123,823, 2022 Kan. App. Unpub. LEXIS 242 (Kan. Ct. App. Apr. 29, 2022)

Adverse possession has its origin in the English common law.  It’s a concept whereby someone who knows that they don’t have legal title to land can gain title by possessing the land long enough without the owner’s permission.  There are various elements to adverse possession that have been added over time, but basically if someone openly and knowingly takes possession of someone else’s land and does so for a long enough period of time set by state law, that person can end up the owner of the land via a quiet title action if the true owner knows of the possession and doesn’t do anything within the statutory timeframe to stop it. 

Adverse possession was at issue in this case. 

The parties disputed the location of the property line between their tracts.  The plaintiff routinely planted crops up to what the plaintiff believed to be the property line, but that planting interfered with the crop farming plans of the defendant’s tenant.  The plaintiff also regularly used a portion of the defendant’s field as a road to access the plaintiff’s crops.  In 2015, the defendant offered to sell the disputed area to the plaintiff and told the plaintiff to stop accessing the plaintiff’s crops via the defendant’s field.  Each party hired surveyors, but the surveyors reached different conclusions as to the property line. In March of 2016, the defendant built a fence based on the property line that the defendant’s surveyor found, which was 17 feet beyond what the plaintiff believed to be the property line. In March 2017, the plaintiff sued to quiet title to the field up to the crop line they farmed to by adverse possession and sought either a prescriptive easement or easement by necessity.  The trial court held that the plaintiff had adversely possessed the land in dispute and had acquired a prescriptive easement across the defendant’s property. 

On appeal, the appellate court upheld the trial court’s determination that the plaintiff had acquired the strip in question by adverse possession.  The plaintiff had used the property for the statutory timeframe in an open, exclusive and continuous manner upon belief of true ownership.  Use by others for recreational purposes, the appellate court reasoned, did not negate the exclusivity requirement because the use was infrequent compared to the plaintiff’s farming activity on the disputed land.  However, the appellate court reversed the trial court on the prescriptive easement issue because both the plaintiff and the defendant used the alleged area on which a prescriptive easement was being asserted.  Thus, the plaintiff had not used the easement exclusively.  The appellate court remanded to the trial court the issue of whether an easement by necessity had arisen because the trial court had not considered the issue. 

Note:  Exclusivity is a key element of an adverse possession/prescriptive easement claim

Farm Bankruptcy

Bankruptcy is a cyclical.  With the significant downturn in the economy driven largely by incomprehensible energy policy, it is looking as if 2023 will be an even tougher year for many parts of the agricultural sector.  Existing operating loans will be renewed at higher interest rates, and this year’s inputs that were prepaid before major price increases may not work to avoid price increases next year.  Thus, farm bankruptcies and foreclosures may tick up in 2023. 

One of the key points of a farm bankruptcy is that a reorganization plan must be file in a timely manner and in good faith.  A debtor cannot act in bad faith towards creditors.

The following case makes the points, and also points out that a farm bankruptcy requires planning as well as a plan. 

Chapter 12 Case Dismissed for Unreasonable Delays

In re Bradshaw, No. 20-40948-12, 2022 Bankr. LEXIS 1424 (Bankr. D. Kan. May 19, 2022) 

The debtor filed Chapter 12 bankruptcy in late 2020 but failed to file a confirmable plan for 18 months. The debtor also failed to meet many other Chapter 12 requirements.  As a result, the Chapter 12 Trustee filed a motion to dismiss the case under 11 U.S.C. § 1208(c) which allows a case to be dismissed for the debtor’s unreasonable delay or gross mismanagement.  Before the court, the Trustee pointed to the debtor’s failure to file a plan in a timely fashion, denial of plan confirmation, continuous loss to the bankruptcy estate and absence of a reasonable likelihood of rehabilitation. The Trustee also noted that the debtor did not file taxes in 2016, 2017, or 2018 and the returns filed in 2019 and 2020 were insufficient. The debtor did not consistently file monthly operating reports and the debtor’s proposed plan did not meet basic bankruptcy code requirements. 

The court also noted that the Trustee had no way of monitoring the debtor’s case properly because the debtor only filed three of eighteen monthly reports. Without monthly operating reports, it was impossible to determine if the estate could be rehabilitated. The debtor also had no income from farming operations with no prospect of an improved financial situation.  The debtor also gambled with estate property and failed to account for, liquidate, or preserve estate property. The bankruptcy estate was uninsured, and the debtor had abandoned it.  The court concluded that this amounted to the debtor’s gross mismanagement of the estate. The court noted that the debtor had ninety days to file a plan and after eighteen months and had not done so. While the debtor proposed one plan in April of 2021, it was denied, and no amended plan was submitted. This constituted an unreasonable delay and prejudice to creditors. The court granted the Trustee’s motion to dismiss the case. 

Note:   Don’t simply file Chapter 12 without an idea of where you are headed with your farming/ranching operation.  Chapter 12 is designed for farmers that intend on continuing in farming after restricting the business to make it viable into the future.  It’s not for those that don’t have a plan for the business into the future.

June 9, 2022 in Bankruptcy, Real Property | Permalink | Comments (0)

Monday, June 6, 2022

Wisconsin Seminar and…ERP (not Wyatt) and ELRP


Next week is the first of two summer ag tax and estate/business planning conferences that Washburn Law School is putting on.  Next week’s event on June 13 and 14 will be at the Chula Vista Resort, near the Wisconsin Dells.  One of the matters addressed on Day 1 will be issues that have arisen concerning the USDA’s Emergency Relief Program (ERP).  I have received numerous questions over the past few weeks concerning the program and we will be addressing them at the conference.

Issues with the ERP – it’s the topic of today’s post.

In General

I won’t go into too much detail about the ERP here because Paul Neiffer and I will do that at the Wisconsin conference.  What follows are comments that Paul and I have been providing to those raising questions of us in recent days.  Paul has also recently blogged on the issue and with today’s post I will largely summarize and reiterate what he has commented on for the readers of this blog.  In addition, there are additional meetings occurring in D.C. this week with IRS which will hopefully result in greater clarification on some presently unclear issues (not covered in this post).  If there are additional clarifications, we will discuss those at next week’s event in Wisconsin. 

The Extending Government Funding and Delivering Emergency Assistance Act (P.L. 117-43) (Act) was signed into law on September 30, 2021.  The Act includes $10 billion for farmers impacted by weather disasters during calendar years 2020 and 2021.  $750 million is to be directed to provide assistance to livestock producers for losses incurred due to drought or wildfires in calendar year 2021 (the Emergency Livestock Relief Program – (ELRP)).

Livestock provisions. 

To receive a Phase 1 payment, a livestock producer must have suffered grazing losses in a county rated by the U.S. Drought Monitor as having a severe drought) for eight consecutive weeks or at least extreme drought during the 2021 calendar year been approved for the 2021 Livestock Forage Relief Program (LFP). Those who would have normally grazed on federal but couldn’t be due to drought are eligible for a Phase 1 payment if they were approved for a 2021 LFP.  Various FSA Forms will need to be submitted. 

ELRP Payment Calculation – Phase One

Payments are based on livestock inventories and drought-affected forage acreage or restricted animal units and grazing days due to wildfire reported on Form 2021 CCC-853.  A payment will equal the producer’s gross 2021 LFP calculated payment multiplied by 75%, and will be subject to the $125,000 payment limitation. 

Crop insurance (or NAP) requirement.  In late 2021, the USDA provided some guidance to producers impacted by various weather-related events.  The former Wildfire and Hurricane Indemnity Program (WHIP+) was retooled and renamed as the ERP.  ERP will have two payments – two phases.  Phase 1 is presently underway, and Phase 2 may not happen until 2023.  ERP payments may be made to a producer with a crop eligible for crop insurance or noninsurance crop disaster assistance (NAP) that is subject to a qualifying disaster (which is defined broadly) and received a payment.  Droughts (a type of qualifying disaster) are rated in accordance with the U.S. Drought Monitor, where the qualifying counties can be found.

To reiterate, an ERP payment will not be made to any producer that didn’t receive a crop insurance or NAP payment in 2020 or 2021.  Because of this requirement, crop insurance premiums that an ERP recipient has paid will be reimbursed by recalculating the ERP payment based on the ERP payment rate of 85 percent 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 Phase 1 payments based on elected coverage. 

Note:  ERP payments are for damages occurring in 2020 and 2021 – so they are not deferable. 

Computation of payment and limits.  Once a producer submits their data to the FSA, an ERP application will be sent out for the producer to verify.  Applications started going out to producers in late May.  An ERP payment replaces the producer’s elected crop insurance coverage.  It’s based on a percentage with the total indemnity paid using the recalculated ERP percentage with any crop insurance or NAP payment subtracted. 

The ERP payment limit is $125,000 for specialty crops.  For all other crops, its $125,000 combined.  But, for an applicant with average adjusted gross income (AGI) (based on the immediate three prior years but skipping the first year back) that is comprised of more than 75 percent from farming activities, 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 is separate payment limit for each of 2020 and 2021. 

Note:  If the three-year computation of average AGI shows a loss, the enhanced payment limit is not available even if more than 75 percent of AGI is from farming activities.  In addition, the three-year computation is simply the applicant’s net income from farming compared with all of the applicant’s other sources of income as reported on the tax return. 

Definition of farm income.  Farm income for ERP purposes includes net Schedule F income; pass-through income from farming activities; farm equipment sale gains (if farm income exceeds two-thirds of overall AGI); wages from a farming entity; IC-DISC income from an entity that materially participates in farming (has a majority of gross receipts from farming).  Also counting as farm income for ERP purposes is income from packing, storing, processing, transporting and shedding of farm products. 

Certification.  To get the enhanced payment limit, a CPA or attorney must prepare a letter to be submitted with Form FSA-510 certifying that the applicant’s AGI is over the 75 percent threshold.  The FSA has a Form letter than can be used for this that is contained in its Handbook.  The FSA 6-PL, Apr. 29, 2022, Para. 489 discusses the 75 percent test and pages 8-73 through 8-74 is where the sample letter is located.  The “certification” may allow married farmers to eliminate the off-farm income of a spouse and make it possible to meet the 75 percent test if it otherwise would not be met.


There are many finer details to the ERP as well as the ELRP that I haven’t covered in this post.  As I noted above, Paul Neiffer and I will be covering all of your questions at the conference next week in Wisconsin.  Also addressed at the conference will be a discussion of what's going on in the economy and U.S. and worldwide markets that are impacting agriculture.   If you haven’t registered, the conference is also broadcast live online and there’s still time to register.  Here’s the registration link:

June 6, 2022 in Business Planning, Income Tax, Regulatory Law | Permalink | Comments (0)

Monday, May 30, 2022

Recent Court Decisions Involving Taxes and Real Estate

The courts are constantly deciding tax issues.  Two recurring themes in numerous cases involve timing of asset sales and recordkeeping/substantiation.  Those two issues are on display in court opinions that I summarize.  On the real estate side of the ledger fence issues loom large (and always have) as do partition actions (don’t leave property at death to your children in co-equal undivided interests – just don’t) and warrantless searches of farmland. 

Recent court opinions involving taxes and real estate – it’s the topic of today’s post.

Recent Tax Cases of Interest

Questions Remain on “Unforeseen Circumstances” Exception Under I.R.C. §121

Webert v. Comm’r, T.C. Memo. 2022-32

The petitioners, a married couple, bought a home in 2005.  The wife was diagnosed with cancer later that year and underwent costly treatments.  They resided in the home until 2009 and then rented out the home and resided in another home the husband owned.  The sold the first home in 2015.  They filed joint returns for tax years 2010 through 2015.  During those years, they reported income from the lease of the first home on Schedule E.  They reported that they used the home for personal purposes for 14 days in 2010 and zero days in 2011 through 2015. Their depreciation schedules mirrored the number of fair rental days reported for the property on their Schedule E. On their 2015 return, they reported the sale of the first home but excluded the gain from gross income.  The IRS audited and asserted that the income from the sale of the home should have been reported and moved for summary judgment.  The Tax Court granted summary judgment to the IRS on the issue of whether the petitioners used the home as their principal residence for at least two of the last five years immediately preceding the sale as I.R.C. §121 requires.  They did not.  However, the Tax Court determined that issues of material fact remained on whether the wife’s health problems were the primary reason for the sale such that the gain might be excludible because the sale was on account of health or other unforeseen circumstance in accordance with I.R.C. §121(c)(2)((B).  

Jewelry Gift Not Properly Substantiated – Charitable Deduction Denied

Albrecht v. Commissioner, T.C. Memo. 2022-53

 In 2014, the petitioner donated approximately 120 pieces of Native American jewelry to a museum, a qualified charity.  The museum executed a “Deed of Gift” which specified, in part, that “all rights, titles, and interests” in the jewelry were transferred from the donor to the donee upon donation unless otherwise stated in the Gift Agreement.  The petitioner claimed a charitable deduction for the donation on her 2014 return and supported the claimed deduction by submitting the “Deed of Gift” documentation.  The IRS denied the deduction on the basis that the “Deed of Gift” documentation did not meet the substantiation requirements of I.R.C. §170(f)(8)(B) that require a description of the donated item(s), whether the donee provided any form of consideration in exchange for the donation, and a good faith estimate of the value of the donation. The IRS pointed out that the “Deed of Gift” documentation from the museum did not state whether the museum provided any goods or services in return for the donation. In addition, the terms of the “Deed of Gift” documentation with the museum referred to a superseding agreement, “the Gift Agreement,” which left open the question of whether the donor retained some title or rights to the donation, and also indicated that the petitioner’s documentation did not include the entire agreement with the done.  The Tax Court agreed with the IRS and held that the petitioner did not comply with the substantiation requirements of I.R.C. §170(f)(8)(B) and denied the charitable deduction. 

Legal Issues Related to Real Estate

Court Construes State Fence Law 

Yin v. Aguiar, 146 Haw. 254, 463 P.3d 911 (2020)

The plaintiff leased property from a third party for growing sweet potatoes. Under the lease, the plaintiff was responsible for keeping cattle from damaging his crop. The plaintiff filed a complaint against a neighboring cattle owner claiming that the cattle damaged over 13 acres of the plaintiff’s sweet potato crop and the landowner’s fence in the amount of $190,000. The cattle owner claimed he was not liable because the fence between the properties was not a legal fence.  The fence was less than 4 and ½ feet tall and was made from hog wire, which did not meet the state law requirements for a legal fence.  The cattle owner further pointed to the plaintiff’s lease, which stated the plaintiff was responsible for keeping cattle off the leased property. The state Supreme Court determined that that it was inappropriate to interpret state fence law to hold cattle owners solely responsible for properly fenced or entirely unfenced property (including property enclosed with improper fencing) because that did not comport with  the legislative intent of the fence laws.  But, the Supreme Court also concluded that to hold the plaintiff liable for the damage due to a clause in his lease agreement would be against public policy because upholding the clause would be contrary to state fence law that holds livestock owners responsible for escaped livestock in certain situations. The state Supreme Court remanded the case to the circuit court for further proceedings consistent with its opinion.

“Improvements” Valued in Partition Action

Claeys v. Claeys, No. 124,032, 2022 Kan. App. LEXIS 16 (Kan. Ct. App. May 6, 2022)

Two brothers each inherited an undivided one-third interest in farmland, and the wife of a deceased brother owned the other one-third interest via a trust created for her benefit.  She filed a partition action seeking to sever the co-ownership. The brothers counterclaimed, asserting they improved the value of the land and that her share should be offset to account for the improvements. The brothers obtained a water permit, installed an $83,000 ten-tower irrigation system to convert the dry land to irrigation crop farming, and spent over $10,000 on piping and a water meter.  The irrigation system was one brother’s personal property.  The sister in-law did not contribute to the cost of these improvements. Three commissioners were appointed to appraise the land and they valued the dryland at $390,000 and the irrigated land at $2,065,000.  She elected to take the smaller tract that was not worth as much. The commissioners determined that because her tract was less valuable, the brothers owed her $428,333 to account for her one-third interest. The trial court ultimately ordered the brothers to pay her the $428,333 for her one-third interest in the higher-valued land based on a finding that improvements were limited to physical structures and equipment.  $50,000 of the $428,333 was placed in escrow and the brothers filed a counterclaim that the $50,000 represented her one-third interest in the increased value from irrigation and should be credited against what they owed her.  The trial court ruled for the sister-in-law on the counterclaim, finding that the increase in value was attributable solely to the pivot irrigation system.  As personal property of one of the brothers, the irrigation system was not an “improvement.”  The trial court awarded the $50,000 to the sister-in-law.  On appeal, the appellate court held the trial court erred when it found the brothers did not improve the land.  The appellate court determined that Kansas law requires a broader inquiry into possible improvements to the land other than just physical structures and equipment.  The appellate court held that the improvements enhanced the property’s condition by increasing productivity and were not mere repairs or replacements.  Changing the land’s status from dry to irrigated and obtaining a water right improved the value of the land.  Accordingly, the appellate court held that such “improvements” should be considered to offset the sister-in-law’s share in the property and remanded the case to the trial court.

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 plaintiffs owned farmland on which they hunted or fished.  They marked fenced portions of their respective tracts where they hunted and 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.  The defendant has appealed, and the case is ongoing.  


The cases summarized in this post point out several important things:  1) for purposes of the gain exclusion rule of I.R.C. §121, usage of the principal residence as a “principal residence” is critical, as is the timing of the sale; 2) the substantiation rules for charitable deductions must be closely followed; 3) fence law statutes tend to be old and can be complex and somewhat difficult and confusing to apply; 4) leaving land at death to children in co-equal undivided interests often creates issues, including partition actions and difficulties in equating each separate tract; and 5) the warrantless search of farmland is a continuing issue in agriculture. 

May 30, 2022 in Income Tax, Real Property | Permalink | Comments (0)

Wednesday, May 25, 2022

When Can Business Deductions First Be Claimed?


When beginning a business, at what point in time do business-related expenses become deductible?  That’s an interesting question not unlike the “chicken and the egg” dilemma.  Which came first – the business or the expense?  To have deductible business expenses, there must be a business.  When did the business begin?  That’s a key determination in properly deducting business-related expenses. 

Deducting costs associated with starting a business – it’s the topic of today’s post.

Categorization – In General

The Code allows deductions for various expenses that are related to a taxpayer’s investments that don’t amount to a business if the expenses are ordinary and necessary for the production or collection of income or are for the management, conservation or maintenance of property held for the production of income. I.R.C. §212.

Once the business begins, all of the ordinary and necessary expenses of operating the business (on a basis that is regular, continuous and substantial) that are paid or incurred during the tax year are deductible. I.R.C. §162.  But, business start-up costs are handled differently.  I.R.C. §195.

Start-Up Costs

I.R.C. §195(a) generally precludes taxpayers from deducting startup expenditures.  However, by election, a taxpayer can deduct business start-up expenses on the return for the year that the business begins. I.R.C. §195(b).  The election is irrevocable.  Treas. Reg. §1.195-1(b).  The deduction is the lesser of the amount of start-up expenses for the active trade or business, or $5,000 reduced (but not below zero) by the amount by which the start-up expenses exceed $50,000.  I.R.C. §195(b)(1)(A); I.R.C. §195(b)(1)(A)(i).  Once the election is made, the balance of start-up expenses is deducted ratably over 180 months beginning with the month in which the active trade or business begins.   I.R.C. §195(b)(1)(B); Treas. Reg. §1.195-1(a).  This all means that in the tax year in which the taxpayer’s active trade or business begins, the taxpayer can deduct the $5,000 amount (if that’s the lesser of, etc.) and the ratable portion of any excess start-up costs. 

The election is normally made on a timely filed return for the tax year in which the active trade or business begins.  However, if the return that year was timely filed without the election, the election can be made on an amended return that is filed within six months of the due date for the return (excluding extensions).  The amended return should clearly indicate that the election is being made and should state, “Filed pursuant to section 301.9100-2” at the top of the amended return.  Without the election, the start-up costs should be capitalized. 

What are start-up expenses?  Amounts paid or incurred in connection with creating an active trade or business are startup expenditures. I.R.C. §195(c). More specifically, start-up costs are amounts that the taxpayer pays or incurs for: investigating the creation or acquisition of an active trade or business; creating an active trade or business; or activities that the taxpayer engages in for profit and for the production of income before that day on which the active trade or business begins, in anticipation of the activities becoming an active trade or business, and which would be deductible in the year paid or incurred if in connection with an active trade or business.  I.R.C. §§195(c)(1)(A)(i-iii); 195(c)(1)(B).  Common types of start-up expenses include advertising costs; salaries and wages; and expenses related to travel.  See, e.g., IRS Field Service Advice 789 (1993).  But, interest expense, state and local taxes, and research and experimental expenses are not start-up expenses.  I.R.C. §195(c)(1). 

Start-up expenses are limited to expenses that are capital in nature rather than ordinary.  That’s an important point because it means that I.R.C. §195 does not bar the deductibility of ordinary and necessary expenses a taxpayer incurs in an ongoing activity for the production of income under I.R.C. §212.  In addition, it makes no difference that the activity is later transformed into a trade or business activity under I.R.C. §162.  For example, in Toth v. Comr., 128 T.C. 1 (2007), the taxpayer started operating a horse boarding and training facility for profit in 1998.  The activity showed modest profit the first few years, but had really taken off by 2004.  For 1998 and 2001, the taxpayer claimed expenses from the activity on Schedule C as ordinary and necessary business expenses deductible in accordance with I.R.C. §162, but she later determined that the expenses should be deducted in accordance with I.R.C. §212 as miscellaneous itemized deduction on Schedule A (which are presently suspended through 2025).  However, the IRS took the position that the taxpayer anticipated that the horse activity would become an active trade or business and, as such, her expenses had to be capitalized under I.R.C. §195.  The Tax Court agreed with the taxpayer.  Start-up expenses, the Tax Court said, were capital in nature rather than ordinary.  Thus, once her income producing activity began her expense deductions were not barred by I.R.C. §195.  It didn’t matter that the activity later became a trade or business activity under I.R.C. §162. 

When does the business begin?  A taxpayer cannot deduct or amortize startup expenditures if the activities to which the expenditures relate fail to become an “active trade or business.”  See I.R.C. §§195(a), (c).  There are no regulations that help define when a trade or business begins, so the question is answered based on the facts and circumstances of a particular situation.   To be engaged in a trade or business, a taxpayer must: (1) undertake an activity intending to make a profit, (2) be regularly and actively involved in the activity, and (3) actually have commenced business operations.  See, e.g., McManus v. Comr., T.C. Memo. 1987-457, aff’d., 865 F.2d 255 (4th Cir. 1988).  In addition, the courts have held that a taxpayer is not engaged in a trade or business “until such time as the business has begun to function as a going concern and performed those activities for which it was organized.” Richmond Television Corp. v. United States, 345 F.2d 901, 907 (4th Cir. 1965), vacated and remanded on other grounds, 382 U.S. 68 (1965). Likewise, an activity doesn’t have to generate sales or other revenue for the business to be deemed to have begun.  Cabintaxi Corp. v. Commissioner, 63 F.3d 614, 620 (7th Cir. 1995), aff’g., in part, rev’g. in part, and remanding T.C. Memo. 1994-316; Jackson v. Commissioner, 864 F.2d 1521, 1526 (10th Cir. 1989), aff’g., 86 T.C. 492 (1986). However, merely researching or investigating a potential business is not enough.  Dean v. Commissioner, 56 T.C. 895, 902-903 (1971).

Recent Tax Court Cases

Business Had Begun, but Lack of Substantiation Dooms Deductions

Smith v. Comr., T.C. Sum. Op 2019-12

In this case, the Tax Court was convinced that the petitioner had started his vegan food exporting business, noting that the petitioner had been peddling his vegan food products in Jamaica, the Dominican Republic, Brazil, Argentina and Columbia.  However, he was having trouble getting shelf space.  Thus, for the tax year at issue, he showed expenses associated with the activity of about $41,000 and gross sales of slightly over $2,000.   The IRS largely disallowed the Schedule C expenses due to lack of documentation and tacked on an accuracy-related penalty.  After issuing the statutory notice of deficiency, the IRS said the expenses were not deductible because they were start-up expenditures.  Because IRS raised the I.R.C. §195 issue at trial, the IRS bore the burden of proof on the issue.  The Tax Court determined that the taxpayer was, based on the facts, engaged in a trade or business.  He had secured products to sell, actively marketed those products, attended food shows and other meetings around the Caribbean and South America and had established a network to find potential customers.  Thus, I.R.C. §195 did not apply to limit the deduction of the expenses – they would be deductible under I.R.C. §162.  Or would they?

To be deductible under I.R.C. §162 as an ordinary and necessary business expense on Schedule C (or Schedule F), the taxpayer must substantiate the expenses.  Here’s where the IRS largely prevailed in Smith.  The Tax Court determined that the taxpayer had not substantiated his expenses.  Thus, the expenses were not deductible beyond (with a small exception) what the IRS allowed.  The Tax Court also upheld the accuracy-related penalty.

Lack of Trade/Business Eliminates Farm-Related Deductions

Costello v. Comr., T.C. Memo. 2021-9

Here, the Tax Court addressed the deductibility of start-up costs associated with associated farming activities.  In the case, the petitioners, a married couple, were residents of California but the wife conducted a farming operation in Mexico for which she reported a net loss on Schedule F for every year from 2007 to 2014.  She began raising chickens to sell for meat in 2007, but couldn’t recall selling any of the chickens through 2011 and only had one sale of anything during that timeframe – a $264 loss on the resale of livestock.  She then switched to raising chickens for egg production, but soon determined that the venture wouldn’t be profitable due to an increased cost of feed.  She then sold what eggs had been produced for $1,068 and switched back to selling chickens for meat in 2012.  She didn’t sell any chickens in 2012 or 2013 and her plan to begin selling chickens in 2014 was thwarted when the flock was destroyed by wild dogs. Also, during 2007-2011, she attempted to grow various fruits and vegetables, but the activity was discontinued because the soil was not capable of production due to a nearby salt flat.  As a result, she had no sales revenue, only expenses that she deducted.  She then tried to grow peppers in 2012, but insects destroyed the crop and there was no marketable production.  Later that year, she acquired three cows and three calves in hopes to “make the calves big, sell them, impregnate the mothers…repeat.”  She had to sell the cows in 2013 for $4,800 because there was insufficient forage on the 6,500-acre tract.  The $4,800 was the only farm activity income reported for 2013. In 2012 and 2013, the taxpayers reported deductible business expenses on their Schedules C and Schedule F, later reaching an agreement with the IRS that the Schedule C expenses should have been reported on Schedule F. 

The IRS disallowed the deductions, determining that the wife didn’t conduct a trade or business activity for profit and because the business had not yet started during either 2012 or 2013. The Tax Court agreed with the IRS, concluding that the farming activities never moved beyond experimentation and investigation into an operating business. Although the Tax Court reasoned that some of the wife’s farming activities could have constituted an active trade or business, costs were not segregated by activity. In addition, income from the sale of eggs, the Tax Court noted, was an incidental receipt that was only realized after the wife had abandoned that venture.  Also, the there was no itemization of costs or basis in the cattle activity to allow for an estimation of any deductible loss.  

No Trade or Business Means No Business-Related Deductions 

Antonyan v. Comr., 2021-138 

The petitioner bought 10 acres in the Mojave Desert in 2012/2013, about a mile away from any road.  He intended to develop the property’s natural resources and then rent the parcels to farmers for organic farming.  He devised a business plan under which he would build a barn-like structure; obtain USDA certification that the property complied with organic farming standards; install an irrigation system on the property; and build an access road to the property.  By 2015, the petitioner had partially installed a water tank and rainwater collection system on the property, explored and mapped the property, and experimented with growing certain plants on the property. He also used the property for recreational activities.  The petitioner started the construction of a barn-like structure in 2015.  He purchased building materials, rented a commercial truck and tractor-trailer to transport materials to the property, created an unpaved road to access the property, and hired workers to assist in building the structure. The petitioner accomplished this work on weekends. 

The petitioner was a full-time engineer.  On his 2015 return, the petitioner’s Schedule C reported no gross income and claimed deductions for car and truck expense, travel expense, start-up costs and amortization.  The IRS disallowed the deductions.   The Tax Court agreed with the IRS on the basis that the petitioner was not engaged in a trade or business in 2015 but was merely in the stage of setting up a trade or business and didn’t produce any evidence that he was actively engaging with potential customer to rent the property during 2015.   The Tax Court also denied any deductions for start-up costs and amortization expenses because there was no active trade or business in 2015.  


When a business is in its early phase, it’s important to determine the proper tax treatment of expenses.  It’s also important to determine if and when the business begins.  The Tax Cuts and Jobs Act makes this determination even more important.  As the recent Tax Court cases indicate, proper documentation and substantiation of expenses is critical to preserve deductibility. 

May 25, 2022 in Income Tax | Permalink | Comments (0)

Sunday, May 22, 2022

2021 Bibliography


In the past, I have posted bibliographies of my articles by year to help readers researching the various ag tax and ag law topics that I write about.  The blog articles are piling up, with more 750 available for you to read and use for your research for clients (and yourself).  The citations contained in the articles are linked so that you can go directly to the source.  I trust that you find that feature helpful to save you time (and money) in representing clients.

Today, I provide you with the bibliography of my 2021 articles (by topic) as well as the links to the prior blogs containing past years.  Many thanks to my research assistant, Kennedy Mayo, for pulling this together for me.

Prior Years

Here are the links to the bibliographies from prior years:

Ag Law and Taxation 2020 Bibliography

Ag Law and Taxation – 2019 Bibliography

Ag Law and Taxation – 2018 Bibliography

Ag Law and Taxation – 2017 Bibliography

Ag Law and Taxation – 2016 Bibliography


2021 Bibliography

Below are the links to my 2021 articles, by category:


The “Almost Tope Ten” Ag Law and Ag Tax Developments of 2020

Continuing Education Events and Summer Conferences

Agricultural Law Online!

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

The Agricultural Law and Tax Report

Is a Tax Refund Exempt in Bankruptcy?

Ag Law and Tax Potpourri

Montana Conference and Ag Law Summit (Nebraska)

Farm Bankruptcy – “Stripping,” “Claw-Back” and the Tax Collecting Authorities (Update)


For Continuing Education Events and Summer Conferences

Agricultural Law Online!

Recent Happenings in Ag Law and Ag Tax

C Corporate Tax Planning; Management Fees and Reasonable Compensation – A Roadmap of What Not to Do

Will the Estate Tax Valuation Regulations Return?

June National Farm Tax and Estate/Business Planning Conference

August National Farm Tax and Estate/Business Planning Conference

C Corporation Compensation Issues

Planning for Changes to the Federal Estate and Gift Tax System

The Agricultural Law and Tax Report

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

Intergenerational Transfer of Family Businesses with Split-Dollar Life Insurance

Ohio Conference -June 7-8 (Ag Economics) What’s Going On in the Ag Economy?

Montana Conference and Ag Law Summit (Nebraska)

Farm Valuation Issues

Ag Law Summit

The Illiquidity Problem of Farm and Ranch Estates

When Does a Partnership Exist?

Gifting Assets Pre-Death – Part One

Gifting Assets Pre-Death (Entity Interests) – Part Two

Gifting Pre-Death (Partnership Interests) – Part Three

The Future of Ag Tax Policy – Where Is It Headed?

Estate Planning to Protect Assets From Creditors – Dancing On the Line Between Legitimacy and Fraud

Fall 2021 Seminars

Corporate-Owned Life Insurance – Impact on Corporate Value and Shareholder’s Estate

Caselaw Update

S Corporations – Reasonable Compensation; Non-Wage Distributions and a Legislative Proposal

2022 Summer Conferences – Save the Date


The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Three

Continuing Education Events and Summer Conferences

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Three

Agricultural Law Online!

Prescribed Burning Legal Issues

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

The Agricultural Law and Tax Report

Mailboxes and Farm Equipment

Statutory Immunity From Liability Associated With Horse-Related Activities


The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Three

Continuing Education Events and Summer Conferences

Agricultural Law Online!

Deed Reformation – Correcting Mistakes After the Fact

Considerations When Buying Farmland

Recent Court Decisions of Interest

The Potential Peril Associated With Deferred Payment Contracts


Continuing Education Events and Summer Conferences

Final Ag/Horticultural Cooperative QBI Regulations Issued

Agricultural Law Online!


The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020

Continuing Education Events and Summer Conferences

Agricultural Law Online!

The Agricultural Law and Tax Report

Estate Planning to Protect Assets From Creditors – Dancing On the Line Between Legitimacy and Fraud

Recent Court Decisions of Interest


Continuing Education Events and Summer Conferences

Agricultural Law Online!

Recent Happenings in Ag Law and Ag Tax

Court and IRS Happenings in Ag Law and Tax

Valuing Ag Real Estate With Environmental Concerns

Ag Law and Tax Potpourri

No Expansion of Public Trust Doctrine in Iowa – Big Implications for Agriculture

Key “Takings” Decision from SCOTUS Involving Ag Businesses

Montana Conference and Ag Law Summit (Nebraska)

Navigable Waters Protection Rule – What’s Going on with WOTUS?


The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Two

Continuing Education Events and Summer Conferences

Agricultural Law Online!

What Now? – Part Two

Will the Estate Tax Valuation Regulations Return?

June National Farm and Tax and Estate/Business Planning Conference

August National Farm Tax and Estate/Business Planning Conference

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

The Revocable Living Trust – Is it For You?

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

Court Developments of Interest

The Agricultural Law and Tax Report

Planning for Changes to the Federal Estate and Gift Tax System

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

The Revocable Trust – What Happens When the Grantor Dies?

Intergenerational Transfer of Family Businesses with Split-Dollar Life Insurance

Ohio Conference –June 7-8 (Ag Economics) What’s Going On in the Ag Economy?

Reimbursement Claims in Estates; Drainage District Assessments

Montana Conference and Ag Law Summit (Nebraska)

Farm Valuation Issues

Ag Law Summit

The Illiquidity Problem of Farm and Ranch Estates

Planning to Avoid Elder Abuse

Gifting Assets Pre-Death – Part One

Gifting Assets Pre-Death (Entity Interests) – Part Two

The Future of Ag Tax Policy – Where Is It Headed?

Estate Planning to Protect Assets From Creditors – Dancing On the Line Between Legitimacy and Fraud

Tax Happenings – Present Status of Proposed Legislation (and What You Might Do About It)

Corporate-Owned Life Insurance – Impact on Corporate Value and Shareholder’s Estate

Tax (and Estate Planning) Happenings

Selected Tax Provisions of House Bill No. 5376 – and Economic Implications

2022 Summer Conferences – Save the Date


The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Two

The “Top Ten” Agricultural Law and Ag Tax Developments of 2020 – Part One

Continuing Education Events and Summer Conferences

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Four

Final Ag/Horticultural Cooperative QBI Regulations Issued

Agricultural Law Online!

Recent Happenings in Ag Law and Ag Tax

Deducting Start-Up Costs – When Does the Business Activity Begin?

What Now? – Part One

C Corporate Tax Planning; Management Fees and Reasonable Compensation – A Roadmap of What Not to Do

Where’s the Line Between Start-Up Expenses, the Conduct of a Trade or Business and Profit Motive?

June National Farm Tax and Estate/Business Planning Conference

Selling Farm Business Assets – Special Tax Treatment (Part One)

Tax Update Webinar

Selling Farm Business Assets – Special Tax Treatment (Part Two)

Selling Farm Business Assets – Special Tax Treatment (Part Three)

August National Farm Tax and Estate/Business Planning Conference

Court and IRS Happenings in Ag Law and Tax

C Corporation Compensation Issues

Tax Considerations When Leasing Farmland

Federal Farm Programs and the AGI Computation

Tax Potpourri

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

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

Court Developments of Interest

The Agricultural Law and Tax Report

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

The Revocable Trust – What Happens When the Grantor Dies?

Ohio Conference -June 7-8 (Ag Economics) What’s Going On in the Ag Economy?

What’s the “Beef” With Conservation Easements?

Is a Tax Refund Exempt in Bankruptcy?

Tax Court Happenings

IRS Guidance On Farms NOLs

Montana Conference and Ag Law Summit (Nebraska)

Tax Developments in the Courts – The “Tax Home”; Sale of the Home; and Gambling Deductions

Recovering Costs in Tax Litigation

Tax Potpourri

Weather-Related Sales of Livestock

Ag Law Summit

Livestock Confinement Buildings and S.E. Tax

When Does a Partnership Exist?

Recent Tax Developments in the Courts

Gifting Assets Pre-Death – Part One

Gifting Pre-Death (Partnership Interests) – Part Three

The Future of Ag Tax Policy – Where Is It Headed?

Tax Happenings – Present Statute of Proposed Legislation (and What You Might Do About It)

Fall 2021 Seminars

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

Farm Bankruptcy – “Stripping,” “Claw-Back” and the Tax Collecting Authorities (Update)

Caselaw Update

Tax Issues Associated With Easements

S Corporations – Reasonable Compensation; Non-Wage Distributions and a Legislative Proposal

Tax Reporting of Sale Transactions By Farmers

The Tax Rules Involving Prepaid Farm Expenses

Self Employment Taxation of CRP Rents – Part One

Self-Employment Taxation of CRP Rents – Part Two

Self-Employment Taxation of CRP Rents – Part Three

Recent IRS Guidance, Tax Legislation and Tax Ethics Seminar/Webinar

Tax (and Estate Planning) Happenings

Selected Tax Provisions of House Bill No. 5376 – and Economic Implications

Recent Court Decisions of Interest

The Potential Peril Associated With Deferred Payment Contracts

Inland Hurricane – 2021 Version; Is There Any Tax Benefit to Demolishing Farm Buildings and Structures?

2022 Summer Conferences – Save the Date

The Home Sale Exclusion Rule – How Does it Work When Land is Also Sold?

Gifting Ag Commodities To Children

Livestock Indemnity Payments – What Are They? What Are the Tax Reporting Options?

Commodity Credit Corporation Loans and Elections


Continuing Education Events and Summer Conferences

Agricultural Law Online!

The Agricultural Law and Tax Report


The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Three

Continuing Education Events and Summer Conferences

Agricultural Law Online!

Prescribed Burning Legal Issues

Ag Zoning Potpourri

Court and IRS Happenings in Ag Law and Tax

Is That Old Fence Really the Boundary

Court Developments of Interest

The Agricultural Law and Tax Report

Deed Reformation – Correcting Mistakes After the Fact

Valuing Ag Real Estate With Environmental Concerns

Ag Law and Tax Potpourri

Montana Conference and Ag Law Summit (Nebraska)

Farm Valuation Issues

Considerations When Buying Farmland

The Home Sale Exclusion Rule – How Does it Work When Land is Also Sold?


The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Two

 The “Top Ten” Agricultural Law and Ag Tax Developments of 2020 – Part One

Continuing Education Events and Summer Conferences

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Two

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Four

Agricultural Law Online!

Recent Happenings in Ag Law and Ag Tax

Prescribed Burning Legal Issues

Packers and Stockyards Act Amended – Additional Protection for Unpaid Cash Sellers of Livestock

Federal Farm Programs and the AGI Computation

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

The Agricultural Law and Tax Report

The FLSA and Ag’s Exemption From Paying Overtime Wages

The “Dormant” Commerce Clause and Agriculture

Trouble with ARPA

No Expansion of Public Trust Doctrine in Iowa – Big Implications for Agriculture

Key “Takings Decision from SCOTUS Involving Ag Businesses

Reimbursement Claims in Estates; Drainage District Assessments

Mailboxes and Farm Equipment

Montana Conference and Ag Law Summit (Nebraska)

California’s Regulation of U.S. Agriculture

Checkoffs and Government Speech – The Merry-Go-Round Revolves Again

Is There a Constitutional Way To Protect Animal Ag Facilities

Caselaw Update

Recent Court Decisions of Interest

Livestock Indemnity Payments – What Are They? What Are the Tax Reporting Options?


Continuing Education Events and Summer Conferences

Agricultural Law Online!

Cross-Collateralization Clauses – Tough Lessons For Lenders

The Agricultural Law and Tax Report

The “EIDL Trap” For Farm Borrowers

The Potential Peril Associated With Deferred Payment Contracts


Continuing Education Events and Summer Conferences

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Three

Agricultural Law Online!

The Agricultural Law and Tax Report

Montana Conference and Ag Law Summit (Nebraska)

May 22, 2022 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Thursday, May 19, 2022

Correcting Depreciation Errors (Including Bonus Elections and Computations)


One of the common errors made on a tax return involves depreciation.  Depreciation errors can result from, among other things, a math error, a posting error, or an incorrect method.  Depreciation errors are corrected by either filing an amended return or filing a change in accounting method form.

Basic Principle

It is important to note that errors are errors and accounting methods are not errors.  Errors are corrected by amending returns.  Accounting methods are corrected by filing Form 3115.  An amended return can be filed to correct for depreciation method problems (wrong method or life) if the next year’s return has not yet been filed. 

Automatic Consent Procedure

The IRS’s automatic consent procedures for taxpayers who have adopted an impermissible method of accounting for depreciation (or amortization) and have either claimed no allowable depreciation, less depreciation than allowable, or more depreciation than allowable is provided in the guidance at Rev. Proc. 2015-13, 2015-13, 2015-5 IRB 419.

Note:  Rev. Proc. 2019-43, 2019-43, 2019-48 IRB 1107 has the latest list of automatic consent procedures.  While several revenue procedures have been issued that modify or add to that list, Rev. Proc. 2019-43 is the latest of the full listing.

Taxpayers who qualify under the automatic procedure are permitted to change to a method of accounting under which the allowable amount of depreciation is claimed. The unclaimed depreciation from years before the year of change is considered as a net negative adjustment in the year of change and are deducted in full on the return for the year of change.

The 2-year Rule

The use of an incorrect method of depreciation is considered the use of an incorrect accounting method.  Once an incorrect accounting method has been used for two years, Form 3115 is required to change accounting methods back to a correct method, or to begin taking depreciation. 

Note:   If no depreciation had been taken and only one year has passed the return may be corrected via amendment because the incorrect method had only been used for one year.

Amended Returns

A depreciation error that is not subject to the accounting method change filing requirements are to be corrected via an amended return in the following situations:

  • The incorrect amount of depreciation was claimed due to a mathematical error made in any year;
  • The incorrect amount of depreciation was claimed due to a posting error made in any year;
  • An incorrect amount of depreciation was claimed on property placed in service in tax years ending before the statute of limitations expired (but not due to an established accounting method);
  • The amount of expense method depreciation (I.R.C. §179) is being changed;
  • An election is being made to apply the $2,500/$5,000 de minimis safe harbor rules (within its own time period requirements of return due date plus extension); and

Caution:  If the election out for bonus depreciation wasn’t made, the accounting method change provisions apply, and an amended return cannot be filed if two years have gone by. If only one year, the taxpayer has a choice of amending the return or proceeding under the rules governing a change in accounting method. But filing an amended return may not be an option for a partnership.  If the bonus election was made, a change to not make the election may only be made via a superseding return.

Amending returns will only correct depreciation errors that have occurred in the last three years. Errors that have occurred before that cannot be “caught up” on current or amended returns and will only be “caught up” when the asset is sold using a Form 3115 and Code 107. These errors must be from applying impermissible accounting methods. Accounting method issues are fixed by filing Form 3115.

Change in Accounting Method - Form 3115

IRS Form 3115, Change in Accounting Method, is used to correct depreciation if the correction relates to the misapplication of an accounting method. This includes the omission of depreciation.  When depreciation for an asset is inadvertently left off the return, the IRS treats the omission as the adoption of an incorrect method of accounting if the subsequent year’s return has been filed.  Thus, the correction of the omission may only be by the filing of Form 3115.  

Note:  When changing methods of accounting from not taking depreciation (incorrect method) to taking depreciation (correct method) use Code 7 on Form 3115 if the asset is still in use, code 107 if disposed.

Generally, Form 3115 must be attached to the taxpayer’s tax return for the year of change by the due date (including extensions). A copy must also be filed with the IRS no later than when the original Form 3115 is filed with the taxpayer’s return.  Rev. Proc. 2015-13  allows the use of one Form 3115 to correct mistakes on more than one asset.

When Form 3115 is required.  Depreciation changes that constitute a change in accounting method are:

  • Changing from not taking depreciation to taking depreciation. (Because this is a change from an impermissible method to a permissible method, use Code 7 on Form 3115);
  • Corrections in methods or conventions (use Code 7 on Form 3115);
  • Changes from a permissible method to another permissible method (use Code 8 on Form 3115);

Note:  Generally, there is only one permissible recovery period.  If the taxpayer used the wrong recovery period.  If the taxpayer used the wrong recovery period, it is a change from impermissible to permissible.  For a taxpayer with multiple assets that need to be changed the Code is 200.

  • Correcting depreciation on leasehold improvements from using the incorrect life of the lease term to the correct life of the asset (usually 15 or 39 years). (Use Code 199 on Form 3115.)

Note:  Rev. Proc. 2015-13 is also to be used to correct depreciation after an asset has been sold.

Rev. Proc. 2015-13 allows a taxpayer to recover depreciation deductions that have been mistakenly overlooked, for which, under the “allowed or allowable” rule the taxpayer had to reduce basis in the asset, effectively making the “allowed or allowable” penalty disappear. Code 107 on Form 3115 is to be used to “catch up” omitted depreciation on an asset when it is sold.

When Form 3115 is not required.  Depreciation changes that do not require Form 3115 because they are not considered changes in an accounting method include (and which may only be made on an amended return) are as follows:

  • A change in computing depreciation because of a change in the use by the same taxpayer;
  • Changes in placed-in-service dates;
  • A change in useful lives;
  • Making a late depreciation election or revoking a timely valid depreciation election.

Note:   A change from not claiming bonus depreciation to claiming bonus is a revocation of the election and is not an automatic accounting method change. This change requires IRS advance consent to change an election.

Procedural aspects.  Form 3115 is filed to correct the accounting method for depreciation., the total depreciation adjustment, an I.R.C. §481 adjustment, is deducted in full in the year of change if it is negative. If the adjustment is positive, it must be added in ratably over 4 years, except that if the adjustment is positive but less than $50,000 in total, the taxpayer may elect to add it in to income in full in the year of change.

Form 3115 may be filed at any time for any year.  If it is filed for an asset that was sold in a prior year, the taxpayer should use Code 7 on page one of Form 3115 if the taxpayer still owns the asset.  If the asset was sold during the year, the applicable Code is 107. 

Filing requirements.  Rev. Proc. 2015-13 requires that a signed copy of Form 3115 be filed to the IRS office. No advance approval is required to correct the error, as this is an automatic approval change in most cases. There is no user fee.

The original Form 3115 should be filed with the tax return for the year of change. The original must be filed by the due date of the return, plus extension. There is a 6-month automatic extension of the due date if the return was timely filed, and an amended return (with this change) is filed within 6 months.

When filing Form 3115, the additional statements listed below must be attached:

  • A detailed description of the former and new methods of accounting;
  • A statement describing the taxpayer’s business or income-producing activities;
  • A statement of the facts and law supporting the new method of accounting, new classification of the item of property, and new asset class;
  • A statement identifying the year in which the item of property was placed in service.

TCJA and Bonus Depreciation

The Tax Cuts and Jobs Act (TCJA) increased the additional first year bonus depreciation deduction from 50 to 100%.  In addition, the property eligible for bonus depreciation was expanded to include certain used depreciable property and certain film, television, or live theatrical productions.  Also, the placed-in-service date was extended to before January 1, 2027, and the date on which a specified plant is planted or grafted by the taxpayer was extended to before January 1, 2027.

The TCJA created three additional first year depreciation deduction elections:

  • A taxpayer can elect not to deduct the additional first year depreciation for all qualified property that is in the same class of property and placed in service by the taxpayer in the same tax year;
  • A taxpayer can elect to deduct 50-percent, instead of 100%, additional first year depreciation for all qualified property acquired after September 27, 2017, and placed in service by the taxpayer during its taxable year that includes September 28, 2017; and
  • A taxpayer can elect to deduct additional first year depreciation for any specified plant that is planted after September 27, 2017, and before January 1, 2027, or grafted after and before those dates to a plant that has already been planted. If the taxpayer makes this election, the additional first year depreciation deduction is allowable for the specified plant in the taxable year in which that plant is planted or grafted.


Depreciation errors are not uncommon.  Fortunately, there are procedures that can be used to correct many of the mistakes that have been made.

May 19, 2022 in Income Tax | Permalink | Comments (0)

Monday, May 16, 2022

Deducting Soil and Water Conservation Expenses


The tax Code allows a farmer to deduct expenses that were incurred during the tax year for the purpose of soil or water conservation of farmland, or to prevent the farmland’s erosion of land used in farming.  I.R.C. §175.  Not deducting the expenses constitutes an election not to deduct which is binding in subsequent years.  In that case, the expenditures increase the basis of the property to which they relate.  Also, once a method of reporting such expenses is adopted, it must be followed in subsequent years unless the IRS agrees to a change.

Other issues also arise when dealing with tax issues surrounding the treatment of soil and water conservation expenses in terms of qualified expenses, the procedure for claiming the deduction and potential recapture.

Deducting soil and water conservation expenses – it’s the topic of today’s post.

Deductible Expenditures

Soil and water conservation expenses that qualify under the I.R.C. §175 provision must be paid or incurred for soil or water conservation purposes with respect to land used in farming, or for the prevention of erosion on farmland.  I.R.C. §175(a).  Qualified expenses include various types of earth moving on farmland using in the business of farming.  Expenses for leveling, conditioning, grading, terracing and contour furrowing are all eligible as are costs associated with the control and protection of diversion channels, drainage ditches, irrigation ditches, earthen dams, water courses, outlets and ponds.  Even the cost of eradicating brush and the planting of windbreaks is eligible.  I.R.C. §175(c)(1).  Also included are drainage district assessments (and soil and water conservation district assessments) if such assessments would have been a deductible expense if the taxpayer had paid them directly.  I.R.C. §175 (c)(1)(B).

Deductibility Requirements

Taxpayer engaged in farming.  Several requirements must be met before soil and water conservation expenditures can be deducted.  As noted above, the taxpayer must be engaged in the business of farming.  A farm operator or landowner receiving rental income under a material participation crop share or livestock share lease satisfies the test.  Treas. Reg. §1.175-3.  Under that type of lease, the landlord bears the risk of production and the risk of price change.  A share lease where the landlord’s report the income from it on Form 4835 also satisfies the test.  However, a cash lease doesn’t meet the test.  That’s a rental activity.

Land used in farming.  The expenditures must pertain to land used in farming - to produce crops or sustain livestock.  Specifically, the term “land used in farming” means land “used by the taxpayer or his tenant for the production of crops, fruits, or other agricultural products or for the sustenance of livestock.”  I.R.C. §175(c)(2).

Improvements that are made to land that hasn’t been previously used in farming are not eligible.  But, prior farming activity by a different taxpayer counts as does a different type of agricultural use.  Treas. Reg. §1.175-4(a).  In addition, expenses associated with assets that qualify as deductible as soil and water conservation expenses are not necessarily precluded from being depreciated by a subsequent purchaser of the real estate on which qualifying property has been placed.  For example, in Rudolph Investment Corp. v. Comm’r, T.C. Memo. 1972-129, the court allowed the taxpayer to depreciate earthen dams and earthen water storage tanks located on ranchland even though the structures qualified for a current deduction under I.R.C. § 175.

NRCS plan and ineligible expenditures.  The expenditures must be consistent with a conservation plan approved by the Natural Resources Conservation Service (NRCS) or, if there are no NRCS plans for the area, a state (or local) plan.  I.R.C. §175(c)(3).  See also 2021 IRS Pub. 225 (Ch. 5).  On this point, expenditures for draining or filling of wetlands or land preparation for center-pivot irrigation are not deductible as soil and water conservation expenses. I.R.C. §(c)(3)(B).  Similarly, expenses to clear land so that it can be farmed are not eligible and must be added to basis.  IRS Pub. 225, Chapter 5, also points out that ineligible expenditures include those for various structures such as tanks, reservoirs, pipes, culverts, canals, dams, wells, or pumps composed of masonry, concrete, tile (including drainage tile), metal or wood.  The costs associated with these items are recovered through depreciation.  Similarly, costs associated with clearing land to prepare it for farming are not eligible and must be added to basis.  Likewise, expenses that are currently deductible as repairs or are otherwise currently deductible under I.R.C. §162 as an ordinary and necessary business expense are not claimed under I.R.C. §175.  Treas. Reg. §1.175-2(b)(2).

Deduction limit.  The deduction may not exceed 25 percent of the taxpayer's “gross income derived from farming” in any taxable year.  I.R.C. §175(b).  The term “gross income derived from farming” includes gain from the sale of draft, dairy, breeding or sporting purpose livestock, but not gains from the sale of machinery or land.  Excess amounts may be carried over to the succeeding years subject to the same 25 percent limit. 

Note:   It is possible that qualified expenditures could be subject to the 25 percent limitation if the farm taxpayer defers a sufficient amount of grain sales, for example, such that gross farm income is decreased.    

How to Claim the Deduction

Line 12 of the 2021 Schedule F (Form 1040) is where soil and water conservation expenses can be reported.  As noted above, if they are not claimed they are to be added to the land’s basis.  In addition, as noted above, the decision to either currently deduct or capitalize soil and water conservation expenses is made in the first year in which the expenses are incurred and establishes a method of accounting.  To change that method of accounting requires IRS approval.


If a deduction is taken for soil and water conservation expenses on farmland or ranchland and the land is disposed of within ten years of its acquisition, part or all of the deductions taken are recaptured as ordinary income up to the amount of gain on the disposition or the amount deducted multiplied by a percentage (as noted below), whichever is lower.  I.R.C. §1252.  The amount of recapture depends upon how long the land was held before disposition. For land held five years or less, all of the deductions are subject to recapture.  For land held more than five years but less than ten, a sliding scale applies.  A sale or disposition in the sixth year recaptures 80 percent, within the seventh year 60 percent, within the eighth year 40 percent, and within the ninth year 20 percent, of the deductions.  If the land was held for more than nine years, there is no recapture of soil and water conservation deductions. 

To restate, in the event recapture applies, the recaptured amount cannot exceed the amount of gain on the land.  Also, if only a portion of the land is disposed of, the deductions attributable to the entire parcel are allocated to each part in proportion to the fair market value of each at the time of disposition.  If disposition of the land is by gift, tax-free exchange or transfer at death, no gain is recognized from recapture.


The current deduction for soil and water conservation expenses can be a helpful provision for numerous farmers.  When a farmer has qualifying expenses it’s a helpful tool to include in the tax planning arsenal.

May 16, 2022 in Income Tax | Permalink | Comments (0)

Tuesday, May 10, 2022

Tax Court Caselaw Update


It’s been a while since I did a post on tax developments from the Tax Court.  Today is the day to provide that update on some recent Tax Court decisions that bear on various aspects of taxation that impact tax planning and tax preparation.  I will do this again soon because there have been many important Tax Court decisions recently – too many to summarize in a single post.

An update of recent tax cases – it’s the topic of today’s post.

S Election Must Be Revoked To Be a C Corporation. 

Chan v. Comr., T.C. Memo. 2021-136

The petitioners operated a restaurant via their S corporation.  They failed to file tax returns for two years and didn’t report the business income on their personal returns.  The IRS audited, reconstructed their income using the bank deposits method and disallowed all expenses.  The petitioners claimed that they operated the restaurant via a C corporation.  The IRS rejected that claim, noting that the petitioners had not affirmatively revoked the S election.  The Tax Court upheld the IRS position with respect to the petitioners’ type of entity.  However, the Tax Court determined that material facts existed concerning other issues and gave the petitioners a chance to demonstrate the expenses associated with the business. 

Lesson:  Pay attention to the rules for forming as well as changing an entity type.  There are formal elections that must be made or revoked. 

Penalties Imposed on Donated Conservation Easement Transaction. 

Plateau Holdings, LLC, Waterfall Development Manager, LLC, Tax Matters Partner, T.C. Memo. 2021-133

The petitioner donated a conservation easement to a qualified charity and claimed a $25.5 million charitable donation deduction. The IRS challenged the valuation of the easement and its validity in an earlier decision, the Tax Court agreed, disallowed the deduction and imposed a 40 percent penalty for gross overvaluation of the easements.  In an earlier case, the Tax Court determined that the correct value of the easement donation was $2.7 million and imposed a 40 percent penalty for gross valuation misstatement, resulting in an additional tax of $9,103,120.  The Tax Court also disallowed the charitable deduction because the easements were not protected in perpetuity due to a provision in the deeds granting the easements to the charity that reduced the charity’s proportionate share of the sale proceeds by in impermissible carve-out for donor improvements upon a judicial extinguishment of the easements.  In the present case, the IRS sought an additional 20 percent penalty for negligence due to the petitioner’s substantial understatement of tax under I.R.C. §6662(a) and (b)(1)-(2).  The 20 percent penalty would apply to the portion of the underpayment resulting from the Tax Court’s decision in the prior case that the petitioner was not entitled to a charitable deduction.  The Tax Court did not allow the 20 percent accuracy-related penalty because the petitioner had reasonable cause and acted in good faith with respect to the claimed charitable deduction corresponding to the correct valuation of the easements. 

Lesson:  The IRS closely examines conservation easement donation transactions, but must clearly establish the elements for imposing a negligence penalty.  Precise deed drafting and good valuations are essential.    

IRS Properly Denied Installment Agreement

Roberts v. Comr., T.C. Memo. 2021-131

The IRS may consider a taxpayer as qualified for an installment agreement to pay an outstanding tax obligation upon the satisfaction of six requirements: 1) the taxpayer files any delinquent returns; 2) if applicable, the taxpayer files any outstanding employment tax returns; 3) if applicable, the taxpayer makes all current payroll tax deposits; 4) the taxpayer completes Form 433-B with the financial information (supported by documentation) needed to negotiate a payment arrangement to satisfy the delinquent taxes; 5) the taxpayer provided the financial information to the IRS agent working the case and requests and installment agreement in writing specifying the amount per month intended to be paid, the date the payments will begin and the tax periods the installment agreement covers; and 6) the taxpayer must comply with IRS deadlines for providing additional documentation or information.  In this case, the IRS denied the petitioner’s request for an installment agreement because the petitioner was not current on her Federal tax filings and didn’t supply financial information on Form 433-A.  The petitioner also didn’t provide the IRS with a specific proposal for the installment payments.  The Tax Court upheld the denial by the IRS.

Lesson:  If you are seeking an installment agreement payment plan with IRS, make sure to have your records in place along with a well-thought-out plan to present to the IRS. 

Company Founder Was Employee

REDI Foundation, Inc. v. Comr., T.C. Memo. 2022-34

The petitioner was formed in 1980 to serve as a vehicle for one of its officers to conduct seminars on real estate development.  The petitioner was granted I.R.C. §501(c)(3) status.  The officer in question also was a member of the petitioner’s board of directors.  The petitioner was inactive for almost all years from 1980 to 2010 and offered the officer’s seminars only in 1980 and 1990.  In 2010, the petitioner offered an online course to the public.  The office exercised complete control over the petitioner’s online course, often working 60 hours per week with the course and its students.  The petitioner’s sole source of income was derived from tuition associated with the online course, and the officer was paid by the petitioner based on enrollment from the course.  For the petitioner’s 2015 tax year, the petitioner reported total revenue of $255,605 on Form 990 and salaries, other compensation and employee benefits of $91,918.  The petitioner issued the officer a Form 1099-Misc. for the $91,918 and did not file Form 941 for any of the periods at issue.  No employer tax returns reporting payments to the officer as salary or wages were filed.  Upon audit, the IRS sought additional information concerning the treatment of the officer as an independent contractor, and information on whether the petitioner met the requirements for Section 530 employment tax relief.  In response, the petitioner claimed that the officer was never an employee and Section 530 relief was inapplicable.  IRS determined the officer to be an employee for employment tax purposes and that the petitioner was not entitled to Section 530 relief.  The IRS assessed employment tax liabilities and penalties under I.R.C. §6656.  The Tax Court agreed with the IRS, noting that the officer had a hand in every aspect of the petitioner’s business and that, as a result, his work as a corporate officer was more than minor.  In particular, the Tax Court pointed out that the only exception from employee status for a corporate officer is for an officer that performs only minor services and does not and is not entitled to receive remuneration for services.  The Tax Court noted that the officer provided services that constituted the corporation’s entire income and was paid for those services.  As such, the Tax Court concluded, it was a “fair inference” that he did so as an office and as a statutory employee.  The fact that he described what he paid himself as “royalties” did not make them so, and the Form 1099-Misc. that he issued to himself was self-serving.  As a statutory employee, Section 530 relief did not apply.  Penalties were also imposed for failure to file Form 941s and for failure to pay.  

Lesson:  You are an employee if you direct the business of the corporation and the corporation’s sole income comes from the services you provide. 

Value of Airline Tickets Included in Gross Income

Mihalik v. Comr., T.C. Memo. 2022-36

The petitioner is a retired airline pilot that participated in United Airline’s Retiree Pass Travel Program (RPTP). In 2016, United, through the RPTP, provided free airline tickets to the petitioner, his wife, daughter, and two adult relatives. The petitioner did not include the value of the free tickets two “enrolled friends” (likely relatives) in income on their 2016 tax return on the basis that it was a de minimis fringe benefit.   United Airlines issued Form 1099-Misc. to the petitioner for the relatives’ ticket values and the IRS determined that the value of the tickets provided to the two adult relatives was required to be included and issued a notice of deficiency containing an adjustment for the omitted income. Total tax due was $2,862.00.  The Tax Court agreed with the IRS’ position and granted summary judgment.  The Tax Court noted that the petitioner failed to allege any facts or legal argument to counter the IRS position.  The Tax Court determined that the value of the relatives’ tickets was not excludible under I.R.C. §132(a)(1) as a “no-additional-cost services” because the relatives were not the petitioner’s dependent children.  The tickets were also not excludible under I.R.C. §132(a)(4) as a “de minimis fringe” because the tickets had a value high enough that accounting for their provision was not unreasonable or administratively impracticable.

Lesson:  Some fringes are excludible (coffee; tea; doughnuts and pastries; soft drinks; local telephone calls; use of employer’s office equipment for occasional personal use, etc.) and some things are not (season tickets; employer-provided automobiles other than very limited use, etc).

Evidentiary Issues Sink Taxpayer 

Kohout v. Comr., T.C. Memo. 2022-37

The petitioners, a married couple, operated a medical funding and real estate business through a wholly-owned S corporation. Inc.  The husband was the sole shareholder.  On its 2013 Form 1120S, the S Corporation reported gross receipts of $1,829,524.  For the 2013 tax year, the IRS determined a $923,280 deficiency and accuracy-related penalties, under section I.R.C. §6662(a), in the amount of $184,676. The petitioners claimed that they overstated the S corporation’s gross receipts for the 2013 taxable year by $955,599, and that there was sufficient basis in one of the S corporation’s subsidiaries to deduct pro rata shares of a loss for the 2013 taxable year. None of the agreements related to the S corporation’s operations were presented to the IRS, and the record was void of any evidence of income that the S corporation received from the operations. The petitioner testified that he altered the QuickBooks computer files on multiple occasions after the S corporation returns were prepared, including during the IRS audit, and due to a computer crash, computer files for the S corporation and its subsidiaries were destroyed. However, the evidence did show that the S corporation made and received money transfers to and from its many disregarded subsidiaries, and those transfers—and evidence of the many bank accounts used by the S corporation for the transfers—were at issue.  But, the petitioners, after engaging an accountant to reconstruct the S corporation’s books, believed that the S corporation’s income was overstated when he signed and filed the S corporation’s return and their personal returns. The reconstruction expert prepared and sought to admit summaries of the S corporation’s bank statements, some of which were near 60 pages in length.  The Tax Court held the petitioners liable for $923,000.  They failed to prove they had overreported their income or that they were entitled to a deduction for pass-through losses.  The petitioners did not provide rental statements and invoices that would have corroborated the recalculation of their 2013 gross receipts.  The pass-through loss deduction was denied due to lack of proof of sufficient basis in the S corporation. 

Lesson:  Be careful with summarizing client tax information.  The Tax Court approves of summaries, but only if they comport with Rule 1006.  Under that rule, “[t]he proponent [of evidence] may use a summary, chart, or calculation to prove the content of voluminous writings, recordings, or photographs that cannot be conveniently examined in court.”  To comply with Rule 1006, a summary must be “an accurate compilation of the voluminous records sought to be summarized.”  

May 10, 2022 in Income Tax | Permalink | Comments (0)

Friday, May 6, 2022

Joint Tenancy and Income Tax Basis At Death


Given the current level of the federal estate and gift tax applicable exclusion amount set at $12.06 million for decedent’s dying in 2022 and gifts made in 2022, the prospect of a taxable estate at death is a concern for very few.  What is much more important for most people, however, is income tax basis planning.  That’s because property that is included in a decedent’s estate at death receives an income tax basis equal to the property’s fair market value as of the date of death.  I.R.C. §1014.  As a result of this rule, much of current estate planning involves techniques to cause inclusion of property in a decedent’s estate at death.  Even though the property will be subjected to federal estate tax, the value will be excluded from tax by virtue of the unified credit that can offset up to $12.06 million of taxable estate.

Joint Tenancy Basics

Joint forms of property holding between husband and wife have been widely used among farm families because of certain supposed advantages, one of which is the simplicity of transferring property upon death.  A distinguishing characteristic of joint tenancy is the right of survivorship.  That means that the surviving joint tenant or tenants become the full owner(s) of the jointly held property upon the death of a fellow joint tenant regardless of the terms of the deceased joint tenant’s will. 

Upon a conveyance of real property to two or more persons, a tenancy-in-common is generally creates a tenancy in common unless it is clear in the deed or other conveyancing document that a joint tenancy is intended. 

Example:  Alec Trician conveys Blackacre is conveyed to “Michael and Kelsey, husband and wife.” Michael and Kelsey own Blackacre as tenants-in-common.  To own Blackacre as joint tenants, Blackacre needed to be conveyed to them as required by state law.  The typical language for creating a joint tenancy is to “Michael and Kelsey, husband and wife, as joint tenants with right of survivorship and not as tenants in common.”

Estate Tax Treatment of Joint Tenancy Property  

Non-spousal rule.  For joint tenancies involving persons other than husbands and wives, property is taxed in the estate of the first to die except to the extent the surviving owner(s) prove contribution for its acquisition. I.R.C. § 2040(a).  This is the “consideration furnished” rule.  As a result, property could be taxed fully at the death of the first joint tenant to die (if that person provided funds for acquisition) and again at the death of the survivor.  Whatever portion is taxed in the estate of the first to die also receives a new income tax basis based on the fair market value of that portion at the date of death.

Example:  Bob and Bessie Black, brother and sister, purchased a 1,000-acre Montana ranch in 1970 for $1,000,000.  Bob provided $750,000 of the purchase price and Bessie the remaining $250,000.  At all times since 1970, they have owned the ranch in joint tenancy with right of survivorship.  Bob died in 2022 when the ranch had a fair market value of $2,500,000.  Seventy-five percent of the date of death value, $1,875,000 will be included in Bob’s estate.

Bessie, as the surviving joint tenant will now own the entire ranch.  Her income tax basis in the ranch upon Bob’s death is computed as follows:

       $1,875,000 (Value included in Bob’s estate)

        + 250,000  (Bessie’s contribution toward purchase price)


Thus, if Bessie were to sell the ranch soon after Bob’s death for $2,500,000, she would incur a federal capital gain tax of $75,000, computed as follows:

       $2,500,000 (Sale price)

       - 2,125,000 (Bessie’s income tax basis)

          $375,000   Taxable gain

                    x.20    (Capital gain tax rate)

            $75,000  (Tax due)

Note:  While property held in joint tenancy is not be included in the “probate estate” for probate purposes, the value of the decedent’s interest in jointly held property is potentially subjected to federal estate tax and state inheritance or state estate tax to the extent the decedent provided the consideration for its acquisition. 

Martial joint tenancies.  For joint tenancies involving only a husband and wife, the property is treated at the first spouse’s death as belonging 50 percent to each spouse for federal estate tax purposes. I.R.C. § 2040(b).  This is known as the “fractional share” rule.  Thus, only one-half of the value is taxed at the death of the first spouse to die.  Although no federal estate tax is incurred on the property passing to the surviving spouse, only one-half receives a new income tax basis equal to fair market value at the death of the deceased spouse in the hands of the surviving spouse. It does not matter which spouse provided the consideration for the spousal joint property.  I.R.C. §1014.

Observation:  An estate planner should carefully analyze the effect of joint property holding on basis adjustment at the death of one of the joint owners.  Generally, only a one-half interest in qualified joint interests will receive a step-up in basis.  However, if the first spouse to die had owned all the property, a full step-up would have been obtained. 

If inception of the tenancy involved a gift by the decedent to the surviving spouse, the survivor’s basis in the property will equal the original transferred basis.  As a result, the sale of the property by the surviving spouse could result in a capital gain. 

Special rule.  In 1992, the Sixth Circuit Court of Appeals applied the consideration furnished rule to a husband-wife joint tenancy in farmland with the result that the entire value of the jointly held property was included in the gross estate of the husband, the first spouse to die. Gallenstein v. United States, 975 F.2d 286 (6th Cir. 1992).     The full value was subject to federal estate tax but was covered by the 100 percent federal estate tax marital deduction, eliminating federal estate tax.  In addition, the entire property received a new income tax basis which was the objective of the surviving spouse.  The court reached this result because of statutory changes to the applicable Internal Revenue Code sections that were made in the late 1970s.  To take advantage of those changes, the court determined, it was critical that the jointly held property at issue was acquired before 1977. 

Under the facts of the case, the farmland was purchased in 1955 for $38,500 exclusively with the husband’s funds.  The surviving wife sold the farmland in 1988 for $3,663,650 after her husband’s death in late 1987.  Under the pre-Tax Reform Act of 1976 rules on joint tenancy contribution, a decedent’s gross estate included all of the value of property held in joint tenancy with another expect the portion of that value contributed by the other person, instead of arbitrarily including one-half of the value of the joint tenancy property.  The surviving wife argued that there was nothing in any legislation that applied the 50 percent inclusion rule to pre-1977 joint interests, but that such interests were still subject to the full marital deduction under the 1981 Act.   

The Gallenstein court reasoned that the 1976 Act applied only to joint interests created after December 31, 1976, and that the 1981 amendments which resulted in the one-half taxability expressly applied to decedents dying after December 31, 1981.  The 1981 amendments did not repeal the January 1, 1977, effective date of the 1976 amendments, which did not apply to joint interests created before 1977.  Because the surviving spouse as joint tenant had made no contribution to the property, she was entitled to a full step-up in basis.  The result was that the entire gain on sale was eliminated because of the full basis step-up. 

In 1996 and 1997, the federal district court for Maryland reached a similar conclusion. Anderson v. United States, 96-2 U.S. Tax Cas. (CCH) ¶60,235 (D. Md. 1996); Wilburn v. United States, 97-2 U.S. Tax Cas. (CCH) ¶50,881 (D. Md. 1997).  Also, in 1997, the Fourth Circuit Court of Appeals followed Gallenstein as did a federal district court in Florida.  Patten v. United States, 116 F.3d 1029 (4th Cir. 1997), aff’g, 96-1 U.S. Tax Cas. (CCH) ¶ 60,231 (W.D. Va. 1996); Baszto v. United States, 98-1 U.S.Tax Cas. (CCH) ¶60,305 (M.D. Fla. 1997). 

In 1998, the Tax Court agreed with the prior federal court opinions.  Under the Tax Court’s reasoning, the fractional share rule cannot be applied to joint interests created before 1977.  Hahn v. Comm’r, 110 T.C. 140 (1998).  This is a key point.  If the jointly held assets had declined in value, such that death of the first spouse would result in a lower basis, the fractional share rule would result in a more advantageous result for the survivor in the event of sale if the survivor could not prove contribution at the death of the first to die. In late 2001, the IRS acquiesced in the Tax Court’s opinion.  Acq, 2001-42, I.R.B. 319.


While there are estate planning drawbacks for owing property in joint tenancy at death, particularly in estates with values greater than the unified credit exemption equivalent.  It also presents challenges where qualification for certain post-mortem estate planning techniques is critical, and because of it is an inflexible ownership structure.  However, as the unified credit exemption equivalent has increased dramatically since 2017, joint tenancy has gained popularity.  Also, for pre-1977 marital joint tenancies where one spouse provided all of the funds to acquire the property and that spouse dies, the full value of the property will be included in the decedent’s gross estate.  But, in many of these estates, the full value will be excluded from federal estate tax.    More importantly, the surviving spouse will receive an income tax basis equal to the value of the property at the time of the first spouse’s death.   In agricultural, many pre-1977 marital joint tenancies involving farmland exist. 

May 6, 2022 in Estate Planning, Income Tax | Permalink | Comments (0)

Wednesday, May 4, 2022

Ag Law (and Medicaid Planning) Court Developments of Interest


Agricultural law is a dynamic area of the law.  There is always something going on in the courts, with the IRS and in the economy that has relevance to legal issues.  With today’s post I look at some recent developments of importance to farmers and ranchers, including an interesting Texas case involving Medicaid planning.

Recent court developments involving agricultural producers and farm/ranch families. 

Hog is a “Good” Potentially Subject to State Product Liability Law 

Tyson Fresh Meats, Inc. v. Dykhuis Farms, Inc., et al., No. 3:21-CV-90 RLM-MGG, 2022 U.S. Dist. LEXIS 59710 (N.D. Ind. Mar. 31, 2022)

The plaintiff claimed it bought hogs from a company that subcontracted with the defendant to raise the hogs.  The defendant delivered 267 hogs to the plaintiff which processed the hogs and commingled the meat with other meat at its plant.  Two days later, the defendant told the plaintiff that the hogs hadn’t gone through a required withdrawal period for a certain supplement.  As a result, the plaintiff had to dispose more than 1.7 million pounds of “contaminated” fresh meat.  The plaintiff sued for negligence and breach of state (Indiana) product liability law.  The defendant claimed that it provided a service rather than a product and that hogs were not “products” subject to product liability law.  The defendant motioned for dismissal of the case, but the court held that the service-product distinction couldn’t be resolved on a motion to dismiss. 

On appeal, the appellate court held that “goods” under the Indiana Product Liability Law covered “all things” that are “movable” when contracted for, including “the unborn young of animals” and adult animals.  On the negligence claim, however, the appellate court determined that the plaintiff failed to adequately allege that the defendant owed the plaintiff a duty of care.  Thus, the plaintiff was not allowed to proceed with the negligence claim. 

No Standing to Challenge Hog Operation Permits 

Sierra Club v. Stanek, No. 123,023, 2022 Kan. App. Unpub. LEXIS 193 (Kan. Ct. App. Apr. 1, 2022)

The defendant granted four swine facility permits over the plaintiff’s objection. The plaintiff sought review under the Kansas Judicial Review Act (KJRA), claiming that the defendant misinterpreted the relevant statutes and regulations. The trial court agreed and reversed the defendant’s decision.  On appeal, the permittees requested that the defendant grant modified permits so that they could continue operations.  The defendant issued modified permits and the plaintiff sued.    The appellate court held that the plaintiff lacked standing to petition for judicial review, reversed the trial court’s decision and remanded the case with directions to dismiss the plaintiff’s petition and reinstate the original permits. 

Supreme Court Won’t Hear Kansas Case Involving Secret Filming. 

Kelly v. Animal Legal Defense Fund, cert. den., No. 21-760, 2022 U.S. LEXIS 2153 (U.S. Sup. Ct. Apr. 25, 2022)

In 2021, the U.S. Court of Appeals for the Tenth Circuit, held that a Kansas law making it a crime to take pictures or record videos at a covered facility (primarily a slaughterhouse) “without the effective consent of the owner and with the intent to damage the enterprise” was unconstitutional.  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 was narrowly tailored to a compelling state interest in suppressing the “speech” involved.  The dissent pointed out (consistent with the Eighth Circuit) that “lies uttered to obtain consent to enter the premises of an agricultural facility are not protected speech.”  According to the Eighth Circuit, the First Amendment does not protect a fraudulently obtained consent to enter someone else’s property.  The Tenth Circuit disagreed and held the Kansas law unconstitutional.  Animal Legal Defense Fund, et al. v. Kelly, 9 F.4th 1219 (10th Cir. 2021).  The state of Kansas sought U.S. Supreme Court review. Pet. for cert. filed, (U.S. Sup. Ct. Nov. 17, 2021).  On April 25, 2022, the U.S. Supreme Court declined to hear the case. 

Prior Occupancy of Home Not Required For Exclusion Under Medicaid Rules 

Texas Health & Human Services Commission v. Estate of Burt, No. 03-20-00462-CV, 2022 Tex. App. LEXIS 2556 (Tex. Ct. App. Apr. 21, 2022)

The decedent and his wife bought a home in 1974 and lived there until late 2010 when they sold it to their daughter.  They then moved into a rental property that the daughter owned.  In early 2017, the couple entered a skilled nursing facility and shortly thereafter bough a one-half interest in their original home to “secure home equity in a home that they could return to if one or both of them should be able to leave the nursing home.”  The same day, they filled out the plaintiff’s form designating the home as their place of residence and indicating an intent to return.  After the purchase, they had about $2,000 remaining in their bank accounts.  They then sought Medicaid benefits, effective immediately. 

After both the decedent and his wife died shortly thereafter, the application was denied due to a finding of “resources in excess of program limits” because the plaintiff included the couple’s interest in the home as an available countable resource for Medicaid purposes. After the last of them to die, a debt of $23,479.35 was left owing to the nursing facility.  Their daughter appealed the plaintiff’s decision to deny Medicaid benefits, but a hearing officer and the plaintiff’s Legal Services Attorney upheld the denial due to the couple’s inability to establish prior occupancy of the home as a principal place of residence.  As such, the plaintiff determined, none of the equity value of the home could be excludible for Medicaid eligibility purposes. 

The daughter sought judicial review, claiming that the home should have been excluded from her parent’s countable resources for Medicaid eligibility purposes under 42 U.S.C. §1382b(a)(1).  This statute provides that a Medicaid applicant’s home is not an available asset for Medicaid eligibility purposes and is defined as any personal residence in which the applicant has an ownership interest.  State (Texas) law contains an identical definition.  1 Tex Admin. Code §§358.103(38), (69).  Under federal regulations, “place of residence” is defined as “the dwelling the individual considers his or her established or principal home and to which, if absent, he or she intends to return.”  Program Operations Manual System, SI 01130.100A.2.  Again, state law on this point is identical, defining a home as the “place of residence of the applicant or applicant’s spouse if the applicant “occupies or intends to return to the home.”  1 Tex. Admin. Code §358.348(a)(1) mirroring 20 C.F.R. §416.1212.  The plaintiff adopted an identical regulation requiring prior occupancy consistent with the Texas statutory provision.  Accordingly, the plaintiff asserted that because the decedent and wife did not have any ownership interest in a home at the time they entered the nursing home, they had no excludible home to which they could intend to return to at that time.  In other words, the plaintiff’s subjective intent was to be ignored and the plaintiff read a “prior occupancy” requirement into the applicable regulations construing 42 U.S.C. §1382b(a)(1) and the comparable Texas provision.

The trial court ruled that the plaintiff’s interpretation was unreasonable and not supported by substantial evidence, reversed the plaintiff’s decision and remanded the case.  The plaintiff appealed, but the appellate court determined that the plaintiff’s interpretation requiring prior occupancy of a home was incorrect. While the plaintiff argued that because the couple bought their interest in the home after entering the nursing facility, they could not be viewed as “intending to return” to it and, as a result, it could not be considered their “home.”  The appellate court noted that “intent to return” in the federal regulation applied only to the continued exclusion of the home before the time the applicant left the property, and that the federal regulation specified that an applicant’s principal place of residence is the place the person considers to be the person’s established home – the subjective intent of the applicant(s). 

While there were no prior Texas appellate decisions directly on point, the appellate court did cite a local county district court opinion in a letter ruling where the court stated, “if Congress had intended to require prior occupancy, it would have been simple to state it.”  That appellate court went on to reason the purpose of Medicaid is better served by allowing an applicant to claim the home exemption for a home that a Medicaid recipient buys or inherits while in a nursing facility, as long as the recipient intends (subjectively) to return to the home upon discharge from the facility.  The appellate court found this reasoning persuasive, found a contrary Arkansas court opinion on the issue that held the opposite to be unpersuasive (Groce v. Director, Arkansas Department of Human Services, 82 Ark. App. 447, 117 S.W.3d 618 (Ark. Ct. App. 2003)), and concluded that there was no “prior actual residence requirement” under Medicaid.  Thus, the plaintiff’s regulatory interpretation was an improper reading of the statute.  As a result, the appellate court affirmed the trial court’s decision. 


The legal issues keep on rolling involving agriculture.  It will be interesting to see if the Texas Medicaid court decision is appealed.  As noted, there is a split of authority on that issue that has implications for long-term care planning.  I will do another recent development blog soon. 

May 4, 2022 in Contracts, Estate Planning, Regulatory Law | Permalink | Comments (2)

Sunday, May 1, 2022

Summer 2022 Farm Income Tax/Estate and Business Planning Conferences


The Washburn Law School Summer 2022 national conferences on ag income tax and ag estate and business planning are approaching.  The first one will be June 13-14 at the Chula Vista Resort near the Wisconsin Dells.  The second conference will be in Durango, Colorado, at Fort Lewis College on August 1-2.

Registration is now open for both the Wisconsin event in mid-June and the Colorado event in early August. 

Wisconsin Dells, Wisconsin

Here’s the link to the online brochure and registration for the event at the Chula Vista Resort on June 13-14:

A block of rooms is available for this seminar at a rate of $139.00 per night plus taxes and fees. To make a reservation call (855) 529-7630 and reference booking ID "#i60172 Washburn Law School." Rooms can be reserved at the group rate through May 15, 2022. Reservations requested after May 15 are subject to availability at the time of reservation.

An hour of ethics is provided at the end of Day 2.

The conference will also be broadcast live online for those that cannot attend in person.  Online attendees will be able to interact with the presenters, if desired. 

Here’s a rundown of the topics by day, for more detail see the registration at the link provided above:

Day 1 (at both Wisconsin and Durango)

  • Tax Update: Key Rulings and Cases
  • Reporting of WHIP and Other Government Payments
  • Fixing Bonus Elections and Computations
  • Research and Development Credits
  • Farm NOLs
  • The Taxability of Retailer Reward Programs; Tax Rules Associated with Demolishing Farm Structures
  • IRS-CI: Emerging Cyber Crimes and Crypto Tax Compliance
  • Reporting of machinery trade transactions
  • Inventory accounting issues
  • Early termination of CRP contracts;
  • Partnership reporting;
  • Weather-related livestock sales; and
  • Contribution margin analysis

Day 2 (Wisconsin)

  • Estate and Business Planning Caselaw and Ruling Update
  • The Use of IDGTs (and other strategies) For Succession Planning
  • Anticompetitive Conduct in Agriculture
  • Post-Death Dissolution of S Corporation Stock and Stepped-Up Basis; Last Year of Farming; Deferred Tax liability and Conversion to Form 4835
  • Agricultural Finance and Land Situation
  • Post-Death Basis Increase: Is GallensteinStill in Play?; Using an LLC to Make an S Election
  • Getting Clients Engaged in the Estate/Business Planning Process
  • Ethical Problems in Estate and Income Tax Planning 

Day 2 (Durango)

  • Estate and Business Planning Caselaw and Ruling Update 
  • The Use of IDGTs (and other strategies) For Succession Planning 
  • Estate Planning to Minimize Income Taxation: From the Mundane to the Arcane
  • Oil and Gas Royalties and Working Interest Payments: Taxation, Planning and Oversight
  • Economic Evaluation of a Farm Business 
  • Appropriation Water Rights - Tax and Estate Planning Issues
  • Ethically Negotiating End of Life Family Issues 

Here’s the link to the online brochure and registration for the event in Durango at Fort Lewis College on August 1-2:

Online Attendance

Both the Wisconsin and Colorado conferences will also be broadcast live online for those that cannot attend in person.  Online attendees will be able to interact with the presenters, if desired. For those attending online, please indicate on your registration whether you would like to have a hardcopy of the conference materials sent to you.

Other Points

There are many other important details about the conferences that you can find by reviewing the online brochures. 

Looking forward to seeing you there or having you participate online.  If you do tax, estate planning or business succession planning work for clients or are involved in production agriculture in any way, this conference is for you.  Each event will also have a presentation involving the farm economy that you won’t want to miss.  Also, if you aren’t needing to claim continuing education credits, you qualify for a lower registration rate.

I am looking forward to seeing you there. 

May 1, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Thursday, April 28, 2022

Proposed Estate Tax Rules Would Protect Against Decrease in Estate Tax Exemption


The Treasury has proposed regulations that would prevent certain decedents’ estate from being subject to federal estate tax if the federal estate and gift tax applicable exclusion amount drops to $5 million (adjusted for inflation) for deaths after 2025 as it is set to do so under current law.  The Tax Cuts and Jobs Act enacted in late 2017 set the applicable exclusion amount at $10 million for deaths occurring and taxable gifts made after 2017 (adjusted for inflation).  I.R.C. §2010(c)(3).  The amount, for 2022, is $12.06 million per person/estate. 

A proposed estate/gift tax regulation on the applicable exclusion amount – it’s the topic of today’s post.


Historical.  Estate and gift taxes were unified into a single system in 1976 and remained unified through 2003. The systems are re-unified for transfers occurring after 2010. Under this unified system, gift taxes are calculated based on accumulated taxable gifts made by an individual during life. Estate taxes are calculated on the decedent’s taxable estate at death, reduced by gift taxes paid on post-1976 taxable gifts (except for gift taxes paid within three years of death). A “unified” estate and gift tax credit is available to offset estate tax liability and is a function of the amount of applicable exclusion available at death.  In other words, the credit will be an amount that offsets the tax liability to the extent of the applicable exclusion available to the decedent’s estate at death. 

Computation of federal estate tax.  A decedent’s taxable estate is determined by subtracting from the decedent’s gross estate (adjusted for gifts and gift tax within three years of death except for amounts covered by the federal gift tax annual exclusion), costs of estate administration, allowable losses, the marital deduction, and charitable deduction. Taxable gifts after 1976 (those not covered by the federal gift tax annual exclusion, marital deduction or charitable deduction) are included in the taxable estate for purposes of determining the amount of prior use of the unified credit and the point to begin figuring federal estate tax on the graduated tax schedule.

Potential problem.  Based on this manner of calculating a decedent’s taxable estate, a question arises if the applicable exclusion amount that applies at the time of a decedent’s death is different from the amount that applied with respect to any post-1976 taxable gifts made by the decedent during life.  For example, assume a donor made a large taxable gift in 2020 what was completely offset by the unified credit.  If the donor died in 2026 (under current law) when the applicable exclusion amount is lower, would those prior gifts now be deemed to be taxable gifts that are pulled back into the estate for estate tax purposes?  In other words, would those prior taxable gifts be “clawed back” and treated as includible in the decedent’s estate under I.R.C. §2001(b)? 

2019 final regulations.  In 2019, final regulations were issued specifying that gifts made at a time when the applicable exclusion exceeded the amount of the exclusion at death would not be pulled back into the estate at death.  84 Fed. Reg. 64995 (Nov. 26, 2019) creating Treas. Reg. §20.2010-1(c).  The regulations addressed the situation of persons that make lifetime gifts after 2017 and before 2025.  The basic idea of the final regulations is that a donor’s estate is not to be taxed on completed gifts that were not subject to gift tax when made because of a higher applicable exclusion amount than applies at the time of death.  In other words, if a person makes a $12.06 million gift in 2022 (the full exclusion amount) and dies after 2025, the applicable exclusion amount will be $12.06 million rather than $5 million (adjusted for inflation from 2011 to the year of death). 

Note:  Specifically, the final regulations specify that the portion of the unified credit allowed in computing estate tax that is attributable to the applicable exclusion amount is the sum of the amounts attributable to the exclusion amount that is allowed as a credit when computing the gift tax payable on gifts the decedent made during life. 

If a person makes a lifetime gift that is less than the full applicable exclusion amount for the year of the gift, but the gifted amount exceeds the exclusion amount for the year of death, there is no recapture. Instead, the exclusion for computing estate tax at death will be the amount of the exclusion for the year of death.  For example, if an individual makes a $5 million gift in 2022 (when the applicable exclusion amount for estate and gift tax purposes is $12.06 million) and dies after 2025 when, under current law, the exemption will be $5 million (adjusted for inflation from 2011), the individual’s estate tax liability will get the benefit of the exclusion as of the date of the gift.  In the example, that would be $12.06 million and a taxable gift amount of the difference between the exclusion at the time of the gift and the exclusion as of date of death will not be pulled back into the estate for estate tax purposes.

Note:  Under current law, the applicable exclusion amount is a “use it or lose it” concept.  It works to the benefit of a person that lives beyond 2025 to the extent gifts made after 2018 and before 2026 exceed the applicable exclusion amount at the time of death. 

The final regulations also clarify that the rule allowing the surviving spouse to “port” any unused amount of the applicable exclusion at the first spouse’s death (known as the deceased spouse unused exclusion amount (DSUEA) to be added to the surviving spouse’s exclusion amount is retained.  This means that the applicable exclusion amount for the first spouse to die will increase the exclusion available to the surviving spouse.  For instance, assume Mary dies in 2022.  The applicable exclusion amount for 2022 is $12.06 million. Assume that her husband, Dave, elects portability.  If Dave dies after 2025, his applicable exclusion will be the exclusion amount for the year of death (assume $5 million plus an inflation adjustment) plus the $12.06 million DSUEA from Mary’s estate.  If Dave were to make taxable gifts, any DSUEA is deemed to be applied to those gifts before his exclusion amount is applied.  If Dave dies after 2025, the DSUEA applied to his taxable gifts isn’t reduced.  The total amount of applicable credit that was used in computing Dave’s gift tax based on the DSUEA, plus the credit determined without claw-back would be available for computing estate tax in Dave’s estate.  Treas. Reg. §20.2010-1(c).

The 2019 regulations, however, didn’t address the issue of how to treat incomplete gifts such as retained life estates or transfers subject to powers of appointment.  These testamentary transfers are also included in the decedent’s gross estate at death (as “includable gifts”) and could be “clawed-back” into the estate at death if the applicable exclusion amount were lower at that time than it was at the time of the transfer. 

Note:  The 2019 regulations also didn’t address whether the post-2025 reduction in the applicable exclusion amount will impact allocations of the generation-skipping exemption made during 2018-2025.

Proposed Regulations

The proposed regulations remove these “includable gifts” from the estate tax computation.  NPRM Reg-118913-21 (Apr. 26, 2022); 87 Fed. Reg. 24918 (Apr. 27, 2022).  Specifically, the proposed regulation would remove from being clawed back into the decedent’s estate, the value of: (1) gifts that were subject to a retained life estate or subject to other powers or interests (See I.R.C.§§2035-2038 and I.R.C. §2042); (2) gifts made by enforceable promise to the extent unsatisfied at death; (3) transfers of certain applicable retained interests in corporations, partnerships or trusts. (I.R.C. §§2701-2702); and (4) transfers that would have been include in (1)-(3) above but for the transfer, relinquishment or elimination of an interest, power or property within 18 months of the decedent’s death by the decedent alone or in conjunction with any other person, or by any other person.  Prop. Treas. Reg. §20.2010-1(c)(3).  These transfers are removed from the possibility of claw back to the extent the taxable amount is 5 percent or less of the total amount of the transfer (as of the date of the transfer).   

The proposed regulations contain numerous explanatory examples.  Example 1, Prop. Treas. Reg. §20.2010-1(c)(3)(iii) is reproduced below and is based on the assumption that “the basic exclusion amount on the date of the gift was $11.4 million, the basic exclusion amount on the date of death is $6.8 million, and both amounts include hypothetical inflation adjustments. The donor's executor does not elect to use the alternate valuation date and, unless otherwise stated, the donor never married and made no other gifts during life.”

Example 1:

“Individual A made a completed gift of A's promissory note in the amount of $9 million. The note remained unpaid as of the date of A's death. The assets that are to be used to satisfy the note are part of A's gross estate, with the result that the note is treated as includible in the gross estate for purposes of section 2001(b) and is not included in A's adjusted taxable gifts. Because the note is treated as includible in the gross estate and does not qualify for the 5 percent de minimis rule in paragraph (c)(3)(ii)(A) of this section, the exception to the special rule found in paragraph (c)(3) of this section applies to the gift of the note. The credit to be applied for purposes of computing A's estate tax is based on the $6.8 million basic exclusion amount as of A's date of death, subject to the limitation of section 2010(d). The result would be the same if A or a person empowered to act on A's behalf had paid the note within the 18 months prior to the date of A's death.”

The Proposed Regulations also include examples of gifts to a grantor-retained annuity trust and a grantor retained income trust. 

Effective Date

The proposed regulation, once finalized, is applicable to estates of decedent’s dying on or after April 27, 2022.  The proposed rules are open for comments and requests for a public hearing for the 90-day period beginning April 27, 2022. 


The proposed regulation is an important one for larger estates that face potential estate tax liability because of prior taxable gifts.  If the applicable exclusion amount does drop after 2025, the IRS position will result in these estates not having an estate tax burden caused by prior tax-free gifts made when the exclusion was higher being pulled back into the estate and taxed at death because of a lower exclusion amount at that time.  Certain “includable gifts” may also escape claw back.

April 28, 2022 in Estate Planning | Permalink | Comments (0)

Tuesday, April 26, 2022

Is Your Farm or Ranch Protected From a Warrantless Search?


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. 

Warrantless searches of private agricultural land and the scope of curtilage – it’s the topic of today’s post.

In General

Curtilage is generally defined as the land immediately surrounding an individual’s home or dwelling, including any closely associated buildings and structures, but not any “open fields” or buildings or structures that contain separate activities conducted by others.  See Hester v. United States, 265 U.S. 57 (1924); Oliver v. United States, 466 U.S. 170 (1984).  For example, in United States v. Ritchie, 312 Fed. Appx. 885 (9th Cir. 2009), the court held that a trailer used occasionally as a place to sleep while performing farm chores did not constitute a “home” for purposes of establishing a Fourth Amendment protection in the curtilage of the home. 

Curtilage and Agriculture

Multi-factor test.  The extent of the curtilage is defined with reference to the proximity of it to the home.  Key factors are whether the area at issue is included within an enclosure surrounding the home, the nature of the uses to which the area is put, and the steps taken by the resident to protect the area from observation by passersby.  These are known as the “Dunn factors” based on United States v. Dunn, 480 U.S. 294 (1987).  One key case applying the factors was United States v. Gilman, No. 06-00198 SOM, 2007 U.S. Dist. LEXIS 32524 (D. Haw. May 2, 2007), aff’d, sub nom., United States v. Terragna, 390 Fed. Appx. 631 (9th Cir. 2010), cert. den., Terragna v. United States, 562 U.S. 1191 (2011).  In this case, which turned the typical curtilage analysis on its head, the court held that all evidence that was seized from a shed was to be suppressed because the shed was not within the curtilage of the residence for which a search warrant had been issued.  The court reasoned that the home and shed were not enclosed by a fence or natural boundary, and there was no evidence that the shed was used for illegal activities.  In addition, the court noted that the defendant took no steps to prevent the observation of the shed from passersby.

Another instructive case applying the Dunn factors is Wilson v. Florida, 952 So. 2d 564 (Fla. Ct. App. 2007).  In that case, a warrantless search was allowed of a greenhouse that was not within the curtilage of the defendant’s home.  The greenhouse was used to manufacture controlled substances.  It was not locked and was made of semitransparent materials.  The court determined that there was no reasonable expectation of privacy with respect to the greenhouse to which the protection against an illegal search and seizure extended.

The “open fields doctrine.”  Obviously, a great deal of farming and ranching activities occurs in the “open” and the courts have held that, under the “open fields doctrine,” government officials can make warrantless searches of such areas.  Here’s a sample of some of the more prominent cases involving the doctrine:

  • In United States v. Kirkwood, No. CR11-5488RBL, 2012 U.S. Dist. LEXIS 65214 (W.D. Wash. May 9, 2012), an open clearing near a rural home that separated the home and outbuildings from a wooded area functioned as curtilage. The court determined that the area was suitable for activities associated with the home and the use of the area associated with the home.
  • In Westfall v. State, 10 S.W.3d 85 (Tex. Ct. App. 1999), a sheriff entered a pasture without a warrant. The sheriff seized cattle and charged the owner with cruelty to animals.  The warrantless search was challenged, but was upheld under the open fields doctrine.
  • In Trimble v. State, 842 N.E.2d 798 (Ind. 2006),the court upheld a conviction for cruelty to a dog even though the police did not have a search warrant to search the defendant’s home.  While the dog house was within the curtilage of the home, the court determined that the defendant had no expectation of privacy because the dog was visible from the route any visitors to the property would be expected to use.
  • In Hill v. Commonwealth, 47 Va. App. 442, 624 S.E.2d 666 (2006),the court upheld convictions for violations of the Virginia Food Act even though an administrative inspection of the defendant’s goat cheese manufacturing facility was conducted without a search warrant. The court determined that the state had a significant interest in protecting public health and that even though the facility was located within the curtilage of the defendant’s home, it was subject to search because it was functioning as commercial property.
  • In United States v. Boyster, 436 F.3d 986 (8th Cir. 2006), open fields were found not to be within the curtilage of the defendant’s home. The fields were within the plain view of an aerial flyover and were 100 yards from the defendant’s residence and not enclosed by a fence and no other precautions had been taken to keep the growing marijuana from being visible by others.  Thus, the fields were not protected by the Fourth Amendment.
  • In State v. Nance, 149 N.C. App. 734, 562 S.E.2d 557 (N.C. Ct. App. 2002),a warrantless search was upheld under the open fields doctrine, where the animals observed were in plain view from the nearby road. However, the court noted that the seizure of items in plain view may require a warrant absent exigent circumstances.

Recent Cases

Ohio case.  The scope of curtilage in an ag setting was at issue in State v. Powell, No. 27580, 2017 Ohio App. LEXIS 5096 (Ohio Ct. App. Nov. 22, 2017).  The defendant was charged with seven counts of cruelty to animals. A humane agent for the local Humane Society testified that she was constantly getting complaints, both from the public, next door neighbors, news and also from the County Sherriff’s Office regarding the defendant’s horse not being fed and a pig being stuck. The agent testified that she responded to the area based upon only seeing two of the three horses she knew were normally on the property. The agent also testified that she heard the pigs squealing and followed the sound of animal distress, a sound which she recognized through her experiences as a humane agent. She stated that she first observed the pigs on January 3, 2017. At this time, they were standing in “liquid mud” and she smelled “fecal and urine ammonia” coming from the pen. Fecal and urine ammonia is toxic to pigs. She further stated that pigs were at risk of hypothermia due to the cold weather. The agent spoke with the defendants concerning the condition of the pig pen and the fact that it needed to be remedied along with the pigs’ food and water. The humane agent stated that she and the defendants agreed on a timetable for these items to be remedied. The defendants stated that they would work on it through the week remedy the situation in a timely manner, and that the pigs would be provided food and water. The humane agent testified that when she returned to the property the next day, the pigs were in the same condition and the weather was getting colder. Finally, on her third trip to the property, the humane agent stated the pigs lacked food and fresh water, and that they were “actively freezing to death.” The outside temperature had fallen to six degrees, according to the humane agent. The humane agent arranged for the removal of the pigs from the property on January 7, 2017 at around 12:30 a.m.

The defendant filed a motion to suppress the evidence obtained by the humane agent as the result of an illegal warrantless search of the curtilage surrounding their home. The trial court sustained the defendant’s motion to suppress, and the state appealed. On appeal, the appellate court reversed. The appellate court noted that while curtilage is considered to be part of a defendant’s home and, as such, is entitled to Fourth Amendment protection, the agent’s testimony revealed that the home on the property was uninhabitable due to a collapsed roof and no windows. In addition, the evidence showed that the pig pen was 100 yards from the vacant home, and the pig pen was not in an enclosure surrounding the vacant home. There also was no evidence that steps had been taken to protect the area from observation from the adjacent lane, such as the erection of a privacy fence, locked gates or “No Trespassing” signs. Thus, the court concluded that the pig pen was not within the defendant’s residence or its curtilage, and that the defendant’s observation of the pigs was not a “search” for purposes of the Fourth Amendment. Accordingly, the trial court’s judgment was reversed, and the matter remanded for further proceedings. 

Tennessee case.  Another key case involving the curtilage issue and agricultural property is that of Hollingsworth v. Tennessee Wildlife Resources Agency, 423 F. Supp. 3d 521 (W.D. Tenn. 2019).  In January of 2018, the plaintiff went out before sunrise to hunt ducks on his property.  While traveling down an interior path, the lights of his pickup reflected off something attached to a tree.  He stopped and got out of his pickup and examined the reflection more closely with a flashlight.  He found a trail camera with a transmitting antenna, photo storage and SIM card attached to the tree with zip ties.  Tree limbs that might obscure the view of the camera had been removed.  He removed the camera and discovered that over one thousand photos of himself, his family and friends had been transmitted to someone for several months.  The camera’s storage card also contained photographs of two government agents – one employed by the defendant and the other one being an agent of the U.S. Fish and Wildlife Service.  They had trespassed onto the plaintiff’s property (the property was posted as “No Trespassing”) and installed the camera on a tree located on the interior of the plaintiff’s property.  The plaintiff sued alleging that the installation of the camera violated his Fourth Amendment Rights under both the U.S. and Tennessee Constitutions.  He also sued the agents for criminal and common law trespass under state law.  Both defendants moved to dismiss the case. 

The defendants claimed that they didn’t violate the plaintiff’s Fourth Amendment rights by virtue of the “open fields” doctrine and, if they did, they were entitled to qualified immunity as government agents.  The USFWS also claimed it was entitled to sovereign immunity.  The plaintiff conceded the sovereign immunity claim, but asserted that the open fields doctrine did not apply particularly because the defendants had to pass through two gates and fences to reach the interior of the plaintiff’s property.  The plaintiff analogized the zip-tying of cameras to trees as comparable to placing a tracking device to the underbody of an automobile (which is impermissible without a warrant).  The plaintiff also claimed that the Tennessee Constitution provided greater protection from a warrantless search than the Fourth Amendment. 

The trial court followed an unreported Sixth Circuit decision with facts directly on point with the current case.  Spann v. Carter, 648 F. App’x. 586 (6th Cir. 2016).  There the appellate court held that the plaintiff’s farm and hunting property constituted an “open field” and that government agents did not, as a result, violated the plaintiff’s Fourth Amendment rights by installing cameras on the property.  The trial court also cited other federal court cases holding that the use of cameras by federal and state game officials to monitor private property did not violate the constitutional rights of the property owner.  In addition, the trial court distinguished a car as a personal “effect” from a tree not near a residence.  Accordingly, the trial court granted judgment as a matter of law to the defendants.

State Constitutions/Legislation

Some state constitutions protect the privacy of open fields in the same manner as a private dwelling.  Other states have statutes that are designed with that same intent.  A new Kansas law attempts to provide greater protection to landowners from warrantless searches, but may turn out to not actually achieve its purpose.  H.B. 2299, signed into law on April 18, 2022, and effective July 1, 2022, bars any employee of the Kansas Department of Wildlife and Parks (KDWP) from conducting unauthorized “surveillance” on private property without a warrant, court order or subpoena.  Had the legislative language stopped at that point or simply state that privately-owned agricultural land is to be treated as a private dwelling, there would have been no question that ag landowners would have been secure from warrantless searches in open fields.  However, the new statute continues, “…unless [also] authorized pursuant to…the [C]onstitution of the United States…”.  The provision also does not bar surveillance of private property by a wildlife biologist when the primary purpose of the surveillance is to locate and retrieve a missing person or track wildlife movement or migration.  “Surveillance is defined as the “installation and use of electronic equipment or devices on private property, including but not limited to, the installation and use of a tracking device, video camera or audio recording device, to monitor activity or collect information related to the enforcement of laws of the state of Kansas.”

Note:  By authorizing a warrantless search if it complies with the “Constitution of the United States” the legislation arguably fails to address the “open fields” warrantless search concerns of agricultural landowners.  As noted above, the Supreme Court has construed the Fourth Amendment’s protection against warrantless searches to not apply to private land that doesn’t immediately surround the residence (even if posted “No Trespassing”).


Warrantless searches can be an important issue for farmers and ranchers, particularly with respect to the possibility of inadvertent violations of the criminal provisions of environmental laws.  In addition, when a landowner posts their property as “No Trespassing” to purposely exclude the public from entry and put the public on notice that a deliberate entry will expose the entrant to criminal liability, that posting should be respected, even by the government.  A “No Trespassing” warning is an express manifestation of the owner’s intent to have privacy.  If the government seeks entry into such an area, a reasonable reading of the Constitution requires the government to gather probable cause and secure a search warrant before entering. 

April 26, 2022 in Criminal Liabilities | Permalink | Comments (0)

Friday, April 22, 2022

Missed Tax Deadline & Equitable Tolling


Sometimes procedural requirements in tax law are not jurisdictional.  What that means is that the requirements just tell a taxpayer to take certain procedural steps at particular times.  The requirements don’t condition a court’s authority to hear the case on the taxpayer complying with those steps.  One of those procedural requirements is the 30-day timeframe to file a petition with the Tax Court that asks the Tax Court to review an IRS collection due process (CDP) determination.  Is that requirement one that must be satisfied to confer jurisdiction on the Tax Court or not. If not, the doctrine of “equitable tolling” will apply and the Tax Court may be able to hear the case even though the deadline wasn’t technically satisfied.  This issue reached the Supreme Court, and the Court has now decided the matter in a case involving a small law firm in North Dakota.

IRS CDP challenges and Tax Court review and the issue of equitable tolling – it’s the topic of today’s post.


In 2015, the IRS notified the plaintiff (a law firm) about the failure to file employee tax withholding forms.  The plaintiff didn’t respond, and the IRS imposed a 10 percent intentional disregard penalty of $19,250.  The plaintiff challenged the penalty in a Collection Due Process (CDP) hearing, which resulted in the penalty being imposed, with interest.  On July 28, 2017, the IRS Office of Appeals mailed its CDP hearing determination to sustain the proposed levy on the plaintiff’s property to collect the penalty plus interest.  That plaintiff received the notice on July 31, 2017, which informed the plaintiff that the deadline for submitting a petition for another CDP hearing was 30 days from the date of determination – August 28, 2017.  As an alternative, the plaintiff could petition the Tax Court to review the determination of the IRS Office of Appeals.  But, again, the statutory time frame for seeking Tax Court review involved filing a petition with the Tax Court within 30 days of the determination.  I.R.C. §6330(d)(1).  The plaintiff filed its petition with the Tax Court on August 29, 2017 – one day late.  Accordingly, the IRS moved to dismiss the plaintiff’s petition on the grounds that the Tax Court lacked jurisdiction.  The plaintiff, however, claimed that the statute was not jurisdictional (even though the statute says “(and the Tax Court shall have jurisdiction with respect to such matter).”  Instead, the plaintiff claimed that the filing deadline was subject to “equitable tolling” and that the 30-day deadline should be computed from the date the notice was received.  The Tax Court disagreed with the plaintiff and issued an order dismissing the case for lack of jurisdiction on the basis that I.R.C. §6330(d)(1) was jurisdictional.  Boechler, P.C. v. Comr., No. 18578-17 L (U.S. Tax Ct. Feb. 15, 2019).

Note:  When equitable tolling is applied, a court has the discretion to ignore a statute of limitations and allow a claim if the plaintiff did not or could not discover the “injury” until after the expiration of the limitations period, despite due diligence on the plaintiff’s part.  

Appellate Decision

The plaintiff appealed.  The appellate court pointed out that a statutory time limit is generally jurisdictional when the Congress clearly states that it is and noted that the Ninth Circuit had recently held that the statute was jurisdictional.  Duggan v. Comr., 879 F.3d 1029 (9th Cir. 2018).  The appellate court went on to state that the “statutory text of §6330(d)(1) is a rare instance where Congress clearly expressed its intent to make the filing deadline jurisdictional.”   On the plaintiff’s claim that pegging the 30-day timeframe to the date of determination was a Due Process or Equal Protection violation, the appellate court disagreed.  The appellate court, on this issue, noted that the plaintiff bore the burden to establish that the filing deadline is arbitrary and irrational.  Ultimately, the appellate court determined that the IRS had a rational basis for starting the clock on the 30-day timeframe from the date of determination because it streamlines and simplifies enforcement of the tax code.  Measuring the 30 days from the date of receipt, the appellate court pointed out, would cause the IRS to be unable to levy at the statutory uniform time and, using the determination date as the measuring stick safeguards against a taxpayer refusing to accept delivery of the notice as well as supports efficient tax enforcement.   Boechler, P.C. v. Comr., 967 F.3d 760 (8th Cir. 2020).

U.S. Supreme Court

The U.S. Supreme Court, on September 30, 2021, agreed to hear the case. Boechler, P.C. v. Comr., cert. granted, 142 S. Ct. 55 (2021).  Both the plaintiff and the IRS focused on the test for equitable tolling set forth in United States v. Kwai Fun Wong, 575 U.S. 402 (2015).  That case involved 28 U.S.C. §2401(b), a statute that establishes the timeframe for bring a tort claim against the United States.  There a slim 5-4 majority held that a rebuttable presumption of equitable tolling applied.  The presumption can be rebutted if the statute shows that the Congress “plainly” gave the time limits “jurisdictional consequences.”  In that instance, time limits would be jurisdictional and not subject to equitable tolling.  

The beef came down to how to read the statute.  The statute at issue, I.R.C. §6330(d)(1) states in full:


The person may, within 30 days of a determination under this section, petition the Tax Court for review of such determination (and the Tax Court shall have jurisdiction with respect to such matter).”

The IRS asserted that “such matter” refers to the petition that has been filed with the Tax Court that meets the 30-day deadline.  This is the view that the appellate court adopted as did the Ninth Circuit in Duggan.  However, the plaintiff claims that “such matter” refers to “such determination” and, in turn, “determination under this section” with no additional jurisdictional requirement involving timely filing.  According to this view, the Tax Court’s jurisdiction is not limited to IRS determinations for which a petition is filed with the Tax Court within 30 days.  As such, equitable tolling can apply.  Indeed, this is the view that the D.C. Circuit utilized in Myers v. Commissioner, 928 F.3d 1025 (D.C. Cir. 2019) in a case involving a whistleblower tax statute that is similarly worded. 

The Supreme Court, in a unanimous opinion, agreed with the plaintiff’s interpretation of the statute.  Boechler v. Comr., No. 20-1472 (U.S. Sup. Ct. Apr. 21, 2022).  The Court expressed its disdain for the way the Congress crafted the statutory language, noting that “such matter” over which the Tax Court had jurisdiction has an unclear antecedent and that the statute, as a result, “does not clearly mandate the jurisdictional reading.”  The Court noted that the plaintiff’s reading had an “edge” under the last-antecedent rule – the correct antecedent is usually the closest reasonable one.  But the Court noted there were also other plausible ways to read “such matter.”  It could refer to “such determination” or it could refer to the list of matters that may be considered during the CDP hearing under I.R.C. §6330(c).  Neither of those readings ties the Tax Court’s jurisdiction to the filing deadline.  In addition, the Court found the IRS interpretation to be less than clear, and that the jurisdictional clarity in I.R.C. §6330(e)(1) pointed out the lack of jurisdictional clarity in I.R.C. §6330(d)(1).  There were also other tax provisions enacted about the same time as I.R.C. §6330(d)(1) that more clearly linked jurisdiction to a filing deadline.  See, e.g., I.R.C. §§6404(g)(1) and 6015(e)(1)(A).

According to the Court, because I.R.C. §6330(d)(1) was not jurisdictional, it was presumptively subject to equitable tolling.  See Irwin v. Department of Veterans Affairs, 498 U.S. 89 (1990).  The Court stated, “equitable tolling is a traditional feature of American jurisprudence and a background principle against which Congress drafts limitations periods…[even] outside the realm of Article III courts.” 


It's always a good idea to meet a tax deadline.  There's no questioning that.  Here, the plaintiff didn’t respond to the IRS notice, missed the filing deadline and then came up with a creative (but correct) argument to get itself out of a bad result.  There was no confusion about the deadline.  On the other hand, it’s nice to see the Supreme Court hold Congress’ feet to the fire.  A statute conferring jurisdiction must clearly do so, and the drafters didn’t do that in this case by creating an unclear antecedent.  Maybe that’s not as bad as a dangling participle, but the poor drafting landed a case in the Supreme Court’s lap and ultimately bailed out a small law firm in North Dakota.  Certainly, the IRS will continue to try to get late-filed Tax Court petitions dismissed for lack of jurisdiction, but Boechler provides another weapon for claiming that equitable tolling applies. 

Note:  The Supreme Court didn’t determine whether the plaintiff was entitled to equitable tolling.  That will be the issue on remand and will be determined based on the facts. 

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

Monday, April 18, 2022

IRS Audit Issue – S Corporation Reasonable Compensation


One of the areas of “low-hanging fruit” for IRS auditors in recent years involves the issue of reasonable compensation in the S corporation context.  But what does “reasonable compensation” mean?  The instructions to Form 1120S, the return for an S corporation, says, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”  But that still doesn’t answer the question of what “reasonable compensation” is.  The question is important because setting compensation properly avoids IRS assessing tax, penalties, and interest. 

What is “reasonable compensation” and how is it determined?  Reasonable compensation for an S corporation shareholder-employee – it’s the topic of today’s post.

In General 

An S corporation shareholder must include in income the shareholder’s pro rata share of the S corporation earnings for the year.  The pro rata share can be split between compensation for services and a deemed or actual distribution of S corporate income.  The distinction matters because employment-related taxes apply to compensation paid for the shareholder’s services, but do not apply to deemed or actual distributions of S corporate income.  I.R.C. §1373; Rev. Rul. 59-221. 1959-1 C.B. 225.  Thus, compensation that is “too low” in relation to the services rendered to the S corporation results in the avoidance of payroll taxes. i.e., the employer and employee portions of Federal Insurance Contributions Act (FICA) taxes and the employer Federal Unemployment Tax Act (FUTA) tax.  S corporation flow-through income is taxed at the individual level and is (normally) not subject to self-employment tax.  Also, in addition to avoiding FICA and FUTA tax via S corporation distributions, the 0.9% Medicare tax imposed by I.R.C. §3101(b)(2) for high-wage earners (but not on employers) is also avoided by taking income from an S corporation in the form of distributions. 

Note:  The different tax treatment of employment-related wages and compensation for services rendered to the S corporation provide an incentive for S corporation shareholder-employees to take less salary relative to distributions from the corporation.  With the Social Security wage base set at $147,000 for 2022, setting a shareholder-employee’s compensation beneath that amount with the balance of compensation consisting of dividends can produce significant tax savings. 

IRS Examination of “Employee” Status

What is an “employee”?  Many S corporations, particularly those that involve agricultural businesses, have shareholders that perform substantial services for the corporation as officers and otherwise.  In fact, the services don’t have to be substantial.  Indeed, under a Treasury Regulation, the provision of more than minor services for remuneration makes the shareholder an “employee.”  Treas. Reg. §31.3121(d)-1(b).  Once, “employee” status is achieved, the IRS views either a low or non-existent salary to a shareholder who is also an officer/employee as an attempt to evade payroll taxes and, if a court determines that the IRS is correct, the penalty is 100 percent of the taxes owed.   “Wages” for federal employment tax purposes means all remuneration for employment. I.R.C. §3121(a); 3306(b).  The Regulations point out that the form in which payment is made doesn’t matter.  The real question is whether compensation was made for employment.  Treas.  Reg. §§31.3121(a)-1(b) and 31.3306(b)-1(b).  If it was, employment taxes apply to both the employee and the S corporation.  See, e.g., Veterinary Surgical Consultants, P.C. v. Comr., 117 T.C. 141 (2001), aff’d. sub. nom., Yeagle Drywall Co., 54 Fed. Appx. 100 (3d Cir. 2002). 

Definition of “wages.”  For employment tax purposes, “wages” means remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.  I.R.C. §§3121(a); 3306(b); 3401(a).  The remuneration must be paid for services of any nature performed by an employee.  I.R.C. §3121(b).  It is immaterial how an employer characterizes the payment, and the form of the payment also does not matter.  Treas. Regs. §§31.3121(a)-1; (c) and (e); 31.3401(a)-1 – (a)(2) and (a)(4).  In addition, an employee cannot waive the right to receive wages and characterize payments received as something other than wages. 

Audit focus.  An IRS audit on the issue tends to focus on the amount of compensation, whether it is reasonable based on the facts and whether the proper amount of employment-related taxes have been paid.  The burden is on the corporation to establish that the salary amount under question is reasonable.  Likewise, IRS is likely to not distinguish between payments an S corporation makes to a shareholder that are allegedly attributable to the shareholder’s status as an officer and shareholder rather than as an employee.  The courts have supported the IRS on this point, and repeatedly point out that employee status is achieved once anything more than minor services are provided to the corporation.  Id.; I.R.C. §3121(d)(1). 

The IRS also has the authority to reclassify “distributions” made to an S corporation shareholder as payment for wages.  I.R.C. §7436; Rev. Rul. 74-44, 1974-1 C.B. 287.  The reclassification issue can be a critical issue when a shareholder’s family member provides capital or services to the corporation.  In that situation the IRS has the power to make any adjustments necessary to reflect the reasonable value of the capital or services provided based on the particular facts.  Key to any IRS adjustment would be what the corporation would have had to pay for the capital or services had it not been provided by a family member who was also not a shareholder in the S corporation.  Likewise (and a big issue in some farming operations), if a shareholder’s family member has an interest in another pass-through entity and that entity provides services or capital to the S corporation, the IRS can make appropriate adjustments to reflect the value of the services and/or capital provided. 

Note:  A “family member” of an S corporation shareholder includes only the shareholder’s spouse, ancestors, lineal descendants and any trust for the primary benefit of any of these individuals.  Treas. Reg. §1.1366-3.

Determining Reasonableness

What’s the source of gross receipts?  A key question in determining reasonableness of compensation is the source of S corporation gross receipts and the shareholder’s activity (if any) in generating those receipts.  What did the shareholder/employee do for the S corporation?  Or, alternatively, did the S corporation’s gross receipts derive from the personal services of non-shareholder employees or shareholders?  If the gross receipts derived from non-shareholder personal services (as well as capital and equipment) payments in return are nonwage distributions – hence, not subject to employment taxes.  If the source of the S corporation’s gross receipts is from shareholder personal services, payments for those services are wages even if those personal services did not directly produce the gross receipts. 

Note:  If S corporate gross receipts derive from the services of non-shareholder employees, or capital and equipment, then they should not be associated with the shareholder/employee’s personal services, and it is reasonable that the shareholder would receive distributions as well as compensation.  Alternatively, if most of the gross receipts and profits are associated with the shareholder’s personal services, then most of the profit distribution should be classified as compensation.

In addition to the shareholder/employee’s direct generation of gross receipts, the shareholder/employee should also be compensated for administrative work performed for the other income-producing employees or assets.  As applied in the ag context, for example, this means that reasonable compensation for a shareholder/employee in a crop farming operation could differ from that of a shareholder-employee in a livestock operation.

IRS factors.  The IRS examines numerous factors to determine if reasonable compensation has been paid.  The following is a list of some of the primary ones:

  • The employee’s qualifications;
  • Training and experience;
  • The nature, extent, and scope of the employee’s work;
  • The amount of time and effort devoted to the S corporation’s business activities;
  • The S corporation’s dividend history;
  • The size and complexities of the business; a comparison of salaries paid;
  • The prevailing general economic conditions;
  • Comparison of salaries with distributions to shareholders;
  • The prevailing rates of compensation paid in similar businesses;
  • Whether payments are made to non-shareholder employees;
  • The timing and manner of paying bonuses to key people in the S corporation;
  • The presence of any compensation agreements;
  • The taxpayer’s salary policy for all employees (are any formulas used for determining compensation?);
  • What is the amount paid out as salary as compared to amounts distributed as profit: and
  • In the case of small corporations with a limited number of officers, the amount of compensation paid to the particular employee in previous years.

Court Cases on Reasonable Compensation

Before 2005, the court cases involved S corporation owners who received all of their compensation in form of dividends.  Most of the pre-2005 cases involved reclassifications on an all-or-nothing basis.  In 2005, the IRS issued a study entitled, “S Corporation Reporting Compliance.”  Now the courts’ focus is on the reasonableness of the compensation in relation to the services provided to the S corporation.  That means each situation is fact-dependent and is based on the type of business the S corporation is engaged in and the amount and value of the services rendered. 

Recent cases.  For those interested in digging into the issue further, the following cases are instructive:

  • Watson v. Comr., 668 F.3d 1008 (8th Cir. 2012);
  • Sean McAlary Ltd., Inc. v. Comr., T.C. Sum. Op. 2013-62;
  • Clary Hood, Inc. v. Comr., T.C. Memo. 2022-15;
  • Glass Blocks Unlimited v. Comr., T.C. Memo. 2013-180; and
  • Scott Singer Installations, Inc. v. Comr., T.C. Memo. 2016-161; A.O.D. 2017-04 (Apr. 10, 2017) (in result only).

Each of these cases provides insight into the common issues associated with the reasonable compensation issue.  The last two also address distributions and loan repayments in the context of reasonable compensation of unprofitable S corporations with one case being a taxpayer victory and the other a taxpayer loss. 

Reasonable compensation for an ag producer.  Based on the above analysis and commentary, what would “reasonable compensation be for a farmer or rancher as a shareholder of an S corporation?  The answer is that “it depends.”  Certainly, there is no need to set compensation at the Social Security wage base - $147,000 for 2022.  An acceptable compensation rate (in the eyes of the IRS) will depend on numerous factors, including whether the business involves livestock.  Wage rates for ag labor can be obtained from many Land Grant Universities.  For an owner/manager, an additional amount of compensation should be added to the labor rate to reflect managerial and administrative duties.  An acceptable range is likely somewhere in the $40,000-$70,000 range.  But, that is merely a suggested range.  Each S corporation will need to carefully determine what it believes is a reasonable rate based on the circumstances and document in corporate records how that rate was determined.  A commitment should then be made to revisit compensation levels on a periodic basis.

Note:  As a rule-of-thumb, when considering whether or not to utilize the S corporation structure is achieving tax savings of at least $10,000 annually.  With an S election comes additional bookkeeping, payroll and unemployment tax filings and other administrative duties. 

Return Preparation

It is critical that workpapers associated with the preparation of an S corporation’s return include sufficient documentation supporting the level of compensation to a shareholder-employee.  That documentation should evidence, at a minimum, the type of work the shareholder performed for the corporation, the hours of work spent on corporate business, and how the compensation level was determined. 

Other Issues

Qualified Business Income.  S corporate reasonable compensation also bears on the shareholder’s qualified business income (QBI) deduction (I.R.C. §199A) computation.  An S corporation shareholder is allocated a pro rata share of the S corporation’s QBI.  As part of that computation, the S corporation deducts W-2 wages (including reasonable compensation paid to shareholders) as an expense allocable to the corporation’s trade or business when the corporation calculates its QBI deduction.  Treas. Reg. §1.199A-2(b).  But the shareholder cannot increase the shareholder’s QBI by the amount of reasonable compensation the S corporation pays.  Treas. Reg. §1.199A-3(b)(2)(ii)(H).

Note:  There are numerous factors that determine whether a particular type of entity will generate a relatively larger QBI deduction.  One of those factors, in the S corporation context, is the level of “reasonable compensation” paid to shareholder-employees.  

Shareholder advances.  In small, closely-held S corporations in which a family farming (or other) business is operated, there sometimes is a tendency to use the S corporation to pay personal expenses on a shareholder’s behalf.  The question that arises in this situation is whether the payment constitutes wages as compensation for services rendered to the corporation that are subject to federal employment taxes.  Key to answering this question is determining whether a bona fide debtor-creditor relationship exists.  A genuine intent to create a debt coupled with a reasonable expectation of repayment that comports with economic reality is critical in establishing that the payment should not be characterized as wages.  If the corporation reports the amounts advanced on its general ledger and corporate returns as loans, and actual payments on the advanced funds are made, the argument is strengthened that the amounts advanced are not wages.  Clearly, the use of interest-bearing secured promissory notes also bolsters the argument that advances are not wages.  But, if the advances are merely a paper transaction where the outstanding “loan” balance is credited against undistributed income and any rental payments the corporation owes to a shareholder, the “loan” constitutes wages for FICA and FUTA purposes.  See, e.g., Gale W. Greenlee, Inc. v. United States, 661 F. Supp. 642 (D. Colo. 1985). 


The bottom line is that “reasonable compensation” means that is must be reasonable for all of the services the S corporation owner performs for the corporation.  Because there is no safe harbor for reasonable compensation, the best strategy is to research and document reasonable compensation every year.  That will provide a defensible position if the IRS raises questions on audit. 

April 18, 2022 in Business Planning, Income Tax | Permalink | Comments (0)