Monday, January 30, 2017
Agricultural law is often “law by the exception.” Numerous situations exist where being a “farmer” or being engaged in “agriculture” results in different, and more favorable, treatment under the law. One of those areas of favorability has to do with the tax treatment of property that is used for agricultural purposes.
One might think that it is easy to determine if a tract of land is used for an agricultural purpose. Often it is. The property is either cropped or grazed. But, other situations are not as easy. Today, we take a look at those blurry situations.
Mechanics of Real Property Taxation
In many states, real property is listed and valued every two years. In each year in which real property is not regularly assessed, the assessor lists and assesses any real property not included in the previous assessment and any improvements made since the previous assessment. Normal and necessary repairs up to a threshold amount per building per year do not increase the taxable value. The tax rate, typically expressed in dollars per $1,000 of actual value, is applied against actual value or a percentage of actual value. Actual value is usually the “fair and reasonable market value” of the property. “Market value” is defined as the result of a “fair and reasonable exchange in the year in which the property is listed and valued between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and each being familiar with all the facts relating to the particular property.”
In general, the actual value of agricultural property is to be determined on the basis of productivity and net earning capacity on the basis of use for agricultural purposes. This typically results in lower valuation for real property tax purposes for agricultural property than nonagricultural property. Thus, to obtain favorable tax treatment, the parcel in question must be used as farm or ranch land for agricultural purposes in accordance with the particular state statute. While agricultural dwellings are typically valued as rural residential property and are assessed at the same percentage of actual value as other residential property, the lower “use” valuation of agricultural real estate when compared with nonagricultural real estate has spawned numerous cases construing the boundary of the definition of “agricultural land” and “agricultural activities.”
The following is a listing of some of the more illustrative cases that provide a flavor of the issues that can arise and how the courts deal with them:
- In Drost v. Mahaska County Board of Review, et al., 840 N.W.2d 726 (Iowa Ct. App. 2013), the court held that the assessment of $410,480 was correct instead of the plaintiffs’ claimed $75,000. Even though the plaintiffs had sold a wetland easement on 283 acres to the federal government, the ag land still had “net earning capacity,” encompassing potential productivity.
- Under Colorado law (Colo. Rev. Stat. § 39-1-102(3.5)), agricultural products must originate from the land’s productivity. There have been numerous cases involving the application of the statute. For example, in Welby Gardens Co. v. Colorado Bd. of Assessment Appeals, 56 P.3d 1121 (Colo. Ct. App. 2002), even though greenhouses produced horticultural products, and the statute defined agriculture as including horticulture, the products did not originate from the land’s productivity and the property was not eligible to be taxed as farm property.
- In Bond County Board of Review v. Property Tax Appeal Board, 796 N.E.2d 628 (Ill. Ct. App. 2003), subdivided lots used for raising and storing of hay and storing of logs were properly valued as agricultural land. The statute did not require subdivided lots to be assessed as residential property.
- In Schmeig v. County of Chisago, 740 N.W.2d 770 (Minn. 2007), Minnesota law, “agricultural land” defined as “all land used during the preceding year for agricultural purposes,” and the statute contemplated that a particular tract may be subject to more than one classification. The classification of the entire tract as commercial was not appropriate where bees were raised on part of the tract.
- In Hanneken v. Missouri State Tax Commission, No. 96-73000 (Dec. 19, 1996), a portion of lake front property was accepted into a governmental conservation program for timber improvement. The tract qualified for agricultural classification even though it was not part of an ongoing farming operation and there would be a long-time period before trees would be harvestable.
- In Mollica v. Divison of Property Valuation and Review, 2008 Vt. 60 (2008), a “Christmas Cottage” on a Christmas tree farm used as sales office and warming hut for customers during Christmas season and rented guest house during off-season remained eligible for enrollment in a tax abatement program as farm property. The property was used as “rental property” only during the “non-farm” season and still remained actively used in a farming operation during Christmas tree harvesting season.
- In In re Goddard, 39 Kan. App.2d 325 (2008), a sawmill operation was not “farming” for purpose of state ad valorem property tax exemption, but a yarding tractor used to harvest trees was exempt farm equipment.
- In another Colorado case, Douglas County Board of Equalization v. Clarke, 921 P.2d 717 (Colo. 1996), the taxpayer was required to prove that actual grazing of the parcel at issue occurred during the tax year unless there was a conservation practice being utilized that prevented grazing.
- Also in Colorado, C.P. Bedrock, LLC v. Denver County Board of Equalization, 259 P.3d 514 (Colo. Ct. App. Apr. 14, 2011), writ of cert. dismissed, 2011 Colo. LEXIS 569 (Colo. Sup. Ct. Jun. 20, 2011), the property at issue did not qualify as “agricultural” property for tax purposes. There was no grazing of livestock or crop growing activities present, and the property was not sufficiently connected by use with other land so as to be classified as agricultural land. The property was also not used for conservation purposes.
- In Elmstad v. Lane County Assessor, No. TC-MD 101235D, 2011 Ore. Tax LEXIS 226 (Or. Tax Ct. Jun. 6, 2011), the taxpayer was not entitled to ad valorem real property tax assessment as farm because the property was not used primarily for making profit. The taxpayer’s testimony was that he intended to start vineyard and grow hay and blueberries and filberts on 9.27 acres. The statute focused on the current use of the land, and the land had been laying fallow for more than one year. The sales of a few pounds of honey was insufficient to show a profit motive.
- In Terry v. Sperry, et al., 130 Ohio St. 3d 125, 956 N.E.2d 276 (2011), involved a situation where, under the applicable state statute, township zoning commissions, boards of township trustees or boards of zoning appeals were barred from prohibiting agricultural uses on land or the use of buildings or structures incident to “agricultural uses.” Under the statute, a township could not regulate the zoning of buildings used primarily for venting and selling wine, and no requirement existed that venting and selling of wine be a secondary or subordinate use of the property or that viticulture be the primary use of the property. Thus, the township could not prohibit use of property for venting and selling wine if any part of property used for viticulture.
- In McLendon v. Nikolits, No. 4D15-4003, 2017 Fla. App. LEXIS 765 (Fla. Ct. App. Jan. 25, 2017),the defendant, county property appraiser, denied the plaintiff’s request for an ag tax classification on all of the plaintiff’s property. The plaintiff owned a five-acre tract and used the land to raise wild birds for sale as pets – aviculture. The plaintiff spent about $50,000 to buy cages, sheds, fences, feeders and structures for storage. From 2006-2012, the defendant classified the property as agriculture because of its dual use for aviculture and cattle. In 2012, the defendant denied an ag tax classification for the requested 4.5 acres, instead issuing it for 2.25 acres. The plaintiff appealed to the Value Adjustment Board (VAB) which held that the entire 4.5 acres should have ag classification. In 2013, the defendant denied ag classification to the portion of the property used for aviculture, which decision was reversed by the VAB. The defendant appealed the VAB’s decision and also denied ag classification for tax year 2014. Both parties motioned for summary judgment. The trial court ruled for the defendant on the basis that only poultry qualified as ag under the applicable statute and entered summary judgment for the defendant. On further review, the appellate court reversed. The appellate court held that if, on remand, the plaintiff could establish that aviculture is useful to humans, then agricultural classification should apply. The court reached that conclusion because the applicable statute defined “farm product” as “any…animal…useful to humans.”
The cases illustrate that in situations that don’t involve traditional crop or livestock usage of real estate can lead to interesting property tax questions. Niche farming activities are an example. A new one recently involves marijuana growing activities in those states where it is legal under state law. In any event, it is a good idea to be familiar with the particularities of state law. Each state defines “agriculture” and “agricultural activity” differently and the court constructions of those statutes also vary. Determining what state law is and bringing an activity within the definition of “agriculture” can save tax dollars.
Thursday, January 26, 2017
Many farmers and ranchers produce agricultural products under a production contract for someone else. These contracts generally provide for the raising of livestock, birds or crops with the farmer supplying the facilities and labor and the integrator supplying the livestock, birds or seeds and the feed and other supplies. The integrator generally retains title to the livestock, birds or crops and the contract generally establishes the amount paid to the farmer by the quantity and quality of the final product. Many of these contracts are forms drafted by the integrator, with no terms negotiated by the parties. That feature, by itself can raise an issue about fairness. Other issues can include the economic impact of production contracts.
But what about insurance? Does a farmer’s comprehensive general liability policy cover losses sustained by livestock produced under contract? The insurance angle is the focus of today’s post
As noted above, it’s not uncommon for livestock (particularly hogs) and poultry to be produced under contract. But, with livestock raised in a farmer’s barns that are owned by someone else, which party is responsible for any loss that occurs to the animals? The producer or the supplier? Typically, the party that has the control over the livestock (or poultry) produced under contract is the liable party. Indeed, production contracts commonly state that, even though the supplier owns the livestock/poultry, the producer is responsible for any death loss.
In that event, it is important that the producer has insurance coverage for any losses to the livestock or poultry. But, the standard farm comprehensive liability policy probably does not cover losses if that loss can in any way be attributed to the negligence of the producer to animals in the “care, custody or control” of the producer.
There are numerous cases involving the question of insurance coverage for livestock and poultry produced under contract. In many of those cases, the producer has even identified in advance that they needed additional coverage for livestock and/or poultry raised on contract and, as a result, has sought additional coverage. The additional coverage that is purchased is typically in the form of a “custom feeding endorsement” that says that if “the bodily injury or property damage arises from the activities of care or raising of livestock or poultry by an insured person for any other person or organization in accordance with a written or oral agreement…” the policy provides coverage. But, what does that language mean? One recent Iowa court decision illustrates the problem that faces contract growers.
In the Iowa case, Schulz Farm Enterprises, Inc. v. IMT Insurance, No. 15-1960, 2017 Iowa App. LEXIS 11 (Iowa Ct. App. Jan. 11, 2017), the plaintiff farming operation contracted with a company to custom feed hogs that the plaintiff owned at a third party’s site. The company was to take delivery of 50-pound hogs and raise and care for them until they reached 275 pounds. The plaintiff owned the hogs, but they were under the care of the company. The company contacted its insurance agent to get coverage for the custom feeding of the hogs, telling the agent that the company neither owned the hogs nor the facility in which they were raised, but that the company was responsible for the care and feeding of the hogs and building maintenance. The agent recommended a liability policy, and a custom feeding endorsement for an additional $118 annually. The custom feeding endorsement extended coverage for custom feeding and deleted exclusions in the liability policy that pertained to custom feeding. The ventilation system in the building failed when an electrical breaker tripped and 837 hogs died. The company filed a claim with the defendant for coverage, and the defendant denied coverage. The company then assigned its claim to the plaintiff who sued the defendant, the insurer.
The trial court granted the defendant’s motion for summary judgment. On appeal, the plaintiff claimed that because the endorsement deleted the exclusions pertaining to custom feeding, the death of the hogs produced in the custom feeding operation was a covered loss. However, the court determined that the custom feeding endorsement functioned only to remove the exclusion for bodily injury or property damage arising out of the insured’s performance of, or failure to perform, relating to the custom feeding of the hogs. In other words, by removing that exclusion, the company had coverage for bodily injury or property damage to others or the insured as a result of the custom feeding operation (i.e., damage caused by the hogs). But, the court determined that the endorsement did not eliminate the exclusion of coverage for damage to the hogs. Damage to the building caused by fire, smoke or explosion was a covered loss. The court reached this conclusion because the company paid only $118 annually for the endorsement which the court believed did not correspond to the additional risk of insuring the hogs. The court believed that the $118 annual charge did reflect the additional risk of damage caused by the hogs. The court provided no data for its conclusion (I don’t know whether there was data in the record) and no analysis of the endorsement language, instead merely citing a 2013 opinion of the state (IA) Supreme Court where the Court held that a custom feeding endorsement did not cover the loss of 535 feeder pigs that died due to suffocation.
Pointers for Producers
Contract growers seeking insurance coverage for the potential loss of the livestock or poultry produced under contract should take several common-sense steps to protect themselves. It’s a good thing to start with a general review of the comprehensive farm liability policy. Is there a custom farming exclusion? Is there exclusionary language involving “care, custody or control”? There likely is. If so, then a custom feeding endorsement to the policy should be acquired. But, that endorsement should contain language that specifically addresses both of those exclusions and specifically overrides them. So, it’s really important to know exactly what the policy covers and that it covers what it needs to cover. That is the case even if the owner of the livestock/poultry has coverage under their own policy. It’s even a good idea try to get a written opinion from the insurance company delineating the specific types of death loss events that are covered under the policy.
Uncovered losses for contract-produced livestock/poultry can result in significant financial problems for the producer. It’s not only the producer that could face severe financial hardship. A lender that provides financing for the producer is also at risk if that borrower defaults. So, both the producer and the lender have a vested interest in making sure that losses to the animals/poultry are covered. There are specific endorsements that exist that cover specific losses such as death loss of livestock by suffocation (such as when a building ventilation system fails). Indeed, in one case about four years ago, the court upheld an insurance company’s denial of a $24,075 claim filed by a small farming operation that was raising hogs on contract when the hogs died as a result of suffocation. After the litigation ended, the company started selling another endorsement covering livestock death by suffocation.
So, endorsements do exist that can cover the type and causes of losses that a producer needs coverage for. Producers, and their counsel, should be very careful to ensure that the coverage that is obtained is precisely what is needed.
Just another thing for contract grower to think (and worry) about.
Tuesday, January 24, 2017
The present economic conditions in agriculture are reminiscent of the 1980s. For those of you that attended the agribusiness symposium last September put on by Washburn University School of Law and Kansas State University, you saw the close parallels. One of the legislative attempts to assist farm producers during that time involved the creation of an agricultural supply dealer’s lien in those states that were experiencing an extraordinarily high number of agricultural bankruptcies.
For those farmers and ranchers, it was likely that all of their property was claimed subject to perfected security interests under Article 9 of the Uniform Commercial Code, leaving the supply dealer as an unsecured creditor with large unpaid bills. Thus, the theory behind an ag supply dealer lien is that parties who supply necessary inputs such as seed, feed, fertilizer, chemicals and petroleum products should have a method whereby they are assured of payment for the inputs supplied to agricultural producers.
Various Statutory Approaches; Various Issues
Agricultural supply dealer lien statutes are rather complex, but most follow a common procedure. One common type gives an ag commodity dealer that sells an ag product a lien on the ag product or its sale proceeds. But what if the input subject to the lien is feed that is consumed by livestock that are collateral for another lender’s security interest? The Idaho statute, for example, specifies that the lien only extends to an “agricultural product” or the “proceeds of the sale of the agricultural product.” As a result, one court has held that the lien was extinguished when it was consumed as feed by the livestock because “livestock” were not included in the statutory definition of “agricultural products.” Farmers National Bank v. Green River Dairy, LLC, 318 P.3d 622, 155 Idaho 853 (2014). But, another court, construing a different state statute has held that the ag supply dealer lien applied to the full amount of feed supplied and fully attached to the animals consuming it. In re Schley, No. 10-03252, 2017 Bankr. LEXIS 115 (Bankr. N.D. Iowa Jan. 13, 2017).
For crop input suppliers, when a farmer or rancher attempts to purchase supplies on credit or on open account, the supplier can obtain a lien on the crops produced with those inputs. But, there is typically a process the supplier must go through. For instance, under the Iowa statute (a statute that has been litigated frequently), the supplier must discover what other parties, if any, have a security interest in the purchaser's crops or livestock. Iowa Code §570A. The supplier is required to contact these creditors and inquire about the purchaser's financial abilities. This puts the creditors on notice that the supplier may be attempting to take a statutory lien. The creditors can either agree to finance the purchase or send the supply dealer the buyer's financial records. If the creditors refuse to extend credit, the supply dealer can make the sale and obtain a lien by filing in the appropriate office, usually the Secretary of State's office. The lien is effective at the time of the purchase and is “perfected” by the filing of a financing statement within 31 days of the purchase. The lien applies to crops related to the purchased supply or livestock consuming the feed sold to the farmer by the dealer. The amount of the lien is the amount owed to the dealer for the “retail cost of the agricultural supply, including labor.” Courts have determined that the lien is perfected for the amount of supplies that the debtor buys from the supplier within 31 days before the supplier files the financing statement. See, e.g., In re Shulista, 451 B.R. 867 (Bankr. N.D. Iowa 2011); In re Big Sky Farms, Inc., No. 12-01711, 2014 Bankr. LEXIS 1725 (Bankr. N.D. Iowa Apr. 18, 2014). The lien also extends to the proceeds of the input(s) supplied. In re Schley, 509 B.R. 901 (Bankr. N.D. Iowa 2014). The perfected lien does not continue nor does it cover future advances. If additional supplies are sold to a debtor after the initial 31-day period, another financing statement must be filed within 31 days of sale to perfect the lien for those additional supplies that are provided.
The Iowa ag supply dealer’s lien has been held to beat out a bank’s prior perfected security interest in hogs even though the supply dealer had not provided the statutory certified notice to the creditor (bank) before selling feed to the debtor on credit. In Oyens Feed Supply, Inc. v. Primebank, 808 N.W.2d 186 (Iowa 2011), the court reasoned that the state ag supply dealer lien statute did not provide for the certified notice affirmative defense in the context of a lien in livestock feed dealers. The court was persuaded by the feed dealer’s argument that requiring a feed dealer to comply with the certification requirement would result in a “windfall” for the prior perfected lender who would benefit from the increase in the collateral value (livestock) provided for by the feed supplier. Such “superpriority” status, however, only applies to the extent the acquisition value of the livestock is exceeded by the livestock’s value at the time the lien attaches or its ultimate sale price. The secured lender still has priority up to the livestock’s acquisition price.
Most state statutes provide that an agricultural supply dealer lien is superior to subsequently filed Article 9 security interests, and of equal priority to Article 9 interests already in existence. However, Minn. Stat. § 514.952 (1994) provides that upon a supplier providing a lender a lien notification statement and the lender refuses in writing within 10 days to issue a letter of commitment, the rights of the lender and supplier are unaffected. The statute was at issue in Underwood Grain Co. v. Harthun, 563 N.W.2d 278 (Minn. Ct. App. 1997), where a lender with a prior perfected interest in cattle was determined to have priority over an agricultural production input lien upon refusal to issue a letter of commitment. Also, it’s important to understand whether a state ag lien statute applies to crops “produced” with the supplier's inputs. There might be a time limit specified in the statute. See, e.g, In re Schlote, 177 B.R. 315 (Bankr. D. Neb. 1995).
A question can arise concerning the total amount of inputs a supply dealer's lien secures. For instance, in Tracy State Bank v. Tracy-Garvin Cooperative, 573 N.W.2d 393 (Minn. Ct. App. 1998), a farmer borrowed money from a bank and granted the bank a security interest in the farmer's property. The bank perfected the interest. The farmer obtained feed on credit from a supplier and the supplier filed with the bank a notification of agricultural input lien, listing the lien amount at $65,000. The bank received the notification, but did not respond to it, thus giving the supplier a priority lien for $65,000 under Minnesota law. The supplier, however, actually provided the farmer with $73,748 in feed during the dates listed and the farmer paid on the account during that period such that the debt stood at $44,682 when the farmer liquidated the farm. The supplier argued that the lien protected a revolving line of credit of up to $65,000 regardless of the payments made by the farmer so that the entire $44,682 was covered by the lien. The bank argued that only $65,000 of the total amount supplied on credit, less the amounts paid by the farmer, was subject to the lien. The court held that, under Minnesota law, the notification stated the retail cost of the anticipated production inputs to be provided. Therefore, the notification statement's listing of $65,000 established the total limit on the inputs covered by the lien. The court also noted that if a supplier provides more than the notification amount, Minnesota law allows the notification to be amended to provide for priority for the additional amount. Because the plaintiff did not file an amended notification, the lien covered only $65,000 of the feed less the amounts the farmer actually paid on the debt.
Because statutory liens grant “super priority” status only to the extent that they are perfected, it is important that a party seeking to gain super priority status understand the particulars of the statutory lien and follow the requirements to perfect the lien as intended. It is also important to clearly understand the type of lien obtained because nuances exist amongst state statutory liens. For example, in First National Bank v. Profit Pork, LLC, et al., 820 N.W.2d 592 (Minn. Ct. App. 2012), a feed supplier was found to have a production-input lien rather than a superior feeder’s lien under a different statutory provision because the supplier also provided nutritional advice, feed and labor to produce custom-made feed for the debtor. As previously noted, the Iowa ag supply dealer’s lien statute is perfected only for the amount of supplies that are purchased from the supplier within 31 days before the supplier files the financing statement. The perfected lien does not continue, nor does it cover future advances. Thus, if additional supplies are sold to a debtor after the initial 31-day period, another financing statement must be filed within 31 days of the sale to perfect the lien for those additional supplies that are provided. In re Shulista, 451 B.R. 867 (Bankr. N.D. Iowa 2011). But, there is no limit on the amount that is purchased from the supplier, even if it is for future periods.
There remain some unanswered questions about ag supply dealer liens. For example, where must an ag supply dealer’s lien be filed? Is it to be filed in the state where feed is supplied, or in the state of incorporation of the owner of the livestock, if that is different? Clearly, the safest course of action would be to file in both states as it is relatively inexpensive to do so and avoids the necessity of litigation to determine whether the lien was properly filed. Also, what about a feedlot owner that provides feed to cattle in the feedlot? Can the feedlot owner file an ag supply dealer’s lien to secure the value of the feed supplied to the cattle? Some feedlot owners have filed these liens seeking to assert a lien prior to the lien of the bank. Will that work?
This is just one of the topics that will be discussed at next weeks’ farm financial distress seminar at Washburn law school. If you can’t attend in person, the seminar will be simulcast live over the web. If you work with farm/ranch clients that are dealing with a difficult economic situation, this seminar and the accompanying materials is what you need. Here’s registration information: http://washburnlaw.edu/employers/cle/farmersandranchers.html
Friday, January 20, 2017
It’s not uncommon that a right of refusal is utilized when agricultural land is sold. It could be used to facilitate estate and succession planning objectives, avoid an unwanted co-tenant, give preference to a longstanding farm tenant, or give a neighbor a chance to own an adjacent tract that would fit well into their current farming operation. But, the actual drafting language of the provision can have an important impact. If the drafting language is not precise, it can void the right of refusal as being in violation of the Rule Against Perpetuities. That’s today’s focus – the application of an ancient rule to a modern contract provision that is commonly used in agricultural real estate transactions.
The Rule Against Perpetuities
While some states have repealed it, the vast majority of states retain the Rule Against Perpetuities (RAP). Basically, the rule puts a time limit to a restriction on a conveyance of real estate. Under the common-law rule, the restriction can’t last more than 21 years after a particularly identified person dies. So, you can’t tie up property for too long after the lives of the people living at the time the instrument was drafted creating the conveyance. The RAP dates back to the late 1600s in England, and it is typically difficult to apply (as evidenced by the numerous court decisions that have struggled with it).
So what does the RAP have to do with a right of refusal associated with the sale of farmland? If the right of refusal is not drafted carefully, the RAP could void the conveyance. Whether it does or not largely depends on how great a restriction it puts on the alienability (transferability) of land, so careful drafting is the key to staying out of litigation on the matter. A recent case from Kansas illustrates these points.
In a recent case from Kansas, Trear v. Chamberlain, et al., No. 115,819, 2017 Kan. App. LEXIS 56 (Kan. Ct. App. Jan. 13, 2017), the plaintiff bought some real estate from a married couple in 1986. The purchase contract contained a right of refusal stating that if the defendants (the sellers) offered to sell the land adjoining the land the plaintiff purchased, the plaintiff would be offered a right to buy the land at a price and on terms that the parties mutually agreed upon. The adjoining land contained the couple’s home. The right of refusal was to lapse if the parties could not agree on purchase terms. The purchase contract was also “binding upon the heirs, legal representatives, and assigns of the parties hereto.” That language inadvertently ended up creating an issue with the RAP.
The husband-seller died in 2013 and his surviving wife sought to sell the adjoining tract later that same year. As a result, her lawyer sent a letter to the plaintiff offering to sell it to him for $289,000. The plaintiff did not respond to the offer, and the surviving wife listed the tract with a real estate company for $295,000. The plaintiff did not make an offer on the property. The tract did not sell and was taken off of the market. The surviving wife then sold 64 of the 73 acres of the adjoining tract (not including the house) to her daughter and a third party for $91,125. Upon learning of the sale, the plaintiff sued to enforce the right of refusal and to have the property transferred to himself. The surviving wife, her daughter and the third party motioned for summary judgment. The trial court determined that the right of refusal violated the RAP and was nullified. Another issue not relevant for our discussion here is that the trial court determined that the right of refusal did not violate the Statute of Frauds because the adjoining tract could be identified.
On appeal, the appellate court reversed on the RAP issue, finding that the right of refusal, based on a 1994 Kansas Supreme Court decision, was a personal right to the plaintiff that expired on his death and couldn’t be passed to anyone else. In addition, the court determined that the contract language making the contract binding on the “heirs, legal representatives and assigns” made the contract binding on the seller’s heirs, legal representatives and assigns as long as the plaintiff was living. In addition, the right of refusal was not voided by the plaintiff’s failure to act on the surviving wife’s first offer of the property to the plaintiff. There had not yet been an offer from anyone else for the property at the time it was offered to the plaintiff. Thus, the right of refusal had not been triggered. But, when the surviving wife sold some of the remaining tract to her daughter and a third party, the plaintiff was not given the opportunity to buy it on the same terms as the right of refusal required. Because the price at which it was sold to the daughter and third party was much less than the price at which the full tract was offered to the plaintiff, that raised a fact issue as to good faith resulting in the court denying the summary judgment motion. However, the appellate court upheld the trial court’s determination that the contract satisfied the Statute of Frauds - the contract was in writing, the material terms were stated with reasonable certainty and the adjoining tract could be identified.
As noted earlier, rights of refusal are often used in real estate transactions involving farm and ranch land. So, how can a right of refusal be drafted to avoid questions about its enforceability? A mere de minimis restraint on the alienability of property won’t violate the RAP. So, if a right of refusal arises only when a property owner receives a bona fide offer and the holder of the right chooses not to purchase the property and the owner remains free to sell to the third party, the RAP will likely not be violated. That’s why the right of refusal in the Kansas case didn’t violate the RAP. But, if the right is tied to a fixed price or a long time-period during which the holder can chose to buy the property, then it runs a higher risk of violating the RAP. By not tying the right of refusal to a fixed price the seller can sell the property for market value and will still have an incentive to improve it and offer it for sale.
It’s also probably a good idea for a right of refusal to also clearly specify how notice of the offer to buy is to be sent to the holder of the right. How soon after receiving an offer must the holder be notified? It’s best to allow the holder to have a reasonable time to arrange for financing, conduct surveys and perform due diligence with respect to environmental and USDA regulatory issues. On this point, it can speed the process along if the third-party offeror is required to share information pertinent to the property (such as surveys, etc.) with the holder of the right refusal. Also, in what manner is the holder to be notified? How much time does the holder have to respond to the notice? Must the holder’s response, if the holder want to exercise the option, match precisely the terms and conditions of the third party’s offer? What if there are any non-monetary terms of the offer? In addition, a good contract should specify that the landowner cannot create any restrictions on the property (such as easements, for example) that would run counter to the holder’s known future use of the property.
Another point to consider when drafting a right of refusal is to clearly define what triggers the exercise of the right. Is it triggered only by an offer by a third party? What if the landowner dies and the property is transferred via will? What if it is gifted? What if the owner gets in financial trouble and the property is sold at a foreclosure sale or in bankruptcy? Do those events trigger the exercise of the right of refusal? The question is basically whether those events rise to the level of a bona fide purchase.
A right of refusal is a useful and commonly tool in agricultural land sales. But, language used to create the right is critical to avoiding misunderstandings and benefit both the seller of the property and the holder of the right.
Wednesday, January 18, 2017
Check-offs are back in the news. In Oklahoma, federal authorities are investigating the possible embezzlement of about $2.5 million in beef checkoff funds, and in Montana a federal Magistrate Judge has enjoined the Montana beef checkoff from spending funds received from the checkoff. There’s also separate litigation ongoing over the use of checkoff funds in the federal district court in D.C.
So, what’s all of the fuss about? Checkoff programs (as well as federal marketing orders) involve constitutional free speech issues. It’s a matter that’s important to many ag producers and is worth understanding the legal issues that are involved.
Check-Offs and the Constitution
An assessment (or “check-off”) is typically levied on handlers or producers of commodities with the collected funds to be used to support research promotion and information concerning the product. For example, the beef check-off involves the levy of a $1.00/head at the time livestock are sold. Such check-off programs have been challenged on First Amendment free-speech grounds. For example, in United States v. United Foods, Inc., 533 U.S. 405 (2001), the U.S. Supreme Court held that mandatory assessments for mushroom promotion under the Mushroom Promotion, Research, and Consumer Identification Act violated the First Amendment. The assessments were directed into generic advertising, and some handlers objected to the ideas being advertised.
Lower courts have also addressed the government speech issue with respect to agricultural check-off programs. For example, in Livestock Marketing Association v. United States Department of Agriculture, 335 F.3d 711 (8th Cir. 2003), cert. granted sub. nom., Veneman v. Livestock Marketing Association, 541 U.S. 1062 (2004), the Eighth Circuit held unconstitutional the beef check-off authorized under the Beef Promotion and Research Act of 1985. The court ruled that the mandatory assessment of one dollar per-head violated the free-speech rights of those who objected to the generic advertising of beef funded by the check-off because cattle producers and sellers were not regulated nearly to the extent the California tree fruit industry was regulated in an earlier Supreme Court opinion, Glickman v. Wileman Brothers & Elliott, Inc., 521 U.S. 457 (1997). As such, the beef industry was similar to the mushroom industry, and United Foods controlled. The court also ruled that the beef check-off did not constitute government speech.
The Supreme Court agreed to hear the Livestock Marketing Association case on the narrow grounds of whether the beef check-off was government speech, reversed the Eighth Circuit and upheld the check-off against a free-speech challenge as government speech. Johanns v. Livestock Marketing Association, 544 U.S. 550 (2005). The case involved (in the majority’s view) a narrow facial attack on whether the statutory language of the Act created an advertising program that could be classified as government speech. That was the only issue before the Court.
While the government speech doctrine is relatively new and is not well-developed, prior Supreme Court opinions not involving agricultural commodity check-offs indicated that to constitute government speech, a check-off must clear three hurdles - (1) the government must exercise sufficient control over the content of the check-off to be deemed ultimately responsible for the message; (2) the source of the check-off assessments must come from a large, non-discrete group; and (3) the central purpose of the check-off must be identified as the government’s. Based on that analysis, it was believed that the beef check-off would clear only the first and (perhaps) the third hurdle, but that the program would fail to clear the second hurdle. Indeed, the source of funding for the beef check-off comes from a discrete identifiable source (cattle producers) rather than a large, non-discrete group. The point is that if the government can compel a targeted group of individuals to fund speech with which they do not agree, greater care is required to ensure political accountability as a democratic check against the compelled speech. That is less of a concern if the funding source is the taxpaying public which has access to the ballot box as a means of neutralizing the government program at issue and/or the politicians in support of the program. While the dissent focused on this point, arguing that the Act does not establish sufficient democratic checks, Justice Scalia, writing for the majority, opined that the compelled-subsidy analysis is unaffected by whether the funds for the promotions are raised by general taxes or through a targeted assessment. That effectively eliminates the second prong of the government speech test. The Court held that the other two requirements were satisfied inasmuch as the Act vests substantial control over the administration of the check-off and the content of the ads in the Secretary.
Separate from the speech issue, the Supreme Court’s analysis in United States v. United Foods, Inc., has been used as the basis for other courts deciding checkoff cases. In one case, the court granted challengers to the Washington apple checkoff a preliminary injunction against the checkoff, pending trial. In re Washington State Apple Advertising Commission, 257 F. Supp. 2d 1290 (E.D. Wash. 2003). The court found that the apple industry was highly regulated but that the regulation did not collectivize the marketing of apples and that no government speech was involved. Another court held the Florida citrus “box tax” unconstitutional because the advertising purchased with the “box tax” was not government speech and no comprehensive regulation of the citrus industry was found. Tampa Juice Services, Inc. v. Florida, No. 6C-6-00-3488 (Fla. Cir. Ct. Mar. 31, 2003). The Louisiana Fur and Alligator Public Education and Marketing Fund and the Louisiana Alligator Resource Fund has been held unconstitutional for the same reasons. Pelts & Skins, L.L. C. v. Jenkins, 259 F. Supp. 2d 482 (M.D. La. 2003). Similarly, the California grape checkoff has been held unconstitutional because the court found no collectivization of the marketing aspects of the industry, and 90 percent of assessment money was spent on generic advertising of grapes. Delano Farms Co. v. California Table Grape Commission, 318 F.3d 895 (9th Cir. 2003). The same analysis has resulted in the dairy checkoff being ruled unconstitutional. Cochran v. Veneman, 359 F.3d 263 (3d Cir. 2004), rev’g, 252 F. Supp. 2d 126 (M.D. Pa. 2003). The court specifically noted the extensive regulation of the marketing aspects of the dairy industry concerning price and production.
Other Recent Checkoff Litigation
In 2011, the Office of Inspector General for the USDA initiated an audit of the Beef Checkoff Program, released it in 2013, withdrew it, and later re-released it in 2014. The checkoff program bars the producer-derived funds from being used for policy activities. The initial audit said that the National Cattleman Beef Association (NCBA) was in full compliance, but the re-released audit removed that statement. Before the OIG audit, there was an independent audit that disclosed problems with the use of checkoff funds by NCBA. In 2013, a livestock market advocacy group (assisted by the Humane Society of the U.S.) filed a Freedom of Information Act (FOIA) request with respect to OIG the audit reports. After that filing, the OIG withdrew the initial audit for further consideration. In 2014, the same group filed a complaint for injunctive relief against the OIG requesting that the OIG make a final determination and release all required records related to the audits. The advocacy group sought the information to determine if there is a connection between the drop in cattle-producer numbers and the price of calves and losses, and the use of checkoff funds. The NCBA claims that the audit activities will weaken the checkoff and asserts that the audits have found the NCBA to be in full compliance with the checkoff rules. In 2016, the NCBA sought to intervene in the injunction case, and in late September the advocacy group filed its response. NCBA sought intervention because some of the information in the audit reports involved confidential business information unrelated to the checkoff. It has been reported that there are approximately 9.300 pages of financial data involving the beef checkoff. The case is filed in the U.S. District Court for the District of Columbia and a ruling is soon expected on the NCBA’s request for intervention. It’s an interesting case. The U.S. Supreme Court has ruled, as noted above that the beef checkoff is government speech. That’s true for the program as a whole, but what about the business information that’s involved? That’s a dicey issue and it will be interesting to see how the court sorts it out.
In the Montana litigation, Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Vilsack, No. CV-16-41-GF-BMM-JTL, D. Mont. Dec. 12, 2016), a cattle rancher group, claimed that the federal law requiring funding of the Montana Beef Council (MBC) via funds from the federal beef checkoff was constitutionally defective. The court, as part of the findings and recommendations of a U.S. Magistrate Judge, determined that the plaintiff had standing and had stated a claim upon which relief could be granted. Under the Beef Checkoff, a $1.00/head fee is imposed at the time cattle are sold. The money generated funds promotional campaigns and research, and state beef councils can collect the funds and retain half of the collected amount with the balance going to the Cattleman’s Beef Production and Research Board (Beef Board). But, a producer can direct that all of the producer’s assessment go to the Beef Board. The plaintiff claimed that the use of the collected funds violated their First Amendment rights by forcing them to pay for “speech” with which they did not agree. The defendant (USDA) motioned to dismiss, but the Magistrate Judge denied the motion. The court determined that the plaintiffs had standing, and that the U.S. Supreme Court had held in prior cases that forcing an individual to fund a private message that they did not agree with violated the First Amendment. Any legal effect of an existing “opt-out” provision was not evaluated. The court also rejected the defendant’s claim that the case should be delayed until federal regulations with respect to the opt-out provision were finalized because the defendant was needlessly dragging its heels on developing those rules and had no timeline for finalization. The court entered a preliminary injunction barring the MBC from spending funds received from the checkoff. The court’s decision will be reviewed by the federal trial court. On December 23, 2016, the defendant filed its objections to the Magistrate Judge's recommendations, and on January 5, 2017, the plaintiff filed its opposition brief to the defendant's objections.
There’s a lot going on right now in agriculture concerning check-offs. It’s a big issue for many producers. In 2017, the courts will decide the pending litigation mentioned above and there is also more litigation that isn’t mentioned above. Also, the change in leadership at USDA may have some influence on what the future holds for agricultural check-offs.
Monday, January 16, 2017
Last week I posted on the accumulated earnings tax and the personal holding company tax. Those two taxes are possible in the C corporation context, and there could be more C corporations formed in the future if the corporate tax rate is cut as proposed.
Another issue related to C corporation is the opposite side of the coin. What if C corporate shareholders want out of the C corporate form? Perhaps there is hostility among the shareholders, or the C corporation no longer fits with the estate and succession planning desires of the family. Or maybe there is some other reason to change the structure of the business.
Well, when it comes to getting out of the C corporate structure, most of the options aren’t good from a tax standpoint. But, a “Type D” divisive reorganization can be a tax-favored way to get out of the C corporation and also satisfy the family’s estate and business planning objectives. The Type D divisive reorganization is the most widely used type of corporate reorganization for farming and ranching operations and is carried out in three steps. First, a subsidiary corporation is formed. Then, an exchange of property for stock occurs by carving out the machinery, livestock and land that is to be transferred to the new subsidiary. Finally, the new owners of the subsidiary give up the stock in the parent corporation for all of the stock in the subsidiary. At this point, the subsidiary is cut loose from the parent corporation. If the reorganization is conducted properly, it should be tax-free. However, a corporate division will not be tax-free unless it is carried out for a legitimate business purpose and there is an active trade or business. Those two requirements are the focus of today’s post.
Tax-free Reorganization Basics
A separation of business interests through a divisive reorganization in accordance with I.R.C. §368 and §355 is the only tax-free method of separating a corporation’s business. There are various types of reorganizations in the Code but, as noted above, a " Type D" reorganization is governed by I.R.C. §368(a)(1)(D) which requires that after the transfer of assets to a newly created subsidiary corporation in exchange for stock in that entity, the original corporation must distribute the stock of the new corporation to its shareholders in a transaction qualifying under I.R.C. §355.
Business Purpose Requirement
In order for I.R.C. §355 to apply to the distribution of the newly-formed entity’s stock, the distribution cannot principally be a device for the distribution of earnings and profits of either or both corporations. I.R.C. §355(a)(1)(B). The reorganization must be motivated, in whole or substantial part, by a corporate business purpose rather than a shareholder purpose. That’s a determination that is based on all of the facts and circumstances surrounding the transaction.
So, what qualifies as an acceptable business purpose? Clearly, if the sole purpose of a transaction is to minimize federal income taxes, the transaction is likely doomed. See, e.g., Wortham Machinery Co. v. United States, 521 F.2d 160 (10th Cir. 1975). But, serious shareholder disagreements that could negatively affect the efficient operation of the corporation’s business qualify as a legitimate reason to divide the business tax-free. See Athanasios v. Comr., T.C. Memo. 1995-72; Treas. Reg. §1.355-2(b). That is good news for farming and ranching operations where there is family disharmony that could threaten the future of the operation. See also Priv. Ltr. Rul. 9713020 (Dec. 30, 1996). The corporation might be able to be divided tax-free with one shareholder or shareholder group being separated from another shareholder or group.
But, there doesn’t necessarily have to be family problems for a corporate division to qualify as tax-free. The IRS has ruled that a family farming operation can be divided and the business purpose requirement of Treas. Reg. § 1.355-2(b) satisfied even though the distribution is intended, in part, to further estate planning goals and family harmony. This is similar to Treas. Reg. §1.355-2(b)(5) which says that a valid business purpose can exist even though the shareholder split is amicable rather than hostile where the reason for the split is different shareholder business interests. In the IRS ruling, Rev. Rul, 2003-52, 2003-1 C.B. 960, the IRS ruled that the reorganization was motivated by substantial nontax business reasons, and accordingly met the I.R.C. §355 tax-free divisive reorganization rules. Although the reorganization advanced the personal estate planning goals of the parents and promoted family harmony, substantial business reasons were associated with the separation of the two children from the single business activity that the corporation used to conduct.
Active Business Requirement
I.R.C. §355 requires that after the distribution of the subsidiary corporation’s stock, both corporations must be engaged in the “active conduct of a trade or business.” I.R.C. §355(b)(1)(A). The Code does not define “active trade or business,” but the regulations state that, “A corporation shall be treated as engaged in a trade or business…if a specific group of activities are being carried on by the corporation for the purpose of earning income or profit, and the activities included in such group include every operation which forms a part of, or a step in, the process of earning income or profit. Such group of activities ordinarily must include the collection of income and the payment of expenses.” Treas. Reg. §1.355-3(b)(2)(ii). A rental activity is not considered an active business for this purpose “unless the owner performs significant services.”
A Type D reorganization can be complicated when the farm or ranch operation has an existing lease or leases with respect to its land. For various reasons, it is fairly common for farm and ranch corporations to operate its business activity on certain tracts of land and lease other tracts to others – either unrelated tenants or shareholders. In these situations, it is common for the shareholders to want to transfer the leased ground (and perhaps some equipment) to the newly created corporation so that the departing shareholder(s) can operate that ground separately. But, this can create the potential for a fully taxable corporate separation if the IRS determines that the property transferred to the newly created subsidiary (the leased land) has not been used in the active conduct of a trade or business. Treas. Reg. §1.355-3(b)(2)(iii).
This all means that the type of lease matters, as does the involvement of the corporation with that leased land. As noted earlier, the leasing of land generally does not constitute the active conduct of a trade or business. Treas. Reg. §1.355-3(b)(2)(iv)(B). Thus, If the primary asset to be transferred to the newly-created corporation is land leased to tenant farmers or to a shareholder, the corporate division may be unable to meet the requirement that both corporations are engaged in an active trade of business with a five-year history (another requirement not discussed in this post).
A standard cash lease arrangement would fail the active trade or business requirement. Under the regulations, a corporation conducts an active business only when the corporation itself performs, “active and substantial management and operational functions. In the case of a farm or ranch corporation leasing property under a crop-share arrangement, the degree of involvement of the officers and employees of the original corporation in the management and operational functions relating to the leased property will determine whether the corporate division can be accomplished tax-free.
Instructive on the leasing issue for farming operations are two IRS rulings. Practitioners should compare Revenue Ruling 73-234, 1973-1 C.B. 180 with Rev. Rul. 86-126, 1986-2 CB 58. What those ruling instruct is that merely leasing agricultural land under a crop-share arrangement, by itself, will not be treated as an active business within the meaning of I.R.C. §355. A corporation leasing agricultural land will have to demonstrate more than a moderate degree of involvement in the managerial decisions relating to the farm or ranch activity. This seems to indicate that a lease that meets the definition of a material participation crop-share lease for I.R.C. §1402 purposes is necessary. In addition, the corporation must perform substantial managerial and operational activities. Such things as hiring seasonal workers; supplying and maintaining equipment, arranging financing, planning crop rotation, planting and harvesting, selling crops and accounting to the tenant farmers are all helpful in meeting the standard.
Documenting a Type-D Reorganization
Over a decade ago, the IRS said it would no longer issue rulings on whether a proposed transaction qualified as a Type D reorganization. While that’s still the case for the overall transaction, the IRS will now issue a letter ruling, upon request, on whether a distribution has a corporate business purpose or is a device for purposes of I.R.C. §355, but only when a legal issue is present and the matter is not entirely factual. Rev. Proc. 2016-45, 2016-37 I.R.B. 344. So, it’s still necessary to document in detail how a transaction meets all the requirements of a divisive reorganization, including the business purpose and active trade or business tests.
We’ve just scratched the surface of the details involved when a Type D corporate reorganization transaction is utilized. But, for some farm and ranch operations, it is an option that can work well to facilitate estate and business planning goals when a C corporation is involved.
Thursday, January 12, 2017
The current financial situation in agriculture is difficult for many producers. Low crop and livestock prices, falling land values and increasing debt levels are placing some ag producers in a serious bind. Chapter 12 bankruptcy is an option for some, although the current debt limits of Chapter 12 are barring some from utilizing its relief provisions.
When dealing with financial distress, restructuring debt is often involved. This is one of the topics that Joe Peiffer (of Peiffer Law in Cedar Rapids, Iowa) and I will be addressing at Washburn Law School on February 1 during our 3-hour CLE event, “Common Problems Faced by Farmers and Ranchers in Difficult Financial Times.” The seminar will also be simulcast live over the web for those that cannot attend in-person. Here’s the link for registration: http://washburnlaw.edu/farmersandrancherscleregister
One of the issues that we will be addressing are the strategies that can be used to negotiate with creditors and restructure debt. While many ag deals are done at the coffee shop or while leaning-up against the pick-up or a fencepost, debt restructuring negotiations with creditors don’t typically occur in that manner. Today’s post is a bit of a teaser of the upcoming seminar that is my summary of Joe’s thoughts on debt restructuring and the options and opportunities that might be present during that process.
Debt Restructuring Negotiations
Debt restructuring negotiations do not involve a formal, specifically prescribed process with one exception – mediation. Rather, debt restructuring negotiations take place informally. However, when mediation is utilized, it is a formal process that is often prescribed by state law. So, what makes for a successful debt restructuring negotiation? As with any negotiation on any subject, it is critical to understand what each party views as important. What are their priorities? For a creditor, collecting on a delinquent debt is always of supreme importance. Likewise, if there is a non-delinquent, marginal loan, the creditor will be interested in obtaining guarantees, either private or via government entities such as the USDA or the Small Business Administration. The creditor will also likely attempt to obtain additional collateral so that the farm debtor’s line of credit can continue and any projected loss to the creditor is minimized or eliminated.
On the other side, a farmer’s goals typically include staying on the farm and continuing the farming business. The farmer probably also wants to maintain ownership of assets and their lifestyle. Also, another common goal of farm debtors is to get the farming operation to the most economical size (often downsizing) without triggering a tax bill that can’t be paid.
Once the goals of the creditors and the farmer are identified, they must be prioritized. That’s when reality begins to set in. Are the goals realistic? Are there any that can’t be achieved? Those that can’t be achieved must be eliminated and the realistic goals focused on. Creditors have to realize that debts won’t be paid in full and on time. Farm debtors have to understand that they can’t retain all of their farm assets. So, the parties should strive to find common ground somewhere in the middle. There probably are some areas of agreement that can be reached. But, to get there, both parties will likely have to compromise. Neither the creditors nor the farm debtor should view negotiations in absolutist terms. Still, even if a mediation agreement is reached and a release obtained, that doesn’t meet that the parties still won’t end up in court. To avoid litigation, some “out-of-the-box” thinking will likely be required.
Being creative. Joe relates a matter that he dealt with a few years ago. He was representing a farm debtor and the banker showed a great willingness to be creative in dealing with the farmer’s debt situation. The balance on the loan owed the bank exceeded the collateral values by well over $1,000,000. The farm debtor had a dairy operation that was losing money to the tune of more than $70,000 every month, and there was virtually no likelihood of a successful reorganization. At mediation, the banker suggested that if the farmer would immediately surrender the cows, calves, grain, sileage and other personal property securing the loan, and agree to surrender the farm under non-judicial foreclosure he would pay Joe's clients $100,000. The banker's reasoning was that by paying the farm debtor $100,000, the amount he expected to pay his attorney if the farmer filed a Chapter 12 bankruptcy, the farmer could have a fresh start and he would speedily obtain control of the collateral minimizing his losses.
The farm debtor put a great deal of thought into the prospect of getting $100,000 and not having the uncertainty of a bankruptcy. They opted to take the money offered to them. The deal was structured so that the bank’s $100,000 payment was in consideration for them selling their homestead to the Bank. Because the money constituted proceeds from the sale of their homestead, the funds were exempt under state (IA) law from the claims of their other creditors for a reasonable time to allow purchase of a later homestead. After closing, the farm debtor held the proceeds in a “Homestead Account” separate from all other money they. They did not add other money to that account, nor did they spend the money in that account until they purchased a new homestead.
Non-Judicial Foreclosure Can be Beneficial
The use of a non-judicial foreclosure provided under state law (in Iowa, the procedure is set forth in Iowa Code § 654.18) allows farmers and their creditors to fashion remedies that can be mutually beneficial. This remedy can be utilized either before or as a part of a mediated settlement. The creditor gets possession and ownership of the real estate collateral much quicker than would be the case in a traditional foreclosure. The right of redemption and right of first refusal present in a traditional foreclosure are eliminated. The creditor waives any deficiency that could exist if the collateral cannot cover the indebtedness. But, of course, a farm debtor must be mindful of the potential for discharge of indebtedness income if this procedure is utilized and the farmer has exempt assets that could make them solvent once a deficiency is forgiven.
A benefit to a farm debtor of non-judicial foreclosure is that the creditor is generally able to make other beneficial concessions. Also, under a non-judicial foreclosure, the farmer deeds the farm to the creditor subject to a period of time (typically five-business days) during which the transaction can be cancelled. If the transaction is not cancelled, the creditor gives notice of the non-judicial foreclosure to junior lien holders who then a period of time (generally 30 days) to redeem from the creditor and each other.
Deed Back to Bank with Sale of Homestead Back to Farmer on Real Estate Contract
During the farm financial crisis of the 1980s in many parts of the Midwest and Great Plains, farm and ranch debt restructurings often involved debtors deeding back their farms to the creditor with the creditor then selling back the house and an acreage on a real estate contract. This approach allowed the farmer to retain the homestead while allowing the bank to realize cash from the balance of its real estate collateral. But, if the debtor missed a payment, the bank, could institute a contract forfeiture procedure that would take only 30 days to finish once the Notice of Forfeiture was properly served after mediation.
Sale of Non-Essential Assets in the Tax Year Before Filing Chapter 12
The “right-sizing” of a farm operation must always be considered as a part of a debt restructuring negotiation. If the farmer has over-encumbered assets it can be in his best interest to liquidate some assets, reduce debt and restructure the farming operation. The liquidation of assets that are not absolutely necessary to the “newer” farming operation can also have the effect of decreasing the farmer’s level of debt beneath the maximum allowable so that the farmer is eligible to file Chapter 12. However, selling-off of farm assets often leads to incurring significant income taxes. But, in a Chapter 12 farm bankruptcy, a special tax provision, 11 U.S.C. §1222(a)(2)(A), can be utilized to move taxes from a priority to a non-priority position which can then result in the taxes being discharged.
Formal Written Agreements Contained in Bank Minutes are Essential
Under federal law, to be enforceable in the event the institution is declared insolvent, debt restructuring agreement involving federally insured institutions must be in writing, approved by the board of directors, sealed and included in the bank’s minutes. Reliance on any oral agreements with a bank is not wise as they are unenforceable (see, e.g., Iowa Code § 535.17 and 12 U.S.C. §1823(e)). If the bank goes broke and the Debt Settlement Agreement is not memorialized as is required by 12 U.S.C. § 1823(e), the FDIC or the purchaser of the notes from the FDIC will not be bound by the Debt Settlement Agreement. Thus, if any agreement with a bank is to be enforced, it must be in writing signed by the proper parties and comply with any statutorily-required formalities.
As Joe has pointed out on numerous occasions, debt restructuring negotiations provide farmers and their creditors with substantial opportunities to reach an agreement that satisfies both parties’ needs. Preparation is the key to a successful negotiation for both creditors and farmers. Consideration of the other party’s priorities and needs can lead to opportunities for cooperation that will minimize the need for court intervention and bankruptcies. Frequently, the need to “right-size” a farming operation will lead to significant income tax consequences that can only be addressed in a Chapter 12 bankruptcy. When this occurs, cooperation between the creditor and farmer can allow the creditor to receive the liquidation proceeds of most of its collateral in the tax year before filing the bankruptcy while allowing the farmer to avail himself of the favorable tax provisions of 11 U.S.C. § 1222(a)(2)(A). All parties to debt restructuring negotiations should be prepared to accept reality, make reasonable concessions and consider the needs of the other party to reach agreement.
This is just a sample of one of the numerous issues that Joe and I will discuss at the law school seminar on February 1. Again, if you can’t attend in-person, you can watch a live simulcast over the web of our presentations. Here’s the link for registration information: http://washburnlaw.edu/farmersandrancherscleregister
Tuesday, January 10, 2017
C corporations were all the rage in agriculture in the 1960s and 1970s. Many farming operations were structured that way in those decades and farmland was placed inside them. However, with the advent of limited liability companies in the late 1970s in Wyoming and Colorado (and, later, all states) and other unique entity forms, and a change in the tax law in 1986, they became less popular. 2017, however, could be the start of renewed interest in the C corporate form. A primary driver of what might cause some to reconsider the use of the C corporation is that President-elect Trump campaigned in part on reducing the corporate tax rate. Similarly, in the summer of 2016, the U.S. House Ways and Means Committee released a proposed “blueprint” for tax reform that also contained a lower corporate tax rate. If that happens, the use of C corporations may be back in vogue to a greater extent than presently.
If C corporations do gain in popularity, there are a couple of C corporate “penalty” taxes that practitioners need to remember are lurking in the background. In addition, a recent IRS Chief Counsel Advice (C.C.A. 201653017 (Sept. 8, 2016)) illustrates that the IRS hasn’t forgotten that these penalty taxes exist. Today’s post takes a look at the basic rules of the accumulated earnings tax and the personal holding company tax – two C corporate penalty taxes that can be problematic.
Accumulated Earnings Tax
The accumulated earnings (AE) tax is in addition to a corporation's regular income tax. I.R.C. §531. The AE tax is designed to prevent a corporation from being used to shield its shareholders from the individual income tax through accumulation of earnings and profits, and applies to “accumulated taxable income” of the corporation (taxable income, with certain adjustments. I.R.C. §535). There is substantial motivation, even in farm and ranch corporations, not to declare dividends because of their unfavorable tax treatment. Dividends are taxed twice, once when they are earned by the corporation and again when corporate earnings are distributed as dividends to the shareholders. This provides a disincentive for agricultural corporations (and other corporations) to make dividend distributions. Consequently, this leads to a build-up of earnings and profits within the corporation.
The AE tax (at a rate of 20 percent) applies only to amounts unreasonably accumulated during the taxable year. Indeed, the computation of “accumulated taxable income” is a function of the reasonable needs of the business. So, the real issue is the extent to which corporate earnings and profits can accumulate before triggering application of the accumulated earnings tax. To that end, the statute provides for an AE credit which specifies that all corporations are permitted to accumulate earnings and profits of $250,000 without imposition of the tax. I.R.C. §535(c)(2)(A). However, the credit operates to ensure that service corporations (fields of health, law, engineering, architecture, accounting, actuarial science, performing arts and consulting) only have $150,000 leeway. I.R.C. §535(c)(2)(B). But, remember, not every corporation that exceeds $250,000 (or $150,000) of accumulated earnings and profits will trigger application of the accumulated earnings tax. That’s because the tax applies only if a particular corporation has accumulated more than $250,000 (or $150,000) in earnings and profits and the accumulation is beyond the reasonable needs of the business.
Reasonable business needs. For agricultural corporations, it is important that legitimate business reasons for accumulating earnings and profits in excess of $250,000 be sufficiently documented in annual meeting minutes and other corporate documentation. IRS regulations concede that some accumulations may be proper, and agricultural corporations should try to base their need for accumulating earnings and profits on the IRS guidelines. Treas. Reg. §1.537-2(b). For instance, an acceptable reason for accumulation is to expand the business through the purchase of land, the building of a confinement unit or the acquisition of additional machinery or equipment. Similarly, earnings and profits may be accumulated to retire debt, hire additional people, provide necessary working capital, or to provide for investments or loans to suppliers or customers in order to keep their business. Conversely, the IRS specifically targets some accumulations as being improper. Treas. Reg. §1.537-2(c). These include loans to shareholders or expenditures of funds for the benefit of shareholders, loans with no reasonable relationship to the business, loans to controlled corporations carrying on a different business, investments unrelated to the business and accumulations for unrealistic hazards. Thus, while there are many legitimate business reasons for accumulating excess earnings and profits, there are certain illegitimate reasons for excess accumulations which will trigger application of the accumulated earnings tax.
This all means that it is very important that the corporation's annual meeting minutes document a plan for utilization of accumulated earnings and profits. For example, in Gustafson's Dairy, Inc. v. Comm'r, T.C. Memo. 1997-519, the AE tax was found not applicable to a fourth-generation dairy operation with one of the largest herds in United States at one location. The corporation had accumulations of $4.6 million for herd expansion, $1.6 million for pollution control, $8.2 million to purchase equipment and vehicles, $2 million to buy land, $3.3 million to retire a debenture, and $1.1 million to self-insure against loss of herd. The court found those accumulations to be reasonable particularly because the dairy had specific, definite or feasible plans to use the accumulations, which were documented in corporate records. Those corporate records (minutes) also showed how the corporation computed its working capital needs. The key point is that the corporation had a specific plan for the use of corporate earnings and profits, knew its working capital needs, and wasn’t simply trying to avoid tax.
Personal Holding Company (PHC) Tax
The other penalty tax applicable to C corporations is the PHC tax. I.R.C. §§541-547. This tax is imposed when the corporation is used as a personal investor. The PHC tax of 20 percent for tax years after 2012 is levied on undistributed PHC income (taxable income less dividends actually paid, federal taxes paid, excess charitable contributions, and net capital gains).
To be a PHC, two tests must be met. The first test is an ownership test, and is satisfied if five or fewer people own more than 50 percent of the corporate stock during the last half of the taxable year. Most farming and ranching operations automatically meet this test. The second test is an income test and is satisfied if 60 percent or more of the corporation's adjusted ordinary gross income (reduced by production costs) comes from passive investment sources. See, e.g., Tech. Adv. Memo. 200022001 (Nov. 2, 1991).
The potential problem of rental income. Rental income is included in adjusted ordinary gross income unless adjusted rental income is at least 50 percent of adjusted ordinary gross income, and dividends for the taxable year equal or exceed the amount (if any) by which the corporation's non-rent personal holding company income for that year exceeds 10 percent of its ordinary gross income. In other words, if the mixture of rental income and other passive income sources exceed 10 percent and the rental income exceeds 50 percent, the PHC tax could be triggered. Thus, farming and ranching corporations engaged predominantly in rental activity may escape application of the PHC tax. But if the corporation's non-rent personal holding company income (dividends, interests, royalties and annuities) is substantial, the corporation must make taxable dividend distributions to avoid imposition of the PHC tax. Thus, for corporations owning agricultural land that is cash rented out and the corporation's only passive income source is cash rent, there is no PHC tax problem.
For many farm and ranch corporations, the problem of being a PHC is serious. A common scenario is for a farmer or rancher to retire with a tenant or child continuing to farm or ranch the land and pay rent. If the operation has been incorporated, the receipt of rents could cause the corporation to be a PHC. In this situation, it is critical to have the proper type of lease to avoid imposition of the PHC tax. For example, in Webster Corporation v. Comr., 25 T.C.55 (1955), the IRS argued that a farm corporation had become a personal holding company. The IRS lost, but only because the lease was a material participation crop share lease and substantial services were being provided by a farm manager. The farm manager's activities were imputed to the corporation as land owner. The court held that income under such a lease was business income and not rental income. However, if the lease is not a material participation share lease, then the landlord receives rent. Certainly, fixed cash rents will be treated as rent. If the corporation receives only rental income, the rents are not PHC income. But if the corporation also receives other forms of investment income, the rents can be converted into personal holding company income.
In the typical farm or ranch corporation setting, there is usually a mixture of rental income and other passive income sources. Over time, the corporation typically builds up a balance in the corporate treasury from the rental income and then invests that money which produces income from other passive sources. As a result, there is, at some point in time, a mixture of rental income and other passive income sources that will eventually trigger application of the personal holding company tax. For farming and ranching operations structured as multiple entities, this is one of the major reasons why the landholding entity should not be a C corporation. The only income that a landholding C corporation entity will have initially is rental income. However, the tendency to invest the buildup of rental income over time will most likely trigger application of the personal holding company tax down the road.
Finally, a limiting factor in both of these taxes is taxable income. If the corporation doesn’t have taxable income, it isn’t accumulating earnings and is not subject to the AE tax. Also, corporations without taxable income are usually not subject to the PHC tax. Use Form 1120, Schedule PH, as a guide.
A more favorable tax climate for C corporations could spawn renewed interest in their formation and usage. But, remember the penalty taxes that can apply. The IRS hasn’t forgotten them, as illustrated by that recent Chief Counsel Advice. That Chief Counsel Advice referenced earlier also points out that that the AE tax can apply even though the corporation is illiquid. It doesn’t depend on the amount of cash available for distribution. It’s based on accumulated taxable income and is not based on the corporation’s liquid assets. In addition, IRS noted, I.R.C. §565 contains consent dividend procedures that a corporation can use to allow the payment of a deemed dividend when a corporation is illiquid. In any event, both the AE tax and the PHC tax are penalty taxes that will be strictly construed. There is no wiggle-room.
So, remember the possible penalty taxes and plan accordingly when utilizing a C corporation.
Friday, January 6, 2017
Today we continue our look this week at the biggest developments in agricultural law and taxation during 2016. Out of all of the court rulings, IRS developments and regulatory issues, we are down to the top five developments in terms of their impact on ag producers, rural landowners and agribusinesses.
So, here are the top five (as I see them) in reverse order:
(5) Pasture Chiseling Activity Constituted Discharge of “Pollutant” That Violated the CWA. The plaintiff bought approximately 2,000 acres in northern California in 2012. Of that 2,000 acres, the plaintiff sold approximately 1,500 acres. The plaintiff retained an environmental consulting firm to provide a report and delineation map for the remaining acres and requested that appropriate buffers be mapped around all wetlands. The firm suggested that the plaintiff have the U.S. Army Corps of Engineers (COE) verify the delineations before conducting any grading activities. Before buying the 2,000 acres, the consulting firm had provided a delineation of the entire tract, noting that there were approximately 40 acres of pre-jurisdictional wetlands. The delineation on the remaining 450 acres of pasture after the sale noted the presence of intact vernal and seasonal swales on the property along with several intermittent and ephemeral drainages. A total of just over 16 acres of pre-jurisdictional waters of the United States were on the 450 acres – having the presence of hydric soils, hydrophytic vegetation and hydrology (1.07 acres of vernal pools; 4.02 acres of vernal swales; .82 acres of seasonal wetlands; 2.86 acres of seasonal swales and 7.40 acres of other waters of the United States). In preparation to plant wheat on the tract, the property was tilled at a depth of 4-6 inches to loosen the soil for plowing with care taken to avoid the areas delineated as wetlands. However, an officer with the (COE) drove past the tract and thought he saw ripping activity that required a permit. The COE sent a cease and desist letter and the plaintiff responded through legal counsel requesting documentation supporting the COE’s allegation and seeking clarification as to whether the COE’s letter was an enforcement action and pointing out that agricultural activities were exempted from the CWA permit requirement. The COE then provided a copy of a 1994 delineation and requested responses to numerous questions. The plaintiff did not respond. The COE then referred the matter to EPA for enforcement. The plaintiff sued the COE claiming a violation of his Fifth Amendment right to due process and his First Amendment right against retaliatory prosecution. The EPA refused the referral due to the pending lawsuit so the COE referred the matter to the U.S. Department of Justice (DOJ). The DOJ filed a counterclaim against the plaintiff for CWA violations.
The court granted the government’s motion on the due process claim because the cease and desist letter did not initiate any enforcement that triggered due process rights. The court also dismissed the plaintiff’s retaliatory prosecution claim. On the CWA claim brought by the defendant, the court determined that the plaintiff’s owner could be held liable as a responsible party. The court noted that the CWA is a strict liability statute and that the intent of the plaintiff’s owner was immaterial. The court then determined that the tillage of the soil causes it to be “redeposited” into delineated wetlands. The redeposit of soil, the court determined, constituted the discharge of a “pollutant” requiring a national pollution discharge elimination system (NPDES) permit. The court reached that conclusion because it found that the “waters” on the property were navigable waters under the CWA due to a hydrological connection to a creek that was a tributary of Sacramento River and also supported the federally listed vernal pool fairy shrimp and tadpole shrimp. Thus, a significant nexus with the Sacramento River was present. The court also determined that the farming equipment, a tractor with a ripper attachment constituted a point source pollutant under the CWA. The discharge was not exempt under the “established farming operation” exemption of 33 U.S.C. §1344(f)(1) because farming activities on the tract had not been established and ongoing, but had been grazed since 1988. Thus, the planting of wheat could not be considered a continuation of established and ongoing farming activities. Duarte Nursery, Inc. v. United States Army Corps of Engineers, No. 2:13-cv-02095-KJM-AC, 2016 U.S. Dist. LEXIS 76037 (E.D. Cal. Jun. 10, 2016).
(4) Prison Sentences Upheld For Egg Company Executives Even Though Government Conceded They Had No Knowledge of Salmonella Contamination. The defendant, an executive of a large-scale egg production company (trustee of the trust that owned the company), and his son (the Chief Operating Officer of the company) pled guilty as “responsible corporate officers” to misdemeanor violations of 21 U.S.C. §331(a) for introducing eggs that had been adulterated with salmonella into interstate commerce from the beginning of 2010 until approximately August of 2010. They each were fined $100,000 and sentenced to three months in prison. They appealed their sentences as unconstitutional on the basis that they had no knowledge that the eggs at issue were contaminated at the time they were shipped. They also claimed that their sentences violated Due Process and the Eighth Amendment insomuch as the sentences were not proportional to their “crimes.” They also claimed that incarceration for a misdemeanor offense would violate substantive due process.
The trial court determined that the poultry facilities were in poor condition, had not been appropriately cleaned, had the presence of rats and other rodents and frogs and, as a result, the defendant and his son either “knew or should have known” that additional salmonella testing was needed and that remedial and preventative measures were necessary to reduce the presence of salmonella. The appellate court agreed, finding that the evidence showed that the defendant and son were liable for negligently failing to prevent the salmonella outbreak and that 21 U.S.C. §331(a) did not have a knowledge requirement. The appellate court also did not find a due process violation. The defendant and son claimed that because they did not personally commit wrongful acts, and that due process is violated when prison terms are imposed for vicarious liability felonies where the sentence of imprisonment is only for misdemeanors. However, the court held that vicarious liability was not involved, and that 21 U.S.C. §331(a) holds a corporate officer accountable for failure to prevent or remedy “the conditions which gave rise to the charges against him.” Thus, the appellate court determined, the defendant and son were liable for negligently failing to prevent the salmonella outbreak. The court determined that the lack of criminal intent does not violate the Due Process Clause for a “public welfare offense” where the penalty is relatively small (the court believed it was), the defendant’s reputation was not “gravely” damaged (the court believed that it was not) and congressional intent supported the penalty (the court believed it did). The court also determined that there was no Eighth Amendment violation because “helpless” consumers of eggs were involved. The court also found no procedural or substantive due process violation with respect to the sentences because the court believed that the facts showed that the defendant and son “had reason to suspect contamination” and should have taken action to address the problem at that time (even though law didn’t require it).
The dissent pointed out that the government stipulated at trial that its investigation did not identify any corporate personnel (including the defendant and son) who had any knowledge that eggs sold during the relevant timeframe were contaminated with salmonella. The dissent also noted that the government conceded that there was no legal requirement for the defendant or corporation to comply with stricter regulations during the timeframe in issue. As such, the convictions imposed and related sentences were based on wholly nonculpable conduct and there was no legal precedent supporting imprisonment in such a situation. The dissent noted that the corporation “immediately, and at great expense, voluntarily recalled hundreds of millions of shell eggs produced” at its facilities when first alerted to the problem. As such, according to the dissent, due process was violated and the sentences were unconstitutional. United States v. Decoster, 828 F.3d 626 (8th Cir. 2016).
(3) The IRS and Self-Employment Tax. Two self-employment tax issues affecting farmers and ranchers have been in the forefront in recent years – the self-employment tax treatment of Conservation Reserve Program (CRP) payments and the self-employment tax implications of purchased livestock that had their purchase price deducted under the de minimis safe harbor of the capitalization and repair regulations. On the CRP issue, in 2014 the U.S. Court of Appeals ruled that CRP payments in the hands of a non-farmer are not subject to self-employment tax. The court, in Morehouse v. Comr., 769 F.3d 616 (8th Cir. 2014), rev’g, 140 T.C. 350 (2013), held the IRS to its historic position staked out in Rev. Rul. 60-32 that government payments attributable to idling farmland are not subject to self-employment tax when received by a person who is not a farmer. The court refused to give deference to an IRS announcement of proposed rulemaking involving the creation of a new Rev. Rul. that would obsolete the 1960 revenue ruling. The IRS never wrote the new rule, but continued to assert their new position on audit. The court essentially told the IRS to follow appropriate procedure and write a new rule reflecting their change of mind. In addition, the court determined that CRP payments are “rental payments” statutorily excluded from self-employment tax under I.R.C. §1402(a). Instead of following the court’s invitation to write a new rule, the IRS issued a non-acquiescence with the Eighth Circuit’s opinion. O.D. 2015-02, IRB 2015-41. IRS said that it would continue audits asserting their judicially rejected position, even inside the Eighth Circuit (AR, IA, MN, MO, NE, ND and SD).
In 2016, the IRS had the opportunity to show just how strong its opposition to the Morehouse decision is. A Nebraska non-farmer investor in real estate received a CP2000 Notice from the IRS, indicating CRP income had been omitted from their 2014 return. The CP2000 Notice assessed the income tax and SE Tax on the alleged omitted income. The CRP rental income was in fact included on the return, but it was included on Schedule E along with cash rents, where it was not subject to self-employment tax. The practitioner responded to the IRS Notice by explaining that the CRP rents were properly reported on Schedule E because the taxpayer was not a farmer. This put the matter squarely before the IRS to reject the taxpayer’s position based on the non-acquiescence. But, the IRS replied to the taxpayer’s response with a letter informing the taxpayer that the IRS inquiry was being closed with no change from the taxpayer’s initial position that reported the CRP rents for the non-farmer on Schedule E.
On the capitalization and repair issue, taxpayers can make a de minimis safe harbor election that allows amounts otherwise required to be capitalized to be claimed as an I.R.C. §162 ordinary and necessary business expense. This de minimis expensing election has a limit of $5,000 for taxpayers with an Applicable Financial Statement (AFS) and $2,500 for those without an AFS. Farmers will fall in the latter category. In both cases, the limit is applied either per the total on the invoice, or per item as substantiated by the invoice. One big issue for farmers and ranchers is how to report the income from the sale of purchased livestock that are held for productive use, such as breeding or dairy animals for which the de minimis safe harbor election was made allowing the full cost of the livestock to be deducted. It had been believed that because the repair regulations specify when the safe harbor is used, the sale amount is reported fully as ordinary income that is reported on Schedule F where it is subject to self-employment tax for a taxpayer who is sole proprietor farmer or a member of a farm partnership. In that event, the use of the safe harbor election would produce a worse tax result that would claiming I.R.C. §179 on the livestock.
An alternative interpretation of the repair regulations is that the self-employment tax treatment of the gain or loss on sale of assets for which the purchase price was deducted under the de minimis safe harbor is governed by Treas. Reg. §1.1402(a)-6(a). That regulation states that the sale of property is not subject to selfemployment tax unless at least one of two conditions are satisfied: (1) the property is stock in trade or other property of a kind which would properly be includible in inventory if on-hand at the close of the tax year; or (2) the property is held primarily for sale to customers in the ordinary course of a trade or business. Because purchased livestock held for dairy or breeding purposes do not satisfy the first condition, the question comes down to whether condition two is satisfied – are the livestock held primarily for sale to customers in the ordinary course of a trade or business? The answer to that question is highly fact-dependent. If the livestock whose purchase costs have been deducted under the de minimis rule are not held primarily for sale to customers in the ordinary course of the taxpayer’s trade or business, the effect of the regulation is to report the gain on sale on Part II of Form 4797. This follows Treas. Reg. §1.1402(a)-6(a) which bars Sec. 1231 treatment (which would result in the sale being reported on Part I of Form 4797). In that event, the income received on sale would not be subject to self-employment tax.
In 2016, the IRS, in an unofficial communication, said that the alternative interpretation is the correct approach. However, the IRS was careful to point out that the alternative approach is based on the assumptions that the livestock were neither inventoriable nor held for sale, and that those assumptions are highly fact dependent on a case-by case basis. The IRS is considering adding clarifying language to the Farmers’ Tax Guide (IRS Pub. 225) and/or the Schedule F Instructions.
(2) TMDLs and the Regulation of Ag Runoff. Diffused surface runoff of agricultural fertilizer and other chemicals into water sources as well as irrigation return flows are classic examples of nonpoint source pollution that isn’t discharged from a particular, identifiable source. A primary source of nonpoint source pollution is agricultural runoff. As nonpoint source pollution, the Clean Water Act (CWA) leaves regulation of it up to the states rather than the federal government. The CWA sets-up a “states-first” approach to regulating water quality when it comes to nonpoint source pollution. Two key court opinions were issued in 2016 where the courts denied attempts by environmental groups to force the EPA to create additional federal regulations involving Total Maximum Daily Loads (TMDLs). The states are to establish total maximum daily TMDLs for watercourses that fail to meet water quality standards after the application of controls on point sources. A TMDL establishes the maximum amount of a pollutant that can be discharged or “loaded” into the water at issue from all combined sources on a daily basis and still permit that water to meet water quality standards. A TMDL must be set “at a level necessary to implement water quality standards.” The purpose of a TMDL is to limit the amount of pollutants in a watercourse on any particular date. Two federal court opinions in 2016 reaffirmed the principle that regulation of nonpoint source pollution is left to the states and not the federal government.
In Conservation Law Foundation v. United States Environmental Protection Agency, No. 15-165-ML, 2016 U.S. Dist. LEXIS 172117 (D. R.I. Dec. 13, 2016), the plaintiff claimed that the EPA’s approval of the state TMDL for a waterbody constituted a determination that particular stormwater discharges were contributing to the TMDL being exceeded and that federal permits were thus necessary. The court, however, determined that the EPA’s approval of the TMDL did not mean that EPA had concluded that stormwater discharges required permits. The court noted that there was nothing in the EPA’s approval of the TMDL indicating that the EPA had done its own fact finding or that EPA had independently determined that stormwater discharges contributed to a violation of state water quality standards. The regulations simply do not require an NPDES permit for stormwater discharges to waters of the United States for which a TMDL has been established. A permit is only required when, after a TMDL is established, the EPA makes a determination that further controls on stormwater are needed.
In the other case, Gulf Restoration Network v. Jackson, No. 12-677 Section: “A” (3), 2016 U.S. Dist. LEXIS 173459 (E.D. La. Dec. 15, 2016), numerous environmental groups sued the EPA to force them to impose limits on fertilizer runoff from farm fields. The groups claimed that many states hadn’t done enough to control nitrogen and phosphorous pollution from agricultural runoff, and that the EPA was required to mandate federal limits under the Administrative Procedure Act – in particular, 5 U.S.C. §553(e) via §303(c)(4) of the CWA. Initially, the groups told the EPA that they would sue if the EPA did not write the rules setting the limits as requested. The EPA essentially ignored the groups’ petition by declining to make a “necessity determination. The groups sued and the trial court determined that the EPA had to make the determination based on a 2007 U.S. Supreme Court decision involving the Clean Air Act (CAA). That decision was reversed on appeal on the basis that the EPA has discretion under §303(c)(4)(B) of the CWA to decide not to make a necessity determination as long as the EPA gave a “reasonable explanation” based on the statute why it chose not to make any determination. The appellate court noted that the CWA differed from the CAA on this point. On remand, the trial court noted upheld the EPA’s decision not to make a necessity determination. The court noted that the CWA gives the EPA “great discretion” when it comes to regulating nutrients, and that the Congressional policy was to leave regulation of diffused surface runoff up to the states. The court gave deference to the EPA’s “comprehensive strategy of bringing the states along without the use of federal rule making…”.
Also, in 2016 the U.S. Supreme Court declined to review a decision of the U.S. Court of Appeals for the Third Circuit which had determined in 2015 that the EPA had acted within its authority under 33 U.S.C. §1251(d) in developing a TMDL for the discharge of nonpoint sources pollutants into the Chesapeake Bay watershed. American Farm Bureau, et al. v. United States Environmental Protection Agency, et al., 792 F.3d 281 (3d Cir. 2015), cert. den., 136 S. Ct. 1246 (2016).
(1) The Election of Donald Trump as President and the Potential Impact on Agricultural and Tax Policy. Rural America voted overwhelmingly for President-elect Trump, and he will be the President largely because of the sea of red all across the country in the non-urban areas. So, what can farmers, ranchers and agribusinesses anticipate the big issues to be in the coming months and next few years and the policy responses? It’s probably reasonable to expect that same approach will be applied to regulations impacting agriculture. Those with minimal benefit and high cost could be eliminated or retooled such that they are cost effective. Overall, the pace of the generation of additional regulation will be slowed. Indeed, the President-elect has stated that for every new regulation, two existing regulations have to be eliminated.
Ag policy. As for trade, it is likely that trade agreements will be negotiated on a much more bi-lateral basis – the U.S. negotiating with one other country at a time rather than numerous countries. The President-elect is largely against government hand-outs and is big on economic efficiency. That bodes well for the oil and gas industry (and perhaps nuclear energy). But, what about less efficient forms of energy that are heavily reliant on taxpayer support? Numerous agricultural states are heavily into subsidized forms of energy with their state budgets littered with numerous tax “goodies” for “renewable” energy.” However, the President-elect won those states. So, does that mean that the federal subsidies for ethanol and biodiesel will continue. Probably. The Renewable Fuels Standard will be debated in 2017, but will anything significant happen? Doubtful. It will continue to be supported, but I expect it to be reviewed to make sure that it fits the market. Indeed, one of the reasons that bio-mass ethanol was reduced so dramatically in the EPA rules was that it couldn’t be produced in adequate supplies. What about the wind energy production tax credit? What about the various energy credits in the tax code? Time will tell, but agricultural interests should pay close attention.
The head of the Senate Ag Committee will be Sen. Roberts from Kansas. As chair, he will influence the tone of the debate of the next farm bill. I suspect that means that the farm bill will have provisions dealing with livestock disease and biosecurity issues. Also, I suspect that it will contain significant provisions crop insurance programs and reforms of existing programs. The House Ag Committee head will be Rep. Conaway from Texas. That could mean that cottonseed will become an eligible commodity for Agricultural Risk Coverage (ARC) and Price Loss Coverage (PLC). It may also be safe to assume that for the significant Midwest crops (and maybe some additional crops) their reference prices will go up. Also, it now looks as if the I.R.C. §179 issue involving the income limitation for qualification for farm program payments (i.e., the discrepancy of the treatment between S corporations and C corporations) will be straightened out. Other federal agencies that impact agriculture (EPA, Interior, FDA, Energy, OSHA) can be expected to be more friendly to agriculture in a Trump Administration.
Tax policy. As for income taxes, it looks at this time that the Alternative Minimum Tax might be eliminated, as will the net investment income tax that is contained in Obamacare. Individual tax rates will likely drop, and it might be possible that depreciable assets will be fully deductible in the year of their purchase. Also, it looks like the corporate tax rate will be cut as will the rate applicable to pass-through income. As for transfer taxes, President-elect Trump has proposed a full repeal of the federal estate tax as well as the federal gift tax. Perhaps repeal will be effective January 1, 2017, or perhaps it will be put off until the beginning of 2018. Or, it could be phased-in over a certain period of time. Also, while it appears at the present time that any repeal would be “permanent,” that’s not necessarily a certainty. Similarly, it’s not known whether the current basis “step-up” rule would be retained if the estate tax is repealed. That’s particularly a big issue for farmers and ranchers. It will probably come down to a cost analysis as to whether step-up basis is allowed. The President-elect has already proposed a capital gains tax at death applicable to transfers that exceed $10 million (with certain exemptions for farms and other family businesses). Repeal of gift tax along with repeal of estate tax has important planning implications. There are numerous scenarios that could play out. Stay tuned, and be ready to modify existing plans based on what happens. Any repeal bill would require 60 votes in the Senate to avoid a filibuster unless repeal is done as part of a reconciliation bill. Also, without being part of a reconciliation bill, any repeal of the federal estate tax would have to “sunset” in ten years.
January 6, 2017 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)
Wednesday, January 4, 2017
This week we are looking at the biggest developments in agricultural law and taxation for 2016. On Monday, we highlighted the important developments that just missed being in the top ten. Today we take a look at developments 10 through six. On Friday, we will look at the top five.
- Court Obscures Rational Basis Test To Eliminate Ag Exemption From Workers' Compensation Law. While this is a state Supreme Court decision, its implications are significant. Most, if not all, states have a statutory exemption from workers’ compensation for employers that are engaged in agriculture. The statutory exemption varies in scope from state to state and, of course, an employer that is otherwise exempt can choose to be covered by the statute and offer workers’ compensation benefits to employees. In this case, the plaintiffs claimed that their on-the-job injuries should be covered under the state (NM) workers' compensation law. One plaintiff tripped while picking chile and fractured her left wrist. The other plaintiff was injured while working in a dairy when he was head-butted by a cow and pushed up against a metal door causing him to fall face-first into a concrete floor and sustain neurological damage. The plaintiffs' claims for workers' compensation benefits were dismissed via the exclusion from the workers' compensation system for employers. On appeal, the appellate court reversed. Using rational basis review (the standard most deferential to the constitutionality of the provision at issue), the court interpreted Sec. 52-1-6(A) of the New Mexico Code as applying to the primary job duties of the employees (as opposed to the business of the employer and the predominant type of employees hired), and concluded the distinction was irrational and lacked any rational purpose. The appellate court noted that the purpose of the law was to provide "quick and efficient delivery" of medical benefits to injured and disabled workers. Thus, the court determined that the exclusion violated the constitutional equal protection guarantee. The court further believed that the exclusion for workers that cultivate and harvest (pick) crops, but the inclusion of workers that perform tasks associated with the processing of crops was a distinction without a difference. The appellate court made no mention that the highest court in numerous other states had upheld a similar exclusion for agriculture from an equal protection constitutional challenge. On further review, the state Supreme Court affirmed. The Court determined that there was nothing to distinguish farm and ranch laborers from other ag employees and that the government interest of cost savings, administrative convenience and similar interests unique to agriculture were not rationally related to a legitimate government interest. The court determined that the exclusion that it construed as applying to ag laborers was arbitrary discrimination. A dissenting judge pointed out that the legislature’s decision to allow employers of farm and ranch laborers to decide for themselves whether to be subject to workers’ compensation or opt out and face tort liability did not violate any constitutionally-protected right. The dissent noted that such ability to opt out was a legitimate statutory scheme that rationally controlled costs for New Mexico farms and ranches, and that 29 percent of state farms and ranches had elected to be covered by workers’ compensation. The dissent also noted that the majority’s opinion would have a detrimental economic impact on small, economically fragile farms in New Mexico by imposing an additional economic cost of $10.5 million annually (as projected by the state Workers’ Compensation Administration). On this point, the dissent further pointed out that the average cost of a claim was $16,876 while the average net farm income for the same year studied was $19,373. The dissent further concluded that the exemption for farming operations was legitimately related to insulating New Mexico farm and ranches from additional costs. In addition, the dissent reasoned that the majority misapplied the rational basis analysis to hold the act unconstitutional as many other state courts and the U.S. Supreme Court had held comparable state statutes to satisfy the rational basis test. The dissent pointed out forcefully that the exclusion applied to employers and that the choice to be covered or not resided with employers who predominately hired ag employees. As such there was no disparate treatment between ag laborers and other agricultural workers. Rodriguez, et al. v. Brand West Dairy, et al., 378 P.3d 13 (N.M. Sup. Ct. 2016), aff’g., 356 P.3d 546 (N.M. Ct. App. 2015).
- 9. COE Jurisdictional Determination Subject to Court Review. The plaintiff, a peat moss mining company, sought the approval of the Corps of Engineers (COE) to harvest a swamp (wetland) for peat moss to use in landscaping projects. The COE issued a jurisdictional determination that the swamp was a wetland subject to the permit requirements of the Clean Water Act (CWA). The plaintiff sought to challenge the COE determination, but the trial court ruled for the COE, holding that the plaintiff had three options: (1) abandon the project; (2) seek a federal permit costing over $270,000; or (3) proceed with the project and risk fines of up to $75,000 daily and/or criminal sanctions including imprisonment. On appeal, the court unanimously reversed, strongly criticizing the trial court's opinion. Based on Sackett v. Environmental Protection Agency, 132 S. Ct. 1367 (2012), the court held that COE Jurisdictional Determinations constitute final agency actions that are immediately appealable in court. The court noted that to hold elsewise would allow the COE to effectively kill the project without any determination of whether it's position as to jurisdiction over the wetland at issue was correct in light of Rapanos v. United States, 547 U.S. 715 (U.S. 2006). The court noted that the COE had deliberately left vague the "definitions used to make jurisdictional determinations" so as to expand its regulatory reach. While the COE claimed that the jurisdictional determination was merely advisory and that the plaintiff had adequate ways to contest the determination, the court determined that such alternatives were cost prohibitive and futile. The court stated that the COE's assertion that the jurisdictional determination (and the trial court's opinion) was merely advisory ignored reality and had a powerful coercive effect. The court held that the Fifth Circuit, which reached the opposition conclusion with respect to a COE Jurisdictional Determination in Belle Co., LLC v. United States Army Corps. of Engineers, 761 F.3d 383 (5th Cir. 2014), cert. den., 83 U.S.L.W. 3291 (U.S. Mar. 23, 2015), misapplied the Supreme Court's decision in Sackett. Hawkes Co., Inc., et al. v. United States Army Corps of Engineers, 782 F.3d 984 (8th Cir. 2015), rev'g., 963 F. Supp. 2d 868 (D. Minn. 2013). In a later decision, the court denied a petition to rehear the case en banc and by the panel. Hawkes Co., Inc., et al. v. United States Army Corps of Engineers, No. 13-3067, 2015 U.S. App. LEXIS 11697 (8th Cir. Jul. 7, 2015). In December of 2015, the U.S. Supreme Court agreed to hear the case and affirmed the Eighth Circuit on May 31, 2016. The Court, in a unanimous opinion, noted that the memorandum of agreement between the EPA and the Corps established that jurisdictional determinations are “final actions” that represent the Government’s position, are binding on the Government in any subsequent Federal action or litigation involving the position taken in the jurisdictional determination. When the landowners received an “approved determination” that meant that the Government had determined that jurisdictional waters were present on the property due to a “nexus” with the Red River of the North, located 120 miles away. As such, the landowners had the right to appeal in Court after exhausting administrative remedies and the Government’s position take in the jurisdictional determination was judicially reviewable. Not only did the jurisdictional determination constitute final agency action under the Administrative Procedure Act, it also determined rights or obligations from which legal consequences would flow. That made the determination judicially reviewable. United States Army Corps of Engineers v. Hawkes Company, 136 S. Ct. 1807 (2016).
- 8. Proposed Regulations Under I.R.C. §2704. In early August, the IRS issued new I.R.C. §2704 regulations that could seriously impact the ability to generate minority interest discounts for the transfer of family-owned entities. Prop. Reg. – 163113-02 (Aug. 2, 2016). The proposed regulations, if adopted in their present form, will impose significant restrictions on the availability of valuation discounts for gift and estate tax purposes in a family-controlled environment. Prop. Treas. Regs. §§25.2704-1; 25.2704-4; REG- 163113-02 (Aug. 2, 2016). They also redefine via regulation and thereby overturn decades of court decisions honoring the well-established willing-buyer/willing-seller approach to determining fair market value (FMV) of entity interests at death or via gift of closely-held entities, including farms and ranches. The proposed regulations would have a significant impact on estate, business and succession planning in the agricultural context for many agricultural producers across the country and will make it more difficult for family farm and ranch businesses to survive when a family business partner dies. Specifically, the proposed regulations treat transfer within three years of death as death-bed transfers, create new “disregarded restrictions” and move entirely away from examining only those restrictions that are more restrictive than state law. As such, the proposed regulations appear to exceed the authority granted to the Treasury by Congress to promulgate regulations under I.R.C. §2704 and should be withdrawn. A hearing on the regulations was held in early December.
- 7. Capitalization Required For Interest and Real Property Taxes Associated with Crops Having More Than Two-Year Preproductive Period. The petitioner (three partnerships) bought land that they planned to use for growing almonds. They financed the purchase by borrowing money and paying interest on the debt. They then began planting almond trees. They deducted the interest and property taxes on their returns. The IRS objected to the deduction on the basis that the interest and taxes were indirect costs of the “production of real property” (i.e., the almonds trees that were growing on the land. The Tax Court agreed with the IRS noting that I.R.C. §263A requires the capitalization of certain costs and that those costs include the interest paid to buy the land and the property taxes paid on the land attributable to growing crops and plants where the preproductive period of the crop or plant exceeds two years. I.R.C. §263A(f)(1) states that “interest is capitalized where (1) the interest is paid during the production period and (2) the interest is allocable to real property that the taxpayer produced and that has a long useful life, an estimated production period exceeding two years, or an estimated production period exceeding one year and a cost exceeding $1 million.” The corresponding regulation, the court noted, requires that the interest be capitalized under the avoided cost method. The court also noted that the definition of “real property produced by the taxpayer for the taxpayer’s use in a trade or business or in an activity conducted for profit” included “land” and “unsevered natural products of the land” and that “unsevered natural products of the land” general includes growing crops and plants where the preproductive period of the crop or plant exceeds two years. Because almond trees have a preproductive period exceeding two years in accordance with IRS Notice 2000-45, and because the land was “necessarily intertwined” with the growing of the almond trees, the interest and tax cost of the land is a necessary and indispensable part of the growing of the almond trees and must be capitalized. Wasco Real Properties I, LLC, et al. v. Comr., T.C. Memo. 2016-224.
6. No Recapture of Prepaid Expenses Deducted in Prior Year When Surviving Spouse Claims Same Deduction in Later Year. The decedent, a materially participating Nebraska farmer, bought farm inputs in 2010 and deducted their cost on his 2010 Schedule F. He died in the spring of 2011 before using the inputs to put the spring 2011 crop in the ground. Upon his death, the inputs were included in the decedent’s estate at their purchase price value and then passed to a testamentary trust for the benefit of his wife. The surviving spouse took over the farming operation, and in the spring of 2011, took a distribution of the inputs from the trust to plant the 2011 crops. For 2011, two Schedule Fs were filed. A Schedule F was filed for the decedent to report the crop sales deferred to 2011, and a Schedule F was filed for the wife to report the crops sold by her in 2011 and claim the expenses of producing the crop which included the amount of the inputs (at their date-of-death value which equaled their purchase price) that had been previously deducted as prepaid inputs by the husband on the couple’s joint 2010 return. The IRS denied the deduction on the basis that the farming expense deduction by the surviving spouse was inconsistent with the deduction for prepaid inputs taken in the prior year by the decedent and, as a result, the “tax benefit rule” applied. The court disagreed, noting that the basis step-up rule of I.R.C. §1014 allowed the deduction by the surviving spouse which was not inconsistent with the deduction for the same inputs in her deceased husband’s separate farming business. The court also noted that inherited property is not recognized as income by the recipient, which meant that another requisite for application of the tax benefit rule did not apply. Estate of Backemeyer v. Comr., 147 T.C. No. 17 (2016).
Those were developments ten through six, at least as I see it for 2016. On Friday, we will list the five biggest developments for 2016.
January 4, 2017 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)
Monday, January 2, 2017
This week we will be taking a look at what I view as the most significant developments in agricultural law and agricultural taxation during 2016. There were many important happenings in the courts, the IRS and with administrative agencies that have an impact on farm and ranch operations, rural landowners and agribusinesses. What I am writing about this week are those developments that will have the biggest impact nationally. Certainly, there were significant state developments, but they typically will not have the national impact of those that result from federal courts, the IRS and federal agencies.
It’s tough to get it down to the ten biggest developments of the year, and I do spend considerable time going sorting through the cases and rulings get to the final cut. Today we take a quick look at those developments that I felt were close to the top ten, but didn’t quite make the list. Later this week we will look at those that I feel were worthy of the top ten. Again, the measuring stick is the impact that the development has on the ag sector as a whole.
Almost, But Not Quite
Those developments that were the last ones on the chopping block before the final “top ten” are always the most difficult to determine. But, as I see it, here they are (in no particular order):
- HRA Relief for Small Businesses. Late in 2016, the President signed into law H.R. 6, the 21st Century Cures Act. Section 18001 of the legislation repeals the restrictions included in Obamacare that hindered the ability of small businesses (including farming operations) to use health reimbursement arrangements (HRAs). The provision allows a "small employer" (defined as one with less than 50 full-time employees who does not offer a group health plan to any employees) to offer a health reimbursement arrangement (HRA) that the employer funds to reimburse employees for qualified medical expenses, including health insurance premiums. If various technical rules are satisfied, the basic effect of the provision is that, effective for plan years beginning after December 31, 2016, such HRAs will no longer be a violation of Obamacare's market "reforms" that would subject the employer to a penalty of $100/day per affected person). It appears that the relief also applies to any plan year beginning before 2017, but that is less clear. Of course, all of this becomes moot if Obamacare is repealed in its entirety in 2017.
- More Obamacare litigation. In a somewhat related development, in May the U.S. District Court for the District of Columbia ruled in United States House of Representatives v. Burwell, No. 14-1967 (RMC), 2016 U.S. Dist. LEXIS 62646 (D. D.C. May, 12, 2016), that the Obama Administration did not have the power under the Constitution to spend taxpayer dollars on "cost sharing reduction payments" to insurers without a congressional appropriation. The Obama Administration had argued that congressional approval was unnecessary because the funds were guaranteed by the same section of Obamacare that provides for the premium assistance tax credit that is designed to help offset the higher cost of health insurance as a result of the law. However, the court rejected that argument and enjoined the use of unappropriated funds due insurers under the law. The court ruled that the section at issue only appropriated funds for tax credits and that the insurer payments required a separate congressional appropriation. The court stayed its opinion pending appeal. A decision on appeal is expected in early 2017, but would, of course, be mooted by a repeal of Obamacare.
- Veterinary Feed Directive Rule. The Food and Drug Administration revised existing regulations involving the animal use of antibiotics that are also provided to humans. The new rules arose out of a belief of bacterial resistance in humans to antibiotics even though there is no scientific proof that antibiotic resistant bacterial infections in humans are related to antibiotic use in livestock. As a result, at the beginning of 2017, veterinarians will be required to provide a “directive” to livestock owners seeking to use or obtain animal feed products containing medically important antimicrobials as additives. A “directive” is the functional equivalent of receiving a veterinarian’s prescription to use antibiotics that are injected in animals. 21 C.F.R. Part 558.
- Final Drone Rules. The Federal Aviation Administration (FAA) issued a Final Rule on UASs (“drones”) on June 21, 2016. The Final Rule largely follows the Notice of Proposed Rulemaking issued in early 2015 (80 Fed. Reg. 9544 (Feb. 23, 2015)) and allows for greater commercial operation of drones in the National Airspace System. At its core, the Final Rule allows for increased routine commercial operation of drones which prior regulations required commercial users of drones to make application to the FAA for permission to use drones - applications the FAA would review on a case-by-case basis. The Final Rule (FAA-2015-0150 at 10 (2016)) adds Part 107 to Title 14 of the Code of Federal Regulations and applies to unmanned “aircraft” that weigh less than 55 pounds (that are not model aircraft and weigh more than 0.5 pounds). The Final Rule became effective on August 29, 2016.
- County Bans on GMO Crops Struck Down. A federal appellate court struck down county ordinances in Hawaii that banned the cultivation and testing of genetically modified (engineered) organisms. The court decisions note that either the state (HI) had regulated the matter sufficiently to remove the ability of counties to enact their own rules, or that federal law preempted the county rules. Shaka Movement v. County of Maui, 842 F.3d 688 (9th Cir. 2016) and Syngenta Seeds, Inc. v. County of Kauai, No. 14-16833, 2016 U.S. App. LEXIS 20689 (9th Cir. Nov. 18, 2016).
- Insecticide-Coated Seeds Exempt from EPA Regulation Under FIFRA. A federal court held that an existing exemption for registered pesticides applied to exempt insecticide-coated seeds from separate regulation under the Federal Insecticide, Rodenticide Act which would require their separate registration before usage. Anderson v. McCarthy, No. C16-00068, WHA, 2016 U.S. Dist. LEXIS 162124 (N.D. Cal. Nov. 21, 2016).
- Appellate Court to Decide Fate of EPA’s “Waters of the United States” Final Rule. The U.S. Court of Appeals for the Sixth Circuit ruled that it had jurisdiction to hear a challenge to the EPA’s final rule involving the scope and effect of the rule defining what waters the federal government can regulate under the Clean Water Act. Murray Energy Corp. v. United States Department of Defense, 817 F.3d 261 (6th Cir. 2016).
- California Proposition Involving Egg Production Safe From Challenge. California enacted legislation making it a crime to sell shelled eggs in the state (regardless of where they were produced) that came from a laying hen that was confined in a cage not allowing the hen to “lie down, stand up, fully extend its limbs, and turn around freely.” The law was challenged by other states as an unconstitutional violation of the Commerce Clause by “conditioning the flow of goods across its state lines on the method of their production” and as being preempted by the Federal Egg Products Inspection Act. The trial court determined that the plaintiffs lacked standing and the appellate court affirmed. Missouri v. Harris, 842 F.3d 658 (9th Cir. 2016).
- NRCS Properly Determined Wetland Status of Farmland. The Natural Resource Conservation Service (NRCS) determined that a 0.8-acre area of a farm field was a prairie pothole that was a wetland that could not be farmed without the plaintiffs losing farm program eligibility. The NRCS made its determination based on “color tone” differences in photographs, wetland signatures and a comparison site that was 40 miles away. The court upheld the NRCS determination as satisfying regulatory criteria for identifying a wetland and was not arbitrary, capricious or contrary to the law. Certiorari has been filed with the U.S. Supreme Court asking the court to clear up a conflict between the circuit courts of appeal on the level of deference to be given federal government agency interpretive manuals. Foster v. Vilsack, 820 F.3d 330 (8th Cir. 2016).
- Family Limited Partnerships (FLPs) and the “Business Purpose” Requirement. In 2016, there were two cases involving FLPs and the retained interest section of the Code. That follows one case late in 2015 which was the first one in over two years. In Estate of Holliday v. Comr., T.C. Memo. 2016-51, the court held that the transfers of marketable securities to an FLP two years before the transferor’s death was not a bona fide sale, with the result that the decedent (transferor) was held to have retained an interest under I.R.C. §2036(a) and the FLP interest was included in the estate at no discount. Transferring marketable securities to an FLP always seems to trigger issues with the IRS. In Estate of Beyer v. Comr., T.C. Memo. 2016-183, the court upheld the assessment of gift and estate tax (and gift tax penalties) with respect to transfers to an FLP because the court determined that every benefit allegedly springing from the FLP could have been accomplished by trusts and other arrangements. There needs to be a separate non-tax business purpose to the FLP structure. A deeper dive into the court opinions also points out that the application of the “business purpose” requirement with respect to I.R.C. §2036 is very subjective. It’s important to treat the FLP as a business entity, not put personal assets in the FLP, or at least pay rent for their use, and follow all formalities of state law.
These are the developments that were important, but just not big enough in terms of their overall impact on the ag sector to make the list of the “top ten.” The next post will take a look at developments ten through six.
January 2, 2017 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)