Monday, February 27, 2017
The Fair Labor Standards Act of 1938 (FLSA) (29 U.S.C. §§ 201 et seq.) as originally enacted, was intended to raise the wages and shorten the working hours of the nation's workers. The FLSA is very complex, and not all of it is pertinent to agriculture and agricultural processing, but the aspect of it that concerns “joint employment” is of major relevance to agriculture.
Most courts that have considered the issue have utilized an “economic realities” or “control” test to determine if one company’s workers are attributable to another employer for purposes of the FLSA. But, in Salinas v. Commercial Interiors, Inc., No 15-1915, 2017 U.S. App. LEXIS 1321 (4th Cir. Jan. 25, 2017), rev’g, No. JFM-12-1973, 2014 U.S. Dist. LEXIS 160956 (D. Md. Nov. 17, 2014), the court reversed the trial court and created a new test for joint employment under the FLSA. This new decision appears to expand the definition of “joint employment” and may create a split of authority in the Circuit Courts of Appeal on the issue. It’s a big issue for certain aspects of agricultural employment and is the focus of today’s post.
FLSA Wage Requirements
One area where the joint employment issue is particularly relevant involves the FLSA wage requirements. The FLSA requires that agricultural employers who use 500 “man-days” or more of agricultural labor in any calendar quarter of a particular year must pay the agricultural minimum wage to certain agricultural employees in the following calendar year. Man-days are those days during which an employee performs any agricultural labor for not less than one hour. The man-days of all agricultural employees count in the 500 man-days test, except those generated by members of an incorporated employer's immediate family. 29 U.S.C. § 203(e)(3). Five hundred man-days is roughly equivalent to seven workers working five and one-half days per week for thirteen weeks (5.5 x 7 x 13 = 501 man-days). Under the FLSA, “agriculture” is defined to include “among other things (1) the cultivation and tillage of the soil, dairying, the production, cultivation, growing and harvesting of any agricultural or horticultural commodities; (2) the raising of livestock, bees, fur-bearing animals, or poultry; and (3) any practices (including any forestry or lumbering operations) performed by a farmer or on a farm as an incident to or in conjunction with such farming operations, including preparation for market, delivery to storage or to market or to carriers for transportation to market.” 29 U.S.C. § 203(f).
The minimum wage must be paid to all agricultural employees except: (1) members of the employer's immediate family, unless the farm is incorporated; (2) local hand-harvest, piece-rate workers who come to the farm from their permanent residences each day, but only if such workers were employed less than 13 weeks in agriculture in the preceding year; (3) children, age 16 and under, whose parents are migrant workers, and who are employed as hand-harvest piece-rate workers on the same farm as their parents, provided that they receive the same piece-rate as other workers; and (4) employees engaged in range production of livestock. 29 U.S.C. § 213(a)(6). A higher monthly wage rate applies to a “ranch hand” who does not work in a remote location and works regular hours. See, e.g., Mencia v. Allred, 808 F.3d 463 (10th Cir. 2015). Where the agricultural minimum wage must be paid to piece-rate employees, the rate of pay for piece-rate work must be sufficient to allow a worker reasonably to generate that rate of hourly income.
A common scenario in many agricultural settings is that a farmer will have crops harvested by an independent contractor. In this situation, the farmer is considered to be a joint employer with the contractor who supplies the harvest hands if the farmer has the power to direct, control, or supervise the work, or to determine the pay rates or method of payment for the harvest hands. 29 C.F.R. § 780.305(c). See also, Gonzalez-Sanchez v. Int’l. Paper Co., 346 F.3d 1017 (11th Cir. 2003). In such event, each employer must include the contractor's employees in the man-day count in determining whether each one's man-day test is met. Each employer is considered responsible for compliance with the minimum wage and child labor requirements of the FLSA with respect to the employees who are jointly employed. A big issue in this realm is, for example, whether a particular crew leader was an independent contractor or an employee of the farmer. In Castillo v. Givens, 704 F.2d 181 (5th Cir. 1983), the crew leader involved was a registered farm labor contractor who recruited and transported an unskilled crew, supervised cotton chopping, kept minimal records and disbursed the crew's pay. In spite of those activities, the crew leader was characterized as an employee of the farmer rather than an independent contractor. The court found it persuasive that the crew leader supplied crews to no other farmer, had no business of his own, did not set crew wages, had no meaningful investment in his “business”, and was dependent economically on the farmer's operation. For purposes of the FLSA, the crew members were considered to be employees of the farmer rather than employees of the crew leader.
The new test. In both Gonzalez-Sanchez and Castillo referenced above, both the Eleventh Circuit and the Fifth Circuit determined whether joint employment existed based on the economics of the relationship of the parties and who controlled the employment situation. Most recently, the Fourth Circuit in Salinas, determined whether joint employment existed under the FLSA based on a two-step process. The case did not involve ag employment, but the principles involved could easily spill-over to cases involving ag employment under the FLSA. In Salinas, a drywall installer was a subcontractor that employed the plaintiffs. The subcontractor employed the plaintiffs on the behalf of a general contractor. The general contractor specified how the employees of the subcontractor would dress while working on a job and also provided all of the tools and equipment for the subcontractor’s employees to use. The general contractor required the subcontractor’s employees to sign in and sign out, and also supervised the subcontractor’s employees’ work every day. The general contractor also told the subcontractor’s employees to tell people that they worked for the general contractor. The employees sued for unpaid overtime under the FLSA based on the joint employment of the subcontractor and the general contractor.
While it seems obvious that joint employment would have existed under the economic realities or control test, the court reached that result but under a different rationale. The court held that the test under the FLSA for joint employment involved two steps. The first step involved a determination as to whether two or more persons or entities share or agree to allocate responsibility for, whether formally or informally, directly or indirectly, the essential terms and conditions of a worker’s employment. The second step involves a determination of whether the combined influence of the parties over the essential terms and conditions of the employment made the worker an employee rather than an independent contractor. If, under this standard, the multiple employers were not completely disassociated, a joint employment situation existed. The court also said that it was immaterial that the subcontractor and general contractor engaged in a traditional business relationship. In other words, the fact that general contractors and subcontractor typically structure their business relationship in this manner didn’t matter. The Salinas court then went on to reason that separate employment exists only where the employers are “acting entirely independent of each other and are completely disassociated with respect to” the employees.
The “complete disassociation” test of the Fourth Circuit appears that it could result in a greater likelihood that joint employment will result in the FLSA context than would be the case under the “economic realities” or “control” test. While the control issue is part of the “complete disassociation” test, joint determination in hiring or firing, the duration of the relationship between the employers, where the work is performed and responsibility over work functions are key factors that are also to be considered. To me, that looks as if joint employment could be found in the Fourth Circuit but perhaps not in a similar situation elsewhere.
Employers (including ag employers) beware in Maryland, North Carolina, South Carolina, Virginia and West Virginia.
Thursday, February 23, 2017
For many persons, estate planning also includes planning for the possibility of long-term health care. Nursing home care is expensive (even though rural Kansas has some of the lowest costs in the country, it can still exceed $5,000/month in those areas) and can require the liquidation of assets to generate the funds necessary to pay the nursing home bill unless appropriate planning has been taken. How will that expense be funded? Medicaid is one option. That’s the joint federal/state program that pays for long-term health care in a nursing home. To be able to receive Medicaid benefits, an individual must meet numerous eligibility requirements but, in short, must have a very minimal level of income and assets. States set their own asset limits and determine what assets count toward the limit. Assets exceeding the limit must be spent on the applicant’s nursing home care before Medicaid eligibility can be established.
Another option is long-term care (LTC) insurance. I get numerous questions concerning LTC insurance. That’s the topic of today’s post
Why not much usage? Like many other industries in recent years, the LTC insurance industry has shrunk dramatically in terms of the number of companies that issue policies. Compared to about 15 years ago, there are only about one-tenth of the number of companies that presently sell LTC policies that were doing so then. Relatedly, annual sales have dropped. The result is that roughly 10 percent of the U.S. population has some sort of long term care plan in place. What I mean by that is any type of plan – LTC insurance or otherwise. Of those 10 percent, LTC insurance would be a component of only a portion of them. So, the point is that LTC insurance is underutilized. Why? Well, LTC insurance suffers from a fundamental problem – those that can afford it don’t need it and those that need it can’t afford it! For example, the annual premiums for a couple around age 60 can vary widely anywhere from $1,700 to over $3,000 depending on the type of policy and type of coverage obtained, and the particular state. That’s a tough amount to swallow for many people.
How much coverage to get? It’s also hard to predict how much coverage is going to be needed. Women typically need it longer than men – about a year and one-half longer so says the U.S. Department of Health and Human Services. If long-term care will cost $75,000 annually (and that’s a conservative estimate), then at least a benefit totaling $150,000-$200,000 is probably necessary as a minimum. To get five years’ worth of benefit coverage, that would indicate sufficient premiums should be paid to get about $400,000 worth of benefits. That could push annual premiums to $5,000 year for that couple near age 60. Why five years? That’s the present ‘look-back” period for asset transfer without adequate consideration. The value of transfers outside that window aren’t deemed to be available to the transferor for Medicaid eligibility purposes. But, keep in mind that the average nursing home stay is slightly less than a year for a male and about a year and one-half for a female (based on some recent studies that I have seen). But, that’s only an average. So, maybe a good rule of thumb is to price a policy based on 2 and 4 years of coverage.
Custodial care. LTC insurance doesn’t only deal with medical issues. It also can be used to pay for daily assistance with common tasks such as bathing and dressing. It’s this “custodial care” dimension that many people will find necessary as they age, whether or not they are in a nursing home. Thus, LTC insurance can be used to plug a “gap” between Medicaid and Medicare. Medicaid can cover institutionalized care, but only after resources have been depleted, and Medicare won’t cover custodial care. So, unless a person has family or friends or is self-insured, there will be a need, but perhaps no way to pay for it while simultaneously avoiding disposing of assets to come up with the funds to pay for custodial care. That’s a tough spot to be in. LTC should be looked at as one possibility in that situation.
Peculiarities of policies. It is possible that some of the LTC policies will discount the premium cost if a couple buys the policies together as a package. Also, watch what the policy says about how you can use the benefits. Do you have to use the entire monthly benefit, or can you use only a part of it and private pay the balance and stretch-out the coverage? Some policies will allow that, but others won’t.
Another detail to look for in a policy is whether premiums can change and, if they can, whether you will be notified of when that will occur. The last thing a person wants to have happen is to pay on a policy for a number of years and then have the premium go up to an extent that they can no longer afford it and they drop the policy as a result.
It’s also a good idea to analyze any particular policy on the basis of whether it is an indemnity plan or a reimbursement plan. An indemnity plan basically means that the insured will get paid a cash benefit that is the same thing as the daily benefit. On the other hand, a reimbursement plan pays the full daily benefit when the actual cost of care either equals or exceeds the daily benefit. Which type of policy is more desirable? Again, it depends. Cash benefit policies cost more, but they do give the policy holder greater flexibility in paying a family member to provide care. To some people, that is in important option to have.
Another question to ask of the insurer is how the policy works if nursing home care is required and the policy holder returns to their home at some later point. It might be that the benefits paid out to cover the nursing home bill will reduce the available benefits if the insured has to go back to the nursing home at some later point in time. That may not be the case, but it is worth knowing what might happen.
From an economic standpoint, examine any given policy to determine if there is inflation protection built in. Nursing home costs will go up. Will the policy benefits also increase? If there is built-in inflation protection, how much does the premium go up? Can this issue be addressed by delaying payment of benefits under the policy once institutionalization occurs? That might be possible.
As an investment, LTC insurance is probably not at the top of the list of the good ones. If it is purchased early and there is no pre-existing condition, and benefits are triggered early on, then it can turn out to be a good deal. But, a person could be better off simply setting aside funds every month in an investment account that is earmarked as being set aside to cover long-term care costs. That’s particularly the case if benefits under the policy won’t be used for some time in the future.
Whether or not to obtain LTC insurance is a difficult decision. There are numerous things to think about, and some of those involve predicting what might happen in the future. How clear is your crystal ball?
Tuesday, February 21, 2017
Every partnership (defined as a joint venture or any other unincorporated organization) that conducts a business is required to file a return for each tax year that reports the items of gross income and allowable deductions. I.R.C. §§761(a), 6031(a). If a partnership return is not timely filed (including extensions) or is timely filed but is inadequate, a monthly penalty is triggered that equals $200 times the number of partners during any part of the tax year for each month (or fraction thereof) for which the failure continues. However, the penalty amount is capped at 12 months. Thus, for example, the monthly penalty for a 15-partner partnership would be $3,000 (15 x $200) capped at $36,000. Such an entity is also subject to rules enacted under the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982. These rules established unified procedures for the IRS examination of partnerships, rather than a separate examination of each partner.
An exception from the penalty for failing to file a partnership return and the TEFRA audit procedures could apply for many small business partnerships and farming operations. However, it is important to understand the scope of the exception, and what is still required of such entities even if a partnership return is not filed. In many instances, such entities may find that simply filing a partnership return in any event is a more practical approach.
Just exactly what is the “small partnership exception”? That’s the focus of today post.
Exception for Failure to File Partnership Return
The penalty for failure to file is assessed against the partnership. While there is not a statutory exception to the penalty, it is not assessed if it can be shown that the failure to file was due to reasonable cause. I.R.C. §6689(a). The taxpayer bears the burden to show reasonable cause based on the facts and circumstances of each situation. On the reasonable cause issue, the IRS, in Rev. Proc. 84-35, 1984-1 C.B. 509, established an exception from the penalty for failing to file a partnership return for a “small partnership.” Under the Rev. Proc., an entity that satisfies the requirements to be a small partnership will be considered to meet the reasonable cause test and will not be subject to the penalty imposed by I.R.C. §6698 for the failure to file a complete or timely partnership return. However, the Rev. Proc. noted that each partner of the small partnership must fully report their shares of the income, deductions and credits of the partnership on their timely filed income tax returns.
So what is a small partnership? Under Rev. Proc. 84-35 (and I.R.C. §6231(a)(1)(B)), a “small partnership” must satisfy six requirements:
- The partnership must be a domestic partnership;
- The partnership must have 10 or fewer partners;
- All of the partners must be natural persons (other than a nonresident alien), an estate of a deceased partner, or C corporations;
- Each partner’s share of each partnership item must be the same as the partner’s share of every other item;
- All of the partners must have timely filed their income tax returns; and
- All of the partners must establish that they reported their share of the income, deductions and credits of the partnership on their timely filed income tax returns if the IRS requests.
Applying the Small Partnership Exception – Practitioner Problems
So how does the small partnership exception work in practice? Typically, the IRS will have asserted the I.R.C. §6698 penalty for the failure to file a partnership return. The penalty can be assessed before the partnership has an opportunity to assert reasonable cause or after the IRS has considered and rejected the taxpayer’s claim. When that happens, the partnership must request reconsideration of the penalty and establish that the small partnership exception applies so that reasonable cause exists to excuse the failure to file a partnership return.
Throughout this process, the burden is on the taxpayer. That’s a key point. In most instances, the partners will likely decide that it is simply easier to file a partnership return instead of potentially getting the partnership into a situation where the partnership (and the partners) have to satisfy an IRS request to establish that all of the partners have fully reported their shares of income, deductions and credits on their own timely filed returns. As a result, the best approach for practitioners to follow is to simply file a partnership return so as to avoid the possibility that IRS would assert the $200/partner/month penalty and issue an assessment notice. IRS has the ability to identify the non-filed partnership return from the TIN matching process. One thing that is for sure is that clients do not appreciate getting an IRS assessment notice.
The Actual Relief of the Small Partnership Exception
Typically, the small partnership exception is limited in usefulness to those situations where the partners are unaware of the partnership return filing requirement or are unaware that they have a partnership for tax purposes, and the IRS asserts the penalty for failing to file a partnership return. In those situations, the partnership can use the exception to show reasonable cause for the failure to file a partnership return. But, even if the exception is deemed to apply, the IRS can require that the individual partners prove that they have properly reported all tax items on their individual returns.
In addition, if the small partnership exception applies, it does not mean that the small partnership is not a partnership for tax purposes. It only means that the small partnership is not subject to the penalty for failure to file a partnership return and the TEFRA audit procedures.
Why does the “small partnership exception” only apply for TEFRA audit procedures and not the entire Internal Revenue Code? It’s because the statutory definition of “small partnership” contained in I.R.C. §6231(a)(1)(B) applies only in the context of “this subchapter.” “This subchapter” means Subchapter C of Chapter 63 of the I.R.C. Chapter 63 is entitled, “Assessment.” Thus, the exception for a small partnership only means that that IRS can determine the treatment of a partnership item at the partner level, rather than being required to determine the treatment at the partnership level. The subchapter does not contain any exception from a filing requirement. By contrast, the rules for the filing of a partnership return (a “partnership” is defined in I.R.C. §761, which is contained in Chapter 1) are found in Chapter 61, subchapter A – specifically I.R.C. §6031. Because a “partnership” is defined in I.R.C. §761 for purposes of filing a return rather than under I.R.C. §6231, and the requirement to file is contained in I.R.C. §6031, the small partnership exception has no application for purposes of filing a partnership return. Thus, Rev. Proc. 84-35 states that if specific criteria are satisfied, there is no penalty for failure to file a timely or complete partnership return. There is no blanket exception from filing a partnership return. A requirement to meet this exception includes the partner timely reporting the share of partnership income, deductions and credits on the partner’s tax return. Those amounts can’t be determined without the partnership computing them, using accounting methods determined by the partnership and perhaps the partnership making elections such as I.R.C. §179.
The small partnership exception does not apply outside of TEFRA. Any suggestion otherwise is simply a misreading of the Internal Revenue Code.
The small partnership exception usually arises as an after-the-fact attempt at establishing reasonable cause to avoid penalties for failure to file a partnership return. The exception was enacted in 1982 as part of TEFRA to implement unified audit examination and litigation provisions which centralize treatment of partnership taxation issues and ensure equal treatment of partners by uniformly adjusting the tax liability of partners in a partnership. It is far from a way to escape partnership tax complexity, and not a blanket exemption from the other requirements that apply to all partnerships. The failure to file a partnership return could have significant consequences to the small partnership. Ignoring Subchapter K also could have profound consequences, the least of which is dealing with penalty notices.
Under the Balanced Budget Act of 2015 (BBA) (Pub. L. No. 114-74, §1101(a), 129 Stat. 584 (2015)), new partnership audit rules are instituted effective for tax returns filed for tax years beginning on or after January 1, 2018 (although a taxpayer can elect to have the BBA provisions apply to any partnership return filed after the date of enactment (November 2, 2015). The BBA contains a revised definition of a “small partnership” by including within the definition those partnerships that are required to furnish 100 or fewer K-1s for the year. If a partnership fits within the definition and desires to be excluded from the BBA provisions, it must make an election on a timely filed return and include the name and identification number of each partner. If the election is made, the partnership will not be subject to the BBA audit provisions and the IRS will apply the audit procedures for individual taxpayers. Thus, the partnership will be audited separately from each partner and the TEFRA rules will not apply, and the reasonable cause defense to an IRS assertion of penalties for failure to file a partnership return can be raised.
Friday, February 17, 2017
Last week I posted a summary of a recent Kansas county district court decision on remand that involved the prior appropriation doctrine. The summary contained the thoughts of my colleague at the Washburn University School of law, Prof. Burke Griggs That post discussed the Haskell County District Court’s recent decision in Garetson Bros. v. American Warrior et al., (Dist. Ct. No. 2012-CV-09), in which the court protected a senior vested water right from impairment by issuing a permanent injunction prohibiting two junior wells from pumping. From a purely judicial standpoint, the case is not complicated. It stands for the proposition that Kansas water law—specifically the prior appropriation doctrine—means what it says: first in time is first in right, and owners of senior wells impaired by junior water rights are entitled to injunctive protections, unqualified by mitigating economic factors.
Today, in part two of the discussion, Prof. Griggs discusses what could be the consequences of the court’s decision.
The Prior Appropriation Doctrine
Westerners supposedly love the prior appropriation doctrine: like frontier whiskey, it is clear and works quickly, even if its effects can be rather harsh. As the Colorado Court of Appeals pointed out long ago in Armstrong v. Larimer County Ditch Co. (27 P. 235, 237 (1891)), the seniors-take-all approach of the prior appropriation doctrine works better than the fair and balanced equities-based approach of eastern water law: it works better because there is not enough water to supply all rights in dry years, and sharing the shortage would make all water rights owners so short of water that no one could make productive use of their share. In the West, as Frank Trelease memorably wrote, “priority is equity.”
If only the issue were that simple. While the clarity of the prior appropriation doctrine shines through the legal decisions in the Garetson case (and especially the earlier and largely controlling opinion in Garetson Bros. v. Am. Warrior, Inc., 347 P.3d 687 (2015)), hydrological, administrative, and political considerations are increasingly clouding that doctrinal clarity.
Hydrological considerations. Garetson is a conflict between rival irrigators who access the non-renewable waters of the Ogallala Aquifer. But, there is also a conflict with groundwater that raises certain hard problems for the prior appropriation doctrine. When the chief engineer shuts off (or “administers”) junior water rights to a stream or river system, the effect of that administration is typically clear and immediate; water prevented from reaching a junior’s canal headgate flows down to supply a senior’s. The administration of rights in an alluvial groundwater system—where the wells are close to the river—has similarly prompt and predictable effects. The Ogallala is different: because its supplies are dispersed and non-renewable, it is not always easy to determine with precision how the groundwater pumping of junior rights in a water rights neighborhood affects or impairs the pumping of a senior right. The architects of the original 1945 Kansas Water Appropriation Act (“KWAA”) recognized this hydrological difference, but deliberately decided to extend the doctrine to groundwater—including the supplies of the Ogallala. The KWAA softened the standards for granting new rights to the Ogallala, but clearly maintained the priority rule for protecting existing rights. The 1957 revisions to the KWAA were focused on allowing the development of new Ogallala water rights, and the chief engineers did their statutory duty: because water was available for rights under these softer standards, more water rights were granted to the Ogallala than the aquifer could durably sustain. As a consequence, by 1970 or so, groundwater depletion was becoming a serious problem. The Kansas Division of Water Resources (“DWR”) responded to this hydrological problem by developing procedures (at K.A.R. 5-4-1 and 5-4-1a) which set forth the process by which DWR investigates and determines impairment complaints in a groundwater system. Despite these procedures, however, a hard hydrological fact of the Ogallala remains: in order to fully protect one groundwater right to the Ogallala, it may be necessary to shut down many junior rights, more rights than are administered in a typical surface water rights administration. This is the principal reason why so few impairment complaints have been filed over the Ogallala. Owners of senior water rights know their rights, but they also know that the administration of junior rights may affect many of their neighbors—as well as junior rights which they themselves own.
Administrative difficulties. The conflict between the legal clarity of the prior appropriation doctrine and the administrative difficulty of determining impairment in a groundwater-exclusive system is one of the central issues in the Garetson case. Although DWR was investigating the impairment of the Garetsons’ senior right, they decided to withdraw their impairment complaint, and took the matter to court directly. K.S.A. 82a-717a and 82a-716 clearly provide a court-based avenue for protecting senior rights, independent of DWR. Under that approach, the senior right holder can obtain injunctive relief upon a finding of impairment—which is just what the Garetsons obtained. However, it is important to note that the facts in Garetson are somewhat unusual. The court was able to use hydrological data along with data concerning pumping effects which DWR and the Kansas Geological Survey had produced during the time in which the Garetsons were pursuing the administrative avenue of resolving their impairment through K.A.R. 5-4-1a. Without such existing data—and the impairment reports which DWR produced in a very timely fashion in this case—the court would likely not have been able to issue its temporary and permanent injunctions so expeditiously.
Kansas water politics. Those who lose in court often seek redress in the legislature, and often do so for less money. The clarity of the court’s injunctions in Garetson has promoted a substantial legislative reaction. In 2016, the defendants (American Warrior) and Southwest Kansas Groundwater Management District #3 sponsored legislation which would have substantially weakened the ability of senior water rights holders to protect their rights through the independent court-based avenues of K.S.A. 82a-716 and 82a-717a. This legislation did not succeed, but the ongoing importance of Garetson prompted the Kansas Department of Agriculture (“KDA”), which exercises supervisory authority over DWR, to consider a legislative compromise between the administrative-based avenues of K.A.R. 5-4-1 and 5-4-1a and the above-mentioned court-based avenues. Together with major agricultural powers such as the Kansas Farm Bureau and the Kansas Livestock Association, they are sponsoring H.B. 2099. http://www.kslegislature.org/li/b2017_18/measures/documents/hb2099_00_0000.pdf
Distilled to its essence, the legislation eliminates the two-avenue approach in favor of a sequential one: the senior water rights holder claiming impairment must first seek administrative relief through DWR to protect his or her right; DWR must promptly act upon the impairment complaint; only then, after the administrative process is complete, can the senior holder pursue an injunction in court. But, this last step might not be necessary, provided that DWR deploys the impairment report in the service of water rights administration.
H.B. 2099 is a classic case of a wide-ranging legislative reaction to a single lawsuit. It raises at least three difficult questions. First of all, is the legislation legally necessary? Not really: Garetson was properly decided, and we have yet to see a snowballing effect wherein thousands of senior water rights owners begin to use the priority doctrine in an ominous way, threatening their junior neighbors. (Such threats would be perfectly legal, albeit impolite.) Second, should a conflict between water users—competing property owners—be completely transformed into a regulatory action in which the chief engineer’s impairment investigation and any consequent decisions about water rights administration are the central issues under judicial review? Perhaps. It is, after all, the chief engineer’s statutory duty to investigate impairment and to protect senior rights. That is why Kansas has an administrative system for water rights protection in the first place. But there is a third and troubling question: does the legislation diminish the courts’ undeniable powers to protect private property rights? Influential stakeholders may jealously guard their political clout, and use it in the legislature to obtain the ends they seek; but the courts are just as jealous and protective of their independent powers to resolve property disputes and to protect property rights, with or without the procedures prescribed by H.B. 2099. Moreover, the KWAA provides numerous protections for owners of senior rights, outside of K.S.A. 82a-716 and 82a-717a. Even if H.B. 2099 were to be enacted, the courts might cite those and other protections to circumvent it—including protections available under the Kansas Judicial Relief Act. They have done it before in construing the scope of the KWAA.
In sum, the Kansas water rights community is again facing a choice: whether to accept the consequences of prior appropriation in a groundwater context, or to attenuate those consequences by limiting the options of senior water rights holders to protect their private property rights. In this they are only human. As St. Augustine famously wrote, “please Lord, grant me chastity and continence, but not yet.”
Wednesday, February 15, 2017
A question that I sometimes get involves an interesting aspect of farm lease law (although it’s probably not unique to agriculture) when the land is co-owned. The question is whether, when co-owned farmland is leased, must all of the co-owners agree to lease the property? On the flip side, must all of them agree to a termination of the lease? Those are interesting and important questions.
A few years ago, I discussed these issues with the former Dean of the University of Iowa College of Law who had written a bit on the matter in the 1960s. Today’s blog post is loosely based on that conversation (and an initial article that my staff attorney Erica Eckley, and myself authored in 2013 – the original article is available at www.calt.iastate.edu).
While most of the caselaw on the issue is relatively dated, there is a recent case from Ohio on point. In H & H Farms, Inc. v. Huddle, No. 3:13 CV 371, 2013 U.S. Dist. LEXIS 72501 (N.D. Ohio May 22, 2013), a married couple owned a tract of farmland. Over a period of time, they transferred undivided fractional interests in the farmland to a son – the defendant in the case. The wife eventually died, with the husband remaining in the farm home. At the time the case was filed, the son owned an undivided 94 percent interest in the farmland and his father owned 6 percent. The plaintiff had been the tenant on the property for a number of years and was the father’s grandson and nephew of the son. The father entered into an 11-year lease with the plaintiff for $150/year. However, the son did not consent to the lease and claimed that it was unenforceable and that the plaintiff would be trespassing if he attempted to farm the land. The plaintiff sought a declaratory judgment regarding the legal sufficiency of the lease, and the son filed a motion to dismiss. There was only one issue before the court - whether a legally plausible claim had been alleged.
The court addressed the legal standard for possession when tenants in common lease real estate. In Ohio, tenants in common each have a distinct title and right to enter upon the entire tract of real estate and take possession of it even if the ownership share is less than other tenants in common. If a tenant in common is not in possession of the real estate (i.e., an absentee landlord), that co-tenant is entitled to receive the reasonable rental value of the property from the co-tenant in possession consistent with the (absentee) co-tenant’s ownership interest. The court also noted that, under Ohio law, when an owner conveys property via a lease, the owner retains the fee simple interest in the property. Ohio courts have held that the possession of the tenant is synonymous with the lessor’s possession. Thus, tenants in common have a present possessory interest in the property. So, the father’s possession under the facts of the case was also the co-tenant’s possession.
The son’s motion to dismiss was based on the argument that a tenant in common cannot convey, encumber, or divest the rights of a co-tenant. The court disagreed because of the principle that a lease does not divest the possession of the land from the co-tenant. The court held that because the son’s possessory rights were not divested, there would be no need for him to approve the lease. Thus, the court declared that the plaintiff had stated a claim for which relief could be granted, and the motion to dismiss would not be granted.
The court, however, went on to state that it believed that when a six percent owner leases a farm to a third party for 11 years, it would be inequitable for the lease to remain with the land following a partition sale. But, that statement was merely dicta because it was not germane to the issue before the court and the motion to dismiss.
So, the tenant’s possessory interest is strong and cannot be disturbed. That also can mean that, absent a provision in a written lease, the landowner doesn’t have the right to hunt the leased ground absent the tenant’s permission. Of course, not allowing the tenant to hunt the ground will likely result in the tenant being terminated as soon as possible under state law.
Accounting for rents. Some states, such as Iowa have a statutory provision on this issue. Iowa Code § 557.16 explicitly states that a co-tenant in possession is liable for the reasonable rent to the co-tenant not in possession. See, e.g., Meier v. Johannsen, 47 N.W.2d 793, 242 Iowa 665 (1951).
Partition action. Because the tenant’s right of possession during the term of the lease is strong and cannot be interfered with, that can mean that once there is a valid lease, the tenant’s rights probably cannot be dislodged by a partition action. Similarly, property that is subject to a life estate cannot be partitioned. Redding v. Redding, 284 N.W. 167, 226 Iowa 327 (1939).
Termination of lease. In Dethlefs v. Carrier, 64 N.W.2d 272, 245 Iowa 786 (1954), a tenant had a written lease on 40 acres of farmland. The land was owned by a brother and sister as tenants in common and the lease was entered into between the tenant and the sister. The brother did not sign the lease. Upon the sister’s death, the brother became the sole owner, but did not follow state law to terminate the lease. The brother claimed that the sister’s death terminated not only her interest in the land, but also terminated the lease and eliminated the requirement that he give notice to terminate the lease. The court disagreed on the basis that, in such a situation, a presumption arises that the lease was made with the knowledge and consent of each co-tenant. There was no evidence to overcome the presumption
Similarly, the tenant’s possessory interest also is an issue when the landlord dies during the term of the lease and a growing crop exists. Entitlement to the crop is fairly clear when the landlord owns a fee simple interest in the leased land — the landlord’s heirs succeed to the landlord’s share of the crop. However, if the landlord owns less than a fee simple interest in the leased land (such as a life estate), the outcome may be different. The question is whether the deceased landlord’s estate or the holder of the remainder interest is entitled to the landlord’s share. In two 1977 Kansas cases, Finley v. McClure, 222 Kan. 637, 567 P.2d 851 (1977) and Rewerts v. Whittington, 1 Kan. App. 2d 557, 571 P.2d 58 (1977), the landlord owned only a life estate interest in certain farm ground and leased it on shares to a tenant. The landlord died before the growing wheat crop was harvested, and the court held that the landlord’s crop share was a personal asset of the landlord, entitling the landlord’s estate to the landlord’s crop share on the basis that growing crops are personal property. The remainderman takes nothing. The Nebraska Supreme Court has reached a similar conclusion. Heinold v. Siecke, 257 Neb. 413, 598 N.W.2d 58 (1999). However, the Colorado Supreme Court has held that the remainderman was entitled to the landlord’s share on the basis that the language in the deed creating the reserved life estate in the decedent had divested the estate of any rights to profits from the crops. Williams v. Stander, 143 Colo. 469, 354 P.2d 492 (1960).
Whenever farmland is owned by multiple parties or the ownership interests include a life estate, a partition action is likely not possible, but an absentee co-tenant may not be required to consent to a lease. It may be that a presumption arises that the lease was made with each co-tenant’s knowledge and consent. An issue also arises if the landlord owns less than a full fee simple interest. If you encounter these issues, consulting legal counsel would be a good idea.
Monday, February 13, 2017
IRS has a long history of challenging taxpayers that it believes are distorting income reporting by use of the cash method of accounting. As examples of the continued IRS attack on farmers using the cash method of accounting, in 2016, the IRS tried to deny a farmer’s surviving spouse a deduction for the cost of inputs she used to plant the crop that he had purchased before death, but died before he could use them to plant the spring crop. Estate of Backemeyer v Comr., 147 T.C. No. 17 (2016). While the farmer had deducted the costs of the inputs as pre-paid expenses in the year before he died, the IRS claimed she couldn’t deduct the same amount the following year on her return even though the value of the inputs were included in his estate under I.R.C. §1014. The IRS position revealed a complete misunderstanding of associated tax rules and the Tax Court let the IRS know it in ruling for the estate.
In 2015, the IRS tried to deny a deduction for a California farming corporation that deducted the cost of fieldpacking materials until the year the materials were actually consumed. The IRS lost the case based on its own regulation. Agro-Jal Farming Enterprises, Inc., et al. v. Comr., 145 T.C. 145 (2015). A year earlier, a federal appeals court, in a case involving a Texas cattle and horse breeding limited partnership sternly disagreed with the IRS attack on that operation’s use of cash accounting via the “farming syndicate rule.” Burnett Ranches, Limited v. United States, 753 F.3d 143 (5th Cir. 2014). Despite the rebuke, the IRS has now issued a non-acquiescence to the court’s decision, signaling that their attack on the cash method will continue. AOD 2017-7; 2017-7 IRB 868.
In both the 2014 Texas case and the 2015 California case, the IRS trotted-out the “farming syndicate” rule in an attempt to bar the deductions. Because the IRS has now issued a non-acquiescence to the 2014 Fifth Circuit decision which signals its intent to continue examining the issue outside the Fifth Circuit, today’s blogpost is a reminder to practitioners of what the IRS is looking for and why the Courts have rejected their theories.
The Farming Syndicate Rule
In the farm and ranch sector, that alleged distortion often arises in the context of pre-payment for inputs such as fertilizer, seed, feed or chemicals. Various tests and rules have been adopted over the years to deal with material distortions of income when pre-purchases are involved. See, e.g., Rev. Rul. 79-229, 1979-2 C.B. 210. One of those rules, which is designed to place a limitation on deductions for farming operations, was developed in the 1970s and is known as the Farming Syndicate Rule. I.R.C. §461(j). The Congress enacted the rule in 1976, and it eliminates “farming syndicates” from taking deductions for feed, seed, fertilizer and other farm supplies before the year in which the supplies are actually used or consumed. The rule establishes two tests for determining whether a farming syndicate is present. A farming syndicate is (1) a partnership or other enterprise (except a regularly taxed corporation) engaged in farming if the ownership interests in the firm have been offered for sale in any offering required to be registered with any federal or state securities agency (I.R.C. §461(j)(1)(A)) or (2) a partnership or other enterprise (other than a C corporation) engaged in farming if more than 35 percent of the losses during any period are allocable to limited partners or “limited entrepreneurs.” I.R.C. §461(j)(1)(B).
IRS Position. The “farming syndicate” rule does not impact many farming and/or ranching operations, but it does catch some of the extremely large operations and a few individuals who are inactive investors in farming operations. That’s because there is an exception to the rule for holdings attributable to “active management.” If an “individual” has actively participated (for a period of not less than 5 years) in the management of the farming activity, any interest in a partnership or other enterprise that is attributable to that active participation is deemed to not be held by a limited partner or a limited entrepreneur. I.R.C. §461(j)(2)(A). That means that the interest doesn’t count toward the 35 percent test. But, IRS has taken a strict interpretation of the statute. In the IRS view, the exception for active management only applies to an “individual.” Indeed, the statute does state, “in the case of any individual [emphasis added] who has actively participated…”. I.R.C. §461(j)(2)(A). Thus, in C.C.A. 200840042 (Jun. 16, 2008), the Chief Counsel’s office determined that a partnership interest held by an S corporation with only one shareholder was to be treated as held by a limited partner for purposes of the farming syndicate rule. The partnership raised and bred livestock, and its members were two trusts along with the S corporation. The S corporation was owned by a trustee who was also a beneficiary of the trusts. One of the trusts was the general partnership of the partnership. The partnership reported income on the cash method, but IRS took the position that the partnership interest that the S corporation held had to be treated as a limited partner interest because it wasn’t held by an “individual.” This was the result, according to the IRS, even though the S corporation’s sole shareholder was an individual. Thus, for purposes of the farming syndicate rule, the interest held by the S corporation was treated as an interest that was held by a limited partner.
Burnett Ranches involved a Texas cattle and horse breeding limited partnership that was 85 percent owned by an S corporation as a limited partner. As such, the limited partnership met the definition of a farming syndicate. However, the court held that the ranch qualified for the active participation exception to the farming syndicate rule even though the majority owner actively participated in managing the cattle operation through the owner’s wholly-owned S corporation. The court noted that the west Texas operation had been family-run for many generations dating back into the 1800s, with the current majority owner family member simply owning her interest via an S corporation. There was no question that that majority owner managed the operation and would satisfy the active management test in her own right. The IRS acknowledged as much. But, IRS said the farming syndicate rule was triggered and cash accounting was not available because the ownership interest was held in an S corporation rather than directly by the majority shareholder as an individual. Consequently, IRS said that the partnership could not use cash accounting for the years in issue – 2005-2007. The limited partnership paid the alleged deficiencies (which amounted to several million dollars) and sued for a refund in federal district court. The sole basis for the IRS denial of the cash method under the farming syndicate rule and the required switch to the accrual method was the fact that the S corporation owned the partnership interest, even though it was an S corporation that was 100 percent owned by the person that performed the entire management function of the business. The district court ruled for the limited partnership.
The IRS appealed, continuing to maintain that the majority owner’s interest in the limited partnership via her S corporation barred the active management exception from applying. The court disagreed, largely on policy grounds. The court noted that the Congressional intent behind the active management exception of I.R.C. §464(c)(2)(A) was to target high-income, non-farm investors, not the type of taxpayer that the majority owner represented. The court stated, “Ms. Marion’s business and ownership history with these ranches and their operations is the very antithesis of the “farming syndicate” tax shelters that §464 was enacted to thwart….”. Indeed, the owner of the S corporation was the current descendant in a long line of descendants of the founder of the ranching operation dating to the mid-1800s. The court went on to state, “[We] doubt that our interpretation of §464 will stymie the I.R.S., an agency tasked with uncovering abusive tax-avoidance schemes of myriad forms, not just those in the nature of a farming syndicate…. We deem it beyond peradventure that her limited partnership interest in Burnett Ranches is excepted from §464’s primary thrust of requiring farming syndicates to employ the accrual basis of accounting.”
The court also noted that the statutory term “interest” was not synonymous with legal title or direct ownership, but rather was tied to involvement with or participation in the underlying business. Thus, the court determined that there was no basis for distinguishing between “the partnership interest of a rancher who has structured his business as a sole proprietorship and a rancher who has structured his business as [a subchapter S] corporation.” The term “individual” was used in the statute to refer to the provision of active management rather than in reference to having an interest in the activity at issue.
The court’s opinion provides needed guidance on the narrow interpretation of the farming syndicate rule by the IRS. The opinion is binding authority inside the Fifth Circuit - Louisiana, Mississippi and Texas. But, with AOD 2017-7; 2017-7 IRB 868, the IRS has signaled that it will pick more battles on the same issue elsewhere. That seems a bit ridiculous on this issue. The IRS is spending its budget to pursue collection of tax dollars based upon its technical reading of required “active participation,” ignoring the 85 percent effective ownership of the person who, as was stipulated, actively participated.
It is no wonder that Congress has reduced the IRS budget over the years trying to send the message to the IRS to go after the real abuses, and don’t bother taxpayers that are trying to comply with the tax laws. This family involved in Burnett Ranches actively managed the ranches for over 150 years, long before the income tax was a problem (and in fact, before the area became part of the United States!). The IRS should leave honest taxpayers alone, and go after syndicates that are truly abusive.
Thursday, February 9, 2017
Many self-employed farmers (as well as other self-employed persons) have an office in their home. If strict rules are satisfied some generous above-the-line business expense deductions can be claimed. But, to claim the expenses the 43-line Form 8829 with complex calculations must be completed and filed unless an optional safe harbor is utilized. A farmer claims the deductions attributable to the home office on Schedule F of Form 1040. IRS Pub. 587 provides helpful worksheets when computing the deduction.
Business Use of the Home
Taxpayers with an office in the residence that is maintained regularly and exclusively for business purposes may deduct the costs associated with that office on IRS Form 8829. The office must be the principal place of business for the taxpayer (the most important or significant place for the business) or it must be a place of business used by clients or customers in the normal course of the taxpayer's trade or business. What does that mean? It means that the home office must be used exclusively and on a regular basis for business purposes – with limited exceptions for day care providers and inventory storage. In addition, the home office is the “principal place of business” if it is used for administrative or management activities of the business or it is the most important place where the business is conducted. Also, an important point for many farming business is that the “home” office can be located in a separate unattached structure on the same property as the home. So, an office in a workshop or unattached garage or similar structure still can generate deductions.
So, what above-the-line deductions can be claimed? The deductible expenses are the “direct expenses” of the home office. Direct expenses include, for example, the costs of painting or repairing the home office, as well as depreciation deductions for depreciable items that are used in the home office. Indirect expenses include expenses associated with maintaining the home office. These expenses include the properly allocable share of utility costs, depreciation, insurance, mortgage interest, and real estate taxes. In addition, if the home office is the “principal place of business,” computers and related equipment used in the home office are not subject to the “listed property” limitations.
In Part II of Form 8829, the overall amount of the deductions associated with the home office is limited by the income attributable to the use of the home office. But, any home office expenses that can't be deducted due to a limitation may be carried over and deducted in later years.
Optional Safe Harbor
Beginning in 2013, an optional safe harbor can be used to calculate the amount of the deduction for expenses associated with the business use of a residence. Rev. Proc. 2013-13. Individual taxpayers who elect this method can deduct an amount determined by multiplying the allowable square footage by $5. The allowable square footage is the portion of the house used in a qualified business use, but not to exceed 300 square feet. Thus, the maximum a taxpayer can deduct annually under the safe harbor is $1,500. In addition, the deduction cannot exceed the amount of gross income derived from the qualified business use of the home (less deductions). It is not possible to carry over any excess to another tax year. The election is made on a timely-filed original tax return, and taxpayers are allowed to change their treatment from year-to-year. However, the election made for any tax year is irrevocable.
The sale-harbor is only available if all of the other requirements for a home-office deduction are satisfied. Thus, the office in the home must be used exclusively for business purposes. In addition, the safe harbor is not really an election. The taxpayer simply chooses to use it at the time the return is filed, on a year-by-year basis.
Many farmers will be able to utilize the office in the home deduction. The IRS has provided a simplified method safe harbor in recent years. But, the safe harbor approach may not maximize the deduction. The approach that provides the best result depends on the situation and the taxpayer’s unique set of facts.
Tuesday, February 7, 2017
Water has a significant influence on agriculture in the United States. Over time, different systems for allocating water have developed. Most of the United States west of the 100th Meridian utilizes the prior appropriation system for purposes of allocating water. The prior appropriation system is based on a recognition that water is more scarce, and establishes rights to water based on when water is first put to a beneficial use. The doctrine grants to the individual first placing available water to a beneficial use, the right to continue to use the water against subsequent claimants. Thus, the doctrine is referred to as a “first in time, first in right” system of water allocation. The oldest water right on a stream is supplied with the available water to the point at which its state-granted right is met, and then the next oldest right is supplied with the available water and so on until the available supply is exhausted. In order for a particular landowner to determine whether such person has a prior right as against another person, it is necessary to trace back to the date at which a landowner's predecessor in interest first put water to a beneficial use. The senior appropriator, in the event of dry conditions, has the right to use as much water as desired up to the established right of the claimant to the exclusion of all junior appropriators.
Water rights in a majority of the prior appropriation states are acquired and evidenced by a permit system that largely confirms the original doctrine of prior appropriation. The right to divert and make consumptive use of water from a watercourse under the prior appropriation system is typically acquired by making a claim, under applicable procedure, and by diverting the water to beneficial use. The “beneficial use” concept is basic; a non-useful appropriation is of no effect. What constitutes a beneficial use depends upon the facts of each particular case.
As applied to groundwater, the prior appropriation doctrine holds that the person who first puts groundwater to a beneficial use has a priority right over other persons subsequently desiring the same water. This doctrine is applied in many western states that also follow the prior appropriation doctrine with respect to surface water. In many of these states, appropriation rights are administered through a state-run permit system.
A water dispute testing the application of the prior appropriation doctrine to groundwater rights in western Kansas had a recent significant development. Today’s post explaining the case are the thoughts of Professor Burke Griggs of Washburn School of Law. Prof. Griggs is part of our Rural Law Program at the law school. Before joining the law school in 2016, Prof. Griggs represented the State of Kansas in federal and interstate water matters, and has advised Kansas' natural resources agencies on matters of natural resources law and policy. He has also been engaged in the private practice of law.
Facts of the Case
On February 1, 2017, the Haskell County Kansas District Court issued its latest decision in Garetson Bros. v. American Warrior et al., (Dist. Ct. No. 2012-CV-09). The case involves a longstanding dispute between rival groundwater pumpers in southwestern Kansas (just west of the 100th Meridian). Applying a fundamental principle of Kansas water law—first in time, first in right— the court protected the plaintiffs’ senior well and groundwater right from impairment by issuing a permanent injunction prohibiting the use of the defendants’ junior rights. Although the case stands for the simple proposition that the prior appropriation doctrine grants senior rights holders the right to enjoin junior groundwater diversions which are impairing their senior rights, the court’s application of the doctrine to groundwater rights which access the Ogallala Aquifer may well produce regulatory and political reactions that are anything but simple.
In terms of Kansas water law, the case is relatively straightforward. The Garetsons own a senior, vested (pre-1945) groundwater right, which depends on the same local source of groundwater supply as two neighboring and junior groundwater rights held by American Warrior, an oil and gas production company. In 2005, the Garetsons filed an impairment complaint with the Kansas Department of Agriculture’s Division of Water Resources (DWR), so that DWR could investigate and resolve the dispute according to K.A.R. § 5-4-1a, which sets forth a detailed procedure for addressing impairment complaints for water from Ogallala Aquifer water sources. For reasons not set forth in the decision, the Garetsons withdrew their complaint in 2007, but later in 2012 sued to obtain an injunction against American Warrior’s pumping, claiming a senior water right under the Kansas Water Appropriation Act (“KWAA”). In November of that year, the trial court appointed the DWR as a fact-finder pursuant to the limited reference procedure set forth at K.S.A. § 82a-725. The DWR filed its first report on April 1, 2013, which found that the Garetson well was being impaired by the two American Warrior wells. Based on the DWR’s uncontested finding of impairment, the Garetsons obtained a preliminary injunction shortly thereafter. After several rounds of motion pleading, the DWR issued its second report on March 27, 2014, also finding impairment, and the court issued a second temporary injunction on May 5 of that year, ordering the curtailment of pumping from the defendant’s two wells.
The Appellate Decision and Remand
The defendants timely filed an interlocutory appeal to reverse the temporary injunction. In 2015, the Kansas Court of Appeals affirmed the district court’s granting of the injunction and remanded the case back to Haskell County. Garetson Bros. v. Am. Warrior, Inc., 347 P.3d 687, 51 Kan. App. 2d 370 (2015), rev. den., No. 14-111975-A, 2016 Kan. LEXIS 50 (Kan. Sup. Ct. Jan. 25, 2016).
The resolution of the central issue on appeal effectively decided the issue on remand. The issue centers on the two distinct definitions of “impairment” under the KWAA. Within the context of reviewing new applications for water rights pursuant to K.S.A. §§82a-711 and 82a-711a, the DWR uses one definition: “impairment shall include the unreasonable raising and lowering of the static water level . . . at the [senior] water user’s point of diversion beyond a reasonable economic limit (emphasis added). However, when the DWR is called upon to protect senior water rights from impairment by already-existing junior water rights, that impairment standard does not include the “beyond a reasonable economic limit” qualifier. K.S.A. §§ 82a717a, 82a-716. Because this dispute concerned the latter situation, the Court of Appeals declined defendant-appellant’s efforts to apply the former definition of impairment, and upheld the injunction.
Remanded back to Haskell County, and before a different judge, the court held hearings in October of 2016. Central to the record in the case were the findings by both the Kansas Geological Survey and the DWR that groundwater levels were declining in the area, and that the defendants’ junior groundwater pumping was responsible for substantially impairing the plaintiffs’ senior right. With these principal conclusions established in the record, the court applied the standard test for permanent injunctions, and found that a permanent injunction should issue in this case. In making that finding, the trial court judge followed the “ordinary definition of impair” [pursuant to K.S.A. §§ 82a-716 and 82a-717] which the legislature intended should apply in situations such as this, where the senior right holder seeks injunctive relief to protect against diversions by junior water right holders, when the diversion “diminishes, weakens, or injures the prior right.” In deciding that an injunction against the defendant’s junior rights should issue, the court declined to adopt a remedy suggested by the DWR in its second report—that the junior water rights surrounding Garetson’s (including those owned by non-parties) could be allowed to operate on a limited and rotating basis. In declining to adopt that remedy, the court stressed that it “does not wish to draft an order that would micro-manage future use” by the junior rights.
The prior appropriation doctrine means what it says when it comes to protecting senior water rights to the Ogallala Aquifer - first in time is first in right. In addition, “impairment” means “impairment,” unqualified by economic reasonableness. Whether Kansas irrigators and the Kansas legislature can accept such clarity will be the subject of a subsequent post, where we will speculate on what type of legislative reaction the case might provoke.
Friday, February 3, 2017
A recent court decision from Michigan involving that state’s recreational use statute raised a question that I sometimes get from farmers, ranchers and rural landowners – just what type of activity does a recreational use statute cover? It’s a good question. The answer is, “it depends.” Each state provision is unique, but there are some basic general points that can be made.
In 1965, the Council of State Governments proposed the adoption of a Model Act to limit an owner or occupier's liability for injury occurring on the owner's property. The stated purpose of the Model Act was to encourage owners to make land and water areas available to the public for recreational purposes by limiting their liability toward persons who enter the property for such purposes. Liability protection was extended to holders of a fee ownership interest, tenants, lessees, occupants, and persons in control of the premises. Land which receives the benefit of the act include roads, waters, water courses, private ways and buildings, structures and machinery or equipment when attached to the realty. Recreational activities within the purview of the act include hunting, fishing, swimming, boating, camping, picnicking, hiking, pleasure driving, nature study, water skiing, water sports, and viewing or enjoying historical, archeological, scenic or scientific sites. Most states have enacted some version of the 1965 Model legislation.
Under the model legislation, an owner or occupier owes no duty of care to keep the premises safe for entry or use by others for recreational purposes, or to give any warning of dangerous conditions, uses, structures, or activities to persons entering the premises for such recreational purposes. Similarly, if an owner, directly or indirectly, invites or permits any person without charge to use the property for recreational purposes, the owner does not extend any assurance the premises are safe for any purpose, confer the status of licensee or invitee on the person using the property, or assume responsibility or incur liability for any injury to persons or property caused by any act or omission of persons who are on the property.
The protection afforded by the Model Act is not absolute, however. Should injury to users of the property be caused by the willful or malicious failure to guard or warn against a dangerous condition, use, structure, or activity, the protection of the act would be lost. Likewise, if the owner imposes a charge on the user of the property, the protection of the act is lost. The 1965 Model Act contained a specific provision that did not exempt anyone from liability for injury in any case where the owner of land charges a fee to the person or persons who enter or go onto the land for recreational purposes. Under most state statutes patterned after the Model Act, if a fee is charged for use of the premises for recreational purposes, it converts the entrant's status to that of an invitee. Some states (such as Wisconsin) establish a monetary limit on what a landowner may receive in a calendar year and still have the liability protection of the statute. The North Dakota statute provides immunity for landowners that invite the public onto their land for recreational rather than commercial purposes, with the distinction between the two classifications largely turning on whether a fee is directly charged.
Signs, Release Language and Gross Negligence
Many fee-based recreational use operations require guests to sign a form releasing the landowner from liability for any injury a guest may sustain while recreating on the premises. To be an effective shield against liability, a release must be drafted carefully and must be clear, unambiguous, explicit and not violate public policy. Courts generally construe release language against the drafter and severely limit the landowner’s ability to contract away liability for its own negligence. Likewise, most courts that have considered the question have held that a parent cannot release a minor child’s prospective claim for negligence. This has led some state legislatures to consider legislation designed to protect organizations while not allowing wrongdoers to escape liability for intentional or grossly negligent conduct. This is where that recent Michigan case fits in.
In Otto v. Inn at Watervale, No. 330214, 2017 Mich. App. LEXIS 68 (Mich. Ct. App. Jan. 17, 2017). the plaintiff, the mother of a 10-year-old girl sued the defendant for burn injuries her daughter suffered while using the defendant’s beach area. The daughter was playing on the beach with friends when she stepped on hot coals that were covered up in the beach’s sand. The defendant had allowed guests in the past to have “fire rings” on the beach, and they had become covered with sand blown by the wind which had not yet been uncovered from the prior fall season. There had also been prior problems with guests not properly extinguishing fires on the beach in the past. The plaintiff sued based in negligence and the defendant moved for summary judgment on the basis that the claim was barred by the state (MI) Recreational Land Use Act (RLUA) (MCL §324.73301). The RLUA bars an action to recover for injuries incurred while on the land of another without paying a fee for the purpose of “fishing, hunting, trapping, camping, hiking sightseeing, motorcycling, snowmobiling, or any other outdoor recreational use or trail use with or without permission,…unless the injuries were caused by gross negligence or willful and wanton misconduct of the owner, tenant or lessee. The trial court granted the defendant’s motion, but allowed the plaintiff to amend the complaint to add gross negligence and willful and wanton misconduct claims. The plaintiff amended the complaint, claiming that the defendant’s conduct was reckless in letting guests have beach bonfires without properly supervising or providing instructions for putting the fires out, and for not properly warning the public of the possibility of hot fire coals. The defendant claimed that the hot coals were buried and not visible and that a reasonable inspection would not have disclosed them and that staff cleaned embers from fire rings on a weekly basis. The trial court again granted summary judgment for the defendant. On appeal, the appellate court reversed. The court noted that a child’s play on a beach was not the type of activity that was of the same kind, class, character or nature of the listed activities in the RLUA. In addition, the court determined that the child was not engaged in “any other outdoor recreational use or trail use.” As such, the RULA did not apply and the court reversed the trial court’s determination.
With increased interest by farm and ranch owners in providing recreational activities to generate additional income, some states have passed ag immunity laws designed to supplement the protection provided by recreational liability acts. In general, the various state statutes provide liability protection for landowners against the injury or death of a participant in a recreational activity arising from the “inherent risks” of the activity. The Colorado statute, for example, is written in this manner.
Recreational use statutes generally do not preclude legal claims based on negligent supervision. In one case from Maine, the plaintiff was engaged in cutting and making firewood on the defendant’s property and was injured while loading a wood splitter. The state recreational use statute covered the harvesting or gathering of forest products and would have shielded the defendant from liability for the plaintiff’s injuries. As a result, the plaintiff alleged negligent supervision and instruction concerning the use of the wood splitter. The court held that the plaintiff’s claim was not precluded by the recreational use statute inasmuch as the statute only precluded claims alleging premises liability, and allowed the case to proceed to trial on the negligent supervision claim. Dickinson v. Clark, 767 A.2d 303 (Me. 2001).
While this discussion just scratches the surface, the point is that a rural landowner should have at least some knowledge of their state’s recreational use statute, or at least have legal counsel that does. Each state’s particular statutory language is unique, and there are a seemingly endless number of situations that could invoke the statute. Given that agricultural land is prone to activities of third party entrants that could create liability situations for the landowner, knowledge of the rules (and insurance) are key.
Wednesday, February 1, 2017
The burden of proof in litigation is an important procedural matter. In civil litigation, the plaintiff bears the burden to prove their case by a preponderance of the evidence. In criminal cases, the government bears the burden to prove that the facts to support the government’s position beyond a reasonable doubt. But, what about the burden of proof in tax litigation? The rule is a bit different. Normally, the taxpayer bears the burden. But, there are circumstances in which the burden can shift to the government. That’s today’s focus.
The Shifting Burden
When a taxpayer gets a notice of deficiency, the taxpayer normally bears the burden of proof. The deficiency is, essentially, presumed to be correct. Thus, the taxpayer bears the burden to prove that the IRS is wrong. But, there is a burden-shifting statute. I.R.C. §7491 states that “If, in any court proceeding, a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the liability of the taxpayer for any tax imposed by subtitle A or B, the Secretary shall have the burden of proof with respect to such issue.” Of course, to shift the burden, the taxpayer must properly substantiate all issues in controversy, maintain records, and reasonably cooperate with the IRS with respect to its requests for meetings, witnesses, information, documents and interviews. However, the statutory burden shifting doesn’t apply to corporations, partnerships, and trusts with a high net worth. For partnerships, a recent law change places the burden on the partnership rather than the partners, which creates issues of its own. But, remember, even if the burden does shift, the taxpayer has the burden of going forward with evidence throughout the trial process.
Facts. A recent case, Cavallaro v. Comr., 842 F.3d 16 (1st Cir. 2016), aff’g. in part, and rev’g. in part, and remanding, T.C. Memo. 2014-189, involved the merger of two corporations, one owned by the parents and one owned by a son. The parents' S corporation developed and manufactured a machine that the son had invented. The son did not patent the invention, and the parents' corporation claimed the research and development credits associated with the machine. The sons' corporation sold the machine (liquid dispenser) to various users, but the intellectual property rights associated with the machine were never formally received. The two corporations were merged for estate planning purposes, with the parents' receiving less stock value than their asset ownership value. The lawyers involved in structuring the transaction "postulated" a technology transfer for significant value from the son to the parents that had occurred in 1987. The transfer was postulated because there were no documents concerning the alleged transaction executed in 1987. Instead, the lawyers executed the transfer documents in 1995. The IRS asserted that no technology transfer had occurred and that the merger resulted in a gift from the parents to the son of $29.6 million for which no gift tax return had been filed and no taxes paid. In essence, the IRS claimed that the parents’ corporation was valueless. But, later, the IRS determined that part of the deficiency was wrong and that the parents’ corporation actually did have some value.
I.R.C. §7491. The parents claimed that the burden of proof shifted under I.R.C. §7491(a)(1). However, the IRS started the examination of the return at issue in the case before the statute took effect. The statute only applies to IRS examinations commenced after July 22, 1998. The IRS beat that effective date by a few months.
Excessive and arbitrary. The parents also claimed that the initial deficiency was excessive and arbitrary (bore no factual relationship to their tax liability) and, as a result, shifted the burden of proof to the IRS. The Tax Court noted that an excessive and arbitrary notice of deficiency can shift the burden of proof to the IRS, but concluded that the deficiency involved valuation issues of the corporations, and that the IRS had a sufficient foundation for the initial notice. Basically, according to the Tax Court, all the IRS had to do was make some sort of evidentiary showing in support of the deficiency and the burden won’t shift.
Procedural rule. But, there is also a procedural rule (Rule 142(a)(1)) that says that even though a notice of deficiency is presumed to be correct, the burden shifts when a “new matter” is raised at trial. This was also tied into the valuation issue. The parents pointed out that the IRS initial notice asserted that their corporation had no value, but then the IRS later claimed that it had some value. That, according to the parents, would shift the burden of proof. But, the Tax Court didn’t think so. The court noted that the issue was valuation throughout the entire process and that the taxpayers knew that. There was no “new matter” so there was no burden shifting under the procedural rule.
Expert witness. One other area where the burden can shift involves expert witnesses. In the case, the Tax Court rejected the expert reports of the taxpayers because the court thought they were based on the assumption that the son’s corporation owned technology that the parents’ corporation owned. That court believed that was an incorrect assumption. Consequently, the government’s expert produced the only report that was based on a correct assumption – that the parents’ corporation owned the technology. So, there was no burden-shifting on this point either.
Tax Court’s conclusion. So, the burden of proof didn’t shift to the IRS and they bore the burden to show the proper amount of their tax liability. But, they didn’t have any valuations to help them do so and had no basis to claim that the government got the valuation issue wrong. The Tax Court was left with adopting the government’s valuation claim even though noting that the court was troubled by the government’s numbers. The end result was that the resulting gift tax (at 1995 rates) was $14.8 million.
Appellate decision. On appeal, the parents claimed that the Tax Court erred by not shifting the burden of proof to the IRS because the original notices of deficiency were arbitrary and excessive and/or because the IRS relied on a new theory of liability. The parents also alleged that the Tax Court incorrectly concluded that the parents’ company owned all of the technology and that the Tax Court erred by misstating their burden of proof and then failing to consider alleged flaws in the IRS expert’s valuation of the two companies. The appellate court reversed and remanded on the issue of the nature of the parents’ burden of proof and the Tax Court’s failure to allow them to rebut the IRS expert’s report. However, the appellate court determined that the parents bore the burden to prove that the deficiency notices were in error and that the burden of proving a gift tax deficiency didn’t shift to the IRS even though the IRS later conceded somewhat on the valuation issue because the initial conclusion of IRS on value was not arbitrary.
The appellate court also determined that the parents could not shift the burden of proof on the grounds that the IRS raised a new matter because the IRS theory that their corporation was undervalued was consistently postulated throughout and the original notices that implied that undervaluation of the parents’ corporation allowed for a disguised gift transfer from the parents to their adult children. The Tax Court’s finding that the parents’ corporation owned the technology was also upheld. But, the appellate court did allow the parents to challenge the IRS expert’s valuation and how the Tax Court handled the objections to the valuation. Thus, the court remanded on that issue.
The end result was that the taxpayers didn’t have to prove the correct amount of their tax liability. They also get a shot to challenge the government’s expert report. If they are successful on the challenge, the Tax Court will have to determine what the tax liability is.
To shift the burden of proof to the IRS in a tax case, substantiate everything, keep good records, and cooperate with the IRS throughout the process. Also, make sure that any experts that are utilized are qualified and base their reports on correct assumptions. If the IRS raises a “new matter” during the litigation, that can also shift the burden.