Thursday, June 15, 2017
Farm Program Payment Limitations and Entity Planning – Part Two
Tuesday’s post started the discussion of how farm program payment limitation rules can impact the estate and business planning for a farmer. That post discussed the basics of the provisions under the 2014 Farm Bill, and discussed PLC and ARC, the overall payment limit, the AGI limitation and the attribution rule.
Today, we dig deeper and examine the “active personal management” rule, recordkeeping requirements and how the rules impact the planning process.
Keep in mind, this is an overview of a very technical subject. Make sure to find counsel that deals with farm programs so that you can properly integrate payment limitation planning into the overall estate and business plan. I am often asked for recommendations of practitioners that have a good grasp of the payment limitation rule that can work with their tax counsel to put an effective plan together. One person I would suggest that may also know others that I am not aware of is Bill Bridgforth in Pine Bluff, Arkansas. He's a good friend that is easy to work with and has a great deal of experience with the payment limitation rules.
Active Personal Management
Three-part test for "active engagement." Under 7 C.F.R. Part 1400, a person must be “actively engaged” in farming to receive farm program payments. To satisfy the “actively engaged in farming” test, three conditions must be met. First, the individual's or entity's share of profits or losses from the farming operation must be commensurate with the individual's or entity's contribution to the operation. Second, the individual's or entity's contributions must be “at risk.” Third, an individual must make a significant contribution of land, capital or equipment, and active personal labor or active personal management.
What is "management“? Active personal management” is defined as significant contributions of management activities that are performed on a regular, continuous and substantial basis to the farming operation – basically the I.R.C. §1402 test for self-employment tax purposes. In addition, the management activities must represent at least 25 percent of the total management time that is necessary for the success of the farming operation on an annual basis, or represent at least 500 hours of specific management activities annually. That is a more defined test for active management than was contained under the previous Farm Bill, which required that the management be “critical to the overall profitability of the farming operation.”
How many "person" determinations can be achieved? The rules also restrict the number of persons that may qualify for payment by making a significant contribution of active personal management. For this purpose, the limit is one person unless the farming operation is large or complex. A "large" farming operation is one that has crops on more than 2,500 acres (planted or prevented from being planted). If the acreage limitation is satisfied, an additional person may qualify upon making a significant contribution of active personal management. If the farming operation satisfies another test of being “complex,” an additional payment limit may be available. This all means that, for large and complex, farming operations, a total of three payment limits may be obtained. Who decides whether a farming operation is "complex"? That determination is made by the State FSA Committee. These rules establish a more restrictive test than was in place before the 2014 Farm Bill became effective. The prior rules did not limit the number of persons that could qualify for farm program payments via the significant contribution of active personal management route. Now, the maximum potential limit is three.
Special rules. Special rules apply to tenant-operated farms and family-owned operations with multiple owners. In some situations, a person meeting specified requirements is considered to be actively engaged in farming in any event. For example, a crop-share or livestock-share landlord who provides capital, equipment or land as well as personal labor, or active personal management meets the test. But, neither a cash rent landlord nor a crop share landlord is actively engaged in farming if the rent amount is guaranteed. Also, if one spouse meets the active engagement test, the other spouse is deemed to meet the test.
Exemption for family operations. The active personal management test applies to non-family general partnerships and joint operations that seek to qualify more than one farm manager based solely on providing management or a combination of management and labor (another rule). However, it does not apply to farming operations where all of the partners, stockholders or persons with an ownership interest in the farming operation (or any entity that is a member of the farming operation) are “family members.” For this purpose, “family member” means a person to whom another member in the farming operation is related as a lineal ancestor, lineal descendant, sibling, spouse or otherwise by marriage. Legally adopted children and step-children count as “family members.”
The rule also doesn’t come into play where only one person attempts to qualify under the rule or when combined with a contribution of labor. The rule also doesn't apply to farming operations that are operated by individuals or entities other than general partnerships or joint ventures.
When multiple payments are sought for a farming operation under the active management rule, the operation must maintain contemporaneous records or logs for all persons that make any contribution of management. Those records must include, at a minimum, the location where the management activity was performed, and the amount of time put into the activity and its duration. In addition, every legal entity that receives farm program payments must report to the local FSA committee the name and social security number of each person who owns, either directly or indirectly, any interest in the entity. Also, the entity must inform its members of the payment limitation rules.
The FSA Handbook (5-PL, Amendment 3) specifies that the farming operation must maintain contemporaneous records or logs for all persons that make management contributions. The records must provide: (1) the location (either on-site or remote) where the management activity was performed; (2) the time spent on the activity and the timeframe in which it occurred; and (3) a description of the activity. FSA Handbook, Paragraph 222A. It is important that the records be maintained and be timely made available to the FSA for their review upon request. FSA Handbook, Paragraph 222B. Fortunately, the FSA provides a Form (CCC-902 MR) to track and maintain all of the necessary information. Note that these are the present references to the applicable FSA Handbook Paragraphs and Form. Those paragraph references and Form number can change. FSA modifies its handbook frequently and Forms are modified and numbers often are changed. Practitioners and their farm clients must be diligent in monitoring the changes.
Two things happen if the necessary records aren’t maintained – (1) the person’s contribution of active personal management for payment eligibility purposes will be disregarded; and (2) the person’s payment eligibility status will be re-determined for that particular program year.
The “substantive change” rule. In general, any structural change of the farming or ranching business that increases the number of payment limits must be bona fida and substantive and not a “scheme or device.” See, e.g., Val Farms v. Espy, 29 F.3d 1570 (10th Cir. 1994). In addition, reliance on the advice of local or state USDA officials concerning the payment limitation rules is at the farmer or rancher's own risk. But, the substantive change rule does not apply to spouses. Thus, for example, a spouse of a partner that is providing active management to a farm partnership can be added to the partnership and automatically qualify as a partnership member for FSA purposes. However, a “substantive change occurs when a “family member” is added to a partnership unless the family member also provides management or labor.
"Scheme or device." The USDA is adept at alleging that a farming operation has engaged in a "scheme or device" that have the purpose or effect of evading the payment limitation rules. But, this potential problem can be avoided if multiple payments are not sought, such as by having one manager for each entity engaged in farming. Of course, this is not a concern if all of the members of a multi-person partnership are family members. If non-family members are part of the farming operation, perhaps they can farm individually or with other non-family members that can provide labor to the farming business. That might be a safe approach.
"Combination" rule. There is also a “combination” rule that can apply when the farming business is restructured. If the rule applies, it will result in the denial of separate “person” status to “persons” who would otherwise be eligible for a separate limit.
Entity type based on size. From an FSA entity planning standpoint, the type of entity structure utilized to maximize payment limits will depend on the size/income of the operation.
For smaller producers, entity choice for FSA purposes is largely irrelevant. Given that the limitation is $125,000 and that payments are made either based on price or revenue (according to various formulas), current economic conditions in agriculture indicate that most Midwestern farms would have to farm somewhere between 3,000 and 4,000 acres before the $125,000 payment limit would be reached. Thus, for smaller producers, the payment limit is not likely to apply and the manner in which the farming business is structured is not a factor.
For larger operations, the general partnership or joint venture form is likely to be ideal for FSA purposes. If creditor protection or limited liability is desired, the partnership could be made up of single-member LLCs. For further tax benefits, the general partnership’s partners could consist of manager-manager LLCs with bifurcated interests.
Farm program payment limitation planning is a complicated mix of regulatory and administrative rules and tax/entity planning. It’s not an area that a producer should engage in without counsel if maximizing payments in conjunction with an estate/business plan is the goal. Unfortunately, only a few practitioners are adept at navigating both the tax planning rules and the FSA regulatory web.