Wednesday, January 30, 2019
Over the past three years, I have written on a couple of occasions about the accommodation doctrine – a mineral owner’s right to use the surface estate to drill for and produce minerals. The doctrine requires a balancing of the interests of the surface and mineral owner. But, at least one court has also applied the doctrine to groundwater. Now, a federal appellate court has applied the doctrine to find that vertical drilling on farmland may constitute a trespass.
An update on the accommodation doctrine in the courts – that’s the topic of today’s post.
Land ownership includes two separate estates in land – the surface estate and the mineral estate. The mineral estate can be severed from the surface estate with the result that ownership of the separate estates is in different parties. In some states, the mineral estate is dominant. That means that the mineral estate owner can freely use the surface estate to the extent reasonably necessary for the exploration, development and production of the minerals beneath the surface. If the owner of the mineral estate has only a single method for developing the minerals, many courts will allow that method to be utilized without consideration of its impact on the activities of the surface estate owner. See., e.g., Merriman v. XTO Energy, Inc., 407 S.W.3d 244 (Tex. 2013).
But, under the accommodation doctrine, if alternative means of development are reasonably available that would not disrupt existing activities on the surface those alternative means must be utilized. In other words, the accommodation doctrine applies if the surface owner must establish that the lessee’s surface use precludes (or substantially impairs) the existing surface use, and that the surface owner doesn’t have any reasonable alternative means to continue the current use of the surface estate. For example, in Getty Oil co. v. Jones, 470 S.W.2d 618 (Tex. 1971), a surface estate owner claimed that the mineral estate owner did not accommodate existing surface use. To prevail on that claim, the Getty court determined that the surface owner must prove that the mineral estate owner’s use precluded or substantially impaired the existing surface use, that the surface estate owner had no reasonable alternative method for continuing the existing surface use, and that the mineral estate owner has reasonable development alternatives that would not disrupt the surface use.
Accommodation Doctrine and Water
A question left unanswered in the 1971 decision was whether the accommodation doctrine applied beyond subsurface mineral use to the exercise of groundwater rights. In 2016, the Texas Supreme Court, in Coyote Lake Ranch, LLC v. City of Lubbock, 498 S.W.3d 53 (Tex. Sup. Ct. 2016), held that it did. Thus, according to the Court, the doctrine applies in situations where the owner of the groundwater impairs an existing surface use, the surface owner has no reasonable alternative to continue surface use, and the groundwater owner has a reasonable way to access and produce water while simultaneously allowing the surface owner to use the surface.
The Court held that the language of the deed for the land involved in the litigation governed the rights of the parties, but that the deed didn’t address the core issues presented in the case. For example, the Court determined that the deed was silent on the issue of where drilling could occur and the usage of overhead power lines and facilities associated with water development. The Court determined that water and minerals were sufficiently similar such that the accommodation doctrine should also apply to water – both disappear, can be severed, and are subject to the rule of capture, etc. The Court also concluded that a groundwater estate severed from the surface estate enjoys an implied right to use as much of the surface as is reasonably necessary for the production of groundwater. Thus, unless the parties have a written agreement detailing all of the associated rights and responsibilities of the parties, the accommodation doctrine would apply to resolve disputes and sort out rights.
In 2018, however, the Texas Court of Appeals, refused to further expand the accommodation doctrine. Harrison v. Rosetta Res. Operating, LP, No. 08-15-00318-CV 2018 Tex. App. LEXIS 6208 (Tex Ct. App. Aug. 8, 2018), involved a water-use dispute between an oil and gas lessee and the surface owner. The plaintiff owned the surface of a 320-acre tract. The surface estate had been severed from the mineral estate, with the minerals being owned by the State of Texas. The plaintiff executed an oil and gas lease on behalf of the State that allowed the lessee to use water from the land necessary for operations except water from wells or tanks of the landowner.
To settle a lawsuit with the plaintiff, the lessee agreed to buy 120,000 barrels of water. The lessee built a frac pit to store the water that it would use in drilling operations and drilled two wells. The lessee then assigned the lease to the defendant. The defendant drilled a third well and had plans to drill additional wells. However, the defendant did not buy water from the plaintiff as the lessee had. Instead, the defendant pumped water from a neighbor and brought temporary waterlines onto the plaintiff’s property to fill storage tanks.
The plaintiff claimed that the defendant (via an employee) orally agreed to continue the existing arrangement that the plaintiff had with lessee and was in violation with an alleged industry custom in Texas – that an oil and gas lessee would only buy water from the surface owner of the tract it was operating. The plaintiff claimed that it wasn’t necessary for the defendant to bring in hoses and equipment because the defendant should have bought the plaintiff’s water from the plaintiff, Not doing so violated the accommodation doctrine. The trial court rejected the plaintiff’s arguments.
The appellate court determined that the plaintiff’s accommodation doctrine arguments appeared to rest on his proposition that because a frac pit was built on his land for use by the former lessee, it unified the use of the land with the oil and gas operations, and when the defendant chose not buy his water it substantially interfered with his existing use of the land as a source of water for drilling operations. Thus, the substantial interference complained of was that the frac pit was no longer profitable because the defendant is not using it to supply water for its operations. The appellate court held that categorizing a refusal to buy goods produced from the land as interference with the land for purposes of the accommodation doctrine would stretch the doctrine beyond recognition. Therefore, because the defendant’s use did not impair the plaintiff’s existing surface use in any way, except in the sense that not buying the water had precluded the plaintiff from realizing potential revenue from selling its water to the defendant, the inconvenience to the surface estate was not evidence that the owner had no reasonable alternative to maintain the existing use. Lastly, the court determined that if it were to hold for the plaintiff on these facts they would, in effect, be holding that all mineral lessees must use and purchase water from the surface owner under the accommodation doctrine if his water is available for use. Accordingly, the appellate court affirmed.
In, Bay v. Anadarko E&P Onshore LLC, No. 17-1374, 2018 U.S. App. LEXIS 36454 (10th Cir. Dec. 26, 2018), the plaintiffs, a married couple, operate a farm in Weld, County, CO. In 1907, the Union Pacific Railroad acquired large swaths of land and sold off surface rights to others, ultimately selling subsurface rights to mineral deposits to the defendant, an oil and gas company. The 1907 deed reserved the following: “First. All coal and other minerals within or underlying said lands. Second. The exclusive right to prospect in and upon said land for coal and other minerals therein, or which may be supposed to be therein, and to mine for and remove, from said land, all coal and other minerals which may be found thereon by anyone. Third. The right of ingress, egress and regress upon said land to prospect for, mine and remove any and all such coal or other minerals; and the right to use so much of said land as may be convenient or necessary for the right-of-way to and from such prospect places or mines, and for the convenient and proper operation of such prospect places, mines, and for roads and approaches thereto or for removal therefrom of coal, mineral, machinery or other material” [emphasis added].
The plaintiffs’ farm was above a large oil and gas deposit. Before 2000, the railroad entered into agreements with surface owners before drilling for oil or gas. Those agreements often included payments to surface owners and provided that the railroad would pay for surface property damages, including crop damages. In 2000, the defendant bought the railroad’s mineral rights in the oil and gas deposit underlying the plaintiffs’ property. In 2004, the defendant leased the mineral rights under the plaintiffs’ farms to an exploration company which drilled three vertical wells on a part of the plaintiffs’ farm. An energy company bought the exploration company in 2006 and drilled four more vertical wells on another part of the plaintiffs’ farm between 2007 and 2011. In an attempt to have fewer wells drilled on their farm and minimize the impact to their farmland, the plaintiffs asked the energy company to drill directionally. The energy company requested $100,000 per directional well. The plaintiffs refused, and the energy company continued to drill vertically. The plaintiffs sued, claiming that the energy company’s surface use constituted a trespass because directional drilling would have resulted in two wells on their property rather than seven. Directional drilling is the norm in the county with one drill site per pad serving 12-36 wells.
The trial court granted a judgment as a matter of law to the defendant on the basis that the defendant had presented sufficient evidence that vertical drilling was the only commercially reasonable practice; that this practice was afforded in the additional rights granted in the original deed; and that the plaintiffs could not establish trespass. On appeal, the appellate court reversed. The appellate court noted that state law held that deeds containing language identical to the “convenient and necessary” language of the deed at issue does not grant mineral owners more rights than what state common law provides. The appellate court also expressed doubt as to whether a mineral reservation in a deed can expand surface or mineral ownership rights unless those rights are clearly defined in accordance with Gerrity Oil and Gas Corp. v. Magness, 946 P.2d 913 (Colo. 1997). The appellate court concluded that the deed at issue in the case was insufficient to expand mineral or surface rights beyond those recognized in state common law. The appellate court also held that the trial court erred by requiring the plaintiffs to show that vertical drilling wasn’t commercially reasonable. Under Gerrity, the appellate court noted, a surface owner can introduce evidence that "reasonable alternatives were available." Once that evidence is introduced, the appellate court determined that it is then up to a judge or jury to "balance the competing interests of the operator and surface owner and objectively determine whether ... the operator's surface use was both reasonable and necessary."
The accommodation doctrine sounds reasonable. But, defining what a reasonable use can be difficult to determine, and if new uses can be asserted the mineral owner’s rights can be diminished. From an economic standpoint, it would seem that the owner of the surface estate as the accommodated party should pay for the extra expense associated with the accommodation. In other words, when the mineral estate owner must accommodate, but at the expense of the surface estate owner, both parties benefit and the surface estate owner can’t get rights back for nothing that it sold when the original grant was created. Some states, such as Kansas, follow this approach.
Monday, January 28, 2019
Last fall, I wrote a blog post where I took a look at a handful of recent court developments involving agricultural law. Since then I have received numerous requests to do another post surveying more court developments involving legal issues that farmers, ranchers, rural landowners and agribusinesses face.
Recent court opinions involving ag law issues – that’s the topic of today’s post.
Each state, even though differences exist in state law, recognize that if an individual possesses someone else's land in an open and notorious fashion with an intent to take it away from them, such person (known as an adverse possessor) becomes the true property owner after the statutory time-period (anywhere from 10 to 21 years) has expired. If use is by permission, the adverse possession statute is never tolled. See, e.g., Engel v. Carlson, No. A-07-016, 2008 Neb. App. LEXIS 94 (Neb. Ct. App. May 13, 2008).
The requirements that the use of the land must be “adverse” and under a “claim of right” are sometimes combined under the requirement that the use of the land be “hostile” to the true owner’s use. For example, in Cannon v. Day, 165 N.C. App. 302, 598 S.E.2d 207 (2004), rev. den., 604 S.E.2d 309 (N.C. 2004), the original owners never granted permission to use a lane, and the neighbor had used the lane for more than 20 years adverse to the true owners. The court determined that the neighbor had adversely possessed the lane and the ownership of it passed to the neighbor’s successors in interest.
The hostility requirement is designed to put the true owner on notice that another party is using the land adversely to the true owner. See, e.g., Groves v. Applen, No. 31241-7-II, 2005 Wash. App. LEXIS 1460 (Wash. Ct. App. Jun. 14, 2005). However, in Kansas, the adverse possession statute does not contain a “hostility” requirement, and the doctrine can be asserted against an undisclosed co-tenant. Buchanan v. Rediger, 26 Kan. App.2d 59, 975 P.2d 1235 (1999).
Recent case. In Collier v. Gilmore, 2018 Ark. App. 549 (Ark. Ct. App. 2018), the Arkansas Court of Appeals held that farming to a cultivation line constituted adverse possession. The parties each gained title to their respective tracts from the same predecessor. In 1972, the plaintiff purchased his tract and believed that he purchased up to the fence where his predecessor had farmed. However, the deed did not include a strip of land up to the fence. Since the 1980’s, the plaintiff farmed up to where the fence was in 1972 believing that to be the property line. Sometime during the 1980’s the defendant received title to the other portion of the predecessor’s original property. The plaintiff sued claiming adverse possession of the strip of land not in the 1972 deed. The trial court agreed.
On appeal, the appellate court affirmed. The appellate court held that the plaintiff’s farming of the disputed strip for several decades was sufficient to establish an intent to hold against the true owner’s rights. The appellate court also determined that the plaintiff’s possession was also hostile because it was greater than the deed anticipated and was without permission of the true owner. While the strip had never been enclosed by a fence or other enclosure, the property line was the cultivation line which had been clearly identified for decades via the plaintiff’s conduct.
In certain situations, one person may be held liable for the tortious acts of another person based on a special relationship between the two. Such liability (called vicarious liability) exists even though the person held liable not have personally committed the act. Often this issue arises in employment situations. An employer may be held vicariously liable for the tortious acts (usually negligent ones) committed by an employee. Thus, if an employee commits a tort during the “scope of employment”, the employer will (jointly with the employee) be liable.
This rule is often described as the doctrine of “respondeat superior”, which means “let the person higher up answer.” Vicarious liability applies to torts committed by employees and generally not to those committed by independent contractors. Therefore, it is critical to determine whether a particular individual was an employee or an independent contractor. While no single factor is dispositive in all cases, an employee is generally one who works subject to the control of the employer concerning the manner and means of performance.
Recent case. In Moreno v. Visser Ranch, Inc., No. F075822, 2018 Cal. App. LEXIS 1194 (Cal. Ct. App. Dec. 20, 2018), at issue was a dairy farm’s liability for a worker involving in an accident. The dairy employed a worker to be on call around the clock to repair equipment at the dairy. The worker was involved in his work vehicle when he was involved in a single vehicle accident. The plaintiff was riding with the worker at the time of the accident. The plaintiff was employed by a third party to perform various services at the dairy and other local farms. On the night of the accident, the worker and plaintiff attended a family function (they were related) not located on the dairy’s property. On the way home after the function, the vehicle they were in left the road and rolled over. The plaintiff was not wearing a seat belt and was seriously injured. The plaintiff sued the driver, dairy farm and the auto manufacturer for negligence. The plaintiff also sued the State and the County based on the dangerous condition of the road where the accident occurred (the road was under construction). The dairy moved for summary judgment on the plaintiff’s respondeat superior claim on the basis that the driver was not acting within the scope of employment when the accident occurred. The trial court granted the motion. The trial court also granted summary judgment for the diary on the issue of liability arising from ownership of the vehicle. The plaintiff was, however, able to recover statutory damages from the driver.
On appeal, the appellate court determined that fact issues remained on the respondeat superior claim. Though the worker and the plaintiff were returning from a family function, the driver was on call 24/7 to respond to issues at the dairy farm. In addition, the appellate court determined that a fact issue remained as to whether the worker was acting within the scope of his employment and benefiting the dairy farm at the time of the accident. The appellate court remanded the case.
Inherently Dangerous Activities
Another aspect of respondeat superior involves activities that the law deems to be inherently dangerous. In this instance, the person making the hire can be held vicariously liable even if the person hired is an independent contractor. For example, in some states, aerial crop spraying is considered evidence of negligence. In these situations, a plaintiff only needs to establish that aerial spraying occurred and damage resulted. A showing of negligence on the part of the individual spraying the crops is not necessary. However, the majority of states still require a showing of negligence before damages can be recovered. In the states not requiring a showing of negligence, the practical effect is to apply a strict liability rule. In these jurisdictions, delegation of the spraying task to an independent contractor does not eliminate a farmer's liability. This problem is so severe that most farm liability policies do not cover the aerial spraying or dusting of crops. The damage award in a crop dusting case is calculated on the basis of the difference between the crop yield that would have normally resulted and the yield actually obtained after the damage, adjusted for any reduction in costs, such as drying or hauling costs. Yield is based on the best evidence available.
Recent case. In Keller Farms, Inc. v. Stewart, No. 1:16 CV 265 ACL, 2018 U.S. Dist. LEXIS 210209 (E.D. Mo. Dec. 13, 2018), the court held that the aerial application of ag chemicals is not an inherently dangerous activity. The case involved a dispute involving damage to the plaintiffs’ trees caused by chemicals that allegedly drifted during aerial application. The plaintiffs attempted to hold both the aerial applicator and the landowner that hired the applicator. The plaintiffs claimed the landowner was vicariously liable for the applicator’s actions because aerial spraying of burndown chemicals is an "inherently dangerous activity."
The trial court granted the defendants’ motion for judgment as a matter of law on the plaintiff's trespass claim, but the remaining issues were left for the jury to resolve. The jury returned a verdict in favor of the defendants on the negligence and negligence per se claims. The plaintiffs filed a motion for a new trial, arguing the verdict was against the weight of the evidence; that the trial court erred in excluding evidence; and that the trial court erred in granting the defendants’ motion for judgment as a matter of law. The trial court, however, denied the plaintiff’s motion for a new trial.
On appeal, the appellate court affirmed. The appellate court determined that the jury’s verdict was not against the weight of the evidence, and that the aerial application of herbicides was commonplace and not inherently dangerous. In addition, the appellate court noted that the defendants’ evidence was that the herbicides did not actually drift onto the plaintiff’s property and that the applicator complied with all label requirements and sprayed during optimal conditions. The appellate court also determined that the trial court had ruled properly on evidentiary matters and that the plaintiff had not proven the alleged monetary damages to the trees properly. The appellate court also upheld the trial court’s denial of the plaintiff’s motion for a new trial.
The legal issues that farmers and ranchers deal with are potentially very large. Today’s post examined just a small slice. It’s always helpful to know what the rules are when the issue arises.
Thursday, January 24, 2019
As noted on Tuesday’s post, the Treasury issued final regulations for the qualified business income deduction (QBID) under I.R.C. §199A on January 18. This provision, of course, provides for a 20 percent deduction on business income received by a sole proprietor or member of a pass-through entity. On Tuesday, I discussed how the final regulations affected rental situations for farmers and ranchers and also how the final rules dealt with aggregation.
In today’s post, I look at numerous other issues associated with I.R.C. §199A and the final regulations that are important to farmers and ranchers
The rest of the story, so to speak, concerning the QBID final regulations and farmers and ranchers – that’s the topic of today’s post.
Proposed regulations. Under the proposed regulations, carryover losses that were incurred before 2018 and that are now allowed in years 2018-2025 will be ignored in calculating qualified business income (QBI) for purposes of the QBID. This is an important issue for taxpayers that have had passive losses that have been suspended under the passive loss rules. While this loss allocation rule is generally favorable, clarification was needed on a couple of points. For instance, could a taxpayer also ignore pre-2018 suspended losses for purposes of the Excess Business Loss rule under I.R.C. §461(l)?
Final regulations. The final regulations, consistent with the regulations issued under former I.R.C. §199, provide that any losses that are disallowed, suspended, or limited under I.R.C. §465 (passive loss rules) §704 and I.R.C. §1365 (or any other similar provision) are to be used on a first-in, first-out basis.
In addition, the final regulations clarify that an NOL deduction (in accordance with I.R.C. §172) is generally not considered to be in connection with a trade or business. Excess business losses (the amount over $500,000 (mfj)) are not allowed for the tax year. However, an Excess Business Loss under I.R.C. §461(l) is treated as an NOL carryover to the next tax year where it reduces QBI in that year. The carry forward becomes part of the taxpayer's NOL carryforward in later years. There is no mention whether this amount gets retested under I.R.C. §461(j) (involving subsidized farming losses). Under prior law, those disallowed losses retained their character in a later tax year. That is no longer the case and it appeared that the NOL generated under I.R.C. §461(l) would not be subject to other loss limitation provisions.
Included and Excluded Items
QBI includes net amounts of income, gain, deduction, and loss with respect to any qualified trade or business. I.R.C. §199A(c). Business-related items that constitute QBI include ordinary gains and losses from Form 4797; deductions that are attributable to a business that is carried on in an earlier year; the deduction for self-employed health insurance under I.R.C. §162(l); and the deductible portion of self-employment tax under I.R.C. §164(f). The final regulations affirm this. Treas. Reg. §1.199A-3(b)(1)(vi). The reduction of QBI for self-employed health insurance, for an S corporation shareholder or partner occurs at the entity level. It is removed for an S corporation, for example on Form 1120-S. It should not be deducted twice. If QBI were reduced by the amount of the I.R.C. §162(l) deduction on Form 1040, QBI would (incorrectly) be reduced twice.
The final regulations also clarify that the deduction for contributions to qualified retirement plans under I.R.C. §404 is considered to be attributable to a trade or business to the extent that the taxpayer’s gross income from the trade or business is accounted for when calculating the allowable deduction, on a proportionate basis.
The final regulations do not address how deductions for state income tax imposed on the individual’s business income or unreimbursed partnership expenses are to be treated. The final regulations also don’t mention whether the deduction for interest expense to a partnership interest or an S corporation interest is business related. Guaranteed payments for the use of capital in a partnership are not attributable to the partnership’s business, unless they are properly allocable to the recipient’s qualified trade or business (not likely). Also excluded from QBI are amounts that an S corporation shareholder receives as reasonable compensation or amounts a partner receives as payment for services under I.R.C. §§707(a) or (c).
Proposed regulations. The proposed regulations appeared to take the position that gain that is “treated” as capital gain is not QBI. Prop. Treas. Reg. 1.199A-3(b)(2)(ii)(A). This interpretation would exclude I.R.C. §1231 gain (such as is incurred on the sale of breeding livestock) from being QBI-eligible. But, it could also be argued that is an incorrect interpretation of the relevant Code provisions. It also is arguably inconsistent with the purpose of the QBID statute. I.R.C. §1222(3) defines long-term capital gain as the gain from the sale or exchange of a capital asset held for more than one year, if and to the extent the gain is taken into account in computing gross income. I.R.C. §1231(a)(1) treats the I.R.C. §1231 gains as long-term capital gain. I.R.C. §199A(a)(2)(B) neither modifies nor makes any other specification. Also, I.R.C. §1222(11) defines “net capital gain” as the excess of the net long-term capital gain for the year over the net short-term capital loss. None of the other provisions on I.R.C. §1222 mention I.R.C. §1231. Simply because, as the proposed regulations state, gain is “treated as” capital gain does not make it capital gain. Rather, “treated as” should be read in a manner that the tax on I.R.C. §1231 gain is computed in the same manner as capital gain. I.R.C. §1231 reflects gain on the disposition of a business asset. As such, the argument is, I.R.C. §1231 gain should be QBI because the purpose of I.R.C. §199A is to provide a lower tax rate on business income. Losses from the sale of short-term depreciable assets (Part II of Form 4797) should not reduce QBI if I.R.C. §1231 gains (Part 1 of Form 4797) are present.
Final regulations. So how did the final regulations deal with this issue? The final regulations remove the specific reference to I.R.C. §1231 and provide that any item of short-term capital gain, short-term capital loss, long-term capital gain, or long-term capital loss, including any item treated as one of these under any Code provision, is not taken into account as a qualified item of income, gain, deduction or loss. That’s comprehensives. It’s basically any item that is reported on Schedule D plus qualified dividends. Qualified dividends are specifically included in the term “capital gain” by reference to I.R.C. §1(h).
Proposed regulations. The proposed regulations provided that “brokering” is limited to trading securities for a commission or a fee. Prop. Treas. Reg. §199A-5(b)(2)(x). Clarification was needed to ensure that brokering of commodities did not constitute a specified service trade or business (SSTB). An SSTB is eligible for the QBID, but under a different set of rules that apply to non-SSTB businesses (such as farms and ranches). For instance, the concern was that under the proposed regulations a person who acquired a commodity (such as wheat or corn for a hog farm), and transported it to the ultimate buyer might improperly be considered to be dealing in commodities. This would have resulted in the income from the activity treated from an SSTB. None of the commodity income would have been eligible for the QBID for a high-income taxpayer.
Final regulations. This is also an important issue for private grain elevators. A private grain elevator generates income from the storage and warehousing of grain; it also generates income from the buying and selling of grain. Is the private elevator’s buying and selling of grain “commodity dealing” for purposes of I.R.C. §199A? If it is, then a significant portion of the elevator’s income will not qualify for the QBID. Clarification was needed to distinguish that these various services involved do not constitute an SSTB making the income non-QBI.
The final regulations clarify that the brokering of agricultural commodities does not constitute an SSTB and does so by pointing to I.R.C. §954.
The final regulations specify that the IRS may provide for methods of computing taxable wages. Simultaneously with the release of the final regulations, the IRS issued Rev. Proc. 2019-11. The Rev. Proc. notes that it applies only for QBID purposes, and recites the W-2 wages definition from the proposed regulations. Thus, statutory employees that a have a Form W-2 with Box 13 marked are not W-2 wages for QBID purposes. Also, wages paid in-kind to agricultural labor are not eligible W-2 wages, but wages paid to children under age 18 are. I explained this distinction in an earlier post that you can read here: https://lawprofessors.typepad.com/agriculturallaw/2018/08/the-qualified-business-income-deduction-and-w-2-wages.html.
The proposed regulations set forth three methods for computing W-2 wages – unmodified box method; modified box 1 method; and the tracking wages method. The Rev. Proc. also provided special rules to use for a short tax year which requires the use of the tracking wages method.
Multiple Trades Or Businesses
The final regulations follow the approach of the proposed regulations concerning a taxpayer that has multiple trades and businesses. Items of QBI that are properly allocable to more than a single trade or business must be allocated among the several trades or businesses to which they are attributed using a reasonable method based on the facts. That method is to be consistently applied each year. The same concept applies for individual items.
Income Tax Basis
Proposed regulations. Under I.R.C. §199A, higher income taxpayers compute their QBID in accordance with a wages/qualified property (QP) limitation. The amount of QP that is used in the limitation is tied to the what is known as the “unadjusted basis in assets” (UBIA). However, the proposed regulations raised some questions about UBIA that needed clarified.
For instance, Prop. Treas. Reg. §1.199A-4(b), Example 3, needed modified. When a tax-free contribution of property to a corporation is involved, the transferor’s unadjusted basis should continue to be the UBIA. The placed-in-service date would be the date that the transferor originally placed the property in service. I.R.C. §351 should simply be viewed as a continuation of the taxpayer’s holding. The only difference is that the asset is being held via the S corporation. Indeed, the tax attributes of the contributed asset remain unchanged. Likewise, the transferor’s depreciation history with respect to the contributed asset carries into the S corporation. Thus, the unadjusted basis should also carry into the corporation.
Final regulations. The final regulations clarify that the UBIA of property received in either an I.R.C. §1031 or 1033 exchange is the UBIA of the relinquished property. In addition, the placed-in-service date of the replacement property is the service date of the relinquished property. Similar concepts apply for transfers that are governed by I.R.C. §§351, 721 and 731.
The final regulations also take the position that property contributed to a partnership or S corporation under the non-recognition rules retains the UBIA of the contributor. In addition, an I.R.C. §743(b) adjustment is QP to the extent of an increase in fair market value over original cost. For entities, the UBIA is measured at the entity level, and the property must be held by the entity as of the end of the entity’s tax year. As for a decedent’s estate, the fair market value of property that is received from a decedent pegs the UBIA and the new depreciation period (for purposes of the computation of the limitation) is reset as of the date of the decedent’s death.
The final regulations specify that a non-grantor trust that is established for “a primary purpose” of avoiding income tax under I.R.C. §199A will be considered to be aggregated with trust settlor/grantor for QBID purposes. In addition, distributable net income (DNI) transferred from a non-grantor trust to a beneficiary is treated as having been received by the beneficiary. This could lead to an increase in the creation of non-grantor, irrevocable, complex trusts.
The final regulations also did not place any limitation on the use of irrevocable trusts that are considered to be owned by the beneficiary(ies). See I.R.C. §678. However, this does not necessarily mean that there should be a rush to create irrevocable trusts. The IRS, supported by the courts, often view the substance of a transaction as more controlling than form when it believes that the entity was created primarily for tax avoidance purposes. See, e.g., Helvering v. Gregory, 293 U.S. 465 (1935).
Under the final regulations, a veterinarian is engaged in the provision of health care and, therefore, is an SSTB. But, no clarity was given as to the treatment of insurance salesmen – they are often statutory employees However, the final regulations do contain a three-year lookback period on the reclassification of workers from employee (W-2) status to independent contractor (Form 1099) reporting. Employees do not have QBI, but independent contractors can.
The final regulations are effective upon being published in the Federal Register. But, in general, a taxpayer can rely on either the final or proposed regulations for tax years that end in 2018. Some parts of the final regulations apply to tax years ending after December 22, 2017, or to tax years ending after August 16, 2018. However, these situations apply to the anti-abuse rules, including the anti-abuse rules that apply to trusts.
Tuesday, January 22, 2019
Last August, the Treasury issued proposed regulations under I.R.C. §199A that was created by the Tax Cuts and Jobs Act (TCJA) enacted in late 2017. REG-107892-18 (Aug. 8, 2018). The proposed regulations were intended to provide taxpayers guidance on planning for and utilizing the new 20 percent pass-through deduction (known as the QBID) available for businesses other than C corporations for tax years beginning after 2017. It expires for years beginning after 2025. While some aspects of the proposed regulations are favorable to agriculture, other aspects created additional confusion, and some issues were not addressed at all (such as the application to agricultural cooperatives).
A public hearing on the final regulations was held in Washington, D.C. on October 16, 2018 and the Treasury released the final QBID regulations on January 18, 2019. The final regulations provide much needed guidance on several key points.
Today’s post does not provide an overview of the 199A provision (for that background information you can read my prior post here https://lawprofessors.typepad.com/agriculturallaw/2018/01/the-qualified-business-income-qbi-deduction-what-a-mess.html and here https://lawprofessors.typepad.com/agriculturallaw/2018/03/congress-modifies-the-qualified-business-income-deduction.html. What I am focusing on today is the impact of the final regulations on farm and ranch businesses - that’s the topic of today’s post.
Multiple businesses. The proposed regulations did provide a favorable aggregation provision that allows a farming operation with multiple businesses (e.g., row-crop; livestock; etc.) to aggregate the businesses for purposes of the QBID. This was, perhaps, the best feature of the proposed regulations with respect to agricultural businesses because it allows a higher income farming or ranching business to make an election to aggregate their common controlled entities into a single entity for purposes of the QBID. This is particularly the case with entities having paid no wages or that have low or no qualified property. Entities with cash rental income already qualified the income as QBI via common ownership (common ownership is required to aggregate) Once the applicable threshold for 2018 ($157,500 for a single filer; $315,000 for a married filing joint return) is exceeded, the taxpayer must have qualified W-2 wages or qualified property basis to claim the QBID. Aggregation, in this situation, may allow the QBID to be claimed (assuming the aggregated group has enough W-2 wages or qualified property).
Proposed regulations. Common ownership is required to allow the aggregation of entities to maximize the QBID for taxpayers that are over the applicable income threshold. Prop. Treas. Reg. §1.199A-4(b). “Common ownership” requires that each entity has at least 50 percent common ownership. But, the common ownership rule does not require every person involved to have an ownership in every trade or business that is being aggregated, or that you look to the person’s lowest percentage ownership. For example, person A could have a 1 percent ownership interest in entity X and a 99 percent ownership interest in entity Y, and an unrelated person could have the opposite ownership (99 percent in x and 1 person in Y) and the entities would have common ownership of 100 percent (the group of people have 50 percent or more common ownership).
But, there was a potential snag with the definition, and it concerned a family attribution rule that could pose issues for farming operations involving family members with multiple generations. The proposed regulations limited family attribution to just the spouse, children, grandchildren and parents. See Prop. Treas. Reg. §1.199A-4(b)(3). In other words, the proposed regulations limited common ownership to lineal ancestors and descendants. Excluded were siblings – which are often involved in farming and ranching businesses. One way to plan around the lack of sibling attribution, for example, was to have one child own 100 percent of one business and another child of the same parent own 100 percent of another business. In that situation, the parent is deemed to have 100 percent ownership of both businesses even though there is no sibling attribution. The two businesses could be aggregated, even though there is no sibling attribution, as long as at least one parent is alive.
The proposed regulations were also unclear concerning whether (for taxpayers over the applicable income threshold) it mattered if the entities are on a calendar or fiscal year-end. In order to elect to aggregate entities together, the proposed regulations required all of the entities in a combined group must have the same year-end, and none can be a C corporation. But, rental income paid by a C corporation in a common group could be QBI if the C corporation was part of that combined group. If this reading were correct, that meant that the rental income could qualify as QBI. That interpretation is beneficial to farming and ranching businesses – many are structured with multiples entities, at least one of which is a C corporation.
Final regulations. Fortunately, the final regulations provide that siblings are included as related parties via I.R.C. §§267(b) and 707(b). Including siblings in the definition of common ownership for QBID purposes will be helpful upon the death of the senior generation of a farming or ranching operation. In addition, the final regulations retain the 50 percent test and clarify that the test must be satisfied for a majority of the tax year, at the year-end, and that all of the entities of a combined group must have the same year-end.
The final regulations also specify that aggregation for 2018 can be made on an amended return. The aggregation election can be made in a later year if it was not made in the first year.
Rental Activities – What’s Business Income?
One of the big issues for farmers and ranchers operating as sole proprietorships or as a pass-through entity is whether land rental income constitutes QBI. The proposed regulations confirmed that real estate leasing activities can qualify for the QBID without regard to whether the lessor participates significantly in the activity. That’s particularly the case if the rental is between “commonly controlled” entities. But, the proposed regulations could also have meant that the income a landlord receives from leasing land to an unrelated party (or parties) under a cash lease or non-material participation share lease may not qualify for the QBID. If that latter situation were correct it could mean that the landlord must pay self-employment tax on the lease income associated with a lease to an unrelated party (or parties) to qualify the lease income for the QBID. Thus, clarification was needed on the issue of whether the rental of property, regardless of the lease terms will be treated as a trade or business for aggregation purposes as well as in situations when aggregation is not involved. That clarification is critical because cash rental income may be treated differently from crop-share income depending on the particular Code section involved. See, e.g., §1301.
Proposed regulations. The proposed regulations also contained an example of a rental of bare land not requiring any cost on the landlord’s part. See Prop. Treas. Reg. §1.199A-1(d)(4), Example 1. This seemed to imply that the rental of bare land to an unrelated third party qualifies as a trade or business. Another example in the proposed regulations also seemed to support this conclusion. Prop. Treas. Reg. §199A-1(d)(4), Example 2. Apparently, this means that a landlord’s income from passive triple net leases (a lease where the lessee agrees to pay all real estate taxes, building insurance, and maintenance on the property in addition to any normal fees that are expected under the agreement) should qualify for the QBID. But, existing caselaw is generally not friendly to triple net leases being a business under I.R.C. §162. Clarification on this point was also needed.
Unfortunately, the existing caselaw doesn’t discuss the issue of ownership when it is through separate entities and, on this point, the Preamble to the proposed regulations created confusion. The Preamble says that it's common for a taxpayer to conduct a trade or business through multiple entities for legal or other non-tax reasons, and also states that if the taxpayer meets the common ownership test that activity will be deemed to be a trade or business in accordance with I.R.C. §162. But, the Preamble also stated that "in most cases, a trade or business cannot be conducted through more than one entity.” So, if a taxpayer has several rental activities that the taxpayer manages, the Preamble raised a question as to whether those separate rental activities can’t be aggregated unless each rental activity is a trade or business. It also raised a question as to whether the Treasury would be making the trade or business determination on an entity-by-entity basis. If so, triple net leases might not generate QBI. But, another part of the proposed regulations extended the definition of trade or business beyond I.R.C. §162 in one circumstance when it referred to “each business to be aggregated” in paragraph (ii). Prop. Treas. Reg. §1.199A-4(b)(i). This would appear to mean that the rental of property would be treated as a trade or business for aggregation purposes. See Prop. Treas. Reg. §199A-1(b)(13).
Final regulations. So how did the final regulations deal with the issue of passive lease income? For starters, the bare land rent example in the proposed regulations was eliminated. Unfortunately, no further details were provided on the QBI definition of trade or business. That means that each individual set of facts will be key with the relevant factors including the type of rental property (commercial or residential); the number of properties that are rented; the owner’s (or agent’s) daily involvement; the type and significance of any ancillary services; the terms of the lease (net lease; lease requiring landlord expenses; short-term; long-term; etc.). Certainly, the filing of Form 1099 will help to support the conclusion that a particular activity constitutes a trade or business. But, tenants-in-common that don’t file an entity return create the implication that they are not engaged in a trade or business activity.
The final regulations clarify (unfortunately) that rental paid by a C corporation cannot create a deemed trade or business. That’s a tough outcome as applied to many farm and ranch businesses and will require some thoughtful discussions with tax/legal counsel about restructuring rental agreements and entity set-ups. Before the issuance of the final regulations, it was believed that land rent paid by a C corporation could still qualify as a trade or business if the landlord could establish responsibility (regularity and continuity) under the lease. Landlord responsibility for mowing drainage strips (or at least being responsible for ensuring that they are mowed) and keeping drainage maintained (i.e., tile lines), paying taxes and insurance and approving cropping plans, were believed to be enough to qualify the landlord as being engaged in a trade or business. That appears to no longer be the case.
Notice 2019-7. Along with the release of the final regulations, the IRS issued Notice 2019-7. The Notice is applicable for tax years ending after December 31, 2017 and can be relied upon until the final Revenue Procedure is published. The Notice provides tentative guidance and a request for comments on the sole subject of when and if a rental activity (termed as a “rental real estate enterprise) will be considered to be an active trade or business. The Notice also provides a safe harbor. While real estate rented or leased under a triple net lease is not eligible under the safe harbor (unless common control allows it), a taxpayer who has an active business of entering into and selling triple net leases may still be considered to be sufficiently active to qualify as a trade or business under existing case law.
The Notice defines a triple net lease to include an agreement that requires the tenant to pay taxes, fees, and insurance, and to be responsible for maintenance in addition to rent and utilities, and includes leases that require the tenant to pay common area maintenance expenses, which are when a tenant pays for its allocable portion of the landlord’s taxes, fees, insurance, and maintenance activities which are allocable to the portion of the property rented. The definition seems to leave open the ability to avoid triple net lease status by having the tenant be responsible for some portion of the maintenance, taxes, fees, insurances, and other expenses that would normally be payable by a landlord. However, failure to meet the safe harbor does not fully preclude the lease from generating QBI.
Note: For landowners receiving annual “wind lease” income for aerogenerators on their farmland, even though the income is received as part of a common controlled group, the actual income is not paid by any member of the controlled group. It is essentially triple net lease income with no services provided by the farmer (or spouse). This income will not be QBI, given the inability of the landowner to provide “services” under the lease agreement.
An individual may rely on the safe harbor, as well as a partnership or S-corporation that owns the applicable interest in the real estate that is leased out (such as farmland). As noted above, the final regulations take the position that the lessor entity must be a pass-through entity (or a sole proprietorship) that owns the real estate directly or through another entity that is disregarded for income tax purposes. Rent that is paid by a C corporation doesn’t count.
Each individual taxpayer, estate or trust can elect to treat each separate property as a separate enterprise, or all similar properties as a single enterprise, for purposes of applying the safe harbor rules, except that commercial and residential real estate cannot be considered as part of the same enterprise for testing purposes. In other words, all commercial rents can be netted as one single enterprise, and all residential rentals can be netted as another enterprise. But, real estate that is under a triple net lease, and real estate used as a residence by the taxpayer cannot be part of an aggregated enterprise for testing purposes because they cannot qualify to be included in the safe harbor.
The Notice specifies that for each separate enterprise, certain requirements must be satisfied each year for the enterprise’s income to be eligible for the safe harbor:
- Maintenance of separate books and records to reflect the income and expenses for each enterprise.
- Aggregate records for properties that are grouped as a single enterprise.
- Contemporaneous records (similar to auto logs) of time reports, logs, etc., with respect to services performed and the party performing the services with respect to tax years beginning January 1, 2019. The requirement is inapplicable to 2018 returns or fiscal year filers for years ending before 2020.
- For tax years 2018 through 2022, 250 or more hours of “rental services” must be performed to qualify the property for the safe harbor in each calendar year. Rental services include time spent by owners, employees, agents, and independent contractors of the owners, which can include management and maintenance companies who have personnel who keep and provide contemporaneous records. Rental services also include advertising to rent or lease properties; negotiating and executing leases; verifying tenant information; collecting rent; daily management and repairs; buying materials and supervising employees and independent contractors.
The safe harbor requirements will most likely be easier to satisfy by taxpayers having multiple properties, and cannot be used by a taxpayer that rents their personal residence(s) out for part of the year. While most rental house scenarios, cash rents and crop shares won’t qualify for the safe harbor, they may qualify under common control without regard to any hour requirement, or they can still generate QBI based on the overall facts and circumstances.
Thursday’s post will continue the discussion of the impact of the final QBI regulations on farming and ranching businesses. In that post, I will look a little further into the trade or business issue, discuss W-2 wages, and examine how the final regulations address the unadjusted basis in assets (UBIA) issue for QBI purposes. In addition, I will comment on numerous miscellaneous provisions, including the treatment of capital gains and the deductions that reduce QBI, just to name a couple. Also, I will take a look at how the final regulations treat commodity transactions, and how they apply to trusts and estates.
Friday, January 18, 2019
Presently, over 300,000 cell/wireless towers have been erected in the United States. Some of those are on farm and ranch land with the landowners having been presented an agreement to sign allowing the wireless carrier to use of some of the land. But, not all agreements are created equally.
What makes a cell/wireless tower agreement a good one? What are the key elements of a good agreement? What should or should not be included in an agreement from the landowner’s perspective? These questions are the topic of today’s post.
The Battle of the Forms
A key point for a landowner to understand is that when presented with an agreement to sign, the standard form of the wireless carrier is one-sided. It is one-sided in the favor of the wireless carrier. That’s to be expected. After all, a maxim of contract law is that the party who drafts a contract drafts the contract in their favor. So, a wireless carrier, via a landowner agreement, will attempt to take as much advantage of a naïve landowner as possible. That means a landowner presented with a wireless carrier’s boilerplate form could incur substantial legal fees to have the form edited in the negotiation process to reach a more balanced agreement that protects the landowner’s property rights.
A better approach might be for attorneys that represent landowners to develop their own standard form that thoroughly protects a landowner’s property rights while also ensuring that the wireless carrier can still experience an economic benefit from the placement of the tower on the landowner’s property.
There are a couple of basic points to be made when drafting a cell/wireless tower agreement. These are: 1) clearly identify the premises that is subject to the agreement; and 2) clearly identify the grant of authority. An exhibit should be included with the agreement that contains the legal description of the subject property along with drawings and/or photos. The more detail that is provided, the easier it will be to police the agreement. That’s particularly true with respect to unauthorized collocations (the placement of additional electronic devices on a tower) and subleases. In addition, any standard agreement should address the usage of common areas and access points. Similarly, the landowner will want the retained right to control signage, conduct and look. Nobody wants an eyesore on their property.
The grant of authority to the carrier involves the property rights that are given to the company. The grant of authority should be either a license or a lease. An easement should not be granted. The grant of an easement may result in granting others access to the same property. Instead, a license is all the legal authority that a wireless company needs. A license simply gives the wireless company exclusive permission to enter the property to establish the tower and perform necessary maintenance activities. A lease can also be utilized if it grants exclusive use to the wireless company and not shared use. In addition, a lease may provide more protection to the landowner in the event of the bankruptcy of the wireless company.
Whether a license or a lease is utilized, some basic elements should be included in the document.
Term. The term of the agreement and any renewal options should be clearly specified. For larger installations of wireless towers, the term is typically a series of five-year terms totaling somewhere between 20 and 30 years. For smaller installations that are placed in a right-of-way, a shorter term is generally better because of uncertainly that may exist due to governmental regulatory authority. Each particular situation will be different in terms of that the optimal term will be, whether an automatic renewal clause should be included and whether actual affirmative notice should be required of renewals.
Care should be given, however, to the use of a clause that gives the wireless company the “option to lease” or a clause that provides for a long “due diligence” period. The problem with those clauses are that they can tie up the site for a set amount of time with no guarantee of rent flowing to the landowner. Relatedly, a landowner should not allow the wireless company to have a long delivery or construction period for obtaining the necessary permits without requiring additional compensation. Ideally, the term of the agreement should begin immediately with a construction period of 30-60 days being added to the overall term.
If the wireless company desires either an option to lease or a due diligence clause, such a clause should be negotiated as an addition to the basic agreement for additional compensation. For instance, a “due diligence” period is a timeframe that the wireless company is given to obtain the necessary legal clearances and ensure that the location works for the company. This landowner should not give this time period away without additional compensation, even if the underlying agreement is not yet in force. Likewise, during this due diligence period, the landowner should consider requiring the wireless to carry insurance for any activities on the site by the company or consultants (and require copies of consultant reports be provided to the landowner), require prior written consent for any borings, and require the wireless company to indemnify the landowner for liability arising from the conduct of the company or consultants, etc.
Rent. The amount of rent or license fee paid to the landowner will depend on whether the installation is inside or outside the existing right-of-way. If it is inside the right-of way, the amount should be a reasonable approximation of cost. If it is outside the right-of-way, it will likely be tied to the market rate. In either event, a landowner should do the necessary “homework” to determine what an appropriate level of compensation should be, but the landowner’s compensation should be comprised of a base amount with additional compensation for collocation (additional devices added to the existing structure). In addition, a provision for late fees, interest and the possibility of holdover should be included in the agreement. Late fees are essentially whatever the landowner is able to negotiate, with interest on late fees typically limited by state law. A “savings” clause should be included to ensure that a state law barring usury won’t be violated. The hold-over rent amount will likely be in the range of 125 percent to 150 percent of the rent amount at the time the hold-over began.
Assignment. Often, the wireless company will desire to assign the lease to another related (affiliate) company, such as a “tower operating company.” Any assignment should require the landowner’s written approval. One option for a landowner to consider is to execute a property management agreement. But, in no event should the landowner agree to release the original wireless company from responsibility for liability associated with hazardous chemicals (battery leakage, etc.) and insurance.
Relatedly, a landowner should not allow the wireless company to sublicense or sublease without the landowner’s prior written approval. In addition, the landowner should retain the ability to consent to any proposed sublicense or sublease involving the placement of another carrier’s equipment (“facilities”) on the existing tower (or other structure). If additional equipment is desired to be placed on the existing tower or structure, additional rent or fees should be paid to the landowner.
Interference. The landowner is legally obligated to provide the tenant with “peaceable possession” of the premises. “Peaceable possession” means that the landowner will provide the premises to the tenant in a condition that will serve the intended purpose(s) of the tenant’s use. As applied to cell/wireless tower license or lease situations, that means that the landowner should not cause any interference problems for the existing tenant or licensee. For facilities and structures that are outside of a right-of-way and entirely on the landowner’s property, the landowner should ensure that subsequent tenants/licensees (collocators) do not cause interference. While the legal burden is on a newcomer to cure interference issues that are caused by the subsequent placement of a facility on an existing tower/structure, the landlord should take steps to ensure the landlord’s non-responsibility for interference or curing the problem. Also, the landlord should ensure that no rights have been granted that could lead to an interference.
Improvements. A significant area of concern for landowners is how to deal with improvements that the wireless company may desire to place on the tower/structure after the initial installation. Any proposed improvement should require detailed plans with prior approval and, of course, additional compensation for the landowner. The landowner should not agree to clause language such as, “approval not to be unreasonably withheld, delayed or conditioned…”. Also, the landowner should control the appearance of any improvements, and require that any improvement by the licensee/tenant be performed in compliance with applicable laws, codes and ordinances. In addition, the licensee/landlord should not be authorized to contract for or on behalf of the licensor or impose any additional expense (such as utilities) on the landowner.
The landowner should ensure that improvements will be maintained and upgraded to continuously be in compliance with applicable laws, and that any new installations will not be heavier, or exceed capacity or space than the original grant permitted. Similarly, the agreement should specify that the wireless company pay for utilities and that the landlord is not responsible for any interruptions in cell/wireless service. Concerning an operational issue, the landowner should not allow the wireless company to use the landowner’s electric connection with a submeter.
Access. The landowner should make sure that the agreement provides sufficient protection related to access to the property. In general, it is advisable to require the landowner to be given 24-hour notice when access to the property is desired or will be occurring. In addition, access to the property should be limited to just what is necessary to accomplish the purpose of gaining access. Also, some provision should be included in the agreement for emergency access to the property. If the wireless facilities are installed on the roof of a building, access to the facilities should be limited to just those areas that the wireless company needs. In addition, if the facility is placed on the top of a commercial building the roof contractor should approve of the access and roof penetrations should be avoided that could possibility invalidate roof warranties. Relatedly, the size, weight and frequency of roof access should be limited. If the installation of the cell/wireless facility is on private land (such as farmland), access should similarly be limited, and provisions included to protect fencing and animals, for example. The burden of maintaining secure fencing should be on the wireless company.
Default. The agreement should provide for events of default and termination by the landlord. Common events of default would be the non-payment of rent by the wireless company or habitual late payments. Likewise, default could be triggered on the violation of any term of the agreement, including non-permitted collocations and the bankruptcy of the wireless company. Consideration may need to be given as to whether a clause should be included that allows default to be cured by a monetary payment provision.
Care should be taken to clearly specify how and when the wireless company can terminate the agreement. Commonly, wireless carriers want a provision included in the agreement that allows them to terminate the agreement for “technological, economic, or environmental” reasons. A landowner should not accept this clause. It is a “get out of jail free” clause for the wireless company. From the landowner’s perspective, the agreement should either bar terminations by the wireless company or allow it for an additional payment (such as rent for the balance of the then-existing term or an amount of rent equal to a year or two).
Decommissioning. Thought should be given in the agreement concerning the ultimate removal of the tower and related improvements. Removal should also apply to improvements that have been made beneath the surface of the property. The manner of removal may depend on the type of facility that has been erected. If possible, the agreement should provide for immediate ownership of the facility/improvement in the landowner (although this likely won’t work if the structure has been added to a light pole that is on the landowner’s property located in a right-of-way). Alternatively, an option can be included in the agreement for the landowner to retain improvements or require removal of structures, footings and foundations.
Miscellaneous provisions. A well-drafted agreement should contain provisions dealing with numerous other issues. The following is a breakdown of the major “miscellaneous” provisions:
- Insurance provisions should apply to contractors and subsidiaries without reciprocal indemnity (which may be banned by state and/or local law). It’s a good idea to have insurance professionals review the insurance provisions.
- A tax provision should clearly state that taxes due are in addition to the rent amount due under the agreement. Likewise, the agreement should make the wireless company pay any increase in any property tax or insurance as a result of the installation and associated improvements.
- A “notice” provision should require that all notices, requests, demands and other communications be in writing and delivered to a specific address, and have multiple government entities copied (such as the city/county clerk; county/township/city engineer, etc.).
- Clause language should be included to limit the ability of the wireless company to store items on the property. This is an environmental concern. Stored batteries and generators can leach, and diesel fuel can leak.
- A provision should be included for attorney fees.
- Give thought as to whether a severability provision should be included as well as a clause providing that the landlord is not liable for brokerage or agent fees.
- A governing law provision should specify that the governing law is where the premises subject to the agreement is located and that jurisdiction is in the state rather than federal court.
- Other clauses to consider include a mortgage subordination provision; a clause providing for the limitation of liability; no relocation assistance (condemnation payments need to go to the landlord); and that time is of the essence.
- A provision addressing the sale of the agreement.
- It might be a good idea to include a provision addressing the possible sale of the agreement.
Perhaps the biggest key for a landowner in achieving a good agreement with a cell/wireless company is to control the drafting process. A good agreement can produce a good economic result for a landowner. A bad agreement that is not put together well can result in undesireable situations for the landowner. Good legal counsel is a must in getting a good agreement that will provide long-term benefits.
Wednesday, January 16, 2019
An important issue for many farmers and ranchers concerns potential liability for injury or damage caused by persons that work on behalf of the farming or ranching business. This is a real concern because of the many potentially dangerous situations that farming or ranching can present with respect to, for example, machinery and equipment, livestock, and a work environment that is subject to weather conditions that can often be less than favorable.
Farm/ranch businesses and liability for the acts of workers – that’s the topic of today’s post.
Employee or Independent Contractor?
In certain situations, one person may be held liable for the tortious acts of another person based on a special relationship between the two even without having personally committed the act that caused liability. This is known as “vicarious liability,” and it can mean that an employer can be liable for the acts of an employee. But, for the employer to be jointly liable with the employee, the employee must have committed the act leading to liability while acting in the “scope of employment.” This rule is often described as the doctrine of “respondeat superior,” which means “let the person higher up answer.” It’s the control by the employer over an employee that justifies joint liability.
Factors for making the distinction. The control issue is a key point. Vicarious liability generally does not apply to conduct of independent contractors. How is that determination made? While no single factor is dispositive in all cases, an employee is generally one who works subject to the control of the employer. See, e.g., Coates v. Anderson, 84 P.3d 953 (Wyo. 2004). This usually requires control both with respect to the manner and means of performing the particular job task. In these situations, the employer is responsible for the acts of the employee committed in the scope of the employee's employment. The “control” required to make a person an employee rather than an independent contractor is usually held to be control over the physical details of the work. It is not enough that the employer exercise control over the general manner in which the work is carried out, there must be control over the physical details of the work in order for an employer-employee relationship to be established. Therefore, if the employer retains control over the manner of performance by specifying how the work is to be accomplished, the time the individual will start working, the lunch break and other breaks, the employer is retaining control over the manner of performance. Likewise, the employer retains control over the means of performance if the employer provides the tools and equipment necessary to complete the job. An employer may also be directly liable to a customer for breaching a duty of care owed to the customer to supervise its employees involved in service for hire or to supply its employees with safe and proper equipment. See, e.g., Eischen, et al. v. Crystal Valley Cooperative, 835 N.W.2d 629 (Minn. Ct. App. 2013). An independent contractor, on the other hand, although hired to produce a certain result, is not subject to the control of the employer while the work is performed.
In any given situation, there may not be any control over the manner of performance, but there may be control over the means of performance. Thus, individuals hiring other persons to accomplish certain tasks should clearly specify whether an employer-employee relationship is to result. This clarity is often lacking in ag settings.
If the subordinate is free to execute the work without being subject to the direction of the principal as to details, that person is usually an independent contractor. A person engaging an independent contractor is generally not liable to third persons for the independent contractor's acts. However, if the work is such that, unless special precautions are taken, there will be a high degree of danger to others, the person hiring the independent contractor will be liable. This is an exception for “inherently dangerous”activities. This rule first applied principally to work which was highly dangerous even if every possible precaution was taken such as might occur with the use of dynamite. More recently, employer liability has been applied where the work to be done by the independent contractor is not “ultra-hazardous” if it is performed without adequate precautions. In this situation, if the independent contractor omits the precautions, the independent contractor's negligence is attributed to the employer. An example could be aerial crop spraying in some states.
“Scope of employment.” A difficult question in the area of respondeat superior is whether, in a particular case, the employee was acting “within the scope of his employment” when the tort occurred. In general, the tort is within the scope of employment if the individual acted with the intent to further the employer's business, even if the means chosen were indirect, unwise, and perhaps even forbidden. Most courts hold that an employee will be deemed to be within the scope of employment even though the employee's intent to serve the employer is coupled with a separate personal purpose.
Most courts hold that if an accident occurs when the employee is traveling from home to work, the employee is not acting within the scope of employment. This seems correct because the employer usually has no “control” over the employee at that time. The result should be the same even if the employer pays the employee a mileage allowance for the trip, and also agrees to pay the employee's hotel expenses for an overnight stay. Likewise, where the employee is returning home after the day's business activities, most courts do not hold an employer liable if the employee commits a negligent act. In one case, the defendant was not liable for the plaintiff's injuries sustained in an auto accident with the defendant's farm tenant while the tenant traveling from the farm to the defendant's home to help mow the defendant's law. The tenant not acting within scope of his job duties as a farm tenant at the time of accident and no evidence was presented that the defendant was in partnership or acting in a joint enterprise with the tenant. Granillo, et al. v. McKinzie, No. 11-07-00241-CV, 2009 Tex. App. LEXIS 728 (Tex. Ct. App. Feb. 5, 2009).
Interesting cases arise in situations involving an employee on a business trip who makes a short “side trip”, or “detour”, for the employee's own purposes. The traditional view has been that while the employee is on the first leg of a side trip, the employee is engaging in what is often called a “frolic and detour” and is thus not within the scope of employment. But, as soon as the employee begins to return towards the path of the original business trip, the employee is once again within the scope of employment, no matter how far afield the employee may be at that point. The recent trend, however, has been to take a less “mechanical” view of the “frolic and detour” problem. Most courts today hold that the employee is within the scope of business if the deviation is “reasonably foreseeable”. Under this approach, the employee might be within the scope of employment even while heading toward the object of a personal errand, if the deviation was slight in terms of distance. But, if the deviation was large and unforeseeable, in terms of miles, then the employee is not within the scope of business even while heading back towards the business goal, at least until returning reasonably near to the original route the employee was supposed to take.
Recent case. In Moreno v. Visser Ranch, Inc., No. F075822, 2018 Cal. App. LEXIS 1194 (Cal. Ct. App. Dec. 20, 2018), the defendant dairy employed a worker to be on call around the clock to repair equipment on the defendant’s various farms as needed. The worker was in his work vehicle when he was involved in a single vehicle accident. The plaintiff was riding with the worker at the time of the accident. The plaintiff was employed by a third party to perform various services at the dairy and other local farms. On the night of the accident, the worker and third party attended a family function (they were related) not located on farm property. On the way home after the function, the vehicle they were in left the road and rolled over. The plaintiff was not wearing a seat belt and was seriously injured. The plaintiff sued the driver, dairy farm and the auto manufacturer for negligence. The plaintiff also sued the State and the County based on the dangerous condition of the road where the accident occurred (the road was under construction). The dairy moved for summary judgment on the plaintiff’s respondeat superior claim on the basis that the driver was not acting within the scope of employment when the accident occurred. The trial court granted the motion. The trial court also granted summary judgment for the dairy on the issue of liability arising from ownership of the vehicle. The plaintiff was, however, able to recover statutory damages from the driver. On appeal, the appellate court determined that fact issues remained on the respondeat superior claim. Though the worker and the plaintiff were returning from a family function, the driver was on call 24/7 to respond to issues at the dairy farm. In addition, the appellate court determined that a fact issue remained as to whether the worker, was acting within the scope of his employment and benefiting the dairy farm at the time of the accident. The appellate court remanded the case.
The potential liability of a farm or ranch business for the conduct of persons working for it is an important issue. Liability often turns on how much control the business exercises over the job tasks. The liability issue and the ways it can occur for any particular farm or ranch business is a good conversation to have with legal counsel.
Monday, January 14, 2019
I will be doing an early tax season 2-hour continuing education event in February, and the date is set for Washburn Law School’s summer ag tax and estate/business planning conference. These events are the topic of today’s post – tax season CLE/CPE and summer seminar.
Tax Season Seminar/Webinar
The Tax Cuts and Jobs Act (TCJA) enacted in late 2017, has dramatically changed the computation of taxable income and tax liability. One result of this tax reform is that practically all farmers and ranchers will see a lower tax liability. One of the primary reasons for this, at least for sole proprietorships and pass-through entities is the 20 percent qualified business income deduction (QBID). Depreciation rules also have changed significantly as have the rules surrounding like-kind exchanges. Indeed, the disallowance of like-kind exchange treatment for post-2017 trades of personal property also has self-employment tax implications that must be accounted for. There are also numerous other provisions that can impact the tax return including changes in various credits, the doubling of the standard deduction, the elimination of many itemized deductions, changes to loss limitation rules and changes to methods of accounting.
On February 8, 2019, I will be conducting a 2-hour CLE/CPE from noon to 2 p.m. (cst). The seminar will be held live at the law school and will also be simulcast over the web. I will cover the latest changes to IRS forms, Treasury Regulations, and any other last-minute developments impacting the filing of returns during the 2019 filing season. Hopefully, the QBID final regulations will be released before the seminar in time to allow analysis and comment. They are due to be released by January 28 but could be released before then unless the partial government shut-down causes a delay. In any event, attendees will get the latest update of what is necessary to know for filing 2018 returns.
For more information about the February 8 event, click here: http://washburnlaw.edu/employers/cle/taxseasonupdate.html
To register click here: http://washburnlaw.edu/employers/cle/taxseasonupdateregister.html
2019 Summer Seminar
Washburn Law School’s rural law program in conjunction with the Department of Agricultural Economics at Kansas State University will be hold it’s 2019 summer farm income tax and estate/business planning seminar in Steamboat Springs, Colorado on August 13 and 14 at the Grand Hotel. On August 13 myself and Paul Neiffer will be addressing key farm income tax planning concepts, particularly how the final regulations under I.R.C. §199A apply in the farm/ranch context. On August 14, myself and others will be addressing important estate and business planning principles that can be applied to farm and ranch estates.
The summer seminar is also being co-sponsored by WealthCounsel, a network of estate and business planning attorneys that provide educational seminars and an automated drafting system, among other things.
Hold the date for the summer seminar and be watching for further details. If you aren’t able to attend in person, the seminar will be live simulcast over the web.
2019 will be another very busy year on the ag tax and estate/business planning front. I hope to see you at any event somewhere along the road.
Thursday, January 10, 2019
Since the blog post on December 31, I have been surveying the biggest developments in agricultural law and taxation of 2018. The first post looked at those developments that were not quite big enough to make the Top 10. Subsequent posts have examined developments 10 through 4. That brings us to today – the biggest three developments of 2018 in agricultural law and taxation.
Number 3 – The 2018 Farm Bill
In general. In late 2018, a new Farm Bill passed the Congress and was signed into law. As for cost, the total estimated price tag for the Farm Bill is $867 billion (a large portion of that total is devoted to Food Stamps) and it didn’t address the estimated $32 billion in in cost overruns on price loss coverage (PLC) and agriculture risk coverage (ARC) of the prior Farm Bill.
The Farm Bill, like prior law, doesn’t treat all entities that are similarly taxed the same under the attribution rules. In other words, an entity must either be a general partnership or a joint venture to not be limited in payment limits at the entity level. Also remaining the same is the $900,000 AGI limitation to be eligible to participate in federal farm programs. The general $125,000 payment limit also remains the same.
Crop reference prices. Reference prices (for PLC) will be the greater of the current reference price; or 85 percent of the average of the marketing year average price for the most recent five-year period, excluding the high and low prices. If base acres were not planted to a covered crop from 2009-2017, the base acres will be maintained but won’t be eligible for any PLC or ARC payments. The old reference price will be used or the “effective reference price” (ERP). The ERP is used each year and used in determining if there will be a PLC payment. The ERP will never be lower than the current reference price and can never be higher than 115% of the current reference price (from the 2014 Farm Bill). That means that it is possible for the reference price to increase when prices decrease. The ERP will be calculated annually based on 85 percent of the Olympic Average of the mid-year average prices for the last five crop years (eliminating the highest and lowest prices). If this number is higher, it is then compared to 115 percent of the current reference price. If it is lower, it will be the effective reference price for that crop year. If it is higher than the 115 percent, it will be limited to 115 percent. Presently, most major crops are not close to any adjustment to the reference price for at least the next couple of years.
The Farm Bill give participating producers a one-time opportunity to update program yields. The update is accomplished by means of a formula. The formula takes 90 percent of the average yield for crops from 2013-2017 and reduces it by a ratio that compares the 2013-2017 national average yields with the average for 2008-2012 crops. That producers a “yield update factor” that determines the portion of the initial 90 percent that can be used to update program yields. The update factor will vary from crop to crop.
As for ARC, it will be based on physical location of the farm and RMA data will have priority. If a farm crosses county lines, ARC payments will be computed on a pro-rata basis in accordance with the acres in each county with irrigated and non-irrigated payments being calculated for each county. Also, the USDA, with respect to ARC, will use a yield plug of 80 percent of the “transitional yield” and will calculate a trend-adjusted yield that will be used in benchmark calculations.
Other features. The Farm Bill contains numerous other provision of importance. The following is a bullet-point list of a few of the more significant ones:
- While a producer is locked into either PLC or ARC for 2019-2020, an annual election can be made to change the election beginning in 2021.
- The dairy margin program has been enhanced significantly such that smaller scale dairy producers are major beneficiaries under the Farm Bill.
- The CRP acreage cap is increased from 24 million acres to 27 million acres by 2023 (with CRP rental rates limited to 90 percent of the county average rental rate for land enrolled via the continuous enrollment option, and 85 percent of the county average for general enrollments). Two million acres are reserved for grasslands.
- The Conservation Stewardship Program (CSP) is reauthorized, but eliminated is the acre-based funding cap and the $18/acre national average payment rate. Spending is also capped at $1 billion annually.
- The Environmental Quality Incentives Program (EQIP) gets enhanced funding (by $.25 billion) with half of the increase pegged for livestock.
- Farm direct ownership loans are increased from $300,000 to $600,000, and guarantees are enhanced from $700,000 to $1,750,000.
- The Farm Bill increases loan rates by 13-24 percent for grains and soybeans. The new loan rates are$2.20 for corn; $6.20 for soybeans; $3.38 for wheat; $2.20 for sorghum; $2.50 for barley; $2.00 for oats.
- Base acres that were planted entirely to grass and pasture from 2009-2017 will not be eligible for farm program payments, but will be eligible for a five-year grassland incentive contract with the “rental amount” set at $18/acre.
- Crop insurance is not significantly changed, but modifications to crop insurance are designed to incentivize the use of cover crops.
- Hemp is added as an “agricultural commodity” eligible for taxpayer subsidies and it is removed from the federal list of controlled substances.
- Nieces nephews and first cousins can qualify for payments without farming;
- Work is not required to get food stamps;
- New taxpayer subsidies are proved for hops and barley.
- The Farm Bill codifies many changes to the National Organic Standards Board and how the Board represents the public and the USDA on matters concerning organic crops.
Number Two - Waters of the United States (“WOTUS”) Developments
In general. The Clean Water Act (CWA) makes illegal the discharging of dredge or fill material into the “navigable waters of the United States” (WOTUS) without first obtaining a permit from the Secretary of the Army acting through the Corps of Engineers (COE). Unfortunately, just exactly what is a WOTUS that is subject to federal regulation has been less than clear for many years and that uncertainty has resulted in a great deal of litigation. In 2006, the U.S. Supreme Court had a chance to clarify the matter but failed. Rapanos v. United States, 547 U.S. 715 (2006). In subsequent years, the Environmental Protection Agency (EPA) attempted to exploit that lack of clarity by expanding the regulatory definition of a WOTUS.
2014 proposed regulation. In March of 2014, the EPA and the COE released a proposed rule defining “waters of the United States” (WOTUS) in a manner that would significantly expand the agencies’ regulatory jurisdiction under the CWA. Under the proposed rule, the CWA would apply to all waters which have been or ever could be used in interstate commerce as well as all interstate waters and wetlands. In addition, the proposed WOTUS rule specifies that the agencies’ jurisdiction would apply to all “tributaries” of interstate waters and all waters and wetlands “adjacent” to such interstate waters. The agencies also asserted in the proposed rule that their jurisdiction applies to all waters or wetlands with a “significant nexus” to interstate waters.
Under the proposed rule, “tributaries” is broadly defined to include natural or man-made waters, wetlands, lakes, ponds, canals, streams and ditches if they contribute flow directly or indirectly to interstate waters irrespective of whether these waterways continuously exist or have any nexus to traditional “waters of the United States.” The proposed rule defines “adjacent” expansively to include “bordering, contiguous or neighboring waters.” Thus, all waters and wetlands within the same riparian area of flood plain of interstate waters would be “adjacent” waters subject to CWA regulation. “Similarly situated” waters are evaluated as a “single landscape unit” allowing the agencies to regulate an entire watershed if one body of water within it has a “significant nexus” to interstate waters.
The proposed rule became effective as a final rule on August 28, 2015 in 37 states and became known as the “2015 WOTUS rule.”
2015 court injunction and 2016 Sixth Circuit ruling. On October 9, 2015, the U.S. Court of Appeals for the Sixth Circuit issued a nationwide injunction barring the rule from being enforced anywhere in the U.S. Ohio, et al. v. United States Army Corps of Engineers, et al., 803 F.3d 804 (6th Cir. 2015). Over 20 lawsuits had been filed at the federal district court level. On February 22, 2016, the U.S. Court of Appeals for the Sixth Circuit ruled that it had jurisdiction to hear the challenges to the final rule, siding with the EPA and the U.S. Army Corps of Engineers that the CWA gives the circuit courts exclusive jurisdiction on the matter. The court determined that the final rule is a limitation on the manner in which the EPA regulates pollutant discharges under CWA Sec. 509(b)(1)(E), the provision addressing the issuance of denial of CWA permits (codified at 33 U.S.C. §1369(b)(1)(E)). That statute, the court reasoned, has been expansively interpreted by numerous courts and the practical application of the final rule, the court noted, is that it impacts permitting requirements. As such, the court had jurisdiction to hear the dispute. The court also cited the Sixth Circuit’s own precedent on the matter in National Cotton Council of America v. United States Environmental Protection Agency, 553 F.3d 927 (6th Cir. 2009) for supporting its holding that it had jurisdiction to decide the dispute. Murray Energy Corp. v. United States, Department of Defense, No. 15-3751, 2016 U.S. App. LEXIS 3031 (6th Cir Feb. 22, 2016).
2017 – The U.S. Supreme Court jumps in and the “suspension rule.” In January of 2017, the U.S. Supreme Court agreed to review the Sixth Circuit’s decision. National Association of Manufacturers v. Department of Defense, et al., 137 S. Ct. 811 (2017). About a month later, President Trump issued an Executive Order directing the EPA and the COE to revisit the Clean Water Rule and change their interpretation of waters subject to federal jurisdiction such that it only applied to waters that were truly navigable – the approach taken by Justice Scalia in Rapanos v. United States, 547 U.S. 715 (2006). The EPA and Corps later indicated they would follow the President’s suggested approach, and would push the effective date of the revised Clean Water Rule to two years after its finalization and publication in the Federal Register. In November of 2017, the EPA issued a proposed rule (the “suspension rule”) delaying the effective date of the WOTUS rule until 2020.
2018 developments. In January of 2018, the U.S. Supreme Court ruled unanimously that jurisdiction over challenges to the WOTUS rule was in the federal district courts, reversing the Sixth Circuit’s opinion. National Association of Manufacturer’s v. Department of Defense, No. 16-299, 2018 U.S. LEXIS 761 (U.S. Sup. Ct. Jan. 22, 2018). The Court determined that the plain language of the Clean Water Act (CWA) gives authority over CWA challenges to the federal district courts, with seven exceptions none of which applied to the WOTUS rule. In particular, the WOTUS rule neither established an “effluent limitation” nor resulted in the issuance of a permit denial. While the Court noted that it would be more efficient to have the appellate courts hear challenges to the rule, the court held that the statute would have to be rewritten to achieve that result. Consequently, the Supreme Court remanded the case to the Sixth Circuit, with instructions to dismiss all of the WOTUS petitioners currently before the court. Once the case was dismissed, the nationwide stay of the WOTUS rule that the court entered in 2015 was removed, and the injunction against the implementation of the WOTUS rule entered by the North Dakota court was reinstated in those 13 states.
This “suspension” rule that was issued in November of 2017 was published in the Federal Register on February 6, 2018, and had the effect of delaying the 2015 WOTUS rule for two years. In the interim period, the controlling interpretation of WOTUS was to be the 1980s regulation that had been in place before the 2015 WOTUS rule became effective. The “suspension rule” was challenged in court by a consortium of environmental and conservation activist groups. They claimed that the rule violated the Administrative Procedures Act (APA) due to inadequate public notice and comment, and that the substantive implications of the suspension were not considered which was arbitrary and capricious, and improperly restored the 1980s regulation.
In June of 2018, the federal district court for the southern district of Georgia entered a preliminary injunction barring the WOTUS rule from being implemented in 11 states - Alabama, Florida, Georgia, Indiana, Kansas, Kentucky, North Carolina, South Carolina, Utah, West Virginia and Wisconsin. Georgia v. Pruitt, No. 2:15-cv-79, 2018 U.S. Dist. LEXIS 97223 (S.D. Ga. Jun. 8, 2018). A prior decision by the North Dakota federal district court had blocked the rule from taking effect in 13 states – AK, AZ, AR, CO, ID, MO, MT, NE, NV, NM, ND, SD and WY. North Dakota v. United States Environmental Protection Agency, No. 3:15-cv-59 (D. N.D. May 24, 2016).
In July of 2018, the COE and the EPA issued a supplemental notice of proposed rulemaking. The proposed rule seeks to “clarify, supplement and seek additional comment on” the 2017 congressional attempt to repeal the Obama Administration’s 2015 WOTUS rule. Repeal would mean that the prior regulations defining a WOTUS would become the law again. The agencies are seeking additional comments on the proposed rulemaking via the supplemental notice. The comment period was open through August 13, 2018.
In August of 2018, the court issued its opinion in the “suspension rule” case. The court agreed with the plaintiffs, determining that the content restriction on the scope of the public comments that the agencies levied during the rulemaking process violated the APA, and enjoined the suspension rule on a nationwide basis. South Carolina Conservation League, et al. v. Pruitt, No. 2-18-cv-330-DCN, 2018 U.S. Dist. LEXIS 138595 (D. S.C. Aug. 16, 2018).
In September of 2018, another federal court entered a preliminary injunction against the implementation of the Obama-era WOTUS rule. This time the injunction applied in Texas, Louisiana and Mississippi, and applied until the court resolved the case on the issue pending before it. The court specifically noted that the public’s interest in having the Obama-era WOTUS rule preliminarily enjoined was “overwhelming.” Texas v. United States Environmental Protection Agency, et al., No. 3:15-CV-00162 (S.D. Tex. Sept. 12, 2018).
On December 11, 2018, the EPA and the COE proposed a new WOTUS definition that is narrower than the 2015 WOTUS definition, particularly with respect to streams that have water in them only for short periods of time. Once the new proposed rule is published in the Federal Register, a 60-day comment period will be triggered. That publication date (and comment period and subsequent hearing) has now been delayed by the partial government shutdown.
Whew! What a trek through the WOTUS landscape!
Number 1 - I.R.C. §199A (and the proposed regulations)
In general. At the top of the list for 2018 stands the qualified business income deduction (QBID) of new I.R.C. §199A as created by the Tax Cuts and Jobs Act (TCJA). The QBID is a 20 percent deduction for sole proprietorships and pass-through businesses on qualified business income effective for years 2018-2025. The new deduction makes tax planning and preparation more complex - much more complex and it impacts all farm and ranch businesses in terms of how to structure the business and tax planning to take advantage of the deduction. In addition, a complex formula applies to taxpayers that are deemed “high income” under the provision. The formula causes a re-computation of the deduction and injects additional planning concerns. In addition, a separate computation applies to agricultural cooperatives and their patrons. The wide application of the new provision throughout the economy and the agricultural sector cannot be understated.
Proposed regulations. On August 8, 2018, the Treasury issued proposed regulations concerning the QBID. While some aspects of the proposed regulations are favorable to agriculture, other aspects create additional confusion, and some issues are not addressed at all. One favorable aspect is an aggregation provision that allows a farming operation with multiple businesses (e.g., row-crop; livestock; etc.) and common ownership to aggregate the businesses for purposes of the QBID. This is, perhaps, the most important feature of the proposed regulations with respect to agricultural businesses because it allows a higher income farming or ranching business to make an election to aggregate their common controlled entities into a single entity for purposes of the QBID.
Similar to the benefit of aggregation, farms with multiple entities can allocate qualified W-2 wages to the appropriate entity that employs the employee under common law principles. This avoids the taxpayer being required to start payroll in each entity. Likewise, carryover losses that were incurred before 2018 and that are now allowed in years 2018-2025 will be ignored in calculating qualified business income (QBI) for purposes of the QBID. This is an important issue for taxpayers that have had passive losses that have been suspended under the passive loss rules.
Other areas of the proposed regulations need clarification in final regulations. As for aggregation and common ownership of the entities to be aggregated, the proposed regulations limit family attribution to just the spouse, children, grandchildren and parents. In other words, common ownership is limited to lineal ancestors and descendants. It would be helpful if the final regulations included siblings in the relationship test. Also, one of the big issues for farmers and ranchers operating as sole proprietorships or as a pass-through entity is whether land rental income constitutes QBI. One of the unclear issues under the proposed regulations is whether income that a landlord receives from leasing land to an unrelated party (or parties) under a cash lease or non-material participation share lease may qualifies for the QBID. It may not. Clarity is needed.
The proposed regulations appear to take the position that gain that is “treated” as capital gain is not QBI. This would appear to exclude I.R.C. §1231 gain (such as is incurred on the sale of breeding livestock) from being QBI-eligible. Clarity is needed on this point also. Other areas needing clarification include the treatment of losses and how to treat income from the trading in commodities. In addition, clarification is needed with respect to various issues associated with a trusts and estates.
2018 was another incredibly active year on the ag law and tax front. 2019 looks like it will continue the pace. Stay dialed in to the blog, website, seminars, TV and radio programs to keep up with the developments as they occur.
Tuesday, January 8, 2019
This week I continue the trek through the Top Ten ag law and tax developments of 2018 with the top six developments. Today’s post goes through numbers six, five and four. On Thursday I will turn attention to the remaining top three developments
Number 6 – U.S. Supreme Court Says States Can Collect Sales Tax on Remote Sellers
South Dakota v. Wayfair, Inc., 138 S. Ct. 2080 (2018)
In 2018, the U.S. Supreme Court handed South Dakota a narrow 5-4 win in its quest to collect taxes from online sales. The Court held that the Constitution’s Commerce Clause did not bar South Dakota from statutorily requiring remote sellers without a physical presence in the state to collect and remit sales tax on goods and services that are sold to buyers for delivery inside the state of South Dakota. In so doing, the Court overruled 50 years of Court precedent on the issue.
Historical precedence. In 1967, the U.S. Supreme Court determined that the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States” in holding that Illinois could not subject a mail order seller located in Missouri to use tax where the seller had no physical presence in Illinois. National Bellas Hess, Inc. v. Illinois Department of Revenue, 386 U.S. 753 (1967). In holding the law unconstitutional, the Court reasoned that subjecting the seller’s interstate business to local “variations in rates of tax…and record-keeping requirements” would violate the purpose of the Commerce Clause “to ensure a national economy free from…unjustifiable local entanglements.”
Twenty-five years later, the Court reaffirmed the limitations of the Commerce Clause on state regulatory authority in Quill Corporation v. North Dakota, 504, U.S. 298 (1992). In Quill, the Court held that a mail order house with no physical presence in North Dakota was not subject to North Dakota use tax for “property purchased for storage, use, or consumption within the State.” The Court followed closely its holding in National Bellas Hess, Inc. because doing so “encourage[d] settled expectations and …foster[ed] investment by businesses and individuals.” As applied to internet sales, Quill (which predated the internet) does not exempt all internet sales from state sales taxes – just sales by sellers who don’t have a physical presence in a particular state. National retailers have a presence in many states.
More recently, the Court examined a Colorado “tattletale” law that required out-of-state sellers with no physical presence in the state “to notify…customers of their use tax liability and to report” sales information back to Colorado. Direct Marketing Association v. Brohl, 135 S. Ct. 1124 (2013). The trial court enjoined enforcement of the law on Commerce Clause grounds. On appeal, the Tenth Circuit held that it couldn’t hear the challenge to the law because the Tax Injunction Act (28 U.S.C. §1341) divested it of jurisdiction and the matter belonged in state court and, ultimately, the U.S. Supreme Court. The Tenth Circuit remanded the case for dismissal of the Commerce Clause claims and dissolution of the permanent injunction. The U.S. Supreme Court reversed and remanded the decision of the Tenth Circuit on the jurisdiction issue and, on remand, the Tenth Circuit, invalidated the Colorado law on Commerce Clause grounds. Direct Marketing Association v. Brohl, 814 F.3d 1129 (10th Cir. 2016).
South Dakota Legislation. S.B. 106 was introduced in the 2016 South Dakota legislative session. It requires the collection of sales taxes from certain remote sellers – those with “gross revenue” from sales in South Dakota of over $100,000 per calendar year or with 200 or more “separate transactions” in the state within the same timeframe. After S.B. 106 was signed into law, the state Department of Revenue soon thereafter began issuing notices to sellers that it thought were in violation of the law. Several out-of-state sellers that received notices did not register for sale tax licenses as the law required, and the state took legal action against them. The result was that the South Dakota Supreme Court invalidated S.B. 106 on Commerce Clause grounds based on the U.S. Supreme Court precedent referenced above. The U.S. Supreme Court agreed to hear the case.
U.S. Supreme Court decision. Article I, Section 8 of the U.S. Constitution says that, “The Congress shall have the power...to regulate commerce…among the several states…”. That was the key point of the Court’s 1967 Bellas Hess, Inc. decision. As noted above, in that case the Court stated that the Commerce Clause grants “exclusive authority [to] Congress to regulate trade between the States.” Apparently, that is not the case anymore, at least according to the majority in Wayfair – Justices Kennedy, Thomas, Ginsburg, Alito and Gorsuch. Under the new interpretation of the Commerce Clause, states can impose sale tax obligations on businesses that have no physical presence in the state. But is that completely true? Can the Court’s opinion be construed as giving the states a “blank check” to tax out-of-state businesses? Maybe not.
In Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), the Court ruled that a state tax would be upheld if it applied to an activity having a substantial nexus with the state; was fairly apportioned; did not discriminate against interstate commerce; and, was fairly related to the services that the state provided. Later, in the Quill case, the Court determined that a physical presence in the taxing jurisdiction was what satisfied the Brady “substantial nexus” requirement.
In Wayfair, the Court determined that a “substantial nexus” could be present without the party subjected to tax having a physical presence in the taxing jurisdiction. But, the key point is that the “substantial nexus” test of Brady remains. Likewise, the other three requirements of Brady remain – fair apportionment; no discrimination against interstate commerce, and; fairly related to services that the state provides. In other words, taxing a business without a physical presence in the state cannot unduly burden interstate commerce. The Wayfair majority determined that the South Dakota law satisfied these tests because of the way it was structured – limited application (based on transactions or dollars of sales); not retroactive; the state was a member of the Streamlined Sales and Use Tax Agreement; the sellers at issue were national businesses with a large online presence; and South Dakota provided tax software to ease the administrative burden.
Implications. Presently, 23 states are “full members” of the Streamlined Sales and Use Tax Agreement. For those states, the Wayfair majority seemed to believe that had the effect of minimizing the impact on interstate commerce. Also, it would appear that any state legislation would have to have exceptions for small businesses with low volume transactions and sales revenue. That’s an important point for many rural businesses that are selling online. Whether a series LLC (in some states such as Iowa) or subsidiaries of a business could be created, each with sales below the applicable threshold, remains to be seen.
Post Wayfair, where will the line be drawn? Wayfair involved state sales tax. Will states attempt to go after a portion of business income of the out-of-state business via income tax? That seems plausible. However, the Interstate Income Act of 1959 (15 U.S.C. §381-384), requires that a business (or individual) have some sort of connection with a state before its income can be taxed (at least with respect to the solicitation of orders for tangible personal property). Is that legislation now unconstitutional too? Or, is there a distinction remaining between taxing receipts as opposed to income? Only time will tell.
Number 5 - Discharges of “Pollutants” To Groundwater
Hawai’i Wildlife Fund v. Cty. of Maui, 881 F.3d 754 (9th Cir. 2018); Upstate Forever, et al. v. Kinder Morgan Energy Partners, LP, et al., 887 F.3d 637 (4th Cir. 2018); Tennessee Clean Water Network v. Tennessee Valley Authority, 905 F.3d 436 (6th Cir. 2018),
Background. 2018 saw a great deal of litigation on the issue of whether the discharge of a “pollutant” into groundwater requires a discharge permit under the Clean Water Act (CWA). Often, the courts have deferred to the EPA position that a point source discharge of a pollutant to groundwater that is hydrologically connected to a “Water of the United States” (WOTUS) is subject to the CWA. However, some courts take the position that a discharge, to be subject to the CWA, must be directed from a point source to a WOTUS. It’s a big issue for agriculture, particularly irrigation crop agriculture.
Ninth Circuit opinion. Early in the year, the U.S. Court of Appeals for the Ninth Circuit said that at least some discharges into groundwater are a CWA-covered event. In the case, the defendant owned and operated four wells at the Lahaina Wastewater Reclamation Facility (LWRF), which is the principal municipal wastewater treatment plant for a city. Although constructed initially to serve as a backup disposal method for water reclamation, the wells have since become the defendant’s primary means of effluent disposal into groundwater and, ultimately, the Pacific Ocean. The LWRF receives approximately 4 million gallons of sewage per day from a collection system serving approximately 40,000 people. That sewage is treated at LWRF and then either sold to customers for irrigation purposes or injected into the wells for disposal. The defendant injects approximately 3 to 5 million gallons of treated wastewater per day into the groundwater via its wells. The defendant conceded, and its expert, confirmed that wastewater injected into wells 1 and 2 enters the Pacific Ocean. In addition, in June 2013 the EPA, the Hawaii Department of Health, the U.S. Army Engineer Research and Development Center, and researchers from the University of Hawaii conducted a study on wells 2, 3 and 4. The study involved placing tracer dye into Wells 2, 3, and 4, and monitoring the submarine seeps off Kahekili Beach to see if and when the dye would appear in the Pacific Ocean. This study, known as the Tracer Dye Study, found that 64% of the treated wastewater from wells 3 and 4 discharged into the ocean.
The plaintiff sued, claiming that the defendant was in violation of the Clean Water Act (CWA) by discharging pollutants into navigable waters of the United States without a CWA National Pollution Discharge Elimination System (NPDES) permit. The trial court agreed, holding that an NPDES permit was required for effluent discharges into navigable waters via groundwater.
On appeal, the appellate court held that the wells were point sources that could be regulated through CWA permits despite the defendant’s claim that an NPDES permit was not required because the wells discharged only indirectly into the Pacific Ocean via groundwater. Specifically, the appellate court held that “a point source discharge to groundwater of “more than [a] de minimis” amount of pollutants that is “fairly traceable from the point source . . . such that the discharge is the functional equivalent of a discharge into a navigable water” is regulated under the CWA.” The appellate court reached this conclusion by citing cases from other jurisdictions that determed that an indirect discharge from a point source into a navigable water requires an NPDES discharge permit. The defendant also claimed its effluent injections are not discharges into navigable waters, but rather were disposals of pollutants into wells, and that the CWA categorically excludes well disposals from the permitting requirements. However, the appellate court held that the CWA does not categorically exempt all well disposals from the NPDES requirements because doing so would undermine the integrity of the CWA’s provisions. Lastly, the plaintiff claimed that it did not have fair notice because the state agency tasked with administering the NPDES permit program maintained that an NPDES permit was unnecessary for the wells. However, the court held that the agency was actually still in the process of determining if an NPDES permit was applicable. Thus, the court found the lack of solidification of the agency’s position on the issue did not affirmatively demonstrate that it believed the permit was unnecessary as the defendant claimed. Furthermore, the court held that a reasonable person would have understood the CWA as prohibiting the discharges, thus the defendant’s due process rights were not violated.
EPA action. After the Ninth Circuit issued its opinion, the EPA, on February 20, 2018, requested comment on whether pollutant discharges from point sources that reach jurisdictional surface waters via groundwater may be subject to Clean Water Act (“CWA”) regulation. Specifically, EPA seeks comment on whether EPA should consider clarification or revision of previous EPA statements regarding the Agency’s mandate to regulate discharges to surface waters via groundwater under the CWA. A number of courts have taken the view that Congress intended the CWA to regulate the release of pollutants that reach “waters of the United States” regardless of whether those pollutants were first discharged into groundwater. However, other courts, have taken the view that neither the CWA nor the EPA’s definition of waters of the United States asserts authority over ground waters, based solely on a hydrological connection with surface waters. EPA has not stated that CWA permits are required for pollutant discharges to groundwater in all cases. Rather, EPA’s position has been that pollutants discharged from point sources that reach jurisdictional surface waters via groundwater or other subsurface flow that has a direct hydrologic connection to the jurisdictional water may be subject to CWA permitting requirements. As part of its request, EPA sought comments on whether it should review and potentially revise its previous positions. In particular, the EPA sought comment on whether it is consistent with the CWA to require a CWA permit for indirect discharges into jurisdictional surface waters via groundwater. The EPA also seeks comment on whether some or all of such discharges are addressed adequately through other federal authorities, existing state statutory or regulatory programs or through other existing federal regulations and permit programs.
Fourth Circuit opinion. Later in 2018, the U.S. Court of Appeals for the Fourth Circuit largely followed the Ninth Circuit’s approach in a case involving somewhat similar facts. The court held that an ongoing addition of pollutants to navigable waters was sufficient for CWA citizen -suit cases. The plaintiffs, a consortium of environmental and conservation groups, brought a citizen suit under the Clean Water Act (CWA) claiming that the defendant violated the CWA by discharging “pollutants” into the navigable waters of the United States without a required discharge permit via an underground ruptured gasoline pipeline owned by the defendant’s subsidiary. The plaintiff claimed that a discharge permit was needed because the CWA defines “point source pollutant” (which requires a discharge permit) as “any discernible, confined and discrete conveyance, included but not limited to any…well…from which pollutants are or may be discharged.” The trial court dismissed the plaintiffs’ claim.
On appeal, the appellate court held that the court had subject matter jurisdiction under the CWA’s citizen suit provision because the provision covered the discharge of “pollutants that derive from a ‘point source’ and continue to be ‘added’ to navigable waters.” Thus, even though the pipeline was no longer releasing gasoline, it continues to be passing through the earth via groundwater and continued to be discharged into regulable surface waters. This finding was contrary to the trial court’s determination that the court lacked jurisdiction because the pipeline had been repaired and because the pollutants had first passed through groundwater. As such, the appellate court determined that, in accord with the Second and Ninth Circuits, that a pollutant can first move through groundwater before reaching navigable waters and still constitute a “discharge of a pollutant” under the CWA that requires a federal discharge permit. The discharge need not be channeled by a point source until reaching navigable waters that are subject to the CWA. The appellate court did, however, point out that a discharge into groundwater does not always mean that a CWA discharge permit is required. A permit in such situations is only required if there is a direct hydrological connection between groundwater and navigable waters. In the present case, however, the appellate court noted that the pipeline rupture occurred within 1,000 feet of the navigable waters. The court noted that the defendant had not established any independent or contributing cause of pollution.
Sixth Circuit opinion. After the Ninth Circuit and Fourth Circuit decisions, the U.S. Court of Appeals for the Sixth Circuit issued another opinion in 2018 on the groundwater/CWA issue. The Sixth Circuit, in concluded that groundwater is not a point source of pollution under the CWA. The defendant in the case was a utility that burns coal to produce energy. It also produced coal ash as a byproduct. The coal ash was discharged into man-made ponds. The plaintiffs, environmental activist groups, claimed that the chemicals from the coal ash in the ponds leaked into surrounding groundwater where it was then carried to a nearby lake that was subject to regulation under the Clean Water Act (CWA). The plaintiffs claimed that the contamination of the lake without a discharge permit violated the CWA and the Resource Conservation and Recovery Act (RCRA).
The trial court had dismissed the RCRA claim, but the appellate court reversed that determination and remanded the case on that issue. On the CWA claim, the trial court ruled as a matter of law that the CWA applies to discharges of pollutants from a point source through hydrologically connected groundwater to navigable waters where the connection is "direct, immediate, and can generally be traced." The trial court held that the defendant’s facility was a point source because it "channel[s] the flow of pollutants . . . by forming a discrete, unlined concentration of coal ash," and that the Complex is also a point source because it is "a series of discernible, confined, and discrete ponds that receive wastewater, treat that wastewater, and ultimately convey it to the Cumberland River." The trial court also determined that the defendant’s facility and the ponds were hydrologically connected to the Cumberland River by groundwater. As for the defendant’s facility, the trial court held that "[f]aced with an impoundment that has leaked in the past and no evidence of any reason that it would have stopped leaking, the Court has no choice but to conclude that the [defendant’s facility] has continued to and will continue to leak coal ash waste into the Cumberland River, through rainwater vertically penetrating the Site, groundwater laterally penetrating the Site, or both." The trial court determined that the physical properties of the terrain made the area “prone to the continued development of ever newer sinkholes or other karst features." Thus, based on the contaminants flowing from the ponds, the court found defendant to be in violation of the CWA. The trial court also determined that the leakage was in violation of the defendant “removed-substances” and “sanitary-sewer” overflow provisions. The trial court ordered the defendant to "fully excavate" the coal ash in the ponds (13.8 million cubic yards in total) and relocate it to a lined facility.
On further review, the appellate court reversed. The appellate court held that the CWA does not apply to point source pollution that reaches surface water by means of groundwater movement. The appellate court rejected the plaintiffs’ assertion that mere groundwater is equivalent to a discernable point source through which pollutants travel to a CWA-regulated body of water. The appellate court noted that, to constitute a “conveyance” of groundwater governed by the CWA, the conveyance must be discernible, confined and discrete. While groundwater may constitute a conveyance, the appellate court reasoned that it is neither discernible, confined, nor discrete. Rather, the court noted that groundwater is a “diffuse” medium that “travels in all directions, guided only by the general pull of gravity.” In addition, the appellate court noted that the CWA regulates only “the discharge of pollutants ‘to navigable waters from any point source.’” In so holding, the court rejected the holdings of the Ninth Circuit and the Fourth Circuit.
That different conclusion by the Sixth Circuit could prove to be very important for irrigation crop agriculture. It may also mean that the U.S. Supreme Court could be asked to clear up the discrepancy.
Number 4 - Air Emission Reporting for Livestock Operations
Fair Agricultural Reporting Method Act (Farm Act) and Subsequent Litigation
Background. Under the Comprehensive Environmental Response, Compensation, and Liability Act (CERCLA) and the Emergency Planning and Community Right-to-Know Act (EPCRA), the federal government is to be notified when large quantities of hazardous materials are released into the environment. Once notified, the Environmental Protection Agency (EPA) has discretion to take remedial actions or order further monitoring or investigation of the situation. In 2008, the EPA issued a final regulation exempting farms from the reporting/notification requirement for air releases from animal waste on the basis that a federal response would most often be impractical and unlikely. However, the EPA retained the reporting/notification requirement for Confined Animal Feeding Operations (CAFOs) under EPCRAs public disclosure rule.
Various environmental groups sued, challenging the exemption on the basis that the EPA acted outside of its delegated authority to create the exemption. On the other hand, agricultural groups claimed that the retained reporting requirement for CAFOs was also impermissible. The environmental groups claimed that emissions of ammonia and hydrogen sulfide (both hazardous substances under CERCLA) should be reported as part of furthering the overall regulatory objective. The court noted that there was no clear way to best measure the release of ammonia and hydrogen sulfide, but determined that continuous releases are subject to annual notice requirements. The court held that the EPA’s final regulation should be vacated as an unreasonable interpretation of the de minimis exception in the statute. As such, the challenge brought by the agriculture groups to the CAFO carve out was mooted and dismissed. Waterkeeper Alliance, et al. v. Environmental Protection Agency, 853 F.3d 527 (D.C. Cir. 2017).
The court’s order potentially subjected almost 50,000 farms to the additional reporting requirement. As such, the court delayed enforcement of its ruling by issuing multiple stays, giving the EPA additional time to write a new rule. However, on March 23, 2018, President Trump signed into law the Consolidated Appropriations Act of 2018, H.R. 1625. Division S, Title XI, Section 1102 of that law, entitled the Fair Agricultural Reporting Method Act (FARM Act), modifies 42 U.S.C. §9603 to include the EPA exemption for farms that have animal waste air releases. Specifically, 42 U.S.C. §9603(e) is modified to specify that “air emissions from animal waste (including decomposing animal waste) at a farm” are exempt from the CERCLA Sec. 103 notice and reporting requirements. “Animal waste” is defined to mean “feces, urine, or other excrement, digestive emission, urea, or similar substances emitted by animals (including any form of livestock, poultry, or fish). The term animal waste “includes animal waste that is mixed or commingled with bedding, compost, feed, soil or any other material typically found with such waste.” A “farm” is defined as a site or area (including associated structures) that is used for “the production of a crop; or the raising or selling of animals (including any form of livestock, poultry or fish); and under normal conditions, produces during a farm year any agricultural products with a total value equal to not less than $1,000.”
2018 litigation. Relatedly, in late 2018, various environmental groups filed suit in the Federal District Court for the District of Columbia to overturn a USDA/FSA regulation that was issued in 2016 that exempts medium-sized (as redefined) CAFOs from environmental review under the National Environmental Policy Act (NEPA) before receiving FSA loans or loan guarantees. The groups claim that proper procedures were not followed when the rule was developed, and seek to have the rule rescinded and reissued after a determination of the potential impacts of the exemption is made with the reissued rule made subject to a public comment period.
Before the regulation was issued in 2016, the FSA performed Environmental Impact Statement (EIS) reviews to assess the impact of a government loan or loan guarantee to a medium-sized CAFO – defined as a facility holding 350 dairy cows, 500 feedlot cattle, 1250 hogs, 27,500 turkeys, and 50,000 chickens. For those facilities meeting the definition of a medium-sized CAFO, the FSA would undertake an EIS before loans or loan guarantees were approved. The results of the EIS were provided to the public before the USDA/FSA dispersed funds. The EIS process could take many months. Under the 2016 regulation, an EIS is not required unless a particular farm/facility has more than 699 dairy cows, 999 fat cattle, 2,499 hogs, 54,999 turkeys, and 124,999 chickens.
Next time I will go through the biggest three developments in ag law and tax. What do you think they might be?
Friday, January 4, 2019
The journey continues through the biggest developments in agricultural law and taxation for 2018. As I mentioned in Wednesday’s post, these developments are selected based on their impact to ag producers, agribusinesses and associated professional service businesses on a nationwide basis. Today I look at what I view as the Eighth and Seventh most important developments of 2018.
Number 8 – COE Wetland Manuals and Congressional Budget Acts Result in Frozen Dirt Being a “Navigable Wetland”
Tin Cup, LLC v. United States Army Corps of Engineers, 904 F.3d 1068 (9th Cir. 2018).
According to its 1987 Manual for delineating wetlands, before the U.S. Army Corps of Engineers (COE) may assert jurisdiction over an alleged wetland, it must find that the area satisfies the three wetland criteria of hydric soil; predominance of hydrophytic vegetation; and wetland hydrology (soil saturation/inundation). Wetland hydrology under the 1987 Manual requires either the appropriate inundation during the growing season or the presence of a primary indicator. Table 5 of the 1987 Manual indicates a nontidal area is not considered to evidence wetland hydrology unless the soil is seasonally inundated or saturated for 12.5 percent to 25 percent of the growing season. A “growing season” is defined as a season in which soil temperature at 19.7 inches below the surface is above 41 degrees Fahrenheit. The 1987 Manual lists six field hydrologic indicators, in order of decreasing reliability, as evidence that inundation and/or soil saturation has occurred: (1) visual observation of inundation; (2) visual observation of soil saturation; (3) watermarks; (4) drift lines; (5) sediment deposits; and (6) drainage patterns within wetlands.
In 1989, the COE adopted a new manual. The 1989 Manual superseded the 1987 Manual. The delineation procedures contained in the 1989 manual were less stringent. Thus, it became more likely that the COE could determine that a particular tract contained a regulable wetland. This change in delineation techniques caught the attention of the Congress which barred the use of the 1989 Manual via the 1992 Budget Act. Pub. L. No. 102-104, 105 Stat. 510 (Aug. 17, 1991). Specifically, the 1992 Budget Act prohibited the use of funds to delineate wetlands under the 1989 Manual "or any subsequent manual not adopted in accordance with the requirements for notice and public comment of the rulemaking process of the Administrative Procedure Act."
The 1992 Budget Act also required the COE to use the 1987 Manual to delineate any wetlands in ongoing enforcement actions or permit application reviews. In the 1993 Budget Act, the Congress again addressed the issue by stating that, “None of the funds in this Act shall be used to identify or delineate any land as a "water of the United States" under the Federal Manual for Identifying and Delineating Jurisdictional Wetlands that was adopted in January 1989 or any subsequent manual adopted without notice and public comment. Furthermore, the Corps of Engineers will continue to use the Corps of Engineers 1987 Manual, as it has since August 17, 1991, until a final wetlands delineation manual is adopted.” Thus, it was clear that Congress mandated that the COE continue to use the 1987 Manual to delineate wetlands unless and until the COE utilized the formal rulemaking process to change the delineation procedure. While the Congress mandated the use of the 1987 Manual to delineate wetlands, it also appropriated funds to the U.S. Environmental Protection Agency (EPA) to contract with the National Academy of Sciences for a review and analysis of wetland regulation at the federal level. See Department of Veterans Affairs and Housing and Urban Development and Independent Agencies Appropriations Act of 1993, Pub. L. 102-389, 106 Stat. 1571 (Oct. 6, 1992); H.R. Rep. No. 102-710, at 51 (1992); H.R. Conf. Rep. No. 102-902 at 41.
This resulted in a report being published in 1995 containing a suggestion that the 1987 Manual either eliminate the requirement of a “growing season” approach to wetland hydrology or move to a region-specific set of criteria for delineating wetlands. Consequently, the COE began issuing regional “supplements” to the 1987 Manual that provided criteria for wetland delineation that varied across the country. For instance, in the COE’s 2007 Alaska Supplement, the COE eliminated the measure of soil temperature contained in the 1987 Manual and replaced it with “vegetation green-up, growth, and maintenance as an indicator of biological activity occurring both above and below ground.”
In this case, the plaintiff was a closely-held family pipe fabrication company in Alaska that sought to relocate its business for expansion purposes. The plaintiff found a suitable location (a 455-acre tract in North Pole) where it would need to lay gravel and construct buildings as well as a railroad spur. Because gravel is contained within the regulatory definition of “pollutant” under the Clean Water Act (CWA) and because the tract was purportedly a “wetland,” the plaintiff had to obtain a discharge permit so that it could place gravel fill on the property before starting construction. The plaintiff received a permit in 2004 and, pursuant to that permit, cleared about 130 acres from the site. In 2008, the plaintiff submitted another permit application to place gravel fill on the site. The COE issued a new jurisdictional determination in 2010, concluding that wetlands were present on 351 acres, including about 200 acres of permafrost – frozen soil. The COE granted the plaintiff a discharge permit to place gravel fill on 118 acres, but included mitigation conditions that the plaintiff objected to.
The plaintiff sued on the basis that the COE’s delineation of permafrost as a wetland was improper and, thus, a discharge permit was not necessary. The COE delineated the permafrost on the tract as wetland based on its 2008 Alaska Supplement. U.S. Army Corps of Engineers, Regional Supplement to the Corps of Engineers Wetland Delineation Manual: Alaska Region (Version 2.0) (Sept. 2007). However, the COE’s 1987 Manual specifically excludes permafrost from the definition of a wetland. The plaintiff argued that the Congress had instructed the COE to continue to use the wetland delineation standards in the 1987 Manual until the COE adopted a “final wetland delineation manual” as set forth in the 1992 and 1993 Budget Acts, as noted above. Thus, because permafrost does not have the required “growing season” (it never reached 41 degrees Fahrenheit at a soil depth of 19.7 inches) it cannot be a wetland. The plaintiff pointed out that by virtue of the issuance of regional supplements to the 1987 Manual, the COE had expanded its jurisdiction over private property by modifying the definition of a “wetland.” Key to the plaintiff’s argument was the point that the Supplement was not a new manual that had been developed in accordance with the formal rulemaking process (e.g., notice, comment, and public hearing). It also was never submitted to the Congress and the Government Accountability Office which, the plaintiff noted, the Congressional Review Act requires before any federal governmental agency rule can become effective. 5 U.S.C. Ch. 8, Pub. L. No. 104-121, §201.
The trial court ruled against the plaintiff, holding that the COE could rely on the 2008 Supplement when delineating a wetland and determining its jurisdiction. The trial court determined that the Budget Acts have no force beyond the funds that they appropriate. That meant that the COE could delineate wetlands in accordance in whatever manner it determined – the 1987 Manual or any subsequent Manual or supplemental guidance that it issued. On appeal, the appellate court affirmed, holding that the 1993 Budget Act did not require the COE to continue using the 1987 Manual to delineate wetlands. The appellate court stated that there is a “very strong presumption” that if an appropriations act changes substantive law, it does so only for the fiscal year for which the bill is passed” unless there is a clear statement of futurity. Because the 1993 Budget Act contained no such statement, the Court held that the requirement for use of the definition of a growing season in accordance with the 1987 Manual expired at the end of the 1993 fiscal year.
The appellate court allowed the COE to expand its jurisdiction over wetlands. That inserts more uncertainty into the already murky legal status of WOTUS. Perhaps in 2019, the U.S. Supreme Court will hear the case. It’s an important one in terms of holding government agencies accountable to the will of the Congress.
Number 7 – To Be “Critical Habitat” Under the ESA, the Habitat Must Be Habitable
Weyerhaeuser Co. v. United States Fish & Wildlife Service, 139 S. Ct. 361 (2018), rev’g., Markle Interests, L.L.C. v. United States Fish & Wildlife Service, 827 F.3d 452 (5th Cir. 2016)
Under the Endangered Species Act (ESA), when a species of plant or animal is listed as endangered or threatened, the Secretary of the Interior must consider whether to designate critical habitat for the species. “Critical habitat” is the specific area within the geographical range occupied by the species at the time of listing that is essential to the conservation of the species. Critical habitat may also include specific areas outside the geographical area occupied by the species at the time it is listed if the USFWS determines that such areas are essential for conservation of the species. It can also include presently “unoccupied critical habitat.” But, must a designated habitat area be an area where the endangered or threatened species can survive? If not, then even more private land could be subjected to regulation under the ESA. The issue made it all the way to the U.S. Supreme Court in 2018.
In 2001, the U.S. Fish and Wildlife Service (USFWS) listed the dusky gopher frog as an endangered species. Among the areas designated as critical habitat was a 1,544-acre site in Louisiana where the frog species had last been seen in 1965. While that acreage was largely comprised of closed-canopy timber, it contained five ephemeral ponds and the USFWS believed that the tract met the statutory definition of “unoccupied critical habitat” because it could be a prime breeding ground for the frog.
The plaintiff owned part of the 1,544-acre tract and leased the balance from a group of landowners that had plans for development of the portion of the tract that they owned. Those development improvements could amount to over $30 million (in timber farming and development) if the USFWS barred all development on the tract. But, according the USFWS, that potential lost economic value would not be “disproportionate” to the conservation benefits of the designation. Consequently, the USFWS decided to not exclude the 1,544-acre tract from the frog’s critical habitat.
The plaintiff and the landowners sued to vacate the designation on the basis that the tract couldn’t be designated as critical habitat because it hadn’t been habitat for the frog since 1965 and couldn’t be habitat without significant modification. The plaintiff also challenged the USFWS decision baes on the cost/benefit calculation. However, the trial court upheld the designation on the basis that the tract fit the definition of “unoccupied critical habitat” essential for the frog’s conservation.
On appeal, the U.S. Court of Appeals for the Fifth Circuit affirmed on the basis that that definition of “critical habitat” did not require “habitability.” The appellate court also determined that the decision of the USFWS was not subject to judicial review. On further review, the Supreme Court unanimously reversed 8-0 (Justice Kavanaugh did not participate). The Court pointed out that to be “critical habitat,” the designated area must first be “habitat.” Indeed, the Court pointed out that once a species is designated as endangered, the Secretary must designate the habitat of the species which is then considered to be critical habitat. 16 U.S.C. §1533(a)(3)(A)(i). That also applied in the context of unoccupied critical habitat that is determined to be essential for conservation of the species – the area must be “habitat.”
Because the appellate court did not interpret the term “habitat” (the appellate court simply concluded that “critical habitat” was not limited to areas that were “habitat”), the Supreme Court vacated the appellate court’s opinion and remanded on this issue. The Supreme Court also disagreed with the appellate court’s holding that the determination of the USFWS to not exclude the tract as critical habitat was not subject to judicial review. The Supreme Court noted that the plaintiff’s claim involving the alleged improper weighing of costs and benefits of the designation as critical habitat was the type of claim that the federal court’s routinely review when determining whether to set aside an agency decision as an abuse of discretion. Thus, the Supreme Court also vacated this part of the appellate court’s decision and remanded on the issue.
The Court’s decision is a big “win” for agriculture and private landowners in general.
We will continue the journey through the remainder of the “Top Ten of 2018” next week. Six more developments to go.
Wednesday, January 2, 2019
In today’s post I continue the series of the biggest developments in agricultural law and taxation for 2018. These developments are selected based on their impact to ag producers, agribusinesses and associated professional service businesses on a nationwide basis. Today I look at what I view as the Tenth and Ninth most important developments of 2018.
Number 10 - Management Activities and the Passive Loss Rules
Robison v. Comr., T.C. Memo. 2018-88
In recent years, the IRS has shown an increased focus on business activities that it believes are being engaged in without an intent to make a profit. Absent a profit intent, the “hobby loss” rules apply and limit deductions to the amount of income from the activity. But, engaging in an activity with a profit intent may not be enough to fully deduct losses from the activity. That’s particularly the case if the taxpayer hires a paid manager to run the operation. In that situation, the IRS may claim that the taxpayer is not materially participating in the activity under the passive loss rules. If the IRS prevails on that argument, loss deductions are severely limited, if not eliminated.
Robison v. Comr., T.C. Memo. 2018-88 involved both the hobby loss rules and the passive loss rules. While the petitioners’ ranching activity was deemed not to be a hobby, the court believed that the taxpayer was not materially participating in the activity. That triggered the application of the passive loss rules.
The petitioners deducted their losses from their ranching activity annually starting in 1999 and were audited by the IRS in 2004 and 2008. Each of those audits concluded with an IRS determination that the petitioners were conducting a trade or business with profit intent (e.g., the activity was not a hobby). In 2010, the petitioners shifted the ranch business activity from horses to cattle. The cattle operation was strictly grass-fed, with the cattle grazing upper-elevation Bureau of Land Management (BLM) land during the summer months. The petitioners negotiated the lease contracts with the BLM. They also hired a full-time ranch manager to manage the cattle. However, the petitioners managed the overall business of the ranch. From 2013-2015, the losses from the ranch declined each year.
The IRS initiated a third audit and claimed that the ranching activity was a “hobby,” and also raised the alternative argument that the petitioners failed to satisfy the material participation test of the passive loss rules. The Tax Court determined that the ranching activity was not a hobby based on the nine factors set forth in Treas. Reg. §1.183-2. However, the court determined that the petitioners had failed to satisfy the material participation test of the passive loss rule. The losses were, therefore, passive and only deductible in accordance with those rules. The court determined that only two of the seven tests for material participation were relevant – the 500-hour test (Treas. Reg. §1.469-5T(a)(1) and the facts and circumstances test (Treas. Reg. §1.469-5T(a)(7)). As for the 500-hour test, the court took issue with the manner in which the petitioners documented their time spent on the ranching activity. The court opined that their logs were merely estimates of time spent on ranch activities that were created in preparation for trial and didn’t substantiate their hours of involvement.
As for the facts and circumstances test, the court determined that the petitioners could not satisfy the test because of the presence of the paid ranch manager. The court made no distinction between the cattle grazing activity which the ranch manager was responsible for and the overall business operations for which the petitioners were responsible. Indeed, on the material participation issue, due to the presence of the ranch manager, all of the personal actions and involvement of the petitioners on which the court based its determination of their profit motive were dismissed as “investor” hours. Treas. Reg. §1.469-5T(b)(2)(ii)(A).
Combining the passive loss rules with a hobby loss argument is not a new tactic for the IRS (it was recently utilized with respect to a Kansas ranch), but the Robison decision certainly indicates that it can be expected to be used more frequently.
The result in Robison is that the losses will only be deductible to the extent of passive income from the activity. Otherwise, the losses remain suspended until the petitioners dispose of their entire interest in the activity in a fully taxable transaction to an unrelated party. I.R.C. §469(g).
Number 9 - Court Orders Chlorpyrifos Registrations Canceled
In August, a federal appellate court ordered the EPA to revoke all tolerances and cancel all registrations for chlorpyrifos. League of United Latin American. Citizens v. Wheeler, 899 F.3d 814 (9th Cir. 2018). The revocation and cancellation was to occur within 60-days of the court’s decision. Chlorpyrifos is sold under many brand names but is most readily recognized as the primary ingredient in Lorsban insecticide (Dow AgroScience). It targets pests such as soybean aphids and spider mites and corn rootworm. Chlorpyrifos is presently used on approximately 8 million soybean acres in the U.S. (approximately 10 percent of the entire U.S. planted soybean acreage). The EPA has established chlorpyrifos tolerances for 80 food crops in the United States. Those crops include fruits, nuts and vegetables. Chlorpyrifos is the only effective option for control of borers in cherry and peach trees. It is also the only control for ants that affect citrus crops. It is used on approximately 40,000 farms in the U.S.
Certain environmental and activist groups filed a petition in 2007 to force the Environmental Protection Agency (EPA) to revoke food tolerances for chlorpyrifos based on the activists’ concerns over its impact on drinking water and alleged neurological impacts on children. The Federal Food, Drug, and Cosmetic Act authorizes the EPA to regulate the use of pesticides on foods according to specific statutory standards, and grants the EPA a limited authority to establish tolerances for pesticides meeting statutory qualifications. The EPA is also subject to safety standards in exercising its authority to register pesticides under the Federal Insecticide, Fungicide, Rodenticide Act (FIFRA). The EPA took no action.
In 2015, the court issued a ruling regarding a 2015 petition that required the EPA to make a decision by October 31, 2015 on whether or not it would establish food tolerances for chlorpyrifos. The EPA replied that it did not have sufficient data to make a decision and, as a result, would seek to ban chlorpyrifos. In late 2015, the EPA issued a proposed rule to revoke the tolerances. However, the EPA reversed course in 2017 and left the tolerances in place citing inconsistent scientific research findings on neurodevelopmental impacts. The EPA sought more time to make a decision which would allow continued scientific research, and sought a deadline of October of 2022 as a deadline to review the registration status. However, the court denied the request and ordered the EPA to take action by March 31, 2017.
In early 2017, the USDA wrote to the EPA and commented on the EPA’s plan to revoke chlorpyrifos tolerances and the EPA’s underlying risk assessment that was issued in late 2016. In its letter, the expressed grave concerns about the EPA process that led the EPA to publish three wildly different human health risk assessments for chlorpyrifos within two years. The USDA also expressed severe doubts about the validity of the scientific conclusions underpinning EPA’s latest chlorpyrifos risk assessment. Even though use of the activists’ study to derive a point of departure was criticized by the Federal Insecticide Fungicide Rodenticide Act Scientific Advisory Panel, the EPA continued to rely on the activists’ study and paired it with an inadequate dose reconstruction approach. Consequently, the USDA called on the EPA to deny the activists’ petition to revoke chlorpyrifos tolerances. According to the USDA, such a denial would allow the EPA to ensure the validity of its scientific approach as part of the ongoing registration review process, without the excessive pressure caused by arbitrary, litigation-related deadlines.
The activist groups then sought review of the EPA’s administrative review process and the court granted review. The court also vacated its earlier order that EPA take action by March 31, 2017, and instructed the EPA to revoke all tolerances and cancel all registrations of chlorpyrifos within 60 days.
The EPA, however, challenged the court’s jurisdiction on the basis that the administrative process had not been completed. The EPA claimed that §346a(h)(1) of the FFDCA did not clearly state that obtaining a 24 U.S.C. §346a(g)(2)(c) order in response to administrative objections is a jurisdictional requirement. As such the 24 U.S.C. §346(g)(2)(C) administrative process deprived the court of jurisdiction until the EPA issued a response (final determinations) to activist groups’ administrative objections under 24 U.S.C. §346a(g)(2)(C). The court held that 24 U.S.C. §346a(g)(2)(C) was not jurisdictional, but was structured as a limitation on the parties rather than the court. The court also held that this case presented “strong individual interests against requiring exhaustion and weak institutional interests in favor of it.” Accordingly, the activist groups did not need to exhaust their administrative remedies. On the merits, the court held that there was no justification for the EPA's decision in its 2017 order to maintain a tolerance for chlorpyrifos in the face of scientific evidence that its residue on food causes neurodevelopmental damage to children. The court held that the EPA was in direct contravention of the FFDCA and the FIFRA. Apparently, none of the evidence concerning the USDA’s doubts about the validity of the EPA’s health risk assessments and conclusions was before the court.
A biting dissent argued that the appellate courts have no jurisdiction in cases such as this one until the EPA makes a final determination.
The EPA has petitioned for a rehearing with the full Ninth Circuit. The 60-day timeframe for revocation and cancellation is suspended pending the court deciding whether to rehear the case. If a rehearing is not granted, it is anticipated that Trump Administration will ask the U.S. Supreme Court to hear the case. In any event, it appears that Lorsban will be available to producers in 2019 as the legal proceedings continue.
In Friday’s post we will continue our journey through a few more of the Top Ten ag law and tax developments of 2018. What do you think might be coming up next in the list?