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?