Developments in Agricultural Law and Taxation

Overview

Earlier in the year I devoted a blog post to a few current developments in the realm of agricultural law and taxation.  That post was quite popular with numerous requests to devote a post to recent developments periodically.  As a result, I take a break from my series of posts on the passive loss rules to feature some current developments.

Selected recent developments in agricultural law and taxation – that’s the topic of today’s post. 

Bankruptcy

While economic matters remain tough in Midwest crop agriculture and dairy operations all over the country and the projection is for the third-lowest net farm income in the past 10 years, it hasn’t resulted in an increase in Chapter 12 bankruptcy filings.  For the fiscal year ended September 30, 2018, filings nationwide were down 8 percent from the prior fiscal year.  However, the number of filing is still about 25 percent higher than it was in 2014.  The filings, however, are concentrated in the parts of the country where traditional row crops are grown and livestock and dairy operations predominate.  For example, according to the U.S. Courts and reports filed by the Chapter 12 trustees, the states comprising the U.S. Circuit Court of Appeals for the Eighth Circuit (Midwest and northern Central Plains) show a 45 percent increase in Chapter 12 filings when fiscal year 2018 is compared to fiscal year 2017.  The Second Circuit (parts of the Northeast) is up 38 percent during the same timeframe.  Offsetting these numbers are the Eleventh Circuit (Southeast) which showed a 47 percent decline in filings during fiscal year 2018 compared to fiscal year 2017.  The far West and Northwest also showed a 41 percent decline in filings during the same timeframe. 

USDA data indicates some rough economic/financial data.  Debt-to-asset ratios are on the rise and the debt-service ratio (the share of ag production that is used for ag payments) is projected to reach an all-time high.  The current ratio for farming operations is projected to reach an all-time low (but this data has only been kept since 2009).  Unfortunately, the U.S. is very good at infusing agriculture with debt capital.  In addition, there are numerous tax incentives for the seller financing of farmland.  In addition, federal farm programs encourage higher debt levels to the extent they artificially reduce farming risk.  This accelerates economic vulnerability when farm asset values decline.

Recent case.  A recent Virginia case illustrates how important it is for a farmer to comply with all of the Chapter 12 rules when trying to get a Chapter 12 reorganization plan confirmed.  In In re Akers, 594 B.R. 362 (Bankr. W.D. Va. 2019), the debtor owed three secured creditors approximately $350,000 in addition to other unsecured creditors. Two of the secured creditors and the trustee objected to the debtor’s proposed reorganization plan. At the hearing on the confirmation of the reorganization plan, it was revealed that the debtor had not provided any of the required monthly reports. As a result, the court denied plan confirmation and required the debtor to put together an amended plan. The debtor subsequently submitted multiple amended plans, and all were denied confirmation because of the debtor’s inaccurate financial reporting and miscalculation of income and expense. In addition, the current proposed plan was not clear as to how much the largest creditor was to be paid. The creditor had foreclosed, and some payments had been made but the payments were not detailed in the plan. The court denied plan confirmation and denied the debtor’s request to file another amended plan and dismissed the case. The court was not convinced that the debtor would ever be able to put together an accurate and manageable plan that he could comply with, having already had five opportunities to do so. 

Contracts

A recent Iowa case illustrates the need for ag producers to put business agreements in writing.  In Quality Egg, LLC v. Hickmans’s Egg Ranch, Inc., No 17-1690, 2019 Iowa App. LEXIS 158 (Iowa App. Ct. Feb. 20, 2019), the plaintiff, in 2002, entered into an oral contract to sell eggs to the defendant via a formula to determine the price paid for the eggs. The business relationship continued smoothly until 2008, when the plaintiff received a check from the defendant that it determined to be far short of the amount due on the account. Notwithstanding the discrepancy, the parties continued doing business until 2011. In 2014, the plaintiff filed sued to recover the amount due, claiming that the defendant purchased eggs on an open account, and still owed about $1.2 million on that account. The defendant counter-claimed, asserting that the transaction did not involve an open account but simply an oral contract to purchase eggs that had been modified in 2008. Consequently, the defendant claimed that the disputed amount was roughly $580,000, based on the modified oral contract.

The trial court jury found that the ongoing series of transactions for the sale and purchase of eggs was an “open and continuous account” at the time of the short pay, yet still found for the defendant. The plaintiff appealed, asserting that the trial court had erred by allowing oral testimony used to prove the existence of a modified oral contract in violation of the statute of frauds. The appellate court remanded for a new trial on the issue, and the second jury trial in 2017 again found for the defendant. The plaintiff again appealed, asserting the statute of frauds as a defense. The plaintiff also asserted that the trial court had failed to instruct the jury on an open account, depriving the jury of the ability to decide the specific elements of its open account claim. The trial court provided only jury instructions on the elements of the breach of contract counter-claim brought by the defendant. On the statute of frauds issue, the appellate court noted that the defendant had admitted written correspondence, checks, and credit statements to support the oral testimony at trial in support of the oral testimony. Thus, the statute of frauds was not violated. However, on the open account jury instruction issue, the appellate court found that the instructions given were improper because the plaintiff’s burden was to prove its claim of money due on an open account, not to disprove an assertion from the defendant of an amended oral contract. The appellate court found that the instructions never mentioned an open account or discussed an open account in any way, and because of that, the jury was never able to render a proper verdict on the plaintiff’s claim. Accordingly, the appellate court concluded that the jury instructions were insufficient and reversed and remanded for a new trial limited to the open-account claim.

Get it in writing! 

Taxation

The qualified business income deduction (QBID) continues to bedevil the tax software programs.  It’s the primary reason that the IRS extended the March 1 filing deadline to April 15.  The IRS also released a draft Form 8995 to use in calculating the QBID for 2019 returns.  But, the actual calculation of the QBID is not that complicated.  The difficult part is knowing what is QBI and whether the specified service trade or business limits apply.  No worksheet is going to help with that.  Understand the concepts!  Also, the IRS now says that a PDF attachment of the safe harbor election for rental activities must be combined with the e-filed return.  In addition, the election must be signed under penalty of perjury.  As I see it, this is just another reason to not use the QBID safe harbor election if you don’t have to.   

The U.S. Senate is finally working on tax extender legislation that will extend provisions that expired at the end of 2017.  The legislation would extend those expired provisions for two years, 2018-2019.  The Senate Finance Committee has released a summary of the proposed bill language:  https://www.finance.senate.gov/imo/media/doc/Tax%20Extender%20and%20Disaster%20Relief%20Act%20of%202019%20Summary.pdf

Court says that “Roberts tax” is a non-dischargeable priority claim in bankruptcy.  United States v. Chesteen, No. 18-2077, 2019 U.S. Dist. LEXIS 29346 (E.D. La. Feb. 25, 2019). The debtor filed Chapter 13 bankruptcy. The IRS filed a proof of priority claim for $5,100.10, later amending the claim to $5,795.10 with $695 of that amount being an excise tax under I.R.C. §5000A as a result of the debtor’s failure to maintain government mandated health insurance under Obamacare. The debtor object to the $695 amount being a priority claim that could not be discharged, and the bankruptcy court agreed, finding that the “Roberts Tax” under Obamacare was not a priority claim, but rather a dischargeable penalty in a Chapter 13 case. On appeal, the appellate court reversed. The appellate court noted that the creditor bore the burden to establish that the Roberts Tax was a priority claim and noted that it was the purpose and substance of the statute creating the tax that controlled whether the tax was a tax or a penalty. The appellate court noted that a tax is a pecuniary burden levied for the purpose of supporting government while a monetary penalty is a punishment for an unlawful act or omission. On this point, the appellate court noted that Chief Justice Roberts, in National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), upheld the constitutionality of Obamacare on the basis that the “shared responsibility payment” was a tax paid via a federal income tax return and had no application to persons who did not pay federal income tax. The appellate court noted that the amount was collected by the IRS and produced revenue for the government. It also did not punish an individual for any unlawful activity and, the appellate court noted, the IRS has no criminal enforcement authority if a taxpayer failed to pay the amount. 

Court says that the IRS can charge for PTINs.In 2010 and 2011, the Treasury Department developed regulations that imposed certain requirements that an individual had to comply with to be able to prepare tax returns for a fee - a person had to become a “registered tax return preparer.” These previously unregulated persons had to pass a one-time competency exam and a suitability check. They also had to (along with all other preparers) obtain a Preparer Tax Identification Number (PTIN) and paying a user fee to obtain the PTIN. The plaintiff class challenged the authority of the government to require a PTIN and charge a fee for obtaining it. The IRS claimed that the regulations were necessary for the need to oversee tax return preparers to ensure good service. I.R.C. §6109(a)(4), in existence prior to the regulations at issue, requires a preparer to provide identification and state that the preparer’s social security number shall be used as the required identification. The regulations at issue, however, required preparers to obtain (at a fee paid to the Treasury) a PTIN as the identifying number. Preparers without a PTIN could no longer prepare returns for a fee. The IRS argued that by creating the PTIN requirement, it had created a “thing of value” which allowed it to charge a fee, citing 31 U.S.C. §9701(b). However, the plaintiffs claimed that the PTIN requirements are arbitrary and capricious under the Administrative Procedure Act or, alternatively is unlawful as an unauthorized exercise of licensing authority over tax return preparers because the fee does not confer a “service or thing of value.”

The trial court determined that the IRS can require the exclusive use of a PTIN because it aids in the identification and oversight of preparers and their administration. However, the trial court held that the IRS cannot impose user fees for PTINs. The trial court determined that PTINs are not a “service or thing of value” because they are interrelated to testing and eligibility requirements and the accuracy of tax returns is unrelated to paying a PTIN fee.  Steele v. United States, 260 F. Supp. 3d 52 (D. D.C. 2017).  A prior federal court decision held that the IRS cannot regulate tax return preparers (Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014), thus charging a fee for a PTIN would be the equivalent of imposing a regulatory licensing scheme which IRS cannot do. The trial court determined that prior caselaw holding that the IRS can charge a fee for a PTIN were issued before the Loving decision and are no longer good law.

On appeal, the appellate court vacated the trial court’s decision and remanded the case. The appellate court determined that the IRS does provide a service in exchange for the PTIN fee which the court defined as the service of providing preparers a PTIN and enabling preparers to place the PTIN on a return rather than their Social Security number and generating and maintaining a PTIN database. Thus, according to the appellate court, the PTIN fee was associated with an “identifiable group” rather than the public at large and the fee was justified on that ground under the Independent Offices Appropriations Act. The appellate court also believed the IRS claim that the PTIN fee improves tax compliance and administration. The appellate court remanded the case for further proceeding, including an assessment of whether the amount of the PTIN fee unreasonable exceeds the costs to the IRS to issue and maintain PTINs. Montrois, et al. v. United States, No. 17-5204, 2019 U.S. App. LEXIS 6260 (D.C. Cir. Mar. 1, 2019), vac’g,. and rem’g., Steele v. United States, 260 F. Supp. 3d 52 (D. D.C. 2017).

Sanders (and Democrat) transfer tax proposals.  The Tax Cuts and Jobs Act (TCJA) increased the exemption equivalent of the federal estate and gift tax unified credit to (for 2019) $11.4 million.  Beginning for deaths occurring and for gifts made in 2026, the $11.4 million drops to the pre-TCJA level ($5 million adjusted for inflation).  That will catch more taxpayers.  This is, of course, if the Congress doesn’t change the amount before 2026.  S. 309, recently filed in the Senate by Presidential candidate Bernie Sanders provides insight as to what the tax rules impacting estate and business planning would look like if he (or probably any other Democrat candidate for that matter) were ever to win the White House and have a compliant Congress. The bill drops the unified credit exemption to $3.5 million and raises the maximum tax rate to 77 percent (up from the present 40 percent.  It would also eliminate entity valuation discounts with respect to entity assets that aren’t business assets, and impose a 10-year minimum term for grantor retained annuity trusts.  In addition, the bill would require the inclusion of a grantor trust in the estate of the owner and would limit the generation-skipping transfer tax exemption to a 50-year term.  The present interest gift tax exclusion would also be reduced from its present level of $15,000.

Conclusion

These are just a snippet of the many developments in agricultural taxation and law recently.  Of course, you can find more of these developments on the annotation pages of my website – www.washburnlaw.edu/waltr.  I also use Twitter to convey education information.  If you have a twitter account, you can follow me at @WashburnWaltr.  On my website you will also find my CPE calendar.  My national travels for the year start in earnest later this week with a presentation in Milwaukee.  Later this month finds me in Wyoming. Also, forthcoming soon is the agenda and registration information for the ag law and tax seminar in Steamboat Springs, Colorado on August 12-14. Hope to see you at an event this year.

On Wednesday, I resume my perusal of the rental real estate exception of the passive loss rules.  I get a break on the teaching side of things this week – it’s Spring Break week at both the law school and at Kansas State University.