Ag Law and Tax In The Courts

Overview

This month’s installment of court developments concerning agriculture in the courts covers recent developments involving the valuation of a timber enterprise; obtaining a tax refund for an estate due to a financial disability; the calculation of a casualty loss; and the growing of hemp.

Ag law and tax developments in the courts – it’s the topic of today’s post.

Estate Tax Valuation

At issue in Estate of Jones v. Comr., T.C. Memo. 2019-101 were the proper valuations, as of May 28, 2009, of limited partner units in a timber business and stock shares in a sawmill. The decedent died in 2014, having established the sawmill business in 1954 and expanding it substantially since then. The decedent bought about 25,000 acres of timber in 1989 and an additional 125,00 acres in 1992. Later in 1992, the decedent formed the limited partnership to invest in, acquire, hold and manage timberlands and real estate and incur debt. The decedent transferred the timberland, which was considered to be the sawmill’s inventory, to the limited partnership in exchange for an interest in the entity.

The decedent began doing some succession planning in 1996 with the intent of keeping the business in the family as a successful operation. That plan included making gifts of interests in the businesses to family members, including significant blocks of stock. Upon the decedent’s death, the IRS challenged the valuation for gift tax purposes of the 2009 transfers of limited partnership interests and interests of the S corporation that owned the sawmill. Transfer of the limited partnership units was also restricted via a buy-sell agreement that contained a right-of-first refusal. Thus, the determination of fair market value of the 2009 transfers had to account for lack of marketability, lack of control, lack of voting rights of an assignee and reasonably anticipated cash distributions allocable to the gifted interests.

The IRS valued the transfers utilizing a net asset value approach and the estate’s expert used a discounted cash flow approach for both the timberland and the mill. The Tax Court agreed with the valuation arrived at by the estate’s expert, a far lower amount than what the IRS had arrived at. 

There are many underlying details concerning the valuation approaches that I am not discussing here.  The major point is, however, that taking care to follow well-established valuation procedures and keeping good records is essential.  The Tax Court will often adopt the approach that is most precise and is substantiated.

Refund Claims Due To Financial Disability

I.R.C. §6511(h) establishes a statute of limitations for filing a claim for refund due to financial disability. The provision provides “an individual is financially disabled if such individual is unable to manage his financial affairs by reason of a medically determinable physical or mental impairment of the individual which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months.” I.R.C. §6511(a)-(c) specifies that, “In the case of an individual, the running of the periods specified in subsections (a), (b), and (c) shall be suspended during any period of such individual’s life that such individual is financially disabled.”  In Carter v. United States, No. 5:18-cv-01380-HNJ, 2019 U.S. Dist. LEXIS 134035 (N.D. Ala. Aug. 9, 2019) a decedent’s estate sought relief on the basis that the estate’s personal representative was financially disabled for a period of time entitling the estate to file a claim for refund after the time period set forth in I.R.C. §6511(a). The estate claimed that it should be treated as in individual for relief purposes. The estate sought a refund of federal estate tax tied to the value of bank stock that the decedent held at the time of death which made up 45 percent of the gross estate value. Unknown at the time of death was that a fraud had been committed against the bank which ultimately led to the bank being shut down and the stock rendered worthless. The personal representative was traumatized by the events, suffering emotional distress which rendered her unable to manage the estate which was substantiated by a physician who maintained that the representative’s disabilities triggered § 6511(h)’s equitable tolling provision so as to excuse the untimely filing of the refund claim.

The court disagreed with the estate’s position, holding that the term “individual” in I.R.C. §6511(h)(1) did not apply to an estate. The court pointed out that I.R.C. §7701(a)(1) defines a person as “an individual, a trust, estate, partnership, association, company or corporation.” The court reasoned that this made it clear that the Congress saw individuals and estates as distinct types of taxpayers, and the use of the term individual in IRC §6511(h) limited the relief to natural persons. The court also noted that even if the estate’s claim weren’t time-barred, it would fail on its own merits because estate tax value is based on the value as of the date of death or the alternate valuation date of six months after death. Simply because the fact of the bank fraud arose post-death didn’t change the fact that it wasn’t known at the time of death and the stock was being actively traded at death, the measuring date for federal estate tax purposes. 

Calculating a Casualty Loss

While the casualty loss deduction rules have been modified for tax years beginning after 2017, the underlying manner in which a casualty loss is to be computed remains largely the same.  Those rules involve documenting the value of the property before the casualty; determining the value after the casualty; income tax basis; and the amount of insurance proceeds received.  It’s a big issue for agriculture particularly because of the exposure of agricultural property to weather.  A recent Tax Court case illustrates how a casualty loss is computed.

In Taylor II v. Comr., T.C. Memo. 2019-102, the petitioner claimed a casualty loss on his 2008 return for damage from a hurricane. An insurance company paid over $2.3 million in claims, and the claimed deduction was $888,345. The petitioner reported a basis in the property of $6.5 million, insurance reimbursement of $2.3 million and a pre-casualty fair market value of $15,442,059 and a post-casualty fair market value of $12,250,000. The pre-casualty FMV was based on the 2009 listing price of the property reduced for time spent on the market. No testimony was provided as to post-casualty FMV.

The Tax Court (Judge Paris) noted that to compute a casualty loss deduction, the pre and post-FMV values of the impacted property must be computed and the property basis must be established. The Tax Court noted that decline in value can alternatively be established via the regulations under I.R.C. §165 if the taxpayer has repaired the property damage resulting from the casualty, the taxpayer may use the cost of repairs to prove the loss of value to the property from the casualty. In that instance, the taxpayer must show that (a) the repairs are necessary to restore the property to its condition immediately before the casualty, (b) the amount spent for such repairs is not excessive, (c) the repairs do not care for more than the damage suffered, and (d) the value of the property after the repairs does not as a result of the repairs exceed the value of the property immediately before the casualty. The Tax Court noted that the record did not establish that the valuations were based on competent appraisals, and didn’t indicate how the petitioner’s CPAs determined the pre or post-casualty FMV of the property, even though the pre-casualty FMV was consistent with the value reported to the insurance company. The Tax Court concluded that the appraisals were not reliable measures of the taxpayer's casualty loss and didn’t rely on them. In addition, the taxpayer received insurance payments that exceed the cost of repairs. That meant that a casualty loss deduction couldn’t be claimed based on the regulations. The Tax Court disallowed any casualty loss deduction. 

Growing of Hemp

The 2018 Farm Bill allows for hemp (not marijuana) production and allows states and Indian tribes to opt for either primary regulatory authority, or USDA authority over any proposed hemp production. Under the primary authority option, a state may submit its own plan to the U.S. Secretary of Agriculture (Secretary). Once a plan is submitted, the Secretary has 60 days to approve or deny the plan. Under the “USDA option,” hemp can be produced under a plan established by the USDA, but the plan must still be submitted to and approved by the Secretary. The Farm Bill provides that the Secretary has explicit authority to set regulations and guidelines that relate to the implementation to both the primary regulatory authority option or the USDA option. On February 27, 2019, the USDA issued a notice that the agency had begun gathering information to promulgate rules and regulations related to the 2018 Farm Bill and the production of hemp in the United States.

In Flandreau Santee Sioux Tribe v. United States Department of Agriculture, No. 4:19-CV-04094-KES, 2019 U.S. Dist. LEXIS 95188 (D. S.D. Jun. 6, 2019), the plaintiff, an Indian tribe, submitted its own proposed hemp production plan in March of 2019.  The Secretary issued a letter in stating that the plan would be approved or denied within 60 days after hemp production regulations were finalized – likely in the fall of 2019. On May 6, the plaintiffs submitted a letter to USDA requesting a waiver of regulatory requirements so that the plaintiff could plant hemp during the 2019 growing season. A meeting was held to discuss the waiver. Later that month the plaintiff sued for a temporary restraining order or preliminary injunction seeking to force the USDA to grant the hemp planting waiver.

A hearing on the temporary restraining order was held in June. After the hearing, the court denied the plaintiff’s motion. The court determined that the plaintiff’s motion was not yet ripe and that the plaintiff was not likely to ultimately succeed on the merits of its claim. The court noted that the Farm Bill gave the Secretary broad discretion with respect to hemp production. In addition, the 60-day window to approve or reject plans did not begin until the USDA finalized regulations. The court also noted that there was no monetary remedy built into the law because the USDA was not required to pay compensation for economic losses. The court also determined that the plaintiff’s potential economic losses did not outweigh the impact on the USDA if the injunction were to be granted. The court noted that the issuance of an injunction would force the USDA to act before it could carefully lay out the regulations on hemp production. Such haste in allowing production could have detrimental long-term effects. 

Conclusion

There’s never a dull moment in ag law and tax.