More “Happenings” In Ag Law and Tax

Overview

The law impacts agricultural operations, rural landowners and agribusinesses in many ways.  On a daily basis, the courts address these issues.  Periodically, I devote a post to a “snippet” of some of the important developments.  Today, is one of those days.

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

IRS Rulings on Portability.

Priv. Ltr. Ruls. 201850015 (Sept. 5, 2018); 20152016 (Sept. 21, 2018); 201852018 (Sept. 18, 2018); 201902027 (Sept. 24, 2018); 201921008 (Dec. 19, 2018); 201923001 (Feb. 28, 2019); 201923014 (Feb. 19, 2019); 201929013 (Apr. 4, 2019).    

Portability of the federal estate tax exemption between married couples comes into play when the first spouse dies and the taxable value of the estate is insufficient to require the use of all of the deceased spouse's federal exemption (presently $11.58 million) from the federal estate tax. Portability allows the amount of the exemption that was not used for the deceased spouse's estate to be transferred to the surviving spouse's exemption so that the surviving spouse can use the deceased spouse's unused exemption plus the surviving spouse’s own exemption when the surviving spouse later dies.  Portability is accomplished by filing Form 706 in the deceased spouse’s and is for federal estate tax purposes only.  Some states that have a state estate tax also provide for portability at the state level.  That’s an important feature for those states – it’s often the case that a state’s estate tax exemption is much lower than the federal exemption.

Sometimes a tax election is not made on a timely basis.  Over the past year, the IRS issued numerous rulings on portability of the federal estate tax exemption and the election that must be made to port the unused portion of the exemption at the death of the first spouse over to the surviving spouse.  In general, each of the rulings involved a decedent that was survived by a spouse, and the estate did not file a timely return to make the portability election. The estate found out its failure to elect portability after the due date for making the election.  The IRS determined that where the value of the decedent's gross estate was less than the basic exclusion amount in the year of decedent's death (including taxable gifts made during the decedent’s lifetime), “section 9100 relief” was allowed. Treas. Reg. §§301.9100-1; 301.9100-3

The rulings did not permit a late portability election and section 9100 relief when the estate was over the filing threshold, even if no estate tax was owed because of the marital, charitable, or other deductions.   In addition, it’s important to remember that there is a 2-year rule under Rev. Proc. 2017-34, 2017-26 I.R.B. 1282 making it possible to file Form 706 for portability purposes without section 9100 relief

Not Establishing a Lawyer Trust Account Properly Results in Taxable Income. 

Isaacson v. Comr., T.C. Memo. 2020-17. 

Attorney trust accounts are critical to making sure that money given to lawyers by clients or third-parties is kept safe and isn’t comingled with law firm funds or used incorrectly. But most people (even some new lawyers) don’t fully understand attorney trust accounts.  An attorney trust account is basically a special bank account where client funds are stored for safekeeping until time for withdrawal.  The funds function to keep client funds separate from the funds of the lawyer or law firm.  For example, a trust account bars the lawyer from using a client’s retainer fee from being used to cover law firm operating costs unless the funds have been “earned.”  But, whether funds have been “earned” has special meaning when tax rules come into play – think constructive receipt here.  This was at issue in a recent Tax Court case. 

In the case, a lawyer received a contingency fee upon settling a case.  He deposited the funds in his lawyer trust account but did not report the deposited amount in his income for the tax year of the deposit claiming that his fee was in dispute and, thus, subject to a substantial limitation on his rights to the funds.  The IRS disagreed and claimed that the account was not properly established as a lawyer trust account under state (CA) law.  The IRS also pointed out that the petitioner commingled his funds with his clients’ funds which gave him access to the funds.  The IRS also asserted that the petitioner should have reported the amount in income even if he later had to repay some of the amount.  The Tax Court agreed with the IRS on the basis that the lawyer failed to properly establish and use the trust account and because the he had taken the opposite position with respect to the fee dispute in another court action.  The income was taxable in the year the IRS claimed. 

Semi-Trailer in Farm Field Near Roadway With Advertising Subject to Permit Requirement. 

Commonwealth v. Robards, 584 S.W.3d 295 (Ky. Ct. App. 2019).

Counties, towns, municipalities and villages all have various rules when it comes to billboard and similar advertising.  Sometimes those rules can intersect with agriculture, farming activities and rural land.  That intersection was displayed in a recent case.

In the case, the defendant owned farm ground along the interstate and parked his semi-trailer within view from the interstate that had a vinyl banner tied to it that advertised a quilt shop on his property.  The plaintiff (State Transportation Department) issued the defendant a letter telling him to remove the advertising material. The defendant requested an administrative hearing.  The sign was within 660 feet of the interstate and was clearly visible from the interstate. The defendant collected monthly rent of $300 from the owner of the quilt shop for the advertisement. The defendant never applied for a permit to display the banner. The defendant uses the trailer for farm storage and periodically moves it around his property. The administrative hearing resulted in a finding that the trailer was being used for advertising material and an order was adopted stating the vinyl sign had to be removed. The defendant did not appeal this order, but did not remove the banner.  The plaintiff sued to enforce the order. After the filing of the suit, the defendant removed the vinyl sign only to reveal a nearly identical painted-on sign beneath it with the same advertising. The plaintiffs amended their complaint alleging that the painted-on sign was the equivalent of the vinyl sign ordered to be removed and requesting that the trial court order its removal. The trial court found that the trailer with the painted-on sign was not advertising material as the semi-trailer was being used for agricultural purposes and was not an advertisement. The court did concede that the semi-trailer was within 660 feet of the right-of-way of the interstate; was clearly visible to travelers on the highway; had the purpose of attracting the attention of travelers; defendant received a monthly payment for maintaining the sign.  On further review, the appellate court reversed and remanded.  The appellate court concluded that the trailer served a dual purpose of agricultural use and advertising and that there was no blanket exemption for agricultural use.  The trailer otherwise satisfied the statutory definition as an advertisement because of its location, visibility, and collection of rental income. The appellate court concluded that the defendant could use the trailer for agricultural purposes in its current location, but that advertising on it was subject to a permit requirement. 

Lack of Basis Information in Appraisal Summary Dooms Charitable Deduction for Conservation Easement Donation. 

Oakhill Woods, LLC v. Comr., T.C. Memo. 2020-24.

 The tax Code allows an income tax deduction for owners of property who relinquish certain ownership rights via the grant of a permanent conservation easement to a qualified charity (e.g.,  to preserve the eased property for future generations).  I.R.C. §170(h).  But, abuses of the provision are not uncommon, and the IRS has developed detailed rules that must be followed for the charitable deduction to be claimed.  The IRS audits such transactions and has a high rate of success challenging the claimed tax benefits.

In this case, the petitioner executed a deed of conservation easement on 379 acres to a qualified land trust in 2010.  The deed recited the conservation purpose of the easement. The petitioner claimed a $7,949,000 charitable deduction for the donation. Included with the petitioner’s return was an appraisal and Form 8283 which requires, among other things, basis information concerning the gifted property or an attached reasonable cause explanation of why the information was not included with the return. Basis information was not included on Form 8283, and the petitioner attached a statement taking the position that such information was not necessary. The IRS denied the deduction for noncompliance with Treas. Reg. §1.170A-13(c)(2). The Tax Court agreed with the IRS, noting that the lack of cost basis information was fatal to the deduction as being more than a minor and unimportant departure from the requirements of the regulation. The Tax Court cited its prior opinion in Belair Woods, LLC v. Comr., T.C. Memo. 2018-159. The Tax Court also rejected the petitioner’s argument that Treas. Reg. §1.170A-13(c)(4)(i)(D) and (E) was invalid. The petitioner claimed that the basis information was required with the return and not the appraisal summary, but the Tax Court rejected this argument because a “return” includes all IRS forms and schedules that are required to be a part of the return. As such, Form 8283 was an essential part of the return. In addition, the Tax Court noted that the underlying statute absolutely required basis information to be included with the appraisal summary and, in any event, the IRS’ interpretation of the statute via the regulation was reasonable. 

Cram-Down Interest Rate Determined. 

In re Country Morning Farms, Inc., No. 19-00478-FPC11, 2020 Bankr. LEXIS 307 (E.D. Wash. Feb. 4, 2020).

A "cramdown" in a reorganization bankruptcy allows the debtor to reduce the principal balance of a debt to the value of the property securing it.  The creditor is entitled to receive the value, as of the effective date of the plan, equal to the allowed amount of the claim.  Thus, after a secured debt is written down to the fair market value of the collateral, with the amount of the debt in excess of the collateral value treated as unsecured debt which is generally discharged if not paid during the term of the plan, the creditor is entitled to the present value of the amount of the secured claim if the payments are stretched over a period of years.  11 U.S.C. §1129(b)(2)(A).    But, how is present value determined?  The U.S. Supreme Court offered clarity in 2004.  The matter of determining an appropriate discount rate was involved in a recent bankruptcy case involving a Washington dairy operation.

The debtor filed Chapter 11 bankruptcy and couldn’t agree with a creditor (a bank) on the appropriate interest rate to be used in the debtor’s reorganization plan. The parties agreed that the “Prime Plus” method set forth in Till v. SCS Credit Corp., 541 U.S. 465 (2004) was the appropriate method to determine the “cram down” interest rate.” The parties agreed that the prime rate was presently 4.75 percent and that an additional amount as a “risk factor” should be added to the prime rate. The debtor proposed a 6 percent interest rate, based on the risk associated with the dairy business. The bank claimed that the appropriate interest rate was 7.75 percent – the highest rate factor under the Till analysis. The bank cited the length of the plan, the volatility of dairy market, the debtor’s capital structure, and conflicting projections from an expert when determining the appropriate risk factor. The court determined that the appropriate interest rate was 7 percent which raised the interest rate on some of the debtor’s loans and lowering it on others. 

Conclusion

There’s never a dull moment in the world of ag law and ag tax.  These are just a few developments in recent weeks.