Friday, November 6, 2020
The courts keep issuing rulings of importance to agricultural producers and others involved in agriculture or who own agricultural land. Also, tax issues of general relevance continue to be resolved in the courts. In today’s post, I take a look at some recent cases involving farm bankruptcy; the “public trust” doctrine; the proper tax classification of a work relationship; on-farm sales of processed beef; and zoning.
A potpourri of ag and tax legal issues – these are the topics of today’s post.
Court Denies Proposed Sale of Land by Chapter 12 Debtor
In re Holthaus, No. 20-40065, 2020 Bankr. LEXIS 3001 (Bankr. D. Kan. Oct. 26, 2020)
The debtors (a married couple) owned farmland in two counties. They filed Chapter 12 bankruptcy and sought to sell three tracts of land through two contracts. 11 U.S.C. §363(b)(1) provides that a trustee "after notice and a hearing, may use, sell or lease, other than in the ordinary course of business, property of the estate." In determining whether to approve a proposed sale under 11 U.S.C. §363, courts generally apply standards that, although stated various ways, represent essentially a business judgment test. The debtors had not filed a reorganization plan at the time of the proposed sale of the land.
The first contract consisted of two parcels totaling 200 acres which would be used as prime cropland. The second contract was for 120 acres of cropland in need of erosion remediation and not eligible for participation in government agricultural programs in its current condition. The debtors claimed that there was an oral agreement to lease the purchased properties back to the debtors for $175 per acre per year after the sale, as well as a right of first refusal if the buyer were to sell the properties, so that the debtors could continue to farm the land. Both contracts were silent as to the amount of rent to be paid and whether the right of first refusal applied to all three of the properties. The debtors proposed to sell the prime cropland for $4,000 per acre, based on a recent sale of another property in the county.
The creditors had mortgage liens on the properties and vigorously opposed the sale of the three properties. The creditors argued that the debtors were undervaluing all three tracts of land. Specifically, the creditors argued that the debtors erred in relying on a past sale in the county to arrive at $4,000 per acre. The creditor argued that the recent sale involved land that included a significant portion of pasture and wasteland, and that the debtors’ land was compromised of high-quality tillable land and no waste. As a result, the creditors argued that the sale price of the prime cropland should be $5,000 per acre.
The bankruptcy court agreed with the creditors and held that the debtors had inadequately priced the prime cropland. However, the bankruptcy court held that the second contract did not undervalue the less desirable cropland. The bankruptcy court noted that although the debtors’ sale did not require satisfaction of outstanding liens, there were significant concerns about some aspects of the proposed sale. First, the debtors’ ability to resume farming would be dependent upon the lease of the three tracts after the sale for rent that would be less than the debtor’s present debt service. Additionally, the debtors’ right to lease would only last as long as the proposed buyer owned the properties. Consequently, the bankruptcy court denied the debtors’ proposed sale primarily due to an inadequate sale price for the prime cropland.
Observation: Clearly, not having the prime cropland exposed to the market through a listing was a problem. If that had been done, there likely would have been testimony (and other evidence) to support the price in addition to the debtor's testimony. Having an appraiser testify could have helped the debtor.
Public Trust Doctrine Inapplicable to Natural Resources Allegedly Harmed by “Climate Change”
I wrote recently about attempts to expand the “public trust” doctrine and the impact such an expansion would have on agricultural production and land ownership. You can read that article here: https://lawprofessors.typepad.com/agriculturallaw/2020/10/the-public-trust-doctrine-a-camels-nose-under-agricultures-tent.html. In that article I discussed a Nevada Supreme Court opinion in which the Court refused to expand the doctrine. Now, the Oregon Supreme Court has likewise refused to expand the doctrine.
In the Oregon case, the plaintiffs claimed that the public trust doctrine required the State of Oregon to protect various natural resources in the state from harm due to greenhouse gas emissions, “climate change,” and ocean acidification. The public trust doctrine has historically only applied to submerged and submersible lands underlying navigable waters as well as the navigable waters. The trial court rejected the plaintiffs’ arguments. On appeal the state Supreme Court affirmed, rejecting the test for expanding the doctrine the plaintiffs proposed. Under that test, the doctrine would extend to any resource that is not easily held or improved and is of great value to the public. The state Supreme Court held that the plaintiffs’ test was too broad to be adopted. The Supreme Court remanded the case to the lower court.
Zoning Ordinance Bars Keeping of Farm Animals
Maffeo v. Winder Borough Zoning Hearing Board, 220 A.3d 1210 (Pa. Commw. Ct. 2019)
The plaintiff owned a two-acre property in an area zoned residential. She kept approximately 50 animals on the property including goats, donkeys, and chickens. The city manager’s office had received numerous noise and odor complaints regarding the animals. The city sent the plaintiff a cease and desist letter giving the plaintiff 20 days to remove the animals. A city ordinance prohibited any person from keeping goats, donkeys, and other farm animals on residentially zoned property. The plaintiff appealed the cease and desist letter to the defendant city, the zoning hearing board. The plaintiff admitted that most of her property was located within a residentially zoned district but argued that a small corner of the property was located in a conservation district allowing for agricultural uses. The zoning board denied the plaintiff’s argument and concluded that although part of the property was zoned for agricultural use, it was undisputed that the plaintiff’s animals were within 200 feet of a residential lot which violated a separate city ordinance.
The trial court affirmed. On appeal, the plaintiff argued the trial court failed to consider evidence that she properly cared for her animals and that her property had not been surveyed. Specifically, the plaintiff argued a letter from the county humane society should have been considered to show she properly cared for her animals. The appellate court held that although the letter was not in the record, both the zoning board and trial court had expressly considered the letter in making their respective rulings. The appellate court noted that the care for the animals was not at issue, but rather whether zoning rules and ordinance permitted the plaintiff to keep farm animals on her property. The appellate court also determined that a zoning survey of the property had been done recently, which showed that most of the property was within a residential district and only a small portion was zoned as conservation. The plaintiff failed to present any evidence to rebut the survey before the hearing board or trial court, therefore the appellate court held that the plaintiff was in violation of the city ordinance. Finally, the plaintiff argued the zoning board was unevenly enforcing its zoning ordinances because a neighbor had testified before the hearing board that he kept chickens on his property and a city officer had told him that doing so did not violate any city ordinance. The appellate court held that this evidence alone was insufficient to establish uneven enforcement without any other evidence presented.
On-Farm Sales of Processed Beef Subject to Sales Tax
Priv. Ltr. Rul. 8115 (Mo. Dept. of Rev., Sept. 25, 2020)
The taxpayer sought a ruling from the Missouri Department of Revenue (MDOR) concerning the sale of beef products from his farm. The taxpayer raises cattle, slaughters them, and then sends the beef out to be processed at a local processing plant. The taxpayer pays the processing plant for its services and then the taxpayer sells the resulting beef products to customers at his farm. The taxpayer’s question was whether the beef sales were subject to sales tax. The MDOR issued a ruling stating that the sales are subject to sales tax at the food tax rate of 1 percent. The MDOR noted that 7 U.S.C. §2012, defines “food” as "any food or food product for home consumption." The taxpayer was selling raw beef at retail for home consumption.
Payments Received By CPA Were Wages and Not S.E. Income; Deductions Disallowed
Thoma v. Comr., T.C. Memo. 2020-67
The petitioner acquired a partial interest in an accounting firm and ultimately became the sole owner of the firm that he operated as a sole proprietorship. The petitioner later went into business with another accountant pursuant to two contracts. One contract purported to be a partnership agreement and the second contract “restated” the first contract. The plaintiff provided accounting services to the firm and also brought his own clients to the firm. He later sold his interest back to the business under an agreement stating that he didn’t retain any management or supervisory role in the business.
During the year of sale of his interest and the following year (2010 and 2011), the business made bi-weekly payments to the petitioner for accounting services. The business issued Schedules K-1 reporting the payments as guaranteed payments to a limited partner with no withholding. The petitioner did not receive any paid sick leave or paid vacation time. The business had a professional liability policy that included the petitioner. The petitioner received a letter from the Department of Justice requesting the records of a client and the petitioner responded to the letter without informing the business. That ultimately resulted in the business locking the petitioner out, barring him from the computer network and placing him on administrative leave and his relationship with the business being terminated.
The petitioner reported his income for 2010 and 2011 as self-employment income allowing him to claim deductions for deposits into his SIMPLE IRA and for health insurance premiums that he paid as well as for one-half of his self-employment tax liability. The IRS disallowed the deductions, recharacterizing the income as wages. That resulted in his expenses being treated as unreimbursed employee expenses deductible only as miscellaneous itemized deductions subject to the two-percent of adjusted gross income floor. Likewise, the petitioner’s health insurance deductions were only deductible as a medical expense deduction and the SIMPLE IRA deduction was disallowed. The IRS also imposed accuracy-related penalties.
The Tax Court agreed with the IRS position, concluding that the petitioner and the other accountant did not intend to carry on a business together or share profit and loss. Thus, they never formed a partnership. The 2010 agreement, the Tax Court determined resulted in an at-will employment arrangement with the petitioner having no management authority. The issuance of the Schedules K-1 were not controlling, but merely a factor in determining the existence of a partnership. The Tax Court also held that the petitioner was not an independent contractor because of the longstanding relationship of the petitioner and the other accountant. The accountant/firm retained the right to fire the petitioner and provided him with professional liability insurance, office space and tax prep software. The firm also retained control over the details of his work and he did not have any opportunity for profit or loss independent of the business. The IRS-imposed penalties were upheld.
The courts again illustrate the numerous legal and tax issues that are relevant for farmers, ranchers rural landowners and taxpayers in general. It’s always a good idea to have competent legal and tax counsel within arm’s reach.