Recent Happenings in Ag Law and Ag Tax

Overview

The world of agricultural law and taxation is certainly pertinent in the daily lives of farmers and ranchers.  In recent days and weeks, the courts have addressed more issues that can make a difference for ag producers.  In today’s post, I examine a few of those.  Those discussed today involve individual and entity taxation as well as environmental and regulatory issues.

More recent developments in ag law and tax - it’s the topic of today’s post.

Flow-Through Entities Can Deduct State and Local Taxes

IRS Notice 2020-75, applicable to specified income tax payments made on or after November 9, 2020

In a Notice, the IRS has said that taxes that are imposed on and paid by a partnership (or an S corporation) on its income are allowed as a deduction by the partnership (or S corporation) in computing its non-separately stated taxable income or loss for the tax year of payment. They are not passed through to the partners or shareholders, where they would be subject to the $10,000 limitation on state and local tax deductions imposed by the Tax Cuts and Jobs Act effective for tax years beginning after 2017.

The IRS did not set a timetable for the issuance of proposed regulations. The IRS issued the Notice in response to some states enacting laws to allow this type of treatment for partnerships and S corporations. Thus, for a flow-through entity to be able to do this for a partnership or S corporation, state law must provide for pass-through entity level taxation. The Notice won't apply unless state law allows this. Merely allowing a pass-through entity to make withholding tax payments on behalf of the owners will not qualify because those withholding tax payments are treated as payments made by the owners and not as payments in satisfaction of the pass -through entity's tax liability. In addition, entities taking advantage of the Notice will reduce allocable taxable income which will, in turn reduce allocable qualified business income for purposes of I.R.C. §199A and, therefore, the qualified business income deduction. 

IRA Distributions Included in Income and Subject to Early Withdrawal Penalty 

Ball v. Comr., T.C. Memo. 2020-152

During 2012 and 2013 the petitioner participated in a SEP-IRA. Chase Bank (Chase) was the custodian. In 2012, he took two distributions from the account totaling over $200,000.  He had the bank deposit the distributions into a Chase business checking account that he had opened in the name of The Ball Investment Account LLC (Ball LLC), of which he was the sole owner and only member. Importantly, Ball LLC was not a retirement account. The petitioner informed Chase that the distributions were early distributions that were not exempt from tax.  The petitioner made real estate loans with the distributed funds. The first loan was repaid in April 2013 with a check payable to "the Ball SEP Account."  The funds were deposited into the SEP-IRA account. He paid off the second loan in installments in 2012 and 2013.  The payments were made with checks made payable to "the Ball SEP Account.”  Chase, as custodian, had no knowledge of or control over the use that Ball LLC made of the distributions that were deposited in the Ball LLC business checking account.  Chase also didn’t hold or control any documents related to the loans Ball LLC made. Chase issued the petitioner a Form 1099-R for the 2012 tax year reporting that the petitioner had received taxable distributions from the SEP-IRA of $209,600. While the petitioner reported the distributions on his Form 1040, he did not include them in gross income and reported no tax and no tax liability.  The IRS issued a CP2000 Notice stating that the petitioner had failed to report the distributions from Chase Bank and that he therefore owed $67,031 in tax and a substantial-understatement penalty of $13,406. The petitioner did not respond to the Notice, and the IRS then sent him a notice of deficiency that determined the deficiency, additional tax, and penalty due. The Tax Court determined that the petitioner had unfettered control over the distributions, rejecting the petitioner’s “conduit agency arrangement” argument. The Tax Court determined that Ball LLC was not acting as an agent or conduit on behalf of Chase when Ball LLC received and made use of the distributions. The Tax Court noted that Chase had no knowledge of how the distributed funds were used after they were deposited in the Ball LLC account at the petitioner’s direction and that nothing in the record showed that petitioner, who controlled Ball LLC, did not have unfettered control over the distributions. The Tax Court determined that the facts of his case were analogous to those in Vandenbosch v. Comr., T.C. Memo. 2016-29 and, as a result, Ball LLC was not a conduit for Chase. As a result, the IRS position that the distributions should be included in the petitioner’s income was upheld. In addition, the petitioner had not yet reached age 59.5 which meant that he was liable for the 10 percent early distribution penalty. The Tax Court also upheld the accuracy-related penalty. 

New ESA Definition of “Habitat” 

85 Fed. Reg. 81411 (Dec. 16, 2020), effective, Jan. 15, 2021

In response to the U.S. Supreme Court decision in Weyerhaeuser Co. v. United States Fish and Wildlife Service, 139 S. Ct. 361 (2018), the United States Fish and Wildlife Service (USFWS) has modified the definition of “habitat” for listed species under the Endangered Species Act (ESA). The modification is the first change in the definition since the Endangered Species Act’s (ESA) enactment in 1973. Under Weyerhaeuser, the U.S. Supreme Court held that an area being designated as habitat is a prerequisite for a designation as “critical habitat.”  The regulation defines “habitat” as “the abiotic and biotic setting that currently or periodically contains the resources and conditions necessary to support one or more life processes of a species.” Thus, to be “habitat” an area must already contain the conditions necessary to support the species it is intended to be habitat for. Thus, only those areas which include the environmental conditions that can provide benefits to the species at issue (one seeking either a listed or endangered species) will be eligible for critical habitat designation. 

Federal Government Must Pay Farmers Millions For Army Corps of Engineers' Mismanagement of Missouri River. 

Ideker Farms, Inc. v. United States, No. 14-183L, 2020 U.S. Claims LEXIS 2548 (Fed. Cl. Dec. 14, 2020)

In 2014, 400 farmers along the Missouri River from Kansas to North Dakota sued the federal government claiming that the actions of the U.S. Army Corps of Engineers (COE) led to and caused repeated flooding of their farmland along the Missouri River. The farmers alleged that flooding in 2007-2008, 2010-2011, and 2013-2014 constituted a taking requiring that “just compensation” be paid to them under the Fifth Amendment. The litigation was divided into two phases – liability and just compensation. The liability phase was decided in early 2018 when the court determined that some of the 44 landowners selected as bellwether plaintiffs had established the COE’s liability. In that decision, the court held that the COE, in its attempt to balance flood control and its responsibilities under the Endangered Species Act, had released water from reservoirs “during periods of high river flows with the knowledge that flooding was taking place or likely to soon occur.” The court, in that case, noted that the COE had made other changes after 2004 to reengineer the Missouri River and reestablish more natural environments to facilitate species recovery that caused riverbank destabilization which led to flooding. Ultimately, the court, in the earlier litigation, determined that 28 of the 44 landowners had proven the elements of a takings claim – causation, foreseeability and severity. The claims of the other 16 landowners were dismissed for failure to prove causation. The court also determined that flooding in 2011 could not be tied to the COE’s actions and dismissed the claims for that year.

The present case involved a determination of the plaintiffs’ losses and whether the federal government had a viable defense against the plaintiffs’ claims. The court found that the “increased frequency, severity, and duration of flooding post MRRP [Missouri River Recovery Program] changed the character of the representative tracts of land.” The court also stated that, “ [i]t cannot be the case that land that experiences a new and ongoing pattern of increased flooding does not undergo a change in character.” The court determined that three representative plaintiffs, farming operations in northwest Missouri, southwest Iowa and northeast Kansas, were collectively owed more than $7 million for the devaluation of their land due to the establishment of a “permanent flowage easement” that the COE created which constituted a compensable taking under the Fifth Amendment.

The impact of the court’s ruling means that hundreds of landowners affected by flooding in six states are likely entitled to just compensation for the loss of property value due to the new flood patterns that the COE created as part of its MRRP. 

Conclusion

As 2021 unwinds, more issues will occur, many of which will likely involve estate and business entity planning along with income tax planning.