Wednesday, July 13, 2022

Durango Conference and Recent Developments in the Courts


On August 1 and 2, Washburn Law School will be hosting a two-day conference on income tax as well as estate and business planning.  Of course, the event emphasizes the application of tax and legal principles to ag producers and rural landowners, but many of the concepts are of general application.  One of the featured sessions at the Durango conference will focus on water rights and how those impact income tax and estate planning for farmers, ranchers and rural landowners.  Of course, throughout the two days we will be covering many issues that apply to clients in a host of possible situations. 

In today’s post, I focus on the Durango water rights session and a few court developments.

Appropriation Water Rights - Tax and Estate Planning Issues (Durango Conference)

This panel session begins with Andy Morehead, an accountant from Eaton, CO, explaining why we are talking about appropriation water rights in tax and estate planning.  The importance of the topic relates to the value of water rights.  Andy will talk about his experience concerning sales and other projects where water rights significantly increased the wealth of individuals, families or entities. 

In Colorado, almost 4,000 wells have been shut in by the State Engineer in the past two decades to maintain streamflow and satisfy downstream priority claims.  A similar number have had their pumping rights limited in some way. Given the rapid development occurring in northeast Colorado and the need for water for the new subdivisions along the front range, there will be major political ramifications if any further reductions are made.  The economic impact is already being felt. A unit (one acre foot) of Colorado Big Thompson storage water now sells for about $65,000.  Approximately 15 years ago, the same volume of water sold for $6,000.  This enhanced value has a significant impact on estates, as does any land with associated water rights.

Following Andy’s opening discussion, John Howe, an attorney in Grand Junction, CO, will follow.  His practice focuses on real estate matters including the leasing of water rights.  John will explain the nature of an appropriation water right, and will also discuss surface rights, tributary and non-tributary groundwater.  John will also address nuances in the adjudication system and the chief engineer’s agency.  Of particular interest to tax practitioners is whether a right to use water is an ownership interest in real property or a right to use water that is personal property.  John will discuss the real/personal property determination. Of course, the focus will be on Colorado, but John may also comment on the real/personal property distinction in adjoining states.  He will also share his experiences with business and succession planning title issues involving water rights and focus on a few of the most common title mistakes made with water right dispositions related to estate planning, divorce, financing and foreclosure, and entity dissolution or division.

Mike Ramsey, a long-time water law practitioner in Garden City, Kansas, will follow John’s discussion by addressing approaches to the valuation of water rights and depletion issues.  Mike will also discuss I.R.C. §1031 exchanges involving disposition of water rights that are interests on real property and other estate tax planning issues associated with water right ownership. 

The Durango conference is going to be a good one that you will want to be a part of, either in-person or online.  For further details about the two-day event click here:

Recent Court Developments

Defendant Properly Sentenced for Falsely Obtaining PPP and EIDL Loans

United States v. Stout, No. 21-1938, 2022 U.S. App. LEXIS 16627 (8th Cir. Jun. 16, 2022)

The defendant was sentenced to 12 months and 1 day in prison followed by 3 years of supervised release and $74,600 in restitution for misrepresenting (along with his wife and his sister) that they owned multiple businesses in order to obtain forgivable Paycheck Protection Program (PPP) loans as well as non-forgivable loans under the Economic Injury Disaster Loan program.  The defendant admitted being the ringleader of the scheme.  The court determined the “intended-loss,” the monetary harm the defendant purposely sought to inflict, was $116,525.56. The amount was calculated using pre-sentence investigation reports. The defendant claimed that his sentence should be reduced on the basis that the trial court should have limited the loss only to the PPP loans. 

The defendant claimed there was no evidence he did not intend to repay the non-forgivable loans, and relied on a 1999 case involving a rancher that misrepresented the number of cattle he owned in order to obtain a loan.  But the rancher in that case took multiple remedial actions to repay the falsely obtained loans such as selling his ranch and equipment, starting a new business, and financing his debt. The appellate court determined that the previous case was not like the defendant’s situation. The defendant provided no evidence that he would do anything to repay the loans and had no businesses that would allow him to repay the loans. The appellate court also concluded that the trial court did not err in considering the defendant’s past fraudulent actions of pawning stolen work computers as a reflection of the defendant’s character.  As a result, the appellate court upheld the trial court’s sentencing determination.

Shareholders Liable for Corporate Tax under “Midco” Transaction. 

Sloan v. Comr., T.C. Memo. 2022-6, on rem. from, 896 F.3d 1083 (9th Cir. 2018), rev’g., T.C. Memo. 2016-115, cert. den., 139 S. Ct. 1348 (2019)

A “Midco” transaction designed to avoid the tax on built-in-gain (BIG) inherent in the appreciation of assets held in a C corporation.  Under a “Midco” transaction the seller engages in a stock sale while the buyer engages in an asset purchase through use of an intermediary company. The sale of stock avoids triggering the BIG tax and the purchaser gets a purchase price income tax basis in the assets.  The IRS, however, often takes the position that the parties engaged in a Midco transaction have tax liability exposure under I.R.C. §6901as a transferee for unpaid taxes and interest on the basis that the selling shareholder.  The IRS could also impose penalties on the transferee parties.  The basic issue is whether the selling shareholder knew or should have known that the intermediary company would incur a tax liability that it had no ability to pay. 

In this case, the petitioners were transferees of C corporate assets via a typical “Midco” transaction where an intermediary company was affiliated with a promoter.  The intermediary company was merely a “shell” company organized offshore that buy the shares of the target company.  The cash of the petitioner’s C corporation (target corporation) flowed through the intermediary to the selling shareholders.  After acquiring the target’s embedded tax liability, the shell company engaged in a transaction purporting to offset the target's realized gains and eliminate the corporate-level tax. The promoter and the target's shareholders then agreed to split the dollar value of the corporate tax that had purportedly been avoided with the promoter keeping as its fee a negotiated percentage of the avoided tax amount. The target's shareholders kept the balance of the avoided corporate tax as a premium above the target's true net asset value (i.e., assets net of accrued tax liability). 

After the transaction there were no assets left in the target corporation and the IRS issued notices of liability to the petitioners as transferees.   In the original Tax Court case, the Tax Court ruled that the petitioners were not liable as transferees on the theory that they and their advisers did not have actual or constructive knowledge of the results of the transaction. On appeal, the appellate court reversed, concluding that the petitioners were at the very least on constructive notice that the entire scheme had no purpose other than tax avoidance. The appellate court also concluded the transfer was a constructively fraudulent transfer under Arizona law.  The U.S. Supreme Court declined to hear the case.  On remand, the Tax Court entered a decision consistent with the IRS’ computations.  Those computations included accuracy-related penalties and IRS recovery of pre-notice interest. 

Iowa Law Providing Limited Nuisance Immunity to CAFOs Upheld

Garrison v. New Fashion Pork LLP, No. 21-0652, 2022 Iowa Sup. LEXIS 86 (Iowa Sup. Ct. Jun. 30, 2022)

The plaintiff claimed that the defendant’s neighboring confined animal feeding operation (CAFO) violated both the Clean Water Act and the Resource Conservation Recovery Act due to manure runoff that caused excessive nitrate levels in the plaintiff’s water sources.  The federal court dismissed the suit on summary judgment for lack of expert testimony to establish the plaintiff’s claim, finding that the alleged violations where wholly past violations, and that water test results showed no ongoing violation of either statute, but rather a slight decrease in nitrate levels since the start of the defendant’s confined animal feeding operation (CAFO).  The federal court also declined supplemental jurisdiction over the plaintiff’s state law claims.  The plaintiff then sued the defendant in state court for nuisance, trespass and violation of state drainage law.  The defendant moved for summary judgment based on statutory immunity of Iowa Code § 657.11 and the plaintiff’s lack of evidence or expert testimony. 

Iowa Code §657.11 provides limited nuisance immunity to a CAFO.  Immunity is granted if the CAFO is following all applicable regulations and is using accepted management practices. The plaintiff, relying on Gacke v. Pork XTRA, L.L.C., 684 N.W. 2d 168 (Iowa 2004) claimed that Iowa Code §657.11 as applied to him was unconstitutional under Iowa’s inalienable rights clause. Under Gacke, for a court to determine whether Iowa Code §657.11(2) is unconstitutional a plaintiff must show they (1) “receive[d] no particular benefit from the nuisance immunity granted to their neighbors other than that inuring to the public in general[,]”; (2) “sustain[ed] significant hardship[,]”; and (3) “resided on their property long before any animal operation was commenced” on neighboring land and “had spent considerable sums of money in improvements to their property prior to construction of the defendant’s facilities.”  All three elements must be established.

The trial court, noting that the plaintiff’s own CAFO (raising of 500 ewes, and at times over 1,000 ewes and lambs, on his property for over 40 years, along with a six-foot tall manure pile) had benefited from immunity, rejected the plaintiff’s constitutional challenge for failure to satisfy Gacke’s three-part test in Gacke.  The trial court then granted the defendant’s summary judgment motion based on the plaintiff’s failure to provide any expert testimony or other evidence to support any exception to the statutory immunity defense or to prove causation or damages. 

On further review, the Iowa Supreme Court affirmed, overruled the three-part test of Gacke and applied rational basis review to reject the plaintiff’s constitutional challenge to Iowa Code §657.11.  The court noted that Iowa Code §657.11A did not eliminate nuisance claims against CAFOs, but rather established reasonable limitations on recovery rights.  The Iowa Supreme Court concluded that the plaintiff failed to preserve error on his takings claim under article I, section 18 of the Iowa Constitution and failed to generate a question of fact precluding summary judgment on statutory nuisance immunity or causation for his trespass and drainage claims. Specifically, the Iowa Supreme Court noted that without accompanying expert testimony, the plaintiff water tests showed neither an increase in nitrate levels nor a spike in nitrate levels that would correlate with manure spreading. The Supreme Court further noted that even assuming an increase in nitrate levels, the plaintiff lacked expert testimony to attribute or correlate any increase in nitrate levels in the stream to the defendants’ actions. Thus, without expert witness testimony that tied the defendant’s alleged misapplication or over-application of manure to the nitrate levels in the plaintiff’s stream, the plaintiff could not, as a matter of law, satisfy his burden of proving that any trespass or drainage violation proximately caused his damages.   The Iowa Supreme Court did not address the plaintiff’s constitutional challenge to the damages limitations in Iowa Code §657.11A(3).

Note:   The Iowa Supreme Court’s opinion didn’t explain how the attorneys for the plaintiff failed to preserve error on the plaintiff’s takings claim and failed to provide expert witness testimony on the tort claims for trespass and drainage issues.  However, the Iowa Supreme Court clearly focused on those deficiencies in its opinion. 


Agricultural law and taxation is a dynamic area of the law focusing on the legal rules surrounding food production, water rights and allocation, and the production and usage of energy.  Of course, taxation is wrapped around all of those issues, as are estate, business and succession planning.  All of these issues will be addressed at the upcoming conference in Durango, CO on Aug. 1 and 2.  While it’s not the same as being there in person the online attendance platform allows you to participate from your own location. 

I am looking forward to seeing you there, or online.

Business Planning, Civil Liabilities, Criminal Liabilities, Water Law | Permalink


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