Thursday, July 28, 2022
Reports are that Senator Joe Manchin has come to an agreement with Senate leadership on tax legislation that is part of a larger package, termed the “Inflation Reduction Act of 2022.” It’s apparently part of the 2022 budget reconciliation bill which only requires a simple majority of the Senate to pass. What are the tax provisions that have been agreed to?
Proposed tax provisions apparently agreed to, and some recent ag-related court decisions – it’s the topic of today’s post.
Reports are that the agreed upon tax package includes a 15 percent corporate alternative minimum tax (AMT) applied to adjusted financial statement income of corporations with profits exceeding $1 billion. A corporation subject to the AMT would be able to claim net operating losses and tax credits against the AMT. In addition, a corporation subject to the AMT would be able to claim tax credits against the AMT as well as regular corporate tax for AMT paid in prior years to the extent the regular tax liability in any year exceeds 15 percent of the corporation’s adjusted financial statement income. The provision would be effective for tax years after 2022.
Also included in the agreement is a change in the tax treatment of carried interest (e.g., the share of profit that general partners receive to compensate them for managing a venture capital fund).
Another proposal would apply the net investment income tax (NIIT) of I.R.C. §1411 to all income. Presently this 3.8 percent tax (which was created as part of Obamacare) applies only to passive income above a threshold. Under the proposal, the additional 3.8 percent tax would apply to adjusted gross income over $400,000 (single) and $500,000 (mfj). This means that there is a substantial “marriage penalty.” In addition, the qualified business income deduction (QBID) of I.R.C. §199A is not part of a taxpayer’s AGI computation. In other words, AGI is not reduced by the 20 percent QBID – AGI is computed before accounting for the QBID. Thus, for a taxpayer that has taxable income at or below the threshold for application of the NIIT as a result of the QBID, the NIIT would be computed on AGI first.
Note: Applying the NIIT to adjusted gross income (including income from both passive and active sources) could result in a sizeable tax increase for many farmers – particularly dairy operations.
There are other tax provisions reported to be in the agreement, including those dealing with “renewable” energy credits. The projected additional revenue from the tax increases is to fund certain “green energy” initiative. The actual text of the legislation is presently slated for the Senate parliamentarian to review on August 3. Full Senate consideration would occur after that date.
Note: There presently is no word on how Senator Sinema views the proposal, although she has stated in the past that she will not support legislation that increases corporate or personal tax rates. While the proposals don’t increase actual rates, they do increase effective rates on certain corporations and individuals.
Also, Senate Finance Committee Chairman Charles Grassley has introduced legislation that would index certain tax benefits to adjust for inflation. The indexed provisions include certain tax credits and deductions such as the Child Tax Credit and the Non-Child Dependent Credit. The bill, known as the “Family and Community Inflation Relief Act,” would also adjust for inflation the American Opportunity Tax Credit, Lifetime Learning Credit, and the Student Loan Interest Deduction. The proposal would also extent the current $10,000 limitation on state and local taxes through 2026.
Recent Ag-Related Court Opinions
Child Support Obligation Computed Based on All Income and Loss from Farming.
Gerving v. Gerving, 969 N.W.2d 184 (N.D. 2022)
The issue in this case was the proper way to calculate a father’s child support obligation. The father conducted a farming operation, and a primary issue was whether only income and gains from farming should count for purposes of child support, or whether losses should also be accounted for. Under child support guidelines, the court must determine the payor’s net income and use that amount to calculate the child support obligation. The trial court calculated the father’s income based only on gains and did not include any related losses incurred from equipment trades and other farm-related transactions. The appellate court held that the trial court erred by not including the farm losses to calculate the father’s self-employment income because those losses must be considered to show actual profit from the farming operation. The appellate court also determined that the father had no income from subleases of farmland.
Deduction for Full Amount of C Corporate Shareholder Compensation Not Deductible
Clary Hood, Inc. v. Comr., T.C. Memo. 2022-15
A big audit issue for farming (and other) corporations is reasonable compensation. This case illustrates that point in a non-farm context. Here, a married couple were the sole shareholders of the petitioner, a corporation engaged in the construction business that graded and prepared land. The petitioner’s growth was irregular from 2000 on. The principal took a relatively modest salary between 2000 and 2012 but took a big increase in the years 2013 to 2016, ostensibly to compensate for earlier years. The company had an outside consulting firm perform an analysis to determine what the principal's compensation should be. The IRS challenged the amount in 2015 and 2016.
The Tax Court examined the usual factors considered in such a case including the employee's qualifications; the nature, extent, and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with gross income and net income; the prevailing general economic conditions; comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; and the salary policy of the taxpayer as to all employees. The Tax Court denied a deduction for the full amount of the compensation. In addition, the IRS assessed an accuracy-related penalty for both years. The taxpayer was able to show that he relied in good faith on the advice of the accounting firm and the Tax Court did not sustain the penalty. However, for the second year the taxpayer could not substantiate its reliance on the outside adviser.
Homeowner’s Policy Doesn’t Cover Farming Injury
Mills v. CSAA General Insurance. Co., No. 21-CV-0479-CVE-JFJ, 2022 U.S. Dist. LEXIS 114741 (N.D. Okla. Jun. 29, 2022)
It’s always good to make sure you understand the extent of coverage you have under an insurance policy, and what is excluded from coverage. This case illustrates that point. Here, the plaintiff became pinned between a trailer and barn while loading cattle, and was hospitalized for several days as a result of his resulting injuries. The plaintiff had a homeowner’s insurance policy with the defendant and filed a claim for coverage under the policy for his injuries. The defendant denied coverage on the basis that the policy only covered claims for bodily or personal injury brought by third parties against the plaintiff, and that the farming endorsement did not extend coverage for the plaintiff’s own bodily injury and incorporated the policy’s exclusion for bodily injury into the farming endorsement.
The plaintiff sued, claiming that he intended to purchase coverage for personal injuries he might suffer while operating his farm and that he had a reasonable expectation of coverage under the policy. He also claimed that the exclusions were “buried in the more than 100 pages of the policy.” The trial court disagreed, determining that the policy’s liability provisions applied only to claims for bodily or personal injury brought by third parties against the plaintiff. The trial court also determined that the policy language was not ambiguous and was not “buried deep” into the policy documents.
Gross Acres, not Tillable Acres, Used for Partition-in-Kind
Mueggenberg v. Mueggenberg, No. 21-0887, 2022 Iowa App. LEXIS 510 (Iowa Ct. App. Jun. 29, 2022)
The two parties were comprised of five siblings, who each had an undivided one-fifth interest in 179.61 acres of farmland. The plaintiffs, three of the siblings, filed for a partition in kind. The court appointed an appraiser to analyze and equally divide the farmland between the three parties. The appraiser determined that partitioning the land into five equal sections would be unworkable because the land’s topography varied greatly. The appraiser recommended the defendants should receive an approximate share of 40 percent comprised of 62 gross acres and all the future easement payments from the energy company that operated a windmill on the land. The appraiser allocated 117.61 gross acres to the plaintiffs. The defendants claimed that they were entitled to 68.64 tillable acres. The appraiser explained that while the acre division was not necessarily 40/60, the land awarded to the defendants was overall more desirable and expensive as it had a higher CSR2 rating.
The trial court agreed with the appraiser and assessed fees and costs to the defendants. On appeal, the appellate court found the defendants’ calculations for a different split were inaccurate as the defendants used tillable acres when they should have used gross acres in the calculation. The defendants also failed to account for the difficulty of dividing the land caused by a non-uniform property line and the existence of terraces. The appellate court affirmed the trial court’s decision to adopt the appraiser’s division but reversed the trial court’s award of attorney’s fees and costs. Accordingly, the appellate court vacated the trial court’s assessment of costs and remanded the case with instructions that only costs arising from the contested matter be assessed to the defendants. The parties were to share all remaining costs proportionately.
Keep your eyes on what, if any, tax proposals come out of the Senate. Increasing taxes on individuals whether via the NIIT or the corporate tax in a recessionary economy (despite the changed definition from the White House) is not a good idea. It’s particularly a bad idea when any additional revenue is to be used to fund inefficient and costly energy proposals to further energy policies that are the driver to the current inflationary problems in the economy.
On the ag law front, make sure to understand how child support is computed in the context of a farmer’s divorce; pay reasonable compensation to shareholder/offices for services rendered; know what is and what is not covered under an insurance policy; and avoid partition actions – they rarely end up in family harmony.