Wednesday, January 20, 2021
Ag Law and Taxation 2020 Bibliography
Overview
Today's post is a bibliography of my ag law and tax blog articles of 2020. Many of you have requested that I provide something like this to make it easier to find the articles. If possible, I will do the same for articles from prior years. The library of content is piling up - I have written more than 500 detailed articles for the blog over the last four and one-half years.
Cataloging the 2020 ag law and tax blog articles - it's the topic of today's post.
BANKRUPTCY
Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech
Unique, But Important Tax Issues – “Claim of Right;” Passive Loss Grouping; and Bankruptcy Taxation
Disaster/Emergency Legislation – Summary of Provisions Related to Loan Relief; Small Business and Bankruptcy
Retirement-Related Provisions of the CARES Act
Farm Bankruptcy – “Stripping, “Claw-Black,” and the Tax Collecting Authorities
SBA Says Farmers in Chapter 12 Ineligible for PPP Loans
The “Cramdown” Interest Rate in Chapter 12 Bankruptcy
Bankruptcy and the Preferential Payment Rule
BUSINESS PLANNING
Partnership Tax Ponderings – Flow-Through and Basis
Farm and Ranch Estate and Business Planning in 2020 (Through 2025)
Transitioning the Farm or Ranch – Stock Redemption
Estate and Business Planning for the Farm and Ranch Family – Use of the LLC (Part 1)
Estate and Business Planning for the Farm and Ranch Family – Use of the LLC (Part 2)
The Use of the LLC for the Farm or Ranch Business – Practical Application
CIVIL LIABILITIES
Top Ten Agricultural Law and Tax Developments from 2019 (Numbers 10 and 9)
Ag Law in the Courts – Feedlots; Dicamba Drift; and Inadvertent Disinheritance
Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech
Dicamba, Peaches and a Defective Ferrari; What’s the Connection?
Liability for Injuries Associated with Horses (and Other Farm Animals)
Issues with Noxious (and Other) Weeds and Seeds
Of Nuisance, Overtime and Firearms – Potpourri of Ag Law Developments
CONTRACTS
The Statute of Frauds and Sales of Goods
Disrupted Economic Activity and Force Majeure – Avoiding Contractual Obligations in Time of Pandemic
Is it a Farm Lease or Not? – And Why it Might Matter
COOPERATIVES
Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 2 and 1)
Concentrated Ag Markets – Possible Producer Response?
CRIMINAL LIABILITIES
Is an Abandoned Farmhouse a “Dwelling”?
https://lawprofessors.typepad.com/agriculturallaw/2020/02/is-an-abandoned-farmhouse-a-dwelling.html
ENVIRONMENTAL LAW
Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 8 and 7)
Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 6 and 5)
Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 4 and 3)
Clean Water Act – Compliance Orders and “Normal Farming Activities”
Groundwater Discharges of “Pollutants” and “Functional Equivalency”
NRCS Highly Erodible Land and Wetlands Conservation Final Rule – Clearer Guidance for Farmers or Erosion of Property Rights? – Part One
NRCS Highly Erodible Land and Wetlands Conservation Final Rule – Clearer Guidance for Farmers or Erosion of Property Rights? – Part Two
NRCS Highly Erodible Land and Wetlands Conservation Final Rule – Clearer Guidance for Farmers or Erosion of Property Rights? – Part Three
The Prior Converted Cropland Exception – More Troubles Ahead?
TMDL Requirements – The EPA’s Federalization of Agriculture
https://lawprofessors.typepad.com/agriculturallaw/2020/10/tmdl-requirements-.html
Eminent Domain and “Seriously Misleading” Financing Statements
ESTATE PLANNING
Ag Law in the Courts – Feedlots; Dicamba Drift; and Inadvertent Disinheritance
Recent Developments Involving Estates and Trusts
What is a “Trade or Business” For Purposes of Installment Payment of Federal Estate Tax?
Alternate Valuation – Useful Estate Tax Valuation Provision
Farm and Ranch Estate and Business Planning in 2020 (Through 2025)
Retirement-Related Provisions of the CARES Act
Are Advances to Children Loans or Gifts?
Tax Issues Associated with Options in Wills and Trusts
Valuing Farm Chattels and Marketing Rights of Farmers
Is it a Gift or Not a Gift? That is the Question
Does a Discretionary Trust Remove Fiduciary Duties a Trustee Owes Beneficiaries?
Can I Write my Own Will? Should I?
https://lawprofessors.typepad.com/agriculturallaw/2020/10/can-i-write-my-own-will-should-i.html
Income Taxation of Trusts – New Regulations
https://lawprofessors.typepad.com/agriculturallaw/2020/10/income-taxation-of-trusts.html
Merging a Revocable Trust at Death with an Estate – Tax Consequences
When is Transferred Property Pulled Back into the Estate at Death? Be on Your Bongard!
‘Tis the Season for Giving, But When is a Transfer a Gift?
INCOME TAX
Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 2 and 1)
Does the Penalty Relief for a “Small Partnership” Still Apply?
Substantiation – The Key to Tax Deductions
Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech
Unique, But Important Tax Issues – “Claim of Right;” Passive Loss Grouping; and Bankruptcy Taxation
Conservation Easements and the Perpetuity Requirement
Tax Treatment Upon Death of Livestock
https://lawprofessors.typepad.com/agriculturallaw/2020/02/tax-treatment-upon-death-of-livestock.html
What is a “Trade or Business” For Purposes of I.R.C. §199A?
Tax Treatment of Meals and Entertainment
Farm NOLs Post-2017
https://lawprofessors.typepad.com/agriculturallaw/2020/03/farm-nols-post-2017.html
Disaster/Emergency Legislation – Summary of Provisions Related to Loan Relief; Small Business and Bankruptcy
Retirement-Related Provisions of the CARES Act
Income Tax-Related Provisions of Emergency Relief Legislation
The Paycheck Protection Program – Still in Need of Clarity
Solar “Farms” and The Associated Tax Credit
Obtaining Deferral for Non-Deferred Aspects of an I.R.C. §1031 Exchange
Conservation Easements – The Perpetuity Requirement and Extinguishment
PPP and PATC Developments
https://lawprofessors.typepad.com/agriculturallaw/2020/06/ppp-and-patc-developments.html
How Many Audit “Bites” of the Same Apple Does IRS Get?
More Developments Concerning Conservation Easements
Imputation – When Can an Agent’s Activity Count?
Exotic Game Activities and the Tax Code
Demolishing Farm Buildings and Structures – Any Tax Benefit?
Tax Incentives for Exported Ag Products
Deducting Business Interest
https://lawprofessors.typepad.com/agriculturallaw/2020/09/deducting-business-interest.html
Recent Tax Court Opinions Make Key Point on S Corporations and Meals/Entertainment Deductions
Income Taxation of Trusts – New Regulations
https://lawprofessors.typepad.com/agriculturallaw/2020/10/income-taxation-of-trusts.html
Accrual Accounting – When Can a Deduction Be Claimed?
Farmland Lease Income – Proper Tax Reporting
Merging a Revocable Trust at Death with an Estate – Tax Consequences
The Use of Deferred Payment Contracts – Specifics Matter
Is Real Estate Held in Trust Eligible for I.R.C. §1031 Exchange Treatment?
INSURANCE
Recent Court Developments of Interest
https://lawprofessors.typepad.com/agriculturallaw/2020/07/recent-court-developments-of-interest.html
PUBLICATIONS
Principles of Agricultural Law
https://lawprofessors.typepad.com/agriculturallaw/2020/01/principles-of-agricultural-law.html
REAL PROPERTY
Signing and Delivery
Abandoned Railways and Issues for Adjacent Landowners
Obtaining Deferral for Non-Deferred Aspects of an I.R.C. §1031 Exchange
Are Dinosaur Fossils Minerals?
https://lawprofessors.typepad.com/agriculturallaw/2020/06/are-dinosaur-fossils-minerals.html
Real Estate Concepts Involved in Recent Cases
Is it a Farm Lease or Not? – And Why it Might Matter
REGULATORY LAW
Top Ten Agricultural Law and Tax Developments from 2019 (Numbers 10 and 9)
Top Ten Agricultural Law and Tax Developments from 2019 (Number 8 and 7)
Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech
Hemp Production – Regulation and Economics
DOJ to Investigate Meatpackers – What’s it All About?
Dicamba Registrations Cancelled – Or Are They?
What Does a County Commissioner (Supervisor) Need to Know?
The Supreme Court’s DACA Opinion and the Impact on Agriculture
Right-to-Farm Law Headed to the SCOTUS?
The Public Trust Doctrine – A Camel’s Nose Under Agriculture’s Tent?
Roadkill – It’s What’s for Dinner (Reprise)
https://lawprofessors.typepad.com/agriculturallaw/2020/10/roadkill-its-whats-for-dinner-reprise.html
Beef May be for Dinner, but Where’s It From?
Of Nuisance, Overtime and Firearms – Potpourri of Ag Law Developments
What Farm Records and Information Are Protected from a FOIA Request?
Can One State Dictate Agricultural Practices in Other States?
SECURED TRANSACTIONS
Family Farming Arrangements and Liens; And, What’s a Name Worth?
Conflicting Interests in Stored Grain
https://lawprofessors.typepad.com/agriculturallaw/2020/03/conflicting-interests-in-stored-grain.html
Eminent Domain and “Seriously Misleading” Financing Statement
SEMINARS AND CONFERENCES
Summer 2020 Farm Income Tax/Estate and Business Planning Conference
Registration Open for Summer Ag Income Tax/Estate and Business Planning Seminar
Summer 2020 – National Farm Income Tax/Estate and Business Planning Conference
Year-End CPE/CLE – Six More to Go
https://lawprofessors.typepad.com/agriculturallaw/2020/12/year-end-cpecle-six-more-to-go.html
2021 Summer National Farm and Ranch Income Tax/Estate and Business Planning Conference
WATER LAW
Principles of Agricultural Law
https://lawprofessors.typepad.com/agriculturallaw/2020/01/principles-of-agricultural-law.html
MISCELLANEOUS
More “Happenings” in Ag Law and Tax
https://lawprofessors.typepad.com/agriculturallaw/2020/02/more-happenings-in-ag-law-and-tax.html
Recent Cases of Interest
https://lawprofessors.typepad.com/agriculturallaw/2020/03/recent-cases-of-interest.html
More Selected Caselaw Developments of Relevance to Ag Producers
Court Developments of Interest
https://lawprofessors.typepad.com/agriculturallaw/2020/04/court-developments-of-interest.html
Ag Law and Tax Developments
https://lawprofessors.typepad.com/agriculturallaw/2020/05/ag-law-and-tax-developments.html
Recent Court Developments of Interest
https://lawprofessors.typepad.com/agriculturallaw/2020/07/recent-court-developments-of-interest.html
Court Developments in Agricultural Law and Taxation
Ag Law and Tax in the Courtroom
https://lawprofessors.typepad.com/agriculturallaw/2020/09/ag-law-and-tax-in-the-courtroom.html
Recent Tax Cases of Interest
https://lawprofessors.typepad.com/agriculturallaw/2020/09/recent-tax-cases-of-interest.html
Ag and Tax in the Courts
https://lawprofessors.typepad.com/agriculturallaw/2020/11/ag-and-tax-in-the-courts.html
Of Nuisance, Overtime and Firearms – Potpourri of Ag Law Developments
Bankruptcy Happenings
https://lawprofessors.typepad.com/agriculturallaw/2020/12/bankruptcy-happenings.html
January 20, 2021 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Sunday, January 17, 2021
Agricultural Law Online!
Overview
For the Spring 2021 academic semester, Kansas State University will be offering my Agricultural Law and Economics course online. No matter where you are located, you can enroll in the course and participate in it as if you were present with the students in the on-campus classroom.
Details of this spring semester’s online Ag Law course – that’s the topic of today’s post.
Course Coverage
The course provides a broad overview of many of the issues that a farmer, rancher, rural landowner, ag lender or other agribusiness will encounter on a daily basis. As a result, the course looks at contract issues for the purchase and sale of agricultural goods; the peril of oral contracts; the distinction between a lease and a contract (and why the distinction matters); and the key components of a farm lease, hunting lease, wind energy lease, oil and gas lease, and other types of common agricultural contractual matters. What are the rules surrounding ag goods purchased at auction?
Ag financing situations are also covered – what it takes to provide security to a lender when financing the purchase of personal property to be used in the farming business. In addition, the unique rules surrounding farm bankruptcy is covered, including the unique tax treatment provided to a farmer in Chapter 12 bankruptcy.
Of course, farm income tax is an important part of the course. Tax planning is perhaps the most important aspect of the farming business that every-day decisions have an impact on and are influenced by. As readers of this blog know well, farm tax issues are numerous and special rules apply in many instances. The new tax law impacts many areas of farm income tax.
Real property legal issues are also prevalent and are addressed in the course. The key elements of an installment land contract are covered, as well as legal issues associated with farm leases. Various types of interests in real estate are explained – easements; licenses; profits, fee simples, remainders, etc. Like-kind exchange rules are also covered as are the special tax rules (at the state level) that apply to farm real estate.
A big issue for some farmers and ranchers concerns abandoned railways, and those issues are covered in the course. What if an existing fence is not on the property line?
Farm estate and business planning is also a significant emphasis of the course. What’s the appropriate estate plan for a farm and ranch family? How should the farming business be structured? Should multiple entities be used? Why does it matter? These questions, and more, are addressed.
Agricultural cooperatives are important for the marketing of agricultural commodities. How a cooperative is structured and works and the special rules that apply are also discussed.
Because much agricultural property is out in the open, that means that personal liability rules come into play with respect to people that come onto the property or use farm property in the scope of their employment. What are the rules that apply in those situations? What about liability rules associated with genetically modified products? Ag chemicals also pose potential liability issues, as do improperly maintained fences? What about defective ag seed or purchased livestock that turns out to not live up to representations? These issues, and more, are covered in the scope of discussing civil liabilities.
Sometimes farmers and ranchers find themselves in violation of criminal laws. What are those common situations? What are the rules that apply? We will get into those issue too.
Water law is a very big issue, especially in the western two-thirds of the United States. We will survey the rules surrounding the allocation of surface water and ground water to agricultural operations.
Ag seems to always be in the midst of many environmental laws – the “Clean Water Rule” is just one of those that has been high-profile in recent years. We will talk about the environmental rules governing air, land, and water quality as they apply to farmers, ranchers and rural landowners.
Finally, we will address the federal (and state) administrative state and its rules that apply to farming operations. Not only will federal farm programs be addressed, but we will also look at other major federal regulations that apply to farmers and ranchers.
Further Information and How to Register
Information about the course and how to register is available here: https://www.enrole.com/ksu/jsp/session.jsp?sessionId=442107&courseId=AGLAW&categoryId=ROOT
You can also find information about the text for the course at the following link: https://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/principlesofagriculturallaw/index.html
If you are an undergraduate student at an institution other than Kansas State, you should be able to enroll in this course and have it count as credit towards your degree at your institution. Consult with your academic advisor to see how Ag Law and Economics will transfer and align with your degree completion goals.
If you have questions, you can contact me directly, or submit your questions to the KSU Global Campus staff at the link provided above.
I hope to see you in class beginning on January 26!
January 17, 2021 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Friday, January 8, 2021
Continuing Education Events and Summer Conferences
Overview
There are a couple of online continuing education events that I will be conducting soon, and the dates are set for two summer national conferences in 2021.
Upcoming continuing education events – it’s the topic of today’s post.
Top Developments in Agricultural Law and Tax
On Monday, January 11, beginning at 11:00 a.m. (cst), I will be hosting a two-hour CLE/CPE webinar on the top developments in agricultural law and agricultural taxation of 2020. I will not only discuss the developments, but project how the developments will impact producers and others in the agricultural sector and what steps need to be taken as a result of the developments in the law and tax realm. This is an event that is not only for practitioners, but producers also. It’s an opportunity to hear the developments and provide input and discussion. A special lower rate is provided for those not claiming continuing education credit.
You may learn more about the January 11 event and register here: https://washburnlaw.edu/employers/cle/taxseasonupdate.html
Tax Update Webinar – CAA of 2021
On January 21, I will be hosting a two-hour webinar on the Consolidated Appropriations Act, 2021. This event will begin at 10:00 a.m. (cst) and run until noon. The new law makes significant changes to the existing PPP and other SBA loan programs, CFAP, and contains many other provisions that apply to businesses and individuals. Also, included in the new law are provisions that extend numerous provisions that were set to expire at the end of 2020. The PPP discussion is of critical importance to many taxpayers at the present moment, especially the impact of PPP loans not being included in income and simultaneously being deductible if used to pay for qualified business expenses. Associated income tax basis issues loom large and vary by entity type.
You may learn more about the January 21 event and register here: https://agmanager.info/events/kansas-income-tax-institute
Summer National Conferences
Mark your calendars now for the law school’s two summer 2021 events that I conduct on farm income tax and farm estate and business planning. Yes, there are two locations for 2021 – one east and one west. Each event will be simulcast live over the web if you aren’t able to attend in-person. The eastern conference is first and is set for June 7-8 at Shawnee Lodge and Conference Center near West Portsmouth, Ohio. The location is about two hours east of Cincinnati, 90 minutes south of Columbus, Ohio, and just over two hours from Lexington, KY. I am presently in the process of putting the agenda together. A room block will be established for those interested in staying at the Lodge. For more information about Shawnee Lodge and Conference Center, you made click here: https://www.shawneeparklodge.com/
The second summer event will be held on August 2-3 in Missoula, Montana at the Hilton Garden Inn. Missoula is beautifully situated on three rivers and in the midst of five mountain ranges. It is also within three driving hours of Glacier National Park, and many other scenic and historic places. The agenda will soon be available, and a room block will also be established at the hotel. You may learn more about the location here: https://www.hilton.com/en/hotels/msogigi-hilton-garden-inn-missoula/
Conclusion
Take advantage of the upcoming webinars and mark you calendars for the summer national events. I look for to seeing you at one or more of the events.
January 8, 2021 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Friday, January 1, 2021
The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020
Overview
It’s the time of year again where I sift through the legal and tax developments impacting U.S. agriculture from the past year, and rank them in terms of their importance to farmers, ranchers, agribusinesses, rural landowners and the ag sector in general.
As usual, 2020 contained many legal and tax developments of importance to the agricultural sector. Of course, there were major tax law changes that occurred as a result of the federal government’s response to various state governors shutting down businesses in their states and locking down their economies with resulting economic harm. The other issues continued their natural ebb and flow in reaction to the economics governing the sector and policy and regulatory implementations.
It’s also difficult to pair things down to ten significant developments. There are other developments that are also significant, but perhaps less so on a national scale. So, today’s post is the first installment in a series devoted to those developments that were left on the cutting table and didn’t quite make the “Top Ten” for 2020.
The “almost top ten of 2020” (in no particular order) – that’s the topic of today’s post.
Withheld Tax Not Deprioritized in Bankruptcy
In In re DeVries, 621 B.R. 445 (8th Cir. B.A.P. 2020), rev’g., No. 19-0018, 2020 U.S. Bankr. LEXIS 1154 (Bankr. N.D. Iowa Apr. 28, 2020)
A major aspect of Chapter 12 bankruptcy is the ability to deprioritize governmental claims (e.g., taxes). But, does the provision cover withheld taxes? Is so, Chapter 12 is even more valuable to farm debtors.
In this case, the debtors filed Chapter 12 and sold a significant amount of farmland and farming machinery in 2017, triggering almost $1 million of capital gain income and increasing their 2017 tax liability significantly. The tax liability was offset to a degree by income tax withholding from the wife’s off-farm job. Their amended Chapter 12 plan called for a refund to the estate of withheld federal and state income taxes. The taxing authorities objected, claiming that the withheld amounts had already been applied against the debtor’s tax debt as 11 U.S.C. §553(a) allowed. The debtors claimed that 2017 legislation barred tax debt arising from the sale of assets used in farming from being offset against previously collected tax. Instead, the debtors argued, the withheld taxes should be returned to the bankruptcy estate. If withheld taxes weren’t returned to the bankruptcy estate, the debtors argued, similarly situated debtors would be treated differently.
The bankruptcy court was faced with the issue of whether 11 U.S.C. §1232(a) entitled the bankruptcy estate to a refund of the withheld tax. Largely based on legislative history, the trial court concluded that 11 U.S.C. §1232(a) overrode a creditor’s set-off rights under 11 U.S.C. §553(a) in the context of Chapter 12. The debtors’ bankruptcy estate was entitled to a refund of the withheld income taxes.
On appeal, the bankruptcy appellate panel for the Eighth Circuit reversed. The appellate panel determined that 11 U.S.C. §1232(a) is a priority-stripping provision and not a tax provision and only addresses the priority of a claim and does not establish any right to or amount of a refund. As such, nothing in the statue authorized a debtor’s Chapter 12 plan to require a taxing authority to disgorge, refund or turn-over pre-petition withholdings for the benefit of the bankruptcy estate. The statutory term “claim,” The court reasoned, cannot be read to include withheld tax as of the petition date. Accordingly, the statute was clear and legislative history purporting to support the debtor’s position was rejected.
Bankruptcy and the Preferential Payment Rule – The Dean Foods Matter
A decade ago, the preferential payment rule arose in the context of the VeraSun bankruptcy. In late 2020, the issue back in relation to bankruptcy filing of Dean Foods, the largest dairy subsidiary company in the United States. Dean Foods and its forty-three affiliates filed Chapter 11 bankruptcy on November 12, 2019 in the United States Bankruptcy Court for the Southern District of Texas, which is being jointly administered under case no. 19-36313. In the fall of 2020, Dean Foods and its affiliates filed a joint Chapter 11 plan of liquidation. Dairy farmers that sold milk to Dean Farms shortly before the bankruptcy filing then started receiving letters demanding repayment of the amount paid for those milks sales.
The preferential payment rule does come with some exceptions. The exceptions basically comport with usual business operations. In other words, if the transaction between the debtor and the creditor occurred in the normal course of the parties doing business with each other, then the trustee’s “avoidance” claim will likely fail.
Exchange for new value. The bankruptcy trustee cannot avoid a transfer to the extent the transfer was intended by the debtor and the creditor (to or for whose benefit such transfer was made) to be a contemporaneous exchange for new value given to the debtor, and occurred in a substantially contemporaneous exchange. 11 U.S.C. §547(c)(1)(A-B). A contemporaneous exchange for new value is not preferential because it encourages the creditor to deal with troubled debtors and because other creditors are not adversely affected if the debtor’s estate receives new value. See, e.g., In re Jones Truck Lines, 130 F.3d 323 (8th Cir. 1997). “New value” as used in Section 547(c) means “money or money’s worth in goods, services, or new credit.” 11 U.S.C. § 547(a)(2). An exchange for new value is presumed substantially contemporaneous if the transfer of estate property is made within seven days of the transfer of the new value. See, e.g., In re Mason, 189 B.R. 932 (Bankr. N.D. Iowa 1995).
Ordinary course of business. The bankruptcy trustee also cannot avoid a transfer to the extent that the transfer was in payment of a debt that the debtor incurred in the ordinary course of the debtor’s business (or financial affairs) with the creditor, and the transfer was made in the ordinary course of business or financial affairs of the debtor and the creditor; or was made according to ordinary business terms. 11 U.S.C. §547(c)(2)(A)-(B). If the transaction at is the first between the parties, “the transaction must be typical compared to both parties’ past dealings with similarly-situated parties. In re Pickens, No. 06-01120, 2008 Bankr. LEXIS 6 (Bankr. N.D. Iowa Jan. 3, 2008).
The vast majority of dairy farmers receiving the demand letters should be able to demonstrate that the milk sales were in the ordinary course of business. But, just knowing the exceptions to the rule is vitally important.
Appellate Court Upholds $750,000 Compensatory Damage Award in Hog Nuisance Suit
McKiver v. Murphy-Brown, LLC, 980 F.3d 937 (4th Cir. 2020)
Here, the plaintiffs were pre-existing neighbors to the defendant’s large-scale confinement hog feeding facility conducted by a third-party farming operation via contract. The facility annually maintained nearly 15,000 of the defendant’s hogs that generated about 153,000 pounds of feces and urine every day. The waste was disposed of via lagoons and by spreading it over open “sprayfields” on the farm. The plaintiffs sued in state court in 2013 for nuisance violations, but later dismissed that action and refiled in federal court after learning of the defendant’s control over the hog feeding facility naming the defendant as the sole defendant.
The federal trial court coordinated 26 related cases against similar hog production operations brought by nearly 500 plaintiffs into a master case docket and proceeded with trials in 2017. In this case, the jury awarded $75,000 in compensatory damages to each of 10 plaintiffs and $5 million in punitive damages to each plaintiff. The punitive damage award was later reduced to $2.5 million per plaintiff after applying a state law cap on punitive damages.
On appeal, the appellate court determined that the trial court had properly allowed the plaintiffs’ expert testimony to establish the presence of fecal material on the plaintiffs’ homes and had properly limited the expert witness testimony of the defendant concerning odor monitoring she conducted at the hog facility. The appellate court also rejected the defendant’s claim that the third party farming operation should be included in the case as a necessary and indispensable party. The appellate court also affirmed the trial court’s holding concerning the availability of compensatory damages beyond the rental value of the property and the jury instruction on nuisance. The appellate court also concluded that the trial court properly submitted the question of punitive damages to the jury. The appellate court reversed the trial court’s admission of financial information of the defendant’s corporate grandfather and combining the punitive damages portion of the trial with the liability portion, but held that such errors did not require a new trial. However, the appellate court remanded the case for a consideration of the proper award of punitive damages without consideration of the grandparent’s company’s financial information (such as compensation amounts to corporate executives).
It’s also important to note that while North Carolina law was involved in this case, as a result of this litigation several states, including Nebraska and Oklahoma, have recently amended their state right-to-farm laws with the intent of strengthening the protections afforded farming operations.
Shortly after the appellate court reached its decision, the defendant's parent company (China-based WH Group Ltd and its U.S.-based pork producer Smithfield Foods, Inc.) announced that it settled the nuisance suits brought by hundreds of plaintiffs. Smithfield Foods, Inc. said that the settlement, "takes into account the divided decision of the court."
Lifetime Ban on Owning Firearms For Filing Tax Returns With False Statement
Folajtar v. The Attorney General of the United States, 980 F.3d 897(3rd Cir. 2020)
Any law that impairs a fundamental constitutional right (any of the first ten amendments to the Constitution) is subject to strict scrutiny – or at least it’s supposed to be. The right to bear arms, as the Second Amendment, is a fundamental constitutional right. Thus, any law restricting that right is to be strictly scrutinized. But, does a convicted felon always permanently lose the right to own a firearm. What if the felony is a non-violent one? These questions were at issue in this case.
The plaintiff pleaded guilty in 2011 to willfully making a materially false statement on her federal tax returns. She was sentenced to three-years’ probation, including three months of home confinement, a $10,000 fine, and a $100 assessment. She also paid back taxes exceeding $250,000, penalties and interest. Her conviction triggered 18 U.S.C. §922(g)(1), which prohibits those convicted of a crime punishable by more than one year in prison from possessing firearms. The plaintiff’s crime was punishable by up to three years’ imprisonment and a fine of up to $100,000.
As originally enacted in 1938, 18 U.S.C. §922(g)(1) denied gun ownership to those convicted of violent crimes (e.g., murder, kidnapping, burglary, etc.). However, the statute was expanded in the 1968. Later, the U.S. Supreme Court recognized gun ownership as an individual constitutional right in 2008. District of Columbia v. Heller, 554 U.S. 570 (2008). In a split decision, the majority reasoned that any felony is a “serious” crime and, as such, results in a blanket exclusion from Second Amendment protections for life. The majority disregarded the fact that the offense was non-violent, was the plaintiff’s first-ever felony offense, and was an offense for which she received no prison sentence. The majority claimed it had to rule this way because of deference to Congressional will that, the majority claimed, created a blanket, categorical rule.
The dissent rejected the majority’s categorical rule, pointing out that the plaintiff’s offense was nonviolent, and no evidence of the plaintiff’s dangerousness was presented. The dissent also noted that the majority’s “extreme deference” gave legislatures the power to manipulate the Second Amendment by simply choosing a label. Instead, the dissent reasoned, when the fundamental right to bear arms is involved, narrow tailoring to public safety is required. Because the plaintiff posed no danger to anyone, the dissent’s position was that her Second Amendment rights should not be curtailed. Likewise, because gun ownership is an individual constitutional right, the dissent pointed out that the Congress bears a high burden before extinguishing it. Post-2008, making a categorical declaration is insufficient to satisfy that burden, according to the dissent.
Expect this case to be headed to the U.S. Supreme Court.
Conclusion
That’s the first part of the trip through the “almost Top 10” of 2020. I will continue the trek through the list next time.
January 1, 2021 in Bankruptcy, Civil Liabilities, Criminal Liabilities | Permalink | Comments (0)
Wednesday, December 16, 2020
Bankruptcy Happenings
Overview
The courts keep cranking out the bankruptcy opinion involving farmers and others. The uniqueness of the cases presents interesting issues that are important to understand – not only for those involved in the litigation, but for others that can learn the various issues that can arise in a bankruptcy matter.
In today’s post, I take a look at several bankruptcy-related issues that came up in recent cases – the payment of administrative claims; the deprioritization of taxes in a Chapter 12 bankruptcy; and the necessity of clarity when describing collateral in a security agreement and financing statements.
A potpourri of bankruptcy-related matters – it’s the topic today’s post.
Administrative Expense Claimant Not Entitled to Notice of Conversion.
In re Roberts, 610 B.R. 900 (Bankr. D. N.M. 2019)
Bankruptcy lawyers wouldn’t likely assist a client through the bankruptcy process unless getting paid for their services were ensured. But, the services of a bankruptcy attorney are essential to for the parties involved – structuring a successful reorganization of the business in a reorganization bankruptcy; ensuring proper payment to creditors in a liquidation bankruptcy; and seeing to it that the debtor’s expectations are met in difficult circumstances.
The Bankruptcy Code ensures that bankruptcy legal counsel gets paid by allowing legal fees to be paid as an administrative expense of the bankruptcy. It’s an expense that is entitled to priority over the claims of general unsecured creditors with pre-petition claims. See 11 U.S.C. §§503(b); 507(a)(2).
In Roberts, the debtors had farmed for forty years before filing Chapter 11 bankruptcy. Although the debtors were farmers, they were not eligible to file Chapter 12 (farm) bankruptcy as family farmers due to excessive debt. Unfortunately for the debtors, they filed Chapter 12 before the Congress, in August of 2019, increased the debt level for Chapter 12 filers.
Several creditors objected to the debtors’ reorganization plan, arguing that the plan had significant deficiencies. After mounting expenses and the disbarment of their lawyer for unethical conduct, the debtors were forced to retain new bankruptcy counsel and file a new plan. The creditors argued that the new plan also contained deficiencies, namely that the plan did not propose to pay unsecured creditors in full. After the change in law that increased the debt limit for Chapter 12 filers, the debtors and creditors agreed to convert the case to chapter 12. The debtors’ initial bankruptcy counsel objected, arguing that she had not been given adequate notice of the conversion as an administrative expense claimant, and it would be inequitable to convert the case because her claim might be converted to a pre-petition claim.
The bankruptcy court held that the debtors were eligible to convert their pending Chapter 11 case to Chapter 12 and that the debtors need not give administrative claimants notice of their motion to convert. The bankruptcy court determined that the debtors only needed to give notice to the trustee and all creditors when seeking to convert their case. An administrative claimant is not a “creditor” as that term is defined in the Bankruptcy Code. 11 U.S.C. §101(10).
Further, the bankruptcy court held that the debtors’ conversion would not cause any administrative expense claims to be treated as pre-petition claims. The prior bankruptcy counsel argued that her administrative expenses would be subordinated upon conversion of the Chapter 11 case to a Chapter 12. The bankruptcy court, however, held that while that argument was true for converting a Chapter 11 case to a Chapter 7, when a Chapter 11 case is converted to Chapter 12, the Chapter 12 plan must provide for full payment of all Chapter 11 administrative expenses. Finally, the bankruptcy court held that conversion to Chapter 12 was equitable as it gave the debtors a chance to reorganize, and it gave the creditors and administrative expense claimants the best chance of getting paid.
Withheld Tax Not Deprioritized in Bankruptcy
In In re DeVries, No. 20-6011, 2020 Bankr. LEXIS 3323 (B.A.P. 8th Cir. Nov. 25, 2020), rev’g., No. 19-0018, 2020 U.S. Bankr. LEXIS 1154 (Bankr. N.D. Iowa Apr. 28, 2020)
The debtors filed Chapter 12 and sold a significant amount of farmland and farming machinery in 2017, triggering almost $1 million of capital gain income and increasing their 2017 tax liability significantly. The tax liability was offset to a degree by income tax withholding from the wife’s off-farm job. Their amended Chapter 12 plan called for a refund to the estate of withheld federal and state income taxes.
In the fall of 2019, the debtors submitted pro forma state and federal tax returns as well as their traditional tax returns for 2017 to the bankruptcy court in conjunction with the confirmation of their amended Chapter 12 plan. The pro-forma returns showed what the debtors’ tax liability would have been without the sale of the farmland and farm equipment. The pro-forma returns also showed, but for the capital gain, the debtors would have been entitled to a full tax refund of the taxes already withheld from the wife’s off-farm job. The amended plan required the IRS and the Iowa Department of Revenue (IDOR) to refund to the debtors’ bankruptcy estate withheld income taxes. The taxing authorities objected, claiming that the withheld amounts had already been applied against the debtor’s tax debt as 11 U.S.C. §553(a) allowed. The debtors claimed that 2017 legislation barred tax debt arising from the sale of assets used in farming from being offset against previously collected tax. Instead, the debtors argued, the withheld taxes should be returned to the bankruptcy estate. If withheld taxes weren’t returned to the bankruptcy estate, the debtors argued, similarly situated debtors would be treated differently.
The bankruptcy court was faced with the issue of whether 11 U.S.C. §1232(a) entitled the bankruptcy estate to a refund of the withheld tax. The IRS and IDOR claimed that 11 U.S.C. §553(a) preserved priority position for tax debt that arose before the bankruptcy petition was filed. The court disagreed, noting that 11 U.S.C. §1232(a) deals specifically with how governmental claims involving pre-petition tax debt are to be treated – as unsecured, non-priority obligations. But the court noted that 11 U.S.C. §1232(a) does not specifically address “clawing-back” previously withheld tax. It merely referred to “qualifying tax debt” and said it was to be treated as unsecured and not entitled to priority.
Referencing the legislative history behind both the 2005 and 2017 amendments, the bankruptcy court noted that the purpose of the priority-stripping provision was to help farmers have a better chance at reorganization by de-prioritizing taxes, including capital gain taxes. The court pointed to statements that Sen. Charles Grassley made to that effect. The bankruptcy court also noted that the 2017 amendment was for the purpose of strengthening (and clarifying) the original 2005 de-prioritization provision by overturning the result in Hall v. United States, 566 U.S. 506 (2012) to allow for de-prioritization of taxes arising from both pre and post-petitions sales of assets used in farming. Accordingly, the court concluded that 11 U.S.C. §1232(a) overrode a creditor’s set-off rights under 11 U.S.C. §553(a) in the context of Chapter 12. The debtors’ bankruptcy estate was entitled to a refund of the withheld income taxes.
On appeal, the bankruptcy appellate panel for the Eighth Circuit reversed. The appellate panel determined that 11 U.S.C. §1232(a) is a priority-stripping provision and not a tax provision and only addresses the priority of a claim and does not establish any right to or amount of a refund. As such, nothing in the statue authorized a debtor’s Chapter 12 plan to require a taxing authority to disgorge, refund or turn-over pre-petition withholdings for the benefit of the bankruptcy estate. The statutory term “claim,” The court reasoned, cannot be read to include withheld tax as of the petition date. Accordingly, the statute was clear and legislative history purporting to support the debtor’s position was rejected.
Adequate Protection Denied Due to Unperfected Security Interest
In re Blackjewel L.L.C.,No. 3:19-bk-30289, 2020 Bankr. LEXIS 3413 (Bankr. S.D. W. Va. Dec. 7, 2020)
In this case, the debtor was a coal company that voluntarily filed for Chapter 11. The debtor operated 32 properties and held more than 500 mining permits around the country. At the time it filed bankruptcy, the debtor owed six million dollars to its 1,700 workers in Wyoming and Central Appalachia, $32 million to an international investment firm, and over $17 million in ad valorem taxes (the country version of severance taxes that contribute to local services and state education). In total, at the time of filing, the debtor owed approximately $245 million to various creditors and had $138,000 in a bank account.
The debtor and creditor entered into a loan and security agreement in connection with a note and other financial accommodations. The creditor filed a financing statement, indicating collateral that included debtor accounts, receivables and inventory. After amending the original loan and security agreement, the creditor filed a new financing statement that no longer referred to the debtor accounts, receivables and inventory. The new financing statement indicated a security interest in the debtor’s bank accounts, accounts receivable, and liens. The debtor and creditor then entered into a joinder agreement, where another business joined the original debtor as a co-borrower under the loan and security agreement. As a result, the creditor filed a new financing statement with respect to the new debtor again indicating a security interest in the debtors’ bank accounts, accounts receivable, and liens. The debtors subsequently entered into a coal purchase and sale agreement (PSA) with another party.
When the debtors filed their Chapter 11 petition, they had failed to pay prepetition wages to employees related to the PSA. The debtors and other party settled, whereby the other party paid the debtors for post-petition accounts receivable pertaining to the PSA. The debtors used the bulk of the settlement to pay employees for unpaid work. The creditor filed a motion for adequate protection, requesting payment of the residual settlement proceeds as a form of adequate protection. The creditor argued that it held a valid security interest in the debtors’ accounts receivable and the proceeds thereof. The debtors argued that the settlement proceeds could not be proceeds of the debtors’ prepetition accounts receivable because at the time of the petition date, there were no accounts receivable owed to the debtors. The creditor argued that it held a prepetition perfected security interest that included the debtors’ PSA and the proceeds thereof.
The bankruptcy court held that the creditor had established its security interest in the debtors’ PSA. Specifically, the bankruptcy court held that because the debtors had granted the creditor a security interest in all its receivables under the loan and security agreement, the creditor had a security interest in the contract rights to the PSA. However, the bankruptcy court held that the creditor failed to establish that its security interest in the PSA and its proceeds was perfected. The creditor argued that it perfected its security interest in the PSA by filing a financing statement when the co-borrower joined the original debtor under the loan and security agreement. The bankruptcy court held that the description of the collateral in the financing statement was insufficient as it did not reasonably identify the debtors’ PSA by specific reference or other means as determined under the UCC. The bankruptcy court held that creditor’s financing statement that indicated a security interest in all the debtors’ accounts receivable was insufficient to perfect its security interest under the UCC. The bankruptcy court noted that there is a distinction between a security interest in accounts receivable and a security interest in an underlying contract such as the PSA at issue. Further, the court noted that the creditor’s financing statement did not contain any specific reference to the PSA, while other specific contracts were described.
The creditor argued that its financing statement should be read to indicate collateral consisting of agreements related to the payment of accounts receivable. Alternatively, the debtors argued that the creditor had a lien on the debtors’ liens and not an independent lien on the prepetition PSA. The bankruptcy court agreed with the debtors, and held that adopting the creditor’s interpretation would lead to a security interest in all debtors’ agreements and in all debtors’ agreements related to the payment of the debtors’ agreements. Finally, the bankruptcy court held that it would have been inequitable for any liens to attach to the post-petition proceeds in this case as the proceeds arose out of unencumbered inventory to the estate. The bankruptcy court held that allowing the creditor to receive the proceeds would have been inequitable to the unsecured creditors. As a result, the bankruptcy court denied the creditor’s motion for adequate protection due to its unperfected security interest.
Clearly, had the financing statement referenced “all assets” the creditor would have prevailed. Also, if the financing statement had said “collateral described on the security agreement,” then other parties examining it would have contacted the creditor to verify the collateral. The statements made on a financing statement are critical and can make a huge difference in perfection.
Conclusion
Bankruptcy is complex and good bankruptcy counsel is a must. The issues are varied and the best results can be obtained by being able to spot issues that might arise in advance and make proper plans. Also, words matter on financing instruments.
December 16, 2020 in Bankruptcy | Permalink | Comments (0)
Thursday, December 3, 2020
Bankruptcy and the Preferential Payment Rule
Overview
Economic times continue to be difficult in much of agriculture. 2020 has been a difficult year economically for many agricultural producers as well as commodity processors and other agribusinesses. An issue that frequently arises in bankruptcies of purchasers of agricultural products like grain, livestock, fruit or milk is known as the “preferential payment rule.” It can be a surprise not only to farmers in financial distress, but also to creditors who receive payment for agricultural goods sold shortly before the buyer files bankruptcy. It’s an issue that can arise in the normal course of doing business before bankruptcy is filed when nothing “unusual” appears to be happening.
A decade ago, the preferential payment rule arose in the context of the VeraSun bankruptcy. Now, it’s back in relation to bankruptcy filing of Dean Foods, the largest dairy subsidiary company in the United States. Dean Foods and its forty-three affiliates filed Chapter 11 bankruptcy on November 12, 2019 in the United States Bankruptcy Court for the Southern District of Texas, which is being jointly administered under case no. 19-36313. Earlier this week, Dean Foods and its affiliates filed a joint Chapter 11 plan of liquidation.
Farmers that sold milk to Dean Farms shortly before the bankruptcy filing are now receiving letters demanding repayment of the amount paid for those milks sales. Do these demand letters need to be responded to? Are they legitimate? The answer rests in the bankruptcy code’s preferential transfer rule.
For today’s article, I have asked for insight from one of the premier farm bankruptcy attorneys in the country. Joe Peiffer of Ag and Legal Business Legal Strategies of Cedar Rapids, Iowa helped author today’s article. His insights on how farmers should respond to the demand letters being sent to farmers on behalf of Dean Foods are particularly insightful.
The preferential payment rule, a unique bankruptcy provision – it’s the topic of today’s post.
In General
11 U.S.C. §547 provides in general that when a debtor makes a payment to a creditor and the debtor files bankruptcy within 90 days of making the payment, the bankruptcy trustee can “avoid” the payment by making the creditor pay the amount received to the bankruptcy estate where it will be distributed to the general creditors of the debtor. 11 U.S.C. §547(b)(4)(A). The timeframe expands from 90 days to one year if the creditor is an “insider.” 11 U.S.C. §547(b)(4)(B). The rule can come as a shock to a creditor that has received payment, paid their own creditors from the funds received from the debtor, and now has no funds to pay the bankruptcy estate to satisfy the bankruptcy trustee’s avoidance claim.
However, there is a jurisdictional limit. When the bankruptcy trustee seeks to recover a money judgment of less than $25,000, any associated legal action must be brought in the defendant’s (dairy farmer’s) home jurisdiction. 28 U.S.C. § 1409(b). Thus, a New York dairy farmer could only be sued in New York and a Wisconsin dairy farmer could only be sued in Wisconsin, etc., etc. Out of 1,881 dairy farmers identified as potentially having been paid by Dean Foods within 90 days of the bankruptcy filing, 708 have total payments under the $25,000 threshold.
There is also an administrative priority provision that can possibly apply. Under this provision, claims for deliveries that are made within in 20 days of the bankruptcy filing are elevated to the priority of an administrative expense claim. 11 U.S.C. §503(b)(9). In the Dean Foods bankruptcy, the 20-day timeframe would apply to deliveries made on or after October 23, 2019 until the petition date of November 12, 2019. The provision only covers deliveries. It does not cover payments. Of the 13,510 potentially preferential payments listed in the Dean Foods Statement of Financial Affairs, 1,590 could potentially cover deliveries made in that 20-day period.
Exceptions
The preferential payment rule does come with some exceptions. The exceptions basically comport with usual business operations. In other words, if the transaction between the debtor and the creditor occurred in the normal course of the parties doing business with each other, then the trustee’s “avoidance” claim will likely fail.
Exchange for new value. The bankruptcy trustee cannot avoid a transfer to the extent the transfer was intended by the debtor and the creditor (to or for whose benefit such transfer was made) to be a contemporaneous exchange for new value given to the debtor, and occurred in a substantially contemporaneous exchange. 11 U.S.C. §547(c)(1)(A-B). A contemporaneous exchange for new value is not preferential because it encourages the creditor to deal with troubled debtors and because other creditors are not adversely affected if the debtor’s estate receives new value. See, e.g., In re Jones Truck Lines, 130 F.3d 323 (8th Cir. 1997). “New value” as used in Section 547(c) means “money or money’s worth in goods, services, or new credit.” 11 U.S.C. § 547(a)(2). An exchange for new value is presumed substantially contemporaneous if the transfer of estate property is made within seven days of the transfer of the new value. See, e.g., In re Mason, 189 B.R. 932 (Bankr. N.D. Iowa 1995).
Ordinary course of business. The bankruptcy trustee also cannot avoid a transfer to the extent that the transfer was in payment of a debt that the debtor incurred in the ordinary course of the debtor’s business (or financial affairs) with the creditor, and the transfer was made in the ordinary course of business or financial affairs of the debtor and the creditor; or was made according to ordinary business terms. 11 U.S.C. §547(c)(2)(A)-(B). If the transaction at is the first between the parties, “the transaction must be typical compared to both parties’ past dealings with similarly-situated parties. In re Pickens, No. 06-01120, 2008 Bankr. LEXIS 6 (Bankr. N.D. Iowa Jan. 3, 2008).
So how can a farmer demonstrate an ordinary course of business? Basically, it is shown by demonstrating that the transfer to the debtor was consistent with a pattern of previous transfers between the parties. Business transactions between the parties that are within the norm of industry practice are essential to establishing that the transactions occurred in the ordinary course of business. Also, a payment that is made in the “ordinary course of business” between the debtor and the creditor will involve invoices that are paid in the time period required on the invoice, or payment made in accordance with industry custom or past dealings.
Settlement Payment Via Forward Contract. A trustee also cannot avoid a transfer that is a settlement payment made by a forward contract merchant in connection with a commodity contract or forward contract entered before the bankruptcy petition is filed. 11 U.S.C. §546(e).
Security interest. A trustee also cannot avoid a transfer that creates a security interest in property that the debtor acquires that secures new value given in accordance with a security agreement that contains a description of the property as collateral and is perfected on or before 30 days after the debtor receives possession of the property.
Recent Case
A recent court decision from Arkansas illustrates how the preferential payment rule can apply in an agricultural setting. In Rice v. Prairie Gold Farms, No. 2:17CV126 JLH, 2018 U.S. Dist. LEXIS 51678 (E.D. Ark. Mar. 28, 2018), the debtor was a partnership engaged in wheat farming activities. The debtor entered into two contracts for the sale of wheat with a grain broker. The contracts called for a total of 10,000 bushels of wheat to be delivered to the broker anytime between June 1, 2014 and July 31, 2014. In return, the debtor was to be paid $6.78/bushel for 5,000 bushels and $7.09/bushel for the other 5,000 bushels for a total price of $69,350. The debtor delivered the wheat in fulfillment of the contracts on July 21, 2014 and August 4, 2014 and received $71,957.10 later in August, in return for a total delivery of 10,813.07 bushels.
The grain broker debtor subsequently filed Chapter 11 bankruptcy on October 23, 2014 (which was later converted to Chapter 7). The Chapter 7 trustee sought to avoid the payment for the farmer’s wheat crop by the grain broker as a preferential transfer under 11 U.S.C. §547(b) and return the money paid to the farmer for his wheat crop to the bankruptcy estate for distribution to creditors. The trial court disagreed with the trustee, noting that 11 U.S.C. §547(c)(1) disallowed avoidance of a transfer if it is made in a contemporaneous exchange for new value that the debtor received. The trustee claimed that the transfer of wheat was not contemporaneous because the contract was entered into in May and the wheat was not delivered and payment made until over two months later.
The trial court determined that the transfer was for new value and payment occurred in a substantially contemporaneous manner corresponding to the delivery of the wheat. Thus, the exception of 11 U.S.C. §547(c)(1) applied. The court also noted that the wheat sale contracts were entered into in the ordinary course of the debtor’s business and, thus, also met the exception of 11 U.S.C. §547(c)(2). The debtor and the grain broker had a business history of similar transactions, and the court noted that the trustee failed to establish that the wheat contracts were inconsistent with the parties’ history of business dealings.
In the Arkansas case, the court noted that the parties had prior dealings that they conducted in the same manner and that nothing was out of the ordinary. There wasn’t any attempt to defraud creditors or shield assets from the reach of creditors. That’s really the point behind the preferential transfer rule. For those that continue conducting business as usual, the rule won’t likely come into play.
Response to Preference Demands
Information gathering. For a farmer or other creditor that receives a demand letter from attorneys representing Dean Foods or any other debtor in bankruptcy, it is important to immediately assemble documentation to provide to competent bankruptcy counsel to respond to the demand for return of the preferential transfer.
Dairy farmers that were selling milk to Dean Foods directly or to a subsidiary that have received preference demand letters should assemble the following:
- Payment evidence, such as milk check stubs or electronic funds transfer receipts. This will show when the milk was delivered to the dairy, as well as when the dairy made payment for the milk.
- Contracts for delivery of milk should be provided to counsel as it will assist the farmer in demonstrating that the payment by the dairy qualifies to protect the farmer from the preference demand. Since dairies generally make payment for the milk twice a month like clockwork, the preference demands can be defeated using the ordinary course of business defense outlined above.
- Any other documentation that helps establish a normal, standard industry practice of business dealings with Dean Foods.
Positing a defense. Failure to respond to the preference demand letters will generally mean that the dairy farmer will be sued by the liquidation trust in the United States Bankruptcy Court for the Southern District of Texas in Houston, TX. Such a lawsuit will seek to recover the payments made within 90 days of the bankruptcy filing.. In the Dean Foods bankruptcy this would mean payments that cleared the dairy’s bank after August 14, 2019.
In many instances, demands for the return of payments made to farmers are made without any consideration by the demanding party having considered whether the defenses to a preference action, such as ordinary course of business, is applicable. The demands are frankly extortion demands seeking some money without any actual right to the money. The parties demanding return of the preferences are banking on the willingness of the farmer to purchase a release rather than consider defenses and respond to the preference demand so they can avoid the cost of defense of the preference action in Houston, TX. In the VeraSun bankruptcy case, a group of lawyers formed the VeraSun Preference Defense Group to analyze and propose responsive letters to the parties demanding the return of the allegedly preferential payments. Most of the thousands of demands were withdrawn when the indefensible demands were exposed. A similar effort should be mounted in the Dean Foods bankruptcy.
Conclusion
Understanding the preferential payment rule is important, especially in the context of agricultural bankruptcies. The matter can get complicated in agricultural settings with the use of deferred payment contracts, forward grain contracts and the various types of unique business relationships that farmers enter into with the purchasers of their commodities. Competent legal counsel well-trained in the intricacies of agricultural law is a must.
December 3, 2020 in Bankruptcy | Permalink | Comments (0)
Friday, November 6, 2020
Ag and Tax In the Courts
Overview
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”
Chernaik v. Brown, 367 Or. 143 (2020)
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.
Conclusion
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.
November 6, 2020 in Bankruptcy, Income Tax, Real Property, Regulatory Law | Permalink | Comments (0)
Monday, October 12, 2020
Principles of Agricultural Law
Overview
The fields of agricultural law and agricultural taxation are dynamic. Law and tax impacts the daily life of a farmer, rancher, agribusiness and rural landowner practically on a daily basis. Whether that is good or bad is not really the question. The point is that it’s the reality. Lack of familiarity with the basic fundamental and applicable rules and principles can turn out to be very costly. As a result of these numerous intersections, and the fact that the rules applicable to those engaged in farming are often different from non-farmers, I started out just over 25 years ago to develop a textbook that addressed the major issues that a farmer or rancher and their legal and tax counsel should be aware of. After three years, the book was complete – Principles of Agricultural Law - and it’s been updated twice annually since that time.
The 47th edition is now complete, and it’s the topic of today’s post – Principles of Agricultural Law.
Subject Areas
The text is designed to be useful to farmers and ranchers; agribusiness professionals; ag lenders; educational professionals; lawyers, CPAs and other tax preparers; undergraduate and law students; and those that simply want to learn more about legal and tax issues. The text covers a wide range of topics. Here’s just a sample of what is covered:
Ag contracts. Farmers and ranchers engage in many contractual situations, including ag leases, to purchase contracts. The potential perils of verbal contracts are numerous and can lead to unnecessary litigation. What if a commodity is sold under forward contract and a weather event destroys the crop before it is harvested? When does the law require a contract to be in writing? For purchases of goods, do any warranties apply? What remedies are available upon breach? If a lawsuit needs to be brought to enforce a contract, how soon must it be filed? Is a liability release form necessary? Is it valid? What happens when a contract breach occurs? What is the remedy?
Ag financing. Farmers and ranchers are often quite dependent on borrowing money for keeping their operations running. What are the rules surrounding ag finance? This is a big issue for lenders also? What about dealing with an ag cooperative and the issue of liens? What are the priority rules with respect to the various types of liens that a farmer might have to deal with?
Ag bankruptcy. A unique set of rules can apply to farmers that file bankruptcy. Chapter 12 bankruptcy allows farmers to de-prioritize taxes. That can be a huge benefit. Knowing how best to utilize those rules is very beneficial. That’s especially true with the unsettled issue of whether Payment Protection Program (PPP) funds can be utilized by a farmer in bankruptcy. The courts are split on that issue.
Income tax. Tax and tax planning permeate daily life. Deferral contracts; depreciation; installment sales; like-kind exchanges; credits; losses; income averaging; reporting government payments; etc. The list could go on and on. Having a basic understanding of the rules and the opportunities available can add a lot to the bottom line of the farming or ranching operation as well as help minimize the bleeding when times are tough.
Real property. Of course, land is typically the biggest asset in terms of value for a farming and ranching operation. But, land ownership brings with it many potential legal issues. Where is the property line? How is a dispute over a boundary resolved? Who is responsible for building and maintaining a fence? What if there is an easement over part of the farm? Does an abandoned rail line create an issue? What if land is bought or sold under an installment contract? How do the like-kind exchange rules work when farmland is traded?
Estate planning. While the federal estate tax is not a concern for most people and the vast majority of farming and ranching operations, when it does apply it’s a major issue that requires planning. What are the rules governing property passage at death? Should property be gifted during life? What happens to property passage at death if there is no will? How can family conflicts be minimized post-death? Does the manner in which property is owned matter? What are the applicable tax rules? These are all important questions.
Business planning. One of the biggest issues for many farm and ranch families is how to properly structure the business so that it can be passed on to subsequent generations and remain viable economically. What’s the best entity choice? What are the options? Of course, tax planning is a critical part of the business transition process.
Cooperatives. Many ag producers are patrons of cooperatives. That relationship creates unique legal and tax issues. Of course, the tax law enacted near the end of 2017 modified an existing deduction for patrons of ag cooperatives. Those rules are very complex. What are the responsibilities of cooperative board members?
Civil liabilities. The legal issues are enormous in this category. Nuisance law; liability to trespassers and others on the property; rules governing conduct in a multitude of situations; liability for the spread of noxious weeds; liability for an employee’s on-the-job injuries; livestock trespass; and on and on the issues go. Agritourism is a very big thing for some farmers, but does it increase liability potential? Nuisance issues are also important in agriculture. It’s useful to know how the courts handle these various situations.
Criminal liabilities. This topic is not one that is often thought of, but the implications can be monstrous. Often, for a farmer or rancher or rural landowner, the possibility of criminal allegations can arise upon (sometimes) inadvertent violation of environmental laws. Even protecting livestock from predators can give rise to unexpected criminal liability. Mail fraud can also arise with respect to the participation in federal farm programs. The areas of life potentially impacted with criminal penalties are worth knowing, as well as knowing how to avoid tripping into them.
Water law. Of course, water is essential to agricultural production. Water issues vary across the country, but they tend to focus around being able to have rights to water in the time of shortage and moving the diversion point of water. Also, water quality issues are important. In essence, knowing whether a tract of land has a water right associated with it, how to acquire a water right, and the relative strength of that water rights are critical to understand.
Environmental law. It seems that agricultural and the environment are constantly in the news. The Clean Water Act, Endangered Species Act and other federal (and state) laws and regulations can have a big impact on a farming or ranching operation. Just think of the issues with the USDA’s Swampbuster rules that have arisen over the past 30-plus years. What constitutes a regulatory taking of property that requires the payment of compensation under the Constitution? It’s good to know where the lines are drawn and how to stay out of (expensive) trouble.
Regulatory law. Agriculture is a very heavily regulated industry. Animals and plants, commodities and food products are all subject to a great deal of regulation at both the federal and state level. Antitrust laws are also important to agriculture because of the highly concentrated markets that farmers buy inputs from and sell commodities into. Where are the lines drawn? How can an ag operation best position itself to negotiate the myriad of rules?
Conclusion
It is always encouraging to me to see students, farmers and ranchers, agribusiness and tax professionals get interested in the subject matter and see the relevance of material to their personal and business lives. Agricultural law and taxation is reality. It’s not merely academic. The Principles text is one that can be very helpful to not only those engaged in agriculture, but also for those advising agricultural producers. It’s also a great reference tool for Extension educators. It’s also a great investment for any farmer – and it’s updated twice annually to keep the reader on top of current developments that impact agriculture.
If you are interested in obtaining a copy, perhaps even as a Christmas gift, you can visit the link here: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/principlesofagriculturallaw/index.html. Instructors that adopt the text for a course are entitled to a free copy. The book is available in print and CD versions. Also, for instructors, a complete set of Powerpoint slides is available via separate purchase. Sample exams and work problems are also available. You may also contact me directly to obtain a copy.
If you are interested in obtaining a copy, you can visit the link here: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/principlesofagriculturallaw/index.html. You may also contact me directly.
October 12, 2020 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Saturday, July 25, 2020
Recent Court Developments of Interest
Overview
The court decisions of relevance to agricultural producers, rural landowners and agribusinesses keep on coming. There never seems to be a slack time. Today’s article focuses on some key issues involving bankruptcy, business valuation, and insurance coverage for loss of a dairy herd due to stray voltage. More ag law court developments – that’s the topic of today’s post.
Court Determines Interest Rate in Chapter 12 Case
In re Key Farms, Inc., No. 19-02949-WLH12, 2020 Bankr. LEXIS 1642 (Bankr. D. Wash. Jun. 23, 2020)
The bankrupt debtor in this case is a family farming operation engaged in apple, cherry, alfalfa, seed corn and other crop production. The parents of the family own 100 percent of the debtor. In 2014, the debtor changed its primary lender which extended a line of credit to the debtor that the father personally guaranteed and a term loan to the debtor that the father also personally guaranteed. The lender held a first-priority security interest in various real and personal property to secure loan repayment. The debtor became unable to repay the line of credit and the default caused defaults on the term loan and the guarantees. The lender sued to foreclose on its collateral and have a receiver appointed.
The debtor filed Chapter 12 bankruptcy and proposed a reorganization plan where it would continue farming during 2020-2024 in accordance with proposed budgets. The plan provided for repayment of all creditors in full, and repayment of the lender over 20 years at a 4.5 percent interest rate (prime rate of 3.25 percent plus 1.25 percent). The lender opposed plan confirmation.
In determining whether the reorganization plan was fair and equitable to the lender based on the facts, the bankruptcy court noted the father’s lengthy experience in farming and familiarity with the business and that the farm manager was experienced and professional. The court also noted that parents had extensive experience with crop insurance and that they were committing unencumbered personal assets to the plan. In addition, the court took note of the debtor’s recent shift to more profitable crops and a demonstrated ability to manage around cash flow difficulties, and that the lender would be “meaningfully oversecured.” The court also determined that the debtor’s farming budgets appeared to be based on reasonable assumptions and forecasted consistent annual profitability. However, the court did note that the debtor had a multi-year history of operating losses in recent years; was heavily reliant on crop insurance; was engaged in an inherently risky business subject to forces beyond the debtor’s control; had no permanent long-term leases in place for the considerable amount of acreage that it leased; could not anticipate how the Chinese Virus would impact the business into the future; and proposed a lengthy post-confirmation obligation to the lender.
Accordingly, the court made an upward adjustment to the debtor’s prosed additional 1.25 percent to the prime rate by increasing it by at least 1.75 percent. The court scheduled a conference with the parties to discuss how to proceed.
Valuation Discount Applies to Non-Voting Interests
Grieve v. Comr., T.C. Memo. 2020-28
The petitioner was the Chairman and CEO of a company. After his wife’s death, he established two limited liability companies, with a management company controlled by his daughter as the general partner in each entity holding a 0.2 percent controlling voting manger interest and a 99.8 percent nonvoting interest in each entity held by a family trust – a grantor retained annuity trust (GRAT). The petitioner gifted the 99.8 percent interest in the two entities and filed Form 709 to report the gifts. The IRS revised the reported value of the gifts and asserted a gift tax deficiency of about $4.4 million based on a theoretical game theory construct.
According to the IRS, a hypothetical seller of the 99.8 percent nonvoting interests in the two LLCs would not sell the interests at a large discount to the net asset value (NAV), but would seek to enter into a transaction to acquire the 0.2 percent controlling voting interest from the current owner of that interest in order to obtain 100 percent ownership and eliminate the loss in value as a result of lack of control and lack of marketability. In support of this, the IRS assumed that the owner of the 99.8 percent nonvoting interest would have to pay the controlling 0.2 percent voting member a premium above their undiscounted NAV. Under traditional methodology, the IRS expert estimated that a 28 percent discount to the NAV was appropriate for the 99.8 percent nonvoting units. But, instead of accepting that level of discount, the IRS proposed that the owner of the nonvoting units would pay a portion of the dollar amount of the discount from NAV to buy the remaining 0.2 percent voting interest.
The petitioner’s expert used a standard valuation methodology to prepare valuation appraisal reports. This expert applied a lack of control discount of 13.4 percent for the gift to the GRAT and a 12.7 percent lack of control discount for the gift to the irrevocable trust. The valuation firm also applied a 25 percent discount for both gifts.
The Tax Court determined that the IRS failed to provide enough evidence for its valuation estimates. The Tax Court also rejected the IRS assumption of the impact of future events on valuation, noting that the IRS valuation expert reports lacked details on how the discounts were calculated. Thus, the Tax Court rejected the proposed valuation estimates of the IRS and accepted those of the petitioner. The result was a 35 percent discount (total) for entity-level lack of control and lack of marketability compared to a 1.4 percent discount had the IRS approach been accepted.
S Corporation Value Accounts for Tax on Shareholders
Kress v. United States., 327 F. Supp. 2d 731 (E.D. Wisc. 2019)
The taxpayers, a married couple, gifted minority interests of stock in their family-owned S corporation to their children and grandchildren in 2007-2009. The taxpayers paid gift tax on the transfers of about $2.4 million. The taxpayers’ appraiser valued the S corporation earnings as of the end of 2006, 2007 and 2008 as a fully tax-affected C corporation. On audit, the IRS also followed a tax-effected approach to valuation of the S corporation earnings but applied an S corporation premium (pass-through benefit) and asserted that the gifts were undervalued as a result. The IRS assessed an additional $2.2 million of federal gift tax. The taxpayers paid the additional tax and sued for a refund in 2016.
The issue was the proper valuation of the S corporation. Historically, the IRS has not allowed for tax-affected S corporation valuation based on Gross v. Comr., T.C. Memo. 1999-254; Wall v. Comr., T.C. Memo. 2001-75; Estate of Heck v. Comr., T.C. Memo. 2002-34; Estate of Adams v. Comr., T.C. Memo. 2002-80; Dallas v. Comr., T.C. Memo. 2006-212; and Estate of Gallagher v. Comr, T.C. Memo. 2011-148. The IRS also has an internal valuation guide that provides that “…no entity level tax should be applied in determining the cash flows of an electing S corporation. …the personal income taxes paid by the holder of an interest in an electing S corporation are not relevant in determining the fair market value of that interest.”
But other courts have allowed the tax impact on shareholders. See, e.g., Delaware Open MRI Radiology Associates, 898 A.2d 290 (Del. Ct. Chanc. 2006); Bernier v. Bernier, 82 Mass. App. Ct. 81 (2012).
The court accepted the tax-affect valuation but disallowed the S corporation premium that IRS asserted. The court also allowed a discount for lack of marketability between 25 percent and 27 percent depending on the year of the transfer at issue.
Stray Voltage Could Lead to Partial Insurance Coverage
Hastings Mutual Insurance Co. v. Mengel Dairy Farms, Inc., No. 5:19CV1728, 2020 U.S. Dist. LEXIS 87612 (N.D. Ohio May 19, 2020)
The defendant unexpectedly had several cows and calves die and also suffered a loss of milk production and profits. The defendant filed a claimed against the plaintiff for insurance coverage for death of livestock, cost of investigation and repairs, and loss of business profits. The plaintiff investigated the claim, utilizing an electrical company to do so. The electrical company found a stray electrical current present on the property. The plaintiff then hired a fire and explosion company to investigate the property. This investigation resulted in a finding of no stray voltage on the property, but the company did express its belief that stray voltage did cause the defendant’s harm. As a result, the plaintiff paid the insurance claim for death of livestock and repairs, but not for loss of business profits.
The plaintiff then filed an action for a determination under the policy of whether loss of business profits was a covered loss. The plaintiff sought a declaratory judgment specifying that coverage for loss and damage resulting from the stray voltage was not triggered because the defendant was not subject to a “necessary suspension” of farming operations, and that the defendant’s loss or damage had to be directly caused by a “peril insured against” rather than being caused by dehydration which resulted from the cattle’s reaction to the stray voltage. The defendant filed a counterclaim for breach of contract; breach of good faith and fair dealing; and unjust enrichment. The plaintiff moved for summary judgment on the basis that the policy wasn’t triggered for lack of electrocution and that there was no suspension in the defendant’s business operations. The court determined that the policy did not define the term electrocution in the context of dairy animals. As such, the court concluded that the term could be reasonably interpreted to mean death by electrical shock or the cause of irreparable harm. As an ambiguous term, it was defined against the plaintiff and in the defendant’s favor. The court also refused to grant summary judgment on the cause of death issue. In addition, because the defendant did not cease operations, the court concluded that the policy provided no coverage for lost profits. The court also rejected the defendant’s breach of contract claim due to lack of suspending the business and rejected the good faith/fair dealing claim because mere negligence was not enough to support such a claim. The unjust enrichment claim was likewise denied.
Conclusion
The cases discussed above are all quite relevant to agricultural producers. For those struggling financially that find themselves in a Chapter 12, the interest rate utilized in the case is of primary importance. Many factors go into determining the rate, and farming operations can achieve a lower rate by meeting certain factors listed by the court in the decision mentioned above. Likewise, the valuation issue is critical, particularly if the federal estate tax exemption amount were to drop. When federal (and, possibly, state) estate tax is involved, valuation is the “game.” Finally, in all insurance cases, the language of the policy is critical to determine coverage application. Any ambiguous terms will be construed against the company. In all situations, having good legal counsel is a must.
July 25, 2020 in Bankruptcy, Business Planning, Insurance | Permalink | Comments (0)
Friday, July 3, 2020
The “Cramdown” Interest Rate in Chapter 12 Bankruptcy
Overview
In the context of Chapter 12 (farm) bankruptcy, unless a secured creditor agrees otherwise, 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.
What does “present value” mean? It means that a dollar in hand today is worth more than a dollar to be received at some time in the future. It also means that an interest rate will be attached to that deferred income. But, what interest rate will make a creditor whole? A recent decision involving a farming operation in the state of Washington is a good illustration of how courts address the issue.
“Cramdown” and Present Value
When a farmer files a Chapter 12 bankruptcy, the law allows the “cramdown” of a secured creditor if the farmer reorganization plan provides that the secured creditor gets to retain the lien that secures the claim and the value, as of the effective date of the plan, of property to be distributed by the trustee or the debtor under the plan on account of the claim is not less than the allowed amount of the claim. 11 U.S.C. §1225(a)(5)(B)(i)-(ii). The real issue is what “not less than the allowed amount of the claim” means. That’s particularly true when the rule is applied in the context of cash payments that are to be made in the future. In that instance, a value must be derived as of the plan’s effective date, that is discounted to present value. Present value is the discounted value of a stream of expected future incomes. That stream of income received in the future is discounted back to present value by a discount rate.
The determination of present value is highly sensitive to the discount rate, which is commonly expressed in terms of an interest rate. Several different approaches have been used in Chapter 12 bankruptcy cases (and nearly identical situations in Chapters 11 and 13 cases) to determine the discount rate. Those approaches include the contract rate – the interest rate used in the debt obligation giving rise to the allowed claim; the legal rate in the particular jurisdiction; the rate on unpaid federal tax; the federal civil judgment rate; the rate based on expert testimony; a rate tied to the lender’s cost of funds; and the market rate for similar loans.
Supreme Court Decision
In 2004, the U.S. Supreme Court, in, addressed the issue in the context of a Chapter 13 case that has since been held applicable in Chapter 12 cases. Till v. SCS Credit Corporation, 541 U.S. 465 (2004). In Till, the debtor owed $4,000 on a truck at the time of filing Chapter 13. The debtor proposed to pay the creditor over time with the payments subject to a 9.5 percent annual interest rate. That rate was slightly higher than the average loan rate to account for the additional risk that the debtor might default. The creditor, however, argued that it was entitled to a 21 percent rate of interest to ensure that the payments equaled the “total present value” or were “not less than the [claim’s] allowed amount.” The bankruptcy court disagreed, but the district court reversed and imposed the 21 percent rate. The United States Court of Appeals for the Seventh Circuit held that the 21 percent rate was “probably” correct, but that the parties could introduce additional concerning the appropriate interest rate.
On further review by the U.S. Supreme Court, the Court held that the proper interest rate was 9.5 percent. That rate, the Court noted, was derived from a modification of the average national loan rate to account for the risk that the debtor would default. The Court’s opinion has been held to be applicable in Chapter 12 cases. See, e.g., In re Torelli, 338 B.R. 390 (Bankr. E.D. Ark. 2006); In re Wilson, No. 05-65161-12, 2007 Bankr. LEXIS 359 (Bankr. D. Mont. Feb. 7, 2007); In re Woods, 465 B.R. 196 (B.A.P. 10th Cir. 2012). The Court rejected the coerced loan, presumptive contract rate and cost of funds approaches to determining the appropriate interest rate, noting that each of the approaches was “complicated, impose[d] significant evidentiary costs, and aim[ed] to make each individual creditor whole rather than to ensure the debtor’s payments ha[d] the required present value.” A plurality of the Court explained that these difficulties were not present with the formula approach. The Court opined that the formula approach requires that the bankruptcy court determine the appropriate interest rate by starting with the national prime rate and then make an adjustment to reflect the risk of nonpayment by the debtor. While the Court noted that courts using the formula approach have typically added 1 percent to 3 percent to the prime rate as a reflection of the risk of nonpayment, the Court did not adopt a specific percentage range for risk adjustment.
Subsequent Cases
Since the Supreme Court’s Till decision, the lower courts have decided many cases in which they have attempted to apply the Till approach. Indeed, the Circuit Courts have split on whether the appropriate interest rate for determining present value should be the market rate or a rate based on a formula. For example, in a relatively recent Circuit Court case on the issue, the Second Circuit held that a market rate of interest should be utilized if an efficient market existed in which the rate could be determined. In re MPM Silicones, L.L.C., No. 15-1682(l), 2017 U.S. App. LEXIS 20596 (2nd Cir. Oct. 20, 2017). In the case, the debtor filed Chapter 11 and proposed a reorganization plan that gave first-lien holders an option to receive immediate payment without any additional “make-whole” premium, or the present value of their claims by utilizing an interest rate based on a formula that resulted in a rate below the market rate. The bankruptcy court confirmed the plan, utilizing the formula approach of Till. The federal district court affirmed. On further review, the appellate court reversed noting that Till had not conclusively specified the use of the formula approach in a Chapter 11 case. The appellate court remanded the case to the bankruptcy court for a determination of whether an efficient market rate could be determined based on the facts of the case.
Recent Washington Case
A recent case from the state of Washington is a good illustration of how a court can use the Till opinion to fashion an interest rate suitable to the debtor’s particular farming operation. In In re Key Farms, Inc., No. 19-02949-WLH12, 2020 Bankr. LEXIS 1642 (Bankr. D. Wash. Jun. 23, 2020), the debtor was a family farming operation engaged in apple, cherry, alfalfa, seed corn and other crop production. The parents of the family owned 100 percent of the debtor, the farming entity. In 2014, the debtor changed its primary lender which extended a line of credit to the debtor that the father personally guaranteed and a term loan to the debtor that the father also personally guaranteed. The lender held a first-priority security interest in various real and personal property to secure loan repayment. The debtor became unable to repay the line of credit and the default caused defaults on the term loan and the guarantees. The lender sued to foreclose on its collateral and have a receiver appointed.
The debtor then filed Chapter 12 bankruptcy and proposed a reorganization plan where it would continue farming under 2020-2024 in accordance with proposed budgets through 2024. The plan provided for repayment of all creditors in full. The plan proposed to repay then lender over 20 years at a 4.5 percent interest rate (prime rate of 3.25 percent plus 1.25 percent). The lender opposed plan confirmation. A primary issue was what an appropriate cramdown interest rate would be.
The court looked at the unique features of the debtor to set the rate. Indeed, in determining whether the reorganization plan was fair and equitable to the lender based on the facts, the court noted the father’s lengthy experience in farming and familiarity with the business and that the farm manager was experienced and professional. The court also noted that the parents had extensive experience with crop insurance and that they were committing unencumbered personal assets to the reorganization plan. The court also noted the debtor’s shift in recent years to more profitable crops, a demonstrated ability to manage around cash flow difficulties, and that the lender would be “meaningfully oversecured.” The court also determined that the debtor’s farming budgets appeared to be based on reasonable assumptions and forecasted consistent annual profitability.
However, the court did note that the debtor had a multi-year history of operating losses in recent years; was heavily reliant on crop insurance; was engaged in an inherently risky business subject to forces beyond the debtor’s control; had no permanent long-term leases in place for the considerable amount of acreage that it leased; could not anticipate how the Chinese Virus would impact the business into the future; and proposed a lengthy post-confirmation obligation (30 years) to the lender. Accordingly, the court made an upward adjustment to the debtor’s proposed additional 1.25 percent to the prime rate by increasing it by at least 1.75 percent. The court scheduled a conference with the parties to discuss how to proceed.
Conclusion
The interest rate issue is an important one in reorganization bankruptcy. the market rate, as applied to an ag bankruptcy, does seem to recognize that farm and ranch businesses are subject to substantial risks and uncertainties from changes in price and from weather, disease and other factors. Those risks are different depending on the type of agricultural business the debtor operates. A market rate of interest would is reflective of those factors.
July 3, 2020 in Bankruptcy | Permalink | Comments (0)
Tuesday, June 2, 2020
SBA Says Farmers in Chapter 12 Ineligible for PPP Loans
Overview
Economic conditions in agriculture have been difficult for several years. Added to the down economic cycle that much of agriculture has experienced are the severe hits the economy has taken by actions of state governors reacting to the virus. Prices for various agricultural commodities are off significantly and Chapter 12 farm bankruptcy filings are up. One of the measures that the Congress has created to try to provide relief to businesses is the Paycheck Protection Program (PPP). I have written about the details of that program in other posts, but another aspect of the program that impacts farmers has now come into focus – the issue of whether a farmer in Chapter 12 bankruptcy is eligible for a PPP loan.
Chapter 12 filers and PPP loan eligibility – it’s the topic of today’s post.
Chapter 12
Under 1986 amendments to the Bankruptcy Act of 1978, Congress created Chapter 12 bankruptcy for “family farmers.” Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act of 1986, Pub. L. No. 99-554, 100 Stat. 3105 (1986), adding 11 U.S.C. § 1201 et seq. The Act was scheduled to expire on October 1, 1993 but was extended numerous times before being made a permanent part of the Bankruptcy Code by the Bankruptcy Act of 2005, effective July 1, 2005. Chapter 12 was designed as a response to the difficulties that farmers (and fishermen) suffered in the 1980s. Chapter 12 is conceptually and statutorily similar to other reorganization-type bankruptcies, but provides more flexibility in making periodic payments to take into account the seasonal nature of many farming or fishing operations. Under Chapter 12, the debtor proposes a repayment plan that lasts three to five years. Chapter 12 is also less expensive and, in many respects, less complex than other forms of reorganization bankruptcy.
PPP and Applicants in Bankruptcy
On March 27, 2020, the President signed into law the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, Pub. L. No. 116-136, 134 Stat. 281 (2020). The CARES Act amended the Small Business Administration’s (SBAs) existing “7a Loan Program” to create the PPP. The PPP provides loans for eligible small businesses to cover allowed uses including payroll costs, interest on mortgage obligations and rent. The SBA’s First Interim Rule did not address eligibility of bankrupt debtors for the PPP, but it did require an applicant to fill out a form that required the applicant to certify that the applicant was not “presently involved in bankruptcy.” However, in the SBA’s Fourth Interim Final Rule, posted to its website on April 24, 2020, the SBA said in a Q and A that a business would not be approved for a PPP loan if the business was in bankruptcy. The rationale given was that making a PPP loan to an applicant in bankruptcy would be too risky – either via unauthorized use of funds or non-repayment of unforgiven loans.
Implications for Applicants in Bankruptcy
A bankruptcy court in Wisconsin recently dealt with the issue of PPP loan eligibility for a farmer in Chapter 12 bankruptcy. In Schuessler v. United States SBA, No. 20-02065-bhl, 2020 Bankr. LEXIS 1347 (E.D. Wisc. May 22, 2020), the debtors, a married couple operating a farm dairy operation, filed Chapter 12 bankruptcy in late 2018. On the same day, their wholly-owned, limited liability company (LLC) entity that runs the daily farming and dairy operation filed a separate Chapter 12 petition. The debtors direct the farming operation and own the real estate and improvements. The cases were jointly administered, and the debtors’ second amended plan was confirmed on May 8, 2019. The debtors’ income comes primarily from milk sales and from the sale of culled cows. Due to the present economic crisis exacerbated by state governors, the debtors’ milk sale revenue declined by more than 30 percent. Since January of 2019, the wholesale price of milk declined from nearly $19.00 to $12.50 per cwt. In addition, due to slaughterhouse closures, the debtors received much lower than historical prices for their culled cow sales. The debtors listed a significant mortgage and utility expenses on the bankruptcy schedules and noted that they employ 14 people with an average monthly payroll of $59,835.
The debtors applied for a Paycheck Protection Program (PPP) loan from the Small Business Administration (SBA) and were rejected because of their pending bankruptcy case. They otherwise met the requirements of the PPP. Without the loan, there was no doubt that the debtors would be forced to lay off essential employees and would be potentially driven out of business. The debtors then filed for Declaratory Judgment, Writ of Mandamus and Injunctive Relief against the SBA. The bankruptcy court rejected the debtors’ claims and dismissed the complaint.
The bankruptcy court noted that the SBA’s Fourth Interim Final Rule, Section III (4) specified that a debtor in bankruptcy is not eligible for a PPP loan. The issue was whether the SBA’s position violated the anti-discrimination provisions contained in 11 U.S.C. §525(a). Those provisions bar the government from revoking, suspending, or refusing to renew “a license, permit, charter, franchise, or other similar grant” based on a person either being in or having been a debtor in bankruptcy. The bankruptcy court noted that the U.S. Court of Appeals for the Seventh Circuit (to which any appeal would be made) had not yet ruled on the issue of the scope of 11 U.S.C. §525(a), but that four other Circuit Courts of Appeal had. Three of those courts took a narrow view of 11 U.S.C. §525(a) and only the U.S. Court of Appeals for the Second Circuit determined that debtors in bankruptcy couldn’t be denied any “property interests” that were essential to the debtor’s “fresh start” in bankruptcy. Stolz v. Brattleboro Housing Authority, 315 F.3d 80 (2d Cir. 2002).
The bankruptcy court also agreed with the SBA’s reliance on other courts that had recently held that the denial of PPP eligibility to bankrupt debtors did not violate 11 U.S.C. §525(a) because the PPP funds are distributed via “loans” and are, as a result, outside the scope of the antidiscrimination provisions of 11 U.S.C. §525(a). See Cosi, Inc. v. SBA, Adv. No. 20-50591 (Bankr. D. Del. Apr. 30, 2020); Trudy’s Texas Star, Inc. v. Carranza, Adv. No. 20-1026 (Bankr. W.D. Tex. May 7, 2020). In addition, the bankruptcy court noted that in In re Elter, 95 B.R. 618 (Bankr. E.D. Wis. 1989) the refusal to extend a government-guaranteed student loan based on the debtor’s bankruptcy history did not violate 11 U.S.C. §525(a). It was the plain terms of the CARES Act creating the PPP as a subsidized loan guarantee program, the bankruptcy court reasoned, that kept it beyond the anti-discrimination provisions of 11 U.S.C. §525(a) that applied to a “license, charter, franchise, or other similar grant.” While the underlying statute (15 U.S.C. §636(a)(36)(F)(i)) is silent on whether bankrupt debtors are ineligible for PPP loans, the bankruptcy court noted that there was nothing in the statute that suggested the Congress intended to limit the SBA’s rulemaking or that the Congress provided an exhaustive list of eligibility requirements that the SBA couldn’t supplement via rulemaking. Thus, the Fourth Interim Final rule was not beyond the SBA’s delegated authority. In addition, the court held that the Fourth Interim Final Rule did not violate the APA for being arbitrary and capricious. The bankruptcy court noted that had the Congress intended to bar the SBA from denying loan eligibility to applicants in bankruptcy, it could have done so.
Conclusion
The Wisconsin bankruptcy court’s conclusion barring Chapter 12 debtors from PPP eligibility is harsh. It clearly runs counter to the policy objective of Chapter 12 bankruptcy – to keep farming operations in business and servicing their debt after having their debt restructured. Chapter 12 was enacted based heavily on the recognition that farming is subject to numerous factors that can be beyond the control of the particular farmer. That’s certainly the case with the economic collapse brought on by the (largely unconstitutional) actions of various state governors. The bankruptcy court’s decision also runs counter to two other bankruptcy court decisions on the PPP eligibility issue – a bankruptcy court in Texas and one in Vermont. See Hidalgo County Emergency Service Foundation v. Carranza, Adv. No. 20-2006, 2020 Bankr. LEXIS 1174 (Bankr. S.D. Tex. Apr. 25, 2020); and In re Springfield Hospital, Inc., No. 19-10283, 2020 Bankr. LEXIS 1205 (Bankr. D. Vt. May 4, 2020). Indeed, the Texas bankruptcy court also noted the lack of collateral requirements to obtain a PPP loan and that the funds need not be repaid if they were used in a qualified manner, illustrating the minimal-to-non-existent risk to a lender of a borrower’s default.
Congress has been apprised of the SBA’s position and the inconsistent rulings by courts. Unless the Congress takes action (or the SBA changes its mind), more farming operations will fail than otherwise would.
June 2, 2020 in Bankruptcy | Permalink | Comments (0)
Wednesday, May 27, 2020
Ag Law and Tax Developments
Overview
During the last couple of months while various state governors have issued edicts randomly declaring some businesses essential and other non-essential, the ag industry has continued unabated. The same is true for the courts – the ag-related cases and tax developments keep on coming in addition to all of the virus-related developments.
As I periodically do, I provide updates of ag law and tax issues of importance to agricultural producers and others in the ag industry, as well as rural landowners in general.
That the topic of today’s post – a few recent developments in ag law and taxation.
FSA Not Entitled To Set-Off Subsidy Payments
In Re Roberts, No. 18-11927-t12, 2020 Bankr. LEXIS 1338 (Bankr. D. N.M. May 19, 2020)
Bankruptcy issues are big in agriculture at the present time. Several recent blog articles have touched on some of those issues, including bankruptcy tax issues. This case dealt with the ability of a creditor to offset a debt owed to it by the debtor with payments it owed to the debtor. The debtors (husband and wife) borrowed $300,000 from the Farm Service Agency (FSA) in late 2010. The debtors enrolled in the Price Loss Coverage program and the Market Facilitation Program administered by the FSA. The debtors filed Chapter 11 bankruptcy in mid-2018 and converted it to a Chapter 12 bankruptcy in late 2019. The debtors defaulted on the FSA loan after converting their case to Chapter 12.
The debtors were entitled to receive approximately $40,000 of total MFP and PLC payments post-petition. The FSA sought a set-off of the pre-petition debt with the post-petition subsidy payments. The court refused to the set-off under 11 U.S.C. §553 noting that the offsetting obligations did not both arise prepetition and were not mutual as required by 11 U.S.C. §553(a). There was no question, the court opined, that the FSA’s obligation to pay subsidy payments arose post-petition and that the debtors’ obligation to FSA arose pre-petition. Thus, set-off was not permissible.
HSA Inflation-Adjusted Amounts for 2021
Rev. Proc. 2020-32, 2020-24 I.R.B.
Persons that are covered under a high deductible health plan (HDHP) that are not covered under any other plan that is not an HDHP, are eligible to make contributions to a health savings account (HSA) subject to certain limits. For calendar year 2021, an HDHP is a health plan with an annual deductible of at least $1,400 for individual coverage or $2,800 for family coverage, and maximum out-of-pocket expenses of $7,000 for individual coverage or $14,000 for family coverage. For 2021, the maximum annual contribution to an HSA is $3,600 for self-only coverage and $7,200 for family coverage.
Charitable Deduction Allowed for Donated Conservation Easement
Champions Retreat Golf Founders, LLC v. Comr., No. 18-14817, 2020 U.S. App. LEXIS 15237 (11th Cir. May 13, 2020), rev’g., T.C. Memo. 2018-146
The vast majority of the permanent conservation easement cases are losers for the taxpayer. This one was such a taxpayer loser at the Tax Court level, but not at the appellate level. Under the facts of the case, the petitioner claimed a $10.4 million charitable deduction related to the donation of a permanent conservation easement on a golf course. The IRS denied the deduction on the basis that the easement was not exclusively for conservation purposes because it didn’t protect a relatively natural habitat of fish, wildlife, or plants, or a similar ecosystem as required by I.R.C. §170(h)(4)(A)(ii). The IRS also asserted that the donation did not preserve open space for the scenic enjoyment of the general public or in accordance with a governmental conservation policy for the public’s benefit under I.R.C. §170(h)(4)(A)(iii). The Tax Court agreed with the IRS and denied the deduction. The Tax Court determined that the “natural habitat” requirement was not met – there was only one rare, endangered or threatened species with a habitat of only 7.5 percent of the easement area. In addition, the Tax Court noted that part of the golf course was designed to drain into this habitat area which would introduce chemicals into it. Thus, the easement’s preservation of open space was not for public enjoyment nor in accordance with a governmental policy of conservation.
On further review, the appellate court reversed. The appellate court found that the deduction was proper if the donation was made for the protection of a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem or was made for the preservation of open space for the scenic enjoyment of the general public. The appellate court noted that without the golf course, the easement would satisfy the requirements and an easement deduction is not denied simply because a golf course is included. The appellate court remanded the case for a determination of the proper amount of the deduction.
Residence Built on Farm Was “Farm Residence” For Zoning Purposes
Hochstein v. Cedar County. Board. of Adjustment, 305 Neb. 321, 940 N.W.2d 251 (2020)
Many cases involve the issue of what is “agricultural” for purposes of state or county zoning and related property tax issues. In this case, Nebraska law provided for the creation of an “ag intensive district.” In such designated areas, any “non-farm” residence cannot be constructed closer than one mile from a livestock facility. The plaintiff operated a 4,500-head livestock feedlot (livestock feeding operation (LFO)) and an adjoining landowner operates a farm on their adjacent property. The adjoining landowner applied to the defendant for a zoning permit to construct a new house on their property that was slightly over one-half mile from the plaintiff’s LFO. The defendant (the county board of adjustment) approved the permit and the plaintiff challenged the issuance of the permit on the basis that the adjoining landowner was constructing a “non-farm” residence. The defendant affirmed the permit’s issuance on the basis that the residence was to be constructed on a farm. The plaintiff appealed and the trial court affirmed. On further review, the appellate court affirmed. On still further review by the state Supreme Court, the appellate court’s opinion was affirmed. The Supreme Court noted that the applicable regulations did not define the terms “non-farm residence” or “farm residence.” As such, the defendant had discretion to reasonably interpret the term “farm residence” as including a residence constructed on a farm.
Ag Cooperative Fails To Secure Warehouse Lien; Loses on Conversion Claim.
MidwestOne Bank v. Heartland Co-Op, 941 N.W.2d 876 (Iowa 2020)
I dealt with the issue in this case in my blog article of March 27. You may read it here: https://lawprofessors.typepad.com/agriculturallaw/2020/03/conflicting-interests-in-stored-grain.html In the article, I detail many of the matters that arose in this case.
The facts of the case revealed that a grain farmer routinely delivered and sold grain to the defendant, an operator of a grain warehouse and handling facility. The contract between the parties contemplated the sale, drying and storage of the grain. The farmer also borrowed money from the plaintiff to finance the farming operation and granted the plaintiff a security interest in the farmer’s grain and sale proceeds. The plaintiff filed a financing statement with the Secretary of State’s office on Feb. 29, 2012 which described the secured collateral as “all farm products” and the “proceeds of any of the property [or] goods.” The financing statement was amended in late 2016 and continued. The underlying security agreement required the farmer to inform the plaintiff as to the location of the collateral and barred the farmer from removing it from its location without the plaintiff’s consent unless done so in the ordinary course of business. It also barred the farmer from subjecting the collateral to any lien without the plaintiff’s prior written consent. However, the security agreement also required the farmer to maintain the collateral in good condition at all time and did not require the plaintiff’s prior written consent to do so.
The plaintiff complied with the 1985 farm products rule and the farmer gave the plaintiff a schedule of buyers of the grain which identified the defendant. From 2014 through 2017, the farmer sold grain to the defendant, and the defendant remitted the net proceeds of sale via joint check to the farmer and the plaintiff after deducting the defendant’s costs for drying and storage – a longstanding industry practice. The plaintiff, an ag lender in an ag state, claimed that it had no knowledge of such deductions until 2017 whereupon the plaintiff sued for conversion. The defendant did not properly perfect a warehouse lien and the lien claim was rejected by the trial court, but asserted priority on a theory of unjust enrichment. The trial court rejected the unjust enrichment claim.
The state Supreme Court agreed, refusing to apply unjust enrichment principles in the context of Article 9 of the Uniform Commercial Code (UCC). The court did so without any mention of UCC §1-103 (b) which states that, "Unless displaced by the particular provisions of the Uniform Commercial Code, the principles of law and equity” including the law merchant [undefined] and the law relative to capacity to contract; duress; coercion; mistake; principal and agency relationships; estoppel, fraud and misrepresentation; bankruptcy, and other validating or invalidating cause [undefined] supplement its provisions.” This section has been characterized as the "most important single provision in the Code." 1 J. White & R. Summers, Uniform Commercial Code § 5. “As such, the UCC was enacted to displace prior legal principles, not prior equitable principles.” However, the Supreme Court completely ignored this “most important single provision in the Code.” The Court also ignored longstanding industry practice and believed an established ag lender in an ag state that it didn’t know the warehouse was deducting its drying and storage costs before issuing the joint check.
Conclusion
The developments keep rolling in. More will be covered in future articles.
May 27, 2020 in Bankruptcy, Income Tax, Real Property, Secured Transactions | Permalink | Comments (0)
Monday, May 4, 2020
Farm Bankruptcy – “Stripping,” “Claw-Back” and the Tax Collecting Authorities
Overview
As originally enacted, Chapter 12 did not create a separate tax entity for Chapter 12 bankruptcy estates for purposes of federal income taxation. That shortcoming precludes debtor avoidance of potential income tax liability on disposition of assets as may be possible for individuals who file Chapter 7 or 11 bankruptcy. But, an amendment to Chapter 12 enacted nineteen years after Chapter 12 was established made an important change. As modified, tax debt associated with the sale of an asset used in farming can be treated as unsecured debt that is not entitled to priority and ultimately discharged. Without this modification, a farmer faced with selling assets to come up with funds to satisfy creditors could trigger substantial tax liability that would impair the chance to reorganize the farming business under Chapter 12. Such a farmer could be forced into liquidation.
If taxes can be treated as unsecured debt how are taxes that the debtor has already paid to be treated? Can those previously paid or withheld taxes be pulled back into the bankruptcy estate where they are “stripped” of their priority?
Chapter 12 bankruptcy and priority “stripping” of taxes – it’s the topic of today’s post.
2005 Modified Tax Provision
The 2005 Bankruptcy Code allows a Chapter 12 debtor to treat claims arising out of “claims
owed to a governmental unit” as a result of “sale, transfer, exchange, or other disposition of any farm asset used in the debtor’s farming operation” to be treated as an unsecured claim that is not entitled to priority under Section 507(a) of the Bankruptcy Code, provided the debtor receives a discharge. 11 U.S.C. §1222(a)(2)(A). The amendment attempted to address a major problem faced by many family farmers filing Chapter 12 bankruptcy where the sale of farm assets to make the operation economically viable triggered gain which, as a priority claim, had to be paid in full before payment could be made to general unsecured creditors. Even though the priority tax claims could be paid in full in deferred payments under prior law, in many instances the debtor did not have enough funds to allow payment of the priority tax claims in full even in deferred payments. That was the core problem that the 2005 provision was attempting to address.
Nothing in the 2005 legislation specified when the property can be disposed of to have the associated taxes be eligible for unsecured claim status. Of course, to confirm a Chapter 12 plan the taxing agencies must receive at least as large an amount as they would have received had the claim been a pre-petition unsecured claim. On this issue, the United States Court of Appeals for the Eighth Circuit has ruled that a debtor’s pre-petition sale of slaughter hogs came within the scope of the provision, and that the provision changes the character of the taxes from priority status to unsecured such that, upon discharge, the unpaid portion of the tax is discharged along with interest and penalties. In re Knudsen, et al. v. Internal Revenue Service, 581 F.3d 696 (8th Cir. 2009). The court also held the statute applies to post-petition taxes and that those taxes can be treated as an administrative expense. Such taxes can be discharged in full if provided for in the Chapter 12 plan and the debtor receives a discharge. Upon the filing of a Chapter 12, a separate taxpaying entity apart from the debtor is not created.
That is an important point in the context of the 2005 amendment. The debtor remains responsible for tax taxes triggered in the context of Chapter 12. The amendment, however, allows non-priority treatment for claims entitled to priority under 11 U.S.C. §507(a)(2). That provision covers administrative expenses that are allowed by 11 U.S.C. §503(b)(B) which includes any tax that the bankruptcy estate incurs. Pre-petition taxes are covered by 11 U.S.C. §507(a)(8). But, post-petition taxes, to be covered by the amendment, must be incurred by the bankruptcy estate such as is the case with administrative expenses. Indeed, the IRS position is that post-petition taxes are not "incurred by the estate" as is required for a tax to be characterized as an administrative expense in accordance with 11 U.S.C. § 503 (b)(1)(B)(i), and that post-petition taxes constitute a liability of the debtor rather than the estate. See ILM 200113027 (Mar. 30, 2001). The U.S. Circuit Courts of Appeal for the Ninth and Tenth Circuits agreed with the IRS position, as did the U.S. Supreme Court. Hall v. United States, 132 S. Ct. 1882 (2012).
2017 Legislation
H.R. 2266, signed into law on October 26, 2017, contains the Family Farmer Bankruptcy Act (Act). The Act adds 11 U.S.C. §1232 which specifies that, “Any unsecured claim of a governmental unit against the debtor or the estate that arises before the filing of the petition, or that arises after the filing of the petition and before the debtor's discharge under section 1228, as a result of the sale, transfer, exchange, or other disposition of any property used in the debtor's farming operation”… is to be treated as an unsecured claim that arises before the bankruptcy petition was filed that is not entitled to priority under 11 U.S.C. §507 and is deemed to be provided for under a plan, and discharged in accordance with 11 U.S.C. §1228. The provision amends 11 U.S.C. §1222(a)(2)(A) to effectively override the U.S. Supreme Court decision in Hall. As noted above, in Hall the U.S. Supreme Court held that tax triggered by the post-petition sale of farm assets was not discharged under 11 U.S.C. §1222(a)(2)(A). The Court held that because a Chapter 12 bankruptcy estate cannot incur taxes by virtue of 26 U.S.C. §1399, taxes were not “incurred by the estate” under 11 U.S.C. §503(b) which barred post-petition taxes from being treated as non-priority. The 2017 legislation overrides that result. The provision was effective for all pending Chapter 12 cases with unconfirmed plans and all new Chapter 12 cases as of October 26, 2017.
Computational Issues
The 2005 provision also makes no mention of how the amount of priority and non-priority tax claims is to be computed. Operationally, if a Chapter 12 bankruptcy filer has liquidated assets used in the farming operation within the tax year of filing or liquidates assets used in the farming operation after Chapter 12 filing as part of the Chapter 12 plan, and gain or depreciation recapture income or both are triggered, the plan should provide that there are will be no payments to unsecured creditors until the amount of the tax owed to governmental bodies for the sale of assets used in the farming operation is ascertained. The dischargeable tax claims are then added to the pre-petition unsecured claims to determine the percentage distribution to be made to the holders of pre-petition unsecured claims as well as the claims of the governmental units that are being treated as unsecured creditors not entitled to priority. That approach assures that all claims that are deemed to be unsecured claims would be treated equitably.
Methods of computation. To accurately determine the extent of the priority tax claim under the non-priority provision, it is necessary to directly relate the priority tax treatment to the income derived from sources that either satisfy the non-priority provision or do not satisfy it. There are two basic approaches for computing the priority and general dischargeable unsecured tax claims – the proportional method or the marginal allocation method. The proportional method (which is the IRS approach) divides the debtor’s ordinary farming income by the debtor’s total income and then multiplies the total tax claim by the resulting fraction. That result is then subtracted from the debtor’s total tax liability with the balance treated as the non-priority part of the tax obligation. Conversely, under the marginal approach, the debtor prepares a pro-forma tax return that omits the income from the sale of farm assets. The resulting tax liability from the pro forma return is then subtracted from the total tax due on the debtor’s actual return. The difference is the tax associated with the sale of farm assets that is entitled to non-priority treatment.
A shortfall of the IRS’ proportional method is that it merely divides the debtor’s tax obligation by applying the ratio of the debtor’s priority tax claim to the debtor’s total income and then divides the total tax claim. That mechanical computation does not consider any deductions and/or credits that impact the debtor’s final tax liability, and which are often phased out based on income. Instead, the proportional method simply treats every dollar of income the same. The result is that the proportional method, as applied to many debtors, significantly increases the debtor’s adjusted gross income and the priority non-dischargeable tax obligation. The proportional method makes no attempt to measure the type of income, or what income “causes” any particular portion of the tax claim.
The marginal approach was adopted by Eighth Circuit in the Knudsen case as well as the Bankruptcy Court in In re Ficken, 430 B.R. 663 (Bankr. D. Colo. 2009). The appropriate tax allocation method was not at issue in either of the cases on appeal. The Kansas bankruptcy court also rejected the IRS approach in favor of the marginal method. The most recent court decision on the issue has, like earlier cases, rejected the proportional method in favor of the marginal method. In re Keith, No. 10-12997, 2013 Bankr. LEXIS 2802 (Bankr. D. Kan. Jul. 8, 2013).
What About Withheld Tax?
Under the 2005 amendment (and the 2017 legislation) taxes triggered by the sale, exchange, etc., of assets used in farming can be stripped of there priority status in a Chapter 12 farm bankruptcy. However, the debtor’s method for computing the taxes not entitled to priority involves utilization of the debtor’s total tax claim. That means that taxes that have already been withheld or paid through estimated payments should be refunded to the debtor’s bankruptcy estate, where it becomes subject to the priority/non-priority computation, rather than being offset against the debtor’s overall tax debt (with none it subject to non-priority treatment). Of course, the IRS and state taxing authorities object to this treatment.
Iowa bankruptcy case. The issue of how to handle withheld taxes was at issue in a recent case. In In re DeVries, No. 19-0018, 2020 U.S. Bankr. LEXIS 1154 (Bankr. N.D. Iowa Apr. 28, 2020), the debtors, a married couple, filed an initial Chapter 12 reorganization plan that the bankruptcy court held to be not confirmable. The debtors filed an amended plan that required the IRS and the Iowa Department of Revenue (IDOR) to refund to the debtors’ bankruptcy estate withheld income taxes. The taxing authorities objected, claiming that the withheld amounts had already been applied against the debtor’s tax debt as 11 U.S.C. §553(a) allowed. The debtors claimed that the 2017 legislation barred tax debt arising from the sale of assets used in farming from being offset against previously collected tax. Instead, the debtors argued, the withheld taxes should be returned to the bankruptcy estate. If withheld taxes weren’t returned to the bankruptcy estate, the debtors argued, similarly situated debtors would be treated differently.
The debtors sold a significant amount of farmland and farming machinery in 2017, triggering almost a $1 million of capital gain income and increasing their 2017 tax liability significantly. The tax liability was offset to a degree by income tax withholding from the wife’s off-farm job. Their amended Chapter 12 plan called for a refund to the estate of withheld federal and state income taxes. In the fall of 2019, the debtors submitted pro forma state and federal tax returns as well as their traditional tax returns for 2017 to the bankruptcy court in conjunction with the confirmation of their amended Chapter 12 plan. The pro-forma returns showed what the debtors’ tax liability would have been without the sale of the farmland and farm equipment. The pro-forma returns also showed, but for the capital gain, the debtors would have been entitled to a full tax refund of the taxes already withheld from the wife’s off-farm job.
The court was faced with the issue of whether 11 U.S.C. §1232(a) entitled the bankruptcy estate to a refund of the withheld tax. The IRS and IDOR claimed that 11 U.S.C. §553(a) preserved priority position for tax debt that arose before the bankruptcy petition was filed. The court disagreed, noting that 11 U.S.C. §1232(a) deals specifically with how governmental claims involving pre-petition tax debt are to be treated – as unsecured, non-priority obligations. But the court noted that 11 U.S.C. §1232(a) does not specifically address “clawing-back” previously withheld tax. It merely referred to “qualifying tax debt” and said it was to be treated as unsecured and not entitled to priority. Referencing the legislative history behind both the 2005 and 2017 amendments, the court noted that the purpose of the priority-stripping provision was to help farmers have a better chance at reorganization by de-prioritizing taxes, including capital gain taxes. The court pointed to statements that Sen. Charles Grassley made to that effect. The court also noted that the 2017 amendment was for the purpose of strengthening (and clarifying) the original 2005 de-prioritization provision by overturning the result in Hall to allow for de-prioritization of taxes arising from both pre and post-petitions sales of assets used in farming. Accordingly, the court concluded that 11 U.S.C. §1232(a) overrode a creditor’s set-off rights under 11 U.S.C. §553(a) in the context of Chapter 12. The debtors’ bankruptcy estate was entitled to a refund of the withheld income taxes.
Indiana bankruptcy case. In re Richards, No. 18-3418-RLM-12, 2020 Bankr. LEXIS 1181 (Bankr. S.D. Ind. Apr. 29, 2020) was decided the day after DeVries. In Richards, the debtors (a married couple) filed Chapter 12 in May of 2018. The reorganization plan was confirmed in October of 2018. The plan stated that the IRS’s priority claim was zero for 2016 and $5,681 for 2017. The plan also provided that the debtors would liquidate some farm assets in 2018 that would qualify for the priority stripping of 11 U.S.C. §1232. The plan also stated that it was the exclusive means by which “any and all claims” were to be paid post-petition, and that it did not curtail the exercise of a valid right of setoff under 11 U.S.C. §553.
The debtors’ sold farm assets in 2018 and a pro forma return showed that the debtors were entitled to a $6,414 refund. The IRS later amended its claim to show that it had offset the 2018 refund against the debtors’ 2016 priority taxes and the taxes related to the sale of the farm assets in 2018. The debtors objected on the basis that the confirmed plan barred the setoff and wanted the court to order the IRS to issue the 2018 refund to the debtors.
The court noted that the debtors’ plan provided that “no creditor shall take action to collect on any claim, whether by offset or otherwise, unless specifically authorized by this Plan.” The plan also said, “[t]his paragraph does not curtail the exercise of a valid right of setoff permitted under §553.” The court noted that the setoff involved in the case was not a §553 type. Rather, the setoff was of a 2018 tax refund – a post-petition payment that was owed to the debtors but had been applied against the taxes triggered by the sale of farm assets which are treated as a dischargeable, pre-petition tax. As such, the set-off violated the plan.
However, the court determined it couldn’t order the refund be paid to the bankruptcy estate unless the refund were “property of the estate.” On that point, the court noted that nothing in the debtors’ plan or confirmation order provided that post-petition tax refunds remain “property of the estate.” The debtors also had not claimed that the 2018 refund was necessary to fund the plan. Likewise, the trustee didn’t seek the refund to be turned over to the estate. Because the court believed that the refund vested in the debtors upon plan confirmation, it was not “property of the estate.” As such, the court lacked jurisdiction to make any determination of the amount of the turnover of the 2018 refund. The court did note that the debtors were free to modify their reorganization plan.
Conclusion
The Iowa court’s decision is an important one for farmers in financial distress. 11 U.S.C. §1232 is a powerful tool that can assist making a farm reorganization more feasible. The Indiana case is a bit strange. In that case, the debtors were also due a refund for 2016. A pro-forma return for that year showed a refund of $1,300. Thus, the issue of a refund being due for pre-petition taxes could have been asserted just as it was in the Iowa case. Another oddity about the Indiana case is that the 2018 pro-forma (and regular) return was submitted to the IRS in March of 2019. Under 11 U.S.C. §1232, the “governmental body” has 180 days to file its proof of claim after the pro forma tax return was filed. The IRS timely filed tis proof of claim and later filed an amended proof of claim which was identical to the original proof of claim. The IRS filed an untimely proof of claim in one of the other jointly administered cases.
A Notice regarding the use of 11 U.S.C. §1232 should have been filed with the court to clarify the dates of Notice to the IRS (and other governmental bodies) of the amount of the priority non-dischargeable taxes and 11 U.S.C. §1232 taxes to be discharged under the plan. That is when the issue of the refund would have been raised with the IRS. However, in the Indiana case, there was no Notice of the filing of the pro-forma return with the court.
Though not revealed in the court’s opinion, the Indiana case also involved significant 11 U.S.C. §1232 taxes from the sale of farm property in 2017 and 2018. While the Indiana court claimed it lacked authority to force the IRS to issue a refund based on a “property of the estate” argument, that argument leads to a conclusion that is counter to the intent and purpose of I.R.C. §1232. How is 11 U.S.C. §1232 to be operative if a court says it can’t enforce it? Certainly, filing a Notice of intent concerning the priority stripping of 11 U.S.C. §1232 taxes with the court asserting the debtors’ right to receive the tax refund would have teed-up the issue more quickly, one wonders whether a judge intent on negating the impact of 11 U.S.C. §1232 would have decided differently.
Going forward, Chapter 12 reorganization plans should provide that if a pro-forma return shows that the debtor is owed a refund the governmental bodies will pay it.
It is also important to remember that if the debtor does not receive a Chapter 12 discharge, the taxing bodies are free to pursue the debtor as if no bankruptcy had been filed, assessing and collecting the tax as well as all penalties and interest allowed by law including any refunds the taxing bodies are forced to make based on § 1232. Competent bankruptcy counsel that appreciates tax law is a must.
May 4, 2020 in Bankruptcy | Permalink | Comments (0)
Wednesday, April 1, 2020
Disaster/Emergency Legislation – Summary of Provisions Related to Loan Relief; Small Business and Bankruptcy
Overview
The disaster/emergency legislation enacted in late March is wide-ranging and far-sweeping in its attempt to provide economic relief to the damage caused by various federal and state “shut-downs” brought on by a widespread viral infection that originated in China in late 2019 and has spread to the United States. The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) provides relief to small businesses and their employees, including farmers and ranchers, as well as to certain students. Some states have also acted to temporarily stop mortgage foreclosures.
I am grateful to Joe Peiffer of Ag and Business Legal Strategies located in Hiawatha, Iowa, for his input on some of the topics discussed below.
Recent disaster/emergency legislation related to loan relief, small business and bankruptcy – it’s the topic of today’s post.
Deferral of Student Loan Payments
The CARES Act provides temporary relief for federal student loan borrowers by requiring the Secretary of Education to defer student loan payments, principal, and interest for six months, pthrough September 30, 2020, without penalty to the borrower for all federally owned loans. This provides relief for over 95 percent of student loan borrowers.
Bankruptcy Changes
The CARES Act makes the following changes to the bankruptcy Code:
- A one-year increase in the debt limit to $7.5 million (from $2.73 million) for small businesses that file Chapter 11 bankruptcy. For one year after date of enactment, following the bill’s enactment, the measure temporarily excludes federal payments related to COVID-19 from income calculations under Chapter 11 bankruptcy proceedings. It would also allow debtors experiencing hardship because of COVID-19 to modify existing bankruptcy reorganization plans. CARES Act, §1113.
- Individuals and families currently undergoing Chapter 13 bankruptcy may seek payment plan modifications if they are experiencing a material financial hardship due to the virus, including extending payments for up to seven years after the due date of the initial plan payment. This provision expires one year after date of enactment.
- “Income” for Chapter 7 and Chapter 13 debtors does not include virus-related payments from the federal government. This provision expires one year after date of enactment.
- For Chapter 13 debtors, “disposable income” for purposes of plan confirmation does not include virus-related payments. This is also a one-year provision.
“Small Employer” Relief
The CARES Act provides qualified small businesses various options.
- Immediate SBA Emergency Economic Injury Disaster Grants. These $10,000 grants (advances) are to be used for authorized costs such as providing paid sick leave; maintaining payroll to retain employees; meeting increased material costs; making rent or mortgage payments; and repaying obligations which cannot be met on account of revenue losses. The grants are processed directly through the Small Business Association (SBA), but the SBA may utilize lenders (that are an SBA authorized lender) for the processing and making of the grants. A grant applicant may request an expedited disbursement. If such a request is made, the funds are to be disbursed within three days of the request. The CARES Act also removes standard program requirements including that the borrower not be able to secure credit elsewhere or that the borrower has been in business for at least a year, as long as the business was in operation as of January 31, 2020. CARES Act, §1110.
- Traditional SBA Economic Injury Disaster Loans (EIDL). The CARES Act expands this existing program such that the SBA can provide up to $2 million in loans to meet financial obligations and operating expenses that couldn’t be met due to the virus such as fixed debts, payroll, accounts payable and other bills attributable to actual economic injury. The loans are available to businesses and organizations with less than 500 employees. The interest rate is presently 3.75 percent and cannot exceed 4 percent for small businesses that can receive credit elsewhere. Businesses with credit available elsewhere are ineligible. The interest rate for non-profits is 2.75%. The length of the loan can be for up to 30 years with loan terms determined on a case-by-case basis, based on the borrower’s repayment ability. Applications will be accepted through December of this year.
- Forgivable SBA 7(a) Loan Program Paycheck Protection Loans. The Paycheck Protection Loan Program (PPP) is an extension of the existing SBA 7(a) loan program with many of the existing restrictions on 7(a) loans waived for a set timeframe including guarantee and collateral requirements and the requirements that the borrower cannot find credit elsewhere. In addition, a small business loan borrower is eligible for loan forgiveness on existing SBA 7(a) loans. The 7(a) loan program is the SBA's primary program for providing financial assistance to small businesses. For borrowers with an existing 7(a) loan, the SBA will pay principal, interest, and any associated loan fees for a six-month period starting on the loan’s next payment due date. Payment on deferred loans start with the first payment after the deferment period. However, this relief does not apply to loans made under the PPP.
- For purposes of the PPP, a “qualified small business” is defined as a business in existence as of February 15, 2020 paying employees or independent contractors that does not have more than 500 employees or the maximum number of employees specified in the current SBA size standards, whichever is greater; or if the business has more than one location and has more than 500 employees, does not have more than 500 employees (those employed full-time, part-time or on another basis) at any one location and the business' primary NAICS code starts with "72" (Accommodation and Food Service – e.g., hotels, motels, restaurants, etc.); or is a franchisee holding a franchise listed on the SBA's registry of approved franchise agreements; or has received financing from a Small Business Investment Corporation.
Farmers and ranchers are eligible for PPP loans if the business has 500 or fewer employees; or the business has average annual gross receipts of $1 million or less. If neither of those tests can be satisfied, the ag business can still qualify if the net worth of the business does not exceed $15 million and the average net income after federal income taxes (excluding carry over losses) for the two full fiscal years before the date of the PPP application does not exceed $5 million. Affiliation rules are used, when applicable, in determining qualification under the tests.
Sole proprietorships and self-employed individuals (i.e., independent contractors) may qualify under this program if the sole proprietor/self-employed person has a principal residence in the United States, and the individual filed or will file a Schedule C for 2019.
Note: While the SBA guidance on the issue only refers to Schedule C businesses, it seemed that “Schedule F” should be able to be substituted. Further guidance, discussed below, has added some clarity to the issue.
Additionally, certain I.R.C. §501(c)(3) organizations; qualified veterans’ organizations; employee stock ownership plans; and certain Tribal businesses are also eligible. Ineligible businesses are those that have engaged in any illegal activity at the federal or state level; household employers; any business with a 20 percent or more owner that has a criminal history; any business with a presently delinquent SBA loan; banks; real estate landlords and developers; life insurance companies; and businesses located in foreign countries.
The terms and conditions, like the guaranty percentage and loan amount, may vary by the type of loan. The lender must be SBA-approved. The loan proceeds can be used for payroll costs (up to a per-employee cap of $100,000 of cash wages (as prorated for the covered period)); a mortgage or rent obligation; payment of utilities; and any other debt obligation incurred before the “covered period” (February 15, 2020 – June 30, 2020) – however, amounts incurred on this expense is not eligible for forgiveness) plus compensation paid to an independent contractor of up to $100,000 per year. Included in the definition of “payroll costs” are salary, wages, commissions, or similar compensation; guaranteed payments of a partner in a partnership and a partner’s share of income that is subject to self-employment tax (subject to a per-partner cap of $100,000); cash tips; payment for vacation, parental, family, medical or sick leave; an allowance for dismissal or separation; payments for providing group health care benefits, including insurance premiums; payment of retirement benefits; payment of state or local tax assessed on the compensation of employees; and agricultural commodity wages. Not included in the computation of payroll costs are Federal FICA and Medicare taxes and Federal income tax withholding (but, SBA has subsequently taken the position that this is to be ignored such that the computation should be based on gross payroll); any compensation paid to an employee whose principal place of residence is outside the United States (e.g., H-2A workers); qualified sick leave and family leave wages that receive a credit under the Families First Coronavirus Response Act.
Note: Wages for an H-2A worker employed under an H-2A contract for over 180 days can establish their U.S. address as their principal residence and include their wages in average payroll. Once, associated utility costs should also count as eligible expenses.
Under the PPP, the bank can lend up to 250 percent of the lesser of the borrower’s average monthly payroll costs (before the virus outbreak) or $10,000,000 (with some exclusions including compensation over $100,000). For example, if the prior year’s payroll was $300,000, the maximum loan would be $62,500 (total payroll of $300,000 divided by 12 months = 25,000 x 2.5 = $62,500). The SBA guarantee is 100 percent.
Note: For farm borrowers, some lenders have been reported as claiming that the receipt of a PPP loan makes the farmer ineligible for the ag part of the CARES Act Food Assistance Program. That is incorrect. It is also incorrect that the receipt of a PPP loan by a farmer impacts the farmer’s USDA subsidies. The is no statutory support for either of those propositions.
Self-employed taxpayers became eligible for loans on April 10, 2020. For a self-employed taxpayer, the loan amount is based on the taxpayer’s net self-employment earnings, limited to $100,000 of net self-employment income. The maximum loan to a self-employed taxpayer is set at 20.8333 percent of self-employment earnings (plus other payroll costs). For a Schedule C taxpayer, that amount can be determined from line 31 (net profit). If that amount is over $100,000, the loan is limited to $100,000. If line 31 is a loss, the loan amount would normally be zero, but one-half of employee payroll costs can be added in. For a 2019 Schedule F, the applicable line is line 34. A copy of the taxpayer’s 2019 Schedule C (or Schedule F) must be provided to SBA.
Note: The SBA has taken the position that a loss is shown on line 34 of Schedule F that the taxpayer does not qualify for any loan based on earnings and could only qualify for a loan based on employee payroll costs.Thus, the income of a farmer reported on Form 4797 (as the result of an equipment trade, for example, will not qualify. Thus, while a farmer’s Schedule F income might be a loss, but significant income may be present on Form 4797 (which is not subject to self-employment tax), such a farmer will not be able to reconcile the Schedule F to include all equipment gains. Likewise, gains attributable to farmland and buildings are also excluded. Presently, it is unknown whether rental income that is not reported Schedule F qualifies (such as that reported on either Schedule E or on Form 4835).
The amount of loan forgiveness for a self-employed taxpayer equals 2/13 of the 2019 line 31 income. Thus, for a loan that is limited to $20,833, the amount forgiven would be $15,384 ($100,000/52 x 2.5).
For partnerships, filing is at the partnership level. This precludes each partner from receiving a loan. The law is unclear, however, whether income is based on guaranteed payments to partners or partnership gross receipts. According to the SBA’s interpretation, a partnership is allowed to count all employee payroll costs. In addition, the partnership can count all self-employment income of partners computed as the total self-employment income reported on line 14a of Schedule K/K-1. That amount is then reduced by any I.R.C. §179 expense deduction claimed; unreimbursed partnership expenses claimed, and depletion claimed on oil and gas properties. That result is then multiplied by 92.35% to arrive at net self-employment earnings. If the final amount exceeds $100,000, it is to be reduced to $100,000.
Note. Multiplying by 92.35% for Schedule F farmers appears not to be required but may be required in a future announcement since the same calculations usually apply to Schedule C and Schedule F filers on Schedule SE.
Note: Many farm partnerships have a manager managed LLC structure that allows for a reduction in self-employment tax. Even though this income is considered to be ordinary income, it appears that none of that income will qualify for a PPP loan.
Note: S or C corporations are only allowed to use taxable Medicare wages & tips from line 5c of Form 941. These wages are subject to FICA and Medicare taxes.
Based on the SBA position, if it is determined to apply to Form 943 filers, commodity wages will not be allowed for calculating total employee payroll costs. Thus, it is possible that if a farmer received an original PPP loan using commodity wages, the loan may need to be revised.
Likewise, if a taxpayer has an interest in more than one partnership that are treated as self-employed entities, a question remains as to whether each entity can qualify for a loan. For instance, if a farmer is a partner in three partnerships and earns at least $100,000 of net self-employment earnings in each partnership, can each partnership use the farmer’s full $100,000 compensation limit or must it be allocated among each partnership?
For an LLC that is taxed as a partnership, only the amount a partner receives as a guaranteed payment is taxed as self-employment income. For taxpayer’s with interests in multiple single-member LLCs, a holding company can file for the entities under its ownership or each entity can file for a loan. What is not known is whether if only one entity is profitable whether a loan can be filed only for the profitable entity. Similarly, it is not known whether a taxpayer’s compensation from each entity is allowed in full (if it is doesn’t exceed $100,000/entity) even though total earnings exceeds $100,000, or whether the taxpayer’s compensation is limited to $100,000.
The interest rate is set at one percent and cannot exceed 4 percent. Payments, including principal, interest and fees can be deferred anywhere from six to 12 months, and the SBA will reimburse lenders for loan original origination fees. A borrower can then apply for loan forgiveness to the extent the loan proceeds were used to cover payroll costs (at least 75 percent), mortgage interest, rent and utility payments during the eight-week period following loan disbursement.
Note: According to the SBA, the forgivable portion of the non-payroll costs is limited to 25 percent.
The borrower must have been in business as of February 15, 2020 and employed employees and paid salaries and taxes or had independent contractors and filed Form 1099-MISC for them. Guarantee fees are waived, and the loans are non-recourse to the borrower, shareholders, members and partners of the borrower. There is no collateral that is required, and the borrower need not show an inability to secure financing elsewhere before qualifying for financing from the SBA.
The SBA will pay lenders for processing loans under the Payroll Protection Program in an amount of 5 percent of the loan up to $350,000; 3 percent of the loan from $350,000 to $2 million; and 1 percent of loans of $2 million or more. Lender fees are payable within five days of disbursement of the loan.
A borrower under the PPP can apply for loan forgiveness on amounts the borrower incurs after February 14, 2020, in the eight-week period immediately following the loan origination date (e.g., the receipt of the funds) on the following items (not to exceed the original principal amount of the loan): gross payroll costs (not to exceed $100,000 of annualized compensation per employee); payments of accrued interest on any mortgage loan incurred prior to February 15, 2020; payment of rent on any lease in force prior to February 15, 2020 (no differentiation is made between payments made to unrelated third parties and related entities (self-rents)); fuel for business vehicles and, payment on any utilities, including payment for the distribution of electricity, gas, water, transportation, telephone or internet access for which service began before February 15, 2020. The amount forgiven is not considered taxable income to the borrower. Documentation of all payment received under the PPP is necessary to receive forgiveness. Any amount that remains outstanding after the amount forgiven is to be repaid over two years, after a six-moth deferral, at a one percent interest rate.
Note: For a sole proprietorship or self-employed individual, it is unclear whether the loan forgiveness amount is based on eight weeks of self-employment income in 2019 plus amounts spent on qualified amounts, or whether the amount forgiven is limited to eight weeks of self-employment income.
The amount forgiven will be reduced proportionally by any reduction in the number of full-time equivalent employees retained as compared to the prior year. The proportional reduction in loan forgiveness also applies to reductions in the pay of any employee. The reduction if loan forgiveness applies when the reduction of employees or an employee’s prior year’s compensation exceeds 25 percent. It is increased for wages paid to employees that are paid tips. A borrower will not be penalized by a reduction in the amount forgiven for termination of an employee made between February 15, 2020 and April 26, 2020, as long as the employee is rehired by June 30, 2020.
Note: For both the loan calculation and the amount of forgiveness a taxpayer cannot include any owner’s health insurance or retirement payments. Reference is to simply be made to Schedule C or Schedule F net income.
Note: As for loan forgiveness for the self-employed owner compensation, apparently Schedule C (of Schedule F) compensation shown on the 2019 return is used. This amount is then divided by 52 (weeks in the year) and multiplied by eight. The resulting amount is (apparently) forgiven.
The SBA “audits” the requirements that taxpayers certify both that there was economic uncertainty and that the funds were actually needed in order to keep employees on the payroll and paid during the period February 15, 2020 through June 30, 2020. For farmers, with sufficient liquidity that not poised to shut-down, being able to establish that that the funds were needed for payroll purposes could be difficult to establish. This could be particularly true for grain farmers and others that are currently planting crops, have sufficient liquidity or lines-of-credit available, and have an adequate percent of their crop insured and have the ability to pay their employees. For dairy, livestock and produce operations, it will likely be much easier to satisfy the payroll requirement. Clearly, documentation as to the need for the loan is critical to maintain, as is documentation after the end of the eight-week loan forgiveness period.
Note: A taxpayer that receives a PPP loan is ineligible for the Employee Retention Tax Credit. (discussed next), and is barred from applying for unemployment.
Certain qualified small businesses are eligible for loan forgiveness of certain SBA loans. A “covered loan” is a loan added under new §7(a)(36) of the Small Business Act (15 U.S.C. §636(a)). The amount forgiven is equal to the sum of costs incurred and payment made during the eight-week period beginning on the covered loan’s origination date. Forgiven amounts are excluded from gross income up to the principal amount of the loan. To be forgiven, loan proceeds must be used to cover rent paid under a lease agreement in force before February 15, 2020; a mortgage that was entered into in the ordinary course of business that is the borrower’s liability, and is a mortgage on real or personal property incurred before February 15, 2020; or utilities (electricity, gas, water transportation, telephone or internet access) for which service began before February 15, 2020. The borrower must verify that the amount for which forgiveness is requested was used for the permissible purposes. The amount of loan forgiveness is subject to a reduction formula tied to employee layoffs. The numerator of the formula it the average number of full-time employees per month. The denominator is, at the borrower’s election, the average number of full-time employees per month employed from Feb. 15, 2019 to Jun. 30, 2019 or the average number of full-time employees per month employed from Jan. 1, 2020 to Feb. 29, 2020.
Note: Expenses attributable to loan forgiveness (rent, mortgage, utilities, etc.) are not deductible. See I.R.C. §265.
Employers with seasonal employees use a different formula to calculate payroll costs. A seasonal employer uses the average total monthly payments for payroll for the twelve-week period beginning Feb. 15, 2019; or, by election, Mar. 1, 2019 through Jun. 1, 2019. As an alternative, the employer may choose to use any consecutive 12-week period between May 1, 2019 and September 15, 2019. Thus, if payroll costs are much higher in the summer time to harvest crops, the employer will qualify for a larger PPP loan.
To receive any loan forgiveness, the employer must spend at least 75 percent of the loan proceeds on labor costs. There is also a reduction formula for employee salaries and wages, with the amount forgiven reduced by the amount of any reduction in salary or wages of any employee during the covered period. That is the excess of 25 percent of total salary and wages for the most recent quarter for that employee. For purposes of this formula, employees earning over $100,000 are excluded. If an employer rehires the employees or raises salaries and wages back to their prior level by Jun. 30, 2020, the rehire is not considered for purposes of the formula. CARES Act, §1106.
- Employee Retention Credit. If a government order requires an employer to partially or fully suspend operations due to the virus (there is no statutory definition of “partially” or “fully”), or if business gross receipts have declined by more than 50 percent as compared to the same quarter in the immediately prior year, the employer can receive a payroll tax credit equal to 50 percent of employee compensation (“qualified wages”) up to $10,000 (per employee) paid or incurred from March 13, 2020 and January 1, 2021. For employers with greater than 100 full-time employees, qualified wages are wages paid to employees when they are not providing services (“services” is undefined) due to the coronavirus-related circumstances described above. For eligible employers with 100 or fewer full-time employees, all employee wages qualify for the credit, whether the employer is open for business or subject to a shut-down order. Qualified wages must not “exceed the amount such employee would have been paid for working an equivalent duration during the 30 days immediately preceding such period.” As noted, the credit applies to the first $10,000 of compensation, including health benefits, paid to an eligible employee. The credit is provided for wages paid or incurred from March 13, 2020 through December 31, 2020.
- The credit is allowed in each calendar quarter against Medicare tax or the I.R.C. §3221(a) tax imposed on employers at the rate of 50 percent of wages paid to employees during the timeframe of the virus limited to the applicable employment taxes as reduced by any credits allowed under I.R.C. §§3111(e) and (f) as well as the tax credit against amounts for qualified sick leave wages and qualified family leave wages an employer pays for a calendar quarter to eligible employees under the FFCRA. Thus, “applicable employment taxes” are reduced by the I.R.C. §§3111(e)-(f) credits and those available under the FFCRA. Then, the resulting amount is reduced by the Employee Retention Credit. If a negative amount results, the negative amount is treated as an overpayment that will be refunded pursuant to I.R.C. §6402(a) and I.R.C. §6413(b). CARES Act, §2301.
- Express Loan Program. The SBA’s Express Loan Program loan limit is increased to $1 million (from $350,000) until December 31, 2020. This program features an accelerated turnaround time for SBA review, with a response to applications within 36 hours. CARES Act, §1102(c).
- Tax Credit to Fund Paid Sick Leave. An employer with an employee that is paid sick-leave on account of the virus receives a FICA tax credit (employer share only) equal to the lesser of wages plus health care costs or $511 per day for up to 10 days. An employer providing sick leave to an employee with a sick family member, the credit is $200 per day, up to a maximum of $10,000.
Planning strategies. For businesses with immediate cashflow needs, a $10,000 EIDL grant can be applied for. Simultaneously, application can be made for PPL program loan. But, as noted, the basis for the separate loans and the costs being paid with each loan are different. An application can then be made seeking loan forgiveness. If this approach is inadequate, a traditional EIDL loan can be applied for. Also, if the business has sufficient cashflow, one of the FICA/Medicare tax credit options can be considered. Also, for employers with employees impacted by the virus or are caring for affected family members, the sick leave credit or the employee retention credit can be utilized if business operations were suspended or if gross receipts declined substantially.
Conclusion
The CARES Act contains many provisions that small employers can utilize to bridge the economic divide created by the government reaction to the virus. As the new programs are implemented rules will be developed that should address presently unanswered questions. The SBA has up to 30 days following the enactment of the CARES Act to issue regulations implementing and providing guidance on certain CARES Act provisions. In addition, the Treasury Department is required to issue regulations implementing and providing guidance under many CARES Act provisions. Issuance of regulations and guidance could delay loan approval and disbursement or modify/waive certain loan requirements.
The disaster/emergency legislation also made numerous tax changes. Those will be addressed in a future post.
April 1, 2020 in Bankruptcy, Business Planning, Income Tax, Regulatory Law | Permalink | Comments (0)
Tuesday, March 3, 2020
Recent Cases of Interest
Overview
The cases and rulings of relevance to agricultural producers, ag businesses and rural landowners continue to churn out. In today’s post a take a brief look at three of them – a couple of bankruptcy-related cases and a case involving a claim of constitutional takings.
“Shared Responsibility” Payment Is Not a “Tax”
United States v. Chesteen, No. 19-30195 (5th Cir. Feb. 20, 2020), rev’g., No. 18-2077, 2019 U.S. Dist. LEXIS 29346 (E.D. La. Feb. 25, 2019).
In a bankruptcy proceeding, some unsecured creditors receive a priority in payments over other unsecured creditors. These are termed “priority claims” and they are not subject to being discharged in bankruptcy. Priority claims are grouped into 10 categories with descending levels of priority. 11 U.S.C. §507(a)(1)-(10). One of those priority claims is for “allowed unsecured claims of governmental units” to the extent the claims are for “a tax on or measured by income or gross receipts…”. 11 U.S.C. §507(a)(8). But, does that provision apply to the penalty that had to be paid through 2018 for not having an acceptable form of government-mandate health insurance under Obamacare – the so-called “Roberts Tax”? The U.S. Court of Appeals for the Fifth Circuit recently answered that question.
In the case, the debtor filed Chapter 13 bankruptcy. The IRS filed a proof of priority claim for $5,100.10, later amending the claim to $5,795.10 with $695 of that amount being an excise tax under I.R.C. §5000A as a result of the debtor’s failure to maintain government mandated health insurance under Obamacare. The debtor objected to the $695 amount being a priority claim that could not be discharged, and the bankruptcy court agreed, finding that the “Roberts Tax” under Obamacare was not a priority claim, but rather a dischargeable penalty in a Chapter 13 case. On appeal, the federal trial court reversed, holding that the penalty was a tax that was a non-dischargeable priority claim. The trial court noted that the creditor bore the burden to establish that the Roberts Tax was a priority claim and noted that it was the purpose and substance of the statute creating the tax that controlled whether the tax was a tax or a penalty. The trial court noted that a tax is a pecuniary burden levied for the purpose of supporting government while a monetary penalty is a punishment for an unlawful act or omission. On this point, the trial court noted that Chief Justice Roberts, in National Federation of Independent Business v. Sebelius, 567 U.S. 519 (2012), upheld the constitutionality of Obamacare on the basis that the “shared responsibility payment” was a tax paid via a federal income tax return and had no application to persons who did not pay federal income tax. The trial court noted that the amount was collected by the IRS and produced revenue for the government. It also did not punish an individual for any unlawful activity and, the trial court noted, the IRS has no criminal enforcement authority if a taxpayer failed to pay the amount.
On further review, the appellate court reversed, reinstating the bankruptcy court’s determination. The appellate court held that the “Roberts Tax” was not entitled to priority in bankruptcy because it was not among the types of taxes listed in the bankruptcy code to have priority treatment under 11 U.SC. §507(a)(8)(E)(i). The appellate court noted that the “Roberts Tax” could not be a priority tax claim in a debtor’s bankruptcy estate because the “tax” applied only when a person failed to buy the government-mandated health insurance, rather than when a transaction was entered into. As such, the “Roberts Tax” was a penalty that could be discharged in bankruptcy. The appellate court also noted that the “tax” zeroed out the “tax” beginning in 2019, thereby nullifying any tax effect that it might have had.
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).
Under the reorganization provisions of the Bankruptcy Code (Chapters 11, 12 and 13), a debtor can reorganize debts and pay for most (but not all) secured property by paying the present value of the collateral (what the collateral is presently worth) rather than the entire debt. The procedure for doing this is commonly known as a “cram down” – the terms of the repayment are forced upon the creditor. The debtor must pay the present value of the collateral (the creditor’s allowed secured claim) via the reorganization bankruptcy. Because the repayment of the written-down debt will be paid over time in accordance with the reorganization plan, an interest rate is attached to ensure that the creditor receives the present value of the claim. But, what is the appropriate interest rate in such a setting and how is it determined? Over the years, courts struggled in determining the appropriate interest rate to use in a reorganization bankruptcy cram-down setting. The U.S. Supreme Court settled the waters with a decision in 2004 by using the “Prime Plus” method. The issue of the appropriate interest rate was again as issue in a dairy bankruptcy case from the state of Washington.
In the case, the debtor filed Chapter 11 bankruptcy and the debtor and the bank could not agree 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 debtors proposed a 6 percent interest rate, based on the risk associated with their 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 the 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 lowered it on others.
Reversion to Agricultural Use Classification Not a Taking
Bridge Aina Le’a, LLC v. State Land Use Commission, No. 18-15738, 2020 U.S. App. LEXIS 5138 (9th Cir. Feb. 19, 2020).
Sometimes, a governmental body enacts a statute or promulgates a regulation that restricts a private property owner’s use of their property. The restriction on land use may be so complete that, in effect, the restriction amounts to the government “taking” the property. However, these regulatory restrictions on private property usage do not involve a physical taking of the property but can still give rise to Fifth Amendment concerns and trigger the payment of “just compensation” to the landowner. The legal issues concerns the point at which a defacto regulatory taking has occurred.
In a key case decided in 1978, the U.S. Supreme Court set forth a multi-factored balancing test for determining when governmental regulation of private property effects a taking requiring compensation. In Penn Central Transportation Co. et al. v. New York City, the 438 U.S. 104 (1978), the Court held that a landowner cannot establish a “taking” simply by being denied the ability to exploit a property interest believed to be available for development. Instead, the Court ruled that in deciding whether particular governmental action effects a taking, the character, nature and extent of the interference with property rights as a whole are the proper focus rather than discrete segments of the owner’s property rights. Later, the Court determined that the touchstone for deciding when a regulation is a taking is whether the restriction on property usage is functionally equivalent to a physical taking of the property. Lingle, et al. v. Chevron U.S.A. Inc., 544 U.S. 528 (2005). The issue of a regulatory taking came up in a recent case from Hawaii.
Under the facts of the recent case, 1,060 acres of undeveloped land on the northeast portion of the Island of Hawaii were designated as conditional urban use. For the 40 prior years, the tract was part of a 3,000-acre parcel zoned for agricultural use. In 1987, the landowner at the time sought to develop a mixed residential community of the 1,060 acres as the first phase of development on the entire 3,000 acres. The landowner petitioned the defendant to reclassify the 1,060 acres as urban. The defendant did so in 1989 on development conditions that ran with title to the land. The land remained undeveloped at the time the plaintiff acquired it in 1999. In 2005, the defendant amended the condition so that fewer affordable housing units needed to be developed. Developmental progress was hampered by the requirement that the plaintiff prepare an environmental impact statement for the development project.
In late, 2008, the defendant ordered the plaintiff to show cause for the nondevelopment. In the summer of 2010, some affordable housing units had been constructed, but upon inspection they were determined to not be habitable. The developer then stated that it lacked the funds to complete the development. In 2011, the defendant ordered the land’s reversion to its prior agricultural use classification due to the unfulfilled representations that the land would be developed. The land was given its conditional urban use classification based on those representations. The plaintiff was one of the landowners and challenged the reversion as illegal, and that it amounted to an unconstitutional regulatory taking of the land. The trial court jury found for the plaintiff on the constitutional claim and the trial court denied the defendant’s motion for a judgment as a matter of law.
On further review, the appellate court reversed The appellate court stated held that no taking had occurred under the multi-factor analysis of Penn Central Transportation Company v. City of New York, 438 U.S. 104 (1978), because the reclassification did not result in the taking of all of the economic value of the property. Rather, the land retained substantial economic value, albeit at a much lesser amount than if it were classified as urban and developed. An expert valued the land at approximately $40 million as developed land and $6.36 million with an agricultural use classification. The appellate court held that the $6.36 million was neither de minimis nor derived from noneconomic uses. Thus, the defendant was entitled to judgment as a matter of law on the issue that a complete economic taking had occurred. It had not. The appellate court also held that the reversion did not interfere substantially with the plaintiff’s investment-backed expectations given that the development conditions were present at the time the plaintiff acquired the property and the plaintiff could expect them to be enforced. The appellate court also determined that the defendant acted properly in protecting the plaintiff’s due process rights by holding hearings over a long period of time. Thus, the appellate court concluded, no reasonable jury could conclude that the reversion effected a taking under the Penn Central factors. The appellate court vacated the trial court’s judgment for the plaintiff and reversed the trial court’s the trial court’s denial of the defendant’s motion for judgment as a matter of law, affirmed the trial court’s dismissal of the plaintiff’s equal protection claim and remanded the case.
Conclusion
The developments of relevance to agricultural interests keep rolling in. There will be more discussed in future posts.
March 3, 2020 in Bankruptcy, Environmental Law, Regulatory Law | Permalink | Comments (0)
Tuesday, February 18, 2020
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.
February 18, 2020 in Bankruptcy, Estate Planning, Income Tax, Regulatory Law | Permalink | Comments (0)
Thursday, February 6, 2020
Family Farming Arrangements and Liens; And, What’s A Name Worth?
Overview
Farmers, ranchers and agribusinesses engage in various transactions and arrangements on a daily basis, perhaps often without much thought given to the legal consequences if the arrangement or transaction goes awry. In those situations, when the unexpected happens, it’s useful to know what legal recourse might be available. Better yet, it’s good to know what the rules are in advance of something happening.
In today’s post, I look at two recent cases that illustrate common situations in agriculture that present interesting legal entanglements.
One type of ag lien, and getting the debtor’s name precisely correct on a lending document – these are the topics of today’s post.
Application of a Harvester’s Lien
States have lien statutes that can apply in various situations. Often they can come into play when one party that supplies services or goods doesn’t get paid and a state lien statute allows the aggrieved party to apply a lien to particular property or income of the non-paying party to secure repayment. But, each type of lien is unique and the particular requirements of the applicable lien statute must be followed closely. One such lien was at the heart of an Iowa case recently.
In Kohn v. Muhr, No. 18-2059, 2019 Iowa App. LEXIS 1064 (Iowa Ct. App. Nov. 27, 2019), a father farmed with his son – a common occurrence in agriculture. Each of them owned land separately, but they farmed with the father’s equipment on all of the land. The father farmed between 6,500 and 8100 acres, and the son approximately 7,000 to 7,500 acres of land. The son paid his father $400,000 for equipment and other expenses. The father contacted a custom harvester in the fall of 2016 to harvest 2,000 acres of corn. Before the work started, the father provided the custom harvester with crop-insurance maps specifying the fields to be harvested. The maps identified the son as the insured party. The father instructed the custom harvester to deliver the corn to multiple elevators in the father’s name. Stored grain was also delivered in the son’s name to elevators and an ethanol plant. Harvest did not conclude until April 8 or 9, 2017, because of weather. Neither the plaintiff nor son paid the custom harvester for the harvesting within 10 days of completion of the harvesting, and the custom harvester filed a lien against both the father and the son for the non-payment.
The father refused payment due to performance issues, and the harvester issued a demand letter. A couple of months later, the father and his bank requested that the harvester remove the father from the lien arguing that the crop was the son’s. The lien was preventing the father from making a margin call. A few days later, the son paid the harvester for the harvesting services and the lien was extinguished. The father then sued the harvester for wrongful filing of a financing statement to secure the lien, claiming that his commodity contracts were involuntarily liquidated and that he incurred financial damages when reestablishing his place in the grain trading market after the lien was extinguished. The father requested statutory and punitive damages. The harvester counterclaimed for breach of contract, seeking reimbursement for reasonable expenses and a declaratory judgment that the filing of the financing statement was authorized under state law. Both parties filed for summary judgment.
The trial court found that the father was a “debtor” under the Iowa Code §571.1B, and that the harvester had personally contracted for the harvesting services, took possession of the grain at the elevator, and commingled the harvested grain in the on-farm storage. The trial court granted partial summary judgment in favor of the harvester as to the properness of the lien filing.
The appellate court affirmed. On appeal, the father claimed that he was not a “debtor” that a lien could be filed against but was merely an agent for his son. The appellate court rejected this argument because it hadn’t been raised at the trial court level. While the harvester worked the son’s property, it was the father that contacted the harvester to arrange for the harvesting and other work. The father was the party responsible for ensuring the property at issue was harvested. The appellate court deemed the situation to be comparable to a contractor/subcontractor arrangement to provide services on the son’s property. As such, the father was “a person for whom the harvester render[ed] such harvesting services” and was a “debtor” under the applicable statute against which the harvester’s lien could apply.
The Importance of Getting A Debtor’s Name Precisely Correct
Ag business sometimes finance purchases of their inventory by farmers and ranchers. Other times, such purchases are financed by a lender such as a bank. In all situations, to “perfect” it’s interest in the debtor’s collateral, it is imperative that the debtor’s name be spelled correctly. The states set forth various rules for determining the parameters of what a correct spelling means. This is an important point, because claiming an interest in collateral involves filing a document informing the public of the creditor’s interest in the debtor’s collateral. So, if the debtor’s name isn’t correct, another potential creditor checking the public record may not find the first lender’s interest and lend the debtor additional funds that otherwise wouldn’t have been loaned.
A recent Kansas case illustrates how important it is to get a debtor’s name correct on a publicly filed lending instrument. In In re Preston, No. 18-41253, 2019 Bankr. LEXIS 3864 (Bankr. D. Kan. Dec. 20, 2019), the debtor filed Chapter 12 bankruptcy in the fall of 2018 and his proposed reorganization plan treated a creditor’s security interest in the debtor’s non-titled personal property (including a combine and header) as unperfected (and, hence, unsecured) on the basis that the creditor’s filed financing statements did not correctly state the debtor’s name. In 2015, the debtor had purchased a combine and header from the creditor on an installment basis. The creditor filed a UCC-1 financing statement to perfect its purchase money lien in the combine and a separate financing statement to protect its lien in the header. Both financing statements listed the debtor’s name as "Preston D.Dennis" (with a period but no space). “Preston” was included in the box for Surname, and "D.Dennis" was in the box for “First Personal Name.” The "Additional name(s)/initial(s)" box was blank. The debtor referred to himself as "D. Dennis Preston" (with a period and a space) and his driver's license displayed his name as "Preston D Dennis" (without a period but with a space). The "Additional name(s)/initial(s)" box was blank.
The debtor’s argument that the creditor’s security interest in the combine and header were unsecured was based on the failure to satisfy Kan. Stat. Ann. §84-9-503 (both the collateral and the debtor were located in Kansas). That provision states that, for individual debtors with a Kansas driver’s license or identification card, the name of the debtor is sufficiently stated “only if the financing statement provides the name of the individual which is indicated on the driver’s license or identification card.” Kan. Stat. Ann. §84-9-503(a)(4). While minor errors or omissions on a financing statement will not cause a security interest to fail, a financing statement is deemed to be seriously misleading (and unperfected) if it doesn’t list the debtor’s name exactly as listed on the debtor’s driver’s license or identification card. Kan. Stat. Ann. §84-9-506(b). But, if the financing statement could be found by performing a search using the filing office’s standard search logic, it is not “seriously misleading” even if it fails to comply with Kan. Stat. Ann. §84-9-503(a)(4). The debtor claimed that the creditor’s interests were unsecured for failure to comport with Kansas law and because a search of the debtor’s name as denoted on the financing statements using standard search logic did not reveal the interests.
The bankruptcy court agreed with the debtor, finding that that the debtor’s name as indicated on the financing statements which did not match the debtor’s driver’s license was seriously misleading. The financing statements should have stated Preston as Debtor's surname, D as his first name, and Dennis as his middle name. The lack of a space and the period were material. The bankruptcy court rejected the creditor’s argument, made without authority, that a driver’s license does not identify the fields as "first," "personal," or "middle," and there is nothing to indicate that periods and spaces change what constitutes a name. The result was that the creditor’s security interests in the combine and header were unperfected, and the bankruptcy court sustained the debtor’s objection to the creditor’s proof of claim. A space and a period proved to be a very costly mistake – a several hundred-thousand-dollar mistake.
Conclusion
The two cases discussed today illustrate rather common scenarios in agriculture. But, they have rather serious ramifications. One slip-up on the law can really cause substantial problems for a farming or ranching operation, or even an agribusiness.
February 6, 2020 in Bankruptcy, Secured Transactions | Permalink | Comments (0)
Wednesday, January 29, 2020
Unique, But Important Tax Issues – “Claim of Right”; Passive Loss Grouping; and Bankruptcy Taxation
Overview
It’s not unusual for a taxpayer to present the tax preparer with unique factual situations that aren’t commonplace and have very unique rules. Today’s post digs into three of those areas that often generate many questions from practitioners, and also aren’t handled easily by tax software.
Unique, but important tax issues - the topic of today’s post.
“Claim of Right” Doctrine Denies Remedy for Stock Sale
Heiting v. United States, No. 19-cv-224-jdp, 2020 U.S. Dist. LEXIS 10967 (W.D. Wisc. Jan. 23, 2020)
In 1932, the U.S. Supreme Court created the “claim of right” doctrine. American Oil Consolidated v. Burnet, 286 U.S. 417 (1932). It applies when a taxpayer receives income, but the income is subject to a contingency or other significant restriction that might remove it from the taxpayer. In that situation, the taxpayer need not recognize the income. In essence, the doctrine applies when the taxpayer doesn’t have a fixed right to the income. If the taxpayer ultimately has to return the income that has been recognized, the taxpayer might be entitled to receive an offsetting deduction or a tax credit. I.R.C. §1341.
The “claim of right” doctrine arose in a recent Wisconsin federal court case in a rather unique situation. Under the facts of the case, the plaintiffs, a married couple, created a revocable living trust in 2004 and amended it in 2012. The trust was created under Wisconsin law and named a bank as trustee with a different bank as successor trustee. The trust language gave the trustee broad discretion to invest, reinvest, or retain trust assets. However, the trust barred the trustee from doing anything with the stock of two companies that the trust held. The trustee apparently did not know of the prohibition and sold all of the stock of both companies in late 2015, triggering a taxable gain of $5,643,067.50. The sale proceeds remained in the trust. Approximately three months later, in early 2016, the trustee learned of the trust provision barring the stock sale and repurchased the stock with the trust’s assets. The grantors then revoked the trust later in 2016.
On their 2015 return, the plaintiffs reported the gain on the stock sale and paid the resulting tax. On their 2016 return, the plaintiffs claimed a deduction under I.R.C. 1341 for the tax paid on the stock sale gain the prior year. The IRS denied the deduction and the plaintiffs challenged the denial. The IRS motioned to dismiss the case. The plaintiffs relied on the “claim of right” doctrine of I.R.C. §1341– they reported the income and paid the tax. Under I.R.C. §1341, the plaintiffs had to: (1) establish that they included the income from the stock sale in a prior tax year; (2) show that they were entitled to a deduction because they did not have an unrestricted right to the income as of the close of the earlier tax year; and (3) show that the amount of the deduction exceeds $3,000. If the requirements are satisfied, a taxpayer can claim the deduction in the current tax year or claim a credit for the taxes paid in the prior year.
The IRS claimed that the plaintiffs could not satisfy the second element because the plaintiffs were not actually required to relinquish the proceeds of the stock sale. The court agreed, noting that once the stocks were sold the plaintiffs had the unrestricted right to the proceeds as part of the revocable trust, as further evidenced by them revoking the trust in 2016. The court noted that neither the trustee nor the plaintiffs had any obligation to repurchase the stock. The court also noted that under Wisconsin trust law, the plaintiffs could have instructed the trustee to do anything with the proceeds of the stock sale, and that they had the power to consent to the trustee’s action of selling the stock. In other words, they were not duty-bound to require the trustee to buy the stock back. Accordingly, the court determined that I.R.C. §1341 did not provide a remedy to the plaintiffs, and that any remedy, if there was one, would be against the trustee.
Grouping and the Passive Loss Rules
Eger v. United States, 405 F. Supp. 3d 850 (N.D. Cal. 2019)
Under I.R.C. §469, the deduction of losses from a “passive activity” is limited to the amount of passive income from all passive activities of the taxpayer. Stated another way, a passive activity loss is the excess of the aggregate losses from all passive activities for the year over the aggregate income from all passive activities for that particular year. For taxpayers with multiple activities, Treas. Reg. §1.469-4(c)(1) provides for a grouping of legal entities if the activities constitute an appropriate economic unit for the measurement of gain or loss. Also, rental activities can generally be grouped together. Grouping can be helpful to satisfy the material participation tests of I.R.C. §469 to avoid the application of the passive loss rules. This grouping issue came up in a recent federal case in Oklahoma involving rental activities.
In the case, the plaintiff was a real estate professional within the meaning of I.R.C. §469(c)(7) that owned three properties (vacation properties) in different states that he offered for rent via management companies at various times during the year in issue. The plaintiff reserved the right for days of personal use of each rental property. The plaintiff sought to group the vacation rental properties with his other rental activities as a single activity for purposes of the material participation rules of I.R.C. §469. The IRS denied the grouping on the basis that the vacation rental properties were not rental properties on the basis that the average period of customer use for the vacation rentals was seven days or less as set forth in Treas. Reg. §1.469-1T(e)(3)(ii)(A), and that the petitioner was the “customer” rather than the management companies.
The court agreed with the IRS position on the basis that the plaintiff’s retained right to use each vacation property eliminated the management companies from having a continuous or recurring right to use the property when applying the test of Treas. Reg. §1.469-1(e)(3)(iii)(D) providing for measuring the period of customer use. As such, the facts of the case differed substantially from the contracts at issue in White v. Comr., T.C. Sum. Op. 2004-139 and Hairston v. Comr., T.C. Memo. 2000-386. Thus, the management companies were not customers with a continuous right to use the properties, but merely provided marketing and rental services for the petitioner to rent out the properties.
Prior Bankruptcy Filings Extends Non-Dischargeability Period
In re Nachimson v. United States, 606 B.R. 899 (Bankr. W.D. Okla. 2019)
The creation of the bankruptcy estate as a new taxpayer, separate from the debtor, highlights the five categories of taxes in a Chapter 7 or 11 case. Category 1 taxes are taxes where the tax return was due more than three years before filing. These taxes are dischargeable unless the debtor failed to file a return or filed a fraudulent return. Category 2 taxes are the taxes due within the last three years. These taxes are not dischargeable but are entitled to an eighth priority claim in the bankruptcy estate, ahead of the unsecured creditors. Category 3 taxes are the taxes for the portion of the year of bankruptcy filing up to the day before the day of bankruptcy filing. If the debtor's year is closed as of the date of filing, the taxes for the first year, while not dischargeable, are also entitled to an eighth priority claim in the bankruptcy estate. If the debtor's year is not closed, the entire amount of taxes for the year of filing are the debtor's responsibility. Category 4 taxes are the taxes triggered on or after the date of filing and are the responsibility of the bankruptcy estate. Taxes due are paid by the bankruptcy estate as an administrative expense. If the taxes exceed the available funds, the tax obligation remains against the bankruptcy estate but does not return to the debtor. Category 5 taxes are for the portion of the year beginning with the date of bankruptcy filing (or for the entire year if the debtor's year is not closed) and are the responsibility of the debtor.
In a recent Oklahoma case, the debtor filed Chapter 7 in late 2018 after not filing his 2013 and 2014 returns. The 2013 return was due on October 15, 2014, and the 2014 return was due April 15, 2015. The debtor had previously filed bankruptcy in late 2014 (Chapter 13). That prior case was dismissed in early 2015. The debtor filed another bankruptcy petition in late 2015 (Chapter 11). Based on the facts, the debtor had been in bankruptcy proceedings during the relevant time period, (October 15, 2014, through October 25, 2018) for a total of 311 days. 11 U.S.C. § 523(a)(1)(A) provides, in general, that a discharge of debt in bankruptcy does not discharge an individual debtor from any debt for an income tax for the periods specified in 11 U.S.C. § 507(a)(8). One of the periods provided under 11 U.S.C. § 507(a)(8), contained in 11 U.S.C. § 507(a)(8)(A)(i), is the three years before filing a bankruptcy petition. Also, 11 U.S.C. § 507(a)(8) specifies that an otherwise applicable time period specified in 11 U.S.C. § 507(a)(8) is suspended for any time during which the stay of proceedings was in effect in a prior bankruptcy case or during which collection was precluded by the existence of one or more confirmed bankruptcy plans, plus 90 days. When a debtor files multiple, successive bankruptcy cases, the ordinary operation of the automatic stay 11 U.S.C. § 507(a)(8) is altered by 11 U.S.C. § 362(c)(3)(A) which specifies that if a debtor had a case pending within the preceding one-year period that was dismissed, then the automatic stay with respect to any action taken with respect to a debt or property securing that debt terminates with respect to the debtor on the 30th day after the filing of the later case.
The debtor sought to have his 2013 and 2014 tax liabilities discharged in the present bankruptcy case under 11 U.S.C. §523(a)(1)(A) on the basis that the filing dates for those returns were outside the three-year look-back period. The IRS took the position that the three-year “look-back” period was extended due to the debtor's bankruptcy filings. The court agreed with the IRS, noting that the three-year look-back period began on October 25, 2015. However, the court concluded that an issue remained as to whether the look-back period extended back 401 days, or only for the first 30 days following each bankruptcy filing as provided by 11 U.S.C. § 362(c)(3)(A). Based on a review of applicable bankruptcy case law, the court concluded that the tolling provision of 11 U.S.C. § 507(a)(8) was not impacted by the automatic nature of 11 U.S.C. § 362(c)(3)(A). Instead, for purposes of the tolling provision, the stay of proceedings was in effect in each of debtor's three previous cases until each was dismissed. Therefore, the court found that the look-back period extended back three years plus 401 days. Since the debtor filed the bankruptcy petition in the present case on October 25, 2018, the three-year plus 401-day look-back period reached back to September 19, 2014. Because the debtor's 2013 and 2014 tax liabilities were due after that date (including the extension for the 2013 liability), neither was dischargeable in the current bankruptcy case.
Conclusion
Some clients have standard, straightforward returns. Others have very complicated returns that present very unique issues. The cases discussed today point out just three of the ways that tax issues can be very unique and difficult to sort out.
January 29, 2020 in Bankruptcy, Income Tax | Permalink | Comments (0)
Monday, January 27, 2020
Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech
Overview
A couple of weeks ago I did a post on some recent developments in the courts involving ag law and ag tax. Since that time, there have been additional important court developments. Before getting deep into tax season, it may be a good idea to provide a summary of a few of these cases.
More ag law and tax developments in the courts – it’s the topic of today’s post.
Bankruptcy Discharge and Fraud
In re Kurtz, 604 B.R. 349 (Bankr. D. Neb. 2019)
A major feature of bankruptcy in the United States is the ability to discharge at least some debt. This makes possible the “fresh start” for debtors. But, some debtors and debts are not eligible for discharge. Of the several categories of debts that aren’t eligible for discharge, one category is reserved for debts associated with the debtor’s fraudulent conduct. In this case, the creditor was a landlord and the debtor was the farm tenant who put up hay and other crops on the landlord’s land. The parties did not have a written lease agreement, but the landlord assumed the lease was a 50-50 crop share agreement where the parties would split the expenses and the sale proceeds equally. The record was unclear as to what the tenant understood the relationship to be, but he did make statements to others that it was a cash rent lease. The tenant did not pay the landlord after the first two cuttings of hay because he incurred expenses while cutting. After the third cutting was bailed the landlord contacted the tenant about payment. The tenant told the landlord that he could have the proceeds from the third cutting of hay and that the tenant was finished farming for the landlord. The tenant paid a third party to stack the hay. When the landlord attempted to sell the hay he discovered that the tenant had already given the hay to a third party to settle a debt. Both parties submitted expenses related to the hay crop that year.
The landlord filed a complaint in the tenant’s bankruptcy case alleging fraud and misrepresentation seeking that the debt to the landlord not be discharged. The bankruptcy court agreed, determining that the landlord proved that the tenant’s obligation of $5,916.50 was exempt from discharge because of the debtor’s false representation. The bankruptcy court determined that the full debt owed to the landlord was $22,292.84 based on the oral lease, but that the only part of that amount derived from fraud was the amount related to the third cutting of hay - $5,370.50 plus $546 for stacking. The balance of the unpaid debt arose from a general misunderstanding that wasn’t settled before the debtor put up the first two hay cuttings. The only blatant dishonesty, the bankruptcy court determined, concerned the third cutting.
Aerial Application of Ag Chemicals Not Inherently Dangerous
Keller Farms, Inc. v. Stewart, No. 1:16 CV 265 ACL, 2018 U.S. Dist. LEXIS 210209 (E.D. Mo. Dec. 13, 2018), aff’d. sub. nom., Keller Farms, Inc. v. McGarity Flying Service, LLC, No. 18-3755, 2019 U.S. App. LEXIS 36664 (8th Cir. Dec. 11, 2019)
This case involves a dispute involving alleged damage to the plaintiffs’ trees caused by chemicals that allegedly drifted during aerial application. The plaintiffs attempted to hold liable both the aerial applicator and the landowner that hired the applicator. The plaintiffs claimed the landowner was vicariously liable (liable because of the relationship with the applicator) for the applicator’s actions because aerial spraying of burndown chemicals is an "inherently dangerous activity." The trial court granted the defendants’ motion for Judgment as a Matter of Law on the plaintiff's trespass claim, but the remaining issues were left for the jury to resolve. The jury returned a verdict in favor of the defendants on the negligence and negligence per se claims. The plaintiffs filed a motion for a new trial, arguing the verdict was against the weight of the evidence; that the trial court erred in excluding evidence; and that the trial court erred in granting the defendants’ Motion for Judgment as a Matter of Law. The trial court, however, denied the plaintiff’s motion for a new trial.
On appeal, the appellate court affirmed. The appellate court determined that the jury’s verdict was not against the weight of the evidence, and that the aerial application of herbicides was commonplace and not inherently dangerous. In addition, the appellate court noted that the defendants’ evidence was that the herbicides did not actually drift onto the plaintiffs’ property and that the applicator complied with all label requirements and sprayed during optimal conditions. The appellate court also determined that the trial court had ruled properly on evidentiary matters and that the plaintiff had not proven the alleged monetary damages to the trees properly. The appellate court also upheld the trial court’s denial of the plaintiff’s motion for a new trial.
The Line Between Nondeductible Start-Up Expenses and Deductible Business Expenses
Primus v. Comr., T.C. Sum. Op. 2020-2
The petitioner lived in New York and bought a property in Quebec containing 200 maple trees with a significant number of them being mature, maple syrup-producing trees. The tract contained other types of trees and pasture ground and hay fields and a small amount of ground suitable for growing crops. There were also various improvements on the tract. Before collecting sap and producing syrup, the petitioner thinned underbrush and later installed a pipeline to collect sap. Sap production began in 2017. When the petitioner bought the property in 2012, the cleared the areas of the tract where he planned to plant blueberry bushes. He ordered 2,000 blueberry bushes in 2014 and planted them in 2015. He reported a substantial amount of farming-related expenses in 2012 and 2013, with most of the expenses attributable to costs of repairs to improvements on the property. The petitioner deducted expenses attributable to preparatory costs for the production of selling maple syrup and blueberries as trade or business expenses under I.R.C. §162 (or as I.R.C. §212 expenses for income-producing property).
The IRS denied the deductions, asserting that they were nondeductible start-up expenses under I.R.C. §195 on the basis that the petitioner had not yet begun the business of producing maple syrup and blueberries. The Tax Court upheld the IRS position. The Tax Court noted that expenses are not deductible as trade or business expenses until the business is actually functioning and performing the activities for which it was organized. Here, the petitioner had not actually started selling blueberries or sap in either 2012 or 2013. That meant that the expenses incurred in 2012 and 2013 were incurred to prepare the farm to produce sap and plant blueberries, and were nondeductible startup expenses. The thinning activities, while a generally acceptable industry practice, did not establish that the business had progressed beyond the startup phase. In addition, during the years at issue, the petitioner had not collected sap, installed any infrastructure needed to convert sap into syrup, or bought any blueberry bushes.
Lying With Purpose of Harming Livestock Facility is Protected Speech
Animal Legal Defense Fund v. Schmidt, No. 18-2657-KHV, 2020 U.S. Dist. LEXIS 10202 (D. Kan. Jan. 22, 2020)
The plaintiffs are a consortium of activist groups regularly conduct undercover investigations of livestock production facilities. Some of the plaintiffs gain access to farms through employment without disclosing the real purpose for which they seek employment (and lie about their ill motives if asked) and wear body cameras while working. For those hired into managerial and/or supervisory positions, they gain the ability to close off parts of the facility to avoid detection when filming and videoing. The film and photos obtained are circulated through the media and with the intent of encouraging public officials, including law enforcement, to take action against the facilities. The employee making the clandestine video or taking pictures, is on notice that the facility owner forbids such conduct via posted notices at the facility. The other plaintiffs utilize the data collected to cast the facilities in a negative public light, but do no “investigation.”
In 1990, Kansas enacted the Kansas Farm Animal and Field Crop and Research Facilities Protect Act (Act). K.S.A. §§ 47-1825 et seq. The Act makes it a crime to commit certain acts without the facility owner’s consent where the plaintiff commits the act with the intent to damage an animal facility. Included among the prohibited acts are damaging or destroying an animal facility or an animal or other property at an animal facility; exercising control over an animal facility, an animal from an animal facility or animal facility property with the intent to deprive the owner of it; entering an animal facility that is not open to the public to take photographs or recordings; and remaining at an animal facility against the owner's wishes. K.S.A. § 47-1827(a)-(d). In addition, K.S.A. § 47-1828 provides a private right of action for "[a]ny person who has been damaged by reason of a violation of K.S.A. § 47-1827 against the person who caused the damage." For purposes of the Act, a facility owner’s consent is not effective if it is induced by force, fraud, deception duress or threat. K.S.A. § 47-1826(e). The plaintiff challenged the constitutionality of the Act, and filed a motion for summary judgment. The defendant also motioned for summary judgment on the basis that the plaintiffs lacked standing or, in the alternative, the Act barred trespass rather than speech.
On the standing issue, the trial court held that the plaintiffs lacked standing to challenge the portions of the Act governing physical damage to an animal facility (for lack of expressed intent to cause harm) and the private right of action provision, However, the trial court determined that the plaintiffs did have standing to challenge the exercise of control provision, entering a facility to take photographs, etc., and remaining at a facility against the owner’s wishes to take pictures, etc. The plaintiffs that did no investigations but received the information from the investigations also were deemed to have standing on the same grounds. On the merits, the trial court determined that the Act regulates speech by limiting what the plaintiffs could say and by barring pictures/videos. The trial court determined that the provisions of the Act at issue were content-based and restricted speech based on viewpoint – barring only that speech that would harm an animal facility. The trial court determined that barring lying is only constitutionally protected when it is associated with a legally recognizable harm, and the Act is unconstitutional to the extent it bars false speech intended to damage livestock facilities. Because the provisions of the Act at issue restrict content-based speech, its constitutionality is measured under a strict scrutiny standard. As such, a compelling state interest in protecting legally recognizable rights must exist. The trial court concluded that even if privacy and property rights involved a compelling state interest, the Act must be narrowly tailored to protect those rights. By focusing only on those intending to harm owners of a livestock facility, the Act did not bar all violations of property and privacy rights. The trial court also determined that the Governor was a proper defendant.
The status of the litigation presently rests with the Kansas Attorney General and the Governor to determine the next step(s) to be taken.
Conclusion
There is never a dull moment in agricultural law and taxation. I will provide more updates like this is in future posts.
January 27, 2020 in Bankruptcy, Civil Liabilities, Criminal Liabilities, Income Tax | Permalink | Comments (0)
Friday, January 17, 2020
Principles of Agricultural Law
Overview
The fields of agricultural law and agricultural taxation are dynamic. Law and tax impacts the daily life of a farmer, rancher, agribusiness and rural landowner practically on a daily basis. Whether that is good or bad is not really the question. The point is that it’s the reality. Lack of familiarity with the basic fundamental and applicable rules and principles can turn out to be very costly. As a result of these numerous intersections, and the fact that the rules applicable to those engaged in farming are often different from non-farmers, I started out just over 25 years ago to develop a textbook that addressed the major issues that a farmer or rancher and their legal and tax counsel should be aware of. After three years, the book was complete – Principles of Agricultural Law - and it’s been updated twice annually since that time.
The 46th edition is now complete, and it’s the topic of today’s post – Principles of Agricultural Law.
Subject Areas
The text is designed to be useful to farmers and ranchers; agribusiness professionals; ag lenders; educational professionals; laywers, CPAs and other tax preparers; undergraduate and law students; and those that simply want to learn more about legal and tax issues. The text covers a wide range of topics. Here’s just a sample of what is covered:
Ag contracts. Farmers and ranchers engage in many contractual situations, including ag leases, to purchase contracts. The potential perils of verbal contracts are numerous as one recent bankruptcy case points out. See, e.g., In re Kurtz, 604 B.R. 549 (Bankr. D. Neb. 2019). What if a commodity is sold under forward contract and a weather event destroys the crop before it is harvested? When does the law require a contract to be in writing? For purchases of goods, do any warranties apply? What remedies are available upon breach? If a lawsuit needs to be brought to enforce a contract, how soon must it be filed?
Ag financing. Farmers and ranchers are often quite dependent on borrowing money for keeping their operations running. What are the rules surrounding ag finance? This is a big issue for lenders also? For instance, in one recent Kansas case, the lender failed to get the debtor’s name exactly correct on the filed financing statement. The result was that the lender’s interest in the collateral (a combine and header) securing the loan was discharged in bankruptcy. In re Preston, No. 18-41253, 2019 Bankr. LEXIS 3864 (Bankr. D. Kan. Dec. 20, 2019).
Ag bankruptcy. A unique set of rules can apply to farmers that file bankruptcy. Chapter 12 bankruptcy allows farmers to de-prioritize taxes. That can be a huge benefit. Knowing how best to utilize those rules is very beneficial.
Income tax. Tax and tax planning permeate daily life. Deferral contracts; depreciation; installment sales; like-kind exchanges; credits; losses; income averaging; reporting government payments; etc. The list could go on and on. Having a basic understanding of the rules and the opportunities available can add a lot to the bottom line of the farming or ranching operation.
Real property. Of course, land is typically the biggest asset in terms of value for a farming and ranching operation. But, land ownership brings with it many potential legal issues. Where is the property line? How is a dispute over a boundary resolved? Who is responsible for building and maintaining a fence? What if there is an easement over part of the farm? Does an abandoned rail line create an issue? What if land is bought or sold under an installment contract?
Estate planning. While the federal estate tax is not a concern for most people and the vast majority of farming and ranching operations, when it does apply it’s a major issue that requires planning. What are the rules governing property passage at death? Should property be gifted during life? What happens to property passage at death if there is no will? How can family conflicts be minimized post-death? Does the manner in which property is owned matter? What are the applicable tax rules? These are all important questions.
Business planning. One of the biggest issues for many farm and ranch families is how to properly structure the business so that it can be passed on to subsequent generations and remain viable economically. What’s the best entity choice? What are the options? Of course, tax planning is part and parcel of the business organization question.
Cooperatives. Many ag producers are patrons of cooperatives. That relationship creates unique legal and tax issues. Of course, the tax law enacted near the end of 2017 modified an existing deduction for patrons of ag cooperatives. Those rules are very complex. What are the responsibilities of cooperative board members?
Civil liabilities. The legal issues are enormous in this category. Nuisance law; liability to trespassers and others on the property; rules governing conduct in a multitude of situations; liability for the spread of noxious weeds; liability for an employee’s on-the-job injuries; livestock trespass; and on and on the issues go. It’s useful to know how the courts handle these various situations.
Criminal liabilities. This topic is not one that is often thought of, but the implications can be monstrous. Often, for a farmer or rancher or rural landowner, the possibility of criminal allegations can arise upon (sometimes) inadvertent violation of environmental laws. Even protecting livestock from predators can give rise to unexpected criminal liability. Mail fraud can also arise with respect to the participation in federal farm programs. The areas of life potentially impacted with criminal penalties are worth knowing, as well as knowing how to avoid tripping into them.
Water law. Of course, water is essential to agricultural production. Water issues vary across the country, but they tend to focus around being able to have rights to water in the time of shortage and moving the diversion point of water. Also, water quality issues are important. In essence, knowing whether a tract of land has a water right associated with it, how to acquire a water right, and the relative strength of that water rights are critical to understand.
Environmental law. It seems that agricultural and the environment are constantly in the news. The Clean Water Act, Endangered Species Act and other federal (and state) laws and regulations can have a big impact on a farming or ranching operation. Just think of the issues with the USDA’s Swampbuster rules that have arisen over the past 30-plus years. It’s good to know where the lines are drawn and how to stay out of (expensive) trouble.
Regulatory law. Agriculture is a very heavily regulated industry. Animals and plants, commodities and food products are all subject to a great deal of regulation at both the federal and state level. Antitrust laws are also important to agriculture because of the highly concentrated markets that farmers buy inputs from and sell commodities into. Where are the lines drawn? How can an ag operation best position itself to negotiate the myriad of rules?
Conclusion
The academic semesters at K-State and Washburn Law are about to begin for me. It is always encouraging to me to see students getting interested in the subject matter and starting to understand the relevance of the class discussions to reality. The Principles text is one that can be very helpful to not only those engaged in agriculture, but also for those advising agricultural producers. It’s also a great reference tool for Extension educators.
If you are interested in obtaining a copy, you can visit the link here: http://washburnlaw.edu/practicalexperience/agriculturallaw/waltr/principlesofagriculturallaw/index.html
January 17, 2020 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
