Tuesday, February 18, 2020
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.
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.
There’s never a dull moment in the world of ag law and ag tax. These are just a few developments in recent weeks.
Thursday, February 6, 2020
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.
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.
Wednesday, January 29, 2020
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
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.
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.
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
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.
There is never a dull moment in agricultural law and taxation. I will provide more updates like this is in future posts.
Friday, January 17, 2020
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.
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?
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)
Monday, December 30, 2019
It’s the time of year again where I sift through the legal and tax developments impacting 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, 2019 contained many legal developments of importance. There were relatively fewer major tax developments in 2019 compared to prior years, but the issues ebb and flow from year-to-year. It’s also difficult to pair things down to ten significant developments. There are other developments that are also significant. So, today’s post is devoted to those developments that were left on the cutting table and didn’t quite make the “Top Ten” for 2019.
The “almost top ten of 2019” – that’s the topic of today’s post.
Chapter 12 Debt Limit Increase
To be eligible for Chapter 12 bankruptcy, a debtor must be a “family farmer” or a “family fisherman” with “regular annual income.” A “family farmer” is defined as an individual or individual and spouse who earned more than 50 percent of their gross income from farming either for the taxable year preceding the year of filing or during the second and third tax years preceding filing; have more than 50 percent of their debt be debt from a farming operation that the debtor owns or operates; and, the aggregate debt must not exceed a threshold amount. That threshold amount has only adjusted for inflation since enactment of Chapter 12 in 1986, even though farms have increased in size and capital needs faster than the rate of inflation. When enacted, 86 percent of farmers were estimated to qualify for Chapter 12. That percentage had declined over time due to the debt limit only periodically increasing with inflation and stood at $4,411,400 as of the beginning of 2019. Thus, fewer farmers were able to use Chapter 12 to deprioritize taxes associated with the sale of farm assets used in the farming operation and ultimately put together a reorganization plan that will allow the farmer to stay on the farm to continue production activities, make restructured loan payments and have some debt written off. However, as of August 23, 2019, the debt limit for a family farmer filing Chapter 12 was increased to $10,000,000 for plans filed on or after that date. H.R. 2336, Family Farmer Relief Act of 2019, signed into law on Aug. 23, 2019 as Pub. L. No. 116-51.
Which Government Agency Sues a Farmer For a WOTUS Violation?
In 2019, a federal trial court allowed the U.S. Department of Justice (DOJ) to sue a farmer for an alleged CWA dredge and bill permit violation without a specific recommendation from the Environmental Protection Agency (EPA). The farmer was alleged to have discharged “pollutants” into a “waters of the United States” (WOTUS) as a result of tractor tillage activities on his farmland containing or near to wetlands contiguous to a creek that flowed into a WOTUS. Staff of the U.S. Army Corps of Engineers (COE) saw the tilled ground and investigated. The COE staff then conferred with the EPA and referred the matter to the U.S. Department of Justice (DOJ). The DOJ sued (during the Obama Administration) for enforcement of a CWA §404 permit “by the authority of the Attorney General, and at the request of the Secretary of the Army acting through the United States Corps of Engineers.” The DOJ alleged that the equipment "constituted a 'point source'" pollutant under the CWA and "resulted in the placement of dredged spoil, biological materials, rock, sand, cellar dirt or other earthen material constituting “pollutants” (within the meaning of 33 U.S.C. § 1362(6)) into waters of the United States. The DOJ alleged that the defendant impacted water plants, changed the river bottom and/or replaced Waters of the United States with dry land, and "resulted in the 'discharge of any pollutant' within the meaning of 33 U.S.C. § 1311(a)." The farmer moved for summary judgment on the basis that the CWA authorizes only the EPA Administrator to file a CWA §404 enforcement action and that the court, therefore, lacked jurisdiction. The court disagreed and determined that the defendant could be sued by the U.S. Department of Justice upon the mere recommendation of the COE and without a specific recommendation from the EPA alleging a CWA violation, and in a situation where the CWA did not determine any CWA jurisdiction and only the COE did. This finding was despite a 1979 Attorney General opinion No. 197 determining that the EPA and not the COE has the ultimate authority to construe what is a navigable WOTUS. Ultimately, the parties negotiated a settlement costing the farmer over $5 million. United States v. Lapant, No. 2:16-CV-01498-KJM-DB, 2019 U.S. Dist. LEXIS 75309 (E.D. Cal. May 3, 2019). United States v. Lapant, No. 2:16-CV-01498-KJM-DB, 2019 U.S. Dist. LEXIS 93590 (E.D. Cal. Jun. 3, 2019).
USDA’s Swampbuster “Incompetence”
How does the USDA determine if a tract of farmland contains a wet area that is subject to the Swampbuster rules? That’s a question of key importance to farmers. That process was at issue in a 2019 case, and the court painted a rather bleak and embarrassing picture of the USDA bureaucrats. In fact, the USDA-NRCS was brutalized (rightly so) by the appellate court’s decision for its lack of candor and incompetence. I will skip the details here (I covered the case in a blog post earlier in 2019), but the appellate court dealt harshly with the USDA. The USDA uses comparison sites to determine if a particular site is a wetland subject to Swampbuster rules. In this case, the USDA claimed that 7 C.F.R. § 12.31(b)(2)(ii) allowed them to select a comparison site that was "on the same hydric soil map unit" as the subject property, rather than on whether the comparison site had the same hydrologic features as the subject tract(s). The appellate court rejected this approach as arbitrary and capricious, noting that the NRCS failed to try an "indicator-based wetland hydrology" approach or to use any of their other tools when picking a comparison site. In addition, the appellate court noted a COE manual specifies that, “[a] hydrologist may be needed to help select and carry out the proper analysis" in situations where potential lack of hydrology is an issue such as in this case. However, the NRCS did not send a hydrologist to personally examine the plaintiff’s property, claiming instead that a comparison site was not even necessary. Based on 7 C.F.R. §12.32(a)(2), the USDA claimed, the removal of woody hydrophytic vegetation from hydric soils to permit the production of an agricultural commodity is all that is needed to declare the area "converted wetland." The appellate court concluded that this understanding of the statue was much too narrow and went against all the other applicable regulatory and statutory provisions by completely forgoing the basis of hydrology that the provisions are grounded in. Accordingly, the appellate court reasoned that because hydrology is the basis for a change in wetland determination, the removal of trees is merely a factor to determine the presence of a wetland, but is not a determining factor. In addition, the appellate court pointed out that the NRCS never indicated that the removal of trees changed the hydrology of the property during the agency appeal process – a point that the USDA ignored during the administrative appeal process. The court’s decision is a step in the right direction for agriculture. Boucher v. United States Department of Agriculture, 934 F.3d 530(7th Cir. 2019).
No More EPA “Finger on the Scales”
During 2019, a federal trial court ruled that the EPA has the authority to bar persons currently receiving grant money from the EPA to serve on EPA scientific advisory committees. That’s an important development for the regulated community, including farmers and ranchers. The court’s opinion ended an Obama-era EPA policy of allowing EPA advisory committee members to be in present receipt of EPA grants. At issue in the case was a directive of the Trump-EPA regarding membership in its federal advisory committees. The directive specified “that no member of an EPA federal advisory committee be currently in receipt of EPA grants.” The directive reversed an Obama-era rule that allowed scientists in receipt of EPA grants to sit on advisory panels. That rule was resulting in biased advisory committees stacked with committee members that opposed coal and favored an expansive “Waters of the United States” rule among other matters. In defending its policy change, the EPA explained that “while receipt of grant funds from the EPA may not constitute a financial conflict of interest, receipt of that funding could raise independence concerns depending on the nature of the research conducted and the issues addressed by the committee.” Thus, the change was necessary “to ensure integrity and confidence in its advisory committees.” The trial court found the EPA’s explanation to be within the zone of reasonableness. Based on these findings, the trial court held that the EPA action was rational, considered the relevant factors and was within the authority delegated to the agency. The court granted the EPA’s motion to dismiss the case. Physicians for Social Responsibility v. Wheeler, 359 F. Supp. 3d 27 (D. D.C. 2019).
Coming-To-The-Nuisance By Staying Put?
Nuisance lawsuits filed against farming operations are often triggered by offensive odors that migrate to neighboring rural residential landowners. In these situations courts consider numerous factors in determining whether any particular farm or ranch operation is a nuisance. Factors that are of primary importance are priority of location and reasonableness of the operation. Together, these two factors have led courts to develop a “coming to the nuisance” defense. This means that if people move to an area they know is not suited for their intended use, they should be prohibited from claiming that the existing uses are nuisances. But, what if the ag nuisance comes to you? Is the ag operation similarly protected in that situation? An interesting Indiana court case in 2019 dealt with the issue. In the case, the defendants were three individuals, their farming operation and a hog supplier. Basically, a senior member of the family retired to a farm home on the premises and other family members established a large-scale confined animal feeding operation (CAFO) on another part of the farm nearby. The odor issue got bad enough that the retired farmer sued. However, the court determined that the CAFO was operated properly, had all of the necessary permits, and was within the zoning laws. The court noted that the plaintiff alleged no distinct, investment-backed expectations that the CAFO had frustrated. The court upheld the state right-to-farm law and also determined that a “taking” had not occurred because the plaintiff had not sold his home and moved away from the place where he grew up and lived all of his life. Himsel v. Himsel, No. 18A-PL-645, 2019 Ind. App. LEXIS 181 (Ind. Ct. App. Apr. 22, 2019).
Obamacare Individual Mandate Unconstitutional
In his decision in 2012 upholding Obamacare as constitutional, Chief Justice Roberts hinged the constitutionality of the law on the individual mandate (contained in I.R.C. §5000A) being a tax and, therefore, within the taxing authority of the Congress. Thus, if the tax is eliminated or the rate of the penalty tax taken to zero is the law unconstitutional? That’s a possibility now that the tax rate on the penalty is zero for tax years beginning after 2018. In late 2018, a federal district court noted that the payment was distinct from the individual mandate and determined that the individual mandate was no longer constitutional as of January 1, 2019 because it would no longer trigger any tax. In addition, because the individual mandate was the linchpin of the entire law, the court determined that the provision could not be severed from the balance of the law. As a result, the court reasoned, as of January 1, 2019, Obamacare no longer had any constitutional basis. Texas v. United States, 340 F.3d 579 (N.D. Tex. 2018). In 2019, the appellate court affirmed. Texas v. United States, No. 19-10011, 2019 U.S. App. LEXIS 37567 (5th Cir. Dec .18, 2019). The appellate court determined that the individual mandate was unconstitutional because it could no longer be read as a tax, and there was no other constitutional provision that justified that exercise of congressional power. Watch for this case to end up back before the Supreme Court. The case is of monumental importance not only on the health insurance issue. Obamacare contained many taxes that would be invalidated if the law were finally determined to be unconstitutional.
These were the developments that didn’t quite make the “Top 10” of 2019. In Wednesday’s post, I will start the trek through the Top 10 of 2019.
Monday, September 9, 2019
When facing financial trouble and bankruptcy, don’t forget about the taxes. While Chapter 12 bankruptcy contains a provision allowing for the deprioritization of taxes, there is no comparable provision for other types of bankruptcies. But, for Chapter 7 and 11 filers, there is a possibility that taxes could be dischargeable in bankruptcy. That’s because under those bankruptcy code provisions, a new tax entity is created at the time of bankruptcy filing.
But, discharging taxes in bankruptcy is a tricky thing. It involves timing and, perhaps, not filing successive cases.
The discharge of tax liability in bankruptcy – it’s the topic of today’s post.
The Bankruptcy Estate as New Taxpayer
As noted, for Chapter 7 (liquidation bankruptcy) or Chapter 11 (non-farm reorganization bankruptcy), a new tax entity separate from the debtor is created when bankruptcy is filed. That’s not the case for individuals that file Chapter 12 (farm) bankruptcy, or Chapter 13 bankruptcy, and for partnerships and corporations under all bankruptcy chapters. In those situations, the debtor continues to be responsible for the income tax consequences of business operations and disposition of the debtor's property. Thus, payment of all the tax triggered in bankruptcy is the responsibility of the debtor. The only exception is that Chapter 12 filers can take advantage of a special rule that makes the taxes a non-priority claim. 11 U.S.C. §1232.
Categories of taxes. 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 Chapter 11 case.
- Category 1 taxes are taxes where the tax return was last timely due more than three years before filing. If an extension was filed, an individual’s return can last be timely filed on October 15th. In this case, the tax is dischargeable provided the bankruptcy is filed on or after October 16th three years after the year the tax return was filed. 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. Most bankruptcy trustees abandon assets if the taxes incurred will make the bankruptcy estate administratively insolvent.
- 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.
The election to close the debtor’s tax year. In general, the bankrupt debtor’s tax year does not change upon the filing of bankruptcy. But, debtors having non-exempt assets that will be administered by the bankruptcy trustee may elect to end the debtor’s tax year as of the day before the bankruptcy filing.
Making the election creates two short tax years for the debtor. The first short year ends the day before bankruptcy filing and the second year begins with the bankruptcy filing date and ends on the bankrupt’s normal year-end date. If the election is not made, the debtor remains individually liable for income taxes for the year of filing. But, if the election is made, the debtor’s income tax liability for the first short year is treated as a priority claim against the bankruptcy estate, and can be collected from the estate if there are sufficient assets to pay the bankruptcy estate’s claims through the eighth priority. If there are not sufficient assets to pay the income tax, the remaining tax liability is not dischargeable, and the tax can be collected from the debtor at a later time. The income tax the debtor owes for the years ending after the filing is paid by the debtor and not by the bankruptcy estate. Thus, closing the debtor’s tax year can be particularly advantageous if the debtor has substantial income in the period before the bankruptcy filing. Conversely, if a net operating loss, unused credits or excess deductions are projected for the first short year, a short year election should not be made in the interest of preserving the loss for application against the debtor’s income from the rest of the taxable year. Even if the debtor projects a net operating loss, has unused credits or anticipates excess deductions, the debtor may want to close the tax year as of the day before bankruptcy filing if the debtor will not likely be able to use the amounts, the items could be used by the bankruptcy estate as a carryback to earlier years of the debtor (or as a carryforward) and,
But, in any event, if the debtor does not act to end the tax year, none of the debtor’s income tax liability for the year of bankruptcy filing can be collected from the bankruptcy estate. Likewise, if the short year is not elected, the tax attributes (including the basis of the debtor’s property) pass to the bankruptcy estate as of the beginning of the debtor’s tax year. Therefore, for example, no depreciation may be claimed by the debtor for the period before bankruptcy filing. That could be a significant issue for many agricultural debtors.
Consider the following example:
Sam Tiller, a calendar year/cash method taxpayer, on January 26, 2019, bought and placed in service in his farming business, a new combine that cost $400,000. Sam is planning on writing off the entire cost of the new combine in 2019. However, assume that during 2019, Sam’s financial condition worsens severely due to a combination of market and weather conditions. As a result, Sam files Chapter 7 bankruptcy on September 5, 2019.
If Sam does not elect to close the tax year, the tax attributes (including the basis of his property) will pass to the bankruptcy estate as of the beginning of Sam’s tax year (January 1, 2019). Therefore, Sam would not be able to claim any of the depreciation for the period before he filed bankruptcy (January 1, 2016, through September 4, 2019).
The Timing Issue - Illustrative Cases
As you have probably already figured out, timing of the bankruptcy filing is critical to achieving the best possible tax result. Unfortunately, it’s often the case that tax considerations in bankruptcy are not sufficiently thought out and planned for to achieve optimal tax results. Unfortunately, this point is illustrated by a couple of recent cases.
Filing too soon. In Ashmore v. Comr., T.C. Memo. 2017-233, the petitioner claimed that his 2009 tax liability, the return for which was due on April 15, 2010, was discharged in bankruptcy. He filed Chapter 7 on April 8, 2013. That assertion challenged whether the collection action of the IRS was appropriate. As indicated above, the Tax Court noted that taxes are not dischargeable in a Chapter 7 bankruptcy if the return can last be timely filed within three years before the date the bankruptcy was filed. Because the petitioner filed bankruptcy a week too soon, the Tax Court held that his 2009 taxes were not dischargeable and could be collected. As a result, the IRS settlement officer did not abuse discretion in sustaining the IRS levy. In addition, the Tax Court, held that the IRS did not abuse the bankruptcy automatic stay provision that otherwise operates to bar creditor actions to collect on debts that arose before the bankruptcy petition was filed.
The Tax Court’s conclusion in Ashmore is not surprising. The three-year rule has long been a part of the bankruptcy code. Indeed, in In re Reine, 301 B.R. 556 (Bankr. W.D. Mo. 2003), the debtor filed the Chapter 7 bankruptcy petition more than three years after filing the tax return, but within three years of due date of return. The court held that the debtor’s tax debt was not dischargeable.
The peril of multiple filings. In Nachimson v. United States, No. 18-14479-SAH, 2019 Bankr. LEXIS 2696 (Bankr. W.D. Okla. Aug. 23, 2019), the debtor filed Chapter 7 on October 25, 2018 after not filing his tax returns for 2013 through 2016. Immediately after filing bankruptcy, the debtor filed an action claiming that his past due taxes were discharged under 11 U.S.C. §523(a)(1). After extension, the debtor’s 2013 return was due on October 15, 2014. His 2014 return was due April 15, 2015. The 2016 return was due on April 15, 2016. The 2016 return was due April 15, 2017. The debtor had previously filed bankruptcy in late 2014 (Chapter 13), but the case was dismissed on January 14, 2015 after lasting 80 days. He then filed a Chapter 11 case on November 5, 2015, but it was dismissed on April 13, 2016 after 160 days. After that dismissal, he filed another Chapter 11 case on October 20, 2016, but it was dismissed on December 30, 2016 after 71 days. He filed the present Chapter 7 case, as noted, on October 25, 2018. Thus, as of October 25, 2018, he had been in bankruptcy proceedings from October 15, 2014 through October 25, 2018 -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 income tax debt for the periods specified in 11 U.S.C. §507(a)(8). One of the periods contained in 11 U.S.C. §507(a)(8)(A)(i), is the three-year period before the bankruptcy petition is filed. Importantly, 11 U.S.C. §507(a)(8)(A)(ii)(II) specifies that an otherwise applicable time period specified in 11 U.S.C. §507(a)(8) is suspended for any time during which a governmental unit is barred under applicable non-bankruptcy law from collecting a tax as a result of the debtor’s request for a hearing and an appeal of any collection action taken or proposed against the debtor, plus 90 days; plus 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.
So, what does all this mean? It means that when a debtor files multiple, successive bankruptcy cases, the ordinary operation of the automatic stay 11 U.S.C. § 507(a)(8) and the three-year look-back rule 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.
Here, 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. He wanted a rather straightforward application of the three-year rule. However, 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. But the court determined that the real issue was whether the look-back period extended back 401 (311 plus 90) days, or only for the first 30 days following each bankruptcy filing as provided by 11 U.S.C. § 362(c)(3)(A).
The court noted that the Congress, in 2005, amended 11 U.S.C. §507(a)(8) to codify the U.S. Supreme Court decision of Young v. United States, 535 U.S. 43 (2002) where the Supreme 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. In addition, the Congress amended the statute to tack-on another 90 days to the extension. See, In re Kolve, 459 B.R. 376 (Bankr. W.D. Wisc. 2011). The look-back period automatically tolls upon the filing of a previous case. See, e.g., In re Clothier, 588 B.R. 28 (Bankr. W.D. Tenn. 2018). Thus, instead of suspending the look-back period, it extends it and allows the priority and nondischargeability of tax claims to reach further into the past. Thus, the court in the present case determined 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 (80 + 160 + 71 +90) 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.
Bankruptcy planning should necessarily account for taxes. The cases point out that timing of the filing of the bankruptcy petition is critical, and that successive filings can create tremendous complications. Competent legal and tax counsel is a must, in addition to competent bankruptcy counsel.
Friday, August 2, 2019
It’s been about a month since I devoted a blog post to court litigation involving agricultural producers and businesses. So, it’s time to devote another post to the matter as an illustration of how often the law and the business of agriculture intersect. These posts have proven to be quite popular and instructive.
“Ag in the Courtroom” – the most recent edition. It’s the topic of today’s post.
More Bankruptcy Developments
As I have noted in numerous posts over the past couple of years, the difficult economic conditions in much of agriculture in the Great Plains and the Midwest have made bankruptcy law rise in importance. Fortunately, legislation is headed to the President’s desk that will increase the debt limit in Chapter 12 bankruptcy to $10 million and place some of the existing Chapter 12 provisions in Chapter 11 for use by non-farm small businesses. Those were needed pieces of legislation.
A recent Alabama bankruptcy case illustrates the peril of selling loan collateral without the creditors notice and consent. It’s a unique set of facts because the debtor sold the collateral, a tractor, to bail her boyfriend out of jail. In In re Reid, 598 B.R. 674 (Bankr. S.D. Ala. 2019), the Farm Service Agency (FSA) attached itself as a creditor in the debtor’s chapter 7 bankruptcy proceeding. In March of 2016 the debtor took out two FSA loans for a total of $50,000. A security agreement was also executed at the same time granting the FSA a security interest in "All farm equipment . . . and inventory, now owned or hereafter acquired by the Debtor, together with all replacements, substitutions, additions, and accessions thereto, including but not limited to the following which are located in the State of Alabama." A specific list of assets was attached, including a New Holland tractor, ten beef breeding cows, and nine calves. The debtor used the loan proceeds to purchase the equipment and livestock that was listed as collateral.
In June of the same year, the debtor was notified that she could not have cattle on the land she purchased with another loan not at issue in the case. However, the debtor was never notified of the restriction and it was not stated in the purchase contracts. Ultimately, the debtor was given thirty days to vacate the premises. Around this time, the debtor’s equipment and cattle started to go missing. The debtor was also becoming aware that her boyfriend (and father of her children) had a drug problem, and she began to suspect that he was selling the equipment and cattle for drugs. Later, the debtor attempted to stop a man from taking cattle from the property and the man said to take it up with her boyfriend. The debtor did not report the cattle or equipment as stolen. The debtor’s boyfriend was arrested about the same time for drug crimes and eluding the police. The debtor vacated the property with the only collateral remaining at the property being the New Holland tractor, which the debtor listed for sale on Facebook. The debtor testified that she sold the New Holland tractor to an unknown purchaser for between $6,000.00 and $8,000.00. But the exact price and identity of the purchaser could not be found as the debtor deleted her Facebook account. The proceeds of the tractor sale were put towards bail money for the boyfriend. The debtor never made a payment on the loans and vacated the property before the first payment was due.
The FSA attempted to recover the tractor but was unsuccessful. The FSA sought to have the bankruptcy court find the debt owed to the FSA in the amount of $52,048.56 plus interest to be non-dischargeable for fraud; fiduciary defalcation; embezzlement; and willful and malicious injury. The court averaged the alleged selling price of the tractor and rendered $7,000 non-dischargeable. The court also determined that the debtor did not fraudulently obtain the FSA loans, and did not embezzle the collateral because fraud wasn’t present. Because willful and malicious injury was present upon the debtor’s sale of the tractor without notice to the FSA and use of the proceeds for the debtor’s personal benefit, the $7,000 that the debtor received upon sale of the tractor was non-dischargeable.
The Intersection of State and Federal Regulation
Agriculture is a heavily regulated industry. Sometimes that regulation is apparent and sometimes it occurs an a rather unique manner. Sometimes it comes from the federal government and sometimes it is purely at the state and local level. In yet other situations, the regulation is an interesting (and frustrating for those subject to it) blend of federal and state/local regulation.
In 2009, the defendant in Carroll Airport Comm'n v. Danner, No. 17-1458, 2019 Iowa Sup. LEXIS 57 (May 10, 2019), planned to construct a grain leg (bucket elevator) and grain bins. In 2013, the defendant obtained the proper county zoning permits but was told of the need to comply with the airport zoning ordinances. The grain leg stands within 10,000 feet horizontally from the end of plaintiff’s runway. The structure reaches a height of 127 feet off the ground. The parties agree the grain leg intrudes within the airport's protected airspace by approximately sixty feet. After construction began it was evident that there would be issues with the airport zoning ordinances and the plaintiff asked the Federal Airport Administration (FAA) to perform an aeronautical study of the grain leg and its impact on aviation safety. The FAA issued a letter stating, "This aeronautical study revealed that the structure does exceed obstruction standards but would not be a hazard to air navigation." It also warned, “This determination concerns the effect of this structure on the safe and efficient use of navigable airspace by aircraft and does not relieve the sponsor (i.e., the defendant) of compliance responsibilities relating to any law, ordinance, or regulation of any Federal, State, or local government body.” Lastly the FAA requested that the defendant paint the structure and add red lights to the top of it. The defendant did so. The FAA also adjusted the flight patterns in and out of the airport to accommodate this structure. The plaintiff did not seek review under this determination.
Two years later, the plaintiff (the local airport commission) sued alleging the grain leg violated certain building ordinances; city and county zoning ordinances; airport commission regulations; and constituted a nuisance and hazard to air traffic. The plaintiff sought equitable relief—an injunction requiring the defendant to modify or remove the grain leg. The defendant raised an affirmative defense of federal preemption. In June 2017, the trial court found that the grain leg violated state and local zoning ordinances and constituted a nuisance and an airport hazard. The trial court found that the grain leg did not fall within the agricultural exemption to certain zoning laws and rejected the defendants’ affirmative defense that the no-hazard letter preempted state and local zoning ordinances. The appellate court affirmed, concluding that the doctrines of express, implied, and conflict preemption did not apply to the FAA no-hazard determination. On further review, the state Supreme Court affirmed. The Supreme Court concluded that the FAA no-hazard determination did not preempt local zoning ordinances, was not legally binding, and contained language notifying the defendant that compliance with local rules was required.
Rights involving surface water vary from state-to-state. In some parts of the U.S., however, a party owning land adjacent to a watercourse has what are known as “riparian” rights to the water. But, do those rights apply to man-made lakes, or just natural lakes? The issue came up recently in Incline Village Board of Trustees v. Edler, No. SC97345, 2019 Mo. LEXIS 178 (Mo. Sup. Ct. Apr. 30, 2019).
The defendants owned properties in subdivisions around a lake. One of the properties of the second subdivision abutted the lake. The properties they owned in the first subdivision did not abut the lake. During the creation of the first subdivision, restrictions were added to the land. One such restriction stated, “No structures or other improvements shall be made on or to any common area, including any body of water, other than such structures or improvements which are made by the trustees for the benefit of all lot owners. Except that, the owner of each lot which abuts any body of water, may construct one boat dock on such body of water, provided that, said boat dock extends from said lot and is first approved in writing by the trustees.” All landowners in the first subdivision were entitled to use the lake, even if they did not abut the lake. The second subdivision was not joined with the first one, but it was clear that the second subdivision was excluded from use rights on the lake. Lots in the first subdivision were subject to assessments to maintain the lakes.
The defendants built a dock on the property on the second subdivision. The trustees of the first subdivision defendants sued seeking a declaratory judgment, damages for trespass, and the removal of the dock. The district court ordered removal of the dock and determined that special circumstances existed supporting the award of attorney's fees of $70,000 in favor of the trustees.
On appeal, the appellate court determined that the lake was clearly artificial and, thus, the defendants were not riparian owners. Riparian rights are only extended to landowners adjacent to natural lakes. The appellate court also rejected the defendants’ reliance-based argument. The appellate court noted that the defendants had never had use of the lake for dock purposes or paid assessments for its maintenance. In addition, the defendants’ predecessor in title's deed to the adjacent land explicitly excepted the lake from the transfer. In addition, the plaintiffs had told the defendants of the property restrictions before the dock was built. As for attorney fees, the appellate court determined that there was not any special circumstance to merit an award of attorney fees. The plaintiff had not given any formal warning about not building the dock and the defendants had sought legal advice.
It’s never a dull moment in ag law involving ag producers, agribusinesses and rural landowners. The cases keep on rolling in.
Monday, July 29, 2019
Under 1986 amendments to the Bankruptcy Act of 1978, Congress created Chapter 12 bankruptcies 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. Chapter 12 became a permanent part of the Bankruptcy Code effective July 1, 2005. Numerous requirements must be satisfied for a debtor to qualify for Chapter 12 relief. One of those requirements, the “aggregate debt test” is the subject of a bill, H.R. 2336, that passed the U.S. House on July 25. The legislation increases the maximum aggregate debt a debtor can have and remain eligible for Chapter 12. It’s an important bill because of the economic struggles of many farming operations in certain parts of the country. I have discussed those problems in other posts, such as this one: https://lawprofessors.typepad.com/agriculturallaw/2018/03/chapter-12-bankruptcy-feasibility-of-the-reorganization-plan.html
The proposed increase in the Chapter 12 bankruptcy aggregate debt test - it’s the topic of today’s post.
To be eligible for Chapter 12 bankruptcy, a debtor must be a “family farmer” or a “family fisherman” with “regular annual income.” 11 U.S.C. §§101(19A) & (21). A “family farmer” is defined as an individual or individual and spouse who earned more than 50 percent of their gross income from farming either for the taxable year preceding the year of filing or during the second and third tax years preceding filing, and whose aggregate debts do not exceed $4,411,400. 11 U.S.C. §18). In addition, more than 50 percent of the debt must be debt from a farming operation that the debtor owns or operates. Id. H.R. 2336 proposes to increase the $4,411,400 amount to$10 million.
Changed Nature of Agricultural Production
As noted above, Chapter 12 was added to the Bankruptcy Code in 1986. At that time, much of agriculture was faced with a debt crisis when crop prices declined sharply, interest rates rose sharply, and farmland values, particularly in the Midwest, plummeted. That toxic mix resulted in many farmers, some of whom were very good managers, finding themselves in a precarious economic position. It was this environment that led to Chapter 12’s enactment and, at the time, it was estimated that 86 percent of farmers could qualify for relief under Chapter 12 . At time of enactment, the aggregate debt limit for Chapter 12 was $1,500,000. That debt limit did not increase until 2005 when it was increased to $3.237,000 via an inflation adjustment. The current limit of $4,411,400 is the present inflation-adjusted limit.
According to U.S.D.A. data, total real farm sector debt has now reached the level it was at during the depth of the farm debt crisis in the early 1980s. However, the increase has been particularly accelerated since 2009, with lenders shoring up their collateral positions by increasing debt on real estate to allow them to continue making loans to farmers. But that is only a short-term solution to a deeper problem. Presently, U.S.D.A. data indicates that the current ratio for agriculture (a measure of the ability to pay bill from current assets – it is total current assets divided by total current liabilities) is 1.31. That number indicates that many farmers are facing a liquidity crisis, and it is generally the position of ag economists that the ratio should be between 1.5 and 3.0.
In addition, U.S.D.A. data also indicates that the working capital compared to the value of farm production is at .09, further supporting the notion that a liquidity crisis is looming for even more farmers. Working capital is the amount of liquid funds that a business has available to meet short-term financial obligations. It is calculated by subtracting current liabilities from current assets, and it provides the short-term financial reserves that are available. In other words, it measures the ability of a farming operation to withstand a financial/economic downturn. For healthy farm businesses, ag economists generally take the position that ratio should be in the 15% to 25% range. The current number of nine-percent means that ag operations are “burning” through working capital and are more vulnerable to financial stress.
“Right-Sizing” the Farming Operation
With land increasingly used as collateral, if economic conditions in agriculture remain difficult, the ability of many farmers to stay in business will be further decreased. Some will be forced to “right-size” their farms by selling assets. But doing so has the very real potential of triggering significant taxes – both capital gain and ordinary income caused by depreciation recapture. Historically, this was a very real problem for farmers filing Chapter 12. 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 creditors. Even though the priority tax claims could be paid in full in deferred payments, in many instances the debtor did not have sufficient funds to allow payment of the priority tax claims in full even in deferred payments.
Congress addressed this problem with the 2005 Bankruptcy Act overhaul. That law contained a provision allowing 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. The provision is now contained in 11 U.S.C. §1232, and it is immaterial whether the tax is triggered pre or post-petition.
Back to the Debt Limit
For the above-mentioned reasons, eligibility for Chapter 12 essential for a farmer to be able to deprioritize taxes associated with the sale of farm assets used in the farming operation and ultimately put together a reorganization plan that will allow the farmer to stay on the farm to continue production activities, make restructured loan payments and have some debt written off.
While the Chapter 12 debt limit has only adjusted for inflation since 1986, farms have increased in size and capital needs faster than the rate of inflation. This means that far less than 86 percent of farmers can satisfy the aggregate debt limit of Chapter 12 – the percentage estimated to qualify for Chapter 12 when it was enacted. While Chapter 11 is an alternative reorganization provision, it does not contain the favorable tax rule of a Chapter 12, is more costly to file, has different “timing” rules, and contains an “absolute priority” rule that can severely limit the ability of a farmer to reorganize debts and remain in farming. I discussed the absolute priority rule here: https://lawprofessors.typepad.com/agriculturallaw/2019/07/farmers-bankruptcy-and-the-absolute-priority-rule.html. In addition, for a farm debtor that has aggregate debt over the $4,411,400 limit, it’s not possible to file a Chapter 11, pay debt down beneath the threshold, and convert to Chapter 12.
H.R. 2336 (and the companion Senate bill S. 987) is important legislation designed to restore the availability of Chapter 12 to farmers (but not family fisherman) that were intended to benefit from it when it was enacted in 1986. If the original policy reasons justifying the enactment of Chapter 12 in 1986 remain, the debt ceiling should increase to reflect that rationale. Senate rules are different than those in the House and a Senator’s objection to a bill can cause a bill to stall much more easily than in the House. Presently, Senator Feinstein (D-CA) is objecting to the legislation on the basis that hearings have not been held. However, she is mistaken on that point. Hearings were held last year – on both the House and Senate bills. Senator Durbin (D-IL) is also objecting for other reasons, and Senator Warren (D-MA) is believed to follow whatever Sen. Durbin does.
At this point, interested farmers and others are encouraged to contact their Senators via email before Thursday of this week. After Wednesday, the Senate is recessed. This week will be a key week for many family farmers.
Tuesday, July 9, 2019
Agriculture and the law intersect in many ways. Of course, tax and estate/business planning issues predominate for many farmers and ranchers. But, there are many other issues that arise from time-to-time. Outside of tax, leases and fences are issues that seem to come up repeatedly. Other issues are cyclical. Bankruptcy is one of those issues that has increased in importance in recent months. Of course, legal issues associated with the administration of federal farm programs is big too. In addition, legal issues associated with market structure and competition in various sectors of agriculture are of primary importance particularly in the poultry and cattle sectors.
Periodically, I step away from the technical article aspect of this blog and do a survey of some recent ag-related developments in the courts. That’s what today’s post is about – it’s “ag in the courtroom” day today – at least with respect to a couple of recent cases.
Abandoned Rail Lines
One matter that is a big one in ag for those farms and ranches impacted by it involves the legal issues associated with abandoned rail lines. It’s often a contentious matter, and it doesn’t help that the Congress changed the rules several decades ago to, in the view of many impacted adjacent landowners, diminish private property rights.
Recently, another abandoned rail line case was decided. This time the decision was rendered by the Kansas Court of Appeals. In Central Kansas Conservancy, Inc., v. Sides, No.119,605, 2019 Kan. App. LEXIS 29 (Kan. Ct. App. May 17, 2019), the Union Pacific Railroad acquired a right-of-way over a railroad corridor that it abandoned in the mid-1990s. At issue in the case was a 12.6-mile length of the abandoned line between McPherson and Lindsborg, Kansas. A Notice of Interim Trail Use (NITU) was issued in the fall of 1995. The corridor was converted into a trail use easement under the National Trails System Act. In 1997, Union Pacific gave the plaintiff a "Donative Quitclaim Deed" to the railroad’s easement rights over the corridor, with one-quarter mile of it running through the defendant’s property at a width of 66 feet. Pursuant to a separate agreement, the plaintiff agreed to quit claim deed its rights back to the railroad if the railroad needed to operate the line in the future. By virtue of the easement, the plaintiff intended to develop the corridor into a public trail.
In 2013, the plaintiff contacted the defendant about developing the trail through the defendant’s land. The defendant had placed machinery and equipment and fencing in and across the corridor which they refused to remove. In 2015, the plaintiff sued to quiet title to the .75-mile corridor strip and sought an injunction concerning the trail use easement over the defendant’s property. The defendant admitted to blocking the railway with fencing and equipment, but claimed the right to do so via adverse possession or by means of a prescriptive easement. The defendant had farmed, grazed cattle on, and hunted the corridor at issue since the mid-1990s. The defendant also claimed that the plaintiff had lost its rights to the trail because it had failed to complete development of the trail within two years as the Kansas Recreational Trail Act (KRTA) required.
In late 2016, the trial court determined that the two-year development provision was inapplicable because the Interstate Commerce Commission had approved NITU negotiations before the KRTA became effective in 1996. The trial court also rejected the defendant’s adverse possession/prescriptive easement arguments because trail use easements are easements for public use against which adverse possession or easement by prescription does not apply.
During the summer of 2017 the plaintiff attempted work on the trail. When volunteers arrived, the defendant had placed equipment and a mobile home on the corridor preventing any work. The plaintiff sought a "permanent prohibitory injunction and permanent mandatory injunction." The defendant argued that he had not violated the prior court order because "[a]ll the Court ha[d] done [was] issue non-final rulings on partial motions for summary judgments, which [were], by their nature, subject to revision until they [were] made final decisions." Ultimately, the trial court granted the plaintiff’s request for an injunction, determined that the defendant had violated the prior summary judgment order, but also held that the plaintiff had not built or maintained fencing in accordance with state law.
On appeal, the appellate court partially affirmed, partially reversed, and remanded the case. The appellate court determined that the defendant did not obtain rights over the abandoned line via adverse possession or prescriptive easement because such claims cannot be made against land that is held for public use such as a recreational trail created in accordance with the federal rails-to-trails legislation. The appellate court also determined that the plaintiff didn’t lose rights to develop the trail for failing to comply with the two-year timeframe for development under the KRTA. The appellate court held that the KRTA two-year provision was inapplicable because a NITU was issued before the effective date of the KRTA. However, the appellate court determined that the plaintiff did not follow state law concerning its duty to maintain fences. The appellate court held that Kan. Stat. Ann. §58-3212(a) requires the plaintiff to maintain any existing fencing along the corridor and maintain any fence later installed on the corridor. In addition, any fence that is installed on the corridor must match the fencing maintained on the sides of adjacent property. If there is no fencing on adjacent sides of a landowner’s tract that abuts the corridor, the plaintiff and landowner will split the cost of the corridor fence equally. The appellate court remanded the case for a determination of the type and extent of fencing on the defendant’s property, and that the plaintiff has the right to enter the defendant’s property to build a fence along the corridor. Any fence along the corridor is to be located where an existing fence is located. If no existing fence exists along the corridor, the corridor fence is to be located where the plaintiff’s trail easement is separated from the defendant’s property. The appellate court remanded to the trial court for a reconsideration of its ruling on fence issues.
Feasibility of Chapter 12 Plan
As I mentioned at the beginning of the post, bankruptcy is one of those ag legal issues that has increased in relevancy in recent months. In certain parts of the country Chapter 12 (farm) bankruptcy has been on the rise. Once a farmer qualifies for Chapter 12 (not always an easy task), the reorganization plan was be proposed in good faith and be feasible. Those issues were at stake in a recent case from Iowa.
In In re Fuelling, No. 18-00644, 2019 Bankr. LEXIS 1379 (Bankr. N.D. Iowa May 1, 2019), the debtor was a farmer that granted the bank a first priority lien on all farm assets other than a truck and cash proceeds to the 2017 crop. To pay for the 2017 inputs, the debtor secured financing though another creditor (not the bank). The creditor obtained a subordination agreement from the bank, giving the creditor a $151,000 first priority lien in the 2017 crop sale proceeds. However, the proceeds from the 2017 crop were not enough to repay the creditor or continue making payments to the bank. The debtor filed Chapter 12 bankruptcy in May of 2018. The debtor sold the 2017 crops and various equipment to repay secured creditors. The creditor’s remaining claim was $107,506.45, $66,625.37 of which is secured by the remaining 2017 crop sale proceeds that the debtor still held.
The parties agreed that the bank's secured claim was $214,093.86 for purposes of plan confirmation. The creditors filed a motion for relief that would allow them to collect the remainder of the 2017 crop proceeds. The debtor filed a motion to use cash collateral to start a cattle feeding operation and grant the creditor a lien in the cattle and feed. The debtor also proposed to use rental payments from the grain bins on the property to make interest payments to the creditor and the bank for five years. The entire principal of the loans would come due as a balloon payment at the end of the plan period.
The bank, the Chapter 12 Trustee, the Iowa Department of Revenue, and the creditor objected to the debtor’s plan. The bankruptcy court denied the debtor’s proposed plan and motion to use cash collateral. The creditors’ motion for relief of stay was granted due to the court finding that the debtor’s plan was not feasible. The court denied the plan for multiple reasons. First the plan improperly substituted the creditor’s lien in the crop with a lien in cattle. Second the plan impermissibly utilized rental payments covered by the bank lien for payments towards the other creditors. The court also determined that the debtor’s proposed interest rate was not correct. The court agreed with the bank and the creditor that the plan was not feasible based on the information in the record. The debtor’s health issues, overly optimistic rental rates for the grain bins, and the balloon payment all factored in the court’s decision of lack of feasibility, even though the plan was submitted in good faith. Since the debtor’s plan to feed cattle was impermissible and not feasible, the court did not need any additional analysis to deny the debtor’s motion to use cash collateral. The debtor claimed that the remaining proceeds were necessary for reorganization, but the court concluded that the debtor’s proposed use of the proceeds impermissibly substituted the creditors. In the end, the court simply could not find a permissible way for the funds to be utilized in reorganization.
These are just two recent cases involving ag legal issues. There are many more. This all points out the need for well-trained lawyers in the legal issues that face farmers and ranchers.
Monday, July 1, 2019
Financial and economic continue to predominate in numerous parts of the ag economy. Current statistics show that economic woes are the most difficult in the dairy sector and other areas on a regional basis – particularly parts of the Great Plains and the Upper Midwest.
Initially passed in the midst of the farm debt crisis of the 1980s, Chapter 12 bankruptcy is uniquely tailored to address the needs of farmers in financial distress. That’s particularly true because of a special tax rule and the ability to avoid something known as the “absolute priority” rule of Chapter 11. However, appropriate planning must be utilized for a farmer to take advantage of Chapter 12.
The peril of a farmer not being eligible for Chapter 12 bankruptcy – that’s the topic of today’s post.
I was asked during a recent radio interview what I would tell a farmer or rancher facing potential financial problems if there was only one piece of advice I could give. My response – “listen to your wife.” Why? In many farming and ranching operations, the operating spouse simply works in the business of farming or ranching rather than working on it. There is a big difference between the two. The spouse that works on the business is the one keeping the books and records, tracking income and expense and monitoring the financial strength of the business. The operating spouse often is not tuned-in to these important aspects of the business. Instead, if lenders will continue to lend, the farmer can continue doing what they do best – farm, ranch and… sign lending documents without having legal counsel review them. But, this can lead to ignoring financial problems until it’s too late. Then, it might be necessary to liquidate assets.
This is the problem that Chapter 12 was designed to address. Chapter 12 allows a farmer to downsize the operation so that it can continue. The business gets reorganized, not liquidated. While the sale of assets to “right-size” the operation can trigger significant taxes, Congress added 11 U.S.C. §1222(a)(2)(A) with the overhaul of the Bankruptcy Code in 2005. Under that provision (and an amendment to it that took effect for new Chapter 12 cases on or after October 26, 2017), a Chapter 12 debtor can 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. The amendment addressed a major problem faced by many family farmers filing under Chapter 12 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 creditors. Even though the priority tax claims could be paid in full in deferred payments under prior law, in many instances the debtor operation did not generate sufficient funds to allow payment of the priority tax claims in full even in deferred payments. That was the core problem that the 2005 provision attempted to address.
Among other eligibility requirements, a farmer must have aggregate debt not exceeding $4,411,400. That is presenting a very real problem for many farmers at the present time. If Chapter 12 is not available because a farmer has debt exceeding the limit, what are the options? In terms of bankruptcy, the only viable options are a Chapter 7 liquidation bankruptcy and a Chapter 11 reorganization. But, in terms of reorganization, Chapter 11 is not nearly as favorable to the farm debtor as is Chapter 12 for the reasons noted below. Thus, for a farmer with excessive debt the strategy would be to identify and liquidate underperforming assets; repay creditors; and get the debt limit beneath the $4,411,400 threshold. That will allow the farmer to file Chapter 12 and get a stronger bargaining position in negotiating a debt settlement with creditors and get favorable tax treatment upon sale, etc., of farm assets.
The Perils of Chapter 11
Chapter 11 is the general reorganization provision for individuals and firms operating a business. There is no debt limit associated with Chapter 11, but major drawbacks of Chapter 11 include the relatively short time the debtor has to overcome existing financial problems, and an absolute priority rule that prohibits debtors from retaining ownership of their property unless unsecured creditors receive 100 percent of their claims.
The absolute priority rule. Under 11 U.S.C. §1129(b)(1), a creditor's plan objection will be upheld if the plan: (1) discriminates unfairly; or (2) is not fair and equitable with respect to each non-accepting class of claims or interests that is impaired under the plan. In this context, "impaired" means that the plan alters the rights of a class of creditors compared to the contractual rights prior to bankruptcy. The rule arose from several railroad case about a century ago. For example, in Northern Pacific Railway Co. v. Boyd, 228 U.S. 482 (1913), the debtor’s reorganization plan proposed to not pay the claims of junior creditors. The Court refused to approve the plan. Instead, the Court concluded that an “absolute priority rule,” as applied to a dissenting class of impaired unsecured creditors, must result in a plan being "fair and equitable." As codified, the “fair and equitable” test (i.e., the “absolute priority rule”) is satisfied only if the allowed value of the claim is to be paid in full, or if the holder of any claim or interest that is junior to the dissenting creditors will not receive or retain any property under the plan on account of such junior claim or interest. See 11 U.S.C. §1129(b)(2)(B)(ii).
The absolute priority rule came up in a recent Wisconsin bankruptcy case involving a dairy. In In re Schroeder Bros. Farms of Camp Douglas LLP, No. 16-13719-11, 2019 Bankr. LEXIS 1705 (Bankr. W.D. Wisc. May 30, 2019), a dairy was structured as a limited liability partnership (LLP). The LLP filed Chapter 11 in late 2016. At the time the Chapter 11 petition was filed, the debtor was ineligible to file Chapter 12 because aggregate debts exceeded the limit for Chapter 12 eligibility. The bankruptcy court confirmed the debtor’s reorganization plan in mid-2018. The debtor became unable to make plan payments and the committee of unsecured creditors motioned for the appointment of a liquidating trustee. The debtor objected on the basis that the sale of any assets would trigger capital gain taxes, and the combination of those taxes, the liquidating trustee’s fees, attorney fees and committee attorney fees would completely consume the sale proceeds of the encumbered real estate, farm equipment and cattle rendering the estate insolvent and leaving the individuals subject to pay the unpaid income taxes.
The debtor subsequently claimed that total debts had fallen beneath the debt limit for a Chapter 12 filing and sought to convert the Chapter 11 case to Chapter 12. Doing so would allow the debtor to take advantage of 11 U.S.C. §1222(a)(2)(A) (the predecessor to current 11 U.S.C. §1232) so that capital gain taxes could be treated as an unsecured claim. The committee of unsecured creditors asserted that the non-priority treatment of capital gain taxes was a non-issue because the debtor, as a pass-through entity, had no liability for any taxes. Instead, it would be the partners of the LLP that would have personal liability for taxes arising from asset sales. The debtor claimed it could elect to be taxed as a corporation via IRS Form 8832 upon making an election. Doing so, the debtor claimed, would result in the capital gain taxes being discharged as an unsecured claim. The committee claimed that the debtor was ineligible to convert to Chapter 12 because it was ineligible at the time the petition was filed.
The bankruptcy court agreed with the committee of unsecured creditors. The original petition date of the debtor’s Chapter 11 filing is the measuring date for the debtor’s Chapter 12 eligibility. However, when the debtor filed Chapter 11, the debtor was ineligible for Chapter 12. The bankruptcy court also pointed out that the debtor’s bankruptcy filing did not impact the debtor’s tax status. The bankruptcy court reasoned that allowing the debtor to make an election to be treated for tax purposes as a corporation would violate the absolute priority rule of 11 U.S.C. §1129(b)(2)(B) – a mainstay of Chapter 11. The absolute priority rule, the court noted, bars a court from approving a plan that gives a holder of a claim anything unless objecting classes have been paid in full. Thus, the proposed conversion of tax status would dilute the class of unsecured creditors and shift unfavorable tax treatment to the detriment of creditors. Accordingly, the bankruptcy court determined that the proposed tax election was not in the best interests of the debtor, the bankruptcy estate or the creditor and denied the tax election. The bankruptcy court approved the appointment of a liquidating trustee.
For farmers and ranchers, proper planning is the key to dealing with financial distress so they can utilize the advantages of Chapter 12. In the In re Schroeder Bros. case, a suggested approach for the dairy would have been to file the election to be treated as a C corporation at least one year before filing the bankruptcy petition. Then a pre-petition partial liquidation could have been utilized to get the debt level within the Chapter 12 limit. If the LLP couldn’t be treated taxwise as a C corporation, the farmer would have needed to file Chapter 12 individually to utilize the tax provisions of 11 U.S.C. §1232. In the alternative, two jointly administered petitions could have been filed.
Chapter 11 has serious limitations and is clearly disadvantageous compared to Chapter 12. It’s never too early to seek out competent legal counsel. A great deal of advance planning is often required to obtain the best possible result in a difficult situation.
Friday, May 10, 2019
It’s been a while since I have devoted a post to recent developments, so that’s what today’s post is devoted to. There are always many significant developments in ag law and tax. I was pleased recently when one of my law students, near the conclusion of the course, commented on how many areas of the law that agricultural law touches and how often the rules as applied to farmers and ranchers are different. That is so true. Ag law is daily life for a farmer, rancher, rural landowner, and agribusiness in action.
Recent development in ag law and tax – that’s the topic of today’s post.
Chapter 12 Plan Not Feasible
As I have written in other posts, when a farmer files Chapter 12 bankruptcy, the reorganization plan that is proposed must be feasible. That means that the farmer must estimate reasonable crop yields and revenue based on historical data, and also provide reasonable estimates of expenses. Courts also examine other factors to determine whether a reorganization plan is feasible.
In, In re Jubilee Farms, 595 B.R. 546, 2018 Bankr. LEXIS 4080 (Bankr. E.D. Ky. Dec. 28, 2018), the debtor, a farm partnership operated by two brothers, farmed primarily corn and soybeans. The Debtors filed Chapter 12 bankruptcy in early 2018. In May of 2018, the Debtors filed a joint Chapter 12 plan, but the secured creditors, FCMA and FCS, objected. The debtors filed an amended Chapter 12 plan providing FCMA with a fully secured claim of roughly $2.7 million and FCS with a fully secured claim of roughly $180,000. The plan provided for periodic payments funded primarily by the debtor’s farming income and supplemented by custom trucking and combining revenue. Additional funding in the first year would come from crop insurance and anticipated federal aid for farmers affected by political activity upsetting foreign crop sales.
The creditors and the Trustee objected to the confirmation of the amended plan on various grounds, but the main argument raised was that the amended plan was not feasible, because the debtor’s one-year income and expense projections were limited and unrealistic compared to the debtor’s historical income and expenses. An evidentiary hearing was held to present projected revenue and expenses for the farm and thus determine the feasibility (whether the debtor could make all plan payments and comply with the plan) of the amended plan.
The court analyzed the projected revenues and expenses for the coming year, and the concluded that the plan was not feasible because the debtors had failed to prove that the plan was feasible beyond March 2019. The court stated that if the debtors only had to prove they could make the payments required up to March 2019, the debtors would prevail because the testimony created a reasonable belief that the receipts necessary to make payments up to that time either had or would soon occur. However, beyond March 2019 that was not the case. The court compared the debtors’ projections to calculations using the yield and price per acre that was supported by the record. The record showed that the debtors could only pay anticipated operating expenses and plan payments after March 2019 if the debtor’s unsupported projections were used. The projections using the bushels per acre and price per bushel only showed revenue of $592,000 to $736,000 with expenses of $872,000. Given this lack of ability to pay combined with the debtor’s projections overstating revenue from soybean production during the 2019 crop year the court found that the debtors anticipated receipts simply did not cover the debtors’ obligations to pay operating expenses and plan payments beyond March 2019. Thus, the plan was not feasible and the court denied confirmation of the amended plan.
Grazing Scam Results in Fraud Convictions
There are various scams that one can get caught up in, but they don’t often involve cattle grazing. However, a recent case did involve a cattle grazing scam. In United States v. Hagen, No. 17-3279, 2019 U.S. App. LEXIS 6109 (8th Cir. Feb. 28, 2019), the defendant and his ex-wife set up a company to provide custom grazing in 2004. The ex-wife obtained grazing leases on tribal land from the Bureau of Indian Affairs ("BIA"). The defendant worked with ranchers to set up custom grazing contracts. In 2011, the BIA issued letters to the defendants for non-compliance with leasing procedures. In 2012, the defendants had leased enough pasture to sustain 57.92 cow-calf pairs but contracted to graze with three cattle producers for the lease of 100 cow-calf pairs and 200 heifers. That summer, 70 pairs were grazed for the full term of the grazing contract, and 33 pairs belonging to another rancher were grazed for a day. A third rancher was forced to find other pasture for his heifers. In 2013, the defendants had leased pasture for 91.26 pairs and had contracted with six different producers to graze a total of 380 pairs. A total of $126,500 was paid upfront by the producers. Not a single pair was grazed that summer and no rancher was reimbursed.
In 2014, the defendants had leased pasture for 6.67 pairs and again over-contracted with three ranchers for 300 pairs, who paid $102,500 up front. No pairs grazed during the summer of 2014 and the ranchers were not reimbursed. The defendants were charged with three counts of wire fraud, four counts of mail fraud, and one count of conspiracy to commit mail and wire fraud for their fraudulent contracting/leasing practices. The ex-wife plead guilty to the conspiracy count and testified against the her ex-spouse at trial. He was convicted by a jury on all eight counts. Sentencing included 46 months imprisonment and 3 years of supervised release on each count, restitution in the amount of $236,000, and a $100 special assessment on each count. The defendant appealed on the basis that the evidence was insufficient to prove he had the requisite intent to defraud, and that the two mailings were not in furtherance of any fraud.
The appellate court affirmed the defendant’s conviction of conspiracy to commit mail and wire fraud, but vacated the conviction and special assessments on the other five substantive counts. The appellate court determined that sufficient evidence supported the jury verdict that the ex-husband had conspired to commit fraud by contracting with twelve different cattle producers to graze cattle. Only one of those contracts had been filled, and the defendants failed to issue refunds on the other contracts for the the 2012-2014 grazing seasons. The appellate court also found sufficient evidence to support the jury’s verdict of use of mail and wire to defraud. One of the ranchers had mailed the defendant a $35,000 check, as full payment for the grazing contract and the defendant had cashed the check using a wire transmission a week later. There was a pasture visit where a rancher was assured that the pasture could support 200 pairs. Another contract was signed by the rancher’s son, and another $35,000 check was written to the defendant. This second contract brought the total contracted to graze with the defendant to 200 pairs for $70,000. It later became evident that the defendant only had 40 acres leased, enough to sustain 6.67 pairs. When it came time for delivery, the defendant did not return any calls. The ranch did not graze any cattle that season nor issued refunds for their payments. The appellate court determined that the evidence was sufficient for the jury to conclude that the defendant knowingly only had enough pasture to graze 6 pairs but nonetheless contracted to graze 200 pairs with this rancher. However, the appellate court vacated the convictions and special assessments tied to specific instance of fraud against different ranchers. The dry conditions that limited the length of the grazing season likely lead to a breach of contract for early termination, rather than an intent to defraud. Other mailings by the defendants containing offers to graze cattle were not in furtherance of fraud, and the convictions and special assessments related to these mailings were vacated.
Fences, Boundary Lines and Adverse Possession
Fences and boundary issues present many court cases. It is certainly true that good fences make good neighbors. Bad fences and boundary disputes tend to bring out the worst in neighbors. A recent Alabama case illustrates the issues that can arise when fences and boundary issues are involved. In Littleton v. Wells, No. 2170948, 2019 Ala. Civ. App. LEXIS 20 (Civ. App. Feb. 22, 2019), a predecessor sold 82 acers to the defendants in 2015. This land had been in the same family for generations, however the seller had only been on the property “maybe twice” since 1989. The plaintiffs received title to their property from their parents, who had been there since 1964. There were three fences between the party’s properties. The defendant relied on a 1964 survey when making his purchase, thinking the property line was the middle fence. No survey was completed at that time.
In 2000, the mapping office notified the parties of a “conflict.” The office determined the actual boundary to be closer to the fence on the defendant’s property rather than the middle fence. However, this determination was for tax purposes and was not a substitute for a survey. The plaintiffs also treated the third fence line, like the map office, as the boundary line.
The plaintiffs grazed cattle up to the furthest fence and maintained all the ground between the fences as their own. The plaintiff also testified as to working on the furthest fence as a child in the 1960’s. The plaintiffs also showed that they held annual gatherings and the kids would play in the creek on the disputed ground. There was also evidence that the plaintiffs leased the disputed ground to others. The plaintiffs did not present all the witnesses as to the family’s use of the property up to the furthest fence. Nor was the employee of the map office testimony heard in court.
The trial court determined that the property line was to be the closer center fence, not the third fence as the plaintiffs claimed. The court ordered an official survey to their findings and entered that survey as the final order. The plaintiffs appealed. The appellate court reversed and remanded. The plaintiffs’ challenged the trial court’s denial of their adverse possession claim and determination of the location of the boundary line. The court looked at all the evidence on record from trial, when analyzing the plaintiff’s adverse possession claim. The appellate court held that the record showed that the plaintiffs had been in actual, hostile, open, notorious, exclusive, and continuous possession of the disputed property for more than ten years (the statutory timeframe). The plaintiffs had presented evidence to support every one of those elements and the defendants have not rebutted any element. The only evidence the defendant presented to rebut the plaintiffs’ evidence was a “belief” that he owned up to the second fence. Since the lower court was erroneous in determining the adverse possession claim, the appellate court did not need to analyze the boundary line determination. The court remanded to create a new boundary line that included the property that the plaintiffs had adversely possessed.
There’s never a dull moment in agricultural law. It’s everyday reality in the life of a farmer, rancher, rural landowner and agribusiness.
Friday, March 29, 2019
The developments in agricultural law and taxation keep rolling in. Many of you have requested more frequent posts on recent developments, so today’s post is devoted to just a handful that are important to farmers, ranchers and the professionals that represent them. In today’s post I take a look at a couple of recent farm bankruptcy cases, the use of a trust to hold farm and ranch property, and the rights of grazing permit holders on federal land.
Selected recent developments in agricultural law and tax – it’s the topic of today’s post.
Times continue to be difficult in agriculture with bankruptcy matters unfortunately taking on increased significance. In one recent case, In re Wulff, No. 17-31982-bhl, 2019 Bankr. LEXIS 388 (Bankr. E.D. Wis. Feb. 11, 2019), the debtor filed Chapter 12 bankruptcy and submitted a complete list of creditors. One of the creditors did not receive notice of the bankruptcy because of a bad address but became aware of the debtor’s bankruptcy upon attempting to collect on their account after the proof of claim deadline had passed. There were multiple plans submitted to the court that were rejected for various reasons, but every plan submitted accounted for the creditor that did not have notice. Ultimately, the debtor’s plan was confirmed. After confirmation, the creditor attempted to file a proof of claim and the trustee objected. The creditor maintained that it filed as soon as receiving notice of the proceedings. The court allowed the claim, but that the creditor had not established grounds for an extended timeframe to file the proof of claim. Even so, the court noted that the debtor’s initial plan and amended plans all accounted for the creditor’s claim. All the plans were consistent with the creditor’s late-filed proof of claim. Thus, the court confirmed the debtor’s reorganization plan with the late-filed proof of claim upon a finding that it was consistent with the plan.
In another bankruptcy case, In re Smith, Nos. 17-11591-WRS, 18-1068-WRS, 2019 Bankr. LEXIS 234 (Bankr. M.D. Ala. Jan. 29, 2019), the debtor filed bankruptcy in 2017. At the time of filing, the debtor had a 2006 loan secured by his farmland that had matured. Instead of foreclosing, the creditor bank and the debtor negotiated a renewal in 2012. Another creditor, an agricultural cooperative, held a 2009 lien. In determining priority, the court held that the bank’s liens were prior to the cooperative’s liens. The court determined that the 2012 renewal of the bank note, even if the bank new of the cooperative’s lien, did not cause the bank to lose priority. While the court noted that sometimes an advancement on an existing mortgage causes the underlying mortgage to lose priority over subsequent liens, the court determined that the 2012 renewal was not an advancement. There was no evidence that additional funds were loaned to the debtor by the bank. In addition, the court determined that the bank’s lowering of the interest rate on the obligation did not cause the creditor to lose priority.
Trusts and Estate Planning
Trusts are a popular tool in estate planning for various reasons. One reason is that a trust can help consolidate farming and ranching interests and aid in the succession planning process. The benefit of consolidating farm and ranch property in trust was the issue of a recent Wyoming case. In re Redland Family Trust, 2019 WY 17 (2019), involved a family that has been involved in contentious litigation over a family trust. The case had been before the Wyoming Supreme Court on multiple occasions. The trust was created in 1989 and amended in 1995. The amendment provided for the appointment of a successor trustee; always required the service of two trustees; created a marital trust for the survivor of the settlors; and revised the buyout provision. The grantors and their five children made contributions to the trust. Upon the death of one of the grantors in 2007 one of the children was appointed as co-trustee. Ligation arose when the surviving grantor’s property was not conveyed to the trust and then again involving removal of the trustees, and an appointed trustee moved to have the trust terminated due to the administrative difficulties to administer, family dysfunction, and because the trust no longer served its purpose. The defendants, (including the co-trustee that resigned) asserted that termination was moot and moved to have the new co-trustee removed.
The trial court did not remove the co-trustee and found that the trust was still valid. The trial court found that the co-trustee did not violate any fiduciary duties and that the defendants failed to show gross and willful misconduct to justify her removal. Further the trial court found that the co-trustee’s claims that the trust was invalid should have been raised in the original trust challenge. The trial court determined that the primary reason for the trust (to keep the lands and leases together for the Redland family) had not been frustrated and that the trust remained administratively functional and was not "unlawful, contrary to public policy, or impossible.
On appeal, the Wyoming Supreme Court affirmed. The Court determined that the trust still had a purpose - to keep the ranch holdings together to conduct business. Even though the other purpose of minimizing tax consequences had failed, consolidation of ranch holdings remained a legitimate purpose. The Court also determined that the co-trustee did not violate her fiduciary duties, her duties of impartiality or loyalty, and that her actions did not amount to gross and willful misconduct. In addition, the Court found that the duty of impartiality did not require the trustee to treat all beneficiaries fairly, but simply to act in the best interest of the beneficiaries and equally defend the intentions of the settlors. While the Court could find no precedent with respect to the duty of loyalty the Court held that merely seeking termination of the trust was not a breach of loyalty. In addition, the Court determined that hostility between parties did not warrant removal.
Rights of Grazing Permittees
In the U.S. West, the ability to graze on federally owned land is essential to economic success. An understanding of those rights is essential, and many legal battles in the West involve associated rights and responsibilities on federal land. One of those issues involves the erection of improvements. In Johnson v. Almida Land & Cattle Co., LLC, 2019 Ariz. App. Unpub. LEXIS 140 (Ariz. App. Ct. Jan. 31, 2019), the defendant owned a grazing allotment and was permitted to graze cattle on the allotted Forest Service land in Arizona. Consistent with the grazing permit, the defendant erected an electric fence on the allotment. In June 2011, the plaintiff collided with the fence while riding an off-road motorcycle, when he turned off a Forest Service road onto an unmarked, unimproved “two-track route” which the fence crossed. The plaintiff brought sued for negligence and the defendant moved for summary judgment on the basis that it owed no duty of care to the plaintiff. The trial court granted the motion, agreeing that there was no duty of care under the Restatement (Second) of Torts.
On appeal, the appellate court determined that the issue was whether a federal permittee owes a duty of care to the public with respect to construction of improvements on the land. Determination of that issue, the appellate court reasoned, was dependent on state law. On that point, the appellate court found that a criminal statute will establish a tort duty if the statute is designed to protect the class of persons in which the plaintiff is included, against the risk of the type of harm which has in fact occurred as a result of its violation, regardless of whether the statute mentions civil liability. The relevant AZ criminal statute held that a person commits a misdemeanor of public nuisance if that person knowingly and unlawfully obstructs a “public highway,” “public thoroughfare,” “roadway” or “highway.” The appellate court held that this public nuisance statute prohibiting the obstruction of certain types of pathways, also created a tort duty in those who erect improvements that impact those paths. Based on this interpretation, the court held that AZ law establishes a public policy giving rise to a tort duty with respect to the obstruction of certain types of public pathways. Consequently, a permittee on federal land owes a duty of care to the public when it erects an improvement across a publicly accessible route. However, the appellate court held that the facts were insufficient to determine, as a matter of law, whether the route at issue qualified as a “public highway,” “public thoroughfare,” “roadway” or “highway.” Consequently, the appellate court reversed on the duty of care issue and remanded to determine if the route fell within the scope of the relevant statutes.
Agricultural law is a “goldmine” of issues that landowners, producers and their legal and tax counsel must stay on top of. It’s a dynamic field. In a few more weeks, I will dig back into the caselaw for additional key recent developments.
Monday, March 11, 2019
Earlier in the year I devoted a blog post to a few current developments in the realm of agricultural law and taxation. That post was quite popular with numerous requests to devote a post to recent developments periodically. As a result, I take a break from my series of posts on the passive loss rules to feature some current developments.
Selected recent developments in agricultural law and taxation – that’s the topic of today’s post.
While economic matters remain tough in Midwest crop agriculture and dairy operations all over the country and the projection is for the third-lowest net farm income in the past 10 years, it hasn’t resulted in an increase in Chapter 12 bankruptcy filings. For the fiscal year ended September 30, 2018, filings nationwide were down 8 percent from the prior fiscal year. However, the number of filing is still about 25 percent higher than it was in 2014. The filings, however, are concentrated in the parts of the country where traditional row crops are grown and livestock and dairy operations predominate. For example, according to the U.S. Courts and reports filed by the Chapter 12 trustees, the states comprising the U.S. Circuit Court of Appeals for the Eighth Circuit (Midwest and northern Central Plains) show a 45 percent increase in Chapter 12 filings when fiscal year 2018 is compared to fiscal year 2017. The Second Circuit (parts of the Northeast) is up 38 percent during the same timeframe. Offsetting these numbers are the Eleventh Circuit (Southeast) which showed a 47 percent decline in filings during fiscal year 2018 compared to fiscal year 2017. The far West and Northwest also showed a 41 percent decline in filings during the same timeframe.
USDA data indicates some rough economic/financial data. Debt-to-asset ratios are on the rise and the debt-service ratio (the share of ag production that is used for ag payments) is projected to reach an all-time high. The current ratio for farming operations is projected to reach an all-time low (but this data has only been kept since 2009). Unfortunately, the U.S. is very good at infusing agriculture with debt capital. In addition, there are numerous tax incentives for the seller financing of farmland. In addition, federal farm programs encourage higher debt levels to the extent they artificially reduce farming risk. This accelerates economic vulnerability when farm asset values decline.
Recent case. A recent Virginia case illustrates how important it is for a farmer to comply with all of the Chapter 12 rules when trying to get a Chapter 12 reorganization plan confirmed. In In re Akers, 594 B.R. 362 (Bankr. W.D. Va. 2019), the debtor owed three secured creditors approximately $350,000 in addition to other unsecured creditors. Two of the secured creditors and the trustee objected to the debtor’s proposed reorganization plan. At the hearing on the confirmation of the reorganization plan, it was revealed that the debtor had not provided any of the required monthly reports. As a result, the court denied plan confirmation and required the debtor to put together an amended plan. The debtor subsequently submitted multiple amended plans, and all were denied confirmation because of the debtor’s inaccurate financial reporting and miscalculation of income and expense. In addition, the current proposed plan was not clear as to how much the largest creditor was to be paid. The creditor had foreclosed, and some payments had been made but the payments were not detailed in the plan. The court denied plan confirmation and denied the debtor’s request to file another amended plan and dismissed the case. The court was not convinced that the debtor would ever be able to put together an accurate and manageable plan that he could comply with, having already had five opportunities to do so.
A recent Iowa case illustrates the need for ag producers to put business agreements in writing. In Quality Egg, LLC v. Hickmans’s Egg Ranch, Inc., No 17-1690, 2019 Iowa App. LEXIS 158 (Iowa App. Ct. Feb. 20, 2019), the plaintiff, in 2002, entered into an oral contract to sell eggs to the defendant via a formula to determine the price paid for the eggs. The business relationship continued smoothly until 2008, when the plaintiff received a check from the defendant that it determined to be far short of the amount due on the account. Notwithstanding the discrepancy, the parties continued doing business until 2011. In 2014, the plaintiff filed sued to recover the amount due, claiming that the defendant purchased eggs on an open account, and still owed about $1.2 million on that account. The defendant counter-claimed, asserting that the transaction did not involve an open account but simply an oral contract to purchase eggs that had been modified in 2008. Consequently, the defendant claimed that the disputed amount was roughly $580,000, based on the modified oral contract.
The trial court jury found that the ongoing series of transactions for the sale and purchase of eggs was an “open and continuous account” at the time of the short pay, yet still found for the defendant. The plaintiff appealed, asserting that the trial court had erred by allowing oral testimony used to prove the existence of a modified oral contract in violation of the statute of frauds. The appellate court remanded for a new trial on the issue, and the second jury trial in 2017 again found for the defendant. The plaintiff again appealed, asserting the statute of frauds as a defense. The plaintiff also asserted that the trial court had failed to instruct the jury on an open account, depriving the jury of the ability to decide the specific elements of its open account claim. The trial court provided only jury instructions on the elements of the breach of contract counter-claim brought by the defendant. On the statute of frauds issue, the appellate court noted that the defendant had admitted written correspondence, checks, and credit statements to support the oral testimony at trial in support of the oral testimony. Thus, the statute of frauds was not violated. However, on the open account jury instruction issue, the appellate court found that the instructions given were improper because the plaintiff’s burden was to prove its claim of money due on an open account, not to disprove an assertion from the defendant of an amended oral contract. The appellate court found that the instructions never mentioned an open account or discussed an open account in any way, and because of that, the jury was never able to render a proper verdict on the plaintiff’s claim. Accordingly, the appellate court concluded that the jury instructions were insufficient and reversed and remanded for a new trial limited to the open-account claim.
Get it in writing!
The qualified business income deduction (QBID) continues to bedevil the tax software programs. It’s the primary reason that the IRS extended the March 1 filing deadline to April 15. The IRS also released a draft Form 8995 to use in calculating the QBID for 2019 returns. But, the actual calculation of the QBID is not that complicated. The difficult part is knowing what is QBI and whether the specified service trade or business limits apply. No worksheet is going to help with that. Understand the concepts! Also, the IRS now says that a PDF attachment of the safe harbor election for rental activities must be combined with the e-filed return. In addition, the election must be signed under penalty of perjury. As I see it, this is just another reason to not use the QBID safe harbor election if you don’t have to.
The U.S. Senate is finally working on tax extender legislation that will extend provisions that expired at the end of 2017. The legislation would extend those expired provisions for two years, 2018-2019. The Senate Finance Committee has released a summary of the proposed bill language: https://www.finance.senate.gov/imo/media/doc/Tax%20Extender%20and%20Disaster%20Relief%20Act%20of%202019%20Summary.pdf
Court says that “Roberts tax” is a non-dischargeable priority claim in bankruptcy. United States v. Chesteen, No. 18-2077, 2019 U.S. Dist. LEXIS 29346 (E.D. La. Feb. 25, 2019). 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 object 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 appellate court reversed. The appellate 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 appellate 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 appellate 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 appellate 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 appellate court noted, the IRS has no criminal enforcement authority if a taxpayer failed to pay the amount.
Court says that the IRS can charge for PTINs.In 2010 and 2011, the Treasury Department developed regulations that imposed certain requirements that an individual had to comply with to be able to prepare tax returns for a fee - a person had to become a “registered tax return preparer.” These previously unregulated persons had to pass a one-time competency exam and a suitability check. They also had to (along with all other preparers) obtain a Preparer Tax Identification Number (PTIN) and paying a user fee to obtain the PTIN. The plaintiff class challenged the authority of the government to require a PTIN and charge a fee for obtaining it. The IRS claimed that the regulations were necessary for the need to oversee tax return preparers to ensure good service. I.R.C. §6109(a)(4), in existence prior to the regulations at issue, requires a preparer to provide identification and state that the preparer’s social security number shall be used as the required identification. The regulations at issue, however, required preparers to obtain (at a fee paid to the Treasury) a PTIN as the identifying number. Preparers without a PTIN could no longer prepare returns for a fee. The IRS argued that by creating the PTIN requirement, it had created a “thing of value” which allowed it to charge a fee, citing 31 U.S.C. §9701(b). However, the plaintiffs claimed that the PTIN requirements are arbitrary and capricious under the Administrative Procedure Act or, alternatively is unlawful as an unauthorized exercise of licensing authority over tax return preparers because the fee does not confer a “service or thing of value.”
The trial court determined that the IRS can require the exclusive use of a PTIN because it aids in the identification and oversight of preparers and their administration. However, the trial court held that the IRS cannot impose user fees for PTINs. The trial court determined that PTINs are not a “service or thing of value” because they are interrelated to testing and eligibility requirements and the accuracy of tax returns is unrelated to paying a PTIN fee. Steele v. United States, 260 F. Supp. 3d 52 (D. D.C. 2017). A prior federal court decision held that the IRS cannot regulate tax return preparers (Loving v. IRS, 742 F.3d 1013 (D.C. Cir. 2014), thus charging a fee for a PTIN would be the equivalent of imposing a regulatory licensing scheme which IRS cannot do. The trial court determined that prior caselaw holding that the IRS can charge a fee for a PTIN were issued before the Loving decision and are no longer good law.
On appeal, the appellate court vacated the trial court’s decision and remanded the case. The appellate court determined that the IRS does provide a service in exchange for the PTIN fee which the court defined as the service of providing preparers a PTIN and enabling preparers to place the PTIN on a return rather than their Social Security number and generating and maintaining a PTIN database. Thus, according to the appellate court, the PTIN fee was associated with an “identifiable group” rather than the public at large and the fee was justified on that ground under the Independent Offices Appropriations Act. The appellate court also believed the IRS claim that the PTIN fee improves tax compliance and administration. The appellate court remanded the case for further proceeding, including an assessment of whether the amount of the PTIN fee unreasonable exceeds the costs to the IRS to issue and maintain PTINs. Montrois, et al. v. United States, No. 17-5204, 2019 U.S. App. LEXIS 6260 (D.C. Cir. Mar. 1, 2019), vac’g,. and rem’g., Steele v. United States, 260 F. Supp. 3d 52 (D. D.C. 2017).
Sanders (and Democrat) transfer tax proposals. The Tax Cuts and Jobs Act (TCJA) increased the exemption equivalent of the federal estate and gift tax unified credit to (for 2019) $11.4 million. Beginning for deaths occurring and for gifts made in 2026, the $11.4 million drops to the pre-TCJA level ($5 million adjusted for inflation). That will catch more taxpayers. This is, of course, if the Congress doesn’t change the amount before 2026. S. 309, recently filed in the Senate by Presidential candidate Bernie Sanders provides insight as to what the tax rules impacting estate and business planning would look like if he (or probably any other Democrat candidate for that matter) were ever to win the White House and have a compliant Congress. The bill drops the unified credit exemption to $3.5 million and raises the maximum tax rate to 77 percent (up from the present 40 percent. It would also eliminate entity valuation discounts with respect to entity assets that aren’t business assets, and impose a 10-year minimum term for grantor retained annuity trusts. In addition, the bill would require the inclusion of a grantor trust in the estate of the owner and would limit the generation-skipping transfer tax exemption to a 50-year term. The present interest gift tax exclusion would also be reduced from its present level of $15,000.
These are just a snippet of the many developments in agricultural taxation and law recently. Of course, you can find more of these developments on the annotation pages of my website – www.washburnlaw.edu/waltr. I also use Twitter to convey education information. If you have a twitter account, you can follow me at @WashburnWaltr. On my website you will also find my CPE calendar. My national travels for the year start in earnest later this week with a presentation in Milwaukee. Later this month finds me in Wyoming. Also, forthcoming soon is the agenda and registration information for the ag law and tax seminar in Steamboat Springs, Colorado on August 12-14. Hope to see you at an event this year.
On Wednesday, I resume my perusal of the rental real estate exception of the passive loss rules. I get a break on the teaching side of things this week – it’s Spring Break week at both the law school and at Kansas State University.
Wednesday, February 13, 2019
Farm financial distress remains a big issue in the ag sector at the present time. There has been an uptick in farm and ranch bankruptcy filings over the past few years. This makes bankruptcy law, unfortunately, important to farmers and their legal counsel.
One of the particular rules of bankruptcy concerns the dischargeability of debts. What debts can be erased? What debts cannot? Does a debtor’s conduct during the bankruptcy process matter when it comes to debt discharge?
Bankruptcy debt discharge rules – that’s the topic of today’s post.
Basic Principles of Bankruptcy
The U.S. bankruptcy system is governed by two objectives - (1) a “fresh start” for poor but honest debtors who can obtain a discharge for some (but not all) debts; and (2) a policy of fairness for the unsecured creditors. The bankruptcy process attempts to provide secured creditors (in most instances) with the value of their collateral, and provides a procedure for unsecured creditors to share in the debtor’s assets on a basis of fairness and equality.
A major feature of bankruptcy in the United States, as noted above, is discharge of indebtedness. This makes possible the “fresh start” for individual debtors. While the basic rule is that only debts arising before bankruptcy filing are dischargeable, not all debts can discharged.
Debts Ineligible for Discharge
Categories. Several categories of debts are not eligible for discharge:
- Taxes entitled to a preference (normally those within the last three years), for which a return was not filed or was filed late, or for which a fraudulent return was filed or which the debtor tried to evade, are not dischargeable. Penalties on non-dischargeable taxes are likewise not dischargeable. See, e.g., In re Zuhone, 88 F.3d 469 (7th Cir. 1996).
- A federal income tax lien against exempt property is not discharged in bankruptcy although the debt for the taxes, penalties and interest secured by the lien may be discharged in bankruptcy. The exempt property may be subject to foreclosure and sale to pay the tax lien.
- Debt incurred to pay state and local taxes is not discharged.
- Fines, penalties and forfeitures payable to a governmental unit that are not compensation for pecuniary loss are not dischargeable, nor is debt incurred to pay fines and taxes.
- Student loans that are insured, guaranteed or funded by a government unit, for-profit entity and non-governmental entity unless the loan was “due and payable” more than five years before the filing of bankruptcy are ineligible for discharge.
- Claims neither listed nor scheduled by the debtor in time to permit the creditor to file a timely proof of claim cannot be discharged.
- Alimony and child support is not dischargeable.
- Nonsupport obligations incurred from divorce or separation is not dischargeable.
- Claims based on fraud or defalcation while the debtor was acting in a fiduciary capacity or based on embezzlement or larceny are not eligible for discharge.
- Claims based on willful or malicious injury are not dischargeable. For example, in In re Cantrell, 208 B.R. 498 (B.A.P. 10th Cir. 1997), the debtor's loan agreement required a bank’s prior consent for the sale of secured cattle and that payment for the cattle be by check made out jointly to the debtor and the bank. The debtor sold much of cattle herd without remitting the sale proceeds to the bank. This left much of the loan unpaid and unsecured at the time of bankruptcy filing. The court held that the remaining debt was not dischargeable.
- Debts that were (or could have been) listed in a prior bankruptcy proceeding and were not discharged in the earlier proceeding because of the debtor’s acts or conduct are not eligible for discharge.
- Claims owed to a single creditor aggregating more than $600 for luxury goods and services incurred by an individual on or within 90 days of filing the bankruptcy petition cannot be discharged.
- Cash advances aggregating more than $875 that are consumer credit under an open-end credit plan if incurred on or within 70 days before filing the bankruptcy petition (per line of credit) are not in line for discharge.
- Claims arising from a judgment entered against the debtor for operating a motor vehicle, vessels or aircraft while legally intoxicated are not eligible for discharge.
- Homeowner association, condominium and cooperative fees are not discharged.
- Debt associated with pension and/or profit-sharing plans is not dischargeable.
Fraud. A debtor in financial distress must be very careful not to engage in fraudulent conduct. In general, a debtor is denied discharge for fraudulent conduct within one year of filing the bankruptcy petition or during the bankruptcy case or for failure to explain a loss of assets or preserve sufficient recorded information concerning the debtor's financial condition or business transactions. In general, a creditor doesn’t have to prove that its reliance on the debtor’s misrepresentation was reasonable. The creditor need only show that its reliance was justifiable. See, e.g., In re Eccles, 407 B.R. 338 (B.A.P. 8th Cir. 2009).
Relatedly, claims based on the receipt of money, property or services by fraud, false pretenses or a materially false written statement concerning the debtor's (or an insider’s) financial condition intentionally made to deceive creditors are not in line for discharge. 11 U.S.C. §523(a)(2)(B). This point was illustrated recently by a bankruptcy case from Tennessee involving a farmer.
In In re Blankenship, No. 16-10839, 2019 Bankr. LEXIS 7 (Bankr. W.D. Tenn. Jan. 2, 2019), the defendant filed Chapter 11 bankruptcy in 2016. A month after filing, the defendant sought permission to obtain post-petition financing from the plaintiff (an ag lender) in the form of a crop loan to produce and harvest the debtor’s 2016 soybean crop. To obtain the crop loan, the defendant completed a “Crop Loan Application,” and submitted a “Farm List” to the plaintiff. The paperwork listed the acreage and yearly rent prices for each parcel of land the defendant planned on farming during that year.
The total acreage listed in the paperwork was well over 8,000 acres. Based on the documentation, the plaintiff approved and made a $1,949,880 crop loan to the defendant. In 2017, the defendant converted the Chapter 11 case to a Chapter 7 case and subsequently defaulted on the crop loan, at a time when the outstanding balance was $355,012. The plaintiff sued, claiming that outstanding balance was non-dischargeable under 11 U.S.C. §523(a)(2)(B). As noted above, under that provision, a creditor seeking to have debt excepted from discharge must establish that the debtor, with intent to deceive, used a materially false written statement to obtain a loan from the creditor and that the creditor reasonably relied on the statement to loan funds to the debtor.
The bankruptcy court determined that the Crop Loan Application and the Farm List constituted a written statement, and the fact that the Farm List was not attached to the Crop Loan Application was immaterial. It was more than simply a projection of the acres to be farmed in 2016 - it was a concrete representation of the debtor’s need for $1.9 million. While the documentation indicated that the debtor planned to farm about 8,000 acres, the debtor actually farmed about 5,000 acres and had profit of approximately $1.5 million less than projected in the documentation. Consequently, the bankruptcy court regarded the projected acreage and profit numbers as “substantially untruthful” and “materially false.” The bankruptcy court determined that the there was nothing in the documentation that would have alerted the creditor to the falsity of the information provided, and that the creditor reasonably relied on the information to loan the $1.9 million – an amount necessary for the debtor to plant 8,000 acres. The bankruptcy court also concluded that the debtor had intent to deceive via the false documentation based on the totality of the circumstances including the fact that the debtor had attested that the Farm List was an accurate representation of the amount of land they were going to farm. The bankruptcy court pointed out that the debtor knew that the amount of land actually farmed in the prior year was only 5,200 acres. The bankruptcy court found it inconceivable that the defendant anticipated being able to increase row crop production by almost 50 percent from the previous year based on leasing additional land, while being in an active bankruptcy case. Consequently, the remaining balance of the loan was not dischargeable.
There is no doubt that times are tough in agriculture. When finances get strained, it can take an emotional toll on the parties involved. Even the temptation to engage in conduct that could be construed as fraudulent should be avoided. Legal, financial and tax counsel should be consulted and allowed to assist throughout the painful process of debt adjustment and, perhaps, reorganization of the farming or ranching operation for long-term success. In the Tennessee bankruptcy case discussed above, the debtor was not represented by legal counsel. That was a big mistake.
Monday, December 31, 2018
2018 was a big year for developments in law and tax that impact farmers, ranchers, agribusinesses and the professionals that provide professional services to them. It was also a big year in other key areas which are important to agricultural production and the provision of food and energy to the public. For example, carbon emissions in the U.S. fell to the lowest point since WWII while they rose in the European Union. Poverty in the U.S. dropped to the lowest point in the past decade, and the unemployment rate became the lowest since 1969 with some sectors reporting the lowest unemployment rate ever. The Tax Cuts and Jobs Act (TCJA) doubles the standard deduction in 2018 compared to 2017, which will result additional persons having no federal income tax liability and other taxpayers (those without a Schedule C or F business, in particular) having a simplified return. Wages continued to rise through 2018, increasing over three percent during the third quarter of 2018. This all bodes well for the ability of more people to buy food products and, in turn, increase demand for agricultural crop and livestock products. That’s good news to U.S. agriculture after another difficult year for many commodity prices.
On the worldwide front, China made trade concessions and pledged to eliminate its “Made in China 2025” program that was intended to put China in a position of dominating world economic production. The North-Korea/South Korea relationship also appears to be improving, and during 2018 the U.S. became a net exporter of oil for the first time since WWII. While trade issues with China remain, they did appear to improve as 2018 progressed, and the USDA issued market facilitation payments (yes, they are taxed in the year of receipt and, no, they are not deferable as is crop insurance) to producers to provide relief from commodity price drops as a result of the tariff battle.
So, on an economic and policy front, 2019 appears to bode well for agriculture. But, looking back on 2018, of the many ag law and tax developments of 2018, which ones were important to the ag sector but just not quite of big enough significance nationally to make the “Top Ten”? The almost Top Ten – that’s the topic of today’s post.
The “Almost Top Ten” - No Particular Order
Syngenta litigation settles. Of importance to many corn farmers, during 2018 the class action litigation that had been filed a few years ago against Syngenta settled. The litigation generally related to Syngenta's commercialization of genetically-modified corn seed products known as Viptera and Duracade (containing the trait MIR 162) without approval of such corn by China, an export market. The farmer plaintiffs (corn producers), who did not use Syngenta's products, claimed that Syngenta's commercialization of its products caused the genetically-modified corn to be commingled throughout the corn supply in the United States; that China rejected imports of all corn from the United States because of the presence of MIR 162; that the rejection caused corn prices to drop in the United States; and that corn farmers were harmed by that market effect. In April of 2018, the Kansas federal judge handling the multi-district litigation preliminarily approved a nationwide settlement of claims for farmers, grain elevators and ethanol plants. The proposed settlement involved Syngenta paying $1.5 billion to the class. The class included, in addition to corn farmers selling corn between September of 2013 and April of 2018, grain elevators and ethanol plants that met certain definition requirements. Those not opting out of the class at that point are barred from filing any future claims against Syngenta arising from the presence of the MIR 162 trait in the corn supply. Parties opting out of the class can't receive any settlement proceeds, but can still file private actions against Syngenta. Parties remaining in the class had to file claim forms by October of 2018. The court approved the settlement in December of 2018, and payments to the class members could begin as early as April of 2019.
Checkoff programs. In 2018, legal challenges to ag “checkoff” programs continued. In 2017, a federal court in Montana enjoined the Montana Beef Checkoff. In that case, Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, No. CV-16-41-GF-BMM, 2017 U.S. Dist. LEXIS 95861 (D. Mont. Jun. 21, 2017), the plaintiff claimed that the federal law requiring funding of the Montana Beef Council (MBC) via funds from the federal beef checkoff was unconstitutional. The Beef Checkoff imposes a $1.00/head fee at the time cattle are sold. The money generated funds promotional campaigns and research, and state beef councils can collect the funds and retain half of the collected amount with the balance going to the Cattleman’s Beef Production and Research Board (Beef Board). But, a producer can direct that all of the producer’s assessment go to the Beef Board. The plaintiff claimed that the use of the collected funds violated their First Amendment rights by forcing them to pay for “speech” with which they did not agree. The defendant (USDA) motioned to dismiss, but the Magistrate Judge denied the motion. The court determined that the plaintiffs had standing, and that the U.S. Supreme Court had held in prior cases that forcing an individual to fund a private message that they did not agree with violated the First Amendment. Any legal effect of an existing “opt-out” provision was not evaluated. The court also rejected the defendant’s claim that the case should be delayed until federal regulations with respect to the opt-out provision was finalized because the defendant was needlessly dragging its heels on developing those rules and had no timeline for finalization. The court entered a preliminary injunction barring the MBC from spending funds received from the checkoff. On further review by the federal trial court, the court adopted the magistrate judge’s decision in full. The trial court determined that the plaintiff had standing on the basis that the plaintiff would have a viable First Amendment claim if the Montana Beef Council’s advertising involves private speech, and the plaintiff did not have the ability to influence the advertising of the Montana Beef Council. The trial court rejected the defendant’s motion to dismiss for failure to state a claim on the basis that the court could not conclude, as a matter of law, that the Montana Beef Council’s advertisements qualify as government speech. The trial court also determined that the plaintiff satisfied its burden to show that a preliminary injunction would be appropriate.
The USDA appealed the trial court’s decision, but the U.S. Court of Appeals for the Ninth Circuit affirmed the trial court in 2018. Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. Perdue, 718 Fed. Appx. 541 (9th Cir. 2018). Later in 2018, as part of the 2018 Farm Bill debate, a provision was proposed that would have changed the structure of federal ag checkoff programs. It did not pass, but did receive forty percent favorable votes.
GIPSA rules withdrawn. In the fall of 2016, the USDA sent to the Office of Management and Budget (OMB) an interim final rule and two proposed regulations setting forth the agency’s interpretation of certain aspects of the Packers and Stockyards Act (PSA) involving the buying and selling of livestock and poultry. The proposals generated thousands of comments, with ag groups and producers split in their support. The proposals concern Section 202 of the PSA (7 U.S.C. §§ 192 (a) and (e)) which makes it unlawful for any packer who inspects livestock, meat products or livestock products to engage in or use any unfair, unjustly discriminatory or deceptive practice or device, or engage in any course of business or do any act for the purpose or with the effect of manipulating or controlling prices or creating a monopoly in the buying, selling or dealing any article in restraint of commerce. The “effect” language of the statute would seem to eliminate any requirement that the producer show that the packer acted with the intent to control or manipulate prices. However, the federal courts have largely interpreted the provision to require a plaintiff to show an anti-competitive effect in order to have an actionable claim.
The interim final rule and the two proposed regulations stemmed from 2010. In that year, the Obama administration’s USDA issued proposed regulations providing guidance on the handling of antitrust-related issues under the PSA. 75 Fed. Reg. No. 119, 75 FR 35338 (Jun. 22, 2010). Under the proposed regulations, "likelihood of competitive injury" was defined as "a reasonable basis to believe that a competitive injury is likely to occur in the market channel or marketplace.” It included, but was not limited to, situations in which a packer, swine contractor, or live poultry dealer raises rivals' costs, improperly forecloses competition in a large share of the market through exclusive dealing, restrains competition, or represents a misuse of market power to distort competition among other packers, swine contractors, or live poultry dealers. It also includes situations “in which a packer, swine contractor, or live poultry dealer wrongfully depresses prices paid to a producer or grower below market value, or impairs a producer's or grower's ability to compete with other producers or growers or to impair a producer's or grower's ability to receive the reasonably expected full economic value from a transaction in the market channel or marketplace." According to the proposed regulations, a “competitive injury” under the PSA occurs when conduct distorts competition in the market channel or marketplace. The scope of PSA §202(a) and (b) was stated to depend on the nature and circumstances of the challenged conduct. The proposed regulations specifically noted that a finding that a challenged act or practice adversely affects or is likely to affect competition is not necessary in all cases. The proposed regulations also specified that a PSA violation could occur without a finding of harm or likely harm to competition, contrary to numerous court opinions on the issue.
On April 11, 2017, the USDA announced that it was delaying the effective date of the interim final rule for 180 days, until October 19, 2017, with the due date for public comment set at June 12, 2017. However, on October 17, 2017, the USDA withdrew the interim rule. The withdrawal of the interim final rule and two proposed regulations was challenged in court. On December 21, 2018, the U.S. Court of Appeals for the Eighth Circuit denied review of the USDA decision. In Organization for Competitive Markets v. United States Department of Agriculture, No. 17-3723, 2018 U.S. App. LEXIS 36093 (8th Cir. Dec. 21, 2018), the court noted that the USDA had declined to withdraw the rule and regulations because the proposal would have generated protracted litigation, adopted vague and ambiguous terms, and potentially bar innovation and stimulate vertical integration in the livestock industry that would disincentivize market entrants. Those concerns, the court determined, were legitimate and substantive. The court also rejected the plaintiff’s argument that the court had to compel agency action. The matter, the court concluded, was not an extraordinary situation. Thus, the USDA did not unlawfully withhold action.
No ”clawback.” In a notice of proposed rulemaking, the U.S Treasury Department eliminated concerns about the imposition of an increase in federal estate tax for decedents dying in the future at a time when the unified credit applicable exclusion amount is lower than its present level and some (or all) of the higher exclusion amount had been previously used. The Treasury addressed four primary questions. On the question of whether pre-2018 gifts on which gift tax was paid will absorb some or all of the 2018-2025 increase in the applicable exclusion amount (and thereby decrease the amount of the credit available for offsetting gift taxes on 2018-2025 gifts), the Treasury indicated that it does not. As such, the Treasury indicated that no regulations were necessary to address the issue. Similarly, the Treasury said that pre-2018 gift taxes will not reduce the applicable exclusion amount for estates of decedents dying in years 2018-2025.
The Treasury also stated that federal gift tax on gifts made after 2025 will not be increased by inclusion in the tax computation a tax on gifts made between 2018 and 2015 that were sheltered from tax by the increased applicable exclusion amount under the TCJA. The Treasury concluded that this is the outcome under current law and needed no regulatory “fix.” As for gifts that are made between 2018-2025 that are sheltered by the applicable exclusion amount, the Treasury said that those amounts will not be subject to federal estate tax in estates of decedents dying in 2026 and later if the applicable exclusion amount is lower than the level it was at when the gifts were made. To accomplish this result, the Treasury will amend Treas. Reg. §20.2010-1 to allow for a basic exclusion amount at death that can be applied against the hypothetical gift tax portion of the estate tax computation that is equal to the higher of the otherwise applicable basic exclusion amount and the basic exclusion amount applied against prior gifts.
The Treasury stated that it had the authority to draft regulations governing these questions based on I.R.C. §2001(g)(2). The Treasury, in the Notice, did not address the generation-skipping tax exemption and its temporary increase under the TCJA through 2025 and whether there would be any adverse consequences from a possible small exemption post-2025. Written and electronic comments must be received by February 21, 2019. A public hearing on the proposed regulations is scheduled for March 13, 2019. IRS Notice of Proposed Rulemaking, REG-106706-18, 83 FR 59343 (Nov. 23, 2018).
These were significant developments in the ag law and tax arena in 2018, but just not quite big enough in terms of their impact sector-wide to make the “Top Ten” list. Wednesday’s post this week will examine the “bottom five” of the “Top Ten” developments for 2018.
December 31, 2018 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, November 9, 2018
Legal developments impacting rural landowners, producers and agribusinesses continue to occur. The same can be said for tax developments that impact practitioners and their client base. It’s a never-ending stream.
In today’s post, I examine just a few of the recent developments from the courts of relevance.
Debtor Can Convert Chapter 12 Case to Chapter 11
Can a Chapter 12 bankruptcy case be converted to Chapter 11? That was the issue in In re Cardwell, No. 17-50307-rlj12, 2018 Bankr. LEXIS 3089 (Bankr. N.D. Tex. Oct. 3, 2018). The debtor, an elderly widowed woman, owned three tracts of farmland that she leased out for farming purposes. The tracts served as collateral for loans taken out by her children and grandchildren. The debtor sued a bank and the spouse of a granddaughter for “improprieties on the loans and liens.” The debtor filed Chapter 12, but the bank moved to dismiss the case on the basis that the debtor was not a ‘family farmer.” The debtor then moved to convert the case to Chapter 11. The bank objected, claiming that a Chapter 12 case cannot be converted to a Chapter 11.
While the court noted that there is some authority for that proposition, the court also noted that there is no explicit statutory language that bars a Chapter 12 from being converted to a Chapter 11 and that the courts are split on the issue. Ultimately, the court concluded that 11 U.S.C. §1208(e) allowed for conversion if the proceeding was in good faith and conversion would not be inequitable or prejudicial to creditors. The court also noted that if it dismissed the debtor’s Chapter 12 case, the debtor could simply refile the matter as a Chapter 11 case. The court saw no point in requiring that procedural step as there was no explicit statutory language requiring dismissal and refiling. The court also noted that upon conversion the automatic stay would remain in place, and that the debtor would actually have a more difficult time getting her reorganization plan confirmed as part of a Chapter 11 case as compared to a Chapter 12 case.
Federal Law Preempts Kansas Train Roadway Blockage Law
Burlington Northern Santa Fe Railway (BNSF) operates trains through the town of Bazaar in Chase County, Kansas. At issue State of Kansas v. Burlington Northern Santa Fe Railway Company, No. 118,095, 2018 Kan. App. LEXIS 63 (Kan. Ct. App. Nov. 2, 2018), were two railroad crossings where the main line and the side tracks crossed county and town roads. The side track is used to change crews or let other trains by on the main line. Early one morning, the Chase County Sheriff received a call that a train was blocking both intersections. The Sheriff arrived on scene two hours later and spoke with a BNSF employee. This employee said that he was checking the train but did not state when the train would move. The Sheriff then called BNSF three times. The train remained stopped on both crossings for approximately four hours. The Sheriff issued two citations (one for each engine) under K.S.A. 66-273 for blocking the crossings for four hours and six minutes. K.S.A. 66-273 prohibits railroad companies and corporations operating a railroad in Kansas from allowing trains to stand upon any public roadway near any incorporated or unincorporated city or town in excess of 10 minutes at any one time without leaving an opening on the roadway of at least 30 feet in width. BNSF moved to dismiss the citation, but the trial court rejected the motion.
During the trial, many citizens presented evidence that they could not get to work that day, and a service technician could not reach a home that did not have hot water and was having heating problems. BNSF presented train logs for one of the engines. These logs showed that one engine was stopped in Bazaar for only 8 minutes to change crews and was not in Bazaar at 9:54 a.m. The Sheriff later conceded that he might have been mistaken about the numbers on the engines for the citations. There were no train logs for the other engine. BNSF also stated there could be other alternatives from blocking the crossings but uncoupling the middle of the train would be time consuming and unsafe.
The trial court ruled against BNSF and entered a fine of $4,200 plus court costs. On appeal, BNSF claimed that the Interstate Commerce Commission Termination Act (ICCTA) and Federal Railroad Safety Act (FRSA) preempted Kansas law, and that the evidence presented was not sufficient to prove a violation of Kansas law. The appellate court agreed, holding that the ICCTA, by its express terms contained in 49 U.S.C. 10501(b), preempted Kansas law. While the appellate court noted that the Kansas statute served an “admirable purpose,” it was too specific in that it applied only to railroad companies rather than the public at large. Also, the statute had more than a remote or incidental effect on railway transportation. As a result, the Kansas law infringed on the Surface Transportation Board’s exclusive jurisdiction to regulate the railways in the United States. The appellate court noted that the Surface Transportation Board was created by the ICCTA and given exclusive jurisdiction over the construction, acquisition, operation, abandonment, or discontinuance of railroad tracks and facilities. In addition, the appellate court noted that the Congress expressly stated that the remedies with respect to regulation of rail transportation set forth in the ICCTA are exclusive and preempt other remedies provided under federal or state law. The appellate court did not consider BNSF’s other arguments.
Groundwater Is Not a “Point Source” of Pollution Under the CWA
The defendant in Tennessee Clean Water Network v. Tennessee Valley Authority, No. 17-6155, 2018 U.S. App. LEXIS 27237 (6th Cir. Sept. 24, 2018), is a utility that burns coal to produce energy. It also produces coal ash as a byproduct. The coal ash is discharged into man-made ponds. The plaintiffs, environmental activist groups, claimed that the chemicals from the coal ash in the ponds leaked into surrounding groundwater where it was then carried to a nearby lake that was subject to regulation under the Clean Water Act (CWA). The plaintiffs claimed that the contamination of the lake without a discharge permit violated the CWA and the Resource Conservation and Recovery Act (RCRA).
The trial court had dismissed the RCRA claim, but the appellate court reversed that determination and remanded the case on that issue. On the CWA claim, the trial court ruled as a matter of law that the CWA applies to discharges of pollutants from a point source through hydrologically connected groundwater to navigable waters where the connection is "direct, immediate, and can generally be traced." The trial court held that the defendant’s facility was a point source because it "channel[s] the flow of pollutants . . . by forming a discrete, unlined concentration of coal ash," and that the Complex is also a point source because it is "a series of discernible, confined, and discrete ponds that receive wastewater, treat that wastewater, and ultimately convey it to the Cumberland River." The trial court also determined that the defendant’s facility and the ponds were hydrologically connected to the Cumberland River by groundwater. As for the defendant’s facility, the trial court held that "[f]aced with an impoundment that has leaked in the past and no evidence of any reason that it would have stopped leaking, the Court has no choice but to conclude that the [defendant’s facility] has continued to and will continue to leak coal ash waste into the Cumberland River, through rainwater vertically penetrating the Site, groundwater laterally penetrating the Site, or both." The trial court determined that the physical properties of the terrain made the area “prone to the continued development of ever newer sinkholes or other karst features." Thus, based on the contaminants flowing from the ponds, the court found defendant to be in violation of the CWA. The trial court also determined that the leakage was in violation of the defendant “removed-substances” and “sanitary-sewer” overflow provisions. The trial court ordered the defendant to "fully excavate" the coal ash in the ponds (13.8 million cubic yards in total) and relocate it to a lined facility.
On further review, the appellate court reversed. The appellate court held that the CWA does not apply to point source pollution that reaches surface water by means of groundwater movement. The appellate court rejected the plaintiffs’ assertion that mere groundwater is equivalent to a discernable point source through which pollutants travel to a CWA-regulated body of water. The appellate court noted that, to constitute a “conveyance” of groundwater governed by the CWA, the conveyance must be discernible, confined and discrete. While groundwater may constitute a conveyance, the appellate court reasoned that it is neither discernible, confined, nor discrete. Rather, the court noted that groundwater is a “diffuse” medium that “travels in all directions, guided only by the general pull of gravity.” In addition, the appellate court noted that the CWA regulates only “the discharge of pollutants ‘to navigable waters from any point source.’” In so holding, the court rejected the holdings in Hawai’i Wildlife Fund v. County of Maui, 881 F.3d 754 (9th Cir. 2018) and Upstate Forever, et al. v. Kinder Morgan Energy Partners, LP, et al., 887 F.3d 637 (4th Cir. 2018).
Cash Gifts to Pastor Constituted Taxable Income
In Felton v. Comr., T.C. Memo. 2018-168, the petitioner was the pastor of a church and the head of various church related ministries in the U.S. and abroad, got behind on his tax filings and IRS audited years 2008 and 2009. While most issues were resolved, the IRS took the position that cash and checks that parishioners put in blue envelopes were taxable income to the petitioner rather than gifts. The amounts the petitioner received in blue envelopes were $258,001 in 2008 and $234,826 in 2009. There was no question that the church was run in a businesslike manner. While the church board served in a mere advisory role, the petitioner did follow church bylaws and never overrode the board on business matters. As for contributions to the church, donated funds were allocated based on an envelope system with white envelopes used for tithes and offerings for the church. The white envelopes also included a line marked “pastoral” which would be given directly to the petitioner. The amounts in white envelopes were tracked and annual giving statements provided for those amounts.
The petitioner reported as income the amounts provided in white envelopes that were designated as “pastoral.” Amount in gold envelopes were used for special programs and retreats, and were included in a donor’s annual giving statement. Amounts in blue envelopes (which were given out when asked for) were treated as pastoral gifts and the amounts given in blue envelopes were not included in the donor’s annual giving statement and the donor did not receive any tax deduction for the gifted amounts. Likewise, the petitioner did not include the amounts given in blue envelopes in income. The IRS took the position that the amounts given by means of the blue envelopes were taxable income to the petitioner. The Tax Court agreed, noting that the petitioner was not retiring or disabled. The court also noted that the petitioner received a non-taxable parsonage allowance of $78,000 and received only $40,000 in white envelope donations. The court also upheld the imposition of a penalty because the petitioner, who self-prepared his returns, made no attempt to determine the proper tax reporting of the donations.
The developments keep rolling in. There will be more to write about in a subsequent post.
Monday, November 5, 2018
During the farm debt crisis of the 1980s, Chapter 12 bankruptcy was enacted to provide a means for “family farmers” to receive debt relief in the context of more favorable bankruptcy reorganization rules than would otherwise apply. Now that the farm sector has been going through several down economic years, the use of Chapter 12 has increased again.
Requirements must be satisfied to qualify for Chapter 12 relief. Once that occurs, the farmer- debtor can take advantage of numerous favorable provisions. One of those is the “tools-of-the-trade” exemption. A farm debtor can keep assets exempt from creditors that are needed continue the farming operation.
The tools-of-the-trade exemption in the context of Chapter 12 bankruptcy. That’s the topic of today’s post.
Chapter 12 Eligibility
To be eligible for Chapter 12 bankruptcy, a debtor must be a “family farmer” or a “family fisherman” with “regular annual income.” The term “farming operation” includes farming, tillage of the soil, dairy farming, ranching, production or raising of crops, poultry, or livestock, and production of poultry or livestock products in an unmanufactured state. 11 U.S.C. §101(21). A “family farmer” is defined as an individual or individual and spouse who earned more than 50 percent of their gross income from farming either for the taxable year preceding the year of filing or during the second and third tax years preceding filing, and whose aggregate debts do not exceed $4,153,150 (as of April, 2016). In addition, more than 80 percent of the debt must be debt from a farming operation that the debtor owns or operates.
The U.S. legal system has a long history of allowing debtors to hold specified items of property exempt from creditors (unless the exemption is waived). This, in effect, gives debtors a “head start” in becoming reestablished after suffering economic reverses. Typically, one of the largest and most important exemptions is for the homestead.
Initially even the exempt property is included in the debtor's estate in bankruptcy but the exempt assets are soon returned to the debtor. Only nonexempt property is used to pay the creditors.
In agricultural bankruptcies, one of the more important exemptions listed above is for “tools-of-the-trade.” 11 U.S.C. §522(f) permits the avoidance of non-possessory, non-PMSIs in “implements, professional books, or tools of the trade of the debtor or the trade of a dependent of the debtor” when the security interest impairs an exemption to which the debtor would have been entitled but for the security interest.
Conceivably, many farm assets could qualify as a tool-of-the-trade. For example, some courts have held that livestock held for breeding purposes (In re Heape, 886 F.2d 280 (10th Cir. 1989). large items of farm equipment (In re LaFond, 791 F.2d 623 (8th Cir. 1986), and draft horses (In re Stewart, 110 B.R. 11 (Bankr. D. Idaho 1989) are tools of the debtor's trade. Generally, courts focus on the functional use of an asset in the debtor's business in determining whether the asset is a tool of the debtor's trade.
The debtor must be actively engaged in a farming business to exempt farm assets as tools of the trade. For example, in In re Johnson, 230 B.R. 608 (Bankr. 8th Cir. 1999), the debtor owned a 73-acre rural residence, but had not farmed in past two years and was employed full-time off of the farm. The court held that the farm machinery was not tools of debtor’s trade because the debtor not actively engaged in farming. In any event, to be considered as an exempt tool of the debtor’s trade, the debtor must have a reasonable prospect of continuing in or returning to the farming business. For instance, in In re Henke, 294 B.R. 105 (Bankr. D. N.D. 2003), farm equipment was not exempt as a tool of the trade where the debtor had no reasonable prospect of returning to the farming business.
A recent Kansas Chapter 12 case is a good illustration of how courts analyze the applicability of the tools-of-the-trade exemption. In In re Rudolph, No. 18-40423, 2018 Bankr. LEXIS 3328 (Bankr. D. Kan. Oct. 30, 2018), the debtors (a married couple) significantly reduced the scale of their farming operation before filing Chapter 12. Upon filing Chapter 12, the debtors claimed the Kansas exemption for tools of the trade contained in Kan. Stat. Ann. §60-2304(e). The debtors’ lender (a bank) objected to the exemption on the basis that the debtors had so significantly reduced their farming operations that they were no longer “farmers” as their primary occupation, or that the debtors were only entitled to a percentage of the exemption.
The husband debtor had farmed since 1948 and his wife began working exclusively on the farm in 2007. The bank agreed that if the husband was entitled to the exemption his wife was also. The debtors’ homestead consisted of 17 acres, and the debtors used a portion of it to raise a forage crop for livestock and another portion was used as a hay meadow for livestock grazing. The husband debtor was also the beneficiary of three tracts of land held in trusts established by his parents consisting of almost 500 acres that were a mixture of row crop, hay meadow, pasture and CRP ground. The debtor, via the trust instrument, was responsible for managing those properties.
The bank financed the debtors’ farming operations and when the loans matured in late 2017 the bank sought payment. The debtors’ proposed to pay the loan by retiring from row crop farming and generating funds from the sale of certain farm equipment. At the time of filing, the debtors were no longer row crop farming but were continuing to care for cattle on the trust properties and were managing the CRP acres. Some of the trust properties were rented out, with the debtors maintaining fences and providing nutrients and care for the tenants’ cattle. The debtors also planted fall crops to feed to their own cattle and horses. The debtors inspected the trust lands twice weekly and controlled weeds on the CRP ground and maintained brush control. Their proposed reorganization plan estimated their monthly net farm income as $978.98 and they projected their annual gross farm income to be $21,364 with $20,800 consisting of farm rental income. The debtors testified to the value of the items of personal property that they were claiming as tools of the trade, and the total claimed value did not exceed the statutorily allowed amount.
The court noted that the debtors retained only those farming assets that were necessary to the continuation of their reduced-scale farming operation and turned over other assets to the bank. The debtors also proposed to retain four non-exempt tractors by paying the bank their value in ten semi-annual installments, with interest. The court noted that eligibility for the exemption was to be determined as of the date of filing. As the court pointed out, that’s different than a debtor being eligible for Chapter 12 – which is based on debt and income in the year preceding filing (or the second and third years back). The court also pointed out that the only issues for consideration as to eligibility for the exemption was whether the debtors were engaged in the farming business, and whether the claimed exempt items were regularly and reasonably necessary in carrying on that business.
While the court pointed out that the debtors were no longer engaged in planting and harvesting crops, as of the date the Chapter 12 petition was filed, the court determined that the debtors were engaged in ranching and other farming activities such as cattle grazing, harvesting hay and planting forage crops to feed cattle and horses. The court noted that the debtors also maintained the farmland in the trusts and managed the 3-5 acres of CRP ground. The court specifically determined that while the debtors did not have most of their income come from farming, the tools of the trade exemption does not require that farming be the exclusive or sole means generating income. The court also concluded that the exemption does not require the tools to be used on land the debtor farms for himself (crop/livestock share leases are permissible as is managing CRP ground) or produce something for sale.
The court also rejected the bank’s argument that the debtors couldn’t claim the exemption because they had quit farming as of the time they filed for Chapter 12 as contrary to the evidence. The evidence showed that the debtors had at least temporarily retired from crop farming, but not from ranching and caring for agricultural land as indicated by the retention of some equipment essential to continuing the ranching and ag land maintenance activities. In addition, the debtors’ proposed budget that showed only social security benefits and retirement benefits along with land rent was consistent with the debtors’ testimony that they were reducing their farming activities. The court determined that the debtors were still engaged in the trade or business of farming as of the petition date and were entitled to claim the tools-of-the-trade exemption. However, the court determined that five of the claimed horses were not eligible for the exemption as nonessential to the continuation of the debtors’ farming activities. The court also stated that the bank’s objection to the valuation of the exempt assets would be determined in a separate proceeding unless the parties came to an agreement.
Presently, times are difficult for many agricultural producers. However, Chapter 12 bankruptcy has several very helpful provisions to ease the pain of restructuring the family farming business so that it can continue. The tools-of-the-trade exemption is one of those provisions that can be of assistance.
Thursday, October 18, 2018
For the Spring 2019 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 next spring’s online Ag Law course – that’s the topic of today’s post.
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 is available here:
You can also find information about the text for the course at the following link (including the Table of Contents and the Index):
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 January!
Checkout the postcard (401 KB PDF) containing more information about the course and instructor.
October 18, 2018 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, August 31, 2018
Economic and financial conditions remain tough in much of agriculture. Bankruptcy filings have seen an increase, and that includes the number of Chapter 12 filings. In a Chapter 12 the debtor must file a reorganization plan under which the debtor proposes a plan for paying off creditors. Plan payments generally must pass through the hands of the bankruptcy trustee. The trustee is compensated out of a portion of the plan payments.
But, what if a debtor proposes to make payments directly to the creditors? Doing so would bypass the trustee, and would also bypass the trustee’s fee. It would also mean that all of the payments made under the bankruptcy plan would go to the creditors instead of some of it syphoned off to pay the trustee.
That’s the focus of today’s post – whether a debtor in reorganization bankruptcy can make direct payments to creditors under the debtor’s reorganization plan.
The Reorganization Plan
A Chapter 12 debtor has an exclusive 90-day period after filing for Chapter 12 bankruptcy to file a plan for reorganization unless the court grants an extension. A court may grant additional time only if circumstances are present for which the debtor should not fairly be held accountable. 11 U.S.C. §1221. See e.g., In re Davis, No. CC-16-1390-KuLTa, 2017 Bankr. LEXIS 2169 (B.A.P. 9th Cir. Aug. 2, 2017). If the court determines that the debtor will be unable to make all payments as required by the plan, the court may require the debtor to modify the plan, convert the case to a Chapter 7, or request the court to dismiss the case. In other words, the plan must be feasible. It must also be proposed in good faith. Good faith can be viewed as practically synonymous the requirement that the plan be feasible. See, e.g., In re Lockard, 234 B.R. 484 (Bankr. W.D. Mo. 1999).
The Bankruptcy Trustee
Duties. A trustee is appointed in every Chapter 12 case. A Chapter 12 trustee’s duties are similar to those under Chapter 13. Specifically, a trustee under Chapter 12, is directed to:
* be accountable for all property received;
* ensure that the debtor performs in accordance with intention;
* object to the allowance of claims which would be improper;
* if advisable, oppose the discharge of the debtor;
* furnish requested information to a party in interest unless the court orders otherwise;
* make a final report;
* for cause and upon request, investigate the financial affairs of the debtor, the
operation of the debtor’s business and the desirability of the continuance of the business;
* participate in hearings concerning the value of property of the bankruptcy estate; and
* ensure that the debtor commences making timely payments required by confirmed plan.
In specifying the duties of trustees, Chapter 12 modifies the duty applicable to trustees under other chapters of the Bankruptcy Code to “investigate the financial affairs of the debtor.” Chapter 12 authorizes an investigative role for trustees, as noted above, “for cause and on request of a party in interest....” Thus, it would appear, in a routine case where there is no fraud, dishonesty, incompetence or gross mismanagement, the debtor should be allowed to reorganize without significant interference from the trustee.
Compensation. The compensation of trustees is not to exceed 10 percent of payments made under the debtor’s plan for the first $450,000 of payments. The fee is then not to exceed three percent of aggregate plan payments above that amount. 28 U.S.C. §586(e)(1). The trustee collects the fee from payments received under the plan. 28 U.S.C. § 586(e)(2). That’s an important point - the fee is based on all payments the debtor makes under the plan to the trustee rather than on amounts the trustee disperses to creditors. See, e.g., Pelofsky v. Wallace, 102 F.3d 350 (8th Cir. 1996).
Except as provided in the plan or in order confirming the plan, it is the trustee that is to make payments to creditors under the plan. Courts have generally recognized that payments on fully secured claims that the bankruptcy plan does not modify can be paid directly to the creditor, as can claims not impaired by the plan. However, for claims that are impaired, courts are divided as to whether a court may approve direct payments to creditors.
The issue of who actually disburses the debtor’s payments is important to the trustee because, as noted above, the trustee is entitled to a statutory commission only on funds actually received from the debtor pursuant to the reorganization plan. But, the bankruptcy code does not prevent a debtor from making payments directly to creditors.
So, how does a court decide whether a debtor can make payments directly to creditors and bypass the trustee (and the trustee fee)? Historically, the courts have utilized three approaches for deciding whether a debtor can make direct payment under a Chapter 12 reorganization plan (and thereby bypass the trustee fee). One approach utilizes a blanket rule barring the direct payment of impaired secured creditors. See, e.g., In re Fulkrod, 973 F.2d 801 (9th Cir. 1992). Another approach is, essentially, the direct opposite. Under this approach, debtors can pay secured creditors directly, regardless of their impaired status. See, e.g., In re Wagner, 36 F.3d 723 (8th Cir. 1994). But, the majority approach is to weigh a number of factors in the balance on a case-by-case basis to determine whether direct payments can be made. See, e.g., In re Beard, 45 F.3d 113 (6th Cir. 1995)
The issue came up again in a recent case.
In In re Speir, No. 16-11947-JDW, 2018 Bankr. LEXIS 2359 (Bankr. N.D. Miss. Aug. 8, 2018), the debtor filed Chapter 12 in mid-2016 and a reorganization plan later that year. The plan called for direct payments to the secured creditors but payments to the unsecured creditors would be made to the trustee for distribution. The trustee objected, but the court upheld the direct payments except as applied to one secured creditor based on the application of a 13-factor test. Those factors are:
- The debtor’s past history;
- The debtor’s business acumen;
- Whether the debtor has complied post-filing statutory and court-imposed duties;
- Whether the debtor is acting in good-faith;
- The debtor’s ability to achieve meaningful reorganization absent direct payments;
- How the reorganization plan treats each creditor to which a direct payment is proposed to be made;
- The consent, or non-consent, of the affected creditor to the proposed plan treatment;
- How sophisticated a creditor is, and whether the creditor has the ability and incentive, to monitor compliance;
- The ability of the trustee and the court to monitor future direct payments;
- The potential burden on the trustee;
- The possible effect on the trustee’s salary or funding of the U.S. Trustee system;
- The potential for abuse of the bankruptcy system; and
- The existence of other unique or special circumstances
In balancing the factors, the In re Speir court noted that each factor may be considered, but it is not necessary that equal weight be given to each factor or even to different claims in the same case. Ultimately, what the analysis came down to in In re Speir was a weighing of the necessary compensation for the Trustee against a feasible plan for the debtor. The court noted that the debtor had used the bankruptcy process to substantially modify one secured creditor’s claim and, as a result, had to pay that creditor’s claim through the Trustee. The other secured creditors, the court noted, remained mostly unaffected by the debtor’s bankruptcy and could be paid directly.
While times remain tough in agriculture for some ag producers, Chapter 12 bankruptcy was created specifically to assist farm debtors in distress. The ability to pay creditors directly and bypass the Trustee (and the Trustee’s fee) might be possible. For those in Chapter 12, the issue should be evaluated.