Monday, June 27, 2022

S Corporation Dissolution – Part 1

Overview

The S corporation as an entity choice for the operating part of a farming or ranching business has waned over the years in favor of the general partnership (for larger operations) or the limited liability company (LLC).  While it can provide self-employment tax savings, those savings may also be achieved by using a different entity form.  Also, an S corporation requires a lot of administrative “maintenance” that some might find too cumbersome.  But, an S corporation does avoid the corporate level tax as a “flow-through” entity and is generally easy to switch to a different entity form (depending on the facts). 

While an S corporation might be an acceptable entity choice for professional service businesses such as law firms and accounting firms, it tends not to work as well as the operating entity for a farm or ranch.  The S corporation can also present some tricky issues upon liquidation.

Part one of a two-part series – tax (and income tax basis) issues upon liquidation of an S corporation.  It’s the topic of today’s post. 

For farm businesses large enough to qualify for more than one government farm program payment limit, a partnership will allow qualification.  An S corporation will be limited to a single payment limit. Another drawback of the S corporation is the adverse impact upon death of a shareholder.  That adverse impact is shown in the fact that the heirs of the deceased shareholder do not get the benefit of a step-up in basis in the underlying corporate assets to fair market value as of the date of the shareholder’s death.  Unlike a partnership where the heirs receive a full income tax basis increase for all of the underlying partnership assets, an heir of an S corporation shareholder only receives a basis increase in the corporate stock equal to the fair market value of the S corporation at death. 

Shareholder Death and Corporate Liquidation

Upon the death of an S corporation shareholder, the decedent’s stock ownership interest receives a step-up in basis to fair market value.  This basis adjustment coupled with the basis increase that results from gain recognition inside the corporation upon liquidation of corporate assets (e.g. sale/distribution of assets, real estate, etc.) and the pass-through of the taxation of this gain to the shareholder (on Schedule K-1), results in only one level of taxation being incurred on liquidation, and that is at the shareholder level. 

Since stock basis has been increased by death and pass-through of income, no gain recognition results when cash or property is distributed to the decedent’s estate/heirs (in exchange for stock) to complete the liquidation, since the pass-through gain (Schedule K-1) to the estate/heirs will be offset by a matching loss from liquidation of the stock.

Property Distributions

Distributions of property (other than cash) are treated as though the corporation sold the property to the shareholder for its fair market value, pursuant to I.R.C. §311(b).  The corporation recognizes gain to the extent the property’s fair market value exceeds its adjusted basis.  When appreciated property is distributed to an “S” corporate shareholder in exchange for stock, the gain recognized at the corporate level passes through to all shareholders (via Schedule K-1) based on their percentage ownership in the corporation. 

If the “S” corporation only had one shareholder whose interest is liquidated at death, gain recognition does not cause taxation problems due to a matching loss offset resulting from the stock basis adjustments discussed above.  In other words, when the S corporation recognizes table gain, that gain increases the estate’s basis in the stock in an amount equal to the taxable gain that the S corporation recognizes.  This taxable gain is reported to the estate on the corporation’s final Schedule K-1 (Form 1120S).  The estate’s tax basis in its S corporation stock is increased to the fair market value of the S corporation’s stock upon the shareholder’s death and is further increased as a result of the deemed sale of the S corporation stock upon liquidation.  Simultaneously, the estate recognizes a taxable loss equal to the gain reported to the estate on the corporation’s final Schedule K-1.  The loss on the deemed sale of the S corporation stock in the liquidation is reported on the estate’s or heir’s Schedule D (Form 1040 or Form 1041).  Typically, the S corporation gain on the Schedule K-1 (Form 1120S) reported on Schedule E (Form 1040 or Form 1041) and the loss on the Schedule D will net out with no tax due by the estate or the heirs for the S corporation gain on liquidation. 

Caution.  In some instances, a farming S corporation may have one spouse as a shareholder and own ordinary income assets such as grain and equipment.  Upon the shareholder’s death with the corporate stock passing to the surviving spouse, the sale of those assets by the surviving spouse will trigger ordinary income to the surviving spouse that will be taxed at the highest rate.  If the surviving spouse then liquidates the S corporation, a capital loss will be triggered in a like amount that will be reported at $3,000 per year (or offset against other capital gains). 

Note.  The business will now have a new step-up in basis in all of its asset which the heirs can contribute tax-free to a new partnership. 

However, if the “S” corporation has more than one shareholder, a distribution of property to a single shareholder (deceased or otherwise) in liquidation of their stock interest will result in a taxation event for all corporate shareholders.

Example:  Assume that Farm Corp. has four equal shareholders.  Mary, a shareholder who owns 25 percent of the S corporation’s stock dies.  The corporation distributes farm real estate to Mary’s estate in liquidation of her stock interest.  Mary’s estate would report 25 percent of any gain at distribution and would be able to offset this taxable gain through a matching capital loss created by the liquidation of her stock in Farm Corp.  Unfortunately, the other shareholders would be responsible for paying tax on the remaining 75 percent of any gain.

Note:  An alternative to avoid this taxation problem when there are multiple shareholders in an S corporation is to simply have the remaining shareholders purchase the stock of the deceased shareholder.  Implementing a corporate buy-sell agreement among the shareholders might be advantageous to accomplish the desired result.

A shareholder’s income tax basis in distributed property distributed by the corporation is the property’s fair market value at the date of distribution.  But the distributee shareholder’s holding period begins when the shareholder actually or constructively receives the property, because the distribution is treated as if the property were sold to the shareholder at its fair market value on that date.  Since the shareholder’s basis in the property is its fair market value (rather than a carryover of the corporation’s basis), the corporation’s holding period does not tack on to the shareholder’s holding period.  Thus, the redeeming shareholder would need to hold distributed property for one year after distribution prior to sale to achieve capital gain income tax treatment on a subsequent sale.

Conclusion

In Part Two, I will take a look at some alternatives for avoiding the negative tax consequences associated with liquidating an S corporation.

June 27, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Monday, June 6, 2022

Wisconsin Seminar and…ERP (not Wyatt) and ELRP

Overview

Next week is the first of two summer ag tax and estate/business planning conferences that Washburn Law School is putting on.  Next week’s event on June 13 and 14 will be at the Chula Vista Resort, near the Wisconsin Dells.  One of the matters addressed on Day 1 will be issues that have arisen concerning the USDA’s Emergency Relief Program (ERP).  I have received numerous questions over the past few weeks concerning the program and we will be addressing them at the conference.

Issues with the ERP – it’s the topic of today’s post.

In General

I won’t go into too much detail about the ERP here because Paul Neiffer and I will do that at the Wisconsin conference.  What follows are comments that Paul and I have been providing to those raising questions of us in recent days.  Paul has also recently blogged on the issue and with today’s post I will largely summarize and reiterate what he has commented on for the readers of this blog.  In addition, there are additional meetings occurring in D.C. this week with IRS which will hopefully result in greater clarification on some presently unclear issues (not covered in this post).  If there are additional clarifications, we will discuss those at next week’s event in Wisconsin. 

The Extending Government Funding and Delivering Emergency Assistance Act (P.L. 117-43) (Act) was signed into law on September 30, 2021.  The Act includes $10 billion for farmers impacted by weather disasters during calendar years 2020 and 2021.  $750 million is to be directed to provide assistance to livestock producers for losses incurred due to drought or wildfires in calendar year 2021 (the Emergency Livestock Relief Program – (ELRP)).

Livestock provisions. 

To receive a Phase 1 payment, a livestock producer must have suffered grazing losses in a county rated by the U.S. Drought Monitor as having a severe drought) for eight consecutive weeks or at least extreme drought during the 2021 calendar year been approved for the 2021 Livestock Forage Relief Program (LFP). Those who would have normally grazed on federal but couldn’t be due to drought are eligible for a Phase 1 payment if they were approved for a 2021 LFP.  Various FSA Forms will need to be submitted. 

ELRP Payment Calculation – Phase One

Payments are based on livestock inventories and drought-affected forage acreage or restricted animal units and grazing days due to wildfire reported on Form 2021 CCC-853.  A payment will equal the producer’s gross 2021 LFP calculated payment multiplied by 75%, and will be subject to the $125,000 payment limitation. 

Crop insurance (or NAP) requirement.  In late 2021, the USDA provided some guidance to producers impacted by various weather-related events.  The former Wildfire and Hurricane Indemnity Program (WHIP+) was retooled and renamed as the ERP.  ERP will have two payments – two phases.  Phase 1 is presently underway, and Phase 2 may not happen until 2023.  ERP payments may be made to a producer with a crop eligible for crop insurance or noninsurance crop disaster assistance (NAP) that is subject to a qualifying disaster (which is defined broadly) and received a payment.  Droughts (a type of qualifying disaster) are rated in accordance with the U.S. Drought Monitor, where the qualifying counties can be found.

To reiterate, an ERP payment will not be made to any producer that didn’t receive a crop insurance or NAP payment in 2020 or 2021.  Because of this requirement, crop insurance premiums that an ERP recipient has paid will be reimbursed by recalculating the ERP payment based on the ERP payment rate of 85 percent and then backing out the crop insurance payment based on coverage level.     

In addition, the ERP requires that the producer receiving a payment obtain either NAP or crop insurance for the next crop years.  Also, a producer that received prevented planting payments can qualify for Phase 1 payments based on elected coverage. 

Note:  ERP payments are for damages occurring in 2020 and 2021 – so they are not deferable. 

Computation of payment and limits.  Once a producer submits their data to the FSA, an ERP application will be sent out for the producer to verify.  Applications started going out to producers in late May.  An ERP payment replaces the producer’s elected crop insurance coverage.  It’s based on a percentage with the total indemnity paid using the recalculated ERP percentage with any crop insurance or NAP payment subtracted. 

The ERP payment limit is $125,000 for specialty crops.  For all other crops, its $125,000 combined.  But, for an applicant with average adjusted gross income (AGI) (based on the immediate three prior years but skipping the first year back) that is comprised of more than 75 percent from farming activities, the normally applicable $900,000 AGI limit is dropped, and the payment limit goes to $900,000 for specialty crops and $250,000 for all other crops.  There is separate payment limit for each of 2020 and 2021. 

Note:  If the three-year computation of average AGI shows a loss, the enhanced payment limit is not available even if more than 75 percent of AGI is from farming activities.  In addition, the three-year computation is simply the applicant’s net income from farming compared with all of the applicant’s other sources of income as reported on the tax return. 

Definition of farm income.  Farm income for ERP purposes includes net Schedule F income; pass-through income from farming activities; farm equipment sale gains (if farm income exceeds two-thirds of overall AGI); wages from a farming entity; IC-DISC income from an entity that materially participates in farming (has a majority of gross receipts from farming).  Also counting as farm income for ERP purposes is income from packing, storing, processing, transporting and shedding of farm products. 

Certification.  To get the enhanced payment limit, a CPA or attorney must prepare a letter to be submitted with Form FSA-510 certifying that the applicant’s AGI is over the 75 percent threshold.  The FSA has a Form letter than can be used for this that is contained in its Handbook.  The FSA 6-PL, Apr. 29, 2022, Para. 489 discusses the 75 percent test and pages 8-73 through 8-74 is where the sample letter is located.  The “certification” may allow married farmers to eliminate the off-farm income of a spouse and make it possible to meet the 75 percent test if it otherwise would not be met.

 Conclusion

There are many finer details to the ERP as well as the ELRP that I haven’t covered in this post.  As I noted above, Paul Neiffer and I will be covering all of your questions at the conference next week in Wisconsin.  Also addressed at the conference will be a discussion of what's going on in the economy and U.S. and worldwide markets that are impacting agriculture.   If you haven’t registered, the conference is also broadcast live online and there’s still time to register.  Here’s the registration link:  https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html

June 6, 2022 in Business Planning, Income Tax, Regulatory Law | Permalink | Comments (0)

Sunday, May 22, 2022

2021 Bibliography

Overview

In the past, I have posted bibliographies of my articles by year to help readers researching the various ag tax and ag law topics that I write about.  The blog articles are piling up, with more 750 available for you to read and use for your research for clients (and yourself).  The citations contained in the articles are linked so that you can go directly to the source.  I trust that you find that feature helpful to save you time (and money) in representing clients.

Today, I provide you with the bibliography of my 2021 articles (by topic) as well as the links to the prior blogs containing past years.  Many thanks to my research assistant, Kennedy Mayo, for pulling this together for me.

Prior Years

Here are the links to the bibliographies from prior years:

Ag Law and Taxation 2020 Bibliography

https://lawprofessors.typepad.com/agriculturallaw/2021/01/ag-law-and-taxation-2020-bibliography.html

Ag Law and Taxation – 2019 Bibliography

https://lawprofessors.typepad.com/agriculturallaw/2021/02/ag-law-and-taxation-2019-bibliography.html

Ag Law and Taxation – 2018 Bibliography

https://lawprofessors.typepad.com/agriculturallaw/2021/03/ag-law-and-taxation-2018-bibliography.html

Ag Law and Taxation – 2017 Bibliography

https://lawprofessors.typepad.com/agriculturallaw/2021/04/ag-law-and-taxation-2017-bibliography.html

Ag Law and Taxation – 2016 Bibliography

https://lawprofessors.typepad.com/agriculturallaw/2021/04/ag-law-and-taxation-2016-bibliography.html

 

2021 Bibliography

Below are the links to my 2021 articles, by category:

BANKRUPTCY

The “Almost Tope Ten” Ag Law and Ag Tax Developments of 2020

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-almost-top-ten-ag-law-and-ag-tax-developments-of-2020.html

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

What’s an “Asset” For Purposes of a Debtor’s Insolvency Computation?

https://lawprofessors.typepad.com/agriculturallaw/2021/04/whats-an-asset-for-purposes-of-a-debtors-insolvency-computation.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

Is a Tax Refund Exempt in Bankruptcy?

https://lawprofessors.typepad.com/agriculturallaw/2021/06/is-a-tax-refund-exempt-in-bankruptcy.html

Ag Law and Tax Potpourri

https://lawprofessors.typepad.com/agriculturallaw/2021/06/ag-law-and-tax-potpourri.html

Montana Conference and Ag Law Summit (Nebraska)

https://lawprofessors.typepad.com/agriculturallaw/2021/07/montana-conference-and-ag-law-summit-nebraska.html

Farm Bankruptcy – “Stripping,” “Claw-Back” and the Tax Collecting Authorities (Update)

https://lawprofessors.typepad.com/agriculturallaw/2021/10/farm-bankruptcy-stripping-claw-back-and-the-tax-collecting-authorities-update.html

BUSINESS PLANNING

For Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

Recent Happenings in Ag Law and Ag Tax

https://lawprofessors.typepad.com/agriculturallaw/2021/01/recent-happenings-in-ag-law-and-ag-tax.html

C Corporate Tax Planning; Management Fees and Reasonable Compensation – A Roadmap of What Not to Do

https://lawprofessors.typepad.com/agriculturallaw/2021/02/c-corporate-tax-planning-management-fees-and-reasonable-compensation-a-roadmap-of-what-not-to-do.html

Will the Estate Tax Valuation Regulations Return?

https://lawprofessors.typepad.com/agriculturallaw/2021/02/will-the-estate-tax-valuation-regulations-return.html

June National Farm Tax and Estate/Business Planning Conference

https://lawprofessors.typepad.com/agriculturallaw/2021/03/june-national-farm-tax-and-estatebusiness-planning-conference.html

August National Farm Tax and Estate/Business Planning Conference

https://lawprofessors.typepad.com/agriculturallaw/2021/03/august-national-farm-tax-and-estatebusiness-planning-conference.html

C Corporation Compensation Issues

https://lawprofessors.typepad.com/agriculturallaw/2021/03/c-corporation-compensation-issues.html

Planning for Changes to the Federal Estate and Gift Tax System

https://lawprofessors.typepad.com/agriculturallaw/2021/05/planning-for-changes-to-the-federal-estate-and-gift-tax-system.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

The “Mis” STEP Act – What it Means To Your Estate and Income Tax Plan

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-mis-step-act-what-it-means-to-your-estate-and-income-tax-plan.html

Intergenerational Transfer of Family Businesses with Split-Dollar Life Insurance

https://lawprofessors.typepad.com/agriculturallaw/2021/05/intergenerational-transfer-of-family-businesses-with-split-dollar-life-insurance.html

Ohio Conference -June 7-8 (Ag Economics) What’s Going On in the Ag Economy?

https://lawprofessors.typepad.com/agriculturallaw/2021/05/ohio-conference-june-7-8-ag-economics-whats-going-on-in-the-ag-economy.html

Montana Conference and Ag Law Summit (Nebraska)

https://lawprofessors.typepad.com/agriculturallaw/2021/07/montana-conference-and-ag-law-summit-nebraska.html

Farm Valuation Issues

https://lawprofessors.typepad.com/agriculturallaw/2021/08/farm-valuation-issues.html

Ag Law Summit

https://lawprofessors.typepad.com/agriculturallaw/2021/08/ag-law-summit.html

The Illiquidity Problem of Farm and Ranch Estates

https://lawprofessors.typepad.com/agriculturallaw/2021/08/the-illiquidity-problem-of-farm-and-ranch-estates.html

When Does a Partnership Exist?

https://lawprofessors.typepad.com/agriculturallaw/2021/09/when-does-a-partnership-exist.html

Gifting Assets Pre-Death – Part One

https://lawprofessors.typepad.com/agriculturallaw/2021/09/gifting-assets-pre-death-part-one.html

Gifting Assets Pre-Death (Entity Interests) – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2021/09/gifting-assets-pre-death-entity-interests-part-two.html

Gifting Pre-Death (Partnership Interests) – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2021/09/gifting-pre-death-partnership-interests-part-three.html

The Future of Ag Tax Policy – Where Is It Headed?

https://lawprofessors.typepad.com/agriculturallaw/2021/09/the-future-of-ag-tax-policy-where-is-it-headed.html

Estate Planning to Protect Assets From Creditors – Dancing On the Line Between Legitimacy and Fraud

https://lawprofessors.typepad.com/agriculturallaw/2021/09/estate-planning-to-protect-assets-from-creditors-dancing-on-the-line-between-legitimacy-and-fraud.html

Fall 2021 Seminars

https://lawprofessors.typepad.com/agriculturallaw/2021/09/fall-2021-seminars.html

Corporate-Owned Life Insurance – Impact on Corporate Value and Shareholder’s Estate

https://lawprofessors.typepad.com/agriculturallaw/2021/10/corporate-owned-life-insurance-impact-on-corporate-value-and-shareholders-estate-.html

Caselaw Update

https://lawprofessors.typepad.com/agriculturallaw/2021/10/caselaw-update.html

S Corporations – Reasonable Compensation; Non-Wage Distributions and a Legislative Proposal

https://lawprofessors.typepad.com/agriculturallaw/2021/10/s-corporations-reasonable-compensation-non-wage-distributions-and-a-legislative-proposal.html

2022 Summer Conferences – Save the Date

https://lawprofessors.typepad.com/agriculturallaw/2021/12/2022-summer-conferences-save-the-date.html

CIVIL LIABILITIES

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-almost-top-ten-ag-law-and-ag-tax-developments-of-2020.html

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-almost-top-ten-ag-law-and-ag-tax-developments-of-2020-part-three.html

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-top-ten-agricultural-law-and-tax-developments-of-2020-part-three.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

Prescribed Burning Legal Issues

https://lawprofessors.typepad.com/agriculturallaw/2021/02/prescribed-burning-legal-issues.html

Damaged and/or Destroyed Trees and Crops – How is the Loss Measured?

https://lawprofessors.typepad.com/agriculturallaw/2021/03/damaged-andor-destroyed-trees-and-crops-how-is-the-loss-measured.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

Mailboxes and Farm Equipment

https://lawprofessors.typepad.com/agriculturallaw/2021/07/mailboxes-and-farm-equipment.html

Statutory Immunity From Liability Associated With Horse-Related Activities

https://lawprofessors.typepad.com/agriculturallaw/2021/12/statutory-immunity-from-liability-associated-with-horse-related-activities.html

CONTRACTS

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-almost-top-ten-ag-law-and-ag-tax-developments-of-2020-part-three.html

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

Deed Reformation – Correcting Mistakes After the Fact

https://lawprofessors.typepad.com/agriculturallaw/2021/05/deed-reformation-correcting-mistakes-after-the-fact.html

Considerations When Buying Farmland

https://lawprofessors.typepad.com/agriculturallaw/2021/11/considerations-when-buying-farmland.html

Recent Court Decisions of Interest

https://lawprofessors.typepad.com/agriculturallaw/2021/12/recent-court-decisions-of-interest.html

The Potential Peril Associated With Deferred Payment Contracts

https://lawprofessors.typepad.com/agriculturallaw/2021/12/the-potential-peril-associated-with-deferred-payment-contracts.html

COOPERATIVES

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Final Ag/Horticultural Cooperative QBI Regulations Issued

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

CRIMINAL LIABILITIES

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-almost-top-ten-ag-law-and-ag-tax-developments-of-2020.html

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

Estate Planning to Protect Assets From Creditors – Dancing On the Line Between Legitimacy and Fraud

https://lawprofessors.typepad.com/agriculturallaw/2021/09/estate-planning-to-protect-assets-from-creditors-dancing-on-the-line-between-legitimacy-and-fraud.html

Recent Court Decisions of Interest

https://lawprofessors.typepad.com/agriculturallaw/2021/12/recent-court-decisions-of-interest.html

ENVIRONMENTAL LAW

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

Recent Happenings in Ag Law and Ag Tax

https://lawprofessors.typepad.com/agriculturallaw/2021/01/recent-happenings-in-ag-law-and-ag-tax.html

Court and IRS Happenings in Ag Law and Tax

https://lawprofessors.typepad.com/agriculturallaw/2021/03/court-happenings-in-ag-law-and-tax.html

Valuing Ag Real Estate With Environmental Concerns

https://lawprofessors.typepad.com/agriculturallaw/2021/05/federal-estate-tax-value-of-ag-real-estate-with-environmental-concerns.html

Ag Law and Tax Potpourri

https://lawprofessors.typepad.com/agriculturallaw/2021/06/ag-law-and-tax-potpourri.html

No Expansion of Public Trust Doctrine in Iowa – Big Implications for Agriculture

https://lawprofessors.typepad.com/agriculturallaw/2021/06/no-expansion-of-public-trust-doctrine-in-iowa-big-implications-for-agriculture.html

Key “Takings” Decision from SCOTUS Involving Ag Businesses

https://lawprofessors.typepad.com/agriculturallaw/2021/06/key-takings-decision-from-scotus-involving-ag-businesses.html

Montana Conference and Ag Law Summit (Nebraska)

https://lawprofessors.typepad.com/agriculturallaw/2021/07/montana-conference-and-ag-law-summit-nebraska.html

Navigable Waters Protection Rule – What’s Going on with WOTUS?

https://lawprofessors.typepad.com/agriculturallaw/2021/07/navigable-waters-protection-rule-whats-going-on-with-wotus.html

ESTATE PLANNING

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-almost-top-ten-ag-law-and-ag-tax-developments-of-2020-part-two.html

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

What Now? – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2021/02/what-now-part-two.html

Will the Estate Tax Valuation Regulations Return?

https://lawprofessors.typepad.com/agriculturallaw/2021/02/will-the-estate-tax-valuation-regulations-return.html

June National Farm and Tax and Estate/Business Planning Conference

https://lawprofessors.typepad.com/agriculturallaw/2021/03/june-national-farm-tax-and-estatebusiness-planning-conference.html

August National Farm Tax and Estate/Business Planning Conference

https://lawprofessors.typepad.com/agriculturallaw/2021/03/august-national-farm-tax-and-estatebusiness-planning-conference.html

Farmland in an Estate – Special Use Valuation and the 25 Percent Test

https://lawprofessors.typepad.com/agriculturallaw/2021/03/farmland-in-an-estate-special-use-valuation-and-the-25-percent-test.html

The Revocable Living Trust – Is it For You?

https://lawprofessors.typepad.com/agriculturallaw/2021/04/the-revocable-living-trust-is-it-for-you.html

Summer Conferences – NASBA Certification! (and Some Really Big Estate Planning Issues – Including Basis)

https://lawprofessors.typepad.com/agriculturallaw/2021/04/summer-conferences-nasba-certification-and-some-really-big-estate-planning-issues-including-basis.html

Court Developments of Interest

https://lawprofessors.typepad.com/agriculturallaw/2021/04/court-developments-of-interest.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

Planning for Changes to the Federal Estate and Gift Tax System

https://lawprofessors.typepad.com/agriculturallaw/2021/05/planning-for-changes-to-the-federal-estate-and-gift-tax-system.html

The “Mis” STEP Act – What it Means To Your Estate and Income Tax Plan

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-mis-step-act-what-it-means-to-your-estate-and-income-tax-plan.html

The Revocable Trust – What Happens When the Grantor Dies?

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-revocable-trust-what-happens-when-the-grantor-dies.html

Intergenerational Transfer of Family Businesses with Split-Dollar Life Insurance

https://lawprofessors.typepad.com/agriculturallaw/2021/05/intergenerational-transfer-of-family-businesses-with-split-dollar-life-insurance.html

Ohio Conference –June 7-8 (Ag Economics) What’s Going On in the Ag Economy?

https://lawprofessors.typepad.com/agriculturallaw/2021/05/ohio-conference-june-7-8-ag-economics-whats-going-on-in-the-ag-economy.html

Reimbursement Claims in Estates; Drainage District Assessments

https://lawprofessors.typepad.com/agriculturallaw/2021/07/reimbursement-claims-in-estates-drainage-district-assessments.html

Montana Conference and Ag Law Summit (Nebraska)

https://lawprofessors.typepad.com/agriculturallaw/2021/07/montana-conference-and-ag-law-summit-nebraska.html

Farm Valuation Issues

https://lawprofessors.typepad.com/agriculturallaw/2021/08/farm-valuation-issues.html

Ag Law Summit

https://lawprofessors.typepad.com/agriculturallaw/2021/08/ag-law-summit.html

The Illiquidity Problem of Farm and Ranch Estates

https://lawprofessors.typepad.com/agriculturallaw/2021/08/the-illiquidity-problem-of-farm-and-ranch-estates.html

Planning to Avoid Elder Abuse

https://lawprofessors.typepad.com/agriculturallaw/2021/08/planning-to-avoid-elder-abuse.html

Gifting Assets Pre-Death – Part One

https://lawprofessors.typepad.com/agriculturallaw/2021/09/gifting-assets-pre-death-part-one.html

Gifting Assets Pre-Death (Entity Interests) – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2021/09/gifting-assets-pre-death-entity-interests-part-two.html

The Future of Ag Tax Policy – Where Is It Headed?

https://lawprofessors.typepad.com/agriculturallaw/2021/09/the-future-of-ag-tax-policy-where-is-it-headed.html

Estate Planning to Protect Assets From Creditors – Dancing On the Line Between Legitimacy and Fraud

https://lawprofessors.typepad.com/agriculturallaw/2021/09/estate-planning-to-protect-assets-from-creditors-dancing-on-the-line-between-legitimacy-and-fraud.html

Tax Happenings – Present Status of Proposed Legislation (and What You Might Do About It)

https://lawprofessors.typepad.com/agriculturallaw/2021/09/tax-happenings-present-status-of-proposed-legislation-and-what-you-might-do-about-it.html

Corporate-Owned Life Insurance – Impact on Corporate Value and Shareholder’s Estate

https://lawprofessors.typepad.com/agriculturallaw/2021/10/corporate-owned-life-insurance-impact-on-corporate-value-and-shareholders-estate-.html

Tax (and Estate Planning) Happenings

https://lawprofessors.typepad.com/agriculturallaw/2021/11/tax-and-estate-planning-happenings.html

Selected Tax Provisions of House Bill No. 5376 – and Economic Implications

https://lawprofessors.typepad.com/agriculturallaw/2021/11/selected-tax-provisions-of-house-bill-no-5376-and-economic-implications.html

2022 Summer Conferences – Save the Date

https://lawprofessors.typepad.com/agriculturallaw/2021/12/2022-summer-conferences-save-the-date.html

INCOME TAX

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-almost-top-ten-ag-law-and-ag-tax-developments-of-2020-part-two.html

The “Top Ten” Agricultural Law and Ag Tax Developments of 2020 – Part One

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-top-ten-agricultural-law-and-ag-tax-developments-of-2020-part-one.html

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Four

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-top-ten-agricultural-law-and-tax-developments-of-2020-part-four.html

Final Ag/Horticultural Cooperative QBI Regulations Issued

https://lawprofessors.typepad.com/agriculturallaw/2021/01/final-aghorticultural-cooperative-qbi-regulations-issued.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

Recent Happenings in Ag Law and Ag Tax

https://lawprofessors.typepad.com/agriculturallaw/2021/01/recent-happenings-in-ag-law-and-ag-tax.html

Deducting Start-Up Costs – When Does the Business Activity Begin?

https://lawprofessors.typepad.com/agriculturallaw/2021/01/deducting-start-up-costs-when-does-the-business-activity-begin.html

What Now? – Part One

https://lawprofessors.typepad.com/agriculturallaw/2021/02/what-now-part-one.html

C Corporate Tax Planning; Management Fees and Reasonable Compensation – A Roadmap of What Not to Do

https://lawprofessors.typepad.com/agriculturallaw/2021/02/c-corporate-tax-planning-management-fees-and-reasonable-compensation-a-roadmap-of-what-not-to-do.html

Where’s the Line Between Start-Up Expenses, the Conduct of a Trade or Business and Profit Motive?

https://lawprofessors.typepad.com/agriculturallaw/2021/02/wheres-the-line-between-start-up-expenses-the-conduct-of-a-trade-or-business-and-profit-motive.html

June National Farm Tax and Estate/Business Planning Conference

https://lawprofessors.typepad.com/agriculturallaw/2021/03/june-national-farm-tax-and-estatebusiness-planning-conference.html

Selling Farm Business Assets – Special Tax Treatment (Part One)

https://lawprofessors.typepad.com/agriculturallaw/2021/03/selling-farm-business-assets-special-tax-treatment-part-one.html

Tax Update Webinar

https://lawprofessors.typepad.com/agriculturallaw/2021/03/tax-update-webinar.html

Selling Farm Business Assets – Special Tax Treatment (Part Two)

https://lawprofessors.typepad.com/agriculturallaw/2021/03/selling-farm-business-assets-special-tax-treatment-part-two.html

Selling Farm Business Assets – Special Tax Treatment (Part Three)

https://lawprofessors.typepad.com/agriculturallaw/2021/03/selling-farm-business-assets-special-tax-treatment-part-three.html

August National Farm Tax and Estate/Business Planning Conference

https://lawprofessors.typepad.com/agriculturallaw/2021/03/august-national-farm-tax-and-estatebusiness-planning-conference.html

Court and IRS Happenings in Ag Law and Tax

https://lawprofessors.typepad.com/agriculturallaw/2021/03/court-happenings-in-ag-law-and-tax.html

C Corporation Compensation Issues

https://lawprofessors.typepad.com/agriculturallaw/2021/03/c-corporation-compensation-issues.html

Tax Considerations When Leasing Farmland

https://lawprofessors.typepad.com/agriculturallaw/2021/04/tax-considerations-when-leasing-farmland.html

Federal Farm Programs and the AGI Computation

https://lawprofessors.typepad.com/agriculturallaw/2021/04/federal-farm-programs-and-the-agi-computation.html

Tax Potpourri

https://lawprofessors.typepad.com/agriculturallaw/2021/04/tax-potpourri.html

What’s an “Asset” For Purposes of a Debtor’s Insolvency Computation?

https://lawprofessors.typepad.com/agriculturallaw/2021/04/whats-an-asset-for-purposes-of-a-debtors-insolvency-computation.html

Summer Conferences – NASBA Certification! (and Some Really Big Estate Planning Issues – Including Basis)

https://lawprofessors.typepad.com/agriculturallaw/2021/04/summer-conferences-nasba-certification-and-some-really-big-estate-planning-issues-including-basis.html

Court Developments of Interest

https://lawprofessors.typepad.com/agriculturallaw/2021/04/court-developments-of-interest.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

The “Mis” STEP Act – What it Means To Your Estate and Income Tax Plan

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-mis-step-act-what-it-means-to-your-estate-and-income-tax-plan.html

The Revocable Trust – What Happens When the Grantor Dies?

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-revocable-trust-what-happens-when-the-grantor-dies.html

Ohio Conference -June 7-8 (Ag Economics) What’s Going On in the Ag Economy?

https://lawprofessors.typepad.com/agriculturallaw/2021/05/ohio-conference-june-7-8-ag-economics-whats-going-on-in-the-ag-economy.html

What’s the “Beef” With Conservation Easements?

https://lawprofessors.typepad.com/agriculturallaw/2021/05/whats-the-beef-with-conservation-easements.html

Is a Tax Refund Exempt in Bankruptcy?

https://lawprofessors.typepad.com/agriculturallaw/2021/06/is-a-tax-refund-exempt-in-bankruptcy.html

Tax Court Happenings

https://lawprofessors.typepad.com/agriculturallaw/2021/06/tax-court-happenings.html

IRS Guidance On Farms NOLs

https://lawprofessors.typepad.com/agriculturallaw/2021/07/irs-guidance-on-farm-nols.html

Montana Conference and Ag Law Summit (Nebraska)

https://lawprofessors.typepad.com/agriculturallaw/2021/07/montana-conference-and-ag-law-summit-nebraska.html

Tax Developments in the Courts – The “Tax Home”; Sale of the Home; and Gambling Deductions

https://lawprofessors.typepad.com/agriculturallaw/2021/07/tax-developments-in-the-courts-the-tax-home-sale-of-the-home-and-gambling-deductions.html

Recovering Costs in Tax Litigation

https://lawprofessors.typepad.com/agriculturallaw/2021/07/recovering-costs-in-tax-litigation.html

Tax Potpourri

https://lawprofessors.typepad.com/agriculturallaw/2021/08/tax-potpourri.html

Weather-Related Sales of Livestock

https://lawprofessors.typepad.com/agriculturallaw/2021/08/weather-related-sales-of-livestock.html

Ag Law Summit

https://lawprofessors.typepad.com/agriculturallaw/2021/08/ag-law-summit.html

Livestock Confinement Buildings and S.E. Tax

https://lawprofessors.typepad.com/agriculturallaw/2021/08/livestock-confinement-buildings-and-se-tax.html

When Does a Partnership Exist?

https://lawprofessors.typepad.com/agriculturallaw/2021/09/when-does-a-partnership-exist.html

Recent Tax Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2021/09/recent-tax-developments-in-the-courts.html

Gifting Assets Pre-Death – Part One

https://lawprofessors.typepad.com/agriculturallaw/2021/09/gifting-assets-pre-death-part-one.html

Gifting Pre-Death (Partnership Interests) – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2021/09/gifting-pre-death-partnership-interests-part-three.html

The Future of Ag Tax Policy – Where Is It Headed?

https://lawprofessors.typepad.com/agriculturallaw/2021/09/the-future-of-ag-tax-policy-where-is-it-headed.html

Tax Happenings – Present Statute of Proposed Legislation (and What You Might Do About It)

https://lawprofessors.typepad.com/agriculturallaw/2021/09/tax-happenings-present-status-of-proposed-legislation-and-what-you-might-do-about-it.html

Fall 2021 Seminars

https://lawprofessors.typepad.com/agriculturallaw/2021/09/fall-2021-seminars.html

Extended Livestock Replacement Period Applies in Areas of Extended Drought – IRS Updated Drought Areas

https://lawprofessors.typepad.com/agriculturallaw/2021/09/extended-livestock-replacement-period-applies-in-areas-of-extended-drought-irs-updated-drought-areas.html

Farm Bankruptcy – “Stripping,” “Claw-Back” and the Tax Collecting Authorities (Update)

https://lawprofessors.typepad.com/agriculturallaw/2021/10/farm-bankruptcy-stripping-claw-back-and-the-tax-collecting-authorities-update.html

Caselaw Update

https://lawprofessors.typepad.com/agriculturallaw/2021/10/caselaw-update.html

Tax Issues Associated With Easements

https://lawprofessors.typepad.com/agriculturallaw/2021/10/tax-issues-associated-with-easements.html

S Corporations – Reasonable Compensation; Non-Wage Distributions and a Legislative Proposal

https://lawprofessors.typepad.com/agriculturallaw/2021/10/s-corporations-reasonable-compensation-non-wage-distributions-and-a-legislative-proposal.html

Tax Reporting of Sale Transactions By Farmers

https://lawprofessors.typepad.com/agriculturallaw/2021/10/tax-reporting-of-sale-transactions-by-farmers.html

The Tax Rules Involving Prepaid Farm Expenses

https://lawprofessors.typepad.com/agriculturallaw/2021/10/the-tax-rules-involving-prepaid-farm-expenses.html

Self Employment Taxation of CRP Rents – Part One

https://lawprofessors.typepad.com/agriculturallaw/2021/11/self-employment-taxation-of-crp-rents-part-one.html

Self-Employment Taxation of CRP Rents – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2021/11/self-employment-taxation-of-crp-rents-part-two.html

Self-Employment Taxation of CRP Rents – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2021/11/self-employment-taxation-of-crp-rents-part-three.html

Recent IRS Guidance, Tax Legislation and Tax Ethics Seminar/Webinar

https://lawprofessors.typepad.com/agriculturallaw/2021/11/recent-irs-guidance-tax-legislation-and-tax-ethics-seminarwebinar.html

Tax (and Estate Planning) Happenings

https://lawprofessors.typepad.com/agriculturallaw/2021/11/tax-and-estate-planning-happenings.html

Selected Tax Provisions of House Bill No. 5376 – and Economic Implications

 https://lawprofessors.typepad.com/agriculturallaw/2021/11/selected-tax-provisions-of-house-bill-no-5376-and-economic-implications.html

Recent Court Decisions of Interest

https://lawprofessors.typepad.com/agriculturallaw/2021/12/recent-court-decisions-of-interest.html

The Potential Peril Associated With Deferred Payment Contracts

https://lawprofessors.typepad.com/agriculturallaw/2021/12/the-potential-peril-associated-with-deferred-payment-contracts.html

Inland Hurricane – 2021 Version; Is There Any Tax Benefit to Demolishing Farm Buildings and Structures?

https://lawprofessors.typepad.com/agriculturallaw/2021/12/inland-hurricane-2021-version-is-there-any-tax-benefit-to-demolishing-farm-buildings-and-structures.html

2022 Summer Conferences – Save the Date

https://lawprofessors.typepad.com/agriculturallaw/2021/12/2022-summer-conferences-save-the-date.html

The Home Sale Exclusion Rule – How Does it Work When Land is Also Sold?

https://lawprofessors.typepad.com/agriculturallaw/2021/12/the-home-sale-exclusion-rule-how-does-it-work-when-land-is-also-sold.html

Gifting Ag Commodities To Children

https://lawprofessors.typepad.com/agriculturallaw/2021/12/gifting-ag-commodities-to-children.html

Livestock Indemnity Payments – What Are They? What Are the Tax Reporting Options?

https://lawprofessors.typepad.com/agriculturallaw/2021/12/livestock-indemnity-payments-what-are-they-what-are-the-tax-reporting-options.html

Commodity Credit Corporation Loans and Elections

https://lawprofessors.typepad.com/agriculturallaw/2021/12/commodity-credit-corporation-loans-and-elections.html

INSURANCE

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

REAL PROPERTY

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-almost-top-ten-ag-law-and-ag-tax-developments-of-2020-part-three.html

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

Prescribed Burning Legal Issues

https://lawprofessors.typepad.com/agriculturallaw/2021/02/prescribed-burning-legal-issues.html

Ag Zoning Potpourri

https://lawprofessors.typepad.com/agriculturallaw/2021/02/ag-zoning-potpourri.html

Court and IRS Happenings in Ag Law and Tax

https://lawprofessors.typepad.com/agriculturallaw/2021/03/court-happenings-in-ag-law-and-tax.html

Is That Old Fence Really the Boundary

https://lawprofessors.typepad.com/agriculturallaw/2021/04/is-that-old-fence-really-the-boundary.html

Court Developments of Interest

https://lawprofessors.typepad.com/agriculturallaw/2021/04/court-developments-of-interest.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

Deed Reformation – Correcting Mistakes After the Fact

https://lawprofessors.typepad.com/agriculturallaw/2021/05/deed-reformation-correcting-mistakes-after-the-fact.html

Valuing Ag Real Estate With Environmental Concerns

https://lawprofessors.typepad.com/agriculturallaw/2021/05/federal-estate-tax-value-of-ag-real-estate-with-environmental-concerns.html

Ag Law and Tax Potpourri

https://lawprofessors.typepad.com/agriculturallaw/2021/06/ag-law-and-tax-potpourri.html

Montana Conference and Ag Law Summit (Nebraska)

https://lawprofessors.typepad.com/agriculturallaw/2021/07/montana-conference-and-ag-law-summit-nebraska.html

Farm Valuation Issues

https://lawprofessors.typepad.com/agriculturallaw/2021/08/farm-valuation-issues.html

Considerations When Buying Farmland

https://lawprofessors.typepad.com/agriculturallaw/2021/11/considerations-when-buying-farmland.html

The Home Sale Exclusion Rule – How Does it Work When Land is Also Sold?

https://lawprofessors.typepad.com/agriculturallaw/2021/12/the-home-sale-exclusion-rule-how-does-it-work-when-land-is-also-sold.html

REGULATORY LAW

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-almost-top-ten-ag-law-and-ag-tax-developments-of-2020-part-two.html

 The “Top Ten” Agricultural Law and Ag Tax Developments of 2020 – Part One

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-top-ten-agricultural-law-and-ag-tax-developments-of-2020-part-one.html

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-top-ten-agricultural-law-and-tax-developments-of-2020-part-two.html

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Four

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-top-ten-agricultural-law-and-tax-developments-of-2020-part-four.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

Recent Happenings in Ag Law and Ag Tax

https://lawprofessors.typepad.com/agriculturallaw/2021/01/recent-happenings-in-ag-law-and-ag-tax.html

Prescribed Burning Legal Issues

https://lawprofessors.typepad.com/agriculturallaw/2021/02/prescribed-burning-legal-issues.html

Packers and Stockyards Act Amended – Additional Protection for Unpaid Cash Sellers of Livestock

https://lawprofessors.typepad.com/agriculturallaw/2021/02/packers-and-stockyards-act-amended-additional-protection-for-unpaid-cash-sellers-of-livestock.html

Federal Farm Programs and the AGI Computation

https://lawprofessors.typepad.com/agriculturallaw/2021/04/federal-farm-programs-and-the-agi-computation.html

Regulation of Agriculture – Food Products, Slaughterhouse Line Speeds and CAFOS

https://lawprofessors.typepad.com/agriculturallaw/2021/04/regulation-of-agriculture-food-products-slaughterhouse-line-speeds-and-cafos.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

The FLSA and Ag’s Exemption From Paying Overtime Wages

https://lawprofessors.typepad.com/agriculturallaw/2021/06/the-flsa-and-ags-exemption-from-paying-overtime-wages.html

The “Dormant” Commerce Clause and Agriculture

https://lawprofessors.typepad.com/agriculturallaw/2021/06/the-dormant-commerce-clause-and-agriculture.html

Trouble with ARPA

https://lawprofessors.typepad.com/agriculturallaw/2021/06/trouble-with-arpa.html

No Expansion of Public Trust Doctrine in Iowa – Big Implications for Agriculture

https://lawprofessors.typepad.com/agriculturallaw/2021/06/no-expansion-of-public-trust-doctrine-in-iowa-big-implications-for-agriculture.html

Key “Takings Decision from SCOTUS Involving Ag Businesses

https://lawprofessors.typepad.com/agriculturallaw/2021/06/key-takings-decision-from-scotus-involving-ag-businesses.html

Reimbursement Claims in Estates; Drainage District Assessments

https://lawprofessors.typepad.com/agriculturallaw/2021/07/reimbursement-claims-in-estates-drainage-district-assessments.html

Mailboxes and Farm Equipment

https://lawprofessors.typepad.com/agriculturallaw/2021/07/mailboxes-and-farm-equipment.html

Montana Conference and Ag Law Summit (Nebraska)

https://lawprofessors.typepad.com/agriculturallaw/2021/07/montana-conference-and-ag-law-summit-nebraska.html

California’s Regulation of U.S. Agriculture

https://lawprofessors.typepad.com/agriculturallaw/2021/08/californias-regulation-of-us-agriculture.html

Checkoffs and Government Speech – The Merry-Go-Round Revolves Again

https://lawprofessors.typepad.com/agriculturallaw/2021/08/checkoffs-and-government-speech-the-merry-go-round-revolves-again.html

Is There a Constitutional Way To Protect Animal Ag Facilities

https://lawprofessors.typepad.com/agriculturallaw/2021/08/is-there-a-constitutional-way-to-protect-animal-ag-facilities.html

Caselaw Update

https://lawprofessors.typepad.com/agriculturallaw/2021/10/caselaw-update.html

Recent Court Decisions of Interest

https://lawprofessors.typepad.com/agriculturallaw/2021/12/recent-court-decisions-of-interest.html

Livestock Indemnity Payments – What Are They? What Are the Tax Reporting Options?

https://lawprofessors.typepad.com/agriculturallaw/2021/12/livestock-indemnity-payments-what-are-they-what-are-the-tax-reporting-options.html

SECURED TRANSACTIONS

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

Cross-Collateralization Clauses – Tough Lessons For Lenders

https://lawprofessors.typepad.com/agriculturallaw/2021/03/cross-collateralization-clauses-tough-lessons-for-lenders.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

The “EIDL Trap” For Farm Borrowers

https://lawprofessors.typepad.com/agriculturallaw/2021/07/the-eidl-trap-for-farm-borrowers.html

The Potential Peril Associated With Deferred Payment Contracts

https://lawprofessors.typepad.com/agriculturallaw/2021/12/the-potential-peril-associated-with-deferred-payment-contracts.html

WATER LAW

Continuing Education Events and Summer Conferences

https://lawprofessors.typepad.com/agriculturallaw/2021/01/continuing-education-events-and-summer-conferences.html

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2021/01/the-top-ten-agricultural-law-and-tax-developments-of-2020-part-three.html

Agricultural Law Online!

https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html

The Agricultural Law and Tax Report

https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html

Montana Conference and Ag Law Summit (Nebraska)

https://lawprofessors.typepad.com/agriculturallaw/2021/07/montana-conference-and-ag-law-summit-nebraska.html

May 22, 2022 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Sunday, May 1, 2022

Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

Overview

The Washburn Law School Summer 2022 national conferences on ag income tax and ag estate and business planning are approaching.  The first one will be June 13-14 at the Chula Vista Resort near the Wisconsin Dells.  The second conference will be in Durango, Colorado, at Fort Lewis College on August 1-2.

Registration is now open for both the Wisconsin event in mid-June and the Colorado event in early August. 

Wisconsin Dells, Wisconsin

Here’s the link to the online brochure and registration for the event at the Chula Vista Resort on June 13-14:  https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html

A block of rooms is available for this seminar at a rate of $139.00 per night plus taxes and fees. To make a reservation call (855) 529-7630 and reference booking ID "#i60172 Washburn Law School." Rooms can be reserved at the group rate through May 15, 2022. Reservations requested after May 15 are subject to availability at the time of reservation.

An hour of ethics is provided at the end of Day 2.

The conference will also be broadcast live online for those that cannot attend in person.  Online attendees will be able to interact with the presenters, if desired. 

Here’s a rundown of the topics by day, for more detail see the registration at the link provided above:

Day 1 (at both Wisconsin and Durango)

  • Tax Update: Key Rulings and Cases
  • Reporting of WHIP and Other Government Payments
  • Fixing Bonus Elections and Computations
  • Research and Development Credits
  • Farm NOLs
  • The Taxability of Retailer Reward Programs; Tax Rules Associated with Demolishing Farm Structures
  • IRS-CI: Emerging Cyber Crimes and Crypto Tax Compliance
  • Reporting of machinery trade transactions
  • Inventory accounting issues
  • Early termination of CRP contracts;
  • Partnership reporting;
  • Weather-related livestock sales; and
  • Contribution margin analysis

Day 2 (Wisconsin)

  • Estate and Business Planning Caselaw and Ruling Update
  • The Use of IDGTs (and other strategies) For Succession Planning
  • Anticompetitive Conduct in Agriculture
  • Post-Death Dissolution of S Corporation Stock and Stepped-Up Basis; Last Year of Farming; Deferred Tax liability and Conversion to Form 4835
  • Agricultural Finance and Land Situation
  • Post-Death Basis Increase: Is GallensteinStill in Play?; Using an LLC to Make an S Election
  • Getting Clients Engaged in the Estate/Business Planning Process
  • Ethical Problems in Estate and Income Tax Planning 

Day 2 (Durango)

  • Estate and Business Planning Caselaw and Ruling Update 
  • The Use of IDGTs (and other strategies) For Succession Planning 
  • Estate Planning to Minimize Income Taxation: From the Mundane to the Arcane
  • Oil and Gas Royalties and Working Interest Payments: Taxation, Planning and Oversight
  • Economic Evaluation of a Farm Business 
  • Appropriation Water Rights - Tax and Estate Planning Issues
  • Ethically Negotiating End of Life Family Issues 

Here’s the link to the online brochure and registration for the event in Durango at Fort Lewis College on August 1-2:  https://www.washburnlaw.edu/employers/cle/farmandranchtaxaugust.html

Online Attendance

Both the Wisconsin and Colorado conferences will also be broadcast live online for those that cannot attend in person.  Online attendees will be able to interact with the presenters, if desired. For those attending online, please indicate on your registration whether you would like to have a hardcopy of the conference materials sent to you.

Other Points

There are many other important details about the conferences that you can find by reviewing the online brochures. 

Looking forward to seeing you there or having you participate online.  If you do tax, estate planning or business succession planning work for clients or are involved in production agriculture in any way, this conference is for you.  Each event will also have a presentation involving the farm economy that you won’t want to miss.  Also, if you aren’t needing to claim continuing education credits, you qualify for a lower registration rate.

I am looking forward to seeing you there. 

May 1, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Monday, April 18, 2022

IRS Audit Issue – S Corporation Reasonable Compensation

Overview

One of the areas of “low-hanging fruit” for IRS auditors in recent years involves the issue of reasonable compensation in the S corporation context.  But what does “reasonable compensation” mean?  The instructions to Form 1120S, the return for an S corporation, says, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are reasonable compensation for services rendered to the corporation.”  But that still doesn’t answer the question of what “reasonable compensation” is.  The question is important because setting compensation properly avoids IRS assessing tax, penalties, and interest. 

What is “reasonable compensation” and how is it determined?  Reasonable compensation for an S corporation shareholder-employee – it’s the topic of today’s post.

In General 

An S corporation shareholder must include in income the shareholder’s pro rata share of the S corporation earnings for the year.  The pro rata share can be split between compensation for services and a deemed or actual distribution of S corporate income.  The distinction matters because employment-related taxes apply to compensation paid for the shareholder’s services, but do not apply to deemed or actual distributions of S corporate income.  I.R.C. §1373; Rev. Rul. 59-221. 1959-1 C.B. 225.  Thus, compensation that is “too low” in relation to the services rendered to the S corporation results in the avoidance of payroll taxes. i.e., the employer and employee portions of Federal Insurance Contributions Act (FICA) taxes and the employer Federal Unemployment Tax Act (FUTA) tax.  S corporation flow-through income is taxed at the individual level and is (normally) not subject to self-employment tax.  Also, in addition to avoiding FICA and FUTA tax via S corporation distributions, the 0.9% Medicare tax imposed by I.R.C. §3101(b)(2) for high-wage earners (but not on employers) is also avoided by taking income from an S corporation in the form of distributions. 

Note:  The different tax treatment of employment-related wages and compensation for services rendered to the S corporation provide an incentive for S corporation shareholder-employees to take less salary relative to distributions from the corporation.  With the Social Security wage base set at $147,000 for 2022, setting a shareholder-employee’s compensation beneath that amount with the balance of compensation consisting of dividends can produce significant tax savings. 

IRS Examination of “Employee” Status

What is an “employee”?  Many S corporations, particularly those that involve agricultural businesses, have shareholders that perform substantial services for the corporation as officers and otherwise.  In fact, the services don’t have to be substantial.  Indeed, under a Treasury Regulation, the provision of more than minor services for remuneration makes the shareholder an “employee.”  Treas. Reg. §31.3121(d)-1(b).  Once, “employee” status is achieved, the IRS views either a low or non-existent salary to a shareholder who is also an officer/employee as an attempt to evade payroll taxes and, if a court determines that the IRS is correct, the penalty is 100 percent of the taxes owed.   “Wages” for federal employment tax purposes means all remuneration for employment. I.R.C. §3121(a); 3306(b).  The Regulations point out that the form in which payment is made doesn’t matter.  The real question is whether compensation was made for employment.  Treas.  Reg. §§31.3121(a)-1(b) and 31.3306(b)-1(b).  If it was, employment taxes apply to both the employee and the S corporation.  See, e.g., Veterinary Surgical Consultants, P.C. v. Comr., 117 T.C. 141 (2001), aff’d. sub. nom., Yeagle Drywall Co., 54 Fed. Appx. 100 (3d Cir. 2002). 

Definition of “wages.”  For employment tax purposes, “wages” means remuneration for employment, including the cash value of all remuneration (including benefits) paid in any medium other than cash.  I.R.C. §§3121(a); 3306(b); 3401(a).  The remuneration must be paid for services of any nature performed by an employee.  I.R.C. §3121(b).  It is immaterial how an employer characterizes the payment, and the form of the payment also does not matter.  Treas. Regs. §§31.3121(a)-1; (c) and (e); 31.3401(a)-1 – (a)(2) and (a)(4).  In addition, an employee cannot waive the right to receive wages and characterize payments received as something other than wages. 

Audit focus.  An IRS audit on the issue tends to focus on the amount of compensation, whether it is reasonable based on the facts and whether the proper amount of employment-related taxes have been paid.  The burden is on the corporation to establish that the salary amount under question is reasonable.  Likewise, IRS is likely to not distinguish between payments an S corporation makes to a shareholder that are allegedly attributable to the shareholder’s status as an officer and shareholder rather than as an employee.  The courts have supported the IRS on this point, and repeatedly point out that employee status is achieved once anything more than minor services are provided to the corporation.  Id.; I.R.C. §3121(d)(1). 

The IRS also has the authority to reclassify “distributions” made to an S corporation shareholder as payment for wages.  I.R.C. §7436; Rev. Rul. 74-44, 1974-1 C.B. 287.  The reclassification issue can be a critical issue when a shareholder’s family member provides capital or services to the corporation.  In that situation the IRS has the power to make any adjustments necessary to reflect the reasonable value of the capital or services provided based on the particular facts.  Key to any IRS adjustment would be what the corporation would have had to pay for the capital or services had it not been provided by a family member who was also not a shareholder in the S corporation.  Likewise (and a big issue in some farming operations), if a shareholder’s family member has an interest in another pass-through entity and that entity provides services or capital to the S corporation, the IRS can make appropriate adjustments to reflect the value of the services and/or capital provided. 

Note:  A “family member” of an S corporation shareholder includes only the shareholder’s spouse, ancestors, lineal descendants and any trust for the primary benefit of any of these individuals.  Treas. Reg. §1.1366-3.

Determining Reasonableness

What’s the source of gross receipts?  A key question in determining reasonableness of compensation is the source of S corporation gross receipts and the shareholder’s activity (if any) in generating those receipts.  What did the shareholder/employee do for the S corporation?  Or, alternatively, did the S corporation’s gross receipts derive from the personal services of non-shareholder employees or shareholders?  If the gross receipts derived from non-shareholder personal services (as well as capital and equipment) payments in return are nonwage distributions – hence, not subject to employment taxes.  If the source of the S corporation’s gross receipts is from shareholder personal services, payments for those services are wages even if those personal services did not directly produce the gross receipts. 

Note:  If S corporate gross receipts derive from the services of non-shareholder employees, or capital and equipment, then they should not be associated with the shareholder/employee’s personal services, and it is reasonable that the shareholder would receive distributions as well as compensation.  Alternatively, if most of the gross receipts and profits are associated with the shareholder’s personal services, then most of the profit distribution should be classified as compensation.

In addition to the shareholder/employee’s direct generation of gross receipts, the shareholder/employee should also be compensated for administrative work performed for the other income-producing employees or assets.  As applied in the ag context, for example, this means that reasonable compensation for a shareholder/employee in a crop farming operation could differ from that of a shareholder-employee in a livestock operation.

IRS factors.  The IRS examines numerous factors to determine if reasonable compensation has been paid.  The following is a list of some of the primary ones:

  • The employee’s qualifications;
  • Training and experience;
  • The nature, extent, and scope of the employee’s work;
  • The amount of time and effort devoted to the S corporation’s business activities;
  • The S corporation’s dividend history;
  • The size and complexities of the business; a comparison of salaries paid;
  • The prevailing general economic conditions;
  • Comparison of salaries with distributions to shareholders;
  • The prevailing rates of compensation paid in similar businesses;
  • Whether payments are made to non-shareholder employees;
  • The timing and manner of paying bonuses to key people in the S corporation;
  • The presence of any compensation agreements;
  • The taxpayer’s salary policy for all employees (are any formulas used for determining compensation?);
  • What is the amount paid out as salary as compared to amounts distributed as profit: and
  • In the case of small corporations with a limited number of officers, the amount of compensation paid to the particular employee in previous years.

Court Cases on Reasonable Compensation

Before 2005, the court cases involved S corporation owners who received all of their compensation in form of dividends.  Most of the pre-2005 cases involved reclassifications on an all-or-nothing basis.  In 2005, the IRS issued a study entitled, “S Corporation Reporting Compliance.”  Now the courts’ focus is on the reasonableness of the compensation in relation to the services provided to the S corporation.  That means each situation is fact-dependent and is based on the type of business the S corporation is engaged in and the amount and value of the services rendered. 

Recent cases.  For those interested in digging into the issue further, the following cases are instructive:

  • Watson v. Comr., 668 F.3d 1008 (8th Cir. 2012);
  • Sean McAlary Ltd., Inc. v. Comr., T.C. Sum. Op. 2013-62;
  • Clary Hood, Inc. v. Comr., T.C. Memo. 2022-15;
  • Glass Blocks Unlimited v. Comr., T.C. Memo. 2013-180; and
  • Scott Singer Installations, Inc. v. Comr., T.C. Memo. 2016-161; A.O.D. 2017-04 (Apr. 10, 2017) (in result only).

Each of these cases provides insight into the common issues associated with the reasonable compensation issue.  The last two also address distributions and loan repayments in the context of reasonable compensation of unprofitable S corporations with one case being a taxpayer victory and the other a taxpayer loss. 

Reasonable compensation for an ag producer.  Based on the above analysis and commentary, what would “reasonable compensation be for a farmer or rancher as a shareholder of an S corporation?  The answer is that “it depends.”  Certainly, there is no need to set compensation at the Social Security wage base - $147,000 for 2022.  An acceptable compensation rate (in the eyes of the IRS) will depend on numerous factors, including whether the business involves livestock.  Wage rates for ag labor can be obtained from many Land Grant Universities.  For an owner/manager, an additional amount of compensation should be added to the labor rate to reflect managerial and administrative duties.  An acceptable range is likely somewhere in the $40,000-$70,000 range.  But, that is merely a suggested range.  Each S corporation will need to carefully determine what it believes is a reasonable rate based on the circumstances and document in corporate records how that rate was determined.  A commitment should then be made to revisit compensation levels on a periodic basis.

Note:  As a rule-of-thumb, when considering whether or not to utilize the S corporation structure is achieving tax savings of at least $10,000 annually.  With an S election comes additional bookkeeping, payroll and unemployment tax filings and other administrative duties. 

Return Preparation

It is critical that workpapers associated with the preparation of an S corporation’s return include sufficient documentation supporting the level of compensation to a shareholder-employee.  That documentation should evidence, at a minimum, the type of work the shareholder performed for the corporation, the hours of work spent on corporate business, and how the compensation level was determined. 

Other Issues

Qualified Business Income.  S corporate reasonable compensation also bears on the shareholder’s qualified business income (QBI) deduction (I.R.C. §199A) computation.  An S corporation shareholder is allocated a pro rata share of the S corporation’s QBI.  As part of that computation, the S corporation deducts W-2 wages (including reasonable compensation paid to shareholders) as an expense allocable to the corporation’s trade or business when the corporation calculates its QBI deduction.  Treas. Reg. §1.199A-2(b).  But the shareholder cannot increase the shareholder’s QBI by the amount of reasonable compensation the S corporation pays.  Treas. Reg. §1.199A-3(b)(2)(ii)(H).

Note:  There are numerous factors that determine whether a particular type of entity will generate a relatively larger QBI deduction.  One of those factors, in the S corporation context, is the level of “reasonable compensation” paid to shareholder-employees.  

Shareholder advances.  In small, closely-held S corporations in which a family farming (or other) business is operated, there sometimes is a tendency to use the S corporation to pay personal expenses on a shareholder’s behalf.  The question that arises in this situation is whether the payment constitutes wages as compensation for services rendered to the corporation that are subject to federal employment taxes.  Key to answering this question is determining whether a bona fide debtor-creditor relationship exists.  A genuine intent to create a debt coupled with a reasonable expectation of repayment that comports with economic reality is critical in establishing that the payment should not be characterized as wages.  If the corporation reports the amounts advanced on its general ledger and corporate returns as loans, and actual payments on the advanced funds are made, the argument is strengthened that the amounts advanced are not wages.  Clearly, the use of interest-bearing secured promissory notes also bolsters the argument that advances are not wages.  But, if the advances are merely a paper transaction where the outstanding “loan” balance is credited against undistributed income and any rental payments the corporation owes to a shareholder, the “loan” constitutes wages for FICA and FUTA purposes.  See, e.g., Gale W. Greenlee, Inc. v. United States, 661 F. Supp. 642 (D. Colo. 1985). 

Conclusion

The bottom line is that “reasonable compensation” means that is must be reasonable for all of the services the S corporation owner performs for the corporation.  Because there is no safe harbor for reasonable compensation, the best strategy is to research and document reasonable compensation every year.  That will provide a defensible position if the IRS raises questions on audit. 

April 18, 2022 in Business Planning, Income Tax | Permalink | Comments (0)

Monday, April 11, 2022

Intergenerational Transfer of the Farm/Ranch Business - The Buy-Sell Agreement

Overview

For many farm and ranch family operations, a buy-sell agreement may be just about as important as a properly drafted will or trust.  This is particularly the case when the goal is to transition the business to a subsequent generation of owners and operators.  Typically funded by life insurance to make them operational, the type of buy-sell utilized, and the drafting of the buy-sell are fundamentally associated with their ability to accomplish succession planning objectives.

Basic pointers on buy-sell agreements – it’s the topic of today’s post.

In General

The traditional buy-sell agreement is designed to provide protection to business co-owners in the event an owner departs.  The agreement allows the continuing owners to acquire the interest of the departing owner in a way that the departing owner (and heirs) are no longer part of the business. 

A buy-sell agreement can also be designed to fund the retirement of the founding generation and/or consolidate ownership among the heirs that are to be the next generation owners/operators.  It can also be designed such that cash flows into the hands of the non-managerial heirs.  In any event, the agreement must be tailored to the facts of each situation and drafted in coordination with the estate plans of the senior generation.  Those estate plans could be complex, including the payment of federal estate tax in installments and special use valuation.  Those techniques have qualification requirements that must be satisfied post-death.  A buy-sell agreement must not complicate satisfying those qualification requirements.  

When considering the use of a buy-sell agreement, there are some fundamental questions that must be answered.

  • What should the method of the buy-out be? Will the farming/ranching entity redeem the departing owner’s interest, or will the remaining owner’s do it? 
  • What triggers the buy-out? Death is an obvious event that triggers a buy-out, but what about the retirement or disability of an owner?
  • How will the buy-out agreement be funded?

The resolution of these questions will depend upon the type of entity structure involved and the estate planning and intergenerational transfer goals of the senior owners.

Type of Buy-Sell Agreements

Buy-sell agreements are generally of three types:

  1. Redemption agreements (a.k.a. entity purchase).  This type of agreement is a contract between the owners of the business and the business whereby each owner agrees to sell his interest to the business upon the occurrence of certain events.
  1. Cross-purchase agreements.  This type of agreement is a contract between or among the owners (the business is not necessarily a party to the agreement) whereby each owner agrees to sell his shares to the other owners on the occurrence of specified events.

  2. Hybrid agreements.  This type of agreement is a contract between the business and the owners whereby the owners agree to offer their shares first to the corporation and then to the other owners on the occurrence of certain events.

Income Tax Consequences for C Corporation Buy-Outs

For redemption agreements, if I.R.C. §§302(b)-303 are not satisfied, the redemption is taxed as a dividend distribution (ordinary income without recovery of basis) to the extent of the stockholder’s allocable portion of current and accumulated earnings and profits, without regard to the stockholder’s basis in his shares.  This can be a significant problem for post-mortem redemptions - the estate of a deceased shareholder would normally receive a basis in the shares equal to their value on the date of death or the alternate valuation date. Thus, dividend treatment can result in the recognition of the entire purchase price as ordinary income to a redeemed estate, whereas sale or exchange treatment results in recognition of no taxable gain whatsoever.

For cross-purchase agreements, unless the shareholder is a dealer in stock, any gain on the sale is a capital gain regardless of the character of the corporation’s underlying assets.  I.R.C. §1221.  For the estate that sells the stock shortly after the shareholder’s death, no gain is recognized if the agreement sets the sale price at the date of death value.  I.R.C. §§1014; 2032.  The purchasing shareholders increase their basis in their total holdings of corporate stock by the price paid for the shares purchased under the agreement, even if the shares are paid for with tax-free life insurance proceeds.

Note:   If an S election is in place, the corporate income is taxed to the shareholders and can be withdrawn from the corporation to fund a cross-purchase agreement without triggering additional tax.  If the triggering event is something other than death, a cross-purchase agreement is required to achieve an increased cost basis to the purchasing shareholder(s). 

A hybrid agreement requires the corporation to redeem only as much stock as will qualify for sale or exchange treatment under I.R.C. §303, and then requires the other shareholders to buy the balance of the available stock. This permits the corporation to finance part of the purchase price, to the extent required to pay estate taxes and expenses and assures sale or exchange treatment on the entire transaction.  I.R.C. §303(b)(3).

Under a “wait and see” type of buy-sell agreement, the identity of the purchaser is not disclosed until the actual time of purchase as triggered in the agreement. The corporation will have first shot at purchasing shares, then the remaining shareholders, then the corporation may be obligated to buy any remaining shares.

Alternative Approaches

The corporation could buy a life insurance policy on the life of each stockholder, with the corporation as the policy owner, premium payer, and beneficiary of these policies. The corporation could then use the life insurance to finance the purchase if, at the end of the first option period, the corporation buys the deceased stockholder’s interest. The corporation could lend the insurance proceeds to the stockholders if, at the end of the corporate option period, it is decided that the surviving stockholders should be the buyers (or to the extent stock remained to be purchased after the corporation’s option expires). Investment payments would be deductible to the stockholders and income to the corporation.

An alternative approach is for each shareholder to buy, pay for, own, and be the beneficiary of a life insurance policy for each of the other shareholders. The surviving shareholders would then receive the proceeds when one shareholder dies, and, if a cross-purchase is indicated and appropriate, use the proceeds as the necessary funds to carry out the buy-sell agreement. The surviving shareholders could also lend the proceeds to the corporation if an entity purchase agreement is utilized, to enable the corporation to buy additional shares, or the surviving shareholders could make capital contributions which would have the effect of increasing each shareholder’s stock basis.

A combination of the above approaches could also be used for funding the wait-and-see buy-sell agreement. For example, the corporation could own cash value life insurance and the owners could own term insurance. Also, the parties could have a split-dollar arrangement whereby the corporation pays for the cash value portion of the premiums and the shareholders own the policy and pay for the term portion of the premiums, with the proceeds split between them.

A buy-sell agreement that imposes employment-related restrictions may create ordinary compensation income (without recovery of basis).  I.R.C. §83.  However, an agreement containing transfer restrictions that are sufficient to render the stock substantially non-vested (substantial risk of forfeiture) may prevent the current recognition of ordinary income.

Advantages and Disadvantages Of Buy-Sell Agreements

Pros.  A well-drafted buy-sell agreement is designed to prevent the sale (or other transfer) of business interests outside the family unit.  In general, a buy-sell agreement is a relatively simple agreement.  It is a contract between family members. There are few formalities to follow under state law, and no filing or registration fees.  It also creates a ready market for an owner’s interest, easing the liquidity problems created by the ownership of a block of closely-held business interests at the owner’s death.  In addition, if the buy-sell is drafted properly, it can help establish the value of the business interests if drafted properly.

Cons.  On the downside, a hybrid or redemption type of buy-sell agreement may not yield favorable tax consequences upon the purchase of business interests in accordance with the agreement.  This is typically not a problem with a cross-purchase agreement.  The basic problem is that a corporate distribution in a redemption of stock is taxed as a dividend (i.e., taxed as ordinary income to the extent of earnings and profits, without recovery of basis), unless it meets the technical requirements of I.R.C. §302(b) or §303. 

As discussed further below, the parties to the agreement must have funds available to buy the stock at the time the agreement is triggered. Typically, life insurance is purchased for each business owner to cover the total purchase price (or at least the down payment). However, the premiums on such policies are not deductible (see I.R.C. §264) and can create a substantial ongoing expense.

Estate Planning Implications

The purchase of a deceased shareholder’s stock can deprive the estate of the advantage of certain post-mortem estate planning techniques such as special use valuation and installment payment of federal estate tax under.  As for the installment payment provision, the sale of all or a substantial part of the shares during the deferral period accelerates the deferred taxes.  I.R.C. §6166 (g)(1)(B).  Thus, it may be a good strategy to plan a series of redemptions or purchases in amounts equal to the taxes that must be paid in each of the fifteen years of the deferral period.

If a buy-sell is not planned well, the agreement can cause a gift of stock to a trust for the surviving spouse not to qualify for the estate tax marital deduction.  In Estate of Rinaldi v. United States, 38 Fed. Cl. 341 (1997), aff’d., 178 F.3d 1308 (Fed. Cir. 1998), cert. den., 526 U.S. 1006 (1999), a purchase option was created in the decedent’s will for a son that was named as trustee of a QTIP trust for the decedent’s surviving spouse.  The court determined that the marital deduction was not available because the son could purchase the stock at book value by ceasing active management in the company.  That result would have been the same had the option been included in an independent buy-sell agreement.

Funding

Life insurance is often the preferred means of funding the testamentary purchases of stock pursuant to a buy-sell agreement because the death benefit is financed by a series of smaller premium payments, and because the proceeds are received by the beneficiary without income tax liability.  See I.R.C. §101.  But, there can be traps associated with life insurance funding.  For instance, proceeds received by a C corporation can increase the corporation’s AMT liability by increasing its adjusted current earnings (even if the proceeds are to be used to redeem the stockholder’s shares).  See IRC §56(g).  Also, life insurance may be sufficient to fund the buyout of a deceased owner’s interest, but may be insufficient to fund the lifetime redemption occasioned by the owner’s disability or retirement.

Other observations.  The cash value of a permanent life insurance policy may be withdrawn by loan or surrender of the policy, but the value may be a very small percentage of the death benefit, inadequate to finance the buy-out. Disability insurance may be used to finance a purchase occasioned by an owner’s disability, but it can be quite expensive, and cannot be applied toward the purchase of an interest of an owner who is retiring or used to prevent the sale of an interest in the business to a buyer outside the family unit.

It is possible to use accumulated earnings of the business to fund a redemption. But, such a strategy may not be treated as a “reasonable need of the business” with the result that the business (if it is a C corporation) could be subject to the accumulated earnings tax.  I.R.C. §531.  However, corporate accumulations used to pay off a note given a stockholder for a redemption is a reasonable need of the business, as a debt retirement cost.  But see Smoot Sand & Gravel Corp. v. Comr., 274 F.2d 495 (4th Cir. 1960), cert. denied, 362 U.S. 976 (1960).

Conclusion

A well-drafted buy sell agreement can be a very useful document to assist in the transitioning of a family business from one generation to the next.  It can also be a useful device for assisting in balancing out inheritances among heirs by making sure the heirs interested in running the family business end up with control of the business and other heirs end up with non-control interests.  In any event, a sound buy-sell agreement is a critical part of many family business succession plans.  

April 11, 2022 in Business Planning | Permalink | Comments (0)

Saturday, April 9, 2022

Farm Economic Issues and Implications

Overview

A firm understanding of the economic context within which the farmers and ranchers operate is necessary for both tax planning and financial planning.  The creation and dissolution of legal entities, the restructuring of debt, and the use of various legal devices for the protection of assets from creditors and preserving inheritances cannot successfully be accomplished without knowledge of agriculture that transcends the applicable legal rules. 

Crop production, energy issues, monetary policy, issues in the meat sector and unanticipated outside shocks have farm-level impacts that professional advisors and counselors need to account for when representing farm and ranch clients.

Current economic issues impacting ag – it’s the topic of today’s post.

Projected Plantings (and Implications)

On March 31, the USDA released its “prospective plantings” report for the 2022 crops. https://www.nass.usda.gov/Publications/Todays_Reports/reports/pspl0322.pdf  The report projects farmers planting 91 million acres of soybeans and 89.5 million acres of corn.  The corn planting number is down 4 percent from last year, and is the lowest acreage estimate over the last five years.  The soybean projection is up four percent from 2021.  Total planted acres are projected to remain about the same as 2021.

Note:  The shift from corn acres to soybean acres was very predictable.  Farmers have calculators and can run the numbers with higher input costs (such as fertilizer).  Corn, as compared to soybeans, requires a greater amount of inputs which have risen in price substantially. 

Projected wheat planted acres is up one percent from 2021, but still is projected to be the fifth lowest total wheat planted acres since 1919.  Grain sorghum is projected to be down 15 percent (1.4 million acres) from 2021, with significant declines projected in Kansas and Texas.  Conversely, barley and sunflower planted acres is projected to increase 11 percent and 10 percent respectively from 2021.  With respect to sunflowers, however, the 2022 projection is still the fifth lowest planted area on record.  Cotton acreage is projected to be up about 800,000 acres.

Implication:  The projected planting numbers indicate that higher protein prices can be expected in the future.

Global Crops

The Russian war with Ukraine will have impacts on global grain trade and create additional issues for U.S. farmers and ranchers.  Russia and Ukraine are leading exporters of food grains.  But, Ukraine ports are closed and Russian imports are being avoided causing rising food prices. In the U.S., the rise is in addition to existing inflationary price increases for most good products.  Russia and Ukraine produce 19 percent of the world’s barley; 14 percent of the world’s wheat; and four percent of the world’s maize.  They also produce 29 percent of total world wheat exports and 19 percent of total world corn exports.  Those numbers are particularly important to countries that depend on imported grain from Russia and Ukraine, with a major issue being the loss of corn exports from Ukraine. 

Note:  U.S. corn exports are projected to rise, but U.S. wheat exports are not.

If the war triggers a global food crisis, the least developed countries that are also likely to be low-income or food-deficit countries are the most vulnerable to food shortages.  This would create a surge in malnutrition in these countries.  Presently, 50 countries rely on Russia and Ukraine for 30 percent of their wheat supply (combined), and 26 countries source at least 50 percent of their wheat needs from Russia/Ukraine.  Egypt and Turkey get over 70 percent of their wheat from Russia/Ukraine.  Russia supplies 90 percent of Lebanon’s wheat and cooking oil.  Grain shortages will hit the poorer African countries particularly hard.  These countries rely on imported bread to feed their expanding populations.  As a whole, in 2020, the  continent of Africa imported $4 billion worth of ag products from Russia (which supplied the majority of the continent’s wheat consumption. 

This combined data indicates an escalation of global food insecurity.  One estimate is that worldwide food and feed prices could rise by 22 percent which could, in turn, cause a surge in malnutrition in developing nations.  Since the war started, total world food output has decreased, resulting in a sharp drop in food exports from exporting countries.  Other food exporting countries have announced new limitations on food exports (or are exploring bans) to preserve domestic supplies.  This will have an impact on international grain markets and will likely have serious implications for the world’s wheat supply.  The extent of such disruptions is unknown at the present time. 

Note:  Russia is also a major fertilizer exporter, supplying 21 percent of world anhydrous exports, 16 percent of world urea exports and 19 percent of world potash exports.  Combined, Russia and Belarus provide 40 percent or world potash exports.  The Russia/Ukraine war will likely have long term impacts on fertilizer prices in the U.S. and elsewhere.  This will have impact crop planting decisions by farmers. 

Energy Policy

Incomprehensible energy policy in the U.S. since late January of 2021 and in Europe have been a financial boon to Russia.  The policy, largely couched in terms of ameliorating “climate change,” has resulted in the U.S. from being energy independent to begging foreign countries to produce more.  The restriction in U.S. production and distribution of oil has occurred at a time of increasing demand coming out of state government mandated shutdowns as a result of the China-originated virus.  The resulting higher energy prices have caused the prices of many products and commodities to increase. 

Monetary Policy

The U.S. economy is incurring the highest inflation in 40 years.  While the employment numbers are improving coming out of virus-related shutdowns, the labor force participation rate is not.  A higher rate of employment coupled with a decrease in the labor force participation rate may mean that workers are taking on multiple (lower paying) jobs in an attempt to stay even with inflation. 

The last time the government attempted to dig itself out of a severe inflationary situation the Federal Reserve raised interest rates substantially to “wring inflation out of the economy.”  The result for agriculture was traumatic, bringing on the farm debt crisis of the 1980s.  The current situation is similar with the Federal Reserve having backed itself into a corner with prolonged, historic low interest rates coupled with an outrageous increase in the money supply caused by massive government spending.  If the Federal Reserve attempts to get out of the corner by just raising interest rates, the end result will likely not be good.  The money supply must be reduced, or worker productivity gains must be substantial.  Higher interest rates are a means to reducing the money supply. 

Meat Sector

In the meat sector, the demand for beef remains strong.  Beef exports are steadily growing.  The current major issue in the sector is the disconnect between beef demand and the beef producer.  Currently, the large meat packers are enjoying record-wide margins.  Cattle producers are being signaled to decrease herd sizes because of the disconnect.  Legislation is being considered in the Congress with the intent of providing more robust and transparent marketing of live cattle.

On the pork side, demand is not as impressive but is improving.

For poultry, demand remains strong and flock sizes are decreasing largely because of the presence of Avian Flu. 

Some states have enacted labeling laws designed to protect meat consumers from deceptive and misleading advertising of “fake meat” products.  The Louisiana law has been held unconstitutional on free speech grounds. Turtle Island Foods SPC v. Strain, No. 20-00674-BAJ-EWD, 2022 U.S. Dist. LEXIS 56208 (M.D. La. Mar. 28, 2022).  Much of the advertising of “fake meat” products is couched not in terms of health benefits, but on reducing/eliminating “climate change.”  Government mandates have been imposed for the sake of “climate change” – a certain amount of ethanol blend in fuel; a certain amount of “renewable” energy to generate electricity, etc.). Could that also happen to the meat industry, but in a negative way?  A concern for the meat industry is whether the government will try to mandate that a certain percentage of meat cuts in a meat case consist of “fake meat” products based on a claim that doing so would further the “save the planet” effort. 

Water Issues

West of the Sixth Principal Meridian, access to water is critical for the success of many farming and ranching operations.  A dispute is brewing between Colorado and Nebraska over water in northeast Colorado that Nebraska lays claim to under a Compact entered into almost 100 years ago.  In the fertile Northeastern Colorado area, the State Engineer has shut-in almost 4,000 wells over the past two decades to maintain streamflow and satisfy downstream priority claims.  A similar number of wells have had their pumping rights limited in some way.  While this is a very diverse agricultural-rich area, water is essential to maintain production.  Given the rapid urban development in this area, the need for water for new subdivisions along the front range will trigger major political ramifications if there are any further reductions in agriculture’s water usage. 

The economic impact of water issues in Northeastern Colorado is already being felt.   The Colorado-Big Thompson Project collects, stores and delivers more than 200,000 acre-feet of supplemental water annually. Melting snowpack in the Colorado River headwaters on the West Slope is diverted through a tunnel beneath the Continental Divide to approximately 1,021,000 million residents and 615,000 acres of irrigated farmland in Northeastern Colorado. A unit (acre-foot) of Colorado Big Thompson water storage is presently selling for approximately $65,000.  Fifteen years ago, it was priced in the $6,000 range.  All other water shares are priced accordingly.  This dramatic increase in price has implications for the structure of farming operations, succession planning and estate valuation. 

Water access and availability will continue to be key to profitability of farms and ranches in the Plains and the West.

Tax Policy

In late March, the White House release its proposed 2023 fiscal year budget (October 1, 2022 – September 30, 2023).  At the same time, the Treasury release its “Greenbook” explanation of the tax provisions contained in the budget proposal.  Many of the proposals are the same as or similar to those included in bills in 2021 that failed to become law. 

Here’s a brief list of some of the proposals:

  • Top individual rate to 39.6 percent on income over $400,000 ($450,000 for married couples;
  • Corporate rate goes to 28 percent (87 percent increase on many farm corporations);
  • Raise capital gain rate to 39.6 percent on income over $1 million;
  • Capital gain tax on any transfer of appreciated property either during life or at death;
  • Partial elimination of stepped-up basis – if to spouse, then carryover; transfer of appreciated property to CRAT would be taxable;
  • Trust assets must be “marked-to-market” every 90 years beginning with any new trust after 1940. The rule would be the same for partnerships or any other non-corporate owned entity.  In addition, no valuation discount for partial interests, and a transfer from a trust would be a taxable event.  Exclusion of $1 million/person would apply.  Any tax on illiquid assets could be paid over 15 years or the taxpayer could elect to pay the tax when the property is sold or is no longer used as a farm (in that event, there would be no 15-year option);
  • All farm income (including self-rents) would be subject to the net investment income tax of 3.8 percent;
  • A minimum tax would apply to those with a net worth over $100 million;
  • Grantor-Retained Annuity Trusts (GRATs) must have minimum term of 10 years. This would essentially eliminate the use of a “zeroed-out” GRAT;
  • Any sale to a grantor trust is taxable and any payment of tax of the trust is a taxable gift;
  • Limitation on valuation discounts (related party rules);
  • R.C. §2032A maximum reduction would increase to $11.7 million
  • Trust reporting of assets would be required if the trust corpus is over $300,000 (or $10,000 of income);
  • Elimination of dynasty trusts;
  • Carried interest income would become ordinary income;
  • R.C. §1031 exchange tax deferral would be limited to $1 million;
  • Depreciation recapture would be triggered on the sale of real estate, which would eliminate the maximum 25% rate.

Note:  The provisions have little to no chance of becoming law, but if some or all were to become law, there would be significant implications for farm and ranch businesses.  Many of those implications would be negative for farming and ranching operations.

Conclusion

Farmland values remain strong.  Indeed, input, machinery costs and land values are outpacing inflation.  For those farmers that were able to pre-pay input expenses in 2021 for 2022 crops, the perhaps much of the price increase of inputs will be blunted until another round of inputs are needed in late 2022 for the 2023 crop.  Also, short-term loans were locked in before interest rates began rising.  That story will also likely be different in early 2023 when those loans are redone. 

The biggest risks to agriculture will continue to be from outside the sector.  Unexpected catastrophic events such as the Russian war with Ukraine, whether (or when) China will invade Taiwan, domestic monetary and fiscal policy, political developments at home and abroad, and regulation of agricultural activities remain the biggest unknown variables to the profitability of farming and ranching operations and agribusinesses. 

An awareness of the economic atmosphere in which farmers and ranchers operate is important to understand for practitioners to provide fully competent advice and counsel with respect to income tax, estate, business and succession planning for farmers and ranchers.

April 9, 2022 in Business Planning, Environmental Law, Estate Planning, Income Tax, Regulatory Law | Permalink | Comments (0)

Tuesday, April 5, 2022

Pork Production Regulations; Fake Meat; and Tax Proposals on the Road to Nowhere

Overview

Last week, there were two court major court developments of importance to agriculture.  In one, the U.S. Supreme court agreed to hear a case from the U.S. Court of Appeals for the Ninth Circuit involving California’s Proposition 12.  That law sets rules for pork production that must be satisfied for the resulting pork products to be sold in California.  In another development, a federal court in Louisiana held that state’s law designed to protect consumers from misleading and false advertising concerning meat products. 

The Supreme Court and Pork Production Regulations

National Pork Producers Council, et al. v. Ross, 6 F.4th 1021 (9th Cir. 2021), cert. granted, No. 21-468, 2022 U.S. LEXIS 1742 (U.S. Mar. 28, 2022) 

Background.  California voters approved Proposition 12 in 2018.  The new law took effect on January 1, 2022.  Proposition 12 bans the sale of whole pork meat (no matter where produced) from animals confined in a manner inconsistent with California’s regulatory standards (largely remaining to be established).  It also establishes minimum requirements on farmers to provide more space for egg-laying hens, breeding pigs, and calves raised for veal. Specifically, the law requires that covered animals be housed in confinement systems that comply with specific standards for freedom of movement, cage-free design and minimum floor space. The law identifies covered animals to include veal calves, breeding pigs and egg-laying hens.

The implementing regulations are to prohibit a farm owner or operator from knowingly causing any covered animal to be confined in a cruel manner, as specified, and prohibits a business owner or operator from knowingly engaging in the sale within the state of shell eggs, liquid eggs, whole pork meat or whole veal meat, as defined, from animals housed in a “cruel manner.”  In addition to general requirements that prohibit animals from being confined in a manner that prevents lying down, standing up, fully extending limbs or turning around freely, the measure added detailed confinement space standards for farms subject to the law. The alleged reason for the law was to protect the health and safety of California consumers and decrease the risk of foodborne illness and the negative fiscal impact on California.  Apparently, California believes that existing state and federal law regulating food products for health and safety purposes was inadequate (or the alleged reason for the law is false). 

Trial court.  In late 2019, several national farm organizations challenged Proposition 12 and sought a declaratory judgment that the law was unconstitutional under the Dormant Commerce Clause. 

Note:   The Dormant Commerce Clause bars states from passing legislation that discriminates against or excessively burdens interstate commerce.  It prevents protectionist state policies that favor state citizens or businesses at the expense of non-citizens conducting business within that state.  The clause is dormant because it is not state outright, but rather implied in the Constitution’s Commerce Clause of Article I, Section 8, Clause 3.

The plaintiffs also sought a permanent injunction preventing Proposition 12 from taking effect.  The plaintiffs claimed that Proposition 12 impermissibly regulated out-of-state conduct by compelling non-California producers to change their operations to meet California’s standards.  The plaintiffs also alleged that Proposition 12 imposed excessive burdens on interstate commerce without advancing any legitimate local interest by significantly increasing operation costs without any connection to human health or foodborne illness.  The trial court dismissed the plaintiffs’ complaint.  

Appellate court decision.  On appeal, the plaintiffs focused their argument on the allegation that Proposition 12 has an impermissible extraterritorial effect of regulating prices in other states and, as such, is per se unconstitutional.  This was a tactical mistake for the plaintiffs.  The appellate court noted that existing Supreme Court precedent on the extraterritorial principle applied only to state laws that are “price control or price affirmation statutes.”   Thus, the extraterritorial principle does not apply to a state law that does not dictate the price of a product and does not tie the price of its in-state products to out-of-state prices.  Because Proposition 12 was neither a price control nor a price-affirmation statute (it didn’t dictate the price of pork products or tie the price of pork products sold in California to out-of-state prices) the law didn’t have the extraterritorial effect of regulating prices in other states.  The appellate court likewise rejected the plaintiffs’ claim that Proposition 12 has an impermissible indirect “practical effect” on how pork is produced and sold outside California.  Upstream effects (e.g., higher production costs in other states) the appellate court concluded, do not violate the dormant Commerce Clause.   The appellate court pointed out that a state law is not impermissibly extraterritorial unless it regulates conduct that is wholly out of state.  Because Proposition 12 applied to California and non-California pork production the higher cost of production was not an impermissible effect on interstate commerce.  The appellate court also concluded that inconsistent regulation from state-to-state was permissible because the plaintiffs had failed to show a compelling need for national uniformity in regulation at the state level.  In addition, the appellate court noted that the plaintiffs had not alleged that Proposition 12 had a discriminatory effect on interstate commerce and, as such, had failed to plead a Dormant Commerce Clause violation. 

Supreme Court grants certiorari.  On March 28, 2022, the U.S. Supreme Court agreed to hear the case.  The issues before the Court are: (1) whether allegations that a state law has dramatic economic effects largely outside of the state and requires pervasive changes to an integrated nationwide industry state a violation of the Dormant Commerce clause, or whether the extraterritoriality principle is now a dead letter; and (2) whether the allegations, concerning a law that is based solely on preferences regarding out-of-state housing of farm animals, state a claim in accordance with Pike v. Bruce Church, Inc., 347 U.S. 132 (1970). In Pike, the Court said a state law that regulates fairly to effectuate a legitimate public interest will be upheld unless the burden on commerce is clearly excessive in relation to commonly accepted local benefits. 

In the current case, while California accounts for about 13 percent of U.S. pork consumption, essentially no pigs are raised there.  Thus, the costs of compliance with Proposition 12 fall almost exclusively on out-of-state hog farmers.  In addition, because a hog is processed into cuts that are sold nationwide in response to demand, those costs will be passed on to consumers everywhere, in transactions that have nothing to do with California. 

Meat Labeling Law Unconstitutional 

Turtle Island Foods SPC v. Strain, No. 20-00674-BAJ-EWD, 2022 U.S. Dist. LEXIS 56208 (M.D. La. Mar. 28, 2022)

Background.  In 2019, Louisiana enacted the Truth in Labeling of Food Products Act (“Act”), with the Act taking effect October 1, 2020.  Among other things, the Act prohibits the intentional misbranding or misrepresenting of any food product as an agricultural product via a false or misleading label; selling a product under the name of an ag product; representing food product as an meat or a meat product when the food product is not derived from a harvested beef, port, poultry, alligator, farm-raised deer, turtle, domestic rabbit, crawfish, or shrimp carcass. 

The LA Dept. of Ag and Forestry (LDAF) developed rules and regulations to enforce the Act with fines of up to $500 per violation per day but had not received any complaints nor brought any enforcement actions against anyone. Indeed, the LDAF determined that plaintiff’s product labels complied with the law. 

The plaintiff produces and packages plant-based meat products that are marketed and sold in LA and nationwide.  Plaintiff’s labels and marketing materials clearly state that its products are plant-based, meatless, vegetarian or vegan, and accurately list the products ingredients.  After the Act passed, the plaintiff refrained from using certain words and images on marketing materials and packages and removed videos from its website and social media to avoid prosecution under the Act. 

Trial court decision.  The plaintiff sued, challenging the constitutionality of the Act on the grounds that the Act violated its freedom of commercial speech.  The plaintiff claimed it would be very expensive to change its labeling and marketing nationwide.  The trial court determined that the plaintiff had standing because “chilled speech” or “self-censorship” is an injury sufficient to confer standing, and that the plaintiff had demonstrated a “serious intent” to engage in proscribed conduct and that the threat of future enforcement was substantial. 

On the merits, as noted, the plaintiff asserted that its conduct was protected commercial speech (both current and future intended) that the Act prohibited.  The trial court noted that commercial speech is not as protected as is other forms of speech.  To be constitutional, the government speech (the Act) must be a substantial governmental interest, advance the government’s asserted interest and not be any more excessive than what is necessary to further the government’s interest.  The trial court determined that the Act was more extensive than necessary to further the state’s interest.  While the interest in protecting consumers from misleading and false labeling is substantial, the defendant failed to establish that consumers were confused by the plaintiff’s labeling.  Thus, the Act failed to directly advance the State’s interest and was more extensive than necessary to further that interest.    The trial court also determined that the defendant failed to show why alternative, less-restrictive means, such as a disclaimer would not accomplish the same goal of avoiding consumer deception/confusion.  The trial court held the Act unconstitutional and enjoined its enforcement. 

“Greenbook” Released

On March 28, the White House released the details of its $6 trillion budget for the 2023 fiscal year (October 1, 2022 – September 30, 2023).  That same day, the Treasury released the Greenbook, its explanations of the revenue proposals.  Many of the provisions are those that were proposed in 2021, but did not become law.  Here’s a brief rundown of the provisions of most significance to farmers and ranchers:

  • Top individual rate to 39.6 percent on income over $400,000 ($450,000 for married couples;
  • Corporate rate goes to 28 percent (87 percent increase on many farm corporations);
  • Raise capital gain rate to 39.6 percent on income over $1 million;
  • Capital gain tax on any transfer of appreciated property either during life or at death;
  • Partial elimination of stepped-up basis – if to spouse, then carryover; transfer of appreciated property to CRAT would be taxable;
  • Transfers of property by gift or at death would be a realization event (eliminates the fair market value at death rule);
  • Trust assets must be “marked-to-market” every 90 years beginning with any new trust after 1940. The rule would be the same for partnerships or any other non-corporate owned entity.  In addition, no valuation discount for partial interests, and a transfer from a trust would be a taxable event.  Exclusion of $1 million/person would apply.  Any tax on illiquid assets could be paid over 15 years or the taxpayer could elect to pay the tax when the property is sold or is no longer used as a farm (in that event, there would be no 15-year option);
  • All farm income (including self-rents) would be subject to the net investment income tax of 3.8 percent;
  • A minimum tax would apply to those with a net worth over $100 million;
  • Long-term capital gains and qualified dividends taxed at ordinary income rates for taxpayers with taxable income exceeding $1 million;
  • Grantor-Retained Annuity Trusts (GRATs) must have minimum term of 10 years. This would eliminate the use of a “zeroed-out” GRAT; also, the remained interest in a GRAT at the time of creation must have a minimum value for gift tax purposes equal to the greater of 25 percent of the value of assets transferred to the GRAT or $500,000.  In addition, there would be limited ability to use a donor-advised fund to avoid the payout limitation of a private foundation;
  • Any sale to a grantor trust is taxable and any payment of tax of the trust is a taxable gift;
  • Limitation on valuation discounts (related party rules);
  • R.C. §2032A maximum reduction would increase to $11.7 million (from current level of $1.23 million);
  • Trust reporting of assets would be required if the trust corpus is over $300,000 (or $10,000 of income);
  • Elimination of dynasty trusts;
  • Carried interest income would become ordinary income;
  • No basis-shifting by related parties via partnerships;
  • Limitation of a partner’s deduction in certain syndicated conservation easement transactions;
  • R.C. §1031 exchange deferral would be limited to $1 million;
  • Depreciation recapture would be triggered on the sale of real estate, which would eliminate the maximum 25% rate;
  • Elimination of credit for oil and gas produced from marginal wells;
  • Repeal of expensing of intangible drilling costs;
  • Repeal of enhanced oil recovery credit;
  • Adoption credit refundable, and some guardianship arrangements qualify; and
  • Expand the definition of “executor” to apply for all tax matters.

The provisions have little to no chance of becoming law, but they are worth paying attention to. 

Conclusion

There’s never a dull moment in agricultural law and tax. 

April 5, 2022 in Business Planning, Estate Planning, Income Tax, Regulatory Law | Permalink | Comments (0)

Friday, April 1, 2022

Captive Insurance – Part Three

Overview

This week, I have been discussing captive insurance.  Part One set forth the definition of captive insurance and how a captive insurance company is treated for income tax purposes as well as how it might be used for estate planning and business succession.  Part Two examined IRS concerns with captive insurance and the results of litigation involving the concept.  Today, in Part Three, I take a look at some recent IRS administrative issues concerning captive insurance and the attempts of the IRS to “crack-down” on the use of the concept to achieve income tax savings and estate planning benefits.  On this point, the most recent developments have not gone well for the IRS.

Captive insurance and recent administrative/regulatory issues – it’s the topic of today’s post.

Administrative Issues

2015 IRS Notice.  Abusive micro-captives have been a concern to the IRS for several years. IRS initiated forensic audits of large captive insurance providers at least a decade ago which resulted in certain transactions making the “Dirty Dozen” tax scam list starting in 2014.  In 2015, the IRS issued a news release that notified taxpayers that it would be taking action against micro-captive insurance arrangements it believes are being used to evade taxes.  IR 2015-16 (Feb. 3, 2015).  Since that time, the IRS has been litigating the micro-captive insurance issue aggressively. 

2016 IRS Notice.  In 2016, the IRS issued a Notice which identified certain micro-captive transactions as having the potential for tax avoidance and evasion.  Notice 2016-66, 2016-47 IRB 745.  In the Notice, the IRS indicated that micro-captive insurance transactions that are the same as, or substantially similar to, the transactions described in the Notice would be considered “transactions of interest.”  Under the Notice, these transactions require information reporting as “reportable transactions” under Treas. Reg. §1.6011 and I.R.C. §§6011 and 6012 for taxpayers engaging in the transactions and their “material advisers.”  Thus, persons entering into micro-captive transactions were required to disclose such transactions to the IRS via Form 8886 and “material advisors” also had disclosure and maintenance obligations under I.R.C. §§6111-6112 and the associated regulations.  In addition, a “material advisor” had to file a disclosure statement (Form 8918) with the IRS Office of Tax Shelter Analysis by January 30, 2017, with respect to such transactions entered into on or after November 2, 2006.  Failure to make the required disclosures came with possible civil and/or criminal penalties.  On December 30, 2016, the IRS extended the disclosure deadline for micro-captive transactions to May 1, 2017.  Notice 2017-08.

Note:  After the issuance of the Notice, the IRS audits of micro-captive arrangements and litigation ramped up substantially.

A manger of captive insurance companies subject to the disclosure requirements challenged Notice 2016-66 in early 2017.  The Notice would have forced the manager to incur substantial compliance costs.  The manager claimed that the Notice constituted a legislative-type rule and, as such, was subject to the mandatory notice-and-comment requirements of the Administrative Procedures Act (APA).  5 U.S.C. §553, et seq.  The manager also claimed that the Notice was invalid as being arbitrary and capricious, and that the IRS failed to submit the rule contained in the Notice to Congress and the Comptroller General as the Congressional Review of Agency Rule-Making Act required.  5 U.S.C. §801.  The manager sought a declaration under the Declaratory Judgment Act (28 U.S.C. §2201) that the Notice was invalid and that an injunction barring the IRS from enforcing the disclosure requirements of the Notice should be issued. 

Note:  Since 2019, the IRS has offered a settlement framework for taxpayers under audit on micro-captive insurance arrangements.  IR 2019-157 (Sept. 16, 2019).  In 2020, the IRS made the settlement framework more restrictive and increased the number of examinations.  IR 2020-26 (Jan. 31, 2021) and IR 2020-241 (Oct. 22, 2020).  Under the 2020 framework, taxpayers are offered reduced accuracy-related penalties of 5, 10 or 15 percent (instead of 20 or 40 percent).  In exchange, a taxpayer must agree to have 90 percent of the premium deductions disallowed for all open tax years, as well as any captive-related expenses such as management fees.  The captive insurance company must also be liquidated, or else there will be a deemed distribution to the owners for the amount of premiums paid to the captive during all years. 

The trial court denied the plaintiffs’ motion for a preliminary injunction, reasoning that the plaintiffs were not likely to succeed on the merits because the claims were likely barred by the Anti-Injunction Act (AIA).  26 U.S.C. §7421. 

Note:  The AIA provides that “no suit for the purpose of restraining the assessment or collection of any tax shall be maintained in any court.”  Instead, a tax can be challenged in court only after the plaintiff pays the disputed tax and files a claim for refund.

The IRS moved to dismiss the plaintiffs’ claims.  The trial court granted the motion and dismissed the case for lack of subject matter jurisdiction.  CIC Services, LLC v. Internal Revenue Service, No. 3:17-cv-110, 2017 U.S. Dist. LEXIS 181482 (E.D. Tenn. Nov. 2, 2017).  The appellate court affirmed.  CIC Services, LLC v. Internal Revenue Service, 925 F.3d 247 (6th Cir. 2019).  On further review, however, the U.S. Supreme Court reversed, vacated the appellate court’s decision, and remanded the case to the trial court.    CIC Services, LLC v. Internal Revenue Service, 141 S. Ct. 1582 (2021).  The Court unanimously held that the AIA did not bar pre-enforcement judicial review of the Notice.  The Court pointed out that while the Notice was “backed by” tax penalties, the plaintiffs’ suit challenged the Notice’s “reporting mandate separate from any tax.” On remand, the trial court set aside the Notice and ordered the IRS to return all documents that it had collected under the Notice.  The trial court stated, “While the IRS may ultimately be correct that micro-captive insurance arrangements have the potential for tax avoidance or evasion and should be classified as transactions of interest, the APA requires that the IRS examine relevant facts and data supporting that conclusion.”  CIC Services, LLC v. Internal Revenue Service, No. 3:17-cv-00110 (E.D. Tenn. Mar. 21, 2022). 

Shortly before the trial court’s remand decision in CIC Services, LLC, the U.S. Court of Appeals for the Sixth Circuit voided IRS Notice 2007-83, 2007-2 CB 960 that established reporting requirements for potentially abusive benefit trust arrangements or face the imposition of civil and/or criminal penalties for engaging in such a “listed transaction.”  Mann Construction, Inc. v. United States, No. 21-1500, 2022 U.S. App. LEXIS 5668 (6th Cir. Mar. 3, 2022), rev’g., 539 F.Supp. 3d 745 (E.D. Mich. 2021).  With Notice 2007-83, the appellate court concluded that the IRS had developed a legislative rule without going through the APA’s required notice and comment procedures.  The Congress had not created any exemption for the IRS from this rulemaking requirement.  Indeed, the appellate court pointed out in Mann Construction, Inc. that the U.S. Supreme Court had rejected the notion that tax law deserves a special “carve-out” from the APA’s notice and comment requirement.  Mayo Foundation for Medial Education & Research v. United States, 562 U.S. 44 (2011). 

Note:  Before getting pushed back by the Courts for rulemaking without following the APA’s rulemaking requirements, the IRS gave some indication that it was also looking at captive insurance company variations.  See IR-2020-226 (Oct. 1, 2020); FAA 20211701F (Feb. 5, 2021).

Filing Obligations

In the summer of 2020, the IRS issued I.R.C. §6112 letters to persons it believed to be a “material advisor” that had failed to report themselves for engaging in an “abusive” transaction.  Since the courts have now voided Notice 2016-66, the filing of Form 8918 and the associated penalties are currently not in play.  But the I.R.C. §6694 preparer penalties are still applicable for taking an unreasonable position on the return.  Also, the IRS could follow the APA’s notice-and-comment procedures and properly adopt its position taken in Notice 2016-66 in the future.  If IRS does, it appears to have attorneys trained to review captive insurance company issues.  Thus, tax practitioners would be well-advised to proceed with caution when engaging with clients interested in captive insurance and examine client files where captive insurance companies have already been established. 

Conclusion

The recent developments surrounding micro-captive arrangements have forestalled the IRS from treating them as “listed transactions” at least until the IRS complies with the APA’s notice and comment requirements.  That’s a big development on the penalty issue, but it doesn’t mean reporting requirements necessary to avoid penalties won’t come back in the future. 

In addition, the caselaw over the past few years provides helpful guidance concerning the proper structuring of captive/micro-captive insurance corporations to provide a more economical means of risk management to business such as farms and ranches.  Also, if structured properly, a micro-captive arrangement can be used to accomplish specific income tax as well as estate and business planning objectives of the owner(s). 

April 1, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Wednesday, March 30, 2022

Captive Insurance – Part Two

Introduction

In Part One earlier this week, I introduced the concept of a captive insurance company. Part One can be found here: https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-one.html  In Part One, I looked at the income tax, estate and gift tax implications of captive companies and how they might be used as part of an overall income tax planning, estate planning and succession planning vehicle to minimize unique risks of the business.      

In Part Two today, I look at the IRS audit issues associated with captive insurance companies and how the courts have addressed the issues. 

Captive insurance companies, IRS audit issues and litigation. It’s the topic of today’s post.

IRS Scrutiny, Litigation and Other Developments

The IRS focus.  Abusive micro-captive corporations have been a concern to the IRS for several years.  The basic issue is where the line is between deductible captive insurance and non-deductible self-insurance.

Note:  The IRS focus centers on the fact that with an I.R.C. §831(b) election premiums can be deducted at ordinary income rates and can then be distributed to owners at capital gain rates.  To the extent claims are not paid, the premiums can be distributed from the captive in a manner that escapes transfer taxes.  Both of these issues, in turn, are centered on whether the captive company is insuring legitimate business risks and that “insurance” is actually involved. 

IRS audits.  IRS initiated forensic audits of large captive insurance providers at least a decade ago, and the IRS activity resulted in certain transactions making the “Dirty Dozen” tax scam list starting in 2014.  In 2015, the IRS put out a news release that notified taxpayers that it would be taking action against micro-captive insurance arrangement that it believes are being used to evade taxes.  IR 2015-16 (Feb. 3, 2015).  In 2016, the IRS issued a Notice which identified certain micro-captive transactions as having the potential for tax avoidance and evasion.  Notice 2016-66, 2016-47 IRB 745.  Since that time, the IRS has been litigating the micro-captive insurance issue aggressively. 

Court cases.  Taxpayers have won court cases involving IRS challenges to the tax treatment of and deductions associated with captive insurance companies.  The wins involved large captive insurance companies.  For instance, in Rent-A-Center v. Comr., 142 T.C. 1 (2014), the Tax Court determined that payments that a subsidiary corporation made to a captive insurance company were insurance expenses deductible under I.R.C. §162.  Likewise, in Securitas Holdings, Inc. v. Comr., T.C. Memo. 2014-225, the Tax Court determined that premiums paid to a brother-sister captive insurance company were deductible.  Also, in R.V.I. Guaranty Co. Ltd. and Subs v. Comr., 145 T.C. 209 (2015), the Tax Court held that insuring against losses in the residual value of an asset leased to third parties was insurance for federal income tax purposes. 

Note:  Importantly, in each of the cases involving taxpayer wins, the Tax Court determined that actual “insurance” was involved. 

But the IRS has won several prominent cases since ramping up its scrutiny.  In Avrahami v. Comr., 149 T.C. 144 (2017), the petitioners (a married couple) owned three shopping centers and several jewelry stores in Arizona.  Via these businesses, they deducted about $150,000 in insurance expenses in 2006.  The petitioners then formed a captive insurance company under the law of the Federation of Saint Kitts and Nevis (the birthplace of Alexander Hamilton).  After the captive insurance company was formed their deductible insurance expenses for the companies increased to over $1.1 million annually, and included coverage for terrorism risks and tax liabilities from an IRS audit. 

The Tax Court upheld the IRS determination that the expenses were non-deductible and that the elections the micro-captive company had made under I.R.C. §953(d) and 831(b) were invalid because the micro-captive company did not qualify as a legitimate insurance business.  The Tax Court noted that proper policy language, actuarial standards, and payment and processing of claims are required to operate as an insurance company. These features were lacking.  In addition, the Tax Court determined that there was inadequate risk distribution, and the actuary did not have any coherent explanation of how he priced the insurance policies.  Also, there had been no claims filed until two months after the IRS initiated an audit.  In addition, a majority of the investments of the micro-captive were in long-term illiquid and partially unsecured loans to related parties – the petitioners’ other entities.  This left little liquid fund from which to pay claims.  All of these facts indicated to the Tax Court that the captive was not a legitimate insurance company. 

Note:  It is important to establish that the captive insurance company was established to reduce or insure against risks, and not just to achieve tax benefits.  In additions, policies must be appropriately priced relative to commercial insurance.  The payment of excess premiums annually for a number of years while few or no claims are made inures against a finding of a legitimate business purpose for creating the captive. 

The next year, the Tax Court in Reserve Mechanical Corp. v. Comr., T.C. Memo. 2018-86, disallowed deductions for insurance premiums based largely on the same reasoning utilized in Avrahami.  The case involved an Idaho company engaged in manufacturing and distributing heavy machinery used for underground mining.  Its business activities were heavily regulated and subject to potential liability risk under various state and federal environmental laws.  To minimize the risk from its business operations in a more cost-effective manner, the owner(s) formed a captive insurance company under the laws of Anguilla, British West Indies to provide itself with an excess pollution policy.  The captive company also provided other policies covering business cyber risk. 

The Tax Court held that the micro-captive company was not a legitimate insurance company because its transactions were not “insurance transactions.”  The Tax Court also determined that the micro-captive didn’t qualify as a domestic corporation.  The Tax Court upheld the IRS’ determination that the company was subject to a 30 percent tax under I.R.C. §881(a) on fixed or determinable annual or periodical (FDAP) income the company received from U.S. sources.  The Tax Court determined that the income was not effectively connected with the conduct of a U.S. trade or business. 

In Syzygy Insurance Co. v. Comr., T.C. Memo. 2019-34, the petitioners had a family business that manufactured steel tanks.  Annual revenue averaged about $55 million.  The business obtained policies from a captive insurance company, but the arrangement, the Tax Court determined, did not resemble insurance transactions.  As it had in the 2018 case, the Tax Court noted that for a company to make a valid I.R.C. §831(b) election, it must transact in insurance.  As noted above, if insurance is actually involved, premiums paid are deductible. The Tax Court analyzed the policies and concluded that there was no risk distribution, the arrangement was not “insurance” in the commonly accepted sense of the term.  Thus, the premium payments were not deductible. They were neither fees or payments for insurance. The Tax Court also noted that the president of the family business had sent an email stating that one of the reasons for leaving the previous insurance arrangement was the decrease in premiums. Judge Ruwe wrote, “It is fair to assume that a purchaser of insurance would want the most coverage for the lowest premiums… The fact that [the president] sought higher premiums leads us to believe that the contracts were not arm’s-length contracts but were aimed at increasing deductions.”

Note:  To reiterate, business deductions must have a business purpose, and not be solely for the purpose of lowering income tax liability.

In early 2021, the Tax Court decided Caylor Land Development v. Comr., T.C. Memo. 2021-30.  In Caylor, the petitioner was a construction company.  The petitioner’s $60,000 annual insurance cost was deemed to be too high.  Beginning in late 2007 the company took out policies from a related micro-captive company formed under the laws of Anguilla.  Doing so caused the petitioner’s insurance bill to increase to about $1.2 million.  The petitioner paid $1.2 million to the captive insurance company on the day of formation and deducted that amount on its 2007 return.   Each year thereafter, the deducted consulting payments (legal, accounting and management fees) were about $1.2 million.  The micro-captive company did not include the $1.2 million in income.  The Tax Court held that the arrangement did not qualify as insurance for tax purposes because the micro-captive company did not provide insurance (because there was no risk distribution).  IN addition, the Tax Court concluded that the arrangement did not resemble any type of commonly accepted notion of insurance.  The Tax Court also upheld 20 percent accuracy related penalties for substantial understatement of tax and for negligence. 

Taxpayer victory – sort of.  In late 2021, the Tax Court entered an order in Puglisi et al. v. Comr, No. 13489 (Nov. 5, 2021). The IRS conceded the case before trial to avoid an adverse ruling on the merits.  The petitioners owned an egg farm in Delaware with more than 1.2 million egg-producing hens.  The farm owned a liability insurance policy but wasn’t able to buy insurance to insure against the Avian flu. 

Note:  In early 2022, reports of Avian influenza surfaced in flocks of chickens in Montana, Nebraska, South Dakota, Iowa and elsewhere.  The presence of this influenza results in the destruction of the flock at great cost to the owner(s). 

As a result, the petitioners formed a captive insurance company to provide that additional coverage.  The captive company was a Delaware corporation operaitng as a reinsurance company.  The egg farm bought insurance from a fronting company.  The fronting company then entered into a reinsurance arrangement with the captive company.  Under the reinsurance arrangement the captive insurance company reinsured 20 percent of all approved claims of the egg farm, and 80 percent of all approved claims of unrelated entities that the fronting company insured. The egg farm was organized as an LLC which resulted in deductions flowing through to the petitioners’ personal returns.  Before the IRS initiated an audit, the egg farm had submitted a total of five claims to the fronting company. 

The IRS audited and issued statutory notices of deficiency (taxes and penalties) exceeding $2.7 million (total) for 2015, 2016 and 2018.  Ultimately, the IRS conceded the deductions and sought an order from the Tax Court that the deficiency was a mere $18,587 for 2015.  The petitioners objected, wanting the Tax Court to rule on whether the fronting company was an insurance company for income tax purposes because the issue of the deductibility of premiums paid to the fronting company would be an issue that would continue to arise annually. and they wanted the issue resolved.  In addition, many other businesses paid insurance premiums to the fronting company that were reinsured, at least in part, by the petitioner’s captive insurance company.  The Tax Court refused to rule on the matter and entered a decision in line with the IRS’ concession.  Presently, it remains to be seen whether the IRS will challenge the petitioners’ captive insurance company in the future. 

Note:  It’s important to note that the IRS continued to maintain that the fronting company was not an insurance company for tax purposes, even though it conceded the tax deficiency issue. 

Conclusion

Captive insurance certainly has come under IRS scrutiny in recent years.  But, if it truly involves insurance and is providing risk-management for unique risks of the business with premiums set at reasonable rates, it is a legitimate concept.  The court cases illustrate those points and show the boundaries of what is an appropriate use of a captive insurance company and what is not.

In Part Three, I will turn my attention to IRS administrative attempts to tighten the screws on captive insurance transactions without following procedural law and the courts pushing the IRS back.  These developments have filing/disclosure implications for tax practitioners and “material advisors.”

March 30, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Monday, March 28, 2022

Captive Insurance – Part One

Overview

Many businesses, including farming and ranching businesses, face rising insurance costs and higher self-insured risks for hazards that were not an issue in the past.  This is particularly true for many ag businesses that face ever-increasing environmental rules and regulations that can impair operational profitability, heightened cyber threats, as well as supply chain and labor issues.  As a result, some of these businesses have begun to investigate and utilize captive (and micro-captive) insurance. 

What is captive insurance and what are the benefits of it?  Where does it fit in the overall income tax and estate/business plan for a business, including farming and ranching operations?  What concerns might the IRS have with captive insurance, and what do those concerns mean for practitioners?

Utilizing captive insurance as part of an income tax and estate/business plan that also is designed to minimize business risk - it’s the topic of today’s post.  Part One of a three-part series. 

Captive Insurance Defined

A captive insurance company is an insurer that is a wholly owned subsidiary that providing risk-mitigation services for its parent company or a group of related companies.  A key to being a true captive insurance company is the provision of risk-mitigation.  Often, the reason for forming a captive insurance company is when a business (the parent company) is unable to find standard commercial insurance to cover risks that are unique to the business.  Without the creation of a captive insurance company, the business is left to self-insure against risks for which it is unable to acquire commercial insurance.  In this situation, a captive insurance company provides the ability to shift self-insured risks to the captive company with policies tailored to fit the unique parent’s unique needs.  The owners of the parent can retain control of the captive’s investments, and may also be able to achieve tax savings and wealth transfer benefits

Note:  Since 2000, the potential risks to a business from contract non-performance (business interruption), a loss of key suppliers and input supplies, cyber-attacks, labor shortages, and administrative and/or regulatory actions have increased substantially.  This is causing businesses (including farming and ranching operations) to search for cost-effective and tax efficient ways to manage these unique risks.   A captive insurance company is viewed as one approach that can satisfy an overall risk-mitigation strategy.  See, e.g., “Once Scrutinized, an Insurance Product Becomes a Crisis Lifeline,” The New York Times (Mar. 20, 2020). 

Income Tax Aspects

Insurance is a transaction that involves an actual insurance risk and involves risk-shifting and risk-distributing.  Helvering v. Le Gierse, 312 U.S. 521 (1941).  Insurance premiums are deductible as an ordinary and necessary business expense under I.R.C. §162(a) if paid or incurred in connection with the taxpayer’s trade or business.  Treas. Reg. §1.162-1(a).  However, amounts set aside in a loss reserve as a form of self-insurance are not deductible.  See, e.g., Harper Group v. Comr., 96 T.C. 45 (1991), aff’d., 979 F.2d 1341 (9th Cir. 1992).  As Judge Holmes stated in Caylor Land & Development, Inc. v. Comr., T.C. Memo. 2021-30, “the line between nondeductible self-insurance and deductible insurance is blurry, and we try to clarify it by looking to four nonexclusive but rarely supplemented criteria:

  • risk-shifting;
  • risk-distribution;
  • insurance risk; and
  • whether an arrangement looks like commonly accepted notions of insurance.”

On the other side of the equation, an insurance company includes premiums that it receives in income, and the company is generally taxed on its income just like any other corporation.  I.R.C. §831(a).  But an insurance company that receives premiums under a certain amount during a tax year can elect to be taxed only on investment income.  I.R.C. §831(b)(1)-(2). 

Note:  For premiums paid to be deductible, the captive must be respected as an insurance company for federal income tax purposes.  Otherwise, what is involved non-deductible self-insurance.  This means that qualified underwriting services must be used to determine the actual cost of similar coverage in the market or via an underwriting evaluation so that the policies are properly designed and the premiums are appropriate.  This is key to getting the desired tax treatment and withstanding an IRS attack.  Setting premiums too high coupled with claims that are less than anticipated will cause the captive’s stock value to rise. That value can be returned to shareholders in a tax-favorable manner as qualified dividends taxed at favorable capital gain rates.  Hence, the importance of the proper structuring of the captive to avoid an IRS attack and the imposition of severe penalties (explained further below).

Estate and Business Planning Aspects

Before the Congress modified I.R.C. §831, the captive or micro-captive corporation could fit rather easily into an estate or succession plan, and could be held in various types of entities depending upon the overall estate and business plan of the owner(s).  A straightforward approach, for example, was to have a parent (or parents) form a captive insurance company and name the children as the shareholders.  As the parents paid the premiums, they achieved insurance coverage for their unique need(s) and transferred wealth to the children.  Establishing the captive, however, must be justified by a legitimate business purpose of insuring risks of the business other than simply transferring wealth in a tax-efficient manner to the children.

Trust ownership.  A trust could be established to own the captive insurance company.  If the trust’s beneficiaries are the grantor’s children and/or grandchildren, it is possible to structure the trust such that the assets of the captive insurance corporation will not be included in the owner’s estate at death. 

LLC/FLP ownership.  Similarly, the captive corporation could be placed in a limited liability company (LLC) or a family limited partnership (FLP).  The ownership structure of the LLC or FLP could involve various classes of ownership held by various members of the owner(s) family.  This structure may be especially beneficial in the context of a small businesses such as a farm or ranch where the senior generation wants to maintain control over the business, investments, and distributions of the captive insurance corporation while simultaneously setting up valuation discounts for minority interest and/or lack of marketability.

Gift tax.  From a federal gift tax standpoint, income tax deductible premiums made for adequate and full consideration are not a gift from the owners of the insured to the owners of the captive insurance company.  Treas. Reg. §§25.2512-1(g)(1); 25-2512-8.  The “full and adequate consideration” test of I.R.C. §2512 applies in the estate tax context such that the premium payments are not pulled back into the decedent/transferor’s estate at death for federal estate tax purposes under I.R.C. §2036 or I.R.C. §2038.  This also means that the generation-skipping transfer tax (GSTT) would not apply.

Statutory modifications.  In late 2015, the Congress passed “extender” legislation that included new rules impacting certain captive insurance companies.  Under the new rules, effective for tax years beginning after 2016, the maximum amount of annual premiums that a captive insurance company may receive became capped (subject to an inflation adjustment).  The cap is $2.45 million for 2022.  In addition, a captive insurance company must satisfy one of two “diversification” tests that bear directly on the ability to transfer wealth to the next generation without transfer tax.  Under this requirement, the ownership of the underlying business of the captive must be within two percent of the ownership of the captive.  The new rule applies to all I.R.C. §831(b) captive insurance companies regardless of when formed. 

Under revised I.R.C. §831(b), a captive that makes an I.R.C. §831(b) election must satisfy one of the following two requirements designed to prevent it from being used as a wealth transfer tool (notice the second requirement is written in the negative – the captive must not satisfy it):

  • No more than 20 percent of the net written premiums (or, if greater, direct written premiums) of the company for the tax year is attributable to any one policyholder;

Note:  I.R.C. §831(b) was retroactively amended by the Consolidated Appropriations Act, 2018 (CAA) such that “policyholder” means “each policyholder of the underlying direct written insurance with respect to such reinsurance or arrangement.”  Thus, a risk management pool itself is not considered to be the policyholder.  Instead, each insured paying premiums into the pool is considered a policy holder.  As long as none of those insureds accounts for more than 20 percent of the total premiums paid to the captive, the 20 percent test is satisfied.  I.R.C. §831(b)(2)(D)

  • The captive company does not meet the 20 percent requirement and no person who holds (directly or indirectly) an interest in the company is a spouse or lineal descendant of a person who holds an interest (directly or indirectly) in the parent company who holds (directly or indirectly) aggregate interests in the company which constitute a percentage of the entire interests in the company which is more than a 2 percent percentage higher than the percentage interests in the parent company with respect to the captive held (directly or indirectly) by the spouse or lineal descendant.

Note:  Essentially, the second requirement means that if the spouse or lineal descendants’ ownership of the captive company is greater than 2 percent of their ownership of the parent company, the second requirement is not satisfied.

The CAA modified the second test (the ownership test) to eliminate spouses from the definition of “specified holder” unless the spouse is not a U.S. citizen.  Thus, the ownership test only applies to lineal descendants of either spouse, spouses that are not U.S. citizens, and spouses of lineal descendants.  I.R.C. §831(2)(B)(iii).  The CAA also added a new aggregation rule to apply to certain spousal interests such that any interest held, directly or indirectly, by the spouse of a specified holder is deemed to be held by the specified holder.  In addition, the CAA modified the ownership test to look at the aggregate amount of an interest in the trade, business, rights or assets insured by the captive, held by a specified holder, spouse or “specified relation.”  I.R.C. §831(b)(2)(B)(iv)(I).  The rule excludes assets that have been transferred to a spouse or other related person by bequest, devise or inheritance from a decedent during the taxable year of the insurance company or the preceding tax year.  Id.

Thus, in the estate planning/succession planning context if a parent (i.e., father or mother) or parents is (are) the sole owner of the parent company and the captive company, the captive company can make the I.R.C. §831 election.  That’s because no lineal descendant has any ownership in the captive company.  But, if a parent(s) is (are) the sole owner of the parent company and the and children own the captive company, the captive cannot make the I.R.C. §831 election (100 percent is more than 2 percent greater than zero percent).  The result is the same if the captive is held (indirectly) in a trust with the children as the beneficiaries.  But, for example, if the parent owns half of the parent company and half of the captive company with the children owning the other half of each entity, the captive company can make the I.R.C. §831 election. 

Note:  If the children meaningfully own the parent company, they can own the captive company.  The converse is also true. 

Given the modifications to I.R.C. §831(b) it remains possible to use a captive insurance company as part of an estate/business succession plan if the ownership of the parent and the captive is structured properly with the appropriate ownership percentages in both the parent and captive business entities.  For example, a captive company could be capitalized with cash from an intentionally defective grantor trust (IDGT) that has been established for the benefit of a child.  I recently posted an article on the use of an IDGT in estate planning.  You may read that article here:

https://lawprofessors.typepad.com/agriculturallaw/2022/03/should-an-idgt-be-part-of-your-estate-plan.html

The gift of funds to the IDGT is a completed gift for federal gift tax purposes and removes that value from the grantor’s estate at death.  The income the IDGT receives from the captive is taxed to the grantor, and the grantor deducts the premiums paid to the captive company and reports the net profits from the captive as a qualified dividend.  That is the case even though the cash flows from the parent company (the family business) to the captive insurance company and then to the IDGT and then on to the grantor’s child/children.  But, again, the ownership percentages of the parent and the captive insurance company must be carefully structured to stay within the borders of I.R.C. §831. 

As an alternative, as noted above, the captive insurance company could be held in an FLP and the parents could gift FLP interests to the children annually consistent with the present interest annual exclusion (presently $16,000 per donee per year (and, spouses can elect “split-gift” treatment)).  Each FLP interest entitles the owner a share of the captive company’s profits.  It may also be possible for the parents to claim valuation discounts on the gifts of interests in the FLP.  But, of course, the percentage ownerships of the parent company and the captive must stay within the “guardrails” of I.R.C. §831.

Conclusion

In Part Two I will examine the issues that give the IRS concern about captive insurance companies and discuss various court cases construing the IRS position.

March 28, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Friday, March 25, 2022

Registration Open for Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

Overview

Last December, I posted a “hold-the-date” announcement for the 2022 summer national farm income tax/estate and business planning conferences that Washburn Law School will be conducting this summer. Earlier this month I devoted a blog article to the itinerary.

Registration is now open for both the Wisconsin event in mid-June and the Colorado event in early August. 

Wisconsin Dells, Wisconsin

Here’s the link to the online brochure and registration for the event at the Chula Vista Resort on June 13-14:  https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html

A block of rooms is available for this seminar at a rate of $139.00 per night plus taxes and fees. To make a reservation call (855) 529-7630 and reference booking ID "#i60172 Washburn Law School." Rooms can be reserved at the group rate through May 15, 2022. Reservations requested after May 15 are subject to availability at the time of reservation.

An hour of ethics is provided at the end of Day 2.

The conference will also be broadcast live online for those that cannot attend in person.  Online attendees will be able to interact with the presenters, if desired. 

Durango, Colorado

Here’s the link to the online brochure and registration for the event at Fort Lewis College on August 1-2:  https://www.washburnlaw.edu/employers/cle/farmandranchtaxaugust.html

An hour of ethics is also provided at the end of Day 2 at this conference.

Just like the Wisconsin conference, this conference will also be broadcast live online for those that cannot attend in person.  Online attendees will be able to interact with the presenters, if desired. 

Other Points

There are many other important details about the conferences that you can find by reviewing the online brochures. 

Looking forward to seeing you there or having you participate online.  If you do tax, estate planning or business succession planning work for clients or are involved in production agriculture in any way, this conference is for you.  Each event will also have a presentation involving the farm economy that you won’t want to miss.  Also, if you aren’t needing to claim continuing education credits, you qualify for a lower registration rate.

See you there. 

March 25, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Friday, March 11, 2022

Farm Wealth Transfer and Business Succession – The GRAT

Overview

The Tax Cuts and Jobs Act (TCJA) significantly increased the federal estate and gift tax exemption, and it is presently at $12.06 million for deaths occurring or gifts made in 2022.  That effectively makes federal estate and gift tax a non-issue for practically all farming and ranching operations, with or without planning.  But it is for some, and business succession planning remains as important as ever. 

Earlier this week I wrote about one possible strategy - the Intentionally Defective Grantor Trust.  Today, I discuss another possible succession planning concept – the grantor-retained annuity trust (GRAT).  It’s another technique that can allow the grantor to “freeze” the value of the transferred assets while simultaneously providing the grantor with a cash flow stream for a specified time-period.  The GRAT technique “freezes” the value of the senior family member’s highly appreciated assets at the value as of the time of the transfer to the GRAT, while providing the senior family member with an annuity payment for a term of years.  Thus, the GRAT can deliver benefits without potential transfer tax disadvantages. 

Transferring interests in a farming business (and other investment wealth) to successive generations by virtue of a GRAT – it’s the topic of today’s post.

GRAT Basics

A GRAT is an irrevocable trust to which assets are transferred.  In return, the grantor receives the right to a fixed annuity payment for a term of years, with the (non-charitable) remainder beneficiaries receiving any remaining assets at the end of the GRAT term.  The fixed payment is typically a percentage of the assets’ initial fair market value computed so as to not trigger gift tax.  In other words, the amount of the taxable gift on the transfer to the GRAT is the fair market value (FMV) of the property transferred less the value of the grantor’s retained annuity interest.  At the end of the grantor’s reserved term, the value of the remainder interest is included in the grantor’s estate for tax purposes.  See I.R.C. §2036; I.R.C. §2039. 

The term of the annuity is fixed in the instrument and is either tied to the shorter of the annuitant’s life or a specified term of years.  The annuity payment can be structured to remain the same each year or (as explained more further below) it can increase up to 120 percent annually.  However, once the annuity is established, additional property cannot be added to the GRAT.  Treas. Reg. §25.2702-3(b)(5).

Note:  The grantor receives the annuity amount annually regardless of the income that the GRAT’s assets produce.  Thus, the trustee’s job is to maximize the total return on the GRAT’s assets from income or principal appreciation.  If the GRAT income is insufficient to pay the annuity, the trustee must be required to invade the GRAT’s principal to do so.  Thus, the assets transferred to the GRAT must produce enough cash flow to pay the annuity amount or must be able to be liquidated by the trustee to pay the annuity.

Because a GRAT is a technique that is based largely on assumptions about what the interest rate will be, ideal assets to transfer to a GRAT are those that are likely to appreciate in value (such as real estate) at a rate exceeding the rate that the IRS applies (the I.R.C. §7520 rate) to the annual annuity payment the GRAT will make.  In that event, the appreciation in the GRAT assets will pass to the GRAT’s beneficiaries without triggering federal gift or estate tax to the grantor.  The actuarial value of the remainder interest in the GRAT that passes to the beneficiaries when the GRAT terminates is a gift to the remainder beneficiaries that is subject to gift tax.  But, if that actuarial value equals the value of the property transferred to the GRAT, there won’t be any gift tax. 

If the grantor outlives the term of the annuity term, the remainder passes to the beneficiaries with no additional estate tax. 

Example:  Faye, at age 55, funded an irrevocable trust with $1,000,000 in March of 2022.  The trust specified that Faye would receive an annual annuity of $50,000 for the next 10 years.  The March 2022 I.R.C. §7520 rate is 2.0 percent.   Based on the IRS specified formula, the value of Faye’s retained interest is $449,130 and the value of the remainder interest is $550,870.  The value of the remainder interest would be subject to gift tax upon the GRAT’s creation.  Because the funding of the GRAT involved a completed gift, when the GRAT terminates there will be no gift tax consequences.  The assets remaining in the GRAT are paid to the remainder beneficiaries without Faye incurring any additional gift tax.  If Faye were to die during the GRAT term with the right to receive further annuity payments, a portion of the GRAT will be included in her estate.  The included portion is that fraction of the GRAT which would be required to be invested at the I.R.C. §7520 rate in effect on Faye’s death to produce income equal to the required annuity payment.  If Faye is married and the right to the balance of the annuity payments passes to her spouse, the interest will qualify for the marital deduction if the spouse receives annuity payments that either pass outright to the surviving spouse or the surviving spouse’s estate, or will pass to a marital trust over which the spouse has a general power of appointment. 

Technical Requirements

Perhaps the most important part of a GRAT is that the trust instrument be drafted property to satisfy I.R.C. §2702.  If I.R.C. §2702 is satisfied, the grantor’s retained interest is a “qualified interest” and is subtracted from the value of the property gifted to the remainder beneficiaries.  If I.R.C. §2702 is not satisfied, the grantor’s retained interest is valued at zero and the entire value transferred to the remainder beneficiaries is a taxable gift.  To be a qualified interest, the grantor’s retained interest must be an interest consisting of the right to receive a fixed amount payable not less than annually that is a fixed percentage of the fair market value of the property in the GRAT determined on an annual basis.  The annuity’s term must be the shorter of the life of the grantor or a specified term of years (but see the discussion surrounding the Tax Court’s decision in Walton, infra.).

Note:  The value of the qualified annuity is determined via I.R.C. §7520.

It is critical to have an accurate appraisal of the assets/interests to be contributed to the GRAT.  If the appraisal is not accurate, the annuity may be determined to not be a qualified interest.  See Atkinson v. Comr., 309 F.3d 1290 (11th Cir. 2002), aff’g., 115 T.C. 26 (2000); C.C.A. 202152018 (Oct. 4, 2021).  This is a particular issue when a potential sale or merger is involved when valuing assets to be contributed to the GRAT. 

A GRAT must make at least one annuity payment every 12-month period that is paid to an annuitant from either the GRAT’s income or principal.  Treas. Reg. §25.2702-3(b)(1).  There is a 105-day window within which the GRAT can satisfy the annual annuity payment requirement.  This is the case if the annuity payment is based on the GRAT’s anniversary date.  Treas. Reg. §25.2702-3(b)(4).  The window runs from the GRAT creation date, which is based on state law.  Notes cannot be used to fund annuity payments, and the trustee cannot prepay the annuity amount or make payments to any person other than the annuitant during the qualified interest term.

Note:  The annuity payment may, alternatively, be based on the taxable year of the GRAT.  If so, the annuity must be paid in the subsequent year by the date on which the trustee must file the GRAT’s income tax return (without extension).  Treas. Reg. §25.2702-3(b)(4).   As noted, the annuity cannot be prepaid.  Treas. Reg. §25.2702-3(d)(4). 

The GRAT must be drafted to require the trustee to actually pay the annuity amount, it is not sufficient for the grantor to merely have a withdrawal right.  Treas. Reg. §25.2702-(3)(b)(1)(i). 

A GRAT is subject to a fixed amount requirement that takes the form of either a fixed dollar amount or a fixed percentage of the initial fair market value of the property transferred to the trust.  Treas. Reg. §25.2702-3(b)(1)(ii).  There is also a formula adjustment requirement that is tied to the fixed value of the trust assets as finally determined for gift tax purposes.  The provision must require adjustment of the annuity amount.  

Note:  The fixed amount need not be the same for each year, but one year’s amount may not vary by more than 120 percent from the amount paid in the immediately prior year.  Treas. Reg. §25.2702-3(b)(1)(ii). 

From a financial accounting standpoint, the GRAT is a separate legal entity.  The GRAT’s bank account is established using the grantor’s social security number as the I.D. number.  Annual accounting is required, including a balance sheet and an income statement.

Tax Consequences of Creating, Funding, Administering and Terminating a GRAT

Grantor trust status.  For income tax purposes, the GRAT is treated as a grantor trust because, by definition, the retained interest exceeds five percent of the value of the trust at the time the trust is created.  I.R.C. §673.  Thus, there is no gain or loss to the grantor on the transfer of property to the GRAT in exchange for the annuity.  There can be issues, however, if there is debt on the property transferred to the GRAT that exceeds the property’s basis.  Also, when a partnership interest is contributed there can be an issue with partnership “negative basis” (i.e., the partner’s share of partnership liabilities exceeds the partner’s share of the tax basis in the partnership assets).  

Note:  It is possible that a GRAT could be a grantor trust for some but not all purposes.  Generally, a GRAT should be a grantor trust for all purposes.  Language can be drafted into the GRAT document ensuring classification as a grantor trust for all purposes. 

Because the trust is a grantor trust, the grantor is taxed on trust income, including interest, dividends, rents and royalties, as well as pass-through income from business entity ownership.  The grantor also can claim the GRAT’s deductions.  However, the grantor is not taxed on annuity payments, and transactions between the GRAT and the grantor are ignored for income tax purposes.  A significant tax benefit of a GRAT is that the sale of the asset between the grantor and the GRAT does not trigger any taxable gain or loss.  The transaction is treated as a tax-free installment sale of the asset.  Also, the GRAT is permitted to hold “S” corporation stock as the trust is a permitted S corporation shareholder, and the GRAT assets grow without the burden of income taxes. 

Gift tax treatment.  For gift tax purposes, the value of the gift equals the value of the property transferred to the GRAT less the value of the grantor’s retained annuity interest.  In essence, the transferred assets are treated as a gift of the present value of the remainder interest in the property.  That allows asset appreciation to be shifted (net of the assumed interest rate that is used to compute present value) from the grantor’s generation to the next generation.

It is possible to “zero-out” the gift value so there is no taxable gift.  This occurs when the value of the grantor’s retained interest equals the value of the property transferred to the trust.  An interest rate formula determined by I.R.C. §7520 is used to calculate the value of the remainder interest.  If the income and appreciation of the trust assets exceed the I.R.C. §7520 rate, assets remaining at the end of the GRAT term that will pass to the GRAT beneficiaries.  The basic idea is to transfer wealth to the subsequent generation with little or no gift tax consequences. 

The grantor’s payment of taxes is not treated as a gift to the trust remainder beneficiaries.  Rev. Rul. 2004-64, 2004-27 I.R.B. 7.  Also, if the trustee reimburses (or has the power to reimburse) the grantor for the grantor’s payment of income tax, the reimbursement (or the discretion to reimburse) does not cause inclusion of the trust assets in the grantor’s estate.  But, it’s important that the trustee be an independent trustee. 

Underperforming GRAT.  If the GRAT underperforms (i.e., the GRAT assets fail to appreciate at a higher rate than the interest rate of the annuity payment), the GRAT can sell its assets back to the grantor with no income tax consequences (assuming the GRAT is a wholly-owned grantor trust).  Rev. Rul. 85-13, 1985-1 C.B. 184.  Then, the repurchased property can be placed in a new GRAT with a lower annuity payment.  The original GRAT would then pay out its remaining cash and collapse.   

Death of Grantor During GRAT Term

If the grantor dies before the end of the GRAT term, a portion (or all) of the GRAT is included in the grantor’s gross estate under I.R.C. §2036.  The amount included in the grantor’s estate is the lesser of the fair market value of the GRAT’s assets as of the grantor’s date of death or the amount of principal needed to pay the GRAT annuity into perpetuity (which is determined by dividing the GRAT annuity by the I.R.C. §7520 rate in effect during the month of the grantor’s death).   Rev. Rul. 82-105, 1982-1 C.B. 133.  

Example:  Bubba died in June 2018 with $700,000 of assets held in a 10-year GRAT.  At the time the GRAT was created in June of 2010 with a contribution of $1.5 million, the annuity was calculated to be $183,098.70 per year (based on an interest rate of 3.8 percent and a zeroed-out gift).   The amount included in Bubba’s gross estate would be the lesser of $700,000 (the FMV of the GRAT assets at the time of death) or $5,385,255.88 (the value of the GRAT annuity paid into perpetuity ($183,098.70/.034)).  Thus, the amount included in Bubba’s estate would be $700,000.   

To minimize the risk of assets being included in the grantor’s estate, shorter GRAT terms are generally selected for older individuals.  There is no restriction in the law as to how long a GRAT term must be.  For example, Kerr v. Comr., 113 T.C. 449 (1999), aff’d., 292 F.3d 490 (5th Cir. 2002) involved a GRAT with a term of 366 days, and there is no indication in the court’s opinion that the term was challenged.  In Priv. Ltr. Rul. 9239015 (Jun. 25, 1992), the IRS blessed a GRAT with a two-year term.  

Perhaps the risk of the grantor dying during the GRAT term has been minimized.  In Walton v. Comr., 115 T.C. 589 (2000), the Tax Court concluded that the value of an annuity payable over a term to the grantor and to the grantor’s estate if the grantor dies during the GRAT term is not reduced by the value of the contingent interest in the grantor’s estate.  The reason the Tax Court gave was because a fixed annuity payable to the grantor or the grantor’s estate does not constitute a “qualified interest” under I.R.C. §2702.  Thus, a GRAT may be created with a fixed term that will not end upon the grantor’s death, and the annuity that is paid to the grantor during life and to the estate at death during the GRAT’s term will be included in the value of the retained annuity interest – and, thus, give a value to the remainder interest.  The IRS may not agree with the result in Walton (particularly outside of the Eighth Circuit).  But, the Tax Court’s opinion is a full Tax Court opinion that is applicable nationwide.

GRAT Advantages and Disadvantages

Advantages.  For large transfers, a GRAT reduces the gift tax cost of transferring assets as compared to a direct gift.  Also, the GRAT receives grantor trust status which allows the grantor to borrow funds from the GRAT and the GRAT can borrow money from third parties (however, the grantor must report as income the amount borrowed).  Tech. Adv. Memo. 200010010 (Nov. 23, 1999)).  Also, the GRAT term can safely be as short as two years. 

Disadvantages.  Upon formation, some of the grantor’s applicable exclusion might be utilized.  But this likelihood has been reduced in recent years given the substantial increase in the federal estate and gift tax exemption amount.  Also, the grantor must survive the GRAT term to avoid having any part of the GRAT assets being included in the grantor’s gross estate (but see the discussion about the Walton case above).  Another potential disadvantage of a GRAT is that notes or other forms of indebtedness cannot be used to satisfy the required annuity payments.  Treas. Reg. §25.2702-3(d)(2).  In addition, the grantor continues to pay income taxes on all of the GRAT’s income that is earned during the GRAT term. 

When to Consider Using a GRAT

So, when should a GRAT be utilized as a part of an estate/business succession plan?  If the grantor has assets that are likely to appreciate more than the I.R.C. §7520 rate, it is a good way to transfer value to the grantor’s children.  Also, in situations where the unified credit exemption has already been used, a zeroed-out GRAT may still be used because it does not trigger a taxable gift to the remainder beneficiaries.   

Conclusion

The GRAT is another way to pass interests in the farming or ranching operation to the next generation.  While it’s not a technique for everyone, it can be helpful for those with substantial wealth a a desire to pass the business to the next generation.  Also, keep in mind that the present level of the federal estate and gift tax exclusion amount of $12.06 million is scheduled to “sunset” after 2025.  After that, under present law, the exclusion will drop to $5 million (in 2011 dollars) with an inflation adjustment. 

March 11, 2022 in Business Planning, Estate Planning | Permalink | Comments (0)

Monday, March 7, 2022

Should An IDGT Be Part of Your Estate Plan?

Overview

Because of the failure of the “Build Back Better” legislation last year, the federal estate tax remains a non-concern for the vast majority of people.  But, for some larger farming operations as well as some non-ag businesses and high-wealth individuals, planning to avoid the full impact of the federal estate tax is necessary.   

Note:  If the Congress does nothing, the federal estate and gift tax exemption will fall to $5,000,000 (in 2011) dollars beginning January 1, 2026. That will subject more estates to potential taxation.

If an estate planning goal is transferring business interests and/or investment wealth to a successive generation, one aspect of the estate plan might involve the use of an Intentionally Defective Grantor Trust (IDGT).  The IDGT allows the grantor to “freeze” the value of the transferred assets while simultaneously providing the grantor with a cash flow stream for a specified time-period.  

The use of the IDGT for transferring asset values from one generation to the next in a tax-efficient manner – it’s the topic of today’s post.

What Is An IDGT?

In general.  An IDGT is an irrevocable trust that is designed to avoid any retained interests or powers in the grantor that would result in the inclusion of the trust’s assets in the grantor’s gross estate upon the grantor’s death. Normally, an irrevocable trust is a tax entity distinct from the grantor and has its own income and deductions (net of distributions paid to beneficiaries) reported on its own income tax return.  Because of the irrevocable nature of the trust, the assets transferred to the trust are generally removed for the grantor’s estate for federal estate purposes. Conversely, a grantor trust is a trust where the income is taxed to the grantor because the grantor is treated as the owner for federal and state income tax.  Thus, a separate return need not be prepared for the trust, but the trust assets are generally included in the grantor’s estate at death. 

An IDGT is characterized by having advantages of both an irrevocable trust for estate tax purposes and a grantor trust for income tax purposes.  For federal income tax purposes, the trust is designed to be a grantor trust under I.R.C. §§671-678.  That means that the grantor (or a third party) retains certain powers causing the trust to be treated as a grantor trust for income tax purposes.  For example, common IDGT provisions include (1) a power exercisable by the grantor (in a non-fiduciary capacity) to reacquire trust assets by substituting assets of equivalent value. I.R.C. §675(4)(C); (2) a power held by a non-adverse party to add to the class of beneficiaries (other than the grantor’s after-born or after-adopted children). I.R.C. §674(a); or (3) a power to enable the trustee to loan money or assets to the grantor from the trust without adequate security. I.R.C. §675(2).

However, those retained powers do not cause the trust assets to be included in the grantor’s estate under I.R.C. §§2036-2042.  This is what makes the trust “defective.”   The seller (grantor) and the trust are treated as the same taxpayer for income tax purposes.  However, an IDGT is defective for income tax purposes only - the trust and transfers to the trust are respected for federal estate and gift tax purposes.  For example, the transfer of property to the trust qualifies for the gift tax annual exclusion of §I.R.C. §2503(b)(1)-(2).  In addition, grantor trust status still applies even though the grantor retains a withdrawal power over income and/or corpus.  See, e.g., Priv. Ltr. Rul. 200606006 (Oct. 24, 2005); Priv. Ltr. Rul. 200603040 (Oct. 24, 2005); Priv. Ltr. Rul. 200729005 (Mar. 27, 2007). 

Note:  The IDGT’s income and appreciation accumulates inside the trust free of gift tax and also free of generation-skipping transfer tax (if the grantor allocates the grantor’s generation-skipping transfer tax exemption to the assets transferred to the trust). 

The IDGT transaction is structured so that a completed gift occurs for gift and estate tax purposes, with no resulting income tax consequences (because the trust is a grantor trust).  

Note:  Because the transfer is a completed gift, the trust receives a carryover basis in the gifted assets.

How Does An IDGT Transaction Work?

Gift.  One approach to funding an IDGT is by the grantor gifting assets to the trust.  If the value of the assets transferred are less than the applicable exclusion amount (presently $12.06 million for deaths or gifts made in 2022 - $24.12 million for a married couple), gift tax is not triggered on the transfer, but the applicable exclusion would be reduced by the amount of the gift.  Form 709 would need to be filed reporting the gift and showing the reduction in the applicable exclusion unified credit. 

Note:  A variant of the outright gift approach involves a part-gift, part-sale transaction.  This is done where it is beneficial to leverage the amount of assets transferred to the IDGT, preserve the applicable exclusion or retain income.    

Sale and note.  Another technique to fund an IDGT involves the grantor selling highly-appreciating or high income-producing assets to the IDGT for fair market value in exchange for an installment note (such as a self-canceling installment note).  There is no capital gains tax on the sale.  In addition, the trust is an eligible S corporation shareholder.   I.R.C.  §1361(c)(2)(A).   The grantor is also not taxed on the interest payments received from the trust.   Rev. Rul. 85-13, 1985-1 C.B. 184.  The installment sale also freezes the value of appreciation on assets sold at the Applicable Federal Rate (AFR).  This is a particularly effective strategy in a low interest rate environment. 

The grantor should make an initial “seed” gift of at least 10 percent of the total transfer value to the trust so that the trust has sufficient capital to make its payments to the grantor.  The sale (or other transaction) between the trust and the grantor are not income tax events, and the trust’s income, losses, deductions and credits are reported by the grantor on the grantor’s individual income tax return.

Interest on the installment note is set at the Applicable Federal Rate (AFR) for the month of the transfer that represents the length of the note’s term.  I.R.C. §1274.

Note:  The mid-term AFR for March of 2022 is 1.73 percent (semi-annual compounding).  Rev. Rul. 2022-4, 2022-10 I.R.B.

The installment note can call for interest-only payments for a period of time and a balloon payment at the end, or it may require interest and principal payments.   Given the current low interest rates, it is reasonable for the grantor to expect to receive a total return on the IDGT assets that exceeds the rate of interest.  Indeed, if the income/growth rate on the assets sold to the IDGT is greater than the interest rate on the installment note taken back by the grantor, the “excess” growth/income is passed on to the trust beneficiaries free of any gift, estate and/or Generation Skipping Transfer Tax (GSTT).

The IDGT technique became popular after the IRS issued a favorable letter ruling in 1995 that took the position that I.R.C. §2701 would not apply because a debt instrument is not an applicable retained interest. Priv. Ltr. Rul. 9535026 (May 31, 1995).  I.R.C. §2701 applies to transfers of interests in a corporation or a partnership to a family member if the transferor or family member holds and “applicable retained interest” in the entity immediately after the transfer.  However, an “applicable retained interest” is not a creditor interest in bona fide debt.   The IRS, in the same letter ruling also stated that a debt instrument is not a term interest, which meant that I.R.C. §2702 would not apply.  If the seller transfers a remainder interest in assets to a trust and retains a term equity interest in the income, I.R.C. §2702 applies which results in a taxable gift of the full value of the property sold.  For instance, a sale in return for an interest only note with a balloon payment at the end of the term would result in a payment stream that would not be a qualified annuity interest because the last payment would represent an increase of more than 120 percent over the amount of the previous payments. 

Note:  For a good article on this point see Hatcher and Manigualt, “Using Beneficiary Guarantees in Defective Grantor Trusts,” 92 Journal of Taxation 152 (Mar. 2000).

A crucial aspect of the installment note from an income tax and estate planning/business succession planning standpoint is that it must constitute bona fide debt.  If the debt amounts to an equity interest, then I.R.C. §§2701-2702 apply and a large gift taxable gift could be created or the transferred assets will end up being included in the grantor’s estate.  In Karmazin v. Comr., T.C. Docket No. 2127-03 (2003), the IRS took the position that I.R.C. §§2701-2702 applied to the sale of limited partnership interests to a trust which would cause them to have no value for federal gift tax purposes on the theory that the notes the grantor received were equity instead of debt.  The case was settled before trial on terms favorable to the taxpayer (the only adjustment was a reduction of the valuation discount from 42 percent to 37 percent) with the parties agreeing that neither I.R.C. §2701 or I.R.C. §2702 applied.  However, IRS resurrected the same arguments in Estate of Woelbing v. Comr., T.C. Docket No. 30261-13 (filed Dec. 26, 2013).  The parties settled the case before trial with a stipulated decision entered on Mar. 25, 2016, that resulted in no additional gift or estate tax.  The total amount of the gift tax, estate tax, and penalties at issue was $152 million. 

Another concern is that I.R.C. §2036 causes inclusion in the grantor’s estate of property the grantor transfers during life for less than adequate and full consideration if the grantor retained for life the possession or enjoyment of the transferred property or the right to the income from the property, or retained the right to designate the persons who shall possess or enjoy the property or the income from it.  But, again, in the context of an IDGT, if the installment note represents bona fide debt, the grantor does not retain any interest in the property transferred to the IDGT and the transferred property is not included in the grantor’s estate at its date-of-death value.

All of the tax benefits of an IDGT turn on whether the installment note is bona fide debt.  Thus, it is critical to structure the transaction properly to minimize the risk of the IRS taking the position that the note constitutes equity for gift or estate tax purposes.  That can be accomplished by observing all formalities of a sale to an unrelated party, providing sufficient seed money, having the beneficiaries personally guarantee a small portion of the amount to be paid under the note, not tying the note payments to the return on the IDGT assets, actually following the scheduled note payments in terms of timing and amount, making the note payable from the trust corpus, not allowing the grantor control over the property sold to the IDGT, and keeping the term of the note relatively short.  These are all indicia that the note represents bona fide debt.      

Pros and Cons of IDGTs

Value freezing.  An IDGT has the effect of freezing the value of the appreciation on assets that are sold to it in the grantor’s estate at the low interest rate on the installment note payable.  Additionally, as previously noted, there are no capital gain taxes due on the installment note, and the income on the installment note is not taxable to the grantor. 

Note:  Any valuation discount will increase the effectiveness of the sale for estate tax purposes. 

Payment of income tax liability.  If the grantor uses funds from outside the IDGT to pay the tax liability on income generated by the assets in the IDGT, that has the effect of leaving more assets in the IDGT for the remainder beneficiaries that would result if the trust were a standard irrevocable trust.  It also reduces the grantor’s taxable estate in an amount equal to the income taxes that the grantor pays and helps to preserve the trust by not reducing it with the trust’s payment of the income taxes. 

Because the grantor pays the income tax attributable to the inclusion of the trust’s income in the grantor’s taxable income, the grantor is not treated as making a gift of the amount of the income tax to the trust beneficiaries for gift tax purposes.  Rev. Rul. 2004-64, 2004-27 I.R.B. 7.  However, there is a difference in the estate tax treatment depending on the trust’s language.  For instance, if the trust’s language (or state law) requires the trustee to reimburse the grantor for the income tax attributable to the inclusion of the trust’s income in the grantor’s taxable income, then the full value of the trust’s assets is includible in the grantor’s gross estate via I.R.C. §2036(a)(1) for federal estate tax purposes  This is true even though the trust’s beneficiaries are not treated as making a gift of the amount of the income tax to the grantor.  Id.   Conversely, if the trust language gives the trust the discretion to reimburse the grantor for that portion of the grantor’s income tax liability attributable to the trust’s income, the discretion (whether exercised or not) will not (by itself) cause the value of the trust’s assets to be includible in the grantor’s gross estate.  But such discretion combined with other facts (such as a pre-existing arrangement regarding the trustee’s exercise of discretion) could cause inclusion of the trust assets in the grantor’s estate.  Id. 

Life insurance.  An IDGT can purchase an existing life insurance policy on the life of the grantor without subjecting the policy to taxation under the transfer-for-value rule. Rev. Rul. 2007-13, 2007-1 C.B. 684.

Grantor’s death during term of note.  On the downside, if the grantor dies during the term of the installment note, the note is included in the grantor’s estate. 

Income tax basis.  There is no stepped-up basis in trust-owned assets upon the grantor’s death. 

Cash flow.  Because trust income is taxable to the grantor during the grantor’s life, the grantor could experience a cash flow problem if the grantor does not earn sufficient income. 

Funding.  There is possible gift and estate tax exposure if insufficient assets are used to fund the trust.  As noted above, 10 percent seed funding is recommended to reduce the risk that the sale will be treated as a transfer with a retained interest by the grantor.    

Administrative Issues with IDGT’s

An IDGT is treated as a separate legal entity.  That means that a separate bank account must be opened for the IDGT so that it can receive the “seed” gift and annual cash inflows and outflows. The grantor’s Social Security number is used for the bank account.   An amortization schedule will need to be maintained between the IDGT and the grantor, as well as annual books and records of the trust.

Conclusion

Structured properly an IDGT can be a useful tool in the estate planner’s arsenal for moving wealth from one generation to the next with minimal tax cost.  That’s especially true for highly appreciating assets and family business assets.  It can be used to shift large amounts of wealth to heirs and create estate tax benefits.  The trust language should be carefully drafted to provide the grantor with sufficient retained control over the trust to trigger the grantor trust rules for income tax purposes, but insufficient control to cause inclusion in the grantor’s estate.  In other words, the trust language must contain sufficient provisions requiring the trust to be deemed a revocable trust for income tax purposes, but an irrevocable trust (as a completed transfer) for estate tax purposes. 

Given the highly technical nature of the IDGT rules, it is critical to get good legal and tax counsel before trying the IDGT strategy.

March 7, 2022 in Business Planning, Estate Planning | Permalink | Comments (0)

Saturday, March 5, 2022

Summer 2022 Farm Income Tax/Estate and Business Planning Conferences

Overview

In December, I posted a “hold-the-date” announcement for the 2022 summer national farm income tax/estate and business planning conferences that Washburn Law School will be conducting this summer.  The itineraries for each event are now finalized and registration will open soon.  Some have already booked their lodging and made travel plans.  The events are the highest quality, most practical professional tax and legacy planning conferences for practitioners with farm and ranch clients you can find anywhere in 2022.  Both conferences will also be simulcast live online in the event you aren’t able to attend in person.  In addition, each conference provides one hour of ethics for attorneys, CPAs and other tax practitioners. 

On June 13 and 14, the conference will be held at the Chula Vista Resort near the Wisconsin Dells.  On August 1 and 2, the conference will be at Fort Lewis College in Durango, Colorado.

In today’s article, I detail the speakers and the itineraries for each location.  2002 summer seminars – it’s the topic of today’s post.

The Speakers

In addition to myself, the following make the line-ups for the conferences:

Wisconsin Dells 

Joining me on Day 1 will be Paul Neiffer.  Paul is a CPA with CliftonLarsonAllen out of Walla Walla Washington.  He and I have worked together on numerous tax conferences for the past decade.  He specializes in income taxation, accounting services, and succession planning for farmers and agribusiness processors.  He is also a contributor at agweb.com and writes the Farm CPA Today blog. 

Also making presentations at the Wisconsin Dells conference will be Carlos Ramon, Dr. Allen Featherstone and Prof. Peter Carstensen.  Here are their brief bios:

Carlos Ramon.  Carlos is the Program Manager, Cyber & Forensic Services, with the IRS Criminal Investigation Division (IRS-CID).  He has over nineteen years of federal law enforcement experience, the last 16 of which have been with the IRS-CID.  With IRS-CID, Carlos has served (among other things) as an ID Theft Coordinator, and Program Manager for Cyber and Forensic Services. He is specially trained in different IRS-CI programs responsible for investigating criminal violations of the Internal Revenue Code and related financial crimes involving tax, money laundering, public corruption, cyber-crimes, identity theft, and narcotics.  Carlos holds a bachelor’s degree in Animal Science from Penn State University, a master’s in business administration from the Inter American University of Puerto Rico, and a Doctorate in Business Administration in Management Information System from the Ana G Mendez University. 

Dr. Allen M. Featherstone.  Dr. Featherstone is the Department Head of the Agricultural Economics Department at Kansas St. University where he also is the Director of the Master in Agribusiness Program.  His academic focus is on agriculture finance and his production economics research has investigated issues such as ground water allocation in irrigated crop production, comparison of returns under alternative tillage systems, the costs of risk, interactions of weather soils, and management on corn yields, analysis of the returns to farm equity and assets, and analysis of the optimizing behavior of Kansas farmers, examining the stability of estimates using duality, and examining the application of a new functional forms for estimating production relationships.

Peter C. Carstensen.  Prof. Carstensen is Professor of Law Emeritus at the University of Wisconsin School of Law.  From 1968-1973, he was an attorney at the Antitrust Division of the United States Department of Justice assigned to the Evaluation Section, where one of his primary areas of work was on questions of relating competition policy and law to regulated industries.  He has been a member of the faculty of the UW Law School since 1973.  He is also a Senior Fellow of the American Antitrust Institute.  His scholarship and teaching have focused on antitrust law and competition policy issues.  IN 2017, he published Competition Policy and the Control of Buyer Power, which received the Jerry S. Cohen Memorial Fund Writing Award for best antitrust book of 2017. 

Durango

The Day 1 lineup and topics are the same at the Durango event as they are at the Wisconsin Dells event.  Joining me on Day 2 at Durango will be the following:

Timothy P. O’Sullivan.  Tim is a senior partner with the Foulston law firm in Wichita, Kansas.  He represents clients primarily in connection with their estate and tax planning and the administration of trusts and estates. As part of his practice, Mr. O’Sullivan crafts wills, testamentary trusts, revocable living trusts, irrevocable trusts, dynasty or other types of generation-skipping trusts, “special needs” trusts, financial and healthcare powers of attorney, living wills, premarital agreements, stock purchase or buy-sell agreements, strategic gifting and estate tax planning, asset protection planning, governmental resource planning (e.g., Medicaid and SSI), family business succession plans, premarital agreements, IRA, 401k or other tax deferred beneficiary designations and deferral strategies, life insurance structures, family limited partnerships and limited liability companies, grantor retained annuity trusts (GRATs), private annuities, self-canceling installment notes (SCINs) and other instruments and estate planning techniques. A substantial portion of Mr. O’Sullivan’s practice also involves advising clients on strategies and provisions which enhance the preservation of family harmony in the estate planning process.

Mary Ellen Denomy.  Mary is a CPA with a specialty in oil and gas accounting, valuations and audits.  She is an Accredited Petroleum Accountant, Certified Fraud Deterrent Analyst and Master Analyst in Financial Forensics.  She has spoken across the country on oil and gas issues, been interviewed frequently and has testified as a successful expert.  Mary Ellen is a former member of the Board of the National Association of Royalty Owners (NARO), the Board of Examiners of the Council of Petroleum Accountants Societies, Past President of NARO-Rockies and former Trustee of Colorado Mountain College.  She is currently a licensed CPA in both Colorado and Arizona.

Mark Dikeman.  Mark is the Associate Director of the Kansas Farm Management Association as part of the Department of Agricultural Economics at Kansas State University.  Mark is responsible for implementing and maintaining an Extension educational farm business management program for commercial farms, resulting in the development of financial and production information to be used for comparable economic analysis by the farms as well as for research, policy and teaching.

John Howe.  John practices law in Grand Junction, Colorado with the law firm of Hoskin, Farina and Kampf.  John was raised in Southwestern Colorado and attended the Colorado School of Mines, graduating in 1983 with a bachelor’s degree in geophysical engineering. After a short stint in the oil and gas exploration industry, John attended the University of Colorado School of Law, graduating in 1989.  Following graduation, he clerked for Justice William H. Erickson of the Colorado Supreme Court and has practiced water and real estate law in Grand Junction for more than thirty years.

Michael K. Ramsey.  Mike is a partner in the firm of Hope, Mills, Bolin, Collins & Ramsey LLP located in Garden City, Kansas.  His law practice includes water rights, landowner oil and gas rights, agricultural business and estate planning.  Mike is a partner in an irrigated farming operation located in southwest Kansas. He has spoken on water law topics in Kansas to attorneys, financial institutions, utility company board members, agricultural producers, legislative committees and others. His clients have included users of surface and groundwater for irrigation, livestock, industrial and municipal purposes and groundwater management districts.  He a co-author with Peck, J. and Pitts, D. of "Kansas Water Rights: Changes and Transfers," 57 J.K.B.A. 21 (July 1988) and author of "Kansas Groundwater Management Districts: A Lawyer's Perspective," Vol. XV No. 3 Kan. J. of Law & Pub. Policy 517 (2006).  Mike’s law degree is from the University of Kansas School of Law.

Andrew Morehead.  Andy is a Public Accountant and Certified Financial Planner with a farm and small business practice in Eaton, Colorado and Torrington, Wyoming. He is a Past President of the National Society of Accountants, and is also a Past President of the Public Accountants Society of Colorado.  Andy is a former cattle rancher and farm equipment dealer in western Wyoming, and has taught at various tax-related professional continuing education programs for many years.

Shawn Leisinger.  Shawn is the Associate Dean for Centers and External Programs where he oversees development of Center programs and events that are held throughout the year. He also coordinates all continuing legal education programs sponsored by Washburn Law and other special events.  Shawn joined Washburn University School of Law on a full-time basis in 2010. Previously he served as Assistant General Counsel to the Kansas Corporation Commission Oil and Gas Conservation Division and as Assistant Shawnee County (Kansas) Counselor. Leisinger has coached the Washburn Law American Bar Association Client Counseling competition team since 2003 and the Negotiation competition team since 2008. He has also taught the Interviewing and Counseling and the Professional Responsibility courses and regularly teaches continuing legal education sessions.

Daily Schedules

Wisconsin Dells.  Here is how the topical sessions break out each day at the Wisconsin Dells conference (the speaker for each topic is indicated in parenthesis after the title of each session):

Day 1:

8:00 a.m.-8:05 a.m. – Welcome and Announcements

8:05 a.m.-9:05 a.m. - Tax Update – Key Rulings and Cases from the Past Year (or so) (McEowen)

This opening session begins with a review of the most significant recent income tax cases, IRS rulings and other tax administrative developments.  This session will help you stay on top of the ever-changing interpretations of tax law that impact your clients.   

9:05 a.m.-9:35 a.m. - Reporting of WHIP and Other Government Payments (Neiffer)

Farmers that participate in federal farm programs have unique tax reporting requirements and the programs have unique tax rules that apply.  This session will provide a review of the basic tax rules surrounding farm program payments, including new USDA programs that have been created for farmers in recent years.  Also reviewed will be the options for deferring revenue protection policies.

9:35 a.m.-9:55 a.m. (Morning Break)

9:55 a.m.-10:20 a.m. - Fixing Bonus Elections and Computations (McEowen)

The TCJA made several changes to bonus depreciation and the IRS issued a Revenue Procedure in 2019 allowing modifications of a bonus election.  Final regulations were published in late 2020 that withdrew a “look-through” rule for partnerships and clarify the application of I.R.C. §743(b) adjustments.  This session brings tax preparers up-to-date on dealing with changes to bonus elections and related computations.

10:20 a.m.-10:50 a.m. - Research and Development Credits (Neiffer)

Beginning in 2022, taxpayers must provide particular information when claiming a refund for research and development credits under I.R.C. §41 on an amended return.  What information is required?  What business components must be identified, and how are research activities performed to be documented?  How can an insufficient claim be perfected?  These issues and more will be addressed.

10:50 a.m.-11:20 a.m. – Farm NOLs (Neiffer)

In 2021, the IRS issued guidance on how farm taxpayers are to handle carryback elections related to farm net operating losses (NOLs) in light of all of the legislative rule changes in recent years.  This session reviews the guidance and illustrates how a farm taxpayer can elect to not apply certain NOL rules of the CARES Act, and how the COVID-Related Tax Relief Act (CTRA) election can be revoked. 

11:20 a.m.-Noon  -  The Taxability of Retailer Reward Programs; Tax Rules Associated with Demolishing Farm Structures (McEowen)

This session addresses the tax issues associated with farm clients receiving “rewards” from retailers that they transact business with.  How are the “rewards” to be reported?  Is the information that the retailer provides to the farmer correct?  This session sorts it out.  In addition, this session covers the proper tax treatment of demolishing farm structures.  Significant weather events in recent months in large areas of farm country destroyed or significantly damaged many farm structures.  When those structured are beyond repair and are demolished, what is the proper way to handle it for tax purposes? 

Noon-1:00 p.m. – Lunch

1:00 p.m.  – 2:15 p.m. IRS-CI: Emerging Cyber Crimes and Crypto Tax Compliance (Ramon)

This session explains how to identify a business email compromise and/or data breach and how to respond to it.  The session will also identify what the Dark Web is and how it is utilized for cybercrimes and identity theft.  Likewise, the session will help attendees to recognize the general terminology and tax treatment pertaining to virtual/crypto currency. In addition, the session will allow participants to gain a better understanding of the efforts by IRS-Criminal Investigation to combat cyber criminals and illicit activity.

2:15 p.m. – 2:45 p.m.  Potpourri – Part 1 (McEowen and Neiffer)

This session includes discussion of numerous tax issues of importance to farmers and ranchers.  The topics covered include how machinery trade transactions are handled and reported on Form 4797 and Form 4562; inventory accounting issues (what is included in inventory; how the Uniform Capitalization Rules impact inventory accounting; when accrual accounting is required; inventory valuation methods; and crop accounting).  Also covered will be the tax treatment of early termination of CRP contracts; partnership reporting; weather-related livestock sales; and contribution margin analysis

2:45 – 3:05 p.m. - Afternoon Break

3:05 p.m. – 4:25 p.m. Potpourri (cont.) (McEowen and Neiffer)

The potpourri session continues…and concludes.

Day 2:

7:30 a.m. – 8:00 a.m. – Registration

8:00 a.m. – 8:05 a.m. – Welcome and announcements

8:05 a.m. – 9:00 a.m. - Estate and Business Planning Caselaw and Ruling Update (McEowen)

Day 2 begins with a review of the big developments in the courts and with the IRS involving estate planning, business planning and business succession.  Stay on top of the issues impacting transition planning for your clients by learning how legal, legislative and administrative developments impact the estate and business planning process.

9:00 a.m. – 9:50 a.m. – The Use of IDGTs (and other strategies) For Succession Planning (McEowen)

Estate planning with intentionally defective grantor trusts (IDGTs) can have many advantages. This session will discuss the ins and outs of IDGTs, including how they may be a part of developing comprehensive estate plans and how they can be tax “effective” for federal estate tax purposes.

9:50 – 10:10 a.m. – Morning Break

10:10 a.m. – 11:25 a.m. – The Ag Economy and the Impact on Farm/Ranch Clients (Part 1)

Between the Upper and Nether Stone: Anticompetitive Conduct Grinding Down Farmers (Carstensen)

Enforcement of antitrust and related competition laws has become a major focus of the Biden Administration.  One primary area of concern is agriculture.  Farmers face significant risks of harm in their supply markets.  The impacts come from a variety of places: equipment which they cannot repair because of restraints imposed by the manufacturer, seeds and other inputs sold by a limited number of suppliers who restrict resale and lower cost distribution, increased prices of fertilizer associated with increased concentration in the production of that input.  On the output side, there is increased concentration in the markets into which farmers sell many of their crops and livestock.  Recently litigation has highlighted how a cartel of poultry integrators exploited growers, consumers, and workers.  Similar claims are pending in other output markets.  This presentation will provide a survey of the issues and the potential for positive or negative impact on farmers and their bottom line.

11:25 a.m. – Noon - Post-Death Dissolution of S Corporation Stock and Stepped-Up Basis; Last Year of Farming; Deferred Tax liability and Conversion to Form 4835 (McEowen)

Noon – 1:00 p.m. – Luncheon

1:00 p.m. – 2:15 p.m. - The Ag Economy and the Impact on Farm/Ranch Clients (Part 2)

Agricultural Finance and Land Situation – (Featherstone)

The current agricultural finance situation and land will be discussed.  Information will be provided on past, recent, and future developments.  Information on the income situation, the financial health of farm operations, and current land market trends will be provided.

2:15 – 2:55 p.m. – Post-Death Basis Increase – Is Gallenstein Still in Play?; Using an LLC to Make an S Election – (McEowen)

Can surviving spouses in non-community property states get a full basis step-up in jointly held property when the first spouse dies?  Gallenstein may still apply for some clients – what are those situations and what does it mean?  Also, the session will examine the procedures involved and the Forms to be filed when an S election is made via a limited liability company. 

2:55 p.m. – 3:15 p.m. Afternoon Break

3:15 p.m. – 3:25 p.m. – Getting Clients Engaged in the Estate/Business Planning Process – (McEowen)

In this brief session, a checklist will be provided designed to assist practitioners in getting clients engaged in the estate, business and succession planning process.  What can be done “jump start” the process for clients?

3:25 p.m. – 4:25 p.m.  – Ethical Problems in Estate and Income Tax Planning – (McEowen)

This session focuses on ethical situations that practitioners often encounter when counseling clients on estate/business planning or income tax planning.  The governing ethical rules are often not carefully tailored for estate and tax planners/preparers, and competing responsibilities often bedevil the professional.  So, how can the estate planning and/or income tax preparer stay “within the rails”?  This session will address the primary rules including the application of relevant portions of Circular 230.

Durango Seminar

Day 1:

8:00 a.m.-8:05 a.m. – Welcome and Announcements

8:05 a.m.-9:05 a.m. - Tax Update – Key Rulings and Cases from the Past Year (or so) (McEowen)

This opening session begins with a review of the most significant recent income tax cases, IRS rulings and other tax administrative developments.  This session will help you stay on top of the ever-changing interpretations of tax law that impact your clients.  

9:05 a.m.-9:35 a.m. - Reporting of WHIP and Other Government Payments (Neiffer)

Farmers that participate in federal farm programs have unique tax reporting requirements and the programs have unique tax rules that apply.  This session will provide a review of the basic tax rules surrounding farm program payments, including new USDA programs that have been created for farmers in recent years.  Also reviewed will be the options for deferring revenue protection policies.

9:35 a.m.-9:55 a.m. - Morning Break

9:55 a.m.-10:20 a.m. - Fixing Bonus Elections and Computations (McEowen)

The TCJA made several changes to bonus depreciation and the IRS issued a Revenue Procedure in 2019 allowing modifications of a bonus election.  Final regulations were published in late 2020 that withdrew a “look-through” rule for partnerships and clarify the application of I.R.C. §743(b) adjustments.  This session brings tax preparers up-to-date on dealing with changes to bonus elections and related computations.

10:20 a.m.-10:50 a.m. - Research and Development Credits (Neiffer)

Beginning in 2022, taxpayers must provide particular information when claiming a refund for research and development credits under I.R.C. §41 on an amended return.  What information is required?  What business components must be identified, and how are research activities performed to be documented?  How can an insufficient claim be perfected?  These issues and more will be addressed.

10:50 a.m.-11:20 a.m. – Farm NOLs (Neiffer)

In 2021, the IRS issued guidance on how farm taxpayers are to handle carryback elections related to farm net operating losses (NOLs) in light of all of the legislative rule changes in recent years.  This session reviews the guidance and illustrates how a farm taxpayer can elect to not apply certain NOL rules of the CARES Act, and how the COVID-Related Tax Relief Act (CTRA) election can be revoked. 

11:20 a.m.-Noon  -  The Taxability of Retailer Reward Programs; Tax Rules Associated with Demolishing Farm Structures (McEowen)

This session addresses the tax issues associated with farm clients receiving “rewards” from retailers that they transact business with.  How are the “rewards” to be reported?  Is the information that the retailer provides to the farmer correct?  This session sorts it out.  In addition, this session covers the proper tax treatment of demolishing farm structures.  Significant weather events in recent months in large areas of farm country destroyed or significantly damaged many farm structures.  When those structured are beyond repair and are demolished, what is the proper way to handle it for tax purposes? 

Noon-1:00 p.m. – Luncheon

1:00 p.m.  – 2:15 p.m. IRS-CI: Emerging Cyber Crimes and Crypto Tax Compliance (Ramon)

This session explains how to identify a business email compromise and/or data breach and how to respond to it.  The session will also identify what the Dark Web is and how it is utilized for cybercrimes and identity theft.  Likewise, the session will help attendees to recognize the general terminology and tax treatment pertaining to virtual/crypto currency. In addition, the session will allow participants to gain a better understanding of the efforts by IRS-Criminal Investigation to combat cyber criminals and illicit activity.

2:15 p.m. – 2:45 p.m.  Potpourri – Part 1 (McEowen and Neiffer)

This session includes discussion of numerous tax issues of importance to farmers and ranchers.  The topics covered include how machinery trade transactions are handled and reported on Form 4797 and Form 4562; inventory accounting issues (what is included in inventory; how the Uniform Capitalization Rules impact inventory accounting; when accrual accounting is required; inventory valuation methods; and crop accounting).  Also covered will be the tax treatment of early termination of CRP contracts; partnership reporting; weather-related livestock sales; and contribution margin analysis

2:45 – 3:05 p.m. - Afternoon Break

3:05 p.m. – 4:25 p.m. Potpourri (cont.) (McEowen and Neiffer)  

The potpourri session continues…and concludes.

DAY 2: 

7:30 a.m. – 8:00 a.m. – Registration

8:00 a.m. – 8:05 a.m. – Welcome and announcements

8:05 a.m. – 9:00 a.m. - Estate and Business Planning Caselaw and Ruling Update (McEowen)

Day 2 begins with a review of the big developments in the courts and with the IRS involving estate planning, business planning and business succession.  Stay on top of the issues impacting transition planning for your clients by learning how legal, legislative and administrative developments impact the estate and business planning process.

9:00 a.m. – 9:45 a.m. – The Use of IDGTs (and other strategies) For Succession Planning (McEowen)

Estate planning with intentionally defective grantor trusts (IDGTs) can have many advantages. This session will discuss the ins and outs of IDGTs, including how they may be a part of developing comprehensive estate plans and how they can be tax “effective” for federal estate tax purposes.

9:45 a.m. – 10:05 a.m.  – Morning Break

10:05 – 11:00 a.m. – Estate Planning to Minimize Income Taxation:  From the Mundane to the Arcane (O’Sullivan)

With the failure of the Biden legislative agenda in 2021 that would have had a deleterious effect on many estate planning techniques, and with estate and gift tax reduction techniques continuing to be relevant (for the immediate future) to a small minority of the population, income tax reduction techniques continue to be the major tax focus of the estate planner’s regimen.  This session will initially address simple, well understood but infrequently utilized- estate planning strategies, and then gravitate to more advanced complex techniques both within and without non-grantor trusts. These techniques can substantially reduce the income taxation burden on beneficiaries of estate plans while carrying out the grantor’s/testator’s other important estate planning goals, including asset protection, maintenance of plan integrity, flexibility and charitable giving.  Learn the techniques that can be implemented for particular clients.

11:00 a.m. – Noon – Oil and Gas Royalties and Working Interest Payments:  Taxation, Planning and Oversight (Denomy)

This presentation will cover how to properly report royalties and working interest payments on current tax returns.  We will then begin to look at estate planning recommendations for your clients.  Also discussed will be issues that you may be able to advise your clients about concerning whether they are being paid according to their agreements.  The session concludes with what it means to be called to be an expert as your client’s CPA.

Noon – 1:00 p.m. - Luncheon

1:00 p.m. – 1:50 p.m. - Economic Evaluation of a Farm Business (Dikeman)

This session will address key components of analyzing the economic health of a farm business.  How much did a farm really make?  Evaluating the economic performance of an agricultural business can be complicated.  With prepaid expenses and generous depreciation options, it is difficult to gauge farm performance especially by looking only at a tax return.  This session will look at the impact of income tax management decisions on the economic performance of a farm business.

1:50 p.m. – 3:05 p.m. – Appropriation Water Rights - Tax and Estate Planning Issues (Mike Ramsey; Andy Morehead; John Howe)

The panel will explore the nature and types of appropriation water rights that practitioners may encounter with their clients, jurisdictional differences and whether the rights are real or personal property interests.  Common ownership, conveyance and title problems will be discussed. Valuation issues will be addressed. There will be discussion about IRC Section 1031 exchanges and depletion issues with examples commonly encountered in sale and transfer transactions.   Concerning estate planning and estate, gift and generation skipping taxation, the potential use and utility of SLATS (spousal lifetime interest trusts), IDGTs (intentionally defective grantor trusts) and IRC Sections 2032A and 6166 will be covered. The emphasis will be on identification of issues with reference materials for further study.  

3:05 -3:25 p.m. – Afternoon Break

3:25 – 4:25 p.m. - Ethically Negotiating End of Life Family Issues (Leisinger)

This ethics exercise takes a look at the sometimes complex processes and issues that arise at end of life for family members.  Participants will be given confidential information and motivations from two different children of a parent who is at end of life and needing to liquidate assets to pay for nursing home care and other expenses.  Ethical rules for attorneys will be discussed and applied to the negotiation exercise and outcomes that participants will be asked to complete as part of the program. 

Conclusion

Registration will open soon for both events and will be available through my website – washburnlaw.edu/waltr.  I will also post here when registration is open and provide the link for you.  Again, if you aren’t able to attend in person, you may attend online.  Also, if you are a law student or undergraduate student interested in attending law school, please contact me personally for details on a discounted registration rate.

March 5, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Monday, December 20, 2021

2022 Summer Conferences – Save the Date

During the summer of 2022 Washburn Law School will be sponsoring farm income tax and farm estate and business planning conferences in Wisconsin and Colorado. 

Please hold the following dates:

  • June 13-14, Chula Vista Resort, Wisconsin Dells, Wisconsin
  • August 1-2, Fort Lewis College, Durango, Colorado

The Chula Vista Resort has been in existence since the late 19th century, and is located three miles north of downtown Wisconsin Dells.  In 2006, the Resort was expanded to add an indoor waterpark along with an 18-hole golf course.  The resort property also contains a riverwalk, a steakhouse and an outdoor wave pool along the Wisconsin River. 

The Durango event in early August will be a beautiful time of the year to be in southwest Colorado.  Attractions include the Durango and Silverton narrow gauge railroad, and numerous historical sights, including Mesa Verde National Park.  To the north of Durango is Telluride, Colorado, another historic western town.

The conferences will provide discussion and analysis of key issues of importance to income tax  planning as well as estate and business planning for farm and ranch clients.   The daily agenda’s for both events is currently being planned, and registration for the events should be available by mid-late January. 

Until then, hold the dates for planning purposes.  I look forward to seeing you at one of these events during the summer of 2022.

December 20, 2021 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Tuesday, October 19, 2021

S Corporations - Reasonable Compensation; Non-Wage Distributions and a Legislative Proposal

Overview

Operating a small business means, in part, paying business taxes.  But, business taxes for many small businesses are different than those that are taken out of an employee’s paycheck.  Under current law, there can be an advantage for many small businesses, particularly those engaged in professional services, to operate in the form of an S corporation.  But, that advantage could be eliminated under a proposal that is under consideration in the Congress.

S corporation tax treatment and a current legislative proposal – it’s the topic of today’s post.

S Corporation Tax Treatment

Many small businesses are subject to the Self-Employment Contributions Act (SECA), and self-employment tax must be paid.  But S corporation shareholders are not subject to SECA tax because the S corporation is treated as separate from the shareholders – its activities are not attributed to its shareholders.  An S corporation must pay its owner-employees “reasonable compensation” for services rendered to the corporation.  That compensation is subject to Federal Insurance Contributions Act (FICA) tax.  But any non-wage distributions to S corporation shareholders are not subject to either FICA or SECA taxes.  Therein lies the “rub.”  Salary that is too low in relation to the services rendered results in the avoidance of payroll taxes.  So, when shareholder-employees take flow-through distributions from the corporation instead of a salary, the distributions are not subject to payroll taxes (i.e., the employer and employee portions of FICA taxes and the employer Federal Unemployment Tax Act (FUTA) tax. 

Note:  FICA requires employers to withhold a set percentage of each employee’s paycheck to cover the Social Security tax, Medicare tax and other insurance costs.  Employer’s must also equally match those withholdings, with the total amount being 15.3 percent of each employee’s net earnings.  Under SECA, a small business owner is deemed to be both the employer and the employee and is, therefore, responsible for the full 15.3 percent “self-employment tax” that is paid out of net business earnings

In accordance with Rev. Rul. 59-221, S corporation flow-through income is taxed at the individual level and is (normally) not subject to self-employment tax.  Also, in addition to avoiding FICA and FUTA tax via S corporation distributions, the 0.9% Medicare tax imposed by I.R.C. §3101(b)(2) for high-wage earners (but not on employers) is also avoided by taking income from an S corporation in the form of distributions.  These are the tax incentives for S corporation shareholder-employees to take less salary relative to distributions from the corporation.  With the Social Security wage base set at $142,800 for 2011, setting a shareholder-employee’s compensation beneath that amount with the balance of compensation consisting of dividends can produce significant tax savings.    

Note:  It is currently projected that the Social Security wage base will be $146,700 for 2022.

Who’s an “Employee”?

Most S corporations, particularly those that involve agricultural businesses, have shareholders that perform substantial services for the corporation as officers and otherwise.  In fact, the services don’t have to be substantial.  Indeed, under a Treasury Regulation, the provision of more than minor services for remuneration makes the shareholder an “employee.”  Once, “employee” status is achieved, the IRS views either a low or non-existent salary to a shareholder who is also an officer/employee as an attempt to evade payroll taxes and, if a court determines that the IRS is correct, the penalty is 100 percent of the taxes owed.   Of course, the burden is on the corporation to establish that the salary amount under question is reasonable.  

Determining Reasonableness

Before 2005, the court cases involved S corporation owners who received all of their compensation in form of dividends.  Most of the pre-2005 cases involved reclassifications on an all-or-nothing basis.  In 2005, the IRS issued a study entitled, “S Corporation Reporting Compliance.”  Now the courts’ focus is on the reasonableness of the compensation in relation to the services provided to the S corporation.  That means each situation is fact-dependent and is based on the type of business the S corporation is engaged in and the amount and value of the services rendered. 

So what are the factors that the IRS examines to determine if reasonable compensation has been paid?  Here’s a list of some of the primary ones:

  • The employee’s qualifications;
  • the nature, extent, and scope of the employee’s work;
  • the size and complexities of the business; a comparison of salaries paid;
  • the prevailing general economic conditions;
  • comparison of salaries with distributions to shareholders;
  • the prevailing rates of compensation paid in similar businesses;
  • the taxpayer’s salary policy for all employees; and
  • in the case of small corporations with a limited number of officers, the amount of compensation paid to the particular employee in previous years.

According to the IRS, the key to establishing reasonable compensation is determining what the shareholder/employee did for the S corporation.  That means that the IRS looks to the source of the S corporation’s gross receipts. If they came from services of non-shareholder employees, or capital and equipment, then they should not be associated with the shareholder/employee’s personal services, and it is reasonable that the shareholder would receive distributions as well as compensation.  Alternatively, if most of the gross receipts and profits are associated with the shareholder’s personal services, then most of the profit distribution should be allocated as compensation. In addition to the shareholder/employee’s direct generation of gross receipts, the shareholder/employee should also be compensated for administrative work performed for the other income-producing employees or assets.  As applied in the ag context, for example, this means that reasonable compensation for a shareholder/employee in a crop farming operation could differ from that of a shareholder-employee in a livestock operation.

Recent Cases

For those interested in digging into the issue further, I suggest reading the following cases:

  • Watson v. Comr., 668 F.3d 1008 (8th Cir. 2012)
  • Sean McAlary Ltd., Inc. v. Comr., T.C. Sum. Op. 2013-62
  • Glass Blocks Unlimited v. Comr., T.C. Memo. 2013-180
  • Scott Singer Installations, Inc. v. Comr., T.C. Memo. 2016-161

Each of these cases provides insight into the common issues associated with the reasonable compensation issue.  The last two also address distributions and loan repayments in the context of reasonable compensation of unprofitable S corporations with one case being a taxpayer victory and the other a taxpayer loss. 

Legislative Proposal

A current proposal, effective for tax years beginning after December 31, 2021, that would change the tax rules applicable to S corporations is being considered as part of the massive spending bills that are currently before the Congress.  The proposal is an attempt to ensure that all of the pass-through business income that an individual receives that has more than $400,000 of adjusted gross income for the tax year is subject to the 3.8 percent Medicare tax – either through the tax on net investment income (I.R.C. §1411) or through the SECA tax.  This outcome would be accomplished by the legislation amending the definition of “net investment income” so that it includes an individual’s gross income and gain from a pass-through business that is not otherwise subject to employment taxes.  That means it would apply to S corporation shareholders who are active in the corporation’s business, but don’t receive a “sufficient” level of compensation.  The proposal would also apply SECA tax to the distributive share of the business income that an S corporation shareholder receives who materially participates in the entity’s business

Note:  The proposal would also apply SECA tax (above a threshold amount) to the distributive shares of partners in limited partnerships and limited liability company (LLC) members that provide services to the entity and materially participate.

Conclusion

If the legislative proposal is enacted into law, it would significantly change the taxation of pass-through entities and owners that have AGI above the $400,000 threshold.  The technique of reducing employment tax by managing compensation levels withing the boundaries set by the IRS and the courts would no longer be a viable strategy.  Also, if enacted, the proposal could incentivize the revocation of the S election in favor of C corporate status.  But, that move depends, at least in part, on where the C corporate tax rate turns out to be  - that’s under consideration in the Congress also. 

Stay tuned. 

October 19, 2021 in Business Planning, Income Tax | Permalink | Comments (0)

Monday, October 11, 2021

Caselaw Update

Overview

It’s been a while since I highlighted a few recent cases for the blog.  Today is that day.  Recently, the court have decided cases about a packing plant’s potential liability exposure to employee claims about the virus; a legal challenge to the beef checkoff; C corporation distributions; and whether a trade or business existed in a rather unique setting.

Caselaw update – it’s the topic of today’s post.

Meat-Packing Plant Employees Can’t Sue Over Virus Claims 

Fields v. Tyson Foods, Inc., No. 6:20-cv-00475, 2021 U.S. Dist. LEXIS 181083 (E.D. Tex. Sept. 22, 2021).

The plaintiffs were defendant’s employees. They sued for negligence and gross negligence, alleging that the defendant failed to take adequate safety measures, such as not providing personal protective equipment and not implementing social-distancing guidelines, which caused them to contract COVID-19. The plaintiffs argued that the defendant failed to satisfy a duty of care to keep its premises in a reasonably safe condition, and that it failed to exercise ordinary care to reduce or eliminate the risk of employees being exposed to COVID-19. The defendant filed a motion to dismiss for a failure to state a claim upon which relief can be granted. The defendant argued that the Poultry Products Inspection Act (PPIA) as promulgated by the Food Safety and Inspection Service (FSIS) of the Department of Agriculture contained an express-preemption clause that foreclosed the plaintiffs’ claims. Additionally, the defendant argued that the recently passed Pandemic Liability Protection Act (PLPA) provided the defendant retroactive protection against damages lawsuits that alleged exposure to COVID-19. The trial court agreed and noted that the PPIA’s express-preemption clause overrode state requirements that are different than the regulations. The trial court noted that although the plaintiffs argued that the defendant failed to impose adequate safety measures to reduce the spread of COVID-19 in its facility, the FSIS promulgated a number of regulations under the PPIA that directly addressed the spread of disease. The trial court held that the duty of care alleged by the plaintiffs’ negligence claim would require the defendant to utilize additional equipment, therefore the plaintiffs’ claims were preempted by federal law. The trial court next addressed the PLPA, which generally shields corporations from liability if an individual suffers injury or death as a result of exposure to COVID-19. The trial court noted that the plaintiffs needed to allege that the defendant either knowingly failed to warn them or remedy some condition at the facility that the defendant knew would expose the plaintiffs to COVID- 19, or that the defendant knowingly contravened government-promulgated COVID-19 guidance. Further, the plaintiffs must allege reliable scientific evidence that shows that the defendant’s conduct was the cause-in-fact of the plaintiffs’ contracting COVID-19. The trial court noted that the plaintiffs failed to provide any reliable scientific evidence that showed that the defendant was the cause-in-fact of the plaintiffs’ contracting COVID-19. Because the plaintiffs merely made conclusory statements that they contracted COVID-19 due to unsafe working conditions, without alleging how or when they contracted COVID-19, the trial court held the plaintiffs’ complaint failed to satisfy the PLPA. Upon granting the defendant’s motion to dismiss, the trial court noted that even if the plaintiffs amended their complaint to satisfy the causation prong, the PPIA preemption clause would still foreclose the plaintiffs’ claims. 

Lawsuit Challenging Changes to Beef Checkoff Continues

Ranchers-Cattlemen Action Legal Fund, United Stockgrowers of America v. United States Department of Agriculture, et al., NO. 20-2552 (RDM), 2021 U.S. DIST. LEXIS 187182 (D. D.C. Sept. 29, 2021).

The plaintiff, a cattle grower association, sued the United States Department of Agriculture (USDA) claiming that the USDA made substantive changes to the Beef Checkoff Program in violation of the Administrative Procedure Act (APA) by entering into memorandums of understanding (MOUs) with various state beef councils. The plaintiff asserted that such amendments should have been subject to public notice-and-comment rulemaking. The MOUs gave the USDA more oversight authority over how the state beef councils could use the funds received from the checkoff. In other litigation, the USDA has been claiming oversight authority (even though not exercised) over state beef councils to argue that the beef checkoff is government speech rather than private speech in order to defeat First Amendment claims. In the present litigation, the USDA motioned to dismiss the case for lack of standing. The court denied the USDA’s motion on the basis that the plaintiff, on the face of its claim, had established sufficient elements of associational standing – that at least one of the plaintiff’s members had suffered a diminished return on investment as a result of the MOUs. The court did not address the factual question of the plaintiff’s standing. The USDA’s had also asserted a defense of claim preclusion but the court postponed examining that issue until additional evidence was submitted allowing the court to fully address the issue of jurisdiction.

Lack of Documentation Leads to Receipt of Constructive Dividends

Combs v. Comr., No. 20-70262, 2021 U.S. App. LEXIS 28875 (9th Cir. Sept. 23, 2021), aff’g., T.C. Memo. 2019-96.

The petitioner was the sole shareholder of a C corporation in which he housed his motivational speaking business. The fees he earned were paid to the corporation. The corporation paid him a small salary which he instructed the corporation not to report as income to him. In addition, he also paid many personal expenses from a corporate account. The IRS claimed that the distributions from the corporation to the petitioner constituted dividends that the petitioner should have included in gross income. The Tax Court noted that if the corporation has sufficient earnings and profits that the distribution is a dividend to the shareholder receiving the distribution, but that if the distribution exceeds the corporation’s earnings and profits, the excess is generally a nontaxable return of capital to the extent of the shareholder’s basis in the corporation with any remaining amount taxed to the shareholder as gain from the sale or exchange of property. The Tax Court noted that the petitioner’s records did not distinguish personal living expenses from legitimate business expenses and did not provide any way for the court to estimate or determine if any of the expenses at issue were ordinary and necessary business expenses. Thus, the court upheld the IRS determination that the petitioner received and failed to report constructive dividends. The appellate court affirmed noting that there was ample evidence to support the Tax Court’s constructive dividend finding and that the petitioner had failed to rebut any of that evidence. 

Suing Ex-Wife Not a Trade or Business

Ray v. Comr., No. 20-6004, 2021 U.S. App. LEXIS 27614 (5th Cir. Sept. 14, 2021).

The petitioner divorced his wife in 1977 and then sued her in state court in 1998 over debts she owed associated with two real estate purchases and credit cards, as well as penalties she owed the petitioner for not providing him with financial statements in a timely manner. During the pendency of the lawsuit in 2020, he sued her two more times in state court and sued her attorneys in federal court. The federal litigation involved losses from trading agreements the petitioner entered into with her involving a futures and options trading method she created. Ultimately, she owed the petitioner about $384,000 for trading losses incurred with funds he deposited into a commodities brokerage account. The petitioner deducted $267,000 in legal fees on his 2014 return and the IRS rejected the deduction, tacking on an accuracy-related penalty. In 2019, the Tax Court disallowed the legal expenses under I.R.C. §162(a), but allowed a deduction for legal costs incurred that were associated with trading agreement losses as production of income expenses under I.R.C. §212(1). The Tax Court also upheld the accuracy-related penalties. On appeal the appellate court largely affirmed the Tax Court, find that the petitioner didn’t prove that his lawsuit to recover the trading agreement losses was related to his work with a trade or business. Also, the appellate court upheld the Tax Court finding that the petitioner didn’t have a profit motive in suing his ex-wife which was required for a deduction under I.R.C. §212(1). However, the appellate court held that the Tax Court erred in concluding that the petitioner lacked some justification for claiming deductions under I.R.C. §162(a) for legal fees relating to the trading agreement losses. As such, the appellate court remanded the penalty issue to the Tax Court. 

Conclusion

Expect challenges to the beef checkoff to continue.  Many livestock ranchers and farmers that also have cattle and pay the checkoff have been irritated about the use of their checkoff dollars and the conduct of state beef councils for many years.  Also, the constructive dividend issue is a big one.  Compensation arrangements for corporate officers/shareholders must be structured properly to avoid the constructive dividend issue.  The IRS does examine that issue.  In addition, the trade or business issue often arises in the context of agricultural activities – particularly when rental arrangements are involved.  Remember, under IRS rules a cash lease is not a farming trade or business – it’s a rental activity.  That can have implications in numerous settings.  But, I have never seen the argument come up before the Ray case in the context of suing an ex-spouse!  That’s an interesting twist.    

October 11, 2021 in Business Planning, Income Tax, Regulatory Law | Permalink | Comments (0)

Tuesday, October 5, 2021

Corporate-Owned Life Insurance – Impact on Corporate Value and Shareholder’s Estate

Overview

A corporate buy-sell agreement funded with life insurance is fairly common in farm and ranch settings where there is a desire to keep the business in the family for subsequent generations and there are both on-farm and off-farm heirs.  When a controlling shareholder dies, it can be a good way to get the control of the business in the hands of the on-farm heirs and income into the hands of the off-farm heirs.  But, how does corporate-owned life insurance impact the value of the company and the value of the decedent’s gross estate?

The impact of corporate-owned life insurance on value – it’s the topic of today’s post.

Background

Valuation is where the “action” is when it come to federal estate tax.  The rule for valuing property for federal estate (and gift) tax purposes is the “willing buyer-willing-seller” test.  Treas. Reg. §25.2512-1.  Whatever price the parties arrive at is deemed to be the property’s fair market value.  Id.  But, how is a corporation to be valued when it will receive insurance proceeds upon the death of a shareholder and the proceeds will be offset by a corporate obligation to redeem the decedent’s stock?  Will the proceeds of an insurance policy owned by a corporation and payable to the corporation be taken into account in determining the corporation’s net worth?  Under the Treasury Regulations, the proceeds do not add to corporate net worth to the extent that they are otherwise reflected in a determination of net worth, prospective earning power, and dividend-paying capacity.  Treas. Reg. §20.2031-2(f).  This means that, for the stockholders that have various degrees of control, the insurance proceeds may be reflected in the pro-rata determination of stock value.  The same is true for proceeds payable to a third party for a valid business purpose that results in a net increase in the corporate net worth.  See Treas. Reg. §20.2042-1(c)(6).

A related question is what the impact is on the decedent’s estate that has stock redeemed?  Does state law matter?

The Blount Case

The issue of corporate valuation when life insurance proceeds are payable to the corporation upon a shareholder’s death for the purpose of funding a stock redemption pursuant to a buy-sell agreement came up in Estate of Blount v. Comr., T.C. Memo. 2004-116.  In Blount, the decedent owned 83.2 percent of a construction company.  There was only one other shareholder, and the two shareholders entered into a buy-sell agreement in 1981 with the corporation.  Under the agreement, the stock could only be sold with shareholder consent.  Upon a shareholder’s death, the agreement specified that the corporation would buy the stock at a price that the shareholders had agreed upon or, if there was no agreement, at a price based on the corporation’s book value. 

In the early 1990s, the corporation bought insurance policies for the sole purpose of ensuring that the business could redeem stock and continue in business.  The policies provided about $3 million, respectively, for the stock redemption.  The corporation was valued annually, and a January 1995 valuation pegged it at $7.9 million. 

The first shareholder died in early 1996 at a time when he owned 46 percent of outstanding corporate shares.  The corporation received about $3 million in insurance proceeds and paid slightly less than that to redeem the shareholder’s stock based on the prior year’s book value.  The decedent was diagnosed with cancer in late 1996.  The 1981 buy-sell agreement was amended about a month later locking the redemption price at the January 1996 value of the corporation.  The decedent died in the fall of 1987.  The corporation paid his estate about $4 million in accordance with the 1996 agreement.  The decedent’s estate tax return reported the $4 million as the value of the shares.  Upon audit, the IRS asserted that the stock was worth about twice that amount based on the corporation being worth about $9.5 million (including the insurance proceeds to the other corporate assets).

Based on numerous expert valuations, the Tax Court started with a base corporate valuation of $6.75 million.  After adding the $3.1 million of insurance paid to the corporation as a non-operating asset upon the decedent’s death, the corporation was worth $9.85 million.  Given the decedent’s ownership percentage of 83.2 percent, the value of the decedent’s stock for estate tax purposes was $8.2 million.  But the Tax Court limited the stock value to slightly less than $8 million which was the amount that the IRS had determined in its original notice of deficiency.  In making its valuation determination, the Tax Court disregarded the buy-sell agreement on the basis that it had been modified and, therefore, didn’t meet the requirement to be binding during life.  In addition, the Tax Court reasoned that the agreement could be disregarded under I.R.C. §2703 because it was entered into by related parties that didn’t engage in arm’s-length negotiation.  Because the Tax Court disregarded the buy-sell agreement, the issue of whether the corporation’s obligation to redeem the decedent’s stock offset the proceeds was not in issue. 

The appellate court affirmed the Tax Court’s decision that the buy-sell agreement couldn’t establish the value of the corporate stock for estate tax purposes primarily because the decedent owned 83.2 percent of the stock and could have changed the agreement at any time, but reversed on the issue of whether the insurance proceeds should be included in the corporation’s value as non-operating assets.  Estate of Blount v. Comr., 428 F.3d 1338 (11th Cir. 2005).  The appellate court determined that the proceeds had already been taken into account in determining the corporation’s net worth.  The buy-sell agreement was still an enforceable liability against the company under state law even though it didn’t set the value of the company for tax purposes.  The appellate court noted that the insurance proceeds were offset dollar-for-dollar by the corporation’s obligation to satisfy its contractual obligation with the decedent’s estate.  The appellate court grounded this last point in Treas. Reg. §20.2031-2(f)(2), which it held precluded the inclusion of life insurance proceeds in corporate value when the proceeds are used for a redemption obligation. 

Note:  The Ninth Circuit also reached the same conclusion in Cartwright v. Comr., 183 F.3d 1034 (9th Cir. 1999).  In Cartwright, the court deducted the insurance proceeds from the value of the organization when they were offset by an obligation to pay those proceeds to the estate in a stock buyout.

Recent Case

Essential facts.  In Connelly v. United States, No. 4:19-cv-01410-SRC, 2021 U.S. Dist. LEXIS 179745 (E.D. Mo. Sept. 21, 2021), two brothers were the only shareholders of a closely-held family roofing and siding materials business.  They entered into a stock purchase agreement that required the company to buy back shares of the first brother to die.  The company then purchased about $3.5 million in life insurance coverage to ensure it had enough cash to redeem the stock.  The brother holding the majority of the company’s shares (77.18 percent) died on October 1, 2013.  The company received $3.5 million in insurance proceeds.  The surviving brother chose not to buy his shares, so the company used a portion of the proceeds to buy the deceased brother’s shares from his estate for $3 million pursuant to a Sale and Purchase Agreement.  Under the agreement the estate received $3 million and the decedent’s son received a three-year option to buy company stock from the surviving brother.  In the event that the surviving brother sold the company within 10 years, the brother and decedent’s son would split evenly any gains from the sale.

The estate valued the decedent’s stock at $3 million and included that amount in the taxable estate.  Upon audit the IRS asserted that the fair market value of the decedent’s corporate stock should have factored-in the $3 million in life-insurance proceeds used to redeem the shares which, in turn, resulted in a higher value of the decedent’s stock than was reported.  The IRS assessed over $1 million in additional estate tax.  The estate paid the deficiency and filed a refund claim in federal district court.

The buy-sell agreement.  The court noted that a stock-purchase agreement is respected when determining the fair market value of stock for estate tax purposes upon satisfying the requirements of I.R.C. §2703(b).  Those requirements are that the agreement must: 1) be a bona fide business arrangement; 2) not be a device to transfer property to members of the decedent’s family for less than full and adequate consideration in the money’s worth; and 3) have terms that are comparable to similar arrangements entered in an arms’ length transaction.  The court also noted several judicially-created requirements – 1) the offering price must be fixed and determinable under the agreement; 2) the agreement must be legally binding on the parties both during life and after death; and 3) the restrictive agreement must have been entered into for a bona fide business reason and must not be a substitute for a testamentary disposition for less than full-and-adequate consideration. 

The IRS expert claimed that the insurance proceeds should be included in the company’s value as a non-operating asset, and that allowing the redemption obligation to offset the insurance proceeds undervalued the company’s equity and the decedent’s equity interest in the company, and would create a windfall for a potential buyer that a willing seller would not accept.  The IRS expert concluded that the fair market value of the company was $6.86 million rather than $3.86 million.  The IRS also took the position that the stock purchase agreement didn’t meet the requirements in the Code and regulations to control the value of the company. 

The estate claimed that the company sold the decedent’s shares at fair market value and that the shares had been properly valued.  Thus, the $3 million in life insurance proceeds were properly excluded from the decedent’s estate based on the appellate opinion in Blount.  The estate claimed that the stock purchase agreement provided a sufficient basis for the court to accept the estate’s valuation as the proper estate-tax value of the decedent’s shares.  On that point, the IRS claimed that the stock purchase agreement was not a bona fide business arrangement and, as such, didn’t control the value of the decedent’s stock.  The IRS position was that the stated estate planning objectives of the stock purchase of continued family ownership of the company were insufficient to make it a bona fide business arrangement, particularly because the brothers did not follow it by disregarding the pricing mechanisms contained in it.

The court passed on the bona fide business arrangement issue because it determined that the estate had failed to show that the stock purchase agreement was not a device to transfer wealth to the decedent’s family members for less than full-and-adequate consideration.  The process that the surviving brother and the estate used in selecting the redemption price bolstered the court’s conclusion that the stock purchase agreement was a testamentary device.  They also did not obtain an outside appraisal or professional advice on setting the redemption price, thereby disregarding the appraisal requirement set forth in the agreement.  The court also noted that the agreement didn’t provide for a minority interest discount for the surviving brother’s shares or a lack of control premium for the decedent’s shares with the result that the decedent’s shares were undervalued.  This also, according to the court, demonstrated that the stock purchase agreement was a testamentary device to transfer wealth to the decedent’s family members for less than full-and-adequate consideration and was not comparable to similar agreements negotiated at arms’ length.

Inclusion of life insurance proceeds in corporate value.  On the issue of whether the life insurance proceeds should be included in corporate value, the court rejected the appellate court’s approach in Blount, finding it to be analytically flawed.  The court concluded that the appellate court in Blount had misread Treas. Reg. §20.2031-2(f)(2), and that the regulation specifically requires consideration to be given to non-operating assets including life insurance proceeds, “to the extent such nonoperating assets have not been taken into account in the determination of net worth.”  The court concluded that the text of the regulation does not indicate that the presence of an offsetting liability means that the life insurance proceeds have already been “taken into account in the determination of a company’s net worth.”  The court concluded that, “by its plain terms, the regulation means that the proceeds should be considered in the same manner as any other nonoperating asset in the calculation of the fair market value of a company’s stock…. And…a redemption obligation is not the same as an ordinary corporate liability.”  There is a difference, the court noted, between a redemption obligation that simply buys shares of stock, and one that also compensates for a shareholder’s past work.  One that only buys stock is not an ordinary corporate liability – it doesn’t change the value of the corporation as a whole before the shares are redeemed.  It involves a change in the ownership structure with a shareholder essentially “cashing out.”   

The court noted that the parties had stipulated that the decedent’s shares were worth $3.1 million, aside from the life insurance proceeds.  The insurance proceeds were not offset by the company’s redemption obligation and, accordingly, the company’s fair market value and the decedent’s shares included all of the insurance proceeds, and the IRS position was upheld.

Conclusion

The Connelly opinion is appealable to the Eighth Circuit, which would not be bound to follow either the Ninth or Eleventh Circuits on the corporate valuation issue.  The opinion does provide some “food for thought” when using life insurance to fund stock buyouts in closely-held business settings.  That will be an even bigger concern if the federal estate tax exemption declines in the future.

October 5, 2021 in Business Planning, Estate Planning | Permalink | Comments (0)

Monday, September 27, 2021

Fall 2021 Seminars

Overview

I receive many requests for my seminar schedule, particularly during the fall season when I am doing training events for tax practitioners.   Today’s post provides a listing (as of today) for my events for the rest of the year.

September 29, 2021 (LaHarpe, Kansas)

This is not a tax event, but a breakfast meeting from 8:00 a.m. – 9:30 a.m. for local landowners impacted or potentially impacted by the Southwest Power Pool Blackberry Line from Wolf Creek Nuclear plant to Blackberry (south of Pittsburg).  I will be discussing real estate principles concerning easements.

October 8, 2021 (Laramie, Wyoming)

This event is for attorneys and CPAs and other tax professionals.  I will be providing an up-to-date discussion and analysis of the current status of proposed tax legislation.  I will also be addressing some other estate and tax planning topics of present importance.  You can learn more about this event and register at the following link:  https://www.washburnlaw.edu/employers/cle/farmranchplanning.html

Kansas State University (KSU) Tax Institutes (October 25 – December 14)

The KSU Tax Institutes are two-day Institutes at six locations across the state of Kansas and two, two-day webinars.  This fall I will be team-teaching Day 1 with Paul Neiffer at Garden City, Kansas and Hays, Kansas.  I will also be team teaching Day 2 at those locations with Ross Hirst, retired IRS.  The three of us will also be teaching Webinar No. 1.  The Garden City Institute is on October 25-26.  The Hays Institute is on October 27 and 28.  Webinar No. 1 is on November 3-4. 

The remaining Institutes will be taught on Day 1 by Prof. Edward A. Morse of Creighton University School of Law and Daniel Waters of Lamson Dugan & Murray in Omaha, Nebraska.  Prof. Morse is also a CPA and is an excellent presenter on tax topics for CPAs and other tax professionals.  He teaches various tax classes at the law school and also operates a farm east of Omaha in Iowa.  Daniel has an extensive tax and estate/business planning practice.  Ross Hirst and I will team teach Day 2 at each of these locations.

The dates for these five Institutes are:  Salina, Kansas on November 8-9; Lawrence, Kansas November 9-10; Wichita, Kansas on November 22-23; Pittsburg, Kansas on December 8-9; and Webinar No. 2 on December 13-14.

You can learn more about the KSU Tax Institutes and the topics that we will be covering, and registration information at the following link:  https://agmanager.info/events/kansas-income-tax-institute

December 16-17 (San Angelo, Texas)

At this two-day conference, I will be focusing on critical income tax and estate/business planning issues.  This event is sponsored by the San Angelo Chapter of the Texas Society of CPAs. 

Other

I also have other in-house training events scheduled this fall for various CPA firms. 

Conclusion

I look forward to seeing you in-person at one of the events this fall.  If you can’t attend in-person, some of the events are online, as noted.   Also, thanks to those listening to the daily two-minute syndicated radio program that airs across the country.  Air plays were up about 30 percent in August compared to July.  

September 27, 2021 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)