Thursday, April 20, 2023
Bibliography – First Quarter of 2023
The following is a listing by category of my blog articles for the first quarter of 2023.
Bankruptcy
Failure to Execute a Written Lease Leads to a Lawsuit; and Improper Use of SBA Loan Funds
Chapter 12 Bankruptcy – Proposing a Reorganization Plan in Good Faith
Business Planning
Summer Seminars
https://lawprofessors.typepad.com/agriculturallaw/2023/03/summer-seminars.html
Registration Now Open for Summer Conference No. 1 – Petoskey, Michigan (June 15-16)
Civil Liabilities
Top Ag Law and Tax Developments of 2022 – Part 1
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 8 and 7
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Contracts
Top Ag Law and Developments of 2022 – Part 2
Failure to Execute a Written Lease Leads to a Lawsuit; and Improper Use of SBA Loan Funds
Double Fractions in Oil and Gas Conveyances and Leases – Resulting Interpretive Issues
Environmental Law
Here Come the Feds: EPA Final Rule Defining Waters of the United States – Again
Top Ag Law and Developments of 2022 – Part 2
Top Ag Law and Developments of 2022 – Part 3
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 10 and 9
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 6 and 5
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 4 and 3
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Estate Planning
Tax Court Opinion – Charitable Deduction Case Involving Estate Planning Fraudster
Happenings in Agricultural Law and Tax
Summer Seminars
https://lawprofessors.typepad.com/agriculturallaw/2023/03/summer-seminars.html
RMD Rules Have Changed – Do You Have to Start Receiving Payments from Your Retirement Plan?
Common Law Marriage – It May Be More Involved Than What You Think
The Marital Deduction, QTIP Trusts and Coordinated Estate Planning
Registration Now Open for Summer Conference No. 1 – Petoskey, Michigan (June 15-16)
Income Tax
Top Ag Law and Developments of 2022 – Part 3
Top Ag Law and Developments of 2022 – Part 4
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 8 and 7
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Tax Court Opinion – Charitable Deduction Case Involving Estate Planning Fraudster
Deducting Residual (Excess) Soil Fertility
Deducting Residual (Excess) Soil Fertility – Does the Concept Apply to Pasture/Rangeland? (An Addendum)
Happenings in Agricultural Law and Tax
Summer Seminars
https://lawprofessors.typepad.com/agriculturallaw/2023/03/summer-seminars.html
RMD Rules Have Changed – Do You Have to Start Receiving Payments from Your Retirement Plan?
Registration Now Open for Summer Conference No. 1 – Petoskey, Michigan (June 15-16)
Real Property
Equity “Theft” – Can I Lose the Equity in My Farm for Failure to Pay Property Taxes?
Happenings in Agricultural Law and Tax
Adverse Possession and a “Fence of Convenience”
Double Fractions in Oil and Gas Conveyances and Leases – Resulting Interpretive Issues
Abandoned Rail Lines – Issues for Abutting Landowners
Regulatory Law
Top Ag Law and Developments of 2022 – Part 2
Top Ag Law and Developments of 2022 – Part 4
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 10 and 9
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 8 and 7
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 6 and 5
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 4 and 3
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Foreign Ownership of Agricultural Land
Abandoned Rail Lines – Issues for Abutting Landowners
Secured Transactions
Priority Among Competing Security Interests
Water Law
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Happenings in Agricultural Law and Tax
April 20, 2023 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)
Tuesday, April 11, 2023
Registration Now Open for Summer Conference No. 1 – Petoskey, Michigan (June 15-16)
Overview
Again this summer, Washburn Law School will be conducting two summer seminars focused on farm and ranch income taxation and farm and ranch estate, business and succession planning. The first of the two events will be in Petoskey, Michigan on June 15-16 at North Central Michigan College. Registration is now open and can be accessed here: https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html
August Conferences in Idaho
The finishing touches are just about complete on the second two-day event this summer which will be at North Idaho College in Coeur d’Alene, Idaho on August 7-8. Both events will also be simulcast live over the web. The Idaho event will feature a “conference within a conference.” The standard two days will be devoted to farm/ranch income tax and farm/ranch estate and business planning topics. But starting a bit later each day and ending slightly earlier, a second conference will be occurring simultaneously in a nearby meeting hall in the same building on the North Idaho College campus devoted to topics in agricultural law. The them of this two-day conference will be on representing the ag client. Many thanks to the Idaho Bar Association, the ag law section of the Idaho Bar, Prof. Rich Seamon and the University of Idaho College of law and others in helping put this conference together. Details on this these two conferences in Coeur d’Alene will be posted here soon with registration information.
June Michigan Conference
The itinerary for the Michigan event is below. The Idaho tax/e.p./b.p. conference follows the same Day 1 itinerary as the Michigan event, but Day 2 in Idaho will have a few different topics and speakers.
Here’s the itinerary for the Michigan conference.
Day 1 Itinerary
7:30-8:00 a.m. – Registration
8:00–8:05 a.m. - Welcome and Announcements
8:05–9:05 a.m. – Tax Update (Cases and Rulings) (McEowen) [60 minutes tax update CPE]
This opening session takes a look at the most significant tax cases and rulings from the courts and the IRS during the past year that have implications for farm and ranch clients, rural landowners, and agribusiness professionals.
9:05–9:45 a.m. – The Definition of “Farm Income” for Farm Program Purposes (Neiffer) [40 minutes tax update CPE]
Many Farm Service Agency programs grant extra payments if AGI from farming is more than 75% of total AGI. This session will review how FSA determine AGI and why it can be substantially different from IRS calculations.
9:45–10:05 a.m. – Morning Break
10:05–10:30 a.m. – Machinery Trades (McEowen) [25 minutes of tax law CPE]
This session examines the trade of farm machinery with no or low basis for new machinery and the resulting gain computation, combined with substantial depreciation claimed on the new machine.
10:30–10:55 a.m. – Selected Topics - Inventory Method Options for Farmers; How Bonus Depreciation and Expense Method Depreciation Can Work Together for Farm Clients (Neiffer) [25 minutes of tax update CPE]
Tax Reform simplified many accounting methods for taxpayers including farmers. We will review those change and why Section 179 can be more beneficial than bonus depreciation.
10:55–11:45 a.m. – Solar Panel Tax Issues; Other Rental Tax Issues (McEowen) [50 minutes of tax law CPE]
This discussion explores the tax issues associated with the placement of solar panels on farmland and also looks at other tax issues associated with rentals that farming operations often encounter.
11:45–12:45 p.m. – Luncheon
12:45 p.m.– 1:45 p.m. – Protecting a Tax Practice From Scammers (IRS CID) [60 minutes of tax law]
What steps can a tax practice take to protect itself from scams, including those from the dark web? What is good office protocol? What are the essential things that can be done and what are the signs to look for to detect scammers?
1:45 p.m.–2:25 p.m. – Selected Topics - Amending Partnership Returns; Corporate Provided Meals and Lodging; Charitable Remainder Trusts for Retiring Farmers (Neiffer) [40 minutes of tax law CPE]
This session will update the required method of amending partnership returns depending on whether the centralized partnership audit regime applies; a review of the change in corporate provided meals and why charitable remainder trusts can save taxes for a retiring farmer especially with increasing interest rates.
2:25-2:45 p.m. – Afternoon Break
2:45–3:10 p.m. – Easement Tax Issues (McEowen) [25 minutes of tax update CPE]
Rural landowners are finding easement tax issues to be more commonplace. This brief session provides a review of the basic tax issues associated with easements, particularly income tax basis offset issues and the character of the easement payments.
3:10–4:00 p.m. – IC-DISC for Farmers; Disallowance of Cash Method for Farming Activities; Accounting for Hedging Transactions; When to Deduct a Purchased Growing Crop (Neiffer) [50 minutes of tax law CPE]
An IC-DISC can cut a farmer’s income taxes in half – we review when it might apply. More farming activities include non-material participating taxpayers. This can cause the entity to be on the accrual method. The reporting of hedging activities is not always intuitive. We review the requirement and the options and when can a farmer deduct purchased growing crop.
4:00–4:25 p.m. – Soil Fertility Deductions (McEowen) [25 minutes of tax law CPE]
When a farm is purchased an allocation of value can be made to depreciable items. One of those items might be excess fertilizer supply. The IRS has a specific procedure that must be followed for valuing the excess amount. This session examines the IRS approach, the amount to be amortized, the timeframe for amortization and the possibility of recapture.
4:25 p.m. - Adjournment
Day 2
Here’s the itinerary for Day 2 of the Michigan event (farm estate and business planning track):
7:30-8:00 a.m. — Registration
8:05-8:55a.m. — Current Developments in Estate and Gift Taxation (McEowen) [50 minutes tax update CPE]
This session provides an update of legislative, regulatory and court developments involving federal estate and gift tax including developments involving a decedent’s gross estate, asset valuation, gifts made during life, retirement plans and miscellaneous issues.
8:55-9:45 a.m. – “Top Ten” Strategies For a Successful Farm Business (Rhea and Dikeman) [50 minutes tax update CPE]
As we look toward the next 12 months, several items deserve increased attention for farm businesses. This presentation delivers a Top 10 list of forward-looking strategies to consider for success. Changes in cost, income, inflation, tax laws, and estate planning are some key topics discussed. These will be on the mind of farms and ranches as they navigate the uncertain economic conditions and the impact of higher asset values, growing debt, and rising interest rates. We will also demonstrate the performance distinctions of top 1/3 producers.
9:45-10:05 a.m. — Morning Break
10:05-10:55 a.m. – Taxes in Probate: Form 1041 and Distribution Deductions (McEowen) [50 minutes tax law CPE]
This session walks the practitioner through the completion of Form 1041, the assets included in the probate estate, possible income generating items for an estate, the handling of capital gain or loss, and estate accounting. A discussion of e-filing and electronic signatures will also be included. In addition, common issues associated with the death of a farmer will be addressed.
10:55 a.m.-11:45 a.m. – SLATs – Why It Might be the Best Option for Your Farmers (Neiffer) [50 minutes of tax law CPE]
This session reviews the various trust options available to farm families to transfer assets to the next generation in a tax efficient manner. The session will then review why a Spousal Lifetime Access Trust (SLAT) might be the best option.
11:45-12:45 p.m. — Lunch
12:45 p.m.-1:35 p.m. – Why Social Security is an Investment, not a Tax (Neiffer) [50 minutes of tax law CPE]
Most farmers view social security as an unnecessary tax. However, with optimal planning, social security maybe one of the best investments they ever make. We review how benefits are calculated, why spousal benefits provide even more bang for their buck and some common claiming options.
1:35 p.m.-2:50 p.m. — Tax Strategies for the Farm and Ranch Client (Rhea and Dikeman) [75 minutes of tax law CPE]
This session highlights several changes were made by the Tax Cuts & Jobs Act of 2017; many sunset after 2025 and demand attention for optimal tax planning strategies the next 3 years. We will also explain how rising inflation rates are at times helping reduce tax liability and when it does not. Rising interest rates and inflated asset values are dramatically shifting costs of farm transitions to the detriment of young and beginning farmers. Stepped-up basis is a big thing; we detail how this can be helpful to farm successors. Unintended consequences of high income and options for tax management after year end are analyzed.
2:50 p.m. – 3:10 p.m. – Afternoon Break
3:10 p.m. – 3:25 p.m. – New Estate Planning Clients – Screening Clients and Gathering Information [15 minutes of tax law CPE]
This session takes a brief look at a suggested approach to handling potential new estate/business planning clients. How to screen clients, identify potential problem clients, engagement letters and information gathering as preparatory to determining the appropriate path forward for the client.
3:25-4:25 p.m. – Ethics for Estate Planners (McEowen) [1 hour of tax ethics CPE]
What are the ethical issues facing practitioners working with clients on estate/business and tax planning matters? How might the Circular 230 rules impact tax professionals in the estate and business planning context when income tax advice is involved? This session looks at some of the common issues that can arise, applicable caselaw, and some of the more unusual situations that might arise that present difficult situations for the planner.
4:25 p.m. — Conference Adjourns
Conclusion
The registration link for the Michigan event can be found here:
As noted above, both days of the conference will be broadcast live online. Also, if you business is interested in being a sponsor, please contact me.
April 11, 2023 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)
Wednesday, March 29, 2023
Summer Seminars
Overview
This summer Washburn Law School will be conducting two summer seminars focused on farm and ranch income taxation and farm and ranch estate, business and succession planning. The first of the two events will be in Petoskey, Michigan on June 15-16 at North Central Michigan College. Registration will open soon. When the law school has that ready, the link will be available on my website: www.washburnlaw.edu/waltr and I will share it here. The second two-day event this summer will be at North Idaho College in Coeur d’Alene, Idaho on August 7-8. Both events will also be simulcast live over the web.
The itinerary for the Michigan event is below. The Idaho event follows the same Day 1 itinerary as the Michigan event, but Day 2 in Idaho will have a few different topics and speakers on Day 2. Also, at the Idaho conference there will also be a dual track running at the same time devoted solely to agricultural law topics. The ag law track will start a bit later in the morning and end earlier than the estate and business planning conference. It will be held at the same location in Coeur d’Alene and the luncheon each day will be for all attendees of each track. Approximately 10 hours of CLE will be available for the ag law topics. I will post more on that once the topics and speakers are completely filled-in for that day.
Day 1 Itinerary
Here's the itinerary for Day 1 at both the Michigan and Idaho locations (farm tax track):
7:30-8:00 a.m. – Registration
8:00–8:05 a.m. - Welcome and Announcements
8:05–9:05 a.m. – Tax Update (Cases and Rulings) (McEowen) [60 minutes tax update CPE]
This opening session takes a look at the most significant tax cases and rulings from the courts and the IRS during the past year that have implications for farm and ranch clients, rural landowners, and agribusiness professionals.
9:05–9:45 a.m. – The Definition of “Farm Income” for Farm Program Purposes (Neiffer) [40 minutes tax update CPE]
Many Farm Service Agency programs grant extra payments if AGI from farming is more than 75% of total AGI. This session will review how FSA determine AGI and why it can be substantially different from IRS calculations.
9:45–10:05 a.m. – Morning Break
10:05–10:30 a.m. – Machinery Trades (McEowen) [25 minutes of tax law CPE]
This session examines the trade of farm machinery with no or low basis for new machinery and the resulting gain computation, combined with substantial depreciation claimed on the new machine.
10:30–10:55 a.m. – Selected Topics - Inventory Method Options for Farmers; How Bonus Depreciation and Expense Method Depreciation Can Work Together for Farm Clients (Neiffer) [25 minutes of tax update CPE]
Tax Reform simplified many accounting methods for taxpayers including farmers. We will review those change and why Section 179 can be more beneficial than bonus depreciation.
10:55–11:45 a.m. – Solar Panel Tax Issues; Other Rental Tax Issues (McEowen) [50 minutes of tax law CPE]
This discussion explores the tax issues associated with the placement of solar panels on farmland and also looks at other tax issues associated with rentals that farming operations often encounter.
11:45–12:45 p.m. – Luncheon
12:45 p.m.– 1:45 p.m. – Protecting a Tax Practice From Scammers (IRS CID) [60 minutes of tax law]
What steps can a tax practice take to protect itself from scams, including those from the dark web? What is good office protocol? What are the essential things that can be done and what are the signs to look for to detect scammers?
1:45 p.m.–2:25 p.m. – Selected Topics - Amending Partnership Returns; Corporate Provided Meals and Lodging; Charitable Remainder Trusts for Retiring Farmers (Neiffer) [40 minutes of tax law CPE]
This session will update the required method of amending partnership returns depending on whether the centralized partnership audit regime applies; a review of the change in corporate provided meals and why charitable remainder trusts can save taxes for a retiring farmer especially with increasing interest rates.
2:25-2:45 p.m. – Afternoon Break
2:45–3:10 p.m. – Easement Tax Issues (McEowen) [25 minutes of tax update CPE]
Rural landowners are finding easement tax issues to be more commonplace. This brief session provides a review of the basic tax issues associated with easements, particularly income tax basis offset issues and the character of the easement payments.
3:10–4:00 p.m. – IC-DISC for Farmers; Disallowance of Cash Method for Farming Activities; Accounting for Hedging Transactions; When to Deduct a Purchased Growing Crop (Neiffer) [50 minutes of tax law CPE]
An IC-DISC can cut a farmer’s income taxes in half – we review when it might apply. More farming activities include non-material participating taxpayers. This can cause the entity to be on the accrual method. The reporting of hedging activities is not always intuitive. We review the requirement and the options and when can a farmer deduct purchased growing crop.
4:00–4:25 p.m. – Soil Fertility Deductions (McEowen) [25 minutes of tax law CPE]
When a farm is purchased an allocation of value can be made to depreciable items. One of those items might be excess fertilizer supply. The IRS has a specific procedure that must be followed for valuing the excess amount. This session examines the IRS approach, the amount to be amortized, the timeframe for amortization and the possibility of recapture.
4:25 p.m. - Adjournment
Day 2 (farm estate and business planning track)
Here’s the itinerary for Day 2 of the Michigan event (farm estate and business planning track):
7:30-8:00 a.m. — Registration
8:05-8:55a.m. — Current Developments in Estate and Gift Taxation (McEowen) [50 minutes tax update CPE]
This session provides an update of legislative, regulatory and court developments involving federal estate and gift tax including developments involving a decedent’s gross estate, asset valuation, gifts made during life, retirement plans and miscellaneous issues.
8:55-9:45 a.m. – “Top Ten” Strategies For a Successful Farm Business (Rhea and Dikeman) [50 minutes tax update CPE]
As we look toward the next 12 months, several items deserve increased attention for farm businesses. This presentation delivers a Top 10 list of forward-looking strategies to consider for success. Changes in cost, income, inflation, tax laws, and estate planning are some key topics discussed. These will be on the mind of farms and ranches as they navigate the uncertain economic conditions and the impact of higher asset values, growing debt, and rising interest rates. We will also demonstrate the performance distinctions of top 1/3 producers.
9:45-10:05 a.m. — Morning Break
10:05-10:55 a.m. – Taxes in Probate: Form 1041 and Distribution Deductions (McEowen) [50 minutes tax law CPE]
This session walks the practitioner through the completion of Form 1041, the assets included in the probate estate, possible income generating items for an estate, the handling of capital gain or loss, and estate accounting. A discussion of e-filing and electronic signatures will also be included. In addition, common issues associated with the death of a farmer will be addressed.
10:55 a.m.-11:45 a.m. – SLATs – Why It Might be the Best Option for Your Farmers (Neiffer) [50 minutes of tax law CPE]
This session reviews the various trust options available to farm families to transfer assets to the next generation in a tax efficient manner. The session will then review why a Spousal Lifetime Access Trust (SLAT) might be the best option.
11:45-12:45 p.m. — Lunch
12:45 p.m.-1:35 p.m. – Why Social Security is an Investment, not a Tax (Neiffer) [50 minutes of tax law CPE]
Most farmers view social security as an unnecessary tax. However, with optimal planning, social security maybe one of the best investments they ever make. We review how benefits are calculated, why spousal benefits provide even more bang for their buck and some common claiming options.
1:35 p.m.-2:50 p.m. — Tax Strategies for the Farm and Ranch Client (Rhea and Dikeman) [75 minutes of tax law CPE]
This session highlights several changes were made by the Tax Cuts & Jobs Act of 2017; many sunset after 2025 and demand attention for optimal tax planning strategies the next 3 years. We will also explain how rising inflation rates are at times helping reduce tax liability and when it does not. Rising interest rates and inflated asset values are dramatically shifting costs of farm transitions to the detriment of young and beginning farmers. Stepped-up basis is a big thing; we detail how this can be helpful to farm successors. Unintended consequences of high income and options for tax management after year end are analyzed.
2:50 p.m. – 3:10 p.m. – Afternoon Break
3:10 p.m. – 3:25 p.m. – New Estate Planning Clients – Screening Clients and Gathering Information [15 minutes of tax law CPE]
This session takes a brief look at a suggested approach to handling potential new estate/business planning clients. How to screen clients, identify potential problem clients, engagement letters and information gathering as preparatory to determining the appropriate path forward for the client.
3:25-4:25 p.m. – Ethics for Estate Planners (McEowen) [1 hour of tax ethics CPE]
What are the ethical issues facing practitioners working with clients on estate/business and tax planning matters? How might the Circular 230 rules impact tax professionals in the estate and business planning context when income tax advice is involved? This session looks at some of the common issues that can arise, applicable caselaw, and some of the more unusual situations that might arise that present difficult situations for the planner.
4:25 p.m. — Conference adjourns
Here’s the itinerary for Day 2 of the Idaho event (farm estate and business planning track):
7:30-8:00 a.m. — Registration
8:05-8:55a.m. — Current Developments in Estate and Gift Taxation (McEowen) [50 minutes tax update CPE]
This session provides an update of legislative, regulatory and court developments involving federal estate and gift tax including developments involving a decedent’s gross estate, asset valuation, gifts made during life, retirement plans and miscellaneous issues.
8:55-9:45 a.m. – Who Wants the Farm; and Should They Get It? (Bosch) [50 minutes of tax law CPE]
9:45-10:05 a.m. — Morning Break
10:05-10:55 a.m. – Taxes in Probate: Form 1041 and Distribution Deductions (McEowen) [50 minutes of tax law CPE]
This session walks the practitioner through the completion of Form 1041, the assets included in the probate estate, possible income generating items for an estate, the handling of capital gain or loss, and estate accounting. A discussion of e-filing and electronic signatures will also be included. In addition, common issues associated with the death of a farmer will be addressed.
10:55 a.m.-11:45 a.m. – SLATs – Why It Might be the Best Option for Your Farmers (Neiffer) [50 minutes of tax law CPE]
This session reviews the various trust options available to farm families to transfer assets to the next generation in a tax efficient manner. The session will then review why a Spousal Lifetime Access Trust (SLAT) might be the best option.
11:45-12:45 p.m. — Lunch
12:45 p.m.-1:35 p.m. – Why Social Security is an Investment, not a Tax (Neiffer) [50 minutes of tax law CPE]
Most farmers view social security as an unnecessary tax. However, with optimal planning, social security maybe one of the best investments they ever make. We review how benefits are calculated, why spousal benefits provide even more bang for their buck and some common claiming options.
1:35 p.m.-2:50 p.m. - Strategies and Considerations for Transferring Farm Ownership and Operations (Hemenway)
This session will explore various issues connected with the transfer of farm ownership to successive generations. Topics will include timing the transfer of labor and management; preparing the next generation for farm ownership; planning for multiple inheritors; and considerations for long-term care and asset protection planning.
2:50 p.m. – 3:10 p.m. – Afternoon Break
3:10 p.m. – 3:25 p.m. – New Estate Planning Clients – Screening Clients and Gathering Information (McEowen) [15 minutes of tax law CPE]
This session takes a brief look at a suggested approach to handling potential new estate/business planning clients. How to screen clients, identify potential problem clients, engagement letters and information gathering as preparatory to determining the appropriate path forward for the client.
3:25-4:25 p.m. – Ethics for Estate Planners (McEowen) [1 hour of tax ethics CPE]
What are the ethical issues facing practitioners working with clients on estate/business and tax planning matters? How might the Circular 230 rules impact tax professionals in the estate and business planning context when income tax advice is involved? This session looks at some of the common issues that can arise, applicable caselaw, and some of the more unusual situations that might arise that present difficult situations for the planner.
4:25 p.m. — Conference adjourns
Conclusion
I look forward to either seeing you in-person at one of these events this summer or online. At the end of Day 1 at the Idaho event, there will be a reception sponsored by the University of Idaho College of Law. Also, many thanks to Teresa Baker at the Idaho Bar Association for her assistance in locating speakers as well as to Prof. Richard Seamon (Univ. of ID College of Law) and Kelly Stevenson (leader of the ag law section off the Idaho Bar) for helping identify topics as well as speakers.
More details and registration links coming soon.
March 29, 2023 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)
Monday, January 30, 2023
Bibliography - July Through December 2022
Overview
After the first half of 2022, I posted a blog article of a bibliography of my blog articles for the first half of 2022. You can find that bibliography here: Bibliography – January through June of 2022
Bibliography of articles for that second half of 2022 – you can find it in today’s post.
Alphabetical Topical Listing of Articles (July 2022 – December 2022)
Bankruptcy
More Ag Law Developments – Potpourri of Topics
Business Planning
Durango Conference and Recent Developments in the Courts
Is a C Corporation a Good Entity Choice For the Farm or Ranch Business?
What is a “Reasonable Compensation”?
https://lawprofessors.typepad.com/agriculturallaw/2022/08/what-is-reasonable-compensation.html
Federal Farm Programs: Organizational Structure Matters – Part Three
LLCs and Self-Employment Tax – Part One
https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-one.html
LLCs and Self-Employment Tax – Part Two
https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-two.html
Civil Liabilities
Durango Conference and Recent Developments in the Courts
Dicamba Spray-Drift Issues and the Bader Farms Litigation
Tax Deal Struck? – and Recent Ag-Related Cases
Ag Law and Tax Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html
More Ag Law Developments – Potpourri of Topics
Ag Law Developments in the Courts
https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html
Contracts
Minnesota Farmer Protection Law Upheld
Criminal Liabilities
Durango Conference and Recent Developments in the Courts
https://lawprofessors.typepad.com/agriculturallaw/20Ag Law Summit
https://lawpr22/07/durango-conference-and-recent-developments-in-the-courts.html
Environmental Law
Constitutional Limit on Government Agency Power – The “Major Questions” Doctrine
More Ag Law Developments – Potpourri of Topics
Court Says COE Acted Arbitrarily When Declining Jurisdiction Over Farmland
Ag Law Developments in the Courts
https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html
Estate Planning
Farm/Ranch Tax, Estate and Business Planning Conference August 1-2 – Durango, Colorado (and Online)
IRS Modifies Portability Election Rule
Modifying an Irrevocable Trust – Decanting
Farm and Ranch Estate Planning in 2022 (and 2023)
Social Security Planning for Farmers and Ranchers
How NOT to Use a Charitable Remainder Trust
Recent Cases Involving Decedents’ Estates
Medicaid Estate Recovery and Trusts
https://lawprofessors.typepad.com/agriculturallaw/2022/12/medicaid-estate-recovery-and-trusts.html
Income Tax
What is the Character of Land Sale Gain?
Deductible Start-Up Costs and Web-Based Businesses
Using Farm Income Averaging to Deal With Economic Uncertainty and Resulting Income Fluctuations
Tax Deal Struck? – and Recent Ag-Related Cases
What is “Reasonable Compensation”?
https://lawprofessors.typepad.com/agriculturallaw/2022/08/what-is-reasonable-compensation.html
LLCs and Self-Employment Tax – Part One
https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-one.html
LLCs and Self-Employment Tax – Part Two
https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-two.html
USDA’s Emergency Relief Program (Update on Gain from Equipment Sales)
Declaring Inflation Reduced and Being Forgiving – Recent Developments in Tax and Law
Ag Law and Tax Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html
Extended Livestock Replacement Period Applies in Areas of Extended Drought – IRS Updated Drought Areas
More Ag Law Developments – Potpourri of Topics
IRS Audits and Statutory Protection
https://lawprofessors.typepad.com/agriculturallaw/2022/10/irs-audits-and-statutory-protection.html
Handling Expenses of Crops with Pre-Productive Periods – The Uniform Capitalization Rules
When Can Depreciation First Be Claimed?
Tax Treatment of Crops and/or Livestock Sold Post-Death
Social Security Planning for Farmers and Ranchers
Are Crop Insurance Proceeds Deferrable for Tax Purposes?
Tax Issues Associated With Easement Payments – Part 1
Tax Issues Associated With Easement Payments – Part 2
How NOT to Use a Charitable Remainder Trust
Does Using Old Tractors Mean You Aren’t a Farmer? And the Wind Energy Production Tax Credit – Is Subject to State Property Tax?
Insurance
Tax Deal Struck? – and Recent Ag-Related Cases
Real Property
Tax Deal Struck? – and Recent Ag-Related Cases
Ag Law Summit
https://lawprofessors.typepad.com/agriculturallaw/2022/08/ag-law-summit.html
Ag Law and Tax Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html
More Ag Law Developments – Potpourri of Topics
Ag Developments in the Courts
https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html
Regulatory Law
Constitutional Limit on Government Agency Power – The “Major Questions” Doctrine
The Complexities of Crop Insurance
https://lawprofessors.typepad.com/agriculturallaw/2022/07/the-complexities-of-crop-insurance.html
Federal Farm Programs – Organizational Structure Matters – Part One
Federal Farm Programs – Organizational Structure Matters – Part Two
Federal Farm Programs: Organizational Structure Matters – Part Three
USDA’s Emergency Relief Program (Update on Gain from Equipment Sales)
Minnesota Farmer Protection Law Upheld
Ag Law and Tax Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html
Animal Ag Facilities and Free Speech – Does the Constitution Protect Saboteurs?
Court Says COE Acted Arbitrarily When Declining Jurisdiction Over Farmland
Ag Law Developments in the Courts
https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html
Water Law
More Ag Law Developments – Potpourri of Topics
January 30, 2023 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, September 11, 2022
September 30 Ag Law Summit in Omaha (and Online)
Overview
On September 30, Washburn Law School with cooperating partner Creighton Law School will conduct the second annual Ag Law Summit. The Summit will be held on the Creighton University campus in Omaha, Nebraska. Last September Washburn Law School conducted it’s first “Ag Law Summit” and held it at Mahoney State Park in Nebraska. This year the Summit returns in collaboration with Creighton University School of Law. The Summit will be held at Creighton University on September 30 and will also be broadcast live online.
The Summit will cover various topics of relevance to agricultural producers and the tax and legal counsel that represent them.
The 2022 Ag Law Summit – it’s the topic of today’s post.
Agenda
Developments in agricultural law and taxation. I will start off the day with a session surveying the major recent ag law and tax developments. This one-hour session will update attendees on the big issues facing ag clients and provide insight concerning the issues that look to be on the horizon in the legal and tax world. There have been several major developments involving agricultural that have come through the U.S Supreme Court in recent months. I will discuss those decisions and the implications for the future. Several of them involve administrative law and could have a substantial impact on the ability of the federal government to micro-manage agricultural activities. I will also get into the big tax developments of the past year, including the tax provisions included in the recent legislation that declares inflation to be reduced!
Death of a farm business owner. After my session, Prof. Ed Morse of Creighton Law School will examine the tax issues that arise when a farm business owner dies. Income tax basis and the impact of various entity structures will be the focus of this session along with the issues that arise upon transitioning ownership to the next generation and various tax elections. The handling of tax attributes after death will be covered as will some non-tax planning matters when an LLC owner dies. There are also entity-specific issues that arise when a business owner dies, and Prof. Morse will address those on an entity-by-entity basis. The transition issue for farmers and ranchers is an important one for many. This session will be a good one in laying out the major tax and non-tax considerations that need to be laid out up front to help the family achieve its goals post-death.
Governing documents for farm and ranch business entities. After a morning break Dan Waters with Lamson Dugan & Murray in Omaha will take us up to lunch with a technical session on the drafting of critical documents for farm and ranch entities. What should be included in the operative agreements? What is the proper wording? What provisions should be included and what should be avoided? This session picks up on Prof. Morse’s presentation and adds in the drafting elements that are key to a successful business succession plan for the farm/ranch operation.
Fence law issues. After a provided lunch, Colten Venteicher who practices in Gothenburg, NE, will address the issues of fence line issues when ag land changes hands. This is an issue that seems to come up over and over again in agriculture. The problems are numerous and varied. This session provides a survey of applicable law and rules and practical advice for helping clients resolve existing disputes and avoid future ones.
Farm economics. Following the afternoon break, a presentation on the current economy and economic situation facing ag producers, ag businesses and consumers will be presented by Darrell Holaday. Darrell is an ag economist and his firm, Advanced Market Concepts, provides marketing plans for ag producers. What are the economic projections for the balance of 2022 and into 2023 that bear on tax and estate planning for farmers and ranchers? How will the war in Ukraine continue to impact agriculture in the U.S.? This will be a key session, especially with the enactment of legislation that will add fuel to the current inflationary fire – unless of course, the tax increases in the legislation slow the economy enough to offset the additional spending.
Ethics. I return to close out the day with a session of ethics focused on asset protection planning. There’s a right way and a wrong way to do asset protection planning. This session guides the practitioner through the proper approach to asset protection planning, client identification, and the pitfalls if the “stop signs” are missed.
Online. The Summit will be broadcast live online and will be interactive to allow you the ability to participate remotely.
Reception
For those attending in person, a reception will follow in the Harper Center Ballroom on the Creighton Campus.
Conclusion
If your tax or legal practice involves ag clients, the Ag Law Summit is for you. As noted, you can also attend online if you can’t be there in person. If you are a student currently in law school or thinking about it, or are a student in accounting, you will find this seminar beneficial.
I hope to see you in Omaha on September 30 or see that you are with us online.
You can learn more about the Summit and get registered at the following link: https://www.washburnlaw.edu/employers/cle/aglawsummit.html
September 11, 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)
Monday, September 5, 2022
Bibliography – January through June of 2022
Overview
Periodically I post an article containing the links to all of my blog articles that have been recently published. Today’s article is a bibliography of my articles from the beginning of 2022 through June. Hopefully this will aid your research of agricultural law and tax topics.
A bibliography of articles for the first half of 2022 – it’s the content of today’s post.
Bankruptcy
“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 8 and 7
Other Important Developments in Agricultural Law and Taxation
Recent Court Cases of Importance to Agricultural Producers and Rural Landowners
Business Planning
Summer 2022 Farm Income Tax/Estate and Business Planning Conferences
Should An IDGT Be Part of Your Estate Plan?
Farm Wealth Transfer and Business Succession – The GRAT
Captive Insurance – Part One
https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-one.html
Captive Insurance – Part Two
https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-two.html
Captive Insurance – Part Three
https://lawprofessors.typepad.com/agriculturallaw/2022/04/captive-insurance-part-three.html
Pork Production Regulations; Fake Meat; and Tax Proposals on the Road to Nowhere
Farm Economic Issues and Implications
https://lawprofessors.typepad.com/agriculturallaw/2022/04/farm-economic-issues-and-implications.html
Intergenerational Transfer of the Farm/Ranch Business – The Buy-Sell Agreement
IRS Audit Issue – S Corporation Reasonable Compensation
Summer 2022 Farm Income Tax/Estate and Business Planning Conferences
Wisconsin Seminar and…ERP (not Wyatt) and ELRP
S Corporation Dissolution – Part 1
https://lawprofessors.typepad.com/agriculturallaw/2022/06/s-corporation-dissolution-part-1.html
S Corporation Dissolution – Part Two; Divisive Reorganization Alternative
Farm/Ranch Tax, Estate and Business Planning Conference August 1-2 – Durango, Colorado (and Online)
Durango Conference and Recent Developments in the Courts
Civil Liabilities
“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 8 and 7
Agritourism
https://lawprofessors.typepad.com/agriculturallaw/2022/03/agritourism.html
Animal Ag Facilities and the Constitution
When Is an Agricultural Activity a Nuisance?
Ag Law-Related Updates: Dog Food Scam; Oil and Gas Issues
Durango Conference and Recent Developments in the Courts
Dicamba Spray-Drift Issues and the Bader Farms Litigation
Tax Deal Struck? – and Recent Ag-Related Cases
Contracts
“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 6 and 5
What to Consider Before Buying Farmland
Elements of a Hunting Use Agreement
https://lawprofessors.typepad.com/agriculturallaw/2022/02/elements-of-a-hunting-use-agreement.html
Ag Law (and Medicaid Planning) Court Developments of Interest
Cooperatives
The Agricultural Law and Tax Report
https://lawprofessors.typepad.com/agriculturallaw/2021/05/the-agricultural-law-and-tax-report.html
Criminal Liabilities
Animal Ag Facilities and the Constitution
Is Your Farm or Ranch Protected From a Warrantless Search?
Durango Conference and Recent Developments in the Courts
Environmental Law
“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 6 and 5
“Top Tan” Agricultural Law and Tax Developments of 2021 – Numbers 2 and 1
The “Almost Top Ten” (Part 3) – New Regulatory Definition of “Habitat” under the ESA
Ag Law and Tax Potpourri
https://lawprofessors.typepad.com/agriculturallaw/2022/02/ag-law-and-tax-potpourri.html
Farm Economic Issues and Implications
https://lawprofessors.typepad.com/agriculturallaw/2022/04/farm-economic-issues-and-implications.html
Constitutional Limit on Government Agency Power – The “Major Questions” Doctrine
Estate Planning
Other Important Developments in Agricultural Law and Taxation
Other Important Developments in Agricultural Law and Taxation (Part 2)
The “Almost Top Ten” (Part 4) – Tax Developments
The “Almost Top 10” of 2021 (Part 7) [Medicaid Recovery and Tax Deadlines]
Nebraska Revises Inheritance Tax; and Substantiating Expenses
https://lawprofessors.typepad.com/agriculturallaw/2022/02/recent-developments-in-ag-law-and-tax.html
Tax Consequences When Farmland is Partitioned and Sold
Summer 2022 Farm Income Tax/Estate and Business Planning Conferences
Should An IDGT Be Part of Your Estate Plan?
Farm Wealth Transfer and Business Succession – The GRAT
Family Settlement Agreement – Is it a Good Idea?
Registration Open for Summer 2022 Farm Income Tax/Estate and Business Planning Conferences
Captive Insurance – Part One
https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-one.html
Captive Insurance – Part Two
https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-two.html
Captive Insurance Part Three
https://lawprofessors.typepad.com/agriculturallaw/2022/04/captive-insurance-part-three.html
Pork Production Regulations; Fake Meat; and Tax Proposals on the Road to Nowhere
Farm Economic Issues and Implications
https://lawprofessors.typepad.com/agriculturallaw/2022/04/farm-economic-issues-and-implications.html
Proposed Estate Tax Rules Would Protect Against Decrease in Estate Tax Exemption
Summer 2022 Farm Income Tax/Estate and Business Planning Conferences
Ag Law (and Medicaid Planning) Court Developments of Interest
Joint Tenancy and Income Tax Basis At Death
More Ag Law Court Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/06/more-ag-law-court-developments.html
Farm/Ranch Tax, Estate and Business Planning Conference August 1-2 – Durango, Colorado (and Online)
IRS Modifies Portability Election Rule
Income Tax
“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 10 and 9
“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 8 and 7
“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 2 and 1
The “Almost Top Ten” (Part 4) – Tax Developments
The “Almost Top 10” of 2021 (Part 7) [Medicaid Recovery and Tax Deadlines]
Purchase and Sale Allocations Involving CRP Contracts
Ag Law and Tax Potpourri
https://lawprofessors.typepad.com/agriculturallaw/2022/02/ag-law-and-tax-potpourri.html
What’s the Character of the Gain From the Sale of Farm or Ranch Land?
Proper Tax Reporting of Breeding Fees for Farmers
Nebraska Revises Inheritance Tax; and Substantiating Expenses
https://lawprofessors.typepad.com/agriculturallaw/2022/02/recent-developments-in-ag-law-and-tax.html
Tax Consequences When Farmland is Partitioned and Sold
Expense Method Depreciation and Leasing- A Potential Trap
Summer 2022 Farm Income Tax/Estate and Business Planning Conferences
income Tax Deferral of Crop Insurance Proceeds
What if Tax Rates Rise?
https://lawprofessors.typepad.com/agriculturallaw/2022/03/what-if-tax-rates-rise.html
Registration Open for Summer 2022 Farm Income Tax/Estate and Business Planning Conferences
Captive Insurance – Part One
https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-one.html
Captive Insurance – Part Two
https://lawprofessors.typepad.com/agriculturallaw/2022/03/captive-insurance-part-two.html
Captive Insurance – Part Three
https://lawprofessors.typepad.com/agriculturallaw/2022/04/captive-insurance-part-three.html
Pork Production Regulations; Fake Meat; and Tax Proposals on the Road to Nowhere
Farm Economic Issues and Implications
https://lawprofessors.typepad.com/agriculturallaw/2022/04/farm-economic-issues-and-implications.html
IRS Audit Issue – S Corporation Reasonable Compensation
Missed Tax Deadline & Equitable Tolling
https://lawprofessors.typepad.com/agriculturallaw/2022/04/missed-tax-deadline-equitable-tolling.html
Summer 2022 Farm Income Tax/Estate and Business Planning Conferences
Joint Tenancy and Income Tax Basis At Death
Tax Court Caselaw Update
https://lawprofessors.typepad.com/agriculturallaw/2022/05/tax-court-caselaw-update.html
Deducting Soil and Water Conservation Expenses
Correcting Depreciation Errors (Including Bonus Elections and Computations)
When Can Business Deductions First Be Claimed?
Recent Court Decisions Involving Taxes and Real Estate
Wisconsin Seminar and…ERP (not Wyatt) and ELRP
Tax Issues with Customer Loyalty Reward Programs
S Corporation Dissolution – Part 1
https://lawprofessors.typepad.com/agriculturallaw/2022/06/s-corporation-dissolution-part-1.html
S Corporation Dissolution – Part Two; Divisive Reorganization Alternative
Farm/Ranch Tax, Estate and Business Planning Conference August 1-2 – Durango, Colorado (and Online)
What is the Character of Land Sale Gain?
Deductible Start-Up Costs and Web-Based Businesses
Using Farm Income Averaging to Deal with Economic Uncertainty and Resulting Income Fluctuations
Tax Deal Struck? – and Recent Ag-Related Cases
Insurance
Tax Deal Struck? – and Recent Ag-Related Cases
Real Property
“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 4 and 3
Ag Law and Tax Potpourri
https://lawprofessors.typepad.com/agriculturallaw/2022/02/ag-law-and-tax-potpourri.html
What to Consider Before Buying Farmland
Elements of a Hunting Use Agreement
https://lawprofessors.typepad.com/agriculturallaw/2022/02/elements-of-a-hunting-use-agreement.html
Animal Ag Facilities and the Constitution
Recent Court Decisions Involving Taxes and Real Estate
Recent Court Cases of Importance to Agricultural Producers and Rural Landowners
More Ag Law Court Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/06/more-ag-law-court-developments.html
Ag Law-Related Updates: Dog Food Scam; Oil and Gas Issues
Tax Deal Struck? – and Recent Ag-Related Cases
Regulatory Law
The “Almost Top 10” of 2021 (Part 5)
https://lawprofessors.typepad.com/agriculturallaw/2022/01/the-almost-top-10-of-2021-part-5.html
The “Almost Top 10” of 2021 (Part 6)
https://lawprofessors.typepad.com/agriculturallaw/2022/02/the-almost-top-10-of-2021-part-6.html
Ag Law and Tax Potpourri
https://lawprofessors.typepad.com/agriculturallaw/2022/02/ag-law-and-tax-potpourri.html
Animal Ag Facilities and the Constitution
Pork Production Regulations; Fake Meat; and Tax Proposals on the Road to Nowhere
Farm Economic Issues and Implications
https://lawprofessors.typepad.com/agriculturallaw/2022/04/farm-economic-issues-and-implications.html
Ag Law (and Medicaid Planning) Court Developments of Interest
Wisconsin Seminar and…ERP (not Wyatt) and ELRP
More Ag Law Court Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/06/more-ag-law-court-developments.html
Ag Law-Related Updates: Dog Food Scam; Oil and Gas Issues
Constitutional Limit on Government Agency Power – The “Major Questions” Doctrine
The Complexities of Crop Insurance
https://lawprofessors.typepad.com/agriculturallaw/2022/07/the-complexities-of-crop-insurance.html
Secured Transactions
“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 6 and 5
Water Law
“Top Ten” Agricultural Law and Tax Developments of 2021 – Numbers 4 and 3
Durango Conference and Recent Developments in the Courts
September 5, 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, August 21, 2022
LLCs and Self-Employment Tax – Part Two
Overview
In Part One of this two-part series, the discussion focused on how the determination is made of whether an LLC member is a limited partner. There it was noted that the IRS/Treasury hadn’t yet finalized a regulation that was initially proposed in 1997 to address the issue. The characterization of an LLC member’s interest is determinative of whether the member has self-employment tax liability on amounts distributed to the member (other than guaranteed payments).
In today’s Part Two of this series, I dig into the self-employment tax issue further. Proper structuring of the entity matters as does the drafting of the LLC operating agreement and the conduct of the members.
Self-employment tax implications of LLCs – when is a member really a limited partner? That’s the topic of today’s post.
LLCs and Self-Employment Tax
Net earnings from self-employment includes the distributive share of income or loss from a trade or business carried on by a partnership. I.R.C. §1402(a). Thus, the default rule is that all partnership income is included, unless it is specifically excepted. Whether LLC members can avoid self-employment tax on their income from the entity depends on their member characterization. Are they general partners or limited partners? Under I.R.C. §1402(a)(13), a limited partner does not have self-employment income except for any guaranteed payments paid for services rendered to the LLC. So, what is a limited partner? The test of whether an interest in an entity treated as a partnership for tax purposes is treated as a limited interest or a general interest, for the purpose of applying the self-employment tax is stated at Prop. Reg. §1.1402(a)-2(h), issued in 1997.
Note: Immediately after the Proposed Regulation was issued, the Congress passed a statute prohibiting the IRS from finalizing the Regulation within one year. Nothing further has been forthcoming. Although still in Proposed Regulation form, this regulation remains the best available authority.
The Proposed Regulation establishes a three-part general rule, with two exceptions, that may permit limited partner treatment under certain conditions. A third exception to limited partner treatment applies in the context of professional service businesses (e.g., law, accounting, health, engineering, etc.). Under the general rule, a member is not treated as a limited partner if: (1) the member has personal liability for the debts or claims against the LLC by reason of being a member; (2) the member has authority under the state’s LLC statute to enter into contracts on behalf of the LLC; or (3) the member participated in the LLC’s trade or business for more than 500 hours during the LLC’s tax year. Prop. Treas. Reg. §1.1402(a)-2(h)(2).
An exception applies only if the interest-holder owns a single class of interest (regardless of whether there are multiple classes outstanding) and failure of the 500-hour test is the sole reason for treatment of the interest as a general interest. In addition, the interest held must meet certain threshold requirements:
- There must be at least one member holding the same class of interest who meets all three of the requirements under the general rule, without application of any exceptions;
- The share of that class of interest held by those members must be “substantial” (with respect to the class of interest at issue and not with respect to the entity as a whole), based on the facts and circumstances (a safe harbor of 20 percent, in aggregate, is provided at Treas. Reg. 1.1402(a)-2(h)(6)(v)); and
- The interests held by those members must be “continuing” (an undefined term).
Another exception to the general rule applies only if the member owns at least two classes of interests and the same threshold requirements are satisfied. This exception may permit a member to treat the distributive share attributable to at least one class as a limited interest if the three requirements of the general rule are met with respect to any class that the member holds. In that case the distributive share attributable to that interest is not subject to self-employment tax. But, the distributive share attributable to any interest held by a member that does not meet the three requirements of the general rule is subject to self-employment tax. This all means that a portion of a member’s total distributive share may be subject to self-employment tax, and some may not be.
Note: Under the general rule, it is likely that the entire distributive share of all members of a member-managed LLC will be subject to self-employment tax because state law likely gives all members the authority to contract. Likewise, LLP statutes likely give management rights which means that the second requirement of the general rule cannot be satisfied. As a result, neither exception to the general rule can be met because both exceptions require at least one member to satisfy all three requirements of the general rule.
The Castigliola case. In Castigliola, et al. v. Comr, T.C. Memo. 2017-62, a group of lawyers structured their law practice as member-managed Professional LLC (PLLC). On the advice of a CPA, they tied each of their guaranteed payments to what reasonable compensation would be for a comparable attorney in the locale with similar experience. They paid self-employment tax on those amounts. However, the Schedule K-1 showed allocable income exceeding the member’s guaranteed payment. Self-employment tax was not paid on the excess amounts. The IRS disagreed with that characterization, asserting self-employment tax on all amounts allocated.
The Tax Court agreed with the IRS. Based on the Uniform Limited Partnership Act of 1916, the Revised Limited Partnership Act of 1976 and Mississippi law (the state in which the PLLC operated), the court determined that a limited partner is defined by limited liability and the inability to control the business. The members couldn’t satisfy the second test. Because of the member-managed structure, each member had management power of the PLLC business. In addition, because there was no written operating agreement, the court had no other evidence of a limitation on a member’s management authority. In addition, the evidence showed that the members actually did participate in management by determining their respective distributive shares, borrowing money, making employment-related decisions, supervising non-partner attorneys of the firm and signing checks. The court also noted that to be a limited partnership, there must be at least one general partner and a limited partner, but the facts revealed that all members conducted themselves as general partners with identical rights and responsibilities. In addition, before becoming a PLLC, the law firm was a general partnership. After the change to the PLLC status, their management structure didn’t change.
The court did not mention the proposed regulations, but even if they had been taken into account the outcome of the case would have been the same. Member-managed LLCs are subject to self-employment tax because all members have management authority. It’s that simple. In addition, as noted below, there is an exception in the proposed regulations that would have come into play.
Note: As a side-note, the IRS had claimed that the attorney trust funds were taxable to the PLLC. The court, however, disagreed because the lawyers were not entitled to the funds.
Structuring to Minimize Self-Employment Tax – The Manager-Managed LLC
There is an entity structure that can minimize self-employment tax. An LLC can be structured as a manager-managed LLC with two membership classes. With that approach, the income of a member holding a manager’s interest is subject to self-employment tax, but if non-managers that participate less than 500 hours in the LLC’s business hold at least 20 percent of the LLC interests, then any non-manager interests held by members that participate more than 500 hours in the LLC’s business are not subject to self-employment tax on the pass-through income attributable to their LLC interest. Prop. Treas. Reg. §1.1402(a)-2(h)(4). They do, however, have self-employment tax on any guaranteed payments.
Service businesses. The manager-managed structure does not achieve self-employment tax savings for personal service businesses, such as the one involved in Castigliola. Prop. Treas. Reg. §1.1402(a)-2(h)(5) provides an exception for service partners in a service partnership. Such partners cannot be a limited partner under Prop Treas. Reg. §1.1402(a)-2(h)(4) (or (2) or (3), for that matter). Thus, for a professional services partnership (such as the law firm at issue in the case), structuring as a manager-managed LLC would have no beneficial impact on self-employment tax liability.
Note: If a member of a services partnership (e.g. LLC) is merely an investor that is not involved in the operations of the LLC as a business and is separately paid for services rendered, any distributive share is not subject to self-employment tax. See, e.g., Hardy v. Comr., T.C. Memo. 2017-16. But, if the distributive share is received from fees from the LLC’s business, the distributive share is subject to self-employment tax. See, e.g., Renkemeyer, Campbell & Weaver, LLP, 136 T.C 137 (2011).
Farming and ranching operations. For LLCs that are not a “service partnership,” such as a farming operation, it is possible to structure the business as a manager-managed LLC with a member holding both manager and non-manager interests that can be bifurcated. The result is that a member holding both manager and non-manager interests is not subject to self-employment tax on the non-manager interest but is subject to self-employment tax on the pass-through income and a guaranteed payment attributable to the manager interest.
Example. Here's what it might look like for a farming operation:
A married couple operates a farming business as an LLC. The wife works full-time off the farm and does not participate in the farming operation. But she holds a 49 percent non-manager ownership interest in the LLC. The husband conducts the farming operation full-time and also holds a 49 percent non-manager interest. But, the husband, as the farmer, also holds a 2 percent manager interest. The husband receives a guaranteed payment for his manager interest that equates to reasonable compensation for his services (labor and management) provided to the LLC. The result is that the LLC’s income will be shared pro-rata according to the ownership percentages with the income attributable to the non-manager interests (98 percent) not subject to self-employment tax. The two percent manager interest is subject to self-employment tax along with the guaranteed payment that the husband receives. This produces a much better self-employment tax result than if the farming operation were structured as a member-managed LLC.
Additional benefit. There is another potential benefit of utilizing the manager-managed LLC structure. Until the net investment income tax of I.R.C. §1411 is repealed, it applies to a taxpayer’s passive sources of income when adjusted gross income exceeds $250,000 on a joint return ($200,000 for a single return). While a non-manager’s interest in a manager-managed LLC is typically considered passive with the income from the interest potentially subject to the 3.8 percent surtax, a spouse can take into account the material participation of a spouse who is the manager. I.R.C. §469(h)(5). Thus, the material participation of the manager-spouse converts the income attributable to the non-manager interest of the other spouse from passive to active income that will not be subject to the 3.8 percent surtax.
Note: Returning to the example above, the result would be that self-employment tax is significantly reduced (it’s limited to 15.3 percent of the husband’s reasonable compensation (in the form of a guaranteed payment) and his two percent manager interest) and the net investment income surtax is avoided on the wife’s income.
Conclusion
The manager-managed LLC provides a better result than the result produced by the member-managed LLC for LLCs that are not service partnerships. For those that are, such as the PLLC in Castigliola, the S corporation is the business form to use to achieve a better tax result. For an S corporation, “reasonable” compensation will need to be paid subject to S.E. tax, but the balance drawn from the entity can be received self-employment tax free. But, for farming operations with land rental income, the manager-managed LLC can provide a better overall tax result than the use of an S corporation because of the ability to eliminate the net investment income tax.
Of course, the self-employment tax and the net investment income tax are only two pieces of the puzzle to an overall business plan. Other non-tax considerations may carry more weight in a particular situation. But for some, this strategy can be quite beneficial.
The decision in Castigliola would appear to further bolster the manager-managed approach – an individual that is a “mere member” appears to now have an even stronger argument for limited partner treatment. In addition, the court didn’t impose penalties on the PLLC because of reliance on an experienced professional for their filing position.
Proper structuring of the LLC and careful drafting of the operating agreement is important
August 21, 2022 in Business Planning, Income Tax | Permalink | Comments (0)
Saturday, August 20, 2022
Ag Law Summit
Overview
Last September Washburn Law School conducted it’s first “Ag Law Summit” and held it at Mahoney State Park in Nebraska. This year the Summit returns in collaboration with Creighton University School of Law. The Summit will be held at Creighton University on September 30, and will also be broadcast live online.
The Summit will cover various topics of relevance to agricultural producers and the tax and legal counsel that represent them.
The 2022 Ag Law Summit – it’s the topic of today’s post.
Agenda
Survey of ag law and tax. I will start off the day with a session surveying the major recent ag law and tax developments. This one-hour session will update attendees on the big issues facing ag clients and provide insight concerning the issues that look to be on the horizon in the legal and tax world.
Tax issues upon death of a farmer. After my session, Prof. Ed Morse of Creighton Law School will examine the tax issues that arise when a farm business owner dies. Income tax basis and the impact of various entity structures will be the focus of this session along with the issues that arise upon transitioning ownership to the next generation and various tax elections.
Farm succession planning drafting language. After a morning break Dan Waters, and estate planning attorney in Omaha, NE, will take us up to lunch with a technical session on the drafting of critical documents for farm and ranch entities. What should be included in the operative agreements? What is the proper wording? What provisions should be included and what should be avoided? This session picks up on Prof. Morse’s presentation and adds in the drafting elements that are key to a successful business succession plan for the farm/ranch operation.
Fences and boundaries. After a provided lunch, Colten Venteicher who practices in Gothenburg, NE, will address the issues of fence line issues when ag land changes hands. This is an issue that seems to come up over and over again in agriculture. The problems are numerous and varied. This session provides a survey of applicable law and rules and practical advice for helping clients resolve existing disputes and avoid future ones.
The current farm economy and future projections. Following the afternoon break, a presentation on the current economy and economic situation facing ag producers, ag businesses and consumers will be presented by Darrell Holaday. Darrell is an economist and his firm, Advanced Market Concepts, provides marketing plans for ag producers. What are the economic projections for the balance of 2022 and into 2023 that bear on tax and estate planning for farmers and ranchers? This will be a key session, especially with the enactment of legislation that will add fuel to the current inflationary fire – unless of course, the tax increases in the legislation slow the economy enough to offset the additional spending.
Ethics. I return to close out the day with a session of ethics focused on asset protection planning. There’s a right way and a wrong way to do asset protection planning. This session guides the practitioner through the proper approach to asset protection planning, client identification, and the pitfalls if the “stop signs” are missed.
Reception
For those attending in person, a reception will follow in the Harper Center Ballroom on the Creighton Campus.
Conclusion
If your tax or legal practice involves ag clients, the Ag Law Summit is for you. As noted, you can also attend online if you can’t be there in person. If you are a student currently in law school or thinking about it, or are a student in accounting, you will find this seminar beneficial.
I hope to see you in Omaha on September 30 or see that you are with us online.
You can learn more about the Summit and get registered at the following link: https://www.washburnlaw.edu/employers/cle/aglawsummit.html
August 20, 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)
Thursday, August 18, 2022
LLCs and Self-Employment Tax – Part One
Overview
Farmers and ranchers often desire to avoid the payment of self-employment tax. Indeed, avoidance of self-employment tax sometimes seems to be a prerequisite for being engaged in a farming or ranching activity. One way to structure the business to minimize self-employment tax might be as a limited liability company (LLC). For an LLC member that truly has a limited partnership interest, self-employment tax savings can be achieved. But truly being a limited partner is the key. The definition of a “limited partner” as an LLC member for self-employment tax purposes has been unclear and confusing for some time.
In today’s Part One of a two-part series, I take a look at how the courts (and IRS) view a limited partner in the context of an LLC. The analysis derives from the passive loss rules and from a proposed regulation issued in the late 1990s.
LLCs and self-employment tax – Part One of a two-part series – it’s the topic of today’s post.
Background
In its 2017-2018 Priority Guidance Plan, the IRS stated that it planned to finalize regulations under I.R.C. §469(h)(2) – the passive loss rules. That provision creates a per se rule of non-material participation for limited partner interests in a limited partnership unless the Treasury specifies differently in regulations. Those regulations were initially issued in temporary form and became proposed regulations in 2012. 2012-9, IRB 434
Passive Loss Rules
The passive loss rules of I.R.C. §469 can have a substantial impact on farmers and ranchers as well as investors in farm and ranch land. The effect of the rules is that deductions from passive trade or business activities, to the extent the deductions exceed income from all passive activities, may not be deducted against other income.
The proper characterization of the loss depends on whether the taxpayer is materially participating in the business. I.R.C. §469(h). But, I.R.C. §469(h)(2) creates a per-se rule of non-material participation for limited partner interests in a limited partnership unless the Treasury specifies differently in regulations. The statute was written before practically all state LLC statutes were enacted and before the advent of LLPs, and the Treasury has never issued regulations to detail how the statue is to apply to these new types of business forms.
Material participation tests. The key question presented in the cases was whether the taxpayer satisfied the material participation test. As mentioned above, a passive activity is a trade or business in which the taxpayer does not materially participate. Material participation is defined as “regular, continuous, and substantial involvement in the business operation.” I.R.C. §469(h)(1). The regulations provide seven tests for material participation in an activity. Temp. Treas. Reg. §1.469-5T(a)(1)-(7).
The tests are exclusive and provide that an individual generally will be treated as materially participating in an activity during a year if:
- The individual participates more than 500 hours during the tax year;
- The individual’s participation in the activity for the tax year constitutes substantially all of the participation in the activity of all individuals (including individuals who are not owners of interests in the activity) for the tax year;
- The individual participates in the activity for more than 100 hours during the tax year, and the individual’s participation in the activity for the tax year is not less than the participation in the activity of anyone else (including non-owners) for the tax year;
- The activity is a significant participation activity and the individual’s aggregate participation in all significant participation activities during the tax year exceeds 500 hours;
- The individual materially participated in the activity for any five taxable years during the ten taxable years that immediately precede the tax year at issue;
- The activity is a personal service activity, and the individual materially participated in the activity for any three taxable years preceding the tax year at issue; or
- Based on all the facts and circumstances, the individual participates in the activity on a regular, continuous, and substantial basis during the tax year
As noted, if the taxpayer is a limited partner of a limited partnership, the taxpayer is presumed to not materially participate in the partnership’s activity, “except as provided in the regulations.” I.R.C. §469(h)(2). The regulations provide an exception to the general presumption of non-material participation of limited partners in a limited partnership if the taxpayer meets any of one of three specific material participation tests that are included in the seven-part test for material participation under Treas. Reg. 1.469-5T(a)(1)-(7). Those three tests are:
- The 500-hour test;
- The five out of 10-year test; and
- The test involving material participation in a personal service activity for any three years preceding the tax year at issue.
Thus, the standard of “material participation” for a limited partner is different than that for a general partner, and the question presented in the cases was whether the more rigorous standard for material participation for limited partners in a limited partnership under I.R.C. §469(h)(2) applied to the taxpayers (who held membership interests in LLCs and LLPs) with the result that their interests were per-se presumptively passive.
Relevant Court Opinions
Courts have concluded, in certain instances, that the holder of a limited liability company (LLC) interest is not treated as holding an interest in a limited partnership as a limited partner for purposes of applying the I.R.C. §469 material participation tests.
For example, in Garnett v. Comr. 132 T.C. 368 (2009), the taxpayers were a married couple that owned interests in various LLCs and partnerships organized under Iowa law, as well as certain tenancy-in-common interests that were all engaged in agricultural production activities. They held direct ownership interests in one LLP and LLC and indirect interests in several other LLPs and LLCs. Their ownership interests were denoted as “limited partners” in the LLP and “limited liability company members” in the LLC – which did have a designated manager. The interests that they held in the two tenancies-in-common were also treated similarly. For tax years 2000-2002, the taxpayers ran up large losses and treated them as ordinary losses.
The IRS claimed that an LLC member is always treated as a limited partner because of limited liability under state law and because the Code specifies that a limited partnership interest never counts as an interest with respect to which the taxpayer materially participates. I.R.C. §469(h)(2). Thus, the IRS characterized the losses as passive, basing their position on the regulation which, for purposes of I.R.C. §469, treats a partnership interest as a limited partnership interest if “the liability of the holder of such interest for obligations of the partnership is limited, under the law of the State in which the partnership is organized, to a determinable fixed amount.” Temp. Treas. Reg. §1.469-5T(e)(3)(i)(B). On the other hand, the taxpayers argued that the Code and regulations did not apply to them because none of the entities that they had interests in were limited partnerships and because, in any event, they were general partners rather than limited partners. The taxpayers also pointed out that the Federal District Court for Oregon had previously ruled that, under the Oregon LLC Act, I.R.C. §469(h)(2) did not apply to LLC members. Gregg v. United States, 186 F. Supp. 2d 1123 (D. Ore. 2000).
The Tax Court first noted that I.R.C. §469(h)(2) was enacted at a time when LLCs and LLPs were either new or nonexistent business entities and, as such, did not refer to those entities. The court also pointed out that the regulations did not refer explicitly to LLPs or LLCs. Accordingly, the court rejected the IRS argument that a limitation on liability automatically qualifies an interest as a limited partnership interest under I.R.C. §469(h)(2). On the contrary, the court held that the correct analysis involved a determination of whether an interest in a limited partnership (or LLC) is, based on the particular facts, actually a limited partnership interest. That makes a state’s LLC statute particularly important. Does it grant LLC and LLP members power and authority beyond those that limited partners have traditionally been allowed.? The IRS conceded that the statute at issue in the case did just that. Other distinguishing features were also present. The court noted that limited partnerships have two classes of partners, one of which runs the business (general partners) and the other one which typically involves passive investors (limited partners). The limited partners enjoy limited liability, but that protection can be lost by participating in the business. By comparison, an LLP is essentially a general partnership in which the general partners have limited liability even if they participate in management. Likewise, the court noted that LLC members can participate in management and retain limited liability.
Note: The court made a key point that it was not invalidating the temporary regulations but was simply declining to write a regulation for the Treasury that applied to interests in LLCs and LLPs. Importantly, the court refused to give deference to the Treasury’s litigating position in absence of such a regulation.
In Thompson v. United States, 87 Fed. Cl. 728 (2009), the taxpayer held a 99 percent interest in an LLC that was formed under the Texas LLC statute. He held the other one percent interest indirectly through an S corporation. The LLC’s articles of organization designated the taxpayer as the manager. The LLC did not make an election to be taxed as a corporation and, thus, defaulted to partnership tax status. The LLC, which provided charter air services, incurred losses in 2002 and 2003 of $1,225,869 and $939,878 respectively which flowed through to the taxpayer. The IRS disallowed most of the losses on the basis that the taxpayer did not meet the more rigorous test for material participation that applied to limited partners in limited partnerships. The taxpayer paid the additional tax of $863,124 and filed a refund claim for the same amount. The IRS denied the refund claim and the taxpayer sued for the refund, plus interest. Both the taxpayer and the IRS moved for summary judgment.
The IRS stood by its position that the more rigorous material participation test applied because the taxpayer enjoyed limited liability by owning the interests in the LLC just like he would if he held limited partnership interests. Thus, according to the IRS, the taxpayer’s interest was identical to a limited partnership interest and the regulation applied triggering the passive loss rules.
The court disagreed with the IRS. While both parties agreed that the statute and regulations trigger application of the passive loss rules to limited partnership interests, the taxpayer pointed out that he didn’t hold an interest in a limited partnership. The court noted that the language of Treas. Reg. § 1.469-5T(e)(3) explicitly required that the taxpayer hold an interest in an entity that is a partnership under state law, and that the Treasury had never developed a regulation to apply to LLCs. It was clear that the taxpayer’s entity was organized under Texas law as an LLC. In addition, the court pointed out that the taxpayer was a manager of the LLC, and IRS had even conceded at trial that the taxpayer would be deemed to be a general partner if the LLC were a general partnership. The court noted that the position of the IRS that an LLC taxed as a partnership triggers application of the Treas. Reg. §1.469-5T(e)(3)(ii) was “entirely self-serving and inconsistent.” The court also stated that it was irrelevant whether the taxpayer was a manager of the LLC or not – by virtue of the LLC statute, the taxpayer could participate in the business and not lose the feature of limited liability.
Hegarty v. Comr., T.C. Sum. Op. 2009-153, is a Tax Court summary opinion where the Tax Court reiterated its position that the reliance by IRS on I.R.C. § 469(h)(2) to treat members of LLCs as automatically limited partners for passive loss purposes is misplaced. Instead, the general tests for material participation apply and the petitioners in the case (a married couple) were determined to have materially participated in their charter fishing activity for the tax year at issue. They participated more than 100 hours and their participation was not less than the participation of any other individual during the tax year.
In Newell v. Comr., T.C. Memo. 2010-23, the taxpayer’s primary business activity was managing various real estate investments. He spent more than one-half of his time and more than 750 hours annually in real property trade or business activities. During the years at issue, the taxpayer was the sole owner of an S corporation that manufactured and installed carpentry items, and his participation is that business qualified as a significant participation activity for purposes of the passive loss rules. He also owned 33 percent of the member interests in a California-law LLC engaged in the business of owning and operating a golf course, restaurant and country club. The LLC was treated taxwise as a partnership. It was undisputed that the taxpayer was the managing member of the LLC. For tax years 2001-2003, IRS claimed that the losses the taxpayer incurred from both the S corporation and the LLC were passive losses that were not currently deductible. While the parties agreed that the taxpayer’s participation in both the S corporation and the LLC satisfied the significant participation activity test under the passive loss rules, IRS again asserted its position that I.R.C. §469(h)(2) required that the taxpayer’s interest in the LLC be treated as a passive limited partnership interest, even though IRS conceded that the taxpayer held the managing member interest in the LLC.
The Tax Court rejected the IRS’ argument, noting again that the general partner exception of Treas. Reg. §1.469-5T(e)(3)(ii) was not confined to the situation where a limited partner also holds a general partnership interest. Under the exception, an individual who is a general partner is not restricted from claiming that the individual materially participated in the partnership. Here, it was compelling that the taxpayer held the managing member interest in the LLC. As such, the taxpayer’s losses were properly deducted.
In Chambers v. Comr., T.C. Sum. Op. 2012-91, the taxpayer owned rental property with his spouse that produced a loss. The taxpayer was also a managing member of an LLC that owned rental properties. The LLC also owned rental property, and produced losses with one-third of the losses allocated to the taxpayer. The taxpayer was also employed by the U.S. Navy. He deducted his rental losses in full on the basis that he was a real estate professional. In order to satisfy the “more than 50 percent test,” he combined his hours spent on his personally-owned rental activity with his management activity for the LLC. The IRS invoked I.R.C. §469(h) to disallow the taxpayer’s LLC managerial hours, but the court disagreed. The court held that the taxpayer’s LLC interest was not defacto passive. Thus, his hours spent in LLC managerial activities counted toward his total “real estate” hours. However, he still failed to meet more than 50 percent test. In addition, the court noted that the fallback test of active participation allowing $25,000 of rental real estate losses was not available because the taxpayer’s AGI exceeded $150,000 for the year in issue.
Conclusion
Whether a member of an LLC is a limited partner or not boils down to the particular provisions of a state’s LLC statute and whether there are sufficient factors under the state statute that distinguish an LLC from a limited partnership. That will be the case until IRS issues regulations dealing specifically with LLCs and similar entities.
As noted above, in late 2011, the Treasury Department proposed regulations defining “limited partner” for purposes of the passive loss rules. Notice of Proposed Rulemaking REG-109369-10 (Nov. 28, 2011). The proposed definition would make it easier for LLC members and some limited partners to satisfy the material participation requirements for passive loss purposes, consistent with the court opinions that IRS has recently lost on the issue. Specifically, the proposed regulations require that two conditions have to be satisfied for an individual to be classified as a limited partner under I.R.C. §469(h)(2): (1) the entity must be classified as a partnership for federal income tax purposes; and (2) the holder of the interest must not have management rights at any time during the entity’s tax year under local law and the entity’s governing agreement. Thus, LLC members of member-managed LLCs would be able to use all seven of the material participation tests, as would limited partners that have at least some rights to participate in managerial control or management of a partnership.
In Part Two, I will dig deeper into the self-employment tax issue.
August 18, 2022 in Business Planning, Income Tax | Permalink | Comments (0)
Friday, August 12, 2022
Federal Farm Programs: Organizational Structure Matters – Part Three
Overview
In this final part of a three-part series on federal farm programs, the focus is on the “active personal management,” issues associated with maintaining good records, and planning implications for farms seeking to maximize payments.
Organizing the farm business with federal farm program payments in mind – it’s the topic of today’s post.
The Active Personal Management Requirement
Three-part test for "active engagement." Under 7 C.F.R. Part 1400, a person must be “actively engaged” in farming to receive farm program payments. To satisfy the “actively engaged in farming” test, three conditions must be met.
- The individual's or entity's share of profits or losses from the farming operation must be commensurate with the individual's or entity's contribution to the operation.
- The individual's or entity's contributions must be “at risk.”
- An individual must make a significant contribution of land, capital or equipment (the “left-hand” requirement) and active personal labor or active personal management (i.e., the “right-hand” requirement).
For a general partnership, each member is treated separately for purposes of the active engagement test. Thus, each partner with an ownership interest must contribute active personal labor and/or active personal management to the farming operation on a regular basis. It is also important that the contribution be identifiable and documentable, as well as separate and distinct from the contributions made by any other partner. Any partner that fails to meet the active engagement requirement criteria is not eligible to participate in the federal farm programs.
Note: The payment of a guaranteed payment (i.e., “salary”) to a partner for providing active labor or management can bar the recipient partner from qualifying for payments. A guaranteed payment for services could mean that the partner does not satisfy the requirement of having made a qualified contribution of active labor or management and may disqualify the partner for a payment.
As noted above, a corporation is treated as a “person” for payment limitation purposes that is eligible for a single payment limit if each member with an ownership interest in the corporation makes a significant contribution of active personal labor or active personal management. In the context of a corporation, it does not matter if a member is compensated for contributions of active personal labor or management. But, it is still required that management or labor be performed on regularly, be identified and be documented. A shareholder’s contribution of labor or management must also be separate and distinct from the contributions of other shareholders or members. In addition, the contribution of all corporate members must be significant and commensurate with contributions to the farming operation.
If any member of the corporation fails to meet the labor or management contribution requirements, any program payment or benefit to the corporation will be reduced by an amount commensurate with the ownership share of that member. An exception applies if (a) at least 50% of the entity’s stock or units is held by members that are “actively engaged in providing labor or management” and (b) the total annual farm program payments received collectively by the stockholders or members of the entity are less than one payment limitation.
Note: A corporation can pay a salary to owners.
Some farming operations are placed in trust for estate planning and business succession planning purposes. For purposes of the farm programs, a revocable trust is treated as the grantor. An irrevocable trust must satisfy the same requirements as does a decedent’s estate. In addition, the interest of the beneficiaries of an irrevocable trust that provide active labor or management must be at least half of the trust’s income interest.
Note: While a revocable trust need not obtain an employer identification number (EIN), an irrevocable trust must do so. Additionally, trusts must provide a tax identification number and in some cases this will come up with FSA in the context of a joint revocable trust where both spouses, as income beneficiaries are seeking program benefits.
A decedent’s estate can meet the active engagement test for two program years after the year of the decedent’s death if the estate makes a significant contribution of land, capital equipment (or a combination thereof). The executor or the heirs collectively must make a significant contribution of active personal labor or active personal management (or a combination thereof) to the farming business. The estate must also satisfy the profit (or loss) sharing rule and at-risk rule must also be satisfied. If the estate remains open for more than two program years post-death, the FSA must be satisfied that the estate remains open for reasons other than to receive program payments.
One spouse’s satisfaction of the active engagement test requirement allows the other spouse to meet the test. If the non-participating spouse meets the ownership requirement with respect to land capital or equipment.
If a child under age 18 as of June 1 of a program year receives payments, the payment are attributed to the child’s parent (or a person appointed by a court). A child under age 18 that is farming on their own is not subject to this rule (if certain other requirements are satisfied).
As for the requirement that a capital contribution be made, the contributed capital must come from a fund or account that is separate and distinct from any other person or entity that has an interest in the farming operation. The source of the capital can be via either a direct contribution of cash or the funds may be borrowed (carefully). For contributions that derive from borrowed funds, the funds must not be a result of any loan that is made to or guaranteed by or co-signed by or secured by any other person, legal entity or joint operation that has an interest in the farming operation and the other person (or entity) must not have such an interest.
Note: Cross-collateralization clauses are frequently encountered in the ag borrowing context. John Deere in particular has a rather egregious clause (from a farm borrower’s perspective) as does the Small Business Administration. Those clauses will likely not be waived. Similarly, security and guarantee clauses will likely not be waived. A solution might be to put both the farm operating entity and the farmland into a general partnership (with each partner in an entity that limits liability).
What is "management“? Active personal management” is defined as significant contributions of management activities that are performed on a regular, continuous and substantial basis to the farming operation – basically the I.R.C. §1402 test for self-employment tax purposes. In addition, the management activities must represent at least 25 percent of the total management time that is necessary for the success of the farming operation on an annual basis, or represent at least 500 hours of specific management activities annually.
Multiple “person” determinations? The rules also restrict the number of persons that may qualify for payment by making a significant contribution of active personal management. For this purpose, the limit is one person unless the farming operation is large or complex. A "large" farming operation is one that has crops on more than 2,500 acres (planted or prevented from being planted). If the acreage limitation is satisfied, an additional person may qualify upon making a significant contribution of active personal management. If the farming operation satisfies another test of being “complex,” an additional payment limit may be available. This all means that, for large and complex, farming operations, a total of three payment limits may be obtained. The determination of whether a farming operation is "complex" is made by the State FSA Committee.
Special rules. Special rules apply to tenant-operated farms and family-owned operations with multiple owners. In some situations, a person meeting specified requirements is considered to be actively engaged in farming in any event. For example, a crop-share or livestock-share landlord who provides capital, equipment or land as well as personal labor, or active personal management meets the test. But, a cash rent landlord does not meet the test nor does a crop share landlord is if the rent amount is guaranteed. Also, if one spouse meets the active engagement test, the other spouse is deemed to meet the test.
Exemption for family operations. The active personal management test applies to non-family general partnerships and joint operations that seek to qualify more than one farm manager based solely on providing management or a combination of management and labor (another rule). However, it does not apply to farming operations where all of the partners, stockholders or persons with an ownership interest in the farming operation (or any entity that is a member of the farming operation) are “family members.” For this purpose, “family member” means a person to whom another member in the farming operation is related as a lineal ancestor, lineal descendant, sibling, spouse or otherwise by marriage. Legally adopted children and step-children count as “family members.”
The rule also doesn’t come into play where only one person attempts to qualify under the rule or when combined with a contribution of labor. The rule also doesn't apply to farming operations that are operated by individuals or entities other than general partnerships or joint ventures.
Record-Keeping Requirements
When multiple payments are sought for a farming operation under the active management rule, the operation must maintain contemporaneous records or logs for all persons that make any contribution of management. Those records must include, at a minimum, the location where the management activity was performed, and the amount of time put into the activity and its duration. In addition, every legal entity that receives farm program payments must report to the local FSA committee the name and social security number of each person who owns, either directly or indirectly, any interest in the entity. Also, the entity must inform its members of the payment limitation rules.
The FSA Handbook (5-PL, Amendment 3) specifies that the farming operation must maintain contemporaneous records or logs for all persons that make management contributions. The records must provide: (1) the location (either on-site or remote) where the management activity was performed; (2) the time spent on the activity and the timeframe in which it occurred; and (3) a description of the activity. FSA Handbook, Paragraph 222A. It is important that the records be maintained and be timely made available to the FSA for their review upon request. FSA Handbook, Paragraph 222B. The FSA provides a Form (CCC-902 MR) to track and maintain all of the necessary information. Note that these are the present references to the applicable FSA Handbook Paragraphs and Form. Those paragraph references and Form numbers can change. FSA modifies its handbook frequently; Forms are modified and numbers often are changed. Practitioners and their farm clients must be diligent in monitoring the changes.
Two things happen if the necessary records aren’t maintained – (1) the person’s contribution of active personal management for payment eligibility purposes will be disregarded; and (2) the person’s payment eligibility status will be re-determined for that particular program year.
Planning Implications
The “substantive change” rule. In general, any structural change of the farming or ranching business that increases the number of payment limits must be bona fida and substantive and not a “scheme or device.” See, e.g., Val Farms v. Espy, 29 F.3d 1570 (10th Cir. 1994). In addition, reliance on the advice of local or state USDA officials concerning the payment limitation rules is at the farmer or rancher's own risk. But the substantive change rule does not apply to spouses. Thus, for example, a spouse of a partner that is providing active management to a farm partnership can be added to the partnership and automatically qualify as a partnership member for FSA purposes. However, a “substantive change occurs when a “family member” is added to a partnership unless the family member also provides management or labor.
Note: As s farming operation grows and want to add substantially more acres, consideration may need to be given to the creation of an additional entity. One approach might be to put all of the farming entities into a general partnership with the “farmer” as the general partner.
"Scheme or device." The USDA is adept at alleging that a farming operation has engaged in a "scheme or device" that have the purpose or effect of evading the payment limitation rules. But this potential problem can be avoided if multiple payments are not sought, such as by having one manager for each entity engaged in farming. Of course, this is not a concern if all of the members of a multi-person partnership are family members. If non-family members are part of the farming operation, perhaps they can farm individually or with other non-family members that can provide labor to the farming business. That might be a safe approach.
"Combination" rule. There is also a “combination” rule that can apply when the farming business is restructured. If the rule applies, it will result in the denial of separate “person” status to “persons” who would otherwise be eligible for a separate limit.
Entity type based on size. From an FSA entity planning standpoint, the type of entity structure utilized to maximize payment limits will depend on the size/income of the operation.
For smaller producers, entity choice for FSA purposes is largely irrelevant. Given that the limitation is $125,000 and that payments are made either based on price or revenue (according to various formulas), current economic conditions in agriculture indicate that most Midwestern farms would have to farm somewhere between 3,000 and 4,000 acres before the $125,000 payment limit would be reached. Thus, for smaller producers, the payment limit is not likely to apply and the manner in which the farming business is structured is not a factor.
For larger operations, the general partnership or joint venture form is likely to be ideal for FSA purposes. If creditor protection or limited liability is desired, the partnership could be made up of single-member LLCs. For further tax benefits, the general partnership’s partners could consist of manager-managed LLCs with bifurcated interests.
Conclusion
Farm program payment limitation planning is a complicated mix of regulatory and administrative rules and tax/entity planning. It’s not an area that a producer should engage in without counsel if maximizing payments in conjunction with an estate/business plan is the goal. Unfortunately, few practitioners are adept at navigating both the tax planning rules and the FSA regulatory web. This makes it important that professionals advising farm clients on farm business organization and the associated tax rules work as a team to produce the best result for clients.
August 12, 2022 in Business Planning, Regulatory Law | Permalink | Comments (0)
Thursday, August 4, 2022
What is “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. 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 Federal Insurance Contributions Act (FICA) taxes and the employer Federal Unemployment Tax Act (FUTA) tax.
Note: The issue of the reasonableness of compensation also can arise in the context of a C corporation. Salaries and benefits to a C corporation shareholder/employee that is “too high” can bring an IRS challenge that some of the compensation is really disguised dividends. An “ostensible salary” paid by a closely held C corporation to one of its few shareholders is likely to constitute a disguised dividend where the amount is “in excess of those ordinarily paid for similar services and the excessive payments correspond or bear a close relationship to the stockholdings of the officers or employees.” Treas. Reg. §1.162-7(b)(1).
“Reasonable compensation” in the context of an S corporation (with a bit of C corporation discussion thrown in) – it’s the topic of today’s post.
Background
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 $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. The savings will likely increase in 2017. It is currently projected that the Social Security wage base will be $155,100 in 2023.
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
Over the past decade there have been some significant cases involving the issue of reasonable compensation in the S corporation context. Some of the prominent ones include:
- David E. Watson, P.C. v. United States, 668 F.3d 1008 (8th Cir. 2012), cert. den., 568 U.S. 888 (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.
In early 2021, the U.S. Tax Court issued its opinion in Ward v. Comr., 2021-32. In Ward, the petitioner conducted her law practice as an S corporation. She was the sole shareholder. For the three tax years at issue, the petitioner reported the net profit or loss from the S corporation on her Form 1040. In addition, for 2011, the S corporation did not treat any of the amount paid to her as wages on Form 941 and did not report any of it as income. In 2012, the petitioner reported $73,448 in payments as income, but neither she nor the S corporation reported the amounts as wages. The petitioner conceded that she was an officer of the S corporation. The IRS asserted that the amounts were wages, and the Tax Court agreed. The de minimis exception of Treas. Reg. §31.3121(d)-1(b) didn’t apply because, as the sole shareholder, she was performing services for the corporation. While the S corporation employed an associate attorney, the petitioner could have claimed that some of the firm’s net profit distributed to the petitioner attributable to the associate attorney’s efforts would not be wages. However, the petitioner provided no evidence of the value that the associate attorney added to the S corporation or whether that value exceeded the associate’s compensation. Thus, the salary payments reported to the petitioner by the S corporation were reportable as compensation.
Note: A side issue in Ward was that the petitioner also had canceled debt income in years when lenders discharged portions of her debt. She failed to provide sufficient evidence of her assets and liabilities for a solvency determination to be made.
And…a C Corporation Reasonable Compensation Case
Another recent case on the reasonable compensation issue illustrates that the matter, as indicated above, can also be a concern for C corporations. In Clary Hood, Inc. v. Comr., T.C. Memo. 2022-15, a married couple were the sole shareholders of a corporation engaged in the construction business that graded and prepared land. The corporation’s growth was irregular from 2000 on. The principal took a relatively modest salary between 2000 and 2012 but took a big increase in the years 2013 to 2016, ostensibly to compensate for earlier years. The company had an outside consulting firm perform an analysis to determine what the principal's compensation should be.
The IRS challenged the compensation amounts for 2015 and 2016. The Tax Court examined the usual factors considered in such a case including the employee's qualifications; the nature, extent, and scope of the employee's work; the size and complexities of the business; a comparison of salaries paid with gross income and net income; the prevailing general economic conditions; comparison of salaries with distributions to stockholders; the prevailing rates of compensation for comparable positions in comparable concerns; and the salary policy of the taxpayer as to all employees. On these points, the relevant facts showed that the corporation had revenue of almost $44 million (net revenue of $7 million) in 2015 and $68 million (net revenue of $14 million in 2016. The principal’s compensation was set at $168,559 with a $5 million bonus in 2015. A comparable arrangement was established for 2016. The principal set the compensation of the other four executives, and none of them were compensated in excess of $234,000. None of them had a bonus exceeding $100,000.
The Tax Court denied a deduction for the full amount of the compensation. While certain factors favored the corporation, the factors addressing comparable pay by comparable concerns, the corporation’s shareholder distribution history, the manner of setting compensation, and the principal’s involvement in the corporation’s business were the most relevant and persuasive factors for the Court. The Tax Court allowed a deduction of no more than $3,681,269 for the 2015 tax year and $1,362,831 for the 2016 tax year.
In addition, the IRS assessed an accuracy-related penalty for both years. The taxpayer was able to show that he relied in good faith on the advice of the accounting firm and the Tax Court did not sustain the penalty. However, for the second year the corporation could not substantiate its reliance on the outside adviser and was responsible for an accuracy-related penalty under I.R.C. §6662 for 2016.
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.
August 4, 2022 in Business Planning, Income Tax | Permalink | Comments (0)
Sunday, July 31, 2022
Is a C Corporation a Good Entity Choice For the Farm or Ranch Business?
Overview
The question often arises with farm and ranch clients that engage in estate, business or succession planning as to what the optimal entity structure is for the business? There’s no easy, one-size-fits-all answer to that question. It simply depends on numerous factors. In fact, the question is best answered by asking a question in return – what do you want the farming or ranching business to look like after you and your spouse are gone? What are your goals and objectives. If planning starts from that standpoint, then it is often much easier to get set on a path for creating an “optimal” entity structure.
One of the recurring questions is whether a C corporation is a good entity choice for the farm or ranch business.
Some thoughts on utilizing a C corporation for the farming or ranching business – that’s the topic of today’s post
Food For Thought
In many planning scenarios it is useful to create a checklist of points to consider that are relevant in the entity selection decision making process. The next step would then be to apply those points to the goals and objectives of the parties. For starters, consider the following:
C corporations. The following are relevant to C corporations:
- A C corporation can be formed tax free if: (1) property is exchanged for property; (2) the transferors (as a group) hold 80 percent or more of the stock immediately after the exchange of property for stock; and (3) the formation is for a business purpose.
Note: Be mindful about making stock gifts shortly after incorporation if doing so would drop the transferor group beneath the 80 percent threshold. How long is “shortly”? There is no clear answer to that question.
- C corporate income is subject to tax at a flat rate of 21 percent.
- A C corporation is not eligible for the 20 percent qualified business income deduction of I.R.C. §199A that is available to a sole proprietor or the member of a pass-through entity (such as a partnership or S corporation).
- While gain that is realized on the sale of stock of a farming corporation can’t be excluded under the special rules that apply to qualified small business stock (I.R.C. §1202), if the stock is that of a corporation engaged in processing activities, the gain can be excluded. There are other rules that can limit (or eliminate) this capital gain exclusion.
- When a C corporation converts to S corporation status, the built-in gains (BIG) tax applies to the built-in gains or income items. R.C. §1374(a). The Tax Cuts and Jobs Act (TCJA) didn’t eliminate the BIG tax, but it did lower it to 21 percent.
- A C corporation has good flexibility in establishing its capitalization structure as well as how it allocates income, losses, deductions and credits.
- A C corporation is potentially subject to additional penalty taxes if too much earnings are accumulated without legitimate, well documented business reasons, or If too much income is passive.
- The alternative minimum tax presently doesn’t apply to C corporate income, but a current proposal would restore it for some corporations starting for tax years after 2022.
- A C corporation can deduct state income tax. This should be contrasted with the TCJA limitation on the deduction of such taxes for individuals that is pegged at $10,000 (including real property taxes on property that is not used in the conduct of the taxpayer’s trade or business). R.C. §164(b)(6).
- A C corporation can provide employees with the tax-free fringe benefits of meals (limited to 50 percent by I.R.C. §274(n)) and lodging that are supported by legitimate business reasons (and satisfy other conditions). This benefit is not available to sole proprietors and partners in a partnership. See, e.g., Rev. Rul. 69-184, 1969-1 C.B. 256. That is also the result for S corporation employees who own, directly or indirectly, more than 2% of the outstanding stock of the S corporation – such persons may not receive certain otherwise tax-free fringe benefits (including meals and lodging). See I.R.C. §1372. Attribution rules apply for determining who is considered to be an S corporation shareholder. R.C. §318.
- A farming or ranching C corporation can generally use the cash method of accounting.
- In some states, a C corporation cannot own or operate agricultural land unless members of the same family own a majority of the corporate stock. State laws differ on the specific rules barring C corporations from being involved in agriculture, and many states not located in the Midwest or the Great Plains don’t have such rules.
- A C corporation faces the potential of a double layer of tax upon liquidation.
- The C corporation generally does provide good estate planning opportunities. In other words, it tends to be a good organizational vehicle for transitioning ownership from one generation to the next.
What About Income Tax Basis?
Given the currently high level of the federal estate tax exemption equivalent of the unified credit (12.06 million per decedent for deaths in 2022), income tax basis planning is high on the priority list. Thus, when federal estate tax is not a potential concern, planning generally focuses on making sure that property is included in a decedent’s estate. This raises some basic planning rules that must be considered:
- For property that is included in a decedent’s estate for purposes of federal estate tax, the basis of that property in the hands of the person inheriting the property is generally the fair market value (FMV) as of the date of the decedent’s death. R.C. §Sec. 1014(a)(1)).
- But, the “stepped-up” basis rule (to the date-of-death value) doesn’t apply to property that is income in respect of a decedent (IRD) under §691. R.C. §1014(c). An item is IRD if it is something that the decedent was entitled to as gross income but wasn’t included in income due to death in accordance with the decedent’s method of accounting. See Treas. Reg. §1.691(a)-1(b). Farmers and ranchers have some common occurrences of IRD such as:
- Deferred gain to be reported from installment sales and deferred sales of crops and livestock;
- The portion (on a pro rata) basis or crop-share rentals due at the time of death;
- Receivables for a cash basis farmer;
- Unpaid wages;
- The value of commodities stored at an elevator (cooperative). Reg. §1.691(a)-2(b), Example 5 (canning factory and processing cooperative).
- Accrued interest income on Series E/EE bonds;
- When a decedent’s estate makes an election under I.R.C. §2032A to value ag land in the estate at its value as ag property (known as the “special use” value) rather than at its fair market value, the basis of the land in the hands of the heir is the special use value. There is no basis “step-up” to fair market value at the time of death. Reg. §§1014(a)(3); 1.1014-3(a).
- While the income of a pass-through entity is taxed only at the owner level, and the pass-through income increases the owner’s tax basis in the owner’s interest in the pass-through entity, a C corporation pays tax at the corporate level and then tax is also paid at the shareholder level on dividends or proceeds of liquidation. In addition, C corporate income does not increase the shareholder’s stock basis.
Just Starting Out – Creating a New Entity
If an organizational structure is initially being put into place, again there are numerous factors to consider in determining whether the farming or ranching business should operate as a C corporation or a pass-through entity. In addition to those factors pointed out above, the following factors should also be considered:
- Is it anticipated that the primary or sole shareholder will hold the corporate stock until death?
- Where will the business be incorporated and do business? If the business will be a C corporation, does the state of incorporation or other states in which the corporation will do business have a state income tax?
- What tax bracket(s) will apply to the shareholders?
- If the underlying business of the corporation would qualify for the 20 percent qualified business income deduction of I.R.C. §199A, what’s the differential between the corporate tax rate of 21 percent and the individual rate less the 20 percent deduction? Will that full 20 percent deduction be available if the entity weren’t a C corporation? This can involve a rather complex analysis.
- What type of assets are involved? Will they appreciate in value? If so, the corporate tax rate of 21 percent plus the second layer of tax on gain of the appreciated asset value at the shareholder level upon liquidation (or on a qualified dividend) will exceed the maximum 23.8 percent capital gain rate that applies to an individual (20 percent rate plus an additional 3.8 percent on passive gain under Obamacare. (I.R.C. §1411)).
Note: A current proposal would apply the 3.8 percent tax to active business income in addition to passive income for tax years beginning after 2022.
- Is it anticipated that the business would retain earnings or pay it out in the form of compensation, rents or other expenses? Growing businesses tend to retain earnings. Paid-out earnings of a C corporation are taxed again at the shareholder level.
- Is income expected to fluctuate widely? If so, remember that the C corporate tax rate is a flat 21 percent.
- Will there be sufficient funds to pay consistent income to the owners of the business? If so, that can mean that (if a C corporation structure is utilized) shareholder-employees can receive tax benefits at the individual level. If a corporate-level loss is incurred in doing so, that loss can be used to offset future taxable income.
- Under the TCJA, losses can offset up to 80 percent of pre-NOL taxable income.
- The loss (for a farming corporation) can be carried back two years. R.C. §172(b)(1)(B).
- From an accounting and tax planning standpoint, is a fiscal year desired? A C corporation can have a fiscal year-end and the individual shareholders can have a calendar year-end.
- If the farming/ranching operation participates in federal farm programs, a C corporation and any other entity type that limits liability (S corporation; limited partnership; limited liability company) will restrict the entity to a single payment limit. That amount will then be split among the owners of the entity. Entity structures that don’t limit liability (e.g., a general partnership) are not subject to a single payment limit.
Note: This is an issue for farming/ranching operations that are potentially eligible for more than $125,000 (the current general payment limit) in federal farm program subsidies annually.
One Entity or Multiple?
Another question that sometimes needs to be addressed is whether the farming/ranching operation should be structured as a single entity or as two or more entities. This question often arises when the family has some heirs that want to operate the farm for the next generation and some heirs that don’t – the classic on-farm, off-farm heir situation. For these families, one approach might be to put the land in one entity (not a C corporation) and the operating assets in another entity (such as a general partnership). The two entities would be tied together with a lease that is (often) designed to minimize self-employment tax. This structure can provide income (in the form of rents) to the off-farm heirs, and control of the operating entity to the on-farm heirs.
Conclusion
So, what is the best entity structure for your farming or ranching operation? The above discussion merely scratches the surface of a very complex matter. However, if you clearly articulate your goals and objectives for the future of your business to your planners, and provide complete information on assets, liabilities, land ownership, current arrangements, family data and dynamics, cropping and livestock history and tax history, then a good plan can be put in place that can, at least in the short-term satisfy your objectives. Then, there must be a commitment to routinely review and update the plan as necessary. There is no “one-size-fits-all” business plan, and plans aren’t static. There is cost involved, of course, but the successful operations realize that the cost is a small compared to the benefits.
July 31, 2022 in Business Planning | Permalink | Comments (0)
Wednesday, July 13, 2022
Durango Conference and Recent Developments in the Courts
Overview
On August 1 and 2, Washburn Law School will be hosting a two-day conference on income tax as well as estate and business planning. Of course, the event emphasizes the application of tax and legal principles to ag producers and rural landowners, but many of the concepts are of general application. One of the featured sessions at the Durango conference will focus on water rights and how those impact income tax and estate planning for farmers, ranchers and rural landowners. Of course, throughout the two days we will be covering many issues that apply to clients in a host of possible situations.
In today’s post, I focus on the Durango water rights session and a few court developments.
Appropriation Water Rights - Tax and Estate Planning Issues (Durango Conference)
This panel session begins with Andy Morehead, an accountant from Eaton, CO, explaining why we are talking about appropriation water rights in tax and estate planning. The importance of the topic relates to the value of water rights. Andy will talk about his experience concerning sales and other projects where water rights significantly increased the wealth of individuals, families or entities.
In Colorado, almost 4,000 wells have been shut in by the State Engineer in the past two decades to maintain streamflow and satisfy downstream priority claims. A similar number have had their pumping rights limited in some way. Given the rapid development occurring in northeast Colorado and the need for water for the new subdivisions along the front range, there will be major political ramifications if any further reductions are made. The economic impact is already being felt. A unit (one acre foot) of Colorado Big Thompson storage water now sells for about $65,000. Approximately 15 years ago, the same volume of water sold for $6,000. This enhanced value has a significant impact on estates, as does any land with associated water rights.
Following Andy’s opening discussion, John Howe, an attorney in Grand Junction, CO, will follow. His practice focuses on real estate matters including the leasing of water rights. John will explain the nature of an appropriation water right, and will also discuss surface rights, tributary and non-tributary groundwater. John will also address nuances in the adjudication system and the chief engineer’s agency. Of particular interest to tax practitioners is whether a right to use water is an ownership interest in real property or a right to use water that is personal property. John will discuss the real/personal property determination. Of course, the focus will be on Colorado, but John may also comment on the real/personal property distinction in adjoining states. He will also share his experiences with business and succession planning title issues involving water rights and focus on a few of the most common title mistakes made with water right dispositions related to estate planning, divorce, financing and foreclosure, and entity dissolution or division.
Mike Ramsey, a long-time water law practitioner in Garden City, Kansas, will follow John’s discussion by addressing approaches to the valuation of water rights and depletion issues. Mike will also discuss I.R.C. §1031 exchanges involving disposition of water rights that are interests on real property and other estate tax planning issues associated with water right ownership.
The Durango conference is going to be a good one that you will want to be a part of, either in-person or online. For further details about the two-day event click here: https://www.washburnlaw.edu/employers/cle/farmandranchtaxaugust.html
Recent Court Developments
Defendant Properly Sentenced for Falsely Obtaining PPP and EIDL Loans
United States v. Stout, No. 21-1938, 2022 U.S. App. LEXIS 16627 (8th Cir. Jun. 16, 2022)
The defendant was sentenced to 12 months and 1 day in prison followed by 3 years of supervised release and $74,600 in restitution for misrepresenting (along with his wife and his sister) that they owned multiple businesses in order to obtain forgivable Paycheck Protection Program (PPP) loans as well as non-forgivable loans under the Economic Injury Disaster Loan program. The defendant admitted being the ringleader of the scheme. The court determined the “intended-loss,” the monetary harm the defendant purposely sought to inflict, was $116,525.56. The amount was calculated using pre-sentence investigation reports. The defendant claimed that his sentence should be reduced on the basis that the trial court should have limited the loss only to the PPP loans.
The defendant claimed there was no evidence he did not intend to repay the non-forgivable loans, and relied on a 1999 case involving a rancher that misrepresented the number of cattle he owned in order to obtain a loan. But the rancher in that case took multiple remedial actions to repay the falsely obtained loans such as selling his ranch and equipment, starting a new business, and financing his debt. The appellate court determined that the previous case was not like the defendant’s situation. The defendant provided no evidence that he would do anything to repay the loans and had no businesses that would allow him to repay the loans. The appellate court also concluded that the trial court did not err in considering the defendant’s past fraudulent actions of pawning stolen work computers as a reflection of the defendant’s character. As a result, the appellate court upheld the trial court’s sentencing determination.
Shareholders Liable for Corporate Tax under “Midco” Transaction.
Sloan v. Comr., T.C. Memo. 2022-6, on rem. from, 896 F.3d 1083 (9th Cir. 2018), rev’g., T.C. Memo. 2016-115, cert. den., 139 S. Ct. 1348 (2019)
A “Midco” transaction designed to avoid the tax on built-in-gain (BIG) inherent in the appreciation of assets held in a C corporation. Under a “Midco” transaction the seller engages in a stock sale while the buyer engages in an asset purchase through use of an intermediary company. The sale of stock avoids triggering the BIG tax and the purchaser gets a purchase price income tax basis in the assets. The IRS, however, often takes the position that the parties engaged in a Midco transaction have tax liability exposure under I.R.C. §6901as a transferee for unpaid taxes and interest on the basis that the selling shareholder. The IRS could also impose penalties on the transferee parties. The basic issue is whether the selling shareholder knew or should have known that the intermediary company would incur a tax liability that it had no ability to pay.
In this case, the petitioners were transferees of C corporate assets via a typical “Midco” transaction where an intermediary company was affiliated with a promoter. The intermediary company was merely a “shell” company organized offshore that buy the shares of the target company. The cash of the petitioner’s C corporation (target corporation) flowed through the intermediary to the selling shareholders. After acquiring the target’s embedded tax liability, the shell company engaged in a transaction purporting to offset the target's realized gains and eliminate the corporate-level tax. The promoter and the target's shareholders then agreed to split the dollar value of the corporate tax that had purportedly been avoided with the promoter keeping as its fee a negotiated percentage of the avoided tax amount. The target's shareholders kept the balance of the avoided corporate tax as a premium above the target's true net asset value (i.e., assets net of accrued tax liability).
After the transaction there were no assets left in the target corporation and the IRS issued notices of liability to the petitioners as transferees. In the original Tax Court case, the Tax Court ruled that the petitioners were not liable as transferees on the theory that they and their advisers did not have actual or constructive knowledge of the results of the transaction. On appeal, the appellate court reversed, concluding that the petitioners were at the very least on constructive notice that the entire scheme had no purpose other than tax avoidance. The appellate court also concluded the transfer was a constructively fraudulent transfer under Arizona law. The U.S. Supreme Court declined to hear the case. On remand, the Tax Court entered a decision consistent with the IRS’ computations. Those computations included accuracy-related penalties and IRS recovery of pre-notice interest.
Iowa Law Providing Limited Nuisance Immunity to CAFOs Upheld
Garrison v. New Fashion Pork LLP, No. 21-0652, 2022 Iowa Sup. LEXIS 86 (Iowa Sup. Ct. Jun. 30, 2022)
The plaintiff claimed that the defendant’s neighboring confined animal feeding operation (CAFO) violated both the Clean Water Act and the Resource Conservation Recovery Act due to manure runoff that caused excessive nitrate levels in the plaintiff’s water sources. The federal court dismissed the suit on summary judgment for lack of expert testimony to establish the plaintiff’s claim, finding that the alleged violations where wholly past violations, and that water test results showed no ongoing violation of either statute, but rather a slight decrease in nitrate levels since the start of the defendant’s confined animal feeding operation (CAFO). The federal court also declined supplemental jurisdiction over the plaintiff’s state law claims. The plaintiff then sued the defendant in state court for nuisance, trespass and violation of state drainage law. The defendant moved for summary judgment based on statutory immunity of Iowa Code § 657.11 and the plaintiff’s lack of evidence or expert testimony.
Iowa Code §657.11 provides limited nuisance immunity to a CAFO. Immunity is granted if the CAFO is following all applicable regulations and is using accepted management practices. The plaintiff, relying on Gacke v. Pork XTRA, L.L.C., 684 N.W. 2d 168 (Iowa 2004) claimed that Iowa Code §657.11 as applied to him was unconstitutional under Iowa’s inalienable rights clause. Under Gacke, for a court to determine whether Iowa Code §657.11(2) is unconstitutional a plaintiff must show they (1) “receive[d] no particular benefit from the nuisance immunity granted to their neighbors other than that inuring to the public in general[,]”; (2) “sustain[ed] significant hardship[,]”; and (3) “resided on their property long before any animal operation was commenced” on neighboring land and “had spent considerable sums of money in improvements to their property prior to construction of the defendant’s facilities.” All three elements must be established.
The trial court, noting that the plaintiff’s own CAFO (raising of 500 ewes, and at times over 1,000 ewes and lambs, on his property for over 40 years, along with a six-foot tall manure pile) had benefited from immunity, rejected the plaintiff’s constitutional challenge for failure to satisfy Gacke’s three-part test in Gacke. The trial court then granted the defendant’s summary judgment motion based on the plaintiff’s failure to provide any expert testimony or other evidence to support any exception to the statutory immunity defense or to prove causation or damages.
On further review, the Iowa Supreme Court affirmed, overruled the three-part test of Gacke and applied rational basis review to reject the plaintiff’s constitutional challenge to Iowa Code §657.11. The court noted that Iowa Code §657.11A did not eliminate nuisance claims against CAFOs, but rather established reasonable limitations on recovery rights. The Iowa Supreme Court concluded that the plaintiff failed to preserve error on his takings claim under article I, section 18 of the Iowa Constitution and failed to generate a question of fact precluding summary judgment on statutory nuisance immunity or causation for his trespass and drainage claims. Specifically, the Iowa Supreme Court noted that without accompanying expert testimony, the plaintiff water tests showed neither an increase in nitrate levels nor a spike in nitrate levels that would correlate with manure spreading. The Supreme Court further noted that even assuming an increase in nitrate levels, the plaintiff lacked expert testimony to attribute or correlate any increase in nitrate levels in the stream to the defendants’ actions. Thus, without expert witness testimony that tied the defendant’s alleged misapplication or over-application of manure to the nitrate levels in the plaintiff’s stream, the plaintiff could not, as a matter of law, satisfy his burden of proving that any trespass or drainage violation proximately caused his damages. The Iowa Supreme Court did not address the plaintiff’s constitutional challenge to the damages limitations in Iowa Code §657.11A(3).
Note: The Iowa Supreme Court’s opinion didn’t explain how the attorneys for the plaintiff failed to preserve error on the plaintiff’s takings claim and failed to provide expert witness testimony on the tort claims for trespass and drainage issues. However, the Iowa Supreme Court clearly focused on those deficiencies in its opinion.
Conclusion
Agricultural law and taxation is a dynamic area of the law focusing on the legal rules surrounding food production, water rights and allocation, and the production and usage of energy. Of course, taxation is wrapped around all of those issues, as are estate, business and succession planning. All of these issues will be addressed at the upcoming conference in Durango, CO on Aug. 1 and 2. While it’s not the same as being there in person the online attendance platform allows you to participate from your own location.
I am looking forward to seeing you there, or online.
July 13, 2022 in Business Planning, Civil Liabilities, Criminal Liabilities, Water Law | Permalink | Comments (0)
Sunday, July 3, 2022
Farm/Ranch Tax, Estate and Business Planning Conference August 1-2 – Durango, Colorado (and Online)
Details
This summer’s second premier national ag income tax and estate/business planning conference will be in Durango, Colorado on August 1 and 2 at Fort Lewis College. The first conference was held at the Wisconsin Dells in mid-June. If you aren’t able to attend in-person, the conference will be live-cast on the web.
Day 1 Itinerary
- I will start off Monday August 1 with a tax update covering key rulings and cases of recent vintage. This session will keep you updated on what the tax issues are in the courts and with the IRS.
- Paul Neiffer with CliftonLarsonAllen will take us through the tax reporting issues with various federal farm programs and the options for deferring crop insurance.
- I will then have a session on correcting depreciation errors. When can an amended return be filed and when is Form 3115 required?
- Paul will then cover research and development credits and how to claim them on an amended return. He will follow this session with another session on farm net operating losses – a tax technique that has been modified several times in recent years. Making and revoking elections will be addressed.
- During the last morning session, I will cover taxation of retailer reward programs from the perspective of both the retailer and the customer. These programs are popular among many ag retailers. I will also address the proper tax treatment of demolishing structures on the farm.
- After the luncheon, Tiffany Robinson of the Criminal Investigation Division of IRS will provide insight from the Division’s perspective on how a business can identify data breaches, how the “Dark Web” is utilized for cyber-crimes, and crypto crimes.
- The afternoon session involves myself and Paul covering numerous farm tax topics from machinery trades to inventory accounting, to early termination of CRP contracts, weather-related livestock sales and contribution margin analysis.
Day 2 Itinerary
- Tuesday August 2 opens with my update of cases and rulings pertaining to farm business structures and estate planning.
- I will follow my opening session with a discussion of succession planning strategies with intentionally defective grantor trusts and grantor-retained annuity trusts.
- After the morning break, Tim O’Sullivan of the Foulston firm in Wichita, Kansas, will address income and estate planning techniques for estates of all sizes and how to fit those techniques with your client’s particular goals and objectives.
- The final morning session will involve Mary Ellen Denomy, a nationally known speaker on oil and gas issues and CPA addressing how to report oil and gas royalties and working interest payments on the tax return; estate plans for clients with oil and gas interests; whether clients are being paid according to their agreements; and the role of the CPA in these situations.
- After the luncheon, Mark Dikeman of the Kansas State University Farm Management Association will provide a session on farm economics and how to analyze the economic health of a client’s farming/ranching business. What is the true financial health of the business as opposed to what the tax return might say?
- The next session is an absolute must if you represent clients with water rights. This panel session will involve three practitioners (one from Kansas (Mike Ramsey) and two from Colorado (Andy Morehead and John Howe) that will cover water rights in the context of income tax and estate/business planning. How do water rights impact sale and transition transactions?
- Shawn Leisinger and I will close out the day with an hour of ethics focusing on asset protection planning - the right way to do it and the potential ethical violations if it is not done properly. This will be an eye-opening session.
Attend Online
If you can’t attend in person, attendance may be virtually.
Accreditation
Washburn Law School is an NASBA certified CPE provider. For accountants, the conference qualifies as GIB, but is also offered in GL format. The conference also qualifies for CLE credit for attorneys.
Additional Information
More information about the conference and how to register can be found at this link: https://www.washburnlaw.edu/employers/cle/farmandranchtaxaugust.html
Conclusion
If you have a rural practice or represent farm and ranch clients on their tax or estate/business planning issues, this conference is a “must attend” conference. I hope to see you there or online.
July 3, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)
Wednesday, June 29, 2022
S Corporation Dissolution – Part Two; Divisive Reorganization Alternative
Overview
In Part One earlier this week, the focus was on the tax issues associated with liquidating an S corporation. In Part One, I noted that the same general liquidation rules apply to an S corporation as to a C corporation. However, the tax cost is significantly smaller unless the S corporation is subject to built-in gains taxation. One other point to note is that an S corporation must be liquidated in the same tax year as the sale/distribution of assets to produce the desired tax result. If a sale/distribution of assets is accomplished in one tax year and the liquidation of the corporation in the following year, the capital loss produced upon liquidation would not offset the capital gain generated by the sale of assets. In such a case, the capital loss produced upon liquidation would only offset other long-term capital gains for the tax year of the liquidation, plus $3,000 of ordinary income. The remaining long-term capital loss would be carried forward to subsequent tax years.
An alternative to liquidating an S corporation is a divisive reorganization – and it’s the topic of today’s post.
Alternative to Liquidation – Divisive Reorganization
An alternative to liquidating an S corporation at the death of the surviving spouse is a divisive reorganization under I.R.C. §355. This can be an option where heirs exist that are interested in continuing the farming/ranching business. In a divisive reorganization, part of the assets of a parent corporation are split-off to one or more (former) shareholders through a new corporation. A divisive reorganization typically involves three major steps:
- Formation of a new subsidiary corporation;
- Transfer of part of the parent corporation’s assets to the subsidiary (usually tax-free); and
- Distribution of the stock in the subsidiary to some of the parent corporation’s shareholders in exchange for their stock in the parent corporation.
A divisive reorganization can be used to divide a single, functionally integrated business (e.g. farming operation) into two separate businesses and will allow surviving shareholders to postpone income recognition that would otherwise occur through corporate liquidation at the death of the first generation shareholders. Treas. Regs. §§1.355-1(b) & 1.355-3(c), Examples 4 & 5. See also, Rev. Rul. 75-160, 1975-1 CB 112; Coady v. Com’r., 33 T.C. 771 (1960), acq., 1965-2 C.B. 4, non. acq., 1960-2 C.B. 8 (withdrawn), aff’d., 289 F.2d 490 (6th Cir. 1961); United States v. Marett, 325 F.2d 28 (5th Cir. 1963).
For a divisive reorganization to be tax-free, five tests under IRC §355 must be met:
- Control test;
- Active conduct of a business” test;
- Distribution of “solely stock or securities”;
- Parent corporation must distribute all of the stock in the subsidiary (or enough for control); and
- Reorganization must not be used “primarily as a device for distribution of earnings and profits.”
While, technically, these five tests must be satisfied for a divisive reorganization to be tax-free, in reality, only two of the tests generally create issues that could prevent a reorganization from being utilized. The two problematic requisites/tests are the active conduct of trade or business requirement and the trade or business requirement.
Active conduct of trade or business. For purposes of I.R.C. §355, a trade or business must have been actively conducted by the distributing parent corporation throughout the five-year period ending on the date of distribution. The regulations under I.R.C. §355 expand this requirement and require continued operation of the business or businesses existing before the implementation of the divisive reorganization. Accordingly, a transitory continuation of one of the active businesses would not satisfy the active trade or business test provided by these regulations. I.R.C. §355(b)(1)(A); Treas. Reg. §1.355-3(a)(1).
Guidance on the active trade or business requirement:
- The holding of stock and securities for investment purposes will not constitute the active conduct of a trade or business. Also, the ownership and rental of real or personal property (e.g., farm real estate) will not constitute the active conduct of a trade or business unless the owner performs significant services with respect to the operation and management of the property. Treas. Reg. §1.355-3(b)(2)(iv).
- Rul. 73-234, 1973-1 CB 180 involved a corporate farming operation where the active conduct of a trade or business test was satisfied. The facts involved a livestock share lease with active involvement. The IRS states, “the fact that a portion of a corporation’s business activities is performed by independent contractors will not preclude the corporation from being engaged in the active conduct of a trade or business if the corporation itself directly performs active and substantial management and operational functions.”
- The active conduct of a trade or business test was not met in Rev. Rul. 86-126,1896-2 CB 158. The facts involved a corporation that cash rented farmland. There was a sharing of expenses. The tenant planted, raised, harvested and sold the crops using the tenant’s equipment. The activities of the corporate officers in leasing the land, providing advice and reviewing accounts were determined to not be substantial enough to meet the active trade or business requirement.
Note. It does not appear that the use of a farm manager (agent) to perform these services for the corporation necessarily impairs the active conduct of a trade or business requirement. Webster Corp. v. Comr., 25 T.C. 55 (1955), acq. 1960-2 C.B. 4,.7, aff’d., Comr. v. Webster Corp., 240 F 2d 164 (2d Cir. 1957). However, the officers and directors must be active in directing the activities of the agent, not mere spectators.
Caution - Tax Planning: The corporation’s officers and directors’ activities for the pre-distribution (5 yr.) and post-distribution (suggested as 2 years or more) time frames should be well documented before a divisive reorganization is undertaken. Also, payment of at least nominal officer/director salaries for services performed should be considered.
Trade or business purpose. Treas. Reg. §1.355-2(b)(2) provides that a corporate business purpose must be a real and substantial non-federal tax purpose germane to the business of the distributing corporation, as well as the controlled corporation. A shareholder purpose (e.g. accomplishing personal estate planning objectives) by itself, is not a corporate business purpose. However, the regulations go on to explain that a shareholder purpose may be so nearly co-extensive with a corporate business purpose as to preclude any distinction between them, in which case the transaction meets the corporate business purpose requirement. A transaction motivated in substantial part by a corporate business purpose will not fail the business purpose requirement merely because it is motivated in part by non-federal tax shareholder purposes.
Note. According to the Treasury Regulation, the whether the business purpose test has been satisfied is generally readily ascertainable (e.g. shareholder disputes or potential therefore, etc.).
Examples. Rev. Rul. 2003-52, 2003-1 C.B. 960 involved a family farming corporation that the parents and their two adult children owned. The children provided active management. One child intended to focus on the livestock side of the business while the other child preferred to operate the grain farming operation. The corporation reorganized into two corporations, with one child receiving the stock of the livestock business and the other child receiving the stock of the grain enterprise. The IRS approved the reorganization on the basis that it was motivated by a substantial non-tax business purpose even though the reorganization advanced the personal estate planning goals of the parents and promoted family harmony.
Private Letter Ruling 200323041 (Mar. 11, 2003) involved the separation of a grain farming business between siblings after their father’s death. The IRS concluded that a corporate split-off that is undertaken to avoid shareholder disputes in a family-owned grain farming corporation (engaged in a single line of business) will constitute a divisive reorganization under I.R.C. §368(a)(1)(D) and the stockholders of the split-off corporation would not recognize gain or loss under I.R.C. §355. See also Priv. Ltr. Rul. 200425033 (Mar. 4, 2004) and Priv. Ltr. Rul. 200422040 (Feb. 13, 2004)(same).
Note. The IRS has ruled that the post-distribution business purpose requirement of I.R.C. Reg. §1.355-2(b) remained satisfied even though the business purpose could not be achieved due to an unexpected change in circumstances following the divisive reorganization. In so ruling, the IRS noted that the “regulations do not require that the corporation in fact succeed in meeting its corporate business purpose, as long as, at the time of the distribution, such a purpose exists and motivates, in whole or substantial part, the distribution.” Rev. Rul. 2003-55, 2003-1 C.B. 961.
Other considerations. While I.R.C. §355 requires that the corporation seeking a divisive reorganization be engaged in the active conduct of a trade or business it does not require that all of the assets of the corporation be devoted to or used in an active trade or business. The corporation may hold non-qualifying assets (generally less than 5% of total) as long as it is engaged in the active conduct of a trade or business. Treas. Reg. §1.355-(3)(a)(ii).
Planning recommendation. It may be advisable to have all shareholders enter into an agreement providing that any shareholder who violates the post-distribution active trade or business rule agrees to pay all taxes incurred by all shareholders if the divisive reorganization fails to pass IRS scrutiny.
Note: In Rev. Proc. 2003-48, 2003-2 C.B. 86, the IRS stated that, for ruling requests after August 8, 2003, it would no longer rule on whether (1) a distribution of stock of a controlled corporation is carried out for business purposes, (2) the transaction is used principally as a device, or (3) a distribution and an acquisition are part of a plan under IRS §355(e). Rather, taxpayers seeking a ruling under IRS §355 must submit representations on these issues for review and determination by IRS.
Conclusion
Tax issues do arise when an S Corporation is dissolved. Fortunately, certain planning steps can be taken to avoid the heirs being denied the benefit of a basis increase in the corporate assets to fair market value at death. A reorganization is one possible tax-efficient planning step that could be utilized. Other planning options (not discussed in this two-part series) include liquidating the S corporation via a merger, and conversion of the S corporation to a partnership.
June 29, 2022 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)
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
Continuing Education Events and Summer Conferences
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?
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)
Farm Bankruptcy – “Stripping,” “Claw-Back” and the Tax Collecting Authorities (Update)
BUSINESS PLANNING
For Continuing Education Events and Summer Conferences
Agricultural Law Online!
https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html
Recent Happenings in Ag Law and Ag Tax
C Corporate Tax Planning; Management Fees and Reasonable Compensation – A Roadmap of What Not to Do
Will the Estate Tax Valuation Regulations Return?
June National Farm Tax and Estate/Business Planning Conference
August National Farm Tax and Estate/Business Planning Conference
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
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
Intergenerational Transfer of Family Businesses with Split-Dollar Life Insurance
Ohio Conference -June 7-8 (Ag Economics) What’s Going On in the Ag Economy?
Montana Conference and Ag Law Summit (Nebraska)
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
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
Gifting Pre-Death (Partnership Interests) – Part Three
The Future of Ag Tax Policy – Where Is It Headed?
Estate Planning to Protect Assets From Creditors – Dancing On the Line Between Legitimacy and Fraud
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
Caselaw Update
https://lawprofessors.typepad.com/agriculturallaw/2021/10/caselaw-update.html
S Corporations – Reasonable Compensation; Non-Wage Distributions and a Legislative Proposal
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
The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Three
Continuing Education Events and Summer Conferences
The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Three
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?
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
CONTRACTS
The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Three
Continuing Education Events and Summer Conferences
Agricultural Law Online!
https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html
Deed Reformation – Correcting Mistakes After the Fact
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
COOPERATIVES
Continuing Education Events and Summer Conferences
Final Ag/Horticultural Cooperative QBI Regulations Issued
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
Continuing Education Events and Summer Conferences
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
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
Agricultural Law Online!
https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html
Recent Happenings in Ag Law and Ag Tax
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
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
Key “Takings” Decision from SCOTUS Involving Ag Businesses
Montana Conference and Ag Law Summit (Nebraska)
Navigable Waters Protection Rule – What’s Going on with WOTUS?
ESTATE PLANNING
The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Two
Continuing Education Events and Summer Conferences
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?
June National Farm and Tax and Estate/Business Planning Conference
August National Farm Tax and Estate/Business Planning Conference
Farmland in an Estate – Special Use Valuation and the 25 Percent Test
The Revocable Living Trust – Is it For You?
Summer Conferences – NASBA Certification! (and Some Really Big Estate Planning Issues – Including Basis)
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
The “Mis” STEP Act – What it Means To Your Estate and Income Tax Plan
The Revocable Trust – What Happens When the Grantor Dies?
Intergenerational Transfer of Family Businesses with Split-Dollar Life Insurance
Ohio Conference –June 7-8 (Ag Economics) What’s Going On in the Ag Economy?
Reimbursement Claims in Estates; Drainage District Assessments
Montana Conference and Ag Law Summit (Nebraska)
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
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
The Future of Ag Tax Policy – Where Is It Headed?
Estate Planning to Protect Assets From Creditors – Dancing On the Line Between Legitimacy and Fraud
Tax Happenings – Present Status of Proposed Legislation (and What You Might Do About It)
Corporate-Owned Life Insurance – Impact on Corporate Value and Shareholder’s Estate
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
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
The “Top Ten” Agricultural Law and Ag Tax Developments of 2020 – Part One
Continuing Education Events and Summer Conferences
The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Four
Final Ag/Horticultural Cooperative QBI Regulations Issued
Agricultural Law Online!
https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html
Recent Happenings in Ag Law and Ag Tax
Deducting Start-Up Costs – When Does the Business Activity Begin?
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
Where’s the Line Between Start-Up Expenses, the Conduct of a Trade or Business and Profit Motive?
June National Farm Tax and Estate/Business Planning Conference
Selling Farm Business Assets – Special Tax Treatment (Part One)
Tax Update Webinar
https://lawprofessors.typepad.com/agriculturallaw/2021/03/tax-update-webinar.html
Selling Farm Business Assets – Special Tax Treatment (Part Two)
Selling Farm Business Assets – Special Tax Treatment (Part Three)
August National Farm Tax and Estate/Business Planning Conference
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
Federal Farm Programs and the AGI Computation
Tax Potpourri
https://lawprofessors.typepad.com/agriculturallaw/2021/04/tax-potpourri.html
What’s an “Asset” For Purposes of a Debtor’s Insolvency Computation?
Summer Conferences – NASBA Certification! (and Some Really Big Estate Planning Issues – Including Basis)
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
The Revocable Trust – What Happens When the Grantor Dies?
Ohio Conference -June 7-8 (Ag Economics) What’s Going On in the Ag Economy?
What’s the “Beef” With Conservation Easements?
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)
Tax Developments in the Courts – The “Tax Home”; Sale of the Home; and Gambling Deductions
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
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
The Future of Ag Tax Policy – Where Is It Headed?
Tax Happenings – Present Statute of Proposed Legislation (and What You Might Do About It)
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
Farm Bankruptcy – “Stripping,” “Claw-Back” and the Tax Collecting Authorities (Update)
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
Tax Reporting of Sale Transactions By Farmers
The Tax Rules Involving Prepaid Farm Expenses
Self Employment Taxation of CRP Rents – Part One
Self-Employment Taxation of CRP Rents – Part Two
Self-Employment Taxation of CRP Rents – Part Three
Recent IRS Guidance, Tax Legislation and Tax Ethics Seminar/Webinar
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
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
Inland Hurricane – 2021 Version; Is There Any Tax Benefit to Demolishing Farm Buildings and Structures?
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?
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?
Commodity Credit Corporation Loans and Elections
INSURANCE
Continuing Education Events and Summer Conferences
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
Continuing Education Events and Summer Conferences
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
Valuing Ag Real Estate With Environmental Concerns
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)
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?
REGULATORY LAW
The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Two
The “Top Ten” Agricultural Law and Ag Tax Developments of 2020 – Part One
Continuing Education Events and Summer Conferences
The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Two
The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Four
Agricultural Law Online!
https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html
Recent Happenings in Ag Law and Ag Tax
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
Federal Farm Programs and the AGI Computation
Regulation of Agriculture – Food Products, Slaughterhouse Line Speeds and CAFOS
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
The “Dormant” Commerce Clause and Agriculture
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
Key “Takings Decision from SCOTUS Involving Ag Businesses
Reimbursement Claims in Estates; Drainage District Assessments
Mailboxes and Farm Equipment
https://lawprofessors.typepad.com/agriculturallaw/2021/07/mailboxes-and-farm-equipment.html
Montana Conference and Ag Law Summit (Nebraska)
California’s Regulation of U.S. Agriculture
Checkoffs and Government Speech – The Merry-Go-Round Revolves Again
Is There a Constitutional Way To Protect Animal Ag Facilities
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?
SECURED TRANSACTIONS
Continuing Education Events and Summer Conferences
Agricultural Law Online!
https://lawprofessors.typepad.com/agriculturallaw/2021/01/agricultural-law-online.html
Cross-Collateralization Clauses – Tough Lessons For Lenders
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
WATER LAW
Continuing Education Events and Summer Conferences
The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Three
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)
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)
