Agricultural Law and Taxation Blog

Protecting Farm Assets and Your Legacy

Overview

Farming and ranching businesses operate on thin margins.  The way ag economists measure it   the operating margin for farming and ranching operations typically refers to the percentage of revenue remaining after covering operating expenses, excluding interest and taxes. It's an important measure of profitability and financial efficiency in agricultural businesses.  But by excluding interest and taxes, the true picture of the operating margin of a farm or ranch is distorted and overestimated.  Interest expense and taxes are a significant factor in determining the true health of an agricultural business.  That’s what much of agricultural law and taxation concerns – taking planning steps to ensure that economic margins are not any tighter than they need to be by avoiding unnecessary “leakage” of funds.

With today’s post, I take a brief look at some things to examine about your farming operation that are outside of the typical ag economic outlook for a farm’s profitability.  I am just scratching the surface on each of these.  Indeed, I teach professional-level continuing education classes on each of these.  And…there are many other legal and tax-related issues that relate to a farm’s bottom line that I don’t address in this brief article.

A few points on improving your operating margin – that’s the focus of today’s post.

Farm Liability Insurance Coverage

A key aspect of protecting your farming and ranching business from economic loss is to make sure that the assets are protected.  That’s where insurance comes into play.  What happens when you have a property loss or liability event on your farm that you think might be covered by your farm’s liability insurance policy?  What are the steps to take to document a claim, valuing the loss, determining the payout and appealing an adverse coverage determination? 

When you have a property loss or liability incident on your farm, the first step is to document the loss event.  Make written notes, take pictures and keep documents.  Also, notify law enforcement if any laws were broken and notify your insurance company with an explanation of how and when the damage occurred and what property was damaged.  Make sure to complete an accounting of the damaged property.  If you end up disagreeing with the carrier’s loss determination, the accounting will make it easier to challenge the payout amount. 

Also, make sure you know how the carrier will compute the amount to be paid.  Will you get replacement value or actual cash value?  A policy that provides for replacement value will serve you better in times of inflation.  Make sure you know whether there is any limit on the payout amount and whether you have to go through arbitration to challenge the carrier’s coverage determination.  Any complaints you have about the carrier can be submitted to the state’s insurance department.  Always provide all of the evidence you have that supports your position.

A property loss or liability event is never fun, but taking these steps can make the recovery process smoother.

Using a Budget to Increase Farm Profitability

While not strictly a legal or tax issue, another way to increase your farm’s profitability is to create a budget that’s monitored and managed throughout the year with adjustments made when needed.  A farm budget serves numerous purposes.  First, it forces you to put everything down on paper and view your farm as a complete operating business with many moving parts.  It also allows you to see how each part affects the others.  Change one of the parts and you’ll see the impact on other parts and on your overall farming operation. 

Once you create a budget, stick to it.  Put unexpected things into the budget and see how your farm’s profitability is affected.  Also, compare your budget to farming industry standard farming budgets.  Often Land Grant University ag colleges will have those and you can learn a lot by the comparison.  Is your bottom line consistent with other farmers in your area?  If not, look for inconsistencies.  Maybe you’re paying too much for inputs or using more water than others. 

You can also use a budget to set goals and establish averages over time that allow you to see whether you are on-track at mid-year, for example.  A budget can also help with optimizing your tax planning – the timing of purchases, the amount of depreciation to claim, whether to defer income or elect income averaging, for instance.

The most profitable farmers create a budget and manage unexpected issues that have the potential take them off track as they arise. 

Protecting the Farm With (and from) Technology

Farm security involves properly caring for animals, screening and training employees, and making sure property boundaries are in good shape.  But it also means defending against technology such as cameras, drones and virtual reality. 

News stories have documented how some activist groups are using drones to take overhead video of confinement livestock operations.  In one instance, activists gained access to hog barns and hid tiny cameras. During a subsequent nighttime raid, they used high speed digital cameras to record the inside of a barn.  The recordings became part of a virtual reality experience on social media to be used against animal agriculture. 

This type of conduct puts animals and the food chain at risk. These farms have strict biosecurity protocols to protect animals against cross-contamination, pathogens, bacteria and viruses.  In addition, the intrusions can damage existing structures.

So, what can be done for protection?  A careful hiring practice is the first line of defense.  Also, use technology such as cameras to your advantage.  In addition, make sure your plan includes standard techniques - check for doors left ajar, unfastened locks, disturbed equipment, hidden cameras and displaced dirt or gravel.

Do you have a security plan for your farm?  It’s often overlooked, particularly by those operations that don’t have livestock.  But it’s something that should be given consideration.

Common Estate Planning Mistakes

An estate planning mistake can be very costly.  I once was consulted to work on a plan for a farmer who had a net worth of about $25 million.  He didn’t have an estate plan.  He didn’t follow through with any of the guidance provided and died without any plan in place.  That ended up costing his family over $8 million in tax that didn’t need to be incurred with proper planning.  That certainly changed the future for his surviving wife and daughter. 

So, not doing anything to make an estate plan is a mistake.  But what are some other common errors to avoid?

Here are a few:

• Make sure title ownership of property complies with your overall estate planning goals and objectives. This includes the proper use of jointly held property, as well as IRAs and other documents that have beneficiary designations. 
• Know what the language in a deed means for purposes of passage of the property at death.
• It’s also probably not a good idea to leave everything outright to a surviving spouse when the family wealth is potentially subject to federal estate tax.
• “Fair” does not mean “equal.” In situations where there are both “on-farm” and “off-farm” heirs, the control of the family business should pass to the “on-farm” heirs, and the “off-farms” heirs should get an income interest that is roughly balanced in value to that of the “on-farm” heirs’ control interest.  Leaving the farm to all the kids equally is rarely a good idea in that situation.
• Don’t let tax issues drive the process.
• Make sure to preserve records and key documents in a secure place where the people that will need to find them know where they are. 
• Also, review the plan periodically. You don’t want to leave out that 6^th child born 25 years after your first one and 12 years after your fifth one.  Just sayin…

Conclusion

Protecting the bottom line of the farm or ranch involves issues beyond the typical economic analysis.  I’ve discussed just a few.

Last week was the start of my 2025 lecture tour across the country.  I had three events. At one of the events, I did two hours of water law, two hours of real estate issues and two hours of fence law.  It was a great group.  One attendee told me he had me in class 30 years ago.  Not sure how I feel about that.    In addition, I started an intensive course at the law school on farm income tax and farm estate/business planning.  That one runs for 3.5 hours each morning and continues each morning this week.  A good group of students are enrolled.

Year-End Musings…

Overview

As 2024 winds down (as I write this it’s after 6:00 p.m. central time) my thoughts turn to some common themes that never hurt to discuss.  The first thing is some tax planning reminders as we transition into a new year. 2025 is currently set to be the last year of the Trump tax cuts and if they aren’t extended or made permanent, then nearly all taxpayers will see a significant tax increase starting in 2026.  It will be interesting to see what the Congress does.  Also on my mind are options for handling long term care costs, powers of attorney, and the portability of a pre-deceased spouse’s unused exclusion amount.

Year-End Tax Planning

Before you turn the calendar to 2025, take a few moments to think through a few important tax planning matters for your farm or ranch.

What are some tax items to think about before 2024 ends?  Many farmers pre-pay expenses.  To obtain a valid prepaid expense, you must request a certain quantity of a product. If a supplier can’t provide that quantity, it isn’t a valid prepaid expense for the year.  You can’t simply go to the co-op and put down a deposit. 

Also remember that if you received Emergency Relief Program Payments this year, they can’t be deferred to 2025.  The payments are for damage that occurred in prior years so they have already been deferred.

If you sold more livestock than usual in 2024 due to weather-related conditions, consider deferring the income.  There are two possible deferability approaches.  One is a straight-up deferability provision, the other one uses the involuntary conversion rules. 

If you bought equipment late in 2024, consider whether it’s better to use bonus depreciation, expense method depreciation, or both.   The rules are different for each provision, so be careful.   As a general rule, if you financed the purchase, you would probably want to elect out of bonus depreciation so you can match up the yearly depreciation amounts with your loan payments.

And if you reside in Iowa, make sure you don’t expire before 2024 does – dying in Iowa gets cheaper in 2025.

Handling Long-Term Care Costs

Planning for long-term care costs should be an element of a complete estate plan for many farm and ranch families. Indeed, the very first law review article I published over 30 years ago was on this topic.  One way to address long-term care costs involves long-term care insurance.  That makes it important to consider the terms and conditions when exploring long-term care policies. 

What are some things to examine when exploring long-term care insurance?  One is the duration of benefits. Policies cover from one to five years.  Also, what triggers payment under the policy?  There will be terms and conditions attached to those triggers. Make sure you understand them

Long-term care policies also have a waiting period that can be anywhere from a few days to a year.  The longer the waiting period for benefits to payout, the lower the policy premiums. Also, consider the daily benefit amount.  Will the policy pay all of the daily long-term care costs or only a percentage?  Perhaps the policy can be tailored to pay only the portion of costs that income doesn’t

Also make sure the policy has an inflation adjustment provision and that you understand the type of inflation adjuster. 

If a policy can be obtained to cover at least the deficiency that income doesn’t cover, all of the family’s assets will be protected. That means you may not have to gift assets to protect them.

Many insurance agents and financial advisors can provide estimates for policies and help you determine the type of policy that might be best for you. 

Powers of Attorney

When doing estate planning make sure not to overlook power of attorney documents. These documents designate who may act on your behalf in making financial and health care decisions if you aren’t able to.  Powers are very important, especially for farmers and ranchers. 

There are generally two types of powers of attorney – financial and health care.  A financial power may be either a durable or a “springing” power.  A durable power authorizes your agent to act on your behalf as soon as the document is executed – it endures your subsequent incompetency.  A springing power only authorizes your agent to act once you have been declared incompetent. 

Also make sure you give thought to the powers that you want your agent to have.  Maybe limiting the agent’s authority to dealing with non-farm assets would be a good approach.  You could also have multiple agents and give one the power to handle farm assets and another the power to deal with non-farm assets.

Without a financial power, a guardian may have to be appointed.

A health care power designates someone else or perhaps your family members collectively to make medical decisions according to your desires as expressed in the power in the event you aren’t able to.

Both types of powers are a critical part of your estate plan.  They both can help avoid management and transition issues for your farming or ranching operation.  If you are going to create an estate plan or update an existing one in 2025, make sure not to forget to make powers of attorney part of your estate plan.

Portability of the DSUEA

In 2025, a decedent’s estate is exempt from federal estate tax up to $13.99 million.  Very few estates are of that size and leave an unused exemption amount behind.  But, since 2011, upon the death of the first spouse of a married couple any unused amount can be transferred to the surviving spouse by filing a federal estate tax return in the deceased spouse’s estate and electing to transfer the unused amount to the surviving spouse. 

When the first spouse of a married couple dies, if the taxable estate is less than $13.99 million (in 2025), any unused amount of the exclusion that offsets estate tax can, by election, be added to the surviving spouse’s exemption.  That’s important because the exemption from estate tax is presently set to fall to $5 million (adjusted for inflation) beginning in 2026.  So, having that extra exemption amount could save tax.  The election is made by filing Form 706 and following the requirements.

The rule has been that an election to transfer the unused exemption amount to the surviving spouse had to be made within two years of the first spouse’s death.  But a couple of years ago the IRS extended the timeframe for making the election to five years from the date of death of the first spouse.  That’s good news for many, including farmers and ranchers.

Thanks for reading the blog during 2024.  As some have noted, the detailed tax legal writings have switched primarily to my Substack at mceowenaglawandtax.substack.com.  For those of you who subscribe to my Substack, thank you. 

See you in 2025.

Legislation in the Lame-Duck; Drones, Wills, Disease and Fencerows – Sunday Afternoon Thoughts

What Might Happen in the Lame-Duck?

Now that the election is over, what are the prospects for legislation during the “lame-duck” session given that there are (at the present time) only about 15 legislative days remaining?  I categorize the possibilities into three categories – legislation that “must pass” during the session; legislation that “may pass” during the session; and legislation that is “unlikely to pass.” 

• Must Pass
  • Disaster assistance – for hurricanes, wildfires, tornadoes and the rebuilding of infrastructure such as the Baltimore bridge that was damaged earlier this year.
  • Discretionary funding – this makes up about 30 percent of the federal budget and expires at the end of 2024. The deadline is December 20 to pass the legislation to avoid a government shut-down.
  • Extender legislation – this would be legislation to extend certain critical provisions such as the National Defense Authorization Act
  • Farm Bill – I would put the Farm Bill in this category, but my view is that it is still highly unlikely that the lame-duck session would pass a Farm Bill.
• May Pass
  • Water Resources Development Act – this legislation is for civil works projects for ports and harbors, inland waterways as well as flood and storm protection.
  • Artificial intelligence – legislation is needed to set additional boundaries on the usage of artificial intelligence.
  • Provisions concerning China – multiple bills have been introduced designed to deal with various national security threats of China.
• Unlikely to Pass
  • Farm Bill – I expect an extension again.
  • Expediting permitting for oil and gas projects – the election will clearly result in an ramp-up in oil and gas production in the U.S. and a de-emphasis on less efficient, less reliable, heavily taxpayer subsidized forms of energy production/generation.
  • Railway safety legislation
  • Debt limit – at some point, the Congress will increase the limit again.
  • Rescission legislation – this can be passed without the President’s signature and allows the Congress to revisit spending decisions. This could be done to block Ukraine’s use of Army Tactical Missile Systems (long-range U.S. manufactured missiles) on targets inside Russia.  Russia is now at war with the U.S. by virtue of Pres. Biden’s unilateral decision to approve Ukraine’s use of this type of missile system.  The introduction of this legislation would send a clear message to Pres. Biden and Ukraine’s President that the war lacks significant and bi-partisan support in the Congress.

Drones, Privacy and the U.S. Supreme Court

The use of drones in agriculture is increasing.  Some of the uses of drones include scouting crops and monitoring livestock.  But drones can also be used for questionable purposes. 

All states have drone laws outlining the permissible and impermissible use of drones.  The Texas law, like many other state drone laws, has surveillance provisions and no-fly provisions.  The law says that a drone can’t be used to capture an image of an individual or privately owned real property with the intent to conduct surveillance.  Publication of images captured in that manner is prohibited. Newsgathering is not an exempted use.  In addition, the law’s no-fly provision makes it unlawful to fly a drone over certain structures including a confined animal feeding operation.  It’s one of the strictest drone laws in the U.S.

Two media organizations challenged the law as unconstitutional on free speech grounds and the trial court agreed.  But the appellate court reversed.  Nat'l Press Photographers Association v. McCraw, 90 F.4th 770 (5th Cir. Tex. 2024).

In early October of 2024, the U.S. Supreme Court declined to take the case. No. 23-1105, 2024 U.S. LEXIS 4033 (U.S. Sup. Ct. Oct. 7, 2024).   This all means that the Fifth Circuit’s opinion upholding the Texas law is a key decision for agriculture.  This is particularly true because of the vulnerability of farming and ranching operations and agribusinesses that have property in the open to being surveilled by the government, as well as organizations that want to do them harm.  That last point is particularly true with respect to confinement animal operations.  The Fifth Circuit’s upholding of the Texas law’s constitutionality could encourage other states to enact similar legislation.

Challenging a Will Based on a Promise

Sometimes a decedent’s will is challenged by an heir claiming that the decedent was influenced by someone else that caused the decedent to change how their assets would be disposed of.  Or the will might be challenged based on a claim that the decedent wasn’t competent to execute the will.  But can a will be challenged based on the decedent’s promise? 

In a recent case, the plaintiff claimed that she deserved the decedent’s estate because the decedent had promised to give her his farm ground and had named her his agent under his medical and durable powers of attorney. The other persons that received the farm moved to dismiss the claim.  The court noted that an attorney drafted the will, and the decedent signed it with two witnesses present. Both the attorney and witnesses had attested that the decedent was of sound mind and understood the nature and extent of his property when he created and signed the will. There was no contrary testimony.  The court held that the plaintiff failed to establish that the decedent was not in his right mind or that he was subject to undue influence. Mere suspicions and thoughts were not enough to show a genuine issue of material fact regarding the validity of the decedent’s will. The court said that to show an issue of material fact the plaintiff should have presented actual evidence, such as testimony from the decedent’s caretakers.  Simply challenging the will based on an oral promise was not enough.

Liability for Spread of Animal Disease

If you have diseased livestock or diseased premises, what’s your liability for the spread of the disease?  In general, once you know that an animal of yours that is under your control is diseased, you must take reasonable steps to ensure that the animal does not come into contact with healthy, uninfected livestock of anyone else.  Several states require restraint of animals that are known to have an infectious or contagious disease from running at large or coming into contact with other animals. 

Absent a written lease that says differently, a landlord is generally not liable for damages to a tenant if the premises causes the tenant’s healthy animals to become diseased.  That means if a tenant has healthy animals and brings those animals onto the landlord's diseased or contaminated premises and the animals become diseased themselves, it will be difficult for the tenant to recover against the landlord. The tenant takes the premises “as is.”  If the tenant fails to ask whether the leasehold is disease or contamination free, the landlord has no duty to disclose that fact to the tenant.  Actual deceit on the landlord’s part is required.

For a tenant to get legal protection, a landlord would either have to admit liability or specify responsibility in writing for any disease-related damages associated with the leased premises.

Issues When Cleaning Out a Fencerow

The winter months are often the time to clean out fence rows.  But the cleanup process can generate legal issues that you might not have thought about. 

When you’re cleaning out a fence row issues can arise that you hadn’t thought about.  For example, what if there’s a tree in the fence line.  In that situation, each adjacent owner has an ownership interest in the tree.  But, if only the branches or roots extend past the property line and onto an adjoining neighbor’s property, the branches and roots don’t give the neighbor an ownership interest in the tree.  The tree is considered to be jointly owned, and you could be liable for damages if you cut it down and your neighbor objects.  But you can trim branches that hang over onto your property.  That’s an important point, for example, if you are dealing with a thorn tree that can puncture tires.

Always make sure to trim branches, bushes and vines on a property line with care.  Keep the neighbor’s rights in mind when doing the cleanup work.  Also, if a neighbor’s tree falls onto your property, it’s your responsibility to clean up the mess – but you can keep the resulting firewood.  The converse is also true.  It’s also not a trespass to be on your neighbor’s side of the fence when doing fence maintenance, such as cleaning out a fence row.

More Legal and Tax Issues for Farmers and Ranchers

Introduction

I have been on the road with seminars a lot recently and haven’t had time to write much for the blog.  I am off the road now for a few days and thought I’d take a moment to write about a few more legal and tax issues that farmers and ranchers must deal with on occasion.  And, now that the political season is over (for the moment) I will pen my thoughts on that and the implications for agriculture and the producers of food and fiber for my substack – mceowenaglawandtax.substack.com 

For today, however, I dive into water rights and conservation easements, the handling of long-term care costs, the definition of a tax home, negative easements and landlocked parcels.  Those are the topics of today’s post

Water Rights and Conservation Easements

Water is generally plentiful in the Eastern U.S., but not in the West.  So, if you grant a conservation easement on your farm to a land trust that requires water to fulfill its objectives, that can raise some legal issues in the more arid parts of the country. What are the big issues?  For starters, make sure you know what the precise water rights are.  Most title insurance policies and title opinions on real estate won’t tell you anything about water rights associated with the land.

If there are water rights on the donated land, you’ll need to determine if the rights are material to the easement’s conservation purpose.  If so, then determine what’s required to enforce those rights.  You’ll also need to restrict the use of the water rights consistent with the easement’s conservation purpose.  And you should make sure the water rights are maintained and used, and not abandoned.  If they aren’t enforced, you could lose the charitable deduction you claimed for donating the easement.  And it could cause other problems for the land trust. 

Needless to say, grants of permanent conservation easements on land with water rights require careful drafting of deed language.  Make sure you get good legal advice.  The value of the charitable deduction associated with the donation of a conservation easement is almost always claimed to be very large.  

Handling Long-Term Care Costs

Planning for long-term care costs should be an element of a complete estate plan for many farm and ranch families.  One way to address long-term care costs involves long-term care insurance.  That makes it important to consider the terms and conditions when exploring long-term care policies. So, what are some things to examine when exploring long-term care insurance?  One is the duration of benefits. Policies cover from one to five years.  Also, what triggers payment under the policy?  There will be terms and conditions attached to those triggers. Make sure you understand them

Long-term care policies also have a waiting period that can be anywhere from a few days to a year.  The longer the waiting period for benefits to pay out, the lower the policy premiums. Also, consider the daily benefit amount.  Will the policy pay all of the daily long-term care costs or only a percentage?  Perhaps the policy can be tailored to pay only the portion of costs that income doesn’t. In that event, all the family’s assets will be protected, and you may not have to gift assets to protect them.

Also make sure the policy has an inflation adjustment provision and that you understand the type of inflation adjuster. 

Many insurance agents and financial advisors can provide estimates for policies and help you determine the type of policy that might be best for you. 

Where’s Your Tax Home?

The tax Code allows an employee or independent contractor to deduct temporary travel expenses while away from home. The problem is that “home” does not necessarily mean what you might think. 

If you travel on business but are not “away from home” your travel expenses are nondeductible personal expenses.  So, what does “home” mean?  The IRS says that “home” is defined by being in the vicinity of your work. If you choose to live a great distance away for personal reasons, that means that the travel between the personal residence and the place of business is not business related. So, if you don’t relocate soon after you’re hired to work at a place of business that is far from your residence, you can’t deduct travel expenses to and from the new place of business. 

If you are hired for an “indefinite” assignment your tax home likely switches to the new place of business soon after the date you are hired.  If you don’t have a regular place of business and move from area to area for jobs, the IRS says you can’t be “away from home” because you don’t have a tax home, and you can’t deduct travel-related expenses.   

These “tax home” rules sometimes trip up farmers and ranchers that have non-farm jobs.  Make sure you keep the rules straight to know when you can deduct travel-related expenses.

Negative Easements for Light, Air and View

An easement can be either affirmative or negative.  Most easements are affirmative and entitle the holder to do certain things on the land subject to the easement.  But if your land is subject to a negative easement, you can’t do certain things.  Negative easements are the same as restrictive covenants on land.  Examples include riparian rights, lateral and subjacent support rights, and the right to be free from nuisances. However, most courts refuse to recognize a negative easement for light, air and view.  With one exception – malice.

For example, in a case involving two Miami beach hotels, the court allowed a proposed 14-story addition to one hotel that would block the sunlight on an adjoining hotel’s beachfront and cabana.  The law didn’t recognize a negative easement for light, air or view.  Fontainebleau Hotel Corporation v. Forty-Five Twenty-Five, Inc., 114 So. 2d 357 (Fl. Ct. App. 1959).  But a different court shut down a pig farm on a four-acre parcel in town next to a motel.  The pig farm wasn’t operated with any semblance of a real farming operation.  Coty v. Ramsey Associates, 149 Vt. 451, 546 A.2d 196 (1988).   Conditions were so bad that the court didn’t have much trouble determining that it had been created for “spite” and with malice and was a nuisance.  So, while the motel owner didn’t have a negative easement for light, air or view, the pig farm was shut down and was liable for damages because of the owner’s bad conduct.  

Accessing Landlocked Parcels

Sometimes agricultural land is landlocked with no access to a public roadway.  This can happen in several ways, but often arises when a portion of a tract is sold off, resulting in a landlocked parcel.  In that event, how does the new owner get access?  There are generally two possibilities.

The law may imply the existence of an easement from prior use if there has been a conveyance of a physical part of the grantor's land and before the conveyance there was a usage on the land that, had the two parts then been severed, could have been the subject of an easement that was required to use the adjacent parcel.

The law may also imply an easement based on necessity if the facts involve a conveyance of a physical part of the grantor's land, and after severance of the tract into two parcels, it is “necessary” to pass over one of them to reach a public road from the other.  No pre-existing use needs to be present.  Instead, the severance creates a land-locked parcel unless its owner is given implied access over the other parcel.

Ag land transactions should have any access easements specifically agreed upon in writing and recorded on the land records.  This can help avoid future disputes.

Accumulated Earnings; Starting in Farming; Ag Data and Selling the Farm and Residence

Overview

The legal and tax issues that farmers and ranchers can potentially face are practically innumerable.  Today I have pulled four more out of the hat to briefly discuss.  The first one is one that can occur if you have a C corporation and retain too much of the corporate earnings in the corporation.  The next one discusses the possibility of using the funds in a 401(k) as start-up capital for a farming business.  Will it work?  What might be a trigger for the IRS to examine?  Then I turn my attention to Ag Data.  With any technology there are pros and cons.  What might some of those be for Ag Data?  Finally, I briefly discuss how to best utilize the home-sale gain exclusion rule when selling a farm.

More food for thought on the topic of ag law and taxes – it’s the topic of today’s post.

Accumulated Earnings Tax

The accumulated earnings tax is a tax you may not have heard about.  But, if your farming business is in a C corporation or an S corporation that used to be a C corporation, it’s a tax you should be aware of. 

The accumulated earnings tax is a 20 percent penalty that is imposed when a corporation retains earnings over $250,000 that are beyond the reasonable needs of the business instead of paying dividends.  Not paying dividends avoids the shareholder-level tax on dividends. 

Whether a purpose exists to avoid the shareholder-level tax is a subjective determination based on the facts and circumstances.  Don’t unreasonably accumulate corporate earnings while not paying dividends.  Also, don’t use corporate earnings for investments unrelated to the farming business.  Corporate loans to a shareholder for personal purposes are a “no-no” as is the use of corporate funds for a shareholder’s personal benefit.

Make sure you document why you are retaining earnings.  Such reasons as needing cash to buy more farmland or insuring against business risks or buying out a senior member of the family business are fine.

But, again, make sure you record your reasons for the accumulations in your corporate annual meeting minutes and other corporate documents.  And remember, if the accumulated earnings tax applies, it’s in addition to what the corporate tax liability is.  It’s a pure penalty.

Using a 401(k) for Start-Up Capital

One of the drawbacks to starting in farming on a full-time basis is the lack of capital.  But you just might have a substantial asset that you could tap to create the necessary working capital. 

If you have a 401(k), you might be able to use the funds to start a farming business.  To do this, you will need to create a C corporation to establish a 401(k) plan and then roll over your current 401(k) at the old employer into the new 401 (k) plan.  The new plan will then buy shares in the corporation and become an owner.  The money put into the corporation will then become the working capital that the corporation can use to buy equipment and plant crops and so forth. 

There is no limit on how much stock the 401(k) can buy.  This means that unlike borrowing money from a 401(k) which is limited to $50,000 or cashing in the plan and paying taxes and a 10 percent penalty on the funds received, you can maximize the amount of capital you put into the farm business.

The IRS has noted some abuses with these transactions.  Some people have set up a corporation simply to buy a motor home for example.  If you do that and get audited, you can expect the IRS to disallow the purchase for tax purposes.  But if you use the cash to create a farming entity and will be actively farming, there should be no issue with using your 401(k) to fund it. Actively farming – that’s the key.

Ag Data and Proof of Damages

Farmers have several reasons to collect ag data about their farming practices.  One of those might be to prove damage to crops in court.  In one recent case, the management of a lake dam increased the lake level and made farm field tile in the area ineffective to drain significant rainfalls.  The result was that water ponded in the fields and significantly reduced crop yields.  But could the farmer prove his damages in terms of lost yield and revenue?

With harvesting data, the court was able to see exactly where the flooded areas of the fields were and how flooding specifically affected yields.  The data showed that flooding, and not soil type, was the reason for the lower yields in the flooded parts of the fields.  Drone photos were also used to confirm the yield data.  The court could see how the pictures of the fields matched the harvest data.  Comparison data from nearby fields that did not drain into the lake watershed was also used to show what the yield would have been without the elevated lake level. 

The court awarded the farmer almost $500,000 in damages for crop loss and field tile.  Ag data helped make the case and will be an important part of many ag tort cases in the future.  

The case is Houin v. Indiana Department of Natural Resources, 205 N.E.3d 196 (Marshall Co. Cir. Ct. 2021), aff'd. in part and rev'd in part, Indiana Department of Natural Resources v. Houin, 191 N.E.3d 241 (Ind. Ct. App. 2022).

Utilizing the Home Sale Exclusion When Selling the Farm

When selling the farm, how much land can be carved out and sold with the farm home to qualify for a special tax break? 

For married taxpayers that file jointly up to $500,000 of gain that is attributable to the sale of the taxpayer’s principal residence can be excluded from income. It’s one-half of that amount for a taxpayer that files as a single person.  But what if the farm sale also involves the residence?  How much (if any) of the farmland and outbuildings can be included with the residence to fill up that $500,000 amount?

Under current tax regulations, farmland can be treated as part of the principal residence if it is adjacent to land containing the home and is used as part of or along with the home. What is the practical application of those requirements?  The IRS rulings and court decisions indicate that the barnyard and areas used in connection with the home can be included as the “residence” portion of the sale.  Also, local zoning rules can come into play.  For many farm sales, an acre or two can likely be included with the home. 

Of course, each situation is dependent on the facts and the outcome depends on the particular situation.  But, if the facts support it, including at least some adjacent land with the principal residence can be a significant tax-saving technique.  It’s best to fill up that $500,000 amount if your facts allow you to do it.

Conclusion

It’s harvest season, so for those of you in harvest be careful and use common sense.  I have been on the road quite a bit recently – from North Dakota to Iowa to western Nebraska.  This week my travels take me to Idaho for an all-day tax seminar followed by a day of Steelhead fishing on the Salmon River.  Hopefully, I’ll get some good pictures to share with you.  Then it’s on to west Texas for two-days of tax lecturing.  Then a couple of events in Kansas before the fall KSU Tax Institutes begin.  I have also mixed in a couple of events for high school students – trying to plant seeds in the minds of young people of the need for well-trained rural attorneys.  I enjoy their questions and their enthusiasm and energy.  A tip of my hat to their teachers – I couldn’t do it.

Contracts, Estate Planning and Wetlands

Overview

Digital contracts are becoming more common for farmers and ranchers.  That means there are some unique legal issues that might arise.  The first part of today’s article takes a brief look at what those might be. 

An estate planning tool in light of the uncertainty of whether the Trump tax cuts (Tax Cuts and Jobs Act (TCJA)) is a spousal lifetime access trust (SLAT).  I provide a very brief explanation of what a SLAT is. 

A new court decision from a federal court in Idaho provides insight as to how the Sackett test concerning the definition of a wetland under the Clean Water Act is to be applied.  The case involved an Idaho farming operation.  I survey the court’s decision.

Digital contracts, SLATs and wetlands – the topics of today’s blog

Digital Contract Basics

There are certain core elements to every contract – offer, acceptance and consideration. And, in general, there must be a meeting of the minds as to the essence of the contract.  A question is how those elements are satisfied in the context of digital contracts. For starters, any offer should include definite terms.  Vague terms will be interpreted according to the parties’ past course of dealing, if any, or be construed against the drafter, or be filled in based on law and precedent.  Make sure you know what you are signing, whether paper or digital

In addition, an acceptance must mirror the offer.  Any change in the terms means “no deal” until the original offeror accepts the new terms.  So, be careful with a digital contract where you “click to accept” the contract’s terms.  Make sure you know what you’re accepting.

Another requirement is consideration – an amount of payment.  But with a digital contract what about a free trial use period?  For example, could you sue a free online service provider when the product doesn’t work as promised?  Doubtful because of no consideration.

And make sure to read a digital contract – it’s easy for the offer, acceptance and consideration to get buried in the fine print.  A “meeting of the minds” is essential.   

Spousal Lifetime Access Trusts

Future tax policy is uncertain right now and a big concern for some farmers and ranchers is what the federal estate tax exemption will be after 2025.  If the exemption level drops, one strategy that might be effective to lessen a future estate tax burden is a spousal lifetime access trust, or SLAT. 

A SLAT is an irrevocable trust designed to provide income to a beneficiary spouse while removing the trust’s assets from the grantor spouse’s taxable estate. As an irrevocable trust, it can’t be modified or revoked, and the assets can’t be returned to the donor spouse.  The trustee must ensure that the trust assets are used according to the trust’s terms, and that the beneficiary spouse gets the income from the trust for life. 

When the beneficiary spouse dies, the remaining trust assets pass to designated beneficiaries free of estate tax.

The technique could work well now while the estate tax exemption is high - allowing a significant amount of asset value to be transferred to the trust and offset by the exclusion.  The value would also not be included in the beneficiary spouse’s estate. 

If a SLAT can be funded with assets that will appreciate, the tax benefits can be maximized.  One downside, however, is that the ultimate beneficiaries won’t get a step-up in basis at the time of the beneficiary spouse’s death.

Waters of the United States

The U.S. Supreme’s Court’s decision in the Sackett case in May of 2023 changed the way a “wetland” is defined for purposes of the federal government’s jurisdiction under the Clean Water Act (CWA).  The most recent lower court decision involving the new definition as applied to a farmer involves a case out of Idaho.

In United States v. Ace Black Ranches, LLP, No. 1:24-cv-00113- DCN, 2024 U.S. Dist. LEXIS 156797 (D. Idaho Aug. 29, 2024), the Environmental Protection Agency (EPA) claimed that the defendant discharged “pollutants” into a navigable water of the United States (a river that passes through the defendant’s ranch) and associated wetlands without a Clean Water Act discharge permit. The EPA and the U.S. Army Corps of Engineers (COE) notified the defendant that it was going to start investigating potential CWA violations. The defendant withdrew its initial consent to the investigation and filed a complaint and motion for preliminary injunction. The case was dismissed. The EPA then obtained an administrative warrant and inspected the ranch in 2021 and 2023. The EPA then sued, claiming that the ranch had violated the CWA by illegally discharging pollutants by constructing multiple road crossings in the Bruneau River (a navigable water) and associated wetlands which impeded the flow of water and polluted the river. The EPA also claimed that the defendant “disturbed the riverbed” by mining sand and gravel from the river, and that the defendant’s construction of a center pivot irrigation system cleared and leveled “nearly all of the Ranch’s wetlands.” The EPA sought a permanent injunction that would bar the ranch from further discharges and would require the ranch to restore the impacted parts of the river.

The ranch moved for dismissal for failure to state a claim. The court granted the defendant’s motion and dismissed the case. The court determined that the EPA failed to sufficiently specify in its complaint that the wetlands at issue had a continuous surface connection with the Bruneau River to be considered indistinguishable from it (the requirement needed to satisfy the “adjacency test” established in Sackett v. Environmental Protection Agency, 598 U.S. 651 (2023)). It was not enough for the EPA to assert that it could clear up any confusion during discovery. The court noted that the EPA had to put forth sufficient allegations at the pleading stage to entitle it to discovery. As such, the EPA failed to state a claim upon which relief could be granted. However, the court gave the EPA an opportunity to amend its complaint within 30 days of the court’s order.

‘Til next time…

More Legal and Tax Issues Involving Farmers and Ranchers

Overview

With today’s article I look at more legal and tax issues that farmers and ranchers need to know about.  Being aware of legal and tax issues is a means of overall risk management for the operation. 

More discussion of legal and tax issues – it’s the topic of today’s post.

Getting Sued in Another State – The Personal Jurisdiction Issue

Walters v. Lima Elevator Co., 84 N.E.3d 1218 (Ind. Ct. App. 2017)

If you engage in a business transaction involving your farm or ranch in another state and a lawsuit is filed based on that transaction, does that state’s legal system have jurisdiction over you?  In 1945, the U.S. Supreme Court said that a party (particularly a corporation or a business) could be sued in a state if the party had “minimum contacts” with that state.  International Shoe Company v. State of Washington, 326 U.S. 310 (1945).  Over time, many courts have wrestled with the meaning of “minimum contacts,” but it basically comes down to whether the party is deriving the benefit of doing business with that particular state or is sufficiently using the resources of that state.  That’s oversimplifying the application of the Court’s reasoning, but I think you get the point.

In terms of applying the “minimum contacts” theory to farm businesses, a recent case provides a good illustration.  In the case, a Michigan farmer ordered seed from an Indiana elevator about 20 miles away.  It was the third time he had done this.  He bought the seed on credit, and when it was ready he went to the elevator to pick it up.  When he didn’t pay for the seed, the elevator sued him in the local court in Indiana.  He sought to dismiss the case on the basis that the Indiana court didn’t have jurisdiction over him. He claimed that he lacked sufficient minimum contacts with Indiana to be sued there.  The court disagreed.  The Michigan farmer had “purposely availed” himself of the privilege of conducting business in Indiana.  Because of that, the court reasoned, he could have reasonably anticipated being subject to the Indiana judicial system if he didn’t pay his bill.  His due process rights were also not violated – his farm was less than 20 miles away from the Indiana elevator.

If you intentionally conduct business in a state and are sued as a result of your contacts and actions with that state, that state’s courts will likely have personal jurisdiction over you.

Social Security Planning for Farmers

Introduction

Part of retirement planning for a farmer includes Social Security benefits.  Relatedly, if you are nearing retirement age you might be asking yourself when you should start drawing Social Security benefits. The answer is, “it depends.”  But there are a few principles to keep in mind.

The first point to keep in mind is that maximum Social Security benefits can be received if you don’t withdraw benefits until you reach full retirement age – that’s presently between ages 66 and 67.  Additional benefits can be achieved for each year of postponement until you reach age 70.  Another point is that some Social Security benefits are reduced once certain income thresholds are reached.  For 2024, if you haven’t reached full retirement age and earn more than $22,320, benefits get reduced $1 for every $2 above the limit.  During the year in which you reach full retirement age, the earnings limit is $59,520 with a $1 dollar reduction for every $3 dollars over the limit. Once you hit full retirement age, the limit on earning drops off. 

In-kind wages count toward the earnings limitation test, but employer-provided health insurance benefits don’t.  Also, federal farm program payments are not earnings for years other than the first year you apply for Social Security benefits. 

So, when should you start drawing benefits?  It depends on your particular situation and your retirement plan.  The Social Security Administration has some useful online calculators that can help.  Check out ssa.gov.

Common Estate Planning Mistakes of Farmers

What are some common mistakes that farmers and ranchers make when it comes to estate planning? 

Consider the following:

• Not ensuring title ownership of property complies with your overall estate planning goals and objectives. This includes the proper use of jointly held property, as well as IRAs and other documents that have beneficiary designations. 
• Not knowing what the language in a deed means for purposes of passage of the property at death.
• Leaving everything outright to a surviving spouse when the family wealth is potentially subject to federal estate tax.
• Thinking that “fair” means “equal.” If you have both “on-farm” and “off-farm” heirs, the control of the family business should pass to the “on-farm” heirs, and the “off-farms” heirs should get an income interest that is roughly balanced in value to that of the “on-farm” heirs’ control interest.  Leaving the farm to all the kids equally is rarely a good idea in that situation.
• Letting tax issues drive the process.
• Not preserving records and key documents in a secure place where the people that will need to find them know where they are. 
• And not routinely reviewing your plan. Life events may have changed your goals or objectives.

I could list more, but these are some big ones.  Try to avoid these mistakes with your estate plan.

When is a Partnership Formed?

Farmers and ranchers often do business informally.  That informality can raise a question of whether the business arrangement has created a partnership.  If that is determined to be the case, numerous legal issues might be created. 

A big potential issue is that of unlimited liability.  Partners are jointly and severally liable for the debts of the partnership that arise out of partnership business.  Also, a partnership files its taxes differently than do individuals, and assets that are deemed to be partnership assets could pass differently upon the death of someone deemed to be a partner.

So how do you know if your informal arrangement is a partnership?  From a tax standpoint, if you’re splitting net income from the activity rather than gross, IRS could claim the activity is a partnership.  While simply jointly owning assets is not enough, by itself, to constitute a partnership, if you refer to you and your co-worker as “partners” or create a partnership bank account or fill out FSA documents as a “partnership,” a court could conclude the activity is a partnership.  Most crop-share or livestock share leases are not partnerships, but you must be careful.  It’s best to execute a written lease and clearly state that no partnership is intended if you don’t want questions to come up.

The IRS missed asserting that an informal partnership arrangement had been created by a mother and her daughter in a Tax Court case last year involving an Oklahoma ranch, and also lost on a hobby loss argument.  Carson v. Comr., 2024 U.S. Tax Ct. LEXIS 1624 (U.S. Tax Ct. May 18, 2023).  Don't count on IRS missing the same arguments in your situation.

Conclusion

There will be more issues to discuss next time.

More Legal Scenarios Involving Farmers and Ranchers

Overview

As I have noted many times before.  There are many ways in which the law intersects with the daily lives of farmers and ranchers.  Today’s article addresses several of those areas.  Just a little thinking out loud on a random basis.

Self-defense; Good Samaritan laws; preparing for the exit; and cleaning out fencerows – some random topics addressed in today’s post.

Self-Defense

A common question in agricultural settings is how far you can go in defending your personal property from those that would cause damage or steal.  

Agricultural property is often exposed to those who might want to steal, damage or destroy. Where’s the line drawn in far you can go to protect it?  In general, to protect property from vandalism and theft, you have a right to use force that is reasonably necessary under the circumstances.  But you can’t use force beyond what could reasonably be believed necessary under the circumstances, and you can’t use such force as is likely to lead to great bodily injury or death. 

A famous Iowa case from the early 1970s points out that you can’t use force that could physically harm or kill another person in defending your personal property if your life isn’t likewise threatened.  For instance, be careful using guard dogs to ward off trespassers.  The general rule with respect to guard dogs is that you can’t use any more force through an animal than you could personally.  So, if a guard dog injures or kills an intruder, it is the same as if you had done it. Likewise, liability for a dog's dangerous propensities cannot be avoided by posting a sign notifying trespassers of a dog's presence. 

You can take steps to protect your property. Just don’t use any force that is more than what is necessary for the situation.

Relatedly, what can you do within the bounds of the law to defend yourself from an animal such as a dog or a bull or other farm animal that isn’t yours?  In recent years, some states have enacted “stand your ground” provisions that allow you to use whatever force you think is necessary to protect yourself from an equivalent threat, up to and including lethal force.  You don’t have a duty to get away before using force. But you can’t just fire away at will.  Your use of deadly force must be justified – and that you’ll have to prove.  You don’t get a presumption that you could use deadly force. 

In rural settings, the issue often comes up with dogs and livestock that don’t belong to you.  If the animal threatens you with great bodily harm or death, then you can take the animal’s life.  But you’ll have to establish through video or eyewitness testimony that your action was justified.  You’ll likely be charged with animal cruelty or damage to property and then you must establish that you acted properly based on the circumstances.  Remember whether you acted properly is based on whether you had a reasonable fear for your life.  A jury will determine that question if the matter ends up in court. 

So, only take an animal’s life when it’s the last resort, and make sure you have evidence to back up your action. 

Good Samaritan Laws

You’re not legally required to render aid to another person who is in peril.  But does the law provide any protection if you try to help? 

The law used to discourage people from helping others in peril.  One extreme example was the Genovese case in Queens, New York in 1964.  Many people watched from their homes as Kitty Genovese was attacked in the early morning hours on her return to her apartment from work.  No one did anything until it was too late.  They later said that they feared liability for getting involved.  This event helped spur the enactment in all states of “Good Samaritan” laws.

A Good Samaritan law specifies that if you help a person in peril without expectation of compensation, you can only be held liable for injuries resulting from recklessness or willful intent to injure.  These state laws also provide slightly different treatment for emergency medical technicians and hospital staff.

Even though the law doesn’t require you to help someone else in peril, if you do you won’t be liable for any injuries resulting from your attempt to help unless your assistance is reckless, or you intentionally injure the person.  Kitty’s situation was horrible, but it did result in a good change in the governing legal rules. And, in agricultural settings, the rule can also apply in situations where aid is rendered to livestock in peril. 

Preparing for the Exit

When it comes to estate planning, we tend to think of wills and trusts and powers of attorney.  But there are other things you can do before those documents are drafted that will make creating those documents easier and smooth the transition upon death. 

When you work on your estate plan, don’t forget to organize and document other information for those that will need it.  A good idea is to put in a binder a list of your retirement plan information, and copies of health and life insurance policies. Burial plot location and funeral instructions.  Also, provide your email, computer and phone passwords as well as bank account information and data about your debts and bills.  Also, put in that binder copies of your driver’s license, birth certificate, social security card, and marriage license.  Also include documents related to real estate, a list of your assets, land that you own, stored crops, livestock and marketing contracts.  Also include copies of crop insurance policies and USDA program contracts and all your key business relationships. 

Make sure the right person knows where to find the binder and make sure they have access to it. 

Having this information collected will be helpful for any additional steps in the estate planning process. It will also likely allow more efficient use of an attorney’s time in drafting the necessary documents for your estate plan.

Issues when Cleaning Out a Fencerow

Cleaning up fencerows seems to be an ongoing project.  But the cleanup process can generate legal issues that you might not have thought about. 

When you’re cleaning out a fence row legal issues can arise that you might not have thought about.  For example, what should you do if there’s a tree in the fence line?  In that situation, each adjacent owner has an ownership interest in the tree. It’s considered to be jointly owned and you could be liable for damages if you cut it down and your neighbor objects.  But, if only the branches or roots of a tree extend past the property line and onto an adjoining neighbor’s property, the branches and roots don’t give the neighbor an ownership interest in the tree.  In that situation, you can trim the branches that hang over onto your property.  That’s an important point, for example, if you are dealing with a thorn tree that can puncture tires.

Always make sure to trim branches, bushes and vines on a property line with care.  Keep the neighbor’s rights in mind when doing the cleanup work.  Maintaining good communication is aways beneficial when property line work is involved.  Also, if a neighbor’s tree falls onto your property, it’s your responsibility to clean up the mess – but you can keep the resulting firewood.  The converse is also true.  And it’s not a trespass to be on your neighbor’s side of the fence when doing fence maintenance, such as cleaning out a fence row.

Conclusion

There will be more issues to discuss next time.

More Legal and Planning Issues to Ponder

Overview

There’s always something to think about or plan for when it comes to ag law and tax.  Just educating yourself about law and tax in terms of being able to identify the issues that might arise can be very helpful to your farming business if you then find legal and tax counsel to assist you with your plan or take steps to minimize your legal exposure. 

More things legal and tax to ponder – it’s the topic of today’s post.

Sweat Equity – Don’t Count on It

Farming arrangements tend to be informal.  That can include reliance upon “sweat equity” as a transition plan.  The next generation builds up the business by investing money and time with the belief of ownership and control in the future.  All goes well…until it doesn’t.  The next generation may believe that their reward for “sweat equity” that is based on trust and commitment will be eventual ownership and control of the family farming operation.  But, this informality can be a risky approach.  The antidote to this risk is to formalize and document relationships and expectations and write out a solid plan for the future.  Also, maintaining clear and open communication and dealing in actual dollars is also important.  Sweat equity can’t be invested and it can’t be saved. 

If you want the business to continue into the next generation, make sure to structure the business with a solid operating agreement so that the farming heir is protected from losing the business due to issues with siblings.  If siblings are to be bought out, think through how the payments would be made. 

While sweat equity built up by working hard for future rights is commendable, it can lead to serious family fights and disappointment.  The last thing the next generation wants is to have invested substantial time and money in the family farm to end up not ever getting ownership and control. 

It’s money well spent to put a succession plan in place.  What’s your family farm legacy worth?

Farmers and Estimated Tax 

If you’re a farmer, you can make one estimated tax payment each year on January 15. If you don’t do that, you can elect to file and pay 100 percent of your income tax liability by March 1 each year.  This all means that qualification as a “farmer” is critical.  To be a farmer for estimated tax purposes, at least two-thirds of your gross income must be from farming.  Some items of income don’t qualify as farm income such as cash rent.  But gains from selling livestock do, and starting with 2023 returns, gains from selling or trading farm equipment also count as farm income.   

So if you have too much cash rent, you might not be a “farmer” for estimated tax purposes. But, if you qualified in 2023, you’ll automatically qualify in 2024. If you didn’t qualify last year, then make sure you don’t have too much non-farm income so that you’ll qualify this year.

If you don’t meet the definition of a farmer and you don’t make any estimated tax payments, you’ll get hit with a penalty.  Also, as a non-farmer, you’ll have to pay in the lesser of 100 percent of your 2023 tax or 90 percent of 2024 tax. 

If you think that this might apply to you, make sure to review it with your tax advisor to see what your options are.  You might have time this year to restructure lease arrangements or sell livestock or equipment so that you have enough farm income to count as a farmer.

Negligent Entrustment

If you have a farm employee, what’s the extent of your liability exposure, and what steps should you take to minimize those potential legal problems?  In a Texas case last year, a young man was killed while riding an ATV driven by the teenage son of a farming operation’s employee.  The accident occurred off the farm’s premises during a fishing excursion. The farm owner was sued for wrongful death based on negligent entrustment.  Both the trial court and the appellate court determined that there was no negligent entrustment because there wasn’t a special relationship between the ATV driver and the farm.  He wasn’t an employee and the accident occurred while the ATV was being used for personal rather than business purposes.  The courts also pointed out that the farm owner didn’t know or have reason to know that the employee’s son was an unlicensed driver or didn’t know how to handle an ATV. 

As a farm owner, make sure to carefully train employees on usage of farm equipment, machinery and vehicles.  A written guide for usage of these items in an employee handbook might be a good idea.  Address issues such as off-farm use and use by family members.  Also, make sure your liability insurance is adequate by getting a thorough review of what the policy does and does not cover.  Those steps could help minimize your liability exposure.

The case is Mitschke v. Borromeo, No. 07-20-00283-CV, 2023 Tex. App. LEXIS 5117 (Tex. Ct. App. Jul. 12, 2023).

Current Deduction vs. Capitalization

You can claim a tax deduction for amounts spent for repairs on your farm. But an expense that improves property cannot be currently deducted.  So, where’s the line drawn between the two?

The rules as to what is a currently deductible “repair” and what must be capitalized, added to basis and depreciated over time have never provided a bright line. The basic issue is distinguishing between deductible ordinary and necessary expenses paid or incurred during the tax year in carrying on a trade or business, and amounts spent to restore property.  Amounts paid for incidental repairs are currently deductible.  But amounts paid for new property or for permanent improvements or betterments that increase the value of any property, as well as amounts spent to restore property should be capitalized and added to basis.

Expenses for materials and supplies are fully deductible if the items purchased will be used in the farming business over the next 12 months – that includes replacement tractor tires.  There is a safe harbor rule that can be used, but any amount beyond the safe harbor that is paid to improve existing property should be capitalized.  The rules are detailed and tricky.

So, the next time you overhaul that tractor engine or replace disc blades or work on your pivot irrigation equipment, make sure you know the tax rules that apply beforehand so you can get the best tax result for your farming business. 

Conclusion

Just some thoughts today to get you thinking about what can improve the bottom line of your farming operation.

Of Fences; Agritourism; Liquidity; Solar Panels & Blight; and Trees and Motorists

Overview

With today’s post I focus on additional common issues that farmers, ranchers and rural landowners frequently face. 

Fence Disputes

One of the more common questions that I get involves disputes concerning fences.  Fences are often critical in agriculture, so how can a dispute over fencing get resolved within the bounds of the law?   A good place to start is by checking the land records to see if prior owners had recorded a fence agreement.  If they did, the agreement would bind you and your neighbor.  If there is no recorded fence agreement, you could execute a new one and have it recorded with the County Register of Deeds.  Once it’s recorded it will bind all future owners.

If a boundary is in dispute because of conflicting surveys, any boundaries and markers set by the first survey control in a conflict with a subsequent survey.  This is true even if there were errors in the original survey. 

When a boundary dispute involves a disagreement between surveys, consider how the use of the land has been affected by the original survey’s location of the boundary.  If the fence was erected along the old but erroneous survey line, and you and your neighbor have actively farmed to the fence line, the fence should not be moved.  If the fence does not follow either the original survey or the later survey, the true boundary line may need to be designated.

As a last resort, if the issue is building or maintaining a fence, the “fence viewers” can be called to come out and make a view and a determination of responsibility.  Each state has its own procedure for requesting a fence view and resolving fence building and maintenance disputes. Do you know the rules in your state?

Agritourism

Most states have agritourism laws that are designed to provide enhanced liability protection for injuries to participants or spectators associated with the inherent risks of a covered activity.  Agritourism is generally defined broadly to include such things as corn mazes, hayrides, tours, roadside stands and other similar activities.  Posting warning signs might also be required to receive the protection of the statute, as might the registering of the property with the state. 

On the liability issue, a landowner is generally protected except for “wanton or willful” negligence.  Also, having participants sign liability release forms may be required.  State law might also provide tax credits and might protect the property’s ag tax classification.    

Engaging in an agritourism activity on your farm can be a good way to generate additional income, but make sure you know the details of your state’s law.  Also, your comprehensive farm liability policy probably won’t cover any claim arising from an agritourism activity.  That’s because it’s likely to be defined as a non-farm business pursuit of the insured that falls within an exception to coverage. 

Farms and Ranches – The Liquidity Problem

Concerns about the possibility of a reduced federal estate tax exemption are big in agriculture.  If a drop in the exemption would impact the farming or ranching business, is there a plan in place to pay the resulting tax?  It’s a real problem because ag estates are typically illiquid – farmers are often “asset rich, but cash poor.” 

Liquidity refers to how easy it is to convert an asset into cash.  Farmers and ranchers often have assets worth a substantial amount in terms of market value but may lack sufficient cash to meet current needs.  What is at the heart of the liquidity problem?  Farming and ranching often involves a substantial investment in capital assets.  There typically isn’t a pile of liquid funds or assets that can be easily converted into cash.  This can create problems upon death particularly if the goal is to keep the farm or ranch in the family for subsequent generations and there are both on-farm and off-farm heirs.  This is a big problem for some. 

While many estates don’t have an estate tax problem under current law, they could if the exemption drops.  For instance, a current gross estate of about $14 million or twice that for a couple would not incur any federal estate tax, but if the exemption drops to about half of those levels starting in 2026 as will happen if Congress doesn’t act, the tax bill could be substantial.  If there aren’t liquid funds to pay the tax, then the money will have to be borrowed or assets sold.  That’s not a good result, but there are planning steps that can be taken to correct the potential problem.  Yes, estate and business planning will cost, but solid plans for most people can be established for a fairly economical price – especially when you consider that the cost if for the protection and furtherance of your family’s farming/ranching legacy.

Solar Panels and Zoning

Many local zoning rules leave the door wide open to the potential for farmland to be converted into usage for solar panels – with no extra step required to go from agricultural to solar.  Some of this is occurring on prime farmland.  But leasing farmland for the placement of solar panels can destroy the land’s potential to return to farming.  That’s because often fine sand is spread on the farmland where the panels will be placed to kill off plant growth under the panels.  This doesn’t happen in every situation, but where it does, it destroys the possibility of growing anything in that field again without incurring significant remediation costs.  And solar energy agreements may only require remedial work at the end of the contract – which could be 50 years or so into the future.

One study has forecast that 83 percent of solar energy development will be on farm and ranchland unless current government policies are changed.  About half of that amount is projected to be on the nation’s most productive soil. 

Local zoning and planning commissions are at the forefront of the issue.  Rezoning or permitting should be necessary to convert farmland to solar fields – solar power generation is an industrial use.  Traditionally a change in zoning classification involves a public process.  That should be the case in this instance too.

Liability to Motorists

Here’s one I don’t get every day, although there are cases from time-to-time on this, and there was a somewhat related Kansas case a few years ago on the issue of a landowner’s duty (if any) to trim trees and brush near roadways.  The question is whether you are responsible if a tree on your farm falls onto an adjacent road and causes injury? 

The issue came up in a recent Texas case.  There a windstorm uprooted a large oak tree on a farm, and it fell across a road.  A driver hit the tree and sued for her injuries.  She claimed the farmer failed to inspect the farm premises to ensure that objects on the farm were not a hazard to motorists.  The farmer pointed out that there was no evidence that she had received any notice regarding problems with the tree and produced an affidavit from an arborist that the tree was healthy and would have required tremendous wind to blow it down. 

The court ruled for the farmer – there is no duty to parties injured off premises because the landowner is not in possession and control of those areas.  In addition, the court said that a landowner doesn’t owe a duty to make an adjoining road safe or to warn travelers of potential danger.  There can be exceptions in special situations, but none of those applied in the case.  For example, this case involved a farm in a rural area and there was no evidence that the farmer knew or should have known of the danger posed by the tree, and any potential danger wasn’t evident by looking at the tree.

And…motorists have a duty to drive according to the conditions – that includes being able to spot a large oak tree blocking both lanes of a road in time to avoid hitting it.

The case is Bell v. Cain, No. 06-23-00060-CV, 2024 Tex. App. LEXIS 1993 (Tex, Ct. App. Mar. 21, 2024).

Rural Practice Digest - Substack

Overview

I have started a new Substack that contains the “Rural Practice Digest.”  You can access it at mceowenaglawandtax.substack.com.  While I will post other content from time-to-time that is available without a paid subscription, the Digest is for paid subscribers.  The inaugural edition is 22 pages in length and covers a wide array of legal and tax topics of importance to agricultural producers, agribusinesses, rural landowners and those that represent them.

Contents

Volume 1, Edition 1 sets the style for future editions - a lead article and then a series of annotations of court opinions, IRS developments and administrative agency regulatory decisions.  The lead article for Volume 1 concerns losses related to cooperatives.  The USDA is projecting that farm income will be down significantly this year.  That means losses will be incurred by some and some of those will involve losses associated with interests in cooperatives.  The treatment of losses on interests in cooperatives is unique and that’s what I focus on in the article.

The remaining 19-pages of the Digest focus on various other aspect of the law that impacts farmers and ranchers. Here’s an overview of the annotation topics that you will find in Issue 1:

• Chapter 12 Bankruptcy
• Partnership Election – BBA
• Valuation Rules and Options
• S Corporation Losses
• Nuisance
• Fair Credit Reporting Act
• Irrigation Return Flow Exemption and the CWA
• What is a WOTUS?
• EPA Regulation Threatens AI
• Trustee Liability for Taxes
• Farm Bill
• Tax Reimbursement Clauses in IDGTs
• QTIP Marital Trusts and Gift Tax
• FBAR Penalties
• Conservation Easements
• Hobby Losses
• Sustainable Aviation Fuel
• IRS Procedures and Announcements
• Timeliness of Tax Court Petition
• BBA Election
• SCOTUS Opinion on Fees to Develop Property
• Quiet Title Act
• Animal I.D.
• “Ag Gag” Update
• What is a “Misleading” Financing Statement
• Recent State Court Opinions
• Upcoming Seminars

Substack Contents

In addition to the Rural Practice Digest, I plan on adding video content, practitioner forms and other content designed to aid those representing agricultural clients in legal and tax matters, and others simply interested in keeping up on what’s happening in the world of agricultural law and taxation.

Conclusion

Thank you in advance for your subscription.  I trust that you will find the Digest to be an aid to your practice.  Your comments are welcome.  mceowenaglawandtax.substack.com

Musings in Agricultural Law and Taxation – of Conservation Easements; IDGTs and Takings

Overview

The ag law and tax world continues to go without rest.  It’s amazing how frequently the law intersects with agriculture and rural landowners.  It really is “where the action is” in the law.  From the U.S. Supreme Court all the way to local jurisdictions, the current developments just keep on rolling.

More recent developments in ag law and tax – it’s the topic of today’s post.

An Easement is Not Worth More than the Underlying Property

Oconee Landing Property, LLC, et al. v. Comr., T.C. Memo. 2024-25

In the latest round of the continuing saga involving donated conservation easement tax fraud, the Tax Court uncovered another abusive tax shelter.  IRS guidelines make it clear that a conservation easement’s value is the value of the forfeited development rights based on the land’s highest and best use.  To qualify as a highest and best use, a use must satisfy four criteria: (1) the land must be able to accommodate the size and shape of the ideal improvement; (2) a property use must be either currently allowable or most probably allowable under applicable laws and regulations; (3) a property must be able to generate sufficient income to support the use for which it was designed; and (4) the selected use must yield the highest value among the possible uses. 

Note:  A tract’s highest and best use is merely a factor in determining fair market value. It doesn’t override the standard IRS valuation approach – that being the price at which a willing buyer and a willing seller would arrive at.  See, e.g., Treas. Reg. §1.170A-1(c)(2).  See also Boltar LLC v. Comr., 136 T.C. 326 (2011).

In this case, the taxpayer donated 355 acres of undeveloped land to a land trust.  The 355-acre tract was part of a larger tract that was a nationally recognized golf resort with associated developments.  When the larger tract wouldn’t sell, the taxpayer became interested in the possibility of granting a conservation easement on the 355 acres.  Ultimately, the taxpayer valued the 355 acres at about $60,000 per acre and claimed a charitable deduction for the entire amount - $20.67 million.  The IRS disallowed the deduction due to lack of donative intent – the entire scheme involved a pre-determined agreement to secure inflated appraisals so that investors would be able to deduct more than their respective investments. 

Note:  The amount of the deduction that can be claimed is subject to a limitation based on a percentage of the taxpayer’s contribution base.  I.R.C. §170(b)(1)(H).  However, if the donor is a “qualified farmer or rancher” and the donated property is used in agricultural or livestock production, the deduction may be up to 100 percent of the donor’s contribution base.  I.R.C. §170(b)(1)(E)(iv).  For corporate farms and ranches, see I.R.C. §170(b)(2)(B) and for the definition of a “qualified farmer or rancher” see I.R.C. §170(b)(1)(E)(v) and Rutkoske v. Comr., 149 T.C. 133 (2017). 

While the Tax Court determined that the donated easement had value, it agreed with the IRS that the value of the tract was approximately $5 million.  However, the lack of a qualified appraisal as the regulations require be attached to the return wiped out any associated deduction.  Simply setting a target value for the appraiser to hit coupled with the taxpayer’s knowledge that the value was overstated is not a qualified appraisal. 

Note:  Form 8283, Section B, as an appraisal summary must be fully completed and attached to the return for noncash donations greater than $5,000. 

In addition, the Tax Court pointed out that the 355-acre tract had been transferred to a developer (a partnership) who then donated the easement.  That meant that the donation was of ordinary income property which limited any deduction to the basis in the property.  Because there was no evidence offered as to the basis of the property, the deduction was zero.  I.R.C. §170(e)(1)(A).

For good measure, the Tax Court tacked on a gross overstatement penalty of 40 percent.  In determining the penalty, the Tax Court agreed with the IRS position that the highest and best use of the tract was as a “speculative hold for mixed-use development” and the easement was worth less than $5 million.  The Tax Court also tacked on a 20 percent penalty on the portion of the underpayment that wasn’t associated with the erroneous valuation. 

Note:  The rules associated with donated conservation easements are technical and must be precisely complied with.  While large tax savings can be achieved by donating a permanent conservation easement (especially for farmers and ranchers), carefully following all of the rules is critical.  Predetermining a valuation is a big “no-no.” 

IRS Changes Position on Gift Tax Treatment of IDGT Tax Reimbursement Clauses

C.C.A. 202352018 (Nov. 28, 2023) 

An Intentionally Defective Grantor Trust, or IDGT, is a tool used in estate planning to keep assets out of the grantor’s estate at death, while the grantor is responsible for paying income tax on the trust’s earnings.  Those tax payments are not gifts by the grantor to the beneficiaries.  If that tax burden proves to be too much it has been possible to give an independent trustee discretion to distribute funds from the trust to the grantor for making those tax payments.  The IRS said in 2016 that also wouldn’t trigger any gift or income tax consequences for the grantor.  Priv. Ltr. Rul. 201647001 (Aug. 8, 2016).  But now IRS says that a reimbursement clause in an IDGT does trigger gift tax when the trustee distributes trust funds to the grantor.  IRS now deems such a clause to result in a change in the beneficial interests in the trust rather than constituting merely being administrative in nature. 

Note:  While the IRS did not address the issue, it would seem that if state law authorizes the trustee to reimburse the grantor, as long as the trust doesn’t prohibit reimbursement, no gift tax should be triggered.  

“Takings” Cases at the U.S. Supreme Court

Devillier v. Texas, 144 S. Ct. 938 (2024) 

Sheetz v. El Dorado County, 144 S. Ct. 893 (2024) 

Devillier – Is the Fifth Amendment “self-executing”?  The family involved in Devillier has farmed the same land for a century.  There was no problem with flooding until the State renovated a highway and changed the surface water drainage.  In essence, the renovation turned the highway into a dam and when tropical storms occurred, the water no longer drained into the Gulf of Mexico.  Instead, the farm was left flooded for days, destroying crops and killing cattle.  The family sued the State of Texas to get paid for the Taking.

Note:  Constitutional rights don’t usually come with a built-in cause of action that allows for private enforcement in courts – in other words, “self-executing.”  They’re generally invoked defensively under some other source of law or offensively under an independent cause of action. 

The family claimed that the Takings Clause is an exception based on its express language – “nor shall private property be taken for public use, without just compensation.”  The case was removed to federal court and the family won at the trial court.  However, the appellate court dismissed the case on the basis that the Congress hadn’t passed a law saying a private citizen could sue the state for a constitutional taking.  In other words, the federal appellate court determined that the Fifth Amendment’s Takings Clause isn’t “self-executing.” 

The U.S. Supreme Court agreed to hear the case with the question being what the procedural vehicle is that a property owner uses to vindicate their right to compensation against a state.  The U.S. Supreme Court unanimously reversed the lower court, although it did not hold that the Fifth Amendment is “self-executing.”  Texas does provide an inverse condemnation cause of action under state law to recover lost value by a Taking. The Supreme Court noted that Texas had assured the Court that it would not oppose the complaint being amended so that the case could be pursued in federal court based on Texas state law. 

Sheetz - traffic impact mitigation fee and government extortion.  Sheetz claimed that a local ordinance requiring all similarly situated developers pay a traffic impact mitigation fee posed the same threat of government extortion as those struck down in Nollan v. California Coastal Commission, 483 U.S. 825 (1987), Dolan v. City of Tigard, 512 U.S. 374 (1995), and Koontz v. St. Johns River Water Management District, 570 U.S. 595 (2013). Those cases, taken together, hold that if the government requires a landowner to give up property in exchange for a land-use permit, the government must show that the condition is closely related and roughly proportional to the effects of the proposed land use. 

In this case, Sheetz claimed that test meant that the county had to make a case-by-case determination that the $24,000 fee was necessary to offset the impact of congestion attributable to his building project - a manufactured home on a lot that he owns in California.  He paid the fee, but then filed suit to challenge its constitutionality under the Fifth Amendment.   The U.S. Supreme Court unanimously ruled in his favor.  The Court determined that nothing in the Takings Clause indicates that it doesn’t apply to fees imposed by state legislatures. 

Summer Seminars – Branson and Jackson Hole

Registration for both of the national summer seminars that Paul Neiffer and I will be doing is now open.  The Branson (College of the Ozarks) seminar is in-person only, but the Jackson Hole event is offered both in-person and online.  For those attending the Jackson Hole seminar in-person, a room block is established at the Virginian Resort at a reduced rate.

The topics that we will cover are the same at both locations (although the material for Jackson Hole will be updated and current through mid-July).

Here’s a list of the topics we will be covering:

• Federal Tax Update
• Farm Bill Update
• Beneficial Ownership Information (BOI) Reporting
• Depreciation Planning
• Tax Planning Considering the Possible Sunset of TCJA
• How Famers Might Benefit from the Clean Fuel Production Tax Credit
• Conservation Easements
• Federal Estate and Gift Tax Update
• SECURE Act 2.0
• Split Interest Land Transactions
• Manager-Managed LLCs
• Types of Trusts
• Monetized Installment Sales
• Charitable Remainder Trusts or Cash Balance Plans
• Special Use Valuation
• Buy-Sell Agreements (planning in light of the Connelly decision)

Registration

For more information about the Branson event, and registration, click here:   https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html

For more information about the Jackson Hole event, and registration, click here:   https://www.washburnlaw.edu/employers/cle/farmandranchtaxaugust.html

Branson Summer Seminar on Farm Income Tax and Estate/Business Planning

Overview

On June 12-13, I will be conducting a farm income tax and farm estate and business planning seminar at the Keeter Center on the campus of College of the Ozarks near Branson, MO.  This is a live, in-person presentation only.  No online option is available.  My partner in presentation is Paul Neiffer.  Paul and I have done these summer events for a number of years and are teaming up again this summer to provide you with high quality training on the tax issues you deal with for your farm and ranch clients.

Topics

Here’s a list of the topics that Paul and I will be digging into:

• Federal Tax Update
• Farm Bill Update
• Beneficial Ownership Information (BOI) Reporting
• Depreciation Planning
• Tax Planning Considering the Possible Sunset of TCJA
• How Famers Might Benefit from the Clean Fuel Production Tax Credit
• Conservation Easements
• Federal Estate and Gift Tax Update
• SECURE Act 2.0
• Split Interest Land Transactions
• Manager-Managed LLCs
• Types of Trusts
• Monetized Installment Sales
• Charitable Remainder Trusts or Cash Balance Plans
• Special Use Valuation
• Buy-Sell Agreements (planning in light of the Connelly decision)

Registration

The link for registration is below and can be found on my website – www.washburnlaw.edu/waltr and the seminar is sponsored by McEowen, P.L.C.  You may mail a check with your registration or register and pay at the door.  Early registration is eligible for a lower rate.  Certification is pending with the National Association of State Boards of Accountancy (NASBA) to qualify for 16 hours of CPE credit and corresponding CLE credit (for attorneys). 

Here is the specific link for the event:  https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html

Jackson Hole

Paul and I will present the same (but updated) seminar in Jackson Hole, Wyoming, on August 5 and 6.  That event will also be broadcasted live online.

We hope to see you there!

Family Settlement Agreement for Farm Family Not Done Properly

Overview

A family settlement agreement is one possible method of resolving conflicts among family members concerning assets and finances, among other issues.  Done properly, a family settlement agreement can outline duties and responsibilities of family members and minimize or eliminate future family disputes.  It is also a legally binding and enforceable contract.  But, before a family settlement agreement is entered into, the family must carefully consider the purpose and scope of the agreement.  The problems that need to be addressed should lead to provisions drafted into the agreement designed to resolve those problems. 

A recent case from Iowa illustrates how not to go about executing a family settlement agreement – it’s the topic of today’s post.

Facts of the Case

In In re Estate of Schultz, No. 22-1671, 2024 Iowa App. LEXIS 217 (Iowa Ct. App. Mar. 6, 2024),   the decedent and her husband were longtime farmers.  He died in 2001 and the decedent died in 2019.  They divided the farmland between them equally in value and executed mirror-image wills in 1998, that left the surviving spouse a life estate in the deceased spouse’s half of the farm property with the remainder interest passing equally to their four children upon the surviving spouse’s death. 

Note:  At the time the wills were prepared in 1998, the total value of the couple’s farmland was approximately $11 million.  For deaths in 1998, the federal estate tax applicable exclusion was $625,000 with a top rate of 55 percent.  Accordingly, the marital deduction wills with the credit shelter and life estate portions in each will was the proper approach from a federal estate tax minimization standpoint at the time.

The couple’s only son farmed with his father and on his own after his father’s death.  In 2003, the son accompanied his mother to see her attorney.  She changed her will to divide her farmland into specific farms and distributed them among her four children:  four farms totaling 420 acres to the son; three farms totaling 151 acres to the three daughters to share equally; and one farm of 230 acres to be divided equally between all of the children along with her other property.  The 2003 will named the son and one daughter as executors of the estate, but only the son was aware of the 2003 amended will.  In addition, the decedent named the son and a different daughter as agents under a power of attorney.  While the daughter named as agent under the power was not told of the designation, the son told another sister that she no longer needed to help their mother with her finances and bills.  At about the same time, the decedent entered into a 16-year farm lease with the son with rent set at $70 per acre. 

The sisters discovered the existence of the amended will in 2014 and all of the children and their mother met with an attorney to have the 1998 will restored.  The attorney, after meeting with the mother privately, determined that she lacked testamentary capacity to change the 2003 will and suggested a family settlement agreement as an alternative.  The mother and the four children entered into a family settlement agreement that divided all of the mother’s property equally among them upon her death.  The decedent did not sign the agreement and two of the four siblings died before their mother (including the son).  Upon the decedent’s death, a surviving daughter (as executor) sought to probate the decedent’s will.  The attorney for the estate filed the family settlement agreement with the court the same day.  After the 16-year lease expired, the executor also began renting 607 acres of farmland for $100 per acre for three years.  She signed the lease as both tenant and landlord with her husband and son also signing as tenants.   

Trial Court Decision

The probate (trial) court admitted the will and family settlement agreement and the daughter distributed the decedent’s estate according to the terms of the family settlement agreement.  The trial court determined that the Family Settlement Agreement was valid and distributed the decedent’s estate in accordance with that agreement (25 percent to a surviving sister; 25 percent to the sister serving as executor; 12.5 percent each to two children of a predeceased sister; and 8.33 percent to the three children of the pre-deceased brother. The trial court also found that the decedent only changed her will in 2003 because of the son’s improper influence. 

The children of the predeceased brother objected, claiming that the family settlement agreement was invalid, and that the daughter improperly accounted for estate assets and had engaged in self-dealing.  The trial court determined that the executor had not engaged in self-dealing and directed the executor to either “amend” or “clarify” the accounting issue.

Appellate Court Has Different Views

On appeal, the appellate court reversed on the issue of the validity of the family settlement agreement.  The appellate court found that the family settlement agreement was not valid. The parties’ interests had not yet vested because the mother was still living at the time and two of her children predeceased her, and their children were not party to the family settlement agreement – a requirement of state law.  Iowa Code §633.273(1).  The siblings’ expectancy interest passed to their children, but they hadn’t signed the family settlement agreement at the time it was admitted to probate.  The appellate court remanded with directions for the trial court to hold further proceedings on the validity of the decedent’s 2003 will. 

The appellate court also determined that the accounting issue was not properly before the court.  However, the appellate court affirmed the trial court’s finding that the daughter that served as executor had not engaged in self-dealing.  The rental amount was appropriate, and improvements made on the farmland were legitimate.  The appellate court noted that state law requires court approval for self-dealing transactions (Iowa Code §633,155), but that the trial court retroactively approved the rental agreement and paying labor costs for the improvements.  

Conclusion

There were various problems with this entire situation.  The family was essentially trying to treat the family settlement agreement as a testamentary device.  Without the mother’s signature and satisfaction of the formalities for a will, that won’t work.  Also, state law was not followed in all respects to make the agreement valid.  The accounting and self-dealing issues were the result of sloppiness by the executor and, perhaps, the attorney for the estate. 

There’s a right way and a wrong way to do a family settlement agreement.  This case grades over into the wrong way.

2023 in Review – Ag Law and Tax Developments (Part 2)

Overview

Today’s article is the second in a series discussing the top developments in agricultural law and taxation during 2023.  As I work my way through the series, I will end up with the top ten developments from last year.  But I am not there yet.  There still some significant developments to discuss that didn’t make the top ten list.

Significant developments in ag law and tax during 2023, but not quite the top ten – it’s the topic of today’s post.

Scope of the Dealer Trust

In re McClain Feed Yard, Inc., et al., Nos., 23-20084; 23-20885; 23-20886 (Bankr. N.D. Tex. 2023)

The Packers and Stockyards Act of 1921 (PSA) (7 U.S.C. §§ 181 et seq.), applies to transactions in livestock or poultry in interstate commerce involving a covered a packer, dealer, market agency, swine contractor, or live poultry dealer.  The PSA creates statutory trusts and requires bonds of market participants which may provide funds to reduce losses incurred by unpaid cash sellers of livestock or poultry.  A similar provision applies for perishable commodities created by the Perishable Agricultural Commodity Act. 7 U.S.C. § 499e(c).

Historically, there have been numerous attempts to amend the PSA to create a “Dealer Trust” that would establish a statutory trust similar to the Packer Trust created by the PSA at 7 U.S.C. § 196. These efforts succeeded with legislation signed into law on December 27, 2020, that adds new Section 318 to the PSA.  Codified at 7 U.S.C. § 217b.

The Dealer Trust’s purpose is to protect unpaid cash sellers of livestock from the bankruptcy of feeders, brokers and small processors.  The new law puts unpaid cash sellers of livestock ahead of prior perfected security interest holders.  It’s a provision like the trust that exists for unpaid cash sellers of grain to a covered grain buyer.  The first case testing the scope of the Dealer Trust Act is winding its way through the courts.

A case involving the new Dealer Trust Act hit the courts in 2023.  Over 100 livestock producers have $122 million in unpaid claims against three defunct cattle operations, and a lender says one of the feedyards sold about 78,000 cattle and didn’t pay on the loans.  The problems stem from a $175 million Ponzi and check-kiting scheme that the debtors were engaged in.

One issue is what the trust contains for the unpaid livestock sellers.  Is it all assets of the debtors?  It could be – for feedyards and cattle operations, practically all the income is from cattle sales.  So far, USDA has approved for payment only $2.69 million of claims for cash sellers of livestock, claiming that the balance is owed to non-cash sellers not covered by the law. 

The law is new, so it’s not clear yet what is a trust asset for the benefit of the cash livestock sellers, and what assets, if any, are in the debtors’ bankruptcy estates.  We should learn the answer to those questions in 2024. 

Equity Theft

Tyler v. Hennepin County, 598 U.S. 631 (2023)

Equity that a homeowner has in their home/farm is the difference between the value of the home or farm and the remaining mortgage balance.  It’s a primary source of wealth for many owners.  Indeed, the largest asset value for a farm or ranch family is in the equity wrapped up in the land.  In the non-farm sector, primary residences account for 26 percent of the average household’s assets.  Certainly, the government has the constitutional power to tax property and seize property to pay delinquent taxes on that property.  But is it constitutional for the government to retain the proceeds of the sale of forfeited property after the tax debt has been paid?  That was a question presented to the U.S. Supreme Court in 2023.

In this case, Hennepin County. Minnesota followed the statutory forfeiture procedure, and the homeowner didn’t redeem her condominium within the allotted timeframe.  The state ultimately sold the property and bagged the proceeds – including the homeowner’s equity in the property.    

She sued, claiming that the county violated the Constitution’s Takings Clause (federal and state) by failing to remit the equity she had in her home.  She also claimed that the county’s actions amounted to an unconstitutional excessive fine, violated her due process and constituted an unjust enrichment under state law.  The trial court dismissed the case and the Eighth Circuit affirmed finding that she lacked any recognizable property interest in the surplus equity in her home.  On further review, the U.S. Supreme Court unanimously reversed.  The Court held that an unconstitutional taking had occurred. 

All states have similar forfeiture procedures, but only about a dozen allow the state to keep any equity that the owner has built up over time.  Now, those states will have to revise their statutory

forfeiture procedures.

Customer Loyalty Rewards

Hyatt Hotels Corporation & Subsidiaries v. Comr., T.C. Memo. 2023-122

Many companies, including agribusiness retailers, utilize customer loyalty programs as a means of attracting and keeping customers.  Under the typical program, each time a customer or “member” buys a product or service, the customer earns “reward points.”  The reward points accumulate and are computed as a percentage of the customer’s purchases.  When accumulated points reach a designated threshold, they can then be used to buy an item from the retailer or can be used as a discount on a subsequent purchase (e.g., cents per gallon of off a fuel purchase).  Some programs make be structured such that a reward card is given to the customer after purchases have reached the threshold amount.  The reward card typically has no cash value and expires within a year of being issued.  A “loyalty rewards” program is a cost to the retailer and a benefit to the customer, triggering tax issues for both. 

In Hyatt, the petitioner established a “Gold Passport” rewards program in 1987 that provided its customers with reward points redeemable for free future stays at its hotels (the petitioner own about 25 percent of its branded hotels with the balance owned by third parties who license the petitioner’s IP and/or management services).   Under the program, the petitioner required hotel owners to make payments into an operating fund (Fund) when a customer earned “points.”  The petitioner was the custodian of the Fund and compensated a hotel owner out of the Fund when a guest redeemed reward points for free stays.  The petitioner determined the rate of compensation. The petitioner invested portions of the Fund's unused balance in marketable securities which generated gains and interest.  In 2011, the petitioner changed the compensation formula to increase the amount it could hold for investment.  The petitioner also used the Fund to pay administrative and advertising expenses that it determined were related to the rewards program. 

The points could not be redeemed for cash and were not transferrable.  In addition, any particular member hotel could not get the payments to the Fund back except by providing free stays to members.  The Fund allocated from 46-61 percent to reward point redemptions.  Fund statements described the funds as belonging to the hotel owners that paid into the Fund.  The petitioner’s Form 10-K filed with the SEC treated the Fund as a “variable interest entity” eligible for consolidated reporting.  When the petitioner provided management services to member hotels, payments into the Fund were reported as “expenses.” 

The petitioner did not report the Fund’s revenue into gross income with respect to the hotels it did not own and did not claim any deductions for expenses paid on the basis that petitioner was a mere trustee, agent or conduit for hotel owners rather than a true owner of the Fund.  But, the petitioner did claim deductions for its share of program expenses associated with the 25 percent of hotels that it owned.  The petitioner reported Fund assets and liabilities on a consolidated basis on Schedule L.  The petitioner’s Form 1120 did not state that it was using the trading stamp method or include any statement concerning Treas. Reg. §1.451-4.  The petitioner’s position was that third-party owners should make their own decision about tax treatment of the money they paid to the Fund.  

The IRS audited and took the position that the petitioner was using an improper accounting method which triggered an I.R.C. §481 adjustment requiring the including in the petitioner’s income the cumulative amounts from 1987 (Fund revenue less expenditures).  The IRS asserted an adjustment of $222.5 million and additional adjustments in 2010 and 2011.  The petitioner disagreed and filed a Tax Court petition. 

The Tax Court determined that the amounts the petitioner received related to the customer reward program (i.e., Fund revenue) were revenue includible in gross income because of the petitioner’s significant control over the Fund.  That control indicated that the petitioner had retained a beneficial interest in the Fund, and the exception under the “trust fund” doctrine established in Seven-Up Co. v. Comr., 14 T.C. 965 (1950), acq., 1950-2 C.B. 4, did not apply. 

Hyatt lays down a good “marker” for tax advisers with clients that offer loyalty reward programs to customers. Retail businesses that offer such programs will want to ensure that their program is structured in a manner that can fit within the trust fund doctrine’s exception for excluding program funds from gross income.

Basis of Assets Contained in an Intentionally Defective Grantor Trust (IDGT)

Rev. Rul. 2023-2, 2023-16 I.R.B. 658

An IDGT is an irrevocable trust that is designed to avoid any retained interests or powers in the grantor that would result in the inclusion of the trust’s assets in the grantor’s gross estate upon the grantor’s death. Normally, an irrevocable trust is a tax entity distinct from the grantor and has its own income and deductions (net of distributions paid to beneficiaries) reported on its own income tax return. But there is language included in an IDGT that causes the income to be taxed to the grantor.  So, a separate return need not be prepared for the trust, but you still get the trust assets excluded from the grantor’s estate at death.  It also allows the grantor to move more asset value to the beneficiaries because the grantor is paying the tax.

Note:  The term “intentionally defective grantor trust” refers to the language in the trust that cause the trust to be defective for income tax purposes (the trust grantor is treated as the owner of the trust for income tax purposes) but still be effective for estate tax purposes (the trust assets are not included in the grantor’s gross estate). 

This structure allows the IDGT’s income and appreciation to accumulate inside the trust free of gift tax and free of generation-skipping transfer tax, and the trust property is not in the decedent’s estate at death.  This will be an even bigger deal is the federal estate tax exemption is reduced in the future from its present level of $13.61 million.  Another benefit of an IDGT is that it allows the value of assets in the trust to be “frozen.” 

A question has been whether the assets in an IDGT receive a stepped-up basis (to fair market value) when the IDGT grantor dies.  Over the years, the IRS has flip-flopped on the issue but in 2023 the IRS issued a Revenue Ruling taking the formal position that the trust assets do not get a stepped-up basis at death under I.R.C. §1014 because the trust assets, upon the grantor’s death, were not acquired or passed from a decedent as defined in I.R.C. §1014(b).  So, the basis of the trust assets in the hands of the beneficiaries will be the same as the basis in the hands of the grantor. 

Not getting a stepped-up basis at death for the assets in an IDGT is an important consideration for those with large estates looking for a mechanism to keep assets in the family over multiple generations at least tax cost.  An irrevocable trust may still be appropriate for various reasons such as asset protection and overall estate tax planning.  But, the IRS ruling does point out that it’s important to understand all of the potential consequences of various estate planning options.

2023 in Review – Ag Law and Tax

Overview

As 2024 begins, it’s good to look back at the most important developments in agricultural law and tax from 2023.  Looking at things in retrospect provides a reminder of the issues that were in the courts last year as well as the positions that the IRS was taking that could impact your farming/ranching operation.  Over the next couple of weeks, I’ll be working my way through the biggest developments of last year, eventually ending up with what I view as the Top Ten developments in ag law and tax last year.

The start of the review of the most important ag law and tax developments of 2023 – it’s the topic of today’s post.

Labor Disputes in Agriculture

Glacier Northwest, Inc. v. International Brotherhood of Teamsters Local Union No. 174, 143 S. Ct. 1404 (2023)

In 2023, the U.S. Supreme Court ruled that an employer can sidestep federal administrative agency procedures of the National Labor Relations Board and go straight to court when striking workers damage the company’s property rather than merely cause economic harm.  The case involved a concrete company that filed a lawsuit for damages against the labor union representing its drivers.  The workers filled mixer trucks with concrete ready to pour knowing they were going to walk away.  The company sued for damage to their property – something that’s not protected under federal labor law.  The Union claimed that the matter had to go through federal administrative channels first. 

The Court said the case was more like an ordinary tort lawsuit than a federal labor dispute, so the company could go straight to court.  Walking away was inconsistent with accepting a perishable commodity. 

There’s an important ag angle to the Court’s decision.  Where there are labor disputes in agriculture, they are often timed to damage perishable food products such as fruit and vegetables.  Based on the Court’s 8-1 opinion, merely timing a work stoppage during harvest might not be enough to be deemed economic damage, unless the Union has a contract.  But striking after a sorting line has begun would seem to be enough.

Swampbuster

Foster v. United States Department of Agriculture, 68 F. 4th 372 (8th Cir. 2023)

Another 2023 development involved the application of the Swampbuster rules on a South Dakota farm.  In 1936, the farmer’s father planted a tree belt to prevent erosion. The tree belt grew over the years and collects deep snow drifts in the winter. As the weather warms, the melting snow collects in a low spot in the middle of a field before soaking into the ground or evaporating.  In 2011, the USDA called the puddle a wetland subject to the Swampbuster rules that couldn’t be farmed, and it refused to reconsider its determination even though it had a legal obligation to do so when the farmer presented new evidence countering the USDA’s position.

The farmer challenged the determination in court as well as the USDA’s unwillingness to reconsider but lost.  This seems incorrect and what’s involved is statutory language on appeal rights under the Swampbuster program. The Constitution limits what the government can regulate, including water that doesn’t drain anywhere.  In addition, the U.S. Supreme Court has said the government cannot force people to waive a constitutional right as a condition of getting federal benefits such as federal farm program payments. 

We’ll have to wait and see whether the Supreme Court will hear the case.

Railbanking

Behrens v. United States, 59 F. 4th 1339 (Fed. Cir. 2023)

Abandoned rail lines that are converted to recreational trails have been controversial.  There are issues with trespassers accessing adjacent farmland and fence maintenance and trash cleanup.  But perhaps a bigger issue involves property rights when a line is abandoned. A federal court opinion in 2023 provided some guidance on that issue. 

In 2023, a federal court clarified that a Fifth Amendment taking occurs in Rail-to-Trail cases when the trail is considered outside the scope of the original railway easement. That determination requires an interpretation of the deed to the railroad and state law.  Under the Missouri statute involved in the case the court said the railroad grant only allowed the railroad to construct, maintain and accommodate the line.  Once the easement was no longer used for railroad purposes, the easement ceased to exist.  Trail use was not a railroad purpose. The removal of rail ties and tracks showed there would be no realistic railroad use of the easement and trail use was unrelated to the operation of a railway.

The government’s claim that the trail would be used to save the easement and that the railway might function in the future was rejected, and the court ruled that the grant was not designed to last longer than current or planned railroad operation.  As a result, a taking had occurred. 

CAFO Rules

Dakota Rural Action, et al. v. United States Department of Agriculture, No. 18-2852 (CKK), 2023 U.S. Dist. LEXIS 58678 (D. D.C. Apr. 4, 2023)

In 2023, USDA’s 2016 rule exempting medium-sized CAFOs from environmental review for FSA loans was invalidated.  A medium-sized CAFO can house up to 700 dairy cows, 2,500 55-pound hogs or up to 125,000 chickens.  The rule was challenged as being implemented improperly without considering the impact on the environment in general.  The USDA claimed that it didn’t need to make any analysis because its proposed action would not individually or cumulatively have a significant effect on the human environment.  So, the agency categorically exempted medium-sized CAFOs from environmental review.  

But the court disagreed with the USDA and vacated the rule.  The FSA conceded that it made no finding as to environmental impact.  The court determined that to be fatal, along with providing no public notice that it was going to categorically exempt all loan actions to medium-sized CAFOs. 

Don’t expect this issue to be over.  In 2024, it’s likely that the agency will try again to exempt medium-sized CAFOs from environmental review for FSA loan purposes.

Charitable Remainder Annuity Trust Abuse

Gerhardt v. Comr., 160 T.C. No. 9 (2023)

In 2023, the U.S. Tax Court decided another case involving fraud with respect to a charitable remainder annuity trust.  It can be a useful tax planning tool, particularly for the last harvest of a farmer that is retiring.  But a group centered in Missouri caught the attention of the criminal side of IRS. 

The fact of the case showed that farmers contributed farmland, harvested crops, a hog-finishing barn and hog equipment to Charitable Remainder Annuity Trusts.  The basic idea of a CRAT is that once property is transferred to the trust the donor claims a charitable deduction for the amount contributed with the income from the CRAT’s annuity spread over several years at anticipated lower tax brackets.  But contributing raised grain to a CRAT means you can’t claim a charitable deduction because you don’t have any income tax basis in the grain.  In addition, there are ordering rules that govern the annuity stream coming back to the donor.  Ordinary income is taxed first – which resulted from the contribution of the crops and depreciation recapture on the hog-finishing barn and equipment.  

The farmers involved got into the CRATs by reading an ad in a farm magazine.  The Department of Justice prosecuted the promoters that dished out the bad advice. 

Get good tax advice if you consider using a CRAT.  They can be a good tax planning tool but can create a mess if the rules aren’t followed.

Conclusion

This is the first pass at some of the biggest developments in ag law and tax during 2023.  In my next post, I’ll continue the journey.

Probate Fees - How Much are They?

Overview

One of the reasons that people give for transferring property to a revocable trust during life is to avoid probate at death.  That can be accomplished if all of the decedent’s property has been transferred to the trust before death.  To make sure that occurs, the trust is often accompanied with a pour-over will.  The property that hasn’t been retitled into the name of the trustee of the trust is “poured over” into the trust at death. 

But just how much are probate fees?  How are they determined?  That’s the topic of today’s post.

Establishing Probate Fees

The avoidance of probate is often tied to the desire to avoid probate fees and maintain privacy.  As for fees, how much can be anticipated?  The answer depends.  The more complex the estate, and/or the more issues that come up post-death, the estate can anticipate incurring more probate fees.  The converse is also true.  In some states, a flat percentage of the gross estate value can be charged as an attorney fee for the estate.  That can range anywhere from about 1.5 percent to 6 percent or even higher. 

Kansas probate fees.  In Kansas, state law specifies that, “every fiduciary shall be allowed his or her necessary expenses incurred in the execution of his or her trust and shall have such compensation for services and those of his or her attorneys as shall be just and reasonable.” Kan. Stat. Ann. §59-1717.  There is no statute in Kansas that allows for a percentage fee for handling a decedent’s estate.  It’s not specifically disallowed if the percentage amount is backed up with itemized time sheets and is ultimately deemed reasonable by the probate court.  In essence, then, probate fees are based on an hourly rate for the amount of hours reasonably spent working on the estate.  In addition, an attorney’s fee for handling a decedent’s estate is also based on the eight factors of the Kansas Rules of Professional Conduct (KRPC).  The probate court considers these eight factors when determining whether a fee is appropriate. 

The eight factors are:

• The time and labor required, the novelty and difficulty of the questions involved, and the skill requisite to perform the legal service properly;
• The likelihood, if apparent to the client, that the acceptance of the particular employment will preclude other employment by the lawyer;
• The fee customarily charged in the locality for similar legal services;
• The amount involved and the results obtained;
• The time limitations imposed by the client or by the circumstances;
• The nature and length of the professional relationship with the client;
• The experience, reputation, and ability of the lawyer or lawyers performing the services; and
• Whether the fee is fixed or contingent. KRPC 1.5(a)

Kansas case.  A recent Kansas county district court decision involved the application of the factors.  In In re Estate of Appleby, No. CQ-2023-CV-000008 (Chautauqua Co. Dist. Ct., Nov. 9, 2023), from 2014 until death in 2021, the decedent had been the subject of a conservatorship.  The person that would become the executor of the decedent’s estate was the conservator.   The attorney that represented the executor for the decedent’s eventual estate, represented the conservator during the conservatorship.  The annual billing statements submitted to the conservator for the legal work in the conservatorship were itemized and detailed. The itemized billing statements listed each date services were performed; a description of the services performed on each date; the amount of time worked on each date; the amount charged for the services performed on each date; the total amount of time worked during the billing period; and the total amount charged for work performed during the billing period.  The conservator reviewed the statements, the court approved them and the conservator paid. 

However, for estate administration work, the attorney did not provide the executor with a written representation agreement and did not communicate the basis or rate of the fee he intended to charge the estate.  The executor believed the attorney would bill his time hourly, just as he had done for the previous seven years in the conservatorship matter.

The decedent died on July 6, 2021, with a gross estate value of $4,570,521.11.  However, the attorney only first informed the executor on May 2, 2022, that a fee of three percent of the estate’s gross value would be charged.  The executor informed the attorney that the fee should be based on an hourly rate.  The attorney replied as follows:

“I feel comfortable asking for a fee based upon 3%. If you want to oppose it, that's fine. Please remember that our… service to her predates your appointment as her conservator.  [We]…did quite a bit of "off the books" work for [the decedent] during her lifetime, … and… it would all even out when we handled the estate. Honestly, that's a common approach taken by attorneys ·when they know they'll be handling an estate at a later date. So, I don't know what I can say. I respect your views and your being upfront with me, but I know what the common practice has been and what we've always done.”

Ultimately, on May 30, 2023, the attorney generated a billing statement. The billing statement included descriptions of the work performed between the date of the decedent’s death and May 2023, but the descriptions were not tied to specific dates and did not include the amount of time spent performing any task on any date.  The May 30 billing statement concludes with the application of a 3% fee to the $4,570,521.11 value of the estate assets for a total fee of $137,115.63.  The local magistrate judge awarded the fee on June 5, 2023, and the executor appealed.

On appeal, the attorney estimated that he spent between 420 and 560 hours on the estate at a rate of $240 per hour.  Only specific tasks, based on the review of the emails, amounted to 174-242 hours.  The court then applied the eight factors of Rule 1.5(a) of the KRPC to the facts of the case.  The court noted that the attorney didn’t keep time records, even though being on notice that the executor wanted to know the amount of time that was being billed.  No time records kept.  There was also no engagement letter that had been entered into with the client.  The work on the estate, the court noted, did not involve difficult issues and a paralegal performed much of the work.  The fact that the attorney had billed on a percentage basis for 40 years was severely mitigated by subsequent caselaw specifying that, “"fees which are not supported by meticulous, contemporaneous time records that show the specific tasks being billed should not be allowed."  See, e.g., In re Estate of Trembley, 220 P.3d 1114 (Kan. Ct. App. 2009).  The court also noted that the attorney had a previous 7-year relationship with executor as conservator and billed hourly for the work on the conservatorship. 

Ultimately, the court approved what it deemed to be a reasonable fee of fee of $58,080 (down from the $137,115.63 requested).  In percentage terms, the approved fee worked out to be slightly less than 1.3 percent of the estate value.  

In reaching its decision, the court noted that approving attorney fees for work on an estate is a fact-based determination.  The fees must be supported by contemporaneous time records.  If they aren’t, an “award of…fees based on a percentage of an estate is not reasonable, regardless of the local custom.” 

Note:  The court also pointed out that the attorney involved “serves on the Kansas Board of Discipline for Attorneys.”

Conclusion

The fear of large and outrageous attorney fees for handling estates in Kansas is largely not justified.  The courts operate as an effective “brake” on attorneys trying to charge unjustified fees – at least that’s been the case in Kansas since 2009.  But, that may not be true in other states.  So, for those wanting to avoid probate fees, a revocable trust (or some other type of trust) might be an appropriate estate planning tool.  But, it’s important to understand just how attorney fees in probate are established.  One wonders how many estates in Kansas have been unjustly overbilled since 2009 by the attorney involved in the case.  All it took was one well-informed executor to get the right result.

The Importance of Proper Asset Titling

Overview

For many farmers and ranchers, the land is the most significant asset that is owned, at least in terms of value.  Land value often predominates in a farmer or rancher’s estate.  How the land is titled is important.  Holding title in the proper form facilitates estate planning in accordance with expressed goals and can ease the tax burden upon death or upon subsequent transfer of the property by the heir or heirs.  Conversely, failing to title property appropriately can undermine estate planning expectations, create family disharmony and result in a higher tax burden.

The distinction between co-tenancy and joint tenancy and why it matters – it’s the topic of today’s post.

Tenancy-In-Common

A tenant in common holds an undivided interest in property that does not terminate upon the tenant predeceasing surviving co-tenants.  Upon the death of a tenant in common, that person’s interest passes under that person’s will (or in accordance with state law if there is no will (or trust)) to heirs of the deceased cotenant.  For federal estate and state inheritance/estate tax purposes, only the portion of the property owned by the deceased tenant in common is included in the decedent’s gross estate at death and receives a fair-market basis at death.

Joint Tenancy

The distinguishing characteristic of joint tenancy is the right of survivorship, with the surviving joint tenant or tenants taking all upon the death of a fellow joint tenant regardless of the terms of the deceased joint tenant’s will.  In other words, when a joint tenant dies, the deceased joint tenant’s share in the property passes to the surviving joint tenant (or surviving joint tenants).  It does not pass to the heir of the deceased joint tenant (tenants).  Upon the death of the last of the joint tenants to die, the joint tenancy is extinguished.    

In addition, upon a conveyance of real property, transfer to two or more persons generally creates a tenancy in common unless it is clear in the deed or other conveyancing document that a joint tenancy is intended.  A joint tenancy is created by specific language in the conveyancing instrument.  That specific language, often referred to as “magic words of conveyance,” clearly denotes the survivorship feature of a joint tenancy.  In addition, unless the conveyancing instrument is clear in its intent to create a joint tenancy, the legal presumption is against joint tenancy and that a tenancy-in-common was created.  For example, assume that O conveys Blackacre to “A and B, husband and wife.”  The result of that language is that A and B own Blackacre as tenants in common.  To own Blackacre as joint tenants O needed to convey Blackacre as required by state law to create a joint tenancy.  The language for creating a joint tenancy is typically to “A and B as joint tenants with rights of survivorship” or to “A and B as joint tenants with right of survivorship and not as tenants in common.”

Except for husband-wife joint tenancies, the survivorship feature may generate an unacceptable property disposition pattern upon death.  However, on the death of the first of the joint tenants to die, probate may be simplified or eliminated with title obtained by the surviving joint tenant perfected by showing non-liability for taxes and by proving the death of the decedent by affidavit or death certificate.  This is possible in most (but not all) states.

When it cannot be determined that two (or more) joint tenants have died other than at the same time an interesting problem may arise.  Most states have enacted a simultaneous death statute to handle just such a situation.  Such statutes typically provide that the jointly held property is to be divided into as many equal shares as there were joint tenants and that the share allocable to each joint tenant is to be distributed as if such joint tenant had survived all of the other joint tenants.

A major estate planning limitation of the joint tenancy form of property ownership is that the survivorship right of joint tenancy precludes the use of the life estate-remainder arrangement for the nonmarital portion of the estate to reduce the death tax burden upon the survivor’s death.  The entire property, therefore, will pass to the survivor and may be taxed again in the survivor’s estate.  In addition, another problem with joint tenancy is that each joint tenant has a right to sever the joint tenancy relationship unilaterally (except for tenancies by the entirety).  As a result, a joint tenant furnishing consideration for acquisition of the property in effect grants to the other tenant a revocable interest that could be partitioned and severed at any time.  Consequently, each co-owner has the power to amend or destroy the other’s estate plan.

For marital joint tenancies, upon the death of the first spouse, one-half of the date-of-death value of the jointly held property is included in the first-spouse’s estate.  However, the full value of the jointly held property is included in the first spouse’s estate (and receives a date-of-death income tax basis in the hands of the surviving spouse) if the marital joint tenancy was established before 1977 and the spouse that bought the property died after 1981 (Gallenstein v. United States, 975 F.2d 286 (6th Cir. 1992)). 

Joint tenancy is not a cure-all for tax planning but, depending upon the circumstances, it may be a convenient means of owning and passing property.  For total estates of each of the husband and wife under $22.8 million (for 2019), there is no federal estate tax liability.  Therefore, joint ownership may serve a useful purpose as a will substitute in the first estate for estates that are not potentially subject to federal estate tax.  However, since it is not known which joint tenant will die first, the estate of the surviving joint tenant will be subject to probate as an intestate estate (where death occurs without a will), unless the survivor prepares a will or otherwise disposes of the property.  For combined spousal estates exceeding $22.8 million (for 2019) in value, joint tenancy ownership may expose a portion of the total estate of the surviving joint tenant to additional taxes, causing an otherwise unnecessary reduction of the estate assets passing to the heirs or other beneficiaries.

Recent Case

A recent case from Texas illustrates the difference between tenancy-in-common and joint tenancy.  It also illustrates how misunderstandings about how property is titled can create family problems.  In Wagenschein v. Ehlinger, 581 S.W.3d 851 (Tex. Ct. App. 2019), a married couple had seven children.  The parents also owned a tract of land.  Upon the last of the parents to die, each child held an undivided one-seventh interest as tenants in common in the tract.  In 1989, the heirs sold the land but executed a deed reserving a royalty interest.  The deed reservation read as follows:  “THERE IS HEREBY RESERVED AND EXCEPTED from this conveyance for Grantors and the survivor of Grantors, a reservation until the survivor's death, of an undivided one-half (1/2) of the royalty interest in all the oil, gas and other minerals that are in and under the property and that may be produced from it. Grantors and Grantors' successors will not participate in the making of any oil, gas and mineral lease covering the property, but will be entitled to one-half (1/2) of any bonus paid for any such lease and one-half (1/2) of any royalty, rental or shut-in gas well royalty paid under any such lease. The reservation contained in this paragraph will continue until the death of the last survivor of the seven (7) individuals referred to as Grantors in this deed.” 

An oil and gas company drilled a producing well in 2010 and began paying royalties to the heirs. As each heir died, the credited their royalty interest to the surviving heirs of each deceased heir.  That had the effect of increasing the respective royalty payments of the surviving heirs.  There were no problems until 2015.  In 2015, a child of a deceased heir sued claiming that the deed crediting the royalty reservation to “Grantors and Grantors’ successors” created a “tenancy in common” and not a “joint tenancy”.  If the deed created a tenancy in common, the children of the deceased heirs, rather than the surviving heirs, would inherit their parents’ royalty interests.  The trial court disagreed, noting that while the deed used “successor”, it only did so once and clearly and unambiguously reserved the royalty interest to the heirs and the “survivor[s]” of the heirs, rather than their “successors”, “heirs” or “beneficiaries.”  As such, the trial court concluded that the deed unambiguously created a joint tenancy with the right of survivorship, rather than a tenancy in common that the children of the deceased heirs could inherit.   Thus, as each heir died, their interest in the tract passed to the surviving siblings, not their children.  On appeal, the appellate court affirmed.  Further review was denied.

Conclusion

Properly titling property is important for various reasons – not the least of which is to fulfill expectations on property passage.  In the Texas case, confusion over how property was titled resulted in a family lawsuit.  Regardless of how the case would have been decided, some in the family would not be pleased.   

Funding a Buy-Sell Agreement with Corporate Owned Life Insurance – Will Corporate Value Be Enhanced?

Overview

In part one of this series (published back on July 3), I discussed buy-sell agreements in general and noted how beneficial they can be in the intergenerational transfer of a farm or ranch where keeping the business in the family is the key goal.  There I covered buy-sell agreements in general, the various types of agreements and common triggering events. 

With today’s article I dive deeper into other issues associated with buy-sell agreements -valuation rules and funding approaches.  A recent court opinion points out the importance of following the valuation procedures set forth in the buy-sell agreement.

Part two of a two-part series on buy-sell agreements – it’s the topic of today’s post.

Valuation 

While very few farming and ranching operations (and small businesses in general) are subject to the federal estate tax because of the current level of the exemption, some are.  For those that are, in addition to providing a market for closely held shares at a determinable price, the buy-sell agreement can serve as a mechanism for establishing the value of the interest for estate tax purposes – or otherwise establish value of the decedent’s interest at death.

General rule.  In general, the value of a closely held business (or other property) is determined without regard to any option, agreement, or other right to acquire or use the property at a price less than the FMV of the property, or any restriction on the right to sell or use the property.  I.R.C. §2703(a).

Exception – statutory requirements.  A buy-sell agreement can establish the value of a deceased owner’s interest if six basic requirements are satisfied.  Three of the requirements are statutory and three have been judicially created.  The statutory requirements are found at I.R.C. §2703(b). 

The statutory requirements specify that the buy-sell agreement must:

• Be a bona fide business arrangement; I.R.C. §2703(b)(1)
• Not be a device to transfer property to members of the decedent’s family for less than full and adequate consideration in money or money’s worth; I.R.C. §2703(b)(2) and
• Contain terms that are comparable to other arrangements entered into by persons in arms’ length transactions.  I.R.C. §2703(b)(3)

A buy-sell agreement must satisfy each of the three statutory requirements if family members own 50 percent or more of the property subject to the restriction.  An agreement is deemed to satisfy all three of the statutory requirements if more than 50 percent of the value of the property subject to the restriction is owned directly or indirectly by individuals who are not members of the transferor’s family.  The interests owned by the nonfamily members must be subject to the same restrictions as the property owned by the transferor.  Treas. Reg. §25.2703-1(b)(3). 

Exception – caselaw requirements.  Judicial opinions have created three additional requirements that a buy-sell agreement must satisfy to be effective to establish the value of a decedent’s interest.  See, e.g., Estate of True v. Comr., 390 F.3d 1210 (10th Cir. 2004); St. Louis County Bank v. United States, 674 F.2d 1207 (8th Cir. 1982).  Based on these cases, the agreement must also: contain a purchase price that is fixed and determinable under the agreement; be legally binding during life and after death; and have been entered into for a bona fide business reason and not be a substitute for a testamentary disposition for full and adequate consideration. To establish the purchase price with certainty an appropriate valuation method must be established. An independent party valuation will not only satisfy the requirements of I.R.C. §2703 but also provide an estimate of the potential funding obligation and the liquidity expectations of the seller/estate. See Rev Rul. 59-60 as amplified by Rev. Rul. 83-120,1983-2 CB 170.

The courts have indicated that preserving a business with family control for purposes of continuity and management can serve as a bona fide business arrangement.  See St. Louis County Bank v. United States, 674 F.2d 1207 (8th Cir. 1982); Estate of Lauder v. Comr., T.C. Memo. 1992-736; Estate of Gloeckner v. Comr., 152 F.3d 208 (2nd Cir. 1998).  This includes planning for the future liquidity needs of the decedent’s estate.  Estate of Amlie v. Comr., T.C. Memo. 2006-76.  But an entity that consists only of marketable securities is not a bona fide business arrangement.  Holman v. Comr., 601 F.3d 763 (8th Cir. 2010).  The long-established position of the IRS is that, “It is always necessary to consider the relationship of the parties, the relative number of shares held by the decedent, and other material facts to determine whether the agreement represents a bona fide business arrangement or a device to pass the decedent’s shares to the natural objects of his bounty for less than an adequate and full consideration in money or money’s worth.”  Rev.Rul 59-60, 1959-1 CB 137. See also Estate of True v. Comr., T.C. Memo 2001-167, aff’d., 390 F.3d 1210 (2004); Estate of Blount v. Comr., T.C. Memo. 2004-116.  

Note:  The business reasons for executing the buy-sell agreement should be documented.   

The buy-sell agreement must not simply be a device to reduce estate tax value.  This requires more than expressing a desire to maintain family control of the business.  See, e.g., Estate of True v. Comr., 390 F.3d 1210 (10th Cir. 2004); Estate of Lauder v. Comr., T.C. Memo. 1992-736.  In addition, a buy-sell agreement must have terms that are comparable to other buy-sell agreements that are entered into at arms-length. This requirement is satisfied if the agreement is one that unrelated parties in the same line of business could have reached in an arms’ length transaction.  Treas. Reg. §25.2703-1(b)(4).  This fair bargain standard is typically based on expert opinion testimony. 

Funding Approaches

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

The use of life insurance.  Typically, life insurance is purchased for each business owner to cover the total purchase price (or at least the down payment). However, the premiums on such policies are not deductible (see I.R.C. §264) and can create a substantial ongoing expense.

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

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

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

Other Approaches

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

Potential Problem of Life-Insurance Funding

One potential problem of a corporation being the beneficiary of a life insurance policy designed to fund the buy-out of a deceased shareholder is that the IRS could argue that the policy proceeds are included in the corporate value.  In Estate of Blount v. Comr., T.C. Memo. 2004-116, the issue was whether the insurance proceeds contractually deduction to the redemption of corporate shares being valued be treated as corporate property for valuation purposes.  The decedent owned 83 percent of the stock in a corporation at death.  There was a life insurance policy owned by the company that provided some $3.1 million to pay off the mandated buyout of the shares under a buy-sell agreement providing for a fixed value of the decedent shares. The buy-sell agreement value was held not to be controlling for estate tax purposes, mainly because the deceased owned 83 percent of the stock and could have changed the agreement at any time. Furthermore, the court determined that the buy-sell agreement was not similar to those involved in arm’s length transactions.

The 11^th circuit reversed on the basis that the redemption obligation of the buy-sell agreement was a liability that offset the value of the death benefits used to fund the redemption. Estate of Blount v. Comr., 428 F.3d 1338 (11th Cir. 2005).  Thus, even if the death benefits were included in the corporate value, there was a corresponding offsetting liability that would be accounted for by a “reasonably competent business person interested in acquiring the company.”  Id. 

Note:  In a decision preceding the Tax Court’s decision in Blount, the Ninth Circuit court deducted the insurance proceeds from the value of the organization when they were offset by an obligation to pay those proceeds to the estate in a stock buyout.  Cartwright v. Comr., 183 F.3d 1034 (9th Cir. 1999).   

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

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

The district court noted that a stock-purchase agreement is respected when determining the fair market value of stock for estate tax purposes upon satisfying the requirements of I.R.C. §2703(b) (as noted above), and the additional judicially created requirements (also noted above).    The IRS expert claimed that the insurance proceeds should be included in the company’s value as a non-operating asset, and that allowing the redemption obligation to offset the insurance proceeds undervalued the company’s equity and the decedent’s equity interest in the company, and would create a windfall for a potential buyer that a willing seller would not accept.  The IRS expert concluded that the fair market value of the company was $6.86 million rather than $3.86 million.  The IRS also claimed that the stock purchase agreement failed to control the value of the company.  The estate claimed that the company sold the decedent’s shares at fair market value and that the shares had been properly valued.  Thus, according to the estate, the $3 million in life insurance proceeds were properly excluded from the decedent’s estate based on the appellate opinion in Blount.  The estate claimed that the stock purchase agreement provided a sufficient basis for the court to accept the estate’s valuation as the proper estate-tax value of the decedent’s shares.  On that point, the IRS claimed that the stock purchase agreement was not a bona fide business arrangement and, as such, didn’t control the value of the decedent’s stock.  The IRS position was that the stated estate planning objectives of the stock purchase of continued family ownership of the company were insufficient to make it a bona fide business arrangement, particularly because the brothers did not follow it by disregarding the agreement’s pricing mechanisms. 

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

On the issue of whether the life insurance proceeds should be included in corporate value, the court rejected the appellate court’s approach in Blount, finding it to be analytically flawed.  The court concluded that the appellate court in Blount had misread Treas. Reg. §20.2031-2(f)(2), and that the regulation specifically requires consideration to be given to non-operating assets including life insurance proceeds, “to the extent such nonoperating assets have not been taken into account in the determination of net worth.”  The district court concluded that the text of the regulation does not indicate that the presence of an offsetting liability means that the life insurance proceeds have already been “taken into account in the determination of a company’s net worth.”  The district court concluded that, “by its plain terms, the regulation means that the proceeds should be considered in the same manner as any other nonoperating asset in the calculation of the fair market value of a company’s stock…. And…a redemption obligation is not the same as an ordinary corporate liability.”  There is a difference, the court noted, between a redemption obligation that simply buys shares of stock, and one that also compensates for a shareholder’s past work.  One that only buys stock is not an ordinary corporate liability – it doesn’t change the value of the corporation as a whole before the shares are redeemed.  It involves a change in the ownership structure with a shareholder essentially “cashing out.”  The court noted that the parties had stipulated that the decedent’s shares were worth $3.1 million, aside from the life insurance proceeds.  The insurance proceeds were not offset by the company’s redemption obligation and, accordingly, the company’s fair market value and the decedent’s shares included all of the insurance proceeds, and the IRS position was upheld. 

On appeal the U.S Court of Appeals for the Eighth Circuit affirmed.  Connelly v. United States, 70 F.4th 412 (8th Cir. 2023).  The appellate court held that the stock purchase agreement requiring the redemption of a deceased shareholder’s shares did not affect the value of the shares for estate tax purposes under I.R.C. §2703 because it did not provide for a fixed price or a formula for arriving at one. Instead, the agreement merely laid out two mechanisms by which the brothers might agree on a price - mutual agreement or appraisal. As for the appraisal approach, there was nothing in the agreement that fixed or prescribed a formula or measure for determining the price that the appraisers would reach. Thus, neither mechanism constituted a fixed or determinable price for valuation purposes. The appellate court determined that the $3 million that the corporation actually paid for the deceased brothers shares constituted an amount determined after death that was derived by an agreement between the brothers and not by any formula in the buy-sell agreement.

As for the value of the corporation (and, hence, the deceased brother’s interest in the corporation), the appellate court determined that the life insurance proceeds were an asset that increased the shareholders’ equity and that an obligation to redeem shares is not a liability in the ordinary business sense.  Thus, the proper valuation of the corporation in accordance with I.R.C.  §§2042 and 2031 must include the life insurance proceeds without treating the obligation to redeem shares as an offsetting liability.  The court reasoned that in order for a willing buyer at the time of the brother’s death to own the stock outright, a willing buyer would account for control the life insurance proceeds and therefore would pay up to $6.86 million for the corporation, quote taking into account end quote the life insurance proceeds and then either extinguishing the agreement or redeeming the shares. Conversely, the appellate court determined that a hypothetical willing seller of the corporation would not find acceptable a price of $3.86 million with the knowledge that the company would be receiving $3 million in life insurance proceeds.

To illustrate its rationale, the appellate court explained explain that if it valued the corporation without accounting for the life insurance proceeds intended for redemption, then upon the brother’s death each share was worth $7,720 before redemption.  After redemption, the deceased brother’s interest is extinguished, with the surviving brother having full control of the corporation’s $3.86 million value.  The appellate court noted that this would essentially quadruple the value of the surviving brother’s shares, but that treating the life insurance as an offsetting liability would leave the stock value undisturbed (which was the estate’s position). The economic reality of the situation, the appellate court concluded, was that the life insurance proceeds was an asset that increased shareholders’ equity.  The buy-sell agreement thus had nothing to do with being a corporate liability. 

Note:  A separate insurance LLC could be used to fund a buy-sell agreement in light of Connelly.  The insurance LLC would collect the life insurance proceeds on the deceased owner.  The LLC’s value would not be increased by the death benefit because it is allocated to the other owners in accordance with the buy-sell agreement due to special allocations in a LLC taxed as a partnership.  See I.R.C. §704.  A formal appraisal would likely only be required if there is real estate or some other difficult to value asset that the LLC owns.  This does add a layer of complexity, but if there are more than two owners the additional complexity may be worth it.

Arguably, there is now a split on this issue between the 8th Circuit on one hand, and the 9th and 11th Circuits on the other (keep in mind the brothers in Connelly didn’t follow the buy-sell agreement).  Indeed, a petition for certiorari was filed with the U.S. Supreme Court on August 15, 2023.  Will the Supreme Court agree to hear Connelly?  Not very likely at all. 

Conclusion

A buy-sell agreement can be a very important part of a succession plan for a family farming/ranching business (or any small, family-owned business for that matter).  However, it’s critical that the agreement be drafted properly and followed by the business owners.