Agricultural Law and Taxation Blog

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.

Ag Law and Tax – More Potpourri of Issues

Overview

The never-ending stream of legal and tax issues facing farmers and ranchers continues unabated.  There’s never a dull moment.  In today’s article I take a brief look as several of the issues that farmers and ranchers.

More ag law and tax potpourri of issues – it’s the topic of today’s post.

 Pre-Paid Farm Expenses and Death

Many cash-basis farmers pre-pay next-year’s input expenses in the current year and deduct the expense against current year income.  The IRS has specific rules for pre-paying and deducting.  In addition, what happens if you pre-pay and deduct expenses for inputs and then die before using them?

Three conditions must be satisfied to currently deduct pre-paid input expenses.  The pre-purchase must involve a binding contract for the purchase of specific goods of a minimum quantity that you will use in your farming business over the next year; you must have a business purpose for the purchase; and the pre-purchase must not materially distort your income over time.   Make sure you have a written contract for your pre-purchases that specifically identifies the goods you are buying to use in your farming business – such as seed, feed and fertilizer.  It’s not too difficult to come up with a business purpose for the pre-purchases such as locking in a price or a supply.

But what if you pre-pay for inputs in the fall and then die in the Spring after you file your tax return deducting the cost but before you can use the inputs?  For a cash basis farmer, those inputs are inventory at death.  That means they’ll be included in your estate and, assuming you have a surviving spouse they can pass to the surviving spouse who can then use them to put the crops in the ground and deduct their cost again on that year’s return. 

This happened in a Tax Court case a few years ago, and the IRS denied the deduction on the surviving spouse’s return as having already been taken.  But the surviving spouse won.  That’s the way the tax Code works because of the step-up in basis of the inputs at the death of the first spouse.

The case is Backemeyer v. Comr., 147 T.C. No. 17 (2016).

Expensing the Cost of Raising Calves

Often large ranches or dairies that are on the accrual method of accounting assume that the cost of cattle and cows must be capitalized and depreciated.  But that assumption may be only partially correct. 

So how should a ranch or a dairy on the accrual method handle the cost of cattle and cows purchased for dairy production or breeding?  While the normal rule is capitalization, the cost to raise calves born on the farm may be expensed as incurred, even if the accrual method of accounting is used.  That’s the case if the farm is not a tax shelter.  While the tax shelter rule hardly ever applies in the farm setting, it can if 35 percent or more of losses are allocated to limited partners.  An active farmer is not a limited partner and if the interest was passed down in a multi-generational family business, it’s also not a limited partner interest under the tax shelter rules.  

It's crucial that the animals are produced in a “farming business.”  That can be an issue if a significant part of the income comes from processing or packing milk products, for example.  In that situation, check to see whether there is more than a single business and how much income each business generates.

Of course, these complications can be avoided if a switch to the cash method of accounting can be made. That might be possible because many times the use of the accrual method is for non-tax business reasons.

Filing of False Forms 1099-Misc.

IRS Form 1099-Misc.is used to report various types of income.  It’s an information return that you send to another taxpayer.  Some of the most common reasons for filing Form 1099-Misc. include anyone you paid more than $600 to for the year for work performed for your business, professional services of any amount, royalty payments and other payments such as prize money or rent.  But be careful who you send a Form 1099-Misc. to. 

In a recent case, a farmer bought the defendant’s land at a court-ordered tax sale.  Shortly thereafter, the plaintiff received Forms 1099-Misc. reporting more than $15 million in connection with the land. The receipt of the Forms was due to the defendant’s issuance of them in retaliation for the plaintiff’s purchase of the land.

There are rules that penalize this behavior, and the plaintiff sued for damages for the fraudulently filed Forms.  The court agreed and imposed a per-Form penalty of the greater of $5,000 or actual damages and ordered that the Forms 1099(c) should reflect $0 in income paid.

So, if you get upset with someone, don’t think you can create a tax problem for them by filing a phony Form 1099-Misc.  It just might come back to bite you.

The case is Scot Thompson Farms, LLC v. Hap Holdings Trust, No 8:23CV25, 2023 U.S. Dist. LEXIS 107772 (D. Neb. Jun. 21, 2023), appeal filed, No. 23-2712 (8th Cir. Jul. 26, 2023) and case dismissed when appellant failed to timely file documents.

Beneficial Ownership Reporting & Unauthorized Practice of Law

At the beginning of 2024 a new reporting requirement kicked in for many businesses.  It’s part of a law designed to crack down on the use of shell corporations to evade paying taxes.  Presently, the courts are sorting out whether the requirement is constitutional.  Another question is whether a non-lawyer can fill out the report and file it. 

The new reporting rule requires most businesses that file with the state to register with the Financial Crimes Enforcement Network and file a report listing the business owners.  The filing is done online.  Businesses in existence before 2024 have until the end of this year to file. New businesses this year have 90 days to file.  Certain farm entities are exempt, but most smaller entities are not.  Even if your farm entity is exempt, you might have an equipment LLC, a land LLC, or any other related entity that’s not. 

Recently New Jersey took the position that if the report for a business is simple, a non-lawyer can complete it and file it.  A complex report must be completed by an attorney.  On the other hand, a recommendation has been made to the Iowa Supreme Court that it’s not the unauthorized practice of law for a non-lawyer to complete the report and file it.  That seems incorrect inasmuch as certain trusts that hold business interests are “reporting entities” and these trusts are very complex and will need to be interpreted. 

That means in Iowa your CPA or other tax professional can complete the report and file it for you.  Whether they will is an entirely separate question.

Blowing Dirt and Liability

Occasionally, there are news reports about traffic accidents due to blowing dirt from farm fields.  It tends to happen in the Spring during planting season when high winds blow dirt across a roadway and severely limit visibility.  That raises a legal question - is a farmer or other rural landowner responsible for injuries or death resulting from accidents where blowing dirt from their field is a factor? 

The matter of soil erosion from farm fields has been a concern of the federal and state governments for many years.  Federal programs designed to address soil erosion were first established as a result of the 1930s Dust Bowl, and some state laws also go back that far.

State provisions typically require landowners to take certain actions designed to minimize soil erosion.  In Kansas, for example, county commissioners can take action to minimize soil erosion.  The Iowa statute was upheld in 1979 against a constitutional challenge. 

But what about the liability issue for a farmer that owns land adjacent to a roadway?  The answer is that a farmer will generally not be liable for injuries or death resulting from obscured visibility due to blowing dirt if the farmer is following an approved soil conservation plan for the farm or is otherwise using generally accepted good farming practices. 

Conclusion

So many issues to discuss – these are the ones that have been on my mind recently. 

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.

FBAR; Read Before Signing; Reporting 4-H Income and Attorney-Client Privilege

Overview

One of the things that my law students learn shortly into a new semester is that agricultural law covers a wide array of topic matters and will address many areas of the law that they have yet to be exposed to.  That is on display in today’ blog article.

Post-death FBAR penalties, reading contracts, proper reporting of 4-H Fair income, and a limitation on the attorney-client privilege – these are the topics of today’s post.

FBAR Penalties Post-Death

In recent years some American farmers have started farming operations in foreign countries, particularly in South America.  For these farmers, a provision of the Bank Secrecy Act is important, and the penalties are harsh if the rule is violated. 

If you have a foreign account containing $10,000 or more, you must report it to the IRS by the annual tax filing deadline.  In a United States v. Gaynor, No. 2:21-cv-00382-JLB-KCD, 2023 U.S. Dist. LEXIS 157733 (M.D. Fla. Sept. 6, 2023), a surviving spouse inherited her husband’s foreign bank and investment accounts when he died in 2003.  She didn’t learn about the accounts for some time and, as a result, didn’t make the required filings with the financial crimes network – a branch of the IRS.  She eventually got everything reported. When she died in 2021, the IRS came after the estate for almost $20 million in penalties for a willful failure to file the required forms for several years.  But the court said her failure to file wasn’t willful.  So, the estate escaped having to pay the enormous amount. 

If you have farming activities outside the U.S. and have foreign bank accounts, make sure you file Form FinCen 114 and report those accounts each year to the IRS.  The penalties can be huge – especially if the failure to file was willful.  And, they can be imposed on your estate post-death. 

If this reporting requirement might apply to you, ask your tax professional about it.

The Necessity of Reading Contracts Before Signing

I am sure you have heard it said that you shouldn’t sign anything before reading it.  We’ve all violated that rule in some fashion.  Most of the time, there might not be any consequences, but sometimes those consequences can be significant.  That’s especially true when it comes to financial documents.In a recent case, a farmer consolidated loans with a local bank in return for a 30-year installment note.  Or so he thought.  Actually, the note said that he had 30 years to pay it off with annual payments unless the bank decided to demand payment in full at any time.  He didn’t read that part.  He also thought the interest rate was a fixed 4.25 percent, but that was only for the first five years.  After that the rate became variable.  He signed the note and the associated paperwork and was current on the payments through the first three years, when the bank demanded payment in full in 14 days.

Local banks don’t normally sell these types of instruments on a secondary market.  That should be a tip that you won’t get a long-term fixed rate. What happened in this situation was that the bank was looking at recently submitted financials and determined that while the farmer was able to make the current annual payment, that wouldn’t be the case when the interest rate became a much higher variable rate.  So, the bank called the loan. 

That left the farmer with limited options – either pay the note in full immediately, get the bank to sign a forbearance agreement and get a loan from another bank with better terms, mediate the dispute or file Chapter 12 bankruptcy.  None of those are great options. 

Make sure you read and understand what you sign.  The legal consequences of not doing so can be significant.

Proper Reporting of 4-H Fair Sale Income

Members of 4-H clubs or FFA Chapters often raise livestock as part of the educational program.  When that livestock is sold at the end of the fair, what are the tax issues that are involved?

When a 4-H or FFA animal is sold after the fair, the net income should be reported on the other income line of the 1040.  It’s not subject to self-employment tax if the animal was raised primarily for educational purposes and not for profit and was raised under the rules of the sponsoring organization.  It’s also not earned income for “kiddie-tax” purposes.  But, if the animal was raised as part of an activity that the seller was engaged in on a regular basis for profit, the sale income should be reported on Schedule F.  That’s also true if the 4-H or FFA member has other farming activities.  By being reported on Schedule F, it will be subject to self-employment tax.

There are also other considerations.  For example, if the seller wants to start an IRA with the sale proceeds, the income must be earned.  Also, is it important for the seller to earn credits for Social Security purposes? 

Raising livestock as a 4-H or FFA project can provide valuable life-lessons in responsibility.  By understanding the tax rules associated with the project sales, it can also teach a valuable lesson in business.

Crime-Fraud Exception to the Attorney-Client Privilege

Communications between an attorney and client are protected by the attorney-client privilege.  But if the legal advice given leads to you engaging in an illegal or fraudulent activity, the advice may not be protected, and serious consequences could result.  I’ll be back in a moment to discuss.

Normally, communications with your attorney are protected from disclosure.  But an exception applies if your attorney provides legal advice that leads to you committing a fraudulent act or crime.  See, e.g., United States v. Zolin, 491 U.S. 554 (1989).  For the rural attorney the exception can come up in bankruptcy planning as well as estate planning where asset protection is involved.  There are legitimate strategies to utilize, but others are not and can be challenged as fraudulent or illegal.    This area of the law requires careful attention to detail both by the attorney and the client and the rules can be complex. 

Make sure you get sound planning advice from your attorney and maybe have a second set of eyes in the firm look over a proposed plan.  If you are working with a solo practitioner, get permission to have the plan reviewed.  The law does allow a degree of asset protection when it comes to estate planning as well as farm bankruptcy.  But it must be done properly.  If you get good advice and don’t follow it, you could end up in serious legal trouble and maybe even as a target of a grand jury investigation.  

Those would not be pleasant experiences.

Conclusion

There are many ways that the law intersects agriculture.  Again, this just is a brief sample of some of the ways.

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

From the Desk…and Email…and Phone… (Ag Law Style)

Overview

Today’s post is a summary of just a snippet of the items that have come across my desk in recent days.  It’s been a particularly busy time.  The semester has ended at the two universities I teach at, exams are graded and now the seminar season heats up in earnest for the rest of the year.  This week it’s Branson for a two-day farm tax and farm estate/business planning seminar.  Then it’s back to the law school to do the anchor leg of the law school’s annual June CLE.  Next week it’s a national probate seminar and a fence law CLE.  The following week involves battling the IRS on a Tax Court case and the line between currently deductible expenses and those that must be capitalized.  Oh, and I’ll soon start a new subscription publication.  The first edition of the first volume is about ready.  So stay tuned.

For now, today’s post is on miscellaneous ag law topics.

Aerial Crop Dusting

Most cases involving injury to property or to individuals are based in negligence.  That means that someone breached a duty that was owed to someone else that caused damage to them or injured their property.  But there are some situations where a strict liability rule applies.  One of those involves the aerial application of chemicals to crops.  It is perhaps the most frequent application of the doctrine to agriculture. It’s based on the notion that crop dusting is an inherently dangerous activity. In addition, some states may have regulations applicable to aerial crop dusting.  For example, in Arkansas, violation of aerial crop spraying regulations constitutes evidence of negligence, and the negligence of crop sprayers can be imputed to landowners. 

If you utilize crop dusting as part of your farming operation, it’s best from a liability standpoint to hire the work done.  In that event, if chemical drift occurs and damages a neighbor’s crops, trees or foliage, you won’t be liable if you didn’t control or were otherwise involved in how the spraying was to be done.  Especially if all applicable regulations are followed.

Right of First Refusal

A right of first refusal allows the holder the right to buy property on the same terms offered to another bona fide purchaser.  Once notified, the holder can either choose to buy the property on the same terms offered to a third party or decline and allow the owner to sell to the third party.  A right of first refusal can be useful in ag land transactions when there is a desire to ensure that a party has a chance to acquire the property. 

A right of first refusal can be useful in certain settings involving the sale of agricultural land.  Perhaps a longstanding tenant would like to be given a chance to acquire the leased land.  Or maybe a certain family member should be given the chance to buy into the family farming operation.  But it is critical that the property actually be offered to the holder of the right before it is sold to someone else.  If that doesn’t happen the owner can be sued for monetary damages and the third party that had either actual or constructive notice of the right of first refusal can be sued for specific performance.

When a right of first refusal is involved, it’s a good idea to record it on the land records to put the public and any potential buyer on notice.  Also, investigate changes concerning the property – such as to whom lease payments are being made.  The holder must stay vigilant to protect their right.

Ag Leases and Taxes

Leasing farmland is critical to many farmers and farming operations.  What’s the best way to structure an ag lease from a tax standpoint?  Tenants and landlords are often good at understanding the economics of a farm lease and utilize the best type of lease to fit their situation.  A farm lease can be structured to appropriately balance the risk and return between the landlord and tenant. 

There are also many income tax issues associated with leasing farmland.  For the tenant farmer, the lease income is income from a farming business.  That means it’s subject to self-employment tax.  It also means that the tenant can take advantage of the tax provisions that are available for persons that are engaged in the trade or business of farming. 

Whether the landlord gets those same tax advantages depends on whether the landlord is materially participating.  If so, the landlord has self-employment income, but is eligible to exclude at least a portion of USDA cost-share payments from income. The landlord can also deduct soil and water conservation expenses, as well as fertilizer and lime costs.  A landlord engaged in farming can also elect farm income averaging, can receive federal farm program benefits, and can have a special use valuation election made in the estate at death to help save federal estate tax. 

The right type of lease can be very beneficial. 

Corporate Loans

Lending corporate cash to shareholders of a closely-held corporation can be an effective way to give the shareholders use of the funds without the double-tax consequences of dividends.  But an advance or loan to a shareholder must be a bona fide loan to avoid being a constructive dividend.  In addition, the loan must have adequate interest. If it doesn’t meet these criteria, it will be taxed as a dividend distribution.  In addition, it’s not enough for you to simply declare that you intended the withdrawal to be a loan.  There must be additional reliable evidence that the transaction is a debt.  So, what does the IRS look for to determine if a loan is really a loan?

If you have unlimited control of the corporation, there’s a greater potential for a disguised dividend, and if the corporation hasn’t been paying dividends despite having the money to do so, that’s another strike.  Did you record the advances on the corporate books and records as loans and execute notes with interest charged, a fixed maturity date and security given?  Were there attempts to repay the advances in a bona fide manner?  The control issue is a big one for farming and ranching corporations, and few farm corporations pay dividends.  This makes it critical to carefully build up evidence supporting loan characterization. 

NewH-2A Rule

The H-2A temporary ag worker program helps employers who anticipate a lack of available domestic workers.  Under the program foreign workers are brought to the U.S. to perform temporary or seasonal ag work including, but not limited to, labor for planting, cultivating, or harvesting.  Recently, the Department of Labor published a Final Rule designed to enhance protections for workers under the H-2A program. 

Effective June 28, a new Department of Labor final rule will take effect.  The rule is termed, “Improving Protections for Workers in Temporary Agricultural Employment in the United States.”   The rule will impact the temporary farmworker program.  The rule’s purpose is to increase wage transparency, clarify when an employee can be terminated for cause, and prevent employer retaliation among temporary seasonal ag workers. There are also expanded transportation safety requirements, new employer disclosure requirements and new rules for worker self-advocacy.   

The rule is lengthy and complex, but here’s a few points of particular importance:

• New restrictions on an employers’ ability to terminate workers;
• Workers employed under the H-2A program have the right to payment for three-fourths of the hours offered in the work contract, even if the work ends early; housing and transportation until the worker leaves; payment for outbound transportation; and, if the worker is a U.S. worker, to be contacted for employment in the next year, unless they are terminated for cause.
• An employer may only terminate a worker “for cause” when the employer demonstrates the worker has failed to comply with employer policies or rules or to satisfactorily perform job duties after issuing progressive discipline, unless the worker has engaged in egregious misconduct. The rule establishes five conditions that must be satisfied to ensure disciplinary and/or termination processes are justified and reasonable.
• For vehicles that are required by Department of Transportation regulations to be manufactured with seat belts, the employer must retain and maintain those seat belts in good working order and prohibit the operation of a vehicle unless each worker is wearing a seat belt.

Only applications for H-2A employer certifications submitted to the Department of Labor on or after August 29 will be subject to the new rule. 

You can expect legal challenges to the rule.  But, in the meantime, if you use temporary foreign workers on your farm, you should start creating and implementing policies and procedures to comply with the new rule as well as updating your existing H-2A applications.

The rule is published at 89 Fed. Reg. 33898.

Conclusion

The topics in ag law and tax are diverse.  There’s never a dull moment. 

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!

New Tax Legislation Proposed

Introduction

On January 31, the U.S. House overwhelmingly passed tax legislation containing provisions of importance to farmers and ranchers in particular and many taxpayers in general.  H.R. 7024, known as the “Tax Relief for American Families and Workers Act of 2024,” is scored at nearly $78 billion and contains some retroactive provisions.  Some of the key provisions modify the employee retention credit (ERC), widen eligibility for the child tax credit (CTC), reinstate expensing for research and experimental (R&E) costs; increase expense method depreciation; and reinstate bonus depreciation to 100 percent for 2023. 

The legislation is currently before the U.S. Senate where it appears to have bipartisan support, if not immediate space on the Senate calendar. 

Pending tax legislation – it’s the topic of today’s post.

Details

ERC.  The IRS has been making significant efforts to eliminate abuses of the ERC.  The Congress constructed the ERC poorly which made it ripe for promoters to scam businesses, including farm businesses into thinking that they were eligible for the credit or eligible for more than what was appropriate.  The bill prevents additional ERC claims as of January 31, 2024 – moving up the current April 15, 2025, deadline. 

Note:  To put the cost of the ERC in perspective, the Joint Committee on Taxation says sunsetting the ERC as of January 31, 2024, would save $77.1 billion in spending. 

The bill makes several changes relevant to the ERC with respect to a “COVID-ERTC promoter.”  That’s a person who “aids, assists, or advises on an affidavit, refund, claim, or other document related to the ERC” if the person charges fees based on the amount of the credit or meets a gross receipts test.

The bill also makes other changes to the ERC relevant to a “COVID-ERTC promoter” as follows:

• Extends the statute of limitations for the IRS to audit ERC claims from the current five years from the date of the claim to six years for claims involving a COVID-ERTC promoter.

• Increases the penalty for aiding and abetting the understatement of a tax liability to the greater of $200,000 ($10,000 in the case of a natural person) or 75 percent of the promoter’s gross income derived (or to be derived) from providing aid, assistance, or advice with respect to a return or claim for ERC refund or a document relating to the return or claim.

• Requires a promoter to comply with due-diligence requirements (similar to the due-diligence requirements applying to paid tax return preparers) with respect to a taxpayer's eligibility for (or the amount of) an ERC.  Each failure to comply comes with a $1,000 penalty. 
• Require a promoter to file return disclosures and provide lists of clients to the IRS on request similar to those that “material advisers” are required to provide with respect to listed transactions.

CTC

The bill makes the following changes to the CTC:

• An increase in the maximum refundable amount per child to $1,800 in tax year 2023 from $1,600. That amount then increases to $1,900 in 2024 and $2,000 in 2025.  Inflation adjustments also apply for 2024 and 2025.   

• For tax years 2023-2025, the CTC is to be computed by multiplying a taxpayer’s earned income exceeding $2,500 by 15 percent, with the resulting amount multiplied by the number of qualifying children.

• For 2024 and 2025, a taxpayer would be able to use the taxpayer’s earned income from the prior tax year to compute the maximum child credit, but only if the taxpayer’s earned income in the prior year was higher than the current year.

R&E costs.  The bill would amend I.R.C. §174 to reverse (at least temporarily) the impact of the Tax Cuts and Jobs Act (TCJA) provision requiring amortization of domestic R&E costs.  That change under the TCJA requires amortization over a five-year period effective for tax years beginning after 2021. The bill would maintain current deductible through 2025.   

Business interest.   For tax years beginning before 2018, business interest (such as is paid on loans for farmland, machinery, buildings, operating lines, etc.) was fully deductible.  For tax years beginning after 2017 and before 2022, deductible business interest is limited to business income plus 30 percent of the taxpayer’s adjusted taxable income (ATI) for the tax year that is not less than zero.  The computation of ATI is determined without regard to any deduction allowable for depreciation, amortization, or depletion (i.e., earnings before interest, taxes, depreciation, and amortization (EBITDA)).

The bill specifies that, for taxable years beginning after December 31, 2021, and before January 1, 2024, ATI is computed with regard to deductions allowable for depreciation, amortization, or depletion (i.e., earnings before interest and taxes (EBIT)). However, ATI may be computed as EBITDA, if elected, for such taxable years. For taxable years beginning after December 31, 2023, and before January 1, 2026, ATI is computed as EBITDA. For taxable years beginning after December 31, 2025, ATI is computed as EBIT.

Note:  The limit is computed at the entity level with any disallowed amounts carried over to the succeeding year.

The otherwise existing rules would continue to apply.  That means that any disallowed amount is treated as paid or accrued in the succeeding tax year.  However, businesses entitled to use cash accounting (i.e., those with average annual gross receipts not exceeding $30 million for 2024) are not subject to the limitation.  Special rules apply to excess business interest of partnerships. In addition, a farming business may elect out of the limitation.  I.R.C. §163(j)(7)(C).

Bonus depreciation. The bill would retroactively extend I.R.C. §168 bonus depreciation for qualified property at 100 percent for property placed in service after Dec. 31, 2022, and before Jan. 1, 2026 (Jan. 1, 2027, for longer production period property and certain aircraft) and for specified plants planted or grafted after Dec. 31, 2022, and before Jan. 1, 2026.   Under current law, bonus depreciation was capped at 80 percent for 2023 and is 60 percent for 2024. 

Note:  The retroactive nature of this provision could cause numerous issues.  Many farm assets are 20-year or less MACRS property and have uniquely benefitted from bonus depreciation.  This is particularly true because the personal property trade provisions of the TCJA can cause large machinery purchases that exceed the I.R.C. §179 threshold which then causes taxpayers to utilize bonus depreciation.   

Sec. 179 expensing. The bill would also increase the I.R.C. §179 maximum deductible amount to $1.29 million for 2024 (up from $1.22 million), reduced by the amount by which the cost of the qualifying property exceeds $3.22 million (up from $3.05 million). Those amounts would be adjusted for inflation after 2024.

Other provisions.  The bill also includes an increase in the threshold for information reporting on Forms 1099-NEC, Nonemployee Compensation, and 1099-MISC from $600 to $1,000, effective for payments made after 2023. 

Conclusion

Will the bill pass the Senate?  Probably.  But that won’t likely occur before March 1.  Of course, that’s the date that many farmers use for filing returns.  As a result, for those that have already made decisions concerning depreciation, the CTC, and, perhaps, the deductibility of interest, amended returns will need to be filed.  Will IRS waive the penalties if farm returns (for those that didn’t pay estimated tax) are filed after March 1?  That may not be known until very late in February.  This all increases the chance for errors on returns.  In addition, IRS forms and tax preparation software will need to be revised which will create anxiety due to pending deadlines.  Retroactive tax legislation is rarely a good idea from a return preparation standpoint.

The Big Issues for 2024

Introduction

What are likely to be the most prominent issues in agricultural law and tax in 2024?  I have just finished looking back at 2023 as to what I viewed as the top issues of 2023, so it’s time to take a look forward to what might be the key issues in law and tax that will impact ag producers and the sector as a whole. 

Looking ahead at what might be the biggest issues in ag law and tax in 2024 – it’s the topic of today’s post.

Important “Takings” Case at the Supreme Court

DeVillier v. Texas, 63 F.4th 416 (5th Cir. 2023)

What are likely to be the big issues in ag law and tax in 2024?  One involves a case currently at the U.S. Supreme Court with the matter concerning the government’s taking of private property and the requirement under the Fifth Amendment that the government pay for what it takes.  The case involves a Texas farmer and was argued last month.

The family involved in a case 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.  In essence, the farm had been turned into a retention pond. 

The farmer sued the State to get paid for the taking.  Once the case got to federal court, the appellate court dismissed it, saying he couldn’t sue under the Fifth Amendment – only State officials can because Congress hadn’t passed a law saying a private citizen could sue the state.  But the appellate court’s opinion is out-of-step with other court opinions on the issue.  The Fifth Amendment contains a remedy when the government takes your property – you get paid for it. The Constitution matters.

The outcome will be an important one for agriculture. 

Taxing Wealth and the U.S. Supreme Court

Moore v. United States, 36 F.4th 930 (9th Cir. 2022)

This year the U.S. Supreme Court will decide a case on whether the Congress can tax a person’s wealth without a tax realization event such as a sale.  It’s a huge issue for agriculture. 

A case presently before the U.S. Supreme Court involves the question of whether the Congress can tax wealth without a tax realization event.  The taxpayers in the case owned 11 percent of a corporation in India that is more than 50 percent controlled by U.S. persons.  It doesn’t pay dividends but reinvests its earnings into its business of making tools for sale to farmers.  Under the 2017 tax law in the U.S., the company was subjected to a tax that year on its undistributed earnings and profits from 1986 to 2017 which became the obligation of the taxpayers to the extent of their ownership.  They got a $15,000 tax bill from the IRS. 

They sued because they hadn’t sold any stock or done anything to trigger the tax.  They lost and the Supreme Court heard arguments in early December.  If the law is upheld it’s estimated it will bring in $340 billion in revenues.  And it would open the door for the Congress to tax your unrealized gains that could wipe out the stepped-up basis rule at death.  That would be a tough result for many farming operations.

USDA’s “Climate Smart Projects”

Another big issue in 2024 will likely involve the USDA’s attempts to manipulate producers’ behavior by providing taxpayer funding for what it calls “Climate-Smart Agriculture.”  Presently, USDA has poured about $3 billion tax dollars into getting farmers to enroll in projects such as those designed to reduce methane emissions and sequester carbon.  It’s termed the USDA’s “Partnership for Climate Smart Commodities Projects,” and flows from the SEC’s plans that were announced in 2022 to force all publicly traded companies to submit an Environmental, Social, Governance” (ESG) report.  Five months later the USDA’s project was announced.  It’s not just farmers that are on the take.  So far, $90 million has been paid to agricultural giant Archer Daniels Midland; $95 million to the Iowa Soybean Association; and $40 million dollars to Farm Journal.  27 universities have also received various amounts (all in the millions of dollars each). 

But with the funding comes a loss of freedom.  Just ask a Dutch, Polish, Irish, French, German or Sri Lankan farmer how such an agenda has worked for them.  The USDA’s expressed goal is to get farmers and ranchers to calculate greenhouse gas emissions.  In the USDA’s words, “implementation and monitoring of climate smart practices.”  Indeed, USDA has worked with Colorado State University to develop a “planner tool” to be able to measure conservation practices on farms. Pilot projects focused on reducing methane emissions, improving soil quality and carbon sequestration.  Once the emissions from a farm become measurable, they will be regulated.  With regulation comes a loss of freedom and a further loss of smaller farming and ranching operations that are least likely to be able to bear the compliance cost. 

Consumers will also be harmed.  A new study published by the Economic Research Center at the Buckeye Institute finds that, as a result of the USDA’s climate agenda, a typical family of four will have to spend an extra $1,300 annually for food.  This is on top of the double-digit inflation consumers have faced since 2021.  The study also explains that the USDA’s climate agenda will result in much higher costs for diesel, propane, fertilizer and other ag production inputs.  The authors of the study note that, “Federal policymakers are pursuing expensive climate-control and emissions policies that have largely failed in Europe.”  The study can be accessed here:  https://www.buckeyeinstitute.org/library/docLib/2024-02-07-Net-Zero-Climate-Control-Policies-Will-Fail-the-Farm-policy-report.pdf

In 2024, will questions arise concerning the premise underlying the USDA’s efforts?  Also expect further questions to be raised about the funding.  The Ag Secretary says he can use the CCC to fund the climate agenda for agriculture.  Some in Congress don’t agree. 

But one thing’s for sure, the current political climate surrounding agriculture is seeking greater restrictions on farming practices.  That will assuredly increase the cost of farming and make it more difficult for smaller operations to survive.

Farm Bill Developments

An issue on the radar in ag law and tax in 2024 will be the continued discussions about a new Farm Bill.  The 2018 Farm Bill is set to expire at the end of September.  Cost will be an issue.  The CBO projects that continuing the current Farm Bill for ten years would cost more than $1.4 trillion with 84 percent of that going into nutrition programs.  Given increasing budget deficits, the debt ceiling and budget battles, the cost of the Farm Bill will be a big discussion point in 2024. 

Crop reference prices will be on the table as will whether nutrition spending should be meshed with farm income and ag conservation.  Other key issues will likely involve the amount of crop insurance premium subsidies, the amount of acreage in the CRP and eligibility for SNAP benefits. 

All of this depends on the political process.  Possibly, the Congress will view the Farm Bill as a way to compromise on a bill critical to rural economies.  Or the opposite could occur, and agreements reached only when they absolutely must be.  If that happens, that will cause uncertainty for markets, consumers, ag retailers and producers in general.

The Farm Bill debate will be an issue to monitor throughout 2024.

SCOTUS on Chevron Deference

Relentless, Inc. v. United States Department of Commerce, 62 F.4th 621 (1st Cir. 2023)

Loper Bright Enterprises v. Raimondo, 45 F.4th 359 (D.C. Cir. 2022)

A big issue in the world of ag law and tax in 2024 will involve the issue of government administrative agency deference. The U.S. Supreme Court is considering two cases involving the issue of how much deference should be given administrative agency rules such as those of the USDA or the EPA, for example. 

The two cases involve whether the National Marine Fisheries Service can require the herring industry to bear the costs of observers on fishing boats who monitor conservation and management practices.  The lower courts simply deferred to the determination of the fishery service that the industry should pay the costs.  That’s the typical outcome – you lose a dispute with the USDA, for example, and once you get to court the court simply defers to the agency unless the agency was completely out of bounds with its interpretation of the law.  If the agency’s interpretation was reasonable, the agency wins.  That’s the standard the Court established in 1984 in its Chevron decision. 

In 2022, the Supreme Court limited the deferential standard (it completely ignored Chevron in another 2022 case) when a question of national economic policy is involved, but now the court has an opportunity to lower the deferential standard on a broader scope.  If it does, farmers and ranchers may have better luck in disputes with government agencies and be able to more frequently overcome the presumption that the government is almost always right when Congress hasn’t written a clear statute.

Court Vacates Dicamba Registrations

Center for Biological Diversity v. United States Environmental Protection Agency, No. CV-20-00555-TUC-DCB, 2024 U.S. Dist. LEXIS 20307 (D. Ariz. Feb. 6, 2024)

Recently, a federal court vacated the registrations of three Dicamba products that EPA had approved for over-the-top applications.  The decision comes at a time when many soybean and cotton farmers have already purchased seed and chemicals and will soon be planting the 2024 crop. 

The court said the EPA didn’t follow the notice and comment provisions of the Federal Insecticide, Fungicide, Rodenticide Act (FIFRA) when it issued the registrations and also violated the Administrative Procedure Act (APA) (and the Endangered Species Act) by not allowing public input on whether over-the-top Dicamba has unreasonable adverse effects on the environment. 

In 2020 a federal appellate court vacated the registrations finding that the EPA failed to assess risks and costs for non-users of over-the-top Dicamba.  National Family Farm Coalition v. United States Environmental Protection Agency, 960 F.3d 1120 (9th Cir. 2020).  The EPA made amendments in 2022 and 2023 and approved new uses which the court has now said were approved improperly.

The ruling cancels any benefits of planting Dicamba seeds, and there may not be enough supply of other traits to replace the Dicamba market share.  If farmers are forced to plant Dicamba trait soybeans or cotton without the correct chemical to utilize the gene, they will likely use alternatives that will, in turn, magnify the known issues of the Dicamba chemical problems.   

Comment:  While the timing of the court’s decision is awful, the result is good overall in that it holds the “feet” of the EPA to the “fire” of the administrative process.  It also raises the question of whether the EPA deliberately violated the public notice and comment procedures that are clearly established in the law.  It’s difficult to believe that the EPA lawyers, particularly after losing in the Ninth Circuit on virtually the same issue in 2020, didn’t know that failing to follow the procedural rules for approving the registrations would lead to the registrations being invalidated. 

Perhaps the judge in the case will stay the ruling until the next crop year to reduce the potential for even more harm from a herbicide that should never have been allowed to be used. 

Certainly, this issue will be one that stays on the “front burner” for some time. 

Conclusion

That’s what I see as being the biggest issues in law and tax facing agriculture in 2024.  Only time will tell, but I suspect some of these will end up on my 2024 “Top Ten” list next January.

Top Ten Developments in Agricultural Law and Taxation in 2023 – (Part Four): The Employee Retention Credit

Overview

Today’s article is fourth in a series concerning the Top Ten ag law and tax developments of 2023.  To recap, here’s the list of the top developments so far:

• 10 - Court orders removal of wind farm.
• 9 – Reporting Rules for Foreign Bank Accounts
• 8 – New Business Information Reporting Requirements
• 7 – “Renewable” Fuel Tax Scam
• 6 – Limited Partners and Self-Employment Tax
• 5 – COE Mismanagement of Missouri River Water Levels

That brings me to the fourth most important development in ag law and tax of 2023 – it’s the topic of today’s post.

Employee Retention Credit (ERC)

Background.  The ERC is a refundable tax credit enacted in 2020 to provide an incentive for qualified businesses to keep employees on the payroll.  While 2021 legislation eliminated most employers’ ability to claim the ERC for wages paid beginning with the fourth quarter of 2021, it remains possible that some business may still qualify.  An eligible business that didn’t claim the credit when the original employment tax return was field can claim the ERC by filing an adjusted employment tax return.  That Form, Form 941-X (943-X for farm businesses) can be filed up to three years after initially filing or two years after paying, whichever is later.  Thus, claims can be filed with respect to unclaimed credits for 2020 until April 15, 2024, and until April 15, 2025, for 2021 unclaimed credits. 

Note:  Pending legislation (the Tax Relief for American Families and Workers Act) would bar filing any ERC claims as of January 31, 2024.  If a claim is finalized and ready to mail before January 31, 2024, it should be sent via certified mail

The ERC is complex, which led to confusion and opened a door for potential fraud.  One area of confusion concerned the modifications for various periods of time.  For the timeframe March 13, 2020, through the end of 2020 eligible trades or businesses were those that were partially or fully suspended due to orders from a government authority, or sustained a decline in gross receipts of at least 50 percent for the same calendar quarter in 2019.  Of course, farm and ranch operations were not shut down during the virus years, and the virus years tended to correspond to strong commodity price years such that many farm and ranch businesses did not experience a drop in gross receipts. 

Note:  The definition of “gross receipts” for ERC purposes contained complicated parent/sub rules, common ownership rules, as well as deemed ownership rules.  A farmer could not determine the ERC by simply looking at the Schedule F.  

Self-employed persons weren’t eligible for the 2020 ERC for their own wages, but the ERC could be claimed on wages paid to other employees.  For the first three quarters of 2021, an eligible business was one that either sustained partial or full suspension of business activities by action of the government or experienced a decline of at least 20 percent of gross receipts for the same calendar quarter in 2019.  For businesses that didn’t exist in 2019, 2020 could be used as a comparison.  The same rule as before applied to self-employed persons. 

Note:  The ERC was ended as of Sept. 30, 2021, except for “startup recovery businesses” that could claim the credit on wages paid for the balance of 2021.

The credit was tied to the number of employees a business hired, and different rules applied to full-time as compared to part-time employees.  Again, the rules changed on this computation for 2020 and 2021.  In addition, not all wages counted for ERC purposes. 

For 2020, the amount of the credit was equal to 50 percent of up to $10,000 in qualified wages per employee (including amounts paid toward health insurance) for all eligible calendar quarters beginning March 13, 2020, and ending Dec. 31,

For 2021, the credit was equal to 70 percent of up to $10,000 in qualified wages per employee (including amounts paid toward health insurance) for each eligible calendar quarter beginning Jan. 1, 2021, and ending Sep. 30, 2021.

Fraud.  The IRS announced that it had received 3.6 million claims as of September 2023, But, on Sept. 14, 2023, the IRS announced "an immediate moratorium through at least the end of the year" on processing new ERC claims.  IRS said it was taking the action because of fraud concerns, in particular involving businesses that had been "pressured and scammed by aggressive promoters and marketing" into filing questionable claims.

Note:  The moratorium impacted legitimate claims by farm businesses (and other businesses) that were counting on receipt of the credit amounts. 

In October, the IRS announced a "special withdrawal process" for business owners who had filed a possibly ineligible claim, but not yet received the money, allowing them to withdraw it without facing penalties or interest.  IRS also made allowance for businesses that had received the ERC but later learned it shouldn’t have.  By the end of 2023, the IRS reported that pending applicants had withdrawn claims amounting to more than $100 million.

Note:  The lucrative nature of the ERC combined with the complex rules attracted “mills” that perpetrated ERC fraud.  For instance, many orchards and other types of labor-intensive ag business easily qualified for six-figure ERC amounts for each quarter in 2021. 

Many ERC promoters claimed that supply chain issues during the virus years automatically qualified a business for the ERC.  IRS issued guidance on this issue that wasn’t clear, but then later stated that the supply chain issues do not automatically qualify a business for the ERC.  Indeed, IRS stated that only wages paid during the suspension or shutdown qualify.  This again caused tax preparers in many situations to consider amending payroll and income tax returns to make corrections before IRS discovered the matter and issued a notice for taxes, interest and penalties. 

In late 2023, the IRS announced a voluntary disclosure program letting employers who received questionable ERCs pay them back at a discounted rate.  This amnesty program was also part of the agency’s efforts to combat ERC fraud.  Under the program, IRS will provide amnesty if 80 percent of the improperly received ERC is paid back.  Doing so removes the possibility of interest and penalties and provides a greater avenue for businesses to return the improperly received ERC having already lost some of it to a bogus ERC promoter.  Businesses must apply to the voluntary disclosure program by March 22, 2024.  Certain qualifications must be satisfied for a business to participate in the program.    

Note:  Pending legislation (the Tax Relief for American Families and Workers Act) includes substantial fines for those involved in erroneous or false claims.  

Conclusion

Normally a tax credit would not make the “top ten” list.  However, the magnitude of the problems associated with the ERC and the frequency with which tax preparers representing farmers and ranchers had to deal with it throughout 2023 (and continuing into 2024) pushed it to the upper half of the top ten list.

Three more developments to go.  What do you think are the top three?

Top Ten Developments in Agricultural Law and Taxation in 2023 – (Part Two)

Overview

With the immediately previous blog article I started the journey through what I believe are the Top Ten developments in ag law and tax of 2023.  In that article I wrote about developments ten, nine and eight.  Today, it’s the seventh and sixth most important ones.   Again, all of these make my Top Ten list because of their significance on a national level to farmers, ranchers, rural landowners and agribusiness in general.

Developments seven and six of 2023 – that’s the topic of today’s post.

7. Prison Sentences for Five People Involved in Billion Dollar Biofuel Tax Fraud Conspiracy (i.e., the Dermen/Kingston Conspiracy)

Number seven on my list topped the IRS Criminal Investigation Divisions case list for 2023.  Involved is one of the largest tax fraud schemes in the history of the United States and it ultimately led in 2023 to the sentencing of five individuals for their roles in a $1 billion biofuel tax conspiracy.  The conspiracy occurred from 2010 to 2018 and involved money laundering, mail fraud and the fraudulent claiming of more than $1 billion in refundable renewable fuel tax credits.

At the foundation of the criminal activity was the Renewable Fuel Standard (RFS) created in 2005 and expanded in 2007.  Under the RFS, the government offers lucrative subsidies and tax credits to companies that convert crops such as soybeans and corn, as well as other products, into “renewable” fuels – the most common of which is corn ethanol.  Included in the RFS are biofuel production incentives known as renewable identification numbers (RINs).  Under EPA rules, a 38-digit number designed to track each gallon of ethanol or biodiesel from the producer to the point of sale.  Ethanol RINs remain with the fuel until it is pumped by a consumer at the gas station.  However, biodiesel RINs can be sold separately as credits that can be traded.  This allows oil refiners who failed to blend the government-mandated amount of biodiesel to buy RINs to make up the difference without paying a fine.  However, it also allowed for the possibility that a RIN price could be negotiated by a biofuel company with an oil refiner with the company using a fake 38-digit number.  The RIN buyer would then claim to have shipped the biofuel to be refined.  No fuel was actually bought or sold, and both the buyer and seller were in on the scam. 

Note:  Estimates are that the blending government mandate has resulted in about 40 percent of U.S. corn production being converted into ethanol annually.  The estimated taxpayer subsidies of corn farmers have exceeded $71 billion since 2005. 

The biggest RFS scam ever involved the parties mixed-up in this development.  The perpetrators created the appearance of biodiesel production and sale to claim the tax credits.  IRS actually paid out more than $511 million in credits to their biodiesel company that then distributed the proceeds among them as the company’s owners.  After pleading guilty, one conspirator was sentenced to 40 years in prison plus over $1 million in restitution and personal financial liability.  Another got 18 years in prison plus over $500 million in restitution and another $338 million in personal financial liability.  Three others were sentenced to 12, 7 and six years in prison and ordered to pay over $500 million in restitution combined. 

The IRS said the case, “has been one of unprecedented fraud against the United States and its citizens and is one of the most egregious examples of tax fraud in U.S. history.”   

     6. Self-Employment Tax and Limited Partners

Soroban Capital Partners LP v. Comr., 161 T.C. No. 12 (2023)

A question in self-employment tax planning is whether an LLC member is a limited partner.  In 1997 the IRS/Treasury issued a proposed regulation to address the issue, but it has never been finalized.  The regulation establishes a fact-based analysis based on participation in management to determine limited partner status.  A limited partner doesn’t participate in management.    For businesses other than those providing professional services, characterization of an LLC member’s interest is determinative of whether the member has self-employment tax liability on amounts distributed to the member (other than guaranteed payments).  That means that proper structuring of the entity matters as does the drafting of the LLC operating agreement and the conduct of the members. 

Here's what it might look like for a farming operation:

A married couple operates a farming business as an LLC.  The wife works full-time off the farm and does not participate in the farming operation.  But she holds a 49 percent non-manager ownership interest in the LLC.  The husband conducts the farming operation full-time and also holds a 49 percent non-manager interest.  But, the husband, as the farmer, also holds a 2 percent manager interest.  The husband receives a guaranteed payment for his manager interest that equates to reasonable compensation for his services (labor and management) provided to the LLC.  The result is that the LLC’s income will be shared pro-rata according to the ownership percentages with the income attributable to the non-manager interests (98 percent) not subject to self-employment tax.  The two percent manager interest is subject to self-employment tax along with the guaranteed payment that the husband receives.  This produces a much better self-employment tax result than if the farming operation were structured as a member-managed LLC. 

In late 2023, the U.S. Tax Court issued a fully reported opinion confirming that state law classifications of a partner’s interest is not conclusive on the self-employment tax issue.  ordinary income to its limited partners. However, the petitioner excluded distributions of ordinary income to its limited partners from its computation of net earnings from self-employment.  Its basis for doing so was that the limited partners’ interest conformed to state law.  The IRS disagreed asserting that wasn’t enough and that the functions and roles of the limited partners also had to be analyzed for self-employment tax purposes. The Tax Court agreed with the IRS.

At issue was the definition of a “limited partner” for purpose of the exception from s.e. tax under I.R.C. §1402(a)(13).  The Tax Court noted that the proposed regulations provided a definition, that the Congress froze the finalization of the regulation for six months and has said very little about the issue since the freeze was lifted and has not provided a definition.  The Tax Court noted that it had applied a “functional analysis” test in Renkemeyer, Campbell & Weaver, LLP, 136 T.C 137 (2011), but that this was the first time the Tax Court was asked to determine the self-employment tax status of limited partner in a state law limited partnership (having passed on the issue in a 2020 case). 

The Tax Court determined that the functional analysis test applied based largely on statutory construction of I.R.C. §1402(a)(13) which excludes from self-employment tax “the distributive share of any item of income or loss of a limited partner, as such.”  The Court concluded that the “as such” language meant that there wasn’t a blanket exclusion for a limited partner.  Instead, the statute only applies to a limited partner that is acting as a limited partner.  If a limited partner is anything more than merely an investor, self-employment tax applies to the partner’s distributive share. 

Note:  The Tax Court noted that the petitioner cited legislative history in an attempt to support its position, but that the legislative history actually supported the position of the IRS.  The Tax Court also noted that the petitioner put forth “myriad other arguments” none of which were persuasive.  The petitioner even cited language in the instructions for Form 1065 which it claimed defined a limited partner, but the Tax Court noted that the definition did not purport to define a limited partner. 

The Tax Court held that a functional inquiry into the roles and activities of the petitioner’s individual partners under I.R.C. §1402(a)(13) “involves factual determinations that are necessary to determine Soroban’s aggregate amount of net earnings from self-employment.”  Accordingly, the Tax Court denied the petitioner’s motion for summary judgment and set forth the rule going forward in evaluating the application of self-employment tax for limited partners in professional service businesses.

The manager-managed LLC provides a better result than the result produced by the member-managed LLC for LLCs that are not service partnerships.  For those that are, the S corporation is the business form to use to achieve a better tax result.  For an S corporation, “reasonable” compensation will need to be paid subject to S.E. tax, but the balance drawn from the entity can be received self-employment tax free.  But, for farming operations with land rental income, the manager-managed LLC can provide a better overall tax result than the use of an S corporation because of the ability to eliminate the net investment income tax.   

Of course, the self-employment tax and the net investment income tax are only two pieces of the puzzle to an overall business plan.  Other non-tax considerations may carry more weight in a particular situation.  But for some, this strategy can be quite beneficial.

Soroban Capital Partners LP lays down the rule that it’s not enough to simply hold a limited partnership interest under state law (in the context of a professional service business).  A limited partner must truly be acting as an investor and no more. 

Proper structuring of the LLC and careful drafting of the operating agreement is important. 

Conclusion

I will continue the trek through the “Top Ten” of 2023 in the next post.

Top Ten Developments in Agricultural Law and Taxation in 2023 – (Part One)

Overview

With my two prior blog articles I started looking at some of the most significant developments in agricultural law and taxation during 2023.  With today’s article I begin the look at what I view as the ten most significant developments in 2023.  These make my Top Ten list because of their significance on a national level to farmers, ranchers, rural landowners and agribusiness in general.

Developments ten through eight of 2023 – that’s the topic of today’s post.

10. Entire Commercial Wind Development Ordered Removed

United States v. Osage Wind, LLC, No. 4:14-cv-00704-CG-JFJ,

2023 U.S. Dist. LEXIS 226386 (N.D. Okla. Dec. 20, 2023)

In late 2023, a federal court ordered the removal of an entire commercial wind energy development (150-megawatt) in Oklahoma and set a trial for damages.  The litigation had been ongoing since 2011 and was the longest-running legal battle concerning wind energy in U.S. history.  The ruling follows a 2017 lower court decision concluding that construction of the development constituted “mining” and required a mining lease from a tribal mineral council which the developers failed to acquire.  United States v. Osage Wind, LLC, 871 F.3d 1078 (10th Cir. 2017).  The court’s ruling granted the United States, the Osage Nation and the Osage Minerals Council permanent injunctive relief via “ejectment of the wind turbine farm for continuing trespass.”

The wind energy development includes 84 towers spread across 8,400 acres of the Tallgrass Prairie involving leased surface rights, underground lines, overhead transmission lines, meteorological towers and access roads.  Removal costs are estimated at $300 million.  In 2017, the U.S. Circuit Court of Appeals for the Tenth Circuit held that the wind energy company’s extraction, sorting, crushing and use of minerals as part of its excavation work constituted mineral development that required a federally approved lease.  The company never received one.  The Osage Nation owns the rights to the subsurface minerals that it purchased from the Cherokee Nation in the late 1800s pursuant to the Osage Allotment Act of 1906.  The mineral rights include oil, natural gas and the rocks that were mined and crushed in the process of developing the project. 

In its decision to order removal of the towers, the court weighed several factors but ultimately concluded that the public interest in private entities abiding by the law and respecting government sovereignty and the decision of courts was paramount.  The court pointed out that the defendant’s continued refusal to obtain a lease constituted interference with the sovereignty of the Osage Nation and “is sufficient to constitute irreparable injury.” 

Note:  The lengthy litigation resulting in the court’s decision is representative of the increasing opposition in rural areas to wind energy production grounded in damage to the viewshed, landscape and wildlife.  During 2023, including the court’s opinion in this case, there were 51 restrictions or rejections of wind energy projects and 68 rejections of solar energy projects.  See, Renewable Rejection Database, https://robertbryce.com/renewable-rejection-database/

9.         Reporting Foreign Income

Bittner v. United States, 598 U.S. 85 (2023)

The Bank Secrecy Act of 1970 requires U.S. financial institutions to assist U.S. government agencies in detecting and preventing money laundering by, among other things, maintaining records of cash purchases of negotiable instruments, filing currency transaction reports for cash transactions exceeding $10,000 in a single business day, and reporting suspicious activities that might denote money laundering, tax evasion and other crimes.  The law also requires a U.S. citizen or resident with foreign accounts exceeding $10,000 to report those account to the IRS by filing FinCEN Form 114 (FBAR) by the due date for the federal tax return.  The failure to disclose foreign accounts properly or in a timely manner can result in substantial penalties. 

In this case, the plaintiff was a dual citizen of Romania and the United States.  He emigrated to the United States in 1982, became a U.S. citizen, and lived in the United States until 1990 when he moved back to Romania.  He had various Romania investments amounting to over $70 million.  He had 272 foreign accounts with high balances exceeding $10,000.  He was not aware of the FBAR filing requirement for his non-U.S. accounts until May of 2012.  The initial FBARs that he filed did not accurately report all of his accounts.  In 2013, amended FBARs were filed properly reporting all of his foreign accounts.  The IRS audited and, in 2017, computed the plaintiff’s civil penalties at $2,720,000 for a non-willful violation of failing to timely disclose his 272 foreign account for five years 2007-2011.

The plaintiff denied liability based on a reasonable cause exception.  He also claimed that the penalty under Section 5321 of the Bank Secrecy Act applied based on the failure to file an annual FBAR reporting the foreign accounts, and that the penalty was not to be computed on a per account basis. 

The trial court denied the plaintiff’s reasonable cause defense and held him liable for violations of the Bank Secrecy Act.  The trial court determined that the penalty should be computed on a per form basis and not on a per account basis.  Thus, the trial court computed the penalty at $50,000 ($10,000 per year for five years).  On appeal, the appellate court affirmed on the plaintiff’s liability (i.e., rejected the reasonable cause defense), but determined that the penalty was much higher because it was to be computed on a per account basis. 

On further review, the U.S. Supreme Court (in a 5-4 decision) determined that the penalty was to be computed on a per form basis and not a per account basis.  The Court’s holding effectively reduced the plaintiff’s potential penalty from $2.72 million to $50,000.  The majority relied on the text, IRS guidance, as well as the drafting history of this penalty provision in the Bank Secrecy Act.  The Court did not address the question of where the line is to be drawn between willful and non-willful conduct for FBAR purposes. 

Note:  The Supreme Court’s decision was a major taxpayer victory.  However, the point remains that foreign bank accounts with a balance of at least $10,000 at any point during the year must be reported.  This is an important point for U.S. citizen farmers and ranchers with farming interests in other countries. 

8. New Corporate Reporting Requirements

            Corporate Transparency Act (CTA), P.L. 116-283

Overview.  The Corporate Transparency Act (CTA), P.L. 116-283, enacted on January 1, 2021 (as the result of a veto override), as part of the National Defense Authorization Act, was passed to enhance transparency in entity structures and ownership to combat money laundering, tax fraud and other illicit activities. In short, it’s an anti-money laundering initiative designed to catch those that are using shell corporations to avoid tax.  It is designed to capture more information about the ownership of specific entities operating in or accessing the U.S. market.  The effective date of the CTA is January 1, 2024.   

Who needs to report?  The CTA breaks down the reporting requirement of “beneficial ownership information” between “domestic reporting companies” and “foreign reporting companies.”  A domestic reporting company is a corporation, limited liability company (LLC), limited liability partnership (LLP) or any other entity that is created by filing of a document with a Secretary of State or any similar office under the law of a state or Indian Tribe.  A foreign reporting company is a corporation, LLC or other foreign entity that is formed under the law of a foreign country that is registered to do business in any state or tribal jurisdiction by the filing of a document with a Secretary of State or any similar office. 

Note:  Sole proprietorships that don’t use a single-member LLC are not considered to be a reporting company. 

Reporting companies typically include LLPs, LLLPs, business trusts, and most limited partnerships and other entities are generally created by a filing with a Secretary of State or similar office. 

Exemptions.  Exemptions from the reporting requirement apply for securities issuers, domestic governmental authorities, insurance companies, credit unions, accounting firms, tax-exempt entities, public utility companies, banks, and other entities that don’t fall into specified categories.  In total there are 23 exemptions including an exemption for businesses with 20 or more full-time U.S. employees, report at least $5 million on the latest filed tax return and have a physical presence in the U.S.   But, for example, otherwise exempt businesses (including farms and ranches) that have other businesses such as an equipment or land LLC or any other related entity will have to file a report detailing the required beneficial ownership information.  Having one large entity won’t exempt the other entities. 

What is a “Beneficial Owner”?  A beneficial owner can fall into one of two categories defined as any individual who, directly or indirectly, either:

• Exercises substantial control over a reporting company, or
• Owns or controls at least 25 percent of the ownership interests of a reporting company

Note:  Beneficial ownership is categorized as those with ownership interests reflected through capital and profit interests in the company.

What must a beneficial owner do?  Beneficial owners must report to the Financial Crimes Enforcement Network (FinCEN).  FinCEN is a bureau of the U.S. Department of the Treasury that collects and analyzes information about financial transactions to combat domestic and international money laundering, terrorist financing and other international crimes.  Beneficial owners must report their name, date of birth, current residential or business street address, and unique identifier number from a recognized issuing jurisdiction and a photo of that document.  Company applicants can only be the individual who directly files the document that creates the entity, or the document that first registers the entity to do business in the U.S.  A company applicant may also be the individual who is primarily responsible for directing or controlling the filing of the relevant document by someone else. This last point makes it critical for professional advisors to carefully define the scope ot engagement for advisory services with clients.

Note:  If an individual files their information directly with FinCEN, they may be issued a “FinCEN Identifier” directly, which can be provided on a BOI report instead of the required information.

Filing deadlines.  Reporting companies created or registered in 2024 have 90 days from being registered with the state to file initial reports disclosing the persons that own or control the business. NPRM (RIN 1506-AB62) (Sept 28, 2023). If a business was created or registered to do business before 2024, the business has until January 1 of 2025 to file the initial report.  Businesses formed after 2024 must file within 30 days of formation.  Reports must be updated within 30 days of a change to the beneficial ownership of the business, or 30 days from when the beneficial owner becomes aware of or has reason to know of inaccurate information that was previously filed. 

Note:  FinCEN estimates about 32.6 million BOI reports will be filed in 2024, and about 14.5 million such reports will be filed annually in 2025 and beyond. The total five-year average of expected BOI update reports is almost 12.9 million.

Penalties.  The penalty for not filing is steep and can carry the possibility of imprisonment.  Specifically, noncompliance can result in escalating fines ranging from $500 per day up to $10,000 total and prison time of up to two years.    

State issues.  A state is required to notify filers upon initial formation/registration of the requirement to provide beneficial ownership information to the FinCEN.  In addition, states must provide filers with the appropriate reporting company Form.

How to report.  Businesses required to file a report are to do so electronically using FinCEN’s filing system obtaining on its BOI e-filing website which is accessible at https://boiefiling.fincen.gov. 

Note:  On December 22, 2023, FinCEN published a rule that governing access to and protection of beneficial ownership information. Beneficial ownership information reported to FinCEN is to be stored in a secure, non-public database using rigorous information security methods and controls typically used in the Federal government to protect non-classified yet sensitive information systems at the highest security level. FinCEN states that it will work closely with those authorized to access beneficial ownership information to ensure that they understand their roles and responsibilities in using the reported information only for authorized purposes and handling in a way that protects its security and confidentiality.

Conclusion

I will continue the trek through the “Top Ten” of 2023 in the next post.

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.

Tax Issues with Customer Loyalty/Reward Programs

Overview

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. 

Tax issues associated with customer “loyalty” programs – it’s the topic of today’s post.

Treasury Regulations – Impact on Retailers

When is economic performance?  Treasury Regulation §1.461-4(g)(3) addresses the treatment of rebates and refunds and specifies that economic performance occurs when payment is made to the person to whom the liability is owed.  The IRS position is that a retailer cannot claim a deduction until the points are actually redeemed because the event fixing the retailer’s liability occurs when a member reaches the minimum number of points for redemption and actually redeems the points. Internal Revenue Manual 4.43.1.12.6.5(5); Priv. Ltr. Rul. 200849015 (Dec. 5, 2008).   But, for an accrual basis taxpayer, the taxpayer’s liability becomes fixed (and, hence, a deduction can be claimed) when the customers earn the rewards.  Giant Eagle, Inc. v. Comr., 822 F.3d 666 (3d Cir. 2016), rev’g., T.C. Memo. 2014-146. A deduction is not deferred until the customer redeems the rewards. 

Note:   The IRS does not agree on this point and only follows the Third Circuit’s decision in cases appealable to the Third Circuit that cannot be distinguished.  A.O.D. 2016-03 (Oct. 3, 2016).

Two requirements.  Treasury Regulation §1.451-4 addresses trading stamps and premium coupons that are issued with sales and are redeemable in cash, merchandise or “other property.”  Most retailer customer loyalty programs likely satisfy both tests. The National Office of IRS, in a matter involving an accrual basis supermarket chain that had a rewards program that allowed customers to get a certain amount of gas for free depending on purchases of products, said that the supermarket could take a current deduction for the value of the gas rewards. F.S.A. 20180101F (Nov. 7, 2017).   The IRS reached that result by concluding that the gas rewards were being redeemed for “other property.” Treas. Reg. §1,451-4(a)(1).  Clearly, the rewards were issued on the basis of purchases.

Loyalty reward programs that might not satisfy the “redeemable in cash, merchandise or other property test” might be programs that provide customers with cents-off coupons.  With these programs, the IRS could argue that a customer’s right to redeem the coupon is conditioned on a future purchase and, as a result, the coupon liability should be matched to the later sale when the liability becomes fixed and determinable and economic performance occurs.  I.R.C. §461.

Timing of deduction.  The regulation provides that the estimated redemption costs of premium coupons issued in connection with the sale of merchandise is deductible in the year of the merchandise sale, even though the reserves for future estimated redemption costs are not fixed and determinable and don’t otherwise meet the economic performance rules of the all-events test.  Internal Revenue Manual 4.43.1.12.6.5(4).

Retailers with loyalty programs that satisfy the two tests of Treas. Reg. §1.451-4 may find the use of this method preferential from a tax standpoint.  For retailers that can qualify but are not presently using the Treas. Reg. §1.451-4 approach, a method change is required. The method change is achieved by using the advance consent procedures of Rev. Proc. 97-27. 1997-1 C.B. 680. If a loyalty program does not meet the requirements to use Treas. Reg. §451-4, the redemption liability is treated as a deduction and not as an exclusion from income.  Thus, the redemption liability is taken into account in the tax year in which the liability becomes fixed and determinable and economic performance occurs under I.R.C. §461.  That will, in general, be the year in which the customer redeems the loyalty rewards. 

Tax Issues for Customers

Anikeev, et ux. v. Comr., T.C. Memo. 2021-23

In 2021, the Tax Court issued an opinion providing guidance on how a taxpayer, as a user of a rewards program is to report the transactions on the taxpayer’s return, and whether the IRS “rebate rule” is applicable.  In Anikeev, the petitioners, husband and wife, spent over $6 million on their credit card between 2013 and 2014. Nearly all of these purchases were for Visa gift cards, money orders or prepaid debit card reloads that the couple later used to pay the credit card bill.  The credit card earned them five percent cash back on certain purchases after they spent $6,500 in a single calendar year. Before purchases were sufficient for them to reach the five percent level, the card earned one percent cash back on certain purchases.

Rewards were issued in the form of “rewards dollars” that could be redeemed for gift cards and statement credits.  In 2013, the petitioners redeemed $36,200 in rewards dollars from the card as statement credits in 2013 and $277,275 in 2014.  The petitioners did not report these amounts as income for either year.  The IRS audited and took the position that the earnings should have been reported as “other income” as an exception to the IRS “rebate rule.”  Under the rule, when a seller makes a payment to a customer, it’s generally seen as a “price adjustment to the basis of the property.”  It’s a purchase incentive that is not treated as income.  Instead, the incentive is treated as a reduction of the purchase price of what is purchased with the rewards or points. Thus, points and cashback earned on spending are viewed as a non-taxable purchase price adjustment.  The petitioners cited this rule, pointing out that the “manner of purchase of something…does not constitute an accession of wealth.  The IRS, however, claimed that the rewards were taxable upon receipt irrespective of how the gift cards were later used. 

The Tax Court noted that the gift cards were a “product.”  Thus, the portion of their reward dollars associated with gift card purchases weren't taxable.  However, the Tax Court held that the petitioners’ direct purchases of money orders and reloads of cash into the debit cards using their credit card was different in that the petitioners were buying “cash equivalents” rather than a rebate on a purchase.  Thus, the transaction did not involve the purchase of a product subject to a price adjustment.  The purchase of a cash equivalent was different than obtaining a product or service.  Because there was no product or service obtained in connection with direct money order purchases and cash reloads, the reward dollars associated with those purchases were for taxable cash infusions. 

The Tax Court also noted that the petitioners’ practice would most often have been ignored if it had not been for the petitioners’ “manipulation” of the rewards program using cash equivalents.  Thus, the longstanding IRS rule of not taxing credit card points did not apply.  Importantly, the Tax Court held that reward points become taxable when massive amounts of cash equivalents are purchased to generate wealth.  The petitioners did this by buying money orders and funding prepaid debit cards with a credit card for cash back, and then immediately paying the credit card bill. 

Note:  The Tax Court stated that it would like to see some reform in this area that provides guidance on the issue of credit card rewards and the profiting from buying cash equivalents with a credit card. 

Tax Issues for Retailers

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

Facts of the case.  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.   

Note:  Most third-party owners simply deducted payments to the Fund when paid regardless of whether economic performance would have occurred for expenses accrued for redemption, advertising and operating costs. 

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. 

Fund revenue includible in income.  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. 

Note:  The “trust fund” doctrine allows for the exclusion from gross income of funds received in trust, subject to a legally enforceable restriction that the funds be spent entirely for a specific purpose, where the taxpayer does not profit, gain or benefit from spending the funds for that purpose.  In Hyatt, the Tax Court determined that the trust fund doctrine did not apply because the petitioner: 1) mandated participation and payments into the Fund; 2) controlled the amounts of program payments to the Fund and the payments from the Fund; 3) made the decisions as to how Fund amounts were to be invested; 4) accrued interest and realized gains on investments in the Fund; and 5) decided whether Fund amounts would cover advertising and/or administrative costs.  In other words, the petitioner received more than “incidental and secondary” benefits from the Fund.

In addition, the Tax Court pointed out that the petitioner benefited directly from the Fund based, in part, on the Fund generating goodwill among customers that lead to increased bookings and royalties and fees.  Indeed, the petitioner owned approximately 25 percent of the hotels that paid into the fund which indicated a clear benefit to the petitioner’s own interests. 

No I.R.C. §481 adjustment.  However, in a major win for the petitioner, the Tax Court also determined that the petitioner’s treatment of Fund revenue and expenses did not amount to the adoption of a method of accounting.  Thus, no I.R.C. §481 adjustment was required.  The petitioner’s consistent and total exclusion of Fund revenue and expense did not involve timing and, therefore, was not a method of accounting. The petitioner had simply excluded the Fund amounts from gross income and would have continued to do so if the Fund had ended and the amounts in the Fund distributed to member hotels.   

Note:  The normal statute of limitation of I.R.C. §6501 does not apply when an accounting method change has occurred.  Had the petitioner adopted an impermissible accounting method, the IRS would not have been time-barred to make adjustments. 

Trading stamp method inapplicable.  As for the application of the “trading stamp method” of reporting income and expense, the petitioner claimed that Fund gross receipts should be offset by both the current year reward redemptions and the estimated cost of future tax year reward redemptions (i.e., an acceleration of deduction beyond actual program costs). The Tax Court disagreed on the basis that a hotel stay, which is either characterized as a license or a leasehold, would not qualify as merchandise, cash or other property as the trading stamp method required. The Tax Court also clarified that “other property” for purposes of Treas. Reg. §1.451-4 means property similar to merchandise or cash.  “Other property” is not a hotel stay.  It is, rather, tangible property.

Conclusion

The Anikeev and Hyatt cases lay down good “markers” 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.  Hyatt is basically a win for the taxpayer, because most of the adjustments that IRS proposed were time-barred once the Tax Court determined that a method of accounting had not been adopted. 

For retailers with customer reward programs, conforming closely to the “trust fund doctrine” is essential to achieving the desired tax treatment. 

More Issues in Ag Law and Tax for Farmers, Ranchers and Rural Landowners

Overview

The issues in the courts and with the IRS that are important to farmers and ranchers keep on coming.  Soon, I will be posting what I view to be the biggest developments of 2023.  For today’s post, I summarize some key matters and pose some year-end tax planning thoughts for which there still might be time to utilize for the 2023 return.

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

Important “Takings” Case at Supreme Court

DeVillier v. Texas, 63 F.4th 416 (5th Cir. 2023)

The government has the right to take your property from you if it wants it for a public use.  But, under the Fifth Amendment, the government must pay you for it.  The right to receive just compensation for property the government takes is in the Fifth Amendment.  It’s an important issue for farmers and ranchers because of how critical land ownership is to farming and ranching.  A case soon to be argued at the U.S Supreme Court involving a Texas farmer tests the limits of the government’s taking power. 

The family involved in the case has farmed the same land for a century.  There never was a 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.  In essence, the farm had been turned into a retention pond. 

The farmer sued the State to get paid for the taking of his farm.  Once the case got to federal court, the appellate court dismissed it, saying that the farmer couldn’t sue under the Fifth Amendment – only State officials can.  But that seems incorrect.  The Fifth Amendment contains a remedy when the government takes your property – you get paid for it. 

The U.S. Supreme Court agreed to hear the case on Sept. 29, 2023.  The oral argument date is set for January 16, 2024.  The Court’s decision will likely be issued by the end of June.  The outcome will be an important one for agriculture. 

Tax Treatment of Income from Farm-Related Assets

Breeding fees.  If you report income from breeding fees and then later issue a refund, still report the breeding fees as income in the year received, but then take a deduction when the refund is made.

Soil, sod and other minerals.  Report the sale of soil, sod and other minerals on a regular basis as ordinary income.  For mineral deposits, the disposition could be held to be a sale reported as capital gain.  But that probably is not going to be the case in most situations because a lease was likely involved.   

Crop share or livestock share rent is included in income in the year it is reduced to money (or its equivalent), fed to livestock or donated to charity. For livestock, the amount of cash received during the tax year from the sale of livestock is included in gross income. 

Farmland and breeding stock.  Gains and losses arising from the sale of certain capital assets such as farmland and breeding livestock get a special, capital gain, tax treatment that is often at a lower rate than the seller’s individual rate.

Land trades.  If you trade land, if the trade is even in dollars there still could be ordinary gain to report unless you trade bare land for bare land.  This often comes as a surprise to farmers trading land.

Tax Strategy for Purchased Livestock

A key question for many farmers is whether livestock purchased for draft, dairy or breeding purposes should be depreciated or included in inventory.  While purchased livestock that are held primarily for sale must be included in inventory, livestock that are purchased or raised for draft, breeding or dairy purposes may be depreciated.  What’s the best tax strategy – should you include them in inventory or depreciate them?  As with many tax questions, the answer “depends.”

Depreciation is beneficial for several reasons – it’s an ordinary deduction that reduces your net and self-employment income; any depreciation recapture is not subject to self-employment tax for sole proprietors and partners in a partnership; and the amount of gain in excess of original cost can qualify to be taxed at favorable capital gains rates.

So, is this a better tax result than capitalizing livestock and holding them in inventory?  The answer turns on whether a current deduction for depreciation will outweigh subsequent capital gain treatment upon sale.  For high volume sales generating significant income, an inventory method might be better.

If you use accrual accounting, generally the livestock should be inventoried at the lowest possible value.  But carefully select the inventory method that is utilized. 

Is a “Legal” Fence a “Sufficient” Fence?

If your fence meets the state law requirements for a “legal” fence, is that enough to shield you from liability if your animals get out and cause damage?  Not necessarily.  A legal fence must also be a "sufficient" fence.  Having a legal fence does not mean that you won’t be liable for damage your animals cause if they escape. Not having a legal fence is negligence. So, having a legal fence is the minimum standard, but it is not necessarily a sufficient fence for livestock.  There are numerous cases that have involved a legal fence where the court held it was not deemed to be a sufficient fence.

This issue often comes up with animals other than cattle. But it can come up with cattle also. The situation is based on the facts, but the point is if your fence meets the requirements to be a legal fence, that's just the first step of the analysis. It still must be a sufficient fence to keep your animals in if you live in a "fence-in" jurisdiction – which is most of the country.

Don't cause issues with your neighbor by insisting that your fence meets the minimum statutory requirements. That's literally the least you can do.  You must do more under the law.

Entire Commercial Wind Development Ordered Removed

United States v. Osage Wind, LLC, No. 4:14-cv-00704-CG-JFJ,

2023 U.S. Dist. LEXIS 226386 (N.D. Okla. Dec. 20, 2023)

A federal court has now ordered the removal of an entire commercial wind energy development in Oklahoma and set a trial for damages.  The litigation has been ongoing for over 10 years.  The ruling follows a 2017 lower court decision concluding that construction of the development constituted “mining” and required a mining lease from a tribal mineral council which the developers failed to acquire. 

The wind energy development includes 84 towers spread across 8,400 acres of leased surface rights, underground lines, overhead transmission lines, meteorological towers and access roads. In 2017, the U.S. Circuit Court of Appeals for the Tenth Circuit held that the wind energy company’s extraction, sorting, crushing and use of minerals as part of its excavation work constituted mineral development that required a federally approved lease.  The company never received one.

In its decision to order removal of the towers, the court weighed several factors but ultimately concluded that the public interest in private entities abiding by the law and respecting government sovereignty and the decision of courts was paramount.

Optimizing Tax Liability

Many farmers often want to eliminate income taxes every year.  But maybe a better strategy over the long run is to optimize the amount paid each year.  That can be done in several ways, and there still might be time to use some of the techniques on your 2023 return. 

As a farmer you can file and pay income taxes by March 1 or simply pay one estimated tax payment on January 15 and then pay the balance on April 15.  To do this, the amount you need to pay by January 15 is the lesser of 100 percent of the prior year’s tax or two-thirds of this year’s tax.  With higher interest rates, the saving on deferring tax for six weeks can add up.  Do the math to figure out what the best approach is for you.

Also, you can decide to not defer grain contract income by reporting the income in 2023.  Similarly, only the portion of crop insurance payments received in 2023 that relate to yield loss is deferable.  The price loss portion is not deferable into 2024. 

For 2024, if you have children under the age of 18 that work on your farm, paying them wages won’t trigger payroll tax.  If they are older, pay them in grain to get the same result.  Also, consider gifts of grain to children to drop your tax liability and not create one for a child.

Conclusion

Just some “odds and ends” to think about this last week of December. 

Conservation Easement Valuation Upheld – Reasonable Cause Defense at Issue

Overview

The donation of a permanent conservation easement on farm or ranch land can provide a significant tax benefit to the donor.  The donor can receive an income tax deduction equal to the FMV of the contributed conservation easement at the time of the donation (I.R.C. §170(h); Treas. Reg. §1.170A-14); an estate tax benefit at death by excluding the fair market value of the donated easement from the donor’s (landowner’s) gross estate (I.R.C. §2031(c)(1)-(2)); and a possible reduction in property taxes (dependent on state law).  In addition, during life, the donor retains the right to sell or transfer the property subject to the easement restrictions.

Note:  The rules are complex and must be carefully complied with to obtain the tax benefits that are possible – qualified farmers and ranchers can deduct up to 100 percent of their income (i.e., the contribution base).  I.R.C. §170(b)(1)(E)(iv)(I). For others, the limit is 50 percent of annual income. I.R.C. §170(b)(1)(B). 

IRS Concerns

The key to securing a tax deduction for the donation of a permanent conservation easement is the proper drafting of the easement deed (as well as an accurate and detailed appraisal of the property).  That’s the instrument that conveys the legal property interest of the easement to the qualified charity (qualified land trust, etc.).  This document must be drafted very precisely. For example, the donor must not reserve rights that are conditioned upon the donee’s consent.  This is termed a deemed consent provision, and it will cause the donated easement to fail to be a perpetual easement – one of the requirements to get a charitable contribution deduction.  See Treas. Regs. §§1.170A-14(e)(2); 1.170A-14(g)(1); 1.70A-14(g)(6)(ii).

The IRS also takes the position that the perpetuity requirement is not met if a mortgage on the property is not subordinated.  For instance, in Palmolive Building Investors, LLC v. Comr., 149 T.C. 380 (2017), a charitable deduction was denied because the mortgages on the property were not subordinated to the donated façade easements as Treas. Reg. §1.170A-14(g)(2) requires.  In addition, the deed at issue stated that the mortgagees had prior claims to extinguishment proceeds.  That language violated the requirement set forth in Treas. Reg. §1.170A-14(g)(6)(ii).  A savings clause in the deed did not cure the defective language because the requirements of I.R.C. §170 must be satisfied at the time of the easement is donated. 

The case law also supports the IRS position that development rights and locations for development cannot be reserved on the property subject to the easement if it changes the boundaries for the easement.  In other words, the IRS position is that the easement deed language must place a perpetual encumbrance on specifically defined property that is fixed at the time of the grant.  However, if the easement only allows the boundary of potential development to be changed on a portion of a larger parcel that is subject to the easement restrictions and neither the acreage of potential development nor the easement is enhance, the perpetuity requirement remains satisfied.  See, e.g., Bosque Canyon Ranch II, L.P. v. Comr., 867 F.3d 547 (5th Cir. 2017); Treas. Reg. §1.170A-14(f).

Another problem with easement deeds that the IRS watches for is whether the deed language allows the donor and donee to mutually agree to amend the deed.  If this reserved right is present, the IRS takes the position that the easement is not perpetual in nature and does not satisfy the perpetuity requirement of I.R.C. §170(h)(2)(C).  But there is an exception.  Amendment language is allowed if any subsequent transfer by the donee (via amendment language in the deed) facilitates the conservation purpose of the original transfer to the donee organization.  Treas. Reg. §1.170A-14(c)(2); see also Butler v. Comr., T.C. Memo. 2012-72. 

Another requirement is that the taxpayer must disclose (on Form 8283) the income tax basis in the property being subjected to a conservation easement that is donated to a qualified charity.  This is part of the substantiation requirements for non-cash charitable donations.

Recent Case

In Murfam Enterprises, LLC v. Comr., T.C. Memo. 2023-73, the petitioner was a partnership owned by the Murphy family who began a hog empire in North Carolina and is largely credited with reshaping the hog production industry into the large-scale, confinement facility, contract production structure that it is today.  In 1999, the partnership acquired a 6,171-acre tract of undeveloped rural land in North Carolina, largely covered in trees. The partnership obtained a certificate permitting it to engage in raising hogs on 1,115 acres of the property.  The certificates were a restriction that “ran with the land” subjecting any future owner to the same restriction.  The certificates authorized the raising of up to 58,752 swine in a feeder-to-finish facility, or 19,538 sows in a “farrow-to-wean” facility.  In 2007, the state of North Carolina imposed a moratorium on any new certificates, but existing certificates would remain honored.  In 2010, the family decided not to clear the land and build more hog facilities, preferring instead to use the land for recreational purposes.  The partnership then donated a permanent conservation easement on the 1,115 acres where hog production was allowed, thereby making the certificates useless.  An expert valued the easement at $5.745 million (based on the before-and-after approach).

The IRS audited the partnership return and proposed to reduce the charitable contribution to $446,000.  The IRS did not assert any penalty and did not claim that the charitable deduction should be denied based on the partnership’s failure to fully complete Form 8283.

The partnership challenged the IRS position in Tax Court.  In its answer, the IRS (for the first time) asserted a gross valuation misstatement penalty under I.R.C. §6662(e) or (h).  The IRS also, alternatively, argued for an accuracy-related penalty under I.R.C. §6662(a). 

Note:  On the penalty issue, the IRS bore the burden of proof, which also meant that the IRS had to establish that the partnership lacked reasonable cause for any errors on the return regarding the charitable deduction.    

Later, in a pretrial memo, the IRS claimed that the charitable deduction should be denied in full because of the partnership’s failure to substantiate the donation by not providing the income tax basis of the property on Form 8283. 

Tax Court agreed with the IRS that the partnership’s failure to report the basis for the land on Form 8283 did not comply with the applicable regulations, but that a deduction could still be allowed if the failure to comply with the regulation was due to reasonable cause and not a result of willful neglect.  I.R.C. §170(f)(11)(A)(ii)(II).  The Tax Court noted that the partnership relied on professional tax preparers to prepare the return and that the partnership had provided accurate and necessary information to the CPA firm to prepare the return appropriately (as testified to by the CPA firm).   

Note:  The record did not reveal whether the partnership actually provided the basis information to the CPA firm, there was also no evidence showing why it was not provided.  The IRS failure to cross examine witnesses and not claim that the partnership withheld evidence from the preparers until its reply brief was fatal to its position.

On the valuation, the Tax Court determined the value of the easement was $5.637 million rather than the $5.745 million reported on the return (and substantially more than IRS claimed).  The Tax Court also determined that the highest and best use of the property was as a farrow-to-wean operation, and that the expert report of the IRS was flawed in several respects.  

Ultimately, the partnership avoided the imposition of any penalties.  Importantly, the IRS did not assert a gross valuation misstatement penalty for which reasonable cause would not have been a defense.  See, e.g., Murphy v. Comr., T.C. Memo. 2023-72 (in a case involving the same family, a charitable deduction not disallowed due to omission on return because of reasonable reliance, but gross valuation penalty imposed because the petitioner seriously overstated the value of the donated easements). 

Conclusion

Murfam Enterprises, LLC v. Comr., T.C. Memo. 2023-73, was a big win for the partnership on the novel issue which party bears the burden of proof on the reasonable cause defense when the IRS raises the issue of noncompliance with the substantiation rules of I.R.C. §170(f)(11) as a new matter in litigation and reasonable cause for the noncompliance is at issue. 

Fortunately, the partnership hired competent professionals to prepare the return.  It was not the partnership’s fault that the CPA firm failed to follow the rules associated with preparing the return on which a large charitable deduction was claimed.  Clearly, the shift of the burden of proof to the IRS aided the partnership (along with the procedural failures of the IRS leading up to and at trial in the case). 

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.