Wednesday, May 24, 2023
Tax Potpourri – Hobby Losses; Employer-Provided Housing; Tax Computation for Fuel Blenders; and Conservation Easement Deeds
Overview
Recently, the U.S. Tax Court has issued opinions involving several areas that also can involve farmers and ranchers. With today’s post I highlight some of those recent cases and provide some context for how the issues might apply to agricultural producers and/or agribusinesses.
Recent Tax Court cases (and a Rev. Rul.) of interest – it’s the topic of today’s post.
IRS Focuses on Wrong Issues – Loses Hobby Loss Argument
Carson v. Comr., No. 23086-21S (U.S. Tax Ct. Mar. 22, 2023)
The Oklahoma ranch at issue was originally owned by the petitioner’s grandmother and then inherited by petitioner’s mother. In 2009, as part of a family succession plan, the petitioner’s mother transferred the ranch to a revocable trust. Under the trust’s terms, if the mother died and was predeceased by the petitioner’s stepfather, the ranch would pass equally to the petitioner and her brother. If the petitioner’s stepfather were alive at the time of the mother’s death, the ranch would remain in trust for his life and then distribute equally to the petitioner and her brother upon the stepfather’s death. The petitioner and her mother executed two separate agreements in 2013 and 2016 whereby the petitioner agreed to contribute financially to the ranch and that the petitioner and her mother would jointly agree about the amount, if any, of cash distributions from ranch earnings would be made to the petitioner. From 2014 to 2019, the petitioner paid the ranch expenses, but the mother reported on her return the income from cattle sales. The petitioner did not receive any cash distributions from ranching activities and as a result did not report ranch income. The petitioner’s children participated in rodeos, and the income from the rodeo activities were reported on the petitioner’s Schedule F under “livestock activities.” For 2017, the petitioner’s Schedule F reported gross income of $2,741 and deductions of $128,990 from the ranching activity. For 2018, the petitioner’s Schedule F reported gross income of $8,063, including $1.867 of compensation for labor services performed by the children for local ranches and $6,196 for the children’s rodeo competition winnings. Expense deductions claimed on Schedule F were $133,929. From 2014-2019, the petitioner reported cumulative losses of $502,742 on Schedule F which far exceeded the cumulative Schedule F gross income and largely offset the ordinary income of the petitioner and her husband (primarily wage income). IRS audited and determined that the Schedule F activity was rodeo and not ranching, ignoring the fact that the Schedule F expenses were predominantly from the ranching activity. As a result, the IRS determined that the rodeo activity was not engaged in with the requisite profit motive and disallowed all Schedule F deductions for 2017 and 2018. The Tax Court determined that the IRS had focused improperly on the rodeo activity rather than the ranching activity, noting that the petitioner had credibly testified that the Schedule F activities primarily related to the ranch and not to rodeos. As such, the losses related to the ranching activity and not the rodeo activity, and the IRS failed to challenge the profit motive of the ranching activity. The Tax Court refused to allow the IRS to refocus its challenge to the Schedule F deductions on the ranching activity, holding that the IRS had waived its right to do so. Thus, the activity reported on Schedule F for 2017 and 2018 was deemed to be engaged in for profit.
Note: It's puzzling why the IRS didn't question the arrangement between the petitioner and her mother. It's equally puzzling why the IRS focused solely on the Schedule F income resulting from the children’s rodeo activity. The arrangement between the petitioner and her mother was more akin to that of a partnership, and the fact that the ranch was in a revocable trust meant that the mother could revoke the trust at any time. That fact could have easily led IRS to claim that there really wasn’t a trade or business activity being conducted between the petitioner and her mother. Indeed, the expenses the petitioner paid were really the trust’s expenses meaning that it was the trust that was conducting the trade or business activity. It's also puzzling why the IRS did not focus on the fact that the arrangement was designed to prevent the petitioner from recognizing any income. But the IRS mistakenly claimed that the primary purpose of the business was to fund the rodeo activities of the children. There was no attempt to find and examine relevant information concerning the ranching activity.
Value of Employer-Provided Housing Not Excludible from Income
Smith v. Comr., T.C. Memo. 2023-6
The petitioner was an Air Force veteran and engineer who accepted an offer of employment with a defense contractor to work as an engineer in Australia. He was given options for housing - 1) a furnished house for which he would have to report the fair rental value on his return; or 2) a payment to compensate him for the cost or owning or renting housing. He accepted company-provided housing approximately 11 miles from his work location. After eight years of living in the company-provided housing, the company ceased providing housing and he had to find housing on his own. For 2016 and 2017, the petitioner reported the value of the housing provided to him on his return, but then filed amended returns that claimed an offsetting deduction for “employee benefit programs.” On his 2018 return he reported the value of the housing but also claimed a deduction for “employee benefit programs.” The IRS disallowed the deductions. The Tax Court noted that certain conditions must be satisfied to exclude the value of employer-provided lodging from income under I.R.C. §119 – the lodging must be furnished for the convenience of the employer; furnished on the business premises; and the employee must be “required to accept the lodging as a condition of employment. The Tax Court determined that the lodging was not furnished on the business premises. The petitioner’s occasional business activities at the home were not sufficient to establish that the housing was integral to the employer’s business activities and the housing was not necessary for the performance of his duties.
Note: There are numerous cases involving farms and ranches on the issue of employer-provided meals and lodging with the focus being on the definition of the “business premises” and “for the convenience of the employer.”
Excise Tax Expense Rather Than Gross Excise Tax Liability Used in Computing COGS for Fuel Blender
Growmark, Inc. v. Comr., 160 T.C. No. 11 (2023)
The petitioner, an agricultural supply cooperative that also blends fuel (including ethanol and biodiesel), serves the supply needs of its member-patrons that are primarily independent farmers. The petitioner incurred an I.R.C. §4801 fuel excise tax liability when it removed a taxable fuel that it owned as a position holder (holding inventory in a fuel distribution facility) from a rack at a distribution facility. The I.R.C. §4801 tax was also incurred with respect to the gallons of ethanol and biodiesel when it removed and sold the ethanol or biodiesel as part of an alcohol fuel mixture or biodiesel mixture. During the tax years at issue, the excise tax reflected the petitioner’s fuel mixtures for sale to third parties for use as a fuel. The ethanol that the petitioner produced and then blended with taxable fuel was eligible for either the alcohol fuel mixture excise tax credit of I.R.C. §6426(a)(1) and (b) or the alcohol mixture income tax credit under I.R.C. §40(a)(1). However, the petitioner only claimed the alcohol fuel and biodiesel mixture excise tax credits under I.R.C. §6426 for all of the alcohol fuel and biodiesel mixtures it produced and sold during 2009 and 2010. The petitioner filed Form 720 (Quarterly Excise Tax Credit Tax Return) for each of the quarters beginning or ending within its tax years 2009-2010 and claimed the credit on the Forms. As noted above, as a fuel blender the petitioner could reduce its taxable income from fuel mixture sales by subtracting its cost-of-goods-sold (COGS), including certain federal excise taxes. For each year in issue, the petitioner filed Form 1120-C (cooperative tax return) on which it included in its cost-of-goods-sold (COGS) its actual excise tax expense (excise tax liability less the amount of tax credits allowed under I.R.C. §6426). That caused the petitioner’s COGS to be lower and its taxable income higher than it would have been had its excise tax liability not been reduced by the tax credits it received. The petitioner later claimed that it could claim its gross excise tax liability unreduced by the tax credits it received as part of its COGS. The IRS disagreed. Thus, the issue was whether the petitioner had to reduce deductions based on fuel tax liability or include the refundable fuel tax credits in income. IRS had previously taken the position that when there is no actual excise tax liability, a purely refundable fuel tax credit does not reduce any deduction for fuel or create any addition to income. C.C.A. 201342010 (Aug. 29, 2013). When there is actual fuel tax liability, the IRS position is that the credits must first offset this liability and reduce the deduction for tax expense (or COGS) or be included in income. See Notice 2015-65, 2015-35, IRB 235; C.C.A. 201406001 (Jan. 13, 2014). The IRS has also won several court cases on the issue. See Sunoco, Inc. v. United States, 908 F.3d 710 (Fed. Cir. 2018), cert. den., 140 S. Ct. 46 (2019); Delek US Holdings, Inc. v. United States, 32 F.4th 495 (6th Cir. 2022); Exxon Mobil Corporation v. United States, 43 F. 4th 424 (5th Cir. 2022). The Tax Court agreed with the IRS, noting that the legislative history and the statutory construction supporting the conclusion that the tax credits must first be used to offset tax liability – actual excise expense rather than gross excise tax liability must be used to calculate COGS.
Note: The facts of the case did not allow the Tax Court to address the situation where the entity generating the fuel tax credit is separate from the activity generating the excise tax liability. Potentially, it could be possible to achieve the result the petitioner sought by structuring the taxpayer’s business differently.
Safe Harbor Language Provided for Conservation Easement Deeds
Notice 2023-30, 2023-17 IRB 766
Under Section 605(d)(1) of the SECURE 2.0 Act, which was enacted as part of the Consolidated Appropriations Act, 2023, P.L. 117-328, the IRS was required to provide safe harbor language for extinguishment and boundary line adjustment clauses in conservation easement deeds by April 28, 2023. IRS issued this Notice on April 24, 2023, providing the safe harbor language and triggering a 90-day period for a donor to amend an easement deed to substitute the safe harbor language for the corresponding language in the original deed. Thus, under Section 605(d)(2) of the Secure Act 2.0, donors are allowed, but not required, to amend their deeds to include this language. Donors wanting to make the change must do so by July 24, 2023. Any amendment will be treated as effective as of the date of the recording of the original easement deed. IRS points out in the Notice that an amendment cannot be made for any easement deed relating to any contribution that was part of a reportable transaction or was a transaction that was not treated as a qualified conservation contribution by reason of I.R.C. §170(h(7); a transaction for which a charitable deduction contribution had been disallowed by the IRS and the donor was contesting the disallowance in federal court before the amended deed was recorded; or a transaction for which a claimed charitable deduction for the contribution resulted in an underpayment and a penalty under I.R.C. §6662 or §6663 had been finally determined.
May 24, 2023 in Income Tax | Permalink | Comments (0)
Saturday, April 22, 2023
Deductibility of Personal Interest and the Home Mortgage Exception
Overview
The rules for the deductibility of interest can be a bit tricky. Also, to properly account for interest, the definition of interest is critical. In addition, there apparently is some confusion that has arisen concerning the proper classification of lender fees for tax purposes.
Today’s article takes a look at the deductibility of one of the classifications of interest – personal interest. A subsequent article will take a look at the tax deductibility of investment interest and business interest.
The tax treatment of personal interest and the exception for mortgage interest - it’s the topic of today’s post.
Background
Presently, there exist different rules for the three types of interest: personal interest, investment interest and business interest. For farmers and ranchers, the bulk of farm interest should be deductible as business interest. That makes the classification of interest the end of the inquiry critical to determining the proper tax treatment.
Personal Interest and the Exception for Mortgage Interest.
Personal interest is not deductible unless the debt is secured by a mortgage on the principal residence, which is referred to a qualified residence interest. I.R.C. §§163(h)(2)(D); (h)(3). Generally, qualified residence interest is any interest paid on a loan secured by the taxpayer’s main home and one other residence. See, e.g., Boehme v. Comr., T.C. Memo. 2003-81 (where loan was acquisition debt, but repayment was secured by taxpayer’s right to receive future lottery payments rather than the residence, loan interest was not qualified residence interest). If the other residence is rented out, the taxpayer or a member of the taxpayer’s family must use the second home for more than the greater of two weeks or 10 percent of the number of days when the residence is rented for a fair rent to persons other than family members. The loan may be a mortgage to buy the home, or a second mortgage. The exception to the rule of nondeducibility of personal interest applies to “qualified residence interest.” That is defined as interest associated with the taxpayer's principal residence on the first $750,000 ($375,000 if married filing separately) of indebtedness. These limits apply to the combined amount of loans used to buy, build or substantially improve the taxpayer’s main home and second home. The deduction is on a per taxpayer basis to unmarried co-owners of a qualified residence. See, e.g., Voss v. Comr., 796 F.3d 1051 (9th Cir. 2015).
Note: A higher limitation applies ($1 million ($500,000 if married filing separately)) if the mortgage interest is attributable to indebtedness incurred before December 16, 2017. Through 2022 this threshold also included mortgages taken out before October 13, 1987.
If the residence contains a business office for which a home office deduction is claimed, an allocation must be made between the part of the home that is the qualified home and the part that is not. The business portion of the home mortgage interest allowed as a deduction is included in the business use of the home deduction that is reported on Schedule C (Form 1040), line 30, or Schedule F (Form 1040), line 32. For taxpayers that itemize deductions on Schedule A, the personal part of the deductible mortgage interest is reported on Schedule A, line 8a or 8b and the business portion is reported on Schedule C (or F).
Mortgage interest is not deductible unless the taxpayer files either Form 1040 or 1040-SR and itemizes deductions on Schedule A. Also, the mortgage must be secured debt on a qualified home in which the taxpayer’s has an ownership interest. The mortgage must provide that the home satisfies the debt in the event of default. The mortgage must be recorded, and both the taxpayer and the lender must intend that the loan be repaid. A “wraparound mortgage” is secondary financing and is not secured debt unless it is recorded or otherwise perfected under state law.
Note. For tax years 2018 through 2025, an interest deduction is no longer available for home equity indebtedness unless the indebtedness is used to buy, build or substantially improve the taxpayer’s personal residence that secures the loan. The total loan balance (first mortgage and home equity loan is subject to the $750,000 (mfj) limitation. IR 2018-32, Feb. 21, 2018.
An election can be made to treat secured mortgage debt as not secured by the home. The election may only be revoked with IRS consent. The election might make sense in situations where the debt would be fully deductible as business debt regardless of whether it qualifies as home mortgage interest and would allow a greater interest deduction on another debt that would give rise to a deduction for home mortgage interest.
Unique Situations
Divorce. Questions concerning the deductibility of qualified residence interest can arise in unique situations. For example, if a divorce decree or separation agreement requires the taxpayer to make all of the mortgage payments on a jointly owned home with an ex-spouse, the taxpayer and the ex-spouse may each treat one-half of the interest payments as qualified residence interest if the home is a qualified residence. IRS Pub. No. 504 (2022), p. 14.
Retirement plan. If a loan from a qualified retirement plan is characterized as a distribution and is a bona fide loan, the interest may satisfy the definition of qualified residence interest. F.S.A. 200047022 (Aug. 22, 2000).
Trust or estate. Simply transferring title of a qualified residence to a trust does not disqualify the grantor’s continued payment of interest on the indebtedness as deductible qualified residence interest. See, e.g., Investment Research Associates Limited & Subsidiaries v. Comr., T.C. Memo. 1999-407. After the grantor dies, if the estate or a trust pays interest on a mortgage attributable to a residence that the estate or trust holds, the interest is treated as qualified residence interest if the residence is a qualified residence of a beneficiary having a present or residuary interest in the estate or trust. I.R.C. §163(h)(4)(D).
Mortgage interest refunds. The IRS ruled in Rev. Rul. 92-91, 1992-2 CB 49, that an interest overcharge due to the lender’s miscalculation of an adjustable-rate mortgage that the cash basis borrower paid was deductible in the year paid as qualified residence interest even though it was reimbursed in a later tax year.
Conclusion
A subsequent article will take a look at investment interest and business interest. Included in the discussion will be the issue of whether loan extension fees meet the definition of deductible business interest. That’s an issue that arisen recently with respect to some farm loans.
April 22, 2023 in Income Tax | Permalink | Comments (0)
Thursday, April 20, 2023
Bibliography – First Quarter of 2023
The following is a listing by category of my blog articles for the first quarter of 2023.
Bankruptcy
Failure to Execute a Written Lease Leads to a Lawsuit; and Improper Use of SBA Loan Funds
Chapter 12 Bankruptcy – Proposing a Reorganization Plan in Good Faith
Business Planning
Summer Seminars
https://lawprofessors.typepad.com/agriculturallaw/2023/03/summer-seminars.html
Registration Now Open for Summer Conference No. 1 – Petoskey, Michigan (June 15-16)
Civil Liabilities
Top Ag Law and Tax Developments of 2022 – Part 1
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 8 and 7
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Contracts
Top Ag Law and Developments of 2022 – Part 2
Failure to Execute a Written Lease Leads to a Lawsuit; and Improper Use of SBA Loan Funds
Double Fractions in Oil and Gas Conveyances and Leases – Resulting Interpretive Issues
Environmental Law
Here Come the Feds: EPA Final Rule Defining Waters of the United States – Again
Top Ag Law and Developments of 2022 – Part 2
Top Ag Law and Developments of 2022 – Part 3
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 10 and 9
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 6 and 5
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 4 and 3
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Estate Planning
Tax Court Opinion – Charitable Deduction Case Involving Estate Planning Fraudster
Happenings in Agricultural Law and Tax
Summer Seminars
https://lawprofessors.typepad.com/agriculturallaw/2023/03/summer-seminars.html
RMD Rules Have Changed – Do You Have to Start Receiving Payments from Your Retirement Plan?
Common Law Marriage – It May Be More Involved Than What You Think
The Marital Deduction, QTIP Trusts and Coordinated Estate Planning
Registration Now Open for Summer Conference No. 1 – Petoskey, Michigan (June 15-16)
Income Tax
Top Ag Law and Developments of 2022 – Part 3
Top Ag Law and Developments of 2022 – Part 4
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 8 and 7
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Tax Court Opinion – Charitable Deduction Case Involving Estate Planning Fraudster
Deducting Residual (Excess) Soil Fertility
Deducting Residual (Excess) Soil Fertility – Does the Concept Apply to Pasture/Rangeland? (An Addendum)
Happenings in Agricultural Law and Tax
Summer Seminars
https://lawprofessors.typepad.com/agriculturallaw/2023/03/summer-seminars.html
RMD Rules Have Changed – Do You Have to Start Receiving Payments from Your Retirement Plan?
Registration Now Open for Summer Conference No. 1 – Petoskey, Michigan (June 15-16)
Real Property
Equity “Theft” – Can I Lose the Equity in My Farm for Failure to Pay Property Taxes?
Happenings in Agricultural Law and Tax
Adverse Possession and a “Fence of Convenience”
Double Fractions in Oil and Gas Conveyances and Leases – Resulting Interpretive Issues
Abandoned Rail Lines – Issues for Abutting Landowners
Regulatory Law
Top Ag Law and Developments of 2022 – Part 2
Top Ag Law and Developments of 2022 – Part 4
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 10 and 9
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 8 and 7
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 6 and 5
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 4 and 3
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Foreign Ownership of Agricultural Land
Abandoned Rail Lines – Issues for Abutting Landowners
Secured Transactions
Priority Among Competing Security Interests
Water Law
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Happenings in Agricultural Law and Tax
April 20, 2023 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Tuesday, April 11, 2023
Registration Now Open for Summer Conference No. 1 – Petoskey, Michigan (June 15-16)
Overview
Again this summer, Washburn Law School will be conducting two summer seminars focused on farm and ranch income taxation and farm and ranch estate, business and succession planning. The first of the two events will be in Petoskey, Michigan on June 15-16 at North Central Michigan College. Registration is now open and can be accessed here: https://www.washburnlaw.edu/employers/cle/farmandranchtaxjune.html
August Conferences in Idaho
The finishing touches are just about complete on the second two-day event this summer which will be at North Idaho College in Coeur d’Alene, Idaho on August 7-8. Both events will also be simulcast live over the web. The Idaho event will feature a “conference within a conference.” The standard two days will be devoted to farm/ranch income tax and farm/ranch estate and business planning topics. But starting a bit later each day and ending slightly earlier, a second conference will be occurring simultaneously in a nearby meeting hall in the same building on the North Idaho College campus devoted to topics in agricultural law. The them of this two-day conference will be on representing the ag client. Many thanks to the Idaho Bar Association, the ag law section of the Idaho Bar, Prof. Rich Seamon and the University of Idaho College of law and others in helping put this conference together. Details on this these two conferences in Coeur d’Alene will be posted here soon with registration information.
June Michigan Conference
The itinerary for the Michigan event is below. The Idaho tax/e.p./b.p. conference follows the same Day 1 itinerary as the Michigan event, but Day 2 in Idaho will have a few different topics and speakers.
Here’s the itinerary for the Michigan conference.
Day 1 Itinerary
7:30-8:00 a.m. – Registration
8:00–8:05 a.m. - Welcome and Announcements
8:05–9:05 a.m. – Tax Update (Cases and Rulings) (McEowen) [60 minutes tax update CPE]
This opening session takes a look at the most significant tax cases and rulings from the courts and the IRS during the past year that have implications for farm and ranch clients, rural landowners, and agribusiness professionals.
9:05–9:45 a.m. – The Definition of “Farm Income” for Farm Program Purposes (Neiffer) [40 minutes tax update CPE]
Many Farm Service Agency programs grant extra payments if AGI from farming is more than 75% of total AGI. This session will review how FSA determine AGI and why it can be substantially different from IRS calculations.
9:45–10:05 a.m. – Morning Break
10:05–10:30 a.m. – Machinery Trades (McEowen) [25 minutes of tax law CPE]
This session examines the trade of farm machinery with no or low basis for new machinery and the resulting gain computation, combined with substantial depreciation claimed on the new machine.
10:30–10:55 a.m. – Selected Topics - Inventory Method Options for Farmers; How Bonus Depreciation and Expense Method Depreciation Can Work Together for Farm Clients (Neiffer) [25 minutes of tax update CPE]
Tax Reform simplified many accounting methods for taxpayers including farmers. We will review those change and why Section 179 can be more beneficial than bonus depreciation.
10:55–11:45 a.m. – Solar Panel Tax Issues; Other Rental Tax Issues (McEowen) [50 minutes of tax law CPE]
This discussion explores the tax issues associated with the placement of solar panels on farmland and also looks at other tax issues associated with rentals that farming operations often encounter.
11:45–12:45 p.m. – Luncheon
12:45 p.m.– 1:45 p.m. – Protecting a Tax Practice From Scammers (IRS CID) [60 minutes of tax law]
What steps can a tax practice take to protect itself from scams, including those from the dark web? What is good office protocol? What are the essential things that can be done and what are the signs to look for to detect scammers?
1:45 p.m.–2:25 p.m. – Selected Topics - Amending Partnership Returns; Corporate Provided Meals and Lodging; Charitable Remainder Trusts for Retiring Farmers (Neiffer) [40 minutes of tax law CPE]
This session will update the required method of amending partnership returns depending on whether the centralized partnership audit regime applies; a review of the change in corporate provided meals and why charitable remainder trusts can save taxes for a retiring farmer especially with increasing interest rates.
2:25-2:45 p.m. – Afternoon Break
2:45–3:10 p.m. – Easement Tax Issues (McEowen) [25 minutes of tax update CPE]
Rural landowners are finding easement tax issues to be more commonplace. This brief session provides a review of the basic tax issues associated with easements, particularly income tax basis offset issues and the character of the easement payments.
3:10–4:00 p.m. – IC-DISC for Farmers; Disallowance of Cash Method for Farming Activities; Accounting for Hedging Transactions; When to Deduct a Purchased Growing Crop (Neiffer) [50 minutes of tax law CPE]
An IC-DISC can cut a farmer’s income taxes in half – we review when it might apply. More farming activities include non-material participating taxpayers. This can cause the entity to be on the accrual method. The reporting of hedging activities is not always intuitive. We review the requirement and the options and when can a farmer deduct purchased growing crop.
4:00–4:25 p.m. – Soil Fertility Deductions (McEowen) [25 minutes of tax law CPE]
When a farm is purchased an allocation of value can be made to depreciable items. One of those items might be excess fertilizer supply. The IRS has a specific procedure that must be followed for valuing the excess amount. This session examines the IRS approach, the amount to be amortized, the timeframe for amortization and the possibility of recapture.
4:25 p.m. - Adjournment
Day 2
Here’s the itinerary for Day 2 of the Michigan event (farm estate and business planning track):
7:30-8:00 a.m. — Registration
8:05-8:55a.m. — Current Developments in Estate and Gift Taxation (McEowen) [50 minutes tax update CPE]
This session provides an update of legislative, regulatory and court developments involving federal estate and gift tax including developments involving a decedent’s gross estate, asset valuation, gifts made during life, retirement plans and miscellaneous issues.
8:55-9:45 a.m. – “Top Ten” Strategies For a Successful Farm Business (Rhea and Dikeman) [50 minutes tax update CPE]
As we look toward the next 12 months, several items deserve increased attention for farm businesses. This presentation delivers a Top 10 list of forward-looking strategies to consider for success. Changes in cost, income, inflation, tax laws, and estate planning are some key topics discussed. These will be on the mind of farms and ranches as they navigate the uncertain economic conditions and the impact of higher asset values, growing debt, and rising interest rates. We will also demonstrate the performance distinctions of top 1/3 producers.
9:45-10:05 a.m. — Morning Break
10:05-10:55 a.m. – Taxes in Probate: Form 1041 and Distribution Deductions (McEowen) [50 minutes tax law CPE]
This session walks the practitioner through the completion of Form 1041, the assets included in the probate estate, possible income generating items for an estate, the handling of capital gain or loss, and estate accounting. A discussion of e-filing and electronic signatures will also be included. In addition, common issues associated with the death of a farmer will be addressed.
10:55 a.m.-11:45 a.m. – SLATs – Why It Might be the Best Option for Your Farmers (Neiffer) [50 minutes of tax law CPE]
This session reviews the various trust options available to farm families to transfer assets to the next generation in a tax efficient manner. The session will then review why a Spousal Lifetime Access Trust (SLAT) might be the best option.
11:45-12:45 p.m. — Lunch
12:45 p.m.-1:35 p.m. – Why Social Security is an Investment, not a Tax (Neiffer) [50 minutes of tax law CPE]
Most farmers view social security as an unnecessary tax. However, with optimal planning, social security maybe one of the best investments they ever make. We review how benefits are calculated, why spousal benefits provide even more bang for their buck and some common claiming options.
1:35 p.m.-2:50 p.m. — Tax Strategies for the Farm and Ranch Client (Rhea and Dikeman) [75 minutes of tax law CPE]
This session highlights several changes were made by the Tax Cuts & Jobs Act of 2017; many sunset after 2025 and demand attention for optimal tax planning strategies the next 3 years. We will also explain how rising inflation rates are at times helping reduce tax liability and when it does not. Rising interest rates and inflated asset values are dramatically shifting costs of farm transitions to the detriment of young and beginning farmers. Stepped-up basis is a big thing; we detail how this can be helpful to farm successors. Unintended consequences of high income and options for tax management after year end are analyzed.
2:50 p.m. – 3:10 p.m. – Afternoon Break
3:10 p.m. – 3:25 p.m. – New Estate Planning Clients – Screening Clients and Gathering Information [15 minutes of tax law CPE]
This session takes a brief look at a suggested approach to handling potential new estate/business planning clients. How to screen clients, identify potential problem clients, engagement letters and information gathering as preparatory to determining the appropriate path forward for the client.
3:25-4:25 p.m. – Ethics for Estate Planners (McEowen) [1 hour of tax ethics CPE]
What are the ethical issues facing practitioners working with clients on estate/business and tax planning matters? How might the Circular 230 rules impact tax professionals in the estate and business planning context when income tax advice is involved? This session looks at some of the common issues that can arise, applicable caselaw, and some of the more unusual situations that might arise that present difficult situations for the planner.
4:25 p.m. — Conference Adjourns
Conclusion
The registration link for the Michigan event can be found here:
As noted above, both days of the conference will be broadcast live online. Also, if you business is interested in being a sponsor, please contact me.
April 11, 2023 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)
Friday, March 31, 2023
RMD Rules Have Changed – Do You Have to Start Receiving Payments from Your Retirement Plan?
Overview
Taxpayers have numerous options for saving for retirement, whether working for an employer or self-employed. But, there are limitations that apply to how much can be deposited each year into a retirement account and other rules apply that specify when distributions from retirement accounts must begin. If distributions are not taken when they should, penalties can apply.
The rules can be tricky, and the Congress has modified the rules in recent years. One of those changes applies to some people and will require the beginning of distributions (a required minimum distribution (RMD)) from certain retirement accounts by April 1, 2023 – tomorrow.
Rules involving RMDs from retirement accounts – it’s the topic of today’s post.
RMDs
Funds cannot be kept in a retirement account indefinitely. In general, distributions must be made from an IRA, SIMPLE IRA, SEP IRA, or retirement plan account when the account owner reaches age 72 (73 if age 72 is attained after Dec. 31, 2022). Normally, an RMD must be made by the end of the year. But, for those turning 72 during 2022, the first RMD may be made as late as April 1, 2023. This rule applies to IRAs, 401(k)s and similar workplace retirement accounts.
Note: For persons with a Roth IRA, funds need not be withdrawn during life. But the beneficiaries of the account are subject to the RMD rules. Designated Roth accounts in a 401(k) or 403(b) plan are subject to the RMD rules for 2022 and 2023. 2023 RMDs must be taken by April 1, 2024. However, for 2024 and later years, RMDs are no longer required from designated Roth accounts.
This April 1 rule only applies for the first year that an RMD is required. For later years, the RMD must be made by the end of the year – December 31. As a result, any taxpayer that received their RMD for 2022 in 2023 (on or before April 1 of 2023) must also receive their RMD for 2023 by the end of 2023. This means that both distributions will be taxable in 2023.
Employees. Individuals that are still employed by the plan sponsor, and who are not a 5 percent owner, may delay taking RMDs from workplace retirement plan until they retire, if the plan so allows. But, even those that are still employed must begin taking an RMD starting at age 72 from traditional IRAs, SEP, SIMPLE and SARSEP IRA plans.
Plans requiring an RMD. As noted above, RMDs are not required with respect to Roth IRAs. Likewise, for 2024 and later years, RMDs aren’t required to be taken from designated Roth accounts. The RMD rules, however, apply to traditional IRAs, SEPs and Simple IRAs during the owner’s life. RMDs are also required to be taken by owners of 401(k) plans, 403(b) and 457(b) plans.
Age change. While the rule as to when an account owner must start taking an RMD has been the year in which the owner reaches age 72, starting in 2023, the required RMD must begin for the year in which the account owner turns 73. In other words, for account owners that turned 72 in 2022, the first RMD must be taken by April 1, 2023, with the RMD computed based on the account balance as of the end of 2021. For those reaching age 72 in 2023, there is no RMD requirement for this year. Instead, the first RMD will be for 2024 because that will be the year in which the individual will turn 73. The first RMD for these persons must be taken by April 1, 2025.
Meeting RMD Requirements. The RMD requirement can be satisfied by withdrawing from multiple accounts – traditional IRAs, SEPs, SIMPLEs and SARSEPs. Withdrawals need not be taken from each account the owner holds. What is required is that the total withdrawals must be at least what the total RMD requirement.
Calculating the RMD. The IRS provides Publication 590 to assist in computing the RMD. Publication 590 contains RMD tables that are used to calculate the RMD. Basically, from the table an account owner will locate their age on the IRS Uniform Lifetime Table, find the “life expectancy factor” corresponding to their age, and then divide the account balance as of December 31 of the prior year by the current life expectancy factor. The computation is different if the account owner’s spouse is the only primary beneficiary and is more than 10 years younger than the owner. In that instance, the IRS Joint Life and Last Survivor Expectancy Table (contained in Pub. 590) is used. The account owner’s life expectancy factor is based on the ages of both the account owner and spouse. The formula, however, does not change.
For persons with multiple retirement plans, the RMD is to be calculated separately for each plan. But the RMDs can be combined, and the total amount withdrawn from a single plan or any combination of plans.
Conclusion
RMDs from retirement plans can be confusing, and for those with multiple accounts it’s probably best to consult with a financial and/or tax advisor to help with determining the best withdrawal strategy.
March 31, 2023 in Estate Planning, Income Tax | Permalink | Comments (0)
Wednesday, March 29, 2023
Summer Seminars
Overview
This summer Washburn Law School will be conducting two summer seminars focused on farm and ranch income taxation and farm and ranch estate, business and succession planning. The first of the two events will be in Petoskey, Michigan on June 15-16 at North Central Michigan College. Registration will open soon. When the law school has that ready, the link will be available on my website: www.washburnlaw.edu/waltr and I will share it here. The second two-day event this summer will be at North Idaho College in Coeur d’Alene, Idaho on August 7-8. Both events will also be simulcast live over the web.
The itinerary for the Michigan event is below. The Idaho event follows the same Day 1 itinerary as the Michigan event, but Day 2 in Idaho will have a few different topics and speakers on Day 2. Also, at the Idaho conference there will also be a dual track running at the same time devoted solely to agricultural law topics. The ag law track will start a bit later in the morning and end earlier than the estate and business planning conference. It will be held at the same location in Coeur d’Alene and the luncheon each day will be for all attendees of each track. Approximately 10 hours of CLE will be available for the ag law topics. I will post more on that once the topics and speakers are completely filled-in for that day.
Day 1 Itinerary
Here's the itinerary for Day 1 at both the Michigan and Idaho locations (farm tax track):
7:30-8:00 a.m. – Registration
8:00–8:05 a.m. - Welcome and Announcements
8:05–9:05 a.m. – Tax Update (Cases and Rulings) (McEowen) [60 minutes tax update CPE]
This opening session takes a look at the most significant tax cases and rulings from the courts and the IRS during the past year that have implications for farm and ranch clients, rural landowners, and agribusiness professionals.
9:05–9:45 a.m. – The Definition of “Farm Income” for Farm Program Purposes (Neiffer) [40 minutes tax update CPE]
Many Farm Service Agency programs grant extra payments if AGI from farming is more than 75% of total AGI. This session will review how FSA determine AGI and why it can be substantially different from IRS calculations.
9:45–10:05 a.m. – Morning Break
10:05–10:30 a.m. – Machinery Trades (McEowen) [25 minutes of tax law CPE]
This session examines the trade of farm machinery with no or low basis for new machinery and the resulting gain computation, combined with substantial depreciation claimed on the new machine.
10:30–10:55 a.m. – Selected Topics - Inventory Method Options for Farmers; How Bonus Depreciation and Expense Method Depreciation Can Work Together for Farm Clients (Neiffer) [25 minutes of tax update CPE]
Tax Reform simplified many accounting methods for taxpayers including farmers. We will review those change and why Section 179 can be more beneficial than bonus depreciation.
10:55–11:45 a.m. – Solar Panel Tax Issues; Other Rental Tax Issues (McEowen) [50 minutes of tax law CPE]
This discussion explores the tax issues associated with the placement of solar panels on farmland and also looks at other tax issues associated with rentals that farming operations often encounter.
11:45–12:45 p.m. – Luncheon
12:45 p.m.– 1:45 p.m. – Protecting a Tax Practice From Scammers (IRS CID) [60 minutes of tax law]
What steps can a tax practice take to protect itself from scams, including those from the dark web? What is good office protocol? What are the essential things that can be done and what are the signs to look for to detect scammers?
1:45 p.m.–2:25 p.m. – Selected Topics - Amending Partnership Returns; Corporate Provided Meals and Lodging; Charitable Remainder Trusts for Retiring Farmers (Neiffer) [40 minutes of tax law CPE]
This session will update the required method of amending partnership returns depending on whether the centralized partnership audit regime applies; a review of the change in corporate provided meals and why charitable remainder trusts can save taxes for a retiring farmer especially with increasing interest rates.
2:25-2:45 p.m. – Afternoon Break
2:45–3:10 p.m. – Easement Tax Issues (McEowen) [25 minutes of tax update CPE]
Rural landowners are finding easement tax issues to be more commonplace. This brief session provides a review of the basic tax issues associated with easements, particularly income tax basis offset issues and the character of the easement payments.
3:10–4:00 p.m. – IC-DISC for Farmers; Disallowance of Cash Method for Farming Activities; Accounting for Hedging Transactions; When to Deduct a Purchased Growing Crop (Neiffer) [50 minutes of tax law CPE]
An IC-DISC can cut a farmer’s income taxes in half – we review when it might apply. More farming activities include non-material participating taxpayers. This can cause the entity to be on the accrual method. The reporting of hedging activities is not always intuitive. We review the requirement and the options and when can a farmer deduct purchased growing crop.
4:00–4:25 p.m. – Soil Fertility Deductions (McEowen) [25 minutes of tax law CPE]
When a farm is purchased an allocation of value can be made to depreciable items. One of those items might be excess fertilizer supply. The IRS has a specific procedure that must be followed for valuing the excess amount. This session examines the IRS approach, the amount to be amortized, the timeframe for amortization and the possibility of recapture.
4:25 p.m. - Adjournment
Day 2 (farm estate and business planning track)
Here’s the itinerary for Day 2 of the Michigan event (farm estate and business planning track):
7:30-8:00 a.m. — Registration
8:05-8:55a.m. — Current Developments in Estate and Gift Taxation (McEowen) [50 minutes tax update CPE]
This session provides an update of legislative, regulatory and court developments involving federal estate and gift tax including developments involving a decedent’s gross estate, asset valuation, gifts made during life, retirement plans and miscellaneous issues.
8:55-9:45 a.m. – “Top Ten” Strategies For a Successful Farm Business (Rhea and Dikeman) [50 minutes tax update CPE]
As we look toward the next 12 months, several items deserve increased attention for farm businesses. This presentation delivers a Top 10 list of forward-looking strategies to consider for success. Changes in cost, income, inflation, tax laws, and estate planning are some key topics discussed. These will be on the mind of farms and ranches as they navigate the uncertain economic conditions and the impact of higher asset values, growing debt, and rising interest rates. We will also demonstrate the performance distinctions of top 1/3 producers.
9:45-10:05 a.m. — Morning Break
10:05-10:55 a.m. – Taxes in Probate: Form 1041 and Distribution Deductions (McEowen) [50 minutes tax law CPE]
This session walks the practitioner through the completion of Form 1041, the assets included in the probate estate, possible income generating items for an estate, the handling of capital gain or loss, and estate accounting. A discussion of e-filing and electronic signatures will also be included. In addition, common issues associated with the death of a farmer will be addressed.
10:55 a.m.-11:45 a.m. – SLATs – Why It Might be the Best Option for Your Farmers (Neiffer) [50 minutes of tax law CPE]
This session reviews the various trust options available to farm families to transfer assets to the next generation in a tax efficient manner. The session will then review why a Spousal Lifetime Access Trust (SLAT) might be the best option.
11:45-12:45 p.m. — Lunch
12:45 p.m.-1:35 p.m. – Why Social Security is an Investment, not a Tax (Neiffer) [50 minutes of tax law CPE]
Most farmers view social security as an unnecessary tax. However, with optimal planning, social security maybe one of the best investments they ever make. We review how benefits are calculated, why spousal benefits provide even more bang for their buck and some common claiming options.
1:35 p.m.-2:50 p.m. — Tax Strategies for the Farm and Ranch Client (Rhea and Dikeman) [75 minutes of tax law CPE]
This session highlights several changes were made by the Tax Cuts & Jobs Act of 2017; many sunset after 2025 and demand attention for optimal tax planning strategies the next 3 years. We will also explain how rising inflation rates are at times helping reduce tax liability and when it does not. Rising interest rates and inflated asset values are dramatically shifting costs of farm transitions to the detriment of young and beginning farmers. Stepped-up basis is a big thing; we detail how this can be helpful to farm successors. Unintended consequences of high income and options for tax management after year end are analyzed.
2:50 p.m. – 3:10 p.m. – Afternoon Break
3:10 p.m. – 3:25 p.m. – New Estate Planning Clients – Screening Clients and Gathering Information [15 minutes of tax law CPE]
This session takes a brief look at a suggested approach to handling potential new estate/business planning clients. How to screen clients, identify potential problem clients, engagement letters and information gathering as preparatory to determining the appropriate path forward for the client.
3:25-4:25 p.m. – Ethics for Estate Planners (McEowen) [1 hour of tax ethics CPE]
What are the ethical issues facing practitioners working with clients on estate/business and tax planning matters? How might the Circular 230 rules impact tax professionals in the estate and business planning context when income tax advice is involved? This session looks at some of the common issues that can arise, applicable caselaw, and some of the more unusual situations that might arise that present difficult situations for the planner.
4:25 p.m. — Conference adjourns
Here’s the itinerary for Day 2 of the Idaho event (farm estate and business planning track):
7:30-8:00 a.m. — Registration
8:05-8:55a.m. — Current Developments in Estate and Gift Taxation (McEowen) [50 minutes tax update CPE]
This session provides an update of legislative, regulatory and court developments involving federal estate and gift tax including developments involving a decedent’s gross estate, asset valuation, gifts made during life, retirement plans and miscellaneous issues.
8:55-9:45 a.m. – Who Wants the Farm; and Should They Get It? (Bosch) [50 minutes of tax law CPE]
9:45-10:05 a.m. — Morning Break
10:05-10:55 a.m. – Taxes in Probate: Form 1041 and Distribution Deductions (McEowen) [50 minutes of tax law CPE]
This session walks the practitioner through the completion of Form 1041, the assets included in the probate estate, possible income generating items for an estate, the handling of capital gain or loss, and estate accounting. A discussion of e-filing and electronic signatures will also be included. In addition, common issues associated with the death of a farmer will be addressed.
10:55 a.m.-11:45 a.m. – SLATs – Why It Might be the Best Option for Your Farmers (Neiffer) [50 minutes of tax law CPE]
This session reviews the various trust options available to farm families to transfer assets to the next generation in a tax efficient manner. The session will then review why a Spousal Lifetime Access Trust (SLAT) might be the best option.
11:45-12:45 p.m. — Lunch
12:45 p.m.-1:35 p.m. – Why Social Security is an Investment, not a Tax (Neiffer) [50 minutes of tax law CPE]
Most farmers view social security as an unnecessary tax. However, with optimal planning, social security maybe one of the best investments they ever make. We review how benefits are calculated, why spousal benefits provide even more bang for their buck and some common claiming options.
1:35 p.m.-2:50 p.m. - Strategies and Considerations for Transferring Farm Ownership and Operations (Hemenway)
This session will explore various issues connected with the transfer of farm ownership to successive generations. Topics will include timing the transfer of labor and management; preparing the next generation for farm ownership; planning for multiple inheritors; and considerations for long-term care and asset protection planning.
2:50 p.m. – 3:10 p.m. – Afternoon Break
3:10 p.m. – 3:25 p.m. – New Estate Planning Clients – Screening Clients and Gathering Information (McEowen) [15 minutes of tax law CPE]
This session takes a brief look at a suggested approach to handling potential new estate/business planning clients. How to screen clients, identify potential problem clients, engagement letters and information gathering as preparatory to determining the appropriate path forward for the client.
3:25-4:25 p.m. – Ethics for Estate Planners (McEowen) [1 hour of tax ethics CPE]
What are the ethical issues facing practitioners working with clients on estate/business and tax planning matters? How might the Circular 230 rules impact tax professionals in the estate and business planning context when income tax advice is involved? This session looks at some of the common issues that can arise, applicable caselaw, and some of the more unusual situations that might arise that present difficult situations for the planner.
4:25 p.m. — Conference adjourns
Conclusion
I look forward to either seeing you in-person at one of these events this summer or online. At the end of Day 1 at the Idaho event, there will be a reception sponsored by the University of Idaho College of Law. Also, many thanks to Teresa Baker at the Idaho Bar Association for her assistance in locating speakers as well as to Prof. Richard Seamon (Univ. of ID College of Law) and Kelly Stevenson (leader of the ag law section off the Idaho Bar) for helping identify topics as well as speakers.
More details and registration links coming soon.
March 29, 2023 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)
Saturday, March 11, 2023
Happenings in Agricultural Law and Tax
Overview
The legal issues in agricultural law and tax are seemingly innumerable. The leading issues at any given point in time are often tied to the area of the country involved. In the West and the Great Plains, water and grazing issues often predominate. Boundary disputes and lease issues seem to occur everywhere. Bankruptcy and bankruptcy taxation issues are tied to the farm economy and may be increasing in frequency in 2023 – the USDA projects net farm income to be about 16 percent lower in 2023 compared to 2022. Of course, estate planning, succession planning and income tax issues are always present.
With today’s post, I take a look at some recent cases involving ag issues. A potpourri of recent cases – it’s the topic of today’s post.
Dominant Estate’s Water Drainage Permissible.
Thill v. Mangers, No. 22-0197, 2022 Iowa App. LEXIS 961 (Iowa Ct. App. Dec. 21, 2022)
The plaintiffs sued their neighbor, the defendant, for nuisance. Rainwater from the defendant’s property would run off onto the plaintiffs’ property. In the 1950s and 1960s the city installed a few culverts to help with the water drainage. The water drained into an undeveloped ground area where the plaintiffs later built their home. The plaintiffs tried numerous ways to block the flow, ultimately causing drainage problems for the defendant who then tried to direct the excess water back onto the plaintiffs’ property. The plaintiffs claimed that defendant’s activity caused even more damage to their property than had previously occurred, causing a neighbor to also complain. All of the parties ended up suing each other on various trespass and nuisance claims. The trial court dismissed all of the claims because the court believed that all of the parties’ actions caused the water drainage problems. The appellate court explained that the defendant, as the owner of the dominant estate, had a right to drain water from his land to the servient estate (the plaintiffs’ property) and if damage resulted from the drainage, the servient estate is normally without remedy under Iowa Code §657.2(4). The only time a servient estate could recover damages is if there is a substantial increase in the volume of the water draining or if the method of drainage is substantially changed and actual damage results. Under Iowa law, the owner of the servient estate may not interrupt or prevent the drainage of water to the detriment of the dominant owner. The plaintiffs argued that the defendant violated his obligation by installing a berm and barricade, and presented expert testimony showing that the water flow changed when the defendant added the features, but the defendant had his own expert who provided contrary testimony. The appellate court held that the defendant’s expert was more reliable because the defendant’s expert used more historical information and photographs to analyze how the water historically flowed rather than focusing on the current condition of the neighborhood as did the plaintiffs’ expert. When the plaintiffs’ expert looked at these historical photographs, he even agreed with the defendant’s expert that the natural flow of water was through the culverts onto the plaintiffs’ property. The appellate court affirmed the trial court’s finding that the plaintiffs did not prove that the defendant substantially changed the method or manner of the natural flow of water, because the water would have flowed the same way with or without the defendant’s berm and barricade.
Mortgage Interest Deduction Disallowed
Shilgevorkyan v. Comr., T.C. Memo. 2023-12
The petitioner claimed a mortgage interest deduction for 2012 associated with a home that his brother purchased for $1,525,000 in 2005. The purchase was financed with a bank loan. The brother and his wife were listed as the borrowers on the loan. The brother (and wife) and another brother also took out a $1,200,000 construction loan. Both loans were secured by the home. The construction loan was used to build a separate guesthouse on the property. In 2010, one brother executed a quit claim deed in favor of the petitioner with respect to the property. During 2012, the petitioner didn’t make any loan payments and was not issued a Form 1098 for the year. While the petitioner lived in the guesthouse for part of 2012, he did not list the property as being his place of residence or address. On his 2012 return, the petitioner claimed a $66,354 deduction for one-half of the total mortgage interest paid for the year as reported on Form 1098 that was issued to his brother and his brother’s wife. The IRS disallowed the deduction and the Tax Court agreed. The petitioner failed to prove that the debt on the property was his obligation, did not show ownership (legal or equitable) in the property, and the quitclaim deed did not convey title to him under state law. The Tax Court also determined that the petitioner failed to establish that the residence was his “qualified residence.”
Charitable Deduction Case Will Go to Trial on Numerous Issues
Lim v. Comr., T.C. Memo. 2023-11
During 2016 and 2017, the petitioners (a married couple) were the sole shareholders of an S corporation. In late 2016, after making a presentation to the petitioners concerning “The Ultimate Tax, Estate and Charitable Plan,” an attorney formed a “Charitable Limited Liability Company” for the petitioners to use as a vehicle for making charitable donations. The attorney agreed to transfer assets to the LLC, to transfer LLC units to a charity and to provide the supporting valuation documentation for the donation. He also agreed to represent them before the IRS and the Tax Court if the return(s) were later examined. His fee would be the greater of $25,000 or 6 percent of the “deductible amount” of assets capped at $1 million, plus 4 percent of the “deductible amount” of assets exceeding $1 million. The assets transferred to the LLC were five promissory notes with a face amount of $2,008,500. This generated a fee for the attorney of $84,000 based on a presupposed “deductible amount” of $1,600,000 even though the assets were not appraised until late January of 2017, which valued them at $1,600,000. The fee was to be paid in installments over six months beginning in January of 2017.
The attorney also created a second LLC in late December of 2016 with the petitioners as the managers, the attorney as the registered agent, and the petitioners’ S corporation as the single member. Petitioners promised to pay the second LLC $2,008,500 (the promissory notes) in seven years.
The charitable recipient was a Foundation (an I.R.C. §501(c)(3) organization) for which the attorney was the registered agent. The petitioners claimed that their S corporation donated “units” of the second LLC to the Foundation and claimed a charitable deduction. The IRS denied the deduction, partly on the basis of a lack of evidence that any property was actually transferred to the Foundation. The petitioners did not offer any explanation as to when or how the “units” were created or what physical form they took. The petitioners also claimed that they received an acknowledgement letter of the donation from the Foundation dated January 1, 2017. The letter referred to 1,000 units of an LLC that did not exist during 2016 or as of January 1, 2017. It was not addressed to the S corporation, but to the petitioner (wife) at their residence in a different city than the S corporation. The letter also was not signed by any person and appeared to be a form letter with taxpayer-specific information in bold font. It also did not refer to any property that the S corporation allegedly donated on December 31, 2016.
On January 4, 2017, the attorney submitted an appraisal, but it lacked substance. The appraisal asserted that LLC interests were donated to the Foundation in 2016, but did not denote how many interests had been contributed. The claimed charitable deduction was $1,608,808. The attorney also attached his curriculum vitae stating that he was a CPA, a certified valuation analyst and a licensed attorney in Kentucky. Also attached to the appraisal was a one-page “certification” on which the attorney stated that his fee was not contingent on the report in any manner and that he didn’t have any interest or bias with respect to the parties involved. This was despite his having arranged the entire transaction and being the registered agent for the second LLC.
The S corporation filed Form 1120S for 2016 and attached a copy of the appraisal and Form 8283 which described the donated property as “LLC units” with a basis of $2,008,500 that had been acquired by purchase, and an “appraised market value” of $1,608,808. The petitioners reported a non-cash charitable deduction of $1,608,808 on Schedule A that flowed through to them from the S corporation. Because the amount of the deduction exceeded the maximum allowable deduction for 2016, they claimed a $1,195,073 deduction for 2016 and carried the balance of $415,711 to their 2017 return.
The IRS audited the petitioners’ 2016 and 2017 returns and disallowed the charitable deductions for lack of substantiation. The petitioners challenged the disallowance in the Tax Court and the IRS moved for partial Summary Judgment. The Tax Court determined that the appraisal was not a “qualified appraisal” within the meaning of I.R.C. §170(f)(11)(C). Treas. Reg. §1.170A-13(c)(6)(i) requires, among other things, that “no part of the fee arrangement for a qualified appraisal can be based, in effect, on a percentage (or set of percentages) of the appraised value of the property.” Accordingly, the attorney’s fee was a prohibited appraisal fee within the meaning of the regulation. However, the Tax Court held that the petitioners had shown reasonable cause for failure to comply with the substantiation requirements of I.R.C. §170. They had presented sufficient proof that they relied upon professionals in claiming the charitable contribution deduction. Accordingly, the Tax Court denied the IRS summary judgment on this issue. The Tax Court also denied summary judgment to the IRS on the issue of whether the written acknowledgement was a “contemporaneous written acknowledgement” of the contribution in accordance with I.R.C. §170(f)(8)(A). Accordingly, the Tax Court granted the Summary Judgment motion of the IRS in part, while the remaining issues will be set for trial.
Note: In 2018 the Department of Justice filed a complaint against the attorney, alleging that he promoted the “Ultimate Tax Plan” as a tax evasion scheme. He was accused of running a $35 million federal tax advice scam offering fake deductions using three bogus charities for 19 years. The complaint alleged that he was at the helm of "a national charitable-giving tax scheme" that targeted "wealthy individuals in high tax brackets facing large tax liabilities.” He settled with the Government and agreed to a permanent injunction. On April 26, 2019, the U.S. District Court for the Southern District of Florida entered a final judgment of permanent injunction against him, holding that he had engaged in conduct penalizable under I.R.C. §6700 by promoting the “Ultimate Tax Plan.” The court permanently enjoined him from, among other things, promoting “the Ultimate Tax Plan or any plan or arrangement that is substantially similar.” The court ordered the attorney to perform other actions as well in relation to the plan.
Document Filed with FSA Not a Valid Lease
Coniglio v. Woods, No. 06-22-00021-CV, 2022 Tex. App. LEXIS 8926 (Tex. Ct. App. Dec. 7, 2022)
Involved in this case was land in Texas that the landowner’s son managed for his father who lived in Florida. The landowner needed the hay cut and agreed orally that the plaintiff could cut the hay when necessary. The hay was cut on an annual basis. So that he could receive government farm program payments on the land, the plaintiff filed a “memorialization of a lease agreement” with the local USDA Farm Service Agency (FSA). The landowner’s son also signed the agreement at the plaintiff’s request, but later testified that he didn’t believe the document to constitute a written lease. After three years of cutting the hay, the landowner wanted to lease the ground for solar development, and the plaintiff was told that the hay no longer needed to be cut and there would be no hay profits to share. The plaintiff sued for breach of a farm lease agreement. The trial court ruled in favor of the plaintiff on the basis that the form submitted to the USDA was sufficient to show the existence of a lease agreement. On appeal, the defendant claimed that the document filed with the FSA did not satisfy the writing requirement of the statute of frauds. The appellate court agreed, noting that the document didn’t contain the essential terms of the lease. It didn’t denote the names of the parties, didn’t describe the property, didn’t note the rental rate, and didn’t list any conditions or any consideration. Accordingly, the appellate court determined that no valid lease existed and reversed the trial court’s judgment.
Conclusion
I’ll provide another summary of recent cases in a subsequent post.
March 11, 2023 in Estate Planning, Income Tax, Real Property, Water Law | Permalink | Comments (0)
Sunday, February 26, 2023
Deducting Residual (Excess) Soil Fertility – Does the Concept Apply to Pasture/Rangeland? (An Addendum)
Overview
Note: Last week I posted the following article. In response to numerous questions I have received over the past few months, I have now updated the article to address whether the deduction under I.R.C. §180 applies to pasture/rangeland. The new section on this issue can be found near the end of this article immediately preceding the concluding paragraph.
When farmland is purchased, depreciation can be claimed on depreciable assets associated with the farmland starting with the first tax year in which possession of the land is taken. The amount claimed is tied to the portion of the total cost of the farmland that can be allocated to any depreciable asset, such as fencing, field drainage tile, grain storage facilities, farm buildings, and irrigation equipment, just to name a few of the more common depreciable items.
In certain parts of the Midwest, above average soil fertility is also eligible for expense deductions. The concept is known as “residual soil fertility” and it can be available to farmland buyers that didn’t farm the acquired property within the immediately prior crop year.
Deductions associated with residual soil fertility, that’s the topic of today’s post.
The Deduction
I.R.C. §180 allows a taxpayer engaged in the trade or business of farming to annually elect (by deducting the expense on the return) the cost of fertilizer, lime, potash, or other materials which enrich, neutralize or condition land used in farming. If these fertilization costs are not expensed, they are required to be capitalized with expense deductions being amortized over a presumed useful life (similar to field drainage tile and/or fencing). This means that residual soil fertility is a capital asset in the hands of an operating farmer, crop-share landlord or cash rent landlord when farmland is acquired, with the cost amortized over the useful life of the asset. That useful life is typically three to four years. The general 15-year amortization rules don’t apply. Instead, the IRS position is that fertilizer costs should be amortized based on the percentage of use or benefit each year. That likely means that straight-line amortization probably does not apply. An agronomist or other soil scientist may be able to provide sufficient information so that the property annual expense allocation can be determined. See, e.g., IRS Pub. 225, Chapter 4.
Note: Usually about 60 percent is deducted in the first year, 30 percent in the second year and the last 10 percent in the third year.
For farmland inherited from a decedent, the date of the decedent’s death is the measurement date for determining whether residual soil fertility exists. If it does, the cost can be amortized by the decedent’s estate and/or the beneficiaries of the estate that receive the farmland.
In 1995, the IRS published a Market Segment Specialization Program (MSSP) addressing residual soil fertility. IRS MSSP, Guideline on Grain Farmers (Training 3149-133, Jul. 1995). In the MSSP, the IRS notes that a deduction for residual fertilizer supply will be denied unless the taxpayer can establish (1) beneficial ownership of the residual fertilizer supply; (2) the presence and extent of the residual fertilizer; and (3) that the residual fertilizer supply is actually being exhausted. In addition, the MSSP instructs IRS examining agents to make sure that the values assigned to depreciable farm assets is reasonable. See also, Tech. Adv. Memo. 9211007 (Dec. 3, 1991).
Allocation. The actual deduction might be less than the agronomist’s value of the excess amount. If the land’s value combined with the value of the excess fertility exceed the purchase price of the land, an allocation must be done for each one based on their respective fair market values. For example, assume that farmland is purchased for 8,000/acre. An agronomist pegs the excess fertility at $4,000/acre. Comparable land in the area without excess fertility sells for $7,000/acre. When the $4,000/acre for excess fertility is added to the land value without excess fertility, the total is $11,000. Thus, the land is 63.6 percent of the total value, and the excess fertility is 36.4 percent. The purchase price was $8,000/acre. 36.4 percent of that amount is $2,912/acre. That will be the amount that IRS will accept as the deduction for excess fertilizer supply – not the $4,000/acre that the agronomist determined.
Procedure
So, how can a taxpayer establish the presence and extent of residual fertilizer supply and that it is actually being exhausted? For starters, if farmland has an actual excess soil fertility base it will normally bring a price premium upon sale. That’s the same rationale that applies when farmland with good fences, field drainage tile and grain storage facilities is purchased – a price premium applies to factor in the existence of those assets. As for residual fertilizer supply, the excess amount can be measured by grid sampling. A buyer can anticipate that grid sampling will cost of approximately $4-$8 per acre. Agronomists and agricultural soil testing labs follow certain guidelines and procedures that they use to determine average (base) soil fertility for various soil types. Once grid soil samples are obtained, the fertility levels of those samples are compared to the base fertility guideline levels for particular soil types to establish the amount of “excess” fertility on a tract of acquired farm real estate.
The key is to obtain data for the established base soil fertility for the type of soil on the purchased farmland from comparable tracts and comparable soil types. By establishing the base soil fertility, the actual sampling on the purchased property will reveal whether excess residual fertilizer is present. That soil sampling should occur on or before the buyer takes possession of the farmland. For farmland that is inherited, the sampling should occur before the buyer applies any new fertilization.
Documentation
While the IRS does not require it, perhaps the best way to document the deduction for excess soil fertility is to provide for the allocation of value to the amount of above average soil fertility in the purchase contract for the farmland. In addition, a written summary of how the computation was made and the time period over which it would deplete due to crop production should be obtained from the agronomist or other expert involved. This will be beneficial for establishing the proper amortization period for the excess soil fertility and will provide substantiation of the deduction upon any subsequent IRS (or state) audit. Depending on the soil type involved, the deduction could range from $50 per acre to over $700 per acre – perhaps exceeding 10 percent of the land’s value.
Recapture
If a deduction for excess fertilizer supply is claimed and the land is later sold, the amount of the selling price attributable to the excess fertility will be recaptured as ordinary income. It does not qualify for capital gain treatment. Any remaining gain will be taxed at capital gain rates. Of course, if the taxpayer continues to own the land until death recapture is avoided.
Application to Pasture/Rangeland?
In recent months, I have been asked by numerous tax professionals about the assertion in certain marketing materials of private agronomic firms asserting that the I.R.C. §180 deduction can provide a substantial tax deduction for residual fertilizer supply on pasture and/or rangeland. In the meantime, I have conducted further research and discussed the matter with soil scientists and rangeland management specialists. The following is what I have gleaned from those conversations.
In general. The starting point on this particular question is to note that the IRS has not specifically addressed the application of I.R.C. §180 to pasture or rangeland. Indeed, the only IRS guidance on the excess soil fertility issue is the 1991 TAM and the MSSP referred to above. But, I.R.C. §180 does indicate that “land used in farming” for purposes of the provision includes “land used…for the sustenance of livestock.” So, in theory, the same concepts that apply to cropland apply to land used for grazing. However, the makeup and value of the minerals differs. With pasture and rangeland the value of potassium and phosphorous contained in the soil is much less than the value of the same minerals in soil used to raise row crops. The value per unit is simply not the same such that the owner of the grazing land would simply not apply fertilizer (especially at the current high prices) to enhance the land’s value – the economics disincentivize such activity.
Native pasture. The nutrient balance on a native pasture is very tight and there is no “excess” nutrient in a native pasture system. These systems are rarely if ever fertilized with commercial fertilizer or external manure applications, with the exception being (perhaps) for a native field that is hayed. Nitrogen can increase production and allow increased stocking rates, but is simply not profitable to do so. Native hay meadows are sometimes fertilized with 30-40# nitrogen and 10# phosphorous. Fertilizing native grass usually increases any cool-season grasses in the stand (e.g., Kentucky bluegrass and annual bromes) and increases broadleafs. Prescribed burning in the late spring is then recommended to set those unwanted species back the next year.
Native rangeland is very efficient as using N and gets nitrogen from lightning/rainfall and non-symbiotic fixation (e.g Clostridium and Azotobacter). There may be some symbiotic N fixation by native legumes. The year after a drought, biomass on rangeland may increase because of unused N in the soil, if rainfall is normal or above. This increase in production not only relies on moisture, but on how the pasture was managed during the year of drought.
Marketing material. The marketing material of the agronomic firms that I have seen that are in the business of measuring soil fertility makes a broad statement that I.R.C. §180 applies to grazing land. While true on its face, pasture grass is not the same as cropland when it comes to nutrients. While the concept applies equally, the application does not. Given that rangeland has a lower per acre fair market value than does cropland and the excess soil fertility (even if it is present and can be measured) would be less than what is present on cropland, any associated I.R.C. §180 deduction would likely be insufficient to justify the work to claim the deduction – and it is a deduction and not as valuable to the taxpayer as a credit.
The marketing material also states in numerous places that the firm asserting the deduction can apply to grazing land is not making any “recommendations, representations, or guarantees regarding the income tax implications” and that it is “…NOT intending to provide the Client with legal, tax or accounting advice.” The marketing material also states that the company makes “no express or implied warranties of any kind…regarding…[the] business deduction that can be claimed by Client…”. Clearly these firms are not standing behind their analysis when it comes to claiming a deduction based on their reports. Thus, a buyer of land that does so thinking that a substantial tax deduction may be forthcoming may have no recourse against these firms if the IRS disagrees. But, the buyer would know the nutrient content of the soil. That is worth something to the buyer, but not likely much (if any) of a tax deduction.
Conclusion
When farmland is acquired, an allocation of value can be made to depreciable items. In certain parts of the country, a depreciable item might be residual fertilizer supply. If it can be established with appropriate data, a tax benefit is available. It’s important, however, to follow the IRS guidelines. As applied to grazing land, however, the deduction is quite likely to be so small as to not justify the cost of the soil sampling and the associated tax work to claim the deduction.
Also, in some states, following the IRS guidance on deducting excess soil fertility may not be good enough.
February 26, 2023 in Income Tax | Permalink | Comments (0)
Tuesday, February 21, 2023
Deducting Residual (Excess) Soil Fertility
Overview
When farmland is purchased, depreciation can be claimed on depreciable assets associated with the farmland starting with the first tax year in which possession of the land is taken. The amount claimed is tied to the portion of the total cost of the farmland that can be allocated to any depreciable asset, such as fencing, field drainage tile, grain storage facilities, farm buildings, and irrigation equipment, just to name a few of the more common depreciable items.
In certain parts of the Midwest, above average soil fertility is also eligible for expense deductions. The concept is known as “residual soil fertility” and it can be available to farmland buyers that didn’t farm the acquired property within the immediately prior crop year.
Deductions associated with residual soil fertility, that’s the topic of today’s post.
The Deduction
I.R.C. §180 allows a taxpayer engaged in the trade or business of farming to annually elect (by deducting the expense on the return) the cost of fertilizer, lime, potash, or other materials which enrich, neutralize or condition land used in farming. If these fertilization costs are not expensed, they are required to be capitalized with expense deductions being amortized over a presumed useful life (similar to field drainage tile and/or fencing). This means that residual soil fertility is a capital asset in the hands of an operating farmer, crop-share landlord or cash rent landlord when farmland is acquired, with the cost amortized over the useful life of the asset. That useful life is typically three to four years. The general 15-year amortization rules don’t apply. Instead, the IRS position is that fertilizer costs should be amortized based on the percentage of use or benefit each year. That likely means that straight-line amortization probably does not apply. An agronomist or other soil scientist may be able to provide sufficient information so that the property annual expense allocation can be determined. See, e.g., IRS Pub. 225, Chapter 4.
Note: Usually about 60 percent is deducted in the first year, 30 percent in the second year and the last 10 percent in the third year.
For farmland inherited from a decedent, the date of the decedent’s death is the measurement date for determining whether residual soil fertility exists. If it does, the cost can be amortized by the decedent’s estate and/or the beneficiaries of the estate that receive the farmland.
In 1995, the IRS published a Market Segment Specialization Program (MSSP) addressing residual soil fertility. IRS MSSP, Guideline on Grain Farmers (Training 3149-133, Jul. 1995). In the MSSP, the IRS notes that a deduction for residual fertilizer supply will be denied unless the taxpayer can establish (1) beneficial ownership of the residual fertilizer supply; (2) the presence and extent of the residual fertilizer; and (3) that the residual fertilizer supply is actually being exhausted. In addition, the MSSP instructs IRS examining agents to make sure that the values assigned to depreciable farm assets is reasonable. See also, Tech. Adv. Memo. 9211007 (Dec. 3, 1991).
Allocation. The actual deduction might be less than the agronomist’s value of the excess amount. If the land’s value combined with the value of the excess fertility exceed the purchase price of the land, an allocation must be done for each one based on their respective fair market values. For example, assume that farmland is purchased for 8,000/acre. An agronomist pegs the excess fertility at $4,000/acre. Comparable land in the area without excess fertility sells for $7,000/acre. When the $4,000/acre for excess fertility is added to the land value without excess fertility, the total is $11,000. Thus, the land is 63.6 percent of the total value, and the excess fertility is 36.4 percent. The purchase price was $8,000/acre. 36.4 percent of that amount is $2,912/acre. That will be the amount that IRS will accept as the deduction for excess fertilizer supply – not the $4,000/acre that the agronomist determined.
Procedure
So, how can a taxpayer establish the presence and extent of residual fertilizer supply and that it is actually being exhausted? For starters, if farmland has an actual excess soil fertility base it will normally bring a price premium upon sale. That’s the same rationale that applies when farmland with good fences, field drainage tile and grain storage facilities is purchased – a price premium applies to factor in the existence of those assets. As for residual fertilizer supply, the excess amount can be measured by grid sampling. A buyer can anticipate that grid sampling will cost of approximately $4-$8 per acre. Agronomists and agricultural soil testing labs follow certain guidelines and procedures that they use to determine average (base) soil fertility for various soil types. Once grid soil samples are obtained, the fertility levels of those samples are compared to the base fertility guideline levels for particular soil types to establish the amount of “excess” fertility on a tract of acquired farm real estate.
The key is to obtain data for the established base soil fertility for the type of soil on the purchased farmland from comparable tracts and comparable soil types. By establishing the base soil fertility, the actual sampling on the purchased property will reveal whether excess residual fertilizer is present. That soil sampling should occur on or before the buyer takes possession of the farmland. For farmland that is inherited, the sampling should occur before the buyer applies any new fertilization.
Documentation
While the IRS does not require it, perhaps the best way to document the deduction for excess soil fertility is to provide for the allocation of value to the amount of above average soil fertility in the purchase contract for the farmland. In addition, a written summary of how the computation was made and the time period over which it would deplete due to crop production should be obtained from the agronomist or other expert involved. This will be beneficial for establishing the proper amortization period for the excess soil fertility and will provide substantiation of the deduction upon any subsequent IRS (or state) audit. Depending on the soil type involved, the deduction could range from $50 per acre to over $700 per acre – perhaps exceeding 10 percent of the land’s value.
Recapture
If a deduction for excess fertilizer supply is claimed and the land is later sold, the amount of the selling price attributable to the excess fertility will be recaptured as ordinary income. It does not qualify for capital gain treatment. Any remaining gain will be taxed at capital gain rates. Of course, if the taxpayer continues to own the land until death recapture is avoided.
Conclusion
When farmland is acquired, an allocation of value can be made to depreciable items. In certain parts of the country, a depreciable item might be residual fertilizer supply. If it can be established with appropriate data, a tax benefit is available. It’s important, however, to follow the IRS guidelines. Also, in some states, following the IRS guidance on deducting excess soil fertility may not be good enough.
February 21, 2023 in Income Tax | Permalink | Comments (0)
Sunday, February 5, 2023
Tax Court Opinion - Charitable Deduction Case Involving Estate Planning Fraudster
Overview
The rules surrounding charitable giving can be rather complicated when the gift is not of cash and is of a significant amount. Those detailed rules were at issue in a recent U.S. Tax Court case. What made the case even more interesting was that it also involved taxpayers that got themselves connected with an estate planning and charitable giving fraudster that the U.S. Department of Justice eventually shut down. This is the second significant Tax Court decision in the past six months involving charitable giving. The Furrer farm family of Indiana was involved with a charitable remainder trust scenario that was structured completely wrong (see my blog article here: https://lawprofessors.typepad.com/agriculturallaw/2022/12/how-not-to-use-a-charitable-remainder-trust.html) and now another case.
The rules on charitable giving and a recent case involving a chartable giving scam. It’s the topic of today’s blog article.
Background
The Tax Code allows a deduction for any charitable contribution made during the tax year. I.R.C. §170(a)(1). The amount must be “actually paid during the tax year” and the taxpayer bears the burden to prove the surrender of dominion and control over the property that was contributed to a qualified charity. See, e.g., Pollard v. Comr., 786 F.2d 1063 (11th Cir. 1986); Goldstein v. Comr., 89 T.C. 535 (1987); Fakiris v. Comr., T.C. Memo. 2020-157.
For charitable contributions consisting of anything other than money, the amount of the contribution is generally the fair market value of the property at the time of the contribution. Treas. Reg. §1.170A-1(c)(1). For non-cash contributions exceeding $5,000 (at one time), the taxpayer must obtain a “qualified appraisal” of the property. I.R.C. §170(f)(11)(C). This includes attaching to the return a fully completed appraisal summary on Form 8283. Id.; Treas. Reg. §1.170A-13(c)(2). When a non-cash contribution exceeds $500,000, a copy of the appraisal must be attached to the return. I.R.C. §170(f)(11)(D). If the donor is an S corporation or a partnership, the qualified appraisal requirement is the obligation of the entity and not the members or shareholders. Id.
A “qualified appraisal” is one that is conducted by a “qualified appraiser” using generally accepted appraisal standards and otherwise satisfies the applicable regulations. A qualified appraisal is “qualified” only if it is “prepared, signed, and dated by a qualified appraiser.” Treas. Reg. §1.170A-13(c)(3)(i)(B). There are 11 categories of information that the appraisal must include. Id. subdiv. (ii). One of those is that “[N]o part of the fee arrangement for a qualified appraisal can be based, in effect, on a percentage (or set of percentages) of the appraised value of the property.” Treas. Reg. §1.170A-13(c)(6)(i). See also Alli v. Comr., T.C. Memo. 2014-15.
There is a reasonable cause exception for failing to satisfy the substantiation requirements. I.R.C. §170(f)(11)(A)(ii)(II). To use the reasonable cause exception, the taxpayer must show that willful neglect is not present based on the facts and circumstances. If the exception applies, the charitable deduction may be allowed. See, e.g., Belair Woods, LLC v. Comr., T.C. Memo. 2018-159.
Recent Case
In Lim v. Comr., T.C. Memo. 2023-11, during 2016 and 2017, the petitioners (a married couple) were the sole shareholders of an S corporation. In late 2016, after making a presentation to the petitioners concerning “The Ultimate Tax, Estate and Charitable Plan,” an attorney formed a “Charitable Limited Liability Company” for the petitioners to use as a vehicle for making charitable donations. The attorney agreed to transfer assets to the LLC, to transfer LLC unites to a charity and to provide the supporting valuation documentation for the donation. He also agreed to represent them before the IRS and the Tax Court if the return(s) were later examined. His fee would be the greater of $25,000 or 6 percent of the “deductible amount” of assets capped at $1 million, plus 4 percent of the “deductible amount” of assets exceeding $1 million. The assets transferred to the LLC were five promissory notes with a face amount of $2,008,500. This generated a fee for the attorney of $84,000 based on a presupposed “deductible amount” of $1,600,000 even though the assets were not appraised until late January of 2017 which valued them at $1,600,000. The fee was to be paid in installments over six months beginning in January of 2017.
The attorney also created a second LLC in late December of 2016 with the petitioners as the managers, the attorney as the registered agent, and the petitioners’ S corporation as the single member. Petitioners promised to pay the second LLC $2,008,500 (the promissory notes) in seven years.
The charitable recipient was a Foundation (an I.R.C. §501(c)(3) organization) for which the attorney was the registered agent. The petitioners claimed that their S corporation donated “units” of the second LLC to the Foundation and claimed a charitable deduction. The IRS denied the deduction, partly on the basis of a lack of evidence that any property was actually transferred to the Foundation. The petitioners did not offer any explanation as to when or how the “units” were created or what physical form they took. The petitioners also claimed that they received an acknowledgement letter of the donation from the Foundation dated January 1, 2017. The letter referred to 1,000 units of an LLC which did not exist during 2016 or as of January 1, 2017. It was not addressed to the S corporation, but to the petitioner (wife) at their residence in a different city than the S corporation. The letter also was not signed by any person and appeared to be a form letter with taxpayer-specific information in bold font. It also did not refer to any property that the S corporation allegedly donated on December 31, 2016.
On January 4, 2017, the attorney submitted an appraisal, but it lacked substance. The appraisal asserted that LLC interests were donated to the Foundation in 2016, but did not denote how many interests had been contributed. The claimed charitable deduction was $1,608,808. The attorney also attached his curriculum vitae stating that he was a CPA, a certified valuation analyst and a licensed attorney in Kentucky. Also attached to the appraisal was a one-page “certification” on which the attorney stated that his fee was not contingent on the report in any manner and that he didn’t have any interest or bias with respect to the parties involved. This was despite him having arranged the entire transaction and being the registered agent for the second LLC.
The S corporation filed Form 1120S for 2016 and attached a copy of the appraisal and Form 8283 which described the donated property as “LLC units” with a basis of $2,008,500 that had been acquired by purchase, and an “appraised market value” of $1,608,808. The petitioners reported a non-cash charitable deduction of $1,608,808 on Schedule A that flowed through to them from the S corporation. Because the amount of the deduction exceeded the maximum allowable deduction for 2016, they claimed a $1,195,073 deduction for 2016 and carried the balance of $415,711 to their 2017 return.
The IRS audited the petitioners’ 2016 and 2017 returns and disallowed the charitable deductions for lack of substantiation. The petitioners challenged the disallowance in the Tax Court and the IRS moved for partial Summary Judgment. The Tax Court determined that the appraisal was not a “qualified appraisal” within the meaning of I.R.C. §170(f)(11)(C). Treas. Reg. §1.170A-13(c)(6)(i) requires, among other things, that “no part of the fee arrangement for a qualified appraisal can be based, in effect, on a percentage (or set of percentages) of the appraised value of the property.” Accordingly, the attorney’s fee was a prohibited appraisal fee within the meaning of the regulation. However, the Tax Court held that the petitioners had shown reasonable cause for failure to comply with the substantiation requirements of I.R.C. §170. They had presented sufficient proof that they relied upon professionals in claiming the charitable contribution deduction. Accordingly, the Tax Court denied the IRS summary judgment on this issue. The Tax Court also denied summary judgment to the IRS on the issue of whether the written acknowledgement was a “contemporaneous written acknowledgement” of the contribution in accordance with I.R.C. §170(f)(8)(A). Accordingly, the Tax Court granted the Summary Judgment motion of the IRS in part, while the remaining issues will be set for trial.
Note: In 2018 the Department of Justice filed a complaint against the attorney, alleging that he promoted the “Ultimate Tax Plan” as a tax evasion scheme. He was accused of running a $35 million federal tax advice scam offering fake deductions using three bogus charities for 19 years. The complaint alleged that he was at the helm of "a national charitable-giving tax scheme" that targeted "wealthy individuals in high tax brackets facing large tax liabilities.” He settled with the Government and agreed to a permanent injunction. On April 26, 2019, the U.S. District Court for the Southern District of Florida entered a final judgment of permanent injunction against him, holding that he had engaged in conduct penalizable under I.R.C. §6700 by promoting the “Ultimate Tax Plan.” The court permanently enjoined him from, among other things, promoting “the Ultimate Tax Plan or any plan or arrangement that is substantially similar.” The court ordered the attorney to perform other actions as well in relation to the plan.
Conclusion
When non-cash gifts are made to charity particular rules must be followed for a charitable deduction to be claimed. Unfortunately, there are those engaged in unscrupulous techniques that prospective donors must be on the alert for.
February 5, 2023 in Estate Planning, Income Tax | Permalink | Comments (0)
Monday, January 30, 2023
Bibliography - July Through December 2022
Overview
After the first half of 2022, I posted a blog article of a bibliography of my blog articles for the first half of 2022. You can find that bibliography here: Bibliography – January through June of 2022
Bibliography of articles for that second half of 2022 – you can find it in today’s post.
Alphabetical Topical Listing of Articles (July 2022 – December 2022)
Bankruptcy
More Ag Law Developments – Potpourri of Topics
Business Planning
Durango Conference and Recent Developments in the Courts
Is a C Corporation a Good Entity Choice For the Farm or Ranch Business?
What is a “Reasonable Compensation”?
https://lawprofessors.typepad.com/agriculturallaw/2022/08/what-is-reasonable-compensation.html
Federal Farm Programs: Organizational Structure Matters – Part Three
LLCs and Self-Employment Tax – Part One
https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-one.html
LLCs and Self-Employment Tax – Part Two
https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-two.html
Civil Liabilities
Durango Conference and Recent Developments in the Courts
Dicamba Spray-Drift Issues and the Bader Farms Litigation
Tax Deal Struck? – and Recent Ag-Related Cases
Ag Law and Tax Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html
More Ag Law Developments – Potpourri of Topics
Ag Law Developments in the Courts
https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html
Contracts
Minnesota Farmer Protection Law Upheld
Criminal Liabilities
Durango Conference and Recent Developments in the Courts
https://lawprofessors.typepad.com/agriculturallaw/20Ag Law Summit
https://lawpr22/07/durango-conference-and-recent-developments-in-the-courts.html
Environmental Law
Constitutional Limit on Government Agency Power – The “Major Questions” Doctrine
More Ag Law Developments – Potpourri of Topics
Court Says COE Acted Arbitrarily When Declining Jurisdiction Over Farmland
Ag Law Developments in the Courts
https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html
Estate Planning
Farm/Ranch Tax, Estate and Business Planning Conference August 1-2 – Durango, Colorado (and Online)
IRS Modifies Portability Election Rule
Modifying an Irrevocable Trust – Decanting
Farm and Ranch Estate Planning in 2022 (and 2023)
Social Security Planning for Farmers and Ranchers
How NOT to Use a Charitable Remainder Trust
Recent Cases Involving Decedents’ Estates
Medicaid Estate Recovery and Trusts
https://lawprofessors.typepad.com/agriculturallaw/2022/12/medicaid-estate-recovery-and-trusts.html
Income Tax
What is the Character of Land Sale Gain?
Deductible Start-Up Costs and Web-Based Businesses
Using Farm Income Averaging to Deal With Economic Uncertainty and Resulting Income Fluctuations
Tax Deal Struck? – and Recent Ag-Related Cases
What is “Reasonable Compensation”?
https://lawprofessors.typepad.com/agriculturallaw/2022/08/what-is-reasonable-compensation.html
LLCs and Self-Employment Tax – Part One
https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-one.html
LLCs and Self-Employment Tax – Part Two
https://lawprofessors.typepad.com/agriculturallaw/2022/08/llcs-and-self-employment-tax-part-two.html
USDA’s Emergency Relief Program (Update on Gain from Equipment Sales)
Declaring Inflation Reduced and Being Forgiving – Recent Developments in Tax and Law
Ag Law and Tax Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html
Extended Livestock Replacement Period Applies in Areas of Extended Drought – IRS Updated Drought Areas
More Ag Law Developments – Potpourri of Topics
IRS Audits and Statutory Protection
https://lawprofessors.typepad.com/agriculturallaw/2022/10/irs-audits-and-statutory-protection.html
Handling Expenses of Crops with Pre-Productive Periods – The Uniform Capitalization Rules
When Can Depreciation First Be Claimed?
Tax Treatment of Crops and/or Livestock Sold Post-Death
Social Security Planning for Farmers and Ranchers
Are Crop Insurance Proceeds Deferrable for Tax Purposes?
Tax Issues Associated With Easement Payments – Part 1
Tax Issues Associated With Easement Payments – Part 2
How NOT to Use a Charitable Remainder Trust
Does Using Old Tractors Mean You Aren’t a Farmer? And the Wind Energy Production Tax Credit – Is Subject to State Property Tax?
Insurance
Tax Deal Struck? – and Recent Ag-Related Cases
Real Property
Tax Deal Struck? – and Recent Ag-Related Cases
Ag Law Summit
https://lawprofessors.typepad.com/agriculturallaw/2022/08/ag-law-summit.html
Ag Law and Tax Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html
More Ag Law Developments – Potpourri of Topics
Ag Developments in the Courts
https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html
Regulatory Law
Constitutional Limit on Government Agency Power – The “Major Questions” Doctrine
The Complexities of Crop Insurance
https://lawprofessors.typepad.com/agriculturallaw/2022/07/the-complexities-of-crop-insurance.html
Federal Farm Programs – Organizational Structure Matters – Part One
Federal Farm Programs – Organizational Structure Matters – Part Two
Federal Farm Programs: Organizational Structure Matters – Part Three
USDA’s Emergency Relief Program (Update on Gain from Equipment Sales)
Minnesota Farmer Protection Law Upheld
Ag Law and Tax Developments
https://lawprofessors.typepad.com/agriculturallaw/2022/09/ag-law-and-tax-developments.html
Animal Ag Facilities and Free Speech – Does the Constitution Protect Saboteurs?
Court Says COE Acted Arbitrarily When Declining Jurisdiction Over Farmland
Ag Law Developments in the Courts
https://lawprofessors.typepad.com/agriculturallaw/2022/12/ag-law-developments-in-the-courts.html
Water Law
More Ag Law Developments – Potpourri of Topics
January 30, 2023 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)
Friday, January 27, 2023
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 2 and 1
Overview
Today’s article concludes my look at the top ag law and tax developments of 2022 with what I view as the top two developments. I began this series by looking at those developments that were significant, but not quite big enough to make the “Top Ten.” Then I started through the “Top Ten.”
The top two ag law and tax developments in 2022 – it’s the topic of today’s post.
Recap
Here’s a bullet-point recap of the top developments of 2022 that I have written about:
- Nuisance law (the continued developments in Iowa) - Garrison v. New Fashion Pork LLP, 977 N.W.2d 67 (Iowa Sup. Ct. 2022).
- Minnesota farmer protection law - Pitman Farms v. Kuehl Poultry, LLC, et al., 48 F.4th 866 (8th Cir. 2022).
- Regulation of ag activities on wildlife refuges - Tulelake Irrigation Dist. v. United States Fish & Wildlife Serv., 40 F.4th 930 (9th Cir. 2022).
- Corps of Engineers jurisdiction over “wetland” - Hoosier Environmental Council, et al. v. Natural Prairie Indiana Farmland Holdings, LLC, et al., 564 F. Supp. 3d 683 (N.D. Ind. 2021).
- U. S. Tax Court’s jurisdiction to review collection due process determination - Boechler, P.C. v. Commissioner, 142 S. Ct. 1493 (2022).
- IRS Failure to Comply with the Administrative Procedure Act - Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022); Green Valley Investors, LLC v. Commissioner, 159 T.C. No. 5 (2022).
- State law allowing unconstitutional searches unconstitutional - Rainwaters, et al. v. Tennessee Wildlife Resources Agency, No. 20-CV-6 (Benton Co. Ten. Dist. Ct. Mar. 22, 2022).
- No. 10 – USDA’s Emergency Relief Program and the definition of “farm income.”
- No. 9 - USDA decision not to review wetland determination upheld - Foster v. United States Department of Agriculture, No. 4:21-CV-04081-RAL, 2022 U.S. Dist. LEXIS 117676 (D. S.D. Jul. 1, 2022).
- No. 8 - Dicamba drift damage litigation - Hahn v. Monsanto Corp., 39 F.4th 954 (8th Cir. 2022), reh’g. den., 2022 U.S. App. LEXIS 25662 (8th Cir. Sept. 2, 2022).
- No. 7 – The misnamed “Inflation Reduction Act.”
- No. 6 – Caselaw and legislative developments concerning “ag gag” provisions.
- No. 5 - WOTUS final rule.
- No. 4 – Economic issues
- No. 3 – Endangered Species Act regulations
No. 2 – California Proposition 12
National Pork Producers Council, et al. v. Ross, 6 F.4th 1021 (9th Cir. Jul. 28, 2021), cert. granted, 142 S. Ct. 1413 (2022)
In a huge blow to pork producers (and consumers of pork products) nationwide, the U.S. Court of Appeals for the Ninth Circuit has upheld California’s Proposition 12 in 2021. Proposition 12 requires any pork sold in California to be raised in accordance with California’s housing requirements for hogs. This means that any U.S. hog producer, by January 1, 2022, was required to upgrade existing facilities to satisfy California’s requirements if desiring to market pork products in California. In early 2022, the U.S. Supreme Court announced that it would review the Ninth Circuit’s opinion.
While each state sets its own rules concerning the regulation of agricultural production activities, the legal question presented in this case is whether one state can override other states’ rules. The answer to that question involves an analysis of the Commerce Clause and the “Dormant” Commerce Clause.
The Commerce Clause. Article I Section 8 of the U.S. Constitution provides in part, “the Congress shall have Power...To regulate Commerce with foreign Nations and among the several states, and with the Indian Tribes.” The Commerce Clause, on its face, does not impose any restrictions on states in the absence of congressional action. However, the U.S. Supreme Court has interpreted the Commerce Clause as implicitly preempting state laws that regulate commerce in a manner that disrupts the national economy. This is the judicially-created doctrine known as the “dormant” Commerce Clause.
The “Dormant” Commerce Clause. The dormant Commerce Clause is a constitutional law doctrine that says Congress's power to "regulate Commerce ... among the several States" implicitly restricts state power over the same area. In general, the Commerce Clause places two main restrictions on state power – (1) Congress can preempt state law merely by exercising its Commerce Clause power by means of the Supremacy Clause of Article VI, Clause 2 of the Constitution; and (2) the Commerce Clause itself--absent action by Congress--restricts state power. In other words, the grant of federal power implies a corresponding restriction of state power. This second limitation has come to be known as the "Dormant" Commerce Clause because it restricts state power even though Congress's commerce power lies dormant. Willson v. Black Bird Creek Marsh Co., 27 U.S. 245 (1829). The label of “Dormant Commerce Clause” is really not accurate – the doctrine applies when the Congress is dormant, not the Commerce Clause itself.
Rationale. The rationale behind the Commerce Clause is to protect the national economic market from opportunistic behavior by the states - to identify protectionist actions by state governments that are hostile to other states. Generally, the dormant Commerce Clause doctrine prohibits states from unduly interfering with interstate commerce. State regulations cannot discriminate against interstate commerce. If they do, the regulations are per se invalid. See, e.g., City of Philadelphia v. New Jersey, 437 U.S. 617 (1978). Also, state regulations cannot impose undue burdens on interstate commerce. See, e.g., Kassel v. Consolidated Freightways Corp., 450 U.S. 662 (1981). Under the “undue burden” test, state laws that regulate evenhandedly to effectuate a local public interest are upheld unless the burden imposed on commerce is clearly excessive in relation to the local benefits.
The Court has never held that discrimination between in-state and out-of-state commerce, without more, violates the dormant Commerce Clause. Instead, the Court has explained that the dormant Commerce Clause is concerned with state laws that both discriminate between in-state and out-of-state actors that compete with one another, and harm the welfare of the national economy. Thus, a discriminatory state law that harms the national economy is permissible if in-state and out-of-state commerce do not compete. See, e.g., General Motors Corp. v. Tracy, 117 S. Ct. 811, 824-26 (1997). Conversely, a state law that discriminates between in-state and out-of-state competitors is permissible if it does not harm the national economy. H.P. Hood & Sons, Inc. v. Du Mond, 336 U.S. 525 (1949).
California Proposition 12 Litigation
In 2018, California voters passed Proposition 12. Proposition 12 bans the sale of whole pork meat (no matter where produced) from animals confined in a manner inconsistent with California’s regulatory standards. Proposition 12 established minimum requirements on farmers to provide more space for egg-laying hens, breeding pigs, and calves raised for veal. Specifically, the law requires that covered animals be housed in confinement systems that comply with specific standards for freedom of movement, cage-free design and minimum floor space. The law identifies covered animals to include veal calves, breeding pigs and egg-laying hens. The implementing regulations prohibit a farm owner or operator from knowingly causing any covered animal to be confined in a cruel manner, as specified, and prohibits a business owner or operator from knowingly engaging in the sale within the state of shell eggs, liquid eggs, whole pork meat or whole veal meat, as defined, from animals housed in a “cruel manner.” In addition to general requirements that prohibit animals from being confined in a manner that prevents lying down, standing up, fully extending limbs or turning around freely, the measure added detailed confinement space standards for farms subject to the law. The alleged reason for the law was to protect the health and safety of California consumers and decrease the risk of foodborne illness and the negative fiscal impact on California.
In late 2019, several national farm organizations challenged Proposition 12 and sought a declaratory judgment that the law was unconstitutional under the dormant Commerce Clause. The plaintiffs also sought a permanent injunction preventing Proposition 12 from taking effect. The plaintiffs claimed that Proposition 12 impermissibly regulated out-of-state conduct by compelling non-California producers to change their operations to meet California’s standards. The plaintiffs also alleged that Proposition 12 imposed excessive burdens on interstate commerce without advancing any legitimate local interest by significantly increasing operation costs without any connection to human health or foodborne illness. The trial court dismissed the plaintiffs’ complaint. National Pork Producers Council, et al. v. Ross, No. 3:19-cv-02324-W-AHG (S.D. Cal. Apr. 27, 2020).
On appeal, the plaintiffs focused their argument on the allegation that Proposition 12 has an impermissible extraterritorial effect of regulating prices in other states and, as such, is per se unconstitutional. This was a tactical mistake for the plaintiffs. The appellate court noted that existing Supreme Court precedent on the extraterritorial principle applied only to state laws that are “price control or price affirmation statutes.” National Pork Producers Council, et al. v. Ross, No. 20-55631, 2021 U.S. App. LEXIS 22337 (9th Cir. Jul. 28, 2021). Thus, the extraterritorial principle does not apply to a state law that does not dictate the price of a product and does not tie the price of its in-state products to out-of-state prices. Because Proposition 12 was neither a price control nor a price-affirmation statute (it didn’t dictate the price of pork products or tie the price of pork products sold in California to out-of-state prices) the law didn’t have the extraterritorial effect of regulating prices in other states.
The appellate court likewise rejected the plaintiffs’ claim that Proposition 12 has an impermissible indirect “practical effect” on how pork is produced and sold outside California. Id. Upstream effects (e.g., higher production costs in other states) the appellate court concluded, do not violate the dormant Commerce Clause. The appellate court pointed out that a state law is not impermissibly extraterritorial unless it regulates conduct that is wholly out of state. Id. Because Proposition 12 applied to California and non-California pork production the higher cost of production was not an impermissible effect on interstate commerce.
The appellate court also concluded that inconsistent regulation from state-to-state was permissible because the plaintiffs had failed to show a compelling need for national uniformity in regulation at the state level. Id. In addition, the appellate court noted that the plaintiffs had not alleged that Proposition 12 had a discriminatory effect on interstate commerce.
Simply put, the appellate court rejected the plaintiffs’ challenge to Proposition 12 because a law that increases compliance costs (projected at a 9.2 percent increase in production costs that would e passed on to consumers) is not a substantial burden on interstate commerce in violation of the dormant Commerce Clause.
As noted above, the U.S. Supreme court decided to review the Ninth Circuit’s opinion. Unfortunately, the Supreme Court has been careless in applying the anti-discrimination test, and in many cases, neither of the two requirements--interstate competition or harm to the national economy--is ever mentioned. See, e.g., Hughes v. Oklahoma, 441 U.S. 322 (1979). The reason interstate competition goes unstated is obvious – in most cases the in-state and out-of-state actors compete in the same market. But, the reason that the second requirement, harm to the national economy, goes unstated is because the Court simply assumes the issue away. The Supreme Court’s decision in 2023 is a highly anticipated one for agriculture and the dormant Commerce Clause analysis and application in general.
No. 1 – The “Major Questions” Doctrine
West Virginia, et al. v. Environmental Protection Agency, et al., 142 S. Ct. 2587 (2022)
Clearly, the biggest development of 2022 that has the potential to significantly impact agriculture and the economy in general is the Supreme Court’s opinion involving the Environmental Protection Agency’s (EPA’s) regulatory authority under the Clean Air Act (CAA). The Court invoked the “major question” doctrine to pair back unelected bureaucratic agency authority and return policy-making power to citizens through their elected representatives. The future impact of the Court’s decision is clear. When federal regulations amount to setting nationwide policy and when state regulations do the same at the state level, the regulatory bodies may be successfully challenged in court.
The case involved the U.S. Supreme Court’s review of the EPA’s authority to regulate greenhouse gas emissions from existing power plants under the CAA. The case arose from the EPA’s regulatory development of the Clean Power Plan (CPP) in 2015 which, in turn, stemmed from then-President Obama’s 2008 promise to establish policy that would bankrupt the coal industry. The EPA claimed it had authority to regulate CO2 emissions from coal and natural-gas-fired power plants under Section 111 of the CAA. Under that provision, the EPA determines emission limits. But EPA took the position that Section 111 empowered it to shift energy generation at the plants to “renewable” energy sources such as wind and solar. Under the CPP, existing power plants could meet the emission limits by either reducing electricity production or by shifting to “cleaner” sources of electricity generation. The EPA admitted that no existing coal plant could satisfy the new emission standards without a wholesale movement away from coal, and that the CPP would impose billions in compliance costs, raise retail electricity prices, require the retirement of dozens of coal plants and eliminate tens of thousands of jobs. In other words, the CPP would keep President Obama’s 2008 promise by bypassing the Congress through the utilization of regulatory rules set by unelected, unaccountable bureaucrats.
The U.S. Supreme Court stayed the CPP in 2016 preventing it from taking effect. The EPA under the Trump Administration repealed the CPP on the basis that the Congress had not clearly delegated regulatory authority “of this breadth to regulate a fundamental sector of the economy.” The EPA then replaced the CPP with the Affordable Clean Energy (ACE) rule. Under the ACE rule, the focus was on regulating power plant equipment to require upgrades when necessary to improve operating practices. Numerous states and private parties challenged the EPA’s replacement of the CPP with the ACE. The D.C. Circuit Court vacated the EPA’s repeal of the CPP, finding that the CPP was within the EPA’s purview under Section 7411 of the CAA – the part of the CAA that sets standards of performance for new sources of air pollution. American Lung Association v. Environmental Protection Agency, 985 F.3d 914 (D.C. Cir. 2021). The Circuit Court also vacated the ACE and purported to resurrect the CPP. In the fall of 2021, the U.S. Supreme Court agreed to hear the case.
The Supreme Court reversed, framing the issue as whether the EPA had the regulatory authority under Section 111 of the CAA to restructure the mix of electricity generation in the U.S. to transition from 38 percent coal to 27 percent coal by 2030. The Supreme Court said EPA did not, noting that the case presented one of those “major questions” because under the CPP the EPA would tremendously expand its regulatory authority by enacting a regulatory program that the Congress had declined to enact. While the EPA could establish emission limits, the Supreme Court held that the EPA could not force a shift in the power grid from one type of energy source to another. The Supreme Court noted that the EPA admitted that did not have technical expertise in electricity transmission, distribution or storage. Simply put, the Supreme Court said that devising the “best system of emission reduction” was not within EPA’s regulatory power.
Clearly, the Congress did not delegate administrative agencies the authority to establish energy policy for the entire country. While the Supreme Court has never precisely defined the boundaries and scope of the major question doctrine, when the regulation is more in line with what should be legislative policymaking, it will be struck down. The Supreme Court’s decision is also broad enough to have long-lasting consequences for rulemaking by all federal agencies including the USDA/FSA. The decision could also impact the Treasury Department’s promulgation of tax regulations.
The Supreme Court’s decision returns power to the Congress that it has ceded over the years to administrative agencies and the Executive branch concerning matters of “vast economic and political significance.” But it’s also likely that the Executive branch and the unelected bureaucrats of the administrative state will likely attempt to push the envelope and force the courts to push back. It’s rare that the Executive branch and administrative agencies voluntarily return power to elected representatives as was done in numerous instances from 2017 through 2020.
Conclusion
Agricultural law and tax issues were many and varied in 2022. In 2023, the U.S. Supreme Court will issue opinions in the California Proposition 12 case and the Sackett case involving the scope of the federal government’s jurisdiction over wetlands. Also, there has been a major development in the Tax Court involving tax issues associated with deferred grain contracts that has resulted in a settlement with IRS, the terms of which cannot be disclosed at this time. If 2022 showed a trend with USDA it is that the USDA will continue several “hardline” positions against farmers – a narrow definition of farm income; broad regulatory control over wet areas in fields; and ceding regulatory authority to the EPA and the COE. The U.S. Supreme Court is also anticipated to issue on opinion with potentially significant implications for Medicaid planning.
Of course, the expanding war against Russia being fought in Ukraine will continue to dominate ag markets throughout 2023. At home, the general economic data is not good and that will have implications in 2023 for farmers and ranchers. On January 26, the U.S Bureau of Economic Analysis issued a report (https://www.bea.gov/) showing that the U.S. economy grew by 2.9 percent in the fourth quarter of 2022 and 2.1 percent for all of 2022. But, the report also showed that economic growth in the economy is slowing. Business investment grew by a mere 1.4 percent in the fourth quarter of 2022, consisting almost entirely of inventory growth. That will mean that businesses will be forced to sell off inventories at discounts, which will lower business profits and be a drag on economic growth in 2023. Nonresidential investment was down 26.7 percent due to the increase in home prices, increased interest rates and a drop in real income. On that last point, real disposable income dropped $1 trillion in 2022, the largest drop since 1932 - the low point of the Great Depression. Personal savings also dropped by $1.6 trillion in 2022. This is a "ticking timebomb" that is not sustainable because it means that consumers are depleting cash reserves. This indicates that spending will continue to slow in 2023 and further stymie economic growth - about two-thirds of GDP is based on consumer spending. Relatedly, the Dow was down 8.8 percent for 2022, the worst year since 2008. 2022 also saw a reduction in the pace of international trade. Imports dropped more than exports which increases GDP, giving the illusion that the economy is better off.
Certainly, 2023 will be another very busy year for rural practitioners and those dealing with legal and tax issues for farmers and ranchers.
January 27, 2023 in Civil Liabilities, Environmental Law, Income Tax, Regulatory Law, Water Law | Permalink | Comments (0)
Saturday, January 21, 2023
Top Ten Agricultural Law and Tax Developments of 2022 – Numbers 8 and 7
Overview
Today I continue the journey through what I believe to be the Top 10 developments in agricultural law and agricultural taxation of 2022. Today, I look at developments number eight and seven.
No. 8 – Dicamba Drift Damage Litigation
Hahn v. Monsanto Corp., 39 F.4th 954 (8th Cir. 2022), reh’g. den., 2022 U.S. App. LEXIS 25662 (8th Cir. Sept. 2, 2022)
Damage from the drift of Dicamba has been an issue in certain parts of the country for the past two years. Over that time, I have written on the technical aspects of Dicamba and the underlying problems associated with Dicamba application. In 2022, the Dicamba saga continued with litigation involving Missouri’s largest peach farm.
In Bader Farms, Inc. v. Monsanto Co., et al., No. MDL No. 1:18md2820-SNLJ, 2019 U.S. Dist. LEXIS 114302 (E.D. Mo. July 10, 2019), the plaintiff is Missouri’s largest peach farming operation and is located in the southeast part of the state. claimed that his peach orchard was destroyed after the defendants (Monsanto and BASF) allegedly conspired to develop and market Dicamba-tolerant seeds and Dicamba-based herbicides. The suit alleged that the two companies collaborated on Xtend (herbicide resistant cotton seed) that was intended for use with a less volatile form of Dicamba with less drift potential. But, as of 2015 neither Monsanto nor BASF had produced the new, less volatile, form of Dicamba. That fact led the plaintiff to claim that the defendants released the Dicamba-tolerant seed with no corresponding Dicamba herbicide that could be safely applied. As a result, the plaintiff claimed, farmers illegally sprayed an old formulation of Dicamba that was unapproved for in-crop, over-the-top, use and was highly volatile and prone to drift. The plaintiff claimed its annual peach crop revenue exceeded $2 million before the drift damage, and an expert at trial asserted that the drift caused the plaintiff to lose over $20 million in profits. While many cases had previously been filed on the dicamba drift issue, the plaintiff did not join the other litigation because it focused on damages to soybean crops. The plaintiff’s suit also involved claims for failure to warn; negligent training; violation of the Missouri Crop Protection Act (MCPA); civil conspiracy; and joint liability for punitive damages.
Monsanto moved to dismiss the claims for failure to warn; negligent training; violation of the MCPA; civil conspiracy; and joint liability for punitive damages. BASF moved to dismiss those same counts except the claims for failure to warn. The trial court granted the motion to dismiss in part. Monsanto argued that the failure to warn claims were preempted by the Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA), but the plaintiff claimed that no warning would have prevented the damage to the peaches. The trial court determined that the plaintiff had adequately plead the claim and denied the motion to dismiss this claim. Both Monsanto and BASF moved to dismiss the negligent training claim, but the trial court refused to do so. However, the trial court did dismiss the MCPA claims. The trial court noted that civil actions under the MCPA are limited to “field crops” which did not include peaches. The trial court, however, did not dismiss the civil conspiracy claim based on concerted action by agreement, but did dismiss the aiding and abetting portion of the claim because that cause of action is not recognized under Missouri tort law. The parties agreed to a separate jury determination of punitive damages for each defendant.
Note: The case went to trial in early 2020 and was one of more than 100 similar Dicamba lawsuits. Bayer, which acquired Monsanto in 2018 for $63 billion, announced in June of 2020 that it would settle dicamba lawsuits for up to $400 million.
At trial, the jury found that Monsanto had negligently designed or failed to warn for 2015 and 2016 and that both defendants had done so for 2017 to the time of trial. The jury awarded the plaintiff $15 million in compensatory damages and $250 million in punitive damages against Monsanto for 2015 and 2016. The jury also found that the defendants were acting in a joint venture and in a conspiracy. The plaintiff submitted a proposed judgment that both defendants were responsible for the $250 million punitive damages award. BASF objected, but the trial court found the defendants jointly liable for the full verdict considering the jury’s finding that the defendants were in a joint venture. Bader Farms, Inc. v. Monsanto Co., et al., MDL No. 1:18-md-02820-SNJL, 2020 U.S. Dist. LEXIS 34340 (E.D. Mo. Feb. 28, 2020).
BASF then moved for a judgment as a matter of law on punitive damages or motion for a new trial or remittitur (e.g., asking the court to reduce the damage award), and Monsanto moved for a judgment as a matter of law or a new trial. The trial court, however, found both defendants jointly liable, although the court lowered the punitive damages to $60 million (from $250 million) after determining a lack of actual malice. The trial court did uphold the $15 million compensatory damage award upon finding that the correct standard under Missouri law was applied to the farm’s damages. Bader Farms, Inc. v. Monsanto Co, et al., MDL No. 1:18md2820-SNLJ, 2020 U.S. Dist. LEXIS 221420 (E.D. Mo. Nov. 25, 2020). The defendants filed a notice of appeal on December 22, 2020.
In Hahn v. Monsanto Corp., 39 F.4th 954 (8th Cir. 2022), reh’g. den., 2022 U.S. App. LEXIS 25662 (8th Cir. Sept. 2, 2022), the appellate court partially affirmed the trial court, partially reversed, and remanded the case. The appellate court determined that the trial court incorrectly instructed the jury to assess punitive damages for Bayer (i.e., Monsanto) and BASF together, rather than separately, and that a new trial was needed to determine punitive damages for each company. Indeed, the appellate court vacated the punitive damages award and remanded the case to the trial court with instructions to hold a new trial only on the issue of punitive damages.
However, the appellate court did not disturb the trial court’s jury verdict of $15 million in compensatory damages. On the compensatory damages issue, the appellate court held that the trial court properly refused to find intervening cause as a matter of law for the damage to the plaintiff’s peaches. On that point, the appellate court determined that the spraying of Dicamba on a nearby farm did not interrupt the chain of events which meant that the question of proximate cause of the damage was proper for the jury to determine. The appellate court also held that the was an adequate basis for the plaintiff’s lost profits because the award was not based on speculation. The appellate court noted that the peach orchard had been productive for decades, and financial statements along with expert witness testimony calculated approximately $20.9 million in actual damages. The appellate court also determined that the facts supported the jury’s determination that the defendants engaged in a conspiracy via unlawful means – knowingly enabling the widespread use of Dicamba during growing season to increase seed sales.
No. 7 – The Misnamed “Inflation Reduction Act”
If ever there has been a deceptively misnamed piece of legislation, this is it. An Act with $750 billion of newly minted money to will not reduce inflation. Words have no meaning. I suppose that we are supposed to believe that the following provisions of the bill will reduce inflation:
- $3 billion for the U.S. Postal Service to buy new electric mail trucks;
- $3 billion for the EPA to oversee block grants for “environmental justice;”
- $40 billion total to the EPA which includes $30 billion for “disadvantaged communities” (keep in mind that the total annual budget of the EPA is about $10 billion);
- $750 million to the Interior Department for new hires;
- $10 million to the USDA to be spent on “equity commissions” to “combat” racism;
- $25 million to the Government Accountability Office to determine, “whether the economic, social and environmental impacts of the funds described in this paragraph are equitable;”
- Via a budget gimmick to keep the amount outside of the Act’s price tag are amounts to the Energy Department for existing “green” energy loan programs and a new energy loan-guarantee program.
Ag Program Spending
The Act contains a great deal of spending on ag conservation-related programs. Here are the primary provisions:
- EQIP - $8.45 billion additional funding over Fiscal Years 2023-2026. Prioritizes funding for reduction of methane emissions from cattle (e.g., cattle passing gas) and nutrient management activities (e.g., diets to reduce bloating in cows).
- CSP - $3.25 billion additional funding over same time frame.
- Ag Conservation Easement Program (ACEP) - $1.4 billion over same time frame for easements or interests in land that will reduce, capture, avoid or sequester carbon dioxide, or methane oxide emissions with land eligible for the program. ACEP incorporates the Wetlands Reserve Program, the Grasslands Reserve Program and the Farm and Ranch Lands Protection Program.
- Regional Conservation Partnership Program - $4.95 billion over same timeframe for cover cropping, nutrient management, and watershed improvement.
- $4 billion for drought relief that prioritizes the CO basin.
- The U.S. Forest Service gets $1.8 billion for hazardous fuels reduction projects on USFS land.
- $14 billion for rural development and lending projects.
- $3.1 billion to USDA to provide payments to distressed borrowers.
- $2.2 billion to USDA for farmers, ranchers and forest landowners that have been discriminated against in USDA lending programs (i.e., reparations).
- $5 billion to USDA for National Forest System to fund forest reforestation and wildfire prevention.
The IRS gets approximately $80 billion in IRS funding (over next 10 years) to hire 87,000 agents. The IRS currently has 78,000 agents, but 50,000 are set to retire in the next few years. $46 billion is to be dedicated to enforcement and is anticipated to increase the number of audits by $1.2 million annually. $25 billion is earmarked for IRS operations, $5 billion for business systems modernization. IRS taxpayer services, which many tax practitioners would say as the most in need of funding, gets the short end of the stick with $4 billion.
Conclusion
I will continue looking at the biggest developments of 2022 in ag law and tax in the next post.
January 21, 2023 in Civil Liabilities, Income Tax, Regulatory Law | Permalink | Comments (0)
Saturday, January 14, 2023
Top Agricultural Law and Tax Developments of 2022 – Part 4
Overview
Today’s blog article continues the series that began earlier this week reviewing the top ag law and tax developments of 2022. I am working my way through those developments that were significant, but not quite of national significance to make the “Top Ten” of 2022.
More ag law and tax developments of 2022 – it’s the topic of today’s post.
State Law Allowing Warrantless Searches Unconstitutional
Rainwaters, et al. v. Tennessee Wildlife Resources Agency, No. 20-CV-6 (Benton Co. Ten. Dist. Ct. Mar. 22, 2022)
The Fourth Amendment protects against illegal searches and seizures. In general, government officials must secure a search warrant based on probable cause before searching an area unless the owner gives consent. However, the Fourth Amendment’s protection accorded to “persons, houses, papers and effects,” does not extend to all open areas contiguous to a person’s home, but rather only to the home itself and its surrounding “curtilage” – the area immediately surrounding and associated with the defendant’s home.
The scope and extent of curtilage is an important issue to farming and ranching operations. Farming, hunting, recreational and other activity occurs on private land that is not located in the surrounding vicinity of the home. Indeed, there may not even be a home on the tract. Does that mean that government agents can conduct a warrantless search on such property? The ability to do so has become much easier with the new technological developments.
In addition to the Fourth Amendment protection, in recent years numerous states have enacted legislation designed to provide what is believed to be greater protection from warrantless searches to rural property owners. Sometimes those laws find themselves at odds with other state laws that allow certain government officials access to property to perform “official” duties. Other times, those state laws providing access by government officials without a warrant are challenged as unconstitutional. That is indeed what happened in a Tennessee case in 2022.
In the case, the plaintiffs owned farmland on which they hunted or fished. They marked fenced portions of their respective tracts where they hunted and also posted the tracts as “No Trespassing.” Tennessee Wildlife Resources Agency (TWRA) officers entered onto both tracts on several occasions and took photos of the plaintiffs and their guests without permission or a warrant. Tennessee law (Tenn. Code Ann. §70-1-305(1) and (7)) allows TWRA officers to enter onto private property, except buildings, without a warrant “to perform executive duties.” The TWRA officers installed U.S. Fish & Wildlife Service surveillance cameras on the plaintiffs’ property without first obtaining a warrant to gather information regarding potential violations of state hunting laws. The plaintiffs challenged the constitutionality of the Tennessee law and sought injunctive and declaratory relief as well as nominal damages. The defendants moved for summary judgment arguing that the plaintiffs lacked standing and that there was no controversy to be adjudicated.
The trial court found the Tennessee law to be facially unconstitutional. The trial court noted that the statute at issue reached to “any property, outside of buildings” which unconstitutionally allowed for warrantless searches of a home’s curtilage. The trial court also determined that the officers’ information gathering intrusions were unconstitutional searches rather than reasonable regulations and restrictions, and that the statute was comparable to a constitutionally prohibited general warrant. It was unreasonable for the TWRA officers to enter onto occupied, fenced, private property without first obtaining consent or a search warrant. The trial court also held the plaintiffs had standing to sue because they experienced multiple unauthorized entries onto their private property, and that declaratory relief was an adequate remedy. The trial court awarded nominal damages of one dollar.
Note: The defendant appealed the trial court’s decision. Expect more developments in this case in 2023 as well as additional developments in other states on the warrantless search issue.
IRS Failure to Comply with the Administrative Procedure Act (APA)
Mann Construction, Inc. v. United States, 27 F.4th 1138 (6th Cir. 2022); Green Valley Investors, LLC v. Commissioner, 159 T.C. No. 5 (2022)
Several court decisions in 2022 invalidated IRS action for not following federal law in developing regulations that implement the tax code. For instance, in Mann Construction, the plaintiff challenged IRS Notice 2007–83, which designated certain employee benefit plans featuring cash value life insurance policies as listed transactions.
Note: A listed transaction is a transaction that is the same as or substantially similar to one of the types of transactions that the IRS has determined to be a tax avoidance transaction. IRS identifies these transactions by notice, regulation, or other form of published guidance as a listed transaction.
Generally, the Code imposes a 20 percent accuracy-related penalty on a taxpayer who has a “reportable transaction” understatement. The penalty is 30 percent if the taxpayer fails to make certain disclosure requirements that I.R.C. §6011 requires. That Code section imposes a penalty on a person who fails to include information about a reportable transaction on a return. A reportable transaction is one that is the same as or “substantially similar to” a tax avoidance transaction (a.k.a. a “listed transaction”) that the IRS has identified by a Notice, Regulation or some other form of published guidance. Pursuant to IRC §6707A, a failure to report a listed transaction subjects the taxpayer to potential monetary penalties and criminal sanctions.
Note: The minimum penalty for failure to report a listed transaction is $10,000 ($5,000 for a natural person). The maximum penalty is $200,000 ($100,000 for a natural person).
In Mann Construction, the plaintiff had put a cash value life policy plan into effect from the 2013 to 2017 tax years. In 2019, the IRS determined that the plan fit the description identified in Notice 2007–83 and imposed penalties on the plaintiff and its shareholders for failing to disclose their participation. The plaintiff paid the penalties and then sued for a refund alleging that the IRS failed to comply with the notice and comment requirements of the Administrative Procedure Act (APA).
Note: Under the APA, a federal agency must undertake a Notice of Public Rulemaking when developing a legislative rule. The Notice is published in the Federal Register and typically provides 60 days for public comment and 30 days for the agency to reply.
The trial court ruled for the Government. However, the Sixth Circuit reversed, finding that the Notice was invalid because of the APA violation. The IRS argued that it was not required to comply, as the Notice was only an “interpretive rule” and not a “legislative rule.” However, the Sixth Circuit concluded that the Notice fell on the legislative side. This rulemaking imposed new duties on taxpayers that Congress had not articulated. Congress had delegated the authority to the IRS to determine which transactions will be deemed “a tax avoidance transaction,” and the Notice attempted to do that. The mere fact that the statute permitted some interpretation of the term “tax avoidance transaction” did not remove the Notice from the legislative category. Moreover, Congress did not exempt this from the scope of the APA.
The IRS also argued that Treas. Reg. §1.6011-4(b) allowed the IRS to identify reportable and listed transactions “by notice, regulation, or other form of published guidance.” The Court responded that Congress, not the IRS, gets to amend APA requirements.
In Green Valley Investors, LLC, the petitioner claimed charitable contribution deductions for several syndicated conservation easement transactions. Effective December 23, 2016, the IRS had identified all syndicated conservation easement transactions from January 1, 2010, forward (and substantially similar transactions) as “listed transactions.” Notice 2017-10, 2017-4 I.R.B. 544. That designation imposed substantial reporting requirements not only on the participants in such transactions, but also on their material advisors, for as long as the statute of limitations with respect to the transaction remained open. The IRS denied the deductions and imposed various reportable transaction penalties. The petitioner challenged the IRS position on the basis that the IRS failed to comply with the notice-and-comment requirements of the APA. U.S. Tax Court followed the rationale in Mann Construction in holding that Notice 2017-10 was also invalid because of a failure to satisfy the notice and comment requirements of the APA. The Tax Court determined that Notice 2017-10 was a legislative rule because when the IRS identified syndicated conservation easement transactions as a listed transaction it was not merely providing its interpretation of the law or reminding taxpayers of pre-existing duties. Instead, the Tax Court determined, the IRS was imposed new duties in the form of reporting and recordkeeping requirements on taxpayers and their material advisors. These substantive new duties that exposed taxpayer to noncompliance penalties meant that the Notice was a legislative rule subject to the APA’s notice-and-comment requirement.
Note: Also, in CIC Services, Inc. v. Internal Revenue Service, 2022 U.S. Dist. LEXIS 63545 (E.D. Tenn. Mar. 21, 2022), the court invalidated Notice 2016-66, casting doubt on enforcement against micro captive insurance. Likewise, in GBX Assoc., LLC v. United States, 2022 U.S. Dist. LEXIS 206500 (N.D. Ohio Nov. 14, 2022), the federal district court followed Green Valley Investors, Inc. in invalidating Notice 2017-10, but it refused to apply a nationwide injunction to enforcement, binding only the parties and leaving this issue for further judicial development.
These cases invalidating IRS Notices for failure of the agency to follow the APA’s notice-and-comment requirements are important to farmers and ranchers. USDA regulations often shade the line from an interpretive rule into one that is legislative. The cases provide helpful guidance on where that line is located.
Conclusion
I will continue my journey through the top ag law and tax developments of 2022 in my next post.
January 14, 2023 in Income Tax, Regulatory Law | Permalink | Comments (0)
Monday, January 9, 2023
Top Ag Law and Tax Developments of 2022 – Part 3
Overview
Today’s blog article continues the series that began earlier this week reviewing the top ag law and tax developments of 2022. I am working my way through those developments that were significant, but not quite of national significance to make the “Top Ten” of 2022.
More ag law and tax developments of 2022 – it’s the topic of today’s post.
Tax Court has Equitable Jurisdiction to Review CDP Determination
Boechler, P.C. v. Commissioner, 142 S. Ct. 1493 (2022)
The petitioner, a two-person North Dakota law firm, was assessed an “intentional disregard” penalty. The IRS notified them of an intent to levy. They requested and received a CDP (Collection Due Process) hearing, in which appeals sustained the proposed levy. I.R.C. §6330(d)(1) requires a Tax Court petition to be filed within 30 days, but the firm filed one day late. The Tax Court dismissed the petition for lack of jurisdiction. The Eighth Circuit affirmed on the ground that the statutory requirement for filing was jurisdictional and thus could not be waived. In a unanimous decision, the U.S. Supreme Court ruled that the 30-day period was not a jurisdictional requirement largely due to lack of clarity in I.R.C. §6330(d)(1). Moreover, the Supreme Court reasoned that its decision preserved the possibility for a court to apply equitable tolling to benefit taxpayers in this context, who often acted without counsel. While the application of equitable tolling would depend on further proceedings, the law firm will get the chance to make its case.
Comment: Although the Supreme Court’s decision does not create greater clarity, it may avoid some injustice. Eighth Circuit Judge Kelly wrote a concurring opinion in which he stated that a jurisdictional approach is a “drastic” measure that may impose a disproportionate burden on low-income taxpayers. This concurring opinion may have been what convinced the U.S. Supreme Court to hear the case.
Additional Note: In late 2022, the Tax Court addressed the issue of the right to judicial review of an IRS deficiency proceeding in accordance with I.R.C. §6213(a). In Hallmark Research Collective v. Comr., 159 T.C. No. 6 (2022), the petition was electronically filed one day late. The Tax Court held that the statute was clear in specifying that the IRS must issue a deficiency notice and that the taxpayer must respond by filing a Tax Court petition within a 90-day time limit. As such, the 90-day time limit is a prerequisite of jurisdiction. The court concluded that deficiency proceedings are based in statute and cannot be equitably tolled.
COE Improperly Declined Jurisdiction
Hoosier Environmental Council, et al. v. Natural Prairie Indiana Farmland Holdings, LLC, et al., 564 F. Supp. 3d 683 (N.D. Ind. 2021)
Note: I’m reaching back into 2021 to grab this case. I didn’t see it until early in 2022, and it should have been on last year’s list. But, nevertheless, I want to include it as a significant development for 2022 albeit it was a 2021 federal court decision from Indiana.
This case involved the issue of the U.S. Army Corps of Engineers (COE) deciding not to regulate a wet area on a farm and whether the decision not to exercise jurisdiction was done properly. The court’s decision is instructive on the procedure for determining the existence of a wetland, what “prior converted cropland is” and how the agency should properly decline to regulate
The defendant acquired farmland to build and operate a concentrated animal feeding operation (CAFO) with over 4,350 dairy cows. The COE inspected the property and concluded that much of the land was not subject to the Clean Water Act (CWA). The plaintiffs, two environmental groups, sued alleging that the defendant violated the CWA and that the COE’s administrative jurisdictional determination violated the Administrative Procedures Act (APA). The land at issue was drained in the early 1900's via the creation of several large ditches and drainage canals to move surface water into the Kankakee River 9.5 miles downstream. The CAFO was constructed on what had been a lakebed over a century ago, and two of the drainage ditches are on the defendant’s land.
Note: The lake was totally drained in the early 1990s to make farmland. Vested with that is the right to maintain the drain. See, e.g., Barthel v. United States Department of Agriculture, 181 F.3d 934 (8th Cir. 1999). It is immaterial what the size of the lake was or whether it was where a marsh was at some time in the past. The land at issue was completely transformed to farmland long before the defendant acquired the land at issue.
The primary issue before the court was whether the COE’s determination that the land was prior converted wetland (and therefore not subject to COE regulation) was arbitrary and capricious. The court examined the record to determine if the COE followed its own guidance for delineating wetlands. The court noted that the administrative record lacked any description of the prior drainage system (the series of medial and lateral ditches transecting the property before defendant’s alterations), the defendant’s new drainage system, how these systems were designed to function, and whether they were effective in removing wetland hydrology from the area.
Note: While the plaintiffs made much ado about the COE’s lack of consideration of the hydrology of the land before the farm’s alterations, that is largely an irrelevant point. Famers are entitled to maintain the “wetland and farming regime” on the land and may engage in whatever drainage activities necessary to keep that historic farming activity and production. The land in question had been converted to farmland many decades earlier and had been constantly maintained in that status.
The court examined aerial photographs, noting that there was an absence of data identified in the COE’s “Midwest Supplement” to assess the relevant drainage factors, including how the existing and current drainage systems were designed to function, whether they were effective in removing wetland hydrology from the area, and when any conversion occurred. The absence of these sources, coupled with an absence of any meaningful discussion of the hydrology of the site before the defendant’s alterations, led the court to believe that the COE failed to follow the procedures outlined in its own guidance in deciding the land was prior converted cropland. The COE also reviewed 14 aerial photographs that spanned from 1938 to 2017. Those photos showed the presence of row cropping and offered no evidence of potential wetlands. Relying on aerial photographs, the COE expert’s determination, and a determination of the Natural Resources Conservation Service to conclude that wetlands did not exist, was certainly appropriate.
Note: In addition, the court’s analysis on this point seems suspect. The COE did not need to find and document all three factors. The hydrology had been materially altered to enable consistent row crop farming. In that situation wetland hydrology is not present, and the area in question is not a wetland. As a result, other levees, systems, or dams do not alter area hydrology because there is no wetland hydrology present to alter. The court referred to the COE’s 1987 Manual for its conclusion that the COE didn’t follow its own procedures. However, the 1987 Manual was established to evaluate recent alterations to undisturbed wetland. The court incorrectly applied this standard to materially hydrologically altered wetland where the alteration had occurred a century earlier. As such, the land in issue was prior converted wetland. The court incorrectly applied the standards of the 1987 Manual to the facts before it involving alterations that occurred over 100 years ago.
The court also determined that there was no indication in the record that the aerial photographs were used to assess hydrology characteristics of the defendant’s land before alterations were made, how the drainage systems were designed to function, and how effectively and efficiently they could convert land from wetland to upland. Further, the court noted there was also no explanation why the COE skipped these steps. The COE took the position that its review of aerial photographs was sufficient to determine the land’s normal circumstances. The court disagreed, determining that the evidence did not support the COE’s claim that its decision was based on identified relevant factors. Instead, the court concluded that the COE made impermissible post hoc justifications. If reliance on its own manuals was not warranted in this situation, the court stated, the COE needed to provide a rationale. As such, the court determined that the evidence did not support the COE’s argument that its decision was rationally based on the relevant wetland hydrological factors before concluding the land was prior converted cropland. Absent that rationale, the COE’s determination of wetland status of the defendant’s farmland was arbitrary and capricious.
Note: The COE followed its correct procedure in this case contained in the Midwest Supplement and also accepted a prior USDA determination as to the land’s status for federal farm program purposes. The ditches and drains that were legally installed successfully removed wetland hydrology. The COE did not deviate from its own regulatory guidance and procedures, but the court assumed that it did. There was no need for the COE to find and document all three wetland characteristic factors. The elimination of wetland hydrology eliminates the possibility that the land was a wetland.
Concerning the lateral ditch, the plaintiffs claimed that the record did not support the COE’s conclusion that the lateral ditches were irrigation canals that drained uplands and lacked relatively permanent flow. The plaintiffs pointed to a lack of administrative record and the claimed failure of the COE to follow the relevant factors that it lists in its Approved Jurisdictional Determination Form. The court also held that the COE’s finding of non-jurisdiction over the lateral ditches was arbitrary and capricious.
The court remanded the case to the COE to conduct a more thorough investigation of the defendant’s tract.
Note: For farmers, the case is a frustrating one. At issue was land that had been farmed for over 80 years and the right to continue to farm consistent with the historic drainage of the property was caught up in bureaucratic red tape. The court’s expansive view of standing and lack of understanding of the actual science behind the hydrology and geographic facts of the case created a problem for a dairy operation that should have never happened. What was involved in the case were shallow ditches dug into prior converted wetland. That is an activity that the Clean Water Act does not regulate.
Conclusion
I will continue my journey through the top developments in ag law and tax in a subsequent post.
January 9, 2023 in Environmental Law, Income Tax | Permalink | Comments (0)
Thursday, December 22, 2022
January Tax Update Webinar and 2023 Summer National Seminars
Overview
Next month, on January 20, I will be doing a two-hour tax update webinar on key tax changes and updates for the 2023 filing season. As I write this, the Congress is considering yet another massive spending bill that contains important tax provisions. Indeed the Senate has passed the bill and sent it to the House. It seems that long gone are the days where the Congress could pass legislation addressing specific tax issues and not have to include technical tax matters in a massive spending bill with all kinds of miscellaneous (i.e., garbage) provisions. This makes the January 20 webinar important. This will be (as of now) right before the start of the tax filing season. Be watching for a link to register.
Omnibus Legislation – Retirement Provisions
One of the topics that I will address in the 2-hour webinar on January 20 are the tax provisions in the Omnibus legislation (assuming the Congress passes the bill) will be the retirement-related provisions. As the bill stands as of now, here are just a few of the retirement-related provisions:
- Increased required minimum distribution (RMD) age. The provision increases the current beginning RMD age from 72 to 73 effective January 1, 2023, and then to age 75 effective January 1, 2033. Act, Sec. 107
- Excise tax. This provision reduces to 25 percent and, under certain circumstances, practically eliminates the excise tax imposed on failure to take the RMD. This provision is effective for tax years beginning after the date of enactment. Act, Sec. 302.
- Catch-up contributions. While the dollar amount that can be elected to be deferred annually is capped, those who are age 50 and older can defer an additional (“catch-up) amount. Starting in 2025, this provision increases the current catch-up limit to the greater of $10,000 ($5,000 for SIMPLE plans) or 50 percent more than the regular catch-up amount in 2024 (2025 for SIMPLE plans). Act, Sec. 109
- Penalty-free withdrawals. This provision would allow penalty-free withdrawals for “unforeseeable or immediate financial needs relating to necessary personal or family expenses, capped at $1,000 and limited to once every three years (or once annually if the distribution is repaid within three years). Act, Sec. 115.
There are numerous other provisions. In fact, there are over 100 provisions designed to expand coverage, increase retirement savings, and otherwise make the retirement plan rules more streamlined. I will address the full run-down of what passes at the January 20 webinar.
Summer 2023 Events
Mark your calendars for the law school’s summer 2023 national ag tax seminars, those will be on June 15-16 in Petosky, Michigan and August 7 and 8 in Coeur ‘d Alene, Idaho. More information will be coming on those in the next few weeks as the programs get built out. The Michigan event will be the standard farm income tax, farm estate and business planning seminar. The August event in Idaho will have the standard farm income tax, farm estate and business planning topical coverage, but there will be a separate concurrent track each day on various agricultural law topics. Those topics will cover real estate issues, environmental issues, water law, ag torts, leasing arrangements, and other issues facing rural practitioners. You will be able to pick and choose the sessions that you would like to attend. Both the Michigan conference and the Idaho conference will be live broadcast online.
Conclusion
I hope that you will be able to join the online webinar on January 20 as well as one of the summer events. There are always many legal issues to discuss involving farm and ranch clients.
December 22, 2022 in Income Tax | Permalink | Comments (0)
Sunday, December 11, 2022
Does Using Old Tractors Mean You Aren’t a Farmer? And the Wind Energy Production Tax Credit – Is it Subject to State Property Tax?
Overview
Two recent court opinions highlight how unique tax law can be. In a recent U.S. Tax Court decision, the court was faced with an IRS challenge of deductions largely because of the manner in which the farming operation was conducted. In a decision of the Oklahoma Supreme Court, the Court determined that the Federal Production Tax Credit, was not subject to state property tax.
Recent tax cases – it’s the topic of today’s post.
IRS Questions Farming Practices, But Tax Court Allows Most Deductions
Hoakison v. Comr., T.C. Memo. 2022-117
The petitioners, a married couple, farm in southwest Iowa. The wife worked off-farm at a veterinary clinic, and the husband was a full-time delivery driver for United Parcel Service (UPS). He purchased his first farm in 1975 four years after graduating high-school and started a cow-calf operation. The petitioners lived frugally and always avoided incurring debt when possible by purchasing used equipment with cash with the husband doing his own repairs and maintenance. The petitioners were able to weather the farm crises of the early-mid 1980s by farming in this manner. Ultimately, the petitioners owned five tracts totaling 482 acres. The tracts are noncontiguous and range anywhere from six to 14 miles apart. On the tracts, the petitioners conduct a row-crop and cow-calf operation. He worked on the farms early in the mornings before his UPS shift and after his shift ended until late into the night.
Over the years, the petitioners acquired approximately 40 tractors with 17 in use during the years in issue (2013-2015). The tractors had specific features or used a variety of mounted implements to perform the various tasks needed to operate the various farms. Certain tractors were dedicated to a particular tract and attached to implements to save time and effort in taking the implements off and reattaching them. The petitioners also have several used pickup trucks and a machine shed that was used to store farm equipment. The petitioners’ tax returns for 2013-2015 showed farm losses each year primarily due to depreciation and other farm expenses.
The IRS disallowed significant amounts of depreciation and other farm expense deductions largely on its claim that the petitioners were not engaged in a farming business, but rather were engaged in a “nostalgic” activity with an excessive and unnecessary amount of old tractors. The IRS also took the position that the petitioners’ pickups and other vehicles were subject to the strict substantiation requirements of I.R.C. §274(d). The Tax Court disagreed as to the trucks that had been modified for use on the farm and were only driven a de minimis amount for personal purposes but agreed as to one pickup that was used to travel from farm to farm and to the UPS office. The Tax Court also pointed out that farm tractors are not listed property.
Note: I.R.C. §274(d) excludes from the strict substantiation requirements any "qualified nonpersonal use vehicle." A "qualified nonpersonal use vehicle" is "any vehicle which, by reason of its nature, is not likely to be used more than a de minimis amount for personal purposes." I.R.C. §274(i). The strict substantiation requirements of I.R.C. §274(d) generally apply to any pickup truck or van "unless the truck or van has been specially modified with the result that it is not likely to be used more than a de minimis amount for personal purposes." Treas. Reg. § 1.274-5(k)(7). Other qualified nonpersonal use vehicles not subject to the strict substantiation requirements of I.R.C. §274(d) include any vehicle designed to carry cargo with a loaded gross vehicle weight over 14,000 pounds, combines, flatbed trucks, and tractors and other special purpose farm vehicles. Treas. Reg. §1.274-5(k)(2)(ii)(C), (F), (J) and (Q).
As to the disallowed depreciation on certain tractors, the IRS asserted that the tractors were not used in the petitioners’ farming business because, according to the IRS, the husband was a collector of antique tractors and that the acquisition and maintenance of 40 tractors, most of them more than 40 years old served no business purpose and involved an element of “nostalgia.” The Tax Court disagreed, noting that the husband had sufficiently detailed his farming practices – avoidance of debt and personally repairing and maintaining the tractors and other farm equipment so as to avoid hiring mechanic work – and that this was an approach that worked well for them.
The Tax Court also noted that the IRS failed to account for petitioners’ noncontiguous tracts which meant that it was necessary to have various tractors and implements located at each farm to save time moving tractors from farm to farm and assembling and disassembling various attachments. As such, the Tax Court concluded that the items of farm machinery and tractors were used in the petitioners’ farming business and, as such, it was immaterial whether the purchase of the various farm tractors and implements constituted ordinary and necessary expenses. The Tax Court also determined that the machine shed was a depreciable farm building. As to various other farming expenses, the Tax Court allowed the petitioners’ claimed deductions for utilities, insurance, gasoline, fuel, oil and repair/maintenance expenses.
Note: The Tax Court upheld the accuracy-related penalty with respect to the underpayment related to depreciation on assets that had previously depreciated, but otherwise denied it because the petitioners had reasonably relied on a an experienced professional tax preparer
Federal Production Tax Credits Not Subject to Property Tax
Kingfisher Wind, LLC v. Wehmuller, No. 119837, 2022 Okla. LEXIS 84 (Okla. Sup. Ct. Oct. 18, 2022)
The plaintiff developed and built two commercial wind energy projects in Oklahoma that included over 100 aerogenerators, electrical equipment, maintenance facility, substation and transmission lines. The defendant, county assessors, valued the projects at $458 million for property tax purposes. The plaintiff asserted that the projects were worth only $169 million on the basis that value of the federal Production Tax Credits (PTCs) should be excluded for property tax purposes. The assessors claimed that the PTCs were tangible personal property subject to tax because they “are of such an economic benefit to owning, operating, and determining the full fair cash value of the wind farm and its real property, they must be included to determine a fair and accurate taxable ad valorem valuation of the wind farm.” The plaintiff claimed that the PTCs (which have existed since 1992) were intangible personal property that were expressly precluded from property taxation by state law. The PTC is a federal tax credit that is based on the kilowatt hours of electricity produced by certain types of energy generation, such as that generated by the plaintiff’s projects at issue. If a taxpayer has insufficient tax liability to use the PTCs that it is entitled to, it may structure a project such that a tax equity investor will contribute cash in exchange for receiving the excess PTCs. Thus, PTCs are a material economic component of a commercial wind development project and how their value is treated for property tax purposes significantly impacts a project’s return on investment. Oklahoma law taxes all real and personal property that is not otherwise expressly excluded and classifies intangible property as personal property. Thus, the question was whether intangible property (such as PTCs) was expressly excluded. The trial court held that the PTCs were not subject to property tax under Oklahoma law. On further review, the state Supreme Court noted that it had previously deemed computer software, lease agreements, trademarks, databases, and customer lists to be subject to ad valorem taxation. After that decision, Oklahoma law was changed to specify that intangible property shall not be subject to ad valorem tax. The Supreme Court determined that PTCs have limited intrinsic value and can only be claimed or enforced by legal action. The court found that even if PTCs had qualities of both tangible and intangible property, the Oklahoma legislature intended for those “in-between” items to be considered intangible and not subject to ad valorem taxation.
Note: The Court’s decision only construed Oklahoma law. Other states have different statutory and constitutional provisions defining items subject to property tax in those respective states. For instance, the value of the PTC has been held to be subject to property tax in IL, MI, PA, SD and TN. The opposite result has been reached in AZ, GA, MO, OH, OR and WA.
Conclusion
From the IRS claiming that a farmer can’t truly be in the farming business by using old tractors to a case illustrating the economic inefficiency of wind energy without a massive taxpayer subsidy, there’s never a dull moment in tax.
December 11, 2022 in Income Tax | Permalink | Comments (0)
Wednesday, December 7, 2022
How NOT to Use a Charitable Remainder Trust
Overview
A charitable remainder trust can be a useful estate planning tool for a farmer or rancher, particularly one that is ready to retire from farming or ranching. Instead of selling the last crop and reporting the income along with the income from the previous year’s crop that has been deferred to the current year, the crop can be transferred to a charitable remainder trust. Doing so avoids having to report the sale of the crop and the associated self-employment tax that would be triggered. But, a charitable remainder trust is a complex estate planning device that should only be utilized by professionals the understand the rules. A recent Tax Court case involving an Indiana farm couple illustrates how badly things can turn out with a charitable remainder trust if the rules aren’t closely followed.
Charitable remainder trusts – it’s the topic of today’s post.
Background
A charitable remainder trust is an irrevocable trust to which you can donate property, cash or other property. The trust takes a carryover income tax basis in the transferred asset(s). The trust then sells the transferred assets (the sale is not taxable because the seller is a charity) and uses the income from the sale to pay the donor (or other designated person(s)). The payments continue for a specific term of up to 20 years of the life of one or more beneficiaries (typically the transferor). At the end of the term, the remainder of the trust passes to at least one designated charity. The remainder donated to the charity must be at least 10 percent of the initial net fair market value of all of the property placed in the trust.
Types. There are two types of charitable remainder trusts. The type of trust is tied to how payment from the trust is made. A charitable remainder unitrust (CRUT) pays a percentage of the trust value annually to noncharitable beneficiaries. The payments must be at least five percent and not exceed 50 percent of the fair market value of the trust’s assets, valued annually. A charitable remainder annuity trust (CRAT) pays a specific dollar amount each year. The amount is at least 5 percent and no more than 50 percent of the value of the trust’s property, valued as of the date the trust was established.
Tax on payments. Payments from a charitable remainder trust are taxed to the non-charitable beneficiaries. The non-charitable beneficiaries report the income on Schedule K-1 (Form 1041) as distributions of the trust’s income and gains.
The distributions are reported in a particular order.
- Payments are considered to be ordinary income first to the extent the trust had ordinary income for the year and undistributed ordinary income from prior years. This means that if the trust had enough ordinary income to cover all of the payments, all of the payments are taxed as ordinary income. As a result, it is not advisable to transfer ordinary income property to the trust – particularly not ordinary income property with low or no income tax basis.
- Once the trust’s ordinary income is exhausted, payments are taxed as capital gains based on the sale or disposition of the trust’s capital assets. The payments are taxed as capital gain to the extent of the trust’s capital gain for the current year and any undistributed capital gain income from prior years.
- After all of the trust’s ordinary income and capital gain have been distributed, any additional payments are then characterized as other income to the extent of the trust’s current year and accumulated other income.
- Finally, after the first three-tiers of distributions have been made, any further payments are considered to be from the “principal” of the trust and are not taxable.
Charitable deduction. The contribution to a charitable remainder trust will qualify for a partial charitable deduction. The deduction is partial because it is limited to the present value of the charitable organization’s remainder interest calculated as the value of the donated property minus the present value of the annuity that the trust pays to the non-charitable beneficiary (or beneficiaries). Treas. Reg. §1.664-2(c). The deduction is also subject to adjusted gross income and other limits set forth in I.R.C. §170(e).
Tax filing requirements. A charitable remainder trust must file Form 5227 every year. A beneficiary must report any payments received from the trust on Schedule K-1 of Form 1041.
IRS concerns. The IRS closely monitors the use of charitable trusts. It is critical to not inflate the basis of assets transferred to the trust as well as failing to account for the transfer of any assets to the trust. It’s also important to not mischaracterize the distributions of ordinary or capital gain income as distributions of corpus. The ordering rules must be closely followed. There can also be no self-dealing, making an upfront cash payment to a charitable beneficiary in lieu of the remainder interest, or a transfer of the trust’s remainder interest to a non-qualified organization. Also, personal expenses can’t be paid with trust funds, and funds can’t be borrowed from the trust. It’s also prohibited to use loans or forward sales of assets or other financial schemes to hid capital gains or income in the trust.
The Furrer Case
If there ever was a case that provides a roadmap for farmers as to how not to use a charitable remainder, Furrer v. Comr., T.C. Memo. 2022-100 is that case. Indeed, it is almost inconceivable that the farmer couple involved in the case were represented by legal counsel. The arguments made on behalf of the Furrers were that bad.
The Tax Court began its opinion by noted that the Furrers, “after seeing an advertisement in a farm magazine” formed a CRAT. The opinion goes downhill quickly from there for the Furrers. The Furrers raised corn and soybeans on their Indiana farm. In July of 2015, they formed the first of two CRATs, naming their son as trustee. The Furrers were the life beneficiaries, and three qualified charities were designated as remaindermen. They transferred 100,000 bushels of corn and 10,000 bushels of soybeans from their farm to the first CRAT, which then sold the grain for $469,003. The CRAT distributed $47,000 to the charities and used the balance to purchase a Single Premium Immediate Annuity (SPIA), which made annual payments to the Furrers of $84,369 in 2015, 2016 and 2017. The SPIA issued a Form 1099-R to the trustee listing the annuity payments as “gross distributions” and showed a small amount of interest as the “taxable amount.” The Furrers claimed a $47,000 charitable deduction.
The Furrers created a second CRAT in 2016 naming themselves as the lie beneficiaries and seven qualified charities as the remainder beneficiaries. and also funded that trust with grain that they raised. The CRAT sold the grain for $691,827 and distributed $69,294 to the charities. The annuity from this trust was payable over 2016 and 2017 in the amount of $124,921 each year. The SPIA also issued Form 1099-R to the trustee listing the annuity payments as “gross distributions” and showing a small amount of interest as the “taxable amount.” They claimed a charitable deduction of $69,294.
On their 2015 and 2016 returns, they did not claim charitable deductions for their transfers to the CRATs, but reported only the interest income from the SPIA, which was reported to them by the life insurance company providing the annuity. They treated the balance of the annuity distributions that they received as a nontaxable return of corpus under I.R.C. §664(b)(4). They also reported their transfers of crops to the CRATS on Forms 709 for 2015 and 2016, which reflected the fair market value of the crops with a cost basis of zero. The CRATs reported the sales of crops as sales of business property on Form 4797, inexplicably treating the crops as having substantial basis (derived from the purported purchase of the grain at fair market value) that generated a small loss for 2015 and a small gain for 2016. Their son (as trustee) prepared the CRATs’ returns.
On audit, the Furrers claimed they should be entitled to charitable deductions for the in-kind transfers of the crops that were ultimately destined for the charitable remaindermen, which were not claimed on their return. They made this claim even though they had no income tax basis in the grain that was transferred to the CRATs. Incredibly, and despite not including the proper documentation, the IRS Revenue Agent allowed the charitable deductions. But the IRS still issued a notice of deficiency for each year because of the omitted income from the annuity and increased their Schedule F income by $83,440 in 2015, and by $206,967 in 2016 and also in 2017. This resulted in tax deficiencies of $55,040 for 2015, $56,904 for 2016 and $95,907 for 2017. The IRS also tacked on an accuracy-related penalty for each year.
Note: For gifts of property (other than publicly traded securities) valued in excess of $5,000, the taxpayer generally must (1) obtain a qualified appraisal of the property and (2) attach to the return on which the deduction is claimed a fully completed appraisal summary on Form 8283. I.R.C. §170(f)(11)(C). A “qualified appraisal” must be prepared by a “qualified appraiser” no later than the due date of the return, including extensions. I.R.C. §170(f)(11)(E); Treas. Reg. §1.170A-13(c)(3). The taxpayer must also maintain records substantiating the deduction. Treas. Reg. § 1.170A-13(b)(2)(ii)(D). At no time did the Furrers secure an appraisal (“qualified” or otherwise) of the crops they transferred to the CRATs. They also did not attach to their 2015 or 2016 return a completed Form 8283 substantiating the gifts, and they did not maintain the written records that the regulations required. But, even had they done so, they would not have been entitled to any charitable deduction because of the lack of an income tax basis in the grain transferred to the trusts.
After the Furrers filed the Tax Court petition, the IRS conceded the accuracy-related penalties for lack of the immediate supervisor’s approval. But, the IRS attorneys also requested leave to amend its answer to disallow the charitable deductions that the Revenue Agent allowed. The Tax Court held that the IRS carried its burden of proof on the charitable deduction disallowance issue – the Furrers did not substantiate the in-kind donations and they had no income tax basis in the crops. Thus, any charitable deduction was limited to zero regardless of whether they would have satisfied the substantiation requirements. The IRS also maintained that the annuity distributions were fully taxable as ordinary income on the basis that the grain was inventory that the Furrers held for sale to customers in the ordinary course of their farming business. The Tax Court agreed and noted that the Furrers violated the ordering rules for income tax treatment of distributions from the CRATs. The Trusts’ sale of the grain involved a sale of ordinary income property (raised grain). As a result, the annuity was purchased with the proceeds of ordinary income property and any distributions from the trust to the Furrers retained that same ordinary income character. While the Furrers tried to apply the rules of I.R.C. §72 to the annuity distributions, the Tax Court noted that I.R.C. §664 provides a special rule for annuity distributions from CRATS that was not in their favor. In addition, even if I.R.C. §72 applied, the Tax Court noted that the Furrers would not have been able to use the exclusion rule because they had no “investment in the contract” – the funds used to purchase the contract had never been taxable.
Comment: I have no answer as to why this case ended up in the Tax Court. The Furrers were represented by counsel, but there appears to have been some very poor choices made on their behalf. The counsel of record is from California and the Furreres, as mentioned, farm in Indiana. I have no explanation as to how that happened. Many aspects of the set-up of the CRATs was wrong, and by not accepting the adjustment made by the IRS Revenue Agent and filing a Tax Court petition, the Furrers ended up losing the charitable deductions that the Revenue Agent had (mistakenly) allowed! Granted, the Furrers got the accuracy-related penalty to go away, but that was achieved at the price of losing substantial charitable deductions. I also wonder whether the IRS should have conceded on the penalty issue. The Tax Court’s approach to IRS supervisory approval as a prerequisite to applying penalties has been disregarded by two Circuit Courts of Appeal. According to the 11th and 9th Circuits, supervisor approval at any time before assessment is enough to satisfy the statute. See, e.g., Kroner v. Comr., 48 F.4th 1272 (11th Cir. 2022) and Laidlaw’s Harley Davidson Sales, Inc. v. Comr., 29 F.4th 1066 (9th Cir. 2022). Hopefully the Tax Court’s decision will not be appealed to the Seventh Circuit. If it is, the prospect for a favorable outcome for the Furrers is slim to none.
Conclusion
The Furrer case illustrates that the rules surrounding the use of charitable remainder trusts are very complex. Only competent professionals that are experienced in the rules and use of such trusts should be engaged in utilizing them on behalf of clients. While the Tax Court said that the Furrers created the trusts after reading an ad in a farm magazine, I do not know the nature and extent of legal and tax advice they received (if any) in advance. If they were guided by tax counsel in setting up the trusts, the counsel was woefully inadequate. To add insult to injury, as noted, the decision to petition the Tax Court rather than accepting the Revenue Agent’s adjustments put the Furrers in a worse position.
The Tax Court has not yet officially entered its decision in the Furrer case. The 90-day timeframe for appeal does not start until the decision document (which is separate from the court’s opinion) has been entered. Presently, the parties must submit their Tax Court Rule 155 calculations by December 21, 2022. Those calculations will form the basis of the decision document.
December 7, 2022 in Estate Planning, Income Tax | Permalink | Comments (0)
Sunday, November 20, 2022
Tax Issues Associated with Easement Payments – Part 2
Overview
In Part 1 of this series, I noted that an increasingly common issue for rural landowners is that of companies seeking easements across farmland. Often the easements are sought by energy companies for the placement of pipelines or some form of transmission line. The easement transaction involves the landowner receiving compensation for the loss of certain property rights. In Part 1 of this series I focused on the nature of the transaction and the likely tax characterization of the payments a landowner might receive. In today’s Part 2, I look more in-depth at the type of payments a landowner might receive and how they should be reported for tax purposes.
Tax issues associated with easement payments – Part 2 in a series. It’s the topic of today’s post.
Types of Payments
“Bonus” payments. Sometimes a company interested in acquiring an easement will pay an upfront amount to the landowners. The payment will typically reserve the exclusive right to obtain an easement for a period of time with the landowner retaining the payment regardless of whether the company actually acquires an easement within the specified timeframe. The landowner properly reports such a “bonus payment” on Schedule E with the amount flowing to Form 1040. The company would issue a Form 1099-MISC to the landowner, showing the amount of the payment in Box 1.
Damage payments. As noted above, an initial payment made to a landowner for acquisition of an easement could result in income to the landowner or a reduction of the landowner’s basis in the land, or both. That means that a lump sum payment for the right to lay a pipeline across a farm may result in income, a reduction in basis of all or part of the land or both. An amount for actual, current damage to the property caused by construction activities on the property subject to the easement may be able to be offset by basis in the affected property. Examples of this type of payment would be payments for damage to the property caused by environmental contamination and soil compaction. A payment for damage to growing crops, however, is treated as a sale of the crop reported either on line 2 of Schedule F or line 1 of Form 4835 for a non-material participation crop-share landlord. Any payment for future property damage (e.g., liquidated damages), however, is generally treated as rent and reported as ordinary income.
Severance damages. Involuntary conversion concepts may also come into play in an easement transaction. “Severance damages” might be paid when only a part of a property is directly impacted by an easement as compensation for loss of value in the portion not directly impacted. These damages might be paid, for example, when the easement impairs access to the property. But it is important that the easement transaction (or condemnation proceeding if there is one) refer specifically to such damages as “severance damages.” If they are not specifically delineated, they will be treated simply as damage payments. This is an important distinction. Under the involuntary conversion rules of I.R.C. §1033, it is possible for the landowner to defer gain resulting from the payment of severance damages by using the severance damages to restore the property that the easement impacts or by investing the damages in a timely manner in other qualified property.
There is no requirement that the landowner apply the severance damages to the portion of the property subject to the easement. Also, if the easement so impacts the remainder of the property where the pre-easement use of the property is not possible, the sale of the remainder of the property and use of the sale proceeds (plus the severance damages) to acquire other qualified property can be structured as a deferral transaction under I.R.C. §1033.
Temporary easement payments. Some easements may involve an additional temporary easement to allow the holder to have space for access, equipment and material storage while conduction construction activities on the property subject to the easement. A separate designation for a temporary easement for these purposes will generate rental income for allocated amounts. As an alternative, it may be advisable to include the temporary space in the perpetual easement which is then reduced after a set amount of time. Under this approach, it is possible to apply the payment attributable to the temporary easement to the tract subject to the permanent easement. Alternatively, it may be possible, based on the facts, to classify any payments for a temporary easement as damage payments.
Negative easements. A landowner may make a payment to an adjacent or nearby landowner to acquire a negative easement over that other landowner’s tract. A negative easement is a use restriction placed on the tract to prevent the owner from specified uses of the tract that might diminish the value of the payor’s land. For instance, a landowner may fear that their property would lose market value if a pipeline, high-power transmission line or wind aerogenerator were to be placed on adjacent property. Thus, the landowner might seek a negative easement over that adjacent property to prevent that landowner from granting an easement to a utility company for that type of activity from being conducted on the adjacent property. The IRS has reached the conclusion that a negative easement payment is rental income in the hands of the recipient. F.S.A. 20152102F (Feb. 25, 2015). It is not income derived from the taxpayer’s trade or business. In addition, the IRS position taken in the FSA could have application to situations involving the government’s use of a taxpayer’s property to enhance wildlife and/or conservation.
Lease Payments
A right of use that is not an easement generates ordinary income to the landowner and is, potentially, net investment income subject to an additional 3.8 percent tax. I.R.C. §1411. Thus, transactions that are a lease or a license generate rental income with no basis offset. For example, when a landowner grants surface rights for oil and gas exploration, the transaction is most likely a lease. Easements for pipelines, roads, surface sites and similar interests that are for a definite term of years are leases. Likewise, if the easement is for “as long as oil and gas is produced in paying quantities,” it is lease.
The IRS has ruled that periodic payments that farmers received under a “lease” agreement that allowed a steel company to discharge fumes without any liability for damage were rent. In Rev. Rul. 60-170, 1960-1 C.B. 357, the payments from the steel company were to compensate the farmers for damages to livestock, crops, trees and other vegetation because of chemical fumes and gases from a nearby plant. The IRS determined that the payments were rent and, as such, were not subject to self-employment tax.
Note: A lease is characterized by periodic payments. A lease is also indicated when failure to make a payment triggers default procedures and potential forfeiture. In addition, lease payments are not subject to self-employment tax in the hands of the recipient regardless of the landowner’s participation in the activity. Accordingly, the annual lease payment income would be reported on Schedule E (Form 1040), with the landowner likely having few or no deductible rental expenses.
Eminent Domain
Proposed easement acquisitions can be contentious for many landowners. Often, landowners may not willingly grant a pipeline company or a wind energy company, for example, the right to use the landowners’ property. In those situations, eminent domain procedures under state law may be invoked which involves a condemnation of the property. The power of eminent domain is the right of the state government (it’s called the “taking power” for the federal government) to acquire private property for public use, subject to the constitutional requirement that “just compensation” be paid. While eminent domain is a power of the government, often developers of pipelines and certain other types of energy companies are often delegated the authority to condemn private property. The condemnation award (the constitutionally required “just compensation”) paid is treated as a sale for tax purposes.
Note: The IRS view is that a condemnation award is solely for the property taken. But, if the condemnation award clearly exceeds the fair market value of the property taken, a court may entertain arguments about the various components of the award. Thus, it’s important for a landowner to preserve any evidence that might support allocating the award to various types of damages.
Involuntary conversion. While a condemnation award that a landowner receives is treated as a sale for tax purposes, it can qualify for non-recognition treatment under the gain deferral rules for involuntary conversions contained in I.R.C. §1033. Rev. Rul. 76-69, 1976-1 C.B. 219; Rev. Rul. 54-575, 1954-2 C.B. 145. I.R.C. §1033 allows a taxpayer to elect to defer gain realized from a condemnation (and sales made under threat of condemnation) by reinvesting the proceeds in qualifying property within three years. See, e.g., Rev. Rul. 72-433, 1972-2 C.B. 470
The election to defer gain under I.R.C. §1033 is made by simply showing details on the return about the involuntary conversion but not reporting the condemnation gain realized on the return for the tax year the award is received. A disclosure that the taxpayer is deferring gain under I.R.C. §1033, but not disclosing details is treated as a deemed election.
Note: If the taxpayer designates qualified replacement real estate on a return within the required period and purchases the property at the anticipated price within three years of the end of the gain year, a valid election is complete. If the purchase price of the replacement property is lower than anticipated, the resulting gain should be reported by amending the return for the election year. If qualified replacement property within the required three-year period, the return for the year of the election must be amended to report the gain.
Conclusion
Rural landowners are facing easement issues not infrequently. Oil and gas pipelines, wind energy towers, and high voltage power lines are examples of the type of structures that are associated with easements across agricultural land. Seeking good tax counsel can help produce the best tax result possible in dealing with the various types of payments that might be received.
November 20, 2022 in Income Tax | Permalink | Comments (0)
Friday, November 18, 2022
Tax Issues Associated With Easement Payments - Part 1
Overview
Rural landowners often receive payment from utility companies, oil pipeline companies, wind energy companies and others for rights-of-way or easements over their property. The rights acquired might include the right to lay pipeline, construct aerogenerators and associated roads, electric lines and similar access rights. Payments may also be received for the placement of a “negative” easement on adjacent property so that the neighboring landowner is restricted from utilizing their property in a manner that might decrease the value of nearby land.
How are these various types of payment to be reported for tax purposes. It’s an important issue for many farmers, ranchers and rural landowners.
Tax issues with easement payments Part 1 of a series – it’s the topic of today’s post.
Characterizing the Transaction
The receipt of easement payments raises several tax issues. The payments may trigger income recognition or could be offset partially or completely by the recipient’s income tax basis in the land that the easement impacts. Also, a sale of part of the land could be involved. In addition, a separate payment for crop damage could be involved.
Sale or exchange. A sale or exchange triggers gain or loss for income tax purposes. I.R.C. §1001. Is the grant of an easement a taxable event? It depends. In essence, a landowner’s grant of an easement amounts to a sale of the land if after the easement grant the taxpayer has virtually no property right left except bare legal title to the land. For instance, in one case, the grant of an easement to flood the taxpayer’s land was held to be a sale. Scales v. Comr., 10 B.T.A. 1024 (1928), acq., 1928-2 C.B. 35. In another situation, the IRS ruled that the grant of an easement for air rights over property adjoining an air base that caused the property to be rendered useless was a sale. Rev. Rul. 54-575, 1954-2 C.B. 145. The grant of a perpetual easement on a part of unimproved land to the state for a highway, as well as the grant of a permanent right-of-way easement for use as a highway have also been held to be a sale. Rev. Rul. 72-255, 1972-1 C.B. 221; Wickersham v. Comr., T.C. Memo. 2011-178. Also, the IRS has determined that the grant of a perpetual conservation easement on property in exchange for “mitigation banking credits” was held to be a sale or exchange. Priv. Ltr. Rul. 201222004 (Nov. 29, 2011). Under the facts of the ruling, the taxpayer acquired a ranch for development purposes, but did not develop it due to the presence of two endangered species. The taxpayer negotiated a Mitigation Bank Agreement with a government agency pursuant to which the taxpayer would grant a perpetual conservation easement to the government in return for mitigation banking credits to allow the development of other, similarly situated, land. The IRS determined that the transaction constituted a sale or exchange.
Note: The buyer of mitigation credits is likely to be a dealer that won’t hold the credits long enough to achieve capital gain status on sale. But, the ultimate answer to the question of the buyer’s tax status is a fact-dependent determination.
Ordinary income or capital gain? If the payments for the grant of an easement are, in effect, rents for land use the characterization of the payments in the hands of the landowner is ordinary income. For example, in Gilbertz v. United States, 574 F. Supp. 177 (D. Wyo. 1983), aff’d., and rev’d. by, 808 F.2d 1374 (10th Cir. 1987), the taxpayers, a married couple, raised cattle on their 6,480-acre ranch. They held title to the surface rights and a fractional interest in the minerals. The federal government reserved most of the mineral rights. In 1976 and 1977, the taxpayers negotiated more than 50 contracts with oil and gas lessees and pipeline companies to receive payments for anticipated drilling activities on the ranch. The taxpayers reported the payments as non-taxable recovery of basis in the entire ranch with any excess amount reported as capital gain. The IRS disagreed, asserting that the payments were taxable as ordinary income. The taxpayers paid the asserted deficiency and sued for a refund.
The trial court dissected the types of payments involved concluding that the “Release and Damage Payments” were not rents taxable as ordinary income. Instead, the payments from pipeline companies for rights-of-ways and damage to the land involved a sale or exchange and were taxable as capital gain – the pipeline companies had obtained a perpetual right-of-way. On further review, the appellate court held that the “Release and Damage Payments” were not a return of capital to the taxpayers that qualified for capital gain treatment to the extent the amount received exceeded their basis in the land. However, the appellate court affirmed the trial court’s holding that the amounts received from the pipeline companies were properly characterized as the sale of a capital asset and constituted a recovery of basis with any excess taxable as capital gain.
Limited Easements. The grant of a limited easement is treated as the sale of a portion of the rights in the land impacted by the easement, with the proceeds received first applied to reduce the basis in the land affected. Thus, if the grant of an easement deprives the taxpayer of practically all of the beneficial interest in the land, except for the retention of mere legal title, the transaction is considered to be a sale of the land that the easement covers. That means that gain or loss is computed in the same manner as in the case of a sale of the land itself under I.R.C. §1221 or §1231. In addition, only the basis of the land that is allocable to that portion is reduced by the amount received for the grant of the easement. Any excess amount received is treated as capital gain. The allocation of basis does not require proration based on acreage. Instead, basis allocation is to be “equitably apportioned” based likely on fair market value or assessed value at the time the easement is acquired.
Location of the easement. In rare situations where the entire property is impacted by the easement, the entire basis of the property can be used to offset the amount received for the easement. This might be the situation where severance damage payments are received. These types of payments may be made when the easement bisects a landowner’s property with the result that the property not subject to the easement can no longer be put to its highest and best use. This is more likely with commercial property and agricultural land that has the potential to be developed. Severance damages may be paid to compensate the landowner for the resulting lower value for the non-eased property. If severance damages exceed the landowner’s basis in the property not subject to the easement, gain is recognized.
Note: Whether the easement impacts the entire parcel is a question of fact. An easement located across a corner of a tract or along a fence line, may be less likely to be found to impact the entire parcel than would an easement down the middle of a tract.
Conclusion
In Part 2 in this series, I will break down the various types of payments that landowners receive for easements and the proper reporting of those payments. I will also look at the possibility of eminent domain concepts applying to the easement transaction.
November 18, 2022 in Income Tax | Permalink | Comments (0)
