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

https://lawprofessors.typepad.com/agriculturallaw/2022/09/bibliography-january-through-june-of-2022.html.

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

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

Business Planning

Durango Conference and Recent Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/07/durango-conference-and-recent-developments-in-the-courts.html

Is a C Corporation a Good Entity Choice For the Farm or Ranch Business?

https://lawprofessors.typepad.com/agriculturallaw/2022/07/whats-the-best-entity-structure-for-the-farm-or-ranch-business.html

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

https://lawprofessors.typepad.com/agriculturallaw/2022/08/federal-farm-programs-organizational-structure-matters-part-three.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

Civil Liabilities

Durango Conference and Recent Developments in the Courts

https://lawprofessors.typepad.com/agriculturallaw/2022/07/durango-conference-and-recent-developments-in-the-courts.html

Dicamba Spray-Drift Issues and the Bader Farms Litigation

https://lawprofessors.typepad.com/agriculturallaw/2022/07/dicamba-spray-drift-issues-and-the-bader-farms-litigation.html

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.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

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

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

https://lawprofessors.typepad.com/agriculturallaw/2022/09/minnesota-farmer-protection-law-upheld.html

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

https://lawprofessors.typepad.com/agriculturallaw/2022/07/constitutional-limit-on-government-agency-power-the-major-questions-doctrine.html

More Ag Law Developments – Potpourri of Topics

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

Court Says COE Acted Arbitrarily When Declining Jurisdiction Over Farmland

https://lawprofessors.typepad.com/agriculturallaw/2022/10/court-says-coe-acted-arbitrarily-when-declining-jurisdiction-over-farmland.html

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)

https://lawprofessors.typepad.com/agriculturallaw/2022/07/farmranch-tax-estate-and-business-planning-conference-august-1-2-durango-colorado-and-online.html

IRS Modifies Portability Election Rule

https://lawprofessors.typepad.com/agriculturallaw/2022/07/irs-modifies-portability-election-rule.html

Modifying an Irrevocable Trust – Decanting

https://lawprofessors.typepad.com/agriculturallaw/2022/09/modifying-an-irrevocable-trust-decanting.html

Farm and Ranch Estate Planning in 2022 (and 2023)

https://lawprofessors.typepad.com/agriculturallaw/2022/09/farm-and-ranch-estate-planning-in-2022-and-2023.html

Social Security Planning for Farmers and Ranchers

https://lawprofessors.typepad.com/agriculturallaw/2022/11/social-security-planning-for-farmers-and-ranchers.html

How NOT to Use a Charitable Remainder Trust

https://lawprofessors.typepad.com/agriculturallaw/2022/12/how-not-to-use-a-charitable-remainder-trust.html

Recent Cases Involving Decedents’ Estates

https://lawprofessors.typepad.com/agriculturallaw/2022/12/recent-cases-involving-decedents-estates.html

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?

https://lawprofessors.typepad.com/agriculturallaw/2022/07/what-is-the-character-of-land-sale-gain.html

Deductible Start-Up Costs and Web-Based Businesses

https://lawprofessors.typepad.com/agriculturallaw/2022/07/deductible-start-up-costs-and-web-based-businesses.html

Using Farm Income Averaging to Deal With Economic Uncertainty and Resulting Income Fluctuations

https://lawprofessors.typepad.com/agriculturallaw/2022/07/using-farm-income-averaging-to-deal-with-economic-uncertainty-and-resulting-income-fluctuations.html

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

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)

https://lawprofessors.typepad.com/agriculturallaw/2022/08/usdas-emergency-relief-program-update-on-gain-from-equipment-sales.html

Declaring Inflation Reduced and Being Forgiving – Recent Developments in Tax and Law

https://lawprofessors.typepad.com/agriculturallaw/2022/09/declaring-inflation-reduced-and-being-forgiving-recent-developments-in-tax-and-law.html

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

https://lawprofessors.typepad.com/agriculturallaw/2022/09/extended-livestock-replacement-period-applies-in-areas-of-extended-drought-irs-updated-drought-areas.html

More Ag Law Developments – Potpourri of Topics

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

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

https://lawprofessors.typepad.com/agriculturallaw/2022/10/handling-expenses-of-crops-with-pre-productive-periods-the-uniform-capitalization-rules.html

When Can Depreciation First Be Claimed?

https://lawprofessors.typepad.com/agriculturallaw/2022/10/for-depreciation-purposes-what-does-placed-in-service-mean.html

Tax Treatment of Crops and/or Livestock Sold Post-Death

https://lawprofessors.typepad.com/agriculturallaw/2022/11/tax-treatment-of-crops-andor-livestock-sold-post-death.html

Social Security Planning for Farmers and Ranchers

https://lawprofessors.typepad.com/agriculturallaw/2022/11/social-security-planning-for-farmers-and-ranchers.html

Are Crop Insurance Proceeds Deferrable for Tax Purposes?

https://lawprofessors.typepad.com/agriculturallaw/2022/11/are-crop-insurance-proceeds-deferrable-for-tax-purposes.html

Tax Issues Associated With Easement Payments – Part 1

https://lawprofessors.typepad.com/agriculturallaw/2022/11/tax-issues-associated-with-easement-payments-part-1.html

Tax Issues Associated With Easement Payments – Part 2

https://lawprofessors.typepad.com/agriculturallaw/2022/11/tax-issues-associated-with-easement-payments-part-2.html

How NOT to Use a Charitable Remainder Trust

https://lawprofessors.typepad.com/agriculturallaw/2022/12/how-not-to-use-a-charitable-remainder-trust.html

Does Using Old Tractors Mean You Aren’t a Farmer? And the Wind Energy Production Tax Credit – Is Subject to State Property Tax?

https://lawprofessors.typepad.com/agriculturallaw/2022/12/does-using-old-tractors-mean-you-arent-a-farmer-and-the-wind-energy-production-tax-credit-is-it-subject-to-state-prop.html

Insurance

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

Real Property

Tax Deal Struck? – and Recent Ag-Related Cases

https://lawprofessors.typepad.com/agriculturallaw/2022/07/tax-deal-struck-and-recent-ag-related-cases.html

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

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

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

https://lawprofessors.typepad.com/agriculturallaw/2022/07/constitutional-limit-on-government-agency-power-the-major-questions-doctrine.html

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

https://lawprofessors.typepad.com/agriculturallaw/2022/08/federal-farm-programs-organizational-structure-matters-part-one.html

Federal Farm Programs – Organizational Structure Matters – Part Two

https://lawprofessors.typepad.com/agriculturallaw/2022/08/federal-farm-programs-organizational-structure-matters-part-two.html

Federal Farm Programs: Organizational Structure Matters – Part Three

https://lawprofessors.typepad.com/agriculturallaw/2022/08/federal-farm-programs-organizational-structure-matters-part-three.html

USDA’s Emergency Relief Program (Update on Gain from Equipment Sales)

https://lawprofessors.typepad.com/agriculturallaw/2022/08/usdas-emergency-relief-program-update-on-gain-from-equipment-sales.html

Minnesota Farmer Protection Law Upheld

https://lawprofessors.typepad.com/agriculturallaw/2022/09/minnesota-farmer-protection-law-upheld.html

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?

https://lawprofessors.typepad.com/agriculturallaw/2022/10/animal-ag-facilities-and-free-speech-does-the-constitution-protect-saboteurs.html

Court Says COE Acted Arbitrarily When Declining Jurisdiction Over Farmland

https://lawprofessors.typepad.com/agriculturallaw/2022/10/court-says-coe-acted-arbitrarily-when-declining-jurisdiction-over-farmland.html

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

https://lawprofessors.typepad.com/agriculturallaw/2022/10/more-ag-law-developments-potpourri-of-topics.html

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 LLP977 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)

Monday, November 14, 2022

Tax Ethics Seminar/Webinar

Overview

On December 16 I will be doing a two-hour ethics seminar on income tax ethics.  If you are in need of ethics hours to help satisfy your CPE/CLE requirements, this will be a good opportunity for you to gain two hours of credit.

Details

The seminar will consist of two 50-minute sessions.  During the first session I will focus on several specific client situations that can raise ethical issues.  For example, what if a client fails to inform the tax preparer of relevant information that impacts the return?  What is the responsibility of the preparer to ask questions?  How should an engagement letter be used and worded?  What is required “due diligence” of Circular 230? 

Another situation might involve the deferral of self-employment tax as a result of the CARES Act.  This legislation presents unique ethical problems for practitioners.  Again, the issue is often the information that the practitioner has from the client and IRS notices.  On the legislative front, recent changes to penalty-free withdrawals from retirement plans have created confusion among clients and tax preparers.  I will discuss several ethical scenarios these changes create for practitioners.

Another issue that creates ethical concerns for practitioners involves the carryover of suspended losses, capital losses, qualified business losses and net operating losses.  Sometimes these issues arise when a preparer inherits a client from another preparer.  In those situations, what ethical responsibilities does the new preparer have?  What are the rules involving correspondence with the IRS? 

During the second session I will address ethical issues involving other carryover issues such as charitable contributions and I.R.C. §179 carryovers.  There are also numerous credits that can carryover and create various ethical issues for tax preparers.  Also, debt forgiveness from prior years can present difficult ethical issues.  I will also address ethical issues associated with S corporation or partnership basis and education credits. 

To conclude the seminar, I will go over a suggested client questionnaire and go back to the scenarios that have been discussed and evaluate appropriate practitioner approaches as related to Circular 230.

Conclusion

The seminar will be live at Washburn Law School and will also be simulcast over the web.  You may learn more about the ethics seminar and register here:  https://www.washburnlaw.edu/employers/cle/taxethics.html 

November 14, 2022 in Income Tax | Permalink | Comments (0)

Friday, November 11, 2022

Are Crop Insurance Proceeds Deferrable for Tax Purposes?

Overview

There still seems to be a misunderstanding among some farmer about the tax deferability of crop insurance proceeds.  I have seen several comments recently on social media by farmers communicating with each other stating to the effect that crop insurance is always deferable.  That is not correct.  With today’s post, I sort through the proper way to determine whether the receipt of crop insurance is deferable for income tax purposes.

The income tax deferability of crop insurance – it’s the topic of today’s post.

In General

The proceeds from insurance coverage on growing crops are includible in gross income in the year actually or constructively received.  In effect, destruction or damage to crops and receipt of insurance proceeds are treated as a “sale” of the crop.  But taxpayers on the cash method of accounting may elect to include crop insurance and disaster payments in income in the taxable year following the crop loss if it is the taxpayer's practice to report income from sale of the crop in the later year.  I.R.C. §451(d).  A “practice” requires that the taxpayer establish that a substantial part of the crops (more than 50 percent) has been carried over into the following year.  Rev. Rul. 74-145, 1974-1 C.B. 113.  Eligible payments are those made because of damage to crops or the inability to plant crops.  The deferral provision applies to federal payments received for drought, flood or “any other natural disaster.”

Summary:  Deferability is possible if the farmer is on the cash method of accounting and has a practice of deferring the reporting of crop income.  Payments eligible for deferral are payments for crop damage, payments for inability to plant and payments for damage on account of “any other natural disaster.”  The insurance payment must be received in the year of the crop loss.  If payment is received the year after the crop loss, it is not deferable to the next year.

Details

Election.  The election is made by attaching a separate, signed statement to the income tax return for the tax year of damage or destruction or by filing an amended return, and it covers insurance proceeds attributable to all crops representing a trade or business. 

Multiple crops.  If multiple crops are involved, the “substantial portion” test must be met with respect to each crop if each crop is associated with a separate business of the taxpayer.  Otherwise, the 50 percent text is computed in the aggregate if the crops are reported as part of a single business.  Also, a taxpayer may not elect to defer only a portion of the insurance proceeds to the following year.

Revenue and yield policies.  A significant issue is whether the deferral provision also applies to new types of crop insurance such as Revenue Protection (RP), Revenue Protection with Harvest Price Exclusion (RPHPE), Yield Protection (YP) and Group Risk Plan (GRP). As mentioned above, to be deferrable, payment under an insurance policy must have been made as a result of damage to crops or the inability to plant crops. Other than the statutory language that makes prevented planting payments eligible for the one-year deferral, the IRS position as stated in Notice 89-55, 1989-1 C.B. 698 is that agreements with insurance companies providing for payments without regard to actual losses of the insured, do not constitute insurance payments for the destruction of or damage to crops.  Accordingly, payments made under the types of crop insurance that are not directly associated with an insured's actual loss, but are instead tied to low yields and/or low prices, may not qualify for deferral depending upon the type of insurance involved.  For example, RP policies insure producers against yield losses due to natural causes such as drought, rain, hail, wind, frost, insects and disease, as well as revenue losses tied to the difference between harvest price and a projected price.

Summary:  Only the portion attributable to physical damage or destruction to a crop is eligible for deferral.  RPHPE, YP and GRP policies tie payment to price and/or yield and amounts paid under such policies are less likely to qualify for deferral. 

Correct Approach

While the IRS has not specified in regulations the appropriate manner to be utilized in determining the deferrable and non-deferrable portions, the following is believed to be an acceptable approach:

Consider the following example:

Al took out an insurance policy (RP) on his corn crop. Under the terms of the policy the approved corn yield was set at 170 bushels/acre, and the base price for corn was set at $6.50/bushel. At harvest, the price of corn was $5.75/bushel. Al’s insurance coverage level was set at 75 percent, and his yield was 100 bushels/acre. Al’s final revenue guarantee under the policy is 170 bushels x $6.50 x .75 = $828.75/acre. Al’s calculated revenue is his actual yield (100 bushels/acre) multiplied by the harvest price ($5.75/bushel) which equals $575/acre. Al’s insurance proceeds is the guaranteed amount ($828.75/acre) less the calculated revenue ($575/acre), or $253.75/acre.  His physical loss is the 170 bushel/acre approved yield less his actual yield of 100 bushels/acre, or 70 bushels/acre. Multiplied by the harvest price of $5.75/bushel, the result is a physical loss of $402.50/acre. Al’s price loss is computed by taking the base price of $6.50/bushel less the harvest price of $5.75/bushel, or $.75/bushel. When multiplied by the approved yield of 170 bushels/acre, the result is $127.50/acre. 

So, to summarize, Al has the following:

  • Total loss: (1) anticipated income/acre [170 bushels/acre @ $6.50/ bushel = $1105/acre] less (2) actual result [100 bushels/acre @ $5.75/acre = $575.00] for a result of $530.00/acre.
  • Physical loss: 70 bushels/acre x $5.75/bushel harvest price = $402.50/acre
  • Price loss: 170 bushels/acre x $.75/bushel = $127.50
  • Physical loss as percentage of total loss:  $402.50/530 = .7594
  • Insurance payment: $253.75/acre
  • Insurance payment attributable to physical loss (which is deferrable):  $253.75 x .7594 = $192.70/acre
  • Portion of insurance payment that is not deferrable: $253.75 – $192.70 = $61.05/acre

But what if the harvest price exceeds the base price?  Then the above example can be modified as follows:

Assume now that the harvest price of corn was $7.50/bushel. Al’s final revenue guarantee under the policy is 170 bushels/acre x $7.50 x.75 = $956.25/acre. Al’s calculated revenue is his actual yield (100 bushels/acre) multiplied by the harvest price ($7.50/bushel) which equals $750.00/acre. Al’s insurance proceeds are the guaranteed amount ($956.25/acre) less the calculated revenue ($750.00), or $206.25/acre.  His yield loss is the 70 bushels/acre which is then multiplied by the harvest price of $7.50/bushel, for a physical loss of $525/acre.  Al’s price loss is zero because the harvest price exceeded the base price.

So, to summarize, Al has the following:

  • Total loss (per acre): $525.00 (physical loss) + $0.00 (price loss)
  • Physical loss as percentage of total loss:  $525/525 = 1.00
  • Insurance payment: $206.25/acre
  • Insurance payment attributable to physical loss (which is deferrable):  $206.25 x 1.00 = $206.25/acre
  • Portion of insurance payment that is not deferrable: $206.25 – 206.25 = $0.00

Conclusion

Crop insurance will be an important component of income for many farmers this year due to drought.  Make sure you understand the rules for deferability.  Take the advice you receive on social media or at the café or coffee shop with a grain of salt.

On a related point, Emergency Relief Payments received in 2022 are not deferable.  Those payments were for loss sustained in either 2020 or 2021.

November 11, 2022 in Income Tax | Permalink | Comments (0)

Sunday, November 6, 2022

Social Security Planning for Farmers and Ranchers

Overview

Many farmers and ranchers are reaching retirement age for Social Security benefit purposes.  That raises numerous questions involving such things as benefits, earnings, what counts as “wages” and the cash renting of farmland.  These are all important questions for farmers and ranchers to have answers to so that appropriate planning can be engaged in and expectations realized.

Details on Social Security benefits - it's the topic of today’s post.

Full Retirement Age

Once a person reaches “full retirement age” (according to the Social Security Administration) earnings don’t impact Social Security benefits.  The full retirement age used to be 65 for those born in 1937 or earlier. Those born between 1943 and 1954 have a full retirement age of 66. The full retirement age further increases in two-month increments each year to 66 and 10 months for those born in 1959.  For those who turned 62 in 2022, the full retirement age is 67.

During the calendar year in which an individual reaches age 66, an earnings limit applies for the months before the individual reaches full retirement age.  For example, for an individual who turns age 66 during 2022, there is a monthly earnings limit of $4,330 ($51,960 ¸ 12 months) for the months before full retirement age is reached.  Excess earnings for this period result in a $1 reduction in benefits for each $3 of excess earnings received before attaining the age of 66 years and four months.  But, for a person who hasn’t reached full retirement age, benefits are reduced by $1 for every $2 of earnings over the annual limit of $19,560 (for 2022).  As noted above, for those drawing benefits after reaching full retirement age, there is no limit on earnings – benefits are not reduced.

Drawing Benefits

An individual can receive full Social Security benefits if they aren’t drawn until full retirement age is achieved.  Another way to state it is that if an individual delays taking Social Security benefits until reaching full retirement age, the individual receives additional benefits for each year of postponement until reaching age 70.  The rate of increase is a fraction of one percent per month.  In essence, the impact of drawing Social Security benefits before reaching full retirement age is that such a person must live longer to equalize the amount of benefits received over their lifetime compared to waiting until full retirement age to begin drawing benefits.   

Taxability of Benefits

Federal.  About 20 million people each year, some who are undoubtedly farmers and ranchers, pay tax on their Social Security benefits.  These people are commonly in the 62-70 year age range.  Taxing Social Security benefits seems harsh, inasmuch as the person has already paid income tax and Social Security payroll taxes on the earnings that generated the benefits.   But not every dollar of benefits is taxed.  What matters is a person’s total income from non-Social Security sources such as wages and salaries, investment income (and capital gains on those investments), and pension income.  To that amount is added one-half of the person’s Social Security income.  The total amount then is measured against a limit.  For example, a person who files as married-filing-jointly (MFJ) will subject 50 percent of their Social Security benefits subject to tax if the total amount exceeds a base amount - $32,000 for 2022 (it’s $25,000 for a single filer).  The 50 percent changes to 85 percent once the total amount exceeds $44,000 (MFJ) or $34,000 (single) for 2022.  Those are the maximum percentages in theory.  In reality, however, there is a complex formula that often results in less Social Security benefits being taxed than that maximum percentage.  For instance, for taxpayers that fall in the 50 percent taxability range, the amount of Social Security benefits that are included in income is the lesser of one-half of the Social Security benefits for the year or one-half of the difference between combined income and the base amount.  The formula is more complex for those who trigger the 85 percent test. 

Note:  The IRS provides a worksheet to calculate Social Security tax liability in IRS Publication 915.  The formula often results in about 20 percent of Social Security benefits being taxed once the total amount threshold is exceeded. 

State.  The following states tax Social Security benefits to some extent:  Colorado; Connecticut; Kansas; Minnesota; Missouri; Montana; Nebraska; New Mexico; Rhode Island; Utah; Vermont and West Virginia.  The taxability of benefits varies from state to state.  In Kansas, for example, Social Security benefits are exempt if federal AGI is $75,000 or less. Above that threshold, Social Security benefits are taxed to the same extent they are taxed at the federal level.  By comparison, Nebraska, for 2021, did not tax Social Security for joint filers with a federal AGI of $59,960 or less and other taxpayers with a federal AGI of $44,460 or less (the 2022 threshold is not available yet).  For taxpayers exceeding these thresholds, Social Security benefits are taxed to the same extent they are taxed at the federal level.  For 2022, taxpayers can choose to deduct 40% of Social Security benefits on the state return that are included in federal AGI instead of having them taxed in accordance with the above rule.  The optional deduction percentage increases to 60% for 2023, 80% for 2024, and 100% for 2025 and thereafter.

Special Considerations

The “donut” hole.    The computation of Social Security retirement benefits is based on an individual’s earnings record.  That record can include 40-plus years of earnings up to age 62 when eligibility for benefits begins.  Earnings are adjusted based on wage inflation to equivalent dollars when an individual turns 60.  That is the last year earnings are indexed for wage inflation.  Earnings after age 60 are added to the earnings record but are not adjusted for inflation.

A cost-of-living adjustment (COLA) kicks in each year starting at age 62.  The two-year gap where there is neither a wage inflation adjustment nor a COLA is particularly evident this year because of an inflation rate not seen in over 40 years.  Presently this affects people born in 1960 and 1961.  There is nothing that can be done about this; it’s simply tied to when an individual turns age 62. 

Wages in-kind.  Some farmers receive wages in-kind rather than in cash.  In-kind wages such as crops or livestock, count toward the earnings limitations test.  The earnings limit test includes all earnings, not just those that are subject to Social Security (FICA/Medicare) tax.  But, employer-provided health insurance benefits are not considered to be “earnings” for purposes of the earnings limitation test.  They are not taxed as wages.  I.R.C. §3121; SSA Program Operations Manual System, §§RS 01402.040; 01402,048.

Farm programs.  Federal farm program payments that a farmer receives are not deemed to be “earnings” when calculating each calendar year's earnings limitation.  SSA Program Operations Manual System §RS 02505.115.  That is the case except for the initial year of Social Security benefit application.  In that initial year, all FSA program payments are counted along with other earned income and earnings for purposes of the annual earnings limitation test.

Cash rent.  For farmers who cash rent farm ground to their employer, the cash rental income that the farmer receives will likely be treated as “earnings” even though the farmer is getting a wage from the employer.  This is particularly the case if the farmer is farming the ground on the employer’s behalf.  The result would be a “doubling-up” of the wage income and the cash rent income for purposes of the age 62-66 earnings test. 

CRP payments.  For a farmer who is drawing Social Security benefits, whether retired or not, Conservation Reserve Program Payments received are not subject to Social Security tax.  I.R.C. §1402(a)(1). 

Conclusion

Social Security benefit planning is an item that is often overlooked by farmers and ranchers.  However, it is useful to know how such planning may fit into the overall retirement plan.  It is just one piece of the retirement, succession, estate plan that should be considered in terms of how it fits in with other strategies.  While a farmer or rancher may never actually “retire,” there is a benefit to properly timing the drawing of Social Security benefits.  In addition, as noted above, there are some special situations that a farmer or rancher should be aware of.

Also, the Social Security Administration website (ssa.gov) has some useful online calculators that can aid in estimating retirement benefits.  It may be worth checking out. 

November 6, 2022 in Estate Planning, Income Tax | Permalink | Comments (0)

Thursday, November 3, 2022

Tax Treatment of Crops and/or Livestock Sold Post-Death

Overview

When a farmer sells a harvested crop, the tax rules surrounding the reporting of the income from the sale are well understood.  But what happens when a farmer dies during the growing season?  The tax issues are more complicated with the tax treatment of the sale tied to the status of the decedent at the time of death – whether the decedent was a farmer or a landlord.  In addition, if the decedent was a landlord, the type of lease matters. 

The tax rules involving the post-death sale of crops and livestock – that’s the focus of today’s post.

General Rule and the IRD Exception

For income tax  purposes, the basis of property in the hands of the decedent’s heir or the person otherwise acquiring the property from a decedent is the property’s FMV as of the date of the decedent’s death.  I.R.C. §1014(a)(1).   But there is an exception to this general rule.  Income in respect of decedent (IRD) property does not receive any step-up in basis.  I.R.C. §691.  IRD is taxable income the taxpayer earned before death that is received after death. IRD is not included on the decedent’s final income tax return because the taxpayer was not eligible to collect the income before death.

In Estate of Peterson v. Comm’r, 667 F.2d 675 (8th Cir. 1981), the Tax Court set forth four requirements for determining whether post-death sales proceeds are IRD.

  1. The decedent entered into a legal agreement regarding the subject matter of the sale.
  2. The decedent performed the substantive acts required as preconditions to the sale (i.e., the subject matter of the sale was in a deliverable state on the date of the decedent’s death).
  3. No economically material contingencies that might have disrupted the sale existed at the time of death.
  4. The decedent would have eventually received (actually or constructively) the sale proceeds if he had lived.

The case involved the sale of calves by a decedent’s estate.  Two-thirds of the calves were deliverable on the date of the decedent’s death.  The other third was too young to be weaned as of the decedent’s death and the decedent’s estate had to feed and raise the calves until they were old enough to be delivered.  The court held that the proceeds were not IRD because a significant number of the calves were not in a deliverable state as of the date of the decedent’s death.  In addition, the estate’s activities with respect to the calves were substantial and essential.  The Tax Court held that all four requirements had to be satisfied for the income to be IRD, and the second requirement was not satisfied. 

Active farmer or landlord?  Classifying income as IRD depends on the status of the decedent at the time of death. The following two questions are relevant.

  1. Was the decedent an operating farmer or a farm landlord at the time of death? If the decedent was a farm landlord, the type of lease matters. 
  2. If the decedent was a farm landlord, was the decedent a materially participating landlord or a non-materially participating landlord?

For operating farmers (including materially participating farm landlords), unsold livestock, growing crops, and grain inventories are not IRD. Rev. Rul. 58-436, 1958-2 CB 366.  See also Estate of Burnett v. Comm’r, 2 TC 897 (1943).  The rule is the same if the decedent was a landlord under a material participation lease.  These assets are included in the decedent’s gross estate and receive a new basis equal to their FMV as of the decedent’s date of death under IRC §1014.  No allocation  is made between the decedent’s estate and the decedent’s final income tax return.  Treas. Reg. §20.2031-1(b).

From an income tax perspective, all of the growing costs incurred by the farmer before death are deducted on the decedent's income tax return. At the time of death, the FMV of the growing crop established in accordance with a formula is treated as inventory and deducted as sold. The remaining costs incurred after death are also deducted by the decedent's estate. In many cases, it may be possible to achieve close to a double deduction.

If a cash-basis landlord rents out land under a non-material participation lease, the landlord normally includes the rent in income when the crop share is reduced to cash or a cash equivalent, not when the crop share is first delivered to the landlord. In this situation, a portion of the growing crops or crop shares or livestock that are sold post-death are IRD and a portion are post-death ordinary income to the landlord’s estate. That is the result if the crop share is received by the landlord before death but is not reduced to cash until after death. It is also the result if the decedent had the right to receive the crop share, and the share is delivered to the landlord’s estate and then reduced to cash. In essence, for a decedent on the cash method, an allocation is made with the portion of the proceeds allocable to the pre-death period (in both situations) being IRD in accordance with a formula set forth in Rev. Rul. 64-289, 1964-2 CB 173 (1964).  That formula splits out the IRD and estate income based on the number of days in the rental period before and after death with the IRD portion being attributable to the days before death.  If the decedent dies after the crop share is sold (but before the end of the rental period), the proceeds would have been reported on the decedent’s final return.  No prorations would have been required.  If the decedent’s crop share is held until death, when the heirs sell the crop share, the proceeds are allocated between IRD and ordinary income of the decedent’s estate under the formula. 

IRD results from crop share rents of a non-materially participating landlord that are fed to livestock before the landlord’s death if the animals are also owned on shares. If the decedent utilized the livestock as a separate operation from the lease, the in-kind crop share rents (e.g., hay, grain) are treated as any other asset in the farming operation — included in the decedent’s gross estate and entitled to a date-of-death FMV basis.

Crop share rents fed to livestock after the landlord’s death are treated as a sale at the time of feeding with an offsetting deduction.  Rev. Rul. 75-11, 1975-1 CB 27.

Character of Gain

Sale of grain.  Grain that is raised by a farmer and held for sale or for feeding to livestock is inventory in the hands of the farmer. Upon the subsequent sale of the grain, the proceeds are treated as ordinary income for income tax purposes. However, when a farmer dies and the estate (or the person acquiring the property) sells grain inventory the rule had been that if the sale occurred within six months after death, the income from the sale qualified as long-term capital gain if the basis in the crops was determined under the IRC §1014 date-of-death FMV rule.  I.R.C. §1223(9).  That is now one year.  I.R.C. §1223(9)(B).  The two-year holding period requirement still applies to cattle and horses.  However, ordinary income treatment occurs if the crop was raised on land that is leased to a tenant.  See, e.g., Bidart Brothers v. U.S., 262 F.2d 607 (9th Cir. 1959). 

Entity.  If the decedent operated the farming business in a partnership or corporation and the entity is liquidated upon the decedent’s death, the grain that is distributed from the entity may be converted from inventory to a capital asset. See, e.g., Greenspon v. Comm’r, 229 F.2d 947 (8th Cir. 1956). However, to get capital asset status in the hands of a partner or shareholder, the partner or shareholder cannot use the grain as inventory in a trade or business.  Baker v. Comm’r, 248 F.2d 893 (5th Cir. 1957). That status is most likely to be achieved, therefore, when the partner or shareholder does not continue in a farming business after the entity’s liquidation.  

Conclusion

The sale of crops and livestock post-death are governed by specific tax rules.  Because death often occurs during a growing period, it’s important to know these unique rules.

November 3, 2022 in Income Tax | Permalink | Comments (0)

Friday, October 28, 2022

When Can Depreciation First Be Claimed?

Overview

A recent Tax Court opinion starts out with, “During 2015-2017 petitioners were actively engaged in the farming business, growing and selling corn and soybeans. In July 2015, after seeing an advertisement in a farming magazine…”.   That statement gave me the feeling that the court’s opinion was going to quickly head south for the farmer.  I was right.  While the case did not involve the purchase of farm equipment or a farm building, with the onset of fall comes the onset of agribusinesses promoting year-end “deals” on equipment and farm buildings – and the provision of bad tax “advice.”  The common ploy is for the sale to be made in 2022 with the farmer thinking that they will be able to take a sizable deduction on their 2022 taxes for depreciation.  But, the tax year in which depreciation can first be claimed on an asset depends on when an asset is “placed in service.”

When can an asset that is used in the farming business begin to be depreciated?  The “placed in service” issue – it’s the topic of today’s post

“Placed in Service”

A taxpayer can claim a depreciation deduction for assets that are used in the taxpayer’s trade or business or held for the production of income. I.R.C §167(a).  Any depreciable business asset is only depreciable if it has been placed in service during the tax year. Treas. Reg. §1.167(a)-10(b).  “Placed in service” means that the asset is in a state of readiness for use in the taxpayer’s trade or business.  See, e.g., Brown v. Comr., T.C. Sum. Op. 2009-71.  In the year that an asset is placed in service, all or part of the income tax basis can be deducted currently.  Taxpayers generally prefer an earlier placed-in-service date due to the time value of money.  The IRS generally prefers the opposite position.  So, when is a building placed in service?  What about machinery or equipment?  What if equipment was acquired this year but not first used until next year? 

Code, Regulations and Interpretations of IRS and the Tax Court

A key point is that it is not actually necessary that the asset be used in the taxpayer’s trade or business for the taxpayer to begin claiming depreciation attributable to that asset.  Treas. Reg. §1,167(a)-(11)(e)(1) says that property is considered to be placed in service when it is “first placed in a condition or state of readiness and [available] for a specifically assigned function.” 

As noted above, property that is “placed in service” means that it is placed in a state of readiness or availability for use in the taxpayer’s trade or business, regardless of the time of year that the asset is placed in service.  Treas. Reg. §1.167(a)-10(b).  That means that the asset must be ready for the taxpayer to use by the end of the tax year if the taxpayer so desires.  It doesn’t mean that the taxpayer must have begun using the asset in the taxpayer’s trade or business by the end of the tax year.  Unfortunately, the IRS has not been consistent in applying the regulation.  For example, in F.S.A. 199916040 (Apr. 23, 1999), the IRS construed the regulation to require actual operational use in the taxpayer’s trade or business.  The taxpayer purchased compressors to maintain gas pressure in pipelines.  The IRS said deprecation couldn’t begin until the compressors were installed in the pipelines.  In Consumers Power Co. v. Comr., 89 T.C. 710 (1987), the said that an electricity-generating unit should not be deemed to be placed in service until it could operate at rated capacity.   See also Oglethorpe Power Corp., v. Comr., T.C. Memo. 1990-505; Rev. Rul. 73-518, 1973-2 C.B. 54.

However, the IRS has also utilized a less restrictive view on what constitutes placed-in-service.  In Rev. Rul. 76-238, 1976-1 C.B. 55, IRS determined that a building was placed in service when its construction was complete, and it was ready for machinery and equipment to be installed.  Likewise, in Livingston v. Comr., T.C. Memo. 1966-49, the Tax Court held that depreciation was allowable on the completed portions of a building for use in the taxpayer’s business regardless of whether the entire building was completed.

The Stine Case

In Stine, LLC v. United States, No. 2:13-03224, 2015 U.S. Dist. LEXIS 9850 (W.D. La. Jan. 27, 2015), non-acq., 2017-02 (Apr. 10, 2017), the taxpayer operated a retail business that sold home building materials and supplies. The taxpayer built two new retail stores. As of December 31, 2008, the buildings were substantially complete and partially occupied and the taxpayer had obtained certificates of completion and occupancy and customers could enter the stores. However, the stores were not open for business as of the end of 2008. The taxpayer claimed the 50 percent GoZone depreciation allowance for 2008 on the two buildings which created a tax loss for 2008 and allowed the taxpayer to carry back the losses to the 2003-2005 tax years and receive a refund. The IRS disallowed the depreciation deduction on the basis that the taxpayer had not placed the buildings in service and assessed a deficiency of over $2.1 million for tax years 2003-2008. The taxpayer paid the deficiency and sued for a refund. The IRS argued that allowing the depreciation would offend the "matching principle" because the taxpayer's revenue from the buildings would not match the depreciation deductions for a particular tax year. The court held that this argument was "totally without merit."  

On the placed-in-service issue, the IRS maintained that the two buildings were not “open for business” as of the end of the tax year so no depreciation could be claimed for that year.  The court disagreed, noting the government’s own regulation that defied that argument.  The court noted that Treas. Reg. §1.167(a)-11(e)(1) says that placed in service means that the asset is in a condition of readiness and availability for its assigned function. With respect to a building, the court noted that this meant that the building must be in a state of readiness and availability without regard to whether equipment or machinery housed in the building has been placed in service. The court held that there was no requirement that the taxpayer's business must have begun by year-end. Cases that the IRS cited involving equipment (in one case an airplane) being placed in service were not applicable, the court determined. The court also noted that the IRS's own Audit Technique Guide for Rehabilitation Tax Credits stated that "[A] 'Certificate of Occupancy' is one means of verifying the 'Placed in Service' date for the entire building (or part thereof)". The court noted that the IRS had failed to cite even a single authority for the proposition that "placed in service" means "open for business," and that during oral arguments IRS had admitted that no authority existed.  Thus, the court granted summary judgment for the taxpayer and also specified that the taxpayer could pursue attorney fees against the government if desired.

The IRS reaction.  The court’s decision in Stine was based precisely on the regulation.  It’s common sense, also.  For retail businesses that are constructing stores, once the product is received to be placed into the display shelves at the constructed building, the building will be considered to have been placed in service.  That’s what the regulation seems pretty clear about.  The court sure believed so. 

The IRS did not file an appeal with the U.S. Court of Appeals for the Fifth Circuit.  That’s not surprising, considering how badly the IRS lost the case.  Recently, however, the IRS issued a non-acquiescence to the court’s decision.  A.O.D. 2017-02.  That means that the IRS disagrees with the court’s decision and will continue to audit the issue outside of the Western District of Louisiana.  Unfortunately, the IRS didn’t give any reason(s) why it disagreed with its own regulation and audit technique guide on the matter.  That’s understandable – they have none.

Application to Farm Asset Purchases

So, what can we learn from this for a farmer’s later in the tax year purchase of machinery, equipment or a farm building?  An item of property is not deemed to be placed in service if it is simply manufactured and is sitting at the dealership, or if an order has been placed but the property has not yet been built.  Simply signing a purchase contract or taking delivery of a depreciable materials (such as for the construction of a pole barn, etc.) to be used in the taxpayer’s business does not mean that those assets are depreciable – they aren’t yet ready for use in the taxpayer’s business. It doesn’t matter that the taxpayer has paid for the asset.  The key is whether the asset is ready for use in the taxpayer’s business.  But remember, actual use by the end of the current tax year doesn’t matter either.  For a building in which the taxpayer’s retail business is conducted, for example, the store doesn’t have to be open for business in order for the building by the end of the tax year for the building to be deemed to be placed in service for depreciation purposes for that tax year.  Treas. Reg. §1.167(a)-11(e)(1)(i).  The building is considered to be placed in service on the date that its construction is considered to be substantially complete or in the state or readiness and availability regardless of whether depreciable items in the building meet the placed in-service test.  Id.

Conclusion

Be on the lookout for end-of-year promotional ads in farm magazines stating that a contract could be signed, or delivery be taken before year-end to which will allow a depreciation deduction to be available for that year.  That’s not correct.  While the asset need not be “used” by the taxpayer to be placed in service, it still has to be ready and available for use.  Merely signing a contract or taking delivery of parts and materials that have to be assembled is not enough.  Thus, for a farmer that buys equipment this year that will not be ready for use in the farming business until next year, no depreciation deduction will be allowed until 2023.  This is particularly a big issue this year because first-year “bonus” depreciation, while 100 percent for 2022, is schedule to drop to 80 percent for next year and supply chain issues may cause delays.

Make sure you know the rules and don’t get lured into a bad tax result by inaccurate sales information.  Remember, retailers are trying to sell products in a down economy.  They aren’t in the business of providing sound tax advice.

October 28, 2022 in Income Tax | Permalink | Comments (0)

Wednesday, October 26, 2022

Handling Expenses of Crops with Pre-Productive Periods - The Uniform Capitalization Rules

Overview

In the Midwest and the Great Plains, we often think of crop production involving the production a crop within a calendar year.  From a tax standpoint, that means that the deductions for producing the crop and the income from the crop generally offset in the same tax year (assuming the farmer is on the cash basis of accounting and utilizes a calendar tax year).  Of course, expenses can be pre-paid and income deferred, but there is generally an offset.    But the singular year comprising the planting and harvesting of a crop is not the case with fruit and vegetable crops.  Producers of those crops have a significant time-lag between planting and harvest in marketable quantities.

The tax Code allows farmers that have a long-term crop (which includes a fruit, nut or other crop-bearing tree; ornamental tree; vine; bush; sod; or any other crops or yield of a plant that will have more than one crop or yield) to use a special rule for handling crop production expenses.  I.R.C. §263A.  These rules, known as the “uniform capitalization rules” apply to taxpayers that have a long-term crop with more than a two-year pre-productive period.  The rules operate to bar deductions for the costs associated with the crop during the pre-productive period. Instead, the taxpayer must add the associated costs to their tax basis in the crop, or the costs must be included in inventory costs.  They cannot be claimed as a current deduction. 

Note.  Production costs can include everything from direct labor and material costs to indirect rents, taxes and other costs.  For plants, pre-productive period costs include the costs of items such as irrigation, pruning, frost protection, spraying and harvesting. 

Background

Farmers that are not required to use the accrual method of accounting could elect to not have the I.R.C. §263A rules apply with respect to pre-productive period costs.  If an election out is made, the plants are treated as I.R.C. §1245 property and the gains rom selling the plants are I.R.C. §1245 gains to the extent of any expenses that would have been required to be capitalized under I.R.C. §263A as if the election had not been made.  In addition, alternative depreciation (ADS) then had to be used on all farm property and bonus depreciation was not available (but, expense method depreciation could still be utilized).  Under a law passed in 2015, an election was provided to allow bonus depreciation for certain “specified” plants equal to 50 percent of their cost (for 2016) that were planted or grafted after 2015.  Eligible plants were trees or vines that produce nuts or fruits and any other plant with a more than two-year pre-productive period. 

What is the Pre-Productive Period?

For plants, the pre-productive period begins when the seed is planted, or the plant is first acquired by the taxpayer. The pre-productive period ends when the plant is ready to be produced in marketable quantities or when the plant can reasonably be expected to be sold or otherwise disposed of. The pre-productive period, however, is determined not in light of the taxpayer’s personal experience but in light of the weighted average pre-productive period determined on a nationwide basis.

Crops with a Pre-Productive Period Exceeding Two Years

In Notice 2000-45, I.R.B. 2000-36, the IRS provided a list of plants that are grown in commercial quantities in the U.S. having a nationwide weighted average pre-productive period in excess of two years.  Blackberries, raspberries and papaya plants were on the original list, but were removed in 2013.  The current list is as follows:

Almonds           Coffee beans     Kumquats         Oranges                        Pomegranates

Apples              Currants            Lemons                                                Prunes

Apricots            Dates                Limes               Peaches                       

Avocados          Figs                  Mac. Nuts           Pears                          Tangelos

                        Grapefruit         Mangoes           Pecans                          Tangerines

Blueberries       Grapes              Nectarines         Persimmons                  Tangors

Cherries            Guavas             Olives               Pistachio Nuts              Walnuts

Chestnuts          Kiwifruit           Plums

Application to Grapes

The uniform capitalization rule is particularly problematic for grape growers. If the rule requires that all of the expenses associated with growing grapes be capitalized until the time the wine is sold, that would be a really tough rule for wineries because the wine-making process can take many years.  The IRS treats grape growing and winery functions as separate businesses, even though:

  1. the grapes are never subject to sale or other disposition as those terms are used in tax law; and
  2. the taxpayer does not operate their business as two separate and distinct businesses. C.A. 200713023 (Nov. 20, 2006).

In conjunction with that reasoning, the IRS view is that the actual pre-productive period of a grape crop ends no later than the onset of the crushing of the grapes.  Id.  As for the costs incurred between the harvest of the grapes and blossoming of a later crop, IRS requires that a taxpayer must capitalize the direct costs and an allocable portion of the indirect costs of producing the vine. Treas. Reg. §1.263A-1(e).  Preparatory costs of the vine and the pre-productive period costs of the vine that are incurred during the actual pre-productive period of the vine must be capitalized.  The actual pre-productive period of the vine ends when the vine first becomes productive in marketable quantities.  After the end of the actual pre-productive period, pre-productive period costs are generally capitalized to a crop during the pre-productive period o the crop and are deducted as a cost of maintaining the vine when incurred between the end of the actual pre-productive period of one crop and the beginning of the actual pre-productive period of the subsequent crop. 

Note:  Direct and indirect costs include administration costs, depreciation and repairs on farm buildings and farm overhead.  Id. 

Exception for “Field Costs”

A special exception for “field costs” such as irrigating, fertilizing, spraying, and pruning applies to the period between harvesting and the sale of the crop.  Treas. Reg. §1.263A-4(b)(2)(i)(C) (2)(i).  These costs are not required to be capitalized because they do not benefit, and are unrelated to, the harvested crop. They merely maintain and improve the health of the vines, but they do not provide any benefits to the crop which has already been severed from the vines. This field crop exception, however, ends when the pre-productive period of the crop ends, which is the onset of the crush. Thus, pre-productive period costs incurred between the end of the pre-productive period and the blossoming of the later crop are generally deductible as the cost of maintaining the vine.

The bottom line, therefore, is that costs incurred between the harvest of the crop and the end of the pre-productive period must be capitalized unless they are “field costs” that provide no benefit to the already severed crop.   When there is a marketable harvest, the total capitalized costs are depreciated on a straight-line basis over 10 years (for orchards and vineyards).    Expense method depreciation or bonus depreciation is also available. 

TCJA

Under the Tax Cuts and Jobs Act (TCJA), 100 percent bonus depreciation is available through 2022.  In addition, farmers with gross receipts of $25 million or less ($27 million for 2022) can expense all of the direct and indirect costs associated with plantings - including the costs of the plants.  This means that the requirement of using I.R.C. §263A is eliminated for these farmers.  For those farmers that made the election to expense direct and indirect costs of production, but not have bonus depreciation available, it is not known whether an election can be made to come back into the system.  If such an election can be made and the taxpayer’ gross revenue is less than the applicable threshold, all costs can be deducted currently under the 100 percent bonus provision.  If an election cannot be made, costs must be expensed but bonus is not available on all farm assets.  This will be the case even if the taxpayer had not planted any orchards or vineyards for several years. 

This raised a question.  What if a farmer elected under I.R.C. §263A(d)(3) to expense the direct and indirect costs of production, thereby becoming unable to claim bonus depreciation and being required to use ADS?  Many farmers with vineyards and orchards did this to be able to deduct costs as incurred.  It was in irrevocable election, but the TCJA raised a question as to whether they could elect to come back into the system.  The problem was that these farmers had no way to revoke the election and utilize the TCJA provision eliminated the uniform capitalization rules for a qualified “small business” other than to request (at great expense) an IRS Private Letter Ruling. 

Example:

Raymond and Verda, a farm couple, planted an orchard in 2012.  Their gross revenues are less than the threshold for utilizing cash accounting.  They elected to expense all costs of the orchard.  That had the effect of barring them from claiming bonus depreciation on any farm assets.  In 2018, they bought $1,500,000 of farm equipment.  If they cannot elect back into the prior system, they won’t be able to claim any bonus depreciation on the new farm equipment and can only take expense method depreciation.  If they can elect back into the old rules, that then entire $1,500,000 of farm equipment purchased in 2018 will qualify for bonus depreciation.

In the spring of 2020, the IRS provided a mechanism for taxpayers that had elected out of I.R.C. §263A under prior law to revoke the election. Rev. Proc. 2020-13, 2020-11 I.R.B.  Under the election, a taxpayer with average annual gross receipts of $25 million or less (adjusted for inflation) over the prior three years (through 2025) are excluded from I.R.C. §263A.  For tax years beginning after 2018, the revocation election is to be made on the taxpayer’s original return, including extensions, for the tax year for which the taxpayer wants to revoke the election.  The election is accomplished by not capitalizing the costs of plants; changing depreciation to GDS unless the property at issue is otherwise required to use ADS (e.g., bonus depreciation is not allowed); and continuing to treat plants that are or have been treated as I.R.C. §1245 property for prior tax years as I.R.C. §1245 property. 

Conclusion

For farmers with a crop that has more than a two-year pre-productive period, the tax rules for handling the associated expenses can be confusing. 

October 26, 2022 in Income Tax | Permalink | Comments (0)

Sunday, October 23, 2022

IRS Audits and Statutory Protection

Overview

Much has been made of the provision in the “Inflation Reduction Act” that would allow the IRS to hire over 80,000 agents.  To an extent, this is necessary.  The IRS currently has 78,000 agents, but 50,000 of them are set to retire in the next few years.  Title I, Part 3, Sec. 10301 of H.R. 5376 is entitled, “Enhancement of Internal Revenue Service Resources.”  The provision allocates $3,181,500 to “taxpayer services,” $45,637,400,000 to “enforcement,” $25,326,400,000 to “operations support,” $4,750,700,000 to “Business Systems Modernization,” $15,000,000 for IRS to develop a report to the Congress within nine months of enactment of the law on the cost of developing and running a free direct efile tax return system; $403,000,000 to the Treasury Inspector General for Tax Administration; $104,533,803 to the Office of Tax Policy; $153,000,000 to the U.S. Tax Court; and $50,000,000 to the Treasury Department Offices for implementation.

It’s the enforcement funding that received much of the public’s attention.  The enforcement funding provision is by far the most funded provision and reads as follows:

“For necessary expenses for tax enforcement activities of the Internal Revenue Service to determine and collect owed taxes, to provide legal and litigation support, to conduct criminal investigations,… to provide digital asset monitoring and compliance activities, to enforce criminal statutes related to violations of internal revenue laws and other financial crimes….”

Clearly the emphasis of the Congressional funding is to ramp up taxpayer audits rather than improving IRS service.  Taxpayers preparing their own returns will certainly be targeted – that’s “low hanging fruit” for the IRS.  Also, small businesses will likely be in the crosshairs of the IRS as will any businesses that deal in cash.  It also appears the emphasis is intended to include cryptocurrency transactions. 

Experiencing a tax audit can be a traumatic experience.  Often, the level of trauma depends on the examining agent(s).  It can also depend on how aggressive the IRS National Office is on the issue under examination.  With the massive increase in funding, IRS can “afford” to be more aggressive. But, a question is that once an audit is completed can the IRS return to the same issue involving the same tax year and with the same taxpayer and get a “do-over”?  In other words, how many times can the IRS audit the same issue?  The increased funding will give the IRS the chance to do this.  But can it?

The ability of IRS to re-audit issues that have been examined and resolved – it’s the topic of today’s post.

Applicable Code Section

In 1921, the Congress enacted I.R.C. 7605(b) as a reaction to constituent complaints that the IRS was abusing its power by subjecting taxpayers to unnecessary audits.  See H.R. Rep. No. 67-350, at 16 (1921).  Based on the recorded legislative history, the purpose of the new Code section was to relieve taxpayers from “unnecessary annoyance” by the IRS.  See statement of Sen. Penrose at 61 Cong. Rec. 5855 (Sept. 28, 1921). 

I.R.C. §7605(b) states as follows:

“No taxpayer shall be subjected to unnecessary examination or investigations, and only one inspection of a taxpayer’s books of account shall be made for each taxable year unless the taxpayer requests otherwise or unless the Secretary, after investigation, notifies the taxpayer in writing that an additional inspection is necessary.”

Thus, the provision bars the IRS from conducting “unnecessary examination or investigations” and conducting more than a single investigation of a taxpayer’s “books of account” for a tax year.  But, if any investigation is legitimate, the courts generally don’t get in the way of the IRS.  Instead, the courts have tended to focus on the “unnecessary” language in the statute rather than the “single investigation” part of the provision.  See, e.g, United States v. Schwartz, 469 F.2d 977 (5th Cir. 1972); United States v. Kendrick, 518 F.2d 842 (7th Cir. 1975).  In addition, the provision has been interpreted so as to not prevent an IRS agent from “diligently exercising his statutory duty of collecting the revenues.”  Benjamin v. Comr., 66 T.C. 1084 (1976).  The public purpose of collecting revenues duly owed is of utmost importance to the courts, and the statutory provision is not to be read in such a broad manner as to defeat that purpose.  At least that’s how the U.S. Court of Appeals construed the statute in a 1963 case.  DeMasters v. Arend, 313 F.2d 79 (9th Cir. 1963).   

Recent Case

In 2020, the U.S. Tax Court addressed the application of I.R.C. §7605(b) in a case involving a surgeon (the petitioner) that inherited his mother’s IRA upon her death in 2013 – one that she had received upon her husband’s (the petitioner’s father) death.  In Essner v. Comr., T.C. Memo. 2020-23, the petitioner then took distributions from the IRA in 2014 and 2015.  He didn’t tell his return preparer that he had taken sizable distributions in either 2014 or 2015, and didn’t ask for guidance from the preparer on how to treat the distributions for tax purposes.  Even though he received a Form 1099-R for the distributions received in 2014 and 2015, he didn’t report them in income for either year.  The IRS Automated Underreporting (AUR) program, caught the discrepancy on the returns and generated a notice to the petitioner seeking more information and substantiation.  After a second notice, the petitioner responded in handwriting that he disagreed with having the distributions included in income.  While the AUR review was ongoing, the IRS sent the petitioner a letter in late 2016 informing him that his 2014 return had been selected for audit and requesting copies of his 2013 through 2015 returns.  The audit focused on various claimed expenses, but did not focus on the IRA distributions.  The examining agent was unaware of the AUR’s actions concerning the 2014 and 2015 returns.  The examining agent sent the petitioner a letter in early 2017 with proposed adjustments, later revising it upon receipt of additional information.  Neither letter mentioned the issue with the IRA distributions, and the petitioner sent a letter to the IRS agent requesting confirmation that his IRA distribution received in 2014 was not taxable.  17 days later, the petitioner filed a Tax Court petitioner challenging a notice of deficiency that the AUR had generated seven days before the examining agent’s original letter proposing adjustments to the 2014 return.  About seven months later the IRS issued a notice of deficiency to the petitioner asserting a $101,750 tax deficiency for the 2015 tax year and an accuracy-related penalty.  The petitioner filed another Tax Court petition concerning the 2015 tax year. 

At trial, the petitioner couldn’t establish that any portion of the distributions he received represented a return of his father’s original investment and the Tax Court sustained the IRS position that the distributions were fully taxable.  The petitioner also claimed that I.R.C. §7605(b) barred the IRS from assessing the proposed deficiency for 2014 because the concurrent review of the 2014 return by the AUR and the agent constituted a “second inspection” of his books and records for 2014.  The Tax Court, based on its prior decision in Digby v. Comr., 103 T.C. 441 (1994), framed the issue of whether the examination was unnecessary or unauthorized, and noted that the U.S. Supreme Court has explained that I.R.C. §7605 imposes “no severe restriction” on the power of the IRS to investigate taxpayers.  United States v. Powell, 379 U.S. 48 (1964).  The Tax Court noted that the AUR didn’t inspect the petitioner’s books, but merely based its review on third-party information returns – there was no “examination” of the 2014 return.  Accordingly, the Tax Court concluded that the AUR program’s matching of third-party-reported payment information against his already-filed 2014 return was not an “examination” of his records.  There was no violation of I.R.C. §7605(b).  The Tax Court also upheld the accuracy-related penalty.

Recent Chief Counsel Legal Advice

In 2021, the IRS Chief Counsel’s Office addressed the I.R.C. §7605(b) issue with respect to net operating loss (NOL) carrybacks.  This time the outcome was favorable for the taxpayer.  Under the facts of CCM 20202501F (May 7, 2020), the taxpayer was a hedge fund operator and a former investment banker that bought a vineyard.  The vineyard also included a house, guesthouse, caretaker’s house, and olive grove. The IRS conducted an audit resulting in the issuance of a Notice of Proposed Adjustment disallowing all expenses and depreciation deductions related to the vineyard for the prior tax years under audit. The IRS took the position that the vineyard was a hobby activity under I.R.C. §183 for those years.

On further review, the IRS Appeals Office determined that the taxpayer’s vineyard activity was not a hobby for those tax years based on its conclusion that all of the nine-factors contained in Treas. Reg. §1.183-2(b) were in the taxpayer’s favor and, as a result, the deductions and expenses claimed in those years were allowable which resulted in a net operating loss (NOL). The IRS again audited the taxpayer in a later year on the hobby activity issue.  Also at issue was whether the taxpayer could deduct an NOL carryforward originating from the tax years that had previously been audited and for which IRS Appeals had determined that the vineyard activity was not a hobby The taxpayer asserted that the second audit stemmed from previously audited tax years and violation I.R.C. §7605(b) as a repetitive audit. The IRS sought guidance from the IRS Chief Counsel’s Office (CCO).

The CCO noted that I.R.C. §7605 bars the IRS from conducting more than a single inspection of a taxpayer’s books of account for a tax year to prevent an “unnecessary” examination or “unnecessary annoyance.” As noted above, existing caselaw does not prevent the IRS from auditing a later year based on a taxpayer’s transactions that originated from records that had been part of a prior audit.  However, the CCO concluded the taxpayer’s situation was different. Here, the CCO noted, the taxpayer had been previously examined and prevailed at the IRS Appeals Office level. The losses allowed in the prior years under examination were properly carried forward, and IRS was disallowing the NOL carryforward on the second audit for the same reason that the IRS Appeals Office had previously considered and ruled in the petitioner’s favor. The CCO determined that this amounted to a “second examination” or “repetitive audit” that I.R.C. §7605 barred. Had the NOL carryforward been disallowed for a different reason, the CCO noted, a second examination would have been proper. 

Conclusion

Almost 100 years ago, the Congress determined that taxpayers needed protection against abuses from the IRS.  That determination manifested itself in I.R.C. §7605(b) which was enacted within the first ten years of the creation of the tax Code.  But, whether or not the IRS can get a “second-bite” at the audit apple is highly fact-dependent. 

With the increased funding, if it stays in place, will certainly lead to increased audits.  There is some statutory protection, however, against IRS audit abuse.

October 23, 2022 in Income Tax | Permalink | Comments (0)

Thursday, October 6, 2022

More Ag Law Developments – Potpourri of Topics

Overview

The courts have continued to issue decisions of relevance to farmers, ranchers and rural landowners.  In today’s post, I take a look at some of them from around the country.  From property rights to income tax to bankruptcy to herbicide crop damage and landowners disputing over drainage – it’s covered below.

Court Says Public Has Right to Use Private Riverbeds

Adobe Whitewater Club of N.M. v. N.M. State Game Comm'n., No. S-1-SC-38195, 2022 N.M. LEXIS 34 (N.M. Sup. Ct. Sept. 1, 2022)

 The plaintiffs, various environmental and recreation groups, sued the New Mexico State Gaming Commission (Commission), claiming a regulation of the Commission violated the public’s right to use parts of New Mexico’s rivers.  In 2017, the Commission, promulgated a regulation that outlined a process for landowners to obtain a certificate allowing them to close public access to segments of public water flowing over private property.  The plaintiffs challenged the regulation as unconstitutional. Article XVI, Section 2 of the New Mexico state constitution states, “the unappropriated water of every natural stream, perennial or torrential, within the state of New Mexico, is hereby declared to belong to the public.” The issue was whether the public’s right to use the public waters included the right to use the privately owned waterbeds. The New Mexico Supreme Court determined that riverbeds were considered navigable waterways and were subject to the “public trust doctrine.”  The private landowners along the riverbed intervened in the lawsuit and claimed the public would be considered trespassers on their land and they could exclude the trespassers. The Court disagreed, finding that the public has the right to use private land when reasonably necessary to gain access to or enjoy public rivers. The Court stated, “A determination of navigability only goes to who has title to the bed below the public water, not to the scope of the public use.”  As such the court concluded that the public had access to such rivers to float, wade, fish and engage in other recreational activities that would have a minimal impact on the rights of private property owners.   In addition, the Court held that such waters are and always have been public.  Accordingly, the Court invalidated the Commission’s regulation. 

Retained Ownership of Minable Surface Negates Conservation Easement Deduction.

C.C.A. 202236010 (Sept. 9, 2022)

The Chief Counsel’s office of IRS has taken the position that a conservation easement donation is invalid if the donor owns both the surface estate of the land burdened by the easement as well as a qualified mineral interest that has never been separated from the surface estate, and the deed retains any possibility of surface mining to extract subsurface minerals.  In that instance, the conservation easement doesn’t satisfy I.R.C. §170(h).  The IRS said the result would be the same even if the donee would have to approve the surface-mining method because the donated easement would not be donated exclusively for conservation purposes in accordance with I.R.C. §170(h)(5).  The IRS pointed out that Treas. Reg. §1.170A-14(g)(4) states that a donated easement does not protect conservation purposes in perpetuity if any method of mining that is inconsistent with the particular conservation purposes of the contribution is permitted at any time.  But, the IRS pointed out that a deduction is allowed if the mining method at issue has a limited, localized impact on the real estate and does not destroy significant conservation interests in a manner that can’t be remedied.  Surface mining, however, is specifically prohibited where the ownership of the surface estate and the mineral interest has never been separated.  On the specific facts involved, the IRS determined that the donated easement would not be treated at being made exclusively for conservation purposes because the donee could approve surface mining of the donor’s subsurface minerals.  

Family Farms Not Part of Bankruptcy Estate.

Ries v. Archer (In re Archer), Nos. 17-20045-RLJ-7, 19-02001, 2022 Bankr. LEXIS 2250 (Bankr. N.D. Tex. Aug. 12, 2022)

A chapter 7 trustee sought a declaration that certain farm ground was a part of the bankrupt estate. The debtors, a married couple, had eight children, who all but one became medical doctors. The debtors had funded their children’s education throughout their lives with funds derived from the family farm. They owned 14 sections of land in Moore County, Texas, (northwest Texas) comprising what was referred to as the “Moore County Farm.”  Although, the deed from 1988 for the land listed the defendant’s children’s IRA as the grantee-buyer of the land, the children did not have IRAs at the time or played any part in purchasing the land. The children were not given any right to manage or operate the Moore County Farm so long as the debtors were mentally competent. Beginning in 1998, the USDA and CRP program began making payments to some of the defendant’s children and in 2007 farmers who rented land from the Moore County Farm began to pay some of the children. The children began to open accounts and lines of credit associated with the expenses of the Moore County Farm. From 2005 to 2017, the debtors instructed some of their children to apply as “New Producers” to the Federal Crop Insurance Program. Through this program they were provided with favorable crop insurance as “managers” of a farm, but none of the children had managerial control. Ultimately, the children were charged with and convicted of insurance fraud. Along with the 1988 deed, the debtors executed a warranty deed for the Moore County Farm to some of the children in 2006 and later transferred the farm to the children’s IRAs. In 2008, one of the defendant’s children purchased 670 acres in Randall County, referred to as the “Randall County Farm”. The debtors ultimately had primary authority and control of the farming operations of the Randall County Farm along with the Moore County Farm and had full control over the finances and accounting of the farms. The children did pay for some of the expenses on the Randall County Farm, but overall, the debtors operated the two farms as one entity.  There were no further legal issues until 2011 when one of the debtors’ cows was hit by a motorist who sustained serious injuries because of the accident and filed suit. The court awarded the man $8.95 million in damages to be paid by the debtors. The debtors then filed Chapter 7 bankruptcy. The bankruptcy court noted that the children had shared significant responsibilities over the Moore County Farm with their father and that their father wanted to pass the property to his children through the deeds. The court concluded that just because the debtors continued to run the farm did not mean they did not want to ultimately gift the land to the children. The bankruptcy trustee argued this was another scam set up by the family, but the court was not convinced given the common desire of parents to devise property to their children. The evidence showed that the debtors’ intent was for the children to own the farms and operate them for enjoyment.  Based on these considerations, the court concluded that the Moore County Farm was not part of the bankruptcy estate. The trustee claimed that the Randall County Farm should have been a part of the estate. Because one of the children who purchased the land negotiated a conservation plan with the USDA, received CRP payments, and paid for the farm expenses, the child was the true owner of the Randall County Farm and could not be considered part of the bankruptcy estate. 

FIFRA Doesn’t Preempt State-Based Warranty Claims

Kissan Berry Farm v. Whatcom Farmers Cooperative, et al., No. 82774-0-I, 2022 Wash. App. LEXIS 1766 (Wash. Ct. App. Sept. 6, 2022)

The plaintiffs, five state of Washington red raspberry farms, claimed that the use of herbicide Callisto in 2012 killed their berry plants causing more than $2.5 million in lost production for 2012 and two following crop years.  Callisto’s use was recommended by an agronomist working on behalf of. the defendant. Callisto’s maker, Syngenta was also named in the suit.  Callisto’s label stated that it was safe for use on red raspberries. The label also indicated that usage could result in some crop damage and that compensation for crop damage was limited to the price of the herbicide.  The plaintiffs asserted that Syngenta and the agronomist had made various warranties that Callisto was safe for use on red raspberries.  Syngenta’s position that the Federal Insecticide, Fungicide, and Rodenticide Act (FIFRA) preempted the farmers’ claims.  The trial court agreed on the basis that the plaintiffs’ claims would have required Syngenta to change the product label due to state law.  The appellate court reversed based on Bates v. Dow Agrosciences LLC, 544 U.S. 431 (2005). Under Bates, state law cannot require a change to a federally approved label, but state-based claims for breach of warranty are not preempted.   the Supreme Court found that a pesticide manufacturer who is found liable for state law breach of express warranty claims is not then induced to change their federally registered pesticide label.

Comparative Fault for Unmaintained Waterway

Watters v. Medinger, No. 21-1076, 2022 Iowa App. LEXIS 667 (Iowa Ct. App. Aug. 31, 2022)

The parties had been in various legal spats involving farmland for over a decade.  The plaintiff owned farmland adjacent to the defendant that contained waterways.  The plaintiff sued the defendant claiming the defendant altered his land in various ways causing extreme degradation and erosion along the plaintiff’s waterways.  The trial court determined that the plaintiff was contributorily negligent for failing to maintain or mow around the waterways, which allowed for ragweed to grow. The ragweed destroyed the grass along the waterway, which meant the water would flood quicker than it would have if grass could absorb some of the moisture. The trial court found that the defendant’s construction of a new cattle shed and addition of drain tiles did cause damage to the plaintiff’s property, but the at that time the plaintiff had already stopped properly maintaining the waterway. The trial court awarded the plaintiff $2,000 in damages to repair the damage caused by the erosion. The plaintiff appealed claiming that the damage award was insufficient.  The appellate court reviewed the plaintiff’s argument that the jury instruction was improper regarding comparative fault. The plaintiff tried to argue that he could not repair any part of the erosion until the drainage issues were solved. The appellate court held the plaintiff failed to address the failure to maintain the waterway before the draining issues arose. A farm tenant testified that the plaintiff’s property was already in “tough shape” before the defendant made any changes to his property. The appellate court held the comparative fault instruction was proper, because there was “a causal connection between the plaintiff’s fault and the claimed damages.”  Further, the appellate court held the award of damages was sufficient because the jury settled on an amount within the range of evidence based on expert testimony. Just because the amount was at the low end of the range did not mean the amount was insufficient. The appellate court affirmed the trial court’s decision to deny the plaintiff’s motion for a new trial.

Conclusion

Agricultural law and taxation is a very dynamic discipline.  There is never a dull moment -more fodder for my radio shows and TV interviews, and content for my books and seminars.

October 6, 2022 in Bankruptcy, Civil Liabilities, Environmental Law, Income Tax, Real Property, Water Law | Permalink | Comments (0)

Friday, September 30, 2022

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

Overview

Each year, by the end of September, the IRS provides guidance on the extension of the replacement period under I.R.C. §1033(e)(2)(B) for livestock sold on account of drought, flood or other weather-related condition.  The extended replacement period allows taxpayers additional time to replace the involuntarily converted livestock with like-kind replacement animals without triggering gain on the sale.  Significant parts of the Midwest and Great Plains in 2022 have experienced severe drought with many cattle being sold as a result.  That makes the tax rules surrounding distress sales of livestock critical to understand.

The IRS recently issued its 2022 guidance on the issue on the extended replacement period for drought (and other weather-related) sales of livestock.

Background

With Notice 2022-43, 2022-42, I.R.B., the IRS issued its annual Notice specifying those areas that are eligible for an extension of the replacement period for livestock that farmers and ranchers must sell because of severe weather conditions (drought, flood or other weather-related conditions).  For livestock owners in the listed areas that were anticipating that their replacement period would expire at the end of 2022 now have at least until the end of 2023 to replace the involuntarily converted livestock.

Involuntary Conversion Rules

In general.  I.R.C. §1033(e) provides that a taxpayer does not recognize gain when property is involuntarily converted and replaced with property that is similar or related in service or use.  Under I.R.C. §1033(e)(1), the sale or exchange of livestock that a taxpayer holds for draft, dairy or breeding purposes in an amount exceeding the number of livestock that the taxpayer would normally sell under the taxpayer’s usual business practice, is treated as a non-taxable involuntary conversion if the sale of the livestock is solely on account of drought, flood or other weather-related conditions. The weather-related conditions must result in the area being designated as eligible for assistance by the federal government. 

Note:   For purposes of this rule, poultry does not count as “livestock.”  Likewise, livestock raised for other purposes, such as slaughter or sport, are also not eligible for this relief.

The replacement period.  The livestock must be replaced with "like-kind" livestock. I.R.C. §1033(a)(1). Normally, the replacement period is four years from the close of the first tax year in which any part of the gain from the conversion is realized. I.R.C. §1033(e)(2)(A).  But the Treasury Secretary has discretion to extend the replacement period on a regional basis for “such additional time as the Secretary deems appropriate” (apparently without limit) if the weather-related conditions that resulted in the federal designation continue for more than three years.  I.R.C. §1033(e)(2)(B). If the IRS doesn’t extend the four-year replacement period, a taxpayer can request such an extension.  I.R.C. §1033(a)(2)(B)(ii). 

Note:  It is not clear when the three-year period begins.  It may begin on the date the area is designated as being eligible for assistance by the federal government or when the weather-related conditions begin.  IRS clarification is needed.

Note:  Any extension of the replacement period on a regional basis also extends the period in which a cash basis farmer may elect to defer gain for a year on the sale of excess livestock sold on account of weather-related conditions under I.R.C. §451(g). 

If the involuntary conversion of livestock is on account of drought and the taxpayer’s replacement period is determined under I.R.C. §1033(e)(2)(A), the extended replacement period under I.R.C. §1033(e)(2)(B) and Notice 2006-82, 2006-2 C.B. 529 is until the end of the taxpayer’s first taxable year after the first drought-free year for the applicable region.  That is defined as the first 12-month period that ends on August 31 in or after the last of the taxpayer’s four-year replacement period and does not include any weekly period for which exceptional, extreme or severe drought is reported for any location in the applicable region.  The “applicable region” is the county (and all contiguous counties) that experienced the drought conditions on account of which the livestock was sold or exchanged

Note:   If an area is designated as not having a drought-free year, the extended replacement period applies.

Thus, for a taxpayer who qualified for a four-year replacement period for livestock sold or exchanged on account of drought and whose replacement period is scheduled to expire at the end of 2022 (or, for a fiscal-year taxpayer, at the end of the first tax year that includes August 31, 2022), the replacement period extends until the end of the taxpayer’s first taxable year ending after a drought-free year for the applicable region.  In other words, eligible farmers and ranchers with a drought replacement period presently scheduled to expire on December 31, 2022, will now, in most instances, have until the end of their next tax year to replace the sold livestock (e.g., Dec. 31, 2023). 

Determining Eligible Locations

One way to determine if a taxpayer is in an area that has experienced exceptional, extreme or severe drought is to refer to the U.S. Drought Monitor maps that are produced on a weekly basis by the National Drought Mitigation Center  The U.S. Drought Monitor maps are archived at  https://droughtmonitor.unl.edu/Maps/MapArchive.aspx

Another way, of course, is to wait for the IRS to publish its list of counties, which it is required to issue by the end of September each year.

In accordance with the 2022 IRS Notice on the matter, the following is a list of the counties (and other areas) for which the 12-month period ending August 31, 2022, is not a drought-free year:

Alabama

Counties of Colbert and Lauderdale.

Alaska

Boroughs of Denali, Kenai Peninsula, and Matanuska-Susitna. Census area of Yukon-Koyukuk. Municipality of Anchorage.

Arizona

Counties of Apache, Cochise, Coconino, Graham, Greenlee, La Paz, Maricopa, Mohave, Navajo, Pima, Pinal, Santa Cruz, Yavapai, and Yuma.

Arkansas

Counties of Arkansas, Ashley, Baxter, Benton, Boone, Bradley, Calhoun, Carroll, Chicot, Clark, Clay, Cleburne, Cleveland, Columbia, Conway, Craighead, Crawford, Crittenden, Dallas, Desha, Drew, Faulkner, Franklin, Fulton, Garland, Grant, Greene, Hempstead, Hot Spring, Howard, Independence, Izard, Jackson, Jefferson, Johnson, Lafayette, Lawrence, Lee, Lincoln, Little River, Logan, Lonoke, Madison, Marion, Miller, Mississippi, Montgomery, Nevada, Newton, Ouachita, Perry, Phillips, Pike, Polk, Pope, Pulaski, Randolph, Saint Francis, Saline, Scott, Searcy, Sebastian, Sevier, Sharp, Stone, Union, Van Buren, Washington, White, and Yell.

California

Counties of Alameda, Alpine, Amador, Butte, Calaveras, Colusa, Contra Costa, Del Norte, El Dorado, Fresno, Glenn, Humboldt, Imperial, Inyo, Kern, Kings, Lake, Lassen, Los Angeles, Madera, Marin, Mariposa, Mendocino, Merced, Modoc, Mono, Monterey, Napa, Nevada, Orange, Placer, Plumas, Riverside, Sacramento, San Benito, San Bernardino, San Diego, San Francisco, San Joaquin, San Luis Obispo, San Mateo, Santa Barbara, Santa Clara, Santa Cruz, Shasta, Sierra, Siskiyou, Solano, Sonoma, Stanislaus, Sutter, Tehama, Trinity, Tulare, Tuolumne, Ventura, Yolo, and Yuba.

Colorado

Counties of Adams, Alamosa, Arapahoe, Archuleta, Baca, Bent, Boulder, Broomfield, Chaffee, Cheyenne, Clear Creek, Conejos, Costilla, Crowley, Custer, Delta, Denver, Dolores, Douglas, Eagle, Elbert, El Paso, Fremont, Garfield, Gilpin, Grand, Gunnison, Hinsdale, Huerfano, Jackson, Jefferson, Kiowa, Kit Carson, Lake, La Plata, Larimer, Las Animas, Lincoln, Logan, Mesa, Mineral, Moffat, Montezuma, Montrose, Morgan, Otero, Ouray, Park, Phillips, Pitkin, Prowers, Pueblo, Rio Blanco, Rio Grande, Routt, Saguache, San Juan, San Miguel, Sedgwick, Summit, Teller, Washington, Weld, and Yuma.

Connecticut

Counties of Fairfield, Hartford, Litchfield, Middlesex, New Haven, New London, Tolland, and Windham.

Florida

Counties of Alachua, Broward, Charlotte, Collier, DeSoto, Dixie, Gilchrist, Glades, Hendry, Lee, Levy, Martin, Okeechobee, Palm Beach, and Sarasota.

Georgia

Counties of Bryan, Bulloch, Chatham, Colquitt, Columbia, Dawson, Dougherty, Effingham, Elbert, Evans, Franklin, Gilmer, Hall, Hart, Liberty, Long, Lumpkin, McIntosh, Madison, Mitchell, Murray, Oglethorpe, Pickens, Tattnall, Tift, Turner, Wayne, and Worth.

Hawaii

Counties of Hawaii, Honolulu, Kalawao, Kauai, and Maui.

Idaho

Counties of Ada, Adams, Bannock, Bear Lake, Benewah, Bingham, Blaine, Boise, Bonner, Bonneville, Boundary, Butte, Camas, Canyon, Caribou, Cassia, Clark, Clearwater, Custer, Elmore, Franklin, Fremont, Gem, Gooding, Idaho, Jefferson, Jerome, Kootenai, Latah, Lemhi, Lewis, Lincoln, Madison, Minidoka, Nez Perce, Oneida, Owyhee, Payette, Power, Shoshone, Teton, Twin Falls, Valley, and Washington.

Illinois

Counties of Alexander, Boone, Carroll, Champaign, Coles, DeKalb, Douglas, Edgar, Jo Daviess, Kane, Lake, Lee, McHenry, Moultrie, Ogle, Piatt, Rock Island, Stephenson, Vermilion, Whiteside, and Winnebago.

Iowa

Counties of Adair, Adams, Appanoose, Benton, Black Hawk, Boone, Bremer, Buchanan, Buena Vista, Butler, Carroll, Cass, Cedar, Cerro Gordo, Cherokee, Clarke, Clay, Clinton, Crawford, Davis, Delaware, Des Moines, Dickinson, Dubuque, Emmet, Fayette, Floyd, Franklin, Greene, Grundy, Hamilton, Hancock, Hardin, Harrison, Henry, Humboldt, Ida, Iowa, Jackson, Jasper, Jefferson, Johnson, Jones, Keokuk, Kossuth, Lee, Linn, Lucas, Madison, Mahaska, Marion, Marshall, Monona, Monroe, Montgomery, O'Brien, Palo Alto, Plymouth, Pocahontas, Polk, Poweshiek, Sac, Scott, Sioux, Story, Tama, Union, Van Buren, Wapello, Warren, Washington, Webster, Woodbury, and Wright.

Kansas

Counties of Allen, Anderson, Barber, Barton, Bourbon, Butler, Chautauqua, Cherokee, Cheyenne, Clark, Clay, Cloud, Coffey, Comanche, Cowley, Crawford, Decatur, Dickinson, Edwards, Elk, Ellis, Ellsworth, Finney, Ford, Gove, Graham, Grant, Gray, Greeley, Greenwood, Hamilton, Harper, Harvey, Haskell, Hodgeman, Jewell, Kearny, Kingman, Kiowa, Labette, Lane, Lincoln, Logan, Lyon, McPherson, Marion, Marshall, Meade, Mitchell, Montgomery, Morton, Nemaha, Neosho, Ness, Norton, Osborne, Ottawa, Pawnee, Phillips, Pratt, Rawlins, Reno, Republic, Rice, Riley, Rooks, Rush, Russell, Saline, Scott, Sedgwick, Seward, Sheridan, Sherman, Smith, Stafford, Stanton, Stevens, Sumner, Thomas, Trego, Wallace, Washington, Wichita, Wilson, and Woodson.

Kentucky

Counties of Ballard, Breckinridge, Caldwell, Calloway, Carlisle, Christian, Edmonson, Fulton, Graves, Grayson, Hardin, Hart, Hickman, Livingston, Lyon, McCracken, Marshall, and Trigg.

Louisiana

Parishes of Acadia, Allen, Ascension, Assumption, Avoyelles, Beauregard, Bienville, Bossier, Caddo, Calcasieu, Caldwell, Cameron, Catahoula, Claiborne, Concordia, De Soto, East Baton Rouge, East Carroll, East Feliciana, Evangeline, Franklin, Grant, Iberia, Iberville, Jackson, Jefferson, Jefferson Davis, Lafayette, Lafourche, La Salle, Lincoln, Livingston, Madison, Morehouse, Natchitoches, Orleans, Ouachita, Plaquemines, Pointe Coupee, Rapides, Red River, Richland, Sabine, Saint Bernard, Saint Charles, Saint Helena, Saint James, Saint John the Baptist, Saint Landry, Saint Martin, Saint Mary, Tangipahoa, Tensas, Terrebonne, Union, Vermilion, Vernon, Washington, Webster, West Baton Rouge, West Carroll, West Feliciana, and Winn.

Maine

Counties of Androscoggin, Cumberland, Franklin, Hancock, Kennebec, Knox, Lincoln, Oxford, Piscataquis, Sagadahoc, Somerset, Waldo, and York.

Massachusetts

Counties of Barnstable, Berkshire, Bristol, Dukes, Essex, Franklin, Hampden, Hampshire, Middlesex, Norfolk, Plymouth, Suffolk, and Worcester.

Michigan

County of Gogebic.

Minnesota

Counties of Aitkin, Anoka, Becker, Beltrami, Benton, Big Stone, Blue Earth, Brown, Carlton, Carver, Cass, Clay, Clearwater, Cook, Cottonwood, Crow Wing, Dakota, Douglas, Faribault, Grant, Hennepin, Hubbard, Isanti, Itasca, Jackson, Kandiyohi, Kittson, Koochiching, Lac qui Parle, Lake, Lake of the Woods, Le Sueur, Lincoln, Lyon, McLeod, Mahnomen, Marshall, Martin, Meeker, Mille Lacs, Morrison, Murray, Nicollet, Norman, Otter Tail, Pennington, Pine, Pipestone, Polk, Pope, Ramsey, Red Lake, Redwood, Renville, Rice, Roseau, Saint Louis, Scott, Sherburne, Sibley, Stearns, Stevens, Todd, Wadena, Washington, Watonwan, Wilkin, Wright, and Yellow Medicine.

Mississippi

Counties of Adams, Alcorn, Amite, Attala, Benton, Bolivar, Calhoun, Carroll, Chickasaw, Claiborne, Clay, Coahoma, Copiah, DeSoto, Franklin, Grenada, Hinds, Holmes, Humphreys, Issaquena, Itawamba, Jefferson, Lafayette, Lawrence, Leake, Lee, Leflore, Lincoln, Madison, Marshall, Monroe, Montgomery, Pike, Pontotoc, Prentiss, Quitman, Sharkey, Sunflower, Tallahatchie, Tippah, Tishomingo, Tunica, Union, Warren, Washington, Wilkinson, and Yazoo.

Missouri

Counties of Barry, Barton, Boone, Butler, Camden, Carter, Cedar, Christian, Cole, Cooper, Crawford, Dade, Dallas, Dent, Douglas, Dunklin, Franklin, Gasconade, Greene, Hickory, Howard, Howell, Iron, Jackson, Jasper, Johnson, Laclede, Lafayette, Lawrence, McDonald, Maries, Miller, Mississippi, Moniteau, New Madrid, Newton, Oregon, Ozark, Pemiscot, Pettis, Phelps, Polk, Pulaski, Reynolds, Ripley, Saint Charles, Saint Clair, Saint Louis, Saline, Scott, Shannon, Stoddard, Stone, Taney, Texas, Vernon, Warren, Wayne, Webster, and Wright.

Montana

Counties of Beaverhead, Big Horn, Blaine, Broadwater, Carbon, Carter, Cascade, Chouteau, Custer, Daniels, Dawson, Deer Lodge, Fallon, Fergus, Flathead, Gallatin, Garfield, Glacier, Golden Valley, Granite, Hill, Jefferson, Judith Basin, Lake, Lewis and Clark, Liberty, Lincoln, McCone, Madison, Meagher, Mineral, Missoula, Musselshell, Park, Petroleum, Phillips, Pondera, Powder River, Powell, Prairie, Ravalli, Richland, Roosevelt, Rosebud, Sanders, Sheridan, Silver Bow, Stillwater, Sweet Grass, Teton, Toole, Treasure, Valley, Wheatland, Wibaux, and Yellowstone.

Nebraska

Counties of Adams, Antelope, Arthur, Banner, Blaine, Boone, Box Butte, Boyd, Brown, Buffalo, Burt, Butler, Cedar, Chase, Cherry, Cheyenne, Clay, Colfax, Cuming, Custer, Dakota, Dawes, Dawson, Deuel, Dixon, Dodge, Douglas, Dundy, Fillmore, Franklin, Frontier, Furnas, Gage, Garden, Garfield, Gosper, Greeley, Hall, Hamilton, Harlan, Hayes, Hitchcock, Holt, Hooker, Howard, Jefferson, Johnson, Kearney, Keith, Keya Paha, Kimball, Knox, Lancaster, Lincoln, Logan, Loup, McPherson, Madison, Merrick, Morrill, Nance, Nemaha, Nuckolls, Otoe, Pawnee, Perkins, Phelps, Pierce, Platte, Polk, Red Willow, Richardson, Rock, Saline, Saunders, Scotts Bluff, Seward, Sheridan, Sherman, Sioux, Stanton, Thayer, Thomas, Thurston, Valley, Washington, Wayne, Wheeler, and York.

Nevada

City of Carson City. Counties of Churchill, Clark, Douglas, Elko, Esmeralda, Eureka, Humboldt, Lander, Lincoln, Lyon, Mineral, Nye, Pershing, Storey, Washoe, and White Pine.

New Hampshire

Counties of Cheshire, Coos, Hillsborough, Merrimack, Rockingham, and Strafford.

New Jersey

Counties of Atlantic, Bergen, Cape May, Cumberland, Essex, Hudson, Hunterdon, Mercer, Middlesex, Monmouth, Morris, Passaic, Salem, Somerset, Sussex, and Union.

New Mexico

Counties of Bernalillo, Catron, Chaves, Cibola, Colfax, Curry, DeBaca, Dona Ana, Eddy, Grant, Guadalupe, Harding, Hidalgo, Lea, Lincoln, Los Alamos, Luna, McKinley, Mora, Otero, Quay, Rio Arriba, Roosevelt, Sandoval, San Juan, San Miguel, Santa Fe, Sierra, Socorro, Taos, Torrance, Union, and Valencia.

New York

Counties of Bronx, Columbia, Dutchess, Kings, Nassau, New York, Orange, Putnam, Queens, Richmond, Rockland, Suffolk, Ulster, and Westchester.

North Carolina

Counties of Alexander, Anson, Beaufort, Bertie, Bladen, Brunswick, Cabarrus, Camden, Carteret, Caswell, Catawba, Chatham, Chowan, Cleveland, Columbus, Craven, Cumberland, Currituck, Dare, Davidson, Davie, Duplin, Edgecombe, Gaston, Gates, Granville, Greene, Halifax, Harnett, Hertford, Hoke, Hyde, Iredell, Johnston, Jones, Lee, Lenoir, Lincoln, Martin, Mecklenburg, Montgomery, Moore, Nash, New Hanover, Northampton, Onslow, Pamlico, Pasquotank, Pender, Perquimans, Person, Pitt, Richmond, Robeson, Rowan, Sampson, Scotland, Stanly, Tyrrell, Union, Wake, Washington, Wayne, Wilkes, Wilson, and Yadkin.

North Dakota

Counties of Adams, Barnes, Benson, Billings, Bottineau, Bowman, Burke, Burleigh, Cass, Cavalier, Dickey, Divide, Dunn, Eddy, Emmons, Foster, Golden Valley, Grand Forks, Grant, Griggs, Hettinger, Kidder, LaMoure, Logan, McHenry, McIntosh, McKenzie, McLean, Mercer, Morton, Mountrail, Nelson, Oliver, Pembina, Pierce, Ramsey, Ransom, Renville, Richland, Rolette, Sargent, Sheridan, Sioux, Slope, Stark, Steele, Stutsman, Towner, Traill, Walsh, Ward, Wells, and Williams.

Oklahoma

Counties of Adair, Alfalfa, Atoka, Beaver, Beckham, Blaine, Bryan, Caddo, Canadian, Carter, Cherokee, Choctaw, Cimarron, Cleveland, Coal, Comanche, Cotton, Craig, Creek, Custer, Delaware, Dewey, Ellis, Garfield, Garvin, Grady, Grant, Greer, Harmon, Harper, Haskell, Hughes, Jackson, Jefferson, Johnston, Kay, Kingfisher, Kiowa, Latimer, Le Flore, Lincoln, Logan, Love, McClain, McCurtain, McIntosh, Major, Marshall, Mayes, Murray, Muskogee, Noble, Nowata, Okfuskee, Oklahoma, Okmulgee, Osage, Ottawa, Pawnee, Payne, Pittsburg, Pontotoc, Pottawatomie, Pushmataha, Roger Mills, Rogers, Seminole, Sequoyah, Stephens, Texas, Tillman, Tulsa, Wagoner, Washington, Washita, Woods, and Woodward.

Oregon

Counties of Baker, Benton, Clackamas, Clatsop, Columbia, Coos, Crook, Curry, Deschutes, Douglas, Gilliam, Grant, Harney, Hood River, Jackson, Jefferson, Josephine, Klamath, Lake, Lane, Lincoln, Linn, Malheur, Marion, Morrow, Multnomah, Polk, Sherman, Tillamook, Umatilla, Union, Wallowa, Wasco, Washington, Wheeler, and Yamhill.

Rhode Island

Counties of Bristol, Kent, Newport, Providence, and Washington.

South Carolina

Counties of Aiken, Allendale, Anderson, Beaufort, Berkeley, Calhoun, Cherokee, Chester, Chesterfield, Clarendon, Colleton, Darlington, Dillon, Edgefield, Fairfield, Florence, Georgetown, Hampton, Horry, Jasper, Kershaw, Lancaster, Lee, Lexington, McCormick, Marion, Marlboro, Newberry, Orangeburg, Richland, Saluda, Sumter, Union, Williamsburg, and York.

South Dakota

Counties of Aurora, Beadle, Bennett, Bon Homme, Brookings, Brown, Brule, Buffalo, Butte, Campbell, Charles Mix, Clay, Corson, Custer, Davison, Deuel, Dewey, Douglas, Edmunds, Fall River, Faulk, Grant, Gregory, Haakon, Hamlin, Hand, Hanson, Harding, Hughes, Hutchinson, Hyde, Jackson, Jerauld, Jones, Kingsbury, Lake, Lawrence, Lincoln, Lyman, McCook, McPherson, Meade, Mellette, Miner, Minnehaha, Moody, Oglala Lakota, Pennington, Perkins, Potter, Roberts, Sanborn, Spink, Stanley, Sully, Todd, Tripp, Turner, Union, Walworth, Yankton, and Ziebach.

Tennessee

Counties of Benton, Carroll, Chester, Crockett, Decatur, Dickson, Dyer, Fayette, Gibson, Hardeman, Hardin, Haywood, Henderson, Henry, Hickman, Houston, Humphreys, Lake, Lauderdale, McNairy, Madison, Maury, Montgomery, Obion, Shelby, Stewart, Tipton, Wayne, Weakley, and Williamson.

Texas

Counties of Anderson, Andrews, Angelina, Aransas, Archer, Armstrong, Atascosa, Austin, Bailey, Bandera, Bastrop, Baylor, Bee, Bell, Bexar, Blanco, Borden, Bosque, Bowie, Brazoria, Brazos, Brewster, Briscoe, Brooks, Brown, Burleson, Burnet, Caldwell, Calhoun, Callahan, Camp, Carson, Cass, Castro, Chambers, Cherokee, Childress, Clay, Cochran, Coke, Coleman, Collin, Collingsworth, Colorado, Comal, Comanche, Concho, Cooke, Coryell, Cottle, Crane, Crockett, Crosby, Culberson, Dallam, Dallas, Dawson, Deaf Smith, Delta, Denton, DeWitt, Dickens, Dimmit, Donley, Duval, Eastland, Ector, Edwards, Ellis, Erath, Falls, Fannin, Fayette, Fisher, Floyd, Foard, Fort Bend, Franklin, Freestone, Frio, Gaines, Galveston, Garza, Gillespie, Glasscock, Goliad, Gonzales, Gray, Grayson, Gregg, Grimes, Guadalupe, Hale, Hall, Hamilton, Hansford, Hardeman, Hardin, Harris, Harrison, Hartley, Haskell, Hays, Hemphill, Henderson, Hidalgo, Hill, Hockley, Hood, Hopkins, Houston, Howard, Hudspeth, Hunt, Hutchinson, Irion, Jack, Jackson, Jasper, Jeff Davis, Jefferson, Jim Hogg, Jim Wells, Johnson, Jones, Karnes, Kaufman, Kendall, Kenedy, Kent, Kerr, Kimble, King, Kinney, Kleberg, Knox, Lamar, Lamb, Lampasas, La Salle, Lavaca, Lee, Leon, Liberty, Limestone, Lipscomb, Live Oak, Llano, Loving, Lubbock, Lynn, McCulloch, McLennan, McMullen, Madison, Marion, Martin, Mason, Matagorda, Maverick, Medina, Menard, Midland, Milam, Mills, Mitchell, Montague, Montgomery, Moore, Morris, Motley, Nacogdoches, Navarro, Newton, Nolan, Nueces, Ochiltree, Oldham, Orange, Palo Pinto, Panola, Parker, Parmer, Pecos, Polk, Potter, Presidio, Rains, Randall, Reagan, Real, Red River, Reeves, Refugio, Roberts, Robertson, Rockwall, Runnels, Rusk, Sabine, San Augustine, San Jacinto, San Patricio, San Saba, Schleicher, Scurry, Shackelford, Shelby, Sherman, Smith, Somervell, Starr, Stephens, Sterling, Stonewall, Sutton, Swisher, Tarrant, Taylor, Terrell, Terry, Throckmorton, Titus, Tom Green, Travis, Trinity, Tyler, Upshur, Upton, Uvalde, Val Verde, Van Zandt, Victoria, Walker, Waller, Ward, Washington, Webb, Wharton, Wheeler, Wichita, Wilbarger, Willacy, Williamson, Wilson, Winkler, Wise, Wood, Yoakum, Young, Zapata, and Zavala.

Utah

Counties of Beaver, Box Elder, Cache, Carbon, Daggett, Davis, Duchesne, Emery, Garfield, Grand, Iron, Juab, Kane, Millard, Morgan, Piute, Rich, Salt Lake, San Juan, Sanpete, Sevier, Summit, Tooele, Uintah, Utah, Wasatch, Washington, Wayne, and Weber.

Vermont

County of Windham.

Virginia

Cities of Chesapeake, Danville, Suffolk, and Virginia Beach. Counties of Accomack, Charlotte, Halifax, Mecklenburg, Northampton, Pittsylvania, and Southampton.

Washington

Counties of Adams, Asotin, Benton, Chelan, Clark, Columbia, Cowlitz, Douglas, Ferry, Franklin, Garfield, Grant, Island, Kittitas, Klickitat, Lincoln, Okanogan, Pend Oreille, San Juan, Skagit, Skamania, Spokane, Stevens, Wahkiakum, Walla Walla, Whatcom, Whitman, and Yakima.

Wisconsin

Counties of Adams, Ashland, Bayfield, Columbia, Dane, Dodge, Douglas, Dunn, Fond du Lac, Grant, Green, Green Lake, Iron, Jefferson, Juneau, Kenosha, Lafayette, Marquette, Milwaukee, Pierce, Polk, Racine, Rock, Saint Croix, Sauk, Walworth, Waukesha, and Winnebago.

Wyoming

Counties of Albany, Big Horn, Campbell, Carbon, Converse, Crook, Fremont, Goshen, Hot Springs, Johnson, Laramie, Lincoln, Natrona, Niobrara, Park, Platte, Sheridan, Sublette, Sweetwater, Teton, Uinta, Washakie, and Weston.

Federated States of Micronesia

States of Chuuk and Pohnpei.

Republic of the Marshall Islands

Atolls of Ailinglaplap, Kwajalein, and Wotje.

Commonwealth of Puerto Rico

Municipalities of Aguas Buenas, Aibonito, Arecibo, Barranquitas, Canovanas, Carolina, Cayey, Ceiba, Cidra, Coamo, Comerio, Corozal, Fajardo, Guayama, Gurabo, Juncos, Las Piedras, Loiza, Luquillo, Naguabo, Naranjito, Orocovis, Ponce, Rio Grande, Salinas, San Juan, Santa Isabel, Trujillo Alto, and Villalba.

United States Virgin Islands

Islands of Saint Croix, Saint John, and Saint Thomas.

September 30, 2022 in Income Tax | Permalink | Comments (0)

Wednesday, September 14, 2022

Ag Law and Tax Developments

Overview

It’s been a while since I last did an case and ruling update. So, today’s post is one of several that I will post in the coming weeks. 

Some recent developments in the courts and IRS – it’s the topic of today’s post.

Retained Ownership of Minable Surface Negates Conservation Easement Deduction

C.C.A. 202236010 (Sept. 9, 2022)

The Chief Counsel’s office of IRS has taken the position that a conservation easement donation is invalid if the donor owns both the surface estate of the land burdened by the easement as well as a qualified mineral interest that has never been separated from the surface estate, and the deed retains any possibility of surface mining to extract subsurface minerals.  In that instance, the conservation easement doesn’t satisfy I.R.C. §170(h).  The IRS said the result would be the same even if the donee would have to approve the surface-mining method because the donated easement would not be donated exclusively for conservation purposes in accordance with I.R.C. §170(h)(5).  The IRS pointed out that Treas. Reg. §1.170A-14(g)(4) states that a donated easement does not protect conservation purposes in perpetuity if any method of mining that is inconsistent with the particular conservation purposes of the contribution is permitted at any time.  But, the IRS pointed out that a deduction is allowed if the mining method at issue has a limited, localized impact on the real estate and does not destroy significant conservation interests in a manner that can’t be remedied.  Surface mining, however, is specifically prohibited where the ownership of the surface estate and the mineral interest has never been separated.  On the specific facts involved, the IRS determined that the donated easement would not be treated at being made exclusively for conservation purposes because the donee could approve surface mining of the donor’s subsurface minerals.

Use of Pore Space Without Permission Unconstitutional

Northwest Landowners Association v. State, 2022 ND 150 (2022)

North Dakota law provides that a landowner’s subsurface pore space can be used for oil and gas waste without requiring the landowner’s permission or the payment of any compensation. The plaintiffs challenged the law as an unconstitutional taking under the Fourth and Fifth Amendments. The trial court held that the law was unconstitutional on its face and awarded attorney’s fees to the plaintiff.  On further review, the North Dakota Supreme Court determined that the plaintiffs had a property interest in subsurface pore space and that the section of the law specifying that the landowners did not have to provide consent to the trespassers to use the land unconstitutionally deprived them of their property rights as a per se taking.  However, the Supreme Court determined that the section of the law allowing oil and gas producers to inject carbon dioxide into subsurface pore space was constitutional.  The Supreme Court upheld the award of attorney fees. 

Net Operating Loss Couldn’t Be Carried Forward

Villanueva v. Comr., T.C. Memo. 2022-27

The petitioner sustained a loss from the disposition of a condominium he owned as a rental property. He reported the date of the loss as August 2013, but a mortgage lender had foreclosed on the condo in May 2009 and the taxpayer lost possession on that date. The IRS denied the deduction on the basis that the petitioner had not claimed the loss on either an original or amended return which meant that there was no loss that could be carried forward. The Tax Court agreed with the IRS, noting that the Treasury Regulations for I.R.C. §165 provide that a loss is treated as sustained during the tax year in which the loss occurs as evidenced by a closed and completed transaction and fixed by identifiable events occurring in such taxable year.  A loss resulting from a foreclosure sale is typically sustained in the year in which the property is disposed of, and the debt is discharged from the proceeds of the foreclosure sale.  Thus, the Tax Court determined that the loss had occurred in 2009 and should have been claimed at that time where it could have then been carried forward. 

Overtime Pay Rate Not Applicable to Construction Work on Farm

Vanegas v. Signet Builders, Inc., No. 21-2644, 2022 U.S. App. LEXIS 23206 (7th Cir. Aug. 19, 2022)

The plaintiff, the defendant’s employee, worked overtime in building a livestock fence for the defendant.  The defendant refused to pay the plaintiff time and a half for overtime. The plaintiff sued the defendant to recover the extra wages. The defendant’s refusal was based on the plaintiff being an agricultural worker not entitled to overtime.  The trial court agreed and dismissed the plaintiff’s claim.  The plaintiff appealed. The appellate court looked to the language of 29 U.S.C. § 213(b)(12) and the work of the plaintiff to determine if the plaintiff would be considered an agricultural employee. The appellate court found the plaintiff’s work was carried out as a separately organized activity outside of the defendant’s agricultural operations. The plaintiff worked for the defendant, but he built the fence on his own without any aid from any of the farm employees. The appellate court noted that another indication the work would not be considered exempt is whether farmers typically hire someone out for the work at issue. If so, it could be an indication the work is separate from agricultural work and would qualify for overtime pay. The appellate court found the defendant failed to provide much evidence to show that the plaintiff worked with agricultural employees and did not show the work was commonly done by a farmer. The appellate court also reasoned that just because the plaintiff was given a visa for agricultural work did not mean his work for the defendant was agricultural. The appellate court reversed the trial court’s decision to dismiss the complaint.

Early Distribution “Penalty” is a “Tax” and Does Not Require Supervisor Approval

Grajales v. Comr., No. 21-1420, 2022 U.S. App. LEXIS 23695 (4th Cir. Aug. 24, 2022), aff’g., 156 T.C. 55 (2021)     

The petitioner borrowed money from her pension account at age 42.  She received an IRS Form 1099-R reporting the gross distributions from the pension of $9,025.86 for 2015.  She didn’t report any of the amount as income in 2015.  The IRS issued her a notice of deficiency for $3,030.00 and an additional 10 percent penalty tax of $902.00.  The parties later stipulated to a taxable distribution of $908.62 and a penalty of $90.86.  The petitioner claimed that she was not liable for the additional penalty tax because the IRS failed to obtain written supervisory approval for levying it under I.R.C. §6751(b). The Tax Court determined that the additional 10 percent tax of I.R.C. §72(t) was a “tax” and not an IRS penalty that required supervisor approval before it would be levied.  The Tax Court noted that I.R.C. §72(t) specifically refers to it as a “tax” rather than a penalty and that other Code sections also refer to it as a tax.  The appellate court affirmed. 

U.S. Fish & Wildlife Service Can Regulate Ag Practices on Leased Land

Tulelake Irrigation Dist. v. United States Fish & Wildlife Serv., 40 F.4th 930 (9th Cir. 2022)

The plaintiffs sued the defendant, U.S. Fish and Wildlife Service, claiming the defendant violated environmental laws by regulating leased farmland in the Tule Lake and Klamath Refuge. The trial court granted summary judgment in favor of the defendant.  The plaintiff appealed.  The appellate court noted that the Kuchel Act and the Refuge Act allow the defendant to determine the proper land management practices to protect the waterfowl management of the area.  Under the Refuge Act, the defendant was required to issue an Environmental Impact Statement (EIS) and Comprehensive Conservation Plan (CCP). The defendant did issue an EIS and CCP for the Tule Lake and Klamath Refuge area, which included modifications to the agricultural use on the leased land within the region. The EIS/CCP required the leased lands to be flooded post-harvest, restricted some harvesting methods, and prohibited post-harvest field work, which the plaintiffs claimed violated their right to use the leased land. The plaintiffs argued that the language, “consistent with proper waterfowl management,” within the Kuchel Act was “nonrestrictive” and was not essential to the meaning of the Act. The appellate court held it was improper to read just that portion of the Act without considering the rest of the Act to understand the intent. The appellate court found the Kuchel Act was unambiguous and required the defendant to regulate the leased land to ensure proper waterfowl management. The Refuge Act allows the defendant to regulate the uses of the leased land, but the plaintiffs argued the agricultural practices were a “purpose” rather than a “use” so the defendant could not regulate it under the Refuge Act. The appellate court found the agriculture on the leased land was not a “purpose” equal to waterfowl management. The appellate court also held the language of the act was unambiguous and determined that agricultural activities on the land was to be considered a use that the defendant could regulate.   The appellate court affirmed the trial court’s award of summary judgment for the defendant.

Crop Salesman Sued for Ruining Relationship with Landowner

Walt Goodman Farms, Inc. v. Hogan Farms, LLC, No. 1:22-cv-01004-JDB-jay, 2022 U.S. Dist. LEXIS 134192 (W.D. Tenn. Jul. 28, 2022)

The plaintiff, a farm tenant, sued the defendant landlord and a third-party ag salesman.  The plaintiff claimed that the salesman wrongly advised the landlord and encouraged the landlord to complain about the plaintiff’s farming practices.  Specifically, the plaintiff’s claims against the salesman were for interference with contract, interference with business relationship, and fraud.  The salesman moved to dismiss each claim, but the trial court denied the motion with respect to the contract interference and interference with business relationship claims.  The trial court, however, dismissed the fraud claim involving the efficacy of corn seed.

Standard Default Interest Rate Not Unconscionable

Savibank v. Lancaster, No. 82880-1-I, 2022 Wash. App. LEXIS 1558 (Wash. Ct. App. Aug. 1, 2022)

The defendant obtained a loan from the plaintiff to purchase his father’s farm before the virus outbreak. The loan agreement stated that the interest rate would increase to 18 percent upon default. The defendant did default when the pandemic hit, and the plaintiff filed a foreclosure and repossession action against the plaintiff. The trial court ruled in favor the plaintiff. The defendant appealed and asserted the 18 percent default interest rate was unconscionable during a pandemic. During the appeal, the defendant claimed the plaintiff should have alerted the defendant to any better loan alternatives but failed to do so. The appellate court, affirmed, finding that the plaintiff had no contractual obligation to make the defendant aware of any better financing agreement.  The appellate court also upheld the trial court’s finding that the 18 percent default interest rate was not unconscionable and was common for agricultural loans with other banks in the area.  The appellate court also noted that the defendant had the opportunity to consult with a lawyer about the loan terms before signing.  The loan terms were standard and straightforward, and the defendant failed to show any evidence as to how the virus caused his default or how it made the default interest rate unconscionable.  In addition, the court noted that the defendant had stopped making loan payments before the virus began to impact the United States. The appellate court also held that the defendant failed to provide any evidence for an unconscionability defense. 

Conclusion

I’ll post additional developments in a subsequent post.

September 14, 2022 in Civil Liabilities, Income Tax, Real Property, Regulatory Law | Permalink | Comments (0)