Sunday, February 28, 2021

Ag Law and Taxation - 2019 Bibliography


Today's post is a bibliography of my ag law and tax blog articles of 2019.  Many of you have requested that I provide something like this to make it easier to find the articles, and last month I posted the bibliography of the 2020 articles.  Soon I will post the bibliography of the 2018 articles and then 2017 and 2016. 

The library of content is piling up.

Cataloging the 2019 ag law and tax blog articles - it's the topic of today's post.


Non-Dischargeable Debts in Bankruptcy

Developments in Agricultural Law and Taxation

More Recent Developments in Agricultural Law

More Ag Law and Tax Developments

Farmers, Bankruptcy and the “Absolute Priority” Rule

Ag in the Courtroom


Key Farm Bankruptcy Modification on the Horizon?

Ag Legal Issues in the Courts

Are Taxes Dischargeable in Bankruptcy?

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2019 


Can a State Tax a Trust with No Contact with the State?

Real Estate Professionals and Aggregation – The Passive Loss Rules  

More Recent Developments in Agricultural Law

Self-Rentals and the Passive Loss Rules    

What’s the Best Entity Structure for the Farm or Ranch Business?

Where Does Life Insurance Fit in an Estate Plan for a Farmer or Rancher?

Recent Developments in Farm and Ranch Business Planning

ESOPs and Ag Businesses – Part One

ESOPs and Ag Businesses – Part Two

Is a Discount for The BIG Tax Available?

Tax Consequences of Forgiving Installment Payment Debt

Ag Law and Tax in the Courts

Shareholder Loans and S Corporation Stock Basis

The Family Limited Partnership – Part One

The Family Limited Partnership – Part Two

Does the Sale of Farmland Trigger Net Investment Income Tax?

Some Thoughts on Ag Estate/Business/Succession Planning

S Corporation Considerations


When is an Employer Liable for the Conduct of Workers?

Selected Recent Cases Involving Agricultural Law

Ag Nuisances – Basic Principles

Do the Roundup Jury Verdicts Have Meaning For My Farming Operation?

What Does a “Reasonable Farmer” Know?

Product Liability Down on the Farm - Modifications

Coming-To-The-Nuisance By Staying Put – Or, When 200 Equals 8,000

More Ag Law and Tax Developments

Public Trust vs. Private Rights – Where’s the Line?

Ag Law in the Courts


Fence Law Basics



Negotiating Cell/Wireless Tower Agreements

Developments in Agricultural Law and Taxation

Ag Contracts – What if Goods Don’t Conform to the Contract?


Top 10 Developments in Ag Law and Tax for 2018 – Numbers 10 and 9

Top 10 Developments in Ag Law and Tax for 2018 – Numbers 8 and 7

Top Ten Agricultural Law and Tax Developments of 2018 – Numbers 6, 5, and 4

Top Ten Agricultural Law and Tax Developments of 2018 – Numbers 3, 2, and 1

Big EPA Developments – WOTUS and Advisory Committees

Does Soil Erosion Pose a Constitutional Issue?

Public Trust vs. Private Rights – Where’s the Line?

More Ag Law and Tax Developments

Eminent Domain and Agriculture

Court Decisions Illustrates USDA’s Swampbuster “Incompetence”

Regulatory Changes to the Endangered Species Act

Irrigation Return Flows and the Clean Water Act

Ag Law in the Courts


Regulatory Takings – Pursuing a Remedy

Does a Pollutant Discharge From Groundwater into a WOTUS Require a Federal Permit?

Groundwater Discharges of Pollutants and the Supreme Court

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2019


Tax Filing Season Update and Summer Seminar!

Time to Review Estate Planning Documents?

Can a State Tax a Trust with No Contact with the State?

Estate Planning in Second Marriage Situations

Valuing Non-Cash Charitable Gifts

Real Estate Professionals and Aggregation – The Passive Loss Rules

Can the IRS Collect Unpaid Estate Tax From the Beneficiaries?

Sale of the Personal Residence After Death

More Recent Developments in Agricultural Law

Thrills with Wills – When is a Will “Unduly Influenced”?

Heirs Liable for Unpaid Federal Estate Tax 28 Years After Death

What’s the Best Entity Structure for the Farm or Ranch Business?

Where Does Life Insurance Fit in an Estate Plan for a Farmer or Rancher?

Recent Developments in Farm and Ranch Business Planning

Wayfair Does Not Mean That a State Can Always Tax a Trust Beneficiary

ESOPs and Ag Businesses – Part One

Issues in Estate Planning – Agents, Promises, and Trustees

The Importance of Income Tax Basis “Step-Up” at Death

Ag Law in the Courts


Co-Tenancy or Joint Tenancy – Does it Really Matter?

Year-End Legislation Contains Tax Extenders, Repealers, and Modifications to Retirement Provisions


Top 10 Developments in Ag Law and Tax for 2018 – Numbers 10 and 9

Top Ten Agricultural Law and Tax Developments of 2018 – Numbers 6, 5, and 4

Top Ten Agricultural Law and Tax Developments of 2018 – Numbers 3, 2, and 1

Tax Filing Season Update and Summer Seminar!

QBID Final Regulations on Aggregation and Rents – The Meaning for Farm and Ranch Businesses

The QBID Final Regulations – The “Rest of the Story”

Can a State Tax a Trust with No Contact with the State?

Tax Matters – Where Are We Now?

New Developments on Exclusion of Employer-Provided Meals

Valuing Non-Cash Charitable Gifts

Passive Losses and Material Participation

Passive Losses and Real Estate Professionals

Developments in Agricultural Law and Taxation

Real Estate Professionals and Aggregation – The Passive Loss Rules

Sale of the Personal Residence After Death

Cost Segregation Study – Do You Need One for Your Farm?

Cost Segregation – Risk and Benefits

Permanent Conservation Easement Donation Transactions Find Their Way to the IRS “Dirty Dozen” List

Self-Rentals and the Passive Loss Rules

More on Self-Rentals


Of Black-Holes, Tax Refunds, and Statutory Construction

What Happened in Tax During Tax Season?

Cost Segregation and the Recapture Issue

S.E. Tax and Contract Production Income

Recent Developments in Farm and Ranch Business Planning

Ag Cooperatives and the QBID – Initial Guidance

Wayfair Does Not Mean That a State Can Always Tax a Trust Beneficiary

Start Me Up! – Tax Treatment of Start-Up Expenses

More on Real Estate Exchanges

2019 Tax Planning for Midwest/Great Plains Farmers and Ranchers

Tax Treatment of Settlements and Court Judgments

ESOPs and Ag Businesses – Part One 

Tax “Math” on Jury Verdicts

Kansas Revenue Department Takes Aggressive Position Against Remote Sellers

Tax-Deferred Exchanges and Conservation Easements

Proper Handling of Breeding Fees

Proper Tax Reporting of Commodity Wages

Tax Consequences of Forgiving Installment Payment Debt

Are Taxes Dischargeable in Bankruptcy?

Ag Law and Tax in the Courts

Refund Claim Relief Due to Financial Disability

Shareholder Loans and S Corporation Stock Basis

The Family Limited Partnership – Part Two

Hobby Losses Post-2017 and Pre-2026 – The Importance of Establishing a Profit Motive

The Importance of Income Tax Basis “Step-Up” at Death

Bad Debt Deduction


More on Cost Depletion – Bonus Payments

Recapture – A Dirty Word in the Tax Code Lingo

Does the Sale of Farmland Trigger Net Investment Income Tax?

Are Director Fees Subject to Self-Employment Tax?

Are Windbreaks Depreciable?

Tax Issues Associated with Restructuring Credit Lines

Is a Tenancy-in-Common Interest Eligible for Like-Kind Exchange Treatment?

Year-End Legislation Contains Tax Extenders, Repealers, and Modifications to Retirement Provisions

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2019


Prevented Planting Payments – Potential Legal Issues?

Ag Law in the Courts



 Negotiating Cell/Wireless Tower Agreements

Selected Recent Cases Involving Agricultural Law

The Accommodation Doctrine – More Court Action

Defects in Real Estate Deeds – Will Time Cure All?

Is there a Common-Law Right to Hunt (and Fish) Your Own Land?

Legal Issues Associated with Abandoned Railways

Public Trust vs. Private Rights – Where’s the Line?

Ag in the Courtroom


More on Real Estate Exchanges

How Does the Rule Against Perpetuities Apply in the Oil and Gas Context?

Ag Law in the Courts


Cost Depletion of Minerals

Co-Tenancy or Joint Tenancy – Does it Really Matter?

“Slip Slidin’ Away” – The Right of Lateral and Subjacent Support

Is a Tenancy-in-Common Interest Eligible for Like-Kind Exchange Treatment?


Top 10 Developments in Ag Law and Tax for 2018 – Numbers 10 and 9

Top Ten Agricultural Law and Tax Developments of 2018 – Numbers 6, 5, and 4

Top Ten Agricultural Law and Tax Developments of 2018 – Numbers 3, 2, and 1

Is There a Common-Law Right to Hunt (and Fish) Your Own Land?

Packers and Stockyards Act – Basic Provisions

Packers and Stockyards Act Provisions for Unpaid Cash Sellers of Livestock

More Recent Developments in Agricultural Law

Ag Antitrust – Is There a Crack in the Wall of the “Mighty-Mighty” (Illinois) Brick House?

Can Foreign Persons/Entities Own U.S. Agricultural Land?

Prevented Planting Payments – Potential Legal Issues?

Eminent Domain and Agriculture

Classification of Seasonal Ag Workers – Why It Matters

Administrative Agency Deference – Little Help for Ag From the Supreme Court

Regulation of Food Products

Ag Legal Issues in the Courts

Kansas Revenue Department Takes Aggressive Position Against Remote Sellers

Court Decision Illustrates USDA’s Swampbuster “Incompetence”

Ag Law and Tax in the Courts

Regulatory Takings – Pursuing a Remedy

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2019


Market Facilitation Program Pledged as Collateral – What are the Rights of a Lender?


Summer 2019 Farm and Ranch Tax and Estate/Business Planning Seminar

2019 National Ag Tax/Estate and Business Planning Conference in Steamboat Springs!

Summer Tax and Estate Planning Seminar!

2020 National Summer Ag Income Tax/Estate and Business Planning Seminar

Fall Seminars



The Accommodation Doctrine – More Court Action

Ag Legal Issues in the Courts

Ag Law in the Courts


Regulating Existing Water Rights – How Far Can State Government Go?

The Politics of Prior Appropriation – Is a Senior Right Really Senior?

Changing Water Right Usage

February 28, 2021 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)

Wednesday, February 10, 2021

Where’s the Line Between Start-Up Expenses, the Conduct of a Trade or Business and Profit Motive?


January 27’s article dealt with the deductibility of start-up costs.  You may read the post here:  In that article, I noted that start -up costs can be deducted by election in the year the business begins – at least to an extent.  Of course, businesses that are starting out often incur tax losses.  The business activity may eventually turn a profit, but how long can a business activity incur losses before the IRS says the business activity is really a hobby and denies loss deductibility.  Start-up expenses; whether a trade or business activity is involved; when when a business activity begins; and how long losses can be sustained and not be deemed to be a hobby – these are all intertwined issues for new business activities.  In addition, if an activity is deemed to be a hobby, the impact of the Tax Cuts and Jobs Act TCJA) for tax years beginning after 2017 is harsh.

Taking another look at tax issues encountered by many new business activities – it’s the topic of today’s post.

Tax Code Rules

For a business expense to be deductible, it generally must be “ordinary and necessary” or be an investment expense.    I.R.C. §§162; 212.  Investment-related deductions under I.R.C. §212 have largely been eliminated by the TCJA.  That puts the emphasis on deductions to be tied to a trade or business activity so that they can be deducted under I.R.C. §162.  The trade or business must be conducted with a profit intent.  If not, the activity is deemed to be a hobby and associated losses are “hobby losses.”

What is a “hobby”?  A “hobby” under the Code is defined in terms of what it is not.  I.R.C. §183.  A hobby activity is essentially defined as any activity that a taxpayer conducts other than those for which deductions are allowed for expenses incurred in carrying on a trade or business or producing income.  I.R.C. §§162; 212.  The determination of whether any particular activity is a hobby activity or not is based on the facts and circumstances of each situation.  It’s a highly subjective determination. 

But the Code provides a safe harbor.  I.R.C. §183(d).  Under the safe harbor, an activity that doesn’t involve horse racing, breeding or showing must show a profit for three of the last five years, ending with the tax year in question.  It’s two out of the last seven years for horse-related activities.  If the safe harbor is satisfied (either for horse activities or other activities, a presumption arises that the activity is not a hobby.  The safe harbor applies only for the third (or second) profitable year and all subsequent years within a five-year (or seven-year) safe-harbor period that begins with the first profitable year.  Treas. Reg. §1.183-1(c). 

What about losses in early years?  As noted above, the safe harbor applies only after a taxpayer incurs a third profitable year within the five-year testing period.  That means that only loss years arising after that time (and within the five-year period) are protected.   Losses incurred in the first several years are not protected under the safe harbor.  It makes no difference whether the activity turns a profit in later years.

Postponing the safe harbor.  It is possible to postpone the application of the safe harbor until the close of the fourth tax year (or sixth (for horse activities) after the tax year the activity begins.  I.R.C. §183(e).   This is accomplished by making an election via Form 5213 to allow losses incurred during the five-year period to be reported on Schedule C.  Thus, if the activity shows a profit for three or more of the five years, the activity is presumed to not be a hobby for the full five-year period.  The downside risk of the election occurs if the taxpayer fails to show a profit for at least three of the five years.  If that happens, a major tax deficiency could occur for all of the years involved.  Thus, filing Form 5213 should not be made without thoughtful consideration.  For example, while the election provides more time to establish that an activity is conducted with a profit intent, it will also put the IRS on notice that an activity may be conducted without a profit intent.  It also extends the statute of limitations for a tax deficiency (and refund claims) associated with the activity.  See, e.g., Wadlow v. Comr., 112 T.C. 247 (1999).    

The burden of proof.  Satisfaction of the safe harbor shifts the burden to prove that the activity is a hobby (i.e., lacks a profit motive) to the IRS.  That means that the IRS can rebut the for-profit presumption even if the safe harbor is satisfied – although it doesn’t tend to do so without extenuating circumstances.   If the presumption does not resolve the issue of whether a farm is being operated for pleasure or recreation and not as a commercial enterprise, a determination must be made as to whether the taxpayer was conducting the activity with the primary purpose and intention of realizing a profit. The expectation of profit need not be reasonable, but there must be an actual and honest profit objective. Whether the requisite intention to make a profit is present is determined by the facts and circumstances of each case with the burden of proof on the farmer or rancher attempting to deduct the losses. See, e.g., Ryberg v. Comm’r, T.C. Sum. Op. 2012-24. 

To assist in making this determination, the IRS has developed nine factors (which are contained in the Treasury Regulations) to be examined in determining whether the requisite profit motive exists.  Treas. Reg. § 1.183-2(b).  Those factors are: 1) the manner in which the taxpayer carries on the activity; 2) the taxpayer’s own expertise or the expertise of the taxpayer’s adviser(s); 3) the time and effort the taxpayer expends on the activity; 4) the expectation that assets used in the activity may appreciate in value; 5) the taxpayer’s success in carrying on similar activities; 6) the taxpayer’s history of income or loss with respect to the activity; 7) the amount of occasional profits, if any, from the activity; 8) the taxpayer’s financial status; and 9) whether there were any elements of personal pleasure or recreation that the taxpayer derived from the activity.     

Showing a Profit Intent - Recent Case

While the IRS is presently not aggressively auditing farming activities that it believes are not conducted with the requisite profit intent.  Just a few days ago, the Tax Court decided a hobby loss case where the taxpayer failed to clear the bar on showing a profit intent for the farming activity that he was attempting to start.

In Whatley v. Comr., T.C. Memo. 2021-11, the petitioner had retired from the banking industry.  Before he retired, in 2003 he purchased a 156-acre tract that had been a timber farm and cattle operation for 350,000.  134 acres of the tract was timber.  It was not an active timber or farming operation when he bought it, but was in the Conservation Reserve Program (CRP).  In 2004, he bought an additional 26 contiguous acres.  That tract had a new (built in 2000) home on it along with a barn and a small caretaker’s house.  On the advice of his long-time CPA, the petitioner created an LLC in 2004.  He owned 97 percent of the LLC, his wife was a one percent owner, and their children owned the balance.  He never transferred the land to the LLC.

For several years, he spent about 700 hours annually maintaining the property without any formal business plan.  There was no timber harvesting because of the land being in the CRP.  The petitioner would occasionally “thin” the trees to allow sunlight to get through to aid the growth of pine trees which would be harvested after many years of growth.  The petitioner testified that he had wanted to introduce cattle “from day one.”  He had consulted with two cattle experts for advice, but he couldn’t remember when the consultations had occurred or what he had learned from those experts.  In reality, however, the petitioner didn’t actually have cattle on the property until at least 2008 – soon after he learned that he was going to be audited.  He also testified that many of what he claimed to be cattle-related activities were really preparatory activities so that cattle could be on the property at some future date.  Those preparatory activities included the installation of fencing and barn repairs.

He ran the LLC very informally, keeping no traditional accounting records such as ledgers, balance sheets, income statements, or cashflow statements.  He didn’t expense the cost of insurance for the property and didn’t maintain a separate bank account or any separate banking records during the years at issue.   For those years, the petitioner filed Form 1065 (partnership return) stating that the LLC’s principal business activity was a “Farm” and the principal product or service was “Cattle.”  This was also how the activity was characterized on the petitioner’s Schedule F.  The petitioner’s tax returns were professionally prepared by the petitioner’s CPA even though the petitioner had a “cattle farm” with no cattle, and a “tree farm” with no timber.  He showed a tax loss from the property for tax years 2004-2008 on Schedule F, with the losses stemming largely from depreciation claimed on two buildings on the property.

The IRS notified the petitioner in early 2008 that it was going to audit the LLC for tax year 2005.  Upon receiving the audit notice, the petitioner put together a forest management plan and brought cattle to the property.  The IRS later expanded the audit to include tax years 2004 and 2006-2008. The IRS disallowed the losses on the basis that the petitioner’s activity on the land was not engaged in with a profit intent.  The IRS also disallowed a large charitable deduction for the petitioner’s deduction of a permanent conservation easement. 

The Tax Court agreed with the IRS, finding that all nine factors of the I.R.C. §183 regulations favored the IRS.   This was despite the Tax Court’s recognition that the facts suggested that the petitioner was attempting to transform the property into a viable farming business. 

TCJA Change

The TCJA suspends miscellaneous itemized deductions for years 2018-2025.  Thus, deductions for expenses from an activity that is determined to be a hobby are not allowed in any amount for that timeframe.  I.R.C. §67(g).  But all of the income from the activity must be recognized in adjusted gross income.  That’s painful, and it points out the importance of establishing the requisite profit intent. 


Hobby activities involving agricultural activities (especially those involving horses) have been on the IRS radar for quite some time.  That’s not expected to change.  It’s also an issue that some states are rather aggressive in policing.  See, e.g., Howard v. Department of Revenue, No. TC-MD 160377R, 2018 Ore. Tax LEXIS 35 (Ore. Tax Ct. Mar. 16, 2018); Feola v. Oregon Department of Revenue, No. TC-MD 160081N, 2018 Ore. Tax. LEXIS 48 (Ore. Tax. Ct. Mar. 27, 2018).  It’s also not an issue that the U.S. Supreme Court is likely to review if the taxpayer receives an unfavorable opinion at the U.S. Circuit Court of Appeals level.  See, e.g., Hylton v. Comr., T.C. Memo. 2016-234, aff’d., No. 17-1776, 2018 U.S. App. LEXIS 35001 (4th Cir. 2018), cert. den., No. 18-789, 2019 U.S. LEXIS 966 (U.S. Sup. Ct. Feb. 19, 2019).

Clearly, the petitioner’s CPA did Whatley did him no favors.  The tax planning and counsel was egregious.  Equally clear, however, was that the petitioner in Whatley was engaged in activities with the intent of ultimately conducting an operating farm.  But does that ultimate end-goal of an activity matter?  Given the nine-factor approach of the regulations, it appears that the IRS could swoop in with a well-timed audit and wipe out what would otherwise be legitimate business expenses.  Should a broader, more long-term view of new business activities be undertaken to evaluate whether a profit intent is present?  In other words, is there a better way to evaluate alleged hobby activities than the present nine-factor approach?  The U.S. Court of Appeals for the Seventh Circuit certainly thinks so.  In Roberts v. Comr., 820 F.3d 247 (7th Cir. 2016), the court called the nine-factor text “goofy” and took issue with start-up expenses being denied as hobby loss expenses.  The Whatley case is appealable to the Eleventh Circuit.

For now, the nine-factor test of the regulations is what is used to determined profit intent and whether the hobby loss rules apply.  As noted, at least one U.S. Circuit Court of Appeals is dissatisfied with the nine-factors.  Will another Circuit follow suit?  Only time will tell whether the nine-factor test has outlived its usefulness.

February 10, 2021 in Income Tax | Permalink | Comments (0)

Monday, February 8, 2021

C Corporate Tax Planning; Management Fees and Reasonable Compensation - A Roadmap of What Not to Do


A recent U.S. Tax Court decision is instructive on how carelessness in tax planning with respect to a C corporation can prove to be costly.  Maintaining detailed books and records; properly invoicing for services rendered to the corporation; carefully planning for and specifying how management fees are to be set and compensated; and paying reasonable compensation are all key components to how a C corporation should be operated.  But, when those aspects of C corporate operational life are not observed, a bad tax outcome is the result.  A recent U.S. Tax Court opinion makes that point clear.

Key aspects of operating a C corporation and the perils of sloppiness – it’s the focus of today’s post.

Corporate Deductions

Treas. Reg. §1.162-7(a) allows a deduction for ordinary and necessary business expenses that are paid or incurred in carrying on a trade or business. See also I.R.C. §162(a)(1).  This includes a reasonable allowance for salaries or other compensation for personal services that are actually rendered to the corporation. Treas. Reg. §1.162-7(a).  That’s a key point in the C (and S) corporation context – compensation must be “reasonable” to be deductible.  Management fees must meet also meet the ordinary and necessary test.  They are part of overall compensation and, overall, compensation must be reasonable – an amount that would typically be paid for similar services by similar businesses under similar circumstances.  The reasonableness test is applied on an individual-by-individual basis rather than whether, for instance, the total compensation to a group of shareholders is reasonable.  In addition, payment must be for actual services.  It must not be a distribution to the shareholders that is disguised as deductible compensation. 

Deducting management fees.  The issue of whether compensation is deductible as payment for services rendered to the corporation is a particular sticky one when the corporation doesn’t have very many shareholders.  In that instance, the courts tend to view the situation lending itself to a greater probability that there is a lack of bargaining at arms’ length between the employees (e.g., shareholders) and the corporate board.  The tendency, at least in the view of the IRS is that “management fees” are not really paid purely for services rendered to the corporation. But, the analysis is based on a facts and circumstances test containing multiple factors – the corporation’s history of distributions to the holders of the corporate equity; whether the management fee paid to a shareholder is proportional to that shareholder’s percentage interest in the corporation; whether the services performed were via the shareholder’s controlled entity and the fee was paid to the shareholder; whether the management fee was negotiated at the beginning of the tax year and paid throughout the year as services were performed; the level of corporate taxable income after deducting management fees that were paid out; whether there was a structure in place for determining the level of management fees.

Recent Tax Court Case

In Aspro, Inc. v. Comr., T.C. Memo. 2021-8, the petitioner was a C corporation in the asphalt paving business incorporated under Iowa law with its principal place of business in Iowa.  The petitioner had three shareholders and did not declare or distribute any dividends to them during the tax years in issue (2012-2014) or in any prior year.  This was despite the petitioner having significant profits before setting management fees.  Thus, the shareholders didn’t receive any return on their equity investment.  The petitioner did not enter into any written management or consulting services agreements with any of its shareholders. Also, there was no management fee rate or billing structure negotiated or agreed to between the shareholders and the petitioner at the beginning of any of the years in issue. 

None of the shareholders invoiced or billed the petitioner for any services provided indirectly via other legal entities that the shareholders controlled. Instead, the petitioner’s Board of Directors would approve the management fees to be paid to the shareholders at a board meeting later in the tax year, when the Board had a better idea how the company was going to perform and how much earnings the company should retain.  However, the Board minutes did not reflect how the determinations were made.  The Board did not attempt to value or quantify any of the services performed on its behalf and simply approved a lump-sum management fee for each shareholder for each year. The amounts were not determined after considering the services performed and their values. There was no correlation between management fees paid and services rendered. In total, the shareholders received management fees exceeding $1 million every year for the years in issue. The management fees were simply paid after-the-fact in an attempt to zero-out the petitioner’s taxable income.

The IRS completely denied the petitioner’s claimed deductions for management fees (and amounts the petitioner claimed for the domestic production activities deduction) for the years in issue.  The Tax Court upheld the IRS position denying the deductions. 

The Tax Court determined that the petitioner failed to prove that the management fees were ordinary and necessary business expenses and reasonable in accordance with Treas. Reg. §1.162-7.  Based on the facts and circumstances, the Tax Court concluded that the absence of the dividend payments where the petitioner had available profits created an inference that at least some of the compensation represented a distribution with respect to corporate stock.  While the management fees loosely corresponded to each shareholder’s percentage interest, the Tax Court inferred that the shareholders were receiving disguised distributions based on each shareholder’s equity interest. 

As for the services rendered to the corporation via the shareholders’ controlled entities, the Tax Court noted that if the services were to be compensated, the petitioner should have invoiced directly for the services.  The services, as a result, did not provide even indirect support for the management fees the petitioner paid to its shareholders. 

The Tax Court also noted that the management fees were not established in advance for services to be provided and there was no management agreement that evidenced any type of arms’ length negotiation to support a fee structure that the parties bargained for.  The shareholders also could not explain how the management fees were determined, and the corporate President (and one of petitioner’s Board members) displayed a misunderstanding of the nature of deductible management fees and stock distributions. 

The Tax Court also pointed out that the effect of the deduction for management fees was to create little taxable income to the petitioner.  That, the Tax Court believed, indicated that the fees were disguised distributions.  The Tax Court further determined that the petitioner’s President rendered no services to the petitioner other than being the president and, as such was already overcompensated by his base salary and bonus totaling approximately $500,000 annually.  Thus, the additional management fee was completely unreasonable as to him. 

Reasonable Compensation

As noted above, to be deductible, compensation in the corporate context must be “reasonable.”  For starters, that means that the corporation must establish the connection between the services that are performed and the compensation (including management fees) that are paid.  In AsPro, Inc., the corporation didn’t meet that burden.  In Aspro, Inc., the Tax Court looked at numerous factors to determine reasonableness – the employee’s qualifications; the work performed for the corporation; the size of the corporation and the complexity of business operations; how salaries compare to corporate gross and net income; general economic conditions in the corporation’s industry; how compensation to the shareholders stacked-up against corporate distributions to those same shareholders; whether the compensation packages for the shareholders was comparable positions in similar businesses; overall salary policy; and past compensation history. 

The Tax Court also noted that some of the U.S. Circuit Courts of Appeal don’t analyze the issue of reasonable compensation based on multiple factors, but rather the amount of compensation an independent investor would pay.  The Circuit Court to which Aspro Inc. would be appealable has not settled on the approach it would use to determine reasonable compensation in the corporate context.


The Aspro, Inc. case is a textbook roadmap case of how to screw up C corporate tax planning.  There was no detailed, thought-out plan backing up the management fees, no clarity or documentation of what services were rendered and how frequently they were rendered, and no substantiation of whether the services were necessary to be paid for in the petitioner’s industry.  There was no management agreement that listed the services to be provided by each contracting party, and no documentation of the level of pay for those services. 

The complete lack of planning and associated documentation in Aspro, Inc. resulted in a tax bill exceeding $1.5 million, plus interest.

Truly a roadmap for disaster.

February 8, 2021 in Business Planning, Income Tax | Permalink | Comments (0)

Monday, February 1, 2021

What Now? – Part One


The title of today’s article seems to be on the minds of many farmers and ranchers in recent days with the beginning of a new Congress and the inauguration of Joe Biden.  I have had many emails, phone calls and conferences with farm families recently that are asking what the impact of tax changes on their businesses and livelihoods might be.  Are structural changes in the form of the farming business required?  Should existing estate plans be reviewed?  What income tax moves should be made?  Should capital assets be sold now?  These are important questions.

Today’s article is Part One of a two-part series on tax changes that might be forthcoming soon and what the changes could mean.  Today, I take a look at possible changes in the income tax world.  In Part Two later this week, I will examine what might happen on the estate planning side of the equation.

Federal Income Taxation Possible Changes

While there is no definite proposed tax bill(s) yet, and no detailed articulation of possible tax legislation has clearly been offered, there were things that candidate-Biden’s people placed on his website before the election. 

Increase in the maximum ordinary and capital gain tax rates.  It now appears possible that the top individual federal income tax rate on ordinary income (as well as net short-term capital gains) could return to a 39.6 percent rate, up from the present 37 percent rate.  Comments were also made that rates on individuals with income (taxable?) above $400,000 would also be increased.  If true, then a married couple filing jointly that is presently in the 32 percent bracket could see a rate increase.  But, again, it’s not clear whether the $400,000 figure is for a married couple filing jointly or for a single person, or whether the threshold refers to gross or taxable income. 

Itemized deductions.  There are a couple of key possibilities to watch with respect to itemized deductions.  Starting in 2018, many itemized deductions were eliminated but, in return, the standard deduction was essentially doubled.  For lower-income individuals this represented a major tax break and tax simplification.  Now, a new policy may reduce the standard deduction to prior levels with a restoration of itemized deductions (for taxpayers that itemize deductions).  The tax benefit of itemized deductions (including charitable deductions and those stemming from a contribution to a pension plan) would appear to be limited to 28 percent for higher-income taxpayers (however that is defined).  Thus, a dollar of itemized deduction would only cut the tax bill by $.28.  A taxpayer in a tax bracket higher than 28 percent would not see a benefit of an itemized deduction any greater than 28 percent on the dollar. 

The so-called “Pease limitation” was repealed for tax years beginning after 2017.  It operated as a “stealth” tax on higher-income taxpayers.  Before it was repealed, it reduced the value of a taxpayer’s itemized deductions by three percent for every dollar of taxable income above a certain threshold – effectively increasing the taxpayer’s marginal tax rate.  The “buzz” is that the Pease limitation would be put back in place. 

As a hat-tip to taxpayers (e.g., voters) in the high-tax states such as California, Illinois and New York, a pre-election policy position indicates that the limit on the deduction for state and local taxes would be removed.  This would be a significant benefit for higher income taxpayers.    

Capital gains.  It is likely that a legislative push will be made to increase the capital gain rates on higher-income individuals.  The present top rate on long-term capital gains is 20 percent.  Thanks to a provision included in Obamacare (adding I.R.C. §1411) that 20 percent rate jumps to 23.8 percent if the gain is passive for married taxpayers filing jointly with modified adjusted gross income exceeding $250,000 ($200,000 for a single filer).   It appears likely that a legislative proposal will include a provision taxing net long-term gains and dividends at the ordinary income rate for taxpayers with income (taxable?) over $1 million.  If the gain is passive, the effective rate would jump to a combined 43.4 percent.  That would amount to a tax increase of 82.4 percent on such gains. 

Observation.  Coupled with state-level taxation of capital gains, the effective rate could exceed 50 percent. 

If capital gain rates increase, that could create a greater incentive to use charitable remainder trusts (CRT).  A CRT is funded by the transfer of property from the donor.  There is no tax on the transfer of the property to the CRT.  The CRT then sells the property tax-free and uses the proceeds to annually pay the beneficiary (typically the donor) a percentage of the market value of the trust. The annual distribution comes first from the trust’s net income and then from principal. The distributions to a non-charitable beneficiary are taxable annually as ordinary income to the extent there is net income to the CRT. The remainder of the distribution is taxable as capital gain to the extent there is accumulated short and long-term capital gain to the CRT calculated using the donor’s carryover tax basis. If the distributions to the beneficiary are larger than the net income and accumulated capital gain of the CRT, the difference is not taxable to the beneficiary.  If a “net income with make-up provisions” CRT is used, it might be possible to delay distributions to a time (up to 20 years) when capital gain and ordinary tax rates are lower.  But, of course, future rates are unknown. 

An intentionally non-grantor trust might also be advisable to avoid an increase in the capital gains tax as well as state income tax (except for New York).  These trusts are very complex and usually work well for large estates in tandem with the high-level (currently) of the federal estate tax exemption.  They became popular after the tax changes that went into effect for tax years beginning after 2017, but could still have merit to avoid a higher capital gains rate and state income tax.   

Self-employment tax.  Presently, for 2021, an employee pays a combined rate of 7.65 percent for Social Security and Medicare.  The OASDI portion is 6.2 percent on earnings up to $142,800.  The Medicare portion (hospitalization insurance) is 1.45 percent on all earnings.  The rate for self-employed persons is the full combined 15.3 percent up to the $142,800 base.  Also, persons with earned income over $200,000 ($250,000 for MFJ) pay an additional 0.9 percent in Medicare taxes due to another provision in included in Obamacare. Thus, for a self-employed person, the rate is 2.9 percent from $142,800 to $200,000 ($250,000 mfj) and then 3.8 percent above those thresholds.

What looks likely to be proposed is that the 12.4 percent OASDI portion would apply to wages and net self-employment income in excess of $400,000.  Whether this is in addition to the existing 3.8 percent tax on incomes at this level or would be the total percentage amount is not clear. 

Observation.  Clearly, if these self-employment tax changes occur, it will incentivize the creation of or conversion of existing entities to S corporations.  Doing so will allow some of the earnings to be received in the form of a salary (subject to self-employment tax) with the balance taken as S corporation dividends (not subject to self-employment tax).  The salary must approximate “reasonable compensation” (I have written a blog article on that issue in the past), but utilizing an S corporation is a good technique (as a rule of thumb) when at least $10,000 of self-employment tax savings can be achieved over other entity forms (including a sole proprietorship).  One concern, of course, would be if the Congress were to eliminate the self-employment tax savings of an S corporation for businesses that provide personal services.

Credits.  One possible proposal is an increase in the child tax credit to $4,000 for a qualifying child ($8,000 for two or more qualifying children).  Apparently, the credit would remain refundable and would start phasing out at income levels above $125,000.  A new credit (refundable?) could be proposed for certain caregivers.

Eligible first-time homebuyers might receive a refundable tax credit of up to $15,000 upon the purchase of a home.  Low-income renters could see a refundable tax credit designed to reduce the cost of rent and associated utilities to no more than 30 percent of monthly income.  Such a provision would be a variation of state-level tax credits for tenants of residential properties that exist in about half of the states.

Other credits can be anticipated to benefit less efficient and more costly forms of energy, while simultaneously reducing or eliminating standard business deductions for the oil and gas industry. 

Real estate-related activities.  What I have seen are discussions about: (1) eliminating the $25,000 deduction for losses related to real estate activities where the taxpayer actively participates in the activity but falls short of material participation (I.R.C. §469(i)): (2) eliminating the like-kind exchange rules for real estate trades; slowing down depreciation for certain types of business property; and eliminating the 20 percent qualified business income deduction of I.R.C. §199A for rental real estate activities. Related to this last point, there are rumblings that the I.R.C. §199A deduction could be eliminated in its entirety.  For many small businesses, that would amount to a effective tax rate increase ranging between three and five percent.

Convert to a Roth? Should a taxpayer move funds from a traditional IRA to a Roth?  The answer, as is the case with many tax-related questions, is that it “depends.”  If tax rates are expected to be higher in the future, it may make tax-sense to make the conversion and pay the tax on the conversion at what is anticipated to be now-lower rates.  But other considerations should be made.  What about the impact of state-level taxes?  What about the impact of the loss of ability to stretch the payout with respect to certain beneficiaries?  Will there be an impact on various ways to offset income with a Roth, such as charitable donations?  Will Medicare premiums be impacted?  What happens if Social Security benefits have already started to be received?  These are some of the considerations that need to be made when considering converting a traditional IRA to a Roth. 

Corporate tax.  It is likely that a legislative tax proposal will increase the corporate tax rate by 33 percent, from its present 21 percent to 28 percent, and restore the alternative minimum tax on corporations above a threshold of annual income.      

Retroactive Tax Increase?

If and when tax changes occur, when will they be effective?  Retroactive tax changes create complexity, but can be legal.  As for complexity, estimated taxes and withholding are based on the law in existence at the time of payment.  If the law changes retroactively, those “pre-paid” taxes now must be recomputed.  To be legal, a retroactive tax law change can satisfy the constitutional due process requirement if it is rationally related to a legitimate purpose of government.  Given the enormous amount of spending that the Congress engaged in during 2020 to deal with the economic chaos, a "legitimate purpose" could be couched in terms of the “need” to raise revenue.  See, e.g., Pension Benefit Guaranty Corporation v. R.A. Gray & Co., 467 U.S. 717 (1984); United States v. Carlton, 512 U.S. 26 (1994); In re Fifield, No. 04-10867, 2005 Bankr. LEXIS 1210 (Bankr. D. Vt. Jun. 20, 2005).  That’s even though historic data indicate that government revenues don’t necessarily increase in the long-term from tax increases.

Of course, tax changes that occur on either a retroactive or date of enactment basis make planning impossible. 


In Part Two, I will turn my attention to what might happen on the estate planning front.

February 1, 2021 in Income Tax | Permalink | Comments (0)

Wednesday, January 27, 2021

Deducting Start-Up Costs – When Does the Business Activity Begin?


One effect of the virus of 2020 is that it has spurred business start-ups by people attempting to generate income in new ways and with new methods.  That raises an important tax question - when beginning a business, what expenses are deductible?  That’s an interesting question not unlike the “chicken and the egg” dilemma.  Which came first – the business or the expense?  To have deductible business expenses, there must be a business.  When did the business begin?  That’s a key determination in properly deducting business-related expenses. 

Deducting costs associated with starting a business – it's the topic of today’s post.

Categorization – In General

The Code allows deductions for various expenses that are related to a taxpayer’s investments that don’t amount to a business if the expenses are ordinary and necessary for the production or collection of income or are for the management, conservation or maintenance of property held for the production of income. I.R.C. §212.

Once the business begins, all of the ordinary and necessary expenses of operating the business (on a basis that is regular, continuous and substantial) that are paid or incurred during the tax year are deductible. I.R.C. §162.  But, business start-up costs are handled differentlyI.R.C. §195.

Start-Up Costs

I.R.C. §195(a) generally precludes taxpayers from deducting startup expenditures.  However, by election, a taxpayer can deduct business start-up expenses on the return for the year that the business begins. I.R.C. §195(b).  The election is irrevocable.  Treas. Reg. §1.195-1(b).  The deduction is the lesser of the amount of start-up expenses for the active trade or business, or $5,000 reduced (but not below zero) by the amount by which the start-up expenses exceed $50,000.  I.R.C. §195(b)(1)(A); I.R.C. §195(b)(1)(A)(i).  Once the election is made, the balance of start-up expenses is deducted ratably over 180 months beginning with the month in which the active trade or business begins.   I.R.C. §195(b)(1)(B); Treas. Reg. §1.195-1(a).  This all means that in the tax year in which the taxpayer’s active trade or business begins, the taxpayer can deduct the $5,000 amount (if that’s the lesser of, etc.) and the ratable portion of any excess start-up costs. 

The election is normally made on a timely filed return for the tax year in which the active trade or business begins.  However, if the return that year was timely filed without the election, the election can be made on an amended return that is filed within six months of the due date for the return (excluding extensions).  The amended return should clearly indicate that the election is being made and should state, “Filed pursuant to section 301.9100-2” at the top of the amended return.  Without the election, the start-up costs should be capitalized. 

What are start-up expenses?  Amounts paid or incurred in connection with creating an active trade or business are startup expenditures. I.R.C. §195(c). More specifically, start-up costs are amounts that the taxpayer pays or incurs for: investigating the creation or acquisition of an active trade or business; creating an active trade or business; or activities that the taxpayer engages in for profit and for the production of income before that day on which the active trade or business begins, in anticipation of the activities becoming an active trade or business, and which would be deductible in the year paid or incurred if in connection with an active trade or business.  I.R.C. §§195(c)(1)(A)(i-iii); 195(c)(1)(B).  Common types of start-up expenses include advertising costs; salaries and wages; and expenses related to travel.  See, e.g., IRS Field Service Advice 789 (1993).  But, interest expense, state and local taxes, and research and experimental expenses are not start-up expenses.  I.R.C. §195(c)(1). 

Start-up expenses are limited to expenses that are capital in nature rather than ordinary.  That’s an important point because it means that I.R.C. §195 does not bar the deductibility of ordinary and necessary expenses a taxpayer incurs in an ongoing activity for the production of income under I.R.C. §212.  In addition, it makes no difference that the activity is later transformed into a trade or business activity under I.R.C. §162.  For example, in Toth v. Comr., 128 T.C. 1 (2007), the taxpayer started operating a horse boarding and training facility for profit in 1998.  The activity showed modest profit the first few years, but had really taken off by 2004.  For 1998 and 2001, the taxpayer claimed expenses from the activity on Schedule C as ordinary and necessary business expenses deductible in accordance with I.R.C. §162, but she later determined that the expenses should be deducted in accordance with I.R.C. §212 as miscellaneous itemized deduction on Schedule A (which are presently suspended through 2025).  However, the IRS took the position that the taxpayer anticipated that the horse activity would become an active trade or business and, as such, her expenses had to be capitalized under I.R.C. §195.  The Tax Court agreed with the taxpayer.  Start-up expenses, the Tax Court said, were capital in nature rather than ordinary.  Thus, once her income producing activity began her expense deductions were not barred by I.R.C. §195.  It didn’t matter that the activity later became a trade or business activity under I.R.C. §162

When does the business begin?  A taxpayer cannot deduct or amortize startup expenditures if the activities to which the expenditures relate fail to become an “active trade or business.”  See I.R.C. §§195(a), (c).  There are no regulations that help define when a trade or business begins, so the question is answered based on the facts and circumstances of a particular situation.   To be engaged in a trade or business, a taxpayer must: (1) undertake an activity intending to make a profit, (2) be regularly and actively involved in the activity, and (3) actually have commenced business operations.  See, e.g., McManus v. Comr., T.C. Memo. 1987-457, aff’d., 865 F.2d 255 (4th Cir. 1988).  In addition, the courts have held that a taxpayer is not engaged in a trade or business “until such time as the business has begun to function as a going concern and performed those activities for which it was organized.” Richmond Television Corp. v. United States, 345 F.2d 901, 907 (4th Cir. 1965), vacated and remanded on other grounds, 382 U.S. 68 (1965). Likewise, an activity doesn’t have to generate sales or other revenue for the business to be deemed to have begun.  Cabintaxi Corp. v. Commissioner, 63 F.3d 614, 620 (7th Cir. 1995), aff’g., in part, rev’g. in part, and remanding T.C. Memo. 1994-316; Jackson v. Commissioner, 864 F.2d 1521, 1526 (10th Cir. 1989), aff’g., 86 T.C. 492 (1986). However, merely researching or investigating a potential business is not enough.  Dean v. Commissioner, 56 T.C. 895, 902-903 (1971).

Two Tax Court Cases

Recently, the U.S. Tax Court has decided two cases involving the deductibility of start-up costs.  In Smith v. Comr., T.C. Sum. Op 2019-12, the Tax Court dealt with I.R.C. §195 and the issue of when the taxpayer’s business began.  The Tax Court was convinced that the petitioner had started his vegan food exporting business, noting that the petitioner had been peddling his vegan food products in Jamaica, the Dominican Republic, Brazil Argentina and Columbia.  However, he was having trouble getting shelf space.  Thus, for the tax year at issue, he showed expenses associated with the activity of about $41,000 and gross sales of slightly over $2,000.   The IRS largely disallowed the Schedule C expenses due to lack of documentation and tacked on an accuracy-related penalty.  After issuing the statutory notice of deficiency, the IRS said the expenses were not deductible because they were start-up expenditures.  Because IRS raised the I.R.C. §195 issue at trial, the IRS bore the burden of proof on the issue.  The Tax Court determined that the taxpayer was, based on the facts, engaged in a trade or business.  He had secured products to sell, actively marketed those products, attended food shows and other meetings around the Caribbean and South America and had established a network to find potential customers.  Thus, I.R.C. §195 did not apply to limit the deduction of the expenses – they would be deductible under I.R.C. §162.  Or would they?

To be deductible under I.R.C. §162 as an ordinary and necessary business expense on Schedule C (or Schedule F), the taxpayer must substantiate the expenses.  Here’s where the IRS largely prevailed in Smith.  The Tax Court determined that the taxpayer had not substantiated his expenses.  Thus, the expenses were not deductible beyond (with a small exception) what the IRS allowed.  The Tax Court also upheld the accuracy-related penalty.

Earlier this week, in Costello v. Comr., T.C. Memo. 2021-9, the Tax Court addressed the deductibility of start-up costs associated with various farming activities.  In the case, the petitioners, a married couple, were residents of California but the wife conducted a farming operation in Mexico for which she reported a net loss on Schedule F for every year from 2007 to 2014.  She began raising chickens to sell for meat in 2007, but couldn’t recall selling any of the chickens through 2011 and only had one sale of anything during that timeframe – a $264 loss on the resale of livestock.  She then switched to raising chickens for egg production, but soon determined that the venture wouldn’t be profitable due to an increased cost of feed.  She then sold what eggs had been produced for $1,068 and switched back to selling chickens for meat in 2012.  She didn’t sell any chickens in 2012 or 2013 and her plan to begin selling chickens in 2014 was thwarted when the flock was destroyed by wild dogs. Also, during 2007-2011, she attempted to grow various fruits and vegetables, but the activity was discontinued because the soil was not capable of production due to a nearby salt flat.  As a result, she had no sales revenue, only expenses that she deducted.  She then tried to grow peppers in 2012, but insects destroyed the crop and there was no marketable production.  Later that year, she acquired three cows and three calves in hopes to “make the calves big, sell them, impregnate the mothers…repeat.”  She had to sell the cows in 2013 for $4,800 because there was insufficient forage on the 6,500-acre tract.  The $4,800 was the only farm activity income reported for 2013. In 2012 and 2013, the taxpayers reported deductible business expenses on their Schedules C and Schedule F, later reaching an agreement with the IRS that the Schedule C expenses should have been reported on Schedule F. 

The IRS disallowed the deductions, determining that the wife didn’t conduct a trade or business activity for profit and because the business had not yet started during either 2012 or 2013. The Tax Court agreed with the IRS, concluding that the farming activities never moved beyond experimentation and investigation into an operating business.   The Tax Court determined that the overall evidence showed that her activities were still largely pre-operational because she was still planting research crops and the money from the sale of eggs was merely incidental after she had decided to abandon her egg production activity and get into livestock production  Accordingly, the expenses were nondeductible startup expenses for the years at issue. In addition, although the Tax Court reasoned that some of the wife’s farming activities could have constituted an active trade or business, costs were not segregated by activity. Also, the there was no itemization of costs or basis in the cattle activity to allow for an estimation of any deductible loss.  


When a business is in its early phase, it’s important to determine the proper tax treatment of expenses.  It’s also important to determine if and when the business begins.  The Tax Cuts and Jobs Act makes this determination even more important.  As the recent Tax Court cases indicate, proper documentation and substantiation of expenses is critical to preserve deductibility. 

January 27, 2021 in Income Tax | Permalink | Comments (0)

Sunday, January 24, 2021

Recent Happenings in Ag Law and Ag Tax


The world of agricultural law and taxation is certainly pertinent in the daily lives of farmers and ranchers.  In recent days and weeks, the courts have addressed more issues that can make a difference for ag producers.  In today’s post, I examine a few of those.  Those discussed today involve individual and entity taxation as well as environmental and regulatory issues.

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

Flow-Through Entities Can Deduct State and Local Taxes

IRS Notice 2020-75, applicable to specified income tax payments made on or after November 9, 2020

In a Notice, the IRS has said that taxes that are imposed on and paid by a partnership (or an S corporation) on its income are allowed as a deduction by the partnership (or S corporation) in computing its non-separately stated taxable income or loss for the tax year of payment. They are not passed through to the partners or shareholders, where they would be subject to the $10,000 limitation on state and local tax deductions imposed by the Tax Cuts and Jobs Act effective for tax years beginning after 2017.

The IRS did not set a timetable for the issuance of proposed regulations. The IRS issued the Notice in response to some states enacting laws to allow this type of treatment for partnerships and S corporations. Thus, for a flow-through entity to be able to do this for a partnership or S corporation, state law must provide for pass-through entity level taxation. The Notice won't apply unless state law allows this. Merely allowing a pass-through entity to make withholding tax payments on behalf of the owners will not qualify because those withholding tax payments are treated as payments made by the owners and not as payments in satisfaction of the pass -through entity's tax liability. In addition, entities taking advantage of the Notice will reduce allocable taxable income which will, in turn reduce allocable qualified business income for purposes of I.R.C. §199A and, therefore, the qualified business income deduction. 

IRA Distributions Included in Income and Subject to Early Withdrawal Penalty 

Ball v. Comr., T.C. Memo. 2020-152

During 2012 and 2013 the petitioner participated in a SEP-IRA. Chase Bank (Chase) was the custodian. In 2012, he took two distributions from the account totaling over $200,000.  He had the bank deposit the distributions into a Chase business checking account that he had opened in the name of The Ball Investment Account LLC (Ball LLC), of which he was the sole owner and only member. Importantly, Ball LLC was not a retirement account. The petitioner informed Chase that the distributions were early distributions that were not exempt from tax.  The petitioner made real estate loans with the distributed funds. The first loan was repaid in April 2013 with a check payable to "the Ball SEP Account."  The funds were deposited into the SEP-IRA account. He paid off the second loan in installments in 2012 and 2013.  The payments were made with checks made payable to "the Ball SEP Account.”  Chase, as custodian, had no knowledge of or control over the use that Ball LLC made of the distributions that were deposited in the Ball LLC business checking account.  Chase also didn’t hold or control any documents related to the loans Ball LLC made. Chase issued the petitioner a Form 1099-R for the 2012 tax year reporting that the petitioner had received taxable distributions from the SEP-IRA of $209,600. While the petitioner reported the distributions on his Form 1040, he did not include them in gross income and reported no tax and no tax liability.  The IRS issued a CP2000 Notice stating that the petitioner had failed to report the distributions from Chase Bank and that he therefore owed $67,031 in tax and a substantial-understatement penalty of $13,406. The petitioner did not respond to the Notice, and the IRS then sent him a notice of deficiency that determined the deficiency, additional tax, and penalty due. The Tax Court determined that the petitioner had unfettered control over the distributions, rejecting the petitioner’s “conduit agency arrangement” argument. The Tax Court determined that Ball LLC was not acting as an agent or conduit on behalf of Chase when Ball LLC received and made use of the distributions. The Tax Court noted that Chase had no knowledge of how the distributed funds were used after they were deposited in the Ball LLC account at the petitioner’s direction and that nothing in the record showed that petitioner, who controlled Ball LLC, did not have unfettered control over the distributions. The Tax Court determined that the facts of his case were analogous to those in Vandenbosch v. Comr., T.C. Memo. 2016-29 and, as a result, Ball LLC was not a conduit for Chase. As a result, the IRS position that the distributions should be included in the petitioner’s income was upheld. In addition, the petitioner had not yet reached age 59.5 which meant that he was liable for the 10 percent early distribution penalty. The Tax Court also upheld the accuracy-related penalty. 

New ESA Definition of “Habitat” 

85 Fed. Reg. 81411 (Dec. 16, 2020), effective, Jan. 15, 2021

In response to the U.S. Supreme Court decision in Weyerhaeuser Co. v. United States Fish and Wildlife Service, 139 S. Ct. 361 (2018), the United States Fish and Wildlife Service (USFWS) has modified the definition of “habitat” for listed species under the Endangered Species Act (ESA). The modification is the first change in the definition since the Endangered Species Act’s (ESA) enactment in 1973. Under Weyerhaeuser, the U.S. Supreme Court held that an area being designated as habitat is a prerequisite for a designation as “critical habitat.”  The regulation defines “habitat” as “the abiotic and biotic setting that currently or periodically contains the resources and conditions necessary to support one or more life processes of a species.” Thus, to be “habitat” an area must already contain the conditions necessary to support the species it is intended to be habitat for. Thus, only those areas which include the environmental conditions that can provide benefits to the species at issue (one seeking either a listed or endangered species) will be eligible for critical habitat designation. 

Federal Government Must Pay Farmers Millions For Army Corps of Engineers' Mismanagement of Missouri River. 

Ideker Farms, Inc. v. United States, No. 14-183L, 2020 U.S. Claims LEXIS 2548 (Fed. Cl. Dec. 14, 2020)

In 2014, 400 farmers along the Missouri River from Kansas to North Dakota sued the federal government claiming that the actions of the U.S. Army Corps of Engineers (COE) led to and caused repeated flooding of their farmland along the Missouri River. The farmers alleged that flooding in 2007-2008, 2010-2011, and 2013-2014 constituted a taking requiring that “just compensation” be paid to them under the Fifth Amendment. The litigation was divided into two phases – liability and just compensation. The liability phase was decided in early 2018 when the court determined that some of the 44 landowners selected as bellwether plaintiffs had established the COE’s liability. In that decision, the court held that the COE, in its attempt to balance flood control and its responsibilities under the Endangered Species Act, had released water from reservoirs “during periods of high river flows with the knowledge that flooding was taking place or likely to soon occur.” The court, in that case, noted that the COE had made other changes after 2004 to reengineer the Missouri River and reestablish more natural environments to facilitate species recovery that caused riverbank destabilization which led to flooding. Ultimately, the court, in the earlier litigation, determined that 28 of the 44 landowners had proven the elements of a takings claim – causation, foreseeability and severity. The claims of the other 16 landowners were dismissed for failure to prove causation. The court also determined that flooding in 2011 could not be tied to the COE’s actions and dismissed the claims for that year.

The present case involved a determination of the plaintiffs’ losses and whether the federal government had a viable defense against the plaintiffs’ claims. The court found that the “increased frequency, severity, and duration of flooding post MRRP [Missouri River Recovery Program] changed the character of the representative tracts of land.” The court also stated that, “ [i]t cannot be the case that land that experiences a new and ongoing pattern of increased flooding does not undergo a change in character.” The court determined that three representative plaintiffs, farming operations in northwest Missouri, southwest Iowa and northeast Kansas, were collectively owed more than $7 million for the devaluation of their land due to the establishment of a “permanent flowage easement” that the COE created which constituted a compensable taking under the Fifth Amendment.

The impact of the court’s ruling means that hundreds of landowners affected by flooding in six states are likely entitled to just compensation for the loss of property value due to the new flood patterns that the COE created as part of its MRRP. 


As 2021 unwinds, more issues will occur, many of which will likely involve estate and business entity planning along with income tax planning.

January 24, 2021 in Business Planning, Environmental Law, Income Tax, Regulatory Law | Permalink | Comments (0)

Wednesday, January 20, 2021

Ag Law and Taxation 2020 Bibliography


Today's post is a bibliography of my ag law and tax blog articles of 2020.  Many of you have requested that I provide something like this to make it easier to find the articles.  If possible, I will do the same for articles from prior years.  The library of content is piling up - I have written more than 500 detailed articles for the blog over the last four and one-half years.

Cataloging the 2020 ag law and tax blog articles - it's the topic of today's post.


Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech

Unique, But Important Tax Issues – “Claim of Right;” Passive Loss Grouping; and Bankruptcy Taxation

Disaster/Emergency Legislation – Summary of Provisions Related to Loan Relief; Small Business and Bankruptcy

Retirement-Related Provisions of the CARES Act

Farm Bankruptcy – “Stripping, “Claw-Black,” and the Tax Collecting Authorities

SBA Says Farmers in Chapter 12 Ineligible for PPP Loans

The “Cramdown” Interest Rate in Chapter 12 Bankruptcy

Bankruptcy and the Preferential Payment Rule


Partnership Tax Ponderings – Flow-Through and Basis

Farm and Ranch Estate and Business Planning in 2020 (Through 2025)

Transitioning the Farm or Ranch – Stock Redemption

Estate and Business Planning for the Farm and Ranch Family – Use of the LLC (Part 1)

Estate and Business Planning for the Farm and Ranch Family – Use of the LLC (Part 2)

The Use of the LLC for the Farm or Ranch Business – Practical Application


Top Ten Agricultural Law and Tax Developments from 2019 (Numbers 10 and 9)

Ag Law in the Courts – Feedlots; Dicamba Drift; and Inadvertent Disinheritance

Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech

Dicamba, Peaches and a Defective Ferrari; What’s the Connection?

Liability for Injuries Associated with Horses (and Other Farm Animals)

Issues with Noxious (and Other) Weeds and Seeds

Of Nuisance, Overtime and Firearms – Potpourri of Ag Law Developments


The Statute of Frauds and Sales of Goods

Disrupted Economic Activity and Force Majeure – Avoiding Contractual Obligations in Time of Pandemic

Is it a Farm Lease or Not? – And Why it Might Matter


Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 2 and 1)

Concentrated Ag Markets – Possible Producer Response?


Is an Abandoned Farmhouse a “Dwelling”?


Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 8 and 7)

Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 6 and 5)

Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 4 and 3)

Clean Water Act – Compliance Orders and “Normal Farming Activities”

Groundwater Discharges of “Pollutants” and “Functional Equivalency”

NRCS Highly Erodible Land and Wetlands Conservation Final Rule – Clearer Guidance for Farmers or Erosion of Property Rights? – Part One

NRCS Highly Erodible Land and Wetlands Conservation Final Rule – Clearer Guidance for Farmers or Erosion of Property Rights? – Part Two

NRCS Highly Erodible Land and Wetlands Conservation Final Rule – Clearer Guidance for Farmers or Erosion of Property Rights? – Part Three

The Prior Converted Cropland Exception – More Troubles Ahead?

TMDL Requirements – The EPA’s Federalization of Agriculture


Eminent Domain and “Seriously Misleading” Financing Statements



Ag Law in the Courts – Feedlots; Dicamba Drift; and Inadvertent Disinheritance

Recent Developments Involving Estates and Trusts

What is a “Trade or Business” For Purposes of Installment Payment of Federal Estate Tax?

Alternate Valuation – Useful Estate Tax Valuation Provision

Farm and Ranch Estate and Business Planning in 2020 (Through 2025)

Retirement-Related Provisions of the CARES Act

Are Advances to Children Loans or Gifts?

Tax Issues Associated with Options in Wills and Trusts

Valuing Farm Chattels and Marketing Rights of Farmers

Is it a Gift or Not a Gift? That is the Question

Does a Discretionary Trust Remove Fiduciary Duties a Trustee Owes Beneficiaries?

Can I Write my Own Will? Should I?

Income Taxation of Trusts – New Regulations

Merging a Revocable Trust at Death with an Estate – Tax Consequences

When is Transferred Property Pulled Back into the Estate at Death?  Be on Your Bongard!

‘Tis the Season for Giving, But When is a Transfer a Gift?



Top Ten Agricultural Law and Tax Developments of 2019 (Numbers 2 and 1)

Does the Penalty Relief for a “Small Partnership” Still Apply?

Substantiation – The Key to Tax Deductions

Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech

Unique, But Important Tax Issues – “Claim of Right;” Passive Loss Grouping; and Bankruptcy Taxation

Conservation Easements and the Perpetuity Requirement

Tax Treatment Upon Death of Livestock

What is a “Trade or Business” For Purposes of I.R.C. §199A?

Tax Treatment of Meals and Entertainment

Farm NOLs Post-2017


Disaster/Emergency Legislation – Summary of Provisions Related to Loan Relief; Small Business and Bankruptcy

Retirement-Related Provisions of the CARES Act

Income Tax-Related Provisions of Emergency Relief Legislation

The Paycheck Protection Program – Still in Need of Clarity

Solar “Farms” and The Associated Tax Credit

Obtaining Deferral for Non-Deferred Aspects of an I.R.C. §1031 Exchange

Conservation Easements – The Perpetuity Requirement and Extinguishment

PPP and PATC Developments

How Many Audit “Bites” of the Same Apple Does IRS Get?

More Developments Concerning Conservation Easements

Imputation – When Can an Agent’s Activity Count?

Exotic Game Activities and the Tax Code

Demolishing Farm Buildings and Structures – Any Tax Benefit?

Tax Incentives for Exported Ag Products

Deducting Business Interest

Recent Tax Court Opinions Make Key Point on S Corporations and Meals/Entertainment Deductions

Income Taxation of Trusts – New Regulations

Accrual Accounting – When Can a Deduction Be Claimed?

Farmland Lease Income – Proper Tax Reporting

Merging a Revocable Trust at Death with an Estate – Tax Consequences

The Use of Deferred Payment Contracts – Specifics Matter

Is Real Estate Held in Trust Eligible for I.R.C. §1031 Exchange Treatment?



Recent Court Developments of Interest


Principles of Agricultural Law



Signing and Delivery

Abandoned Railways and Issues for Adjacent Landowners

Obtaining Deferral for Non-Deferred Aspects of an I.R.C. §1031 Exchange

Are Dinosaur Fossils Minerals?

Real Estate Concepts Involved in Recent Cases

Is it a Farm Lease or Not? – And Why it Might Matter



Top Ten Agricultural Law and Tax Developments from 2019 (Numbers 10 and 9)

Top Ten Agricultural Law and Tax Developments from 2019 (Number 8 and 7)

Ag Law and Tax in the Courts – Bankruptcy Debt Discharge; Aerial Application of Chemicals; Start-Up Expenses and Lying as Protected Speech

Hemp Production – Regulation and Economics

DOJ to Investigate Meatpackers – What’s it All About?

Dicamba Registrations Cancelled – Or Are They?

What Does a County Commissioner (Supervisor) Need to Know?

The Supreme Court’s DACA Opinion and the Impact on Agriculture

Right-to-Farm Law Headed to the SCOTUS?

The Public Trust Doctrine – A Camel’s Nose Under Agriculture’s Tent?

Roadkill – It’s What’s for Dinner (Reprise)

Beef May be for Dinner, but Where’s It From?

Of Nuisance, Overtime and Firearms – Potpourri of Ag Law Developments

What Farm Records and Information Are Protected from a FOIA Request?

Can One State Dictate Agricultural Practices in Other States?


Family Farming Arrangements and Liens; And, What’s a Name Worth?

Conflicting Interests in Stored Grain

Eminent Domain and “Seriously Misleading” Financing Statement



Summer 2020 Farm Income Tax/Estate and Business Planning Conference

Registration Open for Summer Ag Income Tax/Estate and Business Planning Seminar


Summer 2020 – National Farm Income Tax/Estate and Business Planning Conference

Year-End CPE/CLE – Six More to Go

2021 Summer National Farm and Ranch Income Tax/Estate and Business Planning Conference


Principles of Agricultural Law


More “Happenings” in Ag Law and Tax

Recent Cases of Interest


More Selected Caselaw Developments of Relevance to Ag Producers

Court Developments of Interest

Ag Law and Tax Developments

Recent Court Developments of Interest

Court Developments in Agricultural Law and Taxation

Ag Law and Tax in the Courtroom

Recent Tax Cases of Interest

Ag and Tax in the Courts

Of Nuisance, Overtime and Firearms – Potpourri of Ag Law Developments

Bankruptcy Happenings


January 20, 2021 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Sunday, January 17, 2021

Agricultural Law Online!


For the Spring 2021 academic semester, Kansas State University will be offering my Agricultural Law and Economics course online. No matter where you are located, you can enroll in the course and participate in it as if you were present with the students in the on-campus classroom.

Details of this spring semester’s online Ag Law course – that’s the topic of today’s post.

Course Coverage

The course provides a broad overview of many of the issues that a farmer, rancher, rural landowner, ag lender or other agribusiness will encounter on a daily basis. As a result, the course looks at contract issues for the purchase and sale of agricultural goods; the peril of oral contracts; the distinction between a lease and a contract (and why the distinction matters); and the key components of a farm lease, hunting lease, wind energy lease, oil and gas lease, and other types of common agricultural contractual matters. What are the rules surrounding ag goods purchased at auction?

Ag financing situations are also covered – what it takes to provide security to a lender when financing the purchase of personal property to be used in the farming business. In addition, the unique rules surrounding farm bankruptcy is covered, including the unique tax treatment provided to a farmer in Chapter 12 bankruptcy.

Of course, farm income tax is an important part of the course. Tax planning is perhaps the most important aspect of the farming business that every-day decisions have an impact on and are influenced by. As readers of this blog know well, farm tax issues are numerous and special rules apply in many instances. The new tax law impacts many areas of farm income tax.

Real property legal issues are also prevalent and are addressed in the course. The key elements of an installment land contract are covered, as well as legal issues associated with farm leases. Various types of interests in real estate are explained – easements; licenses; profits, fee simples, remainders, etc. Like-kind exchange rules are also covered as are the special tax rules (at the state level) that apply to farm real estate.

A big issue for some farmers and ranchers concerns abandoned railways, and those issues are covered in the course. What if an existing fence is not on the property line?

Farm estate and business planning is also a significant emphasis of the course. What’s the appropriate estate plan for a farm and ranch family? How should the farming business be structured? Should multiple entities be used? Why does it matter? These questions, and more, are addressed.

Agricultural cooperatives are important for the marketing of agricultural commodities. How a cooperative is structured and works and the special rules that apply are also discussed.

Because much agricultural property is out in the open, that means that personal liability rules come into play with respect to people that come onto the property or use farm property in the scope of their employment. What are the rules that apply in those situations? What about liability rules associated with genetically modified products? Ag chemicals also pose potential liability issues, as do improperly maintained fences? What about defective ag seed or purchased livestock that turns out to not live up to representations? These issues, and more, are covered in the scope of discussing civil liabilities.

Sometimes farmers and ranchers find themselves in violation of criminal laws. What are those common situations? What are the rules that apply? We will get into those issue too.

Water law is a very big issue, especially in the western two-thirds of the United States. We will survey the rules surrounding the allocation of surface water and ground water to agricultural operations.

Ag seems to always be in the midst of many environmental laws – the “Clean Water Rule” is just one of those that has been high-profile in recent years. We will talk about the environmental rules governing air, land, and water quality as they apply to farmers, ranchers and rural landowners.

Finally, we will address the federal (and state) administrative state and its rules that apply to farming operations. Not only will federal farm programs be addressed, but we will also look at other major federal regulations that apply to farmers and ranchers.

Further Information and How to Register

Information about the course and how to register is available here:

You can also find information about the text for the course at the following link:

If you are an undergraduate student at an institution other than Kansas State, you should be able to enroll in this course and have it count as credit towards your degree at your institution.  Consult with your academic advisor to see how Ag Law and Economics will transfer and align with your degree completion goals.

If you have questions, you can contact me directly, or submit your questions to the KSU Global Campus staff at the link provided above.

I hope to see you in class beginning on January 26!

January 17, 2021 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 15, 2021

Final Ag/Horticultural Cooperative QBI Regulations Issued


After many months of delay, the IRS has finally issued final regulations providing guidance to agricultural/horticultural cooperatives and patrons on the I.R.C. §199A(a) and I.R.C. §199A(g) deduction for qualified business income (QBI).  The final regulations make several changes to the Proposed Regulations, and are important to patrons of ag cooperatives and return preparers.

The QBI Final Regulations applicable to agricultural/horticultural cooperatives – it’s the topic of today’s post.


The Consolidated Appropriations Act of 2018, H.R. 1625 (Act) became law.  The Act contained a provision modifying I.R.C. §199A that was included in the Tax Cuts and Jobs Act (TCJA) enacted in late 2017.   I.R.C. §199A created a 20 percent QBI deduction for sole proprietorships and pass-through businesses.  However, the provision created a tax advantage for sellers of agricultural products sold to agricultural cooperatives.  Before the technical correction, those sales generated a tax deduction from gross sales for the seller.  But if those same ag goods were sold to a company that was not an agricultural cooperative, the deduction could only be taken from net business income.  That tax advantage for sales to cooperatives was deemed to be a drafting error and has now been technically corrected.

The modified provision removes the TCJA’s QBI deduction provision for ag cooperatives and replaced it with the former (pre-2018) domestic production activities deduction (DPAD) of I.R.C. §199 for cooperatives.  In addition, the TCJA provision creating a 20 percent deduction for patronage dividends also was eliminated.  Also, the modified language limits the deduction to 20 percent of farmers’ net income, excluding capital gains.

The Modification: New I.R.C. §199A(g)

The provision in the Act removes the QBI deduction for agricultural or horticultural cooperatives.  In its place, the former DPAD provision (in all practical essence) is restored for such cooperatives.  Thus, an ag cooperative can claim a deduction from taxable income that is equal to nine percent of the lesser of the cooperative’s qualified production activities income or taxable income (determined without regard to the cooperative’s I.R.C. § 199A(g) deduction and any deduction allowable under section 1382(b) and (c) (relating to patronage dividends, per-unit retain allocations, and nonpatronage distributions)) for the taxable year. The amount of the deduction for a taxable year is limited to 50 percent of the W-2 wages paid by the cooperative during the calendar year that ends in such taxable year. For this purpose, W-2 wages are determined in the same manner as under the other provisions of section 199A (which is not repealed as applied to non-cooperatives), except that “wages” do not include any amount that is not properly allocable to domestic production gross receipts.  A cooperative’s DPAD is reduced by any amount passed through to patrons.

Under the technical correction, the definition of a “specified agricultural or horticultural cooperative” is limited to organizations to which part I of subchapter T applies that either manufacture, produce, grow, or extract in whole or significant part any agricultural or horticultural product; or market any agricultural or horticultural product that their patrons have manufactured, produced, grown, or extracted in whole or significant part. The technical correction notes that Treas Reg. §1.199-6(f) is to apply such that agricultural or horticultural products also include fertilizer, diesel fuel, and other supplies used in agricultural or horticultural production that are manufactured, produced, grown, or extracted by the cooperative.

Note:  As modified, a “specified agricultural or horticultural cooperative” does not include a cooperative solely engaged in the provision of supplies, equipment, or services to farmers or other specified agricultural or horticultural cooperatives.

Impact on patrons.  Under the new language, an eligible patron that receives a qualified payment from a specified agricultural or horticultural cooperative can claim a deduction in the tax year of receipt in an amount equal to the portion of the cooperative’s deduction for qualified production activities income that is: 1) allowed with respect to the portion of the qualified production activities income to which such payment is attributable; and 2) identified by the cooperative in a written notice mailed to the patron during the payment period described in I.R.C. §1382(d).

Note:  The cooperative’s I.R.C. §199A(g) deduction is allocated among its patrons on the basis of the quantity or value of business done with or for the patron by the cooperative.

The patron’s deduction may not exceed the patron’s taxable income for the taxable year (determined without regard to the deduction, but after accounting for the patron’s other deductions under I.R.C. §199A(a)).

What is a qualified payment?  It’s any amount that meets three tests:  

1) the payment must be either a patronage dividend or a per-unit retain allocations;

2) the payment, must be received by an eligible patron from a qualified agricultural or horticultural cooperative; and

3) the payment must be attributable to qualified production activities income with respect to which a deduction is allowed to the cooperative.

An eligible patron cannot be a corporation and cannot be another ag cooperative.   In addition, a cooperative cannot reduce its income under I.R.C. §1382 for any deduction allowable to its patrons by virtue of I.R.C. §199A(g).  Thus, the cooperative must reduce its deductions that are allowed for certain payments to its patrons in an amount equal to the I.R.C. §199A(g) deduction allocated to its patrons.

Transition rule.  A transition rule applied such that the repeal of the DPAD did not apply to a qualified payment that a patron receives from an ag cooperative in a tax year beginning after 2017 to the extent that the payment is attributable to qualified production activities income with respect to which the deduction is allowed to the cooperative under the former DPAD provision for the cooperative’s tax year that began before 2018.  That type of qualified payment is subject to the pre-2018 DPAD provision, and any deduction allocated by a cooperative to patrons related to that type of payment can be deducted by patrons in accordance with the pre-2018 DPAD rules.  In that event, no post-2017 QBI deduction was allowed for those type of qualified payments. This simple statement created surprising results and added complexity to the computations for determining the proper 2018 QBID.  Taxpayers needed to identify sales to non-cooperatives, sales to cooperatives during the year that began in 2017, and sales to cooperatives during the year that began in 2018 to properly compute their 2018 QBID.

Status of Ag Cooperatives and Patrons After the Act

With the technical correction to I.R.C. §199A, where did things stand for farmers?

  • The overall QBI deduction cannot exceed 20 percent of taxable income less capital gain. That restriction applies to all taxpayers regardless of income.  When income exceeds the taxable income threshold , the 50 percent of W-2 wages limitation and qualified property limit are  phased-in.
  • The prior I.R.C. 199 DPAD no longer exists, except as resurrected for agricultural and horticultural cooperatives as noted above. The 20 percent QBI deduction of I.R.C. §199A is available for sole proprietorships and pass-through businesses.  For farming businesses structured in this manner, the tax benefit of the 20 percent QBI deduction will likely outweigh what the DPAD would have produced.
  • While those operating in the C corporate form can’t claim a QBI deduction, the corporate tax rate is now a flat 21 percent. That represents a tax increase for those corporations that would have otherwise triggered a 15 percent rate under prior law and benefitted from DPAD in prior years.
  • For C corporations that are also patrons of an agricultural cooperative, the cooperative’s DPAD does not pass through to the patron.
  • For a Schedule F farmer that is a patron of an agricultural cooperative and pays no wages, there are two steps to calculate the tax benefits. First, the cooperative’s DPAD that is passed through to the patron can be applied to offset the patron’s taxable income regardless of source.  Second, the farmer/patron is entitled to a QBI deduction equal to 20 percent of net farm income derived from qualified non-cooperative sales, subject to the taxable income limitation (presently $329,800 (mfj); $164,900 (single, MFS and HH for 2021).
  • For farmers that pay W-2 wages and sell to ag cooperatives , the QBI deduction is calculated on the sales to cooperatives by applying the lesser of 50 percent of W-2 wages or 9 percent reduction limitation. Thus, for a farmer that has farm income beneath the taxable income limitation , the QBI deduction will never be less than 11 percent (i.e., 20 percent less 9 percent).  If the farmer is above the taxable income limitation the 50 percent of W-2 wages limitation will be applied before the 9 percent limitation.  This will result in the farmer’s QBI deduction, which cannot exceed 20 percent of taxable income.  To this amount is added any pass-through DPAD from the cooperative to produce the total deductible amount.
  • For farmers that sell ag products to non-cooperatives and pay W-2 wages, a deduction of 20 percent of net farm income is available. If taxable income is less than net farm income, the deduction is 20 percent of taxable income less capital gains.  If net farm income exceeds the taxable income limitation the deduction may be reduced on a phased-in basis.
  • The newly re-tooled cooperative DPAD of I.R.C. 199A may incentivize more cooperatives to pass the DPAD through to their patrons.

Proposed Regulations

After a frustrating 2018 tax season experience with respect to associated IRS Forms and IRS computers not recognizing Forms as submitted in accordance with the instructions for the I.R.C. §199A(g) amount, the IRS issued Proposed Regulations concerning the computation of the I.R.C. §199A(g) amount.  REG-118425-18.   The Proposed Regulations clarified that patronage dividends include money, property, qualified written notices of allocations, qualified per-unit retain certificates for which a cooperative receives a deduction under I.R.C. §1382(b), nonpatronage distributions paid in money, property, qualified written notices of allocation, as well as money or property paid in redemption of a nonqualified written notice of allocation for which an exempt cooperative receives a deduction under I.R.C. §1382(c)(2).  But, dividends on capital stock are not included in QBI.  Prop. Treas. Reg. §1.199A-7(c)(1). 

Under Prop. Treas. Reg. §1.199A-7(c), patronage dividends or similar payments may be included in the patron’s QBI to the extent that these payments: (i) are related to the patron’s trade or business; (ii) are qualified items of income, gain, deduction, or loss at the cooperative’s trade or business level; and (iii) are not income from a specified service trade or business (SSTB) (as defined in I.R.C. §199A(d)(2)) at the cooperative level.  But, they are only included in the patron’s income if the cooperative provides the required information to the patron concerning the payments.  Prop. Treas. Reg. §1.199A-7(c)(2).    The transition DPAD rules were reaffirmed in Prop. Treas. Reg. §1.199A-7(h)(2) thus validating the related complex calculations on 2018 tax returns.

The patron’s QBID.  The amount of a patron’s deduction that can be passed through to the patron is limited to the portion of the patron’s deduction that is allowed with respect to qualified production activities income (QPAI) to which the qualified payments (patronage dividends and per unit retains) made to the patron are attributable. I.R.C. §199A(g)(2)(E).     In other words, the distribution must be of tax items that are allocable to the cooperative’s trade or business on behalf of or with a patron.  The cooperative makes this determination in accordance with Treas. Reg. §1.199A-3(b). This is, essentially, the former DPAD computation except that account is taken for non-patronage income not being part of the computation. 

There is a four-step process for computing the patron’s QBID:  1) separate patronage and non-patronage gross receipts (and associated deductions); 2) limit the patronage gross receipts to those that are domestic production gross receipts (likely no reduction here); 3) determine qualified production activities income from the domestic, patronage-sourced gross receipts; 4) apply a formula reduction (explained below).  Prop. Treas. Reg. §1.199A-8(b).

The ”wages” issue.  As noted, the farmer-patron must reduce the “patron’s QBID” by a formula that is the lesser of 9 percent of QBI that relates to qualified payments from the cooperative, or 50 percent of the patron’s W-2 wages paid that are allocable to the qualified payments from the cooperative.  I.R.C. §199A(b)(7)(A)-(B).  In Notice 2019-27, 2019-16 IRB, the IRS set forth various methods for calculating W-2 wages for purposes of computing the patron’s QBID.  See also Prop. Treas. Reg. §1.199A-11.  Because the test is the “lesser of,” a patron that pays no qualified W-2 wages has no reduction.  Remember, however, under I.R.C. §199A(b)(4) and Prop. Treas. Reg. §1.199A-11(b)(1), wages paid in-kind to agricultural labor are not “qualified wages” but wages paid to children under age 18 by their parents are.

I.R.C. §199A(b)(7) requires the formula reduction even if the cooperative doesn’t pass through any of the I.R.C. §199A(g) deduction (the deduction for a patron) to the patron for a particular tax year.  If the patron has more than a single business, QBI must be allocated among those businesses.  Treas. Reg. §1.199A-3(b)(5).  The Proposed Regulations do not mention how the formula reduction functions in the context of an aggregation election.  For example, if an aggregation election is made to aggregate rental income with income from the farming operation, must an allocation be made of a portion of the rental income as part of the formula reduction? 

The formula reduction applies to the portion of a patron’s QBI that relates to qualified payments from a cooperative.  If the patron has negative QBI that is associated with business done with the cooperative, the 9 percent amount will always be lower than the W-2 wage amount. 

An optional safe harbor allocation method exists for patrons with taxable income under the applicable threshold of I.R.C. §199A(e)(2) to determine the reduction.  Under the safe harbor, a patron must allocate the aggregate business expenses and W-2 wages ratably between income from qualified payments and income from other than qualified payments to determine QBI.  Prop. Treas. Reg. §1.199A-7(f)(2)(ii).  Unfortunately, the example contained in the Proposed Regulations not only utilized an apparently unstated “reasonable method of allocation,” but also an allocation of W-2 wage expense that doesn’t match the total expense allocation.   

The amount of deductions apportioned to determine QBI allocable to qualified payments must be equal to the proportion of the total deductions that the amount of qualified payments bears to total gross receipts used to determine QBI. The same proportion applies to determine the amount of W-2 wages allocable to the portion of the trade or business that received qualified payments.    

The part of the Proposed Regulations attempting to illustrate the calculation only mentions gross receipts from grain sales.  There is no mention of gross receipts from farm equipment, for example.  Based on the language of Prop. Treas. Reg. §1.199A-7(f)(2)(ii), gross receipts from the sale of equipment and machinery should be included in the calculation and the farmer would have to allocate gross receipts from equipment sales between patronage and non-patronage income.  Indeed, in prior years, depreciation may have been allocated between patronage and non-patronage income.   Likewise, the example didn’t address how government payments, custom work, crop insurance proceeds or other gross receipts are to be allocated.

This meant that the patron must know the qualified payments from the cooperative that were allocable to the patron that were used in computing the deduction for the patron at the cooperative level that could be passed through to the patron.  This information is contained on Form 1099-PATR Box 7.

A patron with taxable income above the threshold levels that receives patronage dividends (or similar payments) from a cooperative and is conducting a trade or business might be subject to the W-2 wages and “unadjusted basis immediately after acquisition” (UBIA) limitation. In that instance, the patron is to calculate the W-2 wage and UBIA limitations without regard to the cooperative’s W-2 or UBIA amounts.  Prop. Treas. Reg. §1.199A-7(e)(2).  That means  the cooperative (unlike a RPE) does not allocate its W-2 wages or UBIA to patrons.  Instead, a patron allocates (by election) W-2 wages and UBIA between patronage and non-patronage income using any reasonable method based on all the facts and circumstances that clearly reflects the income and expense of each trade or business.  Prop. Treas. Reg. §1.199A-7(f)(2)(i).  

The patron’s QBID that is passed through from the cooperative (which is not limited by W-2 wages at the patron level) is limited to the patron’s taxable income taking into account the non-patron QBID which is limited to 20 percent of taxable income not counting net capital gains.  Any unused patron-QBID is simply lost – there is not carryover or carryback provision that applies.

Identification by the cooperative.  A cooperative must identify the amount of a patron’s deduction that it is passing through to a patron in a notice that is mailed to the patron via Form 1099-PATR during the “applicable payment period” – no later than the 15th day of the ninth month following the close of the cooperative’s tax year.  I.R.C. §199A(g)(2)(A); Prop. Treas. Reg. §1.199A-8(d)(3); I.R.C. §1382(d). 

A patron uses the information that the cooperative reports to determine the patron’s QBID.  If the information isn’t received on or before the Form 1099-PATR due date, no distributions from the cooperative will count towards the patron’s QBI if the lack of reporting occurs after June 19, 2019.  Prop. Treas. Reg. §1.199A-7(c)(3); Prop. Treas. Reg. §1.199A-7(d)(3). 

Final Regulations (TD 9947)

On January 14, 2021 the IRS issued Final Regulations on the cooperative QBI issue.  The Final Regulations make several changes to the Proposed Regulations.  One clarification that likely won’t impact many farmers requires a cooperative to separately determine the amounts of qualified items that relate to non-specified service trades or business (SSTBs) and those that relate to SSTBs when making distributions to patrons.  Treas. Reg. §§1.199A-7(c)(3) and (d)(3). The cooperative is to report the net amount of qualified items from non-SSTBs in distributions to patrons without delineating on a business-by-business basis.  Once a patron receives the information from the cooperative, the patron will have to determine if the qualified item is includible in the patron’s QBI under Treas. Reg. §1.199A-7(c)(2) and whether the qualified item from the SSTB is includible in the patron’s QBI based on the threshold rules of I.R.C. §199A(d)(3).  Treas. Reg. §1.199A-7(d)(3)(i). 

Under the Proposed Regulations, a question existed whether a patron needed to include gain on selling farm equipment, farm program payments, self-rentals, or other similar income sources in calculation of the I.R.C. §199A(g) amount.  The Final Regulations didn’t answer the question. Under the Final Regulations, when calculating the I.R.C. §199A(b)(7) reduction, a patron is to use a “reasonable method” to allocated income between that from qualified payments and that not coming from qualified payments, based on all of the facts and circumstances.  Treas. Reg. §1.199A-7(f)(2)(i).  Basically, that means that a farmer/patron can make their own decision with respect to including or excluding such items.  The only requirement is that a “reasonable method” be utilized.

The final regulations specify that a farmer/patron that aggregates a rental real estate busines and a farming business that does business with a cooperative is to exclude the rental income when calculating the I.R.C. §199A(b)(7) reduction for the patron’s aggregated trade or business.  Similarly, the patron is to allocate rental expense against qualified payments when computing the reduction only to the extent rental expense is related to the qualified payments from the cooperative.  Preamble to TD 9947. 

On the wage issue, qualified payments need not be reduced if the cooperative was limited by the 50 percent of wage limitation.

The Final Regulations provide an example of the effect of negative QBI on the I.R.C. §199A(b)(7) reduction, pointing out that negative QBI from a cooperative results in no adjustment to the reduction computation:

“A farmer conducts two types of agricultural businesses (A and B). Assume the farmer treats A and B as one trade or business for purposes of the [I.R.C. §199A(a)] deduction. The farmer conducts A with non-Specified Cooperatives and B through a Specified Cooperative. The farmer generates $100 of qualifying income through A and receives $100 of qualifying income from a Specified Cooperative in B, all of which is also a qualified payment. The farmer has $180 of qualified expenses. For purposes of the [I.R.C. §199A(a)] deduction, the farmer’s QBI ($20) from the trade or business is used to calculate the deduction, resulting in a $4 deduction. The farmer then must determine if there is any [I.R.C. §199A(b)(7)] reduction to this amount. The farmer reasonably allocates its qualified expenses for purposes of calculating the I.R.C. §199A(b)(7)] reduction and determines $110 of the qualified expenses are allocable to B (and $70 to A). The farmer will use only QBI from B to calculate the [I.R.C. §199A(b)(7)] reduction because that is the only QBI properly allocable to qualified payments. Farmer’s QBI for purposes of [I.R.C. §199A(b)(7)(A)] is negative $10, resulting in a $0 [I.R.C. §199A(b)(7)] reduction (regardless of W-2 wages under [I.R.C. §199A(b)(7)(B)]). ((Preamble to TD 9947)).”

The IRS, in the Final Regulations, maintained its position that cooperatives must calculate two separate deductions – one for patronage and another for nonpatronage activities.  The IRS takes the position in the Final Regulations that nonpatronage income is excluded from the calculation of the deduction, which reduces the overall value of the deduction for cooperatives and patrons.  Income or deductions is from patronage sources if it comes from a transaction that facilitates the cooperative’s marketing, purchasing or services.  If a transaction is merely incidental to the cooperative’s operation, the income or deduction is from nonpatronage sources. 

The IRS claims that the Form 8903 instructions make it clear that separate calculations are necessary for the patronage section of I.R.C. §199A(g) deductions and nonpatronage I.R.C. §199A(g) deductions.  However, there is no support for the IRS position in the statute’s legislative history for the disparate treatment of patronage and nonpatronage source income.  Likewise, the Tax Court (in both Memorandum and Full opinions) has rejected the IRS approach for computing the former domestic production activities deduction of I.R.C. §199 on which I.R.C. §199A is based.  Growmark, Inc. v. Comr., T.C. Memo. 2019-161; Ag Processing, Inc. v. Comr., 153 T.C. 34 (2019).   

The Final Regulations are generally applicable to tax years beginning after January 19, 2021, but can be used for earlier tax years.  Otherwise, for tax years beginning on or before January 19, 2021, the Proposed Regulations apply.


The Final Regulations do clarify a couple of issues that were unclear in the Proposed Regulations.  However, the Final Regulations do not answer the question of whether gain from certain various sources of income for a farmer/patron in the I.R.C. §199A(g) computation.

January 15, 2021 in Cooperatives, Income Tax | Permalink | Comments (0)

Wednesday, January 13, 2021

The “Top Ten” Agricultural Law and Tax Developments of 2020 – Part Four


The biggest three developments of 2020 in ag law and tax are up for discussion today.  2020 was a year of many important developments of relevance to the agricultural industry, but the top three stand out in particular. 

The three most important developments of 2020 – it’s the topic of today’s post.

No. 3 – SCOTUS DACA Opinion

Background.  In mid-2020, the U.S. Supreme Court issued its opinion in Department of Homeland Security, et al. v. Regents of the University of California, et al., 140 S. Ct. 1891 (2020) where the Court denied the U.S. Department of Homeland Security’s (DHS) revocation of the Deferred Action for Childhood Arrivals (DACA).  The Court’s decision is of prime importance to agriculture because the case involved the ability of a federal government agency to create rules that are applied with the force of law without following the notice and comment requirements of the Administrative Procedure Act.  Agricultural activities are often subjected to the rules developed by federal government agencies, making it critical that agency rules are subjected to public input before being finalized.

The DHS started the DACA program by issuing an internal agency memorandum in 2012.  The DHS took this action after numerous bills in the Congress addressing the issue failed to pass over a number of years.  The DACA program illegal aliens that were minors at the time they illegally entered the United States to apply for a renewable, two-year reprieve from deportation.  The DACA program also gave these illegal immigrants work authorizations and access to taxpayer-funded benefits such as Social Security and Medicare.  Current estimates are that between one million and two million DACA-protected illegal immigrants are eligible for benefits  In 2014, the DHS attempted to expand DACA to provide amnesty and taxpayer benefits for over four million illegal aliens, but the expansion was foreclosed by a federal courts in 2015 for providing benefits to illegal aliens without following the procedural requirements of the Administrative Procedure Act as a substantive rule and for violating the Immigration and Naturalization Act.  Texas v. United States, 809 F.3d 134 (5th Cir. 2015), aff’g., 86 F. Supp. 3d 591 (S.D. Tex. 2015)In 2016, the U.S. Supreme Court affirmed the lower court decisions.  United States v. Texas, 136 S. Ct. 2271 (2016).  Based on these court holdings and because DACA was structured similarly, the U.S. Attorney General issued an opinion that the DACA was also legally defective.  Accordingly, in June of 2017, the DHS announced via an internal agency memorandum that it would end the illegal program by no longer accepting new applications or approving renewals other than for those whose benefits would expire in the next six months.  Activist groups sued and the Supreme Court ultimately determined that the action of the DHS was improper for failing to provide sufficient policy reasons for ending DACA.  In other words, what was created with the stroke of a pen couldn’t be eliminated with a stroke of a pen. 

Administrative Procedure Act (APA).  The APA was enacted in 1946.  Pub. L. No. 79-404, 60 Stat. 237 (Jun. 11, 1946).  The APA sets forth the rules governing how federal administrative agencies are to go about developing regulations.  It also gives the federal courts oversight authority over all agency actions.  The APA has been referred to as the “Constitution” for administrative law in the United States.  A key aspect of the APA is that any substantive agency rule that will be applied against an individual or business with the force of law (e.g., affecting rights of the regulated) must be submitted for public notice and comment.  5 U.S.C. §553.  The lack of DACA being subjected to public notice and comment when it was created and the Court’s requirement that it couldn’t be removed in like fashion struck a chord with the most senior member of the Court.  Justice Thomas authored a biting dissent that directly addressed this issue.  He wrote, “Without grounding its position in either the APA or precedent, the majority declares that DHS was required to overlook DACA’s obvious legal deficiencies and provide additional policy reasons and justifications before restoring the rule of law. This holding is incorrect, and it will hamstring all future agency attempts to undo actions that exceed statutory authority.”

Farmers and ranchers often deal with the rules developed by federal (and state) administrative agencies.  Those agency rules often involve substantive rights and, as such, are subject to the notice and comment requirements of the APA.  Failure to follow the APA often results in the restriction (or outright elimination) of property rights without the necessary procedural protections the APA affords. It’s also important that when administrative agencies overstep their bounds, a change in agency leadership has the ability to swiftly rescind prior illegal actions – a point Justice Thomas made clear in his dissent.

No. 2 - Public Trust Doctrine

Background.  Centuries ago, the seas were viewed as the common property of everyone - they weren’t subject to private use and ownership.  Instead, they were held in what was known as the “public trust.”  This concept was later adopted in English law, the Magna Carta, and became part of the common (non-statutory) law of individual states in the United States after the Revolution.  Over the years, this “public trust doctrine” has been primarily applied to access to the seashore and intertidal waters, although recently some courts have expanded its reach beyond its historical application.

But, any judicial expansion of the public trust doctrine results in curtailing vested property rights.  That’s a very important concern for agriculture because of agriculture’s necessary use of natural resources such as land, air, water, minerals and the like.  Restricting or eliminating property rights materially impacts agricultural operations in a negative manner.  It also creates an economic disincentive to use property in an economically (and socially) efficient manner.

How could an expanded public trust doctrine apply?  For farmers and ranchers, it could make a material detrimental impact on the farming operation.  For instance, many endangered species have habitat on privately owned land.  If wildlife and their habitat are deemed to be covered by the doctrine, farming and ranching practices could be effectively curtailed.  What about vested water rights?  A farming or ranching operation that has a vested water right to use water from a watercourse for crop irrigation or livestock watering purposes could find itself having those rights limited or eliminated if, under the public trust doctrine, a certain amount of water needed to be retained in the stream for a species of fish. 

One might argue that the government already has the ability to place those restrictions on farming operations, and that argument would be correct.  But, such restrictions exist via the legislative and regulatory process and are subject to constitutional due process, equal protection and just compensation protections.  Conversely, land-use restrictions via the public trust doctrine bypass those constitutional protections.  No compensation would need to be paid, because there was no governmental taking – a water right, for example, could be deemed to be subject to the “public trust” and enforced without the government paying for taking the right.  

Nevada Case.  Mineral County v. Lyon County, No. 75917, 2020 Nev. LEXIS 56 (Nev. Sup. Ct. Sept. 17, 2020)involved the state of Nevada’s water law system for allocating water rights and an attempt to take those rights without compensation via an expansion of the public use doctrine.  The state of Nevada appropriates water to users via the prior appropriation system – a “first-in-time, first-in-right” system.  Over 100 years ago, litigation over the Walker River Basin began between competing water users in the Walker River Basin.  The Basin covers approximately 4,000 square miles, beginning in the Sierra Nevada mountain range and ending in a lake in Nevada.  In 1936, a federal court issued a decree adjudicating water rights of various claimants to water in the basin via the prior appropriation doctrine. 

In 1987, an Indian Tribe intervened in the ongoing litigation to establish procedures to change the allocations of water rights subject to the decree.  Since that time, the state reviews all changes to applications under the decree.  In 1994, the plaintiff sought to modify the decree to ensure minimum stream flows into the lake under the “doctrine of maintenance of the public trust.”  The federal district (trial) court granted the plaintiff’s motion to intervene in 2013.  In 2015, the trial court dismissed the plaintiff’s amended complaint in intervention on the basis that the plaintiff lacked standing; that the public trust doctrine could only apply prospectively to bar granting appropriative rights; any retroactive application of the doctrine could constitute a taking requiring compensation; that the court lacked the authority to effectuate a taking; and that the lake was not part of the basin. 

On appeal, the federal appellate court determined that the plaintiff had standing, and that the lake was part of the basin.  The appellate court also held that whether the plaintiff could seek minimum flows depended on whether the public trust doctrine allowed the reallocation of rights that had been previously settled under the prior appropriation doctrine.  Thus, the appellate court certified two questions to the Nevada Supreme Court:  1) whether the public trust doctrine allowed such reallocation of rights; and 2) if so, whether doing so amounted to a “taking” of private property requiring “just compensation” under the Constitution. 

The state Supreme Court held that that public trust doctrine had already been implemented via the state’s prior appropriation system for allocating water rights and that the state’s statutory water laws is consistent with the public trust doctrine by requiring the state to consider the public interest when making allocating and administering water rights.  The state Supreme Court also determined that the legislature had expressly prohibited the reallocation of water rights that have not otherwise been abandoned or forfeited in accordance with state water law. 

The state Supreme Court limited the scope of its ruling to private water use of surface streams, lakes and groundwater such as uses for crops and livestock. The plaintiff has indicated that it will ask the federal appellate court for a determination of whether the public trust doctrine could be used to mandate water management methods.  If the court would rule that it does, the result would be an unfortunate disincentive to use water resources in an economically efficient manner (an application of the “tragedy of the commons”).  It would also provide a current example (in a negative way) of the application of the Coase Theorem (well-defined property rights overcome the problem of externalities).  See Coase, “The Problem of Social Cost,” Journal of Law and Economics, Vol. 3, October 1960. 

Oregon CaseIn Chernaik v. Brown, 367 Or. 143 (2020), the plaintiffs claimed that the public trust doctrine required the State of Oregon to protect various natural resources in the state from harm due to greenhouse gas emissions, “climate change,” and ocean acidification. The public trust doctrine has historically only applied to submerged and submersible lands underlying navigable waters as well as the navigable waters. The trial court rejected the plaintiffs’ arguments. On appeal the state Supreme Court affirmed, rejecting the test for expanding the doctrine the plaintiffs proposed. Under that test, the doctrine would extend to any resource that is not easily held or improved and is of great value to the public. The state Supreme Court held that the plaintiffs’ test was too broad to be adopted and remanded the case to the lower court. 

No. 1 – CARES Act, CFAP Programs and Disaster Legislations and CAA, 2021

Quite clearly, the biggest development of 2020 involved the numerous tax and loan provisions enacted in an attempt to offset the loss of income and closure of business resulting from the actions of various state governors as a result of the virus.  Also, the various pieces of legislation made some of the most significant changes to the retirement planning rules in about 15 years.  In addition, tax provisions were contained in disaster legislation that took effect in 2020.  In late December of 2020, the Consolidated Appropriations Act of 2021 (CAA, 2021) was signed into law.  This law made significant changes to the existing Paycheck Protection Program (PPP), and provided another round of payments to farmers and ranchers under the Coronavirus Food Assistance Program (CFAP).  The CAA, 2021 also extended numerous tax provisions that were set to expire at the end of 2020.


2020 was another big year in the ag law and tax world.  There’s never a dull moment. 

January 13, 2021 in Environmental Law, Income Tax, Regulatory Law | Permalink | Comments (0)

Friday, January 8, 2021

Continuing Education Events and Summer Conferences


There are a couple of online continuing education events that I will be conducting soon, and the dates are set for two summer national conferences in 2021. 

Upcoming continuing education events – it’s the topic of today’s post.

Top Developments in Agricultural Law and Tax

On Monday, January 11, beginning at 11:00 a.m. (cst), I will be hosting a two-hour CLE/CPE webinar on the top developments in agricultural law and agricultural taxation of 2020.  I will not only discuss the developments, but project how the developments will impact producers and others in the agricultural sector and what steps need to be taken as a result of the developments in the law and tax realm.  This is an event that is not only for practitioners, but producers also.  It’s an opportunity to hear the developments and provide input and discussion.  A special lower rate is provided for those not claiming continuing education credit.

You may learn more about the January 11 event and register here:

Tax Update Webinar – CAA of 2021

On January 21, I will be hosting a two-hour webinar on the Consolidated Appropriations Act, 2021.  This event will begin at 10:00 a.m. (cst) and run until noon.  The new law makes significant changes to the existing PPP and other SBA loan programs, CFAP, and contains many other provisions that apply to businesses and individuals.  Also, included in the new law are provisions that extend numerous provisions that were set to expire at the end of 2020.  The PPP discussion is of critical importance to many taxpayers at the present moment, especially the impact of PPP loans not being included in income and simultaneously being deductible if used to pay for qualified business expenses.  Associated income tax basis issues loom large and vary by entity type.

You may learn more about the January 21 event and register here:

Summer National Conferences

Mark your calendars now for the law school’s two summer 2021 events that I conduct on farm income tax and farm estate and business planning.  Yes, there are two locations for 2021 – one east and one west.  Each event will be simulcast live over the web if you aren’t able to attend in-person.  The eastern conference is first and is set for June 7-8 at Shawnee Lodge and Conference Center near West Portsmouth, Ohio.  The location is about two hours east of Cincinnati, 90 minutes south of Columbus, Ohio, and just over two hours from Lexington, KY.  I am presently in the process of putting the agenda together.  A room block will be established for those interested in staying at the Lodge.  For more information about Shawnee Lodge and Conference Center, you made click here:

The second summer event will be held on August 2-3 in Missoula, Montana at the Hilton Garden Inn.  Missoula is beautifully situated on three rivers and in the midst of five mountain ranges.  It is also within three driving hours of Glacier National Park, and many other scenic and historic places.  The agenda will soon be available, and a room block will also be established at the hotel.  You may learn more about the location here:


Take advantage of the upcoming webinars and mark you calendars for the summer national events.  I look for to seeing you at one or more of the events.

January 8, 2021 in Bankruptcy, Business Planning, Civil Liabilities, Contracts, Cooperatives, Criminal Liabilities, Environmental Law, Estate Planning, Income Tax, Insurance, Real Property, Regulatory Law, Secured Transactions, Water Law | Permalink | Comments (0)

Thursday, January 7, 2021

The “Top Ten” Agricultural Law and Ag Tax Developments of 2020 – Part One


After working through the “Almost Top Ten” agricultural law and tax developments of 2020, I have now reached what I consider to be the ten biggest developments of 2020 in terms of their significance to the agricultural sector as a whole.  Agricultural law and agricultural tax intersects with everyday life of farmers and ranchers in many ways.  Some of those areas of intersection of good, but some are quite troubling.  In any event, it points the need for being educated and having good legal and tax counsel that is well-trained in the special rules that apply agriculture.

Developments 10 through 8 of the “Top Ten” agricultural law and tax developments of 2020 – it’s the topic of today’s post.

No. 10 – Department of Justice Announces Investigation of Meatpackers

In May of 2020, President Trump asked the U.S. Department of Justice (DOJ) to investigate the pricing practices of the major meatpackers.  In addition, 11 state Attorneys General have asked the DOJ to do the same.  They pointed out in the DOJ request that the four largest beef processors control 80 percent of U.S. beef processing.  According to USDA data, boxed beef prices have recently more than doubled while live cattle prices dropped approximately 20 percent over the same timeframe.  The concern is that the meatpackers are engaged in price manipulation and other practices deemed unfair under federal law.

Questions about the practices of the meatpacking industry are not new – they have been raised for well over a century.  Indeed, a very significant federal law was enacted a century ago primarily because of the practices of the major meatpackers.  So, why is there still talk about investigations?  Is existing law ineffective?

Much of the matter is grounded in concerns about price manipulation by meatpackers.  Section 2020 of the Packers and Stockyards Act (PSA), 7 U.S.C. §§192(a) and (e) makes it unlawful for any packer who inspects livestock, meat products or livestock products to engage in or use any unfair, unjustly discriminatory or deceptive practice or device, or engage in any course of business or do any act for the purpose or with the effect of manipulating or controlling prices or creating a monopoly in the buying, selling or dealing any article in restraint of commerce. This is a distinct concern in the livestock industry.

In June of 2010, the USDA issued proposed regulations providing guidance on the handling of antitrust-related issues under the PSA.  75 Fed. Reg. No. 119, 75 FR 35338 (Jun. 22, 2010).  Under the proposed regulations, "likelihood of competitive injury" was defined as "a reasonable basis to believe that a competitive injury is likely to occur in the market channel or marketplace.”  It includes, but is not limited to, situations in which a packer swine contractor, or live poultry dealer raises rivals' costs, improperly forecloses competition in a large share of the market through exclusive dealing, restrains competition, or represents a misuse of market power to distort competition among other packers, swine contractors, or live poultry dealers.  It also includes situations “in which a packer, swine contractor, or live poultry dealer wrongfully depresses prices paid to a producer or grower below market value, or impairs a producer's or grower's ability to compete with other producers or growers or to impair a producer's or grower's ability to receive the reasonably expected full economic value from a transaction in the market channel or marketplace."  According to the proposed regulations, a “competitive injury” under the PSA occurs when conduct distorts competition in the market channel or marketplace.  The scope of PSA §202(a) and (b) is stated to depend on the nature and circumstances of the challenged conduct. The regulations specifically note that a finding that a challenged act or practice adversely affects or is likely to affect competition is not necessary in all cases.  The proposed regulations note that a PSA violation can occur without a finding of harm or likely harm to competition, but as noted above, that is contrary to numerous court opinions that have decided the issue.  The regulations eventually made it into the form of an Interim Final Rule but were later withdrawn.  82 FR 48594 (Oct. 18, 2017).

If the investigation is actually conducted, results could occur that would be very positive to livestock producers (and consumers) throughout the nation.

No. 9 – Conservation Easements

During 2020, the U.S. Tax Court and the appellate courts continued to issue numerous opinions involving the donation of permanent conservation easements to qualified organizations and the donor claiming an associated charitable deduction.  Presently, the U.S. Tax Court has over 100 cases on its docket involving donated conservation easements.  A donated conservation easement involves a legal agreement between a landowner and either a government agency or a land trust specifying that the donated land must be used in ways that preserve specified conservation/preservation goals. 

Very specific requirements contained in the Internal Revenue Code must be satisfied to secure a charitable deduction for the donor.  Those rules include a requirement that the donated easement be perpetual in nature and that any proceeds received upon judicial extinguishment of the easement be split between the donor and the donee in a prescribed manner.  The easement must also be valued very carefully and meet IRS guidelines.  In addition, syndicated easement transactions receive heightened scrutiny by the IRS.   A syndicated conservation easement transaction is one where the tax benefit is split among various investors.  It is a transaction that the IRS has identified as “abusive” when an appraisal is used to value the donated land that overvalues the land at issue and, thus, inflates the donor’s charitable deduction.

During 2020, the IRS offered a settlement program for persons and entities engaging in transactions that the IRS viewed as improper by allowed such taxpayers to avoid litigation by paying penalties and surrendering any tax benefits already received.  Relatedly, in 2020, the U.S. Senate started investigations into potential abuses involving conservation easements.  In August, the Senate published its findings, concluding the promoters of syndicated conservation easements and those participating in the transactions had avoided paying billions in taxes improperly.  The Senate report termed syndicated conservation easement transactions as an “abusive tax shelter,” and that allowing such deals to continue “could undermine the U.S. Tax system.”

The heightened IRS scrutiny of conservation easement transactions, coupled with the very high rate of success in court challenging the claimed charitable deductions makes it critical that attorneys, other tax advisors and appraisers follow every rule.  Deeds conveying the easement must be very carefully drafted.     The IRS has indicated that it will examine every transaction and litigate all cases where it deems an inappropriate charitable deduction has been claimed.

 No. 8 – Farm Records and FOIA

Telematch, Inc. v. United States Department of Agriculture., No. 19-2372, 2020 U.S. Dist. LEXIS 223112 (D.D.C. Nov. 27, 2020)

Farmers disclose a great deal of information and data to the USDA (federal government) to be able to participate in federal farm programs.  The information/data is often tied to the particular farmer and farm location, thus raising privacy concerns over what persons and/or entities have access to it.  Indeed, in recent years some animal activists opposed to large-scale confinement livestock production have committed acts of vandalism (and worse) against targeted facilities. 

Because the information about farmers, their operations, and the locations of fields and facilities is in the hands of the USDA it is generally subject to disclosure to the public.  In 1967, the Congress enacted the Freedom of Information Act (FOIA).  5 U.S.C. §552.  The FOIA requires the disclosure of federal government documents upon request.   The idea behind the law is to make federal agencies more transparent.  But can a FOIA request reach private information of farmers that is in the USDA’s hands?  Isn’t this personal information private?  It’s an important concern for farmers.  In 2020, a federal court issued an opinion that could prove to be very helpful toward easing the concerns of agricultural producers wanting to ensure that their private information is protected from public exposure. 

In Telematch, the plaintiff was in the business of collecting and analyzing agricultural data from various sources, including the federal government. The plaintiff submitted seven FOIA requests to the USDA for specific records. The records sought included farm, tract, and customer numbers created by the USDA. The USDA created these numbers to assign them to land enrolled in USDA programs and to identify program participants. The USDA denied the plaintiff’s FOIA requests either in part or fully on the basis that the records at issue were geospatial information exempt from disclosure as relating to specific farm locations and specific farmers, and on the basis that the information sought would result in an unwarranted invasion of personal privacy.

The plaintiff administratively appealed the FOIA requests, and then sued in federal court three months later after being unsatisfied with the USDA’s failure to adjudicate the appeal. The plaintiff alleged that the USDA violated the FOIA by withholding the customer, farm, and tract numbers. Additionally, the plaintiff alleged the USDA violated the FOIA by following an unlawful practice of systematically failing to adhere to FOIA deadlines. The plaintiff claimed that no substantial privacy interest was at stake, and the public interest in obtaining the requested information outweighed any privacy concerns.

As a starting point, the trial court noted that the FOIA mandates that an agency disclose records on request, unless the records fall within an exclusion. As to the farm and tract numbers, the trial court held that the USDA properly withheld the information as geospatial information. The trial court held that the farm and tract numbers are geospatial information, as they refer to specific physical locations.  Thus, USDA had properly not disclosed them to the plaintiff. 

The trial court also held that the USDA also properly withheld the customer numbers from disclosure.  Disclosing them, the trial court determined, would have been an invasion of personal privacy.  The court noted that while the customer numbers alone did not reveal information about landowners, they could be combined with other public data to identify individual farmers and reveal information about their farms and financial status. The plaintiff claimed that disclosing the customer, farm, and tract numbers would allow the public to monitor how the USDA was administering its farm programs.  Likewise, the plaintiff argued that the disclosure of the information would let the public determine whether the USDA was overpaying program participants and allow the public to determine whether farmers are complying with the USDA program.  However, the trial court concluded that neither of the plaintiff’s arguments warranted the disclosure of the numbered information because the plaintiff showed no evidence to support its claim of fraud and because the FOIA’s purpose is to shed light on what the government is doing rather than the conduct of USDA program participants. As a result, the court held that the USDA also properly withheld the customer numbers.

As for the plaintiff’s claim that the USDA systematically failed to adhere to FOIA deadlines, the court held that the plaintiff lacked standing for failing to establish the existence of an unlawful policy or practice. The court noted that the USDA responded to the FOIA requests according to then-existing USDA regulations. The regulations stated that FOIA requests served on USDA required prepayments for the request to commence. The plaintiff failed to prepay on some of the requests, and the USDA completed the remainder of the requests within FOIA deadlines. Finally, the court held that the USDA’s failure to adhere to statutory deadlines to process the plaintiff’s administrative appeals did not rise to the level of systematically ignoring FOIA requests.

An appeal was filed in the case on December 21, 2020.


The DOJ investigating meatpackers; tax issues with donated conservation easements; and the privacy of farm data – developments ten through eight.  Next time, I continue working my way toward the most significant ag law and ag tax development of 2020.

January 7, 2021 in Income Tax, Regulatory Law | Permalink | Comments (0)

Sunday, January 3, 2021

The “Almost Top Ten” Ag Law and Ag Tax Developments of 2020 – Part Two


I continue today with my perusal of the biggest developments in agricultural law and taxation from 2020 with the second installment of the “almost top 10” of 2020.  In part one, I covered deprioritization (or the lack thereof) of withheld taxes in a Chapter 12 bankruptcy; the preferential payment rule in bankruptcy involving the Dean Foods matter; the significant ag nuisance jury verdict in North Carolina involving Murphy Brown; and a recent federal court opinion holding that filing a tax return with false information on

Part two of the “almost top ten of 2020” (in no particular order) – that’s the topic of today’s post.

“Renewable” Energy Cash Grants

Section 1603 of the American Recovery and Reinvestment Tax Act (ARRTA) was a green energy subsidy program created by the Congress and signed into law as a part of the 2009 economic “stimulus” package.  The program created a system of cash grants in lieu of investment tax credits for entities that installed various types of alternative energy property such as solar, wind, geothermal, biomass, and hydropower.  The purpose of payments (which were made after a qualified energy system was installed) was to reimburse grant recipients for a portion of the cost they incurred to install the energy systems at business locations.  The program started in 2009 and ended in 2012.

The program is not without criticism and IRS scrutiny.  The IRS rigorously audits companies utilizing the grants and, in some instances, the courts have ruled for the companies when the IRS partially denied the grants.  Those cases primarily involved indemnity agreements that allowed the financiers of the projects to recover their funds elsewhere if the grant was improperly disallowed.  In such “tax equity” deals it is common for the developer that finances a project to indemnify the tax equity investors if the tax benefits are less than expected. See, e.g., Alta Wind I Owner Lessor C v. United States, No. 13-402, 2020 U.S. Claims LEXIS 2071 (Fed. Cl. Oct. 21, 2020).  In Alta, the wind energy company plaintiff claimed that the government underpaid on the Sec. 1603 grant.  The court ruled that the company had alleged sufficient facts and injury to satisfy the constitutional standing requirement for the court to hear the case because the company had purchased the energy facilities at issue via a negotiated business transaction and alleged it had not been paid in full under Sec. 1603.

The IRS also won a significant case in 2020.  In early 2012, the plaintiff placed a qualified wind facility into service at a cost of $433,077,031. The plaintiff applied for a Section 1603 grant (in lieu of tax credits) of $129,923,109. As part of the grant application, the plaintiff submitted a development agreement that claimed to show a “proof of payment” in support of a $60 million development fee. The plaintiff, a “project company,” paid the development fee to its parent company, Invenergy, LLC. The U.S. Treasury awarded the plaintiff a grant of $117,216,098. The Treasury explained that the reason for the $12.7 million shortfall was based on the plaintiff’s excessive cost basis in the facility based on the inclusion of the development fee in the cost basis calculation. The Treasury asserted that the development fee transaction was a sham lacking economic substance shaped solely by tax avoidance motives.

The court agreed. Bank records showed that money passed through the bank accounts of several entities related to the plaintiff by wire transfer and then back into the original account. The court determined that the plaintiff could not establish any business purpose or economic substance to the banking transactions. A CPA from a national firm, as the result of an audit, testified that the development agreement contained no quantifiable services. Invenergy, LLC, was not able to produce any accounting journal entries showing a business purpose for the banking transactions. Thus, the court determined that the evidence showed a development fee with no quantifiable services, circular wire transfers that started and ended in the same bank account on the same day, none of which were corroborated by independent testimony. The court denied the plaintiff reimbursement of the $12,707,011 cash grant, and the U.S. Treasury was entitled to recover an overpayment of $4,380,039. Bishop Hill Energy, LLC, et al. v. United States, 143 Fed. Cl. 540 (2019). The court also reached the same conclusion in California Ridge Wind Energy, LLC v. United States, 143 Fed. Cl. 757 (2019).

The appellate court affirmed, upholding the trial court’s finding that amounts stated by the plaintiff in development agreements pertaining to the wind farms did not reliably indicate the development costs. The appellate court, on a consolidated appeal of the two cases, noted the “round-trip” nature of the payments; the absence in the agreements of any meaningful description of the development services to be provided, and the fact that all, or nearly all, of the development services had been completed by the time the agreements were executed. The appellate court also determined that the services were not quantifiable. As a result, the government could recover $10 million in cash grants from the two companies. California Ridge Wind Energy, LLC v. United States, 959 F.3d 145 (Fed. Cir. 2020).

The case is significant because it could impact the computation of tax credits for future projects. 

Trust Income Tax Regulations

On May 7, 2020, the IRS issued proposed regulations providing guidance on the deductibility of expenses that estates and non-grantor trusts incur.  REG-113295-18. The reason for the proposed regulations is that the Tax Cuts and Jobs Act (TCJA), effective for tax years beginning after 2017 and before 2026, bars individual taxpayers from claiming miscellaneous itemized deductions.  I.R.C. §67(g).  This TCJA suspension of miscellaneous itemized deductions for individuals raised questions as to whether and/or how estates and non-grantor trusts are impacted.  In late September, the IRS finalized the regulations.  TD 9918 (Sept. 21, 2020).

The Final Regulations affirm that deductions for costs which are paid or incurred in connection with the administration of an estate or trust and which would not have been incurred if the property were not held in such trust or estate remain deductible in computing AGI.  In other words, I.R.C. §67(e) overrides I.R.C. §67(g).  However, the Final Regulations do not provide any guidance on whether these deductions (including those under I.R.C. §§642(b), 651 and 661) are deductible in computing alternative minimum tax for an estate or trust.  That point was deemed to be outside the scope of the Final Regulations. 

As for excess deductions, the Final Regulations confirm the position of the Proposed Regulations that excess deductions retain their nature in the hands of the beneficiary.  Treas. Reg. §1.642(h)-2(a)(2).   Excess deductions passing from a trust or an estate have their nature pegged by Treas. Reg. §1.652(b)-3. The nature of excess deductions of a trust or an estate is determined by a three-step process:  1) direct expenses are allocated first (e.g., real estate taxes offset real estate rental income); 2) the trustee can exercise discretion when allocating remaining deductions – in essence, offsetting less favored deductions for individuals by using them against remaining trust/estate income (also, if direct expenses exceed the associated income, the excess can be offset at this step); 3) once all of the trust/estate income has been offset any remaining deductions constitute excess deductions when the trust/estate is terminated that are allocated to the beneficiaries in accordance with Treas. Reg. §1.642(h)-4.  Treas. Reg. 1.642(h)-2(b)(2).   

Lying With Purpose of Harming Livestock Facility is Protected Speech

Animal Legal Defense Fund v. Schmidt, 434 F. Supp. 3d 974 (D. Kan. 2020)

Beginning with Kansas in 1990, several states have enacted legislation designed to protect confined animal production facilities from sabotage activity from groups and individuals opposed to animal agriculture.  The laws generally forbid undercover filming or photography of activity on farms without the owner's consent.  They have been challenged as unconstitutional on numerous occasions. 

In this federal case involving Kansas law, the plaintiffs are a consortium of activist groups regularly conduct undercover investigations of livestock production facilities. Some of the plaintiffs gain access to farms through employment without disclosing the real purpose for which they seek employment (and lie about their ill motives if asked) and wear body cameras while working. For those hired into managerial and/or supervisory positions, they gain the ability to close off parts of the facility to avoid detection when filming and videoing. The film and photos obtained are circulated through the media and with the intent of encouraging public officials, including law enforcement, to take action against the facilities. The employee making the clandestine video or taking pictures, is on notice that the facility owner forbids such conduct via posted notices at the facility. The other plaintiffs utilize the data collected to cast the facilities in a negative public light but do no “investigation.”

In 1990, Kansas enacted the Kansas Farm Animal and Field Crop and Research Facilities Protect Act (Act). K.S.A. §§ 47-1825 et seq.  The Act makes it a crime to commit certain acts without the facility owner’s consent where the plaintiff commits the act with the intent to damage an animal facility. Included among the prohibited acts are damaging or destroying an animal facility or an animal or other property at an animal facility; exercising control over an animal facility, an animal from an animal facility or animal facility property with the intent to deprive the owner of it; entering an animal facility that is not open to the public to take photographs or recordings; and remaining at an animal facility against the owner's wishes. K.S.A. § 47-1827(a)-(d). In addition, K.S.A. § 47-1828 provides a private right of action for "[a]ny person who has been damaged by reason of a violation of K.S.A. § 47-1827 against the person who caused the damage." For purposes of the Act, a facility owner’s consent is not effective if it is induced by force, fraud, deception duress or threat. K.S.A. § 47-1826(e). The plaintiff challenged the constitutionality of the Act, and filed a motion for summary judgment. The defendant also motioned for summary judgment on the basis that the plaintiffs lacked standing or, in the alternative, the Act barred trespass rather than speech.

On the standing issue, the trial court held that the plaintiffs lacked standing to challenge the portions of the Act governing physical damage to an animal facility (for lack of expressed intent to cause harm) and the private right of action provision, However, the trial court determined that the plaintiffs did have standing to challenge the exercise of control provision, entering a facility to take photographs, etc., and remaining at a facility against the owner’s wishes to take pictures, etc. The plaintiffs that did no investigations but received the information from the investigations also were deemed to have standing on the same grounds. On the merits, the trial court determined that the Act regulates speech by limiting what the plaintiffs could say and by barring pictures/videos. The trial court determined that the provisions of the Act at issue were content-based and restricted speech based on viewpoint – barring only that speech that would harm an animal facility. The trial court determined that barring lying is only constitutionally protected when it is associated with a legally recognizable harm, and the Act is unconstitutional to the extent it bars false speech intended to damage livestock facilities. Because the provisions of the Act at issue restrict content-based speech, its constitutionality is measured under a strict scrutiny standard. As such, a compelling state interest in protecting legally recognizable rights must exist. The trial court concluded that even if privacy and property rights involved a compelling state interest, the Act must be narrowly tailored to protect those rights. By focusing only on those intending to harm owners of a livestock facility, the Act did not bar all violations of property and privacy rights. The trial court also determined that the Governor was a proper defendant. 

In a later action, the court entered a permanent injunction against enforcement of Kan. Stat. Ann. §§47-1827(b)-(d).  Animal Legal Defense Fund v. Kelly, No. 18-2657-KHV, 2020 U.S. Dist. LEXIS 58909 (D. Kan. Apr. 3, 2020).  A notice of appeal of the court’s decision was filed on May 1, 2020.  In July, the court trimmed-down the plaintiff’s request of attorney fees and costs from almost $250,000 to slightly over $176,000.  Animal Legal Defense Fund v. Kelly, No. 18-2657-KHV, 2020 U.S. Dist. LEXIS 124,480 (D. Kan. Jul. 15, 2020). 


In the next post, I will continue the look at the “almost Top 10” of 2020 with Part 3.

January 3, 2021 in Estate Planning, Income Tax, Regulatory Law | Permalink | Comments (0)

Thursday, December 24, 2020

Taxation of Settlements and Court Judgments


Farming and ranching, while it can provide a rewarding way of life for those involved, is a very dangerous occupation.  Working with or around machinery and equipment, hazardous chemicals and pesticides, livestock, water, and projects that involve electricity are just some of the activities that can lead to injury or death.   Sometimes, legal recourse is sought and that can lead to a court judgment or a settlement.

How is a monetary court award or settlement taxed?  It’s an important question, particularly when the amount of the award or settlement is large.  A recent IRS private ruling illustrates how the taxation of court awards and settlements are taxed.

The taxation of monetary court awards or settlements – it’s the topic of today’s post.

The Basics

Generally, the courts use a fact based “origin of the claim” test to determine the tax character of court awards and settlement funds. See, e.g., French v. Comr., T.C. Sum. Op. 2018-36.  Under the test, any funds the taxpayer receives are deemed to be a substituted payment for the damages that the taxpayer was alleging.  As a result, an amount recovered will be determined either to be taxable or not subject to tax, with causality the key to the determination.  See, e.g., Lindsey v. Comr., 422 F.3d 684 (8th Cir. 2005)Often, that causality is tied to extrinsic factors such as the details of the litigation, allegations contained in the complaint, and how the settlement negotiations were proceeding. 

The “origin of the claim” test also determines the character of any taxable amount as either ordinary income or capital gain. 

Physical injury or sickness.  Recoveries from out-of-court settlements or as a result of judgments obtained may fall into any one of several categories. Quite clearly, damages received on account of personal physical injury or physical sickness are excluded from income.  I.R.C. §104(a)(2)Amounts received on account of mental distress may be received tax-free if the distress is directly related to personal injury. See, e.g., Barnes v. Comm’r, T.C. Memo. 1997-25. As the regulations point out, nontaxable damages include “an amount received (other than workmen's compensation) through prosecution of a legal suit or action based on tort or tort-type rights, or through a settlement agreement entered into in lieu of such prosecution.”  Treas. Reg. § 1.104-1.

Punitive damages.  Legislation enacted in 1996 specifies that recoveries representing punitive damages are taxable as ordinary income regardless of whether they are received on account of personal injury or sickness. Small Business Job Protection Act of 1996, P.L. 104-188, Sec. 1605(a); See, e.g., O'Gilvie v. United States, 519 U.S. 79 (1996). 

Lost profit.  The 1996 enactment also made it clear that damages not attributable to physical injury or physical sickness are includible in gross income.  In many lawsuits, there is almost always some lost profit involved and recovery for lost profit is ordinary income.  See, e.g., Simko v. Comm’r, T.C. Memo. 1997-9.  For recoveries in connection with a business, if the taxpayer can prove that the damages received were for injury to capital, no income results except to the extent the damages exceed the income tax basis of the capital asset involved.  The recovery is, in general, a taxable event except to the extent the amount recovered represents a return of basis.  Recoveries representing a reimbursement for lost profit are taxable as ordinary income.

Legal Challenge

In 2006, the U.S. Circuit Court of Appeals for the District of Columbia ruled that the distinction drawn in the 1996 amendment was unconstitutional. Murphy v. United States, 460 F.3d 79 (D.C. Cir. 2006). In the case, the plaintiff sued her former employer and was awarded $70,000 ($45,000 for mental pain and anguish and $25,000 for “injury to professional reputation”).  The plaintiff originally reported the entire $70,000 as taxable and then filed amended returns excluding the income.  The IRS maintained that the entire $70,000 was taxable, and the trial court agreed.  On appeal, the court held that the $70,000 was not excludible from income under the statute, but that I.R.C. §104(a)(2) was unconstitutional under the Sixteenth Amendment since the entire award was unrelated to lost wages or earnings, but were, instead, payments for the restoration of the taxpayer’s human capital.  Thus, the entire $70,000 was excludible from income. However, in late 2006, the court vacated its opinion and set the case for rehearing.  Upon rehearing, the court reversed itself and held that even if the taxpayer’s award was not “income” within the meaning of the Sixteenth Amendment, it is within the reach of the power of the Congress to tax under Article I, Section 8 of the Constitution.  In addition, the court reasoned that the taxpayer’s award was similar to an involuntary conversion of assets – the taxpayer was forced to surrender some part of her mental health and reputation in return for monetary damages.”  The U.S. Supreme Court declined to hear the case.  Murphy v. Internal Revenue Service, 493 F.3d 170 (D.C. Cir. 2007), reh’g. den., 2007 U.S. App. LEXIS 22173 (D.C. Cir. Sept. 14, 2007), cert. den., 553 U.S. 1004 (2008).

IRS Private Ruling

In Private Letter Ruling 202050009 (Sept. 10, 2020), the taxpayer was riding his bicycle on his way home from work when he was hit by an automobile.  He was severely and permanently injured, including sustaining a traumatic brain injury resulting in his cognitive impairment.  The taxpayer sued the company that employed the driver that hit him.  The complaint alleged damages on account of the defendant’s negligence, recklessness and the driver’s willful and wanton acts.  Damages were sought for the taxpayer’s medical bills; mental anguish; loss of enjoyment of life; disability; pain and suffering; and other injuries and damages, including loss of consortium for the taxpayer’s wife.  

The trial court jury found the defendant liable and awarded the taxpayer (and spouse) damages for past and future economic damages (medical bills) and for past and future non-economic damages (mental anguish).  The jury also awarded the taxpayer’s wife damages for past and future loss of consortium.

The IRS determined that the taxpayer’s damages were not taxable because the awarded damages were tied to the taxpayer’s physical injuries sustained as a result of the bicycle accident.   

Attorney Fees

As a side-note, if the amount of an award or court settlement includes contingent attorney fees, the portion of the award representing contingent attorney fees is includible in the taxpayer’s gross income.  Comm’r, v. Banks, 543 U.S. 426 (2005), rev’g and rem’g sub. nom., Banks v. Commr, 345 F.3d 373 (6th Cir. 2003).

For fees and costs paid after October 22, 2004, with respect to a judgment or settlement occurring after that date, legislation enacted in 2004 provides for a deduction of attorney’s fees and other costs associated with discrimination in employment or enforcement of civil rights.  I.R.C. § 62(a)(20).


Most legal actions brought by farmers or ranchers against others as a result of business transactions or tort-type injuries often involve an element of lost profit and some involve recovery of basis.  Therefore, there is likely to be at least a partially taxable event.  The proper characterization of recoveries is vitally important.  In addition, there may be a discharge of indebtedness involved and, in some instances, the transaction may be characterized as a “sale” of property to a creditor.

And a very Merry Christmas to all!

December 24, 2020 in Income Tax | Permalink | Comments (0)

Saturday, December 19, 2020

2021 Summer National Farm and Ranch Income Tax/Estate & Business Planning Conference


The curtain has dropped on my 2020 agricultural law and taxation “tour.”  As I write this, I am in transit returning to Kansas (and then Iowa) from the last stop of 2020 in San Angelo, Texas.  Many of you have already asked about the 2021 National Summer Farm/Ranch Income Tax/Estate and Business Planning Conference. 

In today’s article, I take a moment to mention an upcoming event and the summer conference(s). 

January Webinar

On January 11, 2021, I will be doing a live webinar worth two hours of CLE/CPE credit on the biggest developments in agricultural law and taxation during 2020.  I will also examine other significant developments and what the forthcoming legal and tax issues facing agriculture in the immediate future might be.  This webinar is for lawyers and other tax practitioners as wells as farmer, ranchers, agribusiness professionals, rural landowners, ag media and any others that have an interest in what is going on in the legal and tax world that affects agricultural production and land ownership.  I will dive into constitutional issues involving property rights; water law; environmental law and regulation, income tax issues; farm programs; and other legal and tax issues of importance.

You can learn more about and register for the January 11 event here:

Summer 2021 Conferences

Ohio conference.  Two national conferences are being planned for the summer of 2021.  The first event will be in Ohio either at the Salt Fork State Park Lodge and Conference Center near Cambridge, Ohio or at the Shawnee Lodge and Conference Center near Portsmouth, Ohio.  The dates will be either June 1-2; June 7-8 or June 14-15.  I am presently waiting on confirmation that the technology at the locations can meet our needs to provide a high-quality live simulcast of the conference over the internet.  I will announce the dates and location as soon as I have the details finalized, which should be by the end of this month.

You can learn more about the two possible Ohio locations here:;

Missoula, Montana.  The second summer national conference will be held in Missoula, Montana on August 2-3.  You can learn more about the venue for the Montana conference here:   It will also be simulcast live over the internet.

 As the program details are put together, I will provide more details.  Stay tuned.

December 19, 2020 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Sunday, December 6, 2020

Year-End CPE/CLE – Six More to Go


As 2020 winds down so do my continuing education events for the year.  These late year events are important for practitioners that need additional education credit by the end of the year.  I have six more events remaining this year, some in-person and some online.  One event is a two-hour ethics session for those still needing ethics credit before the year ends.

Year-end continuing education opportunities – it’s the topic of today’s post.

Upcoming Events

This week finds me in Salina, Kansas for the second day of a two-day professional tax training event.  This is a comprehensive conference digging into the specifics of what practitioners need to know for preparing 2020 tax returns for clients.  Included will be up-to-the-minute relevant developments from the courts and the IRS as well as all trust return preparation issues and examples.  More information about the Salina event can be found here:

Later this week, on Wednesday, I will be speaking at the AICPA Agriculture Conference.  This national conference is online.  I will be speaking on financial distress tax and non-tax issues facing farmers and ranchers that are struggling financially.  You can learn more about this event here:  The next day, I will be doing another Day 2 of a tax conference.  This event will be online, originating from the campus of Kansas State University (KSU).  This is an approved NASBA event.  Thus, CPAs can receive CPE credit for viewing online.  You can learn more about this event here:

On Friday, I will be doing a two-hour tax ethics session.  This session originates from Washburn Law School and will involve discussion of ethical issues that tax practitioners face when representing clients with tax issues and the preparation of returns.  Also, addressed will be Circular 230 issues and various ethical rules that CPAs and lawyers are subject to when representing clients.  More information about the ethics event can be found here:

The following week finds me in San Angelo, TX on December 17 and 18.  This event is sponsored by the San Angelo Chapter of the Texas Society of CPAs.  I will focus on farm estate and business planning as well as farm income tax.  More information about this event can be found here: and here:  The San Angelo event is my last scheduled event for the year.  It’s been quite a year.  While all of my professional engagements moved online from mid-March until mid-June, about half of them remained online since mid-June.  I start out on the road during the first week of January 2021. 

2021 summer events are being planned for Missoula, Montana as well as east Tennessee.  There possibly will be a third national event in late September.  I also do a number of in-house CPA and law firm training each year.  If your firm is looking for in-house training in 2021 and have an interest in what I can offer, please contact me and I will do my best to get you on the calendar. 

Also, tune in to RFD-TV/SiriusXM each week to hear the hosts interview me concerning various ag law and tax topics.  You can also find me every other Monday morning at 6:00 a.m. (central) on WIBW radio (580 a.m.) and every other Wednesday on KFRM 550 a.m. discussing the biggest and most critical developments in agricultural law and taxation.  All of these shows are captured and posted to the media page of the Washburn Agricultural Law and Tax Report –


2020 has been a challenge for many and has involved modifying the practice of law and/or tax and how client representation is engaged in.  It’s also been a challenge given the new virus-related legislation and the frequent changes that have come by way of questions and answers and various notices, news releases and postings on the IRS website.  Strange times, indeed.

Stay tuned.

December 6, 2020 in Business Planning, Estate Planning, Income Tax | Permalink | Comments (0)

Monday, November 30, 2020

Is Real Estate Held in Trust Eligible For I.R.C. §1031 Exchange Treatment?


A significant amount of farm and ranch land is held in a trust. Trusts are a popular part of many farm and ranch (and other) estate plans.  If farmland or ranchland is contained in a trust, is it still eligible to be exchanged for other real property and have the gain (or loss) on the transaction deferred under I.R.C. §1031?  If so, that means that placing land in a trust for estate planning (or other) reasons doesn’t eliminate the favorable tax consequences of I.R.C. §1031.

Whether real estate held in trust can qualify for like-kind exchange treatment – it’s the topic of today’s post. 

Trusts and I.R.C. §1031 – The Basics

There is no absolute bar against a trust being part of an I.R.C. §1031 transaction.  A trust can qualify if it otherwise satisfies the requirements of I.R.C. §1031.  However, the taxpayer that owns the relinquished property must be the same taxpayer that takes ownership of the replacement property.  This means that the taxpayer’s identity must not change between the time of the relinquishment of the real estate and the time the replacement real estate is received.  

With respect to a trust, the key determinations to be made are who (or what) is the taxpayer and whether the taxpayer’s identity is preserved during the exchange process.  A taxpayer’s identity is not necessarily the same concept than the manner in which property is titled.  Instead, the question is whether the entity holding title to the real estate (such as a trust) that is involved in an exchange preserves the taxpayer’s identity.  If the taxpayer’s identity changes between the time the taxpayer relinquishes the property and the time the replacement property is received, the same taxpayer will not have disposed of and received property.  

Grantor trusts.  If the trust is a grantor trust, such as a revocable trust, generally the grantor, trustee and beneficiary are same person.  Such a trust is a “tax disregarded” entity and all items of income, loss, deduction and credit and are taxed to the grantor.  The trust does not file a return in addition to that of the grantor.   Thus, the grantor can meet the is the taxpayer and the taxpayer’s identity is preserved.  This all means that a revocable living trust can be utilized as an ownership vehicle in a 1031 exchange - the grantor or trustee are considered the taxpayer. But, if the beneficiary is a different individual than the grantor, the beneficiary is not considered to be the taxpayer and cannot directly benefit from an I.R.C. §1031 exchange.

Non-grantor trusts.  Conversely, if the trust is a non-grantor trust (such as an irrevocable trust where the grantor has not retained other powers), the trust is the taxpayer that is engaged in the like-kind exchange transaction.  Unlike a revocable trust, an irrevocable trust has its own tax identification number and is not, for tax purposes, treated interchangeably with the grantor/settlor. But, an irrevocable trust can be a grantor trust if the grantor retains, for example, the “power to control beneficial enjoyment.”  I.R.C. §674. 

“Illinois” Land Trust

An Illinois land trust is comparable to a revocable living trust that is used to hold real estate.  It can be revoked or amended during the grantor’s life.  The trust’s grantor/beneficiary retains all rights and responsibilities of owning the real estate.  A land trust can only hold real estate interests, and the trustee is a professional trustee.  A land trust is recognized in a minority of states - Florida, Georgia, Hawaii, Illinois, Indiana, Montana, South Dakota and Virginia.

For land held in a land trust, title to the real estate is held by the trustee as the owner of the trust, and the trust owner holds the beneficial interest in the trust that holds the title to the property.  That created some uncertainty as to whether a land trust can be involved in an I.R.C. §1031 exchange because I.R.C. §1031 restricts the exchange of a beneficial interest in an asset.  However, the IRS issued a Revenue Ruling in 1992 taking the position that an interest in an Illinois Land Trust is an interest in real property that can be exchanged for like-kind real estate.  Rev. Rul. 92-105, 1992-2 C.B. 204.  While a beneficiary’s interest in a land trust was deemed to be personal property under state (IL) law, that characterization didn’t control the outcome.  The IRS looked at the facts of the particular situation and noted that the trustee was only acting at the discretion of the taxpayer (beneficiary).  The trustee merely held title and could only potentially transfer that title.  Thus, the trust was an agency relationship between the trustee and beneficiary involving the holding and transferring of the title to the real estate contained in the trust.  The taxpayer/beneficiary retained the right to manage and control the trustee, and remained the direct owner of the property for tax purposes.  It was the beneficiary that remained obligated to pay the taxes and other liabilities associated with the trust property, and it was the beneficiary that had the exclusive right to the trust property’s earnings and profits.  Based on those facts, the IRS determined that the beneficiary’s interest in the trust was an interest in real property that could be exchanged for other real property and qualify for deferral of gain (or loss) via I.R.C. §1031

The trust and the relationship of the parties in the 1992 ruling was not determined to be a partnership.  If the IRS had determined that a partnership was involved, that would have meant that the beneficiary’s interest in the real estate in the trust would not have qualified for like-kind exchange treatment – partnership interests are not eligible.  Important to that point, only one beneficiary was involved under the facts of the ruling.  With multiple beneficiaries, it may be easier for the IRS to asset that a partnership exists and deny I.R.C. §1031 eligibility.

Based on Rev. Rul. 92-105, if a trust (or similar arrangement created under state law) is merely an investment vehicle, it can qualify as like-kind to real property under I.R.C. §1031.  That’s certainly the case for a trust if the trustee has title to the real property in the trust; the beneficiary has the exclusive right to direct or control the trustee in dealing with title to the property; and the beneficiary has the exclusive control of the property’s management as well as the obligation to pay any taxes and other liabilities that relate to the property.   When those factors are present, an exchange transaction actually involves the exchange of the underlying trust property rather than an exchange of a certificate of trust beneficial interest, and the gain or loss on the transaction can be eligible for deferral under I.R.C. §1031.

Delaware Statutory Trust 

Twelve years after Rev. Rul. 92-105, the IRS issued another revenue ruling on the issue.  Rev. Rul. 2004-86, 2004-2 C.B. 191 involved a Delaware Statutory Trust (DST) that was formed to hold real property subject to a lease.  A DST is a form of business trust where the owner of a DST share is regarded as owning a beneficial interest in the trust.   Under the facts of the Rev. Rul., the trustee’s powers were limited to only collecting and distributing income.  As such, the DST was merely an investment trust and its interests could be exchanged for real property in an I.R.C. §1031 transaction.  Specifically, Rev. Rul. 2004-86, stands for the proposition that a DST can be utilized for the purchase of replacement property in an I.R.C. §1031 exchange.  However, with more retained powers in the trustee, the IRS said that the trust would be a business trust rather than an investment trust and would not qualify for like-kind treatment.  Consequently, Rev. Rul. 2004-86 is quite limited.  But, if all of the interests in the trust are of a single class that represent undivided beneficial interests of the trust and the trustee cannot vary the trust’s investments, the trust will be an investment trust and its assets can be exchanged for real property with any gain qualifying for deferral under I.R.C. §1031.  On the other hand, if the trustee has greater discretion with respect to the trust property, those additional powers could cause disqualification from I.R.C. §1031 treatment.  Those additional powers could include, for instance, the power to dispose of the real property in the trust and acquire new property, the power to renegotiate leases on the trust property, or approve more than minor modifications or improvements to the property.  If those powers are present, the IRS could take the position that the trust constitutes a business entity not eligible for I.R.C. §1031 treatment.

Perhaps the most important aspect of Rev. Rul. 2004-86 is that the IRS at least impliedly classified the DST as a grantor trust.  Thus, real estate contained in a grantor trust could be exchanged for interests in a grantor trust containing real property and the transaction would qualify for deferral treatment under I.R.C. §1031.  That has important estate planning implications.

Safe Harbor for Trusts Holding Rental Real Estate 

An arrangement with a single class of ownership interests, representing undivided beneficial interest in the trust assets, is classified as a trust if there is no power under the trust agreement to vary the investment of the beneficiaries (“power to vary”).  Treas. Reg. §301.7701-4(c).  As noted above, in Rev Rul. 2004-86 the IRS took the position that a DST formed to hold real property subject to a lease was an arrangement classified as a trust for Federal tax purposes under Treas. Reg §301.7701-4(c). However, the trust would be a business entity and not a trust if the trustee had a power to, among other things, renegotiate the lease with the tenant, to enter into leases with other tenants, or to renegotiate or refinance the mortgage loan whose proceeds were used to purchase the real estate.

After the issuance of Rev. Rul. 2004-86, the IRS provided safe harbors for determining the Federal income tax status of certain securitization vehicles that hold mortgage loans. Under the safe harbors, certain modifications of mortgage loans in connection with forbearance programs described in that guidance are not treated as manifesting a power to vary.  When those safe harbors were issued, the IRS received comments addressing arrangements organized as trusts under Treas. Reg. §301.7701-4(c), and Rev. Rul. 2004-86 that hold rental real property. As a result, the IRS in 2020 provided additional guidance detailing actions that will not constitute a power to vary for purposes of determining whether the arrangement is treated as a trust under Treas. Reg. §301-7701-4(c) and Rev. Proc. 2020-34, Sec. 7.  Rev. Proc. 2020-26, I.R.B. 753.  Section 6 of the safe harbor allows these arrangements to make certain modifications to their mortgage loans and their lease agreements and to accept additional cash contributions without jeopardizing their tax status as trusts.

Specifically, under Rev. Proc. 2020-26, the following do not constitute a power to vary in violation of the regulation: 1) modification of one or more mortgage loans that secure the trust’s real property in a CARES Act forbearance or a forbearance that the trust requested, or agreed to, between March 27, 2020, and December 31, 2020, and that were granted as a result of the trust experiencing a financial hardship due to the actions of state governments in reaction to the China-originated virus; 2) modification of one or more real property leases entered into by the trust on or before March 13, 2020, where the modifications were requested and agreed to on or after March 27, 2020 and on or before December 31, 2020, and the reason for the lease modification is to coordinate the lease cash flows with the cash flows that result from one or more transactions described in the Notice or to defer or waive one or more tenants’ rental payments for any period between March 27, 2020 and December 31, 2020 because the tenants are experiencing a financial hardship due to the COVID-19 emergency; and 3) the acceptance of cash contributions that were made between March 27, 2020, and December 31, 2020, as a result of the trust experiencing financial hardship due to state government conduct in reaction to the China virus. However, the contribution must be needed to increase permitted trust reserves, to maintain trust property, to fulfill obligations under mortgage loans, or to fulfill obligations under real property leases. A cash contribution from one or more new trust interest holders to acquire a trust interest or a non-pro rata cash contribution from one or more current trust interest holders must be treated as a purchase and sale under I.R.C. §1001 of a portion of each non-contributing (or lesser contributing) trust interest holder’s proportionate interest in the trust’s assets. 


For real property contained in trust, if the trustee’s powers are limited, the real property can be exchanged for other real property and qualify for gain (or loss) deferral under I.R.C. §1031.  Land contained in a grantor trust is deemed to be owned by the individual grantor and remains eligible for I.R.C. §1031 treatment.  For land contained in a non-grantor trust, the language of the trust is critical.  For non-grantor trusts, the trust language must place sufficient limitations on the trustee’s powers to allow the trust beneficiary to receive like-kind exchange treatment under I.R.C. §1031.

The virus-related relief granted in 2020 is also helpful for providing guidance on the “power to vary” issue. 

November 30, 2020 in Income Tax | Permalink | Comments (0)

Thursday, November 26, 2020

Of Nuisance, Overtime and Firearms – Potpourri of Ag Law Developments


As readers of this blog know, periodically I write an article focusing on recent court developments.  This is one of those articles.  Recently, federal and state courts have issued some rather significant opinions involving livestock odors, overtime wages for dairy workers and the Second Amendment right to bear arms. 

A potpourri of ag law and related issues – it’s the topic of today’s post.

Appellate Court Upholds $750,000 Compensatory Damage Award in Hog Nuisance Suit

McKiver v. Murphy-Brown, LLC, No. 19-1019, 2020 U.S. App. LEXIS 36416 (4th Cir. Nov. 19, 2020)

A nuisance is an invasion of an individual's interest in the use and enjoyment of land rather than an interference with the exclusive possession or ownership of the land. The concept has become increasingly important in recent years due to land use conflicts posed by large-scale, industrialized confinement livestock operations.  Indeed, the industrialization of agriculture has given rise to nuisance suits brought by farmers against large-scale agricultural operations.

Nuisance law prohibits land uses that unreasonably and substantially interfere with another individual's quiet use and enjoyment of property.  The doctrine is based on two interrelated concepts: (1) landowners have the right to use and enjoy property free of unreasonable interferences by others; and (2) landowners must use property so as not to injure adjacent owners.

Nuisance law is rooted in the common law and has been developed over several centuries as courts settled land use conflicts.  Nuisance law is always changing, and the legal rules vary between jurisdictions.  Nuisance law is important to agriculture because of the noxious odors produced by many farm operations, especially those involving livestock production.

The two primary issues at stake in any agricultural nuisance dispute are whether the use alleged to be a nuisance is reasonable for the area and whether the use alleged to be a nuisance substantially interferes with the use and enjoyment of neighboring land.  Another issue may be whether the complained-of activity is protected by a state right-to-farm statute.

All of these concepts were involved in this case.  Here, the plaintiffs were pre-existing neighbors to the defendant’s large-scale confinement hog feeding facility conducted by a third-party farming operation via contract. The facility annually maintained nearly 15,000 of the defendant’s hogs that generated about 153,000 pounds of feces and urine every day. The waste was disposed of via lagoons and by spreading it over open “sprayfields” on the farm. The plaintiffs sued in state court in 2013 for nuisance violations, but later dismissed that action and refiled in federal court after learning of the defendant’s control over the hog feeding facility naming the defendant as the sole defendant.

The federal trial court coordinated 26 related cases against similar hog production operations brought by nearly 500 plaintiffs into a master case docket and proceeded with trials in 2017. In this case, the jury awarded $75,000 in compensatory damages to each of 10 plaintiffs and $5 million in punitive damages to each plaintiff. The punitive damage award was later reduced to $2.5 million per plaintiff after applying a state law cap on punitive damages.

On appeal, the appellate court determined that the trial court had properly allowed the plaintiffs’ expert testimony to establish the presence of fecal material on the plaintiffs’ homes and had properly limited the expert witness testimony of the defendant concerning odor monitoring she conducted at the hog facility. The appellate court also rejected the defendant’s claim that the third party farming operation should be included in the case as a necessary and indispensable party. The appellate court also affirmed the trial court’s holding concerning the availability of compensatory damages beyond the rental value of the property and the jury instruction on nuisance. The appellate court also concluded that the trial court properly submitted the question of punitive damages to the jury. The appellate court reversed the trial court’s admission of financial information of the defendant’s corporate grandfather and combining the punitive damages portion of the trial with the liability portion, but held that such errors did not require a new trial. However, the appellate court remanded the case for a consideration of the proper award of punitive damages without consideration of the grandparent’s company’s financial information (such as compensation amounts to corporate executives).

It’s also important to note that while North Carolina law was involved in this case, as a result of this litigation several states, including Nebraska and Oklahoma, have recently amended their state right-to-farm laws with the intent of strengthening the protections afforded farming operations. 

Overtime Exemption for Dairy Workers Unconstitutional. 

Martinez-Cuevas v. Deruyter Brothers Dairy, Inc., No. 96267-7, 2020 Wash. LEXIS 660 (Wash. Sup. Ct. Nov. 5, 2020)

Federal law provides an exemption from paying overtime wages for persons employed in agriculture.  Many states have a comparable exemption.  In this case, the exemption contained in Washington law was at issue.

The plaintiffs brought a class action on behalf of 300 of the defendant’s workers challenging the exemption of dairy workers from overtime pay under the Washington Minimum Wage Act. The plaintiffs also claimed that the defendant violated other wage and hour rules. The plaintiffs claimed that the overtime exemption violated the equal protection clause in the state constitution and was racially biased against Hispanic workers.

The state Supreme Court, in a 5-4 decision, the majority held that the exemption undermined a “fundamental right” to health and safety protections for workers in dangerous jobs that the state Constitution guarantees via the privileges and immunities clause. The majority focused on Article II, Sec. 35 of the Washington Constitution requiring the legislature to pass law necessary “for the protection of persons working in…employments dangerous to life or deleterious to health,” and Article I which the majority construed as protecting “fundamental rights of state citizenship.” The majority believed that there was a connection between the requirement that the legislature pass laws to protect workers in dangerous occupations and the minimum wage law, and that the legislature didn’t have a reasonable basis to exclude dairy workers from the overtime pay requirements of the law.

The dissenting justices pointed out that overtime pay is not a fundamental constitutional right and, as such, does not implicated the privileges and immunities clause. Instead, the state legislature has a “wide berth” to decide that laws that are required to carry out that purpose. The dissent pointed out that the legislature could simply repeal the overtime law and no person would have a personal or private common law right to insist on overtime pay absent an employment contract with a term promising overtime pay.

The ruling means that dairy farmers will be required to pay $20.54 per overtime hour beginning in 2021.  That is the case, of course, for the workers that still have a job, have overtime hours and aren’t displaced by automation.

Lifetime Ban on Owning Firearms For Filing Tax Returns With False Statement 

Folajtar v. The Attorney General of the United States, No. 19-1687, 2020 U.S. App. LEXIS 37006 (3rd Cir. Nov. 24, 2020)

Any law that impairs a fundamental constitutional right (any of the first ten amendments to the Constitution) is subject to strict scrutiny – or at least it’s supposed to be.  The right to bear arms, as the Second Amendment, is a fundamental constitutional right.  Thus, any law restricting that right is to be strictly scrutinized.  But, does a convicted felon always permanently lose the right to own a firearm.  What if the felony is a non-violent one?  These questions were at issue in this case.

The plaintiff pleaded guilty in 2011 to willfully making a materially false statement on her federal tax returns. She was sentenced to three-years’ probation, including three months of home confinement, a $10,000 fine, and a $100 assessment. She also paid back taxes exceeding $250,000, penalties and interest. Her conviction triggered 18 U.S.C. §922(g)(1), which prohibits those convicted of a crime punishable by more than one year in prison from possessing firearms. The plaintiff’s crime was punishable by up to three years’ imprisonment and a fine of up to $100,000.

As originally enacted in 1938, 18 U.S.C. §922(g)(1) denied gun ownership to those convicted of violent crimes (e.g., murder, kidnapping, burglary, etc.). However, the statute was expanded in the 1968. Later, the U.S. Supreme Court recognized gun ownership as an individual constitutional right in 2008. District of Columbia v. Heller, 554 U.S. 570 (2008). In a split decision, the majority reasoned that any felony is a “serious” crime and, as such, results in a blanket exclusion from Second Amendment protections for life. The majority disregarded the fact that the offense was non-violent, was the plaintiff’s first-ever felony offense, and was an offense for which she received no prison sentence. The majority claimed it had to rule this way because of deference to Congressional will that, the majority claimed, created a blanket, categorical rule.

The dissent rejected the majority’s categorical rule, pointing out that the plaintiff’s offense was nonviolent, and no evidence of the plaintiff’s dangerousness was presented. The dissent also noted that the majority’s “extreme deference” gave legislatures the power to manipulate the Second Amendment by simply choosing a label. Instead, the dissent reasoned, when the fundamental right to bear arms is involved, narrow tailoring to public safety is required. Because the plaintiff posed no danger to anyone, the dissent’s position was that her Second Amendment rights should not be curtailed. Likewise, because gun ownership is an individual constitutional right, the dissent pointed out that the Congress bears a high burden before extinguishing it. Post-2008, making a categorical declaration is insufficient to satisfy that burden, according to the dissent.

Expect this case to be headed to the U.S. Supreme Court.  Justices Barrett and Kavanaugh have already indicated that they agree with the dissent based on their comments in earlier cases.


There are always significant developments in the law impacting farmers and ranchers and rural landowners.  The three court opinions discussed in this article are each significant in their own respect.  Stay informed.  And, on this Thanksgiving Day 2020, if you don’t have everything you want, be thankful for the things you don’t have that you don’t want.

November 26, 2020 in Civil Liabilities, Criminal Liabilities, Income Tax, Regulatory Law | Permalink | Comments (0)

Tuesday, November 24, 2020

The Use of Deferred Payment Contracts - Specifics Matter


On this blog, I rarely repeat the coverage of an issue that I have already addressed.  The only exception to that basic rule is when there is a major development that materially alters the content of the issue or issues discussed.  But, sometimes I am reminded that some tax issues that seem to me to be obvious and well understood still need to be occasionally repeated.  One of those times is today, based on several recent calls and emails.

The proper structuring of deferred payment contracts – it’s the topic of today’s post.

General Rule

A cash-basis taxpayer accounts for income in the tax year that it is either actually or constructively received.  The constructive receipt doctrine is the primary tool that the IRS uses to challenge deferral arrangements.  Under Treas. Reg. §1.451-2(a)), a taxpayer is deemed to have constructively received income when any of the following occurs:

  • The income has been credited to the taxpayer’s account;
  • The income has been set apart for the taxpayer; or
  • The income has been made available for the taxpayer to draw upon it, or it could have been drawn upon if notice of intent had been given, unless the taxpayer’s control of the receipt of the income is subject to substantial limitations or restrictions.

However, income received under a properly structured deferred payment contract is taxed under the installment payment rules.  IRC §§453(b)(2); 453(l)(2)(A). 

Basic Deferral Arrangements

The most likely way for a farmer to avoid an IRS challenge of a deferral arrangement is for the farmer to enter into a sales contract with a buyer that calls for payment in the next tax year.  This type of contract simply involves the buyer’s unsecured obligation to purchase the agricultural commodities from the seller on a particular date.  Under this type of deferral contract, the price of the goods is set at the specified time for delivery, but payment is deferred until the next year.   If the contract is bona fide and entered into at arm’s length, the farm seller has no right to demand payment until the following year, and the contract (as well as the sale proceeds) is non-assignable, nontransferable and nonnegotiable, the deferral will not be challenged by the IRS.

The following criteria for a deferred payment contract should be met in order to successfully defer income to the following year.

  • The seller should obtain a written contract that under local law binds both the buyer and the seller. A note should not be used;
  • The contract should state clearly that under no circumstances would the seller be entitled to the sales proceeds until a specific date (i.e., a date in a future tax year). The earliest date depends on the farmer’s tax yearend.
  • The contract should be signed before the seller has the right to receive any proceeds, which is normally before delivery. That means that the contract should have been executed before the first crop delivery.    If the contract was not executed until after the crop proceeds were delivered, IRS can argue that the farmer actually had the right to the income, but later chose not to take possession of it until the next calendar year.  An oral agreement to the contrary can be difficult to prove.
  • The buyer should not credit the seller’s account for any goods the seller may want to purchase from the buyer during the year of the deferred payment contract (such as seed and/or fertilizer). Instead, such transactions should be treated separately when billed and paid. 
  • The contract should state that the taxpayer has no right to assign or transfer the contract for cash or other property.
  • The contract should include a clause that prohibits the seller from using the contract as collateral for any loans or receiving any loans from the buyer before the payment date;
  • The buyer should avoid sales through an agent in which the agent merely retains the proceeds. Receipt by an agent usually is construed as receipt by the seller for tax purposes.
  • Price-later contracts (where the price is set in a later year) should state that in no event can payment be received prior to the designated date, even if a price is established earlier.
  • The contract may provide for interest. Interest on an installment sale is reported as ordinary income in the same manner as any other interest income. If the contract does not provide for adequate stated interest, part of the stated principal may be recharacterized as imputed interest or as interest under the original issue discount rules, even if there is a loss. Unstated interest is computed by using the applicable federal rate (AFR) for the month in which the contract is made.

Contracts that lack these specifics run the risk of subjecting the seller to the constructive receipt rules with income recognition in the year of delivery.  Simply delivering the grain under a contract where the grain is credited to an open account with a delay in payment until proper accounting for grain deliveries and other required administrative steps have occurred will not likely be enough to deflect an IRS assertion of constructive receipt.  It may not matter much to the IRS that the farmer-seller is subject to  administrative and processing delays and, as a result, cannot actually receive payment until the next tax year.  The deferred payment contract must be in the proper form. A contract that states that payment is deferred until the next tax year and that it constitutes a voluntary extension of credit by the seller coupled with language stating that it can be changed in writing by the buyer’s authorized agents invites IRS scrutiny. 

Is There a Way To Provide Security? 

After an agricultural commodity is delivered to the buyer but before payment is made, the seller is an unsecured creditor of the buyer.  In an attempt to provide greater security for the transaction, a farmer-seller may use letters of credit or an escrow arrangement.  This could lead to a successful challenge by the IRS on the basis that the letters of credit or the escrow can be assigned, with the result that deferral is not accomplished. 

Although the general rule is that funds placed in escrow as security for payment are not constructively received in the year of sale, it is critical for a farmer-seller to clearly indicate that the buyer is being looked to for payment and that the escrow account serves only as security for this payment.  In addition, any third-party guarantee or standby letter of credit should be nonnegotiable and set up so that it can only be drawn upon in the event of default.  If the escrow account is set up properly, the funds held in escrow, and the accrued interest on those funds, is taxable as income in the year that it provides an economic benefit to the taxpayer. 

Tax Planning 

For deferred sales that are structured properly and achieve income tax deferral, installment reporting is automatic unless the taxpayer makes an election not to use it.  An installment sale is a sale of property with the taxpayer receiving at least one payment after the tax year of the sale. Thus, if a farmer sells and delivers grain in one year and defers payment until the next year, that transaction constitutes an installment sale.  If desired, the farmer can elect out of the installment-sale method and report the income in the year of sale and delivery. 

The election must be made by the due date, including extensions, of the tax return for the year of sale and not the year in which payment is to be received.  The election is made by simply recognizing the entire gain on the taxpayer’s applicable form (i.e., Schedule D or Form 4797), rather than reporting the installment sale on Form 6252, Installment Sale Income.

Because of the all-or-nothing feature (on a per-contract basis) of electing out of installment reporting, it may be advisable for farm taxpayers to utilize multiple deferred payment sales contracts in order to better manage income from year to year.  The election out is made by simply reporting the taxable sale in the year of disposition.  But, when the election out of the installment method is made by reporting the income in the year of the sale, the seller must be careful to make sure that the gain recognized is also not recognized in the following year.  A way to make sure that is done is to record a receivable for the amount of the accelerated sales, with the entry reversed after yearend.

Generally, if the taxpayer elects out of the installment method, the amount realized at the time of sale is the proceeds received on the sale date and the fair market value of the installment obligation (future payments). If the installment obligation is a fixed amount, the full principal amount of the future obligation is realized at the time of the acquisition.

What About An Untimely Death?

If a seller dies before receiving all of the payments under an installment obligation, the installment payments are treated as income in respect of a decedent (IRD).  I.R.C. §691(a)(4).  Therefore, the beneficiary does not get a stepped-up basis at the seller’s death.  The beneficiary of the payments includes the gain on the beneficiary’s return subject to tax at the rate applicable to the beneficiary.  The character of the payments is tied to the seller.  For example, if the payments were long-term capital gain to the seller, they are long-term capital gain to the beneficiary. 

Grain farmers often carry a large inventory that may include grain delivered under a valid deferred payment agreement.  Grain included as inventory but more properly classified as an installment sale may not qualify for stepped-up basis if the farmer dies after delivering the grain but prior to receiving all payments.

The only way to avoid possible IRD treatment on installment payments appears to be for the seller to elect out of installment sale treatment.  IRD includes sales proceeds “to which the decedent had a contingent claim at the time of his death.” Treas. Reg. §1.691(a)-1(b)(3). The courts have held that the appropriate inquiry regarding installment payments is whether the transaction gave the decedent at the time of death the right to receive the payments.  See, e.g., Estate of Bickmeyer v. Comm’r, 84 TC 170 (1985).   This means that the decedent holds a contingent claim at the time of death that does not require additional action by the decedent.  In that situation, the installment payments are IRD.

IRS Guide

Chapter 9 of the IRS Farmers Audit Technique Guide (ATG) provides a summary of income deferral and constructive receipt rules.  The ATG provides a procedural analysis for examining agents to use in evaluating deferred payment arrangements. The ATG is available


Agricultural producers typically have income streams that are less consistent from year to year than do nonfarm salaried individuals.  Deferred payment contracts can be used as key income tax planning tool for farmers.  But, it’s important to make sure they are structured properly to produce the desired tax results. 

November 24, 2020 in Income Tax | Permalink | Comments (0)

Monday, November 16, 2020

Merging a Revocable Trust at Death With an Estate – Tax Consequences


A revocable trust is a popular estate planning tool that is utilized as a will substitute.  Some people view it as a good alternative to a will for several reasons, including privacy and probate avoidance.  Unfortunately, some believe that a revocable trust will also save estate taxes compared to a properly drafted will.  It will not.  The very nature of the revocability of the trust means that the trust property is included in the decedent’s estate at death. 

While estate tax savings are not an issue with a revocable trust, it’s important to understand the income tax issues that can occur when the grantor of the trust dies and the trust assets become part of the grantor’s estate.  There’s a special tax election involved for a “qualified revocable trust” (QRT) and it has particular accounting and income tax consequences.  It can also provide some tax planning opportunities.

The tax and accounting rules surrounding the election to treat a QRT as an estate – it’s the topic of today’s post.

The I.R.C. §645 Election

The issue.  When the grantor of a revocable trust dies, the trust becomes irrevocable.  For tax purposes, the trust will have a calendar year – a short tax year from the date of death through December 31.  In addition, the trust will be a complex trust if the trustee is not required to make immediate distributions.  In that case, depending on the assets in the trust, the trust may earn income that will be taxed in accordance with the rate brackets applicable to a trust.  For 2020, the top rate of 37 percent is reached at $12,951 of trust income.  Of course, one possible solution to this problem is for the trustee to distribute the trust income to the beneficiaries so that it can be taxed at their (likely lower) tax rates.  But, if that additional income has not been planned for it could create tax issues for the beneficiaries such as underpayment penalties. 

Another option may be for the trustee/executor to make the I.R.C. §645 election for a QRT.

Mechanics.  A QRT is a domestic trust (or portion thereof) that is treated as owned by a decedent (a grantor trust) on the date of the decedent’s death by reason of a power to revoke that was exercisable by the decedent or with the consent of the decedent’s spouse.  I.R.C. §645(b)(1)For a QRT, the executor of the decedent’s estate, along with the trustee, can make an election to have the QRT taxed as part of the decedent’s estate for income tax purposes instead of as a separate trust.  I.R.C. §645(a).  In other words, a joint election by both the trust and the estate’s executor is required. 

Without the election, the revocable trust becomes irrevocable upon the decedent’s death and requires a separate income tax return (Form 1041) to report trust income (using a calendar year-end) that is earned post-death.  The merger of the trust and the estate for income tax purposes applies only to tax years that end before the date six months after the final determination of estate tax, or, if there is no estate tax return that is filed (Form 706), two years after the date of death.  I.R.C. §645(b)(2). 

If an executor is not appointed for the estate, the trustee files the election with an explanatory statement that no executor is being appointed for the estate.  The election is made by completing Form 8855 and attaching a statement to Form 1041 providing the name of the QRT, its taxpayer identification number and the name and address of the trustee of the QRT.

Once made, the election causes the trust to be treated for income tax purposes as part of the decedent’s estate for all applicable tax years of the estate ending after the date of the decedent’s death.  Id.  The electing QRT need not file an income tax return for the short year after the date of the decedent’s death.  Instead, the trustee of the electing QRT only need file one Form 1041 for the combined trust and estate under the estate’s TIN, and all income, deductions and credits are combined. 

The election allows a fiscal year-end to be utilized, ending at the end of a month not to exceed one-year after the decedent’s death.  The utilization of a fiscal year for income tax purposes can allow the estate executor to more effectively time the reporting of income and expense to achieve a more advantageous tax result.  For example, assume that an election is made for a QRT resulting in a tax year of December 1, 2020 through November 30, 2021.  A beneficiary receives a distribution on December 23, 2020.  As a result of the election, the beneficiary won’t have to report any income triggered by the distribution until 2021 and will have until April 15, 2022 to file the return that reports the income from the distribution.  Without the election, the distribution would have been taxed to the beneficiary in 2020 and reported on the 2020 return filed on or before April 15, 2021.   

The election can also allow for the loss recognition when a pecuniary bequest is satisfied with property having a fair market value less than basis.  I.R.C. §267(b).  One $600 personal exemption is allowed; the QRT can deduct amount paid to, or permanently set aside for charity; and up to $25,000 in passive real estate losses can be deducted.  I.R.C. §§642(b); 642(c); 469(i)(4).

Once the election is made, it is irrevocable.

Implications.  The I.R.C. §645 election, while resulting in one tax return for purposes of reporting income and expense on Form 1041, the trust and the estate are still treated as separate shares for purposes of calculating the distributable net income (DNI) deduction.  Treas. Reg. §1.645-1(e)(2)(iii).  The election does not combine the estate and trust for purposes of computing the DNI deduction. Thus, distributions can result in different allocation to beneficiaries and different amounts of income tax paid by the estate/trust. 

To illustrate, assume that an estate has $20,000 of income with no distributions made to the trust which, as typical, is the estate’s sole beneficiary.  The trust has $40,000 of income and made a $60,000 distribution to a beneficiary.  The income reported on Form 1041 is $60,000.  Under the Treas. Reg., the estate’s DNI is calculated separately from that of the trust.  In the example, the estate’s share of DNI is $20,000, but it gets no DNI deduction due to the lack of distributions during the tax year.  Conversely, the trust’s share of DNI is $40,000 and the trust’s DNI deduction is the lesser of the total cash distributed or the DNI.  Here, the DNI was less than the actual cash distributed resulting in a DNI deduction of $40,000.  The filed Form 1041 recognizes the $20,000 of taxable income and the beneficiary has $40,000 of income reported on the beneficiary’s individual return. 

Now assume that the estate distributes $20,000 to the trust, the trust’s share of income is $60,000 ($40,000 plus the $20,000 from the estate).  The full $60,000 of income is DNI of the trust, and the $60,000 distribution to the beneficiary causes the full $60,000 to be taxed at the beneficiary’s level.  There is no tax at the trust level to be taxed at the compressed bracket rates applicable to trusts and estates.  This all means that separate accounting for the trust and the estate must be done while the estate is being administered. 

When the election period ends or when the assets of the original trust are distributed to another trust, the new trust will file returns on a calendar year basis.  Thus, a filing will be required for the timeframe from the end of the fiscal year to the end of the calendar year after the termination.  In that instance, the beneficiaries could end up with two K-1s and the benefit of income deferral could be eliminated depending  on the tax bracket that the beneficiary is in.


Clearly there are several things to consider before making an I.R.C. §645 election.  For individuals that die late in the year, the election can allow estate administration to perhaps be completed before a tax return must be filed.  Thus, the first tax return could end up being the final tax return for the estate if the estate is fully administered by the time the return is due.  That would save administrative costs.  Also, the election can provide the ability to shift income into a later tax year; allow funds to be set aside for charity and receive a deduction but not have to distribute the funds until a later time; eliminate the need for estimated tax payments; and hold S corporate stock during the period of estate administration – an advantage over a trust if administration extends beyond two years.  But the separate share rule can complicate the accounting.  The trust and the estate are not combined for calculating the DNI deduction.  Separate accounting for the trust and estate is needed while the estate is being administered.

More things to think about when a decedent dies with a revocable trust.

November 16, 2020 in Estate Planning, Income Tax | Permalink | Comments (0)