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)

Thursday, December 3, 2020

Bankruptcy and the Preferential Payment Rule


Economic times continue to be difficult in much of agriculture.  2020 has been a difficult year economically for many agricultural producers as well as commodity processors and other agribusinesses.  An issue that frequently arises in bankruptcies of purchasers of agricultural products like grain, livestock, fruit or milk is known as the “preferential payment rule.”  It can be a surprise not only to farmers in financial distress, but also to creditors who receive payment for agricultural goods sold shortly before the buyer files bankruptcy.   It’s an issue that can arise in the normal course of doing business before bankruptcy is filed when nothing “unusual” appears to be happening.

A decade ago, the preferential payment rule arose in the context of the VeraSun bankruptcy.  Now, it’s back in relation to bankruptcy filing of Dean Foods, the largest dairy subsidiary company in the United States. Dean Foods and its forty-three affiliates filed Chapter 11 bankruptcy on November 12, 2019 in the United States Bankruptcy Court for the Southern District of Texas, which is being jointly administered under case no. 19-36313.  Earlier this week, Dean Foods and its affiliates filed a joint Chapter 11 plan of liquidation.

Farmers that sold milk to Dean Farms shortly before the bankruptcy filing are now receiving letters demanding repayment of the amount paid for those milks sales.  Do these demand letters need to be responded to?  Are they legitimate?  The answer rests in the bankruptcy code’s preferential transfer rule.

For today’s article, I have asked for insight from one of the premier farm bankruptcy attorneys in the country.  Joe Peiffer of Ag and Legal Business Legal Strategies of Cedar Rapids, Iowa helped author today’s article.  His insights on how farmers should respond to the demand letters being sent to farmers on behalf of Dean Foods are particularly insightful.

The preferential payment rule, a unique bankruptcy provision – it’s the topic of today’s post.

In General

11 U.S.C. §547 provides in general that when a debtor makes a payment to a creditor and the debtor files bankruptcy within 90 days of making the payment, the bankruptcy trustee can “avoid” the payment by making the creditor pay the amount received to the bankruptcy estate where it will be distributed to the general creditors of the debtor.  11 U.S.C. §547(b)(4)(A).  The timeframe expands from 90 days to one year if the creditor is an “insider.”  11 U.S.C. §547(b)(4)(B).  The rule can come as a shock to a creditor that has received payment, paid their own creditors from the funds received from the debtor, and now has no funds to pay the bankruptcy estate to satisfy the bankruptcy trustee’s avoidance claim. 

However, there is a jurisdictional limit.  When the bankruptcy trustee seeks to recover a money judgment of less than $25,000, any associated legal action must be brought in the defendant’s (dairy farmer’s) home jurisdiction.  28 U.S.C. § 1409(b).  Thus, a New York dairy farmer could only be sued in New York and a Wisconsin dairy farmer could only be sued in Wisconsin, etc., etc.  Out of 1,881 dairy farmers identified as potentially having been paid by Dean Foods within 90 days of the bankruptcy filing, 708 have total payments under the $25,000 threshold. 

There is also an administrative priority provision that can possibly apply.  Under this provision, claims for deliveries that are made within in 20 days of the bankruptcy filing are elevated to the priority of an administrative expense claim.  11 U.S.C. §503(b)(9).  In the Dean Foods bankruptcy, the 20-day timeframe would apply to deliveries made on or after October 23, 2019 until the petition date of November 12, 2019.  The provision only covers deliveries.  It does not cover payments.  Of the 13,510 potentially preferential payments listed in the Dean Foods Statement of Financial Affairs, 1,590 could potentially cover deliveries made in that 20-day period. 


The preferential payment rule does come with some exceptions.  The exceptions basically comport with usual business operations.  In other words, if the transaction between the debtor and the creditor occurred in the normal course of the parties doing business with each other, then the trustee’s “avoidance” claim will likely fail. 

Exchange for new value.  The bankruptcy trustee cannot avoid a transfer to the extent the transfer was intended by the debtor and the creditor (to or for whose benefit such transfer was made) to be a contemporaneous exchange for new value given to the debtor, and occurred in a substantially contemporaneous exchange.  11 U.S.C. §547(c)(1)(A-B).  A contemporaneous exchange for new value is not preferential because it encourages the creditor to deal with troubled debtors and because other creditors are not adversely affected if the debtor’s estate receives new value.  See, e.g., In re Jones Truck Lines, 130 F.3d 323 (8th Cir. 1997).  “New value” as used in Section 547(c) means “money or money’s worth in goods, services, or new credit.” 11 U.S.C. § 547(a)(2). An exchange for new value is presumed substantially contemporaneous if the transfer of estate property is made within seven days of the transfer of the new value.  See, e.g., In re Mason, 189 B.R. 932 (Bankr. N.D. Iowa 1995).

Ordinary course of business.  The bankruptcy trustee also cannot avoid a transfer  to the extent that the transfer was in payment of a debt that the debtor incurred in the ordinary course of the debtor’s business (or financial affairs) with the creditor, and the transfer was made in the ordinary course of business or financial affairs of the debtor and the creditor; or was made according to ordinary business terms.  11 U.S.C. §547(c)(2)(A)-(B).  If the transaction at is the first between the parties, “the transaction must be typical compared to both parties’ past dealings with similarly-situated parties.  In re Pickens, No. 06-01120, 2008 Bankr. LEXIS 6 (Bankr. N.D. Iowa Jan. 3, 2008). 

So how can a farmer demonstrate an ordinary course of business?  Basically, it is shown by demonstrating that the transfer to the debtor was consistent with a pattern of previous transfers between the parties. Business transactions between the parties that are within the norm of industry practice are essential to establishing that the transactions occurred in the ordinary course of business.  Also, a payment that is made in the “ordinary course of business” between the debtor and the creditor will involve invoices that are paid in the time period required on the invoice, or payment made in accordance with industry custom or past dealings.

Settlement Payment Via Forward Contract.  A trustee also cannot avoid a transfer that is a settlement payment made by a forward contract merchant in connection with a commodity contract or forward contract entered before the bankruptcy petition is filed.  11 U.S.C. §546(e). 

Security interest.  A trustee also cannot avoid a transfer that creates a security interest in property that the debtor acquires that secures new value given in accordance with a security agreement that contains a description of the property as collateral and is perfected on or before 30 days after the debtor receives possession of the property. 

Recent Case

A recent court decision from Arkansas illustrates how the preferential payment rule can apply in an agricultural setting.  In Rice v. Prairie Gold Farms, No. 2:17CV126 JLH, 2018 U.S. Dist. LEXIS 51678 (E.D. Ark. Mar. 28, 2018), the debtor was a partnership engaged in wheat farming activities.  The debtor entered into two contracts for the sale of wheat with a grain broker. The contracts called for a total of 10,000 bushels of wheat to be delivered to the broker anytime between June 1, 2014 and July 31, 2014. In return, the debtor was to be paid $6.78/bushel for 5,000 bushels and $7.09/bushel for the other 5,000 bushels for a total price of $69,350. The debtor delivered the wheat in fulfillment of the contracts on July 21, 2014 and August 4, 2014 and received $71,957.10 later in August, in return for a total delivery of 10,813.07 bushels.

The grain broker debtor subsequently filed Chapter 11 bankruptcy on October 23, 2014 (which was later converted to Chapter 7). The Chapter 7 trustee sought to avoid the payment for the farmer’s wheat crop by the grain broker as a preferential transfer under 11 U.S.C. §547(b) and return the money paid to the farmer for his wheat crop to the bankruptcy estate for distribution to creditors. The trial court disagreed with the trustee, noting that 11 U.S.C. §547(c)(1) disallowed avoidance of a transfer if it is made in a contemporaneous exchange for new value that the debtor received. The trustee claimed that the transfer of wheat was not contemporaneous because the contract was entered into in May and the wheat was not delivered and payment made until over two months later.

The trial court determined that the transfer was for new value and payment occurred in a substantially contemporaneous manner corresponding to the delivery of the wheat. Thus, the exception of 11 U.S.C. §547(c)(1) applied. The court also noted that the wheat sale contracts were entered into in the ordinary course of the debtor’s business and, thus, also met the exception of 11 U.S.C. §547(c)(2). The debtor and the grain broker had a business history of similar transactions, and the court noted that the trustee failed to establish that the wheat contracts were inconsistent with the parties’ history of business dealings.

In the Arkansas case, the court noted that the parties had prior dealings that they conducted in the same manner and that nothing was out of the ordinary.  There wasn’t any attempt to defraud creditors or shield assets from the reach of creditors.  That’s really the point behind the preferential transfer rule.  For those that continue conducting business as usual, the rule won’t likely come into play.

Response to Preference Demands

Information gathering.  For a farmer or other creditor that receives a demand letter from attorneys representing Dean Foods or any other debtor in bankruptcy, it is important to immediately assemble documentation to provide to competent bankruptcy counsel to respond to the demand for return of the preferential transfer.

Dairy farmers that were selling milk to Dean Foods directly or to a subsidiary that have received preference demand letters should assemble the following:

  • Payment evidence, such as milk check stubs or electronic funds transfer receipts. This  will show when the milk was delivered to the dairy, as well as when the dairy made payment for the milk.
  • Contracts for delivery of milk should be provided to counsel as it will assist the farmer in demonstrating that the payment by the dairy qualifies to protect the farmer from the preference demand. Since dairies generally make payment for the milk twice a month like clockwork, the preference demands can be defeated using the ordinary course of business defense outlined above.
  • Any other documentation that helps establish a normal, standard industry practice of business dealings with Dean Foods.

Positing a defense.  Failure to respond to the preference demand letters will generally mean that the dairy farmer will be sued by the liquidation trust in the United States Bankruptcy Court for the Southern District of Texas in Houston, TX.  Such a lawsuit will seek to recover the payments made within 90 days of the bankruptcy filing.. In the Dean Foods bankruptcy this would mean payments that cleared the dairy’s bank after August 14, 2019.

In many instances, demands for the return of payments made to farmers are made without any consideration by the demanding party having considered whether the defenses to a preference action, such as ordinary course of business, is applicable. The demands are frankly extortion demands seeking some money without any actual right to the money. The parties demanding return of the preferences are banking on the willingness of the farmer to purchase a release rather than consider defenses and respond to the preference demand so they can avoid the cost of defense of the preference action in Houston, TX. In the VeraSun bankruptcy case, a group of lawyers formed the VeraSun Preference Defense Group to analyze and propose responsive letters to the parties demanding the return of the allegedly preferential payments.  Most of the thousands of demands were withdrawn when the indefensible demands were exposed. A similar effort should be mounted in the Dean Foods bankruptcy. 


Understanding the preferential payment rule is important, especially in the context of agricultural bankruptcies.  The matter can get complicated in agricultural settings with the use of deferred payment contracts, forward grain contracts and the various types of unique business relationships that farmers enter into with the purchasers of their commodities.  Competent legal counsel well-trained in the intricacies of agricultural law is a must. 

December 3, 2020 in Bankruptcy | 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)

Saturday, November 21, 2020

When Is Transferred Property Pulled Back Into the Estate At Death? Be on Your Bongard!


When the federal estate tax exemption was much lower than it is now, gifting property played a much greater role in estate planning than it does now.  That gifting could consist of either an outright gift of property or a gift of an interest in an entity.  In either situation, the basic idea was to transfer value away, typically to other family members to keep the transferor’s estate at death beneath the level of the available estate tax exemption at death so that federal estate tax could be avoided. 

However, if a transfer isn’t done correctly, it runs the risk of being pulled back into the decedent’s estate and subjected to federal estate tax at death. 

Avoiding transferred property being included in a decedent’s estate at death – it’s the topic of today’s post.

Tax Code Provision and Tax Court Test

Under I.R.C. §2036, the value of a decedent’s gross estate includes the value of all property to the extent that the decedent had an interest in the property at the time of death.  That includes property that the decedent transferred but retained for life, or for any period of time tied to the decedent’s death the possession or enjoyment of the property.  I.R.C. §2036 also catches a retained right to receive income from the property or the right to designate who possesses the property or the income from the property.  The same is true for a retained right to vote stock of a corporation the decedent controls. 

When will a transfer be respected so that the transferred property will not be included in the transferor’s estate at death?  In Estate of Bongard v. Comr., 124 T.C. 95 (2005), the Tax Court set forth the standard concerning how to determine whether I.R.C. §2036 pulls property back into a decedent's estate. According to the Tax Court, transferred property will be pulled back into the decedent’s estate if the decedent made a transfer of property during life that was not a bona fide sale for adequate and full consideration, and the decedent retained an interest or right in the transferred property.  A sale is bona fide only if the evidence establishes the existence of a legitimate and significant nontax reason exists for the transfer.

Recent Case

The Tax Court’s Bongard standard was at issue in another Tax Court case decided earlier this year.  In Estate of Moore, T.C. Memo. 2020-40, the decedent, at age 88 in late 2004, started negotiations with prospective buyers for the sale of his farm.  However, before he could get the farm sold, he suffered a heart attack and was diagnosed with congestive heath failure.  Doctors told him that he wouldn’t live longer than six months.  Within a week after being discharged from the hospital, and while in in-home hospice care, the decedent worked with an attorney to formalize an estate plan – something he really hadn’t done up to this point in time.  His primary goal was to eliminate potential estate tax.  However, he also wanted to maintain control.  Those two goals can prove difficult to satisfy simultaneously. 

Ultimately, the attorney created various trust for the decedent – a revocable living trust; a charitable lead annuity trust; a trust for his children; a management trust; an irrevocable trust (also for the benefit of his children); and a family limited partnership (FLP).  The management trust (which made a nominal contribution to the FLP upon its formation) held a 1 percent general partner interest in the FLP.  The decedent held a 95 percent limited partnership interest in the FLP.  Each of his four children held a 1 percent limited partner interest. Purportedly, the purpose of the FLP was to provide protection against liability; protection against creditors; bad marriages; and to bring together a dysfunctional family.  Under the terms of the FLP agreement, no single partner could transfer any interest unless all partners agreed.

The decedent transferred all of his property (the farmland and his personal property) to the revocable living trust.  The trust contained a formula that transferred a part of the trust assets to the charitable trust with the goal of causing the least amount of federal estate tax to the estate.  Everything else, after payment of taxes and claims and distributions of specific bequests were specified to pass to the trust for the children.  The management trust held a 1 percent interest as a general partner in the FLP and, upon the decedent’s death, that interest was to be distributed to the trust for his children.  The decedent then transferred (via the revocable living trust) an 80 percent interest in his farmland and $1.8 million worth of assets to the FLP. 

Five days after forming the FLP, and within two months of his death, the decedent sold the farm for almost $17 million.  The FLP and the revocable trust transferred their respective interests in the farmland to the buyer.  The terms of sale allowed the decedent to continue to live on the farm and operate it (in accordance with his capability) until his death. 

After the sale, the decedent directed the FLP to transfer $500,000 to each of his four children in return for a five-year promissory note at a 3.6 percent interest rate per annum.  However, there was no amortization schedule for any of the notes, and none of the children made any payments.  Also, the FLP never attempted to collect on the notes, and the attorney that prepared the estate plan told the children that they didn’t have to pay on the notes.  The FLP then distributed (purportedly a loan) $2 million to the revocable living trust, that the decedent used to pay expenses, including the balance of the $320,000 attorney fee charged to set up all of the trusts and the FLP, and the tax obligation on the sale of the farm. 

Additionally, in late February 2005, the living trust transferred $500,000 to the irrevocable trust, which was treated as a $125,000 gift to each of the four children. Lastly, in early March 2005, the living trust transferred its entire limited interest in the FLP to the irrevocable trust in return for $500,000 cash and a note for $4.8 million. The decedent died in late March of 2005.

The decedent's federal estate tax return reported $53,875 for the management trust's 1% general partnership interest in the FLP; $4.8 million for the note receivable from the irrevocable trust; claimed a $2 million deduction for the debt owed to the FLP and a $4.8 million deduction for a charitable contribution to the charitable trust.  It also reported $1.5 million in taxable gifts; and $475,000 deduction for attorneys' fees associated with the administration of the decedent's estate (reported on Schedule J (the form where estate administration deductions are claimed), which was in addition to the $320,000 charged for establishing the estate plan).

The estate also filed a federal gift tax return for 2005. The return reported gifts of $125,000 for each of the decedent's children in the form of the $500,000 transfer to the irrevocable trust earlier that year.

The IRS issued a notice of deficiency to the estate determining a deficiency of nearly $6.4 million. Additionally, the IRS issued a notice of deficiency determining a gift tax liability of more than $1.3 million for the 2005 tax year.  While the Tax Court was tasked with addressing numerous legal/tax issues, a primary one was whether the value of the farm should be included in the decedent’s estate for tax purposes. 

The Bongard Application

Business purpose.  As noted above, one of the tests established by the Bongard decision is whether a transfer was made for a nontax business purpose.  That is usually evidenced by active management of the transferred asset(s).  But here, the Tax Court noted, the decedent sold the farm days after he transferred it to the FLP.  That meant that there was no business for the children to manage.  Only liquid assets remained in the FLP that the children did not manage.  Instead, and investment advisor was hired to manage the liquid assets.  Also, based on the evidence, there was no legitimate concern about creditor claims (another legitimate purpose for creating the FLP). In addition, the entire estate plan (including the formation of the FLP) was done in the imminence of death as part of a scheme to avoid tax.  The whole plan reeked of being testamentary in nature.

Retained interest.  Also, part of the Bongard test is that the decedent must not retain an interest in the transferred property.  But the Tax Court determined that the decedent had at least an implied agreement to retain possession or enjoyment of the farm property.  Indeed, he continued to live at the farm and made management decisions up to his death and treated the other FLP assets as his own by paying personal expenses (including attorney fees) with them and using FLP assets for making loans to his children.  In essence, he treated the FLP as his pocketbook. 

The retained possession or enjoyment of the transferred property along with the lack of a substantial nontax purpose caused inclusion of the farm property in the decedent’s gross estate at death.  The amount included in the estate was calculated as the value of the farm as of the date of death less the funds that left the estate between the time of the sale and the date of death.  I.R.C. §2043.

Other Issues

The Tax Court also determined that the “loan” from the FLP to the revocable living trust was not really a loan, thereby wiping out an estate tax deduction for the $2 million loan. There was nothing that indicated that it was a loan – no note; no interest; no collateral; no maturity date specified; and no payments were made or demanded. 

The Tax Court also agreed with the IRS that the “loans” to the children were gifts.  Again, like the purported loan from the FLP to the revocable living trust, there was nothing to indicate that the transfers to the children were anything other than gifts.  Those total gifts of about $2 million caused the additional gift tax to be included in the decedent’s estate as gifts within three years of death.  I.R.C. §2035(b). 


The Moore case is an illustration of what not to do.  Of course, the emphasis on avoiding federal estate tax was bigger at the time the planning was engaged in than it is now.  The federal estate tax exemption equivalent of the unified credit was only $1,500,000.  That’s a far cry from the current level of the exemption.  But, for those with large estates that face the potential of federal estate tax, the case clearly points out the peril that unplanned estates face in a rush to tidy matters up before time is up.

In addition, “death bed” estate planning is particularly not good when the planning tries to get too “cute.”  Formalities of entities and transfers must be followed and, when an FLP is involved, the transferor must retain sufficient assets personally to pay living expenses, etc.  Any use of the FLP assets after transfer to the FLP, must be via an agreement that clearly denotes that the assets belong to the FLP and that an appropriate amount is paid for the assets’ usage.  Retained possession and enjoyment of transferred assets is a big “no-no.” 

November 21, 2020 in Business Planning, Estate Planning | Permalink | Comments (0)

Wednesday, November 18, 2020

Beef May Be For Dinner, But Where’s It From?


Product labels abound.  For just about any product, the product label tells the consumer where that product was manufactured.  Food products also carry labels with lots of information.  The purpose is to give the consumer information about the product so that an informed buying decision can be made – including distinguishing products among various competitors.    

A contentious issue for a number of years in the livestock industry has involved the product label for beef.  When the label on a beef meat product in the grocery store says, for example, “Product of the U.S.A.” what message does that convey to the consumer?  What does it mean to you?  The answer is obvious.  But is the answer correct?

Labels on beef products – it’s the topic of today’s post.

Recent Case

If time permitted today, I would dig through the background on meat product labeling a bit more.  The legislative, statutory and regulatory history is quite interesting.  But, time does not permit that excursion today.  So, I will unravel the matter by discussing a recent case.

In Thornton v. Tyson Foods, Inc. et al., No. 1:20-CV-105-KWR-SMV, 2020 U.S. Dist. LEXIS 156059 (D. N.M. Aug. 27, 2020), the plaintiffs are beef producers and consumers that filed suit against the defendant, a producer and seller of beef products to retailers of beef products. The plaintiffs claimed that the defendant misleads retailers and consumers by labeling their beef “Product of the USA” when, in fact, the cattle are raised in foreign countries and imported into the United States as live cattle that are then slaughtered and processed in the United States.

The consumer plaintiff asserted a supposed class action of consumers that were allegedly deceived into paying higher prices for what the consumer believed to be American beef when it was allegedly foreign beef. The cattle producer plaintiff asserted a supposed class action of cattlemen who receive less for their cattle because of the influx of imported cattle that are then sold as a product of the United States. The consumer plaintiff alleged violations of the New Mexico Unfair Practices Act (NMUPA); breach of express warranty; and unjust enrichment. The cattle producer plaintiff also alleged a violation of the NMUPA as well as unjust enrichment, but later sought to amend the complaint to replace the NMUPA claim with a claim for violation of the New Mexico Antitrust Act.

The court noted that federal law via the Federal Meat Inspection Act (FMIA) bars meat from being sold “under any …labeling which is false or misleading, but labeling and containers which are not false or misleading and which are approved by the Secretary are permitted.” The USDA regulates beef labels through the Food Safety Inspection Service (FSIS). The court noted that the FSIS administers a label approval program “ensuring” that no meat products are falsely labeled. The court noted that the label at issue was approved by FSIS and found not to be misleading or false. The court also noted that the phrase “Product of the U.S.A.” to actually mean that the product is derived only from animals that were born, raised, slaughtered, and prepared in the United States. Instead, the phrase “Product of the U.S.A.” only means that the product was slaughtered in the United States. Also, the court noted that the FMIA treats imported beef products as a “domestic” product upon entry into the United States.

Thus, the court concluded, the law and related regulations were clear that cattle born and raised in a foreign country but slaughtered int the United States can be properly labeled as “Product of the U.S.A.” The court determined that the plaintiff’s state law claims were preempted by federal law. In addition, the court held that if the NMUPA claims were not preempted they would fail as a matter of law because the cattleman plaintiff is a competitor of the defendant under New Mexico law and because the defendant’s conduct is permissible under federal law. The unjust enrichment claims also failed as a matter of law because there is nothing unjust about the defendant’s use of a label that has been approved by the federal government. The breach of warranty claim also failed due to lack of pre-suit notice being given to the defendant in accordance with state law. The court also rejected the cattleman plaintiff’s attempt to amend the complaint to asset a violation of the New Mexico Antitrust Act on the basis of preemption by the FMIA, lack of standing and no anti-competitive injury. Consequently, all of the plaintiffs’ claims were either preempted or failed as a matter of law for failure to state a claim for which relief could be granted. The case was dismissed with prejudice. 


There you have it – the phrase, “Product of the U.S.A.” doesn’t mean that the animal from which the labeled meat came from was born and raised in the United States on a domestic cattle ranching operation.  It only means that the animal was slaughtered in the United States.  Words and phrases don’t necessarily mean what they say that they mean. 

The black-robed word peddlers will straighten it all out.

November 18, 2020 in Regulatory Law | 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)

Friday, November 13, 2020

Farmland Lease Income – Proper Tax Reporting


Yesterday’s article focused on the legal aspects of farmer/landowner relationships – tenant, cropper or farm manager.  Another aspect of leasing farmland involves the tax issues.  What is the proper way to report farm rental income?  Is the rental income subject to self-employment tax?  What about estate planning implications?

The tax implications of farmland rental income – it’s the topic of today’s article.

Reporting Farmland Lease Income

Farmland lease income may be reported on one of three possible IRS Forms: (1) Schedule F (Farm Income and Expenses); Form 4835 (Farm Rental Income and Expenses); and Schedule E. The appropriate Form depends upon whether the landlord is "materially participating" in the farming operation. Generally, a landlord receiving cash rent should file Schedule E to report the rental income.  The income is not from a farming operation, but from a rental.  Reporting the rental income on Schedule E also does not trigger the application of self-employment tax.  By statute, “rents from real estate and personal property leased with real estate” are not “trade or business incomeI.R.C. §1402(a).

If the lease is a crop or livestock share-rent arrangement, a materially participating landlord should report the income on Schedule F. If a share-rent landlord is not materially participating, the landlord should report the income on Form 4835.  For lease income that is reported on Schedule F, self-employment tax will apply, except for any portion of the rental income that relates to the rental of real estate improvements (e.g., a farm building or grain bin).  The amount apportioned to real estate improvements should be reported on Schedule E. 

What Is Material Participation?

Material participation is a key concept in the proper reporting of crop/livestock share lease income.  If the landlord materially participates under the lease, the landlord’s rental income is subject to self-employment tax. 

For purposes of self-employment tax being imposed under I.R.C. §1402, a landlord materially participates if all three of the following conditions are satisfied.

  • There is an arrangement between the owner (landlord) of the property and another person, that provides that the other person is to produce agricultural or horticultural commodities on that land;
  • Under the "arrangement", the landlord is to materially participate in the production or the management of the production of the commodities; and
  • The landlord does actually materially participate. R.C. §1402(a)(1).

A landlord also materially participates if the landlord satisfies any one of the four following tests:

Test 1:  The landlord does any three of the following:

  • Advance, pay, or stand good for at least half the direct cost of producing the crop;
  • Furnish at least half the tools, equipment, and livestock used in producing the crop;
  • Consult with your tenant; or
  • Inspect the production activities periodically.

Test 2:  The landlord regularly and frequently makes, or takes an important part in making, management decisions substantially contributing to or affecting the success of the enterprise.

Test 3:  The landlord works 100 hours or more spread over a period of five weeks or more in activities connected with crop production.

Test 4:  The landlord does things that, considered in their total effect, show that the landlord is materially and significantly involved in the production of the farm commodities.

In situations where a farmer either owns land outright or in in entity and cash leases the land to a farming entity in which the farmer materially participates, the rental income can be subject to self-employment tax unless the lease rate is set at fair market value and there is no connection between the lease and the farmer’s employment agreement with the farming entity . Martin v. Comr., 149 T.C. 293 (2017).  To bolster those points, the lease should be in writing and the labor provided to the farming entity should be under a written employment agreement calling for reasonable compensation.

While many farm landlords have only a verbal agreement with the tenant, clearly a written lease makes establishing the presence of material participation easier.  While the presence of material participation causes the rental income to be subjected to self-employment tax, it also can be beneficial for other tax and non-tax reasons – including post-death estate planning purposes. 

Cash Rent Income – Potential Drawbacks

While cash rental income is not subject to self-employment tax, other tax implications should be considered, such as the following:

  • The rental income is not treated as gross farm income for the exception to the estimated tax penalty. R.C. §6654(i).
  • The income does not count for the special treatment of soil and water conservation expenditures under I.R.C. 175.
  • The income will count for the exclusion of cost-sharing payments under I.R.C. 126.
  • The income is also potentially subject to the passive loss limitations of I.R.C. 469.
  • The income won’t count for purposes of expense method depreciation under I.R.C. 179.
  • With a very minor exception, farmland subject to an election under I.R.C. 2032A cannot be cash rented during the ten-year period following the date of the decedent’s death.
  • For a retired farm landlord under age 65 receiving Social Security benefits, cash rental income won’t diminish the payments.


The proper structuring of a farm lease arrangement is important for numerous tax reasons.  Some are more obvious than others, but all are important.  Proper tax planning is the key to obtaining the best result and avoid unintended consequences.

November 13, 2020 in Income Tax | Permalink | Comments (0)

Thursday, November 12, 2020

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


In the agricultural sector, agreements other than leases are sometimes utilized which authorize a person to conduct farming operations on behalf of the landowner.  The status of that person can differ.  The person may be classified as a farm tenant or an employee or a cropper.  What are the differences and why does the classification matter?     

The classification of persons conducting farming operations for a farm landowner – it’s the topic of today’s post.

Status of a Person Conducting Farming Operations

Some farming and ranching operations utilize employees, while other operations hire a farm management company or an individual as an independent contractor with compensation based on a certain number of dollars per acre to prepare, plant, cultivate and harvest. Custom cutters provide combine crews that follow the harvest each year from Texas to Canada. Usually, those who hire custom cutters treat them as independent contractors from a legal perspective.

While the status of a tenant or independent contractor is usually clear, the status of a cropper is less clear. A cropper occupies a legal position somewhere between the status of a tenant and an employee or independent contractor. A person is likely to be a cropper and not a tenant when the landowner supplies land and all the inputs, controls the operation of the farm and pays a portion of the crop to the person who actually raises and harvests the crop.

A cropper, unlike a tenant who has a possessory interest in the leased premises and control over the farming operation, only has permission to be on the land. A cropper does not have any legally enforceable interest in the crops and has only a contract right to be compensated in-kind for the cropper’s labor. This has bearing on whether the farmer is entitled to statutory notice of lease termination under state law.  Under Iowa law, for example, a “cropper” is distinguished from a “tenant.”  The relevant statute defines a person as a cropper rather than a tenant if the landowner supplies the land and the inputs, controls the operation of the farm and pays a portion of the crop to the person raising and harvesting the crop.  In that situation, the farmer has no legally enforceable interest in the crop or land involved, only has a contract right for compensation in-kind for labor provided, and is basically an employee of the landowner (i.e., a wage earner) that is hired to produce a crop. See Henney v. Lambert, 237 Iowa 146, 21 N.W.2d 301 (1946). Therefore, because a cropper does not have any property right in the leased premises, the cropper is not entitled to statutory notice of termination - there is no interest to be terminated.  Instead, a cropper’s “lease” terminates upon harvest of the crop. 

As opposed to a cropper, a farmer operating under a crop-share arrangement with the landowner is a crop-share tenant and not a cropper.  Thus, the statutory notice of termination requirement applies.  For example, in Hoffman v. Estate of Siler, 306 S.W.3d 854 (Mo. Ct. App. 2010), the plaintiff was held to be a year-to-year tenant under an oral farm lease rather than a cropper.  As a result, he was entitled to a statutory 60-day notice of termination of tenancy.  The arrangement was determined to be a typical 50/50 crop-share arrangement. The plaintiff supplied his own farming equipment, made all of the farming decisions, performed unpaid maintenance, applied for government programs and dealt with conservation agents. 

When a question arises with respect to the status of the parties, courts attempt to determine the intent of the parties as evidenced by the terms of the written or oral contract, circumstances surrounding the agreement, the action of the parties and the type of farming operation. Typically, no single factor controls. Instead, an examination of all the factors is necessary in most situations to determine the status of the parties. Indeed, most courts do not find controlling the parties’ characterization of the arrangement. But if a landowner gives exclusive possession of a farm to another party, some courts have held that act to establish a landlord-tenant relationship. As for croppers, a court could find them to be employees instead of independent contractors under a state workers’ compensation law.

Recent Case

The issue of the legal status of a farmer was involved in a recent Arizona case.  In F.S.T. Farms Inc. v. Vanderwey, 2019 Ariz. App. Unpub. LEXIS 1430 (Ariz. Ct. App. 2019), the plaintiff farmed for the defendant. The defendant leased farmland from a company and the plaintiff would farm the land, and both would split the crops produced. The state condemned the land and reached a settlement with the company, causing the defendant to be unable to furnish the land to the plaintiff. Neither the plaintiff nor defendant was a party to the condemnation action, and neither received any part of the settlement.

The plaintiff sued, alleging breach of contract and breach of the implied covenant of good faith and fair dealing. At trial, the main point of contention was whether the sharecrop agreement was a lease giving the plaintiff a property interest or a cropper’s contract creating an employment-like relationship. The plaintiff argued the agreement was a lease entitling him to one-half of the amount allocated to crop loss in settling the condemnation matter – approximately $500,000. While the defendant admitted contractual liability, he argued the agreement was a cropper’s contract, therefore the plaintiff’s damages should be limited to its lost profits totaling $10,000. The trial court jury found the agreement was a cropper’s contract and awarded the plaintiff damages of $207,214.40, equivalent to one-fifth of the settlement allocation.

On appeal, the defendant argued that the jury’s conclusion that the sharecropper agreement was a cropper’s contract necessarily limited the plaintiff’s recovery to $10,000. The appellate court held that as a matter of contract law, the plaintiff’s recovery was limited to the $10,000 in lost profits. The appellate court noted that the agreement provided that the parties would share all crops produced on the property and income received on account of growing and sale of crops from the property, and that while both parties were aware of the condemnation action, neither received any income from the settlement. The appellate court held that contract damages are intended to compensate for what the claimant lost because of the other party’s non-performance, and additional recovery is only available in exceptional circumstances, which were not present in this case. On remand, the trial court must determine the amount of damages on the plaintiff’s claims for breach of contract and breach of the implied covenant of good faith and fair dealing.


It is important that parties to a farming arrangement clearly understand the legal nature of the relationship and the legal implications that flow from that relationship.  Disappointed expectations can lead to litigation, and that’s what farmers and others in rural areas desire to avoid.  

November 12, 2020 in Contracts, Real Property | Permalink | Comments (0)

Friday, November 6, 2020

Ag and Tax In the Courts


The courts keep issuing rulings of importance to agricultural producers and others involved in agriculture or who own agricultural land.  Also, tax issues of general relevance continue to be resolved in the courts.  In today’s post, I take a look at some recent cases involving farm bankruptcy; the “public trust” doctrine; the proper tax classification of a work relationship; on-farm sales of processed beef; and zoning. 

A potpourri of ag and tax legal issues – these are the topics of today’s post.

Court Denies Proposed Sale of Land by Chapter 12 Debtor

In re Holthaus, No. 20-40065, 2020 Bankr. LEXIS 3001 (Bankr. D. Kan. Oct. 26, 2020)

The debtors (a married couple) owned farmland in two counties. They filed Chapter 12 bankruptcy and sought to sell three tracts of land through two contracts. 11 U.S.C. §363(b)(1) provides that a trustee "after notice and a hearing, may use, sell or lease, other than in the ordinary course of business, property of the estate." In determining whether to approve a proposed sale under 11 U.S.C. §363, courts generally apply standards that, although stated various ways, represent essentially a business judgment test. The debtors had not filed a reorganization plan at the time of the proposed sale of the land.

The first contract consisted of two parcels totaling 200 acres which would be used as prime cropland. The second contract was for 120 acres of cropland in need of erosion remediation and not eligible for participation in government agricultural programs in its current condition. The debtors claimed that there was an oral agreement to lease the purchased properties back to the debtors for $175 per acre per year after the sale, as well as a right of first refusal if the buyer were to sell the properties, so that the debtors could continue to farm the land. Both contracts were silent as to the amount of rent to be paid and whether the right of first refusal applied to all three of the properties. The debtors proposed to sell the prime cropland for $4,000 per acre, based on a recent sale of another property in the county.

The creditors had mortgage liens on the properties and vigorously opposed the sale of the three properties. The creditors argued that the debtors were undervaluing all three tracts of land. Specifically, the creditors argued that the debtors erred in relying on a past sale in the county to arrive at $4,000 per acre. The creditor argued that the recent sale involved land that included a significant portion of pasture and wasteland, and that the debtors’ land was compromised of high-quality tillable land and no waste. As a result, the creditors argued that the sale price of the prime cropland should be $5,000 per acre.

The bankruptcy court agreed with the creditors and held that the debtors had inadequately priced the prime cropland. However, the bankruptcy court held that the second contract did not undervalue the less desirable cropland. The bankruptcy court noted that although the debtors’ sale did not require satisfaction of outstanding liens, there were significant concerns about some aspects of the proposed sale. First, the debtors’ ability to resume farming would be dependent upon the lease of the three tracts after the sale for rent that would be less than the debtor’s present debt service. Additionally, the debtors’ right to lease would only last as long as the proposed buyer owned the properties. Consequently, the bankruptcy court denied the debtors’ proposed sale primarily due to an inadequate sale price for the prime cropland. 

Observation:  Clearly, not having the prime cropland exposed to the market through a listing was a problem.  If that had been done, there likely would have been testimony (and other evidence) to support the price in addition to the debtor's testimony.  Having an appraiser testify could have helped the debtor.

Public Trust Doctrine Inapplicable to Natural Resources Allegedly Harmed by “Climate Change” 

Chernaik v. Brown, 367 Or. 143 (2020)

I wrote recently about attempts to expand the “public trust” doctrine and the impact such an expansion would have on agricultural production and land ownership.  You can read that article here:  In that article I discussed a Nevada Supreme Court opinion in which the Court refused to expand the doctrine.  Now, the Oregon Supreme Court has likewise refused to expand the doctrine. 

In the Oregon case, 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. The Supreme Court remanded the case to the lower court. 

Zoning Ordinance Bars Keeping of Farm Animals 

Maffeo v. Winder Borough Zoning Hearing Board, 220 A.3d 1210 (Pa. Commw. Ct. 2019)

The plaintiff owned a two-acre property in an area zoned residential. She kept approximately 50 animals on the property including goats, donkeys, and chickens. The city manager’s office had received numerous noise and odor complaints regarding the animals. The city sent the plaintiff a cease and desist letter giving the plaintiff 20 days to remove the animals. A city ordinance prohibited any person from keeping goats, donkeys, and other farm animals on residentially zoned property. The plaintiff appealed the cease and desist letter to the defendant city, the zoning hearing board. The plaintiff admitted that most of her property was located within a residentially zoned district but argued that a small corner of the property was located in a conservation district allowing for agricultural uses. The zoning board denied the plaintiff’s argument and concluded that although part of the property was zoned for agricultural use, it was undisputed that the plaintiff’s animals were within 200 feet of a residential lot which violated a separate city ordinance.

The trial court affirmed. On appeal, the plaintiff argued the trial court failed to consider evidence that she properly cared for her animals and that her property had not been surveyed. Specifically, the plaintiff argued a letter from the county humane society should have been considered to show she properly cared for her animals. The appellate court held that although the letter was not in the record, both the zoning board and trial court had expressly considered the letter in making their respective rulings. The appellate court noted that the care for the animals was not at issue, but rather whether zoning rules and ordinance permitted the plaintiff to keep farm animals on her property. The appellate court also determined that a zoning survey of the property had been done recently, which showed that most of the property was within a residential district and only a small portion was zoned as conservation. The plaintiff failed to present any evidence to rebut the survey before the hearing board or trial court, therefore the appellate court held that the plaintiff was in violation of the city ordinance. Finally, the plaintiff argued the zoning board was unevenly enforcing its zoning ordinances because a neighbor had testified before the hearing board that he kept chickens on his property and a city officer had told him that doing so did not violate any city ordinance. The appellate court held that this evidence alone was insufficient to establish uneven enforcement without any other evidence presented. 

On-Farm Sales of Processed Beef Subject to Sales Tax 

Priv. Ltr. Rul. 8115 (Mo. Dept. of Rev., Sept. 25, 2020)

The taxpayer sought a ruling from the Missouri Department of Revenue (MDOR) concerning the sale of beef products from his farm. The taxpayer raises cattle, slaughters them, and then sends the beef out to be processed at a local processing plant. The taxpayer pays the processing plant for its services and then the taxpayer sells the resulting beef products to customers at his farm. The taxpayer’s question was whether the beef sales were subject to sales tax. The MDOR issued a ruling stating that the sales are subject to sales tax at the food tax rate of 1 percent. The MDOR noted that 7 U.S.C. §2012, defines “food” as "any food or food product for home consumption." The taxpayer was selling raw beef at retail for home consumption. 

Payments Received By CPA Were Wages and Not S.E. Income; Deductions Disallowed

Thoma v. Comr., T.C. Memo. 2020-67

The petitioner acquired a partial interest in an accounting firm and ultimately became the sole owner of the firm that he operated as a sole proprietorship. The petitioner later went into business with another accountant pursuant to two contracts. One contract purported to be a partnership agreement and the second contract “restated” the first contract. The plaintiff provided accounting services to the firm and also brought his own clients to the firm. He later sold his interest back to the business under an agreement stating that he didn’t retain any management or supervisory role in the business.

During the year of sale of his interest and the following year (2010 and 2011), the business made bi-weekly payments to the petitioner for accounting services. The business issued Schedules K-1 reporting the payments as guaranteed payments to a limited partner with no withholding. The petitioner did not receive any paid sick leave or paid vacation time. The business had a professional liability policy that included the petitioner. The petitioner received a letter from the Department of Justice requesting the records of a client and the petitioner responded to the letter without informing the business. That ultimately resulted in the business locking the petitioner out, barring him from the computer network and placing him on administrative leave and his relationship with the business being terminated.

The petitioner reported his income for 2010 and 2011 as self-employment income allowing him to claim deductions for deposits into his SIMPLE IRA and for health insurance premiums that he paid as well as for one-half of his self-employment tax liability. The IRS disallowed the deductions, recharacterizing the income as wages. That resulted in his expenses being treated as unreimbursed employee expenses deductible only as miscellaneous itemized deductions subject to the two-percent of adjusted gross income floor. Likewise, the petitioner’s health insurance deductions were only deductible as a medical expense deduction and the SIMPLE IRA deduction was disallowed. The IRS also imposed accuracy-related penalties.

The Tax Court agreed with the IRS position, concluding that the petitioner and the other accountant did not intend to carry on a business together or share profit and loss. Thus, they never formed a partnership. The 2010 agreement, the Tax Court determined resulted in an at-will employment arrangement with the petitioner having no management authority. The issuance of the Schedules K-1 were not controlling, but merely a factor in determining the existence of a partnership. The Tax Court also held that the petitioner was not an independent contractor because of the longstanding relationship of the petitioner and the other accountant. The accountant/firm retained the right to fire the petitioner and provided him with professional liability insurance, office space and tax prep software. The firm also retained control over the details of his work and he did not have any opportunity for profit or loss independent of the business. The IRS-imposed penalties were upheld. 


The courts again illustrate the numerous legal and tax issues that are relevant for farmers, ranchers rural landowners and taxpayers in general.  It’s always a good idea to have competent legal and tax counsel within arm’s reach.

November 6, 2020 in Bankruptcy, Income Tax, Real Property, Regulatory Law | Permalink | Comments (0)

Monday, November 2, 2020

Accrual Accounting – When Can a Deduction Be Claimed?


To claim a deduction on the current year’s tax return, a taxpayer using the accrual method must generally show “economic performance” concerning the item(s) for which a deduction is sought and that all events have occurred determining a liability and that the amount of the liability can reasonably be determined.  Treas. Reg. §1.461-1(a)(2)(i). 

These points came up recently in a case involving a California business that provides bulk-packaged tomato products to food processors.  The company also provides customer-branded finished products to the food service industry.  The question was whether the company could increase its cost of goods sold (COGS) for the costs it incurred to restore, rebuild, recondition and retest their manufacturing facilities for the tax years in issue. 

Deducting Expenses

When it comes to claiming a tax deduction, a taxpayer can take it on the return in the tax year that is consistent with the method of accounting that the taxpayer uses to compute taxable income.  I.R.C. §461(a)That means that for an accrual method taxpayer, a business expense can be deducted in the year the expense is incurred.  It doesn’t matter if the actual payment date is in a different year.  See, e.g., Caltex Oil Venture v. Commissioner, 138 T.C. 18 (2012), citing Treas. Reg. §1.461-1(a)(2).  So, when is an expense incurred?  It’s when an “all events” test is satisfied.  See Challenge Publications, Inc. v. Commissioner, T.C. Memo. 845 F.2d1541 (9th Cir. 1988).  Under the test, an item allowable as a deduction, cost or expense (liability) for federal income tax purposes is incurred if: 1) all of the events establishing the liability have occurred; 2) the amount of the liability is determinable with reasonable accuracy; and 3) economic performance has occurred.  Treas. Reg. § 1.446-1(c)(1)(ii)(B); I.R.C. §461(h)(4); Treas. Reg. §§1.461-1(a)(2); 1.461-4.  It must be fixed and absolute.  Brown v. Helvering, 291 U.S. 193 (1934).  It also must be unconditional. Lucas v. North Texas Lumber Co., 281 U.S. 11 (1930). 

The all events test isn’t satisfied, and a deduction isn’t allowed if the tax liability is contingent on the occurrence of a future event.  See Lucas v. American Code Co., 280 U.S. 445 (1930).  Conversely, a liability is established if the required performance is rendered or the date of payment is unconditionally due.  See, e.g., VECO Corp. & Subsidiaries. v. Comr., 141 T.C. 440 (2013).  Another way of stating the matter is that there must be something (such as a contract or a statute) that fixes the taxpayer’s obligation.  See, e.g., Exxon Mobil Corp. v. Commissioner, 114 T.C. 293 (2000); Amergen Energy Co., LLC v. United States, 113 Fed. Cl. 52 (2013).

Recent Case

In The Morning Star Packing Company, L.P., et al. v. Comr., T.C. Memo. 2020-142, the petitioner provided bulk-packaged tomato products to food processors and customer-branded finished products to the food service and retail trades.  The petitioner’s operation accounted for about 25 percent of the California processed tomato production and it supplied approximately 40 percent of the United States ingredient tomato paste and diced tomato markets.”  The petitioner operated around-the-clock during tomato harvest season, and operated under numerous state and federal food safety/cleanliness regulations.  Any violations (or even alleged violations) of those requirements could shut down the petitioner’s operation causing losses due to spoilage and contract defaults with growers and buyers.  Specifically, after the end of a tomato harvest season, the petitioner engaged in extensive clean-up.  If the petitioner didn’t engage in this meticulous post-harvest cleaning and the tomato line were to become contaminated all of the tomato products in the processing line would have to be dumped, the line sterilized at a large cost, and all had to be inspected by federal and state agricultural agencies.  In addition, farmer-sellers would have to be paid for their tomato crops and the petitioner would be in breach of the covenants contained in the credit lines (that required the petitioner to maintain its licenses and keep the equipment in good repair) with its lenders as well as its delivery contracts for processed tomatoes.   

The petitioner incurred costs to restore, rebuild, and retest the manufacturing facilities for use during the next production cycle. The accrued production costs included amounts to be paid for goods and services. The petitioner also maintained reserves to account for future costs associated with restoring, rebuilding, and retesting the manufacturing facilities for use during the next production cycle. The production accrual reserve accounts tracked amounts for production labor, boiler fuel, electricity, waste disposal, chemicals and lubrication, production supplies, repairs and maintenance, lease, production wages, and administration wages.

The accrued production costs were recurring, and the amounts set aside in the reserves covered the costs with reasonable accuracy.  IRS did not challenge the accuracy of the reserves.  The petitioner also documented the economic efficiency reasons why it delayed some of the restorative work as well as retesting and rebuilding work until near the beginning of the next production cycle.  

The petitioner deducted its clean-up costs (good and services, etc.) after a tomato harvest season in that tax year, even though the clean-up work actually occurred in the following tax year.  Economic performance of the production accrual liabilities didn’t occur until the petitioner’s next tax year.  At least that was the position of the IRS.  It claimed that the petitioner could not include the accrued costs in the cost of sales for the current year due to the economic performance requirement of I.R.C. §461(h)(3).  In particular, the IRS asserted that the petitioner couldn’t increase its COGS for the amount of the accrued production costs because the petitioner had not shown that all events had occurred to establish the fact of the liabilities. Economic performance had not occurred with respect to the liabilities to qualify for accrual for the years claimed – the third prong of the “all events” test. 

The petitioner claimed that it was entitled to the deduction because it had bilateral contracts for goods and services to recondition its manufacturing facilities, and that all events had occurred during the tax years in issue to establish the fact of the liabilities for the accrued production costs.  The petitioner also took the position that its credit agreements and multiyear contracts to supply customers with tomato products obligated them to incur the accrued production costs to restore, rebuild, and retest the manufacturing facilities.  The Tax Court disagreed.  The Tax Court noted that the credit agreements did not specifically set forth the petitioner’s obligations to provide a comparably sufficiently fixed and definite basis. Instead, the Tax Court concluded that the credit agreements included nonspecific text and generalized obligations that merely required to maintain its licenses and permits, and secure governmental approvals.  The agreements also also contained general language requiring the petitioner to comply with ‘all laws’, and ‘keep all property useful and necessary in its business in good working order and condition’. That language, the Tax Court concluded, didn’t specify which laws or regulations had to be complied with.  It also didn’t identify with any precision which property must be kept in good working order. The generalized obligations, the Tax Court reasoned, did not establish the petitioner’s  liabilities for the accrued production costs for the years in issue.  In addition, the Tax Court determined that the petitioner’s inclusion of the production costs in COGS for the years in issue result in a more proper match against income than inclusion in the taxable year. 

The petitioner also couldn’t avoid its tax problem by using a fiscal year from October 1 to September 30.  While good business reasons would have supported using such a fiscal year, I.R.C. §706 prevented it.


Clearly, and accrual basis taxpayer must closely scrutinize the liabilities that it seeks to deduct to make sure that all of the requirements of the all-events test  have been met to claim the deduction.  Satisfying the economic performance part of that test also requires careful drafting of credit agreements to fix the liabilities in the appropriate tax year. 

November 2, 2020 in Income Tax | Permalink | Comments (0)

Monday, October 26, 2020

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


I don’t normally bring back a prior blog article for readers, but the articles are stacking up (over 500) and newer readers are frequently joining.  So, some may not know that a prior post exists on a topic they are searching for information about.  Thus, I bring back a topic I wrote about over two years ago for re-posting today (with some updates).

It’s the time of year again when I field questions about whether it is permissible to pick up roadkill.  Often, the question is in relation to big game such as deer or bear or moose.  But, other times the question may involve various types of furbearing animals such as coyotes, raccoons or badgers.  I don’t get too many roadkill questions involving small game.  That’s probably because when small game is killed on the road, it is either not wanted or the party hitting it simply assumes that there is no question that it can be possessed.

There are many collisions involving wildlife and automobiles every year.  One estimate by a major insurance company shows that one out of every 169 motorists in the U.S. hit a deer during 2018.  Between mid-2018 and mid-2019, insurance industry data show that there were almost two million animal insurance claims filed in the United States.  To put it in perspective, that’s almost ten times the number of people that have died with the virus listed as one of their co-morbidities. Perhaps state governors professing deep concern about the number of virus infections should be severely restricting speed limits or mandating no non-essential night-time travel. 

If a wild animal is hit by a vehicle, the meat from the animal is the same as that from animal meat obtained by hunting – assuming that the animal is not diseased.  So, in that instance, harvesting roadkill is a way to get free food – either for personal consumption or to donate to charity.  

What are the rules and regulations governing roadkill?  That’s the topic of today’s post.

State Rules

Presently, the top four states experiencing the highest rate of animal (wildlife)/car with collisions are West Virginia, Montana, Pennsylvania and South Dakota.  Especially in those states, it’s helpful to know the rules that apply when an animal or fowl is struck.

Many states have rules on the books concerning roadkill.  Often, the approach is for the state statutes and the regulatory body (often the state Department of Game and Fish (or something comparable)) to distinguish between "big game," "furbearing animals" and "small game."  This appears to be the approach of Kansas and a few other states.  Often a salvage tag (e.g., “permit”) is needed to pick up big game and turkey roadkill.  This is the approach utilized in Iowa and some other states.  If a salvage tag is possessed, a hunting license is not required.  For furbearing animals such as opossums and coyotes that are roadkill, the typical state approach is that these animals can only be possessed during the furbearing season with a valid fur harvester license.  As for small game, the typical state approach is that these roadkill animals can be possessed with a valid hunting license in-season.  But variations exist from state-to-state. 

An approach of several states is to allow the collection of roadkill with a valid permit.  That appears to be the approach in Colorado, Georgia, Idaho, Illinois, Indiana, Maryland, New Hampshire, North Dakota, New York, Ohio, Pennsylvania and Tennessee.  Other states require the party hitting wildlife and collecting the roadkill to report the incident and collection within 24 hours.  Other states may limit roadkill harvesting to licensed fur dealers.  In these states (and some others), the general public doesn’t have a right to collect roadkill.  In Texas, roadkill-eating is not allowed (although a legislative attempt to remove the ban was attempted in 2014).  South Dakota has legislatively attempted to make roadkill public property.  Wyoming requires a tag be received from the game warden for possessing big game roadkill.  Oregon allows drivers to get permits to recover, possess, use or transport roadkill. 

Other states (such as Alabama) may limit roadkill harvesting to non-protected animals and game animals, and then only during open season.  The Alaska approach is to only allow roadkill to be distributed via volunteer organizations.  A special rule for black bear roadkill exists in Georgia.  Illinois, in certain situations requires licenses and a habitat stamp.  Massachusetts requires that roadkill be submitted for state inspection, and New Jersey limits salvaging roadkill to deer for persons with a proper permit. 

In all states, federally-protected species cannot be possessed.  If a question exists about the protected status of roadkill, the safest approach is to leave it alone.  Criminal penalties can apply for mere possession of federally protected animals and birds.  Similarly, if a vehicle does significant enough damage to wildlife that the animal’s carcass cannot be properly identified to determine if the season is open for that particular animal (in those states that tie roadkill possession to doing so in-season) the recommended conduct is to not possess the roadkill.   

In the states that have considered roadkill legislation in recent years, proponents often claim that allowing licensed hunters to take (subject to legal limits) a fur-bearing animal from the roadside would be a cost-saving measure for the state.  The logic is that fewer state employees would be required to clean-up dead animal carcasses.  Opponents of roadkill bills tend to focus their arguments on safety-related concerns – that having persons stopped alongside the roadway to collect dead animals would constitute a safety hazard for other drivers.  That’s an interesting argument inasmuch as those making this claim would also appear to be asserting that a dead animal on a roadway at night is not a safety hazard.  Others simply appear to argue that collecting roadkill for human consumption is disgusting. 


There is significant variation among state approaches with respect to possession of roadkill.  That means that for persons interested in picking up roadkill, researching applicable state law and governing regulations in advance would be a good idea.  For roadkill that is gleaned from a roadway that is used for human consumption, care should be taken in preparation and cooking.  The present younger generation typically doesn’t have much experience dining on raccoon (they tend to be greasy), opossum shanks and gravy, as well as squirrel.  But, prepared properly, some people view them as a delicacy. 

To date, the USDA hasn’t issued guidelines on the proper preparation of roadkill or where roadkill fits in its food pyramid (that was revised in recent years).  That’s sounds like a good project for some USDA Undersecretary for Food Safety to occupy their time with.  Thanksgiving is just around the corner.

Be careful out there.

October 26, 2020 in Civil Liabilities, Regulatory Law | Permalink | Comments (1)

Friday, October 23, 2020

Eminent Domain and “Seriously Misleading” Financing Statements


Farmers and ranchers encounter numerous legal issues, some more often than others.  Some involve relationships with people that have gone awry, while others are a function of the economic situation surrounding the operation.  Still others involve technical contract issues involving the sale or transfer of agricultural commodities.  Many involve farmland in one fashion or another. 

In today’s article, I examine a couple of recent cases illustrating two legal issues that farmers and ranchers encounter – eminent domain and financing arrangements.  These are the topic of today’s post.

Eminent Domain

The power to “take” private property for public use (or for a public purpose) without the owner's consent is an inherent power of the federal and state government. However, the United States Constitution limits the government's eminent domain power by requiring federal and state governments to pay for what is “taken.” The “takings” clause of the Fifth Amendment has been held to apply to the states since 1897. Chicago, Burlington and Quincy Railroad Co., v. Chicago, 166 U.S. 226 (1897). 

The issue of what constitutes “just compensation” is often the thorny issue when a “taking” has occurred.  Often, the government will “low-ball” a landowner upon the exercise of its eminent domain power.  But, just compensation is to be tied to fair market value of the property taken.  The trick is how fair market value is to be determined.  That precise issue came up in a recent Nebraska case.

Recent case. In Russell v. Franklin County, 27 Neb. Ct. App. 684, 934 N.W.2d 517 (2019), the plaintiffs were landowners whose property consisted of 164 acres that was primarily cropland and pastureland. The property has been in the plaintiffs’ family for many years and includes cropland and pastureland. There was no residence on the property, and the plaintiffs used it for birdwatching, camping, hunting for game and mushrooms, and other recreational purposes. The plaintiffs gave the defendant county permission to cut down trees on the plaintiffs’ property in order to improve visibility for drivers on an adjacent county road. However, the defendant’s employees proceeded to cut down trees from an area not authorized for removal. In total, the defendant cut down 67 trees, affecting 1.67 acres of the plaintiffs’ land.

The plaintiffs filed an inverse condemnation action under Neb. Rev. Stat. §76-705, et seq. against the defendant, alleging an unlawful taking of their property for public use without just compensation. The plaintiffs claimed that the damages should be calculated by determining the replacement cost of the trees and soil from uprooted trees.  In other words, the “just compensation” should be what it would cost to put the property back to its status before the trees outside the permitted area were removed.  To that end, the plaintiffs relied upon an arborist, a salesperson from a nursery and garden center, and a representative from an excavating company to quantify their damages. Together, the experts calculated the cost to return the property to its prior condition to be $150,716.  Conversely, the defendant argued that the damages should be calculated by determining the difference in fair market value of the plaintiffs’ property before and after the trees had been cut down, which its expert said was $200.

The trial court agreed with the defendant and held that the appropriate measure of damages was the difference in the fair market value of the land. The trial court noted that the plaintiffs had argued their case under the state’s eminent domain statutes but were seeking damages based on a tort cause of action. On appeal, the plaintiffs’ argued the trial court applied the wrong measure of damages. The plaintiffs maintained their argument that the proper method for determining damages was to calculate the cost of restoring the property to its preexisting condition. The appellate court held that the correct measure for damages was in fact the difference in the fair market value of the land before and after the trees were cut down. The appellate court noted that Nebraska courts have consistently held that damages in eminent domain cases are measured based on market value of the property. Further, the appellate court pointed out that the state Supreme Court had previously held that vegetation is not valued separately and should only be considered in how its presence affects the fair market value of the land. Finally, the appellate court noted that the plaintiffs’ argument for calculating damages rested on cases that stemmed from tort actions. Because the plaintiffs had argued their case as one under the eminent domain statutes, they could not seek damages under an unlawful destruction of trees or negligence action. 

On further review, the Nebraska Supreme Court affirmed.  Russell v. Franklin County, 306 Neb. 546, 946 N.W.2d 648 (2020)

Financing Statement and Debtor’s Name

Occasionally, a lender loans money on an unsecured basis with the lender's security based solely on the borrower's reputation and promise to repay.  More likely, however, a lender will require collateral to make sure the borrower repays the loan. Usually, the lender requires the borrower to sign a written agreement (security agreement) giving the lender legal rights to the collateral (such as the borrower's crops, livestock or equipment) if the borrower fails to repay the loan. The situation where personal property or fixtures are used to secure payment of a debt or the performance of an obligation is called a secured transaction.  In this transaction, the lender receives a security interest in the debtor’s collateral.  If the debtor fails to repay the obligation, the creditor can have the collateral sold to repay the loan. 

Normally, a security interest in tangible property is perfected by filing a financing statement or by filing the security agreement as a financing statement. Indeed, filing a financing statement usually is the only practical way to perfect when the debtor is a farmer or rancher.

Under UCC § 9-506, a financing statement is effective even if it has minor errors or omissions unless the errors or omissions make the financing statement seriously misleading. A financing statement containing an incorrect debtor’s name is not seriously misleading if a search of the records of the filing office under the debtor’s correct legal name, using the filing office’s standard search logic, if any, discloses the financing statement filed under the incorrect name. However, some states have statutes or regulations defining the search logic to be used and may require that the debtor’s name be listed precisely in accordance with that logic.  A recent Minnesota bankruptcy case illustrates this point.

Recent case.  In a recent bankruptcy case from Minnesota, In re Rancher’s Legacy Meat Co., 616 B.R. 532 (Bankr. D. Minn. 2020), the debtor was a meat packing and processing company that was created by two people (one of which was a creditor) operating under the name of Unger Meat Company (UMC). The creditor leased a building to the debtor that was to be used as a processing plant. The creditor also provided startup funds through two promissory notes. The parties entered into a security agreement that granted the creditor a security interest in all of the debtor’s equipment, inventory, and accounts receivable.

The creditor perfected the security agreement by filing a financing statement with the state. UMC lost money and the creditor entered into an option agreement with a holding company to purchase UMC. Upon finalization of the sale, the holding company subsequently purchased the creditor’s shares in UMC and changed the name of the company to Rancher’s Legacy Meat Company. Fourteen months after the name change, the creditor filed a continuation statement listing the company’s name as UMC. Three years later, the creditor filed an amended continuation statement changing the debtor’s name to Rancher’s Legacy. The creditor began seeking collection on its notes and a few months later the debtor filed for Chapter 11 bankruptcy. The debtor argued that the appropriate procedure to re-perfect the creditor’s security interest was to file a new financing statement upon the debtor’s name change. The creditor claimed that the filings appropriately re-perfected the security interest, entitling the creditor to adequate protection payments. The bankruptcy court looked to local (Minnesota) law, to construe the status of the creditor’s lien. Under Minnesota law, a financing statement becomes seriously misleading and ineffective when it fails to provide the debtor’s correct name. Additionally, when the financing statement is ineffective because of seriously misleading information, an amendment must be made within four months to perfect a security interest.

The bankruptcy court held that the creditor’s security interest lapsed when four months had passed after the creditor’s financing statement became seriously misleading. Further, the bankruptcy court held that the creditor had the ability to re-perfect the security interest by filing a new financing statement. Although the security interest had lapsed, the language of the parties’ security agreement provided the creditor with the opportunity to file a second financing statement. The creditor argued that the multiple filings were sufficient to giver proper notice to any other creditors under the UCC. The bankruptcy court disagreed and held that multiple filings can occasionally give proper notice, but not when the notice had become seriously misleading.

The bankruptcy court held that the validity of the financing statement depended primarily on its ability to give notice of the security interest to other creditors. The purpose of the UCC’s notice system, the bankruptcy court noted, is to provide public notice of a secured interest without requiring parties to piece together several documents. Further, the bankruptcy court noted that the creditor’s argument for multiple filings failed because the original financing statement had lapsed. The creditor’s continuation statements were merely amendments to the original financing statement. However, the original financing statement had lapsed four months after it became seriously misleading. The bankruptcy court held that the continuation statements could not revive the financing statement once it had lapsed. Lastly, the creditor argued that the subsequent filings of the continuation statements should have been enough to re-perfect his security interest.

The bankruptcy court held that even when the creditor’s three filings were read in conjunction, they were ineffective to re-perfect his security interest. The bankruptcy court further pointed out that the UCC specifically provides that continuation statements cannot substitute for financing statements. As a result, the bankruptcy court declared that the creditor became an unsecured creditor at the time the security interests became unperfected. Because the creditor failed to re-perfect the security interest before the debtor filed Chapter 11 bankruptcy, the debtor was not required to provide the creditor with adequate protection payments. 


Eminent domain and getting a debtor’s name correct on a financing statement – two issues that farmers and ranchers frequently encounter.  Also, two issues that illustrate how farmers and ranchers can become entangled in legal matters so easily. 

October 23, 2020 in Environmental Law, Regulatory Law, Secured Transactions | Permalink | Comments (0)

Tuesday, October 20, 2020

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


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.

The impact of an expanded public use doctrine on agriculture – it’s the topic of today’s post.

In General

The U.S. Supreme Court’s first application of the public trust doctrine was in 1842 in Martin v. Lessee of Waddell, 41 U.S.367 (1842). In the case, the issue was who had the right to submerged land and oyster harvesting off the coast of New Jersey.  The Court, largely based on the language in the charter granted by the King to a Duke to establish a colony and for policy and economic reasons, determined that the land area in issue belonged to the state of New Jersey for the benefit of the people of the state.  The Court dealt with the issue again in 1892 in a case involving a railroad that had been granted a large amount of the Chicago harbor. Illinois Central Railroad Company v. Illinois, 146 U.S. 387 (1892).  The Court determined that the government cannot alienate (interfere with) the public’s right to access land under waters that are navigable in fact except for situations where the land involved wouldn’t interfere with the public’s ability to access the water or impair navigation. 

As generally applied in the United States (although there are differences among the states), an oceanfront property owner can exclude the public below the mean high tide (water) line.  See e.g., Gunderson v. State, 90 N.E. 3d 1171 (Ind. 2018)That’s the line of intersection of the land with the water's surface at the maximum height reached by a rising tide (e.g., high water mark).  Basically, it’s the debris line or the line where you would find fine shells.  However, traceable to the mid-1600s, Massachusetts and Maine recognize private property rights to the mean low tide line even though they do allow the public to have access to the shore between the low and high tide lines for "fishing, fowling and navigation.”  In addition, in Maine, the public can cross private shoreline property for scuba diving purposes.  McGarvey v. Whittredge, 28 A.3d 620 (Me. 2011). 

Other applications of the public trust doctrine involve the preservation of oil resources, fish stocks and crustacean beds.  Also, many lakes and navigable streams are maintained via the public trust doctrine for purposes of drinking water and recreation.

Expanding the Doctrine?

As noted above, the public trust doctrine is an ancient concept that guarantees certain rights to the public and causes other rights to be vested in private owners.  Indeed, in the United States, one of the fundamental Constitutional rights denoted in the Bill of Rights is that of the ownership of private property.  Fifth Amendment, U.S. Constitution.  As a fundamental Constitutional right, any infringement on the right is subject to “strict scrutiny” by a court.  Of course, the government (state and federal) retains the right to “take” private property for a public use, but only upon the payment of “just compensation.”  But, any expansion of the doctrine does an “end-run” around the claim that the government has committed a taking that requires compensation – the theory being that the public rights pre-existed and private property rights are automatically subject to them.  An expansion would bring non-justiciable political questions into the courts.  This technique has been tried with attempts to get the courts to decide allegations of harm and restrict usage of private property based on “global warming.”  Largely, the courts have refused citing lack of standing, congressional delegation to administrative agencies and that such claims are non-justiciable political questions.  See, e.g., American Electric Power Company v. Connecticut, 564 U.S. 410 (2011)

The notion that vested (e.g., settled, fixed, inalienable) rights can be usurped by an expanded application of the public trust doctrine makes it easier for regulation of property rights to occur without any concern that a non-physical taking of the property has occurred  that would require the private property owner to be compensated. That’s because the private property taken, the theory is, was a right that the owner never had to begin with.  In turn, an expanded public trust doctrine would require state (and, perhaps, federal) governments to take action to preserve public rights.  If they failed to do so, the legal system would be used to force action.  The courts, then, become a sort of “super legislature” via the public trust doctrine - a “court-packing” technique that is off the radar and out of public view.

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.  That’s a much different outcome than the government imposing regulations on property uses that trigger compensation for an unconstitutional regulatory taking.  In essence the government, via the doctrine, acquires an easement for the protection of certain designated natural resources (such as wildlife and wildlife habitat) that are deemed to be in the public interest.  Instead of elected politicians making these decisions and being accountable to voters, the courts are the enforcers. 

Also, an expansion of the public trust doctrine, from an economic standpoint, would have the unintended consequence of diminishing the incentive of landowners to invest in and improve the natural resource at issue. Private property has value because of the ability to exclude others from use and ownership.  A fundamental principle of economics is that the ability to exclude others from use and ownership increases the owner’s incentive to use the resource wisely.  This was, indeed, borne out in Bitterroot River Protective Association v. Bitterroot Conservation District, 346 Mont. 507 (2008).    

Recent 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. 


Clearly, the state and federal governments can regulate natural resources.  The power to do so is vested in state legislatures and the Congress.  As such, the power is limited by Constitutional protections and by the voting public.  But, an expansion of the public trust doctrine would void those constraints on a theory that a property right that doesn’t exist cannot be taken.  The courts would become a “super legislature” gaining the authority to make public policy decisions.  That would further blur the distinction between legislative bodies and the judiciary and the fundamental legal principle of the separation of powers. 

An expanded public trust doctrine is a big “camel’s nose under the tent” for agriculture.  Farmers and ranchers beware.

October 20, 2020 in Environmental Law, Regulatory Law | Permalink | Comments (0)

Saturday, October 17, 2020

Income Taxation of Trusts - New 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).

New guidance on handling deductions of a non-grantor trust or estate and those that flow to beneficiaries – it’s the topic of today’s post.

Computing Trust/Estate AGI

In general, a trust’s or estate’s AGI is computed in the same manner as is AGI for an individual. I.R.C. §67(e).  However, when computing AGI for trust or an estate, deductions are allowed for administration costs that are incurred in connection with a trust or an estate if those costs would not have been incurred if the property were held individually instead of in a trust or in the context of a decedent’s estateI.R.C. §67(e)(1).  In addition, an estate or trust is entitled to a personal exemption (I.R.C. §642(b)), a deduction for current income distributed from a trust (I.R.C. §651), and a deduction for the distribution of income from an estate or a trust for accumulated income as well as the distribution of corpus (I.R.C. §661). 

But, the TCJA added I.R.C. §67(g) which states, “…no miscellaneous itemized deduction shall be allowed for any taxable year beginning after December 31, 2017, and before January 1, 2026.”  That raised a question of whether the IRS would take the position that the new I.R.C. §67(g) caused the I.R.C. §67(e) expenses to be miscellaneous itemized deductions that a non-grantor trust or estate could no longer deduct.   In 2018, however, the IRS issued Notice 2018-61 to announce pending regulations and stated that I.R.C. §67(e) expenses would remain deductible by virtue of removing them from the itemized deduction category.   

Excess Deductions

Another aspect of non-grantor trust/estate taxation involves “excess deductions.”  When an estate or trust terminates, a beneficiary gets to deduct any carryover (excess) amount of a net operating loss or capital lossI.R.C. §642(h)(1).  The beneficiary can also deduct the trust’s or estate’s deductions for its last tax year that are in excess of the trust’s or estate’s gross income for the year.  I.R.C. §642(h)(2).  These deductions are allowed in computing the beneficiary’s taxable income.  While they must be taken into account in computing the beneficiary’s tax preference items, they cannot be used to compute gross income.  Treas. Reg. §1.642(h)-2(a).  In addition, the character of the deductions remains the same in the hands of a beneficiary upon the termination of an estate or a trust. 

But, the TCJA suspension of miscellaneous itemized deductions clouded the tax treatment of how excess deductions were to be handled.  When a trust or estate terminates with excess deductions they could be treated in the hands of a beneficiary as a miscellaneous itemized deduction that I.R.C. §67(g) disallows.  I say “could be” because an excess deduction could take one of three forms.  It is either comprised of deductions that are allowed when computing AGI under I.R.C. §§62 and 67(e); or it is an itemized deduction under I.R.C. §63(d) that is allowed when computing taxable income; or it is a miscellaneous itemized deduction that the TCJA disallows (through 2025). 

Proposed Regulations

The Proposed Regulations specify that certain deductions of an estate or trust are allowed in computing adjusted gross income (AGI) and are not miscellaneous itemized deductions and, thus, are not disallowed by I.R.C. §67(g). Instead, they are treated at above-the-line deductions that are allowed in determining AGI . The Proposed Regulations also provide guidance on determining the character, amount and manner for allocating excess deductions that beneficiaries succeeding to the property of a terminated estate or non-grantor trust may claim on their individual income tax returns.

Specifically, the Proposed Regulations amend Treas. Reg. §1.67-4 to clarify that I.R.C. §67(g) doesn’t disallow an estate or non-grantor trust from claiming deductions:  (1) for costs which are paid or incurred in connection with the administration of the estate or trust and which would not have been incurred if the property were not held in the trust or estate; and (2) for deductions that are allowed under I.R.C. §§642(b), 651 and 661 (personal exemption for an estate or trust; income distributed currently; and distributions for accumulated income and corpus).

As for excess deductions of an estate or trust, prior Proposed Regulations treated excess deductions upon termination of an estate or non-grantor trust as a single miscellaneous itemized deduction.  The new Proposed Regulations, however, segregate excess deductions when determining their character, amount, and how they are to be allocated to beneficiaries.  The new Proposed Regulations specified that the excess amount retains its separate character as either an amount that is used to arrive at AGI; a non-miscellaneous itemized deduction; or a miscellaneous deduction.  That character doesn’t change in the hands of the beneficiary.  The fiduciary is to separately identify deductions that may be limited when the beneficiary claims the deductions. 

The Proposed Regulations utilize Treas. Reg. §1.652(b)-3 such that, in the year that a trust or estate terminates, excess deductions that are directly attributable to a particular class of income are allocated to that income.  The Preamble to the Proposed Regulations states that excess deductions are allocated to beneficiaries under the rules set forth in Treas. Reg. §1.642(h)-4.  After allocation, the amount and character of any remaining deductions are treated as excess deductions in a beneficiary’s hands in accordance with I.R.C. §642(h)(2).  This accords with the legislative history of I.R.C. §642(h) in seeking to avoid “wasted” deductions. 

The bifurcation of excess deductions into three categories by the Proposed Regulations rather than lumping them altogether miscellaneous itemized deductions disallowed by the TCJA is pro-taxpayer. 

The IRS says that the Proposed Regulations can be relied on for tax years beginning after 2017, and on or before the proposed regulations are published as final regulations.   

Final Regulations

I.R.C. §67(g) doesn’t control.  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. 

Excess deductions.  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).  How is that nature determined?  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).   

Example 2 of the Proposed Regulations was modified in the Final Regulations to permit allocation of personal property tax to income, with any I.R.C. §67(e) expenses distributed to the beneficiary.  Thus, the fiduciary has discretion to selectively allocate deductions to income or distribute them to a beneficiary.  Those excess deductions that are, in a beneficiary’s hands, allowed at arriving at AGI on Form 1040 are to be deducted as a negative item on Schedule 1. 

As the Proposed Regulations required and the Preamble to the Final Regulations confirm, the information concerning excess deductions must be reported to the beneficiaries when a trust or an estate terminates.  Deduction items must be separately stated when, in the beneficiary’s hands, the deduction would be limited under the Code.  The Preamble states that the Treasury Department and the IRS “plan to update the instructions for Form 1041, Schedule K-1 (Form 1041) and Form 1040…for 2020 and subsequent tax years to provide for the reporting of excess deductions that are section 67(e) expenses or non-miscellaneous itemized deductions.”   

Because excess deductions retain their nature in a beneficiary’s hands, any individual-level tax limitations still apply.  Thus, for example, if an excess deduction results from state and local taxes (SALT) that a non-grantor trust or estate pays, is still limited at the beneficiary’s level to the $10,000 maximum amount under the TCJA.  The Final Regulations addressed this issue, but the Treasury determined that it lacked the authority to exempt a beneficiary from the SALT limitation.

The Preamble also notes that beneficiaries subject to tax in states that don’t conform to I.R.C. §67(g) may need access to miscellaneous itemized deduction excess deduction information for state tax purposes.  This burden apparently rests with the fiduciary of the estate/trust and the pertinent state taxing authority.  The IRS declined to modify federal income tax forms to require or accommodate the collection of this information because it is a state tax issue and not a federal one.    

The Final Regulations clarify that a beneficiary cannot carry back a net operating loss carryover that is passed out of a trust/estate in its final year.  Treas. Reg. §1.642(h)-5(a), Ex. 1.  A net operating loss carryover from an estate/trust can only be carried forward by the beneficiary. 


The Final Regulations apply to tax years beginning after their publication in the Federal Register.  They do not apply to all open tax years.  Thus, it is not possible to file an amended return to take advantage of the position of the Final Regulations with respect to excess deductions for a tax year predating the effective date of the Final Regulations. 


The Proposed and Final Regulations are, in general, taxpayer friendly.  Tax planning will likely focus on the allocation of deductions in accordance with classes of income over which the fiduciary can exercise discretion (amounts allowed in arriving at AGI; non-miscellaneous itemized deductions; and miscellaneous itemized deductions).  To the extent that the fiduciary can have excess deductions on termination of an estate or non-grantor trust reduce AGI, that is likely to produce the best tax result for the beneficiary or beneficiaries (with consideration given, of course, to possible TCJA-imposed limitations).  Given the compressed tax brackets applicable to trusts and estates, the position taken in the Proposed and Final Regulations on deduction items and the flexibility given to fiduciaries is welcome news. 

October 17, 2020 in Estate Planning, Income Tax | Permalink | Comments (0)

Thursday, October 15, 2020

Can I Write My Own Will? Should I?


Statistics show that most people do not have a will in place to dispose of their property upon death.  In that event the state where a person is domiciled has a set of rules that will specify who gets the decedent’s property.  If a taker can’t be found under those rules, the state will receive the property. 

Some people don’t get around to executing a will during life.  The reasons for not doing so vary – from not wanting to hire a lawyer; to simply not getting it done.  Other’s may try to write their own will?  Can that be done?  If so, is it a good idea?

Writing one’s own will – it’s the topic of today’s post.

Legal Requirements for a Valid Will

Every state has statutory requirements that a will must satisfy in order to be recognized as valid in that particular jurisdiction.  For example, in all jurisdictions, a person making a will (known as a “testator”) must be of sound mind, generally must know the extent and nature of his or her property, must know who would be the natural recipients of the assets, must know who his or her relatives are, and must know who is to receive the property passing under the will.  A testator lacking these traits does not have testamentary capacity and is not competent to make a will.  Such persons are more susceptible to being influenced by family members and others desirous of increasing their share of the estate of the decedent-to-be. 

Cases involving challenges to wills are common where the testator is borderline competent or is susceptible to influence by others.  However, the fact that the testator was old or in poor health does not, absent other evidence, give rise to a presumption that the testator lacked testamentary capacity or was subject to undue influence.  See, e.g., Lasen v. Anderson, et al., 187 P.3d 857 (Wyo. 2008); In re Estate of Hedke, 278 Neb. 727 (2009)A person that challenges a will on undue influence and lack of testamentary capacity grounds must establish undue influence by clear and convincing proof and that the decedent possessed testamentary capacity despite being unable to comprehend the purchasing power of her estate.  See, e.g., In re Estate of Bennett, 19 Kan. App. 2d 154, 865 P.2d 1062 (1993). 

Generally, a person making a will must be of “full age.” However, in some states persons not yet of the age of majority who are or have been married can execute a will as if they are of full age.

In addition, the will must be in writing and signed at the end by the testator or by someone else in the presence and at the direction of the testator.  In most states, the will must be witnessed by at least two competent and disinterested witnesses who saw the testator sign the will or heard the testator acknowledge it.  A devise or bequest of property in a will to a subscribing witness is void, with narrow exceptions in the law. 

Handwritten Will

In some states, holographic wills (wills that are in the testator’s handwriting but not witnessed) are not admissible.  Other states treat as valid a handwritten will if it meets certain statutory requirements such as being left with the decedent’s other valuable papers or with another person for safekeeping.  See, e.g., In re Church, 466 S.E.2d 297 (N.C. App. 1996).   In Nebraska, for example, a handwritten will is valid if it is signed and dated (in some manner).  The signature can be the testator’s initials.  In re Estate of Foxley, 254 Neb. 204, 575 N.W.2d 150 (1998).  The date can consist of only the month and year.  In re Estate of Wells, 243 Neb. 152, 497 N.W.2d 683 (1993)

Recent Case

In In re Estate of Blikre, 934 N.W.2d 867 (N.D. Sup. Ct. 2019), the decedent’s will devised her estate to her sister, the plaintiff’s wife. The estate consisted of real property and mineral rights. The plaintiff’s wife was originally named the representative of the decedent’s estate, but she died soon after the decedent died. The plaintiff petitioned for appointment as successor personal representative, as did the defendant, who was the decedent’s other sister who had been excluded from the will. Upon the decedent’s death, the plaintiff sought formal probate of the will by attaching a copy of the will to the petition. The defendant argued that the decedent’s will should be considered revoked because the original was missing.

The trial court ordered formal probate of the will, finding that there was insufficient evidence to show the decedent intended to revoke her will. The defendant appealed, arguing that the decedent had a handwritten will that should be formally probated. The defendant claimed the handwritten will revoked the original will and distributed the decedent’s estate to the defendant and her nieces. The appellate court remanded to the trial court to decide this issue. The trial court held that the decedent’s handwritten documents did not express her testamentary intent to distribute her estate and did not revoke her original will.

On appeal, the defendant argued the decedent’s will was invalid because it was not executed in front of two witnesses, and that even if the will were valid, it was replaced by the handwritten will. The appellate court held that the lawyer who notarized the will gave credible evidence that the two witnesses who signed the original will were physically present when it was executed. Further, the appellate court held that although the handwritten documents were written by the decedent, the documents did not amount to a valid handwritten will under North Dakota law. For a handwritten will to be valid, it must express donative and testamentary intent. The appellate court held that the handwritten documents did not clearly express donative intent, but merely listed desires and concerns the decedent had. As for the missing original will, the appellate court noted that the defendant was the only person who accessed a security box that the decedent kept important documents in upon the decedent’s death. Additionally, before the decedent had died, she told the plaintiff to convey mineral deeds to both the plaintiff’s wife and the defendant. At that time, the decedent did not indicate that she had revoked her will. The appellate court determined the combination of the plaintiff’s testimony and defendant’s untrustworthy testimony was able to overcome the presumption that the decedent had revoked the will. 


While an individual may write their own will, it is usually advisable to have an attorney prepare the will.  One reason is because words can mean different things in different contexts.  For example, in Cameron, et. al. v. Bissette, et al., 661 S.E.2d 32 (N.C. 2008), the decedent’s holographic will was ruled void for vagueness because the decedent left “this Land” to certain beneficiaries, but with no explanation of what “this Land” referred to.   In situations where uncertainty is present because of the words used, a court will try to determine the testator’s intent in light of the testator’s lack of skill in will drafting.  See, e.g., In re Estate of Matthews, 13 Neb. App. 812, 702 N.W.2d 821 (2005).

So, to answer the question of whether you can write your own will, the answer is that you can.  Perhaps the better question is whether you should.  That answer is less clear.  But, if you have a farm or ranch or other small business or otherwise have substantial assets, writing your own will is probably not the best idea. Definitely not.

October 15, 2020 in Estate Planning | Permalink | Comments (0)

Monday, October 12, 2020

Principles of Agricultural Law



The fields of agricultural law and agricultural taxation are dynamic.  Law and tax impacts the daily life of a farmer, rancher, agribusiness and rural landowner practically on a daily basis.  Whether that is good or bad is not really the question.  The point is that it’s the reality.  Lack of familiarity with the basic fundamental and applicable rules and principles can turn out to be very costly.  As a result of these numerous intersections, and the fact that the rules applicable to those engaged in farming are often different from non-farmers, I started out just over 25 years ago to develop a textbook that addressed the major issues that a farmer or rancher and their legal and tax counsel should be aware of.  After three years, the book was complete – Principles of Agricultural Law - and it’s been updated twice annually since that time. 

The 47th edition is now complete, and it’s the topic of today’s post – Principles of Agricultural Law.

Subject Areas

The text is designed to be useful to farmers and ranchers; agribusiness professionals; ag lenders; educational professionals; lawyers, CPAs and other tax preparers; undergraduate and law students; and those that simply want to learn more about legal and tax issues.  The text covers a wide range of topics.  Here’s just a sample of what is covered:

Ag contracts.  Farmers and ranchers engage in many contractual situations, including ag leases, to purchase contracts.  The potential perils of verbal contracts are numerous and can lead to unnecessary litigation. What if a commodity is sold under forward contract and a weather event destroys the crop before it is harvested?  When does the law require a contract to be in writing?  For purchases of goods, do any warranties apply?  What remedies are available upon breach? If a lawsuit needs to be brought to enforce a contract, how soon must it be filed? Is a liability release form necessary?  Is it valid?  What happens when a contract breach occurs?  What is the remedy? 

Ag financing.  Farmers and ranchers are often quite dependent on borrowing money for keeping their operations running.  What are the rules surrounding ag finance?  This is a big issue for lenders also?  What about dealing with an ag cooperative and the issue of liens?  What are the priority rules with respect to the various types of liens that a farmer might have to deal with? 

Ag bankruptcy.  A unique set of rules can apply to farmers that file bankruptcy.  Chapter 12 bankruptcy allows farmers to de-prioritize taxes.  That can be a huge benefit.  Knowing how best to utilize those rules is very beneficial.  That’s especially true with the unsettled issue of whether Payment Protection Program (PPP) funds can be utilized by a farmer in bankruptcy.  The courts are split on that issue.

Income tax.  Tax and tax planning permeate daily life.  Deferral contracts; depreciation; installment sales; like-kind exchanges; credits; losses; income averaging; reporting government payments; etc.  The list could go on and on.  Having a basic understanding of the rules and the opportunities available can add a lot to the bottom line of the farming or ranching operation as well as help minimize the bleeding when times are tough.

Real property.  Of course, land is typically the biggest asset in terms of value for a farming and ranching operation.  But, land ownership brings with it many potential legal issues.  Where is the property line?  How is a dispute over a boundary resolved?  Who is responsible for building and maintaining a fence?  What if there is an easement over part of the farm?  Does an abandoned rail line create an issue?  What if land is bought or sold under an installment contract?  How do the like-kind exchange rules work when farmland is traded? 

Estate planning.  While the federal estate tax is not a concern for most people and the vast majority of farming and ranching operations, when it does apply it’s a major issue that requires planning.  What are the rules governing property passage at death?  Should property be gifted during life?  What happens to property passage at death if there is no will?  How can family conflicts be minimized post-death?  Does the manner in which property is owned matter?  What are the applicable tax rules?  These are all important questions.

Business planning.  One of the biggest issues for many farm and ranch families is how to properly structure the business so that it can be passed on to subsequent generations and remain viable economically.  What’s the best entity choice?  What are the options?  Of course, tax planning is a critical part of the business transition process.

Cooperatives.  Many ag producers are patrons of cooperatives.  That relationship creates unique legal and tax issues.  Of course, the tax law enacted near the end of 2017 modified an existing deduction for patrons of ag cooperatives.  Those rules are very complex.  What are the responsibilities of cooperative board members? 

Civil liabilities.  The legal issues are enormous in this category.  Nuisance law; liability to trespassers and others on the property; rules governing conduct in a multitude of situations; liability for the spread of noxious weeds; liability for an employee’s on-the-job injuries; livestock trespass; and on and on the issues go.  Agritourism is a very big thing for some farmers, but does it increase liability potential?  Nuisance issues are also important in agriculture.  It’s useful to know how the courts handle these various situations.

Criminal liabilities.  This topic is not one that is often thought of, but the implications can be monstrous.  Often, for a farmer or rancher or rural landowner, the possibility of criminal allegations can arise upon (sometimes) inadvertent violation of environmental laws.  Even protecting livestock from predators can give rise to unexpected criminal liability.  Mail fraud can also arise with respect to the participation in federal farm programs.  The areas of life potentially impacted with criminal penalties are worth knowing, as well as knowing how to avoid tripping into them.

Water law.  Of course, water is essential to agricultural production.  Water issues vary across the country, but they tend to focus around being able to have rights to water in the time of shortage and moving the diversion point of water.  Also, water quality issues are important.  In essence, knowing whether a tract of land has a water right associated with it, how to acquire a water right, and the relative strength of that water rights are critical to understand.

Environmental law.  It seems that agricultural and the environment are constantly in the news.  The Clean Water Act, Endangered Species Act and other federal (and state) laws and regulations can have a big impact on a farming or ranching operation.  Just think of the issues with the USDA’s Swampbuster rules that have arisen over the past 30-plus years.  What constitutes a regulatory taking of property that requires the payment of compensation under the Constitution?  It’s good to know where the lines are drawn and how to stay out of (expensive) trouble.

Regulatory law.  Agriculture is a very heavily regulated industry.  Animals and plants, commodities and food products are all subject to a great deal of regulation at both the federal and state level.  Antitrust laws are also important to agriculture because of the highly concentrated markets that farmers buy inputs from and sell commodities into.  Where are the lines drawn?  How can an ag operation best position itself to negotiate the myriad of rules?   


It is always encouraging to me to see students, farmers and ranchers, agribusiness and tax professionals get interested in the subject matter and see the relevance of material to their personal and business lives. Agricultural law and taxation is reality.  It’s not merely academic.  The Principles text is one that can be very helpful to not only those engaged in agriculture, but also for those advising agricultural producers.  It’s also a great reference tool for Extension educators. It’s also a great investment for any farmer – and it’s updated twice annually to keep the reader on top of current developments that impact agriculture.

If you are interested in obtaining a copy, perhaps even as a Christmas gift, you can visit the link here:  Instructors that adopt the text for a course are entitled to a free copy.  The book is available in print and CD versions.  Also, for instructors, a complete set of Powerpoint slides is available via separate purchase.  Sample exams and work problems are also available.  You may also contact me directly to obtain a copy.

If you are interested in obtaining a copy, you can visit the link here:  You may also contact me directly. 

October 12, 2020 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, October 9, 2020

TMDL Requirements - The EPA’s Federalization of Agriculture


Pollution from nonpoint agricultural sources (diffused surface runoff), particularly that originating from soil erosion, is more extensive than pollution resulting from feedlot operations.  But, because nonpoint   source pollution is largely dependent upon local topographical conditions, the Congress believed it was best left to the control of the states through the continuing planning process required by §303 (relating to water quality standards) and §208 (areawide waste management plans) of the Clean Water Act (CWA).  However, by virtue of Total Maximum Daily Load (TMDL) requirement, the U.S. Environmental Protection Agency (EPA) asserts that it has the final say on farming activities by dictating the amount of nitrogen, phosphorous and sediment that can come from a particular tract. 

The TMDL requirement and the extent EPA can use it to control farming practices – it’s the topic of today’s post.


Section 303 of the CWA requires states to adopt water-quality standards, to the extent not previously done, and to carry forward those already adopted subject to EPA approval. Standards are to be set for both interstate and intrastate waters, and the standards must be updated periodically and submitted to EPA for review and approval. The standards are to take into account the unique needs of each waterway including “propagation of fish and wildlife” as well as “agricultural...and other purposes.” Any state that fails to set water quality standards is subject to the EPA imposing its own standards on the state. Section 303 does not exempt any rivers or waters, but covers all waters to the full extent of federal authority over navigable waters.

The states are to establish total maximum daily loads (TMDLs) for watercourses that fail to meet water quality standards after the application of controls on point sources.  But, a state must engage in the formal rulemaking process before a TMDL can be used as the basis for a CWA discharge permit.  See, e.g., Fairfield County Board of Commissioners v. Nally, 143 Ohio St. 3d 93 (Ohio Sup. Ct. 2015). A TMDL establishes the maximum amount of a pollutant that can be discharged or “loaded” into the water at issue from all combined sources on a daily basis and still permit that water to meet water quality standards. See, e.g., Anacostia Riverkeeper, Inc., et al. v. Jackson, 713 F. Supp. 2d. 50 (D. D.C. 2010)A TMDL must be set “at a level necessary to implement water quality standards.”  33 U.S.C. § 1313(d)(1)(C).  The calculation must be on a daily basis.  Friends of the Earth v. United States Environmental Protection Agency, 446 F.3d 140 (D.C. Cir. 2006)

The Congress did not define TMDL in the CWA, but the EPA’s regulations break it into a “waste load allocation” for point sources and a “load allocation” for nonpoint sources. A TMDL’s purpose is to limit the amount of pollutants in a watercourse on any particular date.

Federal Control of Nonpoint Source Pollutants?

The big issue.  A significant question is whether the EPA has the authority to regulate nonpoint source pollutants under §303 of the CWA through the TMDL process and require reductions in nonpoint source discharges. This is an important issue for agriculture because the primary source of agricultural pollution is nonpoint source. Indeed, the TMDL requirements were challenged in early 2000 by farm interests as being inapplicable to nonpoint source pollution. In Pronsolino v. Marcus, 91 F. Supp. 2d 1337 (N.D. Cal. 2000), aff’d, sub. nom., Pronsolino v. Nastri, 291 F.3d 1123 (9th Cir. 2002), cert. den., 539 U.S. 926 (2003), the plaintiffs had obtained a permit to harvest timber and became subject to restrictions designed to reduce soil erosion. The state (California) submitted its § 303(d) list to EPA in 1992 and EPA disapproved the list because it excluded 17 water segments that failed to meet water quality standards. Sixteen of those water segments were impaired solely by nonpoint source pollution. EPA, pursuant to § 303(d)(2), established a new list including these waters. The state failed to develop TMDLs for these waters, environmental groups sued EPA to compel development of TMDLs, and EPA entered into a consent decree requiring it to complete TMDLs for these waters if the state failed to do so by March 18, 1998. The state missed the deadline and EPA established the TMDLs. 

The plaintiffs theorized that the restrictions were a by-product of the TMDL criterion and challenged the EPA’s authority to impose TMDL requirements on rivers polluted only by timber-harvesting and other nonpoint sources. The court, however, held that the TMDL requirements, as a comprehensive water-quality standard under the CWA, were designed to apply to every navigable river and water in the country – that is, every navigable water of the United States or “WOTUS.”. Although the court noted that the CWA applied TMDL to point and nonpoint sources differently, it stressed that TMDL was clearly authorized for nonpoint sources. Thus, according to the court, any polluted waterway – whether the source of pollution is point or nonpoint – is subject to TMDL requirements. The case was affirmed on appeal, but the appellate court, in dictum, noted that the statute did not require states to actually reduce nonpoint source pollution flowing into these waters. The appellate court made clear that TMDL implementation of nonpoint source pollution is a matter reserved to the states. Thus, the court appeared to substantially limit the EPA’s ability to require nonpoint source pollution reduction - the EPA can develop TMDLs that highlight the need for aggressive control of nonpoint source pollution, but cannot address nonpoint source pollution by itself. Where a state fails to establish TMDLs, the EPA has the power to implement them.  See also American Farm Bureau Federation, et al. v. United States Environmental Protection Agency, et al., 984 F. Supp. 2d 289 (M.D. Pa. 2013).

Chesapeake Bay.  In 2010, the EPA published a TMDL of nitrogen, phosphorous and sediment that can be released into the Chesapeake Bay watershed. The TMDL set forth a timetable for compliance by the affected states. In addition, states were required to determine how much agriculture had to reduce runoff by adopting new technology and conservation practices. The new rules were legally challenged in 2011 on the basis that the EPA lacked the authority to regulate individual pollutants from farmland and other specific sources.  In 2014, attorneys general from 21 states joined the lawsuit. In mid-2015, the court held that likely economic injury in the form of higher compliance costs was sufficient to confer standing to challenge the TMDL, and that the EPA had acted within its authority under 33 U.S.C. §1251(d) in developing the TMDL.  The court deferred to the EPA’s judgment on the basis that the statutory definition of TMDL was ambiguous – it could reasonably be interpreted to apply to allocations from various sources and geographic areas, etc.  American Farm Bureau, et al. v. United States Environmental Protection Agency, et al., 792 F.3d 281 (3d Cir. 2015)The U.S. Supreme Court declined to hear the case.  Id.  cert. den., 136 S. Ct. 1246 (2016). 

Presently, the litigation over the Chesapeake Bay TMDL is ongoing on the claim that New York and Pennsylvania are not within the standards of the TMDL. 

Other TMDL Details 

Citizen suits?  Traditionally, the courts have not allowed disaffected persons to bring lawsuits claiming an alleged violation of a state water quality standard established in accordance with CWA §303. The standards are generally believed to be too ambiguous and nonspecific. Only specific effluent limitations set forth in an NPDES permit have historically been subject to legal challenge. However, in 1996, the Ninth Circuit Court of Appeals allowed a challenge to an alleged violation of a state water quality standard. Northwest Environmental Advocates v. Portland, 74 F.3d 945 (9th Cir. 1996), cert. den., 518 U.S. 1018 (1996).


Clearly, the Congress did not write language into the CWA that allows the EPA to regulate nonpoint sources of pollution such as run-off from farm fields.  The Congress left that matter up to the states.  But, through the TMDL process, the EPA is able to get around that Congressional barricade.  Via TMDL requirements, the EPA has grabbed the power to say where farming will occur by establishing limits for sediments and nutrients for individual farms.  These are essentially land use decisions that are traditionally within the domain of local governmental bodies, and not a federal government agency.  The EPA’s approach is also incredibly costly.  The Maryland School of Public Policy has estimated that the implementation of the Chesapeake Bay TMDL from 2010-2025 could be as much as $80 billion.,_final,_spring_2012.pdf.

TMDLs – yet another reason why the definition of a WOTUS matters.

October 9, 2020 in Environmental Law | Permalink | Comments (0)

Monday, October 5, 2020

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


Trusts are often used as part of an estate plan for various reasons.  They can be established to take effect during life or be included as part of a will to take effect at death.  They can be revocable or irrevocable.  They can also be established as a “support” trust or as a “discretionary” trust.  A support trust is a trust where the trustee’s responsibility is to provide for the beneficiary’s support such as food, clothing, and shelter.  A discretionary trust, on the other hand, is a trust that has been set up to benefit one or more beneficiaries, but the trustee is given full discretion as to when, if any, trust principal and/or income, are given to the beneficiaries.  With a discretionary trust, the trust beneficiaries have no rights to trust funds.  But, can the trustee of a discretionary trust simply ignore the other beneficiaries?  Is the trustee still accountable for the way the trust assets and income are handled?

The issue of the responsibility of a trustee to other beneficiaries of a discretionary trust – it’s the topic of today’s post.

Recent Kansas Case

Basic facts.  The question of how a trustee relates to other beneficiaries of a discretionary trust came up in a recent Kansas case involving farmland and oil and gas interests.  In Roenne v. Miller, No. 120,054, 2020 Kan. App. LEXIS 72 (Kan. Ct. App. Oct. 2, 2020), the decedent, at the time of her death, had five children and owned royalty interests in oil leases, farmland, a home, as well as cattle, farm equipment and other personal property.  Her will devised a one-half interest in the farmland to a son that was named as trustee of her testamentary trust.  The other one-half interest in the farmland was devised to another son for life with a remainder to his children.  Upon this son dying childless, the remainder would pass to the trustee-son.  All of her livestock and farm machinery along with certain personal property was bequeathed to these two sons equally.  The non-trustee son then assigned his one-half interest in the farm assets and farmland to the trustee-son. 

The decedent’s will clearly specified that the other children were to have no interest in her farmland.  The will directed that the balance of her estate, consisting solely of interests in oil royalties, passed to the testamentary trust.  The trust gave the trustee “uncontrolled” or “exclusive” discretion over trust net income and principal, and provided specifics authorizations for the use of the trust income and principal.  The trust also specified that the trustee was to “only act in a fiduciary capacity” and that the trustee “shall each year render an account of his administration of the trust funds hereunder that the same shall be available for inspection by any of the beneficiaries at any reasonable time.”  In addition, the trust specified that the trustee was liable for any failure to exercise reasonable care, prudence and diligence in the discharge of trustee duties. 

At the time of the decedent’s death, the farmland was encumbered by substantial debt.  The trustee sold the decedent’s home and used the proceeds to pay down debt on some of the farmland.  Other of the farmland was foreclosed upon and the trustee’s wife bought part of it at the foreclosure auction with the trustee’s name later added to the title.  The trustee did pay off a mortgage on one of the oil leases, but also distributed oil lease income to himself over a 19-year period in the amount of $1,300,000.  No bank account was established for the trust and the trustee deposited the oil lease income directly into his personal account that he owned jointly with his wife.  The oil lease income was used to pay down the substantial debt on the farmland and to pay farming expenses.  While the trustee testified that his use of the oil income in such manner did not benefit the trust, he asserted that the would not have taken on the responsibility of executor and trustee unless he could use the oil income to service the debt on to pay off the farm debt and farming expenses.  He testified at trial that he promised the decedent that he “would keep the farm intact whatever way I could.”  In 2013 and 2014, the trustee conveyed the mineral rights from the trust to himself personally as a beneficiary which effectively emptied the trust of assets. 

Trial court.  The other beneficiaries sued the trustee for negligently and fraudulently breaching his fiduciary duties as trustee by converting for his own use the trust income mineral interests. The trial court construed the will and trust together and determined that the decedent’s intent was to give the trustee-son as much power as possible to use trust principal for the benefit of any beneficiary in any amount without limitation.  Additionally, the trial court held that the trustee did not violate his fiduciary duty he owed as a trustee or commit fraud because he relied upon the terms of the trust and had sought out advice from an attorney that advised him that oil income could be used to service debt. He testified that accountants and bankers relied on the trust’s terms in dealing with him and told him that he could use trust income in the manner that he did.  In other words, because the trustee had uncontrolled or exclusive discretion over the trust, the trustee could not be held accountable to the other beneficiaries for his conduct.

Appellate court.  On appeal, the plaintiffs contended that the trial court erred in ruling that the trust language granting the trustee uncontrolled discretion relieved the trustee of his fiduciary duties as a trustee on the basis that such a determination did not square with the law of trusts. The trustee maintained his argument that the trust was a discretionary trust and not a support trust. Consequently, the trust did not require the trustee to make disbursements to the other beneficiaries.  Specifically, the trustee claimed that his conduct conformed to the “prudent investor rule” of Kan. Stat. Ann. §58-24a01, and did not violate his duty of loyalty under Kan. Stat. Ann. §58a-802 because the trust authorized him to transfer trust property to himself. 

The appellate court reversed and remanded.  The appellate court noted that the decedent’s intent in creating the trust was paramount and that the language of the trust was unambiguous in creating a discretionary, as opposed to a support, trust.  No single beneficiary had the right to a distribution.  The trustee had the freedom to act in his capacity as trustee.  As such, the appellate court noted that it could only interfere with that freedom in cases where the trustee abuses discretion, acts in bad faith or acts in a manner that is arbitrary and unreasonable as to amount to bad faith.  A good faith reliance on the express provisions of a trust does not result in trustee liability for breach of trust.  However, even with a fully discretionary trust, the trustee still has fiduciary duties to the beneficiaries of loyalty, impartiality and prudence in accordance with Kan. Stat. Ann. §58a-101 et seq.  These statutory duties, the appellate court noted, cannot be superseded by trust language purporting to give the trustee “uncontrolled” discretion.  A trustee, must still act in good faith and administer the trust for the benefit of the beneficiaries.  While a grantor’s intent is paramount, the law places limits on trustee conduct even in the context of a fully discretionary trust. 

Concerning the duty of loyalty, the appellate court noted that Kan. Stat. Ann. §58a-802(a) requires the trustee to “administer the trust consistent with the terms of the trust and solely in the interests of the beneficiaries.”  The duty preserves the character of the fiduciary relationship between the trustee and the beneficiaries.  The duty of impartiality is an extension of the duty of loyalty and is contained in Kan. Stat. Ann. 58a-803 which specifies that, “If a trust has two or more beneficiaries, the trustee shall act impartially in investing, managing, and distributing the trust property, giving all due regard to the beneficiaries’ respective interests.”  Here, the trustee was one of the five beneficiaries and had a duty to act impartially with respect to the other beneficiaries.  Depositing trust income in the trustee’s personal account, the appellate court held, violated the duty of impartiality. The trust was intended to be for the benefit of all of the decedent’s children, and the trustee’s actions were inconsistent with that intent.

Concerning the duty of prudent administration, Kan. Stat. Ann. §58a-804 states that, “A trustee shall administer the trust as a prudent person would, by considering the purposes, terms, distributional requirements, and other circumstances of the trust.  In satisfying this standard, the trustee shall exercise reasonable care, skill, and caution.” 

The trust stated that the trustee could use trust income to pay farming expenses, convey mineral rights, and execute oil and gas leases.  But, it gave such authorization to the trustee only in his role as a fiduciary and not as a beneficiary. The trust instrument was clear in stating, “All powers given to the trustee or trustees by this instrument are exercisable by the trustees only in a fiduciary capacity.  No power given to the trustees hereunder shall be construed to enable any person to purchase, exchange, or otherwise deal with or dispose of the principal [or] the income therefrom for less than adequate consideration in money or money’s worth.”   This is a key point.  There was no indication in the trust language that the trustee could transfer all of the trust assets to his personal account as a beneficiary to operate his own personal farming operation.  Doing so overrode his duties of loyalty and impartiality.  Although the trustee argued he was relying on an oral promise to maintain the farm, the appellate court noted the mother could have given him all of the royalty interest income, like she did with the farm, in her will.  There was no express trust language allowing the trustee to transfer everything to himself and his wife.  

The appellate court held that despite language in the trust granting the trustee uncontrolled discretion to act, the trustee still had fiduciary duties to all of the beneficiaries.  Those duties, the appellate court determined, had been breached.  The trial court’s focus solely on the discretionary language was in error.  On remand, the trial court must address the trustee’s statute of limitations defense, or any other equitable defenses, and remedies for a breach of trust including a money judgment or a specific sum for restitution.


The recent Kansas decision is a case study in what can go wrong with an estate plan.  It illustrates the classic situation in the farm setting where the parent wants to benefit all of the children equally, but have the farm assets end up in the hands of a particular child.  It’s debatable whether the structure chosen to implement that plan was appropriate.  However, when a trust is utilized, clients and potential trustees should be advised of the basics of trust law, the fiduciary duties that a trustee owes to the beneficiaries and that those statutory duties can’t be extinguished by trust language.  Apparently, some judges need to learn those basics also.  In the Kansas case, voters have already turned the first-term trial court judge out of office when his present term is up.     

October 5, 2020 in Estate Planning | Permalink | Comments (0)