If you have ever bought a pie, you know buying the whole pie is the only way to decide if it makes it Thanksgiving dinner or if you eat it alone in the dark. Consider this, you buy a pie for $10.00. Then If someone gave you 1/4th of a second, exactly the same pie but told you that the pie can’t be eaten until the other owner says so and they get to store the pie, that second pie’s ¼ interest should be worth less than the $2.50 that simple math would suggest. Not if you work for the government.
The IRS released proposed regulations in August that would enhance code sections regarding valuation of privately-held, minority interests that are controlled by the same family. This means LLCs, corporations and partnerships that many farm and small business operators use. It wasn’t out of the blue that the IRS decided to adjust the code, they lost in court and see a potential loss in revenue, so they are changing the rules.
This will impact intra-family interest transfers like when an elder generation gifts a portion of the farm via LLC membership interest to the next generation. The prevailing theory is giving Junior 1/8 of the farm isn’t really worth 1/8 of the total value of the operation because Junior probably still takes orders from Ma and Pa and can’t control the company in any meaningful way and the company is not something that Junior could turn around and sell for 1/8th of the total value to a disinterested party. Think about that pie again.
Valuation principles have long been established showing that Junior interests in privately-held businesses like that are worth less than controlling (Ma and Pa) interests or similar interests in publicly-held companies like Target, IBM and the like . It makes sense that certain adjustments are made when valuing Junior interests in family contexts.
The two most common adjustments are discount for lack of control and the discount for lack of marketability. A discount for lack of control discounts the value of a business interest because Junior does not have the ability to manage the operations of the business and also does not have the ability to control the business. The discount for lack of marketability discounts value of a business interest because the interest cannot be sold and converted to cash as quickly as a publicly traded stock. Many take a 10-20% discount for these impairments.
The IRS has had some leeway in calling out sham discounts however, the latest set of amendments look pretty grim.
They include special valuation rules for such as:
Disregarding Restrictions – No discount for a buy sell restriction on who you can sell your interest to.
•Elimination of Assignee Interest – No discount for the situations where the stock doesn’t have full rights, like when a spouse ends up with the family stock but doesn’t get voting rights.
Three Year Lookback – Makes transfers made within three years of death not eligible for a discount.
Assumed Put Option –Assumes that the junior holder in a family-owned business can sell back at full price within six months. Family owned business do not grant put provisions as they cause liquidity problems which would cripple the operations of the company, when owners can withdraw and demand cash at any time.
Family-owned businesses will lose lose an estate planning tool for families that a valid business purpose for junior interest, like running a farm and separating off farm heirs from on farm decisions.
This is a big change from the ways accepted by the IRS and tax court in years past. It invites a court challenge, which could create uncertainty for an extended period of time.
The regulations are subject to a 90-day public comment through November 2, 2016. Those interested in posting public comments should look at at: https://www.federalregister.gov/articles/2016/08/04/2016-18370/estate-gift-and-generation-skipping-transfer-taxes-restrictions-on-liquidation-of-an-interest
If placed into effect gifts made before the actual implementation will not be subject to the new restrictions (unles the IRS forgets about the Consitutional provision on ex post facto laws). If entities are formed now but gifted after the change they will be subject to the new view. The new rules could be in effect before the end of the year, as early as Dec 2016.
With harvest inbound, your operation may be considering bringing on a person to help run the grain cart, help unload or do relief milking while you handle the harvest. Here is a refresher of the rules you need to be aware of.
Employee versus independent contractor is a something that has been covered here previously, but bottom line is that if you tell the person how what when where and in what order, they are an employee. If you simply tell them what the goal is (i.e. need the field combined and the grain in the grain bin) and they provide some or all of their own equipment, with no rules from you about the order, timing (other than a dead line) and who does the work, they may be an independent contractor and not subject to Employer employee rules.
Next do you have an ag employee?
The IRS defines an agricultural employer as an entity who:
Raises or harvests agricultural or horticultural products (including the raising and feeding of livestock);
Works in connection with the operation, management, conservation, improvement, or maintenance of the farm and its tools and equipment;
Handles, processes, or packages any agricultural or horticultural commodity they produce
The term “farm” includes stock, dairy, poultry, fruit, fur-bearing animals, and truck farms, as well as plantations, ranches, nurseries, ranges, greenhouses or other similar structures used primarily for the raising of agricultural or horticultural commodities, and orchards.
Farm work doesn’t include reselling activities that don’t involve any substantial activity of raising agricultural or horticultural commodities, such as a retail store or greenhouse used primarily for display or storage.
Workers’ Compensation Exemption under Iowa worker’s compensation law
Iowa farmers do not have to provide workers’ compensation for employees unless the payroll amounts to $2,500 in the calendar year. When you have to buy it, all employees will be covered. There are large fines and possible felony charges for not carrying workers’ compensation. Federal law requires a farmer employing H-2A workers provide workers’ compensation to all employees. Workman’s compensation coverage does provide a benefit to you as it is the employee’s only recourse if they are injured and covered. Sometimes money spent upfront prevents greater problems later.
There are some exemptions to the statute for ag-related persons:
The employer’s spouse, parents, siblings, stepchildren (including the spouse’s stepchildren), and the siblings, children and stepchildren of the employer’s spouse whether they are in a partnership or corporation or LLC engaged in farming.
Federal and State Unemployment Taxes
Federal Unemployment Tax is not required for employer’s parent or spouse or by employer’s child under age 21.
State reporting and unemployment insurance taxes must be paid by agricultural employers that paid cash wages of $20,000 or more to agricultural laborers, or employed 10 or more workers in some portion of a day in 20 separate weeks in the current calendar year or preceding calendar year.
Fair Labor Standards Act (FLSA) and Agricultural Employers-Overtime
Employees who are employed in agriculture are exempt from the overtime pay provisions. Agriculture does not include work performed on a farm which is not incidental to or in conjunction with such farmer’s farming operation. Think of the hired man dry walling the basement in the wintertime for the kid’s room.
Any employer in agriculture who did not utilize more than 500 “man days” of agricultural labor in any quarter year is exempt from the minimum wage and overtime pay provisions of FLSA for the current calendar year. A “man day” is defined as any day during which an employee performs agricultural work for at least one hour. Additional exemptions from the minimum wage and overtime provisions of FLSA for agricultural employees apply to the following:
Agricultural employees who are immediate family members of their employer
Those principally engaged on the range in the production of livestock
Employment of your children
If under the age of 18, a parent is not required to withhold social security tax and wages not subject to federal unemployment taxes until reaching the age of 21. As long as the total income doesn’t exceed $6,200 and unearned income doesn’t exceed $350, the child will not owe income tax on their income. You still need to send W-2 and pay a wage that is comparable to work done.
IRS Additional Information
Income tax withholding, Social Security and Medicare (including Additional Medicare Tax when wages are paid in excess of $200,000) are exempt for employer’s child under age 18, but counted for $150 test or $2,500 test. Taxable for spouse of employer.
$150 or $2,500 Test
All cash wages paid to an employee during the year for are subject to social security and Medicare taxes and federal income tax withholding if either of the below is met:
You pay cash wages to an employee of $150 or more in a year for farm work. The $150 test applies separately to each farmworker that you employ.
The total you pay for to all your employees is $2,500 or more during the year.
Compensation paid to H-2A workers for agricultural labor performed in connection with the visa isn’t subject to social security and Medicare taxes and an employer is not required to withhold federal income tax.
Iowa requires a notice by 1 September of a land owner or tenants desire to terminate a farm lease arrangement. Don’t forget that under recent changes in the law , one 38 year old horse on a parcel can provide protection to a tenant as a farm tenant. Those terminations are 1 March unless the parties BOTH agree to an earlier date. When terminating a lease, Iowa Code requires adherence to proper notice. Failure to properly notice a tenant may result in a renewal of the lease under the current terms even if a party dies after the 1 September dead line.
If you and co owner (like a sibling) own a parcel together and the sibling rents it out and you cash your portion of the check, you are providing a strong presumption that you like the current arrangement, if you don’t, you best terminate the relationship by 1 September.
1 September isn’t the only time you can break a lease, failure to pay rent when due will also violate it. In the times of soaring costs of production and falling prices, some tenants have and more will, walk on high rents they are obligated to pay. The land owner has a responsibility to rent the ground out for what they can and then may seek the difference from the original, non paying tenant. Other lease provisions being broken may or may not result in booting the tenant off the land. For other violations, the tenant must be given a right to cure (or fix) the problem, and the violation must be materially harmful.
Like surgery, it is not required that you hire somebody, but it is usually recommended. When you are reviewing a lease or attempting to put one together, some simple rules should be kept in mind with lease,
Get it ALL in writing to prevent misunderstanding and make sure successors in interest (heirs upon death) on both sides understand the terms of the agreement. Make sure both parties sign the lease. Ensure an accurate description of the leased ground is included.
Agree upon compensation for any fall field work completion in the event of non renewal of the lease. Consider fertilizer application that may have multi year benefits and how those get compensated if the parties don’t stay in a relationship. Who gets to control the hunting, fishing and recreation rights, who sprays the weeds and who pays the taxes at the court house are all things that need to be addressed. Unless the lease says otherwise, the tenant gets the above ground portion of the crop.
Pricing isn’t always as simple as looking at the ISU average land values, adding 10% because you have great ground and demanding a check. Average cash rents reported are but one piece of the puzzle, with a rents compared to yield, corn suitability rating and a flat analysis of return on investment as compared to where else that money might earing a return all play a part in determining a fair rent. Operators would be wise to invest in education of the landowners on the costs of operating and why shinny pick ups purchased in December over recent years may have been more about tax planning and less about excess wealth and low rents. Likewise, operators who are renting from land owners facing increased medical costs should attempt to understand that sometimes, the rent is going up on the farm because the cost of housing the spouse or the land owner themselves in a care facility is going up.
If the term of the lease, which can be up to 20 years long, goes over 5 years it needs to be recorded or at least a memorandum of the lease needs to be recorded with some basic essential terms.
The Ag sector is looking at the lowest net farm income in 2016 since 2002, with a drop of 56% from 2013 prices. This is across the board, with decreases in dairy, meat, poultry, vegetable sand feed crops. Why does that matter? Iowa is consistently ranked #2 in gross farm receipts and is responsible for 7.6% of the US gross receipts in the Ag. Further, Farm Asset value is expected to decrease another 1.6% this year and debt to increase 2.3% for farms and non real estate debt to increase 3.8%. Net farm cash income projected for 2014-2015, when the numbers are finally in, down 27% and net farm income is down 37%. Add in a hotter than average July and low commodity prices and it is uncomfortable time in the ag sector.
Why does that matter? Iowa is consistently ranked #2 in gross farm receipts and is responsible for 7.6% of the US gross receipts in the Ag.
I have referred to this last "good run" of farming as the rise of the "shorts farmer". A shorts farmer is one who hasn't had to have livestock to spread out risk or make hay for, can afford to hire out crop scouting and spraying, and can trade equipment to avoid getting covered in grease doing maintenance and repairs. Shorts, while good for swimming, may not be the best gear for the rising waters ahead.
As trouble waters may be brewing, it is appropriate to review some basic concepts that perhaps we in the Ag community haven' t had to consider in quite awhile.
Chapter 7 bankruptcy is a complete liquidation of non exempt assets, leaving the filer with some cash, some basic tools of the trade, the equity in their residence , retirement accounts, and up to $7,000 in equity in a vehicle. Eligibility depends on the size of the household. In Iowa, a single person can file if they are under $46,009 in annual income, 2 person household goes to $60,872 and so on. They can be filed once every 8 years. They are quick, taking about 3-6 months to discharge most debts. Some debts will haunt you to the grave, including tax debt that is less than 3 years old, credit purchases made with in 90 days of filing, alimony/child support, government fines and student loans (with some small relief avaialbe for those who truly can do no work).
Chapter 12 is a bankruptcy tailored for farmers, with the requirement to repay creditors tied to a five year plan that is connected to the production schedule of the ag economy, which is different that a factory. Farmers who file can only have $4,031,575 in debt to be eligible. That is owing $10,000/acre on 403 acre and nothing more, which isn't really that outlandish. Those who don't qualify will go to a 13 or a 11.
If you are thinking about filing a bankruptcy, you can do pre bankruptcy planning. Pull your financial statements, run a cash flow, get your taxes done and filed and meet with an advisor. Sometimes, the lenders can restructure your debts without filing a formal bankruptcy. Iowans have a tendency to hang on too long and miss opportunities to reset the game pieces and as result, end up consulting advisors and bankers when it is already too late.
Beware of gifts or below market sales prior to filing a bankruptcy, These transfers can be set aside and pulled back into a bankruptcy filing. Additionally, creditors who receive payments from someone who files bankruptcy can have those payments pull back into the bankruptcy estate if they were made 90 days prior to the filing. The creditor has some defenses, to include showing that the payments were ordinary business transactions but it can sometimes be more painful monetarily than it is worth.
Think about the round baling being done this summer. The custom operator who waits in the field for the check and cashes it promptly now doesn't care about a 1 March bankruptcy but the operator that avoids conflict and waits to send bills until December may be writing a check to the bankruptcy trustee for the work they did and collected on. If someone who owes you money files bankruptcy and you receive the notice or read it in the paper, stop contacting them at once. You have the opportunity to do some investigation into whether any you are going to get paid, but calling the debtor to ask is not the way to handle it.
Sumner, Iowa Attorney practicing in Iowa primarily in Ag Law, Bankruptcy, Estate Planning, Real Estate Law. Lawyers at the Dillon Law P.C. are dedicated serving Iowa, including but not limited to the cities of Allison, Charles City, Cresco, Decorah, Des Moines, Dubuque, Elkader, Grundy Center, Independence, Manchester, New Hampton, Waterloo, Waverly, Waukon, West Union & Vinton, and the communities that makeup Allamakee, Benton, Black Hawk, Bremer, Buchanan, Butler, Chickasaw, Clayton, Delaware, Dubuque, Fayette, Floyd, Grundy, Howard, Polk, Winneshiek, counties. © 2021 Dillon Law P.C. Sumner Location | 209 E. 1st Street, Sumner, IA 50674 Volga City Location | 502 Washington St, Volga City, IA, 52077. West Union Location | 103 N. Vine Street, West Union, Iowa 52175 West Union, Iowa 52175 We are there most Fridays 10-3 and by appointment. Telephone: (563) 578-1850 Email: firstname.lastname@example.org Home | Attorneys | Blog | Ag Law | Bankruptcy | Estate Planning | Real Estate Law | Contact | Iowa Ag Law Attorney Sumner Taxation Commercial Transactions Production Contracts Labor Hobby Farm Liability Bremer Fayette County Lawyer