Business Succession/Estate Planning

Report
Business Succession/Estate
Planning – Tax, Non-Tax and
Entity Considerations*
Roger A. McEowen**
_______________
*Presented at the 2013 National Farm Business Management Conference, Overland Park, Kansas, June 10, 2013.
**Director of the ISU Center for Agricultural Law and Taxation. Member of the Iowa and Kansas Bar Associations and
licensed to practice in Nebraska.
providing timely, critically objective
information to producers, professionals
and agribusinesses concerning the
application of important developments
in agricultural law and taxation
2321 N. Loop Drive, Suite 200  Ames, IA 50010  (515) 294-5217
H.R. 8 - The Fiscal Cliff Bill
• What the Bill does not do:
– No extension of the payroll tax cut
• 6.2% rather than 4.2% ($113,700 wage base)
• Applies to wages paid and self-employment
income paid with return
• Note:
– Don’t forget .9% Medicare surtax on earned income
exceeding $250,000 (MFJ); ($200,000 single)
– Does not address carried interest
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
Ordinary Income Rates
Old Law:
New Law:
Top rate of 35%,
starting at taxable
income MFJ,
$388,350
Top rate of 39.6%,
starting at $450,000
MFJ taxable income,
$400,000 single.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
New Brackets
MFJ
Single
To $8925
10%
To $17,850
10%
-to $36,250
15%
-to $72,500
15%
-to $87,850
25%
-to $146,400 25%
-to $183,250 28%
-to $223,050 28%
-to $398,350 33%
-to $398,350 33%
-to $400,000 35%
-to $450,000 35%
>$400,000
>$450,000
39.6%
39.6%
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Marriage Penalty Returns
(and is worse than before)
• Example
– Married couple with each earning wages of
$400,000
• Income tax owed - $260,000
• Medicare surtax - $4,950
– Two single persons living together each earning
wages of $400,000
• Income tax owed - $228,000 (total)
• Medicare surtax - $3,600 (total)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
New Brackets
39.6% bracket for trusts begins at $11,950
for 2013(replaces old 35% bracket)
Note: This is the IRS position, but it may
not be correct – rate may only be 35%
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Trust Tax Rates
• Sec. 101(b)(1)(B) of ATRA adds I.R.C. Sec.
1(i)(3), which says that rate of tax under
subsections (a),(b), (c) and (d) rises from
35% to 39.6% for income above the
“applicable threshold”
– Trusts and estates are not taxed under any of
these subsections
– ATRA provides no threshold amounts at which
the 39.6% bracket would start
– Thus, 39.6% bracket should not apply to trusts
and estates
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
Phase-out of itemized deductions
(The “Stealth Tax”)
Itemized deductions phase out for each dollar of AGI over:
•
•
$300,000 (MFJ) $275,000 (HOH)
•
$250,000 (Single filers)
•
$150,000 (MFS)
So, what’s the impact of reinstating PEP and PEASE?
•
PEP reduces personal exemption by 2% for every $2,500 of income
above the threshold amount for single taxpayers and every $1,250 of
income above threshold amount for MFJ
•
Personal exemption is $3,800/person, so a married couple with 2 kids
with incomes above $300,000 (up to about $425,000) will have about
a 4% increase in marginal tax rate
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Pease Limitation
• Pease cuts itemized deductions by 3% of
AGI above the threshold amounts up to
maximum of 80%
• Deductions not included:
– Investment interest
– Medical expenses
– Casualty, theft and wagering losses
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
Phase-out of itemized deductions
(The “Stealth Tax”)
The phase-outs cause tax increases to kick in at
much lower levels.
-Families in 33% bracket could have an
effective marginal rate exceeding 38%
-Families in 39.6% bracket would have an
effective rate over 46% (after adding in
Medicare surtax of 3.8%)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
New Brackets, adjusted for phase outs
Single
MFJ
$183,250-$398,350
(33.99%)
$398,350-$400,000
(36.05%)
$400,000 and up
(40.788%)
$223,050-$398,350
(33.99%)
$398,350-$450,000
(36.05%)
$450,000 and up
(40.788%)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
New Capital Gain Brackets
(as applied to taxable income)
MFJ
Single
To $8925
0%
-to $36,250
0%
-to $400,000 15%
>$400,000
20%
To $17,850
0%
-to $72,500
0%
-to $223,050 15%
-to $398,350 15%
-to $450,000 15%
>$450,000
20%
Adjust for the phase-outs as needed.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
How Do The Higher Rates Apply To Clients
With Both Ordinary Income and LTCGs?
• Example:
– Bob and Mary file as MFJ and have ordinary
income of $300,000 and LTCG of $200,000.
Thus, taxable income after deductions is
$500,000
• Threshold for 39.6% rate is $450,000, so at what rate is
the capital gain taxed? In other words, what is the
ordering rule?
– Does the capital gain get applied to the threshold first, so
that it’s taxed at 15%?
– Does the ordinary income get applied to the threshold first,
so that none of the ordinary income is subject to the 39.6%
rate, and a portion of the capital gain is taxed at 15% and
the balance at 20%?
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Capital Gain/Ordinary Income
Ordering Rule
• Of course, the Congress didn’t answer the
question in H.R. 8
• Look to I.R.C. §1(h)
– Determine portion of taxable income that will be
subject to ordinary rates using graduated rate tables
• Greater of taxable income reduced by capital gain
($300,000), or
• Lesser of
– Amount of income taxed at rates below 25% ($72,500 for MFJ in
2013), or
– Taxable income less adjusted capital gain ($300,000)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Continuing the Example
• The $300,000 of the $500,000 of taxable
income is taxed at ordinary income rates,
subject to the graduated rate tables
– None taxed at 39.6% (even though taxpayer
has taxable income over $450,000) because
their ordinary income does not exceed
$450,000
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Continuing the Example
• How much of the LTCG is subject to the 0% rate?
– H.R. 8 extends the 0% rate for taxpayers otherwise in
the 10% or 15% bracket.
– The amount of the 0% rate is the lesser of:
• Net capital gain ($200,000), and
• The top of the 15% bracket ($72,500) reduced by taxable
income less adjusted taxable gain ($500,000 - $200,000)
[$72,500 - $300,000 = 0]
– Thus, none of the capital gain is taxed at the 0% rate.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Capital Gain Example
• Clay Tile
– $600,000 of Schedule F net income for 2013.
– Sale of farmland in 2013 that had
unharvested crop
• LTCG of $800,000
– $60,000 of itemized deductions
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Capital Gain Example
• Tax issues associated with unharvested crop
– No deductions for expenses (add to basis)
– Gain is LTCG if land held for more than a year
– Allocate portion of selling price to unharvested
crop
– Result changes if retained right to reacquire land
– What about pre-paid expenses?
• Amended return
– Potential application of 3.8 Medicare surtax
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Return to Clinton Era Tax Rates?
• The Administration touts the deal as a “return
to Clinton-era tax rates”
– Not a chance:
• Capital gain rates about 3-5% points higher
• Medicare tax is higher
• Stealth tax makes individual rates higher than
advertised
– Economic growth slowed down (as did revenues)
after the Clinton tax hike
• Real wages declined
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
At least we have an AMT fix
-Single AMT exemption for 2012:
$50,600
-MFJ AMT exemption for 2012:
$78,750
-Adjusted henceforth for inflation
-Retroactive for tax years beginning after 2011, an individual
can offset their entire regular tax liability and AMT liability by
the nonrefundable personal credits
-Adjust for the phaseouts as needed
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
AMT Capital gain rates
They are same as regular tax capital
gain rates, but using AMT taxable
income.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
2
HR 8: the Fiscal Cliff Bill
Permanency of Transfer Tax Provisions
•
•
•
•
Rate raised to 40% (from 35%)
Lifetime exemption remains at $5 million, with inflation
indexing ($5,250,000 for 2013 deaths)
• The exclusion remains coupled
Matching Gifting and GST exemption
“Portability” retained (surviving spouse can inherit
decedent’s unused exemption)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Transfer Tax Changes
• The rate change is easy to deal with
– No carryover effect from year-to-year or from gifts
to estates
– No need to revise familiar estate planning
techniques
– New law doesn’t give any reason to alter existing
plans
• But revisit plans where there have been changes in
finances or personal life
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Transfer Tax Changes
• How the new rate structure works:
– 40% rate reached at a taxable estate or
cumulative gifts of $1 million
• The “run up the brackets” for the first $1 million is
$54,200 (i.e., any tax payable would be $54,200
less than if the tax were a flat 40% from the first
dollar)
– Unified credit is $2,045,800 and offsets a
taxable estate (or taxable gift) of $5.25 million
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
State Estate Taxes
• State estate taxes remain deductible in
calculating the federal taxable estate
• In those states (most of them) that don’t
have an estate tax, or have a state estate
tax that is coupled to the (now extinct)
state death tax credit, 40% will be the only
estate tax rate above the exemption
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
State Estate Taxes
• Most states that have an estate tax tie it to
the pre-2002 federal credit for state death
taxes
– Top rate of 16% for taxable estates over $10.1
million
• In states that follow the federal law and allow
a deduction for the state tax, the total federal
and state top marginal rates will be 48.3%
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Portability
• Made permanent
• Technical correction made
– “Basic exclusion amount” changed to “applicable
exclusion amount” in I.R.C. §2010(c)(4)(B)(i)
• June 15, 2012 portability regulations remain
applicable
• Still have to file Form 706 in first spouse’s
estate to make election
– 9 months after death with 6 month extension
possible
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Impact of Portability
• Since it is now “permanent,” the use of
bypass trusts for all but the wealthiest of
families might be reduced
• But, there are still reasons to use bypass
trusts:
–
–
–
–
–
Protect assets from creditors
Surviving spouse might remarry
Assets might go down in value
Plan might already use a bypass trust
Bypass trusts avoid administrative pitfalls
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Estate Planners Not Irrelevant
• Many non-tax reasons to see an estate
planner:
– Asset protection through entities, trusts, pre-nups
and post-nups
– Planning for long-term health care
– Powers of attorney
– Reviewing beneficiary designations and
coordinating them with estate plan
– Business succession
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
GSTT
• Made permanent is the allocation of the
GSTT exemption and the GSTT inclusion
ratio
• Exemption same as that for estates and
gifts ($5.25 million for 2013)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Transfer Tax Issues
• What was not included in the bill:
– No attack on valuation discounts
– No 10-year term limit on GRATs
– No limit on the duration of the allocation of the
GSTT exemption
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
3
Retroactive business extenders
•
5-year S corporation built-in gain recognition period
• For 2012 and 2013 (10 year rule in 2014)
• Thus, S corporations with BIG that have been an S for at
least 5 years as of the beginning of 2012 or 2013 will
not owe BIG tax on sale of appreciated assets
• If installment sale made after recognition period (e.g. 5
years) and recognition period reverts to 10 years, gain on
installment sale is protected from BIG tax
• If BIG income is carried forward to future years due to
taxable income limitations and BIG period has expired, no
BIG tax on expired amount
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
Energy-Related Provisions
• “Renewable” Energy PTC
• Extended for one year
• Taxpayer can make irrevocable election to take
a 30% energy credit instead of the PTC
• Qualified property defined as being
constructed, reconstructed, erected or acquired
by the taxpayer and the original use of which
commences with the taxpayer
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
2
HR 8: the Fiscal Cliff Bill
Section 179 limit raised for 2013 – and 2012
• Limit for 2012 had been $139,000, with
deduction starting to phase out at
$560,000.
• 2013 limit had been $25,000, with phaseout starting at $200,000
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
2
HR 8: the Fiscal Cliff Bill
Section 179 limit raised for 2013 – and 2012
•
•
•
New law boosts limit for both 2012 and 2013 to
$500,000, with phaseout starting at $2 million.
• Windfall for clients that purchased expensive assets
in 2012 and thought they would be limited to
$139,000
Limit to return to $25,000 in 2014.
The $139,000 amount for 2012 is gone
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
HR 8: the Fiscal Cliff Bill
Section 179 provisions from 2011 extended
•
•
Includes treatment of up to $250,000 in “qualified real
property” expenses and qualification of computer software for
Section 179 treatment.
You can still make or revoke a Section 179 election on an
amended return for open tax year
• Good through tax years beginning before 2014
• Huge planning opportunity
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
3
Bonus Depreciation
• 50% first-year bonus depreciation
extended for 2013
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Expense Method and Bonus
Depreciation
• Sec. 179
– New or used equipment
– No farm buildings, unless they are singlepurpose agricultural/horticultural structures
– Use in trade or business
– Must have income from trade or business
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Expense Method and Bonus
Depreciation
• Bonus Depreciation
– 20-year MACRS property or less
– Must be new
– Farm buildings
• Ordering rule
– Sec. 179 first, then bonus, then regular
MACRS
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Charitable Donation To Charity
From IRA
•
•
•
•
Reinstated for 2012 and extended through 2013
Must be over age 70.5
Limit is $100,000 annually
Donation must be to qualified charity directly (trustee of IRA must
draft check in charity’s name)
• Any distribution received during 12/12 not included in income if
donated during 1/13
• Distribution cannot be taken into account for determining the “other”
charitable contributions to be allowed as a deduction under I.R.C.
Sec. 170
– In other words, the distribution cannot be added to AGI for purposes of the
AGI limitation
• Can help avoid 3.8% Medicare surtax (if desire is to benefit charity)
– Required distribution is passive and counts toward threshold, but not if
donated directly to charity
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
ACA (Obamacare) Provisions
Starting in 2013
7
• Medical expenses (Schedule A)
– Reduced by 10% of AGI for those under age
65
• Applicable if either spouse under age 65
– If 65 or older, reduced by 7.5%
• Applicable if either spouse 65 or older
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
New Excise Tax on Medical
Reimbursement Plans
• I.R.C. Sec. 4376.
– An amendment to ERISA added by ACA.
– Imposes a "fee" on any applicable self-insured health plan for
each plan year ending after 9/30/2012.
• Fee is $1 per average number of lives covered under the plan for plans
that end during fiscal year 2013, $2 thereafter.
• The fee is to be paid by the "plan sponsor" defined as the employer for
plans established or maintained by a single employer.
• An "applicable self-insured plan" is any plan for providing accident or
health coverage if any portion of the coverage is provided other than
through an insurance policy and is established or maintained by 1 or
more employers for the benefit of their employees.
• An excise tax remitted via Form 720.
• First payment is due Jul. 31 for the calendar year 2012. Basically, it's
due seven months after the plan year end. It doesn't apply to plan years
ending after 9/30/2019.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Proposed regulations on 3.8% tax
on “Net Investment Income”
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
The ACA imposes
two related taxes:
6-7
• A 0.9% wage tax high-income individuals,
paired with a 0.9% self-employment tax at the
same income levels. (Sec. 3101(b)(2))
– No employer match on the 0.9% tax
• A 3.8% tax on "investment income" at higher
AGI levels. (Sec. 1411)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Wage/SE tax applies to:
• Wage/SE income over $200,000 for single
filers
• Joint wage/SE income over $250,000 for joint
filers, or
• Wage/SE income over $125,000 for married
taxpayers filing separately.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Wage/SE tax
• Employers will have to withhold when wages for
an individual exceed $200,000. Any shortfall or
overpayment has to be dealt with on the employee
1040.
– Example: Jack and Jill each earn $150,000 in
2013 wage income. Because both are below
$200,000, no 0.9% tax will be withheld on their
wages. When they file their 2013 return, they will
owe $450 (($300,000-250,000) x .9%) as
additional tax on their 1040.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Implications for partners?
Choose your poison!
• If you materially participate in a partnership
with trade or business income, you will have
self-employment income, potentially subject
to the .9% tax – and the old 2.9% Medicare
tax.
• If not, you will have passive income subject to
the 3.8% tax.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Implication for S corporations:
more reason to keep a lid on
"compensation."
• S corporation K-1 income is not subject to
FICA or SE tax.
• Reasonable compensation required.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Implication for Entity Planning
• S corporation is favored over partnerships
because of better ability to avoid both
employment tax and investment income tax
of active owners.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Investment income (Sec. 1411)
• 3.8% tax applies to lesser of “net investment
income" or the excess (if any) of the
taxpayer’s "modified AGI" over:
– $200,000 for single filers
– $250,000 for joint filers, and
– $125,000 for married taxpayers filing
separately.
– Top bracket cutoff for trusts ($11,950 in 2013)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
NII
• The 3.8% surtax is not deductible
• Self-employed persons can’t claim the
surtax as part of the 50% deductible
portion of S.E. taxes under I.R.C. §164(f).
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Investment income includes:
• Interest not derived in the ordinary course of a trade or
business. (Preamble Sec. 5.A)
– This excludes interest earned in a banking business. See
Preamble Sec. 5.A.vi.
• Dividends
• Rents
• Non-qualified annuities to extent taxable and required
minimum distributions
• Royalties
• Capital gains, except from sales of active businesses
• But, include capital gain from sale or liquidation of closely-held C
corporation, even though taxpayer materially participated
• Passive trade or business income
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
“Net Investment Income” Does Not
Include
•
•
•
•
Salary, wages or bonuses
Distributions from IRAs or qualified plans
Pension income
Any income taken into account for selfemployment tax purposes
• Gain on the sale of an active interest in a
partnership or S corporation
• Items which are otherwise excluded or exempt
from income under the income tax law
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Capital gain from the sale of interests in
partnerships and S corporations (1.1411-7)
1. The partnership or S corporation is deemed to
dispose of all of the entity's properties in a fully
taxable transaction for cash equal to the fair
market value of the entity's properties
immediately before the disposition of the
partnership or S corporation interest.
2. Determine the amount of gain or loss for each
property.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Capital gain from the sale of interests in
partnerships and S corporations (1.1411-7)
3. “Applying the rules of chapter 1, the
partnership or S corporation determines the
amount of gain or loss for each property that
is allocable to the interest disposed of by the
transferor.”
4. Adjust out the gain attributable to nonpassive property items from the total gain.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Sec. 1411 tax
• Running investment income through a
pass-through that otherwise has trade
or business income does not avoid the
tax.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Net Investment Income:
Itemized Deductions
• Taken into account to extent allowed as a deduction.
Examples include:
– Investment interest
– Investment expenses (e.g., >2% AGI)
– Income taxes “properly allocable” to gross income.
Allocation based on gross income is proper (1.14114(f)(3)(C)
• Pass-through entity disclosure isn’t addressed. Query
state taxes on pass-through income (e.g. Illinois,
California, Kentucky) and composite state taxes.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
3.8% Surtax – Application to Trusts
and Estates
• 3.8% of lesser of undistributed NII for the tax year,
or the excess (if any) of AGI for tax year, over the
dollar amount at which highest tax bracket begins
($11,950 for 2013).
– Note: If beneficiaries do not have sufficiently high
MAGI and passive income such that they would not
be subject to the 3.8% surtax, and are not otherwise
in the highest marginal tax bracket, fiduciary should
distribute the amount of AGI for trust or estate that
exceeds the threshold for the top rate
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Trusts and Passive Income
• The IRS view is that only the trustee, acting
in its capacity as trustee, can satisfy the
material participation test for a trust
– No regulations
– The one court that has decided the issue said the
IRS position is “arbitrary, subverts common
sense, and attempts to create ambiguity where
there is none”
– Tax Court case pending.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
3.8% Surtax
• Critical terms:
– Net investment income
– Threshold amount
• $200,000 (single)
• $250,000 (MFJ)
• $11,950 (trusts and estates)
– Modified adjusted gross income
• AGI (line 37 of 1040) plus net foreign earned income
exclusion
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Illustration of investment income:
MAGI
Investment
Income
Wages
300,000
Interest
10,000
10,000
Non-qualified Annuity
20,000
20,000
403(b) annuity
30,000
Gain on stock sale
40,000
40,000
Gain on principal
residence
800,000
800,000
Residence gain exclusion (500,000)
(500,000)
Total
370,000
700,000
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Illustration of function of income
threshold:
MAGI
Investment Income
Wages
150,000
Dividends
5,000
5,000
Interest
15,000
15,000
403(b) annuity
30,000
Gain on stock sale
40,000
40,000
Passive Income
15,000
15,000
Non-passive income
5,000
Total
260,000
75,000
Tax Base
10,000
75,000
Tax
380
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Another Example
• Single taxpayer
– $100,000 of salary
– $50,000 of net investment income
– MAGI is $150,000
– MAGI is less than threshold – no 3.8% tax
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Another Example
• Single taxpayer
– $0 employment income
– $225,000 net investment income
– MAGI is $225,000
– MAGI exceeds threshold by $25,000
– Surtax is .038 x $25,000 = $950
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Another Example
• Married filing jointly
– $300,000 combined salary
– $0 net investment income
– No surtax (wages exempt)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Another Example
• MFJ
– $400,000 salary income
– $50,000 net investment income
– Surtax applicable to $50,000 of net
investment income
• .038 x $50,000 = $1,900
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Another Example
• MFJ
– $200,000 salary income
– $150,000 net investment income
– Excess of MAGI over threshold is $100,000
– Surtax is .038 x $100,000 = $3,800
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Another Example
• Single
– $200,000 investment income
– $125,000 RMD from IRA
– MAGI is $325,000
– Excess of MAGI over threshold is $125,000
– Surtax is .038 x. $125,000 = $4,750
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Another Example
• MFJ
– $100,000 pension income
– $150,000 IRA income
– $25,000 tax-exempt interest
– There is no net investment income, so no
surtax
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Passive income tests
• 500 hours in an activity
• Significant participation - 100-to-500 hour activities that add
to 500 hours in a year
• Substantially-all participation in the activity
• 100 hours, and as much as anyone else
• Materially-participated in 5 of last 10 years (or any three
years for personal service businesses)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Special Rule For “Retired"
Farmers
• Material participation in 5 years in the eight
year period before you start drawing social
security is evergreen.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Special rule for real estate
professionals
to avoid "per-se passive" treatment:
threshold test
• 750 hours of participation in real estate
trades or businesses owned, and
• More real estate hours than anything else.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Recharacterization
• Tax rules treat some otherwise passive
income as non-passive, including
– Land rent (under 30% of unadjusted basis
depreciable)
– “Self-rental” to a material participation activity
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Grouping: real estate and other
items. What is an "activity?"
• Sec. 469(c)(7) grouping election for real
estate pros
• Other taxpayers can group appropriate units,
but must disclose groupings and cannot
change absent material change in
circumstances.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Grouping basics (1.469-4(d))
• Rental and trade or business activities may not be
grouped unless one is “insubstantial” with respect
to the other.
• Real property rental activity cannot normally be
grouped with personal property rental.
• You can group activities of renting from one
activity to another if both activities have identical
ownership.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Disclosure of groupings (Rev.
Proc. 2010-13)
• Grouping changes must be disclosed on
returns.
• Once made, groupings can’t be changed by
taxpayer unless initial grouping was “clearly
inappropriate” or there was a “material
change in circumstances”.
• New activity groupings must be disclosed.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Special grouping election in proposed
regulations (Proposed Reg. Sec. 1.46911(b)(3)(iv)).
• May regroup activities in first taxable year beginning
after December 31, 2013 that they are over the
income threshold and have net investment income.
• Taxpayers over the threshold may regroup for 2013.
• Taxpayers may only regroup once under this
provision.
• Regrouping must be disclosed pursuant to 1.4694(e) and other regrouping rules.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Required disclosure (1.1411-7(d))
1. A description of the disposed-of interest;
2. The name and taxpayer identification number
of the entity disposed of;
3. The fair market value of each property of the
entity;
4. The entity's adjusted basis in each property;
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Required disclosure (1.1411-7(d))
5. The transferor's allocable share of gain or loss with
respect to each property of the entity
6. Information on whether property was subject to the
tax
7. The net amount of gain, and
8. The computation of the gain subject to the Sec. 1411
tax.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Self-rental
• Are "self-rentals" that are non-passive subject
to the 3.8% tax as rentals?
– “Self-rental” income that is not passive under
the passive loss “recharacterization” rules will
still be subject to the Sec. 1411 tax. Preamble
Sec. 6.B(i)(b)(3)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Real estate professionals
• Real estate professionals get lame guidance:
– If a taxpayer meets the requirements to be a real
estate professional in section 469(c)(7)(B), the
taxpayer's interests in rental real estate are no
longer subject to section 469(c)(2), and the rental
real estate activities of the taxpayer will not be
passive activities if the taxpayer materially
participates in each of those activities. However, a
taxpayer who qualifies as a real estate professional
is not necessarily engaged in a trade or business
(within the meaning of section 162) with respect to
the rental real estate activities.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Planning issues
• Affects gifting, grouping decisions.
• Compensation issues. If you are going to claim
material participation in an S corporation or LLC,
you should expect to pay wages or SE tax.
• Monitoring participation: if participation is even
potentially iffy, the taxpayer should keep a current
time diary.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Implications for Trusts
• Trusts threshold is the top tax rate bracket under the
proposed regulations (1411(a)(2)).
– Surtax applies to lesser of undistributed NII or the excess of an
estate/trust’s AGI over $11,650
• Regulations allocate investment income between distributed
and undistributed income under usual trust allocation rules.
• Electing small business trusts will have to combine their S
corporation and non-S corporation portions for computing the
tax (Proposed § 1.1411-3(c)(1)(ii)).
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
3.8% Surtax – Planning Strategies
• Anything that reduces NII or MAGI will reduce
or eliminate the 3.8% surtax
• Increase municipal bond investments
• Maximize qualified plan contributions
• Avoid spikes in income
• Structure farm business as a membermanaged LLC
– While non-manager’s interest is passive, spouse
can take into account m.p. of manager-spouse
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Volume B, Chapter 5
SUCCESSION PLANNING
providing timely, critically objective
information to producers, professionals
and agribusinesses concerning the
application of important developments
in agricultural law and taxation
2321 N. Loop Drive, Suite 200  Ames, IA 50010  (515) 294-5217
Reasons Why Businesses Don’t
Have Succession Plans
• Successor doesn’t believe that the predecessor
will ever retire
– Arthur Andersen survey
• Between 25% and 33% of leaders of family businesses don’t
intend to retire or plan to remain involved throughout their
lives
• 30-40% of family businesses have no plan in place
• Taboo subject
– Relationships and emotions involved
– Business may be founder’s self-identification
– Animosity toward younger generation
• Primogeniture
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
OBJECTIVES OF
SUCCESSION PLANNING
•Objectives must drive the
process and must be clearly
articulated
providing timely, critically objective
information to producers, professionals
and agribusinesses concerning the
application of important developments
in agricultural law and taxation
2321 N. Loop Drive, Suite 200  Ames, IA 50010  (515) 294-5217
B197
Objectives of Succession Planning
• Successfully bringing the next generation into
the business
• Providing vocation for next generation
• Establishing a base for a financially
successful business into future
• Providing a plan for the older generation
• Providing an estate plan that is fair to
business and non-business heirs
• Tax minimization
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Thread Through Other Efforts
Estate Planning
Succession Planning
Business Planning
Steps to Successful Succession
Planning
• Determine business owner’s long-term goals
and objectives
• Determine financial needs of business owner
and spouse and develop plan assuring
financial security
• Determine who will manage the business and
develop the management plan
• Determine who will own the business and
how to transfer owner’s interest
• Minimize transfer taxes and establish estate
plan
B198
BUSINESS
ORGANIZATION
STRATEGIES
providing timely, critically objective
information to producers, professionals
and agribusinesses concerning the
application of important developments
in agricultural law and taxation
2321 N. Loop Drive, Suite 200  Ames, IA 50010  (515) 294-5217
Single Entity
Most U.S. Businesses
70 to 75% of farms
and 50-60
percent of nonfarm businesses
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B198
Multiple Entities

OPERATIONAL
ENTITY
Sole Proprietorship
Partnership
LLC
C Corporation
S Corporation
Equipment

REAL ESTATE
ENTITIES
__lease____
Child’s
capital
Parents’
capital
LLC
Operational Entity
• Typical choices include:
– Sole proprietorship
– General partnership
– LLC
– C Corp
– S Corp
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Operational Entity
• Assets Possible to Be Placed into
Business
– Checkbook
– Inventory
– Equipment
– Very Limited Real Estate
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Landholding Entities
• Selected entity is usually sole
proprietorship or LLC
• Typically not wise to put real estate in
corporation
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
•
•
•
•
•
•
•
•
Basic Entity Choices
(See Pages B199-200 for Summary
Table)
Sole Proprietorship
General Partnership
Limited Partnership
Limited Liability Company
Limited Liability Partnership
S Corporation
C Corporation
Cooperatives
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Primary Considerations in
Choosing Entity Form
• Continuity
– Corporation
– Sole proprietorship
– General partnership
• Giles v. Giles Land Co. (Kan. Ct. App. 2012)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Removing a Partner Without
Terminating the Partnership
B201
• Giles v. Giles Land Co. (Kan. Ct. App. Jun.
15, 2012)
– State partnership dissociation statute invoked to
remove the “magnanimous savior of the family”
• Must value and buy-out his interest
• Note: In a limited partnership, a limited
partner can assign their interest without
impacting dissolution
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B201-202
Transferability of Entity Interests
• Transferring entity interests rather than
individual assets
– Partnership interests
– LLC interests
• Is transferred property subject to debt?
• What about bankruptcy exemptions?
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Flexibility
• Corporation – perhaps greatest in terms of
management structure
• Partnership – look to the agreement
• LLC – the agreement controls
– Based on state law, chance for greater
creditor protection
– Passive loss issue
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
LLCs and the Passive Loss Rules
• How is a loss characterized?
– Depends on whether the taxpayer is materially
participating
• Seven tests for material participation
• Per-se rule of non-material participation for limited
partner interests in a limited partnership unless the
Treasury specifies differently in Regulations
– Statute pre-dates states LLC statutes and advent of LLPs
• Three tests for limited partners in a limited
partnership
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
LLCs and the Passive Loss Rules
• I.R.C. §469(h)(2)
– Per-se rule of non-material participation for
limited partner interests in a limited
partnership, unless regulations specify
differently
• “Except as provided in regulations, no interest in a
limited partnership as a limited partner shall be
treated as an interest with respect to which a
taxpayer materially participates.”
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Garnett v. Comr., 132
T.C. No. 19 (2009)
• Taxpayer incurred losses in LLCs and IRS
characterized them as passive under the
“per-se” rule
• Tax Court rejected IRS position
– LLC is materially different than a partnership
– Oregon Federal District Court had already
ruled similarly based on Oregon law
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Thompson v. Comr.,
87 Fed. Cl. 728 (2009)
• IRS position again rejected
– IRS position given no deference
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Hegarty v. Comr.,
T.C. Sum. Op. No. 2009-153
• Follows Thompson and Garnett
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Newell v. Comr., T.C. Memo. 201023
• Is the managing member’s interest in a
California LLC that was classified as a
partnership for income tax purposes a
limited partnership interest for purposes of
Sec. 469?
– IRS said it was
– Court (again) said it was not
– No unforeseeable circumstance present
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Rental Activities and the Passive
Loss Rules
• Remember, Sec. 469 disallows passive
activity losses for any taxable year except
to the extent they offset passive income
– Rental activities are per se passive (with two
exceptions)
• Real estate professionals (Sec. 469(c)(7))
• $25,000 annual deduction if AGI $150,000 or less
(Sec. 469(i))
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Rental Pros
• Losses fully deductible if material
participation present
• But, what is a real estate pro?
– More than 50% of personal services performed in
trades or businesses by taxpayer during year
must be performed in real property trades or
businesses in which taxpayer materially
participates
– 750-hours in real property trades or businesses in
which taxpayer materially participates
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Chambers v. Comr., T.C. Sum. Op.
2012-91
• Real estate professional test invoked
– 750 hours
– More than 50% test
• IRS said petitioner’s hours spent in LLC
management activities didn’t count
– Court disagreed based on Garnett
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Limited and General Partnerships
• Prop. Treas. Reg. (Nov. 25, 2011)
– For purposes of passive loss rules, focus is
on whether taxpayer has right to participate in
management at any time during tax year
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Organizational Options
• Self-Employment Tax
– If an LLC is not conducting a business, there
is no self-employment income.
– If an LLC is conducting a trade or business,
then self-employment income results, unless
the limited partnership exception exists (Sec.
1402(a)(13)).
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B202
Liability
• Sole proprietorships and general
partnerships
– Unlimited liability
• LLCs and corporations
– Limited liability
– Tax issues typically drive the decision
– Charging orders (B203)
• Example 2
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B204
Liquidation Costs
• C Corp
– Highest liquidation cost
– Distributions in excess of stock basis result in
capital gain
• S Corp
– Others
• LLC
– Distribution of assets on tax-free basis
• Discounting of Business Interests
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B206
Organizational Considerations
• Income tax considerations
– Double level tax for corporations other than S
corporations
– Recognition of gain on liquidation for S
corporation liquidating distributions §311(b)
– Flow-through tax considerations with no or limited
gain recognition on liquidation for partnershiptype entities
• LLCs
• LPs
• GPs, etc.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
What To Consider Before Making S
Election
• Unused NOLs of C corporation cannot be
used by S corporation to offset future S
corporation income
• S corporation compensation issues
– Payment of “reasonable” wages
• Payroll tax issue
– Watson case
– No cases involving issue of reasonable compensation
where salary at least at FICA wage base
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B206
Using an S Corp. To Minimize FICA
& Medicare Tax
• Watson, 668 F.3d 1008 (8th Cir. 2012)
– Taxpayer earned 200,000 in 2002 and 2003
from CPA business but paid himself annual
salary of 24,000 (firm established as a
partnership of S corporations)
• Court reclassified about $67,000 of S corp.
dividends as salary for each year resulting in about
$91,000 of FICA/Medicare wages
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
S Corporation Tax Fails (Again)
• S. 2343
– Would have applied payroll tax to taxpayers
with income over $250,000 by requiring them
to include for payroll tax purposes income
received from an S corporation or L.P.
interest in professional services business
where 75 % or more of gross revenue derived
from services of three or fewer shareholders
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
S Corporation Disproportionate
Distributions
B207
• Can make disproportionate distributions to
correct disproportionate distributions
– PLR 201236003 (Apr. 11, 2012)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
S Corp. Debt Basis Regs.
• How to increase basis:
– Bona fide debt
– Circular loans can work
– Guarantees don’t work unless shareholder
actually makes payment
– Unsecured promissory note doesn’t work
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B207
Fringe Benefits
• Health Insurance and retirement plans
– Tax distinctions between various entities
• Qualified retirement plan options
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B210
Valuation Discounting
• FLPs
– No recognition of gain or loss for FIT purposes to
either the party making the transfer or to the
entity. Sec. 721(a)
– Change in theoretical basis for fractional interest.
• Interests in farmland if held by more than one person
may qualify for fractional interest discounts.
– Take the FMV of the land as a whole and subtract the
estimated costs of a partition action divided by the
percentage of land held
– Once land is held by an entity, the valuation of units will be
subject to normal lack of marketability, minority interest
discounts and (perhaps) a control premium
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Valuation Discounting
• FLPs
– Change in status of property for state law
purposes
• Real estate of real property is normally sitused for
purposes of state death tax statutes to the place where
the land is located
– Result not normally changed even if the land is held by a
revocable trust
– NOTE: LLC interests are generally personal property and
personal property is generally sitused to the decedent’s
state of residence
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Family Limited Partnerships
• Keller, et al. v. United States, No. 10-41311, 2012
U.S. App. LEXIS 20119 (5th Cir. Sept. 25, 2012)
– In 1998, $300 million transferred into revocable trust. FLP
later created but not community property bonds that were
to fund it not transferred before wife died on 5/15/00.
• Estate paid over $147 million in estate tax in 2/01
• FLP funded post-death
• FLP funding meant that estate didn’t have funds to pay estate
tax; transaction restructured as $114 million loan and estate
issued promissory note at Feb. ‘01 AFR
• Estate filed claim for refund in 11/01
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Keller v. United States
(5th Cir. Sept. 25, 2012)
• Grounds for refund claim:
– Failed to claim discount
– Failed to claim deduction for interest paid on
loan
• Estate wins
– Under TX law, the intent to transfer the bonds
to the FLP was sufficient – refund of $115
million
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Current Developments in Estate
and Business Planning
• Family limited partnerships (FLPs)
– Estate of Wimmer
• Making sure gifts of FLP interests qualify as
present interests even where restrictions present
– Right to income from the interests
– FLP generated income from its investments
– Some portion of the income would flow to donees on
consistent basis
– Amount flowing to donees could be ascertained
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
You Can’t Take a 40% Discount on
a 100% Interest
• Estate of Lockett
– Mrs. Lockett moved into an assisted living facility
when her health began to decline and formed an
FLP and funded it two years later with cash and
marketable securities from her trust and her
personal assets. Trust later dissolved, and Mrs.
Lockett became sole owner of the partnership.
Two sons listed as general partners in the
agreement, but the sons never contributed any
assets, and their interests were listed as 0 in the
agreement.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Estate of Lockett
• After the funding of the partnership, the
partnership made loans to some of the
children – many of which were documented
in loan agreements with no terms on the
principal payment, but with interest payments
set up. The partnership also purchased some
rental property and Mrs. Lockett kept some
assets out of the partnership to care for
herself.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Estate of Lockett
• Estate filed a tax return and claimed 40%
discount on the partnership assets
• Two issues at trial,
– Whether Mrs. Lockett held the assets
individually or in the partnership; and
– Whether the loans were gifts or loans.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Estate of Lockett
• Court found no evidence of property
contributed by the two sons or gifts of
partnership interest to the two sons.
• After the dissolution of the trust, Mrs. Lockett
directly owned 100% of the partnership
– FLP agreement supplemented that observation
because it provided that if a partner acquired all
the interests of the other partners, the partnership
would dissolve.
– Court ultimately found that the assets belonged to
the estate, so no discounts were justified.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Estate of Turner
• Transferred FLP assets were included in
the decedent’s gross estate.
• Court also addressed the issue of whether
the decedent’s payment of life insurance
policy premiums were subject to the
annual exclusion under Section 2503(b).
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Estate of Turner
• Sloppy Crummey gifting
– Decedent was grantor of irrevocable life insurance trust that had
purchased three separate life insurance policies.
– In 2000-2003, the decedent paid the insurance premiums
directly from a joint checking account instead of transferring
money to the trustees to pay the premiums.
• IRS included the premiums paid on the life insurance policies in the
estate’s total adjusted taxable gifts.
• Tax Court held that the premium payments were a gift of a present
interest and were subject to the annual exclusion under Section
2503(b) – beneficiaries had “right to demand withdrawals from the
trust”
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Other FLP Issues
• Estate of Stone and Estate of Kelly
– Survive attack
– Bona fides
•
•
•
•
•
•
Creation of family asset to be managed by family
Transferors not dependent on distributions from FLP
No commingling of personal and partnership funds
No discounting of interests claimed
Transferors in good health at time of transfer
No evidence of implied agreement
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B213
HEIRS NOT IN THE
BUSINESS
How to achieve equitable
treatment
providing timely, critically objective
information to producers, professionals
and agribusinesses concerning the
application of important developments
in agricultural law and taxation
2321 N. Loop Drive, Suite 200  Ames, IA 50010  (515) 294-5217
Heirs not in the Business
• Usually not wise to involve non-business
heirs in day-to-day operations
– Often do not distribute any income
– Operational business may have day to day
decisions that do not match objectives of
business heirs
– Ownership usually small compared to on
business heirs
– Little incentive for business heirs to buy out
interest of non-business heir
• Value of non-business heir’s minority interest has
severe value discount
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
How to Treat
Non-Business Heirs
•
•
•
•
Inheritance or gift
Beneficiaries or life insurance
Beneficiaries of retirement plans
Acquire interest in business real estate
– Possibly in conjunction with gifting
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
How to Treat
Non-Business Heirs
• The non-business heir may not be distributed
an equal share in the value of assets
• If non-business heir were to receive real
estate
– Subject to long term rental contract in favor of
business heir’s business
– Subject to purchase options favoring business
heir
– Placed into an entity in which either all heirs are
co-owners
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
How to Treat
Non-Business Heirs
• Seldom is it recommended that real estate
be inherited by children as tenants in
common
– Joint decision making difficult
– Each co-owner has power of partition
– Usually no structured buy-out provision
– Often questions of rights of possession
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Other Ways to Minimize Estate
Tax?
B214
• “Charitable Lid” Planning
– An estate plan is created where the testator
leaves a set dollar amount of the estate to the
children with the residuary estate passing to a
charitable organization.
• The portion passing to the charity qualifies for the
estate tax charitable deduction and, thus, puts a lid
on the amount of estate tax owed
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B214
“Charitable Lid” Planning
• Attractive technique when combined with
hard to value assets such as business
interests or family partnership interests
• Good way to defeat an IRS audit
– If IRS challenges the valuation of assets on
audit, any increase in value on audit does not
increase the estate tax due – it simply passes
to the charity
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
“Charitable Lid” Planning
• Key case – Christiansen v. Comr., 130 T.C.
No. 1 (2008)
– Decedent owned cattle ranches in South Dakota
with her husband. He died in 1986 and she
continued to operate the ranches until her death
in 2001. Her entire estate passed to her
daughter, but the will said she could disclaim all
or any portion of her inheritance, with the
disclaimed property passing 75 percent to a
CLAT and 25 percent to a private foundation
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Christiansen Case
• Daughter filed a disclaimer. Largest asset in
estate were FLP interests that carried out
valuation discounts.
– With discounts, decedent’s estate was just over
$6.5 million
– Daughter’s disclaimer resulted in the foundation
and the CLAT receiving about $140,000
– IRS audited and increased FLP interests by about
35% - but that resulted in more property passing
to charity and no increase in estate tax
• Daughter did not retain a continuing interest in the
CLAT after the disclaimer, so no charitable deduction
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Christiansen Case
• IRS appealed the portion of the decision
allowing the enhanced deduction for the
amount passing to the foundation
– Attacks the disclaimer:
• Any amount passing to the charity was contingent
on a condition subsequent (i.e., the Service’s
ultimate determination of value of the decedent’s
estate)
• Adjustment clause in disclaimer should be
declared void on public policy grounds –
discourage them from examining estate tax returns
– Court disagreed with IRS (586 F.3d 1061)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Petter v. Comr., T.C. Memo. 2009-290
• Court upheld a defined-value gift tax clause
and rejected IRS’ policy-based argument
– UPS stock in LLC transferred to IDGTs and
charities, with split determined by formula
– IRS tried to negate defined-value clause based
on policy reasons, but court determined that gift
was of ascertainable value of stock rather than a
specific number of shares or percentage interests
in LLC
• 9th Circuit affirmed on appeal (Aug. 4, 2011)
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Hendrix v. Comr., T.C. Memo.
2011-133
• Court approved transfers with “defined value”
formula provisions to limit gift tax exposure
from the transfers
– Transfer of closely held stock in a gift/sale
transaction to family trusts and gift to Foundation
under coordinated formula provisions was at
arm’s length and not contrary to public policy
– Clause at issue allocated stock between family
trusts and Foundation based on values as
determined by IRS willing buyer/willing seller test
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Wandry v. Comr., T.C. Memo.
2012-88
• Facts:
– Married couple gifted membership units in LLC to children and
grandchildren; transfers made in accordance with dollar value of
gifts and were determined by a fraction (numerator was state dollar
amount and denominator was value of entire company as
determined by IRS or court)
– IRS claimed gifts were of fixed fractional interests in LLC and, as a
result, LLC unit value understated; court determined that defined
value clause reallocated LLC membership units among parties in
conformance with formula in which unit value as of transfer date
was "unknown constant“
– IRS lost
– Appealable to 10th Cir. [Appeal docketed on Aug. 28]
– Case settled in late October
– IRS issued non-acquiescence on Nov. 9, 2012
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Life Estate/Remainder
Arrangements
B225
• Handling Allocated Basis
– Example:
• At death, Sam leaves $500,000 of securities to his wife,
Sara for life, with the remainder passing to his son, Sid.
Sara is 48 at the time Sam dies. Under 20.2031-7A(c),
the life estate factor for a female age 48 is .77488 and
the remainder is .22512. Thus, the present value of the
portion of the uniform basis assigned to Sara’s life
interest is $387,440, with $112,560 assigned to Sid.
Sara sells her life interest to her nephew, Seth, for
$370,000 while she is still 48. Sara does not realize a
loss (Sec. 1001(e)) and her gain is $370,000. Seth’s
basis is $370,000 which is recoverable by amortization
over Sara’s life expectancy
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Life Estate/Remainder
Arrangements
• Handling allocated basis
– Example:
• Same facts, except that Sara retains the life interest
until age 60 and then sells it to Seth when the securities
are worth $650,000. The life estate factor for Sara is
.63226 and the remainder factor is .36774. So, the
present value at the time of the sale assigned to Sara’s
interest is $316,130 and the present value assigned to
Sid’s interest is $183,870. Sara sells her interest for
$410,969 ($650,000 x .63226). Her gain is the amount
realized, and Seth’s basis is $410,969.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Life Estate/Remainder
Arrangements
• Handling allocated basis
– Example:
• Larry died at age 39 owning a pasture worth $18,800 at the time of
death. The land is devised to Lance for life, remainder to Lisa
(unrelated). Shortly after Larry’s death, Lance sells his life estate,
Lance and Lisa jointly sell the entire property to Loraine for $25,000
and divide the proceeds equally. The remainder factor for a 39 year
old male is .20146, thus the present value of the uniform basis
assigned to Lisa’s remainder interest is $3,787.45. On sale, Lance
realizes a loss of $2,512.55 ($15,212.55 - $12,500) [this is the
portion of uniform basis not disregarded] and Lisa’s gain is
$8,712.55 ($12,500 - $3,787.45). Loraine’s basis in the entire
property is $25,000 (none recoverable by amortization deductions
over Lance’s lifetime.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B226
Dynasty Trusts
• The GSTT
– Tremendous planning opportunity through
balance of 2012 to fund GSTT trusts
– Watch for Administration’s continued attempts
to limit planning opportunities
• Limitation on GRATs
• Elimination of valuation discounts via FLPs
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
The GSTT
• Clearly of interest to wealthy clients
• Don’t overlook GSTT trusts for clients with
more modest wealth
• May not be of interest for small estates
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Dynasty Trusts
• Avoidance of transfer taxes for multiple
generations
• Lasts as long as allowed by maximum
term allowed by local law
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Dynasty Trusts
• Mechanics
– Irrevocable trust
– Spendthrift provision
– Initial funding tied to grantor’s transfer tax
exemption
• Take note of the net investment return possible
with enhanced exemption through 2012
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B227
Dynasty Trusts
• Tax aspects
– Not subject to GSTT if grantor allocates
sufficient GSTT exemption to make inclusion
ratio zero
• Must elect to allocate exemption to transfers
• Need to preserve GSTT inclusion ratio for any
additional property transferred to the trust
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Dynasty Trusts
• Tax aspects
– Treated as an irrevocable trust
• Initial funding subject to gift tax and will use up
grantor’s unified credit to extent of excess over
present interest annual exclusion
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B229
Dynasty Trusts
• Can be structured as grantor trust
– Income accumulated tax-free
– During settlor’s lifetime, settlor taxed on trust
income and gains
– How to achieve grantor trust status:
• Trust terms give discretion over distributions of
income and principal that can be exercised by
majority of trustees that are related or subordinate
to settlor
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Trust Term
• Tied to state’s rule against perpetuities
– Establish situs in state with relaxed or no rule
• Trust term should so state
• Appoint trustee located in jurisdiction with
favorable rule
– Works for personal property
– Real property governed by law of state where located
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B230-231
Dynasty Trusts
• Trustee considerations
– Important to select carefully
• Consider limitations on trustee’s exercise of power
• What is the process for replacing a trustee
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Dynasty Trusts
• Trustee as a fiduciary?
– Most courts require that trustee must commit
serious breach before removal will be allowed
– Statutory procedures may apply
– UTC provision does not focus on trustee
conduct
– Trustee retained powers and tax issues
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B230
Structure of the Trust
• Commonly drafted as spendthrift trust so
as to provide asset protection
– Beneficiary cannot assign or transfer or
encumber an interest in net income or
principal of trust
• No creditor attachment until distribution
– Trustee has absolute discretion over
distributions
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
The Use of Life Insurance as a
Succession Planning Tool
B232
• General Comments
– Tax favored status
– What if estate tax (and stepped-up basis) is
repealed
– If in ILIT, death benefits not subject to FET or
GSTT
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Life Insurance
• Benefits of life insurance in business
succession process
– Estate liquidity and asset preservation
• Ownership in ILIT
• Proceeds payable to business owner’s estate via
loans or buying assets from estate at FMV
• ILIT could buy decedent’ s business interest at
discount
– Freeze accomplished
– Cash received by surviving spouse could be gifted to
non-business heirs and/or fund ILIT for benefit of nonbusiness heirs
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Benefits of Life Insurance
•
•
•
•
•
•
•
•
Wealth replacement
Estate equalization
Fund a buy-sell
Tax hedge
Retirement income
Fund stock redemption
Liquidity
NQDC
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Benefits of Life Insurance
•
•
•
•
•
Key-person insurance
GRATs
Asset protection planning
Private annuities and SCINS
Family bank
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
GRATs and GRUTs
• Types of irrevocable trusts
• Established for a fixed term of years and the
donor/grantor retains an income right
– Stated amount paid to donor/grantor annually during
term of trust
• Upon termination, the trust fund is paid to the holders of
the remainder
– GRAT: income interest is a fixed sum of dollars determined at
the outset of the trust, payable annually
– GRUT: Grantor/holder receives amount equal to fixed
percentage of FMV of trust. Percentage is fixed at time GRUT
created. FMV of GRUT is determined annually
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Charitable Lead Annuity Trusts
• Similar to a GRAT, but charity receives the
annuity during the CLAT’s term of years
– Remainder passes to donor’s family at a
reduced gift tax value determined at outset of
the trust
– Donor receives charitable income tax and gift
tax deduction for the annuity
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Qualified Personal Residence
Trusts
• Gifting technique that can be utilized to
transfer house (usually a vacation home – but
can be primary residence) to donor’s children
at a discounted value
– It’s an irrevocable trust to which the house is
transferred and donor reserves right to live in the
house for a term of years, with either the children
owning the house outright at donor’s death or in
trust
– Grantor trust
– If house sold, QPRT can be converted to GRAT
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B233
ILITS
• Basic planning points
– Death benefits held at death
• Allows use of grantor’s gift tax exemption and
GSTT exemption amount
• Multiple beneficiaries can have interest in death
benefits
• Draft with flexibility in mind
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
ILITS – Accomplishing Flexibility
• Donor powers
– Change beneficiaries that will receive
Crummey powers
– Use tiered Crummey powers
– Beneficiaries holding contingent remainders
can have a vested interest in ILIT
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
ILIT Drafting Provisions
• 5 and 5 power applied to entire ILIT
• Ordering rule for donee holding mutiple
withdrawal rights
• Special powerholder with limited power to
appoint trust property during grantor’s
lifetime
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Beneficiary Powers
• Testamentary limited powers of
appointment in beneficiaries
• Power of grantor, grantor’s spouse and
beneficiaries to change trustee
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Trustee Powers
• Discretion to satisfy Crummey notice
requirements
• Crummey powers satisfied against all trust
property
• Allow trustee to appoint guardian for
minors likely to receive Crummey
withdrawal right
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Estate of Turner
• Transferred FLP assets were included in
the decedent’s gross estate.
• Court also addressed the issue of whether
the decedent’s payment of life insurance
policy premiums were subject to the
annual exclusion under Section 2503(b).
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Estate of Turner
• Sloppy Crummey gifting
– Decedent was grantor of irrevocable life insurance trust that had
purchased three separate life insurance policies.
– In 2000-2003, the decedent paid the insurance premiums
directly from a joint checking account instead of transferring
money to the trustees to pay the premiums.
• IRS included the premiums paid on the life insurance policies
in the estate’s total adjusted taxable gifts.
• Tax Court held that the premium payments were a gift of a
present interest and were subject to the annual exclusion
under Section 2503(b) – beneficiaries had “right to demand
withdrawals from the trust”
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B234
Corporate Buy-Sell Agreements
• Entity purchase agreement
– Contract between stockholders and corporation
• Cross purchase agreement
– Contract between stockholders
• Hybrid agreements
– Contract between corporation and stockholders
whereby stockholders agree to offer their shares
first to the corporation and then to other
stockholders
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Advantages of Buy-Sell
Agreements
• Prevention of the sale of stock outside the
family unit
• Relatively simple
• Creates a ready market for the stock
– Remedies a liquidity problem
– Can help set a value for stock
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Disadvantages of Buy-Sell
Agreements
B236
• Hybrid type agreement may pose difficult
tax issue
– Must meet technical requirements of Sec.
302(b) or Sec. 303
• Less tax problems with cross-purchase
agreements
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Buy-Sell Agreement and Life
Insurance
• Provides funds to cover purchase price or
down payment
– Premiums not deductible and can cause
ongoing expense
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Other Post-Mortem Issues
• Buy-out of deceased shareholder’s stock
could jeopardize estate’s making Sec. 6166
election
– Watch acceleration of deferred taxes
• Planning around this?
• Buy-sell could trigger gift of stock to trust for
surviving spouse not to qualify for marital
deduction
– Rinaldi case
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Funding a Buy-Sell
• Life insurance often funds if death is
triggering event
– Proceeds received by beneficiary without
income tax liability
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B237
Funding a Buy-Sell
• Problems with life insurance
– If proceeds received by C corporation can
increase C corporation’s AMT liability by
increasing C corporation’s current earnings
– May not be sufficient to fund lifetime
redemption caused by stockholder’s disability
or retirement
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Funding a Buy-Sell
• Accumulated earnings
– May not be a “reasonable need of the
business” and, thus, could subject corporation
to accumulated earnings tax
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Funding a Buy-Sell
• Buy enough permanent life insurance to
fund post-mortem buyouts, obtain debt
financing to pay for stock bought other
than at death , with use of excess of
postmortem purchase price over insurance
death benefit to pay off loan
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
B236
Income Tax Treatment
• Cross-purchase agreement
– Gain is capital gain regardless of character of
corporation’s underlying assets (unless
shareholder is dealer in stock)
– If estate sells stock shortly after shareholder’s
death, no gain recognized if agreement sets sales
price at date of death value
– Purchasing shareholders increase basis in total
holdings of corporate stock by price paid for
shares purchased via agreement
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Income Tax Treatment
• Redemption agreement
– Must satisfy Secs. 302 or 303 to avoid
dividend treatment
• Big potential problem for post-mortem redemptions
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Income Tax Treatment
• Hybrid agreement
– Corporation must redeem only as much stock
as qualifies for sale or exchange treatment
under Sec. 303, and other shareholders must
buy balance of available stock.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Income Tax Treatment
• “Wait and See” agreement
– Definition
– Alternative approach
– Combination for funding
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Top Ten Developments
in Agricultural Law*
Roger A. McEowen**
________
*Presented at the National Farm Business Management
Conference, Overland Park, Kansas, June 10, 2013.
**Director, Center for Agricultural Law and Taxation, Ames,
Iowa
providing timely, critically objective
information to producers, professionals
and agribusinesses concerning the
application of important developments
in agricultural law and taxation
2321 N. Loop Drive, Suite 200  Ames, IA 50010  (515) 294-5217
Contact Information
• [email protected]
• (515) 294-5217
• www.calt.iastate.edu
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 10
• Court tosses out EPA’s pollution rule
– EME Homer City Generation, L.P. v. Environmental Protection
Agency, et al. (D.C. Cir. Aug. 21, 2012)
• EPA was in the process of promulgating four new pollution rules to diminish the
coal industry
• Court struck down the Cross-state air pollution rule – a cap and trade styled
program to expand existing limitations on sulfur dioxide and nitrogen dioxide
emissions from coal-fired power plants in 28 “upwind” states.
– EPA claimed it had authority to cap emissions that supposedly travel across state lines
– EPA admitted that rule would cost $2.7 billion and force many coal-fired power plants to
close.
• Seven states sued and court ruled that EPA exceeded its authority under CAA
– Upwind states can only be required to reduce their own significant contributions to
downwind state’s non-attainment, not any more
– EPA departed from its own past approach to implementing good neighbor provision
– The litigation could have been avoided, but the U.S. Senate, in 2011
defeated a resolution to nullify the rule
– On Jan. 24, the court denied the Administration’s request for a full court
review of the ruling
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 9
• Defined value clause upheld where no
charitable beneficiary involved
– Wandry v. Comr., T.C. Memo. 2012-88
• IRS revaluation served to reallocate interests in excess
of the defined value to the original donor
• Tax Court provided roadmap of points to follow when
implementing a defined value clause
• Donors made fixed dollar gifts of family LLC units
– Good approach for gifting business interests of
large value and those that are difficult to value
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 8
• Reasonable compensation in the S
corporation context
– David E. Watson, P.C. v. United States, 668 F.3d
1008 (8th Cir. 2012)
• Income can be extracted from S corporation in form of
wages and in distributions (dividends)
– Wages are subject to self employment tax
– Dividends are not subject to self employment or payroll tax
• Case instructive on what is a reasonable compensation
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 7
• Special use valuation regulation invalidated
(again)
– Finfrock v. United States, 860 F. Supp. 2d 651
(C.D. Ill. 2012)
• 25% test
• IRS regulation created requirement not contained in
statute
• IRS regulation invalid even under greater deferential
standard
• Important planning implications
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 6
• Pesticide drift not a trespass
– Johnson, et al. v. Paynesville Farmers Union
Cooperative Oil Co., 817 N.W.2d 693 (Minn. 2012)
• A trespass requires a physical invasion
• Can pesticide drift constitute a physical invasion?
– MN Court of Appeals said “yes”
– MN Supreme Court reversed
» No evidence presented of whether drift reached EPA threshold
of 5 percent
» Must have an intentional and direct physical and tangible entry
– spray drift doesn’t count
» Nuisance and negligence appropriate remedies
» Plaintiffs caused their own damages
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 5
• Wetlands and Swampbuster
– Sackett v. Environmental Protection Agency, 132
S. Ct. 1367 (2012)
• Sec. 404 of Clean Water Act
• EPA “compliance order” technique freezes landowner in
place until permit obtained
– No right to hearing or ability to get judicial review because
compliance order not “final agency action” – so no appeal
rights
– Landowner had no way to force EPA to take action
• Supreme Court unanimously rejected EPA’s argument
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 5
• Swampbuster
– Maple Drive Farms Family Limited
Partnership v. Vilsack (W.D. Mich. Dec. 13,
2012)
• 2.24 acre tract drained in 1964 and crops grown
through 1982
• Drainage deteriorated
• Plaintiff later wants to again grow crops
• Status of land as of December 23, 1985 controls
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 4
• Chapter 12 Bankruptcy Taxation
– Hall v. United States, 132 S. Ct. 1882 (U.S.
2012)
• 2005 BAPCPA provision
– Not applicable to post-petition taxes because no
separate bankruptcy estate from the debtor
– Pre-petition taxes covered by the new rule
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 3
• Constitutional Takings Developments
– The Edwards Aquifer Authority v. Day, 369
S.W.3d 814 (Tex. 2012)
• Groundwater and oil and gas deposits are subject
to the rule of capture
• Historic use – what if groundwater hasn’t been
used in the past?
• Land ownership includes “in-place” groundwater
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 3
• Arkansas Game & Fish Commission v.
United States, (U.S. Sup. Ct. Dec. 4,
2012).
– Recurrent flooding, even of finite duration, are
not categorically exempt from Takings Clause
liability
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 2
• Individual mandate provision of health
care law upheld as “tax”
– National Federation of Independent Business
v. Sebelius, 132 S. Ct. 2566 (2012)
• Individual mandate unconstitutional under the
Commerce Clause
• It is constitutional as a tax
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Development No. 1
• Uncertainty caused by expiring tax legislation
– House passed H.R. 8 during summer 2012, but
Senate refused to take it up until later December
2012
– Delay created major uncertainty in tax, estate and
business planning
– New law makes “permanent” many provisions of
the 2001 law
– Tax increase for all wage earners and other “high”
income taxpayers
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
• The article detailing all of these
developments from 2012 can be found on
the CALT Website homepage
– www.calt.iastate.edu
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Trusts and Passive Income
• The IRS view is that only the trustee, acting
in its capacity as trustee, can satisfy the
material participation test for a trust
– No regulations
– The one court that has decided the issue said the
IRS position is “arbitrary, subverts common
sense, and attempts to create ambiguity where
there is none”
– Tax Court case pending.
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
9-10
Life Insurance Demutualization
• Dorrance (D. Ariz. Mar. 19, 2013)
– Plaintiff’s basis in stock comprised of fixed
component for giving up voting rights and 60
percent of variable component representing
past contributions to surplus
• Basis was slightly over 60 percent of stock value
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Life Insurance Demutualization
• Reuben v. United States, No. CV 11-09448 SJO
(PJWx) (C.D. Cal. Jan. 15, 2013)
– Plaintiff failed to establish that any of the premiums paid
were for membership rights in insurance company
• Consequently, plaintiff did not have an income tax cost basis in
share of stock issued on demutualization when shares
eventually sold in 2005
• Plaintiff failed to offer evidence of purchase price paid for
membership rights in particular as opposed to policy as a whole;
thus, plaintiff failed to satisfy proof burden that income tax basis
other than zero.
• Facts of case distinguishable from those in Fisher, et al. v.
United States, 82 Fed. Cl. 780 (2008)).
2321 N. Loop Drive, Suite 200 
Ames, IA 50010  (515) 294-5217
Thank You!
[email protected]
(515) 294-5217
www.calt.iastate.edu
providing timely, critically objective
information to producers, professionals
and agribusinesses concerning the
application of important developments
in agricultural law and taxation
2321 N. Loop Drive, Suite 200  Ames, IA 50010  (515) 294-5217

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