Volume 9 • Issue 4 • April 2019
The Counselor is a monthly newsletter of Hallock & Hallock dedicated to providing useful information on estate planning, business succession planning and charitable planning issues. In this month’s issue, we will discuss estate planning and business planning for farms and ranches that receive farm program payments. If you are interested in learning more about the ideas and processes discussed in this newsletter, please contact us for an initial consultation.
A unique aspect of planning for farmers and ranchers is the need to consider the impact of farm program payment limitations on the plan. With razor-thin profit margins, it’s more important than ever to maximize farm income from all sources. The way the farming or ranching business is structured can negatively impact eligibility for farm program benefits. Farm programs could include: ARC-PLC, CRP, and CSP, among others.
Farm support began in the 1930s through Depression-era efforts to raise farm household income. The programs were initially intended to be temporary. Though there have been many changes over the years, the 2018 Farm Bill continues farm support. Therefore, the requirements of applicable programs should be reviewed when forming the planning strategy. These limitations include:
- Payment Limitations;
- AGI Limitations; and
- The Actively Engaged in Farming Requirement.
A limitation on the total annual payments that a “person” or “entity” may receive under certain commodity programs has been in effect since the enactment of the Agricultural Act of 1970. A person or entity is defined as:
- An individual;
- A Corporation, LLC, LP, LLLP; and
- A Trust (even potentially a joint revocable living trust).
A general partnership is disregarded and each individual partner is treated as a person or entity. For example, three siblings, Bob Jones, Sam Jones, and Mary Jones own some farmland. The current per “person” limitation for CRP is $50,000 per person. There is a potential of $150,000 in CRP money available for the farm land ($50,000 for each person). However, if Bob, Sam, and Mary form an LLC and put their land into the LLC, now they are only eligible for $50,000 total. If Bob, Sam, and Mary want the asset protection afforded by the LLC, they should consider having a general partnership owned by three LLCs.
In the above graphic, each LLC would be eligible for the full $50,000 CRP payment and the total $150,000 is preserved. Be advised that you must reach an individual by the 4th tier of ownership or there will be a reduction in the amount of the payment.
In determining whether a person has reached his or her per person limitation, payments received on all property are considered. The Attribution Rule provides that individuals and entities are credited with both the amount of payments received directly and also the amount received indirectly by holding an interest in an entity receiving payment. In general, payments to a legal entity are attributed to the persons who have a direct or indirect interest in the legal entity. But, payments made to a joint venture or general partnership are determined by multiplying the maximum payment amount by the number of persons and entities holding ownership interests in the joint venture or general partnership. This means that joint ventures and partnerships are not subject to the attribution rules. The measuring date for purposes of direct attribution is June 1. Payments made to a revocable trust are attributed to the trust’s grantor. The Secretary of Agriculture has directed that the rules be administered to ensure “equitable treatment” of beneficiaries of irrevocable trusts and estates.
There is also a limitation on Adjusted Gross Income (AGI). The AGI limit is now a single, total AGI limit of $900,000 (using a three-year average). Producers whose average AGI exceeds $900,000 are not eligible to receive payments or benefits from most programs. In determining AGI, all income is included and there is no regard for whether the income is farm or non-farm income. The AGI limitation applies to both the owners and the entities. For example, assume Smith Land & Livestock (SLL) receives $100,000 of farm program payments in 2019. SLL’s AGI is $850,000. SLL is entitled to a full payment limitation. But, if one of SLL’s owners has AGI that exceeds the $900,000 threshold, a portion of SLL’s payment limit will be disallowed in proportion to that owner’s percentage ownership. If the owner with income exceeding the $900,000 threshold owns a 25% interest, SLL’s $100,000 of farm program payment benefits will be reduced by $25,000.
A person or entity must be “actively engaged” in farming to receive certain farm program payments. To be “actively engaged in farming” three conditions must be met:
- The individual’s or entity’s share of profits or losses from the farming operation must be commensurate with the individual’s or entity’s contribution to the operation;
- The individual’s or entity’s contributions must be at risk; and
- An individual must make a significant contribution of land, capital or equipment, and active personal labor or active personal management.
Legal entities can be actively engaged if members collectively contribute personal labor or active personal management.
“Active personal management” is defined as a significant contribution of management activities that are performed on a regular, continuous, and substantial basis to the farming operation. The management activities must represent at least 25% of the total management time that is necessary for the success of the farming operation on an annual basis, or represent at least 500 hours of specific management activities annually. That is a more defined test for active management than existed prior to the 2014 Farm Bill, which required that the management be “critical to the overall profitability of the farming operation.”
Special rules apply to tenant-operated farms and family-owned operations with multiple owners. A crop-share or livestock-share landlord who provides capital, equipment, or land as well as personal labor, or active personal management meets the test. A cash rent landlord or crop share landlord is not actively engaged in farming if the rent amount is guaranteed. If one spouse meets the active engagement test, the other spouse is deemed to meet the test.
The active personal management test does not apply to farming operations where all of the partners, stockholders, or persons with an ownership interest in the farming operation (or any entity that is a member of the farming operation) are family members. A “family member” has historically meant a person to whom another member in the farming operation is related as a lineal ancestor, lineal descendant, sibling, spouse, or otherwise by marriage. Legally adopted children and step-children count as family members. The 2018 Farm Bill added first cousins, nieces, and nephews to the definition.
Substantive Change Rule
In general, any structural change of the farming or ranching business that increases the number of payment limits must be bona fide and substantive and not a “scheme or device.” A “substantive change” occurs when a “family member” is added to a partnership unless the family member also provides management or labor. The rule does not apply to spouses. A spouse of a partner that is providing active management to a farm partnership can be added to the partnership and automatically qualify as a partnership member for FSA purposes.
Clearly there are many possibilities for issues to arise if a planner does not understand the impact of planning decisions on a producer’s farm program payments. It is a good idea to discuss changes with your local FSA office. However, reliance on the advice of local or state USDA officials concerning the payment limitation rules is at the farmer’s or rancher’s own risk. As always, use of a qualified planner who understands the potential issues is advisable.
This Newsletter is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.