Source: http://washburn.law/practicalexperience/agriculturallaw/waltr/annotations/businessplanning/index.html
Timestamp: 2018-11-20 07:34:03
Document Index: 654830608

Matched Legal Cases: ['§1362', '§1375', '§1362', '§1361', '§1014', '§1362']

Lack of Marketability Discount Applied for Limited Partnership Interest. Before death, the decedent had created an limited partnership under Texas law. The decedent held a one percent general partner interest and an 88.99 percent limited partner interest. Eight of the decedent’s family members owned the balance of the limited partner interests. The partnership didn’t conduct any meetings and held cash, equities, bonds and mutual funds. The decedent had the power to approve the sale of partnership interests and had a right of first refusal on all sales. The partnership agreement described persons who acquired partnership interests as “assignees.” A few years before death, the decedent purported to create an “assignee” interest in his revocable trust with respect to his 88.99 percent limited partnership interest. The decedent’s estate tax return reported the decedent’s limited partnership interest as an “assignee” of the revocable trust and claimed a 37.2 percent lack of marketability discount and lack of control. The estate based the level of the discount on the notion that the trust only held an assignee interest consistent with the partnership agreement which stated that, “A transferee who was not admitted as a substituted limited partner would hold the right to allocations and distributions with respect to the transferred interest, but would have no right to information or accounting or to inspect the books or records of the partnership and would not have any of the rights of a general or limited partner (including the right to vote on partnership matters)." The IRS reduced the extent of the discount and asserted a deficiency of about $500,000. While the estate claimed that the lack of marketability discount should be 27.5 percent based on a possible holding period until 2075, the Tax Court determined that the decedent’s assignee interest was essentially the same thing as a limited partnership interest. Accordingly, the Tax Court settled on an 18 percent discount for lack of marketability. No discount for lack of control was allowed because the Tax Court found that the partnership interest was significant and carried with it the power to remove the general partner. Streightoff v. Comr., T.C. Memo. 2018-178.
Farm Partnership Not Dissolved on Death of Partner. Two brothers were co-equal partners in a farming partnership. Upon the death of a partner, the partnership continued, but the estate of a deceased partner could not make business decisions without the surviving partner’s approval. Also, the written partnership agreement stated that, “Land owned as tenants in common by [the partners] is contributed to the partnership without charge. The partnership is responsible for all costs and management associated with the land and treats the land as if owned by the partnership. This contribution cannot be retracted except on dissolution of the partnership or agreement by both partners. Any land owned [by] other persons operated by the partnership is leased by the partnership and not by individual partners.” One of the partners died in 2012, and his will devised part of his land to his brother and the rest to his step children and nephew. The land that was devised to the step-children and nephew was burdened with a condition stating that the property should "be sold in a commercially reasonable manner so as to derive the most value therefrom within six (6) months of my death." In 2012 this land was conveyed to the children and they also requested partition and sale of the land held as co-tenants in the partnership. The defendant challenged the conveyance stating the estate should have sold the property rather than conveying it. In 2014 the trial court agreed and vacated the conveyance and returned the property to the deceased partner’s estate. The surviving partner continued to farm, and the deceased partner’s estate brought suit for rent due on the partnership property. The trial court denied the estate rent, stating that partnership was not liable for rent six months after the decedent’s death. They also determined that the agreement continued the partnership for six months so that the surviving partners could decide what to do. The trial court also held that the partnership lacked standing during the litigation between 2012 and 2014 over the conveyance because the estate did not own the property. Finally, the trial court held that the estate did not show that they were due relief as they could not show that the defendant was unjustly enriched. The estate appeals. On appeal, the appellate court affirmed in part, reversed in part, and remanded the case. The appellate court, based on the partnership agreement, determined that the partnership was not dissolved upon death, but that the estate became a partner that was owed profits and losses. The appellate court determined that the district court erred when interpreting the statement, "the partners intended that there be an extended time to deal with a partner leaving or the death of a partner before the necessary wind up of the partnership or its continuation by the remaining partners." The appellate court held that this did not invoke a dissolution and winding up period after one of their deaths. Because the appellate court held that the partnership was not dissolved, and the land was held as co-tenants, there was no rent due. The partnership was still valid, and the land was being used within the guidelines of the agreement. Since the use of the land was correct, the surviving partner was not unjustly enriched, bur was merely continuing the business as a partner. Thus, the appellate court affirmed that the estate was not due any rent between the decedent’s death and sale of the property. However, the estate may be still owed profits from the partnership. Since the estate became a partner, with limited abilities, the court remanded the case for an accounting of profits or losses after the decedent’s death. Estate of Moore v. Moore, 2018 N.D. 221 (2018).
Court Says Corporate Farming Law “Family Farm” Exception Unconstitutional. North Dakota law bars corporations, other than family farming corporations, from owning farm land and engaging in farming or agriculture. The specific statutory language states: “All corporations and limited liability companies, except as otherwise provided in this chapter, are prohibited from owning or leasing land used for farming or ranching and from engaging in the business of farming or ranching. A corporation or a limited liability company may be a partner in a partnership that is in the business of farming or ranching only if that corporation or limited liability company complies with this chapter.” However, by virtue of a 1981 amendment, the statute also states: “This chapter does not prohibit a domestic corporation or a domestic limited liability company from owning real estate and engaging in the business of farming or ranching, if the corporation meets all the requirements of chapter 10-19.1 or the limited liability company meets all the requirements of chapter 10-32.1 which are not inconsistent with this chapter.” This amended language became known as the “family farm exception” because it requires shareholders to have a close family relation who is actively engaged in the operation. Historically, the state attorney general and secretary of state have interpreted the “family farming” exception as a way to allow out-of-state family farming corporations to own farm land and conduct agricultural operations in North Dakota. However, the plaintiff, North Dakota’s largest farm group along with other family farming corporations challenged the law as written on the basis that the law violated the “Dormant Commerce Clause” as discriminating against interstate commerce. The court agreed, enjoining the State from enforcing the family farm exception against out-of-state corporations that otherwise meet the statutory requirements (which the State didn’t do anyway). North Dakota Farm Bureau, Inc. v. Stenehjem, No. 1:16-cv-137, 2018 U.S. Dist. LEXIS 161572 (D. N.D. Sep. 21, 2018).
Failure To Treat Corporation As Entity Separate From Owner Leads To Piercing Of Corporate Veil. The defendant formed a corporation and filed articles of incorporation in 1997. The corporation was reincorporated in 2001 after an administrative dissolution. The corporation was engaged in the business of biosolids management. The defendant was the sole owner and director of the corporation along with being the corporation’s secretary and treasurer. The plaintiff contracted with a small town to be as the general contractor during the construction of a wastewater treatment facility for the town. In early 2010, the plaintiff contracted with the defendant for lagoon sludge removal. The defendant began work, but then ceased work after determining that project would cost more to complete that what the contract was bid for. In 2012, the plaintiff sued for breach of contract and obtained a judgment of $410,066.83 plus interest in 2014. The corporation failed to pay the judgment and the plaintiff sued in 2015 to pierce the corporate veil and recover the judgment personally from the defendant. The trial court refused to pierce the corporate veil and also denied a request to impose a constructive trust and equitable lien on the corporate assets. The plaintiff appealed the denial of piercing the corporate veil. The appellate court determined that the plaintiff had failed to establish that the corporation was undercapitalized – it had assets and was profitable. The plaintiff also did not show that the corporation was undercapitalized at the time it entered into the contract with the plaintiff. There also was no evidence showing that the corporation changed the nature of its work or engaged in an inadequately-capitalized expansion of the business. It was also unclear, the appellate court noted, that the capital transfers from the corporation to the defendant rendered the initial adequate capitalization irrelevant. Thus, the plaintiff failed to establish that the corporation was undercapitalized to an extent that merited piercing the corporate veil. However, the appellate court noted that the evidence illustrated that the defendant commingled personal funds with corporate funds. The defendant used corporate funds for personal purposes, and also failed to maintain separate books and records that sufficiently distinguished them from the defendant personally. In addition, the appellate court noted that the corporation did not follow corporate formalities. The corporation had been dissolved administratively by the Secretary of State in 1998 due to the failure to file a biennial report, but that the corporation continued operations during the time it was dissolved as if the corporation were active. When the new corporation began in 2001, no bylaws, corporate minute book or shareholder ledger were produced. In addition, the new corporation (operating under the same name as the old corporation) was administratively dissolved three times for failure to submit the biennial report (the corporation used the statutory procedure to apply for reinstatement each time). The appellate court determined that the corporation was not considered by the defendant to be a separate entity from himself. Accordingly, the appellate court reversed the trial court and allowed the corporate veil to be pierced and the defendant to be held personally responsible for the judgment. Woodruff Construction, L.L.C. v. Clark, No. 17-1422, 2018 Iowa App. LEXIS 765 (Iowa Ct. App. Aug. 15, 2018).
S Corporation Election Inadvertently Terminated. A C corporation elected S corporate status and had retained earnings and profits from the prior C corporate years. The S corporation had three consecutive tax years in which its passive income exceeded 25 percent of gross receipts. As a result, the S election was terminated in accordance with I.R.C. §1362(d)(3)(A)(i). In addition, the S corporation was subject to the “sting” tax of I.R.C. §1375. However, the IRS determined that the S election was inadvertently terminated because the tax advisors involved in making the S election did not advise about the potential problem with passive income. Priv. Ltr. Rul. 201827010 (Apr. 3, 2018).
Disproportionate Withdrawals Didn’t Create Second Class of S-Corporate Stock. The petitioner and his brother formed an S corporation with the petitioner owning 49 percent of the stock and the brother owning 51 percent. Initially, the petitioner and his brother filed K-1s and returns with each of them reporting their share of S corporate tax items in proportion to their stock interests. But, as time went on, the petitioner’s brother started withdrawing corporate funds for personal use in excess of his proportional interest. The petitioner discovered the brother’s conduct and withdrew from the corporation. The petitioner claimed that he was not responsible for his share of corporate income for the years at issue because his brother’s disproportionate withdrawals created a second class of stock causing the corporation to lose its S status. The court disagreed, noting that there was no evidence that the brother took any steps to redefine shareholders’ rights or create a new class of stock. As a result, the petitioner remained subject to tax on his portion of the S corporate income. Mowry v. Comr., T.C. Memo. 2018-105.
No Minority Shareholder Oppression in Farm Case. This case involved a dispute among family members involved in a farming corporation. The plaintiffs, siblings, sued their parents and another sibling for their share of the business. Between one of the defendant’s divorces and a sibling leaving the farming operation, the stock in the family farm had been re-organized on numerous occasions. In accordance with a 1986 divorce stipulation, all corporate stock was converted to voting stock. However, no corporate documents reflected this change. A 1998 business meeting revealed that each of the shareholders owned 170 shares, but there were no details if there was break down of voting or non-voting shares at this meeting. Contentions within the family farming business (the family was also involved in a bank, bank holding company, and insurance business) had been boiling for decades, but climaxed when dissolution of the farming business was imminent. Starting in 2011, tolling agreements were entered in to. In addition, the defendant sibling offered many times to buy out the plaintiffs. However, the plaintiffs declined. The plaintiffs took their action to Iowa Business Court (a specialty court with judges not subject to public review) claiming that all the stock was voting shares and that the farm should be dissolved due to “minority shareholder oppression.” The business court held that the shares were never all converted to voting shares, and that no minority shareholder oppression occurred. The plaintiffs appealed and the appellate court affirmed. While the plaintiffs pointed to the 1986 separation agreement stating that all the shares were voting shares, the appellate court determined that while the father owned a majority of the shares and made the farm business decisions, the other shareholders never explicitly gave him the authority to change the stock to voting stock as a bargaining chip in the settlement. Thus, this settlement was outside the normal course of the farm business and was unenforceable. In addition, while the articles of incorporation clearly delineated between different shares, and many years of business meeting minutes showed the different stock amounts of each of the shareholders they did not detail the voting rights of the shares. Consequently, the appellate court held that the voting and non-voting status of the shares would be maintained. On the minority shareholder oppression issue, the plaintiffs claimed that a continuing wrong existed that would defeat any statute of limitations argument. In particular, they claimed that the court should consider conduct before 2006 in accordance with the tolling agreement. However, the appellate court disagreed and would only consider post-2006 conduct on the oppression claim. As for oppression, the plaintiffs claimed that the farming operation’s use of cash basis accounting masked much of the profit earned by the farm, and that the defendants were hiding other farm income in home improvements. However, the appellate court noted that cash basis accounting was standard for farming operations and was not oppressive. The plaintiffs also claimed that the farm could have generated more revenue by renting the ground rather than hiring the defendant. However, the appellate court determined that this claim was successfully rebutted by the defendant’s expert witness testimony that the farm had been operated in standard fashion in accordance with sound business practices. The plaintiffs also claimed that the loans assumed by the defendants were not sound. But, a review of the loans showed that the loans were assumed at low interest rates and were within the normal practice of farms. Finally, the plaintiffs claimed that the offers to buy their shares were “low ball” offers that solidified their oppression claim. However, to use this argument, the plaintiffs would have had to offer their shares only to be rejected for a lower price. Thus, the appellate court determined that the shares were never converted to voting shares and there was no evidence of minority shareholder oppression. Van Horn v. R.H. Van Horn Farms, Inc., No. 17-0324, 2018 Iowa App. LEXIS 585 (Iowa Ct. App. Jun. 20, 2018).
LLC Manager’s Failure to Pay Funds To Bank Under Charging Order Was in Bad-Faith. The plaintiffs borrowed money and guaranteed other loans in connection with a real estate development project. The project failed, the loans went into default, and in April of 2010 a bank obtained a $2.4 million judgment against the plaintiffs. To collect its judgment, the bank foreclosed on real property collateral worth about $1.1 million and obtained a charging order against the plaintiffs' one-half economic interest in two California farming limited liability companies (LLCs). When the LLCs made no payments subject to the charging order, the bank foreclosed on the economic interests that the plaintiffs held in the LLCs. At the foreclosure auction, the bank purchased the economic interests for $1.5 million. After the foreclosure, the LLCs sold their real estate, ceased farming, and distributed over $5 million to the bank as the holder of 50 percent of the economic interests in the LLCs. The LLCs then dissolved. The plaintiffs sued the manager of the LLCs who, along with his wife, owned the other half of the LLCs. The plaintiffs alleged a breach of fiduciary duty, arguing that, despite the foreclosure, they retained an interest in their original capital contributions and accumulated capital of the LLC, which they claimed should have been returned to them instead of being included in the $5 million transferred to the bank. The defendants claimed that the plaintiffs had no right to a return of capital and, instead, the bank had a rightful claim to the funds as the holder of one-half of the "economic interests" in the LLCs. The trial court agreed with the defendants, concluding that the plaintiffs retained no rights to a return of capital and, thus, were not damaged by the allegedly wrongful conduct. The appellate court Appeals reviewed the Beverly-Killea Act (Act) which addresses assignments of membership and economic interests. The appellate court construed the Act’s provisions as a whole to mean that “economic interest” includes the right to receive “distributions” and that “distributions” include the transfer of money or property regarded as capital by the LLCs. The appellate court also held that these definitions cannot be altered by the terms of the parties’ LLC agreements. As such, the appellate court determined that the bank, as the holder of the plaintiffs’ economic interest in the LLCs, was entitled to receive distributions of capital. In other words, the appellate court held that plaintiffs’ retained membership interest did not include the right to receive their capital contributions or the capital accumulated in the capital account they held before the foreclosure sale. Therefore, the appellate court agreed with the trial court that the plaintiffs failed to state a cause of action for breach of fiduciary duty based on the defendants’ failure to return the plaintiffs’ original and accumulated capital interest. However, the plaintiffs also argued that the defendants breached their fiduciary duties by failing to make distributions pursuant to the 2010 charging order, which precipitated the Bank’s eventual foreclosure and liquidation of the LLCs. The defendant’s decision not to make distributions under the charging order caused the bank to foreclose on the economic interest of the plaintiffs in the LLCs and in turn caused the LLCs to cease business operations, liquidate their real property, and go out of existence. The appellate court determined that it was reasonable to infer that going out of business and ceasing to exist was not in the best interest of the LLCs and therefore the defendant’s acts and omissions causing this result were not in the best interest of the LLCs. As such, the court concluded that the plaintiffs alleged sufficient facts to show that the defendant’s discretionary decision to make no distributions to the bank under the charging order was not made in good faith and did not serve the best interest of the LLCs or the plaintiffs in their capacity as members. Consequently, the court vacated the trial court’s decision and directed it to enter a new order overruling it’s decision in the defendant’s favor. Garcia v. Garcia, No. F073735, 2018 Cal. App. Unpub. LEXIS 3520 (Cal. Ct. App. May 22, 2018).
S Corporation Land Rents Not Passive; Trust Shareholder Was ESBT. The taxpayer, an S corporation engaged in farming and managing real property had a grantor trust as a shareholder. The taxpayer engaged in four leases involving the farming operation that generated rental income to the taxpayer. The taxpayer sought a ruling on whether the taxpayer’s rental income was passive investment income under I.R.C. §1362(d)(3)(C), and whether the trust would qualify as an electing small business trust (ESBT) under I.R.C. §1361(e). The trust grantor died and the trust beneficiaries were two distributing trusts that are U.S. individuals and two tax-exempt organizations. Each beneficiary received a stepped-up basis under I.R.C. §1014. Three of the leases provide that the taxpayer is a full participant in the farm’s management, and that the tenant could not deviate from the managerial plan without the taxpayer’s approval. The leases were crop-share leases that also split expenses between the taxpayer and the tenant. The fourth lease provided for the tenant’s plowing, land clearing and crop cultivation for a share of the crops. The IRS determined that the taxpayer’s rental income from the leases was not passive investment income under I.R.C. §1362(d)(3)(C), and that the trust qualified as an ESBT because the beneficiaries were qualified beneficiaries and no interest of the trust was acquired by purchase. Priv. Ltr. Rul. 201812003 (Dec. 15, 2017).
Based On Totality of Facts, Corporate Veil Not Pierced. The plaintiff, a trust, was established as a form of estate planning. The trustee used trust assets to purchase a pizza franchise. Later, the trust entered into a written agreement to sell the business to JKLM, Inc., one of the defendants in this case, on contract. The building that the business was located in was sold separately to Dearborn Enterprises, Inc. Kari Dearborn, the other defendant in this case, was the president of JKLM and signed the purchase contract as “Kari Dearborn, president.” The plaintiff did not ask for a personal guarantee from Kari, but did have an attorney prepare and file financing statements against the equipment sold as part of the business. The agreement showed a purchase price of $120,000 and required $15,000 as a down payment. The defendant was incorporated less than a month before the purchase of the business. Statements show the defendant had only $3,000 in assets at the time of the purchase and borrowed the other $12,000 for the down payment from Dearborn Enterprises. During the period the defendant ran the business, loans were made to family members from the corporation. The defendant made monthly payments to the plaintiff for more than two years, but citing the inability to find part-time employees, closed. The plaintiff sued, alleging breach of contract and claiming the corporate veil should be pierced. The trial court determined that the contract was breached. However, the trial court held the plaintiff had not sufficiently proven facts sufficient to pierce the corporate veil. The plaintiff appealed. The plaintiff claimed that the defendant co-mingled its finances with the finances of its shareholders and at least one related entity; failed to follow corporate formalities; and was undercapitalized. The appellate court found that the “loans” the defendant made to shareholders had proper business purposes, such as reducing initial payroll expense, and did not represent co-mingling of assets. In addition, the court acknowledged that a corporation can ratify its prior actions including its corporate formalities. However, at the time the plaintiff incurred the damages caused by the defendant’s breach of contract, no ratification had been completed. The appellate court held that a corporation cannot escape having its corporate veil pierced by ratifying corporate formalities long after the lawsuit has been initiated and damages caused. The appellate court determined that the defendant’s corporate formalities displayed irregularities and did not perfectly follow corporate formalities. However, the appellate court held that the defendant’s actions and those of its officers substantially complied with normal business practices. The appellate court also found that even before purchasing the business, the defendant had four times as much debt as capital. After purchasing the business, the defendant had forty times as much debt as initial contribution. Thus, the court held that the capital contribution was insufficient to consider the defendant properly capitalized. But, even with this fact, the appellate court determined that the plaintiff did not present sufficient evidence to show pierce the corporate veil. According to the appellate court, the balance of evidence showed that the defendant was not operated as a mere shell and existed for a legitimate business purpose. Consequently, the appellate court held upheld the trial court’s determination that the corporate veil should not be pierced. Laddie Nachazel Family Living Trust v. JLKM, Inc., No. 16-2045, 2018 Iowa App. LEXIS 106 (Iowa Ct. App. Feb. 7, 2018).
Homestead Exemption Inapplicable To Corporate-Owned Property. The plaintiff held a lien against a property that the defendant, a corporation, owned. The property was occupied by a third party (the corporation’s president and sole shareholder) that had no individual ownership interest in the property. In 2012, at a time when the property was not occupied, the plaintiff was injured while on the property and sued the defendant for her injuries. In 2014, during the pendency of the litigation, the defendant attempted to quitclaim deed the property to the third party. The deed failed for lack of consideration, lack of corporate seal, lack of evidence of proper corporate capacity or authority for signatures, and the acknowledgement clause signed by the notary was for an individual rather than a corporation. After the attempted transfer, the third party began residing on the property with her family. In late 2015, the trial court awarded the plaintiff almost $400,000 in damages. To collect on the judgment, the plaintiff claimed that the defendant had tried to transfer the property to bar a forced sale of it. The plaintiff sought a constructive trust on the property and injunctive relief that would prevent the defendant from transferring the property. Ultimately, the trial court entered a temporary injunction that prevented the transfer of the property. After a hearing, the trial court determined that the property was protected from a forced sale or transfer to the plaintiff because of its status as a homestead due to the third party’s possession of the property. The appellate court reversed on the basis that the defendant, a corporation, cannot hold a homestead exemption on real estate. The appellate court noted that only a natural person can claim a homestead exemption. Because the attempted transfer of the property to the third party was not successful, the defendant still owned the property. The appellate court distinguished property held in trust where a natural person holds a beneficial interest and can claim a homestead exemption, and the present situation where a natural person did not have any ownership interest in the property, fee simple or otherwise. The court also noted that the third party’s status as sole shareholder and corporate president did not give the third party an interest in the defendant’s property. DeJesus v. A.M.J.R.K. Corporation, No. 2D17-2374, 2018 Fla. App. LEXIS 1843 (Fla. Ct. App. Feb. 9, 2018).
Relief For Partnerships Impacted by Law Change For Return Due Date. The IRS granted relief from late-filing penalties for partnerships (and other entities that may properly file Form 1065) that failed to file their return or extension by the original due date. In the IRS relief, relief was extended to other items (such as funding a contribution to an employee benefit plan by the due date of the return for which a deduction is claimed on the prior year return), except interest on tax due, that were impacted by the change in the law as a result of legislation enacted during the summer of 2015 that changed the due date for partnership returns. Under the legislation, calendar year partnership returns for 2016 became due on March 15, 2017, rather than April 15 as under prior law. In the relief, the IRS noted that a filed Form 1065 will be treated as timely for the first taxable year that began after December 31, 2015, and ended before January 1, 2017, if the entity would have been deemed to timely file under prior law. The IRS also provided instructions for getting reconsideration from IRS of a penalty that had already been assessed. The IRS later revised its guidance such that any act performed by a partnership of other entity that may properly file Form 1065 is deemed to have properly filed if such filing would have been timely under prior law whether the tax year ends in 2016 or 2017. IRS Notice 2017-47, 2017-38 I.R.B. 2017-141, as revised by IRS Notice 2017-71, 2017-51 I.R.B.