On Tuesday I got dose of tax-law education at an event in Manhattan, Kansas, co-sponsored by Kansas State University and Washburn University School of Law.
While there is often discussion about how the downturn in the farm economy compares to the 1980s, some policies created in the 1980s to help distressed farmers haven't kept up with the times.
Joe Peiffer, a bankruptcy attorney from Cedar Rapids, Iowa, highlighted growing complications for farmers under Chapter 12 bankruptcy, a filing status updated in 1986 specifically to help family farmers and small-business fishermen.
One of the problems with is that farmers in states with higher land values likely don't qualify for Chapter 12 bankruptcy any longer The problem is the debt limit allowed for Chapter 12 caps total debts on the farm at $4,031,150. Too many clients coming into his office looking to restructure debt have too much of it to fit into a Chapter 12 bankruptcy. "I'm running that 60% to 80% of the clients who come in are too big for Chapter 12," Peiffer said. "But they are not too big to fail."
Chapter 12 allows farmers to restructure debt without the formation of a creditors' committee. Peiffer said such committees "can be notoriously difficult to deal with" in a Chapter 11 bankruptcy. Debt collection stops and the farmers are afforded a change to put together a payment plan that generally requires three-to-five years to repay for secured creditors.
While Peiffer said more producers are looking for debt relief, their finding Chapter 12 is becoming a bigger problem, not just because of the debt limit, but also because of Supreme Court ruling. The numbers in recent years somewhat bear that out.
It's not clear how many farmers are filing for bankruptcy at the moment, but there are fewer Chapter 12 cases being filed. Federal court data on caseloads shows there were 459 Chapter 12 bankruptcies from July 1, 2015, to June 30, 2016. That was 102 more Chapter 12 filings than a year earlier, but the filings are still down. From 2010-2012, there were an average of 653 Chapter 12 bankruptcies filed.
(Additionally, there is no breakout to detail just how many of Chapter 12 cases were farmers or fishermen.)
Getting into the weeds of bankruptcy and tax complications, Chapter 12 generally allowed farmers to claim "any tax ... incurred by the state" as a dischargeable, unsecured liability. But the IRS pushed a challenge on a case in which the farmers filed for bankruptcy, then sold their farm. The IRS won a 2012 U.S. Supreme Court case by splitting hairs defining taxes generated by the individual farmer and the estate created by the bankruptcy filing.
The Supreme Court declared, in a 5-4 case, that capital gains on a farm liquidation cannot be discharged. (This change affected most business bankruptcies, by the way, not just farmers)
Essentially, the Supreme Court ruling forces that any taxes waived under Chapter 12 must have been incurred on a farm in the year before a farm files for bankruptcy. Otherwise, the taxes remain outstanding.
The impact of that 2012 decision, Hall v. U.S., is that a farmer could be stuck liquidating assets during the bankruptcy and come out three-to-five years later with a tax debt such as capital gains that still needs to be paid. The Arizona farmers in that case not only ended up bankrupt and forced to sell their farm, but the couple was stuck with a $29,000 tax bill as well.
The impact of the Hall case means the timing of a land or equipment sale has a dramatic impact on a farmer's bankruptcy case. In Manhattan, Peiffer hammered on this point as a critical issue for distressed farmers and their attorneys considering a bankruptcy filing. It may be critical to liquidate on the farm the year before filing the bankruptcy.
Peiffer ran through various scenarios of the same farm filing for bankruptcy and liquidating equipment that had more owed on it than the value, or situations where debt is discharged by a bank. Depending on the timing of sales and bankruptcies, federal taxes owed from the insolvency and bankruptcy could more than triple for that distressed farmer. A $500,000 tax owed under one scenario could reach nearly $1.9 million under a worst-case scenario.
"You have to be very careful and timing is everything," Peiffer said.
Peiffer said producers are trying to cash flow their operations trying to get to the end of the year before they file bankruptcy. He also is seeing more farmers in distress coming into his office and faced with the challenge of selling a lot of their assets before the end of the year so they can file bankruptcy in 2017. Some farmers are learning that their lenders aren't going to loan to them for the 2017 crop.
"Some of my farmers are doing some interesting," he said. "They are downsizing and selling virtually everything. They are farming 30 or 40 acres, borrowing machinery from their neighbors to do it. So they qualify as farmers, nothing like they were, but they qualify."
Some farmers have sold off their assets and incurred high capital gain or ordinary income taxes in the process, but they need to keep operating to qualify as a farming operation in 2017. Others are looking to sell but other producers are reluctant to buy so the sale prices for machinery and land also are lower lately.
Other speakers in Manhattan noted the farm economy continues to struggle. Allen Featherstone, department head for the K-State Department of Agricultural Economics, touched these various Points:
-Farm income in Kansas last year, for instance, was the lowest in the state since 1985.
-Given the cost of production has gone up since 2009 -- 17% for corn, 29% for soybeans and 14% for wheat -- there are more pressures on farmers' abilities to cash flow.
-Farmland values are expected to see a sharp decline, which would further eat into farmer equity.
-Repayment capacity has deteriorated significantly in the last two years.
"You are beginning to hear situations where farmers are getting financing for 2017," Featherstone said.
Peiffer stressed that Congress needs to reverse the impacts of the Hall case so producers aren't stretching into rapid liquidation while also stretching their operations into the next calendar year before they file bankruptcy. Further, the $4,031,150 debt limit for Chapter 12 needs to be changed or farmers in several states simply are going to have too much debate to qualify for filing under Chapter 12.
"It doesn't make a lot of sense if you are trying to keep a family farm together," Peiffer said. "You can't do it."
Peiffer said the debt limit needs to be increased to about $10 million. That would allow most strapped family farms in a state such as Iowa to file under Chapter 12 -- not all, but a good portion. "A lot of people I am talking to, it might not work yet," Peiffer said. "But it's better."
Sen. Charles Grassley, R-Iowa, and Sen. Al Franken, D-Minn., introduced a bill in early 2015 to deal with the tax problems created in the Hall case. The bill does not have language changing the debt limit for Chapter 12. https://www.congress.gov/…
Peiffer said he hoped Congress might consider the Chapter 12 changes, ideally in the lame-duck session of Congress.
At the same time, I have not seen any indication that addressing the farm financial situation is going to make it into the legislative priorities in the lame-duck session.
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