Although we don't like to think about farm failures, they do happen. A long stretch of poor commodity prices, improper (or lack of) marketing strategy and overleveraged farms sometimes force the issue.
Farms can try bank workouts and asset sales, but that might not be enough. Sometimes, the best option is to file bankruptcy. Bankruptcy in farming has its own bankruptcy code, Chapter 12. Although bankruptcy has a bad stigma, it allows the farm to restructure and continue operations. In August, the Family Farmer Relief Act of 2019 was signed, which modifies Chapter 12 to make it more accessible to farms. Let's take a look at how Chapter 12 works.
To start, you are eligible to file Chapter 12 Bankruptcy under the following conditions:
Individuals (Schedule F):
-- You are actively farming.
-- Total debts are less than $10 million.
-- At least 50% of fixed debts relate to the farming operation.
-- More than 50% of gross income derives from farming (preceding year or for each of the second and third prior tax years).
-- More than 50% of corporation or partnership is owned by one family or extended family.
-- The family or extended family actively operates the farm.
-- 80% of the value of the entity's assets relate to the farming operation.
-- Total debt does not exceed $10 million.
-- At least 50% of the entity's fixed debt relates to the farming operation.
-- Stock (if any) is not publicly traded.
Chapter 12 automatically stays most collections against the farmer or farm entity. It also protects anyone who cosigned as a guarantor. Unless authorized by the court, a creditor can't take action against the cosigner. This is very important when you have a generational farm and mom or dad might have guaranteed debt.
The goal is to come up with a workable restructuring plan that must demonstrate the ability to cash-flow payments with consistent/regular income. Chapter 12 can provide an option to "right-size" the farm and move forward as a more economically viable farm. The plan does not have to pay unsecured creditors in full as long as the farmer or farm entity agrees to a payment plan. Secured creditors must get paid at least as much as the fair market value of the asset when Chapter 12 was filed. Unsecured creditors must receive as much as they would have if all nonexempt assets were liquidated under a Chapter 7 bankruptcy.
An impartial trustee is appointed in every Chapter 12 case to evaluate the assets and debt, and give an opinion on the feasibility of the plan. If the plan is approved, the trustee disperses payments to the creditors according to the plan. Once the farmer or farm entity has completed the Chapter 12 plan, the court will issue a discharge releasing farmer or farm entity from the debt as provided by the plan.
Why is Chapter 12 different? Under Chapter 12, tax associated with the sale of certain farm assets is treated as unsecure debt. Without this benefit, servicing the tax liability associated with asset sales would take a significant portion of the income from the farming operation that would otherwise be used to pay secured creditors. Under the 2019 change, the farm assets can now be sold before or after filing Chapter 12, and still have some or all of the tax liability discharged.
Editor's Note: Tax Columnist Rod Mauszycki, J.D., MBT, is a tax principal with CLA (CliftonLarsonAllen) in Minneapolis, Minnesota. Read Rod's "Ask the Taxman" column at about.dtnpf.com/tax. Send questions to email@example.com
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