Regulations Open for Comment and Some Observations
New regulations concerning payment eligibility and limitation are open for comment until January 28, 2009. The notice regarding the "interim rule" that "will apply to 2009 and subsequent crop, program, or fiscal year benefits" can be retrived here (search for volume 73, page 79267) or here and states that the rule is already effective, "but subject to modification after the consideration of comments." Under Section 1601 of the bill, it appears that an interim rule is all that is required.
Click on "Read the rest of this post . . . . " for a primer on the changes, a somewhat lengthy discussion of how the eligibility rules have changed, and my take on some problems that they pose. This link and this link are also contained below. They are markups of the amended statutes.
Read the rest of this post . . . .
AGI CAPS
First, there is no average AGI limit (indeed, none of the part 1400 regulations apply) to marketing assistance loans or LDPs. The AGI limitations have been reduced somewhat for other programs. If a person or entity has an average AGI of $500,000 or more from non-farm sources, no direct, counter-cyclical, or ACRE payments are allowed. The regulation's reference to "program payents or benefits as identified in 1400.1" is quite imprecise, 1400.500(b), but it would appear that direct, counter-cyclical, and ACRE payments fall within this reference.
Notably, the AGI limitation for conservation-related payments is twice that for other payments - $1,000,000 - but it does not apply if at least 2/3 of the person or entity's income is farm income. And the whole requirement can be waived by FSA on a case-by-case basis. To me, this makes some sense. If we are purchasing environmental services from farmers through this program, then it is not at all apparent that the income of the seller should matter. Of course, if we are running a welfare program for farmers under the guise of environmental programs, then income should matter.
The limit on farm income (which could apply to entities that do or do not exceed the non-farm income limit) is an average AGI of $750,000 but it only eliminates the producer's ability to get direct payments. The regulation allows this limitation to apply to "other payments made applicable by statute or regulation" but I am unaware of any such payments. Overall, this is a weak and extremely narrow cap, and there has been some talk of further strengthening the limits. Of course, access to income data is necessary to ensure compliance.
There is some opportunity to structure operations to isolate the AGI of a person at acceptable levels. Spouses, for instance need not file separate returns. As before, the statement of an accountant or a lawyer is enough. 1400.501(c)(2). With regard to structuring entities to get an average AGI to an acceptable level, there are two main restrictions. One is contained in 1400.501, which deals with the calculation of the 3-year average AGI. Under the regulation, paragraph (d), a new legal entity will not be regarded as "new" (thus entitling it to a new AGI calculation on a new base period) "to the extent it takes over an existing operation and has any elements of common ownership or interests with the preceding legal entity, or with persons or legal entities with an interest in the "old" legal entity." "When there is such commonality, income of the "old" legal entity will be averaged with that of the "new" legal entity for the base period." In other words, simply forming a new entity is not enough to get a new AGI calculation. However, as the years progress and the base period covers different three-year base periods for the new (but old) entity, the average AGI should come down.
The second limitation on structuring is 1400.503. Basically this provision reduces an entity or joint operation's payment commensurate with the ownership interest of any person or entity that itself exceeds the AGI. Thus, an owner who exceeds the AGI does not make the entity ineligible, but it does reduce the entity's payment commensurate with the ownership interest. As with direct attribution, the tracking of AGI-violating owners only extends to the 4th level of ownership. If an entity or partnership is found there, that ownership results in a reduction of the payment, regardless of whether the entity's average AGI exceeds the limit or not.
SPECIFIC PAYMENT LIMITS
Insofar as specific payments are concerned, the amount of payments each individual or entity can receive is set forth in the bill and regulations for direct payments, counter-cyclical payments, and paymetns under ACRE, SURE, CRP, GRP, WHIP, WRP, NAP, TAP, CSTP, and EQIP. No payment limitation applies to marketing assistance loans and LDPs. Further, payments to entities are attributed to the owners of the entity. So no person should ever exceed the one-payment limitation. However, spouses are now generally regarded as separately eligible and can therefore receive their own payment. So the economic unit of husband and wife will generally get two payments.
ELIGIBILITY
As the spouse provision noted above indicates, the more interesting (and challenging) changes are those dealing with payment eligibility. The combination rules of old are gone. Now that the regime is one of direct attribution that recognizes both individuals and legal entities, there is no need for complex person determinations (though separate and distinct requirements remain). And without the three-entity rule, the incentive to create more persons is eliminated. General partnerships and joint operations are still not regarded as eligible for payments, but rather are conduits through which individuals and entities may satisfy the eligibility criteria.
So there is some simplification that attends these changes. There is, however, still much complexity and the time for comments is short. Thus, I provide a few observations regarding the changes below, with somewhat crude citations to the interim rule. If you are in this business, I urge you to study the regulation and provide comments to make these regulations better.
The general notion of being "actively engaged in farming" has not changed dramatically. The general rule is still one of left-hand [capital, equipment, or land] and right-hand [labor or management] contributions, with overall contributions that are commensurate and at risk. 14oo.201. The notion of "at risk" has now expanded to the phrase "at risk for a loss, with the level of risk being commensurate with the person's or legal entity's claimed share of the farming operation." 1400.201; see also 1400.7.
However, there are some more significant changes within the general rules. 1400.201(c) now provides a list of criteria to take into account in determining whether a person or legal entity is "independently and separately contributing a significant amount of [inputs] to the farming operation." And the definition of active personal management has much more detail than before. 1400.3. Some objectors have been complaining that this is not enough, but I do not know what more can be done. Those who object based on the idea that both management and labor should be required in order to qualify as actively engaged have not read the statute. Here is a markup of the statutory change that I used in my class. The .doc displays best in draft view. 7 U.S.C. 1308-1(b)(2)(A)(i)(II) (new and old) clearly uses the disjunctive. I don't think a regulation to that effect could be written given the statutory language. The same is true of requiring landowners to contribute something more than land. The statute just doesn't allow it. 7 U.S.C. 1308-1(c)(1) (new and old).
As before, there are specific rules for AEF determinations regarding persons (which are now only individuals) 1400.202, joint operations 1400.203, entities 1400.204, and so on. Notably, the financing rules have been moved to these sections of the regulations, and they are somewhat cleaner than they were before. Specifically, the financing rules no longer contain different rules depending upon whether the financed contribution is claimed as a "significant contribution" or a mere contribution that should count for commensurate share purposes. Rather, the rules seem to indicate that all contributions (not just the ones claimed as significant for left-hand side purposes) must be financed properly. See, e.g., 1400.202 (c). And it also appears that loans amongst or secured by others involved in the operation are always allowed (not just for commensurate share purposes) so long as the loan bears the prevailing interest rate and has a reasoanble and customary repayment schedule. 1400.202(c)(2). The rule is poorly worded, but that is my reading of it. If this is right, the "split-note" solution to financing rule/commensurate share problems is no longer necessary.
Notably, leasing is not covered by these modified and relocated financing rules, rather the definitions of equipment and land (as before) provide that such items may be leased from any source. If land is leased from a person or entity "with an interest in the crop or crop proceeds", it must be leased at fair market value. If equipment is leased from a person or entity "with an interest in the farming operation", then it must be leased at fair market value. I do not know why the drafters used different language, but the language chosen for equipment appears to identify a broader set of lessors.
Landowners who contribute owned land to an operation and do not cash rent it are still, by definition, actively engaged. And cash rent tenants still have special rules that they have to satisfy concerning either labor or management and equipment. 1400.301. Notably, the rule has been changed to clearly state how it applies to joint operations and entities that are cash rent tenants. As discussed below, the changes accompanying entity activation may make the cash rent tenant rule problematic for some entities. Notably, there was no statutory change that spurred this rule change. See the markup here. 7 U.S.C. 1308(f)(4) (new); 7 U.S.C. 1308 (e)(4) (old).
Perhaps the most significant changes deal with spouses' and legal entities' status as actively engaged. Spouses of people who are actively engaged are by statute and regulation deemed to provide a significant contribution of labor or management with regard to that farming operation. 1400.202(b). One should still worry with individually qualifying spouses about whether this imputed contribution must be accompanied by a left-hand contribution. There is, however a one-handed rule that appears to shield such spouses from the left-hand side contribution. The adult family member definition and one-handed rule provides that in family-operated operations, adult family members (which include spouses) need only provide the right hand side contribution. 1400.208. So it would appear that spouses within farming operations "conducted by persons, a majority of whom are family members" are eligible for payment, assuming they meet the commensurate share and at risk requirements. It is not clear, however, whether 1400.208 and 1400.202(b) operate together. And, practically speaking, the commensurate share and at risk requirements would counsel in favor of providing the spouse with left-hand side contributions to balance the claimed interest.
It would also make sense to place spouses in a joint operation and have the joint operation provide the left-hand side contributions under 1400.203. Again, however, it is not entirely clear that 1400.202(b) imputes a significant labor and management contribution to the spouse. One option may be to form a general partnership but claim eligibility as individuals under 1400.202, which would necessarily make 1400.202(b) operable. It is unclear, however, whether the left-hand contributions of the partnership would track to the owners in a 1400.202 context. One remedy would be to provide at least one left-hand side input (e.g. equipment) at the individual level, but the remaining contributions could still run afoul of financing rules. In the end, some clarification on how 1400.202(b) relates to other regulations is desperately needed. This need is also apparent with regard to spouses within entities.
Entities are no longer activated by right-hand side contributions from at least 50% of their owners. Now EACH owner must provide a "contribution" of active personal labor, active personal management, or combination of the two. 1400.204(a)(2). Notably, statutory change did not require this regulation. The statute continues to read "collectively make." 7 U.S.C. 1308-1(b)(2)(B)(ii) (this cite is the same for both the old and the new versions). That contribution must be performed on a regular basis, identifiable and documentable, and separate and distinct from the contribution of other owners. It must also be "significant and commensurate". 1400.204(a)(3). But the regulators were not too strict. That is, a passive investors does not totally disqualify the entity from receiving payments. Rather, it results in a reduction in the entity's payment "by an amount commensurate with the ownership share" of the passive investor. So the entity relying on the prior 5o% quantum of owners to activate itself may find that it can only get half a payment.
This new requirement poses other problems in the context of cash rent tenants, spouses, or both.
First, the cash rent tenant rule further complicates this new requirement. If cash rented land is involved, the entity may find that it does not satisfy the cash rent tenant rule. That rule simply cross references the each-owner requirement to activate the entity (1400.204(a)(2)) and demands compliance with it before the entity can be eligible for payments on cash rented land. 1400.301(e). Thus, it may be that a passive investor will eliminate the ability of an entity to satisfy the cash rent tenant rule.
Second, how the spouse rules and the entity rules work together is a problem that is not set forth in the regulation. The problem is further compounded by the presence of cash rented land. Suppose, for example, that a corporation is owned by Husband and Wife, 50-50. The entity rents all land (thus no landowner rule applies), provides all the capital and equipment. Husband performs active personal labor and active personal management. Wife provides no right-hand contributions. Does the rule imputing such a contribution to Wife, 1400.202(b), qualify the entity to receive a full payment, or a half payment if Husband has otherwise met his payment limitation? Does it thereby also fulfill the cash rent tenant rule? It may, but it may not. If not (and perhaps if so, if enough land is involved to get beyond one payment limit), then Husband and Wife would be better off dissolving the entity and operating as a joint operation with the left-hand side contribution made either at the partnership level or individually because (at least if they are qualifying individually) the imputation of labor and management would apply.
That is all I have for now. For practitioners in this arena, comments to USDA are an important part of the rulemaking process (as odd as that process is with these rules), so please offer your thoughts to USDA. And I would be happy to hear how others are reading these rules.
Click on "Read the rest of this post . . . . " for a primer on the changes, a somewhat lengthy discussion of how the eligibility rules have changed, and my take on some problems that they pose. This link and this link are also contained below. They are markups of the amended statutes.
Read the rest of this post . . . .
AGI CAPS
First, there is no average AGI limit (indeed, none of the part 1400 regulations apply) to marketing assistance loans or LDPs. The AGI limitations have been reduced somewhat for other programs. If a person or entity has an average AGI of $500,000 or more from non-farm sources, no direct, counter-cyclical, or ACRE payments are allowed. The regulation's reference to "program payents or benefits as identified in 1400.1" is quite imprecise, 1400.500(b), but it would appear that direct, counter-cyclical, and ACRE payments fall within this reference.
Notably, the AGI limitation for conservation-related payments is twice that for other payments - $1,000,000 - but it does not apply if at least 2/3 of the person or entity's income is farm income. And the whole requirement can be waived by FSA on a case-by-case basis. To me, this makes some sense. If we are purchasing environmental services from farmers through this program, then it is not at all apparent that the income of the seller should matter. Of course, if we are running a welfare program for farmers under the guise of environmental programs, then income should matter.
The limit on farm income (which could apply to entities that do or do not exceed the non-farm income limit) is an average AGI of $750,000 but it only eliminates the producer's ability to get direct payments. The regulation allows this limitation to apply to "other payments made applicable by statute or regulation" but I am unaware of any such payments. Overall, this is a weak and extremely narrow cap, and there has been some talk of further strengthening the limits. Of course, access to income data is necessary to ensure compliance.
There is some opportunity to structure operations to isolate the AGI of a person at acceptable levels. Spouses, for instance need not file separate returns. As before, the statement of an accountant or a lawyer is enough. 1400.501(c)(2). With regard to structuring entities to get an average AGI to an acceptable level, there are two main restrictions. One is contained in 1400.501, which deals with the calculation of the 3-year average AGI. Under the regulation, paragraph (d), a new legal entity will not be regarded as "new" (thus entitling it to a new AGI calculation on a new base period) "to the extent it takes over an existing operation and has any elements of common ownership or interests with the preceding legal entity, or with persons or legal entities with an interest in the "old" legal entity." "When there is such commonality, income of the "old" legal entity will be averaged with that of the "new" legal entity for the base period." In other words, simply forming a new entity is not enough to get a new AGI calculation. However, as the years progress and the base period covers different three-year base periods for the new (but old) entity, the average AGI should come down.
The second limitation on structuring is 1400.503. Basically this provision reduces an entity or joint operation's payment commensurate with the ownership interest of any person or entity that itself exceeds the AGI. Thus, an owner who exceeds the AGI does not make the entity ineligible, but it does reduce the entity's payment commensurate with the ownership interest. As with direct attribution, the tracking of AGI-violating owners only extends to the 4th level of ownership. If an entity or partnership is found there, that ownership results in a reduction of the payment, regardless of whether the entity's average AGI exceeds the limit or not.
SPECIFIC PAYMENT LIMITS
Insofar as specific payments are concerned, the amount of payments each individual or entity can receive is set forth in the bill and regulations for direct payments, counter-cyclical payments, and paymetns under ACRE, SURE, CRP, GRP, WHIP, WRP, NAP, TAP, CSTP, and EQIP. No payment limitation applies to marketing assistance loans and LDPs. Further, payments to entities are attributed to the owners of the entity. So no person should ever exceed the one-payment limitation. However, spouses are now generally regarded as separately eligible and can therefore receive their own payment. So the economic unit of husband and wife will generally get two payments.
ELIGIBILITY
As the spouse provision noted above indicates, the more interesting (and challenging) changes are those dealing with payment eligibility. The combination rules of old are gone. Now that the regime is one of direct attribution that recognizes both individuals and legal entities, there is no need for complex person determinations (though separate and distinct requirements remain). And without the three-entity rule, the incentive to create more persons is eliminated. General partnerships and joint operations are still not regarded as eligible for payments, but rather are conduits through which individuals and entities may satisfy the eligibility criteria.
So there is some simplification that attends these changes. There is, however, still much complexity and the time for comments is short. Thus, I provide a few observations regarding the changes below, with somewhat crude citations to the interim rule. If you are in this business, I urge you to study the regulation and provide comments to make these regulations better.
The general notion of being "actively engaged in farming" has not changed dramatically. The general rule is still one of left-hand [capital, equipment, or land] and right-hand [labor or management] contributions, with overall contributions that are commensurate and at risk. 14oo.201. The notion of "at risk" has now expanded to the phrase "at risk for a loss, with the level of risk being commensurate with the person's or legal entity's claimed share of the farming operation." 1400.201; see also 1400.7.
However, there are some more significant changes within the general rules. 1400.201(c) now provides a list of criteria to take into account in determining whether a person or legal entity is "independently and separately contributing a significant amount of [inputs] to the farming operation." And the definition of active personal management has much more detail than before. 1400.3. Some objectors have been complaining that this is not enough, but I do not know what more can be done. Those who object based on the idea that both management and labor should be required in order to qualify as actively engaged have not read the statute. Here is a markup of the statutory change that I used in my class. The .doc displays best in draft view. 7 U.S.C. 1308-1(b)(2)(A)(i)(II) (new and old) clearly uses the disjunctive. I don't think a regulation to that effect could be written given the statutory language. The same is true of requiring landowners to contribute something more than land. The statute just doesn't allow it. 7 U.S.C. 1308-1(c)(1) (new and old).
As before, there are specific rules for AEF determinations regarding persons (which are now only individuals) 1400.202, joint operations 1400.203, entities 1400.204, and so on. Notably, the financing rules have been moved to these sections of the regulations, and they are somewhat cleaner than they were before. Specifically, the financing rules no longer contain different rules depending upon whether the financed contribution is claimed as a "significant contribution" or a mere contribution that should count for commensurate share purposes. Rather, the rules seem to indicate that all contributions (not just the ones claimed as significant for left-hand side purposes) must be financed properly. See, e.g., 1400.202 (c). And it also appears that loans amongst or secured by others involved in the operation are always allowed (not just for commensurate share purposes) so long as the loan bears the prevailing interest rate and has a reasoanble and customary repayment schedule. 1400.202(c)(2). The rule is poorly worded, but that is my reading of it. If this is right, the "split-note" solution to financing rule/commensurate share problems is no longer necessary.
Notably, leasing is not covered by these modified and relocated financing rules, rather the definitions of equipment and land (as before) provide that such items may be leased from any source. If land is leased from a person or entity "with an interest in the crop or crop proceeds", it must be leased at fair market value. If equipment is leased from a person or entity "with an interest in the farming operation", then it must be leased at fair market value. I do not know why the drafters used different language, but the language chosen for equipment appears to identify a broader set of lessors.
Landowners who contribute owned land to an operation and do not cash rent it are still, by definition, actively engaged. And cash rent tenants still have special rules that they have to satisfy concerning either labor or management and equipment. 1400.301. Notably, the rule has been changed to clearly state how it applies to joint operations and entities that are cash rent tenants. As discussed below, the changes accompanying entity activation may make the cash rent tenant rule problematic for some entities. Notably, there was no statutory change that spurred this rule change. See the markup here. 7 U.S.C. 1308(f)(4) (new); 7 U.S.C. 1308 (e)(4) (old).
Perhaps the most significant changes deal with spouses' and legal entities' status as actively engaged. Spouses of people who are actively engaged are by statute and regulation deemed to provide a significant contribution of labor or management with regard to that farming operation. 1400.202(b). One should still worry with individually qualifying spouses about whether this imputed contribution must be accompanied by a left-hand contribution. There is, however a one-handed rule that appears to shield such spouses from the left-hand side contribution. The adult family member definition and one-handed rule provides that in family-operated operations, adult family members (which include spouses) need only provide the right hand side contribution. 1400.208. So it would appear that spouses within farming operations "conducted by persons, a majority of whom are family members" are eligible for payment, assuming they meet the commensurate share and at risk requirements. It is not clear, however, whether 1400.208 and 1400.202(b) operate together. And, practically speaking, the commensurate share and at risk requirements would counsel in favor of providing the spouse with left-hand side contributions to balance the claimed interest.
It would also make sense to place spouses in a joint operation and have the joint operation provide the left-hand side contributions under 1400.203. Again, however, it is not entirely clear that 1400.202(b) imputes a significant labor and management contribution to the spouse. One option may be to form a general partnership but claim eligibility as individuals under 1400.202, which would necessarily make 1400.202(b) operable. It is unclear, however, whether the left-hand contributions of the partnership would track to the owners in a 1400.202 context. One remedy would be to provide at least one left-hand side input (e.g. equipment) at the individual level, but the remaining contributions could still run afoul of financing rules. In the end, some clarification on how 1400.202(b) relates to other regulations is desperately needed. This need is also apparent with regard to spouses within entities.
Entities are no longer activated by right-hand side contributions from at least 50% of their owners. Now EACH owner must provide a "contribution" of active personal labor, active personal management, or combination of the two. 1400.204(a)(2). Notably, statutory change did not require this regulation. The statute continues to read "collectively make." 7 U.S.C. 1308-1(b)(2)(B)(ii) (this cite is the same for both the old and the new versions). That contribution must be performed on a regular basis, identifiable and documentable, and separate and distinct from the contribution of other owners. It must also be "significant and commensurate". 1400.204(a)(3). But the regulators were not too strict. That is, a passive investors does not totally disqualify the entity from receiving payments. Rather, it results in a reduction in the entity's payment "by an amount commensurate with the ownership share" of the passive investor. So the entity relying on the prior 5o% quantum of owners to activate itself may find that it can only get half a payment.
This new requirement poses other problems in the context of cash rent tenants, spouses, or both.
First, the cash rent tenant rule further complicates this new requirement. If cash rented land is involved, the entity may find that it does not satisfy the cash rent tenant rule. That rule simply cross references the each-owner requirement to activate the entity (1400.204(a)(2)) and demands compliance with it before the entity can be eligible for payments on cash rented land. 1400.301(e). Thus, it may be that a passive investor will eliminate the ability of an entity to satisfy the cash rent tenant rule.
Second, how the spouse rules and the entity rules work together is a problem that is not set forth in the regulation. The problem is further compounded by the presence of cash rented land. Suppose, for example, that a corporation is owned by Husband and Wife, 50-50. The entity rents all land (thus no landowner rule applies), provides all the capital and equipment. Husband performs active personal labor and active personal management. Wife provides no right-hand contributions. Does the rule imputing such a contribution to Wife, 1400.202(b), qualify the entity to receive a full payment, or a half payment if Husband has otherwise met his payment limitation? Does it thereby also fulfill the cash rent tenant rule? It may, but it may not. If not (and perhaps if so, if enough land is involved to get beyond one payment limit), then Husband and Wife would be better off dissolving the entity and operating as a joint operation with the left-hand side contribution made either at the partnership level or individually because (at least if they are qualifying individually) the imputation of labor and management would apply.
That is all I have for now. For practitioners in this arena, comments to USDA are an important part of the rulemaking process (as odd as that process is with these rules), so please offer your thoughts to USDA. And I would be happy to hear how others are reading these rules.
posted by Anthony Schutz at 7:42 AM
2 Comments:
How do they treat a family partnership with 5 members, in regard to CRP payments if the the 5members income exceeds the million dollar limit and they are not active in farming
Anonymous, I apologize for not seeing your comment. Did you find an answer to your question?
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