- Require each actively engaged partner to 1) work at least 1,000 hours annually in providing labor and/or management on the operation, or 2) engage in labor and/or management on the operation for hours equal to at least half the combined hours of labor and management required by his/her share of the operation.
- Define active management to include marketing, securing financing, on-site management such as supervising employees and scheduling field operations and similar activities.
- Drop the requirement that each stockholder in a corporation be actively engaged in labor or management.
- Establish by rule that no one person can provide the active labor or management for operations collectively receiving more than the proscribed limit.
- For payment limitation purposes, allocate payments on crop share leases between the farm operator and the landowner according to the usual and customary crop share rate in instances in which, 1) land is leased at rate lower than the usual and customary rate, and 2) the farm operator would exceed the proscribed limit under a lease at the usual and customary rate.
The 2008 farm bill, like those preceding it, requires farm program participants to be actively engaged in farming - including making a substantial contribution of personal labor or active personal management. The objective of this requirement is to ensure effective enforcement of farm payment limitations.
Without such a requirement, large farms can circumvent the limits by claiming employees, equity investor and others marginally involved in the operation as partners, each qualifying the operation for an additional set of payments up to the proscribed limit. However, USDA has never provided sufficient guidance on what constitutes a substantial contribution of active personal management for effective enforcement.
The problem was illustrated by the April 30, 2004 report of the General Accounting Office (GAO); Farm Program Payments: USDA Needs to Strengthen Regulations and Oversight to Better Ensure Recipients Do Not Circumvent Payment Limitations. GAO found that some members of partnerships qualified as actively in engaged in management by doing as little as participating in three conference calls per year, while never stepping foot on the operation.
In June 16, 2004, testimony to the Senate Finance Committee, Lawrence J. Dyckman, GAO’s Natural Resources and Environment Director wrote that “some recipients appeared to have little involvement with the farming operation for 26 of the 86 FSA compliance review files we examined in which the recipients asserted they made a significant contribution of active personal management to the farming operation.”
To address the problem, GAO recommended that the Secretary of Agriculture direct the Administrator of the Farm Service Agency to develop and enforce measurable requirements defining a significant contribution of active personal management. At the time, USDA declined to implement the GAO recommendation. Again in the interim rule, USDA declined to implement the GAO recommendation.
The rejection of the fundamental core of the GAO recommendation prevents the interim rule from accomplishing any more than causing mega farms to jump through another relatively simple legal hoop to collect unlimited payments.
The interim rule requires only regular participation that is independent and separate from the contributions of other partners. That means partners need only participate in regular conference calls (quarterly) during which each is responsible for one unique aspect of the call. For example, one partner might be responsible for making a recommendation on approval of the quarterly financial statements prepared by management and another for making a recommendation on approval of the quarterly marketing plan prepared by management. Investors will continue to qualify as actively engaged with minimal time commitment and minimal participation in the conduct of day to day on-site management.
A precedent has been established within USDA. Participation on a few conferences calls each year qualifies as a significant contribution of active personal management. The interim rule does not increase the amount of involvement required. It merely tweaks the nature of that involvement. The interim rule will prompt some procedural changes, but little more.
Mega farms will continue to gain unlimited payments by taking on equity investors who only participate on conference calls. It should be noted that under the proposed rule, investors would be considered actively engaged in farming even though they would clearly be considered passive investors by the IRS and blocked from deducting farm losses from ordinary income.
There is only one way to make a substantial contribution substantial: Change USDA precedent by adopting a rule that establishes a quantifiable standard, as GAO recommended, requiring real participation in day to day management on the farm. We recommend a standard based on the current USDA standard for active personal labor. Specifically, we propose that each actively engaged partner be required to:
- Work at least 1,000 hours annually in providing labor and/or management on the operation, or
- Engage in labor and/or management on the operation for hours equal to at least half the combined hours of labor and management required by his/her share of the operation, including marketing, securing financing and on-site management such as supervising employees and scheduling field operations.
A clear definition of management that includes day to day on-site management is critical. Otherwise, the standard will be gamed by narrowly defining management to include only governance functions, enabling the 50 percent standard to be met with minimal involvement. We propose that management be defined to include marketing, securing annual financing, on-site management such as supervising employees and scheduling field operations and similar activities.
While the proposed standard is wholly inadequate in addressing the abuses of mega farms receiving many times the proscribed limit, it overreaches in requiring that all stockholders in a corporation provide active labor or management. Previously, active personal labor or management had to be provided only by shareholders accounting for 50 percent ownership.
The change will reduce payments to many small and mid-size farms that have never received payments in an amount close to the proscribed limit. Family farmers frequently establish corporations for estate planning purposes and over time gift a portion of the stock to adult children who are not actively farming. Under the proposed rule, small farm corporations who have taken that approach will have to reorganize or sacrifice payments on the portion of stock held by adult children who have moved away to pursue other careers.
Surely, USDA can do better than a rule that cuts payments for small family farms unless they incur legal expenses to reorganize, but allows mega farms that already retain the top payment limitation legal experts to continue receiving many times the limit by making small procedural adjustments.
It should be noted that corporations are subject to payment limitations at the corporate level – in stark contrast to general partnerships, in which GAO found the abuse. Partnerships themselves are not subject to the payment limitation. Every partner added to a partnership qualifies the operation for another set of payments up to the proscribed limit, as long as the partner can claim to be actively engaged in farming.
One large farm organized as a general partnership with multiple investors, even investors considered passive investors under federal tax law, can receive multiple times the proscribed limit. In contrast, a corporation is limited to one payment limitation. Consequently, it seems unnecessary to require the same active participation by each and every shareholder in the corporation.
We understand the legitimate concern likely at the core of this requirement. Though one large farm could not receive unlimited payments by using multiple corporate entities, it could receive double the proscribed limit by breaking into two corporations, each with the same principle owner/operator providing active management and holding 51 percent interest. The better means of preventing that abuse is to simply establish by rule that no person can provide the active labor and management for operations collectively receiving more than the limit.
This approach is not only less objectionable than the proposed rule, it is an important reform in its own right. If USDA goes back to requiring active labor and management only by stockholders with 50 percent interest, but doesn’t make this change, single large farms will organize as two corporations. Family stockholder and equity investors will hold up to half the stock, to enable what is in reality a single operation, to receive twice the proscribed limit.
Finally, we recommend that for payment limitation purposes USDA allocate payments on crop share leases between the farm operator and the landowner according to the usual and customary crop share rate, in instances in which, 1) land is leased at rate lower than the usual and customary rate, and 2) the farm operator would exceed the proscribed limit under a lease at the usual and customary rate.
Payment limitation circumvention is almost always about shifting payments from a large farm operator at risk of exceeding the limit to third parties who are not. If other avenues are closed, crop share leases will almost certainly be adjusted to shift payments from large farm operators affected by the limits to certain landlords with limited holdings.
For example, in areas where 50/50 crop share leases are usual and customary, large farm operators would likely begin negotiating leases that offer such landlords a larger share of the crop in return for paying 100 percent of fertilizer, chemical and seed costs. The sole purpose for reformulating the crop share lease would be payment limitation circumvention.
If USDA tightens the rule by quantifying active management, big payment recipients will seek other avenues such as manipulating crop share leases. USDA must block obvious alternative avenues of circumvention if it is to make progress in establishing payment limitations with integrity.
It is critical to recall the reason for creating the actively engaged rule in the Farm Program Payments Integrity Act of 1987.
Congress was responding to public concern over widespread circumvention of farm payment limitations. An expose’ on CBS 60 Minutes described a legal structure dubbed the Mississippi Christmas Tree, whereby a single operation was split into numerous entities with many partners in order to receive many times the proscribed limit on payments.
By limiting payments to active farmers, the law was intended to prevent mega farms from circumventing the limit by claiming employees or equity investors as active farmer partners, each qualifying the operation for another set of payments.
The interim rule does not reflect that intent. It fails to effectively prevent mega farms from circumventing the payment limit, while it reduces payments to smaller farms that have never received close to the limit.
We can do better.