Federal Taxation - Ben E. Muraskin, James A. Lawton, and Tiffani W. Greene

• Publication year: 1998

Federal Taxationby Ben E. Muraskin^*

James A. Lawton^** and Tiffani W. Greene^***

The Court of Appeals for the Eleventh Circuit during 1997 rendered fewer reported decisions dealing with federal tax issues than in prior years. Nevertheless, in one of the biggest developments in cooperative taxation, the Eleventh Circuit decided Gold Kist Inc. v. Commissioner,¹ which involved the interpretation of the tax benefit rule as set forth in the 1983 Supreme Court decisions in Hillsboro National Bank v. Commissioner and United States v. Bliss Dairy, Inc.² Other decisions involved the qualification of corporations as "farm-related taxpayers," employment taxes, federal tax liens, issues on appeal, litigation costs, and a bankruptcy tax issue.

I. Cooperative Taxation and Tax Benefit Rule

In Gold Kist Inc. v. Commissioner, the Eleventh Circuit reversed the Tax Court, concluding that Gold Kist Inc. ("Gold Kist") did not have to recognize income when it redeemed its equity from some of its patrons for less than the amount it deducted in connection with the original issuance of the equity.³ This decision marked the end of a dispute with the Internal Revenue Service ("IRS") that had lasted nearly twenty years.

Gold Kist, a nonexempt farmers' co-operative, is subject to Subchapter T ("Subchapter T") of the Internal Revenue Code of 1986, as amended.⁴ For many years, Gold Kist issued the bulk of its patronage dividends as qualified patronage dividends, which are dividends paid to its patrons partly in cash and partly by the issuance of instruments Gold Kist called "notified equity."⁵ These instruments entitled the holder to receive the stated amount of notified equity at a future time if and when Gold Kist redeemed or revolved the notified equity.⁶ Gold Kist properly claimed a deduction when the notified equity was issued under section 1382(b)⁷ both for the cash and the portion of the dividend paid as notified equity. As provided under section 1385, each of the patrons receiving the qualified patronage dividend consented to take the full stated amount of the dividend, including the stated amount of the notified equity, into income at that time.⁸ Thus, as provided by Subchapter T, earnings of Gold Kist paid out as qualified patronage dividends were taxed once to the patron and not to Gold Kist.⁹

Gold Kist was not required to redeem any of its notified equity from its patrons. Nevertheless, at the discretion of its board, Gold Kist typically revolved or redeemed its notified equity for cash at its full stated amount after approximately twenty years. In addition, Gold Kist would redeem a patron's outstanding notified equity upon the patron's death, also at its full stated amount, even though that patron's notified equity might not be eligible for redemption for a number of years. The redemptions at issue, however, were in a third category. These redemptions were from patrons who had terminated their membership in Gold Kist and had requested payment for their equity. In that instance Gold Kist would redeem the notified equity for cash at its present value. Present value was determined pursuant to company policy based on the current interest rates on Gold Kist's fifteen-year capital certificates of interest and on the assumption that the former member's notified equity otherwise would be revolved at the estimated revolving date, or earlier, based on the former member's anticipated life expectancy using standard mortality tables.¹⁰ Once a member's equity was redeemed early, absent individual approval of the management executive committee of Gold Kist, the former member could not again become a member of Gold Kist.¹¹

It is important to note a number of features surrounding the facts of this third category of redemptions. First, Gold Kist did not have any preconceived plans or programs to redeem specific holders or specific amounts of notified equity, and it did not have any plans or arrangements that would encourage its patrons to terminate membership and withdraw their notified equity early.¹² Second, the redemption was prompted by the patron and not Gold Kist.¹³ Finally, the amount redeemed early represented only one or two percent of the total outstanding balance of notified equity in any given year.¹⁴

Arguing that a portion of the earnings of Gold Kist would otherwise escape being taxed, the IRS took the position that the tax benefit rule required Gold Kist to take into income an amount equal to the difference between the amount deducted by Gold Kist upon the original issuance of the notified equity and the present value amount used to redeem the notified equity early.¹⁵ Gold Kist took the position that this difference was not income to it and put forth two main arguments. First, it argued that the notified equity was equity for tax purposes.¹⁶ As a redemption of equity, the redemption came squarely within the provisions of section 311(a), which provides that no income results from the redemption of "stock" for cash.¹⁷ Further, even if section 311(a) was inapplicable, the federal income tax law has always treated the redemption of equity for cash as a capital transaction not giving rise to taxable income or loss.¹⁸

Second, Gold Kist argued that the tax benefit rule as outlined in the Supreme Court decisions in the companion cases Hillsboro National Bank v. Commissioner and United States v. Bliss Dairy, Inc.¹⁹ did not apply to require income recognition.²⁰ According to the Supreme Court, the tax benefit rule only requires the inclusion of income when "the later event is indeed fundamentally inconsistent with the premise on which the deduction was initially based."²¹ Based in part on the legislative history of Subchapter T, Gold Kist reasoned that a patronage dividend deduction is premised on the patron's consent to include the dividend in income, and nothing changed that fact when Gold Kist subsequently redeemed the notified equity even at less than the full stated amount.²² In addition, Gold Kist stated that there is simply no requirement under Subchapter T that any amount ever be paid to patrons for their notified equity.²³ Thus, to Gold Kist the redemption of the notified equity for less than its stated amount could not be fundamentally inconsistent with the original patronage dividend deduction.²⁴

The Tax Court issued its opinion on June 26, 1995 and rejected Gold Kist's arguments.²⁵ Gold Kist appealed the decision of the Tax Court, and on April 21, 1997, in a per curiam opinion, the Eleventh Circuit found that the tax benefit rule did not require a co-operative to include these amounts in income.²⁶ The Eleventh Circuit agreed with Gold Kist's view that the deduction phase of the transaction was complete after the patron had given consent to include the full stated amount of the patronage dividend in income.²⁷ It also agreed with Gold Kist that the deduction of a qualified patronage dividend is not premised on the assumption that any particular amount, or indeed any amount at all, necessarily will be paid to patrons for their notified equity.²⁸

II. Qualification as a "Farm-Related Taxpayer"

In Golden Rod Farms, Inc. v. United States,²⁹ the Eleventh Circuit considered whether a corporation can qualify as a "farm-related taxpayer" within the meaning of section 464(f)(3)(B),³⁰ an issue of first impression.³¹ Golden Rod Farms, Inc. ("Golden Rod"), an Alabama corporation, raises broiler chickens for resale. In 1987 Golden Rod paid over twenty million dollars for feed and feed ingredients. Golden Rod deducted the entire twenty million dollars from its 1987 income although it had used only a portion of the feed materials during that taxable year.³² In 1988 Golden Rod again deducted the entire amount of its feed purchases despite the fact that only a portion of these materials was used during the taxable year. The IRS asserted that Golden Rod was precluded from deducting the entire amount it spent on feed in the year of purchase because Golden Rod was not a farm-related taxpayer within the meaning of section 464(f)(3)(B). As a result, the IRS assessed deficiencies against Golden Rod for the deductions it claimed on its 1987 and 1988 tax returns for feed purchased in the applicable year but not used in that year. Golden Rod paid the deficiencies, filed an unsuccessful administrative claim for refund, and then filed an action to recover the amount of additional taxes assessed plus interest.³³

The district court held that Golden Rod qualified as a "farm-related taxpayer" under section 464(f)(3)(B),³⁴ and the Eleventh Circuit affirmed.³⁵ In reaching its conclusion, the court of appeals examined the plain language and the legislative history of the statute. To qualify as a farm-related taxpayer under the plain language of the statute, Golden Rod had to be considered a taxpayer in the principal occupation of farming.³⁶

The IRS contended that Golden Rod could not meet the definition of a farm-related taxpayer because corporations, unlike individuals, did not have occupations but rather had trades or businesses.³⁷ The IRS argued that other terms contained in section 464(f)(3)(B) confirmed Congress's intent that a farm-related taxpayer must be an individual. Specifically, the IRS noted that the terms "residence" and "family" only apply to individuals.³⁸

Golden Rod asserted that Congress's use of the term "taxpayer," which is statutorily denned to include corporations as well as individuals, clearly established Congress's intention that a corporation is eligible to qualify as a farm-related taxpayer.³⁹ In addition, Golden Rod argued that "business" and "occupation" are synonymous terms applying equally to corporations and individuals.⁴⁰

After considering both arguments, the court concluded that the statutory phrase was ambiguous and did not plainly exclude corporations.⁴¹ Although the court agreed that the word "occupation" is most commonly used to refer to the job of an individual, it noted that legislatures have used the term...