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We’re back! We are excited to bring back our regular Ag Law Harvest posts, where we bring you interesting, timely, and important agricultural and environmental legal issues from across Ohio and the country. This month’s post provides you with a look into Ohio’s ongoing legal battle of some provisions in the recently enacted “Chicken Bill”, a brief dive into the U.S. Department of Labor’s new H-2A wage rules, a warning about conservation easement fraud, and an explanation of a court’s recent decision to release an insurance company from its duty to defend its insured in a lawsuit. 

Battle of “Chicken Bill.”
Ohio House Bill 507 (“HB 507”), sometimes referred to as “the Chicken Bill” went into effect last month and was widely known for reducing the number of poultry chicks that can be sold in lots (from six to three). However, HB 507 contained other non-poultry related provisions that have caused quite a stir. Environmental groups have sued the State, seeking a temporary restraining order, a preliminary and permanent injunction to prevent HB 507 from going into effect, and a declaratory judgement that HB 507 violates Ohio’s Constitution. Two provisions within HB 507 have specifically caught the attention of the Plaintiffs in this case: (1) a revision to Ohio Revised Code § 155.33 that requires state agencies to lease public lands for oil and gas development (the “Mandatory Leasing Provision”); and (2) a revision to Ohio Revised Code § 4928.01 that defines “green energy” to include energy generated by using natural gas, so long as the energy generated meets certain emissions and sustainability requirements (the “Green Energy Provision”). 

Plaintiffs argue that the Mandatory Leasing Provision will cause irreparable harm to their members’ “environmental, aesthetic, social, and recreational interests” in Ohio’s public lands. Additionally, Plaintiffs assert that the Mandatory Leasing Provision and Green Energy Provision violate Ohio’s Constitution by not following the “One-Subject Rule” and the “Three-Consideration Rule” both of which require transparency when creating and passing legislation in Ohio. The Franklin County Court of Common Pleas recently denied Plaintiffs’ request for a temporary restraining order, reasoning that no new leases would likely be granted until the Oil and Gas Land Management Commission adopts its rules (as required by Ohio law) and that there is “no likelihood of any immediate and irreparable injury, loss, or damage to the plaintiffs.” Since the hearing on Plaintiffs’ request for a temporary restraining order, the State of Ohio has filed its answer denying Plaintiffs’ claims and currently all parties are in the process of briefing the court on the merits of Plaintiffs’ request for a preliminary injunction. 

New H-2A Wage Rules: Harvesting Prosperity or Sowing Seeds of Despair? 
On February 28, 2023, the U.S. Department of Labor (the “DOL”) published a final rule establishing a new methodology for determining hourly Adverse Effect Wage Rates (“AEWR”) for non-range farm occupations (i.e. all farm occupations other than herding and production of livestock on the range) for H-2A workers. The new methodology has been in effect since March 30^th. Late last month Rep. Ralph Norman and the Chairman of the House Committee on Agriculture, Rep. Glenn “GT” Thompson, introduced a resolution of disapproval under the Congressional Review Act, seeking to invalidate the DOL’s final rule. Similarly, the National Council of Agricultural Employers (“NCAE”) released a statement declaring that it has filed a Motion for Preliminary Injunction against the DOL’s new methodology. 

Opponents of the new rule argue that the increased wages that farmers and ranchers will be required to pay will put family operations out of business. On the other hand, the DOL believes “this methodology strikes a reasonable balance between the [law’s] competing goals of providing employers with adequate supply of legal agricultural labor and protecting the wages and working conditions of workers in the United States similarly employed.” Producers can visit the DOL’s frequently asked questions publication to learn more about the new H-2A wage rule. As it stands, the new H-2A regulations remain in effect and producers should be taking all possible steps to follow the new rules. Make sure to speak with your attorney if you have any questions about compliance with H-2A regulations. 

Conservation Easement Fraud – Protecting Land or Preying on Profits? 
For a while now, conservation easements have been utilized by farmers and landowners to preserve their land while also obtaining a substantial tax benefit. But not all actors in the conservation easement sphere are good ones. Earlier this month, a land appraiser in North Carolina pled guilty to conspiring to defraud the United States as part of a syndicated conservation easement tax shelter scheme. According to a press release by the U.S. Department of Justice (“DOJ”), Walter “Terry” Douglas Roberts II of Shelby, North Carolina conspired with others to defraud the United States by inflating the value of conservation easements which led to $1.3 billion in fraudulent tax deductions. Roberts is guilty of inflating the value at least 18 conservation easements by failing to follow normal appraisal methods, making false statements, and manipulating or relying on knowingly manipulated data to achieve a desired tax deduction amount. Roberts faces a maximum penalty of five years in prison and could be forced to pay back a specified amount to the U.S. Government. 

Conservation easement fraud is not new, however. The Internal Revenue Service (“IRS”) has been monitoring the abuse of the conservation easement tax deductions for some time. The IRS has included these fraudulent transactions on its annual “Dirty Dozen” list of tax avoidance scams. The IRS has seen taxpayers, often encouraged by promoters armed with questionable appraisals, take inappropriately large deductions for these types of easements. These promoters twist the law to develop abusive tax shelters that do nothing more than “game the tax system with grossly inflated tax deductions and generate high fees for promoters.” The IRS urges taxpayers to avoid becoming entangled by these dishonest promoters and that “[i]f something sounds too good to be true, then it probably is.” If you have questions about the tax benefits of a conservation easement, make sure to speak with your attorney and/or tax professional.  

Alleged Intentional Acts Not Covered by Insurance. 
An animal feed manufacturer is in hot water, literally. A city in Mississippi has accused Gold Coast Commodities, Inc. (“Gold Coast”), an animal feed manufacturer, of intentionally dumping hot, greasy wastewater into the City’s sewer system. Prior to the City’s investigation into Gold Coast’s alleged toxic dumping, Gold Coast purchased a pollution liability insurance policy from Crum & Forster Specialty Insurance Company (“Crum & Forster”). After an investigation conducted by the City and the Mississippi Department of Environmental Quality, the City filed a lawsuit against the feed manufacturer alleging that it intentionally dumped toxic waste into the City’s sewer system. Gold Coast then notified its insurance company of the potential claim. However, Crum & Forster denied coverage for Gold Coast’s alleged toxic dumping. According to the insurance policy, coverage exists for an “occurrence” defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.” Crum & Forster refused to provide a defense or coverage for Gold Coast in the City’s toxic dumping lawsuit because the City alleges multiple times that Gold Coast acted intentionally, and therefore, Gold Coast’s actions were not an accident and not covered by the policy. 

In response, Gold Coast filed a lawsuit against Crum & Forster asking a federal district court in Mississippi to declare that Crum & Forster is required to defend and provide coverage for Gold Coast under the terms of the insurance policy. On a motion to dismiss, the federal district court in Mississippi dismissed Gold Coast’s lawsuit against the insurance company. The district court reasoned that in the underlying toxic dumping lawsuit, the City is not alleging an accident, rather the City asserts that Gold Coast intentionally dumped the toxic waste. Thus, Crum & Forster is not obligated to provide a defense or coverage for Gold Coast, under the terms of the policy. Gold Coast appealed to the Fifth Circuit Court of Appeals (which has jurisdiction over federal cases arising in Texas, Louisiana, and Mississippi). 

The Fifth Circuit affirmed the decision of the federal district court, rejecting Gold Coast’s claim that Crum & Forster is obligated to provide a defense and coverage for Gold Coast in the City’s toxic dumping lawsuit. Gold Coast argued that the City seeks to recover under the legal theory of negligence in the toxic dumping case, therefore Gold Coast’s actions are accidental in nature. The Fifth Circuit was unconvinced. The Fifth Circuit explained that when reading a complaint, the court must look at the factual allegations, not the legal conclusions. The Fifth Circuit found that the factual allegations in the City’s lawsuit all referred to Gold Coast’s intentional or knowing misconduct and any recovery sought under the theory of negligence is not a factual allegation, instead it is a legal conclusion. The Fifth Circuit concluded that using terms like “negligence” do not “transform the character of the factual allegations of intentional conduct against [Gold Coast] into allegations of accidental conduct constituting an ‘occurrence.’” Thus, the Fifth Circuit affirmed the federal district court’s decision to dismiss Gold Coast’s lawsuit against its insurer. Unless the Supreme Court of the United States decides to take up the case, it looks like Gold Coast is all on its own in its fight against the City. The lesson here is that although insurance is important to have, its equally as important to speak with your insurance agent to understand what types of incidents are covered under your insurance policy. 

What is the key to resolving disagreements over water quality issues in Lake Erie?  Cooperation, according to the federal court judge overseeing a legal battle over Lake Erie. The judge, U.S. District Judge James G. Carr, recently approved a plan that is the result of cooperation between the U.S. EPA, State of Ohio, Lucas County Commissioners, and the Environmental Law & Policy Center.  For almost six years, the parties have been in a legal battle over how to deal with water quality in Western Lake Erie.  But at the encouragement of the court, the parties developed and agreed to a Consent Decree to settle the case.  Judge Carr approved the Consent Decree on May 4, 2023.  Time will soon tell if the cooperation approach will satisfy the parties holding interests in Lake Erie’s water quality.

What led to the Consent Decree?

In the midst of growing concerns about harmful algal blooms and water quality in Western Lake Erie, the Environmental Law & Policy Center and Lucas County Commissioners filed a lawsuit against the U.S. EPA, claiming that the federal agency had failed its obligations to oversee Ohio’s duties to meet water quality standards under the Clean Water Act (CWA).  The CWA requires states to identify waters that do not meet water quality standards and designate them as “impaired waters.”  Once it lists a water as impaired, the state must also rank which waters have the highest need for determining Total Maximum Daily Loads (TMDLs) that set maximum amounts of pollutants that may enter the water.  TMDLs provide a framework for future decisions that affect water quality in the impaired water.

Following a separate lawsuit that challenged Ohio EPA’s designation of some but not all waters in Western Lake Erie as impaired, Ohio EPA assigned impaired water status to all Western Lake Erie waters by 2018.  But Ohio identified the waters as a “low” TMDL priority and stated that it would address water quality the western basin through “alternative measures” rather than preparation of a TMDL. The U.S. EPA, charged with reviewing state actions for compliance with the CWA, approved Ohio’s designation.  The Environmental Law & Policy Center and the Lucas County Board of Commissioners each filed lawsuits against the U.S. EPA for approving Ohio’s approach, and the two lawsuits were consolidated into the current case.  The State of Ohio, not an original party to the litigation, received the court’s permission to intervene as a defendant in the lawsuit.

Several years and many motions and hearings later, Judge Carr admonished both sides of the lawsuit for dragging the matter out in court and leaving Lake Erie’s water quality problem “largely unattended.”  In 2021, before considering separate summary judgment motions the parties had made, the Judge pointed out that no matter his decision, the other party would appeal it and continue the litigation and that “nothing is going to get done.”  Resolving the problems in Lake Erie would only happen if the U.S. EPA, the plaintiffs, and the State of Ohio would “work cooperatively towards accomplishing a meaningful outcome and resolution,” Judge Carr stated.  His resolution on the summary judgment motions would only “kick the can down the road for another two years, at least...” A better solution, said Judge Carr, would be for the parties to resolve the matter through settlement.

With the court’s oversight, the parties engaged in settlement negotiations for nearly two years.  They reached an agreement in 2022.  As required by law, the U.S. EPA filed the proposed agreement, or Consent Decree, in the Federal Register last November and sought public comments to the proposal.  The parties then filed a joint motion to the court, asking Judge Carr to approve the proposed Consent Decree. 

The Consent Decree

The Consent Decree outlines a timeline Ohio EPA must follow to create a TMDL designed to address nutrient and algae impairments for drinking water, aquatic life, and recreational uses by establishing pollutant limits for all Western Lake Erie waters. The agreement requires the plaintiffs to allow additional time for the U.S. EPA to step in and prepare a TMDL if Ohio fails in its efforts to do so.  The Consent Decree also sets up a status report schedule and a dispute resolution process and awards attorney fees and costs to the Plaintiffs.  The agreement does not address the legal sufficiency of the TMDL, and the plaintiffs still hold the right to challenge the legal sufficiency or adequacy of the TMDL. The Consent Decree will end upon performance of all obligations by all parties.

The following summarizes the steps of the agreed upon TMDL schedule.

Approval of the Consent Decree

Judge Carr’s role in reviewing the proposed agreement was to determine if it is “fair, adequate, and reasonable, as well as consistent with the public interest.”  The parties’ submitted a joint motion in support of the Consent Decree that laid out their arguments as follows:

1. The proposed agreement is fair because it was negotiated at length, in good faith, and in recognition of the strengths and weaknesses of each side.
2. Because the proposed agreement addresses Defendant’s alleged violations by providing a schedule for developing a TMDL for Western Lake Erie, it is adequate and reasonable.
3. The Consent Decree is in the public interest and furthers the goals of the Clean Water Act by providing for the timely development of a TMDL that will help “restore and maintain the chemical, physical, and biological integrity of the Nation’s waters” as intended by the Act. It also allows continued citizen rights to participate in the TMDL, does not alter existing regulations for TMDLs, and avoids significant time and expenses associated with ongoing litigation.

Judge Carr agreed with the parties’ arguments and approved the Consent Decree.  In doing so, he praised the work of U.S. District Judge Polster, who oversaw the settlement negotiations, the lawyers for each party, and the State of Ohio.  “Though the work that today’s agreement brings is but a first step, it is a step that has to be taken.  How many more steps lie ahead, and how long they will take, is beyond even guessing,” he stated.  “But there’s reason to hope that, in time, the Maumee River will no longer display, as it has for countless summers, a loathsome foul and slimy green surface as it flows through Toledo on its constant and irresistible course on to Lake Erie’s Western Basin.”

What’s next?

Implementation of the Consent Decree schedule is already underway.  The Ohio EPA issued a draft TMDL or “Nutrient Water Quality Improvement Plan for the Maumee River Watershed” on December 30, 2022, and is currently reviewing comments made during the public comment period that ended on March 8, 2023.  The agency appears to be on schedule for meeting the June 30 deadline for submitting the TMDL to the U.S. EPA for its review. Information on the Draft TMDL is available at https://epa.ohio.gov/divisions-and-offices/surface-water/reports-data/maumee-river-watershed.

But is continued cooperation on the TMDL for Western Lake Erie possible?  Both the plaintiffs in this case submitted comments on the draft TMDL, and both raised concerns about its “shortcomings.”  

“The TMDL just proposes to keep doing the same things that have already failed, focused on voluntary measures and incentive payments to producers,” stated the Environmental Law & Policy Center in its comments, available at https://elpc.org/wp-content/uploads/2023/03/ELPC-Maumee-TMDL-comments-FINAL.pdf. 

“It is critical that the draft TMDL not lack the necessary steps to reduce agriculture phosphorous runoff into Lake Erie and place limits on dissolved reactive phosphorous,” said Lucas County Commissioner Wozniak in comments summarized at https://co.lucas.oh.us/CivicAlerts.aspx?AID=1750.  “We shouldn’t be fooled into settling for half measures and voluntary practices any longer. We are talking about the health of our most valuable resource, and we must have a meaningful TMDL to protect it.”

While the spirit of cooperation encouraged by Judge James G. Carr is at play in the development of a TMDL for Western Lake Erie, whether that spirit will thrive in the debate over the content and future implementation of the TMDL is a critical question. In the words of Judge Carr, how many more steps lie ahead, and how long they will take, is beyond even guessing.  Let’s hope that more litigation isn’t one of those steps.

 

The Consent Decree is available through this link.

Judge Carr's Order on the Consent Decree is at this link.

The recent failures of three banks may have some farmers concerned about the security of their cash reserves.   Many farms hold large reserves of cash, the loss of which would be financially devastating.  The federal government does provide protection through the FDIC but not all financial institutions participate in FDIC, not all account types are covered and there are limits to the protection.  However, with a little bit of planning, even large amounts of cash can be fully protected from bank failures.

 

FDIC

The Federal Deposit Insurance Corporation (FDIC) is an independent agency created by Congress to maintain stability and public confidence in the nation’s financial system. The FDIC insures deposits and examines and supervises financial institutions for safety, soundness, and consumer protection.  FDIC deposit insurance coverage depends on two things: (1) whether your bank is FDIC-insured and (2) whether your chosen financial product is a deposit product.  If a bank fails, the FDIC will immediately ensure that holders of eligible accounts will receive their funds subject to coverage limits.  To determine if a specific financial institution participates in FDIC, the name of the bank can be searched in the following database:  https://banks.data.fdic.gov/bankfind-suite/bankfind.

 

Eligible Accounts

The following accounts are eligible for FDIC coverage:

• Checking accounts
• Savings accounts
• Money Market Deposit Accounts (MMDAs)
• Time deposits such as certificates of deposit (CDs)
• Cashier's checks, money orders, and other official items issued by a bank

Accounts that are not eligible for FDIC coverage are as follows:

• Stock investments
• Bond investments
• Mutual funds
• Crypto Assets
• Life insurance policies
• Annuities
• Municipal securities
• Safe deposit boxes or their contents
• U.S. Treasury bills, bonds or notes¹

 

Coverage Limits

FDIC coverage is not unlimited.  Generally, coverage is capped at $250,000 but can be more depending on the type of account and number of owners/beneficiaries.  The coverage limit for each type of account is as follows:

Single Accounts (Owned by One Person)                  $250,000

Joint Accounts (Owned by Two or More Persons)      $250,000 per co-owner

Corporation, Partnership Accounts                             $250,000

Revocable Trust Accounts                                          $250,000 per owner per unique beneficiary

Irrevocable Trust Accounts                                         $250,000 for each unique beneficiary

Government Accounts                                                $250,000

 

Strategies to Insure Large Reserves of Cash

The account restrictions and coverage limits can be problematic for many farms.  It is not uncommon for farms to hold more than $250,000 in a single account to buy inputs, buy the next farm or as a reserve for lean times.  Consider the following example:

Farmer has $1,000,000 in his individual savings account at Bank Co.  If Bank Co. were to fail, FDIC would only protect $250,000 of his $1,000,000, leaving $750,000 unprotected and at risk.

The following are a few strategies that can be used to insure large cash reserves:

Bank Networks.  Some banks are part of a network that allow eligible accounts to be set up at other, cooperating banks.  The primary bank establishes eligible accounts at other banks and then transfers up to $250,000 into each account.  Continuing the above example, Bank Co. establishes a savings account at three other banks – 1^st Bank Co., 2^nd Bank Co. and 3^rd Bank Co.  Bank Co. then transfers $250,000 to each bank.  Farmer now has fully protected accounts at four different banks and his entire $1,000,000 is shielded with FDIC protection.  Bank Co. took care of setting up the three additional accounts and transferring the funds.

Open Different Types of Eligible Accounts.  FDIC will cover different types of eligible accounts at the same bank.  So, multiple type accounts at the same bank can insure more than $250,000.  In this scenario, Farmer can change his individual account to a joint account by adding his spouse ($500,000 coverage), transfer $250,000 to an account held by his farm corporation and transfer $250,000 to an account owned by his trust.  By adding owners and establishing different types of eligible accounts, Farmer’s entire $1,000,000 can be covered by FDIC and remain at Bank Co.

Open Accounts at Multiple Banks.  This strategy is similar to using a Bank Network except that the account holder establishes the accounts.  The account holder may prefer to personally open accounts at multiple banks rather than allowing his bank to do so.  With this strategy,  Farmer opens savings accounts at 1^st Bank Co, 2^nd Bank Co. and 3^rd Bank Co. and transfers $250,000 to each new account.  Now, Farmer’s entire $1,000,000 is covered by FDIC but at four different banks. 

 

Conclusion

Producers holding funds in accounts not eligible for FDIC coverage or holding funds in excess of FDIC limits should consider implementing strategies to cover any unprotected money.  As the above examples illustrate, it is relatively easy to cause large cash reserves to be entirely insured by FDIC.  The producer’s banker or financial advisor should be consulted to determine the strategy that will work best to protect the maximum amount of funds. 

 

¹ These investments are backed by the full faith and credit of the U.S. government.

What are “Taxable Gross Receipts” Under Ohio’s Commercial Activity Tax?
By: Jeffrey K. Lewis, Esq., Attorney and Program Coordinator, OSU Income Tax Schools and Barry Ward, Leader, Production Business Management; Director, OSU Income Tax Schools

The privilege of doing business in Ohio comes at a cost. Since July 1, 2005, Ohio has imposed an annual Commercial Activity Tax (“CAT”) on taxpayers doing business in Ohio. The CAT is measured by a taxpayer’s “taxable gross receipts” during the tax period, which for most taxpayers will be the calendar year. 

As a general rule, any individual or business entity that is required to register or pay tax under Ohio law is subject to paying Ohio’s Commercial Activity Tax. There are certain “excluded taxpayers” including any taxpayer with $150,000 or less of “taxable gross receipts”, non-profit organizations, governmental entities, and others.

The focus of this article will be on what is and is not a “taxable gross receipt” under the CAT. To determine what is a “taxable gross receipt” a taxpayer must undergo a three-step analysis that starts with determining what is a “gross receipt” under Ohio law. Then a taxpayer must situs (or source) those gross receipts to Ohio in order to calculate their total “taxable gross receipts.” A taxpayer’s total taxable gross receipts will then determine their remaining obligations under the CAT. 

Step 1. Determine total “gross receipts.”

“Gross receipts” are broadly defined in Section 5751.01(F) of the Ohio Revised Code as “the total amount realized by a person, without deduction for the cost of goods sold or expenses incurred, that contributes to the production of gross income of the person, including the fair market value of any property and any services received, and any debt transferred or forgiven as consideration.” In other words, a gross receipt is anything that contributes to a taxpayer’s gross income which includes proceeds from the sale of goods or services and income generated from rentals and leases. 

However, Ohio law excludes numerous items from the definition of gross receipt and therefore those items are excluded from being subject to the CAT. A full list of items excluded from the definition of gross receipts can be found in Ohio Revised Code Section 5751.01(F)(2). Below, Chart 1 provides a list of those exclusions, and the bolded exclusions will be discussed in further detail below. 

It is important to remember a taxpayer’s viewpoint when reading the list of exclusions. A taxpayer must ask themselves: “Did I receive proceeds from the sale or transfer of property, goods, or services, and if so, do those proceeds fall into one of the following categories?” If the receipt of any proceeds falls into one of the categories below, the taxpayer does not have to count those proceeds as gross receipts. 

Chart 1: Proceeds Excluded from “Gross Receipts” 

Interest income. Dividends and distributions; distributive or proportionate shares. Receipts from the sale or transfer of capital assets (I.R.C. § 1221) or assets used in the trade or business (I.R.C. § 1231).  Proceeds from the repayment, maturity, or redemption of an intangible. Receipts from a repurchase agreement or loan. Contributions received by a trust, plan, or other arrangement. Compensation. Stock issuance. Life insurance proceeds.  Gifts or charitable contributions. Money awarded from litigation. Agent’s commission, fee, or other remuneration. Returns and allowances. Receipts from worthless or uncollectible debts (“bad debts”). The sale of an account receivable. Qualified uranium receipts. Certain gross casino revenue. Receipts realized from the sale of agricultural commodities by an agricultural commodity handler. Qualifying integrated supply chain receipts. Certain dyed diesel fuel purchases by railroad companies. Certain receipts related to the sale of tangible personal property and capital equipment in megaprojects. Certain sports gaming receipts. Any receipts for which the tax imposed by the CAT is prohibited by law.

Tax refunds.  Pension reversion. Contributions to capital. Sales or use tax collected.  Receipts of an employer from payroll deductions relating to the reimbursement of the employer for advancing money to an unrelated third party on an employee’s behalf.  Cash discounts allowed and taken. Excise taxes collected. Sale or transfer of a motor vehicle as customer preference (car dealers only). Receipts from a financial institution for services provided to the financial institution in connection with the issuance, processing, servicing, or managing loans or credit accounts. Funds received or used by mortgage brokers. Property, money, and other amounts received by Professional Employer Organizations (“PEOs”) from client employers.  Amounts retained as a commission by persons holding permits to conduct horse-racing meetings. Qualifying distribution center receipts. Receipts realized by an out-of-state disaster business from disaster work conducted in Ohio during a disaster response. Receipts from the sale or transfer of a mortgage-backed security or a mortgage loan by a mortgage lender. Amounts of excess surplus of the state insurance fund received by the taxpayer from the Ohio Bureau of Workers’ Compensation.

 

A Closer Look . . . 
As can be seen from Chart 1, there are numerous exclusions from the definition of “gross receipts.” Below we discuss a few of those exclusions in further detail. 

1. Interest Income.  Interest income, except for the interest earned from a credit sale, is excluded from gross receipts. For example, if a taxpayer earns interest on a savings account, that interest is excluded from the taxpayer’s gross receipts. However, a taxpayer must include any monthly interest earned on an installment contract in their gross receipts. 

Example: A farmer agrees to sell land to a neighbor under a land installment contract. Under the land installment contract, the farmer agrees to convey title to the land to the neighbor and the neighbor agrees to pay the purchase price of the land, plus interest, in monthly payments (the installment payments). The farmer retains title to the land until the neighbor’s installment payment obligations have been fulfilled. In this scenario, the farmer must include the monthly interest earned in their gross receipts. However, the amount earned by the farmer that is applied to the purchase price of the land is not included in the farmer’s gross receipts. 

2. Dividends and distributions; distributive or proportionate shares.  If a taxpayer is a shareholder or member of a corporation, S corporation, or other similar entity, the dividends or distributions paid to the taxpayer from the corporation are expressly excluded from the definition of gross receipts and thus not subject to the CAT. This is also true for the value of any distributive shares or proportionate shares received by the taxpayer by virtue of being a member or partner of a pass-through entity or partnership. 

Example: The “patronage dividends” earned by a farmer or farming business that are members of a cooperative are not included in gross receipts. Cooperatives are formed under Ohio’s corporation statute, and these “patronage dividends” are treated the same as a traditional dividend given to a shareholder of any other corporation.  

3. Sale or transfer of capital assets and assets used in the trade or business of the taxpayer.  Ohio law excludes the receipts from the sale or transfer of an asset, described in either Section 1221 or 1231 of the Internal Revenue Code, from the definition of gross receipt, regardless of the length of time the asset is held, and regardless of any gain or loss realized on the transfer of the asset. 

When it comes to the Commercial Activity Tax, Ohio is only concerned about the types of assets described within Sections 1221 and 1231. Section 1221 describes those assets held for personal or investment purposes (i.e. capital assets) and Section 1231 describes assets used in the trade or business of the taxpayer. 

Interaction between Section 1221 assets and Section 1231 assets. For Ohio CAT purposes, if an asset meets the description in Section 1221’s definition of capital assets or in Section 1231’s description of business assets then the proceeds from the sale of that asset do not need to be included in a taxpayer’s gross receipts. Below is a more detailed explanation of the assets described in Sections 1221 and 1231 of the Internal Revenue Code. 

Section 1221 Property: Assets held for personal use and investment.  Generally, these assets include property held by a taxpayer, whether or not connected with their trade or business, and used for personal or investment purposes. The proceeds earned by a taxpayer from the sale or transfer of these capital assets are not subject to the CAT. 

Section 1231 Property: Assets used in the trade or business of the taxpayer. If an asset is included in the definition of these business assets in Section 1231, then the proceeds from the sale or transfer of the business asset do not need to be included in the taxpayer’s gross receipts. According to Section 1231, property used in the trade or business includes: 

1. 1. 1. Depreciable property including, farm machinery, equipment, etc.(so long as it is not considered “inventory”). The entire gross receipt from the sale or transfer of the depreciable asset is exempt from the CAT, regardless of whether a taxpayer recognizes a gain or loss from the sale, including IRC Section 1245 or 1250 recapture income. 
      2. Real property used in the taxpayer’s trade or business (so long as it is not considered “inventory”); 
      3. Timber, coal, and iron ore that are still in the ground (once the mineral is removed from the ground, however, it is no longer an asset used in the trade or business and instead becomes inventory and thus subject to the CAT); 
      4. Livestock held by the taxpayer for draft, breeding, dairy, or sporting purposes. (Livestock is uniquely defined in the Code of Federal Regulations to include cattle, hogs, horses, mules, donkeys, sheep, goats, fur-bearing animals, and other mammals. Livestock does not include poultry, chickens, turkeys, pigeons, geese, other birds, fish, frogs, reptiles, etc.); and
      5. Unharvested crop on land, which is sold simultaneously to the same person is considered “property used in the trade or business.”

Therefore, if an asset that is sold/transferred is included in the above definition, then the proceeds from that sale/transfer do not need to be included in a taxpayer’s gross receipts.

Examples: The Ohio Department of Taxation has provided some of the following examples to help demonstrate “property used in the trade or business” of a taxpayer and whether the receipts from the sale or transfer of those assets should be included in gross receipts: 

1. A farmer trades in a tractor with a FMV of $50,000 and an adjusted tax basis of $0. The farmer would have $50,000 in recapture income recognized. However, under the CAT, this recaptured income is not included in the farmer’s gross receipts.
2. A farmer selling land, including the crops grown on the land, can exclude receipts from the sale if both the crops and land are simultaneously sold to the same person. Once the purchaser harvests the crop, it becomes part of the purchaser’s inventory, and the purchaser must report the receipt from the sale of that crop in their gross receipts. 
3. A farmer who harvests corn for sale must include the proceeds from the sale of the corn in their gross receipts. 
4. Proceeds from the sale of livestock that are used for draft, breeding, dairy, or sporting purposes are excluded from gross receipts. 
5. Cattle raised for slaughter are not considered Section 1231 property, instead they are viewed as inventory. Therefore, a farmer or other taxpayer who finishes steers in a feed lot for slaughter must include those proceeds earned in gross receipts. 
6. A taxpayer who sells acreage including standing timber can exclude the receipts from this sale from CAT. 
7. A taxpayer who cuts timber for the purpose of selling it in the taxpayer’s trade or business cannot exclude receipts from this transaction from their gross receipts. The opposite is true for a landowner who is not in the business of cutting and selling timber. A landowner that sells timber on their property is selling Section 1221 property. Generally, the landowner is selling title of the timber to another party. The purchaser of the timber will have to include the receipts from the sale of the timber in their gross receipts, but the landowner does not.  
8. There are some special considerations for the sale of a business. For a business that is selling its stock and assets to another entity/taxpayer, the receipts from this sale are excluded from CAT as Section 1221 property. However, those receipts from any outstanding accounts receivable or inventory held by the business at the time of the sale must be included in the business’s gross receipts and thus subject to CAT. 

 

Chart 2 below, provided by the Ohio Department of Taxation, contains a list of different types of assets and whether the receipts from the sale or transfer of these assets are subject to CAT: 

      Chart 2: Examples of Assets Subject to the CAT

Sale or transfer of . . .	Subject to CAT?
Personal residence	NO
Office building sold by investor	NO
Personal car (used for pleasure)	NO
Delivery truck not part of inventory	NO
Stocks and bonds (personal investment)	NO
Accounts receivable	YES
Supplies used in taxpayer’s business	YES
Fishing pole sold at yard sale	NO
Fishing pole sold by a retailer	YES
Jewelry not sold by retailer/wholesaler	NO
Hedging transactions	NO
Personal sailboat (used for pleasure)	NO
Copy machine used for business purposes	NO
Inventory	YES
Golf clubs sold at yard sale	NO
Golf clubs sold by a professional player	NO
Unextracted oil sold with land	NO
Extracted mineral	YES
Cattle (livestock) – non-inventory	NO
Poultry	YES
Farmland with growing crops	NO
Harvested crops	YES
Copyright	YES
Stock certificates	NO
Accounts receivable	YES
Business equipment	NO

 

Step 2. Determine “taxable gross receipts.”

After a taxpayer has calculated their gross receipts, the taxpayer must then determine their “taxable gross receipts.” A “taxable gross receipt” is a gross receipt that is sitused (or sourced) to the state of Ohio. Generally, gross receipts are sourced based on the benefit to the purchaser. Section 5751.033 of the Ohio Revised Code sets forth the rules for determining how to source gross receipts to Ohio. Gross receipts are sitused to Ohio as follows:  

Chart 3: Sourcing Gross Receipts to Ohio

Real Property: Gross rents and royalties Sale or transfer	If the property is located in Ohio, those receipts are sourced to Ohio. Receipts from real property not located in Ohio are not taxable gross receipts.
Tangible Personal Property:  Gross rents and royalties  Sale or transfer	For gross rents and royalties, if the tangible personal property is located or used in Ohio, it is a taxable gross receipt.  For the sale or transfer of tangible personal property, the property is sourced based on where the property is ultimately received after all transportation has been completed. Therefore, only tangible personal property that is ultimately received in Ohio is a taxable gross receipt.
Other Services	The general rule is that the service is sourced based on the benefit to the purchaser. Receipts stemming from services performed in Ohio are taxable gross receipts. Receipts from services performed outside the state of Ohio are not taxable gross receipts.

 

Step 3. Only include those taxable gross receipts for the current tax year. 

Ohio law provides that a “taxpayer’s method of accounting for gross receipts for a tax period shall be the same as the taxpayer’s method of accounting for federal income tax purposes . . .” The taxpayer’s method of accounting will be either the cash method or accrual method of accounting. Under the cash method, a taxpayer reports income in the tax year the income is received. Under the accrual method, a taxpayer reports income in the tax year it is earned, regardless of when payment is received. Therefore, for a taxpayer that uses the cash method of accounting, gross receipts are only included in the tax year that the receipt is received. Take, for example, a grain farmer that enters into a deferred payment contract with the local grain elevator. If the farmer uses the cash method of accounting, the receipt from the sale of the farmer’s grain is included in the year when payment is received. If the farmer uses the accrual method of accounting, the receipt from the sale of the farmer’s grain must be included in the year the farmer entered into the deferred payment contract because that would be the year when the farmer earned the income. 

 

Conclusion. 

In summary, a taxpayer’s obligation under Ohio’s Commercial Activity Tax is largely determined by the amount of “taxable gross receipts” the taxpayer has for the current tax period. A taxpayer must engage in the daunting process of determining what is and is not a “gross receipt” and then must situs (or source) those gross receipts to Ohio in order to calculate their “taxable gross receipts.” However, determining a taxpayer’s obligations under the CAT does not stop there. There are additional requirements such as registration, minimum tax imposed, and filing frequency. For more information about a taxpayer’s obligations under the CAT, please visit the Ohio Department of Taxation’s Commercial Activity Tax (CAT) – General Information website. 

Sources

26 U.S. Code § 1221 – Capital Asset Defined

26 U.S. Code § 1231 – Property Used in the Trade of Business and Involuntary Conversions

26 C.F.R. §1.1231-2 – Livestock held for draft, breeding, dairy, or sporting purposes

Ohio Administrative Code Chapter 5703-29: Commercial Activity Tax

Ohio Department of Taxation – Commercial Activity Tax (CAT) - FAQs

Ohio Department of Taxation – Commercial Activity Tax (CAT) – General Information

Ohio Department of Taxation – CAT 2005-08: Commercial Activity Tax; I.R.C. Section 1221 and 1231 Assets Excluded from “Gross Receipts”

Ohio Department of Taxation – CAT 2005-17:“Taxable gross receipt,” defined

Ohio Department of Taxation – CAT 2006-04: Commercial Activity Tax: Cash Discounts, Defined

Ohio Revised Code Chapter 5751: Commercial Activity Tax