Guilliams v. Commissioner of Revenue

• Decision Date: 24 October 1980
• Docket Number: No. 50720.,50720.
• Citation: 299 NW 2d 138
• Parties: Lee GUILLIAMS, et al., Respondents, v. The COMMISSIONER OF REVENUE, Relator.
• Court: Minnesota Supreme Court

299 N.W.2d 138 (1980)

Lee GUILLIAMS, et al., Respondents, v. The COMMISSIONER OF REVENUE, Relator.

No. 50720.

Supreme Court of Minnesota.

October 24, 1980.

Warren Spannaus, Atty. Gen., and Paul R. Kempainen, Sp. Asst. Atty. Gen., Dept. of Revenue, St. Paul, for relator.

Robert W. Johnson, St. Paul, for respondents.

Heard, considered and decided by the court en banc.

SIMONETT, Justice.

Lee and Sandra Guilliams filed state income tax returns for 1975 and 1976, reporting no tax for 1975 and $175.13 for 1976. After an audit, the Commissioner of Revenue issued his assessment order of August 28, 1978, finding that the taxpayers should have applied the farm loss modification law, which limits the amount of farm loss a taxpayer may offset against nonfarm income, and assessed a tax of $587.65 on the first return and $766.65 on the second.

The taxpayers appealed to the tax court, which by its order of October 18, 1978, reversed the commissioner, holding the farm loss modification law was unconstitutional.¹ Relator, the Commissioner of Revenue, appeals to this court. We reverse.

The question is the constitutionality of Minnesota's farm loss modification law, enacted by the 1973 legislature (1973 Minn. Laws, ch. 737) and codified as Minn.Stat. § 290.09, subd. 29.² Before stating the facts of Mr. and Mrs. Guilliams' situation, it might be well to describe the statute involved and the reasons for its enactment. The law limits the amount of nonfarm income a taxpayer can use to offset farm losses. It works in this fashion:

First, all income "arising from a farm" may be freely offset by farm loss.

Second, any remaining net farm loss may fully offset nonfarm income if nonfarm income is $15,000 or less.

Third, if nonfarm income is above $15,000, a reduction formula is used to determine the amount of farm loss which may be used as an offset. This available deduction decreases as the taxpayer\'s nonfarm income increases. The result of the reduction formula is to give a taxpayer with nonfarm income of $22,500 no off-set, regardless of actual farm loss suffered.

Fourth, notwithstanding the above, any farm loss in the form of interest or taxes may be taken as a deduction by the taxpayer in the current year.

Fifth, any unused farm loss-remaining as a result of the above rules-may be carried back 3 years or carried forward 5 years to offset eligible income (eligibility to be determined by the same rules as above).

It appears the statute was intended to curb a popular tax shelter device whereby substantial sums of nonfarm income are sheltered by farm losses.³ The problem arises because farming operations, since the early days of the income tax, have received more liberal tax treatment. These more liberal rules, granted for federal purposes under the Internal Revenue Code, have been incorporated into Minnesota's income tax law through adoption of the federal adjusted gross income as the starting point for calculating the state tax. Minn.Stat. § 290.01, subd. 20.

Thus, costs of raising breeding livestock, costs of developing farms and orchards, and expenditures for soil and water conservation, fertilizer, and soil conditioners, which ordinarily would be chargeable to a capital account and deferred, may be used by the farmer as a current expense deduction. Moreover, the farmer may elect to use the cash method of accounting and ignore yearend inventories, as well as payables and receivables.⁴

While this liberal treatment for farming may well be desirable on a policy basis, what has happened is "the special tax rules for farmers have been converted into tax shelter arrangements for high bracket investors * * *." McDaniel, Tax Expenditures in the Second Stage: Federal Tax Subsidies for Farm Operations, 49 So.Calif. L.Rev. 1277 at 1281 (1976) (quoting Panel Discussion Before the House Comm. on Ways and Means on the Subject of General Tax Reforms, 93d Cong., 1st Sess. pt. 5, at 615 (1973)). While articles on the tax loss farming problem highlight the abuse of upper tax bracket persons, the problem is apparently more one of a continuum, since it appears "losses become more frequent as individual gross income increases." Note, Farm Tax Advantages after the Tax Reform Act of 1976: Congress Finds the Needle but Misses the Haystack, 27 Cleveland St.Law Rev. 85, 112 (1978) (quoting from Carlin and Woods, Tax Loss Farming, ERS-546, U.S. Dept. of Agriculture, 8-9 (1974)).

We look now at Mr. and Mrs. Guilliams' situation, the facts of which were stipulated to and adopted by the tax court. In 1970, Mr. and Mrs. Guilliams, then living in the Twin Cities, decided they wanted to farm and purchased a farm near Hinckley, where they have resided since 1971. In 1973, with the birth of her child, Mrs. Guilliams quit her city job. Mr. Guilliams, however, continued to work as a computer programmer for Control Data, commuting 146 miles daily. His reason for doing so was to earn the income necessary to become a full-time, successful farmer.

The Guilliams had to extend their date for full-time farming because of inflation and the price-fall experienced by cattlemen in 1974 through 1976. Because of a bad market, they sold their cattle in October 1974 to minimize potential losses, but bought cattle again in 1977. In the taxable years of 1975 and 1976, respondents had no cattle and derived their farm income solely from the sale of hay raised on the farm. During these 2 years, Mr. Guilliams would cut the hay in the morning before going to his job at Control Data and his wife, with some part-time help, would bale it.

In 1975, Mr. and Mrs. Guilliams grossed $7,479 from their farm but had an operating loss of $14,195, which included real estate taxes of $1,013 and interest of $2,042. In the same year, their gross nonfarm income was $20,546.48, which included $19,481.47 wages from Control Data.

In 1976, the gross farm income was $8,556 with a farm operating loss of $13,430, including real estate taxes of $958 and interest of $3,556. In the same year, respondents' nonfarm gross income (adjusted for some rental depreciation) was $20,518.95, including Control Data wages of $20,573.47. As stated above, on both their 1975 and 1976 income tax returns, Mr. and Mrs. Guilliams took their full farm operating loss in calculating their state income tax liability without applying § 290.09, subd. 29. The parties agree that, if the statute is valid, the commissioner applied it correctly in auditing the tax returns.

Mr. and Mrs. Guilliams are "legitimate" farmers. All parties agree. In other words, their farming operation is serious and profit motivated and not a scheme to shelter Mr. Guilliams' income from Control Data; quite the contrary, the nonfarm income was earned in order to stay on the farm, and, as the tax court observes, to preserve the family farm a spouse may well have to supplement farm income with nonfarm earnings. This being so, respondents contend the law's classification, which lumps them with the tax loss farmer, is arbitrary. The tax court agreed, holding the law was a denial of equal protection and uniformity under the federal and state constitutions, respectively, and, further, took their property without due process of law.

We first examine the equal protection claim.⁵ There is, of course, a presumption in favor of the constitutionality of the statute, and the challengers "have the burden to show beyond a reasonable doubt that the act conflicts with the uniformity clause of the state constitution." Contos v. Herbst, 278 N.W.2d 732, 736 (Minn.1979); Miller Brewing Co. v. State, 284 N.W.2d 353 (Minn.1979). Indeed, in the field of taxation, the legislature's power is inherently broader and its exercise more flexible than in other areas. Reed v. Bjornson, 191 Minn. 254, 263, 253 N.W. 102, 106 (1934).

The statute classifies taxpayers with farm and nonfarm income into (1) those with $15,000 or less of nonfarm income, and (2) those with more than $15,000 of nonfarm income. The tax court felt, as respondents urge, that the relevant inquiry should not be the amount of nonfarm income but whether the taxpayer is a legitimate (or "real") farmer or a "tax loss" farmer.

This court has listed three factors to consider in measuring a statutory classification against the equal protection requirement:

(1) The distinctions which separate those included within the classification from those excluded must not be manifestly arbitrary or fanciful but must be genuine and substantial, thereby providing a natural and reasonable basis to justify legislation adapted to peculiar conditions and needs; (2) the classification must be genuine or relevant to the purpose of the law; that is, there must be an evident connection between the distinctive needs peculiar to the class and the prescribed remedy; (3) the purpose of the statute must be one that the state can legitimately attempt to achieve.

Miller Brewing Co. v. State, 284 N.W.2d at 356.

Minn.Stat. § 290.09, subd. 29 (1978), meets these criteria. The purpose of the statute, to take the last factor first, is clearly legitimate, to curb a well-known tax abuse. Further, the classifications are genuine and relevant to the purpose of the law, since it is the farm/nonfarm distinction which is at the root of the problem. And, finally, as to the first factor, the use of nonfarm income to distinguish between two classes of farm income taxpayers is not "manifestly arbitrary or fanciful" but provides "a reasonable basis" for the classification.

Since expenses and accounting procedures are treated differently for farm and nonfarm income, it is reasonable for the legislature to treat the two sources of income differently. Whether or not respondents are "real" farmers is not the point; the statute applies to all persons engaged in farming, real or not, with respect to nonfarm income.

In considering the extent to which farm losses, with their special calculation, might be used to offset nonfarm income, the legislature, as part of...