With losses expected in farming, the topic of farm bankruptcy has come up again. Bankruptcy in farming is not new and even has its own bankruptcy code: Chapter 12. Although bankruptcy has a bad stigma, it allows the farm to restructure and continue operations. It's interesting to look at the numbers. About half of farm bankruptcy filings are in the Midwest, followed by the Southeast (Georgia) and California. Also, on average, three out of 10,000 farms file for bankruptcy each year. So, it's not as uncommon as you might think.

Let's look at how Chapter 12 works. To start, you are eligible to file Chapter 12 bankruptcy under the following conditions:

For individuals (Schedule F):

-- You are actively farming.

-- Total debts are less than $10 million.

-- At least 50% of fixed debts relate to the farming operation.

-- More than 50% of gross income derives from farming (preceding year or for each of the second and third prior tax years).

For farm entities:

-- More than 50% of the corporation or partnership is owned by one family or extended family.

-- The family or extended family actively operates the farm.

-- Eighty percent of the value of the entity's assets relate to the farming operation.

-- Total debt does not exceed $10 million.

-- At least 50% of the entity's fixed debt relates to the farming operation.

-- Stock (if any) is not publicly traded.

Once filed, Chapter 12 automatically stays most collections against the farmer or farm entity. It also protects anyone that cosigned as a guarantor. Unless authorized by the court, a creditor can't act against the cosigner. This is very important when you have a generational farm, and Mom or Dad might have guaranteed debt.

Chapter 12's goal is to come up with a workable restructuring plan. The plan must demonstrate the ability to cash-flow payments with consistent/regular income. Considering the farm economy, this may prove very challenging. However, Chapter 12 can provide an option to "right size" the farm and move forward as a more economically viable farm. The plan does not have to pay unsecured creditors in full as long as the farmer or farm entity agrees to a payment plan. Secured creditors (banks, financed equipment) must get paid as least as much as the fair market value of the asset when Chapter 12 was filed. Unsecured creditors must receive as much as they would have if all nonexempt assets were liquidated under a Chapter 7 bankruptcy.

An impartial trustee is appointed in every Chapter 12 case. The trustee's job is to evaluate the assets and debt of the farmer or farm entity, and give his opinion on the feasibility of the plan. If the plan is approved, the trustee disperses payments to the creditors according to the plan. Once the farmer or farm entity has completed the Chapter 12 plan, the court will issue a discharge releasing the farmer or farm entity from the debt as provided by the plan.

Why is Chapter 12 different from a tax perspective? Under Chapter 12, tax associated with the sale of certain farm assets is treated as unsecure debt. Without this benefit, servicing the tax liability associated with asset sales would take a significant portion of the income from the farming operation that would otherwise be used to pay secured creditors. Under the 2019 change, the farm assets can now be sold before or after filing Chapter 12, and still have some or all the tax liability discharged.

Bankruptcy isn't a bad thing. Sometimes, it's a way to save your farm. It is very complex, so consult a bankruptcy attorney before deciding if Chapter 12 is right for you.

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DTN Tax Columnist Rod Mauszycki, J.D., MBT, is a tax principal with CLA (CliftonLarsonAllen) in Minneapolis, Minnesota. Read Rod's "Ask the Taxman" column at https://www.dtnpf.com/….

Rod Mauszycki can be reached at taxman@dtn.com

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