A $1.3 Million “Distribution” Nobody Saw Coming
Be careful with debt allocations in a farm restructuring
If you’re thinking about reshuffling your farm entities, here’s a Tax Court case worth watching.
Johnson Farms, a cattle and egg operation out of Everton, Missouri, is challenging an IRS notice that says a 2021 restructuring quietly handed two of its partners a taxable distribution they never saw and never received in cash.
The setup is one a lot of family operations will recognize. Johnson Farms ran as a Missouri general partnership owned by four brothers — Joshua, Alex, Brent, and Stephen. In the fall of 2021, they split the business into two new LLCs: one for the farming assets, one to hold the land. The operating company then signed five new promissory notes with a new bank, refinanced the farmland and chicken barns, paid off the old bank loans, and the members personally guaranteed the new debt just as they had guaranteed the old.
The IRS looked at that reshuffle and saw something the family didn’t. It issued a notice asserting a $507,126 underpayment for 2021, plus a $101,425 penalty under Section 6662. The theory: the restructuring reduced certain partners’ shares of partnership liabilities under Section 752(b), and a drop in your share of debt is treated as a deemed cash distribution. The agency put Brent’s relief at $1.1 million and Stephen’s at $188,545 — roughly $1.3 million of “distributions” conjured out of a paperwork change.
Johnson Farms is fighting the entire assessment, arguing the IRS used a mechanical formula instead of reading the actual notes and guaranties and ignored the guarantees the members signed in 2020 and 2021. We’ll see how it plays out. But the warning for the rest of us is already clear.
Why debt allocation is the whole ballgame
