Tax Info for Agriculture Business Types

To educate taxpayers about their filing obligations, this fact sheet, the thirteenth in a series, highlights some income sources and deductible business expenses of farmers. Incorrect reporting of farm income and expenses accounts for part of the estimated $345 billion per year in unpaid taxes, according to IRS estimates.

Income Sources
Farmers may receive income from many sources, but the most common source is the sale of livestock, produce, grains, and other products raised or bought for resale. The entire amount a farmer receives, including money and the fair market value of any property or services, is reported on IRS Schedule F, Profit or Loss From Farming.

Bartering is another income source for farmers. Bartering occurs when farm products are traded for other farm products, property, someone else’s labor or personal items. For example, if a farmer helps another farmer build a barn and receives a cow for his work, the recipient of the cow must report its fair market value as ordinary income. If the farmer uses this cow for business purposes, he may be able to claim depreciation over its useful life as well as deduct the expenses incurred for the cow. However, if the cow is for personal use, no depreciation or expenses for the cow would be deductible.
Other income sources include:

• Cooperative distributions
• Agricultural program payments
• Commodity Credit Corporation (CCC) loans
• Crop insurance proceeds and federal crop disaster payments
• Custom hire (machine work) income

Deductible Expenses

The ordinary and necessary costs of operating a farm for profit are deductible business expenses. An ordinary expense is an expense that is common and accepted in the business. A necessary expense is one that is appropriate for the business.

Among the deductible expenses are amounts paid to farm labor. If a farmer pays his child to do farm work and a true employer-employee relationship exists, reasonable wages or other compensation paid to the child is deductible. The wages are included in the child’s income, and the child may have to file an income tax return. These wages may also be subject to social security and Medicare taxes if the child is age 18 or older.

Another deductible expense is depreciation. Farmers can depreciate most types of tangible property –– except land –– such as buildings, machinery, equipment, vehicles, certain livestock and furniture. Farmers can also depreciate certain intangible property, such as copyrights, patents, and computer software. To be depreciable, the property must

• Be property the farmer owns
• Be used in the farmer’s business or income-producing activity
• Have a determinable life
• Have a useful life that extends substantially beyond the year placed in service

Some expenses paid during the tax year may be partly personal and partly business. Examples include gasoline, oil, fuel, water, rent, electricity, telephone, automobile upkeep, repairs, insurance, interest and taxes. Farmers must allocate these expenses between their business and personal parts. Generally, the personal part of these expenses is not deductible.

For example, a farmer paid $1,500 for electricity during the tax year. He used one-third of the electricity for personal purposes and two-thirds for farming. Under these circumstances, two-thirds of the electricity expense, or $1,000, is deductible as a farm business expense. Records must be maintained to document the business portion of the expense.

If your debt is canceled or forgiven, other than as a gift or bequest to you, you must include the canceled amount in gross income for tax purposes. Report the canceled amount on line 10 of Schedule F (PDF) if you incurred the debt in your farming business. If the debt is a non-business debt, report the canceled amount on line 21 of Form 1040 (PDF).

Form 1099-C

If a federal agency, financial institution, or credit union cancels or forgives your debt of $600 or more, you will receive a Form 1099-C, Cancellation of Debt (PDF). The amount of debt canceled is shown in box 2.

Qualified Farm Debt

You can exclude from income a canceled debt that is qualified farm debt owed to a qualified person. This exclusion applies only if you were solvent when the debt was canceled or, if you were insolvent, only to the extent the canceled debt is more than the amount by which you were insolvent. Your debt is qualified farm debt if both of the following requirements are met.

• You incurred it directly in operating a farming business
• At least 50% of your total gross receipts for the 3 tax years preceding the year of debt cancellation were from your farming business

Special rules apply to presidentially declared disaster area losses. A presidentially declared disaster is a disaster that occurred in an area declared by the president to be eligible for federal assistance under the Disaster Relief and Emergency Assistance Act.

This tax tip discusses the special rules for when to deduct a disaster area loss and the abatement of interest on tax underpayments. For other special rules, see Publication 547.

When to Deduct Disaster Area Losses

If you have a deductible loss from a presidentially declared disaster area, you can elect to deduct that loss on your return or amended return for the immediately preceding tax year. If you make this election, the loss is treated as having occurred in the preceding year.

Note: Claiming a qualifying disaster loss on the previous year's return may result in a lower tax for that year, often producing or increasing a cash refund.

You must make this election to take your casualty loss for the disaster in the preceding year by the later of the following dates:

• The due date (without extensions) for filing your tax return for the tax year in which the disaster actually occurred
• The due date (with extensions) for the return for the preceding tax year

If your deductible loss from operating your farm is more than your other income for the year, you may have a net operating loss (NOL). You may also have an NOL if you had a personal or business-related casualty or theft loss that was more than your income.

Note: If you have an NOL this year, you can carry it to other years and deduct it. You may be able to get a refund of all or part of the income tax you paid for past years, or you may be able to reduce your tax in future years.

Carrybacks

Generally, you carry an NOL back to the two tax years before the NOL year and deduct it from income you had in those years. You can choose not to carry back an NOL and only carry it forward. There are rules for figuring how much of the NOL is used in each tax year and how much is carried to the next tax year. These rules are explained in Publication 536.

Unless you choose to waive the carryback period, as discussed later, you must first carry the entire NOL to the earliest carryback year. If your NOL is not used up, you can carry the rest to the next earliest carryback year, and so on.

Refigured Tax

Refigure your deductions, credits, and tax for each of the years to which you carried back an NOL. If your refigured tax is less than the tax you originally paid, you can apply for a refund by filing Form 1040X, Amended U.S. Individual Income Tax Return (PDF), for each year affected, or by filing Form 1045 (PDF). You will usually get a refund faster by filing Form 1045, and generally you can use one Form 1045 to apply an NOL to all carryback years.

Exceptions to 2-Year Carryback Rule

Eligible Losses

Eligible Losses qualify for longer carryback periods. The carryback period for an Eligible Loss is 3 years. An Eligible Loss is any part of an NOL that:

1. Is from a casualty or theft, or
2. Is attributable to a Presidentially declared disaster for a qualified small business

Note: An eligible loss does not include a farming loss.

Farming Loss

Farming Losses qualify for longer carryback periods. The carryback period for a Farming Loss is 5 years. A Farming Loss is the smaller of:

1. The amount which would be the NOL for the tax year if only income and deductions attributable to farming businesses were taken into account, or
2. The NOL for the tax year

You can choose to treat a farming loss as if it were not a farming loss. If you make this choice, the loss is subject to the 2-year carryback period. For more information, refer to, When To Use an NOL in Publication 536.

Carryovers

If you do not use up the NOL in the carryback years, carry forward what remains of it to the 20 tax years following the NOL year. Start by carrying it to the first tax year after the NOL year. If you do not use it up, carry over the unused part to the next year. Continue to carry over any unused part of the NOL until you use it up or complete the 20-year carryforward period.

For an NOL occurring in a tax year beginning before August 6, 1997, the carryforward period is 15 years.

If you are engaged in a farming business, you may be able to average all or some of your current year's farm income by shifting it to the 3 prior years (base years). The term "farming business " is defined in the instructions for Schedule J (Form 1040) (PDF).
Who Can Use Farm Income Averaging

You can elect to use farm income averaging if, in the year of the election, you are engaged in a farming business as an individual, a partner in a partnership, or a shareholder in an S corporation. You do not need to have been engaged in a farming business in any base year.

Who Cannot Use Farm Income Averaging

Corporations, partnerships, S corporations, estates, and trusts cannot use farm income averaging.

There may be a limit on your deduction for prepaid farm supplies if you use the cash method of accounting to report your income and expenses. This limit will not apply, however, if you meet one of the exceptions, described later.
Deposits are not considered prepaid farm expenses.

What is a Prepaid Farm Expense

Prepaid farm supplies are amounts you paid during the tax year for the following items:

• Feed, seed, fertilizer, and similar farm supplies not used or consumed during the year
• Poultry (including egg-laying hens and baby chicks) bought for use (or for both use and resale) in your farm business that would be deductible in the following year if you had capitalized the cost and deducted it ratably (for example, monthly) over the lesser of 12 months or the useful life of the poultry
• Poultry bought for resale and not resold during the year

What is Not a Prepaid Farm Expense

Prepaid farm supplies do not include any amount paid for farm supplies on hand at the end of the tax year that you would have consumed if not for a fire, storm, flood, other casualty, disease, or drought.

Deduction Limit

You can deduct an expense for prepaid farm supplies that does not exceed 50% of your other deductible farm expenses in the year of payment. You can deduct an expense for any excess prepaid farm supplies only for the tax year you use or consume the supplies.

The cost of poultry bought for use (or for both use and resale) in your farm business and not allowed in the year of payment is deductible in the following year. The cost of poultry bought for resale is deductible in the year you sell or otherwise dispose of that poultry.

If you are in the business of farming, you can choose to currently deduct your expenses for soil or water conservation or for the prevention of erosion of land used in farming. Otherwise, these are capital expenses that must be added to the basis of the land. Conservation expenses for land in a foreign country do not qualify for this special treatment. The deduction cannot be more than 25% of your gross income from farming.

Plan Certification

You can deduct your expenses for soil and water conservation only if they are consistent with a plan approved by the Natural Resources Conservation Service (NRCS) of the Department of Agriculture. If no such plan exists, the expenses must be consistent with a soil conservation plan of a comparable state agency to be deductible. Keep a copy of the plan with your books and records as part of the support for your deductions.

Choosing To Deduct

You can choose to deduct soil and water conservation expenses on your tax return for the first year you pay or incur these expenses. If you choose to deduct them, you must deduct the total allowable amount in the year they are paid or incurred. If you do not deduct the expenses, you must capitalize them.

Note: If you receive cash rental for a farm you own that is not used in farm production, you can not claim soil and water conservation expenses for that farm. These costs must be capitalized into the land basis.

Example:

You own a farm in Iowa and live in California. You rent the farm for $125 in cash per acre and do not materially participate in producing or managing production of the crops grown on the farm. You cannot deduct your soil conservation expenses for this farm. You must capitalize the expenses and add them to the basis of the land.

Normally, you do not report loans you receive as income, and you report income from a crop for the year you sell it. However, if you pledge part or all of your production to secure a CCC loan, you can choose to treat the loan as if it were a sale of the crop and report the loan proceeds as income for the year you receive them. You do not need approval from the IRS to adopt this method of reporting CCC loans, even though you may have reported those received in earlier years as taxable income for the year you sold the crop.

Once you report a CCC loan as income for the year received, you must report all CCC loans in that year and later years in the same way, unless you get approval from the IRS to change to a different method. Refer to Change in Accounting Method in Publication 225, Farmer's Tax Guide.

Note: You can request income tax withholding on CCC loan payments made to you. Use Form W-4V, Voluntary Withholding Request (PDF). Refer to How to Get Tax Help in Publication 225 for information about ordering the form.

How To Choose To Report A CCC Loan As Income

To make the choice to report a loan as income, include the loan as income on line 7a of Schedule F (PDF) for the year you receive it. Attach a statement to your return showing the details of the loan.

Repayment of CCC Loans using CCC Certificates

Farmers who pledge part or all of their production to secure a CCC loan may not be properly reporting market gain when they use CCC certificates in connection with paying off their loans. See IR-2004-38, March 18, 2004, for more information regarding the tax considerations of this transaction.

The National Tobacco Growers Settlement Trust (Trust) is an offshoot of the Master Settlement Agreement (MSA) which was signed in November 1998 to settle claims brought by a majority of the states against certain tobacco manufacturers, to recover health care costs associated with tobacco use. As a result, tobacco manufacturers agreed to pay $5.15 billion to the Trust over a 12-year period, with the first installment of $380 million being paid in 1999 to tobacco landowners, producers, and tobacco quota owners in 14 states.

Since that time, anecdotal information received by the IRS suggests that recipients of the payments may not know the correct tax treatment, i.e., that the funds are taxable income in the year constructively received.

Taxpayers may inquire regarding the federal tax treatment of their payments. For federal tax purposes, these payments are considered gross income per Internal Revenue Code Section 61. Under this Section, Gross Income is defined as, "all income from whatever source derived," except for those items specifically excluded by the Internal Revenue Code.

Eligibility to receive payments under the Trust described above is based upon a formula developed and administered each Trust year by each state Certification entity. Under the terms of the Trust agreement, that formula may be based upon any crop year or years from 1993 forward. However, the State of Maryland (and other States may follow suit) is offering an additional incentive above the National Settlement described above. Under the State of Maryland Buyout, payments are made to eligible recipients in lieu of them growing tobacco or otherwise using their land for tobacco purposes for a 10-year period. All payments received with respect to the State of Maryland Buyout are to be treated as ordinary income (just as if the taxpayer grew and sold tobacco) if the taxpayer is an active farmer subject to self-employment tax, or rental income if the taxpayer rents out their land, as further described below.

Under Section 451 of the Internal Revenue Code and Section 1.451-1(a) of the Income Tax Regulations, taxpayers using the cash receipts and disbursements method of accounting generally include amounts in gross income for the taxable year in which funds are actually or constructively received. With respect to the National Settlement, taxpayers will receive a 1099-Misc statement in January 2002 that reflects the amount they should report on their 2001 return. Verbiage is included on Form 1099 that indicates the applicable time period with respect to payments received (From DECEMBER 29, 2000 through NOVEMBER 20, 2001) that should be included in income on 2001 returns. Those receiving funds under the Maryland Buyout also received a stuffer that detailed the proper tax treatment with respect to the Maryland payments.

The payment is reported as income on different tax forms, however, depending on specific taxpayer situations. For example, a taxpayer who raises and sells a tobacco crop would report the payment as gross income on Schedule F, "Profit or Loss From Farming," and would be subject to applicable self-employment tax. Landowners or tobacco quota owners, who historically have leased their tobacco-related property and did not help to produce the crop, would report the settlement payments as farm rental income on Form 4835, "Farm Rental and Expenses."

IRS Publication 225, "Farmer's Tax Guide," has more information on these forms and how farm income should be reported. If additional information is needed, please contact our toll free number at 1(800) 829-1040

IRS Reminds Farmers, National Tobacco Settlement Payments are Taxable Each Year

WWASHINGTON - Landowners, producers and tobacco quota owners who receive money from the National Tobacco Settlement Trust must report those payments as income each year, the Internal Revenue Service said today. See IR-2003-7, January 21, 2003 for the full text of the information release.

Cost-share payments: Forest Land Enhancement Program (FLEP).
Rev.Rul. 2004-8 (PDF), I.R.B. 2004-10, 544 (March 8, 2004)

The IRS has ruled that the Forest Land Enhancement Program (FLEP) is substantially
similar to the type of programs described in Code Sec. 126(a)(1) through (8) within the meaning of Code Sec. 126(a)(9). Accordingly, all or a portion of cost-share payments received under the FLEP is eligible for exclusion from gross income to the extent permitted by Code Sec. 126. The IRS notes that Code Sec. 126(b)(1) and Reg. § 16A.126-1 can be used to determine what portion, if any, of the cost-share payments is excludable from gross income under Code Sec. 126.

Exclusions from income: Cost-sharing payments: Conservation Reserve Program
Rev.Rul. 2003-59 (PDF), I.R.B. 2003-24, 1014 (June 16, 2003)

The IRS has determined that all or a portion of cost-share payments received under the Conservation Reserve Program (CRP) is eligible for exclusion from gross income to the extent permitted by Code Sec. 126. The CRP is substantially similar to the type of programs described in Code Sec. 126(a)(1) through (8); thus, it falls within the scope of Code Sec. 126(a)(9). However, rental payments and incentive payments made to CRP participants do not qualify as cost-share payments and, therefore, are includible in gross income.
Additional Resources

United States Tax Court
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United States Tax Code
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Small Business Administration (SBA)
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SBA Summary Business Loan Data
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SBA Office of Advocacy: Banking Studies - Small Business Lending in the U.S.
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SBIC Program Financing to Small Business
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