10/24/2017. Farm Expenses. 26 CFR Expenses of Farmers. Ordinary and Necessary

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1 Farm Expenses Kristy Maitre Tax Specialist Center for Agricultural Law and Taxation October 24, CFR Expenses of Farmers Farms engaged in for profit activities A farmer who operates a farm for profit is entitled to deduct from gross income as necessary expenses all amounts actually expended in the carrying on of the business of farming Ordinary and Necessary 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 1

2 Business Expenses In general many of the expenses we will address today will be allowed in other business entities In agriculture, these ordinary and necessary expenses include car and truck expenses, fertilizer, seed, rent, insurance, fuel, and other costs of operating a farm Schedule F itemizes many of these expenses in Part II Those properly deductible expenses not separately listed on the Form are reported on line 32 Form 1040 Schedule F 5 Form 1040 Schedule F 2

3 Expenses Some expenses paid during the tax year may be partly personal and partly business Examples include gasoline, oil, fuel, water, rent, electricity, telephone/cell, vehicle, repairs, insurance, interest and taxes Farmers must allocate expenses between their business and personal Generally, the personal part of these expenses is not deductible Car and Truck Expenses 8 Car and Truck Expenses Farmers, like other business owners, have the option to either: (1) deduct the actual cost of operating a truck or car in their business or (2) deduct the standard mileage rate for each mile of business use Those taxpayers who choose the actual cost method may deduct those expenses related to the business use of the vehicle These include gasoline, oil, repairs, license tags, insurance, and depreciation (subject to certain limits) Farmers choosing this method must keep good records of these expenses 9 3

4 Standard Mileage Rate Instead of using actual costs, under certain conditions taxpayers can use the standard mileage rate The standard mileage rate for each mile of business use is 53.5 cents in 2017 They can use the standard mile age rate for a car or a light truck, such as a van, pickup, or panel truck, they own or lease They cannot use the standard mileage rate if they operate five or more cars or light trucks at the same time The taxpayer is not using five or more vehicles at the same time if they alternate using the vehicles (they use them at different times) for business, Notice Standard Mileage Rate The standard mileage rate cannot be used if the owner has taken a 179 or other depreciation deduction for the vehicle When vehicles are used for both personal and business purposes, the taxpayer may take deductions only for the percentage of use attributable to the business This requires detailed recordkeeping Farmers, however, have a special rule under which they can claim 75% of the use of a car or light truck as business use without any allocation records: Treas. Reg T(b) 11 75% Rule The rule applies if the taxpayer used the vehicle during most of the normal business day directly in connection with the business of farming A farmer chooses this method of substantiating business use the first year the vehicle is placed in service Once that choice is made, it cannot be changed. A farmer who uses his vehicle more than 75% for business purposes should keep records of business use vs. personal use They may then deduct the actual percentage of expenses applicable to the business use 12 4

5 Directly in Connection with the Business of Farming The following are uses directly connected with the business of farming: Cultivating land Raising or harvesting any agricultural or horticultural commodity Raising, shearing, feeding, caring for, training, and managing animals Driving to the feed or supply store Vehicles The PATH Act allows $8,000 in additional first year depreciation for passenger automobiles placed in service in 2016 or 2017 This amount is reduced to $6,400 in 2018 and $4,800 in Depreciation of Vehicles 280F(a) imposes dollar limitations on the depreciation deductions that can be taken on passenger vehicles Passenger vehicles, by definition, weigh 6,000 lbs. gross vehicle weight or less IRS Rev. Proc set the 2017 limits as follows: 15 5

6 IRS Rev. Proc SUV SUVs with a gross vehicle weight rating above 6,000 lbs. are not subject to depreciation limits They are, however, limited to a $25, deduction No depreciation or 179 limits apply to SUVs with a GVW more than 14,000 lbs. Trucks and vans with a GVW rating above 6,000 lbs. but not more than 14,000 lbs. generally have the same limits: no depreciation limitation, but a $25, deduction These vehicles, however, are not subject to the 179 $25,000 limit if any of the following exceptions apply: 17 SUV The vehicle is designed to have a seating capacity of more than nine persons behind the driver's seat The vehicle is equipped with a cargo area at least 6 feet in interior length that is an open area or is designed for use as an open area but is enclosed by a cap and is not readily accessible directly from the passenger compartment or The vehicle has an integral enclosure, fully enclosing the driver compartment and load carrying device, does not have seating behind the driver's seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield 18 6

7 Example John purchased an SUV in February of 2017 for $45,000 as his primary farming vehicle He is able to document 100 percent business use through travel logs The SUV has a GVW of 8,000 lbs. John can expense the SUV as follows in the table John can expense all but $8,500 of the $45,000 purchase in the first year 19 Example Cost SUV $ 45,000 ( 179) $25,000 Result = $20,000 Bonus Depreciation $10,000 Result = $10,000 MACRS Depreciation (five year, 150% DB) $1,500 Adjusted Basis = $8, Example Two Instead of purchasing an SUV, John purchased a long bed pickup truck with a GVW more than 6,000 lbs. Now, John is subject to no 179 deduction limitation, and can immediately expense the entire purchase (assuming he has not used the $510, deduction for other purchases) 21 7

8 Example Three and Four John decides to purchase a light duty pickup truck instead In this case, his entire deduction first year deduction will be limited to $11,160 if he also elects to use bonus depreciation Now suppose John purchases a used light duty pickup truck In this case, because bonus depreciation applies only to new purchases, John s first year deductions are limited to $3, Conservation Issues 23 Conservation Active farmers may be able to deduct the cost of conservation practices implemented as part of an NRCSapproved (or comparable state approved) plan Farmers can elect the 175 soil and water conservation deduction (which is taken in the year the improvements are made) for conservation expenditures in an amount up to 25 % of the farmer s gross income from farming The deduction can only be taken for improvements made on land used for farming 24 8

9 Conservation Excess amounts may be carried forward to future tax years Once the farmer makes this expense election, it is the only method available to claim soil and conservation expenses If the farmer stops farming or dies before the full cost has been deducted, any unused deduction is lost It cannot be capitalized to reduce any gain upon the sale of the farm 25 Conservation Landowners who are not eligible for the deduction must capitalize the expenses (add them to the basis of the property) The 175 deduction is only available to taxpayers engaged in the business of farming 175(a) A taxpayer is engaged in the business of farming if he cultivates, operates, or manages a farm for gain or profit, either as owner or tenant Treas. Reg Conservation A taxpayer who receives a rental (either in cash or in kind) which is based upon farm production is engaged in the business of farming for purposes of the conservation deduction However, a taxpayer who receives a fixed rental (without reference to production) is engaged in the business of farming only if they participate to a material extent in the operation or management of the farm A taxpayer engaged in forestry or the growing of timber is not engaged in the business of farming; nor is a person cultivating or operating a farm for recreation or pleasure rather than a profit 27 9

10 Prepaid Farm Expenses 28 Prepaid Farm Expenses Cash method taxpayers generally can deduct their expenses for the year in which they pay them 461(a); Treas. Reg (a)(1) Some limits to deductions, however, occur with respect to the prepayment of expenses 29 Prepaid Farm Expenses 50% Limit Cash basis farmers are generally allowed to prepay the cost of farm supplies such as feed, seed, and fertilizer by purchasing them in one year, even though they will not use the supplies until the following year This allows farmers to shift deductions to an earlier tax year The amount of the allowable deduction for prepaid expenses is limited by 464 The prepaid farm expenses may not exceed 50% of other deductible farm expenses (including depreciation), unless one of the following exceptions is met: 30 10

11 Prepaid Farm Expenses 50% Limit The prepaid farm supplies expense is more than 50% of the other deductible farm expenses because of a change in business operations caused by unusual circumstances The total prepaid farm supplies expense for the preceding 3 tax years is less than 50% of the total other deductible farm expenses for those 3 tax years To qualify for an exception, the taxpayer must also be farmrelated, meaning that one of the following must apply: Taxpayer s principal residence is on a farm Taxpayer s principal occupation of farming, or Taxpayer is a member of the family of a taxpayer who meets one of the above requirements 31 Prepaid Farm Expenses 50% Limit Note: In Agro Jal Farming Enterprises, Inc. et al. v. Comm., 145 T.C. No. 5 (2015), the Tax Court stated that the 50% limitation applies narrowly to feed, seed, fertilizer, or other similar farm supplies In other words, prepayments for farm supplies falling outside of that category (in the case of Agro Jal, packing materials) may not be subject to that limitation 32 Prepaid Farm Expenses If the prepaid farm supply expenses exceed 50 % of all other expenses (and an exception does not apply), the amount of the expense deduction in excess of 50 percent must be deduced in the later tax year In other words, the excess must be deducted when the supplies are actually used or consumed 33 11

12 Prepaid Farm Expenses Note: Farm syndicates are not allowed to deduct seed, feed, fertilizer or other similar farm supplies until actually used or consumed 464(c)(1) defines farm syndicate as: A partnership or any other enterprise other than a corporation which is not an S corporation engaged in the trade or business of farming, if at any time interests in such partnership or enterprise have been offered for sale in any offering required to be registered with any Federal or State agency having authority to regulate the offering of securities for sale, or A partnership or any other enterprise other than a corporation which is not an S corporation engaged in the trade or business of farming, if more than 35 percent of the losses during any period are allocable to limited partners or limited entrepreneurs 34 Prepaid Farm Expenses The term farming for purposes of 464 means the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity including the raising, shearing, feeding, caring for, training, and management of animals Farming does not include timber 35 Example During 2017, the farmer bought fertilizer ($4,000), feed ($1,000), and seed ($500) for use on the farm in the following year The total prepaid farm supplies expense for 2017 is $5,500 The other deductible farm expenses totaled $10,000 for 2017 Therefore, the deduction for prepaid farm supplies cannot be more than $5,000 (50% of $10,000) for 2017 The excess prepaid farm supplies expense of $500 ($5,500 $5,000) is deductible in a later tax year when used or consumed 12

13 Rev. Proc Some Audit Issues to Think About Rev. Rul , C.B. 210, sets out three tests that must be met in order to deduct the cost of a supply purchased in the current taxable year which will be used in the subsequent taxable year The expense must be a payment for the purchase of supplies, not a deposit The amount is considered a payment if it was made under a binding commitment to accept delivery of a specific quantity at a fixed price, and the farmer is not entitled to a refund or repurchase The prepayment is not merely for tax avoidance, but has a specific business purpose Examples of business benefits are: Fixing maximum prices Securing an assured feed supply Securing preferential treatment in anticipation of shortages Rev. Proc Some Audit Issues to Think About The deduction does not result in a material distortion of income Some factors to consider in determining whether there is a material distortion of income are: The farmer s customary business practices in conducting the farming operation The materiality of the expenditure in relation to the taxpayer s income for the year The time of the year the purchase is made The amount of the expenditure in relation to past purchases 38 Rev. Proc Remember Rev. Rul was written before the passive activity rules of IRC 469 were enacted Consideration of IRC 469 could further limit farming expenses 13

14 Payment for the Purchase of Feed Whether a payment is for the purchase of feed or a deposit depends on the facts and circumstances in each case It is for the purchase of feed if the client can show they made it under a binding commitment to accept delivery of a specific quantity of feed at a fixed price and they are not entitled, by contract or business custom, to a refund or repurchase Payment for the Purchase of Feed The following are some factors that show a payment is a deposit rather than for the purchase of feed: The absence of specific quantity terms The right to a refund of any unapplied payment credit at the end of the contract The seller's treatment of the payment as a deposit The right to substitute other goods or products for those specified in the contract 41 Payment for the Purchase of Feed A provision permitting substitution of ingredients to vary the particular feed mix to meet the livestock's current diet requirements will not suggest a deposit Further, a price adjustment to reflect market value at the date of delivery is not, by itself, proof of a deposit 14

15 Labor Issues 43 Commodity Wages TaxPlace has a presentation covering commodity wages In respecting the time limits of today s presentation the issue will not be discussed As a member of TaxPlace you can view those webinars at any time The issue in itself could extend our webinar by minutes I attached the presentation as a bonus to you material foryourreview Labor Hired Your client can deduct reasonable wages paid for regular farm labor, piecework, contract labor, and other forms of labor hired to work in the farming operations Your client can pay wages in cash or in noncash items such as inventory, capital assets, or assets used in the farming business The cost of boarding farm labor is a deductible labor cost Other deductible costs incurred for farm labor include health insurance, workers' compensation insurance, and other benefits 15

16 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 Depreciation Issues 47 Depreciation and Cost Recovery Farmers are allowed to depreciate assets over a period of years, based upon a recovery period for each type of asset The Modified Accelerated Cost Recovery System (MACRS) is used to recover the basis of most business and investment property placed in service after 1986 MACRS consists of the General Depreciation System (GDS) and the Alternative Depreciation System (ADS) Farming taxpayers use GDS unless they are required to use ADS, most typically because they ve opted out of the uniform capitalization rules 48 16

17 Depreciation and Cost Recovery Farming and ranching property is generally depreciated using the 150 % declining balance method with half year convention (if qualified) 49 Depreciation and Cost Recovery 50 Depreciation and Cost Recovery 51 17

18 Depreciation and Cost Recovery 179 The PATH Act permanently extended and enhanced the 179 deduction for 2015 and beyond For 2017, farmers and small businesses can deduct up to $510,000 of the tax basis of certain business property or equipment placed into service that year Once qualifying purchases reach a threshold of $2,030,000 in 2017, the amount of the deduction is reduced, dollar for dollar for each dollar above the threshold The 179 deduction, as well as the threshold, are indexed for inflation 52 Depreciation and Cost Recovery The 179 deduction applies to both new and used business equipment Because it applies to 15 year property or less, it does not apply to farm buildings, but can be used for single purpose agricultural structures, such as a hog barn In addition to setting a higher deduction amount, the PATH Act also made permanent a provision allowing revocation of the 179 election without IRS consent Once the election is revoked, it cannot again be elected again 53 Additional First Year Depreciation (Bonus Depreciation) The PATH Act also extended 50 % additional first year depreciation, also called bonus depreciation, but only for a time Congress chose to phase out this benefit over a fiveyear period Under this provision, producers can claim an additional first year tax deduction equal to 50 % of the value of qualifying property placed into service during tax years 2015, 2016, and

19 Additional First Year Depreciation (Bonus Depreciation) Congress then reduced the depreciation amount to: 40 % in 2018 and 30 % in 2019 Bonus depreciation is slated to disappear altogether for property placed into service in 2020 or later The bonus depreciation deduction, which is available only for new property, applies to farm buildings, in addition to equipment 55 Additional First Year Depreciation (Bonus Depreciation) Unlike the 179 expense allowance, there is no limit on the overall amount of bonus depreciation that a producer may claim If an item of property qualifies for both 179 expensing and bonus depreciation, the 179 expensing amount is computed first, and then bonus depreciation is taken based on the item s remaining income tax basis It is also important to note that 179 expensing is based on when the taxpayer s tax year begins, whereas bonus depreciation is tied to the calendar year 56 Additional First Year Depreciation (Bonus Depreciation) Trees and Vines The PATH Act also provided a special election to farmers who plant trees or vines that bear fruits or nuts They may choose to deduct 50 % of the cost of planting those trees or vines in the year of planting This rule applies to both farmers who have elected out of the Uniform Capitalization Rules (UNICAP) and those who have not Without this special provision, bonus depreciation was not available to farmers who have elected out of UNICAP 57 19

20 Additional First Year Depreciation (Bonus Depreciation) Trees and Vines Likewise, without this special provision, all tree and vine farmers are required to capitalize planting costs, rather than deduct them This special provision is only in place through 2019 Like other bonus depreciation provisions, it is phasedout for property placed into service after Other Expenses 59 Fertilizer and Lime Under 180, taxpayers engaged in the business of farming may elect to immediately expense the cost of fertilizer and lime (where the benefits last substantially more than one year), rather than to capitalize the expense and depreciate it over the term of its useful life The election is for one year only, but once such an election is made, it may not be revoked without the consent of the IRS This provision applies both to tenants and landlords if the rent is based upon production Cash rent landlords who do not materially participate in the farming operation may not take advantage of this tax benefit 60 20

21 Fertilizer and Lime It is also important to note that this deduction applies only to land used in farming, which is defined as land used by the taxpayer or his tenant for the production of crops, fruits, or other agricultural products or for the sustenance of livestock Initial land preparation costs cannot be deducted Note that the amount of the fertilizer and lime deduction may be limited by the rule that restricts deductions for prepaid farm supplies to 50 percent of all other deductible farm expenses for the year 61 Fertilizer and Lime If the farmer later sells the farmland for which the cost of the fertilizer or lime has been deducted, they must report the amount of the sales price attributable to the unused fertilizer or lime as ordinary income 62 Interest Taxpayers can deduct as a farm business expense interest paid on farm mortgages and other obligations incurred in the farm business Cash method If they use the cash method of accounting, they can generally deduct interest paid during the tax year They cannot deduct interest paid with funds received from the original lender through another loan, advance, or other arrangement similar to a loan They can, however, deduct the interest when they start making payments on the new loan Prepaid interest Under the cash method, they generally cannot deduct any interest paid before the year it is due Interest paid in advance may be deducted only in the tax year in which it is due 21

22 Interest Accrual method If the client uses the accrual method of accounting, they can deduct only interest that has accrued during the tax year However, they cannot deduct interest owed to a related person who uses the cash method until payment is made and the interest is includible in the gross income of that person Allocation of Interest If the client uses the proceeds of a loan for more than one purpose, they must allocate the interest on that loan to each use Allocate the interest to the following categories: Trade or business interest Passive activity interest Investment interest Portfolio interest Personal interest Breeding Fees The client can deduct breeding fees as a farm business expense However, if they use an accrual method of accounting, they must capitalize breeding fees and allocate them to the cost basis of the calf, foal, etc. 22

23 Taxes The client can deduct as a farm business expense the real estate and personal property taxes on farm business assets, such as farm equipment, animals, farmland, and farm buildings They also can deduct the social security and Medicare taxes they pay to match the amount withheld from the wages of farm employees and any federal unemployment tax they pay Allocation of Taxes The taxes on the part of the farm used as a home (including the furnishings and surrounding land not used for farming) are nonbusiness taxes They may be able to deduct these nonbusiness taxes as itemized deductions on Schedule A (Form 1040) To determine the nonbusiness part, allocate the taxes between the farm assets and nonbusiness assets The allocation can be done from the assessed valuations If the tax statement does not show the assessed valuations, check with the tax assessor office State and Local General Sales Taxes State and local general sales taxes on non depreciable farm business expense items are deductible as part of the cost of those items Include state and local general sales taxes imposed on the purchase of assets for use in the farm business as part of the cost the client can depreciate Also treat the taxes as part of the cost if they are imposed on the seller and passed on to the farmer 23

24 State and Federal Income Taxes Individuals cannot deduct state and federal income taxes as farm business expenses Individuals can deduct state and local income taxes only as an itemized deduction on Schedule A (Form 1040) However, they cannot deduct federal income tax Highway Use Tax The client can deduct the federal use tax on highway motor vehicles paid on a truck or truck tractor used in the farm business Form 2290, Heavy Highway Vehicle Use Tax Return Insurance Generally a client can deduct the ordinary and necessary cost of insurance for the farm business as a business expense This includes premiums paid for the following types of insurance Fire, storm, crop, theft, liability, and other insurance on farm business assets Health and accident insurance on farm employees Workers' compensation insurance set by state law that covers any claims for job related bodily injuries or diseases suffered by employees on the farm, regardless of fault Business interruption insurance State unemployment insurance on farm employees (deductible as taxes if they are considered taxes under state law) 24

25 Insurance to Secure a Loan If the client takes out a policy on their life or on the life of another person with a financial interest in the farm business to get or protect a business loan, the premium cannot be deducted as a business expense In the event of death, the proceeds of the policy are not taxed as income even if they are used to liquidate the debt Business Interruption Insurance Use and occupancy and business interruption insurance premiums are deductible as a business expense This insurance pays for lost profits if the business is shut down due to a fire or other cause Report any proceeds in full on Schedule F Part 1 as income Self Employed Health Insurance Deduction If the client is self employed, they can deduct as an adjustment to income on Form 1040 the payments for medical, dental, and qualified long term care insurance coverage for themselves, their spouse, and dependents when figuring the adjusted gross income on the Form 1040 Effective March 30, 2010, the insurance can also cover any child of yours under age 27 at the end of 2017, even if the child was not a dependent Generally, this deduction cannot be more than the net profit from the business under which the plan was established 25

26 Rent and Leasing If the client leases property for use in the farm business, they can generally deduct the rent paid on Schedule F However, they cannot deduct rent paid in crop shares if they deduct the cost of raising the crops as farm expenses Advance Payments Deduct advance payments of rent only in the year to which they apply, regardless of the accounting method Farm Home If the client rents a farm, do not deduct the part of the rental expense that represents the fair rental value of the farm home in which they live 26

27 Other Expenses The following list, while not all inclusive, shows some expenses that can be deducted as other farm expenses on Schedule F, Part II These expenses must be for business purposes and (1) Paid, if the taxpayer uses the cash method of accounting or (2) Incurred, if using the accrual method of accounting Other Expenses Accounting fees Advertising Business travel and meals Commissions Consultant fees Crop scouting expenses Dues to cooperatives Educational expenses (to maintain and improve farming skills) Farm related attorney fees 80 Other Expenses Farm magazines Ginning Insect sprays and dusts Litter and bedding Livestock fees Marketing fees Milk assessment 27

28 Other Expenses Recordkeeping expenses Service charges Small tools expected to last one year or less Stamps and stationery Subscriptions to professional, technical, and trade journals that deal with farming Tying material and containers 82 Tax Preparation Fees The client can deduct as a farm business expense on Schedule F the cost of preparing that part of the tax return relating to the farm business They may be able to deduct the remaining cost on Schedule A (Form 1040) if they itemize their deductions They also can deduct on Schedule F the amount they pay or incur in resolving tax issues relating to the farm business Supplies / Repairs and Maintenance Farmers may generally deduct the cost of materials and supplies in the year in which they are purchased Treas. Reg ; Treas. Reg This would include deducting the cost of fuel, tools, and feed Farmers may also generally deduct most expenses incurred for the repair and maintenance of their farm property This would include deducting expenses for activities such as repairing the roof of a farm building or painting a fence 84 28

29 Supplies / Repairs and Maintenance Expenditures that substantially prolong the life of property, increase its value, or adapt it to a different use, however, must generally be capitalized, not deducted Distinguishing capital expenditures from supplies, repairs, maintenance, and other deductible business expenses is sometimes a difficult process 85 Seeds and Plants Farmers may generally deduct the cost of seeds and plants used to produce a crop for sale This deduction is taken on line 26 of Schedule F This rule does not apply to plants with a pre productive period of more than two years (i.e. trees and vines) Costs for these types of plants must generally be capitalized, not deducted as an ordinary business expense 86 Lease Issues 87 29

30 Lease or Purchase If the client leases a farm building or equipment, they must determine whether or not the agreement must be treated as a conditional sales contract rather than a lease If the agreement is treated as a conditional sales contract, the payments under the agreement (so far as they do not represent interest or other charges) are payments for the purchase of the property Do not deduct these payments as rent, but capitalize the cost of the property and recover this cost through depreciation Conditional Sales Contract Whether an agreement is a conditional sales contract depends on the intent of the parties Determine intent based on the provisions of the agreement and the facts and circumstances that exist when the agreement is made No single test, or special combination of tests, always applies However, in general, an agreement may be considered a conditional sales contract rather than a lease if any of the following is true Conditions The agreement applies part of each payment toward an equity interest the client will receive They get title to the property after they make a stated amount of required payments The amount they must pay to use the property for a short time is a large part of the amount they would pay to get title to the property They pay much more than the current fair rental value of the property 30

31 Conditions The client has the option to buy the property at a nominal price compared to the value of the property when they may exercise the option Determine this value when they make the agreement They have an option to buy the property at a nominal price compared to the total amount they have to pay under the agreement The agreement designates part of the payments as interest, or part of the payments can be easily recognized as interest 91 Example The client leases new farm equipment from a dealer who both sells and leases The agreement includes an option to purchase the equipment for a specified price The lease payments and the specified option price equal the sales price of the equipment plus interest Example Under the agreement, the client is responsible for maintenance, repairs, and the risk of loss For federal income tax purposes, the agreement is a conditional sales contract They cannot deduct any of the lease payments as rent They can deduct interest, repairs, insurance, depreciation, and other expenses related to the equipment 93 31

32 Motor Vehicle Leases Special rules apply to lease agreements that have a terminal rental adjustment clause In general, this is a clause that provides for a rental price adjustment based on the amount the lessor is able to sell the vehicle for at the end of the lease If the rental agreement contains a terminal rental adjustment clause, treat the agreement as a lease if the agreement otherwise qualifies as a lease 7701(h) Leveraged Leases Special rules apply to leveraged leases of equipment (arrangements in which the equipment is financed by a nonrecourse loan from a third party) Revenue Procedure Telephone, Travel, Meals and Recordkeeping 32

33 Telephone Expense The client cannot deduct the cost of basic local telephone service (including any taxes) for the first telephone line they have in the home, even if they have an office in the home However, charges for business long distance phone calls on that line, as well as the cost of a second line into the home used exclusively for the farm business, are deductible business expenses Cell phone charges for calls relating to the farm business are deductible If the cell phone they use for the farm business is part of a family cell phone plan, an allocation must be made to deduct only the portion of the charges attributable to farm business Travel Expenses Farmers can deduct ordinary and necessary expenses they incur while traveling away from home for the farm business They cannot deduct lavish or extravagant expenses Usually, the location of the farm business is considered the home for tax purposes A farmer is traveling away from home if: Their duties require them to be absent from the farm substantially longer than an ordinary work day, and They need to get sleep or rest to meet the demands of work while away from home Travel Expenses If the taxpayer meets these requirements and can prove the time, place, and business purpose of the travel, they can deduct ordinary and necessary travel expenses The following are some types of deductible travel expenses Air, rail, bus, and car transportation Meals and lodging Dry cleaning and laundry Telephone and fax Transportation between your hotel and your temporary work or business meeting location and Tips for any of the above expenses 33

34 Meals A taxpayer ordinarily can deduct only 50% of their business related meals expenses They can deduct the cost of their meals while traveling on business only if the business trip is overnight or long enough to require them to stop for sleep or rest to properly perform their duties They cannot deduct any of the cost of meals if it is not necessary for them to rest, unless you meet the rules for business entertainment Meals The expense of a meal includes amounts spent for their food, beverages, taxes, and tips related to the meal They can deduct either 50% of the actual cost or 50% of a standard meal allowance that covers they daily meal and incidental expenses 101 Recordkeeping Requirements The client must be able to prove their deductions for travel by adequate records or other evidence that will support their own statement Estimates or approximations do not qualify as proof of an expense They should keep an account book or similar record, supported by adequate documentary evidence, such as receipts, that together support each element of an expense 34

35 Recordkeeping Requirements Generally, it is best to record the expense and get documentation of it at the time it is paid If they elect to deduct a standard meal allowance rather than the actual expense, they do not have to keep records to prove amounts spent for meals and incidental items However, they must still keep records to prove the actual amount of other travel expenses, and the time, place, and business purpose of the travel 103 Reimbursements to Employees The client can generally deduct reimbursements paid to employees for travel and transportation expenses they incur in the conduct of the business Employees may be reimbursed under an accountable or non accountable plan Under an accountable plan, the employee must provide evidence of expenses Under a non accountable plan, no evidence of expenses is required If the client reimburses expenses under an accountable plan, deduct them as travel and transportation expenses If they reimburse expenses under a non accountable plan, they must report the reimbursements as wages on Form W2 and deduct them as wages Tenant House Expenses The client can deduct the costs of maintaining houses and their furnishings for tenants or hired help as farm business expenses These costs include repairs, utilities, insurance, and depreciation The value of a dwelling furnished to a tenant under the usual tenant farmer arrangement is not taxable income to the tenant 35

36 The Scoop Upcoming Dates November 1, 2017 December 13, 2017 Held at 8:00 am and 12:00 pm Central time 106 Up Coming Webinars node field seminardate/month Farm Income October 26, 2017 Ethics Part 1 and Part 2 November 13 Ethics Part 1 and Part 2 November 13, 2017 Ethics Part 1 and Part 2 November 14, 2017 Ethics Part 1 and Part 2 December 15, 2017 Ethics Part 1 and Part 2 December 18, 2017 Ethics Part 1 and Part 2 December 19, The Schedule is Finalized for the 44th Annual Federal Income Tax Schools November 2 3, 2017 Maquoketa, Iowa Centerstone Inn and Suites November 6 7, 2017 Le Mars, Iowa Le Mars Convention Center November 8 9, 2017 Atlantic, Iowa Cass County Community Center November 9 10, 2017 Mason City, Iowa North Iowa Area Community College November 16 17, 2017 Ottumwa, Iowa Indian Hills Community College November 20 21, 2017 Waterloo, Iowa Hawkeye Community College December 11 12, 2017 Ames, Iowa and Live Webinar Quality Inn and Suites 36

37 The CALT Staff William Edwards Interim Director for the Beginning Farmer Center Interim Director for the Center for Agricultural Law and Taxation Heady 518 Farm House Ln Ames. Iowa Kristine A. Tidgren Assistant Director E mail: ktidgren@iastate.edu Phone: (515) Fax: (515) The CALT Staff Kristy S. Maitre Tax Specialist E mail: ksmaitre@iastate.edu Phone: (515) Fax: (515) Tiffany L. Kayser Program Administrator E mail: tlkayser@iastate.edu Phone: (515) Fax: (515) Backemeyer v. Commissioner, 147 T.C. No. 17 (Dec. 8, 2016), The tax court explored the interplay between prepaid expenses and the step up in basis A farmer prepaid input expenses for the following crop year before he passed away His wife inherited his property, including the seed, fertilizer, and herbicides, with a stepped up basis The IRS argued that the wife could not again deduct the cost of those inputs when she used them to plant a crop The IRS argued that the tax benefit rule would require recapture of the earlier deduction

38 Backemeyer v. Commissioner, 147 T.C. No. 17 (Dec. 8, 2016), The Tax Court disagreed, finding that the estate tax effectively recaptures 162 deductions by way of its normal operation, obviating any need to separately apply the tax benefit rule Even though this farmer s estate did not owe any estate tax, the fair market value of the inputs was considered for purposes of determining whether such liability existed Recapturing the deduction could effectively result in a double taxation of the value of the farm input 112 De Minimis Safe Harbor under Tangible Property Regulations 113 De Minimis Safe Harbor under Tangible Property Regulations IRS issued the Tangible Property Regulations (T.D. 9636), effective January 1, 2014, to distinguish capital expenditures from supplies, repairs, maintenance, and other deductible business expenses Treas. Reg (a) 1 also provides taxpayers with an option to elect to apply a de minimis safe harbor to amounts paid to acquire or produce tangible property If this election is made, the taxpayer need not determine whether every small dollar expenditure for the acquisition of property is properly deductible or capitalized under the complex acquisition and improvement rules of the regulations

39 De Minimis Safe Harbor under Tangible Property Regulations Instead, the taxpayer must deduct every purchase up to the amount of the safe harbor elected For taxpayers without an applicable financial statement, the safe harbor amount in 2017 is $2,500 If the taxpayer has an accounting procedure in place to expense such amounts, he or she can make the annual election This election is not an accounting method change, but is made by attaching a statement to a timely filed original return 115 De Minimis Safe Harbor under Tangible Property Regulations Once made for a particular tax year, every purchase of tangible property falling within the range of the election must be expensed A taxpayer cannot choose to apply the safe harbor to some items and not to other When a taxpayer elects the de minimis safe harbor, the amount paid is not treated as a capital expenditure, as a repair, or as materials and supplies Instead, the taxpayer deducts the amount of the purchase under Treas. Reg , provided that the expense otherwise constitutes an ordinary and necessary business expense 116 De Minimis Safe Harbor under Tangible Property Regulations If the items to be deducted don t fit into an expense category included on Schedule F, they can be listed on line 32 as other expenses Generally, a taxpayer may not file an amended return to either make or revoke the election for the de minimis safe harbor It is important to note that if a taxpayer later sells property expensed under the safe harbor at a gain, the taxpayer must pay ordinary income tax on the entire sale price

40 De Minimis Safe Harbor under Tangible Property Regulations This is not considered IRC 1221 or 1231property These sales would be reported on Form 4797 (Part II) (Sales of Business Property) If the property was not held for sale in the ordinary course or inventory, the gain should not be subject to self employment tax