10/26/2017. Farm Income. Introduction. Defining Farming

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1 Farm Income Kristy Maitre Tax Specialist Materials Complied by Kristine Tidgren Center for Agricultural Law and Taxation October 26, 2017 Introduction Preparing tax returns for farmers and ranchers requires specialized knowledge of tax rules and provisions that apply only to those in the business of farming Individuals, partnerships, and trusts and estates generally report farm income and expenses on Form 1040, Schedule F Taxpayers use this form to calculate net gain or loss from farming Gains or losses from the sale of farm assets are reported on Form 4797 Whether income is farm income depends upon the operations being conducted and the activities of the person conducting it Different definitions of farming apply to different tax provisions 2 Defining Farming For tax purposes generally, all individuals, partnerships, or corporations that cultivate, operate, or manage farms for gain or profit, either as owners or tenants, are farmers Treas. Reg (d), Income derived from these activities is farm income reported on Schedule F The term farm embraces the farm in the ordinarily accepted sense, and includes stock, dairy, poultry, fruit, truck farms, plantations, ranches, and all land used for farming operations 3 1

2 Introduction Farm entities enjoy many unique benefits under the Internal Revenue Code These advantages provide numerous opportunities for valid income deferral We will cover a select few today IRS Farmers Audit Technique Guide (ATG) is also a valuable tool to assist not only in preparing the tax return, but audit issues and questions that arise in a farm audit Cultivate, Operate, or Manage a Farm as an Owner or Tenant Courts have long reasoned that cultivating, operating, or managing a farm for profit means that the owner or tenant must: (1) Participate to a significant degree in the farming process and (2) Bear a substantial risk of loss in the process See, e.g. Duggar v. Commissioner, 71 T.C. 147 (1978) 5 Cultivate, Operate, or Manage a Farm as an Owner or Tenant Under this definition, a person who operates a feedlot for profit would be considered a farmer, but a supplier of fertilizer would not Although the supplier engages in the activity for a profit and bears a substantial risk of loss, he does not cultivate, operate, or manage a farm for profit as an owner or tenant He is, instead, in the business of merchandising or sales 6 2

3 Example One John provides custom planting services to farmers throughout his region He owns his own equipment and hires employees to assist him John does not own or rent a farm His only purpose for owning the equipment is to provide custom planting services John is paid on a per acre basis for his services Is John a farmer for tax purposes? 7 Example One Cont d Answer: Although John is engaged in farming related activities, he is not a farmer for tax purposes and will not report his income on Schedule F John is not raising or growing the crop, nor does he own or lease the land on which he plants the seed John is providing the service of planting He will report his income and expenses on Schedule C. Note that if John owned or leased a farm on which he conducted farming activities, incidental custom planting work for others would be considered part of his farming operation, and he could report his income from the custom work on Schedule F 8 Profit/Intent to Profit 9 3

4 For Profit Individuals, partnerships, estates, trusts, and S corporations must operate a farm for profit or monetary gain to qualify as a farmer for tax purposes A taxpayer conducts an activity for profit if he or she does so with an actual and honest profit objective Only farmers report income and expenses on Schedule F Those taxpayers engaged in hobby farming are not engaged in the activity for purposes of earning a profit and are thus not farmers for income tax purposes 10 For Profit Hobby farming includes activities engaged in primarily for sport or recreation Such individuals report their income from these hobby activities on Form 1040, line 21 Taxpayers can only deduct the expenses of carrying on hobby activities if they itemize deductions on Form 1040, Schedule A 11 Hobby Farming Deductions for hobby related expenses may not offset income from other activities In deciding whether a taxpayer has operated a farm for a profit, courts consider the following nonexclusive factors: (1) The manner in which the taxpayer carried on the activity (2) The expertise of the taxpayer or his or her advisers (3) The time and effort expended by the taxpayer in carrying on the activity (4) The expectation that the assets used in the activity may appreciate in value 12 4

5 Hobby Farming (5) The success of the taxpayer in carrying on other similar or dissimilar activities (6) The taxpayer's history of income or loss with respect to the activity (7) The amount of occasional profits, if any, which are earned (8) The financial status of the taxpayer and (9) Whether elements of personal pleasure or recreation are involved. Treas. Reg (b) 13 Schedule F Income Amounts received from the sales of products the client raised on the farm for sale (or bought for resale), such as livestock, produce, or grains This includes money and the fair market value of any property or services they received When they sell farm products bought for resale, the profit or loss is the difference between the selling price and the basis in the item Example In 2017, the client bought 20 feeder calves for $27,000 for resale They sold them in 2017 for $35,000 Report the $35,000 sales price on Schedule F, line 1a, subtract the $27,000 basis on line 1b, and report the resulting $8,000 profit on line 1c Sales of Farm Products Raised Income from the sale of farm products raised and sold by a farmer is reported on Line 2 of Schedule F This includes income from the sale of grains, vegetables, fruit, bedding plants, milk, calves, raised market livestock, eggs, and hay Note that crop share (or livestock share) rental income for a materially participating farmer is also reported on Line 2 of Part 1 of Schedule F It is not reportable as income until reduced to cash or cash equivalent 15 5

6 Sales of Farm Products Purchased for Resale Income from the sales of livestock or other items purchased for resale is reported on Line 1a of Part I of Schedule F The cost (or basis) of the livestock is reported on Line 1b and subtracted from the sales price to arrive at gross income, reported on Line 1c Note that the costs of livestock purchased for resale aren t deductible in the year of purchase unless the purchase and sale occur in the same year 16 Income Deferral and Constructive Receipt Farming entities under certain circumstances are allowed to deduct the expenses of growing and harvesting crops while deferring income to later years When a farmer grows and sells his crops in one year and receives payment for the crops in the subsequent year, there is a potential income deferral and constructive receipt issue Easements 18 6

7 Easements and Rights of Way Income received for granting easements or rightsof way on the farm or ranch for flooding land, laying pipelines, constructing electric or telephone lines, etc., may result in income, a reduction in the basis of all or part of the farmland, or both Easements and Rights of Way The taxpayer granted a permanent right of way for a gas pipeline through their property for $10,000 Only a specific part of the farmland was affected The taxpayer reserves the right to continue farming the surface land after the pipe is laid Treat the payment for the right of way in one of the following ways: 20 Easement Payment Treatments If the payment is less than the basis properly allocated to the part of the land affected by the right of way, reduce the basis by $10,000 If the payment is equal to or more than the basis of the affected part of the land, reduce the basis to zero and the rest, if any, is gain from a sale The gain is reported on Form 4797 and is treated as 1231 gain if the taxpayer held the land for more than 1 year 21 7

8 Easements and Rights of Way Easement contracts usually describe the affected land using square feet The basis may be figured per acre One acre equals 43,560 square feet If construction of the pipeline damaged growing crops and the taxpayer later receives a settlement of $250 for the damage, the $250 is income and is included on Schedule F, Line 8 It doesn't affect the basis of the land 22 Easement Issues Wind Farms and Pipelines Many farmers have conveyed easements for wind farms, pipelines, or other projects Some have had the easements taken through eminent domain Permanent and 30 year easements are treated for tax purposes like a sale of the property The landowner reduces his or her basis in the property in the amount of the purchase price of the easement Any amount below zero would be IRC 1231 gain reported on Form Easement Issues Wind Farms and Pipelines It is taxed at long term capital gains rates as long as the property was owned for more than one year Easement payments offered for easements in place less than 30 years are taxed as ordinary income Easement payments are not subject to self employment tax The IRS does require owners to conduct a basis allocation when calculating the tax treatment for the easement In other words, if the easement does not impact an entire tract, the landowner may only reduce the basis of the portion of the tract impact 24 8

9 Easement Issues Wind Farms and Pipelines It should be noted that easements granted for 30 years or more can qualify for like kind exchange treatment under IRC 1031 Similarly, an easement taken through eminent domain proceedings will generally qualify for exchange treatment under IRC Easement Issues Wind Farms and Pipelines Unharvested crops on the property at the time the easement is granted receive IRC 1231 treatment, as long as the underlying property qualifies (i.e. held for more than one year) If the owner is a materially participating farmer, crop damages for future crops are reported on Schedule F as ordinary income Payments made to compensate owners for the temporary use of land during construction are rental payments reported on Schedule E 26 Conservation Easements Farmers and ranchers who donate qualified conservation easements are eligible to deduct from their income the value of the easement in an amount up to 100 percent of their contribution base, which is generally their adjusted gross income A person is a qualified farmer or rancher for this purpose if his or her gross income from farming is more than 50 % of gross income for the year For amounts that cannot be deducted in the year of the donation, a 15 year carryover period applies 27 9

10 Conservation Easements To recognize the tax benefit, a donated conservation easement must be a legally binding, permanent restriction on the use, modification, and development of the property As such, the land use restrictions will bind all current and future owners 28 Qualified Conservation Contribution A qualified conservation contribution is a donation of a: (1) qualified real property interest to a (2) qualified organization (3) exclusively for conservation purposes 29 Qualified Real Property Interest A qualified real property interest is one granting a restriction on the use of real property granted in perpetuity A qualified organization is defined by regulation as a governmental or charitable organization committed to protecting the conservation purposes of the donation 30 10

11 Easements with a Conservation Purpose include Easements that: Preserve land areas for outdoor recreation by, or the education of, the general public Protect a relatively natural habitat of fish, wildlife, or plants, or similar ecosystem Preserve open space (including farmland and forest land) for a public benefit, including those donated for a use consistent with public programs to protect water supplies or maintain or enhance water quality Preserve of a historically important land area or a certified historic structure 31 Agricultural Program Payments 32 Agricultural Program Payments Income Sources from Government Agencies There are many governmental programs which provide benefits to farmers Many of these program payments are taxable to the farmers as income The United States Department of Agriculture (USDA) is responsible for implementing the farm programs legislated by Congress 11

12 Agricultural Program Payments Government payments made to farmers under agricultural programs such as: Agricultural risk coverage (ARC) Price loss coverage (PLC), Approved conservation practices Livestock indemnity payments, or Livestock forage disaster payments are reported to the IRS and to the farmer on Form 1099 G These payments are reported by the taxpayer on Schedule F, Line 4a 34 Commodity Credit Corporation (CCC) Commodity Credit Corporation (CCC) is the source of the majority of the payments made to farmers CCC makes: Loans Price support payments Storage payments and Other payments that may be taxable when received, in a later year, or not at all IRC 77 Commodity Credit Loans Election to include loans in income Amounts received as loans from the Commodity Credit Corporation shall, at the election of the taxpayer, be considered as income and shall be included in gross income for the taxable year in which received Effect of election on adjustments for subsequent years If a taxpayer exercises the election, then the method of computing income must be consistant with respect to all subsequent taxable years unless with the approval of the Secretary a change to a different method is authorized 12

13 Commodity Credit Loans While loans are not typically included as income, 77 allows farmers to elect to treat Commodity Credit Corporation (CCC) loans as income if the farmer has used a commodity as collateral for the loan If such an election is made, the farmer includes the amount of the loan in his or her gross income for the taxable year in which the proceeds of the loan were received This income is reported on Line 5a of Schedule F (Form 1040) 37 Commodity Credit Loans The election is made by attaching a statement showing the details of the loan to a timely filed return If they timely filed the return for the year without making the election, they can still make the election by filing an amended return within 6 months of the due date of the return (excluding extensions) The election applies to all subsequent returns, unless revoked To revoke the election, the taxpayer files a Form 3115 with his or her return requesting a Change of Accounting Method IRS consent is automatic 38 Commodity Credit Corporation (CCC) Loans Attach the statement to the amended return and write Filed pursuant to at the top of the return File the amended return at the same address where the original return was filed When the client makes this election, the amount reported as income becomes the basis in the commodity If they did not report the loan proceeds as income for the year they received them, they must include them in their income in the year of the forfeiture 13

14 Election Impacts Treatment If the election is made to treat CCC loans as income, and the farmer forfeits the crop to CCC, any extra amount received by the CCC on sale of the commodity is income to the taxpayer in the year of receipt (Treas. Reg (a)(1)) The excess sales price over the amount previously reported in income is taxable as ordinary income (Rev. Rul , C. B. 185) Election Impacts Treatment A taxpayer can use cash to repay the loan, purchase CCC Certificates for use in repayment or deliver the pledged collateral as full payment for the loan at maturity 41 Commodity Credit Corporation (CCC) Loans The client can request income tax withholding from CCC loan payments they receive Form W 4V, Voluntary Withholding Request Attach a statement to the return showing the details of the loan 14

15 Form 1099 A If the client forfeits pledged crops to the CCC in full payment of a loan, they may receive a Form 1099 A, Acquisition or Abandonment of Secured Property CCC should be shown in Box 6 The amount of any CCC loan outstanding when they forfeited the commodity should also be indicated on the form Market Gain Under the CCC nonrecourse marketing assistance loan program, the client s repayment amount for a loan secured by their pledge of an eligible commodity is generally based on the lower of the loan rate or the prevailing world market price for the commodity on the date of repayment If they repay the loan when the world price is lower, the difference between that repayment amount and the original loan amount is market gain Market Gain Whether they use cash or CCC certificates to repay the loan, they will receive a Form 1099 G showing the market gain realized Market gain should be reported as follows: If they elected to include the CCC loan in income in the year they received it, do not include the market gain in income However, adjust the basis of the commodity for the amount of the market gain If they did not include the CCC loan in income in the year received, include the market gain in their income Notice addresses gain issues 45 15

16 Example Mike Green Mike Green is a cotton farmer He uses the cash method of accounting and files his tax return on a calendar year basis He has deducted all expenses incurred in producing the cotton and has a zero basis in the commodity In 2015, Mike pledged 1,000 pounds of cotton as collateral for a CCC loan of $2,000 (a loan rate of $2.00 per pound) In 2016, he repaid the loan and redeemed the cotton for $1,500 when the world price was $1.50 per pound (lower than the loan amount) Later in 2016, he sold the cotton for $2,500 Example Mike Green The market gain on the redemption was $.50 ($2.00 $1.50) per pound Mike realized total market gain of $500 ($.50 x 1,000 pounds) How he reports this market gain and figures his gain or loss from the sale of the cotton depends on whether he included CCC loans in income in Included CCC Loan Mike reported the $2,000 CCC loan as income for 2015 on Schedule F, Line 5a, so he is treated as if he sold the cotton for $2,000 when he pledged it and repurchased the cotton for $1,500 when he redeemed it The $500 market gain isn t recognized on the redemption He reports it for 2016 as an agricultural program payment on Schedule F, Line 4a, but doesn't include it as a taxable amount on Line 4b 16

17 Schedule F Line 4 49 Included CCC Loan Mike's basis in the cotton after he redeemed it was $1,500, which is the redemption (repurchase) price paid for the cotton His gain from the sale is $1,000 ($2,500 $1,500) He reports the $2,500 sale on Line 1a and the $1,500 basis on Line 1b After subtracting his basis from the sale, Mike will have a $1,000 gain for 2016 on Schedule F, Line 1c 50 Excluded CCC Loan Mike has income of $500 from market gain in 2016 He reports it on Schedule F, Lines 4a and 4b His basis in the cotton is zero, and his gain from its sale is $2,500 He reports the $2,500 sale on Schedule F, Line 1a, and a zero basis on Line 1b 17

18 Form 4797 Sales of livestock held for draft, breeding, sport, or dairy purposes may result in ordinary or capital gains or losses, depending on the circumstances In either case, the client should always report these sales on Form 4797 instead of Schedule F Animals the client does not hold primarily for sale are considered business assets of the farm Where To Report Sales of Farm Products Sale by Agent If an agent sells the farm products, the client has constructive receipt of the income when the agent receives payment and the client must include the net proceeds from the sale in gross income for the year This applies even if the agent pays in a later year 18

19 Crop Insurance 55 Crop Insurance Farmers can elect to postpone reporting some or all crop insurance income until the year following receipt of the income if the following conditions are met: The farmer uses the cash method of accounting The farmers receives the crop insurance proceeds in the same tax year the crops are damaged The farmer can show that under normal business practice he or she would have included income from the damaged crops in any tax year following the year the damage occurred. 56 Crop Insurance To make this election, the taxpayer reports the amount of the crop insurance proceeds on Line 6a of Schedule F but does not include the amount as taxable income on Line 6b The taxpayer then checks the box on Line 6c and attaches a statement including the following: Name and address of the taxpayer farmer A statement that the farmer is making an election under 451(d) and Treas. Reg The specific crop or crops physically destroyed or damaged 57 19

20 Crop Insurance Statement Requirements Cont d A statement that under normal business practice the farmer would have included income from some or all of the destroyed or damaged crops in gross income for a tax year following the year the crops were destroyed or damaged The cause of the physical destruction or damage and the date or dates it occurred The total payments received from insurance carriers, itemized for each specific crop, and the date each payment was received The name of each insurance carrier from whom payments were received An election is binding for the year unless the IRS approves a request to change it Deferral is not allowed for proceeds received from revenue insurance policies payments for the inability to plant crops 58 Feed Assistance and Payments The Disaster Assistance Act of 1988 authorizes programs to provide: Feed assistance Reimbursement payments, and Other benefits to qualifying livestock producers if the Secretary of Agriculture determines that, because of a natural disaster, a livestock emergency exists These programs include partial reimbursement for the cost of purchased feed and for certain transportation expenses They also include the donation or sale at a below market price of feed owned by the Commodity Credit Corporation Feed Assistance and Payments Include in income: The market value of donated feed The difference between the market value and the price paid for feed bought at below market prices, and Any cost reimbursement received The client must include these benefits in income in the year they receive them They cannot postpone reporting them under the rules for weatherrelated sales of livestock or crop insurance proceeds Report the benefits on Schedule F, Part I, as agricultural program payments They can usually take a current deduction for the same amount as a feed expense 20

21 Conservation Reserve Program Payments 61 Conservation Reserve Program Payments Payments received under the Conservation Reserve Program are generally reported as income on Line 4b of Schedule F This income is usually subject to self employment tax In 2008, Congress specifically provided that taxpayers receiving old age or survivor s benefits or disability benefits are exempt from paying self employment tax on their CRP payments Consequently, farmers or non farmers who receive social security or disability benefits do not pay self employment tax on that income 62 Conservation Reserve Program Payments Additionally, in 2014, the United States Court of Appeals for the Eighth Circuit ruled that CRP payments made to a nonfarmer (someone not materially participating in a farming activity) were not subject to self employment tax Morehouse v. Commissioner, 769 F.3d 616 (8th Cir. 2014), rev'g 140 T.C. 350 (2013) In 2015, IRS declared that it would only follow the 8th Circuit s ruling for cases where the payments were made to a person not engaged in farming and were paid prior to January 1, 2008 October 13, 2015, Action on Decision, IRB

22 Conservation Reserve Program Payments Note that Morehouse, should provide a non farmer receiving CRP payments in the 8th Circuit (which includes Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota) with substantial authority for taking the position that no self employment tax is due on that income A taxpayer taking this position would report the payment on Schedule E as rental income IRS has stated that it will challenge this position if discovered, but if substantial authority is found, the taxpayer is exempt from an underpayment penalty, even if the IRS were to prevail in a challenge 64 Conservation Reserve Program Payments Social security or disability recipients should report CRP payments on the Form 1040 Schedule F, Line 4b They should then back out the amount of the CRP payment on Line b of Form 1040, Schedule SE, to exclude the payment from SE tax liability 65 Custom Hire (Machine Work) Income Custom hire work conducted by a non farmer is reported on Schedule C, not Schedule F Custom hire work conducted by a farmer, however, may generally be reported on Line 7 of Schedule F Note that there is no bright line rule regarding how much custom work may be conducted by a farmer before a Schedule C should be filed for that activity If the custom work is more than incidental, however, a Schedule C should be considered 66 22

23 Other Income Income related to the farming operation, but not reportable elsewhere, is reported on Line 8 of Schedule F This income includes: Bartering income Cancellation of debt income Breeding fees Fees from renting machinery or land that isn't reported on Schedule E (Form 1040) or Form 4835 Any recapture of excess depreciation on any listed property, including any 179 expense deduction, if the business use percentage of that property decreased to 50% or less State and federal fuel or gasoline credits (these are refunds of fuel taxes previously paid and deducted as an expense) 67 Weather Related Sales 68 Weather Related Sales If the client sells or exchanges more livestock, including poultry, than they normally would in a year because of a drought, flood, or other weather related condition, they may be able to postpone reporting the gain from the additional animals until the next year The client must meet all the following conditions to qualify: The principal trade or business is farming The client uses the cash method of accounting The client can show that, under their usual business practices, they would not have sold or exchanged the additional animals this year except for the weather related condition 69 23

24 Weather Related Sales The weather related condition caused an area to be designated as eligible for assistance by the federal government Sales or exchanges made before an area became eligible for federal assistance qualify if the weather related condition that caused the sale or exchange also caused the area to be designated as eligible for federal assistance The designation can be made by the President, the Department of Agriculture (or any of its agencies), or by other federal departments or agencies 70 Weather Related Sales The election to defer income from sales precipitated by drought, flood, or other weather related condition is made by attaching a statement to the return An election to defer income based upon this provision is made separately for each broad generic classification of animals (e.g., hogs, sheep, poultry, and cattle) for which the taxpayer wishes the provision to apply 71 Weather Related Sales Separate elections cannot be made solely because of the animals' age, sex, or breed Treas. Reg (d) The election to defer must be made by the due date of the return (including extensions) for the tax year of the sale Treas. Reg (g) Once made, an election to defer income under this provision can only be revoked with IRS consent 72 24

25 Weather Related Sales Example In 2017, Randi s pasture flooded during a severe rain event Randi s area was declared a federal disaster area As a result of the flood, Randi sold 150 beef cattle, including 100 she would not have sold until 2018 had it not been for the flood Randi received $270,000 for the cattle she sold Because Randi is a cash basis farmer, 451(e)(1) allows her to defer for one year the income she received from the 100 head she sold due to the flood 73 Weather Related Sales Example Randi may report $180,000 of her income [(100/150) x $270,000 = $180,000] in 2018 instead of 2017 by attaching a statement to her timely filed 2017 return, including the following information: Taxpayer sold the 150 animals on July 20, 2017, for $270,000 She is deferring $180,000 of her income from the sale attributable to the 100 cattle that she would not have sold in 2017, but for the flood [(100/150) x $270,000 = $180,000] 74 Weather Related Sales Statement Randi Sharpman, 9786 Rio Way; North Granger, Iowa Taxpayer is postponing gain under 451(e) On July 3, 2017, a flood severely impacted Granger County, Iowa, rendering taxpayer s pasture unsuitable for cattle On August 15, 2017, Granger County, Iowa, was declared a Presidential disaster area because of the flood (see attached declaration) Taxpayer has for the prior three years (2014, 2015, and 2016), sold 49, 50, and 52 cattle respectively In 2017, she would have sold 50 cattle had the flood not occurred Instead, she was required to sell the entire herd, which included 150 head of cattle 75 25

26 Weather Related Sales Note that for 451(e)(1) to apply, the livestock does not always have to be raised or sold in an area directly affected by a weather related condition Rather, the taxpayer must show that the weatherrelated condition affected the water, grazing, or other requirements of the livestock For this to apply, the taxpayer must show that the cost of feed, water, or other weather impacted requirement of the livestock was substantial in relation to the total costs of holding the livestock 76 Weather Related Sales IR , Oct. 18, 2013 Farmers and ranchers who previously were forced to sell livestock due to drought, like the drought currently affecting much of the nation, have an extended period of time in which to replace the livestock and defer tax on any gains from the forced sales Farmers and ranchers who, due to drought, sell more livestock than they normally would may defer tax on the extra gains from those sales To qualify, the livestock generally must be replaced within a four year period 77 Weather Related Sales The IRS is authorized to extend this period if the drought continues The one year extension of the replacement period generally applies to capital gains realized by eligible farmers and ranchers on sales of livestock held for draft, dairy or breeding purposes due to drought Sales of other livestock, such as those raised for slaughter or held for sporting purposes, and poultry are not eligible 78 26

27 Weather Related Sales The IRS is providing this relief to any farm located in a county, parish, city, borough, census area or district, listed as suffering exceptional, extreme or severe drought conditions by the National Drought Mitigation Center (NDMC), during any weekly period between Sept. 1, 2012, and Aug. 31, 2013 All or part of 38 states are listed Any county contiguous to a county listed by the NDMC also qualifies for this relief 79 Weather Related Sales As a result, farmers and ranchers in these areas whose drought sale replacement period was scheduled to expire at the end of 2017 will now have until the end of their next tax year 2018 Because the normal drought sale replacement period is four years, this extension immediately impacts drought sales that occurred during 2009 But because of previous drought related extensions affecting some of these localities, the replacement periods for some drought sales before 2009 are also affected 80 Weather Related Sales In addition, Congress has granted the Secretary of the Treasury discretion to extend the replacement period for taxpayers impacted by prolonged drought Each September, IRS issues a notice publishing the list of counties that were not drought free for the prior year If an area is on that list, an extended replacement period applies Generally, the replacement period is extended until the end of the taxpayer's first tax year ending after the first drought free year 81 27

28 Rents 82 Rents (Including Crop Shares) The rent the client receives for the use of their farmland is generally rental income, not farm income However, if they materially participate in farming operations on the land, the rent is farm income Pasture income and rental If the client pastures someone else's livestock and takes care of them for a fee, the income is from the farming business Enter it as Other income on Schedule F If the client simply rents pasture for a flat cash amount without providing services, report the income as rent on Part I of Schedule E (Form 1040), Supplemental Income and Loss Crop Shares Include rent the client receives in the form of crop shares in income in the year the client converts the shares to money or the equivalent of money It does not matter whether the client uses the cash method of accounting or an accrual method of accounting If the client materially participates in operating a farm from which they receive rent in the form of crop shares or livestock, the rental income is included in self employment income If they do not materially participate in operating the farm, report this income on Form 4835 and carry the net income or loss to Schedule E (Form 1040) The income is not included in self employment income 28

29 Crop Shares the Client Uses to Feed Livestock Crop shares the client receives as a landlord and feed to their livestock are considered converted to money when fed to the livestock The client must include the fair market value of the crop shares in income at that time They are entitled to a business expense deduction for the livestock feed in the same amount and at the same time they include the fair market value of the crop share as rental income Although these two transactions cancel each other for figuring adjusted gross income on Form 1040, they may be necessary to figure self employment tax (material participation) Crop Shares Gifted to Others Crop shares the client receives as a landlord and gives to others are considered converted to money when they make the gift The client must report the fair market value of the crop share as income, even though someone else receives payment for the crop share Example A tenant farmed part of the client s land under a crop share arrangement The tenant harvested and delivered the crop in the client s name to an elevator Before selling any of the crop, the client instructed the elevator company to cancel the warehouse receipt and make out new warehouse receipts in equal amounts of the crop in the names of the client s children 29

30 Example The children sell the crop shares in the following year and the elevator company makes payments directly to the children In this situation, the client is considered to have received rental income and then made a gift of that income They must include the fair market value of the crop shares in the client s income for the tax year the client gave the crop shares to the children 88 Crop Share Loss If the client is involved in a rental or crop share lease arrangement, any loss from these activities may be subject to the limits under the passive loss rules Cooperative Distributions 90 30

31 Cooperative Distributions Cooperative distributions include patronage dividends and perunit retain allocations The cooperative reports these distributions to the IRS on Form 1099 PATR Distributions are taxable to the recipient whether or not they are paid in cash These include patronage dividends, non patronage distributions, per unit retain allocations, redemptions of nonqualified written notices of allocation, and per unit retain certificates 91 Patronage Dividends When a farmer buys supplies from a cooperative, the cooperative may later refund a portion of the purchase price in the form of a patronage dividend The refund generally represents the excess net earning of the cooperative remember cooperatives are not required to make this distribution 92 Patronage Dividends Generally report patronage dividends as income on Schedule F, Lines 3a and 3b, for the tax year received They include the following items: Money paid as a patronage dividend, including cash advances received (for example, from a marketing cooperative) The stated dollar value of qualified written notices of allocation The fair market value of other property 31

32 Cooperative Distributions Taxpayers report only taxable dividends on Schedule F, line 3b To calculate the taxable amount, the farmer subtracts from the amount on line 3a the amount of patronage dividends received from buying personal or family items, capital assets, or depreciable assets Personal items include fuel purchased for personal use, basic local telephone service, and personal long distance calls If a taxpayer cannot determine what the dividend is for, report it as income on lines 3a and 3b The amount of these non taxable dividends must be subtracted from the cost or other basis of these items 94 Cooperative Distributions Tax reporting in Part 1, Schedule F but allocate by source as follows: Attributable to deductible farm expenses taxable Attributable to personal expenses nontaxable Attributable to the purchase of capital assets reduces the assets basis 95 Cooperative Distributions Qualified Written Notice of Allocation Includes the stated dollar value in income in the year received The amount included in income that exceeds the money received becomes the basis in the notice A written notice of allocation is qualified if at least 20% of the patronage dividend is paid in money or by qualified check and either of the following conditions apply: 96 32

33 Cooperative Distributions Qualified Written Notice of Allocation Notice is redeemable in cash for at least 90 days after it is issued The taxpayer agreed to include the stated dollar value in income in the year received by either signing a : Written agreement Getting membership in the cooperative or By endorsing and cashing a qualified check that was paid as part of the same patronage dividend 97 Form 1099 PATR Form 1099 PATR may also show an alternative minimum tax adjustment that you must include on Form 6251, Alternative Minimum Tax Individuals Example Josh bought milk production equipment from his local cooperative for $4,500 Josh began taking depreciation deductions for the seven year MACRS property In the following year, Josh received a patronage dividend from the cooperative in an amount of $400 for purchasing the machine Josh will reduce the basis of the machine by the amount of the dividend and adjust his depreciation deductions accordingly 99 33

34 Per Unit Retain Certificates A per unit retain certificate is any written notice that shows the stated dollar amount of a per unit retain allocation made to the client by the cooperative A per unit retain allocation is an amount paid to patrons for products sold for them that is fixed without regard to the net earnings of the cooperative These allocations can be paid in money, other property, or qualified certificates Per unit retain certificates issued by a cooperative generally receive the same tax treatment as patronage dividends Other Payments The client must include most other government program payments in income Fertilizer and Lime Include in income the value of fertilizer or lime received under a government program There is an offsetting deduction that may be claimed Improvements If government payments are based on improvements, such as a pollution control facility, they must include them in income They must also capitalize the full cost of the improvement Since they have included the payments in income, they do not reduce the basis Cancellation of Debt Generally, if debt is canceled or forgiven, other than as a gift or bequest the client must include the canceled amount in gross income for tax purposes Discharge of qualified farm indebtedness is one of the exceptions to the general rule It is excluded from taxable income Report the canceled amount on Schedule F, line 8, if the client incurred the debt in the farming business If the debt is a nonbusiness debt, report the canceled amount as other income on Form 1040, line 21 34

35 Qualified Farm Debt The client can exclude from income a canceled debt that is qualified farm debt owed to a qualified person This exclusion applies only if they were solvent when the debt was canceled or, if they were insolvent, only to the extent the canceled debt is more than the amount by which they were insolvent This exclusion does not apply to a canceled debt excluded from income because it relates to your principal residence or it takes place in a bankruptcy case The debt is qualified farm debt if both the following requirements are met: The client incurred it directly in operating a farming business At least 50% of the total gross receipts for the 3 tax years preceding the year of debt cancellation were from the farming business Qualified Person This is a person who is actively and regularly engaged in the business of lending money A qualified person includes any federal, state, or local government, or any of their agencies or subdivisions The USDA is a qualified person A qualified person does not include any of the following: A person related to you A person from whom you acquired the property (or a person related to this person) A person who receives a fee from your investment in the property (or a person related to this person) Reduction of Tax Attributes Form 982 A farmer must use special rules to reduce the basis of property for excluded cancelled qualified farm debt Under these rules, qualified property is reduced is the following order: Depreciable qualified property Land that is qualified property and used in the farming business Other qualified property any property used or held for use in a trade or business or for the production of income

36 Form 1099 C If a federal agency, financial institution, credit union, finance company, or credit card company cancels or forgives the debt of $600 or more, the client will receive a Form 1099 C, Cancellation of Debt The amount of debt canceled is shown in Box 2 Fuel Tax Credit and Refund Include any credit or refund of federal excise taxes on fuels in gross income if the client deducted the cost of the fuel (including excise tax) as an expense that reduced the income tax Income Averaging 1301 provides that taxpayers engaged in a farming business or fishing business may be able to average all or some of their farm income by using unused tax brackets from the 3 prior years (base years) to calculate the tax on the current year s income The amount of farm income the taxpayer chooses to have taxed at the prior years available rates is called electable farm income For purposes of this provision, farming business is defined as a trade or business involving the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity

37 Income Averaging Income attributable to the business of farming may be included in electable farm income This includes not only net farm profits calculated on Schedule F, but also net farm income from a partnership, S corporation (including wages), or LLC Wages from a C corporation are not included Electable farm income may also include gains from the sale of property regularly used in a farm business for a substantial period Timber may not be included 109 Income Averaging Taxpayers use Schedule J (Form 1040) to make the income averaging election and to calculate the tax on the electable farm income using the prior three years rates. Income averaging may give farmers a lower tax if the current year s income is high and the taxable income (which includes income from farming) from one or more of the 3 prior years was lower 110 Federal Income Tax Provisions Applying to Farmers Exclusion of income from discharge of indebtedness 108(a)(1)(C) and 1017(b)(4) Limit on deducting charitable contribution of a conservation easement 170(b)(1)(E)(iv) Carryback of net operating losses 172(b)(1)(G) Soil and water conservation expenditures 175 and 1252 Expenditures for fertilizer, lime, and other materials to enrich, condition or neutralize soil 180 Material participation for purposes of the passive loss rules 469(h)(3)

38 Federal Income Tax Provisions Applying to Farmers Domestic production activity deduction [Treas. Reg ] Uniform capitalization of reproductive expenses 263A Record keeping for business use of vehicles [Treas. Reg T(b)] Method of accounting for corporations engaged in farming 447 Cash method of accounting 448 and Treas. Reg (a) Crop insurance or disaster payments 451(d) Weather related sales of livestock 451(e) and 1033(e) 112 Federal Income Tax Provisions Applying to Farmers Deduction of prepaid expenses 464(f) Application of the at risk rules Temp. Treas. Reg T and Prop. Reg Livestock destroyed by disease 1033(d) Disposition of converted wetlands or highly erodible croplands 1257(c)(1)(B) Imputed interest rules 1274(c)(3)(A) Farm income averaging 1301 Self employment tax on rent 1402(a) 113 Federal Income Tax Provisions Applying to Farmers Special use valuation of real estate for estate tax purposes 2032A FICA taxes on commodity wages 3121(a)(8)(A) FUTA taxes 3306(b)(11) and 3306(k)] Excise tax on gasoline and diesel fuel used on farms 6420 and 6427(c) Relief from estimated tax penalties 6654(i)

39 Questions 115 The Scoop Upcoming Dates November 1 December 13, 2017 Held at 8:00 am and 12:00 pm Central time 116 Up Coming Ethics Classes Ethics Part 1 and Part 2 (November 13) Ethics Part 1 and Part 2 (November 14) Ethics Part 1 and Part 2 (December 15) Ethics Part 1 and Part 2 (December 18) Ethics Part 1 and Part 2 (December 19)

40 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 The CALT Staff William Edwards Interim Director for the Beginning Farmer Center Interim Director for the Center for Agricultural Law and Taxation wedwards@iastate.edu 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)

41 Involuntary Conversion 121 Involuntary Conversion Gain or loss from an involuntary conversion of property is usually recognized for tax purposes The client reports the gain or deducts the loss on their tax return for the year they realize it However, depending on the type of property the client may not have to report the gain on the involuntary conversion Involuntary Conversion 1033(e) allows farmers to postpone gain on livestock (other than poultry) held for any length of time for draft, breeding, or dairy purposes when they are sold because of a weather related condition This deferral provision does not apply to livestock used for sporting purposes. To postpone the gain, the taxpayer must generally purchase replacement livestock within two years of the end of the tax year of the sale If the taxpayer s area has been declared eligible for federal assistance, however, that replacement period is extended to four 123 years 41

42 Involuntary Conversion The replacement livestock must be of the same kind as the original livestock (i.e. breeding heifers must be purchased in exchange for breeding heifers, not dairy) Only livestock sold in excess of the number the taxpayer would normally sell under usual business practices, in the absence of weather related conditions, are considered involuntary conversions eligible for gain deferral The election to defer the payment of tax on the gain by purchasing replacement livestock is made by not reporting the deferred gain on the tax return and by attaching a statement showing the details of the involuntary conversion, including: 124 Involuntary Conversion Evidence of the weather related condition that forced the sale or exchange of the livestock A computation of the amount of gain realized on the sale or exchange The number and kind of livestock sold or exchanged The number and kind of livestock that would have been sold or exchanged under usual business practices if the weather related condition had not occurred 125 Livestock Losses If the livestock die from disease, or are destroyed, sold, or exchanged because of disease, even though the disease is not of epidemic proportions, these are treated as involuntary conversions If the livestock were raised or purchased for resale Casualty or theft losses of livestock or produce bought for resale are deductible if the client uses the cash method of accounting If the client reports their income on an accrual method, take casualty and theft losses on property bought for resale by omitting the item from the closing inventory for the year of the loss The client cannot take a separate deduction 42

43 Plant Losses For plants with a pre productive period of more than 2 years, the client may have a deductible loss if they have a tax basis in the plants They usually have a tax basis if they capitalized the expenses associated with these plants under the uniform capitalization rules If the client reports the income on an accrual method, casualty or theft losses are deductible only if the client included the items in their inventory at the beginning of the tax year The client gets the deduction by omitting the item from the inventory at the close of your tax year They cannot take a separate casualty or theft deduction Involuntary Conversion Gain can be postponed under the involuntary conversion rules, if replacement property is purchased within the replacement period If it is not practical to invest sale proceeds in other livestock the proceeds can be used to purchase other property used in farming, but not real property and still qualify for postponement of gain 128 Sales and By Product Sales Almond shells are sold to co generation plants Almond hulls are sold for cattle feed Sale proceeds are received from the huller Prune pits and olive pits may be sold for cattle feed Cotton farmers sell cotton seed as by product One bale of cotton produces 800 pounds of seed The seed is usually sold through the cotton gin Seeds can be used for cattle feed and oil Gin Trash is stems, leaves, etc These can be sold for animal bedding, soil amendments, and to co generation plants. 43