Tax Questions to Consider
Our friends at the IRS (Internal Revenue Service are pretty clear on what they consider taxable income. The way they describe it in their primary farm document is that income is “constructively received” when an amount is credited to your account or made available to you without restriction. You do not need to have possession of the income for it to be treated as income for the tax year. If you authorize someone to be your agent and receive income for you, you have received the income when your agent receives it. However, income is not “constructively received” if your receipt of the income is subject to “substantial restrictions or limitations.” This usually is something like an approved employer-employee deferred-compensation plan or hardship-management funding (Section 457 of the Tax Code). Essentially, the income is not “constructively received” if the taxpayer’s control over its receipt is subject to substantial limitations or restrictions.
You cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. You must report the income in the year the money or property is received or made available (without restriction) to you.
Here are a few examples from the IRS that may help to see how they view the timeliness of your tax liability. Let’s say that you sell an item under a deferred payment contract that calls for payment in a future year, there is no constructive receipt in the year of sale. However, if the sales contract states that you have the right to the proceeds of the sale from the buyer at any time after delivery of the item, then you must include the sales price in income in the year of the sale, regardless of when you actually receive payment. If you use a cash method of accounting, and were entitled to receive a $10,000 payment on a grain contract in December of one year, but would like to be paid in the next year because you think it will benefit your tax situation or account reporting, sorry, that does not work. If the funds were available in December, the IRS figures that you were paid in December. One needs to report all income gained in a particular year within that year. And what if you have debt? What if that debt is paid by another person or canceled by the creditor? You constructively received income. You probably will have to report part or all of this debt-relief as income. That said, You can exclude your canceled debt from income if the debt is debt canceled in a bankruptcy case or when you are insolvent, or it qualified farm property business debt (depending on business structure). Do not forget to remember that this probably means adjustments to your depreciable and non-depreciable property. Time to talk to your tax professional.
Be sure to print out the IRS Farmers Tax Guide, Publication 225 from IRS.gov/forms, and you can request a copy to be mailed to you. Although the following is now several years old, the IRS in their IRS Tax Tip 2016-15, (8 February 2016) summarized ten general points that pertain to filing the Schedule F, Profit or Loss from Farming. Schedule F is the form for any ranch, range, or orchard operation, be it cattle, poultry, fish, fruit or vegetable. These points are every bit as pertinent today:
- Crop insurance. Insurance payments from crop damage count as income. Generally, you should report these payments in the year you get them.
- Sale of items purchased for resale. If you sold livestock or items that you bought for resale, you must report the sale. Your profit or loss is the difference between your selling price and your basis in the item. Basis is usually the cost of the item. Your cost may also include other expenses such as sales tax and freight.
- Weather-related sales. Bad weather such as a drought or flood may force you to sell more head of livestock than you normally would in a year. If so, you may defer tax on the gain from the sale of the extra animals.
- Farm expenses. Farmers can deduct ordinary and necessary expenses (be sure to check out what this means, detailed explanations are available from many on-line sources) that they paid for their business. An ordinary expense is a common and accepted cost for that type of business. A necessary expense means a cost that is proper for that business.
- Employee wages. You can deduct wages you paid to your farm’s full- and part-time workers. You must withhold Social Security, Medicare and income taxes from their wages.
- Loan repayment. You can only deduct the interest you paid on a loan if the loan is used for your farming business. You cannot deduct interest you paid on a personal loan.
- Net operating losses. If your expenses are more than income for the year, you may have a net operating loss. You can carry that loss over to other years and deduct it. You may get a refund of part or all of the income tax you paid in prior years. You may also be able to lower your tax in future years.
- Farm income averaging. You may be able to average some or all of the current year's farm income by spreading it out over the past three years. This may cut your taxes if your farm income is high in the current year and low in the prior three years.
- Tax credit or refund. You may be able to claim a tax credit or refund of excise taxes you paid on fuel used on the farm and for farming.
So, what are some good questions for your session with the tax advisor?
Take a few minutes to scan the following groups of questions. Hi-light or check off the ones that you think you should discuss.
What about rates and deductions?
- What is the optimum bracket for my operation?
- Which brackets have the biggest reduction in tax rate?
- What does it mean that federal taxes are “progressive”?
- What is the optimum tax bracket for my operation?
- Should I pay wages to my kids for work performed on the farm?
- Should I make commodity gifts to my kids or grandkids?
What about basic business structures?
- What is the best business structure for my operation?
- Should I consider incorporating farm assets?
- If I incorporate, should I be a C or S corporation?
- Will a C corporation allow me to deduct my state income taxes if they exceed the $10,000 cap?
- Should I operate as a sole proprietor or set a managed LLC (to reduce self-employment taxes an maximize the Section 199A deduction?
What about asset depreciation?
- How fast (schedule) depreciate assets?
- Does my strategy change if I am financing the purchase of the assets?
- Does my state allow bonus depreciation of Section 179 on my purchases?
- What happens if I purchase farm assets frm a related party?
- Should I consider leasing equipment under the new tax laws?
What about selling and trading assets including land?
- Is it better to trade or sell farm equipment?
- How does my state treat the trade-in of farm equipment?
- What is the tax effect of trading land with or without improvements?
What really is a net operating loss?
- Are there changes to how net operating losses are handled?
- Is it better to report some income to maximize the use of the standard deduction and child tax credits?
- How do net operating losses affect my self-employment income?
How about fringe benefits for employees and documenting those benefits?
- Does this only pertain to C-type corporations?
- What happens to fringe benefits (health insurance, employee lodging, meals)?
Should I incorporate to provide tax-free fringe benefits for housing and meals to me as an owner?
- What are the details needed to provide for these tax-free fringe benefits?
- Will the meal deduction be eliminated in 2026? If so, is it worth pursuing?
What about estate taxes?
- How and under what circumstances could estate taxes affect my operation?
- Should I make major gifts now and in the next six years? (In 2025 the rules are scheduled to change.)
- Does my state have an estate tax, and if so, does it exempt farm property?
- Should I transfer my farm assets into an entity to reduce my taxes?
Six Questions to Ask Your Tax Advisor, Farm Credit Services of America: Common Ground; Spring 2018.
Farmer's Tax Guide. Internal Revenue Service Publication 225 (2017)
Ten Key Tax Tips for Farmers and Ranchers. Internal Revenue Service Tax Tip 2016-15, February 8, 2016.
Reviewed September 2020.