PORTFOLIO

Reporting Farm Income (Portfolio 608)

Tax Management Portfolio, Reporting Farm Income, No. 608-3rd, describes the tax accounting periods and methods available to farmers and ranchers in determining their federal tax liability. Farmers, like all taxpayers, can use the cash method or an accrual method. In addition, farmers may use the crop method. The cash and accrual methods of accounting are modified in the case of farmers by a number of provisions designed to provide relief to farmers and to limit the use of farms as tax shelters.

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DESCRIPTION

Tax Management Portfolio, Reporting Farm Income, No. 608-3rd, describes the tax accounting periods and methods available to farmers and ranchers in determining their federal tax liability. Farmers, like all taxpayers, can use the cash method or an accrual method. In addition, farmers may use the crop method. The cash and accrual methods of accounting are modified in the case of farmers by a number of provisions designed to provide relief to farmers and to limit the use of farms as tax shelters.


This Portfolio analyzes the special rules applicable to farms, including: (1) constructive receipt and deferral of income; (2) gifting of commodities (charitable and non-charitable); (3) sale of commodities after retirement; (4) hedging and speculation with farm commodities; (5) handling disaster payments; (6) excluding cost share payments from income; (7) income averaging for farmers and fishermen; (8) availability of the cash method and its application to farming operations; (9) deduction of prepaid feed expenses; (10) farming inventory methods; (11) application of the uniform capitalization rules to farming, including preproductive period expenses of livestock and growing crops; (12) treatment of Commodity Credit Corporation loans and farm subsidies; (13) handling §1231 gains; (14) income in respect-of-decedent in a farm or ranch setting; (15) limitations on farming syndicates; (16) the crop method of accounting; and (17) changes in method of accounting for farming operations. The Portfolio also discusses the self-employment tax implications in reporting farm income including the handling of Conservation Reserve Program Payments, consequences of renting land to a family-owned entity and the reporting of value-added payments from a cooperative.


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AUTHORS

NEIL E. HARL
Neil E. Harl, B.S. Iowa State University (1955); J.D. University of Iowa College of Law (1961); Ph.D. Iowa State University (1965); member, Iowa Bar; research and writing concentrates on tax aspects of estate and business planning; frequent author and lecturer on these and other subjects.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

II. Deferral of Income

Introductory Material

A. Constructive Receipt

1. Generally

2. Important Areas of Constructive Receipt for Farmers

a. Government Price-Income Support Payments

b. Commodity Certificates

B. Deferral of Income from the Sale of Crops or Livestock into a Year Following the Year of Sale

1. Deferred Payment

a. Sale to Agent of Seller

b. Sale by Agent of Seller - Livestock Sales

c. Advances Paid to the Seller

d. Material Distortion of Income

e. Assignability of Contract

2. Installment Sale Treatment

C. Installment Reporting for Accrual Accounting Taxpayers

D. Pre-1997 Alternative Minimum Tax Liability for Farm Commodity Sales

E. Electing Out of Installment Reporting

F. Price-Later Contracts

III. Sale of Items Purchased for Resale

Introductory Material

A. General Rule

B. Purchase of a Farm

C. Exception for Baby Chicks

IV. Disposition of Commodities Raised and Held Primarily for Sale

Introductory Material

A. Effect of Taxpayer Retirement

B. Gifts of Commodities

1. General Rule

2. Gifts to Charity

3. Charitable Contributions of Commodities by Landlords

4. Gifts to Spouse

V. Payments-in-Kind and Cost-Sharing Programs

A. General Rule

B. Federal Farm Program Payments

C. Cost Sharing Benefits

1. General

2. Requirement That the Exclusion Involve a Capital Improvement

3. Election Not to Have Exclusion Apply

4. Eligibility of Lessors for the Exclusion

5. Recapture

VI. Commodity Credit Corporation Loans

Introductory Material

A. CCC Loans as Loans

1. Examples of Loan Cancellation or Forgiveness

2. Payment-in-Kind

3. Using Commodity Certificates

B. CCC Loans as Income

1. General

2. Request for Permission to Change Method of Reporting: Rules Through 2000

3. Changing Method of Reporting: After 2000

4. Scope of the Election to Treat CCC Loans as Income

5. Figuring Gain After Elections to Treat CCC Loans as Income

6. Marketing Loan Assistance

7. Post-2009 Loss Disallowance Provision

VII. Disaster Provisions

Introductory Material

A. Crop Insurance and Disaster Payments

1. Deferral to Year Following Year of Crop Loss

2. Scope of Election to Defer

a. Prevented Planting Payments

b. Proof of “Prevented Planting”

c. Involuntary Conversion?

3. Eligibility of Federal Disaster Payments

4. The Election

5. Historic Pattern of Deferral

6. Deferral of a Portion of Proceeds

7. Requirement That Payments Involve Destruction or Damage to Crops

8. Recovery for Feed Contamination

9. Klamath Basin Area Legislation

10. Information Reporting

B. Weather-Related Sales of Livestock

1. One-Year Deferral of Gain

a. Principal Business Must Be Farming

b. Requirement that Sale Must Be Weather-Related

c. Sales in Excess of Usual Business Practices

d. The Election

e. Revoking the Election

f. Extended Period for Election

2. Four-Year Reinvestment

a. Meaning of Weather-Related Conditions

b. Number of Livestock Eligible

c. Replacement of Livestock

d. The Election

C. Livestock Sold or Destroyed on Account of Disease

1. Treated as Involuntary Conversion

2. Exposure to Disease

3. Meaning of “Livestock”

D. Replacement of Livestock in Certain Cases

E. Reinvestment Because of Property Involuntarily Converted as a Result of a Federally Declared Disaster

F. Federal Feed Assistance Programs

VIII. Gains and Losses from Commodity Futures

Introductory Material

A. Hedging Versus Speculation

1. Definition of Hedges

2. Speculative Transactions

3. Distinction Between Hedging and Speculation

a. The Insurance Test

(1) Pre-Hedges

(2) Post-Sale Hedges

(3) Whether Hedges Are Capital Transactions

b. The “Direct Relation” Test

B. Accounting for Hedging Transactions

C. Hedge-to-Arrive Contracts

IX. Section 1231 Transactions

Introductory Material

A. Scope of § 1231

B. Held for Draft, Breeding, Dairy or Sporting Purposes

C. Definition of “Livestock”

D. Holding Period

1. Calculating Holding Period

2. Holding Period for Property Passing Through Estate

E. Tax Rates on Long-Term Capital Gains

1. Rates in Effect Currently

2. How Gains and Losses Are Netted

F. Sale of Unharvested Crop

G. Sale of Water

H. Leasing § 1231 Animals to Production Entity

I. Timber and Christmas Trees

X. Other Income Items

Introductory Material

A. Breeding Fees

B. Mineral and Soil Sales

C. Crop Share Rents

D. Pasture Rental

E. Occupancy of Dwelling by Tenant

F. Shared Appreciation Agreements (SAAs)

G. Discharge of Indebtedness

1. General Rule

a. When Discharge of Indebtedness Occurs

b. Discharge of Indebtedness as Gift

c. Discharge of Indebtedness as Self-Employment Income

d. Other Points to Consider

2. Exceptions to the General Rule

a. Debtors in Bankruptcy

b. Insolvent Debtors Not in Bankruptcy

c. Real Property Business Debt

d. Solvent Farm Debtor

(1) Tax Attributes

(2) Basis Reduction

e. Qualified Principal Residence Debt

f. Purchase Price Adjustment

3. Rules for Pass-Through Entities

4. Election to Defer Income from Cancellation of Indebtedness

H. Chapter 12 Bankruptcy Tax Provision

I. Ledger Contracts

1. What Are “Ledger” Contracts?

2. Income Tax Treatment of Payments for the Commodity

3. Are Payments in Excess of Market Price a Loan?

J. Income Tax Consequences of Commodity Exports

1. Extra-Territorial Income Exclusion

a. Repeal of the Extra-Territorial Income Exclusion Act

b. Provisions of the Extra-Territorial Income Exclusion

2. Domestic Production Deduction

a. Overview

b. Trade or Business Requirement

K. Payments under the 2004 Tobacco Reform Act

XI. Income Averaging

Introductory Material

A. Calculating Income Tax from Income Averaging

B. Eligible Taxpayers

C. Sale or Other Disposition of Property

D. Meaning of “Farming Business” (Type of Operation)

E. Meaning of “Farming Business” (Relationship to Operation)

F. Averaging Available Only for Income Tax

G. Calculating the Tax

H. Amended Returns

I. Status of the Taxpayer

J. Effect on the Earned Income Credit

K. Impact of AMT

L. Strategies for Income Averaging

M. Income Averaging for Exxon Valdez Litigation Amounts

XII. Income Tax Consequences of a Divorce

A. Transfer of Income

1. General Rule

2. Complicating Factors

B. General Rule of Nonrecognition of Gain or Loss on Transfer of Property

1. Deferred Income Items

2. Transfers “Incident to a Divorce”

3. Scope of Nonrecognition Treatment

4. Records and Notices

5. Making a § 1041 Election

XIII. Earned Income Credit

Introductory Material

A. Meaning of “Capital Gain Net Income”

B. Modified Adjusted Gross Income

C. Sen. Jeffords' Letter

D. IRS Changes Position on Earned Income Credit

E. Earned Income Credit as Property of the Bankruptcy Estate

F. Claiming the Credit in the Year of Death

XIV. Information Returns

Introductory Material

A. Payments to Truckers

B. Farm Commodities and Commodity Certificates

C. Real Estate Reporting

D. Marketing Loan Gains

XV. Self-Employment Income

Introductory Material

A. Farm Program Payments - General Rule

B. Conservation Reserve Program Payments

1. Retired Land Owners

2. Landowners Who Are Not Retired

a. The Wuebker Decision

b. Distinguishing Ray

3. Landowners Who Retire During the 10-Year CRP Period

4. CCA 200325002

5. Notice 2006-108

6. Post-2009 Loss Disallowance Provision

C. Rents from Personal Property

1. Section 1402 Exclusions

2. Stevenson Case

3. Field Service Advice

4. Lessons for Lessors

D. Renting Land to a Family Entity

1. The Mizell Case

2. Is the Mizell Holding Correct?

3. Subsequent Authority

4. Scope of Mizell

5. Importance of Formalities

6. Applicability Beyond Mizell

7. Solutions

a. Amending Legislation

b. Litigation as a Solution

c. Planning as a Solution

E. Paying Wages In-Kind to Agricultural Labor

1. Handling Payments of Wages In-Kind

2. IRS Rulings on Wages Paid In-Kind

3. Market Segment Specialization Task Force

4. Litigation

F. Other Self-Employment Tax Situations

XVI. Methods of Accounting

Introductory Material

A. General

1. Permissible Methods

2. Adopting Method of Accounting

3. Different Trades or Businesses

B. Cash Receipts and Disbursements Method

1. Exceptions to Option to Elect Cash or Accrual Accounting

a. Limits on Cash Accounting for Corporations

b. Farming Syndicates

c. Pre-Paid Expense Limitations

d. Tax Shelters

2. Reporting Gross Income on the Cash Method

C. Accrual Method of Accounting

1. Inventorying Property

2. Uniform Capitalization Rules

3. Inventory Valuation

a. Cost

b. Lower of Cost or Market

c. Farm Price Method

d. Unit-Livestock-Price Method

D. Crop Method of Accounting

E. “Annual” Accrual Accounting

XVII. Other Sources


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Excerpt from Conference Committee Report to H.R. 2014, the Taxpayer Relief Act of 1997 and General Explanation of Tax Legislation Enacted in 1997 (Enactment of Section 1301 (income averaging))

Worksheet 2 Excerpt from Senate Finance Committee Report on the Tax Reform Act of 1976 (S. Rep. No. 938, 94th Cong., 2d Sess. (1976)) (Enactment of Section 464 and Addition of Farming to Activities Covered by Section 465)

Worksheet 3 Excerpts from Conference Committee Report, Tax Reform Act of 1976 (H.R. 10612), H.R. Rep. No. 1515, 94th Cong., 2d Sess. (1976) (Code Sections 447, 464, and 465)

Worksheet 4 Excerpt from Senate Finance Committee Report on the Revenue Act of 1978 (H.R. 13511), S. Rep. No. 1263, 95th Cong., 2d Sess. (1978) (Exemptions from Section 447 Accrual Accounting Method Requirement)

Worksheet 5 Excerpt from Senate Finance Committee Report on the Technical Corrections Act of 1978 (S. Rep. No. 745, 95th Cong., 2d Sess. (1978)) (Transition Rule Allowing Farming Syndicates to Adopt Accrual Method)

Worksheet 6 Rev. Rul. 79-379, 1979-2 C.B. 204 Sale of Livestock to a Purchaser Subject to the Packers and Stockyards Act

Worksheet 7 Rev. Rul. 74-145, 1974-1 C.B. 113 Election to Defer Reporting of Crop Insurance Proceeds

Worksheet 8 Rev. Rul. 70-72, 1970-1 C.B. 15 Taxation of Tenant Farmer's Dwellings

Worksheet 9 Rev. Rul. 58-162, 1958-1 C.B. 234 Constructive Receipt of Income: Deferred Payment Sales

Worksheet 10 Private Letter Ruling 8001001 - Deferred Payment Contract Between Farmers Cooperative and Patron

Worksheet 11 Notice 89-55, 1989-1 C.B. 696 - Reporting Crop Insurance Proceeds and Disaster Payments

Worksheet 12 Letter From Chief Counsel, IRS to Farmer Program Division, FmHA, May 22, 1989 Restructuring FmHA Debt

Worksheet 13 Excerpt from IRS Pub. 225, Farmers' Tax Guide “Accounting Periods and Methods”

Worksheet 14 Market Segment Specialization Task Force, “Noncash Remuneration for Agriculture Labor: I.R.C. § 3121(a)(8)(A)”

Worksheet 15 Sample Election to Defer Reporting of Crop Insurance Proceeds Under Section 451(d)

Worksheet 16 Sample Election to Defer Reporting Gain on Livestock Sold Because of Weather-Related Conditions Under Section 451(e)

Worksheet 17 Sample Election to Have Exclusion for Cost-Sharing Payments Not Apply Under Section 126(c)

Worksheet 18 Sample Election to Defer Recognition of Gain from Weather-Related Conditions on Sale of Draft, Dairy or Breeding Livestock and to Reinvest the Proceeds Within Four Years Under Section 1033(e)

Worksheet 19 Worksheet for Planning Income Averaging Strategies Under Section 1301

Worksheet 20 Completed Form 3115 for Election to Treat CCC Loans as Loans

Worksheet 21 Planning Guide for Changing CCC Elections

Worksheet 22 Election By Spouses to Use Provisions of Section 1041 in Divorce

Bibliography

OFFICIAL

Statutes:

Primary:

Secondary:

Treasury Regulations:

Related Statutes:

Miscellaneous Treasury Pronouncements:

IRS Publications:

Legislative History:

IRS Pronouncements:

Cases:

UNOFFICIAL

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