Monday, August 29, 2016
One of the issues of interest at the farm income tax seminars in North Dakota last week involved how to report crop insurance proceeds on the tax return. This was particularly the case at the Grand Forks seminar because the sugar beet crop in that area and points north has been exceedingly wet with the result that producers will likely be receiving payments under their policies. I mentioned to the group that one of the blogposts this week would address the issue. So, here goes.
In general, the proceeds from insurance coverage on growing crops are includible in gross income in the year actually or constructively received. In effect, destruction or damage to crops and receipt of insurance proceeds are treated as a “sale” of the crop. But, taxpayers on the cash method of accounting may elect to include crop insurance and disaster payments in income in the taxable year following the crop loss if it is the taxpayer's practice to report income from sale of the crop in the later year. I.R.C. §451(d). Included are payments made because of damage to crops or the inability to plant crops. The deferral provision applies to federal payments received for drought, flood or “any other natural disaster.”
The election is made by attaching a separate, signed statement to the income tax return for the tax year of damage or destruction or by filing an amended return, and it covers insurance proceeds attributable to all crops representing a trade or business. Based on Rev. Rul. 74-145, 1974-1 C.B. 113, to be eligible to make an election, the taxpayer must establish that a substantial part of the crops (more than 50 percent) has been carried over into the following year. If multiple crops are involved, the “substantial portion” test must be met with respect to each crop if each crop is associated with a separate business of the taxpayer. Otherwise, the 50 percent text is computed in the aggregate if the crops are reported as part of a single business. Also, a taxpayer may not elect to defer only a portion of the insurance proceeds to the following year.
A significant issue is whether the deferral provision also applies to new types of crop insurance such as Revenue Protection (RP), Revenue Protection with Harvest Price Exclusion (RPHPE), Yield Protection (YP) and Group Risk Plan (GRP). As mentioned above, to be deferrable, payment under an insurance policy must have been made as a result of damage to crops or the inability to plant crops. Other than the statutory language that makes prevented planting payments eligible for the one-year deferral, the IRS position as stated in Notice 89-55, 1989-1 C.B. 698 is that agreements with insurance companies providing for payments without regard to actual losses of the insured, do not constitute insurance payments for the destruction of or damage to crops. Accordingly, payments made under the types of crop insurance that are not directly associated with an insured's actual loss, but are instead tied to low yields and/or low prices, may not qualify for deferral depending upon the type of insurance involved. For example, RP policies insure producers against yield losses due to natural causes such as drought, rain, hail, wind, frost, insects and disease, as well as revenue losses tied to the difference between harvest price and a projected price.
Only the portion attributable to physical damage or destruction to a crop is eligible for deferral. RPHPE, YP and GRP policies tie payment to price and/or yield and amounts paid under such policies are less likely to qualify for deferral. While the IRS has not specified in regulations the appropriate manner to be utilized in determining the deferrable and non-deferrable portions, the following is believed to be an acceptable approach:
Consider the following example:
Al Beback took out an insurance policy (RP) on his corn crop. Under the terms of the policy the approved corn yield was set at 170 bushels/acre, and the base price for corn was set at $6.50/bushel. At harvest, the price of corn was $5.75/bushel. Al’s insurance coverage level was set at 75 percent, and his yield was 100 bushels/acre. Al’s final revenue guarantee under the policy is 170 bushels x $6.50 x .75 = $828.75/acre. Al’s calculated revenue is his actual yield (100 bushels/acre) multiplied by the harvest price ($5.75/bushel) which equals $575/acre. Al’s insurance proceeds is the guaranteed amount ($828.75/acre) less the calculated revenue ($575/acre), or $253.75/acre. His physical loss is the 170 bushel/acre approved yield less his actual yield of 100 bushels/acre, or 70 bushels/acre. Multiplied by the harvest price of $5.75/bushel, the result is a physical loss of $402.50/acre. Al’s price loss is computed by taking the base price of $6.50/bushel less the harvest price of $5.75/bushel, or $.75/bushel. When multiplied by the approved yield of 170 bushels/acre, the result is $127.50/acre.
So, to summarize, Al has the following:
- Total loss: (1) anticipated income/acre [170 bushels/acre @ $6.50/ bushel = $1105/acre] less (2) actual result [100
bushels/acre @ $5.75/acre = $575.00] for a result of $530.00/acre.
- Physical loss: 70 bushels/acre x $5.75/bushel harvest price = $402.50/acre
- Price loss: 170 bushels/acre x $.75/bushel = $127.50
- Physical loss as percentage of total loss: $402.50/530 = .7594
- Insurance payment: $253.75/acre
- Insurance payment attributable to physical loss (which is deferrable): $253.75 x .7594 = $192.70/acre
- Portion of insurance payment that is not deferrable: $253.75 – $192.70 = $61.05/acre
But, what if the harvest price exceeds the base price? Then the above example can be modified as follows:
Assume now that the harvest price of corn was $7.50/bushel. Al’s final revenue guarantee under the policy is 170 bushels/acre x $7.50 x.75 = $956.25/acre. Al’s calculated revenue is his actual yield (100 bushels/acre) multiplied by the harvest price ($7.50/bushel) which equals $750.00/acre. Al’s insurance proceeds are the guaranteed amount ($956.25/acre) less the calculated revenue ($750.00), or $206.25/acre. His yield loss is the 70 bushels/acre which is then multiplied by the harvest price of $7.50/bushel, for a physical loss of $525/acre. Al’s price loss is zero because the harvest price exceeded the base price.
So, to summarize, Al has the following:
- Total loss (per acre): $525.00 (physical loss) + $0.00 (price loss)
- Physical loss as percentage of total loss: $525/525 = 1.00
- Insurance payment: $206.25/acre
- Insurance payment attributable to physical loss (which is deferrable): $206.25 x 1.00 = $206.25/acre
- Portion of insurance payment that is not deferrable: $206.25 – 206.25 = $0.00
Reporting crop insurance on the return can be tricky. Paul Neiffer (the author of farmcpatoday.com blog) and myself will be covering this issue and others at farm tax seminars in South Sioux City, NE, West Des Moines, IA (webinar also) and Bettendorf, IA this week. The seminars are sponsored by the Iowa Society of CPAs. Maybe we’ll see you there or maybe you’ll join us by webinar. If you attend, let us know what you think of either this blog or Paul’s. We’d love to hear your input.