Wednesday, November 9, 2016
My good friend Paul Neiffer, the author of farmcpatoday.com, often explains that the answer to many tax questions is that “it depends.” So true it is. Change the facts just a bit and you can get a completely different result. The “it depends” answer also applies when it comes to the definition of a farmer for tax purposes. It depends on the particular Code provision that is involved. There are many unique definitional rules. It’s important to have an understanding of the various definitions because special tax breaks often apply to a taxpayer that is a “farmer.” Also, a “farmer” is potentially eligible for federal farm programs.
So, on today’s post, let’s take a look at some of the variation in the definitions.
In general, the I.R.C. §61 definition of a farmer for purposes of determining gross income is a person engaged in agriculture, raising live organisms for food or raw materials. “Farming” includes cultivating, operating, or managing a farm for profit, either as owner or tenant. A “farm” includes a stock, dairy, poultry, fish, fruit, or truck farm. It also includes a plantation, ranch, range, or orchard. A “farmer,” for purposes of inventory and accounting methods, and estimated gross income for estimated tax purposes, is also someone who is engaged in oyster farming, the raising of bees, breeding and raising chinchillas, mink, foxes and other furbearing animals. Treas. Reg. §1.6073-1(B)(2) and Rev. Rul. 57-588, 1957-2 C.B. 305.
However, if a person’s main source of income is from providing agricultural services such as soil preparation, veterinary, farm labor, horticultural, or management on a fee or contract basis, the person is not a farmer for tax purposes and would report their business income on Schedule C rather than Schedule F. Similarly, if a person owns farmland and cash rents it to a tenant to conduct farming activities, the owner is engaged in a rental activity rather than a farming activity. That is important point for numerous provision of the Code, not the least of which are the passive loss rules of I.R.C. §469 and the Net Investment Income Tax of I.R.C. §1411. Cash rent often results in a less favorable tax result for a taxpayer than if that same taxpayer were a material participating landlord.
What it boils down to is that if a landowner is in the business of farming, the landowner's expenses and income are reported on Schedule F where the net income is subject to self-employment tax. Income and expenses associated with a material participation crop share lease are reported on Schedule F. The rental income is subject to self-employment tax and the owner is able to deduct soil and water conservation expenses attributable to the real estate, as well as qualify for the exclusion of cost-sharing payments associated with the rented real estate. Similarly, the landlord could qualify for expense method depreciation under I.R.C. §179. In addition, Conservation Reserve Program (CRP) payments received by a materially participating landlord are subject to self-employment tax if there is a nexus between the CRP land and the landlord’s farming operation.
A landlord who is not materially participating under a crop share lease receives the income from the lease not subject to self-employment tax. While the landlord still qualifies for special treatment of soil and water conservation expenses and is eligible for exclusion of cost-sharing payments, and may, as noted below, be eligible for expense method depreciation, the income is to be reported on IRS Form 4835 rather than the Schedule F.
Income under a cash rent lease is income from a passive rental arrangement and is not subject to self-employment tax. Cash rent landlords do not qualify for special treatment of soil and water conservation expenses but apparently qualify for the exclusion of cost sharing payments received from the USDA. Ltr. Rul. 9014041 (Jan. 5, 1990). As for expense method depreciation, the landlord must be “meaningfully participating” in the management or operations of the trade or business, and avoid the “noncorporate lessor” rules. Income from a cash rent lease is to be reported on the Schedule E -Supplemental Income and Loss.
Farmers are eligible for the cash method of accounting. Even though they have inventories, farmers this special rule makes the cash method available to them. In addition, for farmers on the cash method of accounting, grain, livestock and real estate can be sold on the installment method. Any contract for the sale of goods (other than inventory) is an installment sale and taxable on the installment method if any part of the payment is to be received in a subsequent year. Crops and livestock as inventory-type property are eligible for installment reporting by cash method farmers and ranchers. However, manufacturers and sellers of farm equipment are not eligible for installment reporting. Thom v. United States, 134 F. Supp. 2d 1093 (D. Neb. 2001), aff’d., 283 F.3d 939 (8th Cir. 2002). Along this line, a business that sells seed, fertilizer, pesticides, herbicides, and farm hardware to farmers is not a farmer for purposes of using the cash method of accounting because it does not cultivate, operate, or manage a farm for profit as an owner or a tenant. Ward AG Products, Inc., TC Memo 1998-84. As a result, such a business must use inventories and the accrual method of accounting. That’s the result for any business that is not a farm business where the purchase and sale of merchandise is a material income-producing factor.
In general, Christmas tree "farm" owners are treated as forest owners. Christmas tree "farms" are timber operations for tax purposes. Under the Code, "timber" includes evergreen trees that are more than six years old at the time they are harvested for ornamental purposes.
With respect to livestock pasturing, if an individual pastures someone else’s livestock and takes care of the livestock for a fee, the individual is a farmer and the income belongs on a Schedule F. But, if the individual simply rents pasture for a flat cash amount without providing services the individual is not a farmer and must report the rent on Schedule E. In that situation, the individual is engaged in a rental activity and not a farming activity. That passive status will also have other tax (and possible estate planning) implications.
A shareholder of an S-Corporation engaged in farming can treat compensation received from the corporation as farming income if the compensation is paid by the corporation in the conduct of farming. Also, amounts passed through to the shareholder, is treated as if it were realized directly. Rev. Rul. 87-121.
When employment is considered “farming-related,” the employer must file an annual Form 943.
In general, a taxpayer is an employer of farmworkers if the employees do any of the following types of work:
- Raise or harvest agricultural or horticultural products on a farm, including raising and feeding of livestock;
- Operate, manage, conserve, improve, or maintain a farm and its tools and equipment;
- Perform services in salvaging timber, or brush clearing and/or debris clearing as a result of a hurricane;
- Handle, process, or package any agricultural or horticultural commodity in certain situations; or
- Some other miscellaneous types of farm-related services.
Farmers and certain other persons may be eligible to claim a credit or refund of excise taxes on fuel used in the trade or business of farming.
“Farmers” in the farming business can exclude from income a cancelled debt that is a qualified farm debt owed to a qualified person. Also, a person that meets an income test and an aggregate debt test can file Chapter 12 bankruptcy and be eligible to have tax debts changed from priority to non-priority status. 11 U.S.C. §1222(a)(2)(A).
For purposes of special use valuation, a surviving spouse of a farmer can be considered to be a farmer by providing active management in the farming operation. I.R.C. §2032A(b)(5).
An individual is a farmer for purposes of estimated tax payment rules if:
- Gross income from farming is at least 66.67 percent of total gross income from all sources of the tax year (I.R.C. §6654(i)(2)(A); or
- Gross income from farming shown on the preceding tax year is at least 66.67 percent of the total gross income from all sources shown on the tax return. I.R.C. 6654(i)(2)(B).
An individual “farmer” can elect to average farm income from the farming business. For this purpose, the term “individual” does not apply to an estate or trust, corporations, partnerships or S-corporations. I.R.C. §1301.
USDA (Federal Farm Programs)
To be a farmer eligible potentially eligible for federal farm programs, a farmer must be “actively engaged” in farming to be eligible for certain farm programs. The term applies to either individuals or entities. As an individual/entity they must make a significant contribution to the farming operation of capital, equipment or land and a significant contribution of personal labor or active management. Additionally, the individual/entity share the profits/losses from the operation as well as the contributions would have to be deemed at risk.
It’s been said that agricultural law is “law by the exception.” What that means is that in numerous areas of the law, a different set of rules apply to someone (or an entity) that qualifies as a “farmer.”
The definition of a farmer is different for different provisions in the Code. It also matters for purposes of federal farm programs and other areas of the law. There’s even more detail on additional provisions than are mentioned here. This is just a thumbnail sketch. Further detail can be provided in additional posts. But, for now, this all shows that my friend Paul is correct. For many answers to questions involving tax and law, “it depends.”