Thursday, April 6, 2017
Yesterday the U.S. House Committee on Agriculture Heard Testimony concerning the impact of the tax code on the agricultural industry. I teach farm income tax at the law school, and a significant focus of the course for the students is on those areas of tax law where the rules are different for agricultural producers and agricultural businesses than they are for other taxpayers. The stated (and largely correct) reason for the different treatment of agriculture is that there are unique risks that the sector faces.
One of the speakers at the hearing focused on the uniqueness of farm income tax. I found that interesting and today’s post will summarize the testimony of that speaker – Chris Hesse. Chris is a principal of CliftonLarsonAllen. I am only focusing on the portions of his testimony that dealt with tax issues unique to agricultural producers and businesses. It’s important for legislators to understand these unique provisions and how they apply to agricultural producers.
Installment method. Farm businesses can report income on the installment method. That means that income is recognized when payment is received instead of when the sale is made. This rule can apply to the sales of raised crops and livestock, for example. Nonfarm businesses cannot report the income from the sale of products manufactured or held for sale to customers using the installment method. A seller of ag equipment (e.g., an implement dealer) is not a “farmer” and can’t use the installment method.
Commodity Credit Corporation (CCC) loans. The CCC is the USDA’s financing institution with programs administered by the Farm Service Agency (FSA). Among other things, the CCC makes commodity and farm storage facility loans to farmers where the farmers’ crops are pledged as collateral. These loans are part of the price and income support system of the federal farm programs. Farmers have an option for treating the loan on the return – either as a loan or as income in the year that the loan proceeds are received.
Crop insurance. Farmers can defer the receipt of crop insurance proceeds that are paid for physical damage or destruction to crops. Deferred planting payments are also deferrable. But, if the policy pays based on anything other than physical damage or destruction to covered crops, the payments are not deferrable
Livestock sales on account of weather-related conditions. There are two basic deferral rules that can apply when excess livestock are sold on account of weather-related conditions. I recently blogged on these two rules in light of the wildfires in Kansas, Oklahoma and Texas that has impacted cattle ranchers in those areas. One rule provides for a one-year deferral and the other rule provides the ability to replace the excess livestock with replacement animals and deferral of the gain until the replacement animals are disposed of.
Hedging. As Chris pointed out in his testimony, farmers may reduce price risk for both the sale of crops and livestock and for the purchase of inputs. Puts, calls, and the commodity futures markets are available to hedge prices for the inputs and sales. The hedging opportunities provide ordinary income or loss treatment upon using techniques to lock-in prices. Without this provision, a loss on a commodity futures contract would be capital gain, the deductibility of which is limited to capital gains plus $3,000.
Cancelled debt income. The default treatment for the discharge of indebtedness is as taxable income. However, exclusions are available. One of those is unique to farmers and involves the discharge of qualified farm indebtedness. My blog post of March 29, 2017, dealt with this rule.
Raising livestock. Farmers may deduct the costs of raising livestock, even though dairy cattle, for example, otherwise have a pre-productive period of more than two years. Consequently, when cattle are culled from the breeding or dairy herd, the farmer recognizes I.R.C. §1231 gain, usually taxed as capital gain.
Raising crops. Farmers may deduct the costs of raising crops in the year paid for a cash method farmer, except for those crops that have a more than two-year pre-productive period. But, an election is available for the crops with a more than two-year pre-productive period which allows a current deduction for the costs of establishing the crop. If election is made, depreciation on all farm assets must be computed using slower methods over longer cost recovery periods. The cost of raising the crops is deductible in the year paid for the cash method farmer.
I.R.C. §199. The Domestic Production Activities Deduction (DPAD) of I.R.C. §199 reduces the overall tax rate from growing and production activities for farmers that pay W-2 wages. It’s a nine percent deduction from net farm income (but it doesn’t reduce self-employment income). This provision is uniquely applied to agriculture in the context of cooperatives, farm landlords, crop insurance payments, Farm Service Agency subsidies, custom feeding operations, hedging transactions and the storage of ag commodities.
Fertilizer and soil conditioning expenditures. Farmers can elect to deduct fertilizer and soil conditioner expenses in the year purchased.
Farm supplies. Farm supplies are deductible in the year that they are paid for, rather than in the year of their use.
Charitable donation of conservation easement. Farmers get an enhanced limitation for the donation of a conservation easement. Instead of a 50 percent of adjusted gross limitation for non-farm taxpayers, a farmer or rancher may claim a charitable deduction up to 100 percent of adjusted gross income. If the charitable deduction is greater than the limitation, the excess charitable deduction may be carried forward for up to 15 years.
Charitable contribution of food. Farmers may deduct up to 50 percent of the value of apparently wholesome food given for the benefit of the needy. This provision provides the same incentive to grower/packer/shippers who own cash basis inventory, as provided to the local grocery store that has excess food inventory nearing its expiration date.
Other Provisions Unique to Agriculture
Estimated tax. Form 1040 farmers need not pay estimated taxes if the tax return is filed by March 1. Farmers who don’t file by March 1 can pay one estimated tax payment on January 15. This flexibility helps farmers by not having to pay income tax on expected income that doesn’t arise to the risks mentioned above.
Farm income averaging. Farmers can average their income over a three-year period. This helps deal with fluctuating commodity prices, and is useful upon retirement.
Net operating losses. Farmers have the option of using a net operating loss carryback period of five years, rather than the two-year provision applicable to non-farmers.
Optional self-employment tax. Farmers benefit from the optional self-employment tax, to earn credits toward the Social Security system even though suffering a loss in a current year. Non-farm taxpayers may elect optional self-employment tax for only five years. Farmers do not have a limit.
Farm supplies. Farmers may deduct farm supplies in the year paid, rather than the year consumed (within limits).
Chapter 12 bankruptcy. Farm bankruptcy (Chapter 12) contains a special rule that allows taxes owed to a governmental entity to be changed from priority to non-priority status. This wasn’t in Chris’ testimony, but it’s a crucial provision particularly in this time of financial distress in agriculture. A current problem, however, is that the debt test for Chapter 12 needs to be raised. Numerous farming operations now have aggregate debt levels high enough that they are precluded from filing Chapter 12. For those, the tax provision is of no use.
CRP rents for a farmer receiving Social Security. A special tax rule allows active farmers who receive Conservation Reserve Program (CRP) payments to not pay self-employment tax on those payments if the farmer is also receiving Social Security benefits. This was also not a part of Chris’ testimony.
It was apparent at the hearing that interest deductibility for interest associated with farmland purchases is a key tax provision that should be retained. There had been some discussion during the summer of 2016 that its removal was a possibility. At least that was mentioned as a possibility in the “Blueprint” made public by the House Ways and Means Committee. That doesn’t seem to be the case now. Also, the hearing pointed out that the current tax-deferred exchange rules are necessary to retain.
On the federal estate tax, while the exemptions are high enough to exempt out the vast majority of farmers, the point was made that a significant reason of its inapplicability to farmers is that they engage in costly and time-consuming planning to avoid the tax. That’s what is called a “dead weight loss.” That point is never mentioned by the proponents of keeping the federal estate tax in place who claim they have no evidence of a farm or ranch ever having been sold to pay the tax. The retention of basis “step-up” at death is of particular importance to farm and ranch families.
Another panelist gave testimony that focused on proposals that could incentive farmers that are retiring from farming to transfer their assets before death. I haven’t seen much interest in the Congress over the past few years to enact the proposals suggested, but it’s still good to have the discussion and put the issues back out in the open.
It’s always nice when those in D.C. get to hear from those in the trenches that have to deal with the rules the Congress enacts. Hopefully the hearing was beneficial for the legislators.