Thursday, September 7, 2017
The Commodity Credit Corporation (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.
How is the loan reported for tax purposes? What happens when the loan is paid back? What are the particular IRS rules that apply? These questions are the focus of today’s post.
Tax Reporting Options
When a farmer seals grain (places it in storage and pledges it as collateral to secure a CCC loan), the farmer retains the ability to forfeit the grain in the future if the loan value exceeds commodity prices. Because most CCC loans are nonrecourse, upon maturity, if the loan plus interest is not paid, the forfeiting of the commodity to the CCC as full payment for the loan effectively establishes a minimum price. Why? Because the farmer can forfeit the grain if prices drop below the loan value, and still retain the ability to market the grain later if the commodity price increases. The forfeiting of the loan to the CCC as full payment is known as “redemption.” Once redemption occurs, the farmer can then sell the grain, feed it to livestock or store it.
How are CCC loan proceeds handled for tax purposes? There are two possible methods.
Loan method. By presumption, every farmer treats CCC loans as loans for tax purposes. Thus, for a farmer on the cash method of accounting, there is no taxable income from the loan until the year in which the commodity is sold or the crop is forfeited to CCC in full satisfaction of the loan. If grain is forfeited to the CCC in satisfaction of the loan, the taxpayer will receive a Form 1099-A from the USDA. The amount of the loan forfeited is reported on line 5b of Schedule F with the same amount entered as taxable income on line 5c.
Farmers using the loan method (and their tax preparers) should recognize that the loan method can create a high income with no cash flow in the year the grain is sold. That’s because the loan amount was received in the prior year.
Income method. CCC loans may, by election (and without IRS permission), be treated as income in the year the proceeds of the loan are received. I.R.C. §77. The election can be made at any time (I.R.C. §77(a)), but the IRS has ruled that, if a farmer elects to treat CCC loans as income, it applies to all loans originating that year. Priv. Ltr. Rul. 8819004 (Jan. 22, 1988). Actually, the CCC loan is not income. Rather, the amount reported as income is the cash proceeds of the CCC loan which then serves as the grain’s income tax basis. I.R.C. §1016(a)(8). The amount of the income is entered on line 5a of Schedule F. The election constitutes an adoption of an accounting method and is binding for future years. Treas. Reg. §1.77-1. An election statement reporting the details of the loan must be attached to the farmer’s return for the year the election is made. See IRS Pub. 225 and the Instructions to Schedule F. Also, the election to treat CCC loans as income applies to all commodities for that taxpayer. Treas. Reg. § 1.77-1.
In addition, a taxpayer reporting CCC loans as income can switch automatically to treating CCC loans as loans. Rev. Proc. 2002-9, I.R.B. 2002-3, Section 1.01(1). Loans taken out previously continue to be treated as if the election to report loans as income was still in effect. Under the IRS guidance, the change is made on a “cut-off” basis. In other words, when a taxpayer changes CCC loan reporting methods, the new method applies to current year and subsequent loans. That means that a farmer could be reporting on both methods until prior loans are satisfied. In addition, even if a farmer had made the election to report the CCC loan as income within the past five years, the farmer is still eligible to switch to the loan method. The IRS, in Rev. Proc. 2015-13, Appendix Sec. 2.01(2), waives that five-year prohibition. But, Form 3115 must be attached to the return noting that the change is being made under the automatic consent procedures of Rev. Proc. 2015-14. Also, a copy of Form 3115 must be sent to the IRS in Washington, D.C.
Tax Planning Issues
It is important to understand the tax ramifications of making or not making the election to treat CCC loans as income. For example, assume a farmer is participating in a three-year farmer loan reserve program. If a year of high prices occurs and all of the grain under the three-year loan reserve program is sold, the result is a spike in the taxpayer's income for that year. That is because the grain is income in the year that it is disposed of if an election has not been made to treat the loan as income. In order avoid that result, the farmer is permitted to treat the loans as income. This means the farmer will report the crop into income in the year it was placed under loan. This has the favorable result of evening out year-to-year income by offsetting the income from the crop with the expenses of raising the crop. When the crop is eventually sold, there will be taxable income only to the extent that the sale price exceeds the loan amount.
However, there is an advantage in not paying tax any sooner than required and, therefore, farmers (particularly those in higher brackets) may not want to treat CCC loans as income. The preference may be to roll the income as far as possible without paying tax on it. Thus, it is an important consideration for tax planning purposes to consider whether to treat CCC loans as income or as loans. The point is that a choice is available.
As a summary of the income tax treatment of various dispositions of CCC loans and commodities, consider the following:
- If the loan is paid by forfeiting the commodity to the CCC, no income is reported if an election has been made to treat the loan as income upon receipt. The farmer’s basis in the grain offsets the loan liability. But, there could be either a gain or loss on the farmer’s Schedule F if the farmer’s liability on the loan is more or less than the farmer’s basis in the grain. However, if no election is made, the amount of the loan is reported as income upon forfeiture (redemption).
- If the commodity is redeemed by paying off the loan with cash, the farmer has a basis in the commodity equal to the loan amount if an election has been made to treat the loan as income. If no election was made, the farmer has a zero basis in the commodity.
- If the redeemed commodity is sold, the farmer has income (or loss) equal to the sale price of the commodity less the amount of the loan (which is the basis in the commodity), if an election to treat the loan as income was made. If not, the farmer has income equal to the selling price of the commodity.
- If the redeemed commodity is fed to livestock, the farmer has a feed deduction equal to the amount of the loan (which is the basis in the feed), if an election has been made to treat the loan as income. If no election was made, the farmer does not get a feed deduction.
- Regardless of whether the CCC loan is treated as a loan or as income, interest that the farmer pays to the CCC on the loan is deductible in the year it is paid for a cash-basis farmer.
What if the CCC Loan Is Redeemed in the Same Year It Is Taken Out?
As noted above, normally the repayment of a CCC loan has no tax impact. That’s the case regardless of whether or not the taxpayer has made an election to treat the loans as income. But if a farmer has elected to treat CCC loans as income, the courts are divided as to the outcome if the loans are redeemed in the same year they are taken out. The Fifth Circuit Court of Appeals has held that no income is realized from the loan on a crop redeemed in the same year. Thompson v. Comm’r, 322 F.2d 122 (5th Cir. 1963), aff'g and rev'g, 38 T.C. 153 (1962). On the other hand, the Ninth Circuit Court of Appeals has taken the position that the loan triggers income even though it is redeemed in the same year. United States v. Isaak, 400 F.2d 869 (9th Cir. 1968).
What About Market Gains on CCC Loans?
Similar rules to those discussed above apply to market gains triggered under the CCC nonrecourse marketing assistance loan program. The amount that a farmer has to repay for a loan that is secured by an eligible commodity is tied to the lower of the loan rate or the world market price for the commodity on the loan repayment date. If repayment occurs when the world price is lower than the loan rate, the farmer has “market gain” on the difference. For repayment in cash, the gain is reported on a CCC-1099-G. But, if a CCC certificate is used to repay the loan, there is no Form 1099 reporting. In addition, the farmer’s tax treatment of the market gain is tied to how the farmer treats CCC loans for tax purposes. For farmers that treat CCC loans as loans, the market gain is reported on line 4a of Schedule F and taxable income is reported on line 4b. If the farmer made an election treat CCC loans as income, the market gain is not taxable income. Instead, it reduces the basis in the commodity and defers income until the sale of the grain occurs.
CCC loans are another illustration of how agricultural tax is different from tax for non-farmers. It’s a unique aspect of tax law that is particular to farmers. This is another area of the law that makes having a practitioner that specializes in ag tax of great value.