Saturday, March 12, 2022
Income Tax Deferral of Crop Insurance Proceeds
Generally, crop insurance proceeds must be reported into income in the year they are received. But crop insurance proceeds received in 2021 for crops damaged in 2021 can, by election, be reported into income in 2022. However, to be deferable, crop insurance must be paid on account of actual physical damage or destruction to the taxpayer’s crops. That means that some types of crop insurance may not be deferable or may only be partially deferable. In that event, how is the determination made as to what is deferable and what is not?
The tax deferability of crop insurance proceeds – it’s the topic of today’s post.
What does deferral apply to? 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 normal business practice to report income from sale of the crop in the later year. I.R.C. §451(f); Treas. Reg. §1.451-6(a)(1). Included are payments made because of damage to crops or the inability to plant crops (prevented planting payments). I.R.C. §451(f)(2). The deferral provision applies to federal payments received for drought, flood or “any other natural disaster.” I.R.C. §451(f)(1).
Note: USDA Wildfire and Hurricane Indemnity Program Plus (WHIP+) payments are considered to be the equivalent of “crop insurance.” Thus, payment for damage occurring in 2021that was reimbursed under the WHIP+ program and was received in 2021 may be deferred to the 2022 tax year.
The 50 percent test. Based on Rev. Rul. 74-145, 1974-1 C.B. 113, to be eligible to make an election to defer, the taxpayer must establish that a substantial part of the crop income (more than 50 percent) would have been reported in the following year under the taxpayer’s normal business practice. If the 50 percent test is satisfied, an allocation may not be made between the two years – the taxpayer cannot elect to defer only a portion of the insurance proceeds to the following year. It is an all or nothing election with respect to a single business. But, when insurance proceeds are received on multiple crops, the “substantial portion” test applies to each crop independently if each crop is associated with a separate business of the taxpayer. Otherwise, as noted, the 50 percent test is computed in the aggregate if the crops are reported as part of a single business and the election to defer is all or nothing.
The election. The election is made by attaching a separate, signed statement to the income tax return (or an amended return) for the tax year of damage or destruction. The statement must include the taxpayer’s name and address (or that of the taxpayer’s agent), and must contain the following information:
- A declaration that the taxpayer is making an election under I.R.C. 451(f) and Treas. Reg. §1.451-6(b)(1);
- Identify the specific crop or crops destroyed or damaged;
- State that under the taxpayer’s normal business practice the income derived from the crop(s) destroyed or damaged would have been included in gross income in the taxable year after the taxable year of the destruction or damage;
- Note the cause of the destruction or damage of the crops and the date(s) on which the destruction or damage occurred;
- Specify the total amount of payments received from insurance carriers; and
- Provide the name(s) of any insurance carrier that made payment.
Note: As noted, the election covers insurance proceeds attributable to all crops representing a trade or business. A separate election should be made for each of the taxpayer’s distinct farming businesses for which separate books and records are maintained. In addition, the election is binding for the tax year for which it is made and may only be revoked with IRS consent. Treas. Reg. §1.451-6((b)(2).
A farmer will receive Form 1099-Misc. for crop insurance and either Form 1099-G or Form CCC-1099-G for federal disaster payments. As for the tax return, the election to defer crop insurance proceeds and disaster assistance is made by checking the box on line 6c of Form Schedule F and attaching the statement to the return. The total crop insurance and federal crop disaster payments received for the tax year is reported on line 6a, even if an election is in place to include those amounts in income the next year. The taxable amount is then entered on line 6b. This amount does not include the proceeds that are elected to be include in income in the following year. Then, if any crop insurance or disaster payments were deferred from the prior year into the current year, that amount is to be reported on line 6d.
Deferral of Revenue/Yield-Based Insurance
A significant issue is whether the deferral provision also applies to crop insurance such as Revenue Protection (RP), Revenue Protection with Harvest Price Exclusion (RPHPE), Yield Protection (YP) and Group Risk Plan (GRP). These policies pay based on low revenue or yield. However, the Code requires that, to be deferrable, payment under an insurance policy must have been made as a result of damage or destruction 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 or may not qualify in their entirety.
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 that would withstand IRS scrutiny:
Consider the following example (from, Principles of Agricultural Law, McEowen, Rel. 49-50 (Jan. 2022)):
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
The above approach was developed several years ago by Paul Neiffer and I as we worked on the issue. I then pitched the approach to appropriate IRS personnel in the IRS National Office in Washington, D.C. and was informally told that the approach looked to be appropriate. To this date, however, IRS has not made any official pronouncement that the allocations in the example meet with its approval.
In the 2021 IRS Pub. 225 (Farmer’s Tax Guide) the IRS notes that proceeds received from revenue insurance policies may be the result of either yield loss due to physical damage or to a decline in price occurring from planting to harvest. The IRS states, “For these policies, only the amount of the proceeds received as a result of yield loss can be deferred.” That’s a recognition that an allocation should be made to separate out the deferable portion (relating to yield loss) from the non-deferrable portion (relating to lost revenue). While statements in an IRS publication are not “official” IRS policy and are not substantial authority, the statement is a recognition that an allocation is appropriate.
Weather damage to crops is an issue that arises somewhere across the country on an annual basis, and the deferral rule under I.R.C. §451 can be helpful to maintain consistent tax reporting treatment when crop insurance proceeds and/or federal disaster payments replace the anticipated crop income. However, the rules on deferral are important to follow, and the type of insurance policy may influence the amount, if any, of proceeds that can be deferred. The portion of the insurance proceeds related to yield may be deferred. The portion related to price is not deferable. A crop insurance agent is likely to be able to break out the two components.
As a final note, several high-profile crop insurance fraud cases have been in the courts in recent years. That means that the federal government is examining crop insurance claims closely.