Farm Income and Deductions — Ten Things to Know
Agriculture is an important part of our community, in fact the entire state. It also comes with a whole host of special tax considerations.
If you have a farming business, there are many tax issues you need to consider. Here is a list of 10 that farmers should know.
1. Crop Insurance Proceeds - You must include in income any crop insurance proceeds you receive as the result of crop damage. You generally include them in the year you receive them.
2. Sales Caused by Weather-Related Condition - If you sell more livestock, including poultry, than you normally would in a year because of weather-related conditions, you may be able to postpone reporting the gain from selling the additional animals due to the weather until the next year.
Given current drought conditions, this could be an important benefit for you.
3. Farm Income Averaging - You may be able to average all or some of your current year's farm income by allocating it to the three prior years. This may lower your current year tax if your current year income from farming is high, and your taxable income from one or more of the three prior years was low. This method does not change your prior year tax; it only uses the prior year information to determine your current year tax.
4. Deductible Farm Expenses - The ordinary and necessary costs of operating a farm for profit are deductible business expenses. An ordinary expense is an expense that is common and accepted in the farming business. A necessary expense is one that is appropriate for the business.
5. Employees and Hired Help - You can deduct reasonable wages paid for labor hired to perform your farming operations. This includes full-time and part-time workers. You must withhold social security, Medicare and income taxes on employees.
6. Items Purchased for Resale - You may be able to deduct, in the year of the sale, the cost of items purchased for resale, including livestock and the freight charges for transporting livestock to the farm.
7. Net Operating Losses - If your deductible expenses from operating your farm are more than your other income for the year, you may have a net operating loss. You can carry that loss over to other years and deduct it. You may get a refund of part or all of the income tax you paid for past years, or you may be able to reduce your tax in future years.
8. Repayment of Loans - You cannot deduct the repayment of a loan if the loan proceeds are used for personal expenses. However, if you use the proceeds of the loan for your farming business, you can deduct the interest that you pay on the loan.
9. Fuel and Road Use - You may be eligible to claim a credit or refund of federal excise taxes on fuel used on a farm for farming purposes.
10. Farmer's Tax Guide – The IRS publishes a Farmer's Tax Guide (Publication 225) where you can find more information about farm income and deductions.
A word of caution is warranted here. Many people mistakenly think that just because they buy a piece of land out in the country (one they may even live on) that they have a "farm", allowing them to deduct their "farm" expenses even if they have little or no farm income. This is simply not true.
In order for it to qualify as a legitimate farm business, there must be intent to make a profit or derive income from its operations. For many, this intent doesn't exist. Rather, the "farm" ownership is more of a hobby or even an investment, and doesn't rise to the level of a business.
The IRS uses several factors in determining if the farm is being operated with the requisite intent that would allow it to deduct its expenses even in years where there is little or no income or when the farm loss is being used to offset other sources of income, thus avoiding income taxes on the nonfarm income.
"Farms" consistently running losses that are used to effectively shelter other sources of income are very likely to be questioned, meaning you need to be in a position to prove intent. Tread carefully here!
