Farming is about to become more like manufacturing, at least through the eyes of Internal Revenue Service. Tax reform proposals from both the House and Senate call for changes to the cash method of accounting.
The House proposal allows sole proprietors to use the cash method, no matter their income level. If the farmer is not a sole proprietor, the entity would be allowed to use cash accounting until its three-year average revenue exceeds $10 million. At that point, the entity would be required to switch to accrual accounting.
The Senate proposal requires accrual accounting when gross receipts hit a $10 million three-year average, even if the farmer is a sole proprietor. If this switch results in an income increase, the tax laws allow four years to pay tax on the difference.
Cap for Cash. For example: Farmco Inc. (an S corporation) farms 10,000 acres. Gross receipts in 2010 were $9 million, $9.5 million in 2011, $10.5 million in 2012 and $12 million in 2013. Farmco’s three-year average for 2012 was $9.67 million, which allows it to use cash accounting. In 2013, Farmco’s three-year average jumps to $10.67 million. Since the average is more than $10 million, Farmco must transition to accrual accounting in 2014.
Assume Farmco had 150,000 bu. of corn on-hand valued at $800,000 as of Jan. 1, 2014. Since this is unreported income, Farmco could spread this increase throughout four years, or $200,000 in 2014-2017.
Unsold grain inventory might not be the only adjustment. Current farm-accrual accounting requires farmers to report income as follows: total sales during the year (including deferred payment contracts), plus fair market value of all crops on hand at year-end, less fair market value of all crops on hand at the beginning of the year.
We call this "super accrual" accounting since it requires farmers to report income before they sell the crop. Other companies using accrual accounting only report income when product is sold. But unlike manufacturing companies, the farm-accrual method of accounting allows immediate deduction of crop costs.
The Senate proposal eliminates farm accrual accounting. It’s uncertain what this means, but one possible outcome is that all inventory costs associated with growing a crop will be capitalized. In that case, the entity would capitalize all input costs and some general and administrative costs, including depreciation. Costs would be determined at the time of the switch to the accrual method and then amortized into income throughout four years.
One last proposal might make it tougher for farmers to select the right entity to own farmland. Current laws favor an LLC or partnership owning real estate. It’s easy to transfer land into and out of the entity without incurring tax. Conversely, the transfer of land to a corporation is usually easy in, but hard out. When land is distributed from a corporation, it’s treated as if it were sold at fair market value. This causes the shareholder to pay tax, even though no cash was received.
Land Lock. One proposal calls for partnerships and LLCs to be taxed the same as corporations when it comes to land ownership. It would allow for a nontaxable contribution of land and other property, but if this property was removed from the entity, it would call for immediate taxation based on fair market value.
Normally, I would not write about proposed tax law changes since there are usually many changes between the proposal and the final law. However, when both the Senate and House propose similar changes and the effect can be major for farmers, it’s best to inform you now so you can let your senator and representative know how much you disagree with the proposed changes.
Paul Neiffer is a tax accountant with CliftonLarsonAllen and author of the blog, The Farm CPA. He grew up on a wheat farm in Washington and owns a corn and soybean farm in Missouri. Contact him at paul.neiffer@CLAconnect.com.