The Farm CPA

The Supreme Court just issued a ruling that any capital gains tax owed as a result of selling farmland in a Chapter 12 bankruptcy filing is not dischargeable in bankruptcy and will remain a debt of the farmer.

Chapter 12 is a special type of bankruptcy for farmers.  It allows them to reorganize their assets and liabilities and in most cases allows the farmer to continue farming.  Sometimes, however, the farmer will need to sell part of the farmland to payoff the debt.  If the farmer had incurred income taxes before the bankruptcy, in many cases, this debt for taxes is forgiven as part of the bankruptcy process.

In the current case, the farmer argued that the capital gains tax arising from the sale of farmland should also be forgiven.  The IRS disagreed and the case went all the way to the Supreme Court.  The 5-4 decision was very close, but the final ruling is that this debt is owed by the farmer since the bankrupt estate cannot owe tax.

If you are in a situation like this, it is wise to discuss it with your attorney and tax advisor since it may make more sense to trigger the capital gains tax before you file Chapter 12.

The IRS and Congress has gotten much more aggressive in requiring proper documentation of a charitable donation in excess of $250.  Without this documentation, the IRS has the right to completely deny the deduction even though the taxpayer has a cancelled check AND a letter from the charity.  In order for the deduction to be allowed, the documentation must generally include the following information:

• The amount of cash donated (if any),
• A description of any property other than cash that was donated (an estimate of the value of said noncash property is not required),
• Whether the charity provided any goods or services in exchange for the donation (other than intangible religious benefits), and
• A description and good-faith estimate of the value of any goods and services provided by the charity in exchange for the donation.

Also, the taxpayer needs to receive this before filing their return.

The most often error that we see is the second item.  Many times, the taxpayer will get a listing from the church of all of their donations, but this statement is not included.  If this tax return was audited, the taxpayer would stand a good chance of losing the deduction.

A recent Tax Court case underlines how much this can cost the taxpayer.  In Marshall Cohan case (TC Memo 2012-8), the taxpayer transferred a first right of refusal on valuable property on Martha's Vineyard in exchange for cash and other assets that were value at less than fair market value.  This difference was valued at $2 million by the taxpayer and charity.  The charity provided a written acknowledgement to the taxpayer of what was transferred to the taxpayer, but for some reason did not completely list the assets that the taxpayer transferred to the charity.

The Tax Court agreed with the IRS that the whole $2 million deduction was disallowed and in addition agreed that the taxable gain should have been $15 million instead of the $9 reported.  Bad!

It also appeared that the taxpayer and the charity were playing audit lottery on purposely not reporting all of the items, so the Court agreed that the 20% negligence penalty also applied.  Double Bad!!

Something as little as not completely listing property transferred on a charity transfer can cost taxpayers a large amount of money.

One of the most painful part of being a CPA was responding to IRS notices.  Most of these notices were written in such a way that even a professional tax advisor had problems in determining exactly what the IRS wanted or needed to be done.

The IRS has now announced that it is in the process of revising all of its correspondence to include a plain language explanation of the nature of each notice and will state the actual action that the taxpayer must take in addressing the correspondence.  Many of these letters or notices can be handled without having to call, write or visit an IRS office.

A listing of these redesigned notices and letters, including the number and description are located on the IRS website here.

I am not why it has taken so long to finally do this on the part of the IRS (probably something to do with their antiquated computer system), but it is long overdue and I look forward to see if it really is in "English".

We received the following questions from a reader regarding using a charitable remainder trust:

I am retiring from farming and I have equipment valued at 500,000 ,all of which is fully depreciated. I would like to give this equipment to a charitable trust to get 50,000 over the next 9 years (I think they keep 10%) . Do I give title to the equipment to the trust or sell the equipment in my name and give the trust the money? Or do I need to have the buyer make the check out to the trust to avoid the income tax? Also if I want to give the trust 10,000 bushels of soybeans ($150,000) and have the trust give it back to me over 9 years, do I sell the soybeans in the trust name or my name and give them the cash?

We have had some discussions on charitable remainder trusts (CRT) previously, but a brief recap is in order.  A retiring farmer can transfer fully depreciated equipment or unsold crop with no tax basis to a CRT.  The CRT can sell the assets, pay no tax, invest the proceeds and then provide an annual annuity to the farmer as outlined in this question.  The farmer will pay tax on the income as it is received and it is not subject to self-employment taxes.

To answer the farmer's questions, he must transfer the equipment and the crop to the trust and then have the trust sell the assets.  If he sells for cash, he will recognize all of the gain on the sale and then get a small charitable dedution on the transfer to the trust.  This defeats the purpose of using a CRT.

To make the transfer, he should create a bill of sale showing the transfer from him to the trust.  If the grain is stored at an elevator or coop, he needs to make sure that the business creates a new account for the trust and then transfer the grain to the trust account before selling.

Also, make sure to NOT have a pre-arranged sale of the assets already  in writing before the transfer.  If this happens, technically the farmer is required to report the income in most cases.

With the rapid changes in the bonus depreciation and Section 179 deduction for 2010 to 2012, I thought I would update our farmers on how much Section 179 is available.

For bonus depreciation of new equipment, if the asset is placed in service between Jan. 1, 2012, and Dec. 31, 2012, 50% bonus depreciation is available.

Section 179 rules are a little different, since these provisions are based upon when your fiscal year begins. Many farmers have a C corporation and if their fiscal year begins in 2011, they can take a Section 179 deduction of up to $500,000. For fiscal years beginning in 2012 (including the normal calendar year), a farmer can take Section 179 of up to $139,000, and the phase-out of this deduction begins at $560,000.

Let's show an example:

Farmer Smith has a C corporation with a year beginning Sept. 1, 2011, and ending Aug. 31, 2012. The corporation purchases a new tractor for $300,000 on Nov. 1, 2011, a new combine for $350,000 on March 1, 2012, and two used tractors for $375,000 on June 1, 2012.

The corporation will be able to fully deduct the new tractor bought in November, and then has to make a choice on the new combine bought in March for $350,000. If it does not take Section 179, the 50% bonus depreciation creates a $175,000 deduction plus normal depreciation of $18,750, or $193,750 total. If it takes the full Section 179 on the tractors of $375,000, this leaves $125,000 to apply against the combine, leaving $225,000 available for bonus depreciation, resulting in $112,500 plus depreciation of $12,053, or total Section 179 and depreciation taken of $249,554.  In this case, taking the Section 179 of $125,000 results in a larger total deduction by about $56,000.

If this farmer was a calendar year taxpayer, he would not be able to take any Section 179 on the 2012 purchases, since the total cost of $725,000 exceeds the Section 179 phase-out amount of $699,000 ($560,000 plus $139,000).

Remember, you have to take Section 179 first, then apply bonus depreciation on new assets and depreciate any remaining amount using normal tax depreciation methods.