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October 2013 Archive for The Farm CPA

RSS By: Paul Neiffer, Top Producer

Paul is now part of the fourth generation in America that is involved in farming and hopes the next generation will be involved also. Through his blog he provides analysis and insight to farmer tax questions.

Calculating Cost Basis Wrong Can Be Costly!

Oct 31, 2013

The Tax Court case released the Moore vs. Commissioner case (T.C. Memo 2013-249) yesterday and this is a very good case of how some taxpayers who really should know better, still attempt to fight a losing cause with the IRS in the Tax Court. Here is a brief summary of the facts of the case:

  • Mr. Moore started his career as a CPA ;
  • He then went to work for Dallas Peterbilt, Inc. (an S corporation) which later became ATS;
  • Over time he bought 5% of the company from one shareholder and then later on purchased about $5.8 million of ATS shares from Mr. Baker;
  • Mr. Moore borrowed 100% of the money from ATS (with a promissory note) and paid a total of $5.353 million to Mr. Baker;
  • Mr. Moore then sued ATS claiming that the stock bought from Mr. Baker was only worth $1 million and that he should only be liable for $1 million not $5.353 million. The claim was that Mr. Moore only paid the higher amount as a favor to ATS;
  • The lawsuit was settled for the $1 million amount and Mr. Moore's loan to ATS was reduced to this number which appears to be paid off at a later point in time;
  • In 2005, Mr. Moore sold his stock for $3 million and claimed a basis in his ATS stock of $4,502,519 resulting in a capital loss of $1,502,519;
  • Mr. Moore calculated his basis using the original $5.353 million paid to Mr. Baker less other S corporation adjustments reducing his basis to the amount shown;
  • The IRS audited the return and assessed tax based upon using $1 million for his original basis and indicated a capital gain of $2 million resulting in additional tax of $746,984 plus a Section 6662(a) accuracy-related penalty of $149,397;

 

The Tax Court ruled with the IRS. Since the debt owed and ultimately paid by Mr. Moore was based upon the $1 million value, that is the value that must be used for the basis calculation. Mr. Moore had used a National Top 10 CPA firm and I believe the ultimate benefit is that the Tax Court ruled the $149,397 penalty did not apply, therefore, it was probably worth going to Tax Court to get this eliminated. Also, the Tax Court determined that both the Taxpayer and the IRS forgot to include the original $212,334 paid for the first 5% stock purchase.

The basis in property consists of cash and property "paid" to acquire the property (excluding inherited or gifted property). In this case, the taxpayer argued that the original debt amount should be the basis amount. However, it usually ultimately comes down to what is the actual out-of-pocket cash ultimately paid by the taxpayer will be the basis (other than S corporation adjustments) and in this case, he only paid $1 million plus $212,334.

Most likely the CPA kept track of the stock basis using the original amount paid for the stock and probably was not aware of the law suit that ultimately reduced the value down to a $1 million. If the taxpayer had timely given this information to the CPA, it is highly unlikely this ever would go to Tax Court.

Social Security Announces 1.5% Increase in Benefits

Oct 31, 2013

On Wednesday, October 30, 2013, the Social Security Administration announced that benefits will rise by 1.5% beginning with January payment. This represents a $22.50 monthly increase for a recipient receiving $1,500 per month. This increase will apply to about 63 million Americans receiving benefits.

The SSA also announced that the wage base will increase from $113,700 (2013) to $117,000 in 2014. This represents a 2.9% increase and as we have posted previously, the rate of these annual increases over the next few years is expected to be dramatically greater than any benefit increase. There is a strong chance that the wage base will be at least $200,000 within the next decade. This increase is expected to apply to about 10 million employees and self-employed workers such as farmers.

The Wage Base is the maximum amount that FICA contributions are owed on. For 2014, a worker who earns at least $117,000 will see 6.2% or 7,254 deducted out of their paycheck and the employer will match this amount and remit it to the government. This represents a total of $14,508 for those 10 million Americans up from the maximum $14,098.80 owed in 2013. For self-employed workers, they will contribute both the employee and employer portion.

Setup Your Deferred Payment Contracts Now

Oct 29, 2013

Over the next few weeks we will post some year-end tax tips and today's post deals with using deferred payment contracts.  Since most Midwest farmers are in the midst of harvest right now, this is the time to think about setting up your deferred payment contracts for year-end tax planning.  These contracts call for delivery of the grain to the elevator with payment being deferred until 2014.  Normally, the farmer would report the income from the sale of this grain when he collects the cash in 2014.

However, the tax laws consider these contracts to be an installment sale and the farmer (when preparing his tax return) can elect to accelerate this income into 2013 if this would optimize his tax situation.  Cash basis farmers are one of the few types of taxpayers that are allowed to make this type of election.

The election is on a contract by contract basis so it is important to have at least a couple contracts in the $20-30,000 range to allow for the correct amount of adjustments to income.  If you have only one contract for $150,000, that may not give you the best flexibility.  Another consideration to make sure you note in your records that you have reported in the income early.  We normally record a receivable on the books and then reverse it out at the beginning of the year.  You tax advisor will usually keep track of it too, however, it is better to record it properly on your books.

Relief for Late Payment Penalties for 2012 Tax Returns

Oct 25, 2013

Most farmers are aware that the IRS allowed filing of their income tax return this year by April 15 instead of the normal March 1 "farmer" filing deadline.  What many farmers may not know is if they extended their tax return and ended up paying additional income tax after April 15, they may not owe the late payment penalty that will be assessed by the IRS.

In Notice 2013-24 issued by the IRS on April 15, 2013, relief from the late payment penalty was extended to any farmer who:

  1. Extended their income tax return timely,
  2. Properly estimated their income tax liability using available information, and
  3. Reported that tax liability on their extension.

 

Any resulting tax liability owed should have been paid in with the extension, however, in many cases, additional tax will be owed and the late penalty will be assessed.  However, 2012 tax year filings were unique due to the late release of many income tax forms that farmers commonly use (such as form 4562, Depreciation, form 8903 Domestic Production Activities Deduction, etc.).  Therefore, this Notice allows taxpayers who prepared and filed their extension correctly to get relief from any late penalty charged as long as one of the forms listed in this notice was part of that tax return.  One of these forms will almost be in every farmer's return.

This means that if you filed after April 15 and got a notice from the IRS owing late payment penalties, you should be able to either not pay the penalty by following the Notice's procedures or send a letter to the IRS asking them to abate the penalty and provide a refund to you.

The 2012 tax filing season is probably the most unusual season I have ever been involved with and I am happy to see it done, however, there is some good news for farmers in certain situations such as the one in this post.

 

180 Months Means 180 Months (Not 156)!

Oct 24, 2013

The US Tax Court on Monday, October 21, 2013 released another Case that I found interesting.  In Estate of Helen Trombetta vs. Commissioner, the Tax Court essentially ruled creating a grantor trust with retained interests having a term of 180 months, you better make sure you live for at least 181 months if you want to save on estate taxes.

Helen Trombetta had created a grantor annuity trust and contributed two valuable pieces of real estate to the trust at age 72.  In return, the trust agreed to make monthly payments to her for a term of 180 months.  After that term ended, the trust assets would then go to her children.  At about month 150, Ms. Trombetta was diagnosed with cancer and after reviewing matters with her tax advisor, elected to change the terms of the trust to terminate the month before her death.

Without going into all of the facts and reasons regarding why this case has messy facts (the document to change the term to the month before death actually said the month after death); when a farmer sets up a grantor trust and retains some type of interest in the trust (i.e. a monthly or annual payment); the farmer must make sure to outlive the term of the trust.  If he does not live that long, then in most cases, all of the value of the trust will be included in his estate.

In this case since she died in month 156 and this is less than 180, then the estate owed tax on the full value of the real estate less related debt.

There is a fine line between picking a date far enough in the future to reduce your gift for gift tax purposes versus picking too long of a term and have it included in your estate.  In this case, Ms. Trombetta picked the wrong term and now her heirs have to pay for it.

Is Your Contract Labor Really Wages?!

Oct 24, 2013

I came across an article in Accounting Today recently discussing states clamping down on misclassified employees (Independent Contractors v. Employers).  While this article focuses on the construction industry, it certainly applies to the agriculture industry as well.

Basically, what the employer v. independent contractor boils down to is who is required to pay employment / self-employment taxes and many millions of lost revenue to both states and the IRS due to the loss of payroll related expenses.  In a time of budget crises, states and the IRS are taking higher interest in the matter. 

The IRS, in Topic 762 - Independent Contractor vs. Employee states you must examine the relationship between the worker and the business and all evidence of the degree of control and independence in this relationship should be considered. The facts that provide this evidence fall into three categories – Behavioral Control, Financial Control, and the Relationship of the Parties.

Behavioral Control covers facts that show whether the business has a right to direct and control what work is accomplished and how the work is done, through instructions, training, or other means.

Financial Control covers facts that show whether the business has a right to direct or control the financial and business aspects of the worker's job. This includes:

  • The extent to which the worker has unreimbursed business expenses
  • The extent of the worker's investment in the facilities or tools used in performing services
  • The extent to which the worker makes his or her services available to the relevant market
  • How the business pays the worker, and
  • The extent to which the worker can realize a profit or incur a loss

Relationship of the Parties covers facts that show the type of relationship the parties had. This includes:

  • Written contracts describing the relationship the parties intended to create
  • Whether the business provides the worker with employee-type benefits, such as insurance, a pension plan, vacation pay, or sick pay
  • The permanency of the relationship, and
  • The extent to which services performed by the worker are a key aspect of the regular business of the company

Another wrinkle is if an independent contractor is paid more than $600 in one year by any one person or business; a 1099 is to be issued.  Also, the IRS recently added an area on all business and rental tax returns where the taxpayer states whether or not they have made payments requiring them to file 1099s and if they have or plan to file them, essentially another way to track and ensure payments to independent contractors are properly reported.

As you can see, some of this can leave a bit to interpretation.  Therefore, it is important that if you have any doubt how to treat a worker, talk with your tax advisor.

Taxpayers Want Their Cake, Frosting and Candles!

Oct 22, 2013

In a Tax Court case issued on Monday, October 21 (Van Alen and Tomlinson vs. Commissioner), we find taxpayers who inherited farmland property subject to a Special Use Valuation adjustment under Section 2032A.  This adjustment allows an estate to elect to reduce the value of the land from its "true" fair market value downwards to its value based upon its rental income stream.  For 2013, the maximum downward adjustment allowed is slightly more than $1 million.

In the court case, the estate obtained a value for the farmland of about $1.963 million, however, when the estate Form 706 was prepared, it listed a fair market value for the farmland of $427,500 and then took a Section 2032A adjustment to reduce the net value reported on the return to $144,823.  Even after all of these downward adjustments, the estate still owed about $100,000 in estate taxes.

Several years later, the two children who inherited a substantial part of the farmland, sold an easement for about $900,000 and essentially argued a basis in the farmland based upon the $1.963 million fair market value, not the actual $144,823 fair market value shown on the original estate tax return.  The Tax Code generally states that the basis of inherited property is its fair market value, however, in several situations including values under Section 2032A, a different value is used.  Section 2032A and the related basis rules requires the net value shown on the return ($144,823) be used as the basis for any future sales, not the "gross" fair market value of $1.963 million that it might have been worth at the time of the estate.

The taxpayers argued that the fair market value of $1.963 million obtained in the year of the estate should have been used for the basis.  The Tax Court  shot down all arguments put forward by the taxpayers.  If the estate had reported a $1.963 million value, it would owe close to $500,000 more in estate taxes (there was a marital transfer that would most likely not make all of the extra value taxable at that time).  Therefore, if the court allowed them to use this value, they would escape the extra $500,000 in estate taxes owed at that time and not have any capital gains tax owed at the time of sale.  This is what I would call getting their cake, frosting and candles.  Instead the Tax Court decided to blow out their candles and did not grant any wish to them.   On top of it, the Tax Court allowed an 20% accuracy penalty assessed by the IRS.

The tax laws can be very favorable to farmers at times, but it is important to follow the rules associated with those laws.  If not, it can be very costly as these taxpayers found out.

IRS Releases List of Counties Eligible for Another Year of Livestock Deferral

Oct 19, 2013

Each year the IRS releases a list of those counties affected by drought in the US.  This list is used by ranchers to determine if they have an additional year to defer the gain from selling excess livestock due to drought.  Section 1033 allows ranchers a four-year period to reinvest proceeds from the sale of livestock due to drought into new replacement livestock.  This four-year period can be extended an additional year if the county the taxpayer resides or operates in or any adjacent county is declared to be in a drought condition.  This additional year can be extended for every consecutive year the county is in the drought condition.

In IRS Notice 2013-62, the IRS has listed those counties for this year.  Many of these counties have been on the list since the start of this process several years ago.  In reviewing the list, it appears that almost every county in Texas is listed, whereas there are no counties in Washington state.

Ranchers would rather not have to sell livestock due to drought, but at least the tax laws provide some help in those situations.

Watch out for those Coop Distributions

Oct 16, 2013

While recently working with a client, I came across a situation I typically do not deal with on a routine basis:  non-qualified patronage distributions from a cooperative. 

A qualified distribution is treated as a deduction on the cooperative return and the producer picks up the income amount.  On the contrary, the cooperative does not get a tax deduction when a non-qualified distribution is given and the producer does not pay tax on that amount.  The IRS defines a qualified patronage dividend as amounts paid:

  1. on the basis of quantity or value of business done with or for such patron,
  2. under an obligation of such organization to pay such amount, which obligation existed before the organization received the amount so paid, and
  3. which is determined by reference to the net earnings of the organization from business done with or for its patrons.

The amount paid in cash must also be 20% or greater of the total distribution, which is what caused the distribution I was working with to be non-qualified.  Essentially, the producer’s patronage equity account was increased by the non-qualified distribution amount, but no cash was received by the producer.

To correctly reflect this on the books of the client, we needed to increase the patronage equity account (an asset) as well as patronage income.  You will recall, however, that a non-qualified distribution is not taxable to the producer.  Therefore, we also made an equal adjustment on the schedule M-1 – Reconciliation of Income (Loss) per Books with Income per Return

For example, let’s say Farmer Joe receives a statement from a cooperative that shows he received $5,000 in patronage equity, but nothing was received in cash and also had net income of $100,000.  To correctly state his investment in the cooperative, Farmer Joe would need to increase his investment asset by the $5,000 as well as book net income by $5,000.  Book net income would then be $105,000.  To correctly report this on the tax return, however, there would be an adjustment on the schedule M-1 that decreases taxable income to $100,000.  Farmer Joe will not pay tax on the patronage until it is paid out in cash in the future.

Therefore, it is important to let your tax advisor know of this situation if it arises or give them all documents related to anything patronage as it may go unnoticed otherwise for cash basis taxpayers as no cash was ever received!  This could be even more important if you have financial statements prepared or give the tax return to the bank for any loan renewals as that extra bit of income (as well as an increased asset balance) always helps!

2012 Tax Seasons Officially Bites the Dust

Oct 15, 2013

Most farmers are used to a March 1 tax filing deadline.  However, for many other farmers and other taxpayers, the final individual tax deadline is not April 15 but rather October 15.  And like many of us from our school days, there are certain taxpayers that like to procrastinate (and procrastinate and so on).  As usual, I had about 10 plus clients to get finally all done and processed today, but I just finished up with the last one about an hour ago and am just waiting to see if I get another call or e-mail.

With this deadline passing, our next major deadline is year-end with planning to get our farmers to the right amount of taxable income.  This results in lots of checks being written on December 31, 2013 to make sure they get a deduction (I hope none of our farmers write the check on December 31 and mail after year-end.  That is not good).

Since we have been tied down with tax extensions we have not been able to post as frequently for the last couple of days.

I will be speaking in front of the Michigan Society of CPAs next Tuesday on "Hedge Accounting".  If any of our CPA readers are there, please make sure to stop by and say hi.

Is 2013 the Last Year to Deduct Sales Tax

Oct 03, 2013

Under current law, 2013 is the last year that individual taxpayers will be allowed to deduct sales and use tax on their individual tax return as an itemized deduction. Sales taxes were allowed to be deducted until tax reform was initiated in 1986. The deduction was eliminated for many years (although state income taxes continue their deductibility). About 10 years ago, Congress reinstated the full deduction for sales and use tax, however, you had to make an election to deduct the greater of sales tax or state income taxes. You could not deduct both.

This provision has been extended several times over the last few years, however, with the constant talk about tax reform and the continued dysfunction of Congress, who knows if it will be extended this year. Therefore, if you plan on making large personal purchase such as a car, jewelry or other larger ticket items, you may want to consider purchasing before year-end. You are allowed to deduct in full the sales tax on larger items plus a table amount that the IRS provides.

For example, assume you live in Iowa and your state income taxes for 2013 ends up being $4,500. You purchase an automobile and some jewelry with sales tax of $4,500. This amount plus the table amount yields a total sales tax deduction of $6,000. You are allowed to deduct $6,000 on your tax return. You lose the benefit of the $4,500 state income tax deduction. This benefit is usually for taxpayers in states with no income taxes such as Texas and Washington, etc.

If you may be subject to the alternative minimum tax (AMT) , you must take care in assuming you will get a benefit from sales or state income taxes. AMT does not allow for this deduction, so in many cases, a taxpayer with a large sales or state income tax deduction will ultimately see no benefit from the deduction due to AMT.

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