Sep 22, 2014
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March 2014 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.

Taxpayer Victory in Frank Aragona Trust Case

Mar 27, 2014

The US Tax Court released today their long anticipated decision in the Frank Aragona Trust case. This case had been previously decided in favor of the IRS and then appealed to the Tax Court. The background on the case is as follows:

  • The Frank Aragona Trust was formed by Frank Aragona during his lifetime and after his death, the trustees of the trust were his five children plus an independent trustee. Three of the children trustees were also employees of a LLC which was 100% owned by the trust and two of these children were also part owners of other LLCs which were majority owned by the trust.
  • The trust incurred substantial real estate losses during 2005 and 2006 which were carried back to 2003 and 2004 to get income tax refunds. The IRS audited the tax returns and disallowed those losses due to their conclusion that the trust did not materially participate in these real estate activities. The IRS asserted a trust could not provide personal services to meet the material participation test, only an individual or an C corporation meeting certain requirements.
  • However, the Tax Court decided that a trust could in fact provide personal services and that the activities of its employees and trustees could be attributed to the trust and if they provided enough hours of activity, then the trust could deduct the real estate losses.

In the case of the Frank Aragona Trust, the Tax Court concluded exactly that. They indicated that the services provided by the three trustees (and the employees) were more than sufficient to allow the trust to deduct these real estate losses. Another factor in favor of the trust was the three trustees were employees of a LLC owned 100% by the trust. This allows all of their activities to be attributed to the trust. If these trustees had been employees of a LLC not related to the trust, the case decision may have been decided otherwise.

Many farm holdings have now been placed into trust for the benefit of children and grandchildren. This decision would allow "farming operations" with enough material participation by trustees and employees to fully deduct those losses and not have any income subject to the new 3.8% net investment income tax. However, for most farmland placed in a trust that is cash rented or crop shared, these losses would most likely still not be deductible and any income would be subject to the new 3.8% tax (once trust income exceeds about $13,000).

Although a victory for the taxpayer, it will primarily apply to those larger trusts with major farming or ranching activities.

Painful Form 8879 Process is on its Way

Mar 26, 2014

Almost all of our tax returns that we prepare for farmers are now being electronically filed with the IRS and related state taxing authorities. The form that we need from the client in order to electronically file the return is Form 8879. This form must be signed by an appropriate person for entities and then the taxpayer(s) for individual filing. We do not file this Form with the IRS, but must retain a copy in our records.

Kristy Maitre (formerly with the IRS and now part of Iowa State University's Center for Agricultural Law and Taxation (CALT)) just released a draft of the new instructions for using this form and many of these changes can be painful for tax preparers and their clients.

Electronic signatures are allowed, however, the tax preparer must record the following data:

  • Digital image of the signed form;
  • Date and time of the signature;
  • Taxpayer's computer IP address (remote transaction only);
  • Identity verification: taxpayer's knowledge based authentication passes results has been verified and for in person transactions, confirmation that government picture identification has been verified; and
  • Method used to the sign the record (e.g., typed name), or a system log, or other audit trail that reflects the completion of the electronic signature process by the signer.

There is an Indentity Verificiation Process that must now ensure the validity of any electronically signed record. If there is more than one signature, then each must be verified.

For taxpayers signing the form in our office, we would be required to inspect a valid government picture identification; compare the picture to the applicant, and record the name, social security number, address and date of birth and other personal information on record are consistent with information provided through record checks with the applicable agency or through credit bureaus or similar agencies. If the preparer is unable to complete identity verification after three attempts, then they must obtain a handwritten signature.

As more and more information goes completely digital, it now will require more and more due diligence on us as tax preparers to confirm the identity of the signers of these forms. There has been way too many cases of stolen identities to obtain fraudulent income tax refunds and due these issues, the IRS will most likely issues these instructions for the 2015 tax season.

I am not looking forward to this, but if it substantially reduces fraud, then it is probably worth it.

One More Reason Why Tax Reform is Going After Cash Method

Mar 24, 2014

The IRS issues data regarding income tax information for filers every year. I ran across a posting on the net farm income and loss reported by Schedule F farmers for 2011 and 2012. During each of these years, the USDA estimated that farmers had net farm income in excess of $120 billion.

However, on schedule Fs reported by individual farmers, they showed a net loss in 2011 of about $7.11 billion and for 2012 a net loss of $5.06 billion. There were about 1.845 million schedule Fs filed for these years. Many farmers now report their farm income using a flow-through entity such as an S corporation, LLC or partnership. This income would not be reported as part of this Schedule F loss. However, based upon our history with our farmers who use flow-through entities, their bottom line income or loss is normally not all that much different from Schedule F filers (other than hobby farmers which could distort this number a bit).

Let's assume that these farmers in fact report more income leading to net farm taxable income of $20 billion. This still leaves about $100 billion of net farm income that Congress thinks they can get their hands on. Over a 10 year period assuming an average 30% tax rate, this is about $30 billion of extra taxes flowing to the IRS each year. Over 10 years this adds up to $300 billion and that is one of the reasons why Congress wants to change higher revenue farmers to the accrual method of accounting.

Although this may be a simplistic calculation and does not factor in possible extra Section 179, it is a lot of money and if tax reform goes through, this extra income may be tough for them to pass up.

We will keep you posted on their efforts.

The FSA Issues a Farm Bill Fact Sheet

Mar 19, 2014

The FSA released today a six page fact sheet on the new farm bill. It recaps the major changes that were included in the 900+ page farm bill. Most of the material has been covered on several of our posts over the last month or so.

We are doing a webinar on the new farm bill on Wednesday April 9, 2014 at 10 am Central time. The webinar will cover the major changes included in the new farm bill including some examples of how PLC and ARC work and what farmers should know about the farm bill. Just click here to sign up for the webinar. There is no charge (only potential drawback is you would have to listen to my voice for about 45 minutes).

On a personal note. I am sitting in the Minneapolis airport writing this. I left Pasco yesterday at 4:40 PM and arrived in Kansas City at 11:30 PM (don't worry, I got my 12 hours of work in before I left for the airport). Today, the TV taping crew from Ag Day and Kevin Spafford of the Legacy Project did a taping at a Platte City, Missouri farm family. He had immigrated from Holland about 30 years ago and started a farm from scratch. A great story and it will be aired on Ag Day next Friday March 28. I invite everyone to view the show (I have two separate three minute segments).

Cash Rents Equals Extra 3.8% on Sale

Mar 18, 2014

We had a reader ask the following question:

"Can you give some advice on the impact of retiring from active farming and cash renting the farm as it relates to the 3.8% tax on capital gains. Given a large increase in the land value while actively farming, do you give up the exemption from the 3.8% Obamacare capital gains tax when you or your wife or heirs ultimately sell the farm because you used it for rental or investment income right before it was sold?"

As the reader indicates in his question, the passing of "Obamacare" back in 2010 resulted in a new net investment income tax that applies to cash rents and gains from selling farm land if your adjusted gross income is greater than $250,000. If you are actively involved in farming the land and your ground is owned by a LLC or partnership that rents the ground back to you as the farmer (either as a Schedule F sole proprietor or in an entity), this rent income is not subject to the extra 3.8% tax. The final IRS regulations issued last year indicated that this type of self-rental income is exempt from the tax.

However, once you are done farming and are simply renting the ground to other farmers (including relatives), then the rental income will be subject to the tax and even worse, selling the farmland for a large gain will result in extra tax.

For example, assume Farmer John owns 3,000 acres in a LLC with his wife. They cash rent the ground to his farm S corporation. The cash rent paid each year is $750,000. While he is actively farming, none of the $750,000 of cash rent will be subject to the tax. However, once he retires, all of the cash rent income will be subject to the new 3.8% tax (assuming enough other income to get them over the threshold amount). This results in $28,500 of extra tax each year.

If they sell the land for $30 million and have a gain of $20 million, they will owe capital gains tax of about $4 million (20%) plus another $760,000 for the net investment income tax plus any state income taxes. If they sold the farmland while actively farming, they would still owe the $4 million of capital gains tax, but not the $760,000 of NIIT.

Farmer's average age now exceeds age 58. This new tax may even increase the average in the future.

Real Estate Includes Land but Not For Depreciation Purposes

Mar 17, 2014

We had a reader send in the following comments and question:

"I appreciated your information on the tax reform proposal. In your 4th bullet point on depreciation, you stated that "Most if almost all farm real estate...would be over 40 years and not the current 10 or 20 years." It has been my understanding that land real estate is never depreciable, but farm buildings are depreciable. Does the term "real estate" refer only to land or does it also include farm buildings or structures? Could you help me understand your statement above, and clarify my question?"

When discussing depreciation in regards to farm real estate, we are normally referring only to the buildings or structures that are attached to the land. As the reader indicates, land is never depreciable, however, the buildings attached to the land can be depreciated. They are usually depreciated over either 20 years for most general purpose farm buildings or in the case of single purpose agricultural structures, these are depreciated over 10 years. In some cases, what most people would consider to be a building, such as a potato storage shed, is actually considered more like a piece of "equipment" and usually depreciated over seven years.

The proposed tax reforms by both the Senate and House would stretch these lives out to 40 years for almost all farm buildings. Their is a chance that single purpose ag structures would retain a 10 year life, but I would not count on it if tax reform goes through.

Now many people ask me why does Congress really want to make these changes. depreciation is not an extra deduction, but rather just a timing mechanism for when the deduction will be taken. There lies the rub. The scoring of these tax reform changes are based over a 10 year period. By stretching out the lives to greater than the current lives, more revenue will be generated in the first 10 years. It does not matter that there will be less revenue for Congress after 10 years, they really only care about the first 10 years.

A Bad Day in Court

Mar 14, 2014

The Tax Court today released the Kaplan case. Gary Kaplan was a professional sports bookie. He started his career in the US and then moved it to the Caribbean before finally settling in Costa Rica. During this time, he formed a company called BetOnSports PLC. This company became the most successful overseas sports booking company (although about 98% of its business was from US customers).

In July 2004, BetOnSports went public on the London stock exchange. As part of this transaction, Mr. Kaplan transferred his shares to various trusts based in the Isle of Jersey. The trusts then sold shares in BetOnSports during 2004 and 2005, netting the trusts (really Mr. Kaplan) about $97 million.

In 2006, Mr. Kaplan was sued by the US Government for RICO and other charges and finally settled the case in 2009 for $43,650,000, about one-half of the Mr. Kaplan's remaining assets. As part of the plea bargain, the parties agreed that the government would not try Mr. Kaplan for any other issues related to his betting activities. In return, he would be allowed to keep his remaining funds.

The plea agreement was signed off by all parties and then, you guessed it, the IRS came calling. They issued a tax judgment against Mr. Kaplan in the amount of $24 million of tax, $12 million of various penalties and most likely interest of another few million on top of it. Since at most, Mr. Kaplan only had about $43 million of assets after his plea settlement, he was not pleased to see close to 90% of it going to the IRS.

He sued the IRS in court claiming the statute of limitations had passed. Since he had not filed a tax return for 2004 or 2005, the statute keeps running, so he lost that argument. He also argued that the plea agreement prevented the IRS from bringing a civil claim against him. The Court disagreed. He also pled that the trust's were the owner of the shares. The Court also shot this down by indicating these trusts are in fact grantor trusts. Under grantor trust rules, all income and expense of the trusts are directly attributable to the grantor of the trust.

Therefore, Mr. Kaplan lost on all arguments and owes $40 million to the IRS. This leaves him with $3 million to pay his healthy attorney fees. I am guessing from his original $97 million pay-day, he will end up with less than a $1 million. This is what I call a bad day in court.

This does not have much to do with farming, but, if you are thinking about placing assets in overseas trust to "hide" your income from the IRS; I would not recommend it. I would not want to see you have a bad day in court like Mr. Kaplan.

Permanent Means Permanent

Mar 12, 2014

Many farmers will sell or grant a conservation easement to various organizations. These easements are designed to permanently keep certain farm land out of production due to their sensitive topsoils or other features.

If the granting of the easement is structured properly, the difference between the fair market value of the land before the easement and the value after granting it will result in a charitable deduction. However, in order for the deduction to be allowed, the easement must be permanent. The definition of permanent is usually determined by state law.

The Tax Court yesterday released the Wachter v. Commissioner case that determined under North Dakota Law, an easement can only last for 99 years. Since 99 years is not "permanent", the Court ruled in favor of the IRS and disallowed the charitable deduction for the three year period covered by the case.

The Wachter's held varying interests in WW Ranch, a partnership and Wind River Properties, LLC. WW Ranch entered into an arrangement with North Dakota Natural Resource Trust (NDNRT) regarding a conservation easement. These easements were donated over a three year period (2004-2006). For each year, two appraisals were done, one to determine the value before the easement and the second to determine the value after the easement. Since the property was sold to the trust, the net contribution deduction was equal to the value before the easement less the value after the easement less the amount of sale proceeds. For 2004, the Wachter's took a deduction of $349,000, $247,550 in 2005 and $162,500 in 2006.

North Dakota law regarding easements is unique. It appears to be the only state in the country that limits easements to 99 years by law. Since the Tax Code requires that the conservation easement be of a permanent nature, the Tax Court ruled in favor of the IRS and disallowed all of the easement charitable donations.

The Tax Court case also dealt with certain issues pertaining to cash donations made by the Wachter's to NDNRT during these same years. The dispute revolved around lack of documentation and whether goods and services were provided to the taxpayers by NDNRT. The Tax Court did not give a final ruling on this issue.

The bottom line is that when the Tax Code says permanent, it means permanent.

When to Report Hedging Gains or Losses?

Mar 11, 2014

We had a reader send in the following questions:

"We have an accrual basis farm partnership, for income statement purposes we have used the mark to market approach to the value of the hedge which was at a gain. For income tax purposes can we report the gain or loss when the hedge is closed?"

Many farmers hedge their crops by using futures or futures options contracts. For financial reporting purposes, these gains or losses are marked to market as of the balance sheet statement date. The farmer would record a gain or loss based on the closing prices as of that date.

For income tax purposes, hedges are normally not reported until the hedge is closed. In some cases, a farmer can make an election to mark-to-market their hedges, but normally, the farmer will elect to use the regular method since that allows them to report the gain or loss when the crop is sold (or feed purchased).

The Farm Financial Standards Council has issued new guidelines including a new hedging gain or loss reporting appendix. If you are interested in getting the guidelines, you can access them at the website and I would highly recommend downloading them. The cost is fairly minimal and you will get your value out of them very quickly.

How Much Longer for Section 1031 Exchanges?

Mar 05, 2014

In the budget proposal just released by President Obama, he calls for a cap on the amount of gain that could be deferred under Section 1031. This cap would be $1 million each year indexed for inflation. The tax reform proposals released by both the Senate and the House call for major changes to like-kind exchanges.

Under the Senate proposal released late last year, it would eliminate direct Section 1031 exchanges. Instead, all sales of fixed assets in a pool would be used to reduce the pool amount and if it went negative. At that point, the taxpayer would report the negative amount as gain. For sales of real, no Section 1031 gain deferral would be allowed.

In the House proposal released last week, it eliminates Section 1031 gain deferral completely.

The real estate industry has a very effective lobby, however, when you have the President, the House and the Senate asking for major changes to the tax deferral rules, you must be concerned. Most likely, nothing will happen this year, but in 2015, watch out.

We will keep you posted.

Additional Tax Reform Items

Mar 05, 2014

Last week, we had a quick overview of the tax reform proposals put forth by Dave Camp of the House Ways and Means Committee. After reading about the proposal further, there are some additional items that would affect farmers. Remember, this is just a proposal and nothing will happen this year. There is a chance that some change may occur next year, but nothing this year. Here are some additional items;

  • The current deduction for fertilizer costs would be eliminated. Instead, a farmer would be required to amortize the cost of the useful time period of the fertilizer application.
  • Although farmers would be allowed to retain the cash method of accounting, it appears that if your average sales exceed $10 million, then you would be required to use the UNICAP method for inventories including farmers. This would require these farmers to capitalize all costs related to producing a crop (including most depreciation deductions) and not deduct any of these costs until the crop is sold. This essentially eliminates the cash method of accounting for deductions for these farmers but retains it for sales.
  • The one-year deferral of crop insurance proceeds election would be eliminated.
  • The one-year deferral of livestock sales due to drought would be repealed.
  • Hedging gains and losses would still be reported under the current method. They would not be marked-to-market.

These are the additional farm related items that I found, however, remember, this is not a law and it will not happen this year.

When Will Productivity Start Increasing Again?

Mar 02, 2014

Co Bank provides loans to cooperatives and other Farm Credit Service banks across the country. They also issue a monthly Outlook and for the February issue, Lee Ohanian, an economist with UCLA was interviewed regarding the lack of growth in productivity over the last few years.

In layman's terms, productivity represents the growth in total GDP divided by the number of people in the workforce. The long-term historical average annual growth has been about 2.5%, however, since the recession hit in 2008, the growth rate is about 1.1% per year. To increase this rate, business needs to invest in new equipment and infrastructure and since 2008, they have not done much of this, except for the farming industry. Without the investments by farmers, I would guess the productivity growth rate would be even lower than what it currently is.

Business continues to be worried about the Affordable Care Act (Obamacare), Dodd-Frank, Environmental regulations and demand for their products. Until there is better focus on these items, productivity growth will remained constrained.

Over history, agriculture has been a shining star of productivity growth. In the late 1800s, about 60% of the total workforce was working on farms. Today, one half of one percent of the workforce is engaged in producing food. Over the next few years, this percentage may continue to decline. It is a remarkable success story.

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