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February 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.

Farmers Should be Able to File Tax Returns by Monday

Feb 28, 2013

The IRS announced today that most if not all of the forms that we were waiting on to be released should be final and ready for processing by Monday.  Some software providers may be ready a few hours earlier, but we are guessing that all should be ready on Monday.

If you file on or after Monday, you are not required to pay your tax until April 15.  However, in the past, some of our clients have gotten notices indicating tax amount due before the April 15 deadline when filing too early before actual payment.  If you plan is to pay around April 15, we would suggest waiting to file your return until later in March.

On another note, I attended the first day of the Commodity Classic in Orlando today and visited with several clients, friends and others.  This is a great show to meet other farmers and if you have never attended, I would highly recommend it.

The final crop insurance numbers for corn and soybeans were determined with today's trading.  The price is $5.65 for corn and $12.87 for beans.  The corn price is a few pennies lower than last year and the bean price is about 30 cents higher.  This may provide a tiny bit of incentive to switch to beans, but based on what we are hearing talking to farmers, input providers and others, we do not see too much of a change.  Close to 100 million corn acres but probably 2-3 million short (but we know this can change with weather, etc.).

 

How Step Up in Basis Works

Feb 26, 2013

We received this question from one of our readers yesterday:

"With my husband passing away in October 2012, I have sold the cattle & much of the farm equipment. Now wondering how all will fall out as relates to depreciation. Obviously, the sale price was less than when purchased new. Ex: Used 90 Dump Truck on IRS depreciation @ $7,000 in 2004; had to sell for $1,000 for salvage/parts as repair costs exceeded any greater sales value."

We get questions like this fairly often.  When a person passes away, any assets owned by them will get stepped up to fair market value as of the date of death (or stepped down if the asset is worth less than its adjusted tax basis).  If the asset is owned jointly with their spouse, then in most cases, the half owned by the person passing away will get the step up and the other half will continue to be depreciated by the surviving spouse.

Now for those couples living in a community property state, there is an interesting twist in that both halves get a step-up in basis.  Thus, for taxpayers in those states, they get the double benefit of all assets owned by the community (the deceased spouse and the surviving spouse) getting to adjust their cost basis to fair market value. 

For those assets stepped-up in basis you will begin to depreciate them using the class lives called for by the tax rules (sorry, no bonus depreciation or Section 179).

The nice thing about these rules is that you do not have to go back and try to find our what they originally paid for an asset (if not on the depreciation schedule).  The only documentation required is how you arrived at the fair market value of the asset.

In the example of our reader, even though they paid $7,000 for the Dump Truck and most likely fully depreciated it, they would most likely use $1,000 as their FMV value.  If this is not a community property state, then $500 would be their cost basis since the surviving spouse had fully written down her cost to zero.  In a community property state the basis would be a $1,000 and no gain or loss would be recognized.

Remember that this step-up applies to harvested grain that has not been sold.  If you have sold the grain on a deferred payment contract and have not received the cash yet, this does not get a step-up since it is considered "income"  and income items do not get a step up.

Must Have W2 Wages to Deduct DPAD

Feb 25, 2013

We got this question from a reader today:

"Can  the amount I contribute to my solo 401k as deferred compensation be used as wages when figuring the domestic production activities deduction? I have no other wages."

Several years ago Congress placed into law a Domestic Production Activities Deduction (DPAD) that was primarily in response to the World Trade Organization disallowing some of our other tax incentives.  As a result, farmers are entitled to deduct approximately 9% of their net farm income as long as they meet certain other rules.  One of the rules limits the deduction to 50% of W2 wages. 

If the farmer is sole proprietor and has no employees, then the only DPAD deduction available is if they have a flow-through DPAD deduction from a cooperative. 

In the case of our reader, since he has no employees wages and the solo 401k is not considered wages, then no DPAD deduction is available.

This is a case where it may make sense to pay your spouse a wage to take advantage of the DPAD deduction and in many cases it will allow you to deduct more 401k expense.  The offset is that payroll taxes will be owed on the wages to your spouse and that cost may outweigh the deduction benefit.

Safe to File After March 1

Feb 24, 2013

Although we posted on this subject already, we have received multiple questions from readers and other CPAs regarding filing after March 1.  As of the time of this post, there are most likely at least two major forms that the IRS has not yet released that will directly affect most if not all of our farmers. 

First, is form 8582 which reconciles your passive income and loss calculations assuming you may have some activities that are passive. 

Secondly, Form 8903 which is used to calculate your Domestic Production Activities Deduction (DPAD) has not been released.  Every active farmer will qualify to calculate this deduction (you may not end up with a deduction, but should calculate to verify).  Also, if the farmer is a member of a cooperative that distributes a DPAD deduction to the farmer, you will need to fill out this form to claim the deduction.

Therefore, since there are only about 5 days left before the March 1 deadline and these two forms are not yet formally available, there should be no concern with filing after the March 1 normal filing deadline to take advantage of paying the tax on April 15.  The IRS recognizes that substantial delays have been caused by Congress and the President delaying the new law as long as they did. 

The only time to file by March 1, 2013 is if you have a desire to pay your income tax early.  Otherwise, if you would rather wait until April 15 to pay your tax without a penalty, wait until after March 1 to file your tax return.

Good News for Blackberry, Raspberry and Papaya Farmers

Feb 20, 2013

For farmers who raise certain crops with a longer pre-productive life (over two years) such as apples, oranges, and other similar plants, one of the tax rules under Section 263A require all of the costs associated with planting and growing this crop until it reaches economic production to be capitalized and then depreciated over ten years.  The IRS has a list of  these plants which they periodically update.

The IRS just released Revenue Notice 2013-18 removing blackberries, raspberries and papayas from these rules.  This means cash basis farmers will now be able to deduct normal growing costs associated with these plants from the time of planting forward.  Hard asset costs such as irrigation systems, wells, etc. will still be capitalized and depreciated over their normal life.

Revenue Procedure 2013-20 provides guidance on the timing and procedures to follow in making this change.  This should be welcome news for those farmers since accounting and accumulating these costs can provide heartburn to farmers and their accountants.

Irrigated Cropland Values Surge Higher due to Drought

Feb 19, 2013

The Kansas City Federal Reserve issued their latest Agricultural Credit Conditions report for the 4th quarter of 2012. Due to the widespread drought in their area, irrigated cropland values saw a 13 percent jump in the 4th quarter alone and up 30% for the year. Cash rental rates for irrigated cropland also surged more than 20% from the prior year.

Although fourth-quarter incomes were better than expected, but there is concern about the drought affecting certain areas in the months ahead. Capital spending rebounded in the 4th quarter although loan demand remained low.

More non-farmers appear to be buying farmland for recreation and residential development than the prior year, although levels are still much lower than previous years, primarily due to farmers snapping up most of the available land.

Crop land surged by more than 25% compared to the previous year in Kansas and Nebraska with Missouri not too far behind.

1031 Tax-Deferred Exchange Does Not Always Defer All Taxes!

Feb 18, 2013

With farmland prices at or near an all-time high, many farmers are considering selling their farmland and rolling over the gain into other real estate on a tax-deferred basis using a Section 1031 tax-deferred exchange. Under these rules, the farmer has 45 days from the date of closing (not when you sign the offer) to identify the real estate they wish to buy (usually up to three can be identified without any issue) and then another 135 days or 180 days total to finally close on this replacement property.

The farmer must reinvest the net selling price of the property sold in the purchase of the new property. For example, if land is sold for $1.5 million with $100,000 of selling costs and $400,000 of debt paid off, the farmer must reinvest $1.4 million and at least $1 million of cash. They can pay more than that in cash, but the minimum is the $1 million.

If the farmer meets these rules, they automatically assume there will be no tax due, however, certain things can spring a nasty surprise at tax time.

First, the sale of farmland may also involve the sale of personal property such as wells, fences, grain bins, etc. that are subject to Section 1245 recapture. Farm land can normally be reinvested into any other real estate, however, personal property has greater restrictions on what qualifies. If the farmer sold their $1.5 of farmland, but $300,000 of this was personal property that was not acquired for the same kind, then the farmer will have $300,000 of ordinary income that could easily cost $100,000 without having any cash to pay for it.

Second, if the owner of the property lives in a state separate from their land holdings, the whole gain may be subject to state income taxes. Many states require any replacement property to be reinvested in the state of sale. If not, the state will assess tax when the reinvestment property occurs out of state. For example, assume a Missouri resident owns the $1.5 million farm in Oregon and rolls over the farm land into an apartment building in Missouri. Assuming a $1 million gain, this whole amount will be subject to Oregon tax of about $100,000, again with no cash to pay for it.

Third, many taxpayers assume that these day requirements automatically roll over to the next business day which is not correct for Section 1031 purposes. You must count the actual days and if the 45 day or 180 day date falls on a Saturday, Sunday or Holiday, you must make sure to perform the required task BEFORE that date.

This can be a very complicated transaction and it is very important to review this with a tax advisor that understands these rules.

Is a Dynasty Trust Right for You!

Feb 18, 2013

A common question that arises in our meetings with clients is about making sure that the farm remains in the family for multiple generations.  One option for accomplishing this is the use of a Dynasty Trust.  Many states such as South Dakota, Delaware and Alaska allow for trusts that are either perpetual or last for 100's of years.  This allows the farm family to place land into the trust and make sure that the farmland will remain in the family for multiple generations.  However, there are several questions that you must answer before doing this:

  • Is this what all of the family wants to happen?  Has this been discussed with all of the next generation?  Even though the assets may be placed into a trust, if communication has not occurred, "fights" about this may occur.
  • Is the property large enough to support the dynasty trust structure?  The passing of 500 acres to the next generation in a dynasty trust may make sense, however, once it passes onto the next generation or the one after that and there are suddenly 45 beneficiaries of the trust; the use of a trust may not make sense from an administration standpoint.  The fees to properly allocate income and prepare the tax return may exceed the income generated by the trust.
  • How much control from the "grave" are you trying to achieve.  My friend told me the only way to take his fortune to the grave with him was to write a check that could not be cashed.  Is your desire to control this from the grave or do what is best for the next generation(s).  Sometimes this is the same answer, but many times it is not.
  • Is it better to transfer assets now than to wait for the estate?  In many cases, a transfer during life make more sense than waiting for a step-up in basis.  If the land will remain in the family for multiple generations, there will be no sale anyway.  By gifting now, you may be able to escape estate taxes later.  The dynasty trust can be used during your lifetime.

 

These are some of the important questions that must be answered.  There are most likely many others that apply to your situation.  Now is the time to get help from your advisor on how best to accomplish this.

Another Bill to Reduce Farm Payments is Introduced!

Feb 14, 2013

Four Senators (two Democrats and two Republicans) this week introduced a bill "The Farm Program Integrity Act of 2013" to place a cap on farm payments that an individual farmer can receive and try to close "certain perceived" loopholes in the farm payment program.  This bill closely follows language that was included in the original 2012 Senate farm bill proposal.

The bill would establish a per farm cap of $50,000 on all commodity program benefits plus $75,000 on any loan deficiency payments and marketing loan gains.  This would result in an overall $125,000 per farm cap which is doubled for a husband and wife.  The $50,000 cap would apply to any new farm programs that are developed as part of the final 2013 farm bill (assuming one gets done).

The bill tries to close the perceived loophole that currently allows "non-farmers" to qualify for federal farm payments.  This provision will prevent non-farmers from being able to use the management "loophole" that is in the current law.  The bill would clearly define the scope of people who qualify as actively engaged in farming by only providing management for the farming operation.  However, like most law, it is our opinion that "clearly define the scope" will not be quite as black and white as the Senators would like.

Both the National Farmers Union and the National Sustainable Agriculture Coalition support the bill.

On another related note, as part of the Sequester talks, there is a chance that 2013 Ag payments may be reduced.  The discussion right now is an 8% haircut, but we know anything is possible in this process.

We will keep you posted.

Don't Forget the "Magic Blurb" on Donation Acknowledgements!

Feb 13, 2013

We came across this blog from the Internet and it is a great reminder for all of us that will be getting charity donation acknowledgements between now and when we file your tax return.  In order to claim a charity donation, you must get a written acknowledgement from the charity and retain in your files before you file your tax return.

It is important for this acknowledgement to have the "magic blurb" as follows:

No goods or services were provided in exchange for your donation (or similar wording). 

Without this statement, the IRS, if they audit your return, are allowed to completely deny your charitable donation even if you have a cancelled check and the letter from the charity.  There have been several court cases where the IRS has won and disallowed the donation simply due to the omission of this statement from the charity.

If you get one of these letters this year without this wording, please call the charity and have them reissue it in the proper form and let them know that they need to update their system accordingly.  This simple mistake can be very costly.

Yes! You Can Write Off That New Machine Shop (At Least 50%)

Feb 12, 2013

We got the following question from a reader:

"I built a new farm workshop in 2012, can i take 1/2 of the cost off and depreciate the rest over time? I read something regarding bonus depreciation on workshops and was wondering if this qualifies?"

Bonus depreciation was placed into the tax laws as a result of the 9/11 attacks.  It was designed to provide stimulus to the economy and has allowed up to 100% bonus depreciation on any new assets with a tax life of 20 years or less and you are allowed to deduct that percentage immediately.  Unlike Section 179, there is no income limit, however, it must be new equipment or property.

For most real estate investors, bonus depreciation is not allowed since the tax life is either 27.5 or 39 years.  However, all farm buildings including machine sheds, barns, hay storage, etc. have a 20 year life, therefore, they qualify for bonus depreciation.  If you are building a new machine shed this year, it must be finished and in service by December 31, 2013 to qualify for the 50% bonus depreciation.  The remaining 50% is depreciated over 20 years.

As an example, assume our farmer builds a new workshop for $250,000.  He can immediately deduct 50% of this or $125,000.  The depreciation deduction on the remaining $125,000 is 3.75% or $4,688 for a total deduction of $129,688.  Without bonus depreciation, the farmer would only have a $9,375 depreciation deduction in 2013.

Farmer Filing Due Date Update

Feb 11, 2013

As most of our readers know, the IRS has extended the March 1 farmer filing deadline to April 15, 2013 for those farmers who MISS the March 1 deadline.  One of the major forms that farmers were waiting for was Form 4565 - Depreciation which was released yesterday.

However, there are still several forms that will most likely not get released until after March 1 that are important to farmers.  These include:

  • Form 4136 - Credit for Federal Tax Paid on Fuels,
  • Form 8582 - Passive Activity Loss Limitations, and
  • Form 8903 - Domestic Production Activities Deduction.

 

Most likely the most important form is the last one since almost all farmers will have some type of Domestic Production Activity Deduction calculation to perform.  Therefore, there should be no issue with waiting until after March 1 to file and pay your income tax since these forms are most likely not available until at best, near the original March 1 deadline.

Crop Insurance Proceeds on Feed Consumed by Livestock

Feb 10, 2013

We received the following question(s) from a reader:

"My husband and I received crop insurance proceeds this year due to drought. It was for hay and pasture losses. The insurance company classifies the crop as "forage". If this was hay we would normally feed to our cows in the following year may we defer this income to 2013?"

As we have previously posted, crop insurance proceeds can be deferred if the normal practice is to receive more than 50% of crop proceeds in the following year. The reason for this provision to prevent a bunching up of income in one tax year due to receiving crop sales from the previous year plus the crop insurance proceeds. However, with the introduction of farm income averaging several years ago, this is not the problem that it used to be.

With regards to hay used to feed your cows, receiving crop insurance proceeds for this loss is not deferrable. The premise for denying this is that you are not bunching up income in one tax year. Rather, the crop insurance proceeds that a farmer is receiving is being used to purchase feed that is deductible and thus, the additional feed cost incurred during the year would offset the crop insurance proceeds.

Capital Gains Tax on Inherited Property

Feb 07, 2013

We got this question from one of our readers:

"My wife received about 160 acres when her mother passed away 3 years ago in a trust, which came from her grandfather who left it to her mom in trust.  We were told that we will have to pay capital gains tax on what the value of land was back when her grandfather passed away in 1979.  I found the land was valued at $559 an acre then and she sold it in 2012 for $9000.00 an acre.  Is this true and what will we be paying in capital gain tax’s?"

This was not quite the verbatim question (I changed some of the facts to make it more general for purposes of this post and edited some of the sentence structure), but this answer will most likely apply to 1,000s of farm families in 2012 since many sold their inherited land to escape the higher 2013 capital gains tax rates.

Since the land was left to her mother in trust, the value to be used for capital gains tax purposes is based upon the value when the grandfather passed away.  This trust was most likely set up as a "Grandfather" skipping trust and that is why the land did not get a step up in basis when the mother passed away 3 years ago.  These trusts are designed to skip a generation (or more) and not have to pay any estate tax when the mother passes away, however, the potential drawback is that the land does not get stepped up in value when mom passed away.

Therefore, the total gain is about 160 acres times $8,441 per acre or about $1.35 million.  Inherited property always qualifies for long-term capital gains treatment (even held for less than a year) and therefore, the maximum federal tax is 15% or about $203,000.  If the taxpayer's state imposes an income tax, then that rate would be applied to the same gain.  Let's assume that rate is 9%, then the state income tax would be about $122,000 in state taxes for total combined taxes of $325,000.

If the taxpayers had waited until 2013 to sell the land, their state tax would be the same, but their federal tax rate would be about 25% on most of it or an extra $135,000 of tax.

What Will be the February Insurance Price

Feb 06, 2013

February sets the price level for crop insurance on Corn, Beans and some of the other major crops.  Last year's spring price was $5.68 for corn and $12.55 for beans.

We have had 4 trading days for this month out of 20 total and so far the average corn price is $5.89 and the average bean price is $13.40.  After coming off of the large harvest prices, these levels may seem low, but they are still higher than compared to the same 2012 numbers.

We have 16 trading days to go and this Friday's USDA report may provide a dramatic swing either way.

We will keep you posted.

Hedging Versus Speculation

Feb 04, 2013

We got the following question from a reader today:

"I was wondering how to handle the purchase of corn options on your tax return?"

The answer is one of those "It depends" type answer.  If the farmer is purchasing an option for speculation, i.e. he purchases a corn call option, then he falls under the normal mark-to-market rules and will report any gain or loss under the special provisions of Section 1256. 

These rules call for 60% of the gain to be taxed at favorable long-term capital gains rates and 40% as short-term.  If the option is outstanding at year-end, it will be reported as if it was sold for the closing price and gain or loss will be recognized based on that price.

Capital gains are nice since they may be taxed at a lower rate.  Capital losses are not so nice since you generally can only deduct capital losses against capital gains plus $3,000 (this amount is not indexed for inflation and has been around for several years if not decades).  In some cases, you are allowed to carry back these types of losses to offset income from previous year(s) Section 1256 gains.

If the farmer is purchasing a corn put option as part of his hedging strategy, then the gain or loss is recognized only when he closes out the position and it is reported on his schedule F or other pertinent farm schedule.  Hedging gains or losses are alwasy treated as ordinary loss or income on the pertinent farm schedule.

Remember, if the farmer purchases a corn call option as part of this hedging strategy, this no longer qualifies as a hedge (even though is a normal strategy of selling actuals and buying the "board", for tax purposes, it is not a hedge)  and is considered speculation.  In many cases, the tax treatment can be harsh since if the option produces income, the IRS will treat it as ordinary and if it produces a loss, it will be considered a capital loss (the worst of both).

I would hazard a guess that if we "audited" a 100 farmer's hedging accounts, we would find at least one speculation transaction buried somewhere in each of them.  Do you have any?!

Many States Are Delaying Farmer Filing Deadline Too!

Feb 03, 2013

As discussed in a couple of other posts, the IRS has extended the farmer filing deadline from March 1, 2013 to April 15, 2013 for those farmers who "miss" the March 1 deadline.  We are starting to see various states follow suit as follows:

 

Some states base their filing deadline using the federal law such as Illinois and Kansas.  If you live in one of these states, you may not get a notice stating the state has granted relief until April 15 since they are basing your filing deadline on Federal rules.  If this applies to your situation, we would strongly suggest reviewing this with your tax advisor now to determine if your due date is March 1 or April 15.

Since most state income tax law and e-file systems are based upon the federal form 1040 information, we believe that most states will follow the Federal rules on filing your 2012 form 1040, but as someone said to me lately, "logic and tax law do not necessarily go together".

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