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Agenda
• Depreciation
• Deferred Grain Contracts
• Prepaid Farm Expenses
• Taxation of Easements
• CRP and Self Employment Tax
• Federal Tax Estimates for Farmers
• Farm Income Averaging
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Depreciation Update
• 50% Bonus Depreciation expired at
12/31/13 (new equipment)
• Sec. 179 limitation is currently at
$25,000 (new and used equipment)
– Reduced when property placed in service
exceeds $200,000
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Depreciation Update
• U.S. House has passed a bill in June to
make permanent the $500,000 section 179
limit
• Senate not likely to vote until after
November election
• President has promised to veto the bill
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How Do We Plan for This Uncertainty?
• Bill could be passed on January 1, 2015
and retroactively apply to 2014 year
• How do we make sure that income is
“low enough” if only $25,000 section 179,
but still allow for flexibility if section 179
limit is raised?
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Tax Tip #1
• When selling grain in the current year for
next year payment, be sure to use
multiple contracts to allow income to be
“pulled” into the 2014 tax year if needed
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Deferred Payment Grain Contracts
Background
• Sell grain in the fall (title has transferred)
• Wait to take check on January 1st
• Not income until the following year
• Installment sale contract
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Deferred Payment Grain Contracts
Strategy
• Can elect out of installment sale
• Thus, contract by contract, a farmer may make
an election out of the deferred treatment
• Example: You have a $250,000 grain contract.
If section 179 is passed, then you offset the
increased depreciation expense with this grain
income.
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Tax Tip #2 Amortizing Fertilizer
Expense
• If a higher Sect. 179 limit is passed:
– It may be beneficial to amortize the cost of
fertilizer paid for during the year, instead of
deducting it all in the current year
– Amount used each year would be deductible;
usually over 12 months, but may want to consult
an agronomist
– Works similar to deferred payment grain
contract
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Prepaid Farm Expenses
• Definition: Items that are paid for in the year before
the year in which they are consumed or used
• Specifically includes:
– Feed, seed, fertilizer and other similar farm supplies
– Does NOT include rent or interest expense
– Spring-applied fertilizer and chemicals and seed paid
for in the prior year (paid for, but not yet applied)
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Prepaid Farm Expenses Cont.
• Generally deductible in the year of payment for
cash basis taxpayers (including partnerships
and S corps) if three tests are met:
– Test 1: Payment must be for actual purchase (i.e.
enforceable sale contract)
• Specific quantities of specific item(s)
• No right to refund
• Should not substitute for different items
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Prepaid Farm Expenses Cont.
– Test 2: Needs to be for a business
purpose and not merely for tax avoidance
• Discount/fixing maximum price
• Securing adequate supply
– Test 3: Deduction will not result in a
material distortion of income
• Quantity purchased should be comparable to
quantity used in the next year
• Customary business practice
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Prepaid Farm Expenses Cont.
• Limited to 50% of deductible non-prepaid
farm expenses unless:
– Due to change in business operation
– Due to extraordinary circumstances
– Prepaid farm expenses for last three years total
less than 50% of deductible non-prepaid farm
expenses for last three years
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Prepaid Farm Expenses Cont.
• Example:
– Total farm expenses, including
depreciation on Sch F, of $1 million
– $600,000 represents deductible non-
prepaid items, such as depreciation,
chemicals, fertilizer, interest, etc.
– $400,000 represents prepaid chemicals,
fertilizer and seed to be applied next year
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Prepaid Farm Expenses Cont.
• Is any of the $400,000 limited?
– Non-prepaid expenses are $600,000
– 50% of $600,000 is $300,000
– Therefore, prepaid expenses of $400,000 are limited
to only $300,000
– $100,000 carried over to next year
– Limit is NOT 50% of $1 million
– Note: May be able to avoid limit if under
50% limit for prior three years
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Prepaid Farm Expenses Cont.
• Example of prior three years test:
Prepaid Non-prepaid
Prior Year 1 $275,000 $625,000
Prior Year 2 $300,000 $650,000
Prior Year 3 $325,000 $675,000
Total $900,000 $1,950,000
(46% of non-prepaid)
Since prepaid expenses total less than 50% of non-
prepaid expenses for the prior three years, the current
year 50% limit does not apply.
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Taxation of Easements
• Payments for easements can produce:
– Reductions to basis in land
– Long-term or short-term capital gains
– Ordinary income
• Usually have all of the above on the
same transaction
• Can be eligible for like-kind exchange
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Taxation of Easements Cont.
• Perpetual easement with significant
rights retained, such as the ability to
farm the ground:
– Basis in land affected by the easement is
first reduced to $0 by proceeds
– Any additional proceeds are treated as
gain reported on Form 4797 (usually L/T
capital gain)
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Taxation of Easements Cont.
• Perpetual easement with no rights
retained is treated as a sale of the
underlying affected land
– Essentially the same treatment as when
rights are retained
– It is possible for a loss to be recognized if
basis in affected land is greater than
proceeds
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Taxation of Easements Cont.
• Easements that are of specific duration
(or not perpetual) run the risk of being
treated as ordinary (lease) income by IRS
• Temporary easements are rental income
• Crop damage payments are generally
ordinary income
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Taxation of Easements Cont.
• It is possible to reduce the entire basis
of property by damage proceeds if the
entire property is affected by the
easement (severance damages)
– Example: power lines across the middle of
property that was designed for
development
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CRP SE Tax Update
• Before 2003, IRS stated that if taxpayer materially
participated in a farming operation, CRP payments were
subject to self employment tax
• In 2003, IRS took the position that merely signing the CRP
contract resulted in the taxpayer being engaged in the trade
or business of farming
• In 2008, Congress precluded CRP payments from SE tax for
taxpayers receiving Social Security retirement or disability
benefits
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CRP SE Tax Update Cont.
• In 2013, U.S. Tax Court case decided in favor of
IRS in assessing SE tax on CRP payments on land
inherited by an out-of-state landlord
– If taxpayer cash rented the land, no SE tax
would apply
– Ignored prior court cases that stated the
existence of a trade or business is determined
by facts and circumstances
– Note that active farmers will generally
automatically be subject to SE tax
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CRP SE Tax Update Cont.
• Eight Circuit Court of Appeals heard oral
arguments in June 2014, so stay tuned
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Cash Basis Accounting
• Can you pay expenses this fall and – if
later income is found to be too low – just
postpone the deduction until 2015?
• Not really…
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Cash Basis Accounting
• Generally for all other deductions, the
deduction must be taken when payment
occurs
• Arbitrarily postponing expenses is not
allowed
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Cash Basis Accounting
• Cash Basis Exception #1:
− You can begin depreciating equipment
when you legally own the asset and it is
available for use, regardless of when
payment occurs
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Fed Tax Estimates for Farmers
• March 1st deadline for filing and paying
tax
− Can be difficult to have all K-1s ready and file the
return by March 1st
− Solution?
− Pay a January 15th tax estimate
− Pay tax on April 15th and incur interest charge
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Fed Tax Estimates for Farmers
• Be aware you are only charged interest from
January 15th to April 15th, if you elect to pay late
• Federal interest rates are generally very low,
although they are nondeductible
• Interest figured on the smaller of:
− 100% of prior year tax or
− 67% of current year tax
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Fed Tax Estimates for Farmers
• Current Year Tax x 67% x 90/365 x 3%
• $100 in tax owed = $.50 penalty (one-half of one
percent)
• About a 2% annual interest rate (keep in mind,
nondeductible though)
• $100,000 in tax owed = $500 interest charge
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Farm Income Averaging
• All net farm income is eligible for farm
income averaging, even if the taxpayer
does not qualify as a farmer for the
March 1st filing date
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Farm Income Averaging
• Income that qualifies for farm income
averaging besides Sch F net income:
– Gain on sale of equipment or breeding stock (Form
4797)
– Wages to a shareholder from an S corporation
engaged in farming
– Pass through income from farming from partnerships
and S corporations
– Crop share income, provided there is a written
agreement entered into before tenant begins
significant activities
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Farm Income Averaging
• Income that does NOT qualify for farm
income averaging:
– Farm income passed through from a trust
– Gain from the sale of land
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Farm Income Averaging
• Allows a farmer to take current year
income, which is being taxed at higher
rates, and instead tax that income at the
rates in effect for the prior three years
• With rates being increased starting in
2013, make sure this is being computed
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Farm Income Averaging
• Farm income averaging:
– $150,000 of farm income in 2014
– Take $150,000 / 3 = $50,000
– The $50,000 is then taxed at the marginal rate in
effect for
– 2013
– 2012
– 2011
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Farm Income Averaging
• The income on which self-employment
tax is computed is based upon the
current years income and does NOT get
averaged
– In the prior example, SE tax would be based
upon the $150,000 ($150,000 x 92.35% x
15.3% = $21,194)
