by Neil E. Harl, Charles F. Curtiss Distinguished Professor in Agriculture and Professor of Economics, 515/294-6354, email@example.com
Farm families, heading into 1999, face an unusual number of tax challenges. Some deal with income tax, some with estate tax. But they're all important and deserve attention. Here's a quick run down of a half dozen or so of the leading problem areas.
Earned Income Credit
On November 10, 1998, IRS issued a revenue ruling agreeing that gains from the sales of breeding stock and dairy animals don't count as "disqualified income" for purposes of the earned income credit. That's the credit allowed to low income individuals-so long as their disqualified income isn't above $2,300 (for 1998), $2,350 (for 1999). In 1996, IRS had taken the position that gains from dairy and breeding animals counted. At that time, disqualified income was $2,200, rising to $2,250 in 1997.
The new ruling is good news for low income farm taxpayers. It's possible to claim a refund for 1996 and 1997 and to apply the new rules, also, in 1998.
Conservation Reserve Program payments
In an important decision for self-employed farmers, the Tax Court, in June of 1998, held that Conservation Reserve Payments (CRP) are not subject to the 15.3 percent self-employment tax. The question is whether that decision will stand.
The 1998 decision, Wuebker v. Commissioner, was appealed in late November by the Internal Revenue Service to the Sixth Circuit Court of Appeals. A decision from the Sixth Circuit isn't expected until sometime next year-or even later.
That appeal suggests that those receiving CRP payments in 1998 are expected to follow the 1998 decision but taxpayers may want to wait on filing refunds for 1997 and 1996 until the outcome of the appeal is known. Taxpayers may want to file a claim for refund for the 1995 year before April 15, 1999. After that date a refund for 1995 may be barred by the passage of time.
Hog contract losses
In recent years, several meat packers have entered into three to seven year contracts with producers providing, in some form, a minimum fixed price for slaughter hogs. In many instances, the contract sets a price-say $40 per cwt. If the actual price is lower, a negative "ledger balance" is maintained; if prices rise above that level, losses are eliminated and then positive balances are posted to the ledger account.
The problem is that, with low hog prices, the negative ledger balances have ballooned into six figure amounts in some instances and even higher than that in others. If the packer has not filed a UCC financing statement and does not have a perfected security interest, the packer is unsecured and the packer's rights are subject to security interests already existing in the producer's property.
In most cases, it appears that payments received are income for the producer, despite the negative balance. If and when the producer pays an amount to the packer to settle the negative balance account, that should give rise to an income tax deduction.
Reporting government payments
The regular government farm program payments for 1998 (the so-called "AMTA" payments) are taxable on receipt in 1998. The Spring, 1999, AMTA payment which was made available at the producer's option in the fall of 1998, is taxable whenever it is actually received.
The payments received in early November for "market loss" assistance are taxable on receipt and are not deferrable as disaster payments into 1999.
Crop insurance and disaster payments are normally reported as income in the year of receipt. However, operators and share-rent landlords on the cash method of accounting may elect to defer crop insurance proceeds and federal disaster payments to the following year if the taxpayer has a history of deferring a substantial amount in prior years (generally interpreted as more than 50 percent of the crop). It is not possible to defer only a portion of a crop.
Both crop insurance and disaster payments must be treated the same way if received in the same taxable year. Neither need be deferred, even though the taxpayer is eligible, and both can be deferred if the taxpayer elects. But it is not possible to defer one and not the other if received in the same taxable year. Of course, if received in different taxable years, the payments can be treated differently.
One election covers the insurance proceeds attributable to all crops representing a trade or business. An election counts only for the tax year in which made; application to revoke an election must be made to the District Director of Internal Revenue.
A major concern is whether the newer "revenue insurance" crop insurance contracts meet the tests for deferral. IRS, in the past, has insisted that the crop insurance recovery relate to the condition of the crop in order to be deferrable as crop insurance. Legislation has been introduced (but not yet passed) to extend the deferral opportunity to revenue insurance contracts.
Neither LDP payments nor marketing assistance loan repayment "profits" appear to be eligible for the one-year deferral. The statute refers to "…insurance proceeds received as a result of destruction or damage to crops" or federal disaster payments.
Handling debt workouts
For recourse debt (and most farm debt is recourse debt), the rules governing foreclosure transactions or conveyance of property to the creditor in satisfaction of the debt are fairly straightforward:
(1) the difference between the fair market value (or foreclosure sale price) and the adjusted income tax basis is gain or loss, taxable as capital gain or ordinary income as the case may be and
(2) the difference between the fair market value of the property and the amount of indebtedness discharged is discharge of indebtedness income.
Fundamentally, income from farm commodity sales can be deferred legitimately under two provisions – the installment sale approach and the deferred payment option.
Producers are expected to report into income any advances received during the year on deferred payment sales of commodities that are not bona fide loans. There is authority that advances properly treated as bona fide loans need not be reported into income in the year loan proceeds are received. The problem is in showing that an advance from an elevator or other purchaser of commodities is a bona fide loan.
Family-owned business deduction
The family-owned business exclusion enacted in 1997, was transformed from an exclusion into a deduction in 1998. The maximum deduction is set at $675,000 under the new law; the exemption equivalent of the unified credit is set at $625,000 and continues at that level. Thus, the combined amount is $1,300,000 for 1998 and thereafter. If an estate includes less than $675,000 of qualified family-owned business interests, the unified credit exemption amount is increased on a dollar-for-dollar basis but only up to the applicable exclusion amount otherwise available for the year of death. Thus, the unified credit will vary from estate to estate depending on the amount of the qualified family-owned interest deductions.
Because of amendments in 1998, assets are eligible for the deduction even though cash rented before death if the assets are leased to a family member of the decedent or a family-owned entity. Likewise, assets aren't subject to repayment of the tax benefits (recapture) during the 10-year period after death if cash rented to a member of the qualified heir's family or a family-owned entity as tenant.