Center for Agriculture Law and Taxation, Iowa State University
Farming is a complicated business. Farmers must not only be experts in the field of crop and livestock production, they must also navigate state and federal laws regulating myriad aspects of their businesses. To remain profitable and avoid penalties, farmers must stay on top of tax laws, many of which specifically apply to farming operations. Most farmers find it beneficial to employ experts to prepare and file their tax returns and assist them with tax planning. Nonetheless, it is crucial that farmers, like other business owners, understand the state and federal tax implications of business decisions they make. This article provides a general overview of Schedule F (Form 1040), the backbone of federal farm income and expense reporting for sole proprietors. It is designed to be a helpful primer, not a comprehensive overview or a substitute for professional advice.
Farmers who operate their businesses as a sole proprietorship or through a trust or partnership must file a Schedule F to report their farming income and claim their expense deductions. Income from farming includes income earned from cultivating, operating, or managing a farm for gain or profit, either as an owner or a tenant. Farm income includes that derived from operating stock, dairy, poultry, fish, fruit, or truck farms. It also includes income earned from a plantation, ranch, range, orchard, grove, or nursery specializing in ornamental plants. Farmers who rent their crop ground to a tenant only report the rental income on Schedule F if they receive that income through the sale of crop shares and they materially participate in producing the crop. Cash rental income, on the other hand, is “rental income” reported on Schedule E.
Although Schedule F includes gains or losses from the sales of farm products raised for sale, it does not include gains or losses from the sale of:
• Depreciable Farm Equipment
• Building and Structures
• Livestock held for draft, breeding, sport, or dairy purposes
Schedule F is organized by accounting method. Farmers who use the cash method of accounting complete only Parts I and II of the form. Farmers who use the accrual method of accounting complete Parts II, III, and Part I, line 9. Although there are exceptions, the cash method of accounting allows farmers to generally deduct their expenses in the year in which they pay them. Similarly, they report their income in the year in which it is actually received. Conversely, under the accrual method of accounting, expenses are reported in the year in which they are incurred, regardless of when they are paid. Similarly, in general, income is reported under the accrual method when it is earned, not when it is received.
Although most businesses are required to report their income and expenses using the accrual method, farmers are allowed to use the cash method of accounting. The United States Tax Court has described this as “an historical concession” to provide a “unitary and expedient bookkeeping system for farmers and ranchers in need of a simplified accounting procedure.” Consequently, most farmers continue to use the cash method of accounting.
Farm income is reported on Part I of Schedule F. This income includes that derived from the sale of livestock, produce, and grains raised by the farmer. It also includes payments received from crop insurance and farm programs such as the new agricultural risk coverage and price loss coverage programs. Also reported in Part I are patronage dividends received from a cooperative, custom hire income, and “other income,” such as state gasoline or fuel tax refunds, bartering income, or income from the cancelation of debt.
Farmers report their farm expenses on Part II of Schedule F. The “ordinary and necessary costs” of operating a farm for profit are generally deductible as business expenses. Farmers are typically entitled to a number of important deductions. These do not include any expenses for personal or living expenses that do not produce farm income. Expenses, such as telephone expenses, that may be paid for both business and personal use must be allocated between the two uses. Farmers may only deduct that portion of the expense properly attributed to a business purpose.
Generally, a farmer’s input costs are deductible business expenses. Subject to certain limitations, farmers may also deduct prepaid expenses. This is often an important tax planning tool.
Farmers can deduct the reasonable wages paid for workers hired to assist in the farming operations. Also deductible are employee benefits paid to those workers. Many farmers are able to deduct wages paid to family members, as long as the wages are reasonable and a true employer-employee relationship exists.
One fairly complicated category of deductible expenses is that for “repairs and maintenance.” Generally, farmers may deduct the cost of repairing and maintaining farm property. This includes, for example, the cost of replacing shingles on farm buildings or routine maintenance of farm machinery. Improvements designed to prolong the life of business property, however, must be capitalized, not deducted.
Other common expenses farmers may usually deduct include interest paid on farm mortgages, certain breeding fees, the cost of fertilizer or lime if the benefits last a year or less, real estate and personal property taxes, business insurance, rental payments (for property used in the farm business), depreciation, truck and car expenses, veterinary expenses, and business use of home.
Farmers, like other taxpayers, can deduct business-related fees paid to accountants, bookkeepers, and attorneys, fees for educational expenses designed to improve farming skills, and the costs of subscriptions to farming publications. Those in the business of farming may also deduct many soil and water conservation expenses. The amount of this deduction, however, cannot exceed 25 percent of the amount of gross income received from farming.
Many self-employed farmers are entitled to deduct the cost of medical, dental, and qualified long-term care insurance they purchase for themselves and their family members. This deduction, however, is taken directly on Form 1040 and is not reportable on Schedule F.
As noted above, farming is not an easy business. Although they are encouraged to work with accountants and attorneys, farmers must have some expertise in tax and business planning to make good decisions. This article provides only a basic roadmap of Schedule F, the form on which farmers must report profits or losses from their farming operations. Many additional resources are available. One starting point is Publication 225, the IRS’ Farmer’s Tax Guide. Another resource is Iowa State University’s Center for Agricultural Law & Taxation. The Center offers a number of free resources on its website. It also offers access to a more technical online subscription-service call TaxPlace.
Agro-Jal Farming Enterprises, Inc., et al. v. Comr., 145 T.C. No. 5 (2015).