Q: Tax Playa, I plan on operating a farm in retirement. What are the tax rules?
Aric, Washington DC
A: In general, the rules for farmers (and fishermen, which is a type of agriculture) are similar to other taxpayers. However, there are some advantages farmers have over others, as well as some drawbacks...
For more information on these topics, please consult IRS Publication 225, Farmer's Tax Guide, and IRS Publication 595, Capital Construction Fund for Commercial Fishermen.
The size and legal structure of a farm is what matters most here. There are two major types of tax accounting: cash-method, in which income and expenses are reported in the year realized; and accrual-method, in which income and expenses are reported in the year incurred.
Most farmers (as well as businesses of any kind) use cash method accounting. There are four types of farmers who must use accrual method accounting:
- A farm corporation (other than a family corporation) that had receipts of more than $1,000,000 for any tax year after 1975
- A family corporation (members of one/three families own at least 50% or two families own at least 65% of voting stock) that had receipts of more than $25,000,000 for any tax year after 1985
- A partnership with a corporation as a partner
- A tax shelter (principle purpose is to avoid income tax, or is a limited-partnership farming syndicate)
Farm Income and Expenses
All income from farm sales are reported (for unincorporated entities) on Schedule F. Farm rental is also income that needs to be reported.
Commodity Credit Corporation loans are income. Crop insurance and crop disaster payments are income. Conservation Reserve Program monies are not income. Cost-sharing conservation payments are not income. Quota buyout payments are income, as are tobacco settlement funds. Farm cooperative funds are income.
- If you are cash-method and pre-pay farm expenses, the deduction in the current year is limited to 50% of your non-prepaid farm expenses
- All costs of labor (including tenant housing) are deductible
- Marketing quota penalties are deductible
- Soil and water conservation expenses are deductible
- Land is not depreciable
- Single purpose horticultural structures, crops, and livestock are eligible for Section 179 expensing
- Farmers get accelerated depreciation on farm buildings (20 years), horticultural/agricultural structures (10 years), and livestock (between 3 and 7 years)
If a farm is sold, the farmer has the choice of reporting the entire gain the year of sale, or reporting the gain in installments (gain plus interest plus return of principal) every year thereafter.
A casualty loss is allowed for crops and livestock purchased for resale, but not those grown by farmers.
Farmers need to pay Social Security and Medicare tax for their workers if they pay any one of them more than $150, or all of them more than $2500. In some cases, the crew boss of the workers may be an independent contractor who has workers as employees.
A credit for excise taxes paid for farm use can be made for gasoline, diesel, and kerosene.
Farmers are not required to pay estimated tax if their full tax payment for the prior year is paid by March 1st, or if they expect their income to be 1/3 or more less than the prior year.
A qualifying farmer may elect to average their income over the prior three years rather than pay taxes entirely in the current year.
Fishermen may open a capital construction account to purchase boats and other fishing equipment. Doing so means that the equipment cannot be depreciated or expensed. Contributions to this account are unlimited and deductible against fishing income.