For many, farming and agriculture are passions. In a time where people are turning back to their roots, many people are struggling to learn the ways of agriculture, and also, to make it a profitable business for their family. With high startup costs, losses in crops or livestock, a fluctuating market, and countless other factors, it can be difficult to navigate the business of agriculture.
They say that there are two constants in life, death and taxes. While we do all that we can to fend off the first part of that saying, there is no holding off Tax Day. However, Tax Day tends to invoke fear in farmers more than the average citizen due to conflicting information and ever-changing laws regarding deductions and fluid nature of a farm and its assets.
The first step in tackling your farm’s taxes is to familiarize yourself with Internal Revenue Service’s (IRS) Document 225. This publication lists in details how the federal taxes apply to farms and agriculture. Due to the potential complexity of farm taxes, many farmers opt to use a tax professional or an accountant to handle their tax needs. Often, this is the safest route as it offers trained eyes a chance to make sure that nothing with catch the unwanted attention of the IRS. Also, professionals are often able to locate other deductions or credits that you may miss, simply from your lack of training.
Organizing your documents is a vital aspect of successfully completing your taxes. When it comes to preparing your documents for your tax professional, it is important to bring them as much information, as well organized as possible. Not only will this extra attention to detail help you to manage your bookkeeping, but it will help your tax preparer to be able to focus more on you return, not organization.
When filing your taxes as a farm, you will need to file “Schedule F”. A schedule F form helps you to break down your expenses, and sales. The Schedule F includes questions about sales of livestock, crop insurance, cost of livestock, and cooperative distributions. Familiarizing yourself with the questions on the Schedule F form will help you to know how to break down your income and expenses more effectively.
Where many farmers walk a fine line, is to try and label a hobby farm as a business. A farm should always be run as a proper business unless it truly is just a hobby. To avoid being classified as a “hobby farm”, the IRS looks for farms to show profit for three out of five years. If there is doubt as to whether or not your farm can fulfill this requirement, reevaluate your business plan and look for more income potential for your farm, or see what can be eliminated. Often these small shifts in management can result in profit for your farm.
A problem with consistently showing profit often lies in the fact that farming can be a fickle thing. Unlike many other businesses, farmers are not only subject to the whims of the market and consumers, but also nature. A drought, can quickly and unexpectedly, make a profitable year, one of great loss. This is another scenario where proper bookkeeping habits can prevent a full audit. When examining farm tax documents, the IRS takes into account many factors. Some of the factors that will be investigated are business plans, business like bookkeeping and records, involvement with extension agencies, history of farming success, and even the pursuit of certifications. In the event of a poor year, this extra effort placed into your business can be enough to prove that you were merely a victim of unforeseen circumstances, and not just a hobby farmer in the eyes of the IRS.
In the event of an unforeseen emergency striking your farm, the IRS actually has protections in place for these occasions. If a farmer is forced to sell livestock due to an unforeseen event, they can elect to use Involuntary Conversion rules.
The Involuntary Conversion rules allow you to postpone the “gain” received from selling the livestock, until replacement stock is later sold. Generally, the replacement livestock must be purchases within four years. However, certain exceptions can apply to the timeframe. If your farm is in a federally declared Disaster Area, it is possible to get a grace period for additional time for the replacement period. Also, in extreme cases, a farmer may be allowed to invest forced sale proceeds into another business venture if farming is no longer practical.
When it comes to farm taxes, many people focus only, or mainly, on deducting their expenses and purchases from the year. However, one of the largest, and most overlooked, deductions for the farm is depreciation. Depreciation can be associated with machinery, vehicles, barns, and even animals (if purchased for draft, breeding, sporting or dairy purchases)! In some situations, depreciation can even be associated with preparing the land for agricultural use.
Just like stores, end of year inventory is also required for farms. Inventories should include all unsold items at the end of the year, whether raised or purchased, regardless of if they are held for sale or future use. Even items like feed and seed should be included in your year-end inventory.
When it comes to documenting these items, there are different methods that can be used to assign value to them. The methods used are cost, lower of cost or market, farm-price method and unit-livestock method. When it comes to livestock, they can be classified as a depreciable asset, which is usually done for beginning farmers, or inventoried using the unit-livestock method, which is the common practice in larger operations.
Similar to other businesses, farmers need to document mileage on their vehicles for tax purposes. There are two main methods for reporting mileage of farm vehicles. The actual method, is where the exact, actual miles are recorded and documents. In order to use this method, vehicles need to be use over 50% for the purpose of farming. The mileage method is better suited for those that are not disciplined in their record keeping, and those that claim 75% business use for their vehicle. However, once you begin using the mileage method for your vehicle, you must continue to use this method for your taxes.
Another deduction that is commonly overlooked by farmers is the home office deduction. This deduction is calculated based on the square footage of your residence, and its relation to the size of your office. This deduction is then applied to expenses such as your mortgage interest, real estate taxes, utilities, insurance, depreciation or even rent. In some cases, a farmer’s office is not in their residence, but in a barn or other outbuilding. In these cases, some expenses, like mortgage interest, would have to be allocated in a reasonable manner to account for the space.
Armed with information, the yearly drudgery of Tax Day does not have to be a scary proposition. Through familiarizing yourself with the laws, deductions, and by ensuring that your data is properly documented, you can avoid the audit. When it comes to taxes, an ounce of prevention is truly better than a pound of cure!