Written by Barry Ward, Leader, Production Business Management & Director, OSU Income Tax Schools
Prevented Planting Crop Insurance Indemnity Payments
With unprecedented amounts of prevented planting insurance claims this year in Ohio and other parts of the Midwest, many producers will be considering different tax management strategies in dealing with this unusual income stream. In a normal year, producers have flexibility in how they generate and report income. In a year such as this when they will have a large amount of income from insurance indemnity payments the flexibility is greatly reduced. In a normal year a producer may sell a part of grain produced in the year of production and store the remainder until the following year to potentially take advantage of higher prices and/or stronger basis. For example, a producer harvests 200,000 bushels of corn in 2019, sells 100,000 bushels this year and the remainder in 2020. As most producers use the cash method of accounting and file taxes as a cash based filer, the production sold in the following year is reported as income in that year and not in the year of production. This allows for flexibility when dealing with the ups and downs of farm revenue.
Generally, crop insurance proceeds should be included in gross income in the year the payments are received, however Internal Revenue Code Section (IRC §) 451(f) provides a special provision that allows insurance proceeds to be deferred if they are received as a result of “destruction or damage to crops.”
As prevented planting insurance proceeds qualify under this definition, they can qualify for a 1 year deferral for inclusion in taxable income. These proceeds can qualify if the producer meets the following criteria:
- Taxpayer uses the cash method of accounting.
- Taxpayer receives the crop insurance proceeds in the same tax year the crops are damaged.
- Taxpayer shows that under their normal business practice they would have included income from the damaged crops in any tax year following the year the damage occurred.
The third criteria is the sometimes the problem. Most can meet the criteria, although if producers want reasonable audit protection, they should have records showing the normal practice of deferring sales of grain produced and harvested in year 1 subsequently stored and sold in the following year. To safely “show that under their normal business practice they would have included income from the damaged crops in any tax year following the year the damage occurred” the taxpayer should follow IRS Revenue Ruling 75-145 that requires that he or she would have reported more than 50 percent of the income from the damaged or destroyed crops in the year following the loss. A reasonable interpretation in meeting the 50% test is that a farmer may aggregate the historical sales for crops receiving insurance proceeds but tax practitioners differ on the interpretation of how this test may be met.
One big problem with these crop insurance proceeds is that a producer can’t divide it between years. It is either claimed in the year the damage occurred and the crop insurance proceeds were received or it is all deferred until the following year. The election to defer recognition of crop insurance proceeds that qualify is an all or nothing election for each trade or business IRS Revenue Ruling 74-145, 1971-1.
Tax planning options for producers depend a great deal on past income and future income prospects. Producers that have lower taxable income in the last 3 years (or tax brackets that weren’t completely filled) may want to consider claiming the prevented planting insurance proceeds this year and using Income Averaging to spread some of this year’s income into the prior 3 years. Producers that have had high income in the past 3 years and will experience high net income in 2019 may consider deferring these insurance proceeds to 2020 if they feel that this year may have lower farm net income.
Market Facilitation Payments
When the next round(s) of Market Facilitation Payments (MFPs) are issued, they will be treated the same as the previous rounds for income tax purposes. These payments must be taken as taxable income in the year they are received. As these payments are intended to replace income due to low prices stemming from trade disputes, these payments should be included in gross income in the year received. As these payments constitute earnings from the farmers’ trade or business they are subject to federal income tax and self-employment tax. Producers will almost certainly not have the option to defer these taxes until next year. Some producers waited until early 2019 to report production from 2018 and therefore will report this income from the first round of Market Facilitation Payments as taxable income in 2019.
Producers will likely not have the option of delaying their reporting and subsequent MFP payments due to the fact they are contingent upon planted acreage reporting of eligible crops and not yield reporting as the first round of MFP payments were.
Cost Share Payments
Increased prevented planting acres this year have many producers considering cover crops to better manage weeds and erosion and possibly qualify for a reduced MFP. There is also the possibility that producers will be eligible for cost-share payments via the Natural Resources Conservation Service for planting cover crops. Producers should be aware that these cost-share payments will be included on Form 1099-G that they will receive and the cost-share payments will need to be included as income.
You are advised to consult a tax professional for clarification of these issues as they relate to your circumstances.
This article is being reposted with the author's permission from the Ohio Ag Manager blog.
By: Larry Gearhardt, OSU Extension Asst. Professor, Taxation
For the past several years, Ohio’s farmers have had the enviable task of planning for higher incomes because of historically high crop prices. Year-end tax planning became increasingly important with the passage of the 2012 Fiscal Cliff legislation (passed on January 1, 2013, but made retroactive to 2012). This legislation contained several provisions that penalized high income earners, such as a new 39.6% income tax rate, a 20% tax on capital gains for taxpayers in the 39.6% range, and a new 3.8% net investment income tax and a 0.9% Medicare tax.
Most farmers normally do not have income that exceeds the thresholds that trigger these higher taxes. However, the higher crop prices over the past several years have pushed more farmers into the category where year-end tax planning was critical. Perhaps 2014 will be different because of the plummeting crop prices, but on the flip side, farmers have lost two very important tax planning tools, at least for today. Furthermore, as is often the case, when one sector of agriculture loses, another sector gains. Livestock and poultry farmers are still receiving high prices for their products.
The most important step in year-end tax planning is to establish a date to determine income and expenses for the year. I suggest that around December 1 of this year, the farmer should determine, as close as possible, what his/her income and expenses are for the year. This leaves ample time for the farmer to take action to reduce income taxes, if possible. As soon as the ball drops on New Years Eve, the farmer has lost his opportunity to take action to reduce his taxes in 2014.
There were 55 tax benefits, credits, and exclusions that expired at the end of 2013 and have not been re-authorized. The two most critical tax benefits for farmers that either expired, or were reduced, were bonus depreciation and the section 179 expense deduction. Until the end of 2013, section 179 of the Internal Revenue Code allowed a farmer to deduct up to $500,000 of the cost of capital improvements as an expense in the year of purchase. This amount has been reduced to $25,000 in 2014. In addition to the $500,000 expense deduction, a farmer could take a 50% bonus depreciation in the year of purchase of a capital asset. There is no bonus depreciation for 2014.
There is keen interest in whether or not the section 179 expense deduction will be increased and the bonus depreciation returned. The word out of Washington is that nothing will happen until after the November election. Whether or not any changes happen between the election and the end of the year is anyone’s guess. However, historically, Congress has made the section 179 expense deduction and the bonus depreciation retroactive to the prior year if no action is taken. If a farmer bets on section 179 being increased and bonus depreciation returning, he should take action prior to the end of the year. If he waits until 2015 to purchase that new tractor, it is too late to adjust 2014 taxes.
Besides betting on the section 179 expense deduction and bonus depreciation, another useful tax planning tool is income averaging. Farmers enjoy the ability to look back at the prior three years and average their income over that period of time in the event that the farmer experiences a high income year. This may have limited benefit in light of the high crop prices over the last several years.
The most basic year-end tax planning is timing income and expenses, if possible, so that the income and expenses occur in the year that is most beneficial to the farmer. If 2014 is a high income year, the farmer should delay the receipt of revenue until 2015 and pay for 2015 expenses this year. This becomes especially important under the current circumstances where it appears as if 2015 income will be lower than previous years.
Even though the crop prices are plummeting, those farmers in the livestock and poultry sectors are still enjoying high profit margins. Until we know the future of the section 179 expense deduction and bonus depreciation, the options of livestock and poultry farmers are somewhat limited. The timing of income and expenses becomes more critical with more emphasis placed on deferring income and accelerating expenses. Even though it is not as inviting as in prior years, making capital expenditures and depreciating the cost by MACRS depreciation is still a useful tool.