Tax Considerations for Farmers
Many U.S. farmers may be eligible for specific tax deductions and special treatment on their tax return. These deductions, however, are only eligible if the taxpayer is operating the farm with a goal to make a profit. Subsistence farmers, who cultivate a farm just to feed their families, are not eligible for such deductions. Even if a farm is not profitable, the owner can still apply deductions, provided that the farm is attempting to make a profit.
This tax treatment is not limited to traditional farmers; it also pertain to taxpayers whose business involves raising livestock, growing orchards, dairy farming, raising poultry, tending vineyards, and fishing. There are three primary tax advantages for these types of businesses:
Farmers are entitled to income averaging, wherein a taxpayer engaged in the farming business averages his or her income over the past four years and uses that average to determine this year's taxable rate. If a prior year's income was lower than the current year's income, averaging may allow for a lower taxable rate. Prior to 1986, income averaging was available to all taxpayers. Farmers can still use income averaging, because their income tends to be more volatile.
This means the taxpayer can take a tax deduction that allows him or her to recover the base cost of property. The IRS provides a schedule for how long a particular property must be depreciated. Farm-based businesses are provided certain bonus depreciation which allows for a larger percentage of the upfront costs to be deducted immediately.
Ordinary and Necessary Expenses
In general, taxpayers may deduct ordinary and necessary expenses incurred for their businesses. An ordinary expense is one that is common in the trade or business. A necessary expense is one that helpful or appropriate for a trade or business. Expenses for repairs and maintenance of farming vehicles would be considered ordinary and necessary. The IRS also allows farmers to deduct expenses for soil and water conservation, capped at 25 percent of a taxpayer's income.
As an ordinary and necessary business expense, the costs of feed and other farm supplies are generally deductible in the year of purchase. In addition, farm supplies with a useful life extending beyond the year of payment can be deducted during the year of purchase, with two limitations, one for feed and one for farm supplies:
- Prepaid feed payments cannot be deducted until the taxable year of consumption, unless the expenditure is a payment (not a deposit), is made for a business purpose, (not tax avoidance), and the deduction does not create a material distortion of income.
- The current deduction of prepaid farm supplies and certain poultry costs may be limited to 50 percent of other deductible farm expenses.
Farmers who operate for-profit farms can benefit from these provisions to minimize their tax liability.
Where do I report my Farm Rental Income and Expenses?
Reporting certain rental income and expenses related to farming, agriculture or livestock production activities by a tenant on land you own or sub-lease requires that you use Form 4835, Farm Rental Income and Expenses. Use this form only when you are reporting crop or livestock shares based on your tenant's activities that you receive as rental payment.
There are two key elements in determining whether you must file:
- The most important distinction to understand relates to who is actively managing and performing the agricultural or livestock production operations. Form 4835 should only be used to report farming income and expenses that are based on crops or livestock your tenant produces.If you are the person who manages or performs the activities, or if you are actively involved in the activities, then you should not file this form. Instead, you should report this income using Schedule F.
- Another key factor that governs when you should file a Form 4835 is how the rent for the land you own or sub-lease to a tenant is calculated. It should only be used to report farm rental income that is based on the crops or livestock produced by the tenant. If you receive cash payments as a flat fee (a set amount) in rent payments for pasture or farmland, then you should not file this. Instead, you should report this rental income on Schedule E.
There are a number of other common situations where taxpayers are not sure if they should file Form 4835. Do not file if:
- You are a tenant on agricultural land that is leased or sublet to you. In this case, you should report the income you receive through your farming activities using Schedule F.
- You are filing a tax return for an estate or trust that receives rental income (or has rental expenses) associated with livestock and crop shares. In this case, you should report the income and expenses using Schedule E.
- You are filing a tax return for a partnership or an S-corporation that receives income (or had expenses) associated with crop and livestock shares. In this case, you should report the income and expenses on Form 8825.