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.