America’s agricultural sector has been facing challenges in workforce availability, climate, technology, among many other issues. With the world population expected to hit 9 billion by the year 2050, agriculture businesses will need to ramp up production by up to 70% to accommodate the growing population.

Farms across the U.S are incorporating new and innovative techniques to deal with issues of pesticides, fertilizers, contamination, spoiled produce, harvesting, and diminishing labor force. Thankfully, federal tax credits are available for corporations, individuals, and businesses undertaking research and development efforts to alleviate the current farming and produce challenges while enhancing better yields.

The Research & Development Tax Credit

Research & Development Tax Credits are a government incentive aimed at helping businesses by encouraging and rewarding innovation. The federal Research and Development (R&D) Tax Credit act was enacted in 1981 and allows a credit of up to 13% of eligible spending for new or improved processes and products. R&D tax credits are available to companies engaged in research and development activity, regardless of their size, albeit subject to eligibility.

R&D Eligibility Requirements

Your research/project can qualify for tax credits if it meets the following criteria:

• Improved or new products, processes, or software– Your research qualifies if it relates to a new or enhanced performance, function, or quality of an agricultural component (i.e., process, product, formula, software, or technique).
• Technological in nature- This is to say that the activity(s) to be undertaken must be primarily technical. As such, the activity must be based on principles of science such as biology, computer science, or engineering.
• Eliminates uncertainties- The activity must also tackle uncertainties in the methodology, capabilities, or development process of the business component.
• Process of experimentation- For the research to qualify for the R&D tax credit, the activity must also entail evaluation and experimentation of one or more options through development, refinement, and testing of different alternatives.

Qualified costs include costs of supplies, testing, or patents, research expenses, and employee wages.

Are You Missing Out?

The agricultural sector is rife with activities that are eligible for the R&D tax credit. Check out a few brief examples of the R&D tax credit for agriculture to help you determine your eligibility.

Common Examples of R&D Tax Credits for Agriculture

1. Development of New or Enhanced Storage Techniques

This may entail developing packaging to control temperature and moisture or even a structural design to prevent the produce/product from degradation, contamination, molding, fermentation, or grain clumping.

2. Development of New or Improved Conveyance Chains/Systems

As a product is moved through production, there can be changes to the conveyance design or process to reduce waste/material loss, improve speed, or enhance the process’s dependability. Transport designs such as refrigeration or trucking may also qualify.

3. Development of New or Improved Products or Processes to Maximize Yield

As you seek to improve the growth or returns on livestock or crops, there is a wide range of activities that may qualify here. These include:

• Testing of new or improved techniques of planting and harvesting
• Testing of new or improved fertilizers or chemical additives
• Testing of new or enhanced feeding techniques and feeds to enhance livestock growth and health
• Examining new soil blends including nutrient density, mineral content, and pH 
• Evaluation of new products and methods for preventing disease or pest infestation

4. Development of new or improved software

This may entail developing software meant to facilitate land tracking, produce or material monitoring, and crop selection based on soil characteristics.

5. Development of New or Improved Irrigation Technologies

If you are creating a mechanical, electrical system, or software to automate or streamline an irrigation process, your project is may be eligible for R&D tax credits.

6. Development of New or Improved Techniques or Equipment to Minimize Environmental Impact

This involves equipment or techniques to enhance compliance with evolving environmental legislation or, generally, any other interventions in agriculture meant to promote environmental conservation.

Common Exclusionary Items

It is worth noting that the following items are usually not eligible for R&D tax credits:

1. Equipment investment subject to depreciation
2. Small adjustments to livestock diet or feed components
3. Adapting an existing product to a customer’s specifications
4. Administrative or functional operations that do not contribute or amount to agricultural innovation

How We Can Help

Many agricultural corporations and businesses are still unaware that the government is offering generous R&D incentives or believe that such incentives do not apply to the agricultural sector. Even those aware may fail to grasp the full extent of R&D tax credits that they are entitled to. Have questions? Contact us today to learn more about these unique tax credits and how they might benefit you.

In the farm industry, you quickly learn that farming incomes can fluctuate a great deal from year to year. Yields are affected by many elements outside of your control, such as drought, insect infestations, fire, flood, and the general weather conditions of the year. Some years you will yield significant profits and be subject to higher tax rates. Other years you will be subject to minimum tax liability as your yields provided little profits or even loss. The best way to plan ahead for this income fluctuation and sustain your farm operation is to utilize farm income averaging. Here is everything you need to know about farm income averaging and how to best utilize this tax management tool. 

What is Farm Income Averaging? 

Farm income averaging or FIA is a tax management tool that is available to farmers and ranchers in the United States. This tax management tool can be elected after the end of the tax year. Essentially, this tool allows a certain amount of your farm income to be spread over a three-year period. For example, this is available to prevent farmers from being pushed into a higher tax bracket if they sold a large portion of property or yielded abnormally large profits from a single crop season. Overall, this tax management tool allows you to average your farming income equally over a three-year tax period to prevent being taxed at a higher rate. Averaging your farm income reduces the tax burdens associated with both bountiful and lean yielding years. The IRS form associated with farm income averaging is 1040 Schedule J. This form can be found on the official IRS website. 

To file a 1040 Schedule J, it is not necessary for the individual to have been involved in farming in previous years. The only stipulation is that the individual must be involved in the farming industry in the year that they file. Individuals engaged in any farming business, including sole proprietors, partners, or shareholders in an S corporation, can utilize this tax management tool. Individuals involved in the farming industry through estates and trusts are not eligible to utilize the farm income averaging tool. 

What is Classified as Farm Income for FIA Purposes?

The IRS considers a farming business an operation involved in the trade of cultivating land or the trade of raising or harvesting any agricultural commodities. The IRS excludes the buying and reselling of plants or animals raised by someone else under this classification. 

The farm income for farm averaging purposes is considered by the IRS to be the overall income, deduction, gain, and loss attributable to an individual’s farming business. The rental income on a share of production from a tenant’s farming operation is classified as farming income by the IRS. They also consider the gain on the sale or other disposition of non-land property used in an individual’s general farming operation to be considered farm income. However, cash rent farming operations and compensation received by an employee are not considered farm income by the IRS. 

Key Points to Consider When Utilizing Farm Income Averaging

• Election of Schedule J is made available for taxpayers with farm income after the end of the year.
• Farm income averaging spreads high amounts of farm income over the previous three years.
• Utilizing Schedule J does not change income reporting for the three base years. Instead, it utilizes the portion of the lower tax brackets that were left unused in prior years to determine the current year’s taxes.
• Individuals don’t have to have farm income in the previous years, just in the year of election.
• Cash rent farmers are excluded from farm income averaging.
• Election of Schedule J may be revoked with permission from the IRS.

Connect With Us 

At Lutz, we specialize in providing accounting services. We provide the best tax, accounting, assurance, business consulting, and valuation services to every one of our clients. We are the largest locally owned firm of its kind in Nebraska. Being a Nebraska based firm, we have a strong understanding of the farm industry. We can help you get the most out of your farming operation and answer any questions you may have.

Farm income averaging can be a powerful tax management tool for many farm operations. It allows you to better prepare for the ups and downs that are certain to occur when working in the farm industry. Fluctuating income is the only real certainty when it comes to farming. However, the 1040 Schedule J is not beneficial in all scenarios and is not a substitute for crucial year-end planning by farmers. Contact us today with any questions you may have about taxes, accounting, or business consulting surrounding your farm operation. Your success is our success. We are here to help you get the most out of your farming operation.

Curtis Thompson, Lutz Tax Director, was recently featured in the Nebraska Cattleman Magazine, December 2019, Volume 75, Issue 10 on page 42, for an article about 2019 year-end tax reviews relating to the agriculture industry.

“As we near the end of the second year of the Tax Cuts and Jobs Act (TCJA) of 2017, many of the questions we had at this time last year have been answered, but there are still some questions that remain. The most extensive piece of the Tax Cuts and Jobs Act was IRC Section 199A, commonly referred to as the qualified business income (QBI) deduction. In recap, the QBI deduction is a deduction of 20 percent of the net qualified business income from taxable income for all taxpayers other than C Corporations. There are, however, phaseouts for the QBI deduction for 2019, starting with taxable income as follows: married filing jointly $321,400, married filing separately $160,725, and single/head of household $160,700.”

Mother Nature can be fickle – some years your yield is plentiful, whereas other years crops can be damaged due to significant drought, insect infestations, floods, fire, etc. Thankfully, there are alternatives available for tax reporting purposes if you receive proceeds from crop insurance to cover your losses.

What is Crop Insurance?

In the United States, there are two main types of crop insurance:

• Crop-Hail
• Multi-Peril

Policies are available through the US government’s Federal Crop Insurance Program (FCIP), as well as through private insurance companies.

Crop-Hail insurance isn’t available through FCIP. These policies are offered through private insurance companies. Crop-Hail policies cover damage to crops due to, as the name implies, hailstorms. Hail is a unique weather anomaly that’s able to devastate a large portion of a crop field and leave the rest untouched. Crop-Hail policies can be purchased at any point in the season.

Multi-peril crop insurance (MPCI) is offered through the FCIP. You must purchase this type of policy before your crops are planted. MPCI policies cover many types of loss, such as:

• Excessive drought or rainfall
• Freezing temps
• Blight or other crop diseases

More recent coverage options include:

• Yield protection
• Price protection
• A combination of the two

These types of options can cover you in the event of a low-yield year or market fluctuation.

Ways to Defer Crop Insurance Proceeds

Before you elect to defer any proceeds, it’s important that you’re aware of the following:

• The accounting method you use plays a role – you must use cash accounting
• It must be your normal practice to defer your current taxability to a subsequent year
• If you elect to defer, it applies to all proceeds you receive from crop insurance, regardless of the policy
• When you file taxes for the year in which you’re reporting damages, you must include a deferral election statement along with the facts that support said deferral
• You can amend your return to include a deferral election statement – but, once you’ve elected for deferral, it is irrevocable
• If you’ve opted for coverage that protects in the event of market fluctuation, any applicable proceeds are not eligible for deferment
• If you’re eligible to defer, the gross amount of proceeds prior to offset for premiums, is the amount used to calculate deferral

If you meet these criteria, there are two options for reporting crop insurance proceeds:

1. You can report the proceeds as taxable income in the same year you receive them, or
2. You can take advantage of tax law that states qualified taxpayers can report insurance proceeds or other disaster proceeds in the tax year following the actual loss – if it is your normal practice to report crop sales income the year after you receive it

The second option is a bit tricky. In order to take advantage of the second option, you must be able to prove, had your loss not occurred, that you would still have reported the crop’s income in a subsequent year – and the IRS doesn’t provide a detailed method as to how to prove this. It’s best to speak with your accountant, but a good rule of thumb is that, if you normally sell more than 50% of a crop the year after you harvest, you qualify for deferral.

Benefits of Deferring Crop Insurance Proceeds

It is beneficial for your farm’s bottom line if you’re able to report an insurance payment for a failed crop the year after you actually receive it – especially if you wouldn’t have seen profit from that crop till that following year.

The main benefit of crop insurance is to provide a safety net for those years in which your crops are damaged or otherwise unsellable. Crop insurance pays you what you would have made had you had a normal year – being able to defer those proceeds allows you to recoup any current losses from this year the following year.

OVERVIEW

Farming has a certain intrinsic risk. There are so many variables that could impact your harvest. It’s nice to know that if disaster strikes, you have options. The tax provision allowing deferment of crop insurance payments is a complex one – and has many hoops to scale. By speaking with your accountant, you can gain a better understanding of this strategy and see if you meet the requirements.