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.

Those in farming and various other businesses tied to agriculture may experience some changes due to the 2018 farm bill, depending on their specific operation. The formal name for this bill is the Agricultural Improvement Act of 2018. This bill was signed into law at the end of 2018, and most of the provisions and funding for programs will remain in effect until 2023 or longer. The USDA has published a summary that details most of the important changes and how they will affect certain farmers. Here are a few highlights to the bill changes:

Some highlights include:

• Emergency programs for livestock, bees, and farmed fish will continue without much change.
• The Conservation Reserve Program has an increased acreage cap which will move up to 27 million acres in 2023. Included are pilot programs for long term, 30-year contracts and short term, 3-5 year contracts.
• Price Loss Coverage (PLC) and Agricultural Risk Coverage (ARC) remain
• Both crop insurance and the SNAP program are mostly unaffected and will proceed as under the previous legislation with comparable levels of funding.

The government has budgeted over $400 billion to be spent under this new bill, divided into broad areas which are classified as nutrition, crop insurance, commodities, conservation, and other needs.

The main differences between the 2018 bill and the previous 2014 farm bill are decreases or increases in spending in certain areas, different ways of collecting and managing data, and some programs have not received re-authorization.

Important changes

Agricultural Risk Coverage will now be based on a trend adjusted yield that should result in higher guarantees for farmers. Crop insurance as a whole will receive more accurate data from the USDA-RMA and become a more advanced form of risk management.

Base acre reallocation is not allowed at all under the new bill, which will prevent farmers from legally increasing the base number of acres counted on their land.

PLC and ARC elections will be made for 2019/2020 and then annually for 2021-2023 versus a 5-year election in the previous farm bill.

ARC coverage is now tied to physical county instead of administrative county.

There are new rules and regulations for updating PLC payment yields. Even though a farmer/landowner may be utilizing ARC instead of PLC it is still in their best interest to update their PLC payment yields.

The Conservation Stewardship Program or CSP has been modified from an acre-based program to a dollar-based program.

Loan amounts related direct farming programs have been increased, allowing farmers to borrow more under various credit title programs.

Payment Limitations remain at $125,000 per year. If the payment limitation is being reached it is time to consult with a tax professional to structure entities to obtain more payment limits.

The overall policy of the bill is meant to compensate for lower income levels of many farms in recent years and adjust regulations to compensate for disruptions to agricultural exports. In other words, the government is trying to help farmers earn more or maintain their income levels through more precise regulation. This is partially meant to compensate for recent trade disputes and tariff issues with countries such as China and Mexico that have affected farmers.

In summary, the new farm bill should not have much of a negative effect on most businesses. It seems that loan amounts have been increased, terms for risk management have become more favorable, hemp has been legalized, and most previous programs will continue as in place with little change or disruption. Some farmers may be affected by the new regulations for conservation or base reallocation, but it seems that any impact will be minor or insignificant. Livestock farmers will also probably continue operations as before without noticing any changes in their day to day operations. Anyone concerned about changes in the bill should do some specific research or consult with a legal professional about how their operations will be affected, but it seems that the coverage and commentary surrounding these recent changes has mostly been positive.

Jim Honz, Lutz Tax Shareholder, was recently featured on the Nebraska Grain & Feed Association’s (NEGFA) website for an article about the Tax Cuts and Jobs Act (TCJA) relating to the agriculture industry.

“In December 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), a once-in-a-generation tax bill that provides many generous tax reductions, including lower federal income rates, 100% expensing of depreciable personal property, larger tax credits for children, virtual elimination of the Alternative Minimum Tax, expanded use of Cash Method of Accounting, and a doubled estate tax exemption. It’s almost as if Congress made paying taxes voluntary. Said another way, if you’ve paid taxes on your 2018 return, you didn’t plan hard enough to avoid them.

Businesses seeking to grow and expand can take advantage of the 100% expensing election that applies not only to new property, but also used property. It applies to nearly all business property except land (of course), building structures and property purchased from related parties. Even land improvements such as parking lots, fencing, drainage and irrigation systems, and landscaping are eligible for immediate expensing.”