Things to Know about Farm Income and Deductions

If you have a farming business, there are several tax issues that can impact your tax situation.  The following list includes some of those issues.

1. Crop Insurance Proceeds — You must include in income any crop insurance proceeds that you received as the result of crop damage.  You generally include them in the year it was received.

2. Sales Caused by Weather — If you are a cash method farmer and sell more livestock, including poultry, than you normally would in a year because of drought, flood, or other weather-related conditions, you may be able to postpone reporting the gain from selling the additional animals due to the weather until the next year. To qualify, your area must be designated as eligible for federal assistance.

3. Farm Income Averaging — You may be able to average all or some of your current year's farm income by allocating it to the three prior years.  To qualify, you must be engaged in a farming business as an individual, a partner in a partnership, or a shareholder in an S corporation.  Corporations, estates, and trusts cannot use this averaging method.  This may lower your current year tax if your current year income from farming is high, and your taxable income from one or more of the three prior years was low.  This method does not change your prior year tax; it only uses the prior year information to determine your current year tax.

4. Deductible Farm Expenses — The ordinary and necessary costs of operating a farm for profit are deductible business expenses.  An ordinary expense is considered common and accepted in the farming business.  A necessary expense is one that is appropriate for the business.

5. Employees and Hired Help — Reasonable wages paid for labor hired to perform your farming operations can be deducted.  This includes full-time and part-time workers. You must withhold social security, Medicare and income taxes on employees.

6. Items Purchased for Resale — You may be able to deduct, in the year of the sale, the cost of items purchased for resale, including livestock and the freight charges for transporting livestock to the farm.

7. Net Operating Losses — If your deductible expenses from operating your farm are more than your other income for the year, you may have a net operating loss.  You can carry that loss back 5 years or over to future years and deduct it.  You may get a refund of part or all of the income tax you paid for past years, or you may be able to reduce your tax in future years.

8. Repayment of Loans — You cannot deduct the repayment of a loan if the loan proceeds are used for personal expenses.  However, if you use the proceeds of the loan for your farming business, the interest that you paid on the loan can be deducted.

9. Fuel and Road Use — Off-highway business use of vehicles qualifies for a refund of fuel excise taxes.  You may be eligible to claim a credit or refund of federal excise taxes on fuel used on a farm for farming purposes.

10. Optional Farm Self-Employment Tax Method — A special method of computing the self-employment tax for farmers allows a taxpayer to continue SE tax coverage even in years when profits are small (or even when there is a loss).  A taxpayer who uses one of the optional methods for figuring SE tax also uses the resulting imputed income when calculating the credit for child and dependent care expenses and the earned income credit.

11. Exclusion of Farm Debt Forgiveness Income – Generally, when a lender forgives or cancels a debt, the debtor must report the forgiven debt as cancellation of debt (COD) income on their tax return unless an exception applies.  First, the farm debt is excluded to the extent the taxpayer is insolvent.   An additional farm debt is also excluded under a special farm debt exclusion, provided the indebtedness was incurred directly in connection with the trade or business of farming, and 50% or more of the aggregate gross receipts of the taxpayer for the three tax years before the tax year in which the discharge of the indebtedness occurs is attributable to the trade or business of farming.  This exclusion is limited to the sum of the taxpayer’s tax attributes and basis of qualified property.

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