Help for Sod and Nursery Farms

While its troubles are well known, the farming industry is still one of Americas most important drivers of the U.S. economy. The Federal government has worked diligently to help this industry, by providing grants, subsidies and other benefits. In particular, sod and nursery farming are growing segments that the Code has singled out for special tax treatment.

Accounting Method

The Code offers many exceptions to the general rules, specifically designed to help different segments of the farming industry not only to survive, but to thrive. Use of the cash method of accounting is one such exception. Sec. 447 deals with accounting methods for corporations engaged in farming. Farming taxpayers may also refer to IRS Pub. No. 225, Farmers Tax Guide, for guidance. Both the Code and Pub. No. 225 state that the taxable income of a corporation, or a partnership with a corporate partner, engaged in the trade or business of farming will be computed on the accrual method.

However, Sec. 447(a) and (c) provide exceptions for corporations or partnerships with corporate partners that operate sod or nursery farms, S corporations and corporations with gross receipts of $1 million or less. (According to Sec. 447(d)(1), this threshold is determined by taking the gross receipts of all affiliated corporations (within the meaning of Sec. 1563(a)) into account.) Farmers who qualify, and who otherwise maintain their books on the accrual basis for financial statement presentation, may use the cash method for tax purposes. Use of the cash method allows qualifying farming businesses to pay taxes only on the income they have actually collected, thus helping cashflow, while still maintaining their books on an accrual basis for financial statement presentation, to better assess their financial position.

Help is also available under Sec. 447(d)(2) for family-owned farming businesses with gross receipts of $25 million or less, but specific requirements must be met.

Production Period      

Other tax benefits are available for certain products produced by a farming business and the preproduction costs inherent in the farming industry. Sec. 263A generally requires capitalization of (1) direct costs and (2) an allocable portion of the indirect costs that directly benefit or are incurred in the production of such property. The direct and indirect costs of producing plants generally include preparatory costs allocable to the plants and the preproductive-period costs.

However, an exception exists under Sec. 263A(d)(1) when the preproductive period of producing plants is two years or less and the farming business is not required to use the accrual method under Sec. 447 or 448; Sec. 263A does not apply to the costs of producing such plants.

Sec. 263A(e)(3) defines the preproductive period as the period before a plant, crop or yield is reasonably expected to be sold or otherwise disposed of. It begins when a farming business first incurs costs that directly benefit or are incurred for the plants care and feeding. This generally occurs when the farming business first plants the seed or plant and ends when it is sold. For a plant that will have more than one crop or yield, the actual preproductive period ends when the plant has become productive in marketable quantities.

Thus, in determining taxable income, a farming business that meets these requirements can deduct the costs of producing a plant such as sod. This is a tremendous tax savings opportunity that allows farmers (and prospective farmers) to improve their cashflow.

As with the use of the cash method, a farming business can maintain its financial statements on an accrual basis, capitalizing preproduction and production costs and expensing as cost of sales when the production period is complete, while enjoying a current tax benefit for those same costs when determining the tax bill.

Start-Up Costs

Start-up costs are a concern of every new business owner. Sec. 195 addresses the costs that most businesses incur before starting initial operations. Start-up costs are paid or incurred to investigate the creation or acquisition of an active trade or business, or to create an active trade or business before the business starts. Such costs generally must be capitalized and amortized over 60 months, under Sec. 195(b)(1).

Are preproduction start-up costs deductible, or must they be capitalized under Sec. 195? The Code is very unclear and no regulations exist. Court cases and revenue rulings shed some light on this otherwise murky area. Many of these rulings conclude that the start-up period ends, and an active trade or business begins, when manufacturing begins, rather than when sales actually occur. Because a farmer is essentially a manufacturer of plants, it can be inferred that the start-up period ends when the seed is planted, thus beginning the growth (manufacturing) process. This interpretation further supports the deductibility of preproduction costs discussed above.

Other Benefits

The Code provides still more advantages for farmers. Sec. 464 provides that farming syndicates are allowed deductions only for amounts paid for feed, seed, fertilizer or other farm supplies in the year used or consumed. There is also a separate limit under Sec. 464(f) for farming businesses that do not qualify as syndicates under Sec. 464(c). A cash-basis taxpayer engaged in the business of farming cannot deduct prepaid farm supply expenditures to the extent they exceed 50% of the other deductible farming expenses for the tax year. This rule would not apply if the farming business were considered a qualified farm-related taxpayer under Sec. 464(f)(3)(B) (i.e., any taxpayer whose principal residence is on a farm, who has a principal occupation of farming or who is a member of the family of a taxpayer described above). If a farming business qualifies, its prepaid farm expenses will not be limited by Sec. 464; the entire amount spent for such expenses will be deductible in full in the year purchased.

Sec. 172(b) generally allows a net operating loss (NOL) to be carried back to each of the two tax years preceding, or each of the 20 tax years following, the tax year of the loss. Sec. 172(b)(1)(G) provides that NOLs attributable to a farming business can be carried back five years.

While most taxpayers must pay quarterly estimated taxes, farming businesses enjoy special treatment. Sec. 6654(i)(1) states that farmers are required to make only one installment payment of estimated tax to avoid underpayment penalties. In addition, most taxpayers are required to pay in at least 90% of their current-year tax or 100% of their prior-year tax quarterly. Farmers are only required to pay in at least 66²3% of their current-year tax and need only make one payment (on January 15 following the close of their tax year).

Other code sections include Sec. 108(g), special rules for discharge of qualified farm indebtedness; Sec. 451(d), the deferral of recognition of insurance proceeds from crop destruction; Sec. 180, farmers expenditures; Sec. 34(a)(1), fuel credits for farming businesses; and Sec. 1231(b)(4), which offers a way to convert ordinary income into capital gain income if an unharvested crop and the land on which it is growing are sold. The Code outlines a number of other tax advantages for the farming industry, of which tax advisers should be aware, to properly serve eligible clients.

Conclusion

The tax advantages discussed above offer unique opportunities to qualifying farmers, not afforded to other businesses. These farmers can maintain their books and records on an accrual basis, to measure their financial strength and maintain any debt covenants or other requirements banks may impose, while using the cash method of accounting for tax purposes. Under Secs. 263A and 195, qualifying farmers may also deduct preproduction and production costs when determining taxable income. Although farming businesses will always have their difficulties, the tax advantages discussed may play an important role in their ultimate success or failure.

From Richard E. Hedley, CPA, Aidman, Piser & Company, P.A., Tampa, FL