Income from Farming

When a business earns its income from sales of livestock and produce, payments from agricultural programs and farm rents and other similar sources, it is considered a farming business. Since most small farms use the cash method of accounting to report income and expenses, the following discussion is limited to this method of accounting. However, if items regularly produced in the farming business or used in the farming business are sold on an installment basis, the sale can be reported on the installment method, deferring income until payment is received.

While many income items of farms are similar to nonfarm businesses, there are a number of income items unique to farming. These include:

• Sales of livestock (including poultry) and produce. The sale of livestock classified as Section 1231 property may result in Section 1231 gain or loss (explained in Chapter 6). If crops are sold on a deferred payment contract, you report the income when payment is received.
• Sales of livestock caused by drought, flood, or other weather conditions. While such sales are generally reported in the current year, you can opt to report them in the following year if you can show that you would not have sold the livestock this year but for the weather conditions and you are eligible for federal assistance because of the weather conditions. You must file a separate election with your tax return for the year of the weather conditions for each class of animals (e.g., cattle, sheep). Alternatively, deferral is indefinite, if proceeds are reinvested in similar livestock, until the end of the first tax year ending after the first “drought-free year” (assuming the drought-free year ends in or after the last year of a 4-year replacement period). The IRS lists affected counties (e.g., counties for 2011 were listed in Notice 2011-79; check the IRS web site for affected counties in 2012).
• Sales of timber. Outright sales of timber qualify for capital gain treatment if the timber was held for more than 1 year before the date of disposal. Similar treatment applies to sales of timber under a contract with a retained economic interest. However, for purposes of outright sales, the date of disposal is not deemed to be the date timber is cut; you can elect to treat the payment date as the date of disposal.
• Crop insurance and crop disaster payments received as a result of crop damage. This type of income is generally included in income in the year received. Farmers can request federal income tax withholding at the rate of 7%, 10%, 15%, or 25% by filing Form W-4V, Voluntary Withholding Request.
• Rents, including crop shares. Generally, rents are not treated as farm income but rental income, and these rents are not part of your net income or loss from farming. However, rents are treated as farm income if you materially participate in the management or operations of the farm (material participation is explained later in this chapter).
• Agricultural payments (cash, materials, services, or commodity certificates) from government programs generally are included in income. If you later refund or repay a portion of the payments, you can deduct these amounts at that time. For details on how to treat specific government payments, see IRS Publication 225, Farmer’s Tax Guide.
• Patronage dividends from farm cooperatives through which you purchase farm supplies and sell your farm products are included in income.
• National Tobacco Settlement payments to landowners, producers, and tobacco quota owners in Alabama, Florida, Georgia, Indiana, Kentucky, Maryland, Missouri, North Carolina, Ohio, Pennsylvania, South Carolina, Tennessee, Virginia, and West Virginia. Amounts reported to owners of tobacco quotas in termination of the quota can be reported under the installment method (see Chapter 6).
• Forest health protection payments. Payments to landowners who voluntarily participate in the FHPP are tax free.

Loan proceeds generally are not income. However, farmers who pledge part or all of their production to secure a Commodity Credit Corporation (CCC) loan can make a special election to treat the loan proceeds as income in the year received and obtain a basis in the commodity for the amount reported as income. The election is made by including the loan proceeds as income on Schedule F and attaching a statement to the return showing the details of the loan. Then the amount you report as income becomes your basis in the commodity, so that when you later repay the loan, redeem the pledged commodity, and sell it, you report as income the sale proceeds minus the basis in the commodity. A forfeiture of pledged crops is treated as a sale for this purpose. Farmers who do not make this election must report market gain as income.

The repayment amount generally is based on the lower of the loan rate or the prevailing world market price of the commodity on the date of repayment. If the world price is lower when the loan is repaid, the difference between the repayment amount and the original loan amount is market gain. Whether cash or CCC certificates are used to repay the loan, Form 1099-CCC is issued to show the market gain. Market gain is included in income in the year of repayment if the CCC loan was not included in income in the year received.

Not all income received by farmers and ranchers is includable in gross income. Income from federal or state cost-sharing conservation, reclamation, and restoration programs can be excluded in whole or in part (depending on the program and other factors). Qualifying programs include, but are not limited to, small watershed programs as well as the water bank program under the Water Bank Act, emergency conservation measures program under Title IV of the Agricultural Credit Act of 1978, and the Great Plains conservation program authorized by the Soil Conservation and Domestic Policy Act.

Farm Income Averaging

You can choose to figure the tax on your farming income (elected farm income) by averaging it over the past 3 years. If you make this election, it will lower the tax on this year’s income if income was substantially lower in the 3 prior years. However, it does not always save taxes to average your farming income—it is a good idea to figure your tax in both ways (the usual way and averaging) to determine which method is more favorable to you.

The same averaging option applies to commercial fishermen.