Our unusual growing season, which threw planting intentions, normal crop planting calendars and crop growth development out the window, has resulted in prevented plant acres, crop insurance claims, market facilitation program (MFP) payments, potential cover crop payments, and old crop marketing. What this means, for at least some farms, is a more complicated and non-conventional revenue stream that has tax implications. It is not too early to begin to think about tax planning in this unusual year. In mid-July, Barry Ward, OSU Extension Production Business Management specialist and director of the OSU Agriculture Income Tax Schools, wrote an article on tax planning considerations regarding prevented plant insurance payments, MFP payments, and other cost-share payments. I am including excerpts from that article in this column. The entire article is available on-line at https://u.osu.edu/ohioagmanager/.
“In a normal year, producers have flexibility in how they generate and report income. In a year such as this when they will have a large amount of income from insurance indemnity payments the flexibility is greatly reduced. In a normal year, a producer may sell a part of grain produced in the year of production and store the remainder until the following year to take advantage of higher prices and/or stronger basis.
Generally, crop insurance proceeds should be included in gross income in the year the payments are received, however Internal Revenue Code Section (IRC §) 451(f) provides a special provision that allows insurance proceeds to be deferred if they are received as a result of “destruction or damage to crops.” As prevented planting insurance proceeds qualify under this definition, they can qualify for a 1-year deferral for inclusion in taxable income. These proceeds can qualify if the producer meets the following criteria:
- Taxpayer uses the cash method of accounting.
- Taxpayer receives the crop insurance proceeds in the same tax year the crops are damaged.
- Taxpayer shows that under their normal business practice they would have included income from the damaged crops in any tax year following the year the damage occurred.
The third criteria is the sometimes the problem. Most can meet the criteria, although if producers want reasonable audit protection, they should have records showing the normal practice of deferring sales of grain produced and harvested in year one subsequently stored and sold in the following year. IRS Revenue Ruling 75-145 requires the producer would have reported more than 50 percent of the income from the damaged or destroyed crops in the year following the loss. A reasonable interpretation in meeting the 50% test is that a farmer may aggregate the historical sales for crops receiving insurance proceeds, but tax practitioners differ on the interpretation of how to meet this test.
One big problem with crop insurance proceeds is that a producer can’t divide it between years. Either it is claimed in the year the damage occurred and the crop insurance proceeds were received or it is all deferred until the following year. The election to defer recognition of crop insurance proceeds that qualify is an all or nothing election for each trade or business IRS Revenue Ruling 74-145, 1971-1.
Tax planning options for producers depend a great deal on past income and future income prospects. Producers that have lower taxable income in the last 3 years (or tax brackets that weren’t completely filled) may want to consider claiming the prevented planting insurance proceeds this year and using Income Averaging to spread some of this year’s income into the prior 3 years. Producers that have had high income in the past 3 years and will experience high net income in 2019 may consider deferring these insurance proceeds to 2020 if they feel that this year may have lower farm net income.
When the next round(s) of Market Facilitation Payments (MFPs) are issued, they will be treated the same as the previous rounds for income tax purposes. These payments must be taken as taxable income in the year they are received. As these payments constitute earnings from the farmers’ trade or business, they are subject to federal income tax and self-employment tax. Producers will almost certainly not have the option to defer these taxes until next year. Producers will likely not have the option of delaying their reporting and subsequent MFP payments due to the fact they are contingent upon planted acreage reporting of eligible crops and not yield reporting as the first round of MFP payments were.
Increased prevented planting acres this year have many producers considering cover crops to better manage weeds and erosion and possibly qualify for a reduced MFP. There is also the possibility that producers will be eligible for cost-share payments via the Natural Resources Conservation Service for planting cover crops. Producers should be aware that these cost-share payments will be included on Form 1099-G that they will receive and the cost-share payments will need to be included as income.”
Make sure to consult your tax professional regarding your specific situation.
Rory Lewandowski is an OSU Extension Agriculture & Natural Resources Educator and may be reached at 330-264-8722.
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