Farm Taxes | The Basics
Disclaimer: This material is prepared for informational purposes only, and is not tax advice. Please speak with a tax professional or view the resources at the bottom of the page to see how this information may apply to you.
Whatcom County is home to a lot of farmland, more than 100,000 acres and 1,700 farms according to Choose Whatcom!
If you're a farmer or own a farm that generates income, then it's essential to understand your tax responsibilities related to farming activities. In this article, we'll discuss the basics of farm taxes for a sole proprietor, from determining if your farm is a business or hobby to reporting farm income and expenses.
Is Your Farm a Business or Hobby?
The IRS classifies farms as a business "if you cultivate, operate, or manage a farm for profit, either as owner or tenant. A farm includes livestock, dairy, poultry, fish, fruit, and truck farms. It also includes plantations, ranches, ranges, and orchards, and groves."
If your farm has produced a profit in at least 3 of the last 5 tax years, it is presumed that you are running a farm for profit. Special rules apply to those who breed, train, or race horses where if profit is produced at least 2 years of the last 7 tax years, it is presumed as a business. Additionally, here are some other factors to consider:
Are you operating your farm in a business-like effort?
Does the time and effort you spend on farming indicate an intention to make it profitable?
Do you depend on income from farming for your livelihood?
Are your losses due to circumstances beyond your control or are they normal in the start-up phase of farming?
Do you change your methods of operation in an attempt to improve profitability?
Do you have the knowledge needed to carry on farming as a successful business?
Have you been successful in making a profit in similar activities in the past?
Do you make a profit from farming in some years?
Do you expect to make a future profit from the appreciation of the assets you use in farming?
No factor alone is decisive, but if you answered yes to most of these questions, you are most likely running a farm for profit.
If your farm is a business, you can deduct the ordinary and necessary farming expenses from your income to lower your tax bill. On the other hand, if your farm is a hobby, you cannot deduct expenses beyond the amount of income generated, but you still must report any income generated.
How to Report Farm Income and Expenses
If you're a sole proprietor or single-member LLC, farm income and expenses are reported on a Schedule F, Profit or Loss From Farming. The form includes income from the sale of livestock, produce, grains, and other products related to the farm business, as well as any gains or losses from the sale of farm assets.
Any additional income from other sources such as cooperative distributions, agricultural programs, Commodity Credit Corporation (CCC) loans, and federal crop disaster payments must also be reported as income on a Schedule F.
Before you file a Schedule F, you will need to determine which accounting method to use.
Accounting Method
There are three accounting methods that can be used to keep track of farm income and expenses. Cash Accounting, Accrual Accounting, and a third method that requires IRS approval, known as Crop Method.
Cash Basis
Cash accounting is the simplest of the methods. It involves recording transactions when money changes hands. Any income received during the year will be reported on that year’s tax return.
So if you sell crops and receive payment for it in cash, you record that payment as income when you receive it. Similarly, if you buy a bag of feed and pay for it with cash, you record that as an expense when you purchase it.
In the case of a payment on credit, you will record the transaction once you receive the payment or when you pay off the expense.
Accrual Basis
Accrual accounting is more complex. It involves recording transactions when they occur, regardless of whether money has changed hands. Income is reported in the year it is earned, even if you don’t receive payment until the next year.
So if you sell crops on credit, you record that sale as income even though you haven't received payment yet. Similarly, if you buy feed on credit, you record that as an expense even though you haven't paid for it yet.
Crop Method
This is a special accounting method that requires IRS approval. Farmers who do not harvest and sell their crop in the same year it is planted may be able to use this accounting method. Crop Method allows farmers to deduct the entire cost of producing a crop in the year that it is sold.
Farm Expenses
As a farm business owner, you can deduct ordinary and necessary expenses of farming just like you would with any other business, lowering your tax bill. Common expenses include:
Livestock
Feed, seeds, and fertilizer
Equipment
Repairs and maintenance
Hired labor
Utilities
Rent and lease fees
Insurance
It's essential to keep a record of all expenses related to your farm, even if you aren't sure if it's deductible. In case of an IRS audit, you may be asked to present receipts and explain the items reported.
Estimated Tax Payments
Typically, self-employed individuals who expect to owe more than $1,000 in tax after subtracting income tax withholdings and refundable credits need to make quarterly estimated tax payments throughout the year.
However, there are special rules for qualified farmers. If at least two-thirds of your gross income for the current or previous tax year was from farming, then you are only required to make one estimated tax payment by January 15.
In addition, you are not required to make an estimated tax payment if:
You file your tax return and pay all tax due by March 1 (Please note that this is earlier than the general tax deadline, April 15!)
Your income tax withholding will be at least two-thirds of the total tax owed for that year or 100% of the total tax for the previous tax year
If the due date falls on a weekend or federal holiday, than the deadline is moved to the next business day.
Need Help Filing?
Understanding farm taxes is crucial for any farmer or farm business owner. If you are unsure about how to file your farm taxes, it's always a good idea to seek help from a tax professional. Our tax preparers can help you navigate the complex world of farm taxes and ensure that you are filing correctly. Give us a call at (360) 922-0235 to get started.
