When an IRS examiner looks at a rent or salary payment made to a third party, there's generally no question about the reasonableness of the amount. After all, unrelated parties have adversarial financial interests and the presumption is that the labels and amounts are proper. But if that transaction involves a father-son lease or a family compensation arrangement, watch the IRS focus change! To protect from this increased scrutiny, it's important to have documentation in the form of written leases, written employment agreements, and the like. Without that paperwork, you face the risk of the IRS attempting to recharacterize the transaction in a manner that damages your tax return. Here are some key pointers.
The IRS will look for written contracts such as leases to make sure the arrangements stand as legitimate business transactions. (By Images of Money (CC BY 2.0))
It's common for individuals to have loans to or from their business entity or loans to other family members. Those loans should be a written note and should have an interest rate that exceeds the IRS minimum (the Applicable Federal Rate or AFR) in effect for the month the loan originated.
Many operators will have verbal leases with their landlords. But when it comes to a related-party lease, get it in writing. Furthermore, make sure the rent payments don't exceed the local going rate. Rents above market value tempt the IRS to recharacterize the payments as subject to self-employment tax for assumed services. And in that regard, it helps if the lease states the payments are for the use of the land only, and no labor is provided by the landlord.
Almost every farm operation will have some related-party employment. There should be a written employment agreement, defining both the direct compensation and any fringe benefits. Common fringes include employer-provided health insurance, the use of a vehicle and medical reimbursement plans. Labor arrangements can change frequently, so make sure that, if you have these agreements, they are up to date and reflect current services and fringes.
CORPORATE-PROVIDED MEALS AND LODGING
If the active farming operation is within a C corporation, another fringe benefit that may be in place is corporate-paid meals and lodging. This fringe generally applies in farm and ranch operations where it's necessary to have key employees on the premises 24/7. But there are a number of details to button down in writing: The residence must be owned or leased by the corporation; the fringe benefit should be documented in an employment agreement; and an employee's duties should include preparation of on-premises meals. We also need to have sufficient business activity to justify the fringe, but that's not a matter of paperwork, but rather the facts of the operation.
If any of your paperwork in these areas is lacking or out of date, discuss it with your tax adviser and get matters in order before any IRS exam arises.
Editor's Note: DTN Tax Columnist Andy Biebl is a CPA and tax partner with the accounting firm of CliftonLarsonAllen in Minneapolis, Minn., and a national authority on ag taxation. He will be speaking at the DTN-Progressive Farmer Ag Summit in Chicago Dec. 9-12. For information, go to www.dtnagsummit.com
Pose your tax questions for future columns by e-mailing AskAndy@dtn.com
Posted by Northern Ag Network