The continuing hot temperatures and lack of moisture in our state will most likely result in some significant crop insurance loss claims for the 2021 crop season. While the taxability of crop insurance proceeds is not a new topic, and there have been no significant changes in the related tax reporting rules, it makes sense to review the taxation options going into the later part of 2021.
For cash basis taxpayers, the basic requirement is to report your income in the year it is received. However, if a farmer receives a crop insurance damage claim, there may be an option to defer the taxation of the income until the following year. Here is a summary of the requirements for the deferral:
- The farmer must use the cash method of accounting for income tax purposes.
- The insurance proceeds must be received in the year the crop loss occurred.
- The loss payment must result from the damage or destruction of crops or the inability to plant crops.
- The farmer’s normal business practice is to sell more than 50% of the current year production in a future tax year or years.
Here are a few strategic points to be aware of:
- This is an all or nothing election. An election to defer crop insurance proceeds applies to all proceeds for all crops that are grown within a single trade or business, even if paid for damage to different crops.
- The amount eligible to defer is the gross amount of insurance proceeds. Many times, the payment for crop loss is reduced by the premium due on the policy. Be sure to use the gross amount of proceeds, before reduction for the premium paid directly out of the proceeds.
- For crop revenue coverage claims, the only part of the proceeds eligible for deferral is the amount attributable to lost production or yield. The portion attributable to price alone is not eligible for deferral
- The election can be made by filing an amended tax return in a later year. This provides some flexibility in the following year if profits in the following year are lower than expected.
- The normal business practice requirement is quite rigid. In one case, a business pattern of deferring 1/3 of the current production into later years was not sufficient to qualify for deferral. To be on the safe side, the farmer needs to be able to establish a normal business practice of deferring the sale of “more than 50%” of the current year production.
The analysis behind the decision to defer proceeds can be complex and as we know, there are many options available to farmers to control net income. You should run the numbers prior to year-end and consult with your tax advisor before making a final decision.
Curt Barnekoff, CPA/Montana Grain News