The following article is from Andy Biebl, DTN Tax Columnist.
We’re seeing some record grain prices in areas that sidestepped weather problems. And those high prices lead to questions about the proper method of deferring grain sale income to a future year. Here’s a primer on what you need to know to avoid tax issues on the timing of that income.
Normally, those who produce a good (as opposed to those selling a service) must report on the accrual method of accounting. This causes the revenue to be taxed at the point of sale, not at the point of collection of the proceeds. But farmers are specifically allowed by the tax code to use the cash method for tax purposes. The contractual sale might occur shortly after harvest, but that receivable from the crop sale is not taxed until payment occurs at some later point.
Congress added a second layer of protection to cash method farm sales in 1980, when the IRS started attacking deferred arrangements on the argument farmers had “constructive receipt” at the time of sale. The tax code was amended to allow property produced in farming to be sold under the protection of the installment method of Section 453. The effect is to provide the same protections to a farm grain sale sold for deferred payment as apply to a real estate sale sold on the installment method.
To solidify that deferral, use a written contract. If you want to push $500,000 of income to a later tax year, understand that you will need to deal with some formalities. A recent IRS audit training guide tells their examiners to assume adverse treatment for those doing verbal deals. The dates within the contract are important. It should be executed on or before the grain gets in the hands of the buyer (if not, there should be a storage contract for the period before sale during which the producer still owns the grain). Secondly, set a deferred payment date at which time payment and taxation will occur.
DURATION AND EXTENSIONS
The tax law has no limits on duration of an installment sale. A 2010 crop sale under a payment date of either January 2011 or 2012 is acceptable. But, technically, an installment sale of over six months duration and over $250,000 should include interest. If there is no interest built into the contract, the tax law simply recharacterizes a small amount of the payment from grain sale to interest income — still ordinary income. An extension of the payment due date is permitted, but this negotiation must be in advance of the original due date. Keep the economics in mind: The longer the payment is extended, the greater the risk of default or failure on the part of the buyer.
NO LOANS OR ADVANCES
The selling farmer cannot take any loan or other advances on the sale without being taxed. And the receivable cannot be sold or otherwise collaterized without causing tax acceleration.
As always, these rules can be complicated. See your tax adviser if there are other twists or turns in your deferred grain contracts.
Editor’s Note: DTN Tax Columnist Andy Biebl is a CPA and principal with the accounting and financial consulting firm of LarsonAllen in New Ulm, Minn., and a national authority on ag taxation. Watch a rebroadcast of his year-end tax planning webinar, “Get Ready for Tax Time Bombs” at https://about.dtnpf.com/…. Pose tax questions for upcoming DTN columns by e-mailing AskAndy@dtn.com.
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Posted with DTN Permission by Haylie Shipp