Many of us have dreams of leaving the rat race behind and cultivating our little plot of land in the country. We'd have a few cows, a few chickens -- heck, we'd even grow our own produce and make bread from the wheat we harvest.
We'd never make it.
The life of a farmer is obviously not the same as the life of a trust-funder with a lot of time to kill, or even the homeowner with a 9-to-5 job and a raised bed out back. Even the IRS gets it -- and they're not exactly known for being the most understanding government organization. Farmers receive some interesting tax breaks or relief due to the unpredictable (and often difficult) nature of their business. So let's get our hands dirty and start by learning just how the IRS classifies farms.
Farms vs. Other Businesses
Don't fret if you're thinking to yourself, "Isn't a farm just a business? Does the IRS really make all sorts of exceptions for corn and cows?" Yes, in a lot of ways, the IRS does think of farms as small businesses, and you can see it in some of the rules: Profit is subject to self-employment tax, for instance, and employees are subject to withholding [source: Lee].
But farms also have their own set of exceptions and rules, and you're considered a qualified farmer if at least two-thirds of your income over the past two years has come from farming [source: IRS]. But knowing that farming is similar to running a small business and that qualified farmers have to make their money specifically from farming activities, we should also examine some instances where farming can't be claimed as an occupation. Let's check it out on the next page.
Different Farm Classifications
The IRS does make some interesting exceptions and deductions for farmers. But don't think you can scam the IRS by claiming your backyard vegetable garden as a farm. The IRS is well aware of the difference between "hobby farming" and "we have to take out a second mortgage on the place because the crops failed" farming.
It's important to know the difference, because if you're a for-real farmer, you can deduct expenses even if your business has been operating at a loss for multiple years. Hobby farmers don't get the same breaks; they're not allowed to buy a lot of cool farming equipment, make no money, and then claim a deduction for it. Basically, if you're operating at a profit for three years out of five, you're a business.
Even if you're operating at a loss for several years, the IRS will make exceptions if you meet certain criteria to qualify as a farmer. They set out nine conditions; one of the easiest ones is that the time and income you spend farming indicate an intent to profit. Another is that you or your associates have enough expertise to carry out a profitable farming enterprise [source: IRS]. Meet all nine conditions, and you can be considered a farmer, albeit one with some history of loss.
Hire Someone to Help With Money and Records
While it's not necessarily a tip guaranteed to relieve a tax burden or save you a wad of cash, you should never discount the importance of organization when it comes to your farm and its finances. With that in mind, hiring a professional bookkeeper or accountant could be worth peace of mind, especially if you're concerned your tax return or records leave you vulnerable to an audit.
Once more, the idea that hiring someone to help with taxes in particular could save some dough isn't that far off. For one, if you're itemizing your deductions, then you can actually write off the cost of the previous year's tax preparation. That means you can deduct the fees you paid anyone that helped you file -- or even what you paid for tax preparation software or e-filing.
Know Your Deductions!
Unlike most people -- who generally have to make the choice between itemizing all their deductions or taking the standard deduction -- those who run a farming business can take some deductions as business expenses without having to itemize. It might not sound like that big of a deal, but it can sure help you out. When itemizing, you have to have enough deductions to equal at least 2 percent of your adjusted gross income -- and at that point, you'd need enough of them to beat the standard deduction. Of course, you'd need records and receipts for all of them as well.
As a farmer, you can claim expenses as part of your normal and ordinary farming practice, and you don't have to meet a certain dollar value: The more you have, the better [source: IRS]. For that reason, it's really important you familiarize yourself with as many expense deductions as you can, lest you miss out on a sweet tax write-off. The IRS has a list of deductible farming expenses, and it's quite detailed and varied. For instance, if you prepaid for any supplies during the year and didn't end up using them, you can write them off. You can even write off the cost of fertilizer or lime -- and the costs of applying them [source: IRS].
Insurance Payments From Crop Damage Are Income
Here's some bad news if you're a farmer having a not-so-hot (or maybe way-too-hot) year: Any insurance payments from crop damage have to be counted as income on your tax return. This sounds pretty bleak, as it means that you still have to pay taxes on insurance payments that are designed to save you in times of trouble. Crop disaster payments, which are generally provided by the federal government, are also taxed as income.
There are a couple of ways to minimize your tax burden if you do have to claim crop damage payments. For instance, you can elect to have income tax withheld from crop disaster payments from the government so you aren't hit with a big bill at the end of the year. As for crop insurance payments, you are allowed to postpone paying income tax on them for one year if you use a cash method of accounting and can show that you would include income from the damaged crops in any year following the damage [source: IRS].
All in the Family
It's not at all uncommon for kids to help out around the family home – or the family farm. Free labor might sound good, but you'd be surprised how much actually paying your kids to work on your farm could help out your taxes. You can actually deduct their wages, which lowers your taxable profits.
Unlike grown-ups, you don't have to deduct Social Security if they're under 18, or federal unemployment tax if they're under 21. You can even count ways you already provide for them as wages. Say you pay their phone bill, for instance: You can consider those wages and deduct the dollar amount you pay.
Split the Bills
If you're using part of your home as an office space for the farm, you may be able to take the home office deduction. Keep in mind that the space has to be used exclusively for farm business – it can't be the corner of the playroom where you do the books after the kids are in bed. The easiest way to figure out this deduction is just to multiply the square footage of the space by $5, to a maximum of $1,500.
Additionally, if your home and your farm share the same physical property, you may be paying for both of them in the same utility bills. You can save yourself a lot of tax-time sorting by keeping track of how much of those payments are for the farm (and how much are for your home) throughout the year. You can deduct the farm-related utility expenses from the income the farm is generating. It may even be worth it for your farm to have its own meters for utilities like electricity and water to keep things separate.
Average Your Income
This is one of the coolest exceptions that farmers can make on their taxes -- a way of determining an average tax rate based on three years of income. This provision is designed to give farmers who've had a bumper year a fair tax rate if they have suffered losses in the previous years.
It sounds pretty simple. If you make a lot more one year, you can actually shift some of your income to lower income years. That'll (theoretically) shift you to a lower tax bracket, which of course considerably helps your tax bill. And while it sounds easy, you can probably imagine that it involves some pretty strict requirements -- and it doesn't always mean you get the lower bracket that year. You might find that the rather complicated mathematics results in a more even average over three years but that it doesn't necessarily prevent you from reaching a higher bracket. But for a lot of farmers who are having a great year amid several bad ones, it could help relieve their tax burden quite a bit.
While all of us love to complain about the weather, a farmer really has a right to curse the cold or shake a fist at the sun. The IRS once again disproves its cold, intractable reputation by showing some understanding of the farmer's plight against nature. The stuffily titled "Sales Caused by Weather-Related Conditions" postponement is actually the IRS's way of saying it gets it.
The premise is pretty basic: If you're a farmer who had to sell or exchange more livestock than you normally would have because of weather conditions, you don't have to claim that income as taxable until the next year. If the weather -- we're talking anything from hurricane to drought -- caused you to have to drop inventory fast, you're eligible. You just have to show that it was outside the pattern of your usual business practice. Likewise, you need to prove that the area designated for federal assistance negatively impacted the water, grazing or livestock requirements for your farm. There's some really specific information to convey to the government if you're trying to postpone taxes on livestock sales, so be sure to check out Publication 225 for more detail [source: IRS].
People are nuts about Section 179. And on the surface, you can absolutely see why: It's a way of deducting the cost of certain business expenses and equipment at full value. A lot of business expenses have to be depreciated, meaning that you can knock a fraction off on your taxes every year until the expense is fully deducted. That's great if you're looking to help relieve a tax burden for several years running, but if you're looking for a way to quickly lower your tax bill this year, a full deduction is really appealing.
Obviously, there are some rules for farmers looking to take Section 179 deductions. All the property has to be tangible or real property, and -- surprise surprise -- some of those rules are too complicated to cover here. But know you can deduct any machinery and equipment, some storage tanks and even fur-bearing livestock. (Yes, it's detailed.) You can deduct up to $25,000 using Section 179, as of 2014.
So, are you ready to harvest some more money come tax time? Read on for more tax-related information.
Many Americans don't think about their tax bills until the new year. But there are things you need to do before Dec. 31 if you want to pay less later.
Author's Note: 10 Tax Tips for Farmers
While the current limit for the Section 179 deduction is $25,000, it was at a whopping $500,000 in 2013. Congress let the raised cap expire, but do be diligent about checking with the IRS to make sure there haven't been changes in the law: They can certainly apply a higher limit retroactively and create a much higher deduction again for the 2014 tax year.
- Idlebrook, Craig. "Tax Tips for Farmers: Ten Ways to Make April 15th Less Stressful." Maine Organic Farmers and Gardeners Association. 2014. (Oct. 4, 2014) http://www.mofga.org/default.aspx?tabid=707
- IRS. "Crop Insurance and Crop Disaster Payments -- Agriculture Tax Tips." Sept. 4, 2014. (Oct. 4, 2014) http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Crop-Insurance-and-Crop-Disaster-Payments-Agriculture-Tax-Tips
- IRS. "Farm Business Expenses." 2013. (Nov. 2, 2014) http://www.irs.gov/publications/p225/ch04.html#en_US_2013_publink1000217880
- IRS. "Publication 225." 2013. (Oct. 4, 2014) http://www.irs.gov/publications/p225/ch07.html#en_US_2013_publink1000218173
- IRS. "Ten Things to Know About Farm Income and Deductions." March 26, 2013. (Oct. 4, 2014) http://www.irs.gov/uac/Newsroom/10-Things-to-Know-about-Farm-Income-and-Deductions
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- Keen, Scott. "10 Tax Tips for Farmers." AdviceIQ. June 23, 2014. (Oct. 4, 2014) http://adviceiq.com/articles/scott-keen-10-tax-tips-farmers
- Lee, Bonnie. "Tax Tips for Farmers." Fox Business. April 6, 2014. (Oct. 4, 2014) http://smallbusiness.foxbusiness.com/finance-accounting/2012/04/06/tax-tips-for-farmers/
- Schell, Rich. "It's Tax Time! How to Navigate the Tricky World of Farm Taxes." HobbyFarms. March/April 2004. (Oct. 4, 2014) http://www.hobbyfarms.com/farm-marketing-and-management/farm-income-taxes-14991.aspx
- Smith, Kunz & Associates. "Income Averaging for Farmers." 2014. (Oct. 4, 2014) http://www.smith-kunz.com/news.php?id=6
- Weissman, Jordan. "America's Dumbest Tax Loophole." The Atlantic. April 17, 2012. (Oct. 4, 2014) http://www.theatlantic.com/business/archive/2012/04/americas-dumbest-tax-loophole-the-florida-rent-a-cow-scam/255874/