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Sunday, January 01, 2012

Get Ready For Income Taxes:  Part 4



 

If you did not have extreme weather variations in 2011, your farm was either in a greenhouse or in an Internet board game.  Unusual weather variability was the norm in the past growing season and USDA’s Risk Management Agency expects to pay out more than $11 billion in crop insurance claims for losses.  If you are one of those receiving an RMA indemnity check, how will you treat that payment on your 2011 income tax?  There are some options and some restrictions.

The Internal Revenue Service is quite familiar with crop insurance indemnity payments, along with the practices of farmers who are cash basis taxpayers.  If you are an accrual practitioner,  you already know the payment is taxable in the year received.  However, a cash basis taxpayer can defer the tax liability to the following year, if commodity marketing is typically done in the year following production.  Purdue University tax specialist George Patrick says there are 8 requirements that have to be followed if you plan to do that.  In his annual tax guide for farmers, Patrick says the election statement must include:

1. Name and address of the taxpayer.
2. Statement that the election is being made under I.R.C. Section 451(d).
3. Identification of the specific crops damaged or destroyed.
4. A declaration that, as normal business practice of the taxpayer, the income from the destroyed or damaged crop would have been included in gross income for a tax year following the year the crops were damaged or destroyed.
5. Cause of the damage or destruction of the crop(s).
6. Date of damage or destruction of the crop(s).
7. Total amount of payments received, itemized for each crop and the date when each payment was received.
8. Name(s) of insurance carrier or carriers making the payments. 

What happens if weather destroyed your wheat that is sold in the year produced and also destroyed your corn, which is sold the following year?  Patrick says the IRS has taken the position that if you sold 50% of your crops in the following year, then all income could be deferred to the following year for taxation.  But IRS has also taken a different position and the issue is a bit cloudy.  However, Patrick says there is basis for both and arguments can be made either way.

But the issue that will impact most producers with crop insurance payments is an indemnity payment which is based on both the loss of crop and the loss of price from a revenue insurance policy.  The IRS will only allow deferral of crop insurance indemnity payments if they are made as reimbursement for loss of a crop.  If you have a crop insurance revenue policy that pays when the market price declines, such a payment cannot be deferred, and must be considered income in the year in which the indemnity check arrived.

So what happens if the indemnity payment covered both?  In his 2007 tax guide, Patrick offers an example, which contains losses from both yield and price.
“One procedure to determine the amount of the insurance payment due to the decline in yields of corn is as follows:
Assume: Approved yield is 160 bushels per acre
Base price of corn is $4.06 per bushel
Harvest price of corn is $3.80 per bushel
Insurance coverage level is 75%
Actual yield of 75 bushels per acre
 
The final revenue guarantee level is 160 bushels X $4.06 X 75% = $487.20 per acre
Calculated revenue is 75 bushel actual yield X $3.80 harvest price = $285.00 per acre
Insurance proceeds = $487.20 guarantee - $285.00 calculated = $202.20 per acre
 
Yield loss is 160 bushel approved yield – 75 actual yield = 85 bushels per acre
85 bushel yield loss X $3.80 harvest price = $323.00 value of physical loss per acre
 
Price loss is $4.06 – 3.80 = $0.26 per bushel X 75 actual yield = $19.50 per acre
 
Total loss is $323.00 + $19.50 = $342.50 per acre
Physical loss is $323.00 / $342.50 = 94.31% of total loss
94.31% physical loss X $202.20 insurance proceeds =
$190.60 payment per acre due to physical loss

Based on this procedure, $190.60 per acre of insurance payment would be eligible for possible deferral as the value of the physical loss. The remaining $11.51 of insurance payment would be due to the price decline of the December corn futures and is not eligible for possible deferral.”

If your indemnity payment covered both physical loss of the crop along with the price decline, then plug your numbers into the example and work through the math.

If you market in the year the crop is produced, but did not receive the crop insurance check until the following year, it cannot be moved to the prior year, but will be taxed in the year that it was received.

If you have GRP or GRIP policies, Patrick says those are not based on your own physical loss, those payments must be taxed in the year received.  That is the same with an ACRE payment, which is received after the marketing year has ended and more than a year after the crop is produced.

Summary:
Crop insurance indemnity payments are considered income by the IRS and are taxable.  Cash basis taxpayers have the option to defer them to the next year, if crops are typically marketed the year after production.  Crop insurance payments which are based on both loss of crop and loss of revenue, cannot be deferred, unless a procedure is used to separate the losses.  Group risk payments cannot be deferred, and neither can ACRE payments if earned.

Posted by Stu Ellis on 01/01 at 09:00 PM | Permalink

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