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IRS Eyes 2018 Payment on 2019 Farm Machinery Purchases
In February 2017, the IRS launched a program to audit Schedule F, which most farmers use to report farming income. This schedule can be part of your individual tax return or even part of a trust or partnership return. Apparently, the IRS was concerned by the lack of coverage it had given to farming activities for the last several years.
I have reviewed the IRS Schedule F guidance and will hit some high points here for your benefit. One issue the IRS wants to address is taxpayers deducting hobby losses. If you are not approaching a business with a profit motive, it’s a “hobby” as far as the IRS is concerned, and hobby losses cannot be used to reduce your other taxable income. One strategy that some taxpayers employ is what I will call the quasi-farm. They have a hunting lodge, ATV, and brush-hog on a 100-acre tree farm. Nothing is ever harvested on the tree farm, except bucks during deer season, and the taxpayer deducts all of the costs to maintain the farm. The IRS would call this a hobby and disallow the losses, if it conducted an audit.
Another concern of the IRS is farmers potentially putting down deposits on 2019 purchases in the last few days of 2018. The IRS looks at four factors to make a distinction between a deposit and a currently deductible expense.
- Is the check just a flat amount not related to an invoice for a specific quantity of something?
- Does the farmer have a right to get a refund of the deposit?
- Did the seller treat it as a deposit in his/her books?
- Does the farmer have the right to substitute the supplies prepurchased for other goods?
If the answer is NO to all of those questions, you have currently deductible prepaid supplies rather than a nondeductible deposit.
There is a quirky limit in tax code section 464 related to prepaid farm supplies. You can't deduct prepaid 2019 supplies in excess of 50% of your entire 2018 farm expenses. So, if you had total deductible expenses in 2018 of $200,000, you cannot walk in to the co-op on December 31 and pay for $110,000 of supplies. You'll have $10,000 disallowed for 2018.
There were two other items the IRS mentioned in its 2017 memo to auditors. The first was to check for farmers putting wages paid to employees on the Custom Hire line. Why? I can't be sure, but I suspect that some taxpayers have shown some unofficial payroll on that line (i.e. They paid farm laborers cash or checks without withholding Social Security, Medicare, or Federal taxes.) A Schedule F audit is one way for the IRS to find those unofficial payrolls and ask for the unpaid payroll taxes, penalties, and interest.
The second item was potential personal use of farm fuel. The IRS directs its agents to find out (a) if you have a fuel storage tank on the farm and (b) how you account for personal use of fuel taken out of that tank. It must be a hard thing to prove one way or the other. I suppose that if you have no evidence of buying gasoline for your personal cars, they would tend to think it all comes out of your farm tank. So, you might want to use a credit card at gas stations, rather than cash, in order to have some evidence.
Some other things that can always be in play for an audit are unreported revenue, purchases without receipts or invoices, mileage expense without mileage records, and personal expenditures made through the farm's bank accounts. Upon audit, I've seen taxpayers owe $0 and sometimes over $100,000. It all depends on whether or not your ducks are in a row.