2/20

INCOME TAX

Federal Income Tax Structure

 Gross income – Deductions = taxable income
 Taxable income x tax rate = tax liability
 Tax liability – credits = tax due
 Tax brackets – See table 1 on pg. 6-5
o Want to fill up a bracket all the way without going over into next bracket

Methods of Accounting
 Cash method:
o Report income when received and claim deductions when payments made
 Farmers can utilize the cash method
 Inventory is not reported into income; an inventory remaining at death
receives a new basis
 Accrual method
o Report income when earned and claim deductions when expense is incurred
 Tends to even out income stream, but is more complex

Constructive Receipt Doctrine

 Income is considered constructively received when it is:
o Credited to the taxpayer’s account;
o Set apart for the taxpayer;
o Made available for the taxpayer to withdraw if notice of intent is given
 Income is not constructively received if control is subject to substantial restrictions

IRS Notice: News release– don’t rely – low level

IRS Publications: low level

Private Letter Rule: from taxpayer (base level entry fee is $10k)

Tech Advice Memo (TAM): IRS examining agent has a question

Chief Counsel Memo (CCM): answers the above – same level of authority though

Internal Legal Memo (ILM): IRS to IRS

Revenue Ruling: Official Policy of the IRS – authoritative

Basis (“what you’ve got in it”)
 Manner Acquired
o Purchase
 purchase price
o Inherit
 FMV at date of death
o Gift
 Donor’s basis (“carryover”)
o 1031 Exchange (land only)
 Transferred basis

Left off IRD

Recapture –

Self-Employment Income (in addition to income tax)

 Self-employed individuals pay tax at a net rate of 15.3% on the first $168,600 of
earnings for OASDI purposes

1402(a)
 The term “net earnings from self-employment” means the gross income derived by an
individual from any trade or business carried on by such individual
o Trade or business is based on the facts
o Groetziener
 Passive income is not subject to self-employment tax

1402(a)(1)
 “there shall be excluded rentals from real estate and from personal property leased with
the real estate (including such rentals paid in crop shares, and including payments under
section 1233(a)(2) of the Food Security Act of 1985 (16 U.S.C. 3833(a)(2)) to individuals
receiving benefits under section 202 or 223 of the Social Security Act)
 CRP

1402(a)(1)
 Except that the preceding provisions of this paragraph shall not apply to any income
derived by the owner or tenant of land if (A) such income is derived under an
arrangement, between the owner or tenant and another individual, which provides
that such other individual shall produce agricultural or horticultural commodities
(including livestock, bees, poultry, and fur-bearing animals and wildlife) on such
land, and that there shall be material participation by the owner or tenant (as
determined without regard to any activities of an agent of such owner or tenant) in
the production or the management of the production of such agricultural or
 horticultural commodities, and (B) there is material participation by the owner or
tenant (as determined without regard to any activities of an agent of such owner or
tenant) with respect to any such agricultural or horticultural commodity;

Look at structure of the lease and key in on material participation when tax planning for
clients…… if materially participating in lease then it is subject to SE tax

Nexus is a big thing

If farm operation in Wamego and then crp ground in stevens county – crp income is not self
employment taxable

Contract production income – get separate check for building rent or separate memo itemizing
the breakdown of the amount
 Labor services subject to self employment tax

SE taxable – trade or business income

READ THROUGH DEDUCTIONS on page 38

McNamara – strong taxpayer victory – full tax court opinion – national

Solutions on self-rental leases:

 Lease language: No landlord participation
 Make sure rent does not exceed market rate

Self-Employment Tax Summary (GET FROM SLIDES – 18)

Structuring LLCs for S.E. Taxation

Deductions From Income (pg. 6-38)

Overview
 An income tax deduction attributable to an item of property is limited to the extent the
taxpayer has a basis in that particular item.
 The item(s) of property must be used in the taxpayer’s business to be deductible

Basis
 Purchase price” basis for purchased property
 “Carryover basis” for gifted property
 “Stepped-up” basis for inherited property
Adjusted Basis
 Capital improvements increase basis by the cost of the improvement, and depreciation
allowable reduces the basis
o Note: For cash basis taxpayers, there is no basis increase for financed
improvements until payment is made. Owen v. United States, 34 F. Supp. 2d
1071 (W.D. Tenn. 1999)
 For traded property, basis of new item equals basis of old item plus boot paid, if any
 For tax-free exchanges, basis of new item equals basis of old item

Depreciation
 Available for assets (1) used in the taxpayer’s trade or business or (2) for the production
of income (3) that have a determinable useful life (4) of more than one year
o If less than one year for example – just expense it/write it off
 EX: Replacement tires, seed, fertilizer,

What property is depreciable?

 Depreciable property includes business machinery and equipment, buildings, patents,
purchased livestock and property held for rental
 In essence, the tax law is structured to tax income less the cost of producing that
income

Hess v. Comr. T.C. Sum. Op. 1994-79

 Deduction allowed
o Taxpayer claimed $2,088 deduction for breast implants  Deduction allowed
 Enhanced size to 56FF
 Each implant weighed 10 pounds
o Doubled her income in one year
o Court stated that implants made taxpayer look “freakish”
o Viewed as a depreciable stage prop used in the taxpayer’s trade or business or
for the production of income
Key quote:
“Because petitioner's implants were so extraordinarily large, we find that they were
useful only in her business. Accordingly, we hold that the cost of petitioner's implant
surgery is depreciable.”

Deductions From Income

 Depletion
o Land is not depreciable, but a depletion deduction may be claimed for removal
and disposition of natural resources such as sand, gravel, oil, and minerals
o Land does not have a determinable useful life
o Other nondepreciable items include inventories and personal residences
  Depreciation
o The applicable depreciation system depends upon when an asset was placed in
service
o Three sets of depreciation rules:
1. Property placed in service before 1981;
2. Property placed in service after 1980 and before 1987, and;
3. Property placed in service after 1986.
Note: Some property presently placed in service may be depreciated
under the pre-1981 rules.

Post-1986 depreciation rules - Modified Accelerated Cost Recovery Systems (MACRS)

o The cost of an asset may be recovered over a period shorter than the asset’s useful life
o Cost recovery classes of 3, 5, 7, 10, 15, 20, 27 1/2 and 39 years
o Salvage value is not a factor
o Property is classified on the basis of ADR mid-point life by Congressional legislation or
IRS decree

Post-1986 depreciation rules - (MACRS)

o Three-year property has a mid-point life of four years or less that is used in a farming
business
o Breeding hogs & other personal property with mid-point life of 4 years or less
o Use 150% declining balance method switching to straight- line

200% or 150%?
o Applicable for tax years beginning before 2018, if a taxpayer is not engaged in the trade or
business of farming, the 200% d.b. method may be used
o A grain harvester that contracts with others to cut and haul grain for a per acre fee
and who does not raise or grow any grain or own the underlying land, may use the
200% double declining balance method under MACRS. Tech. Adv. Memo. 9748002,
June 27, 1997
o Same is true for processing activities

Tax Years Beginning After 2017

o Recovery period shortened to 5 years for...
o Machinery or equipment used in a farming business where the original use
originated with the taxpayer  Used farm equipment has a 7-year life
o No 150% method for 3,5,7, and 10-year property

Depreciation Method vs. Recovery Period

o For leased farm assets:
 o For assets leased by a non-farmer to a farmer, the proper depreciation method is
determined by the use to which the owner of the asset puts the asset rather than
the use to which the asset is applied.
o But, the appropriate recovery period is determined by the end use of the asset by
the lessee.

Depreciation
o Post-1986 depreciation rules - (MACRS)
o Five-year property includes assets with a mid-point life of five to nine years that are
used in a farming business
 Breeding cattle
 Dairy cattle
 Sheep
 Goats
 Pickup trucks
 Business autos
o Use 150% declining balance method switching to straight- line

Depreciation
o Post-1986 depreciation rules - (MACRS)
o Seven-year property includes property that has a mid- point life of 10 or more
years, but less than 16 years that is used in a farming business (if not sure, throw
it in 7)
 Most farm machinery
 All equipment
 Fences
 Vineyard trellises – similar to fencing; but irrigation well that is buried
underground is 15-year property
 Grain bins
 Possibly silos
 Unclassified property

Depreciation
o Post-1986 depreciation rules - (MACRS)
o Ten-year property includes property with a mid-point of 16 years or more but
less than 20 years that is used in a farming business
 Single purpose agricultural and horticultural structures
 Trees and vines producing nuts and fruits

Depreciation
o Post-1986 depreciation rules - (MACRS)
o Fifteen-year property includes property with a mid- point life of 20 years or
more but less than 25 years
  Land improvements
 Irrigation systems and wells
 Tile lines
 Landscaping that would be destroyed if buildings were replaced
o Use 150% declining balance method switching to straight-line

Everson v. United States, 95-1 U.S.T.C. ¶50,150 (D. Mont. 1995)

Revenue issue
o Facts: Taxpayer purchased a 3,700 acre ranch for $1,200,000. The ranch contained
250,000 mature trees that had been planted as a windbreak and to prevent soil erosion
and moisture evaporation. The taxpayer allocated $250,000 to the purchase price and
claimed straight-line depreciation on them over 12 years.
o Issue: Are the trees and bushes deductible?
o Conclusion: No. The trees and bushes do not produce revenue.
o Query: Would the trees and bushes be depreciable as a land improvement (15
year property)?
o Case was affirmed on appeal. Court reasoned that the cost of the trees could
have been deducted when planted as a soil and water conservation expense, and
this precluded depreciation. The court’s reasoning appears flawed.

Depreciation
o Post-1986 depreciation rules - (MACRS)
o Twenty-year property includes property with a mid- point life of 25 years or
more other than real property with a mid-point life of 27 1/2 years or more
 Farm buildings
 Farm and ranch houses occupied by a farm tenant
o Use 150% declining balance method switching to straight-line

Depreciation
o Post-1986 depreciation rules - (MACRS)
o 27 1/2 and 39-year classifications are for depreciable residential rental property
 Buildings and structures where 80% or more of gross rental income
represents a structure providing living accommodations
 Farmhouses where resident works off the farm
o Use straight-line method

Depreciation
o Depreciation conventions
o Half-year convention
 In the year the asset is acquired a half-year of depreciation may be
claimed regardless of when the asset is placed in service (for property in
3, 5, 7, 10, 15 and 20-year classes)
  At least 60% of the basis of property purchased during the calendar year
must be placed in service during the first three quarters of the year
o Mid-quarter convention applies if more than 40% of the basis of property
purchased during a taxable year is placed in service during the last three months
of the taxable year.
o If the mid-quarter convention is triggered, it applies to all property placed in
service for the tax year.
 1st quarter - 7/8 3rd quarter - 3/8
 2nd quarter - 5/8 4th quarter - 1/8
o Thus, it may be wise to just trigger the mid-quarter convention, but place most
property in service during the first quarter.

Anti churning rules…

Depreciation of Business Automobiles

o Two options:
o Annually deduct an amount equal to the business standard mileage rate times
the number of business miles driven
 2024 IRS rate – $.67/mile
o Actual costs paid allocable to business miles
o Vehicle must be used 50 or more for business use
o Depreciation deduction tied to business use percentage
o If under 6,000 lbs. of GVW, depreciation is capped
o $12,400 for 1st year
o $19,800 for 2nd year
o 11,900 for 3rd year
o Larger vehicles limited to $28,900 of Sec. 179 (2023)
o No limit if 9 people can sit behind the driver
o No limit if cargo area is 6 ft. or more
o No limit if not seating behind driver
o
o “Listed property” limitations
o Even if use is 100% for business, there is a ceiling on the maximum amount of
depreciation that can be taken in any particular year
o “Listed property” includes:
o Any four-wheeled vehicle used as a means of transportation and rated at 6,000
lbs GVW or less;
o Property used generally for entertainment, recreation or amusement;
o Computers not used exclusively at a regular business establishment; and
o Cellular phones
o “Listed property” limitations
o Annual dollar limitations must be ratably reduced by the percentage of personal
use during the year
  See Example 6 on p. 6-48
o If used 50% or less in the taxpayer’s trade or business, depreciation limited to
alternative depreciation using a five-year recovery period, under the 1/2 year
convention

Depreciation Recapture
o Imposed if property depreciates faster than it declines in value
o On sale or other disposition of personal property, the amount of gain
representing depreciation previously taken is treated as ordinary income (1240?)
 Any excess is capital gain
o On the sale or other disposition of depreciable real property, depreciation in
excess of straight-line is recaptured as ordinary income (1250)

Expense Method Depreciation

o For qualified tangible depreciable personal property, all or part of the income tax basis
can be deducted currently
o $1,220,000 for 2024
o Basis is reduced by amount expensed and then depreciated under MACRS
o The amount expensed is reduced (dollar for dollar) by the amount by which the cost of
qualifying property placed in service during the taxable year exceeds $3,050,000 (for
2024)
o None remains once you get to $4,270,000
o Any property that would have been eligible for investment tax credit is eligible for
expense method depreciation
o Machinery
o Equipment
o Purchased breeding stock
o Pickup trucks
o Any property that would have been eligible for investment tax credit is eligible for
expense method depreciation
o Tile lines
o Fences
o Feeding floors
o Grain bins
o Silos
o Technique to obtain multiple expense method amounts
o Co-ownership of assets with each owning an undivided interest
 Technique unavailable for partnership members
Other Points
o $1,220,000 max
 Phase-out begins at $3,050,000; gone at $4,270,000
 Business income
  Wages and salaries
 Sec. 1231 gains and losses
 Interest from working capital of the business
o Can make or revoke election on amended return
o Non-corporate lessor rule may apply when Sec.179 property is leased (Sec. 179(d(5))
 No Sec. 179 unless term of lease is less than 50% of class life of property; and
 Lessor’s deductions with respect to the property exceed 15% of rental income the
property produces
 See footnote 177 (oral farm lease case)

Sec. 179 (no 179 on farm buildings) see slides

Bonus Depreciation
o Certain property is eligible for additional depreciation of up to 100% of the property’s
adjusted income tax basis for the first year it is placed in service through 2022, then 20%
point reduction per year thereafter.
o Must be “qualified property”
 New property with a recovery period no more than 20 years
 Computer software qualifies
 Qualified leasehold improvement property disqualified presently

Bonus or Expense Method (The Key Rules)

  Sec. 179 available on all new and used qualifying machinery (not real property;
beware non-corporate lessor rules).
 Includes single purpose ag structures such as hog confinement facilities
  Bonus is only available on new purchases with a life of 20 years or less
 Includes almost all new ag buildings

Bonus or Expense Method (The Key Rules)

 Ordering rule:
 Sec. 179, then bonus, then regular MACRS
 Beware Sec. 179 active income limits
 Sec. 179 is based on when the tax year starts, bonus is based on when the asset is placed in
service
 If taxpayer is on the calendar year, there is no difference

“Placed in service” – when it is available for use

Residual Soil Fertility
Rules for Allocation
o Sec. 1060
o Allocate purchase price among assets involved
o Buyer and seller use same allocation rules for a group of assets
o Most farmland sales are not subject to the Sec. 1060 allocation rules (because
most land purchases are not associated with a group of assets
o Is there a state rule requiring buyers and seller to report the transaction and
identify the parties to the transaction?
o If adverse interests involved, IRS will honor allocation

The Deduction
o Sec. 180
o Watch definition of “farmer”
o If fertilization costs not expensed, must be capitalized with expense deductions
amortized over a presumed useful life
 Based on percentage of use or benefit each year
 60/30/10
o For inherited land, date of decedent’s death is measurement date for
determining whether excess soil fertility exists

IRC §199A
  Taxpayers other than C corporations are taxed using the individual rate structure
  Taxpayers previously were allowed a Domestic Production Activities Deduction
(DPAD)
 9% deduction for qualified production activities income
 The deduction was limited to 50% of wages expense
attributable to manufacturing, producing, growing or extracting activities
 Cooperatives were also entitled to DPAD
 Cooperatives could pass all, some or none of the DPAD to patrons

IRC §199A
 20% deduction for qualified business income
 Eff. for tax years beginning after 12/31/17 and before 1/1/26
 Thebasicideaistoallowanon-corporatetaxpayertotakea20%
deduction against the income from their business activity
  Sole proprietor
  S corporate owner
  Member of partnership
  Cooperative patron
  Owner of an interest in a REIT
   Owner of an interest in a qualified publicly traded partnership
 A modified rule applies to a specified service trade or business

Repeal of Section 199

 DPAD repealed for tax years beginning after 2017  Transition rule for patrons of cooperatives
 Qualified payment from co-op received after 2017, attributable to QPAI generating a DPAD for
a year beginning before 2018

Basics of 199A, Deduction for Qualified Business Income

  Taxpayers other than C corporations
  Applies for tax years beginning after 2017 and before 2026
  20% deduction on QBI
  Specified service business income (SSB) ≠ QBI
 Exception based upon threshold income plus phase- out range
  Separate trades or businesses
  Wages and investment limit applied to each business
 Exception based upon threshold income plus phase- out range

I.R.C. §199A
  Only applies for income tax purposes – not s.e. tax or NIIT
  Determined without regard to AMT adjustments (is allowed against AMT)
  Is allowed to arrive at taxable income, but not to arrive at AGI (adjusted gross income)
 The various phase-ins and phase-outs which are based on AGI are not impacted by
I.R.C. §199A
  Not allowed in determining any NOL
  Is allowed to itemizers and non-itemizers (even though it is not part of the
determination of AGI)
  Doesn’t matter if taxpayer is materially involved in the business activity. What matters
is percentage ownership.
  QBI depends on whether taxpayer has ordinary income
  Accuracy-related penalty for substantial understatement applies if understatement is
5% rather than 10%

Farm Program Payment Limitations

 An AGI limit applies
  $900,000
 Computed by using the number shown at the bottom of page 1 of Form 1040
 Used to include the DPAD of I.R.C. §199
 Under the new law, I.R.C. §199 is repealed
 New I.R.C. §199A is not part of the AGI calculation
 Result could be ineligibility for payment limits
 The offset could be a larger deduction

Overall Limit on Deduction

 Deduction claimed after AGI
 Deduction can’t exceed 20% of ordinary income
 Exception for pass-through from cooperative
 Deduction provides no benefit unless taxpayer has positive taxable income

Included/Excluded Items
 QBI amount...
  Does not include reasonable compensation
  Does not include guaranteed payments
  Does not include wage income (including S corporation shareholder wages)
  Does not include capital gain or loss, dividends (or their equivalent)
  Does not include any amount received from an annuity that is not in connection with
a trade or business
  Does not include speculative gains

I.R.C. §199A
 For a sole proprietor the entire bottom line amount of Schedule F (or C) qualifies for purposes
of the deduction
 Thus, the deduction for a sole proprietor may often be larger than if the business were
structured as a partnership or S corporation

rfdtv Nashville live

1.162-12 as long as use life is 1 year or less

Materials and Supplies

• Example:
 Pete (cash method farmer) filled his 4,000 gallon diesel fueltankonDecember30. He expects
to use the fuel in the next 12 months
 Pete can currently deduct the expense
  Listed as a supply inventory on financial statement
  Keeps record of consumption
  Can deduct the expense as necessary to conduct farming
business. Treas. Reg. 1.162-12(a)
Note: The same analysis applies to the purchase of tires to be consumed in next 12 months

Materials and Supplies

 Application to farmers
 Can deduct all amounts actually expended in the carrying on the business o farming.
 Treas. Reg. §1.162-12(a)
 What about non-ag tires?
 Capitalize the cost of the original tires and depreciate them under Sec. 168 under the
same method, period and convention that applies to the vehicle – this is the safe harbor of
Rev. Proc. 2002-27
 Don’t elect the safe harbor if tires normally wear out within a year (then can
expense the original tires)
 Deduct the cost of replacement tires

What About Ag Tires?

  They are not treated as separate components of a unit of property
  Not depreciated separately
  Thus, deduct the cost of replacing the tires
  Bottom line:
 Tractor tires are always deductible when they are purchased to replace tires on an
existing tractor
 They are not deductible when the taxpayer buys a tractor

De Minimis Safe Harbor Election

 Can elect safe harbor to deduct amounts paid to acquire or produce tangible personal
property up to threshold of $5,000/invoice (or per item if taxpayer has an AFS)
 Must have, at the beginning of the tax year, written accounting procedures treating amounts:
  Paid as an expense for non-tax purposes, or
  Amounts paid for property costing less than a specified dollar amount, or
  Amounts paid for property with an economic useful life of 12 months or less

Most Farmers Will Not Have an AFS

 Safe harbor is $2,500
  Establishes a floor for automatic deductibility for costs associated with tangible
personal property acquired or produced during the tax year that are ordinary and
necessary business expenses associated with the taxpayer’s trade or business
 Annual election

Repair/maintenance vs betterment
 Increasing tractor horsepower = betterment
 Overhaul the engine = maintaining and expensed as a repair

Soil and Water Conservation Expenses

Land Clearing Expenses

 Deductibility repealed for expenses incurred after 1985
 Can deduct expenses attributable to pasture maintenance
 Routine brush clearing
 Other maintenance activities that are ordinary and necessary business expenses

STOPPED at Agro-Jal Enterprises