Farm Deduction
The farm deduction is given to farmers who have certain expenses that are incurred in the ordinary and necessary operation of a farm. The deduction is treated much like a business deduction with some exceptions.
The information needed to calculate and claim the farm deduction is found in the Internal Revenue Code Section 62 and Treasury Regulation 1.162-12. It allows a tax deduction for expenses that are incurred in the ordinary and necessary operation of a farm. This includes maintenance of the farm, its buildings and equipment. As always, the exact definition of ordinary and necessary is sometimes hard to pin down with certainty. Usually, the majority of such expenses are certainly ordinary and necessary, but there is always going to be one or two items that appear to be on the bubble.
The regulations are fairly simply for someone using the cash accounting method. When the accrual method of accounting is used, it is important to note that the deductions can not be taken until the money is actually spent, or the services received, or the liability is actually realized. Many farmers use the accrual method which takes in account projected income and expected expenses because of the cyclic nature of the farming operation. The IRS does not recognize a deposit for seed, for example, that is not going to be received until the following planting season, as an expense in the current year.
Internal Revenue Code 464 limits pre-paid supplies if they exceed 50% of the total farm expense deduction. If the pre-paid supplies are actually used during the tax year, they are fully deductible. The intent of IRC 64 is to prevent tax payers from using farms to shelter income that is not related to the farm.
The farm deduction can be taken on certain expenses, however, that are pre-paid when they constitute an actual commitment that is binding and unchanging. There are rules set out that explain the difference between the deposit and the pre-paid expense that clarify how they may be treated in the current tax year. This is the idea of these regulations. They do not exist to rob the farmer of a legitimate deduction, but rather to place it in the proper tax year. This policy prevents the shifting of income and expenses from season to season to create a more favorable tax situation.
The farm deduction is usually allowed for tax payers who have their principal place of residence on a farm or operate a farm as their principal business. It is also applied to members of the family of a tax payer who meets either of these two requirements. The farm deduction is much like any other business expense as far as the Internal Revenue is considered. The idea being that the business, or the farm, is not taxed on its gross income, but only what is truly and legally considered profit. Farm deductions make sure the farmer is not taxed on money that is not profit.