CARL WATTS & ASSOCIATES

June 03, 2013



The farm business may be considered by some as just another business, but it is not quite true and, among other pieces of evidence, the IRS treatment of farm income and loss sets the farm business on a chapter of its own (see Publication 25 Farmer’s Tax Guide).

All individuals, partnerships, or corporations cultivating, operating, or managing farms for gain or profit as owners or tenants are considered to be farmers (with the exception of taxpayers engaged in forestry or timber raising who are not considered farmers.)


Farms include plantations, ranches, ranges and orchards. Farmers may raise livestock, poultry or fish, or grow fruits or vegetables.

Farmers are subject to a variety of taxes at all levels of government, like any other taxpayers: federal income taxes, social security and self-employment taxes, estate taxes, property state income tax, excise taxes, corporate income taxes, and retail sales taxes.

Numerous provisions of federal income tax law allow taxpayers to reduce their tax liability if they undertake certain tax-favored activities.

Farmers benefit from both general tax provisions available to all taxpayers and from provisions specifically designed for farmers.

Normally a taxpayer qualifies as a farmer or fisherman for a certain tax-year if at least two-thirds of the taxpayer’s total gross income was from farming or fishing in either of the two previous years.

Individuals actively engaged in farming activities must file Schedule F along with the standard Federal Income Tax form 1040. The form itself is similar to Schedule C except it contains special items pertinent only to farmers as business owners.

As another special requirement, farmers must indicate, using a six-digit code, the number which best describes their farming activities to facilitate the administration of the IRS.

The farming activities are broken down into three main categories and include crop production, animal production, and forestry and logging. These main categories are further broken down into sub-categories such as vegetable farming, fruit and tree nut farming, beef cattle ranching, aquaculture, and poultry and egg production.


Farmers and ranchers are one of the few manufacturers to be exempted from using the accrual method of accounting, and are permitted to utilize the cash method of accounting. The cash method can be advantageous to farmers and ranchers by allowing for the deferral of income and acceleration of expenses. The cash method requires revenue to be recognized in the year when cash is received and expenses are paid.

Farmers may use the crop method in conjunction with either cash or accrual accounting.

Crop accounting is a special accounting method which allows farmers to deduct the entire cost of raising a crop in the year they realize income from it. If they do not sell the produce of a crop for a year or more after planting it, they are entitled to deduct costs (such as the price of seeds and labor to tend to the plant) in the year they sell. The IRS must pre-approve this deduction.

A farmer’s gross income includes amounts received in cash plus anything of value received instead of cash. Included are:

  • Proceeds from the sale of crops, produce, poultry, and livestock;

  • Fair market value of farm products, other property, or services, received in exchange for farm products or services (i.e., barter income);

  • Prizes for livestock or products;

  • Proceeds from sale of natural deposits;

  • Insurance proceeds to the extent received for the crop destroyed;

  • Patronage dividends;


  • Payments for easement or right of way on farm or ranch land;
  • Proceeds from timber sales;

  • Fee for taking care (pasture) of someone else’s cattle;

  • Rents;

  • Crop shares;

  • Government aid payments;

  • Fuel tax credits or refunds; and

  • Commodity futures (options) gains.

Land and property sales are reported separately and are not considered in determining the net profit or loss.

Sale of livestock for breeding, dairy or sport purposes are also not relevant to the farmer’s profit or loss statement.
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Schedule F
The Farm Business
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The value of produce consumed by farmers and their family isn’t included in the gross income.

Part or all of certain federal or state cost sharing conservation, reclamation, and restoration program payments can be excluded from income.


Under certain conditions, farmers may postpone reporting the sale or purchase of livestock or poultry until the next tax year. To be able to postpone reporting these assets, they must use the cash method of accounting, be able to demonstrate that the sale or purchase was due to extreme weather problems, live in an area that has been designated a weather disaster by the federal government and make your living primarily from farming.


The IRS allows a deduction for any expense necessary for the farming business to operate. This may include a proportional amount of the living expenses for the farmers themselves. Most farms include the farmer's personal residence, which is indistinguishable from the farm itself.

Farmers business expenses list may be quite extensive, however here are some of the items included:

  • Rent paid for farm;
  • Taxes and tax preparation fees;
  • Labor;
  • Repairs;
  • Marketing quota penalties paid for marketing crops in excess of marketing quotas, unless deducted from the amount paid by the buyer to the farmer (who includes only the net amount received in income);
  • Egg-laying hens, and plants, chicks, etc., bought for resale;
  • Feed;
  • Fertilizer;
  • Car and truck expenses;
  • Maintaining houses and furnishings for tenants and hired help, including costs for heat, light, insurance, repairs, and depreciation;
  • Interest on farm mortgages and other obligations incurred to carry on farm business;
  • Educational expenses to maintain and improve farming skills;
  • Ordinary tools of short life (one year or less) or small cost, such as hand tools, shovels and rakes; and
  • Premiums on fire, storm, crop, theft, liability, and other insurance on farm business assets.

Reasonable amounts paid for regular farm labor, piecework, contract, or other labor hired to perform farming operations are deductible.  This includes wages paid in cash and other property.  Deductible labor includes the actual cost of boarding hired farm labor and the costs of their health and workers’ compensation insurance.

Farmers who pay wages in cash include in their deductible labor costs the amount of social security, medicare and income tax withheld from those wages, as well as the portion of the social security and medicare taxes the farmer (as the employer) must pay.

When it comes to paying taxes, another special tax rule for farmers allows them to make a farm income averaging election to compute their current year (election year) income tax liability by averaging, over the prior three-year period (base years), all or a portion of the farmer’s current year income.

Making the income averaging election may result in a lower tax if the farmer’s current year income from farming is high and their taxable income for one or more of the three earlier years was low.

This method does not change the prior year tax. It only uses the prior year information to figure the current year tax.

Farmers don’t have to have been engaged in a farming business in any of the base years in order to make a farm or fishing income averaging election.

Farmers don’t have to pay the estimated tax if they file their return and pay the tax on or before March first of the following year.

If they don’t file their return and pay the tax on or before March first, they need only make one estimated tax payment for the year, which is due on or before January 15 of the following tax year.  A farmer or fisherman may avoid penalty by paying 100% of the previous year’s tax.  The underpayment penalty is based on the difference between the amount of estimated tax they paid by the due date and two third of the actual tax for the year.

The IRS requires all businesses, including farming, to keep records of financial transactions, assets, employee tax payments and profit and loss of the business.

Employee tax records must be kept for four years after the tax is due and asset records for three years after the sale or destruction of the property. All other records must be kept for at least three years after filing taxes.

Farmers face unique business problems and it's no surprise that there are a variety of tax forms, deductions, and tax strategies to assist independent farmers and fishermen. Enrolling professional help to navigate through all the provisions of the tax law is an expense that may return itself many times over.