Agricultural Operations and Deducting Expenses on Your Taxes

Updated: Jul 7, 2020


White barn (Photo by Edwin Remsberg).
White barn (Photo by Edwin Remsberg).

This post should not be construed as legal or tax advice*


For those who do not know, agriculture is the only industry that the Internal Revenue Service (IRS) allows to continue using the cash accounting method for tax purposes. Cash accounting is simply recognizing income when it is received and expenses when paid. For example, Stan harvests corn in 2014 and stores a portion of his crop. Stan sells a portion of the stored crop in 2015, and would not recognize that income on his taxes till 2015. Farms may also choose to use the other accounting method — the accrual method, used by all other industries. Accrual accounting is when you report income and expenses in the year they incur. The idea behind accrual accounting is to allow for the matching of income and expenses.

Why are farms allowed to continue to utilize cash accounting practices and not switch to accrual like other industries? Some have pointed to the fact that many producers do not have the accounting skills necessary to grasp accrual accounting and the move would require producers to incur costs from hiring an accountant or an outside accounting firm (Klinefelter, EB-5077). While I will save the pros and cons of cash accounting versus accrual accounting for the farm financial experts, today I want to discuss a recent tax court ruling on when expenses can be deducted when using cash accounting.


Cornfield (Photo by Edwin Remsberg).
Cornfield (Photo by Edwin Remsberg).

In Agro-Jal Farming Enterprise, Inc. v. Commissioner of Internal Revenue, the U.S. Tax Court considered when an agricultural operation could defer expenses for packing materials. The IRS argued the operation could only deduct the cost of the materials used in the tax year and defer the cost of the unused ones to the tax year when used. Agro-Jal disagreed and argued that the cost of packing materials could be deducted in the year purchased or the year utilized as long as Agro-Jal had not already deducted the expense.

Agro-Jal is a diversified operation producing strawberries, the main crop at issue with the Tax Court. Strawberries are picked and placed in pre-labeled plastic clamshells to save time. Because of concerns Agro-Jal could run out of the pre-labeled plastic clamshells during harvest, Agro-Jal orders in bulk and prepays for large quantities of the clamshells, as deliveries can often take two to four months. Because Agro-Jal uses the cash accounting method, the farm deducts the expenses for the plastic clamshells in the tax year purchased (regardless if used or not).

Issue

As discussed earlier, the issue in this case was the timing of the deduction for the clamshells. The IRS conceded that the packing materials were deductible and the farm could use the cash method. The sole issue was timing of the deduction.


Courts Reasoning


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