If you're a farmer using the cash method to report income and claim expenses, you have flexibility in determining your taxable income on a year-to-year basis. For example, if you hold off on selling crop inventory, you can reduce your income in that year because you only have to record income when it is cashed in. In most cases, it is beneficial for farmers to estimate their cash income before the end of their tax year, as this allows them to plan for their taxes. Even if you expect to bring in income, there is always a chance you will find yourself in a loss position. With that possibility in mind, here are some issues and options every farmer should consider.
Mandatory inventory adjustment
If you are a farmer in a loss position, you should check if a mandatory inventory adjustment is required. If you purchased a bunch of inventory – say, livestock – the government will not permit you to declare that as part of a loss. Instead, a mandatory inventory adjustment is required. If you're in a loss position as a farmer reporting on the cash basis and you have purchased inventory on hand at the end of the year, you must reduce your loss by the mandatory inventory adjustment.
Optional inventory adjustment
In cases where there is not much purchased inventory at the end of the year, we ask farmers, "What inventory are you sitting on?" This is necessary because of something known as an optional inventory adjustment, which gives farmers the option to reduce their loss. Both the mandatory and optional inventory adjustment increase their income, reducing the loss and granting an offsetting deduction in the following year.
Holding off on selling inventory
Imagine you are a farmer who reports on a cash basis and holds off on selling inventory. If you have 1,000 tonnes of corn at $170 per tonne, you're sitting on $170,000 worth of corn inventory at the end of the year. If you turn around and sell it the first day of the new year, that's $170,000 of income. If in the current year your taxable income is low, consider the optional inventory adjustment which allows you to increase your farming income up to a maximum fair market value of inventory on hand at year-end. In the following year, you will receive an offsetting deduction for the smoothing of income from year to year.
Chief source of income
For farmers in a loss position, the next thing to look at is the chief source of income. If farming is your chief source of income, the loss you've incurred can be deducted against any other source of income in the current year. This loss can be carried back three years through any other source of income and carried forward 20 years against any other source of income.
Restricted farm loss rules
If farming is not your chief source of income – you could have employment income or another business income that is not considered subordinate to farming – you are caught in what is called the restricted farm loss rules. Under the restricted farm loss rules, there are restrictions on how much of the loss can be allowed against other sources of income on an annual basis.
How to prepare
Before the end of your fiscal year, you should do a cash basis assessment of your business – you can work with an accountant or even do this yourself – to estimate your income for the year. Many farmers will use these numbers to determine if they want to sell inventory in the current year or hold off until the next year.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
