Income Taxes for Beginning Farmers

Some people start a farm business with a profit motive.  They want income to be more than expenses, so that they will have cash for their family to use.  More people probably start growing plants or raising animals as a hobby- not really caring if they show a profit, but wanting to produce some of their own food.  Quite often, people move from hobby to business little by little over a number of years.

What do you have?  A business or a hobby?  Internal Revenue Service, IRS, calls a hobby farm ‘not for profit’ farming.

If you have a farm business, IRS expects you to file the Form 1040 Schedule F, ‘Profit or Loss from Farming.’  And your profit from the farm moves onto your Form 1040, ‘US Individual Income Tax Return,’ line 18.

If you have a hobby, IRS expects you to show income from the hobby on your 1040, line 21, ‘Other income.’  Expenses from the hobby are claimed if you itemize deductions on Schedule A of Form 1040. 

I work with more than a dozen Extension people from around the country each year to edit the IRS Farmer Tax Guide, Publication 225.  http://www.irs.gov/pub/irs-pdf/p225.pdf  Page 26 of the 2010 Farmer’s Tax Guide includes a section about Not-For-Profit Farming, part of Chapter 4.  There is a limit on deductions that hobbies may claim.  In addition, there are 9 factors that IRS may use to determine whether you have a hobby or a business. 

In the Farmer’s Tax Guide are a couple of definitions of farming and the types of businesses that they consider to be farms.  IRS tends to think that producing a product is farming.  On the other hand, processing a farm product is not farming, so this business would file a Schedule C, the regular business form. 

There are several types of taxes that you used to pay, before you started the farm.  State and federal income tax- directly based on the amount of income that you have, and withheld from your paycheck.  Social Security and Medicare taxes are also based on your earnings, and are withheld from paychecks.  Property taxes on real estate that you own.  Taxes on capital gains- selling things like real estate or mutual funds.  And maybe you are familiar with estate tax following the death of a parent or someone else.

As a farmer, you will be paying income tax based on your profit. Income less expense as shown on your Schedule F.  Depreciation, a non-cash expense, is also included as a farm expense.  You may also have to pay Self Employment tax.  As an employee, you pay half of this and your employer paid half, now that you are self-employed, you pay both halves.  If you hire employees, you will be facing paperwork for your employees- withholding taxes, paying those withheld taxes, and year-end reporting.  You may have to collect sales tax on stuff that you sell that is not food.  And if you happen to sell fuel or alcohol, you may be paying excise tax. 

In order to start with taxes, you need a good set of farm financial records.  Maybe a Farm Account book, or another ledger.  Or maybe Quicken will do the recording and reporting that you need- this will work as long as you are not sending out invoices.  In that case you need a program like QuickBooks- that can record transactions when no cash has changed hands.  Ohio State has an excellent, free,  Quicken manual for farms, http://ohioline.osu.edu/b931/index.html   Oklahoma State has lots of resources for farmers and ranchers about using Quicken, including instructional videos, http://www.agecon.okstate.edu/quicken/      QuickBooks is a more complex program.  UVM Extension has 1-day programs in February of 2011.  Some local high schools have evening programs about QuickBooks.  Some accountants will come to your farm and get you set up properly on QuickBooks.  And there is a QuickBooks Farm Accounting Cookbook that you can buy to help get your farm into QuickBooks, but it is not a beginner’s manual.

If you are going to try to file your farm taxes by yourself, the sample farm return at www.RuralTax.org   might be very useful.  There are other factsheets here also.  If you decide to hire a tax practitioner to file your taxes, be sure to ask them if they have experience with farm returns.  There are several types of credentials that tax practitioners have:  a Certified Public Accountant has taken courses and passed exams, not all CPAs do taxes.  Enrolled Agents have also passed an exam that allows them to represent you in case of an audit.  And now IRS is having everyone who files taxes for hire register with the IRS to become a Registered Preparer. 

You do not need to have your entire tax return done by a professional, maybe you just need pieces of it done- maybe depreciation and payroll taxes- many preparers will be happy to do the pieces that you need help with.  If you need help with your taxes, ask around to find someone:  talk to friends, relatives, people in the same business as you.  Yankee Farm Credit has a number of offices around the state and they prepare taxes.  Keep your eyes open for signs, or advertisements.  Then contact the person and talk with them- is this somebody you can work with and confide in?

It is important that you file taxes, and that you pay them.  People wind up in jail or paying fines if they don’t.  And not knowing the law is not an excuse.  Uncle and Governor both need money.

Here’s the link to a webinar on this topic from Feb 2, 2011:

https://sas.elluminate.com/site/external/launch/play.jnlp?sid=2009421&psid=2011-02-02.1634.M.FE831BE563DDB9F8566D9061EBE70D.vcr

And here is a link to the page on the UVM New Farmer Project website that has documents that Dennis refers to in the webinar:

http://www.uvm.edu/newfarmer/?Page=webinars/webinar_recordings.html&SM=webinars/sub-menu.html

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About Dennis Kauppila

I work with farmers on finances. I started with UVM Extension in 1983, and have worked with hundreds of farmers on issues ranging from starting a farm, how to get a loan, leasing a farm, understanding farm finances, to retiring from farming. I teach 1 or 2 courses for farmers each winter. I am working with several farmers now on business plans, and I continue to work with many farmers on balance sheets and budgeting.
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