A combination of using cash accounting and contract-selling grain, in a year when much of that grain-sales income instead comes from crop insurance, can lead to a "bunching of income for farmers who would normally sell a portion or all of their crop in the year following harvest," says Ohio State University farm management specialist David Marrison. But, if that happens, there is protection from paying a boatload of taxes at once in the form of an Internal Revenue Service (IRS) provision.
The IRS section 451(d) and Treasury Regulation section 1.451-6 allows for the "postponement (for one year) of reporting compensatory payments received for crop losses," Marrison says. In other words, if you have lost income from crop yields but have recovered that income from crop insurance, you won't have to pay taxes on that income even though it all may come in this calendar year, vs. grain sales income that could come months or years down the road.
"Generally, this exception applies when crops cannot be planted or are damaged or destroyed by a natural disaster such as a drought or flood. To qualify for the exception, a farmer must use the cash method for accounting and must show that it is his or her normal business practice for crop income to be reported in the year following the year it was grown (i.e., sold in the following year)," Marrison says in a university report. "The election must cover all eligible crops from a single farming business.
If a farmer has more than one farming business, he or she must make a separate election for each farming business. The exception does not allow the taxpayer to postpone or accelerate reporting a crop loss payment if the payment is received the year after the year of the crop loss. So if the farmer receives his insurance payment in 2013 for the 2012 affected crops, it cannot be deferred."
If you want to postpone reporting crop insurance income this year, Marrison says you'll need to report your insurance proceeds on line 8a of your Schedule F form, but not as a "taxable amount" on line 8b. "Check the box on line 8c and attach a statement to your tax return. It must include the taxpayer's name and address," he says. You'll also need to include the following information on that attachment:
- A statement that you are making a choice under IRC section 451(d) and Treasury Regulation section 1.451-6.
- The specific crop or crops destroyed or damaged.
- A statement that under your normal business practice you would have included income from the destroyed or damaged crops in gross income for a tax year following the year the crops were destroyed or damaged.
- The cause of the destruction or damage and the date or dates it occurred.
- The total payments you received from insurance carriers, itemized for each specific crop and the date you received each payment.
- The total payments you received from insurance carriers, itemized for each specific crop and the date you received each payment.
- The name of each insurance carrier from whom you received payments.
What if you use a crop insurance policy based on variables other than basic acreage? Group risk income protection (GRIP) and group risk protection (GRP) plans pay based on a specified coverage level of average yields or revenue, some of which isn't identified until the next calendar year.
"These insurance payments are not eligible for deferral. As with proceeds from a revenue protection policy, proceeds from a GRP, GRIP, or other risk management policy qualify for the...election to postpone the income to the following year only to the extent the proceeds are paid for damage or destruction of a crop," Marrison says. "Because there is no direct relationship between an individual producer’s yield and insurance payments under GRP and GRIP, insurance payments from those policies are not eligible for deferral."
Ultimately, it's best to hold off on making a tax deferral decision like this until you can meet with your tax accountant "to see if this election is in the best interest for [your] operation," Marrison says.
