Tax Loss Planning for Farmer Clientsby
Mike Pusey, CPA discusses net operating losses for 2018-2020, or tax years beginning in these years, when all or a portion of such loss consists of a “farming loss.” We also note the post-2020 NOL rule for farming losses.
In this article, we review what can qualify for special treatment as a farming loss and the scope of the special Net Operating Loss rule.
The “farming loss” phrase looks to the lesser of the NOL for such year, or the NOL for such year “if only income and deductions attributable to farming businesses” are taken into account (Sec. 172(b)(1)(B)(ii)).
The “farming businesses” phrase here leads to another trail - Section 263A(e)(4) – which, reverting back to the singular, tells us that a farming business includes operating a nursery or sod farm, or raising or harvesting trees bearing fruit, nuts or other crops, or ornamental trees. This is helpful detail, but the statute also reverts to the generic. It tells us a farming business “means the trade or business of farming.”
Looking to the Section 263A regulations for further guidance on what is a “farming business,” we find references to sections 263A(d), 263A(e)’ and Regs. 1.263A-4 for “rules relating to taxpayers engaged in a farming business” (Regs. 1.263A-1(a)(3)(v)). Another portion of these regulations refers to an exception for costs paid or incurred in certain farming businesses, and here again we find a reference to Regs. 1.263A-4 for “specific rules” relating to such taxpayers (Regs. 1.263A-1(b)(3)).
Section 263A(d) tells us that Code provision isn’t to apply to any animal, or plant with a pre-productive period of two years or less which is produced by a taxpayer in a farming business (See Sec. 263A(e)’(4)). Regs. 1.263A-4 has “farming business” in its title, and does get down to details in (a)(5) in defining that term, which we will now summarize. It includes the following:
- cultivation of land
- raising or harvesting any agricultural or horticultural commodity
- example - trade or business of operating a nursery or sod farm
- example – raising, harvesting of trees with fruit, nuts or other crops
- example – raising of ornamental trees (other than evergreens more than six years old when severed from their roots – so the tree’s birthday becomes tax relevant) raising, shearing, feeding, caring for, training, and management of animals (but training your pet in the back yard doesn’t make you a farmer).
“Raising” an agricultural or horticultural commodity doesn’t include buying and reselling plants or animals grown or raised entirely by another. “Raising” includes when the plant or animal is held for further cultivation and development prior to sale. “Harvesting” as used above doesn’t include contract harvesting of a commodity raised by another.
The regulations go on to add such brushstrokes as “all the facts and circumstances,” and looking at what is an “incidental activity.” The regulations contain many more details. For example, “sea plants” may be farmed if they are “tended and cultivated” but not so if they are “merely harvested.” Scope of activity questions are an issue here.
Tax planners need to resolve whether the client is a farmer, or has a portion of their activities that constitute a farm and trace such activities to the NOL, or a portion of the NOL.
Special NOL Rules for Farmers
The literature on our topic makes for difficult reading, in part because of a legislative oversight as to NOLs and the farmer, and some special NOL rules benefitting the farm. The reader may remember a no-carryback except two-year-carryback rule for farm losses, and that rule does appear to have survived. Also keep in mind that the hobby loss rule can also be an issue in farming (Sec. 183).
There were three law changes which radically changed the NOL carryback concept:
- Law change #1 – the Tax Cuts and Jobs Act enacted December, 2017;
- Law change #2 – the Coronavirus Aid, Relief, and Economic Security Act aka the CARES Act enacted March 2020;
- Law change #3 – the Covid-Related Tax Relief Act (CTRA) of 2020 enacted in December 2020 (See Rev. Proc. 2021-14).
Law change #1 generally had the following impact:
(a) limited a post-2017 NOL deduction to 80 percent of taxable income
(b) eliminated the loss carryback
(c) absent waiving the carryback allowed post-2017 farm NOLs to be carried back two years subject to the 80 percent rule
(d) allowed indefinite carryovers
Note that (c) looks to have initially been an indefinite go-forward rule benefitting farmers and that appears to have survived. We find the 2021 instructions to Schedule F telling farmers they can still get the two-year carryback to the extent the NOL reflects farm losses.
Note that (d) refers to allowing indefinite carryovers for NOLs arising in tax years beginning after 2017 while earlier NOLs still have a twenty-year carryover.
Law change #2 generally had the following impact:
(a) eliminated the 80 percent rule as to NOLs, farm and non-farm, arising in 2018-2020
(b) did away with the two-year carryback of farm NOLs
(c) added a five-year carryback rule benefitting farmers and non-farmers for 2018-2020 (more specifically, tax years beginning after 2017 and before 2021)
(d) farmers and non-farmers can waive the five-year carryback.
The NOL rules require the loss to go to the earliest year first. Taxpayers cannot pick and choose a year in the carryback period. When it eliminated the two-year carryback of farmer NOLs, law change #2 drafters didn’t really focus on what if the farmer already carried back two years.
Law change #3 had the following impact:
(a) provided an election saying the farmer can retain the two-year carryback election albeit subject to the 80 percent rule in the carryback year
(b) allows farmers who previously waived carryback to revoke that decision.
See generally the explanations and rather involved details at to elections in Rev. Proc. 2021-14, I.R.B. 2021-229 (See also “IRS Provides Guidance for Farming Loss NOLs,” Kristine Tidgrin, Ag Docket, Perspective on Agricultural Law and Taxation, Iowa State University, July 1, 2021;www.calt.iastate.edu).
As to 2021 and later, does the farmer still get the benefit of the 2-year carryback rule? An IRS site explaining 2021’s Schedule F for farmers says farmers get a 2-year carryback of an NOL arising in 2021.
“An NOL can no longer be carried back to any tax year, unless the NOL is a farming loss. To the extent the NOL is a farming loss, you can carry back the NOL to each of the 2 tax years preceding the tax year of the loss” (“2021 Instructions for Schedule F (2021),” www.irs.gov).
NOL planning often focuses on rate realization on losses, and realization on loss carrybacks versus carryovers keeping in mind potential changes in tax rates. Planning for farm losses has unique near-term considerations and elections under Rev. Proc. 2021-14.
Loss planning generally seems more important than ever as we have entered this new 2021 era of loss carryovers. The deduction environment is generally more restrictive.
A relatively new consideration is the excess loss limitation which can translate into business losses being added to the NOL carryover rather than yielding current benefit (Sec. 461(l); see also section 461(j) which can impose restrictions on farm losses).
In this author’s view, we are entering into a new legislative environment that can unfairly, severely limit the taxpayer’s ability to mitigate the sometimes harsh results of our annual accounting concept.
We are looking at a new 2021 environment in which a taxpayer can make a million on December 31st, lose it January 1st, break-even over two days, and owe tax on a million. You could also project a large NOL carryover expiring at the taxpayer’s death, and having to explain this scenario to the executor and IRS collections staff (See “Net Operating Loss Carryback Repeal Isn’t Getting the Attention It Deserves,” Rojas and Pusey, rojascpa.com, 4/22/17).
While there is now an unlimited NOL carryover, the new general rule in 2021 is also one of no carrybacks, at least for non-farming losses, which can have severe adverse effects.
As noted above, farmers still appear to get their own rather unique mitigation of the annual accounting concept in the form of two-year carrybacks even in 2021 and going forward.
Mike Pusey, CPA served as National Tax Director at Rojas & Associates. He has a BBA and Master of Science in Accounting from Texas Tech where he graduated with honors. He planned to be an accounting professor and worked a year on the Ph. D. at the University of Arizona before beginning his career at KPMG Peat Marwick, where he worked in...