Strawberries. An old joke holds that the tax law has a provision that makes it illegal for farmers to pay taxes. Jokes usually express an underlying truth. The ability of most farm enterprises to deduct expenses on a cash basis is a big part of the joke. A fiscally-alert cash-basis farmer can ease the tax pain of a profitable year by buying up to a year’s worth of feed, seed and supplies on December 31, deducting the whole purchase.
The Tax Court last week upheld a broad use of cash-basis deductions by farmers in a case involving a California strawberry grower, Agro-Jal. This cash-basis deduction challenged case differs from what you might see in a typical Iowa crop or livestock operation. The taxpayer packs the strawberries it grows, and it purchased and deducted the packing materials on a cash basis. The IRS said that such supplies are not the sort of feed, seed and materials allowed to farmers as a cash basis deduction.
Judge Holmes looked at the rules and said the IRS got it wrong. The decision largely hinged on a Section that wasn’t directly in play here, Section 464. This section was enacted to fight an early tax shelter based on allowing cash basis farm deductions to off-the-farm investors by preventing “farm syndicates” from using the cash method. Judge Holmes considered the IRS arguments, and then noted (my emphasis, footnotes omitted):
But section 464 does bolster Agro-Jal’s argument indirectly, because the history of section 464 shows that before its enactment anyone in the farming business could immediately deduct prepaid expenses. Seen against this backdrop, section 464 looks like it was aimed at both especially abusive taxpayers — “farming syndicates” — and to certain especially abused expenses — “feed, seed, fertilizer, or other similar farm supplies.”
I understand this to mean that absent some other provision, farmers can, or could, deduct all prepaid expenses. Judge Holmes went on to consider the tax regulation on deductions of materials and supplies, and concluded that the IRS reading was not supported.
There is another wrinkle. The IRS has re-issued the “materials and supplies” regulation as part of its “repair regs” project, and it has changed the language relied on by the taxpayer. Tax Analysts discusses that change ($link):
Sharon Kay of Grant Thornton LLP said that the reference to the old version of the regs may not help other cash method farm taxpayers understand how to apply the new final tangible property regulations on materials and supplies. “That’s the big question,” she said. “What does this case mean, not just looking back, but actually looking forward under the new tangible property regulations?”
Kay noted that throughout the revisions to the tangible property regs, the IRS had made statements, primarily in the various preambles, that it did not intend for the revisions to substantially change the “determination of the treatment of materials and supplies as either non-incidental or incidental.” She said that the holding in Agro-Jal reflects farm taxpayers’ understanding of the law and general practices.
This may mean the IRS could continue to challenge deductions under the new regulations, hoping for a different result. But for Iowa livestock and crop farmers, whose big prepaid deductions are mostly for advance purchases of feed, seed and fertilizer, cash accounting does not seem to be under immediate threat. And it probably wouldn’t have been even if the IRS had won this case.
Paul Neiffer has more: Cash Basis Farmers Allowed to Deduct All Costs!
It’s summer. The bees are buzzing, and so is Robert D. Flach with a fresh Buzz roundup, including coverage of the new due-date rules.
Robert Wood, Charging $476K For Strippers On Company Card? No Tax Deduction, Jail Instead. That’s a lot of $1 bills.
Peter Reilly, Review Of Julian Block’s Home Seller’s Tax Guide. “The book packs a lot of important information into less than 100 pages. I think that if I had a real estate office, I would be negotiating with Julian to buy copies in bulk to hand to potential clients as a marketing tool.”
Jim Maule, Another Problem with Targeted Tax Credits. “Once tax credits are handed out, everyone wants in on the gravy train.”
Jack Townsend, New Legislation Affecting FBAR and Tax Matters (8/1/15).
Mike Feehan, Urban Legends, Insurance File No. XXIV (Insureblog). “My opinion? Most claims submitted are valid claims. And systematic denial of valid claims is an urban legend.”
Cara Griffith, New York Attempts to Tax Income From Nonresident Lawyer Based on Bar License (Tax Analysts Blog):
“Thankfully, an administrative law judge for the DTA set the division straight. The ALJ concluded that the division’s argument is meritless, inconsistent with the state tax regulations, and inconsistent with New York judiciary laws. “The Division cannot,” the ALJ said, “assert tax merely based on a New York license.”
This is a case where my “sauce for the gander” proposal would allow taxpayers to collect penalties from the state for making a frivolous argument.
Richard Auxier, Recovery cannot save state budgets from politics (TaxVox). “Since then the economy has improved, state tax revenue are growing, and legislatures have more room to maneuver during budget season. Yet havoc still reigns in many statehouses. In fact, it might be getting worse.”
TaxProf, The IRS Scandal, Day 817
Matt Gardner, Innovation Boxes and Patent Boxes: Congress Is Focusing on Corporate Tax Giveaways, Not Corporate Tax Reform. (Tax Justice Blog). The “patent box” would give preferential rates for intellectual property income, which would create a new industry of consultants devoted to making all income I.P. income. Far better to broaden the base and lower rates for everyone.
Kyle Pomerleau, Ways and Means Committee Introduces “Innovation Box” Discussion Draft (Tax Policy Blog). “Simply put, a patent box provides a lower tax rate on income related to intellectual property.”
Most economists, on the other hand, believe that targeted tax incentives may work, but only in the sense that companies get extra cash and say the right things at press conferences. However, the tax breaks often don’t work in the sense of actually boosting state and local economies in any appreciable way. One large high-tech warehouse on the edge of town with 40 workers won’t transform anything. Neither will a dozen.
Billy Hamilton, Tax Analysts ($link)
News from the Profession. Accountant Posts Big Game Hunting Photos, Internet Flips Out (Caleb Newquist, Going Concern). I hope my big game trophy shots never make the internet. Oh, wait…