The key to surviving tax time on the farm? Organization and good records
Living off the land on a homestead or small farm is often perceived as following the simple life. For some it really is, but it could be a mistake to apply the simple lifestyle model when it comes to end-of-year taxes and recordkeeping.
While you may not like the idea of filing a tax return with your state and the U.S. Internal Revenue Service, if you meet a specific income threshold calculated based on income type, your age and filing status, the tax man will cometh.
Operating a farm has its fair share of income sources, expenses, deductions and credits, and a farmer or homesteader needs to get a handle on these records so tax time does not become overwhelming.
What is a farm?
According to the IRS, an individual is in the business of farming of you are cultivating, operating or managing a farm for profit as an owner or tenant. A farm includes livestock, dairy, poultry, fish and fruit.
But your backyard produce sales you make on the side from your garden probably don’t entitle you to IRS or state tax breaks, especially if you also have a full-time job that is not farm related. In this case you are considered a “hobby farmer.”
Hobby farmers are not out of the tax woods when it comes to income, according to the online source Credit Karma and must report any and all income to the IRS derived from sales of goods grown or processed on their farms.
Do you need to keep records?
Keeping receipts and other records that document expenses and income is key when it comes to preparing taxes, according to Diane Lachance, retired tax preparer in Madawaska, Maine.
Records need to be well organized.
“You want to keep receipts and purchase invoices for things like large equipment because they depreciate,” Lachance said. “Keeping these records separately from other receipts is good practice in case of an audit.”
Other receipts that should be kept in their own file include those for supplies like fertilizer and other chemicals as they need to be plugged into specific lines on the tax return documents, Lachance said.
Large farmers and hobby farmers should keep track of all farm related cash inflows and outflows, according to Nicholas Norton, CPA and tax specialist in the Farm Credit East office in Presque Isle, Maine, and full-time farmers should use accounting software or ledgers sheets to keep up with the records.
Norton said it’s also a good idea to file expenses under categories such as supplies, feed or fertilizer to help keep track of expenses.
Lachance agrees but cautions against getting too general with categories.
“Many small farmers add everything under ‘material and supplies,’ which should not be done,” Lachance said. “For example, all on-road vehicle expenses should be kept separately for each vehicle [but] any general costs such as fuel and repairs to off-road trucks and equipment like tractors can be combined.”
Cancelled checks, bank statement, credit card statement should be kept as they can help keep track of expenses, Lachance said, but they do not take the place of an original receipt in case of an audit, so make sure to always file those receipts immediately.
Is farm income different from homestead income?
Yes, there is a difference, but everyone must report income.
“The primary difference is a working farm reports income and expenses on Schedule F, and by doing so informs the IRS they are, in good faith, trying to make a profit,” Norton said. “A hobby farmer reports gross income on the front page of their 1040 and generally is not allowed to deduct their expenses.”
There is a lot of income potential on a hobby farm or homestead, according to Credit Karma. These include money from sold goods, prizes from livestock competitions, bartered goods or canceled debt.
“There are a number of factors the IRS looks at when determining hobby status,” Norton said. “So when in doubt, consult a tax practitioner.”
Because there are so many types of incomes, it is important to keep good records and to keep those records organized for easy retrieval at tax time.
What about expenses and deductions?
As far as the IRS is concerned, the difference between a working farm and a hobby farm is profit motive, according to Tim Poitras, Certified Public Accountant with Chester M. Kearney in Presque Isle, Maine.
That distinction makes all the difference when it comes to itemizing expenses and applying for deduction when preparing your end of year taxes.
For working farms, those organized records are handy when it comes to proving expenses for which deductions are allowed like animal feed, fertilizers, equipment, fuel and home office supplies.
Hobby farmers, on the other hand, are not eligible for these deductions, even though they must report any income earned from their small operations, Poitras said.
Do you need an accountant?
Taxes — federal or state — can be complicated. It’s not a bad idea to secure the services of a licensed accountant to help navigate the tax laws which can change from year to year.
Running your farm is hard work and it would be shame to not benefit from the tax breaks the IRS has made available to large and small farms.
The best way to make sure you are not short changing yourself is to keep organized all year long with your records and then take those records to a tax professional who can help you maximize those deductions and credit to reduce what you ultimately owe in federal and state tax.
“In addition to specialized tax preparers like Farm Credit East, there are also numerous government agencies as well local nonprofit business development agencies who frequently assist farm start-ups,” Norton said. “Generally, both hobby and full-time farmers should consult with a tax professional to file their tax returns.”