Table of Contents
- Chapter 1, Introduction
- Chapter 2, Examination Techniques
- Chapter 3, Industry Issues
- Chapter 4, Cattle Industry
- Chapter 5, Dairy Cattle Industry
- Chapter 6, Horse Industry
- Chapter 7, Sheep And Goat Industry
- Chapter 8, Swine Industry
- Chapter 9, Ratites And Alternative Livestock Industry
- Appendix - A, Glossary-Livestock Terms
- Appendix - B, Interview Questions - By Type
- Appendix - C, Other Sources Of Information
- Appendix - D, Livestock Breed Associations
- Appendix - E, United States Department Of Agriculture
Chapter 1 - Introduction
Purpose of the Guide
The livestock industry is as varied as any other area of farming and agriculture. Methods of bookkeeping within each operation will differ. Due to these variations, this guide provides a focus on the business of breeding, raising, buying, and selling livestock.
This overview, along with the glossary and appendices, provide a basis for communicating with livestock farmers as well as their representatives. Regional differences, however, may result in oversights in terminology. Input from the readers will be invaluable in completing the usefulness of this guide.
The volatility of this market segment makes it one of the most dynamic of any industry we will audit. Domestic and international markets, weather conditions and disasters, medical and health considerations, and the interrelationship between livestock and its feed market are all contributing factors. Financial records will reflect the results of these factors.
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Keeping in Touch With the Industry
Familiarity with an industry being audited will provide a basis for analysis of the information encountered during the audit. It can also yield insights into the attitude and concerns of the taxpayers involved. Accounting aspects are developed during audits and the time spent dealing with books and records. Understanding the attitude and concerns of the taxpayer is enhanced by exposure to the information found in trade journals or general sources. The following sources are helpful in acquiring this exposure.
CD-ROM -- Within the public library system you may find a CD-ROM news service with articles of interest and a search tool which will allow you to find those articles quickly and easily. The service used by the Lubbock (TX) County Library provides key-word search capability into articles from 12,000 publications printed within the last year. Additionally, the library provides access to other library system databases.
PERIODICALS -- Most libraries have a variety of periodicals on the shelf or in microfilm format. Those on the shelf will probably be more current issues which are subsequent to events applicable to the tax return being audited. Microfilmed issues yield reference information which is contemporaneous to your audit.
BULLETIN BOARDS -- Our own bulletin boards provide internal information from many sources. Have you checked out the IS/MSSP Bulletin Board? Not only will you find all the MSSP documents you need, but also forums for discussion of specific interests. Internal as well as Internet e-mail is available for communication.
INTERNET -- Finally, one of the fastest growing and most current source of information is the "net." For those offices with Internet access capability, searches using the right key-words can yield big results. Web sights maintained by governmental agencies, universities, and various trade or industry organizations may provide the extra information needed for a proper understanding of your audit. Recognize the potential unreliability of certain sources of information and beware of the possibility of downloading undesirable computer code (AKA: viruses.)
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Compliance Potential
As in every business, the means for underreporting income is as varied as those who choose to undertake such ventures. The most successful rancher may fail to disclose all income because of the accompanying income tax benefits. Farmers having a very good year with a sudden turnaround just before filing time may be dealing with a cash flow crunch.
Watch for the following situations during audits:
- Sales of livestock through atypical sources. Most livestock in feedlots are sold to buyers from packing plants, other ranchers or to the feedlot directly resulting in easily traced transactions. Livestock sales directly from the ranch, either before placement in feedlots or for those animals which are not normally placed in feedlots, may be to any number of sources with little or no documentation.
- Bartering may account for some sales, especially in registered or specialized livestock which have higher values. Swapping equipment or services for breeding stock or some exotic animal may be found.
- Use of multiple bank accounts with reliance on the bank records for reporting purposes lends itself to misreporting due to exclusion of some records. Funds may also be deposited or invested directly in certain types of accounts which may not be considered in the reporting process. Watch for transfers to/from savings, money market, and investment accounts or certificates of deposit. Any deposits from non-taxable sources, e.g. return of previous investment, should be traced to the source of the originally invested funds.
- Personal expenses deducted as farm expenses are the most common form of misreporting among farmers and ranchers. Farming is a life-style which takes tremendous dedication and focus. All aspects of a farmer's life is centered around the crop or animal and is therefore easily considered to be financially related to the business. Customarily, you will find personal expenses in insurance, gasoline, interest, taxes, utilities, and repairs. Has your farmer elected the 75-percent non-recordkeeping rule of Treas. Reg. section 1.274-6T(b) but failed to limit any expenses other than depreciation? What about a reversal of expenses related to animals butchered for personal consumption?
- Funding livestock activities may result in certain taxable transactions which are not properly reported. Funding transactions between individuals and related business entities may be at little or no interest and require processing as below market interest rate loans. These transactions may also be disguised dividends. Additionally, other taxable funds may be used directly for purchases or against loans without being accounted as income. Family operations may result in loans which become gifts to other family members resulting in potential gift tax issues.
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General Livestock Risks
The livestock industry is dynamic. Working within a true supply and demand economy, the balance between income and expenses can dramatically tilt toward profit or loss depending on any number of factors:
MARKETS -- changes in supply and demand for the particular animals can run the price up or down. Cycles of production; i.e,. increasing production during rising price trends resulting in oversupply of animals which pushes prices down and ranchers out of the business causing prices to rise, etc.; change financial viability rapidly.
WEATHER -- drought, flood, heat spells and blizzards can result in feed cost increases, reduced availability of grazing pasture, or outright death to animals through heat exposure, drowning, or isolation with subsequent starvation.
HEALTH -- as new information, whether fact or supposition, is publicized about health considerations of certain food animals, the public quickly reacts to demand more or less of the animal based on the information. Reaction to England's "mad cow disease" hit the cattle market quickly and hard for a short period of time. Industry efforts to combat these problems are directly related to the recovery time. Long range efforts may be necessary to rebuild markets, e.g,. have you heard that the "new white meat" is pork?
FEED -- seemingly unrelated situations can result in growth or dumping of certain markets. A need to ship more feed corn overseas due to a loss of crop in another part of the world reduces the domestic availability of the feed which drives prices up increasing costs for the rancher and reducing profitability.
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Changes in Methods of Accounting
Several issues identified in this audit technique guide may involve methods of accounting under IRC section 446 and the regulations thereunder. A method of accounting determines the timing of when an item of income or expense is included or deducted for federal income tax purposes. If the practice does or could affect the taxable year (i.e., time) in which income or deductions are reported or deducted, without permanently affecting the taxpayers's lifetime income, it is a method of accounting. [See Rev. Proc. 97-27, 1997-21 I.R.B. 10 (05/27/97), section 2.01.]
If you determine that the taxpayer has been including income or claiming expenses (or cost recovery) at the wrong time, in most instances the taxpayer has been using an improper method of accounting. When this occurs, you should require the taxpayer to change its method of accounting to a proper method. IRC section 446, exclusive of IRC section 446(e), and IRC section 481 will apply to any examination imposed change in accounting method.
Examples of methods or changes in methods of accounting in the general livestock industry include:
- A change from currently deducting freight, registration fees and health related expenses paid or incurred in purchasing work, breeding or dairy animals to capitalizing such costs to the basis of the animals, pursuant to Treas. Reg. section 1.162-12(a);
- Any change to correct the taxpayer's improper depreciation method, recovery period or convention for computing its depreciation deduction;
- A change in the method for determining when a certain type of expense is deducted, as well as when income is reported.
When you require a change to a taxpayer's method of accounting, the method is changed as of the beginning of the year that you require the change. That year is referred to as the "year of change." The new proper method of accounting must be used to determine the taxpayer's taxable income for the year of change and for subsequent years for the accounting item or items to which the change in method of accounting applies.
When you change a taxpayer's method of accounting, the change will ordinarily result in a duplication or omission of income or deductions. This is because taxable income for the years preceding the year of change was determined using the old improper method of accounting and taxable income for the year of change and subsequent years must be determined using the new proper method of accounting.
IRC section 481(a) requires that when there is a change in a taxpayer's method of accounting, the taxpayer must take into account any adjustment(s) necessary solely by reason of the method change to prevent amounts from being duplicated or omitted. The IRC section 481(a) adjustment is computed as of the beginning of the year of change.
If you require a change from an improper to a proper method of accounting as part of an examination and that change in method of accounting results in a positive adjustment under IRC section 481(a), you should ordinarily make the change in the earliest taxable year under examination and include the full amount of the adjustment required under IRC section 481(a) in the computation of the taxpayer's taxable income for the year of change. [See section 2.10 of Rev.Proc. 97-27.] Note, however, that in certain limited and specified situations provided in Rev. Proc. 97-27, a taxpayer under examination may request the consent of the Commissioner to voluntarily change its method of accounting under the provisions of Rev. Proc. 97-27 and receive more taxpayer favorable terms and conditions.
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Conclusion
This guide is not a "cookbook" to help you take the proper steps to audit adjustments in the livestock industry. It is a GUIDE which can point in certain directions and allow you to arrive at your own, carefully considered, properly determined conclusions.
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