Table of Contents
You must consistently use an accounting method that clearly shows your income and expenses. You must also figure your taxable income and file an income tax return for an annual accounting period called a tax year. Only accounting methods are discussed in this chapter. For information on accounting periods, see Publication 538, Accounting Periods and Methods, and the instructions for Form 1128, Application To Adopt, Change, or Retain a Tax Year.
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Cash method
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Accrual method
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Farm inventory
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Special methods of accounting
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Change in accounting method
Publication
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538 Accounting Periods and Methods
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535 Business Expenses
Form (and Instructions)
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1128 Application To Adopt, Change, or Retain a Tax Year
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3115 Application for Change in Accounting Method
See chapter 16 for information about getting publications and forms.
An accounting method is a set of rules used to determine when and how income and expenses are reported. Your accounting method includes not only your overall method of accounting, but also the accounting treatment you use for any material item.
You choose an accounting method for your farm business when you file your first income tax return that includes a Schedule F. However, you cannot use the crop method for any tax return, including your first tax return, unless you receive approval from the IRS. The crop method of accounting is discussed later under Special Methods of Accounting. How to obtain IRS approval to change an accounting method is discussed later under Change in Accounting Method.
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Cash method.
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Accrual method.
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Special methods of accounting for certain items of income and expenses.
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Combination (hybrid) method using elements of two or more of the above.
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A corporation (other than a family corporation) that had gross receipts of more than $1,000,000 for any tax year beginning after 1975.
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A family corporation that had gross receipts of more than $25,000,000 for any tax year beginning after 1985.
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A partnership with a corporation as a partner.
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A tax shelter.
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Members of the same family own at least 50% of the total combined voting power of all classes of stock entitled to vote and at least 50% of the total shares of all other classes of stock of the corporation.
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Members of two families have owned, directly or indirectly, since October 4, 1976, at least 65% of the total combined voting power of all classes of voting stock and at least 65% of the total shares of all other classes of the corporation's stock.
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Members of three families have owned, directly or indirectly, since October 4, 1976, at least 50% of the total combined voting power of all classes of voting stock and at least 50% of the total shares of all other classes of the corporation's stock.
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Its principal purpose is the avoidance or evasion of federal income tax.
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It is a farming syndicate. A farming syndicate is an entity that meets either of the following tests.
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Interests in the activity have been offered for sale in an offering required to be registered with a federal or state agency with the authority to regulate the offering of securities for sale.
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More than 35% of the losses during the tax year are allocable to limited partners or limited entrepreneurs.
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Most farmers use the cash method because they find it easier to keep cash method records. However, certain farm corporations and partnerships and all tax shelters must use an accrual method of accounting. See Accrual method, earlier.
Under the cash method, include in your gross income all items of income you actually or constructively receive during the tax year. If you receive property or services, you must include their fair market value (FMV) in income. See chapter 3 for information on how to report farm income on your income tax return.
Example.
Frances Jones, a farmer, was entitled to receive a $10,000 payment on a grain contract in December 2008. She was told in December that her payment was available. She requested not to be paid until January 2009. However, she must still include this payment in her 2008 income because it was made available to her in 2008.
Example.
You are a farmer who uses the cash method and a calendar tax year. You sell grain in December 2008 under a bona fide arm's-length contract that calls for payment in 2009. You include the sale proceeds in your 2009 gross income since that is the year payment is received. However, if the contract states that you have the right to the proceeds from the buyer at any time after the grain is delivered, you must include the sale price in your 2008 income, regardless of when you actually receive payment.
Under the cash method, generally you deduct expenses in the tax year in which you actually pay them. This includes business expenses for which you contest liability. However, you may not be able to deduct an expense paid in advance or you may be required to capitalize certain costs, as explained under Uniform Capitalization Rules in chapter 6. See chapter 4 for information on how to deduct farm business expenses on your income tax return.
Example.
On November 1, 2008, you signed and paid $3,600 for a 3-year (36-month) insurance contract for equipment. In 2008, you are allowed to deduct only $200 (2/36 x $3,600) of the cost of the policy that is attributable to 2008. In 2009, you'll be able to deduct $1,200 (12/36 x $3,600); in 2010, you'll be able to deduct $1,200 (12/36 x $3,600); and in 2011 you'll be able to deduct the remaining balance of $1,000.
Under an accrual method of accounting, generally you report income in the year earned and deduct or capitalize expenses in the year incurred. The purpose of an accrual method of accounting is to correctly match income and expenses.
Generally, you include an amount in income for the tax year in which all events that fix your right to receive the income have occurred, and you can determine the amount with reasonable accuracy.
If you use an accrual method of accounting, complete Part III of Schedule F (Form 1040).
Under an accrual method of accounting, you generally deduct or capitalize a business expense when both of the following apply.
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The all-events test has been met. This test is met when:
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All events have occurred that fix the fact of liability, and
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The liability can be determined with reasonable accuracy.
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Economic performance has occurred.
Example.
Jane, who is a farmer, uses a calendar tax year and an accrual method of accounting. She enters into a contract with ABC Farm Consulting in 2008. The contract states that Jane must pay ABC Farm Consulting $2,000 in December 2008. It further stipulates that ABC Farm Consulting will develop a plan for integrating her farm with a larger farm operation based in a neighboring state by January 1, 2009. She pays ABC Farm Consulting $2,000 in December 2008. Integration of operations according to the plan begins in May 2009 and they complete the integration in December 2009.
Economic performance for Jane's liability in the contract occurs as the property and services are provided. Jane incurs the $2,000 cost in 2009
An exception to the economic performance rule allows certain recurring items to be treated as incurred during a tax year even though economic performance has not occurred. For more information, see Economic Performance in Publication 538.
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The uniform capitalization rules apply to all costs of raising a plant, even if the preproductive period of raising a plant is 2 years or less.
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The costs of animals are subject to the uniform capitalization rules.
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Cost.
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Lower of cost or market.
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Farm-price method.
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Unit-livestock-price method.
The following examples compare the cash and accrual methods of accounting.
Example 1.
You are a farmer who uses an accrual method of accounting. You keep your books on the calendar tax year basis. You sell grain in December 2008 but you are not paid until January 2009 You must both include the sale proceeds and deduct the costs incurred in producing the grain on your 2008 tax return.
Example 2.
Assume the same facts as in Example 1 except that you use the cash method and there was no constructive receipt of the sale proceeds in 2008 Under this method, you include the sale proceeds in income for 2009 the year you receive payment. Deduct the costs of producing the grain in the year you pay for them.
There are special methods of accounting for certain items of income and expense.
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Amortization, see chapter 7.
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Casualties, see chapter 11.
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Condemnations, see chapter 11.
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Depletion, see chapter 7.
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Depreciation, see chapter 7.
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Farm business expenses, see chapter 4.
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Farm income, see chapter 3.
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Installment sales, see chapter 10.
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Soil and water conservation expenses, see chapter 5.
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Thefts, see chapter 11.
Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly shows your income and expenses and you use it consistently. However, the following restrictions apply.
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If you use the cash method for figuring your income, you must use the cash method for reporting your expenses.
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If you use the accrual method for reporting your expenses, you must use the accrual method for figuring your income.
Once you have set up your accounting method, generally you must receive approval from the IRS before you can change to another method. A change in your accounting method includes a change in:
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Your overall method, such as from cash to an accrual method, and
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Your treatment of any material item, such as a change in your method of valuing inventory (for example, a change from the farm-price method to the unit-livestock-price method).
To obtain approval, you must file Form 3115. You may also have to pay a fee. For more information, see the Form 3115 instructions or Revenue Procedure 2008-52.
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