Tax loss planning for farmer clients

In this article, we look at what may qualify for special treatment as a farm loss and the scope of the special net operating loss rule.

The term “farm loss” means the lesser of the NOL for that year, or the NOL for that year “if only income and deductions attributable to farming business” are considered (Sec. 172(b)(1) (B )(ii)).

The phrase “agricultural business” leads here to another trail – section 263A(e)(4) – which, returning to the singular, tells us that a farming business includes the operation of a nursery or sod, or the raising or harvesting of fruit bearing trees. , nuts or other crops, or ornamental trees. It’s a useful detail, but the law also returns to the credits. He tells us that an agricultural business “means the trade or agricultural business”.

Looking at the Section 263A regulations for more information on what a “farming business” is, we find references to Sections 263A(d), 263A(e)’ and Regs. 1.263A-4 for “rules relating to taxpayers engaged in agricultural activity” (Regs. 1.263A-1(a)(3)(v)). Another part of these regulations refers to an exception for expenses paid or incurred in certain farming businesses, and again we find a reference to O. Reg. 1.263A-4 for the “specific rules” relating to such taxpayers (Reg. 1.263A-1(b)(3)).

Section 263A(d) tells us that the Code provision does not apply to any animal or plant with a pre-production period of two years or less that is produced by a taxpayer in a farming business (see section 263A (e)’ (4)). Reg. 1.263A-4 has “agricultural business” in its title, and goes into detail in (a)(5) to define that term, which we will now summarize. It includes the following elements:

  • cultivation of the land
  • raise or harvest any agricultural or horticultural product
  • example – trade or business operating a nursery or sod farm
  • example – raising, harvesting trees with fruits, nuts or other crops
  • example – breeding of ornamental trees (other than conifers over six years old when cut from their roots – the date of birth of the tree therefore becomes fiscally relevant) breeding, mowing, feeding, care, animal training and management (but training your pet in the backyard doesn’t make you a farmer).

“Raising” an agricultural or horticultural product does not include the purchase and resale of plants or animals grown or raised entirely by another. “Breeding” includes when the plant or animal is kept for further cultivation and development before sale. “Harvesting” as used above does not include contract harvesting of one product raised by another.

The regulations then add brushstrokes such as “all facts and circumstances” and discuss what an “incidental activity” is. The regulations contain much more detail. For example, “sea plants” can be cultivated if they are “cared for and cultivated”, but not if they are “simply harvested”. Questions about scope of activity are an issue here.

Tax planners should determine if the client is a farmer or part of their business constitutes a farm and trace those activities to the NOL or part of the NOL.

Special NOL rules for farmers

The literature on our topic makes reading difficult, in part because of legislative oversight of NOLs and the farmer, and some special NOL rules that benefit the farm. The reader may recall a rule of no carry-forward except for two years for farm losses, and that rule seems to have survived. Also keep in mind that the loss of hobby rule can also be an issue in farming (section 183).

There were three legislative changes that radically changed the concept of NOL deferral:

  • Law Amendment #1 – the Tax Cuts and Jobs Act enacted in December 2017;
  • Law Amendment #2 – the Coronavirus Aid, Relief, and Economic Security Act aka the CARES Act enacted in March 2020;
  • Law Amendment #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 an NOL deduction after 2017 to 80% of taxable income

(b) eliminated loss carryback

(c) in the absence of a waiver of carryback, agricultural NOLs after 2017 could be carried back two years, subject to the 80% rule.

(d) permitted indefinite deferrals

Note that (c) appears to have originally been a rule of indefinite extension for the benefit of farmers and which appears to have survived. We find the 2021 instructions in Schedule F telling farmers that they can still get the two-year carryback as long as the NOL reflects farm losses.

Note that (d) refers to allowing indefinite deferrals for NOLs arising from tax years beginning after 2017, while earlier NOLs still have a twenty-year deferral.

Law change #2 generally had the following impact:

(a) eliminated the 80% rule for NOLs, agricultural and non-agricultural, occurring in 2018-2020

(b) removed the two-year carry-back of agricultural NOLs

(c) added a five-year carry-back rule for the benefit of farmers and non-farmers for 2018-2020 (specifically, tax years beginning after 2017 and before 2021)

(d) farmers and non-farmers may waive the five-year carry-back.

NOL rules require the loss to go to the oldest year first. Taxpayers cannot choose a year within the carryback period. When it eliminated the two-year carry-back of farmers’ NOLs, the drafters of Law Amendment No. 2 didn’t really focus on what would happen if the farmer had already carried back two years.

Law change #3 had the following impact:

(a) has provided an election that the farmer may retain the two-year carryback election, although subject to the 80% rule in the carryback year

(b) allows farmers who have previously waived carry-back to revoke that decision.

See generally the explanations and details rather involved in the elections in Rev. proc. 2021-14, IRB 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) .

From 2021, does the farmer still benefit from the 2-year carry-back rule? An IRS site explaining the 2021 Schedule F for farmers states that farmers get a 2-year carry-back of an NOL occurring in 2021.

“A NOL can no longer be carried forward to a tax year, unless the NOL is a farm loss. To the extent that the NOL is a farm loss, you can carry the NOL forward in each of the 2 tax years preceding the tax year of the loss” (“2021 Instructions for Schedule F (2021)”, www.irs .gov).

Go forward

NOL planning often focuses on realizing rates on losses and realizing loss carrybacks versus carryforwards, keeping in mind potential changes in tax rates. Agricultural loss planning has unique considerations in the short term and elections under Rev. proc. 2021-14.

Loss planning generally seems more important than ever as we entered this new 2021 era of loss carry forwards. The deduction environment is generally more restrictive.

A relatively new consideration is the limitation of excess losses which may result in business losses being added to the NOL carry forward rather than generating current benefits (Sec. 461(l); see also Section 461(j) which may impose restrictions on agricultural losses).

In the opinion of this author, we are entering a new legislative environment which may unfairly and severely limit the ability of the taxpayer to mitigate the sometimes difficult results of our annual accounting concept.

We envision a new 2021 environment where a taxpayer can make a million on December 31, lose it on January 1, break even in two days, and owe taxes on a million. You may also project a large NOL carryback expiring upon the taxpayer’s death and need 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).

Although there is now unlimited NOL carry-back, the new general rule in 2021 is also that of no carry-back, at least for non-farm losses, which can have serious negative effects.

As noted above, farmers still seem to be getting their own rather unique mitigation of the annual accounting concept in the form of two-year rollbacks, even in 2021 and beyond.