A proposal floating in the U.S. House Ways and Means Committee would require all entities (other than individuals) with gross annual receipts over $10 million to use the accrual method of accounting for income tax calculation.
Under current law, farmers may use a cash method of accounting unless they are structured as a C-corporation (with gross receipts of more than $1 million) or as a family corporation (with gross receipts of more than $25 million).
Cash accounting combined with the ability to accelerate expenses and defer income gives farmers and ranchers the flexibility they need to manage their tax burden. Under cash accounting, a farmer may recognize items of income when actually received and can recognize items of expense when actually paid.
"People have been using the cash method for decades and have made decisions that were based on that method," says Purdue Ag Economist Freddie Barnard. "To change it will drastically change the tax liability for a number of operations."
The cash method of accounting presents simpler recordkeeping for most farmers and provides flexibility consistent with cash flow notes Jeff Wald, CEO at Kennedy & Coe, an accounting and consulting firm with agriculture clients throughout the United States.
"Commodity price volatility may dramatically affect the profitability of farming from year to year," wrote Wald in a letter to the U.S. House of Representatives earlier this fall. ""Cash accounting methods allow operations to compensate for price volatility and create greater financial stability for their businesses."
Approximately 95% of Kennedy & Coe's dairy and feedlot clients use cash accounting.
The requirement to force farmers with $10 million or more in gross receipts to use accrual accounting for tax purposes would place a "significant burden on many mid-sized farmers, feedlots and hog, cattle and dairy operations," says Wald.
"Many of our clients who would be affected by this change are third-generation farming operations being run by a father and son or by siblings," says Wald. "Many of these family operations support dozens of employees but run at very thin margins with very low net income."
The combination of historically thin margins, rising costs of production and price volatility can dramatically impact gross receipts that an entity engaged in farming may have from year to year, and may not reflect the actual income or loss reported by the entity. As a result, an entity may be pushed into the accrual method of accounting because of a year or two of unusually high prices.
"Under a cash-basis system a farmer can sell products or pay for inputs based on the farmer's cash flow," says Wald. "This is reflected in the income or loss they report. Under the accrual method, income or losses are not related to actual cash flow and thus can vary dramatically. If farmers are required to use the accrual method, significantly more time and costs will be expended on record keeping and filing claims to carry operating losses back or forward."
The IRS proposal would make accounting significantly more complex for farm operations, adds Wald. "This proposal would limit the ability of producers to compensate for price volatility and extremely narrow margins. It would have an especially adverse impact on feedlots, certain types of cattle, hog and dairy operations and other high-value producers."
Barnard believes the cost to producers to change their record-keeping systems in a timely manner would be substantial. "Some software is tailored to generate information that can then be used to prepare a Schedule F, based on cash accounting. There will be a major impact from changing something like that."
House Ways and Means Committee Chairman Dave Camp, R-Mich., has said that his committee will pass a reform bill by year’s end, and Member-only meetings are reportedly taking place. Contact your accounting firm or tax preparer to get updates on this issue and the likelihood of implementation.