Risks

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Risks Rewards to Year End Feed Buying Revenue
Deferral

• Daniel M. Peregrin, CPA, JD
• Moore Stephens Frost
• Little Rock, Arkansas

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Risks

• Doing it wrong!
• Lose Deductions!
• Deferred Income Comes Current! Wham!
• (Wanna do it right? Call us today!)

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Mitigating the Risk

• Opportunity to fix error in future years -
  Farmers have statutory right to 5 year NOL
  Carryback
• IRS Tax Exam 3 year statute of limitations
• Reference IRC 172(b)(1)(G) and (i)

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Rewards

• Offset Economic Accrual Income
• Offset Other Non-Farm Income at Individual Level
• Positive Cash Flow to Grow Business
• Equal Footing with Competitors

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Further Risks

• Magnitude of Deferred Income - Dealing with your
  Addiction
• Phantom Gain on Ultimate Sale of Farm
• Basis Limitations

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Cash Basis Farming

• Farmers are permitted to use cash-basis
  accounting if
• C-Corporation with Gross Receipts
  lt1,000,000
• Family C-Corporation with Gross Receipts
  lt25,000,000
• S-Corporation
• LLC
• Partnership
• References IRC 447, IRC 448

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Cash Basis Farming3 Front Attack - Mix and Match

• Prepaid Expenses
• Deferred Sales
• Payment of Payables and Accruals

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Advance Payment for Farming Supplies

• Cash-basis taxpayers engaged in the business of
  raising or feeding livestock may deduct feed in
  the year of payment if
• The expenditure is for the purchase of feed and
  not a deposit
• The prepayment is made for a business purpose and
  not for tax avoidance and
• The deduction will not result in a material
  distortion of income
• Reference Revenue Ruling 79-229

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Business Purposes

• Secure a quantity of feed
• Secure a quality of feed
• Secure preferred customer status

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Limits on Deducting Prepaid Feed

• Prepaid farm expenses deductible in the current
  year cannot exceed 50 of the taxpayers
  deductible farming expenses excluding the prepaid
  expenses.
• Reference IRC 464 (f)

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Maximum Quantity Purchased

• A feed supply created by the prepayment of feed
  cannot exceed 12 months of feed needed.
• A supply of over 12 months may create a Capital
  Asset.
• Reference Treas. Reg. 1.461-1(a)(1)

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Deferred Sales

• Cash-basis farmers under an arms-length contract
  calling for payment in the taxable year following
  that in which the farm product was delivered to
  the purchaser may include the revenue in gross
  income for the taxable year in which the payment
  was received.
• Reference Revenue Ruling 58-162

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Deferred Sales Contract Amendment

• Mere withholding of payment by purchaser or
  failure to cash checks received from purchaser
  does not constitute a deferral sale. The
  contract must be amended and executed by the
  party to be bound.

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Rewards Example I
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Rewards Example II
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The Release ValveSimple Example
8,000,000 cash retained
Market Driven, Self-Mitigating Risk 8,000,000 _at_
5 for 1 year 400,000
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Risks Example
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Pushing Out the Wall

• 50 Prepaid Limitation moves with growth
• Cash retained provides capital to grow
• Parasitic Self-Fulfilling Prophecy

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Farm Sale Recognizing Phantom Income
Assume
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Possible Silver Lining in the Phantom Income Dark
Cloud

• IRC 447(f)(3) gives a 10 year spread on
  conversion from cash to accrual.

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Basis Issues

• Pre-payment of feed may result in a net loss for
  the farming entity.
• A farmer cannot take the farming loss against his
  individual income without having or establishing
  basis.

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Basis Issues LLCs Partnerships

• Recourse Liabilities are liabilities for which
  the partner bears the economic risk of loss if
  the liability is not satisfied by the
  partnership.
• Recourse Liabilities increase a partners basis.

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Basis Issues LLCs PartnershipsExample

• D R form a partnership in which profits and
  losses are split 50/50. DR partnership purchased
  pre-paid feed in the amount of 1,000,000 in the
  current year causing a net loss for the
  partnership in the amount of 400,000. D
  personally guarantees a new loan in the amount of
  300,000.
• Note that Rs loss in the current year is limited
  to 50,000 due to lack of basis. This loss will
  be carried forward.

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Basis Issues S-Corporations

• S-Corporations do not distinguish between
  recourse and non-recourse debts.
• The shareholder borrows money personally then
  contributes the proceeds to Additional Paid In
  Capital to establish basis.

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