This week, Joe Kristan (CPA & Shareholder, Roth & Company (Des Moines, Iowa); Editor, Tax Update Blog) discusses the estate tax advantages of cash basis farming.
Death takes all, but leaves the deductions.
Cash-basis accounting and the rule that adjusts the basis of inherited assets to their date-of-death value confounded the IRS in Tax Court yesterday.
Most businesses that produce things have to capitalize their input costs into the costs of their inventory. They wait to get the benefit of the costs on their tax returns as part of the cost of goods sold when they sell the inventory.
Farmers get a better deal. Assuming they are non-corporate farmers who are active in the business, they get to deduct their input costs when paid. This “cash basis” accounting allows farmers to buy seed, feed, and fertilizer at in December to reduce their taxable income, even when they don’t plan to use it until they plant next year’s crop or feed next year’s livestock. The tax planning opportunities are obvious, and jealously guarded by farm state congressmen.
Mr. Backmemeyer farmed 353 acres in Cass County, Nebraska. You cross the northwest corner of Cass County on the drive from Omaha to Lincoln. In November and December of 2010, Mr. Backmeyer laid in inputs he would need for the 2011 crop. He bought seed for $59,623.20 on November 12 and for $49,708.40 on November 20. He bought herbicides of $93,674.43 on December 29, 2010. He bought fertilizer, lime and diesel fuel for $61,935 on December 29, and more fertilizer for $53,305.37 on December 31.
This is standard operating procedure for cash-basis farmers. If he were a manufacturer, these purchases would have had no effect on his 2010 return unless they were incorporated into sold goods during the year. Mr. Backmeyer got to deduct them and reduce his 2010 taxable income.
Mr. Backmayer didn’t get to see his the 2011 crop. He died on March 13, 2011, owning seed, feed and fuel that had cost him $235,490. Because he had already deducted these inputs, his basis in them before his death was zero.
The tax law stepped their basis back up to their date of death fair market value, which his estate computed as their purchase price. His widow then deducted the new basis when she used them to put in the 2011 crop. Here the IRS cried foul. Tax Court Judge Laro explains their argument (my emphasis):
...respondent conceded that Mrs. Backemeyer’s treatment of the farm inputs was correct: She received the assets with a stepped-up basis and contributed them to her sole proprietor farming business, entitling her to deduct the farm inputs in the amount of the stepped-up basis when those assets are used in her business.Nonetheless, respondent maintains, the tax benefit rule requires the inclusion in Mr. Backemeyer’s 2011 income of the prepaid expenses for the farm inputs he had deducted for 2010.
In other words, the IRS wanted the cash-basis deductions back when the farmer died before using them.
Judge Laro found for the taxpayer:
Had Mr. Backemeyer died and Mrs. Backemeyer inherited and used the farm inputs in 2010, the initial section 162 deduction would not have been recaptured for purposes of the income tax.
The reason for this is that the estate tax effectively “recaptures” section 162 deductions by way of its normal operation, obviating any need to separately apply the tax benefit rule. When Mr. Backemeyer died, all of his assets, including the farm inputs, became subject to the estate tax, which operates similarly to a mark-to-market tax when the mark-to-market tax is imposed on zero-basis assets…
Requiring recapture of the section 162 deduction by increasing taxable income on petitioners’ Form 1040 for tax year 2011 would result in double taxation of the value of the farm inputs.
That seems like a reasonable result, even though non-farm assets like inherited retirement accounts can be subject to both estate tax and income tax on the heirs. Whether it makes sense in a world where couples can die owning $11 million with no estate tax is open to debate. If the estate tax is repealed, the argument for basis step-up and double deduction becomes difficult.
Estate of Backmemeyer v. Commissioner, 147 T.C. No. 17 (Dec. 8, 2016)
Paul Neiffer, Tax Court Allows “Double” Deduction of Prepaid Farm Expenses. “The bottom line is that the IRS lost the case and farmers can ‘double deduct’ prepaid farm expenses, but it requires them to die first. I think most farmers will pass on this tax planning option.”
Roger McEowen, IRS Continues (Unsuccessfully) Attack on Cash Accounting By Farmers
Lew Taishoff, HE BOUGHT THE FARM. “And She Also Got the Deduction”
Here’s the rest of this week’s Tax Roundup:
Monday, December 5, 2016
David Herzig, Daniel Hemel, The Art of the (Budget) Deal (Surly Subgroup) “Republicans on Capitol Hill are reportedly planning to use the filibuster-proof budget reconciliation process to repeal the Affordable Care Act and overhaul the tax code.”
Gavin Ekins, Tax Revenues Reach New High Across OECD (Tax Policy Blog). “The increased tax revenue was driven by an increase in income tax collected in the largest OECD economies.”
Jason Dinesen, Why is it Better to File Married Filing Separately in Iowa?
Jim Maule, Why I Don’t Have a Family Foundation
Kay Bell, Some yummy hobby tax tips on National Cookie Day. “And as with all things tax, if you’re reporting hobby income and claiming hobby losses, you need to keep good records.”
Lew Taishoff, THE STEALTH SUBPOENA IS ALIVE AND WELL. “Maybe Judge Holmes and Judge Chiechi ought to get together for a cup coffee and a piece pie, and peradventure discuss bringing Tax Court into the last decade of the Twentieth Century, if not into the second decade of the Twenty-First.”
Martin Coulsen, For those filing U.K. returns, Autumn Statement 2016 – A few personal tax issues (Martin Coulsen, Mercer & Hole Chartered Accountants).
News from the Profession. Anyone Not Adding Disclaimers to the Their Text Messages With Clients Is Probably Asking for It (Caleb Newquist, Going Concern).
Norton Francis, Trump’s Carrier deal sets a bad precedent (TaxVox). “But what’s worse, the Carrier deal sends a bad message to other companies in Indiana like TRW or Rexnord who’ve also announced pending closures: Trump’s plan to make the US more competitive will be negotiated one company at a time. So line up outside Trump Tower and take a number.”
Robert D. Flach , Monday! That means fresh Buzz from Robert D. Flach! Today’s linkfest is heavy on using the tax law for purposes other than just collecting tax.
Robert Wood, 20 Plant Workers’ $420 Million Powerball Win Cleverly Misses Tax Mess. “But cheer up, your chances of winning are small.”
Roger McEowen, Farmland Acquisition – Allocation of Value to Depreciable Items. “In 1995, the IRS produced a Market Segment Specialization Program (MSSP) guideline on Grain Farmers which illustrates that the farm owner allocating purchase price to residual soil fertility must show the amount of soil fertility that is attributable to the prior owner.”
Russ Fox, Won’t Be Getting Off for a Dime. “As we’ve said before and we’ll say again, if you want to be investigated by the IRS stop making payroll tax deposits; as best as we can tell, the IRS investigates 100% of such failures.”
TaxGrrrl, Fix The Tax Code Friday: Corporate Tax Incentives. “Should state or federal authorities provide targeted tax incentives to encourage (or discourage) certain corporate behaviors? If so, what sorts of behaviors?”
TaxProf, Left, Right Slam Trump’s Carrier Tax Deal. But Scott Adams, Dilbert cartoonist, thinks it’s another Trump masterstroke. “Because humans are not rational.” So no matter how stupid and futile the gesture, when it’s the work of a “master persuader,” it’s just great.
TaxProf, The IRS Scandal, Day 1304, Day 1305, Day 1306. Over the weekend I had a Twitter exchange with someone who objected to me linking to Saturday’s scandal installment:
The Tax Foundation seeks Nominations for Outstanding Achievement in State Tax Reform Award. Let’s hope someone in Iowa wins it next year.
Tuesday, December 6, 2016
IRS, Security Summit Partners, Remind Taxpayers to Protect Themselves Online (IRS). “Scammers, hackers and identity thieves are looking to steal taxpayers’ personal information and ultimately their money. But, there are simple steps taxpayers can take to help protect themselves, like keeping computer software up-to-date and being cautious about giving out their personal information.”
Jared Walczak, Trends in State Tax Policy (Tax Policy Blog). One item: The Erosion of Corporate Income Tax Bases.
Jeremy Scott, Renzi’s Loss a Blow to EU but a Victory for Democracy, Populism (Tax Analysts Blog). “It was a boldfaced attempt to transform Italy from a parliamentary democracy to an executive, technocratic state that need pay only scant attention to a portion of the electorate.”
Kay Bell, Taxpayers can now access tax account balances online
Leslie Book, The Practice of Secret Subpoenas in Tax Court: Tax Court Out of Step with Other Courts and IRS Itself (Procedurally Taxing). “The absence of an explicit notice requirement with respect to subpoenas creates the possibility of surprise. In addition to being out of step with other federal courts, it is inconsistent with the Tax Court’s general approach of encouraging parties to communicate and cooperate.”
Lew Taishoff, NOTICING THE WEB. “Judge Wherry reminds us that government agencies have websites.”
News from the Profession. Deloitte’s Brazil Firm Covered Up a Couple of Bad Audits (Caleb Newquist, Going Concern).
Robert D. Flach, ANOTHER SOMETHING TO THINK ABOUT. Robert ponders Iowa’s married filing separate option.
Robert Wood, Seven Crazy Tax Laws Trump Should Change.
Russ Fox, Nominations Due for 2016 Tax Offender of the Year. Win or lose, it’s a dishonor just to be nominated.
TaxGrrrl, Trump Tweets Out Promises To Increase Import Taxes As Carrier, Ford Make Moves. Speaking of crazy.
TaxProf, The IRS Scandal, Day 1307
Tony Nitti, Think A C Corporation Is The Worst Entity Choice For Conducting A Business? Think Again. “There are other considerations, of course, but the pending Trump tax cuts, when coupled with the new-and-improved Section 1202, could well give rise to the golden era of C corporations.” Be careful. It’s easy to become a C corporation, but hard to change your mind.
Wednesday, December 7, 2016
Jack Townsend, Gelfand Article on Defending a Criminal Tax Case. I’ve never been involved in one, but the advice offered looks sound.
Jason Dinesen, Getting Your Business Off to a Good Start, Part 1: Proper Recordkeeping
Kay Bell, Orioles’ Buck Showalter dishes on ‘Seinfeld’ taxes, offering a look at what IRS considers taxable income
Lew Taishoff, HIP TO HIPAA. “Practitioners representing the disciples of Asclepius should get this language in their forms files.”
News from the Profession. Amazon’s Giant Data Transfer Trucks Are an IT Auditor’s Worst Nightmare (Megan Lewczyk, Going Concern).
Robert D. Flach shares his thoughts after attending ANOTHER YEAR-END TAX CLASS.
Roberton Williams, Reforming child and work provisions in the federal income tax (TaxVox). “In a new Tax Policy Center paper, Jim Nunns, Elaine Maag, and Hang Nguyen draw on many recent tax reform proposals to design a plan that would separate the income tax’s work and child provisions, simplify filing, and distribute tax benefits more equally across intended recipients.”
Roger McEowen offers a Tribute To Orville Bloethe. Orville, a fixture in the Iowa tax and legal scene, died this week at age 97.
Russ Fox, Iowa Disbands Forfeiture Team; Settles Lawsuit from Poker Players. “Unfortunately, Iowa still has civil forfeiture laws on the books. Perhaps this settlement and the change in Iowa policy will cause Iowa legislators to end civil forfeiture in the Hawkeye state.”
Sam Brunson, Trump’s Emoluments Tax Problem, Part Two (Surly Subgroup) “It’s not at all clear that section 1043 is available for Trump. Federal conflict-of-interest laws don’t apply to the president, so it’s not obvious that selling his businesses is “reasonably necessary” to comply with such rules.”
Scott Greenberg, Kyle Pomerleau, Stephen J. Entin, Goldman Sachs Analysis of House GOP Blueprint is Questionable (Tax Policy Blog).
TaxGrrrl, Mother Banned From Contact With Son, Must Block Cell Phone, After Guilty Plea In Tax Crime. “According to court documents, Jaquon called his mother from jail and told her just what he needed her to do in order to further his scheme, including creating a number of fictitious companies.”
TaxProf, The IRS Scandal, Day 1308.
Thursday, December 8, 2016
Howard Gleckman, The Questions Trump’s Tariff Tweets Failed To Answer (TaxVox). “It is striking that Trump tweeted these remarks just four days after his nominee for Commerce Secretary, Wilbur Ross, insisted that Trump had never threatened to “willy-nilly” impose blanket tariffs on China.”
Kay Bell, IRS commissioner escapes latest impeachment effort
Kristine Tidgren, Congress Moves to Exempt Qualified Small Employer Health Reimbursements from Onerous ACA Penalty (Ag Docket)
Lew Taishoff forwards Judge Holmes’ thoughts on procedural battles involving Michael Jackson’s estate.
Meg Wiehe, New income taxes, funds for transportation, and revenue shortfalls (Tax Justice Blog). “This week we are bringing you news about states seeking revenue–Alaska, South Dakota, and Utah all weigh the creation of or increases to state personal income taxes; the need, and in some cases the will, for transportation funding in West Virginia, Indiana, Montana, and Louisiana; and revenue shortfalls in Florida, Ohio, Oregon, and Kansas.”
News from the Profession. FASB Might Take a Breather on Standard Setting After Some People Yelled at Them (Caleb Newquist, Going Concern).
Paul Neiffer, New Bill Eliminates Penalties on Reimbursements for Health Insurance. “Although many farmers may have already gone through the hassle of adjusting employee wages to compensate for lost reimbursement plans or underwent some policy or other changes within their farming entities to stay compliant with the ACA, this is a big win for small employers.”
Robert D. Flach offers EVEN MORE TO THINK ABOUT. “Under my change if you use your car for business, either as an employee or a self-employed individual, the standard mileage allowance for business miles would not include a component for depreciation. So, using the 2016 rate as an example, business standard mileage allowance would be 30 cents per mile and not 54 cents.”
Robert Wood, Shorten Tax Disputes With IRS Fast Track Mediation. “The new Fast Track Mediation—Collection may help resolve offer-in-compromise and trust fund recovery penalty issues.”
Russ Fox, IRS Appeals Implements Stupid Policy of Not Sending Initial Contact Letters. Hasn’t the IRS Appeals Office heard of identity theft? Perhaps they’ve heard of the IRS Phone Scams?”
Stephen Olsen, Effect of General Power of Attorney On Reasonable Cause Exception to Penalties (Procedurally Taxing). “The CCA went on to discuss reasonable cause for a person suffering from dementia.”
TaxGrrrl, House Says No To Renewed Efforts To Impeach IRS Commissioner. Considering that he is likely to be out when the new President takes office, it’s hard to see a point in impeachment.
TaxProf, The IRS Scandal, Day 1309
Friday, December 9, 2016
Annette Nellen, Portland Oregon enacts new surtax for high executive pay. It is based on how much more executives are paid than rank-and-file employees. Because we need city councils dictating business pay practices.
Dave Breen, Grinches, Liechtenstein Royal Princes, Bankers, Toymakers (and Offshore Evasion): A Holiday Summons Tale (Procedurally Taxing). “This does not bode well for taxpayers who so far have avoided IRS’s inquiry into their offshore holdings.”
Des Moines Register, Yes, Raygun benefits from tax subsidies (but others get more). Mike Draper, the owner of the Des Moines T-shirt shop famous for its employment of wayward Colombian women, posted a “breaking news” satire on its blog saying it would move wherever it could get the best tax deal.
Howard Gleckman, Border Adjustability Is Already Fueling Tax Reform Controversy.
Jack Townsend, Louisiana Attorney Pleads Guilty to Tax Evasion. Employment taxes are involved, as is often the case.
Jason Dinesen, Getting Your Business Off to a Good Start, Part 2: Can I Keep Scanned Copies of Receipts?
Jim Maule, Uncle Sam Does Not Collect California Income Taxes. Confusing Uncle Sam with Crazy Uncle Jerry.
Kay Bell, 5 ways to protect your identity (& money!) during National Tax Security Awareness Week (& year-round!)
News from the Profession. KPMG Planning a Training Center That Will Surpass Deloitte University in Ridiculousness (Caleb Newquist, Going Concern).
Robert Wood, Prosecutors Pay Bitcoin Ransom, Yet IRS Targets Coinbase Data
TaxGrrrl, Real Madrid Joins In Defense Of Ronaldo After ‘Football Leaks’ Allege Tax Evasion
TaxProf, The IRS Scandal, Day 1310