As the farm economy continues to squeeze margins, farmers across the country are looking for new, creative ways to reduce expenses and keep more dollars in their pockets. This has led to an increased interest in tax strategies that promise significant benefits.

While some strategies have legitimate applications, farmers pursuing tax programs that promise large deductions or credits should take a step back and make sure they understand exactly what they are claiming and whether they can substantiate it.

As the saying goes, it’s better to be safe than sorry.

One strategy receiving increased attention is the tax treatment of “residual fertility” in the soil. The basis for this tax deduction is found in Internal Revenue Code (IRC) § 180. Section 180 was adopted by Congress in 1960 and allows farmers to choose whether to fully deduct the expense of fertilizer or capitalize the expenses over the period of the fertilizer’s effectiveness.

Thirty years after Congress adopted Section 180, the IRS issued an instructive memorandum in a case suggesting there may be a deduction available for the value of residual fertilizer already incorporated into the soil and purchased with farmland. In that case, a farmer purchased farmland along with buildings, irrigation, grain bins and “residual fertilizer supply.” The purchase of the residual fertilizer supply resulted from the previous owner applying a truckload of fertilizer on the land shortly before the sale.

While the IRS denied deduction of the residual fertilizer supply in that case for technical reasons, the memorandum, along with internal guidance, identified circumstances under which deduction for residual fertilizer might be possible. Among other things, the farmer would need to establish the amount of residual fertilizer, demonstrate it came from fertilizer applied by a previous owner and show the residual fertilizer is being depleted over time. 

Another example is the federal research tax credit found in IRC § 174A. Agricultural operations can, in some circumstances, conduct activities that qualify for the credit. However, the rules require more than simply trying different products, collecting production data or improving normal farming practices. Qualified research must satisfy specific and rigorous statutory tests.

Recent litigation demonstrates why these distinctions matter. In one case involving a large agricultural producer, a tax court substantially reduced the amount of research expenses originally claimed because the taxpayer could not adequately substantiate many claimed activities.

It is critical farmers seek advisers who are competent and knowledgeable in the law and be on guard for overaggressive tactics or promises that seem too good to be true. Before signing up for a program, farmers should talk with their CPA, the Alabama Cooperative Extension System or other trusted professionals who can provide independent advice.

In a difficult farm economy, the temptation to pursue additional tax savings is understandable. However, an aggressive tax position can create a much larger problem. It is important to take time to understand what is being claimed — and if it can be supported. 

By Preston Roberts, JD, External Affairs Department Assistant Director

The material presented above is for educational purposes only. The content does not constitute legal advice. If readers require specific advice or services, a lawyer or other professional should be consulted.