DTN Tax Columnist Andy Biebl is a CPA and principal with the accounting firm of LarsonAllen in New Ulm and Minneapolis, Minn., and a national authority on ag taxation. His monthly features also appear in our sister publication, The Progressive Farmer magazine. To pose questions for upcoming columns on DTN, email AskAndy@telventdtn.com

Question:

Can a partnership buy out an individual partner, or do the partners, as individuals, need to make the purchase from the departing partner?

Answer:

Either approach to buying out a retiring or departing partner is acceptable. In many cases, it is more practical to have the entity make the payments (i.e., one payor, not multiple parties). In the tax law, there are basis adjustment elections that neutralize any difference to the two approaches.

But that's the easy part. The tax consequences depend on the contents of the partnership and can be very complicated. The starting point is that the selling partner has capital gain. But then a series of complex partnership provisions apply. Farming entities are particularly difficult, due to the so-called "hot assets" that are typically inside the partnership. The term refers to items that produce ordinary income upon sale. Two common examples that are present in virtually every cash-method farm entity would be the inventory (raised grain and livestock) and the depreciation recapture on equipment and single-purpose buildings. To the extent of the partner's share of these items, the capital gain converts to ordinary income. And if a partner is continuing to render some services, that can also add complexities, especially with respect to the self-employed social security tax aspects.

This is a very technical area of the tax law, and should be planned by a tax adviser with partnership tax expertise. How the agreement is designed and how the labels are attached does make a tax difference, both to the purchasing side and the departing partner.

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Question:

I gave some grain to my son-in-law which amounted to less than $13,000. Am I correct that neither of us owes tax under the gift rule? Also, neither side has to report this on any tax form, right?

Answer:

You are correct on the gift tax side. There is an annual gift tax exclusion under which any one individual can give another up to $13,000 without dealing with the transfer tax system (the combined gift and estate tax system that levies on both lifetime and testamentary transfers). No gift tax reporting is required.

But that's not the whole story. There is still the income tax side to deal with when the son-in-law sells the grain. From your side, as donor, there is no adjustment to your farm expenses, assuming that the gift involved a prior-year crop. You would have already deducted all expenses as a cash method farmer, so the fact that some of your unsold grain is moved elsewhere has no impact on your Form 1040.

But your son-in-law received this grain at a carryover tax basis of zero (because you deducted all expenses associated with the crop), and accordingly he must pay income tax when the sale occurs. Usually these transfers are short-term, meaning that there was less than 12 months from harvest to sale. As a result, your son-in-law would report the sale as a short-term capital gain on Schedule D within his Form 1040. This assumes that he is not involved in the farming operation (i.e., he's not in the business of farming) and this is not grain for labor, but rather simply a gift that you made to a family member.

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Question:

I am in a location that has endured a very bad drought this summer. If the insurance company pays me before the end of 2011, can I defer that income into 2012? I always carry my crop sales into the spring of the following year.

Answer:

Your situation perfectly fits Section 451(d) of the Code, which allows cash method farmers to make an election to defer crop insurance that is received in the year of the damage. If the proceeds appear in 2011, you may electively defer those to 2012 by simply placing an election statement in your tax return, disclosing the details that are requested by the IRS regulations. Line 8 of your Schedule F allows you to clear the 1099 from the insurance company, and to indicate that you are attaching a deferral election.

However, if the insurance does not arrive until 2012, the collection occurs in the year after the sale, and you have already accomplished a deferral. In that case, no tax election is available and the insurance proceeds are reported in 2012.

 

Editor's Note: DTN subscribers can find all of Andy Biebl's recent columns by clicking on the Income and Estate Tax tab on the Farm Business page.

(MZT/AG)

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