Twenty years ago, the ag community and the IRS were in the midst of a major controversy over commodity wages. The statute reads that only cash wages paid to an agricultural employee are subject to payroll taxes. Compensation in kind, such as via commodities, is exempt from Social Security tax and other payroll taxes. The controversy resulted in a set of guidelines to determine if the wage is an exempt commodity transfer or the disguised equivalent of a cash wage.

THE BASICS

The key is to recognize that it is a two-step process. The commodity is transferred to the employee, and the employee accomplishes the sale. The guidelines identify factors to help distinguish if the employee has sufficient "dominion and control" over the commodity. These include the existence of documentation, the marketing of the commodity by the employee, and the employee's risk of gain or loss.

THE PROPER METHOD

A solid commodity wage arrangement begins with an employment agreement defining the employee's share of production for the year. After harvest, when the records are complete, that share is transferred to the employee's title with documentation. The value on the date of transfer becomes the W-2 wage amount for income tax purposes, but it is exempt from payroll taxes. The gain or loss from the sale is reported in the employee's 1040 on Schedule D as a capital gain or loss, probably short-term.

At the time of transfer to the employee, the farm employer needs to release any security interest in that commodity, and also make a record of the value.

CASH EQUIVALENCY

The guidelines attack arrangements that are the equivalent of a cash payment to the employee by a third party. Simply moving grain into an elevator and having the elevator issue a check to the employee is a substitute for cash wages and will be attacked by the IRS. Agreements that define the employee's share by a dollar amount are easily re-characterized by the IRS. Arrangements that provide loans to the employee, to be repaid when the commodity is sold, are considered a constructive cash wage. Using commodity wages for a portion of compensation can be a valuable tool, but this is not a place for casual adherence to the rules.

Editor's Note: DTN Tax Columnist Andy Biebl is a CPA and principal with the accounting firm of LarsonAllen in New Ulm, Minn., and a national authority on ag taxation. His columns appear in our sister publication, The Progressive Farmer and regularly on DTN. Pose your tax questions for future columns by e-mailing AskAndy@dtn.com

(MZT/AG)

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