It’s essential to maintain accurate books for your farm to ensure that your business is as profitable as possible and you get every tax deduction available. In this article, we present ten key farm bookkeeping tips to help your farm.
1. Know What Expenses You Can and Can’t Deduct
To make the most of your tax deduction, it’s important to know what’s an allowable tax deduction. For a comprehensive list of deductible farm expenses, see Part II of Schedule F.
Some examples of expenses that you’re allowed to deduct include:
- Veterinary costs for livestock
- Fertilizers and lime
- Seeds and plants
- Insurance (other than health)
- Storage and warehousing
- Mortgage interest
Here are four expenses that you cannot deduct:
- Expenses of raising anything that you or your family consume.
- Personal or living expenses that don’t produce farm income.
- Personal losses.
- The value of raised animals that died.
2. Classify Workers Correctly as Employees or Independent Contractors
Employers aren’t allowed to freely choose whether a worker is treated as an employee or an independent contractor. There are rules you must follow in making the classification of an independent contractor vs employee, and the courts have provided a list of factors that must be considered in determining if a worker is classified as a 1099 or W-2.
The focus of the factors is to determine the amount of control the company has over the worker—the more control the company has over the worker, the more likely they’re an employee. The IRS groups the factors into three categories: behavioral control, financial control, and the relationship of the parties.
Also, there’s a big difference between how independent contractors and employees are treated for tax purposes. Your farm operation must pay Social Security tax, workers’ compensation, federal unemployment tax, and perhaps other local tax on the wages of employees. However, when you pay independent contractors, you don’t have to worry about those expenses.
If the IRS finds you have misclassified employees as independent contractors, you’ll be required to pay all employment taxes―both your 7.65% and the employee’s 7.65%―for prior periods where the worker was misclassified. Whether the worker paid these taxes in the form of self-employment tax has no bearing on your tax obligation.
3. Capitalize Land Improvement Costs
Certain costs of improving your farmland must be capitalized as an asset rather than deducted against taxable income. You can learn the details of what land improvements must be capitalized by reading IRS Publication 551. The following are examples of expenditures that must be capitalized:
- Cost of surveys
- Cost of removing unwanted buildings from the land, less any proceeds from salvage
- Cost of permanent improvements, such as landscaping
- Cost of improvements that will later be maintained and replaced
- Cost of getting the land in condition for its intended use, such as excavation, grading, draining, and clearing
4. Invest in Powerful Accounting Software
Small to mid-size farms require tools to properly monitor annual seed or livestock costs as well as employee and equipment expenses. They should also manage inventory items, like feed and grain, and create cost centers to track profit and loss by specific farm units. Larger independent or corporate farms with multiple sites require access to the same information but with built-in financial management tools because of the sheer volume of crops or livestock processed daily.
We evaluated the best farm accounting software for a variety of farming needs and selected FarmBooks as the most affordable farm-specific software. It’s ideal for small-scale farmers because it includes real-time inventory management features and built-in payroll at no additional cost. It also tracks both farm and personal income and expenses and offers robust reporting features that will help you assess the financial situation of your farm.
5. Separate Personal & Farm Accounts
The most important thing to remember while running your farm business is to keep your personal and farm transactions separate from each other by using separate bank and credit card accounts for your business transactions. This will save you time by greatly reducing the number of transactions that your bookkeeper must categorize and reconcile as well as make it easier to file your taxes.
With good accounting software, you can track multiple profit centers from the same bank account. However, tracking income and expenses by hand for multiple profit centers will be easier if you have separate bank accounts for each profit center.
6. Determine What You Must Claim as Income
As a farmer, you’ll most likely have multiple sources of taxable income, and there may be some income sources that you weren’t aware that you have to report. These include bartering, canceled debt, and prizes from livestock competitions. Because there are so many income sources that must be reported, it’s important to keep detailed records throughout the year. You’ll report the income, along with your expenses, on Schedule F of Form 1040. Here are some examples of farm income that you may need to report:
- Sales of livestock, produce, grains, and other products you raised
- Income you received from custom hire or machine work
- Sales of livestock and other retail items
- Agricultural program payments
- Distributions from a cooperative
- Gasoline or fuel tax credits or refunds
- Crop insurance proceeds
- Federal crop disaster payments
7. Understand Farm Income vs Rental Income
It’s important to understand the difference between farm income and rental income because they’re taxed differently. The IRS considers “material participation” to be the determining factor as to whether income is farm income or rental income. If you’re a traditional farmer who raises crops or livestock, then you have farm income and are treated as being self-employed. You would file taxes using Schedule F, Profit or Loss from Farming. To learn more about farm income, see IRS Publication 225.
If you rent out your land to farmers but don’t participate in the labor or management of the farming process, you’re considered a landowner and would need to file Form 4835 to report farm rental income. You’ll also need to report rental income based on crop or livestock shares the tenant produces. The main advantage of reporting rental income instead of farm income is that you won’t need to pay self-employment tax on the rental income.
8. Track Business Mileage
Your farming business can deduct a standard rate per mile, which is 58.5 cents for 2022. This rate is applicable for any business mileage driven using your personal vehicle. Be sure to track the purpose of each business trip along with the date and miles driven and submit it for reimbursement with your monthly expenses.
9. Claim a Fuel Tax Credit
If you pay fuel excise tax on gas or diesel used off-road on your farm, you can receive those taxes back as a credit on your income tax return. Be sure to keep your receipts showing the number of gallons you paid excise tax on. Any gallons you purchased for off-road use―generally dyed by the distributor―without paying excise tax aren’t eligible for the credit. Check out IRS Publication 225 to learn more.
10. Keep Track of Your Profitability
Because of the many variables, farm profitability can be difficult to measure, but the only way to truly understand it over time is to use powerful farm accounting software. This will allow you to make forecasts and predictions based on past trends. Here are a few methods of evaluating profitability:
- Month-to-month profit: This is a useful guide to how your farm is performing right now, however it doesn’t help with predicting your future cash flow or profits.
- Revenue or profit per unit area: This is a measure of how much revenue or profit is generated for each unit area of farmland, for example, dollars per hectacre. While this does give a good idea of current farm performance, it doesn’t always take underlying costs into account.
- Economic Farm Surplus (EFS) or similar schemes: This method uses various farm accounting metrics to give an overall performance rating and is favored by accountants.
11. Understand Depreciation Expense
Depreciation expense is the process of allocating the cost of an asset over the useful life of that asset. Farmers must capitalize the cost of fixed assets and depreciate that cost over a period of years, based on a recovery period for each type of asset.
Generally, the costs of the following items, including the costs of hired labor, materials, and installation, are capital expenditures that must be depreciated versus deducted against current income:
- Land and buildings
- Addition, alterations, and improvements to buildings
- Equipment and machinery
- Cars and trucks
- Draft, breeding, sport, and dairy livestock
- Repairs to machinery, equipment, trucks, and cars that prolong their useful life, increase their value, or adapt them to different use
- Water wells, including drilling and equipping costs
- Land preparation costs
For more information about depreciation and how it works, check out our article on the topic.
Frequently Asked Questions (FAQs)
How do you keep track of farm expenses?
The easiest way to keep track of farm expenses is by using accounting software that imports your banking activity automatically. All you’ll need to do is to assign each bank transaction an expense account. See our list of the best farm accounting software to find your best option.
What accounting method do farmers use?
Farmers generally use the cash method of accounting because it’s easy to understand. Expenses are recorded when paid in cash or charged on a credit card. Income is recognized when cash is received.
Accounting for farms comes with its own set of challenges and concepts unique to the industry, such as knowing the correct expenses to deduct and what’s considered income. A basic understanding of these farm accounting tips is essential to ensure the proper management of your farm’s finances.