Once the farmer has a deductible loss, there might be an "excess" loss that cannot be fully utilized within the year that the loss occurred. Here is where a good farm tax return preparer's advice can provide the farmer with substantial tax savings with some planning and strategy.

The farmer's loss for the year may be used to reduce taxes either retroactively or proactively. A farming loss for the tax year, after some adjustments9, may result in a farm net operating loss (NOL). Generally, the amount of farm NOL that is not used within the current year to reduce taxable income can either be:

  • Carried back 5 years10
  • Carried forward 20 years

While farmers have a five-year carryback period, the carryback period for general business NOLs is two years11,which the farmer can elect to have apply instead of the normal farm five-year carryback period.12This election may be important because if the five-year carryback period is used, the farmer's NOL must first be applied to the fifth preceding tax year. After it is determined how much of the NOL is "absorbed" in the fifth preceding year, any remaining NOL is then applied to the fourth preceding year and so on. If the tax savings from using the five-year carryback period is minimal, an election to use the usual business-NOL two-year carryback period may be advantageous because the farm NOL would first be applied to the second preceding tax year, which may provide greater tax savings. Care must be taken when this election is made because once made, it is irrevocable.

In addition, the farmer has the option of waiving the carryback period entirely if it is advantageous to use the farm NOL exclusively in future years13.This election is also irrevocable once it has been made. If the election is not made, the NOL amount must be carried back first. Accordingly, it is important for the farmer to obtain proper tax advice that will provide the farmer with the maximum amount of tax savings and tax refunds from the amount of any available NOL. Other considerations include whether the farmer is operating as a sole proprietor, partner, LLC or S-corporation (in which case any loss will pass through to the farmer personally for use on the farmer's personal return) or as a C corporation (in which case the loss remains at the corporate level for use on corporate tax returns).

 

Notes

1IRC §465


2Treas. Reg. §1.465-1(d)(1)

3There are some exceptions to this rule. See IRC §465(b)(3)

4Treas. Reg. §1.465-1(a)

5The Food, Conservation and Energy Act of 2008, P.L. 110-234

6These material participation tests are found in Treas. Reg. §1.469-5T

7Tax Reform Act of 1986, H.R. Conf. Rep. No. 99-841

8IRS Publication 225, Farmer's Tax Guide (2011), p. 74

9See IRS Publication 536 for details on the method used to calculate a net operating loss (NOL)

10IRC §172(b)(1)(G)

11IRC §172(b)(1)(A)

12IRC §172(i)(3)

13IRC §172(b)(3)

 

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