Farm Income (Schedule F)

Schedule F (Form 1040) is the federal tax form used by sole proprietor farmers to report profit or loss from farming operations. If you operate a farming business as a sole proprietor, single-member LLC (not electing corporate treatment), trust, or estate engaged in agriculture, you must file Schedule F to report your farm income and deductible expenses.

Who Files Schedule F?

A farming business includes the trade or business of:

• Cultivating land
• Raising or harvesting agricultural or horticultural commodities
• Operating nurseries, sod farms, or orchards
• Raising, shearing, feeding, caring for, training, and managing animals
• Stock, dairy, fruit, and truck farms
• Ranches and plantations

Not included: Contract harvesting of crops grown by others, or merely buying/selling products raised entirely by someone else.

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Accounting Methods: Cash vs. Accrual

Farmers may choose between two accounting methods for reporting income and expenses:

Cash Method vs. Accrual Method Comparison

Most farmers prefer the cash method because it provides more control over the timing of income and expenses, allowing for strategic year-end tax planning.

Prepaid Farm Supplies Limitation

Under the cash method, prepaid farm supplies (feed, seed, fertilizer, etc. paid for but not used until the following year) are generally limited to 50% of other deductible farm expenses. Exceptions apply for certain qualified farmers.

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Types of Farm Income

Farm income reported on Schedule F includes:

Commodity Credit Corporation (CCC) Loans

Farmers have two options for reporting CCC loans:

1. Loan Method (Default): Treat as a loan; income recognized when crop is sold or forfeited
2. Income Method (Election): Report loan proceeds as income in the year received

EA Exam Tip: Once you elect the income method, you must continue using it for all future CCC loans unless you get IRS approval (Form 3115) to change back.

Crop Insurance Proceeds Deferral

If you receive crop insurance proceeds in the same year the damage occurred, you may defer the income to the following year if:

• You use the cash method of accounting
• Your normal practice is to sell more than 50% of the crop in the year following harvest
• The election is all or nothing (defer all proceeds or none)

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Farm Expenses (Deductions)

Common deductible farm expenses include:

Standard Mileage Rate (2024)

For farm business use of vehicles: 67 cents per mile

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Special Farm Tax Provisions

1. Farm Income Averaging (Schedule J)

Only individuals (not estates, trusts, or corporations) engaged in farming may use Schedule J to average farm income over the prior 3 years. This can significantly reduce taxes when current-year income is high but prior years had lower income.

How it works:

• Elect to allocate current-year farm income (Elected Farm Income) equally among the 3 prior tax years
• Recalculate taxes for those years using the additional income
• Pay the additional tax computed (at potentially lower brackets)

Eligible income includes: Crop/livestock sales, breeding animal sales, farm equipment gains

EA Exam Tip: Income averaging allows farmers to "fill up" lower tax brackets from prior years, reducing the overall tax on high-income farming years.

2. Net Operating Loss (NOL) Carryback for Farmers

Farming losses have a special 2-year carryback provision:

Key Points:

• Only the farming portion of an NOL qualifies for the 2-year carryback
• The 80% limitation does NOT apply to carryback years before 2021
• Farmers may elect to waive the carryback (irrevocable election on timely-filed return)
• Use Form 1045 for quick refund claims

3. Section 179 Expensing and Bonus Depreciation (2024)

Qualifying farm property:

• New and used farm equipment
• Off-the-shelf software
• Breeding livestock
• Single-purpose agricultural structures (e.g., milking parlors)

Note: Bonus depreciation is phasing down: 40% in 2025, 20% in 2026, 0% in 2027.

4. Soil and Water Conservation Expenses (Section 175)

Farmers may elect to deduct soil and water conservation expenditures up to 25% of gross farm income from farming.

Requirements:

• Must be consistent with an NRCS-approved plan
• Includes: leveling, grading, terracing, contour furrowing, drainage/irrigation ditches, earthen dams, windbreaks, brush eradication
• Excess carries forward to future years

Example: Farmer with $100,000 gross farm income can deduct up to $25,000 of qualifying conservation expenses in one year.

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Self-Employment Tax on Farm Income

Farm net profit is subject to self-employment (SE) tax reported on Schedule SE:

Calculation: SE tax applies to 92.35% of net farm profit

Farm Optional Method

Farmers with low income/losses can use the optional method to earn Social Security credits:

• Eligibility: Gross farm income ≤ $10,380, OR net farm profit < $7,493
• Report: Smaller of 2/3 of gross farm income OR $6,920
• No limit on years this method can be used

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Material Participation (Avoiding Passive Loss Rules)

Farm income/losses are treated as passive unless the farmer materially participates. Passive losses cannot offset other income.

Material participation tests (must meet at least one):

1. More than 500 hours of participation during the year
2. Substantially all participation by individuals
3. More than 100 hours AND not less than any other individual
4. Significant participation activity (100+ hours) when combined with others totals 500+ hours
5. Material participation in any 5 of the prior 10 years
6. Personal service activity with material participation in any 3 prior years
7. Regular, continuous, and substantial participation based on all facts

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Hobby Farm vs. Business Farm

The IRS scrutinizes farm losses to determine if the activity is a legitimate business or a hobby:

Profit Motive Test

If classified as a hobby:

• Losses cannot offset other income
• Expenses only deductible to extent of hobby income

Nine Factors the IRS Considers

1. Manner of operation - Businesslike records and practices?
2. Expertise - Knowledge of farming industry?
3. Time and effort - Substantial time devoted?
4. Asset appreciation - Expectation that land/assets will appreciate?
5. Prior success - Successful in similar activities?
6. Income/loss history - Pattern of losses vs. occasional profits?
7. Profit amounts - Are profits substantial when earned?
8. Financial status - Other income to absorb losses?
9. Personal pleasure - Recreation or hobby elements?

EA Exam Tip: Meeting the 3-of-5 or 2-of-7 year rule creates a presumption of profit motive, but even farms not meeting this test can be considered businesses if other factors support a legitimate profit intent.

Form 5213 Election

New farmers can file Form 5213 to postpone the IRS determination until the activity has been conducted for 5 years (or 7 years for horse activities). This must be filed within 3 years of the return due date where the activity was first reported.

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EA Exam Tips for Farm Income

1. Cash method dominates - Most farmers use cash method for flexibility in timing income/expenses
2. Income averaging is powerful - Schedule J can provide significant tax savings for high-income years
3. 2-year carryback is unique - Farm NOLs get carryback treatment that most businesses lost after TCJA
4. Know the thresholds - Section 179 ($1,220,000), conservation (25% gross farm income), SE tax wage base ($168,800)
5. Crop insurance deferral - Remember the "more than 50% sold next year" requirement
6. CCC loan election is sticky - Once elected, income method continues unless IRS approves change
7. Hobby loss triggers - 3-of-5 years (general) or 2-of-7 years (horses) creates presumption
8. Material participation matters - Passive farm losses cannot offset other income