Deferred Payment Contracts Apply to Related Parties Too
We have written several posts on using a deferred payment contract. A farmer who sells their grain in 2019 but requires payment for the grain in 2020 has a deferred payment contract. The income is normally reported in the year that cash is received, however, farmers are allowed on a “contract-by-contract” basis to bring that income into the year of sale.
For years with very low income, this election allows the farmer to optimize the taxable income shown on the return. We have had discussions with farmers this year that they are hesitating to sell their crop on even a deferred payment basis to the local elevator since they believe that the crop will be even more valuable later.
However, the farmer can sell their crop to any related party on a deferred payment contract now and then determine at year-end if they want to include the contract in income for the current year.
This is now even more important with the new business loss rules. These rules only allow a farmer to report a net business loss of $250,000 ($500,000 for married couples) in any tax year. The excess is carried forward as part of the net operating loss which can only offset 80% of taxable income and will not reduce self-employment income.
Let’s look at an example:
Bill and Mary farm as an S corporation. They have $2 million of grain on hand and without selling any of the grain, they are likely to report a $1 million farm loss for the year. They elect to sell $1.250 million of the grain to themselves in five deferred payment contracts of $250,000 each calling for payment in January of 2020. They personally sell the grain for $1.3 million in March 2020 and pay the corporation $1.25 million at that time. When preparing the 2019 S corporation return, they elect to bring four of the contracts into income to bring taxable income to zero. On their 2020 personal return, they report a $50,000 gain on selling the grain and the S corporation reports the remaining $250,000 of grain sales.
Since this is a related party installment sale, there are several tax rules that are beyond the scope of this post. If you are interested in this type of a transaction, make sure to discuss this with your tax advisor.
Paul Neiffer is a certified public accountant and business advisor specializing in income taxation, accounting services, and succession planning for farmers and agribusiness processors. Paul is a principal with CliftonLarsonAllen in Walla Walla, Washington, as well as a regular speaker at national conferences and contributor at agweb.com. Raised on a farm in central Washington, he has been immersed in the ag industry his entire life, including the last 30 years professionally. Paul and his wife purchase an 180 acre ranch in 2016 and enjoy keeping it full of animals.
Is the $50,000 gain subject to SE Tax?