Watch for Farm Partnership Tax Penalties

In the recent Holdner Tax Court case, the IRS was able to make an argument that the farming operations carried on by father and son were in fact a partnership and not two separate farming operations that should be reported on their respective schedule F.

In the case, the father and son had operated the farm business together since 1977.  However, during these years, the father and son each reported one half of the income on their schedule F.  However, the father arbitrarily reported most of the farm expenses on his return.  Upon audit, the IRS took the position that the farm operation was in fact a partnership and allocated one-half of the income to each and disallowed all of the farm expenses to both.  In addition, the IRS assessed the 20% accuracy penalty against the dad.

The Tax Court reviewed the case and agreed that the farm operation was in fact a partnership, however, they did allow the deductions to be split 50/50.  The Court did uphold the extra 20% penalty assessed against the dad.

I know that many farmers who farm either with their children or siblings do so in an informal farm partnership and usually report their income and deductions on schedule F.  If this allocation is based upon a formal accounting process, then the IRS is not going to have an issue with the reporting.  However, if the income or deductions are allocated based upon the whim of the individuals involved, then the IRS may come in and both disallow the allocation and assess an extra 20% penalty of the tax owed.

If this applies to your farm operation, make sure you review with your tax advisor that you are handling your allocations correctly.