FSA Does Not Understand Tax Return Income

• February 3, 2014
• Paul Neiffer

We received some correspondence from a  CPA whose is battling with the FSA on the definition of AGI for S corporations, LLCs, LLPs, LPs and other similar entities.  The FSA manual on page 6-12 lists the line items from federal income tax returns for computing AGI for purposes of payment limitations.  For corporations filing using Form 1120 (C corporation) the guide computes AGI using line 30 on Form 1120.  Line 30 comprises all taxable income and expenses of the corporation including all non-farm income, sales of raised breeding livestock held more than two years and Section 179 deductions.

For S corporations, the FSA instructions indicate that the agent should pick up line 21 income off of the first page of Form 1120S.  Line 21 income does not reflect all of the income and expenses of a Farm S corporation.  Whereas Section 179 is allowed as a deduction in arriving at line 30 C corporation income or loss, an S corporation reports Section 179 expense on page 3, Schedule K, Line 11.  Also, if the farmer sells raised breeding stock that generates a Section 1231 gain, this is also reported on page 3, Schedule K, Line 9.  Therefore, if a FSA agent simply follows their instructions, they can grossly overstate OR understate the actual AGI of the S corporation.  These same issues apply to LLCs, LLPs and LPs.

As an example, let’s assume we have a farm that files either as a C corporation or an S corporation.  Its gross net income before Section 179 deduction is $900,000 and after Section 179, its net farm income is $400,000.  It has no other items of separately stated income or expense items.  The C corporation will report $400,000 of net farm income on line 30 of Form 1120.  However, the S corporation will report net farm income of $900,000 on line 21.  The Section 179 deduction of $500,000 is completely ignored.  All farmers and tax preparers would conclude that the net farm income of either corporation is exactly the same, however, the FSA will now penalize the S corporation by completely disallowing any direct payments paid since average AGI exceeds $750,000 (assume the previous two years had the same set of facts).

We are trying to pass this information onto the relevant personnel at the FSA, however, these things can take time to change.  If there are any FSA readers getting this blog, we would appreciate your help in getting this resolved.  The FSA manual is over 400 pages long and this is what the local FSA personnel are required to use.  Even if we know it is wrong, it is not wrong to the local office until the manual is updated.

Paul Neiffer, CPA

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