Farm income, like most forms of earnings, is subject to taxes. The Internal Revenue Service not only defines what types of activities are covered within the broad definition of farming, but also lists what types of expenses can be deducted from farm income for tax purposes. Whether you own or manage a farm, understanding the tax code can result in substantial tax savings.
The Internal Revenue Service considers you a farmer if you cultivate, operate or manage a farm for profit. You can own the property or rent the land as well as the equipment you use. Farming activities include raising livestock, producing dairy, poultry, fish, fruit and operating truck farms. Plantations, ranches, ranges and orchards are also considered farms for income tax purposes.
As a broad rule, you can deduct all ordinary costs associated with operating a farm. As it often does, the IRS leaves the definition of ordinary open ended, and in IRS Tax Tip 2012-56 defines ordinary costs as those that are common and accepted in the farming business. The same page on the IRS web site hints that electricity bills are deductible. The hints comes from an example, where a farmer uses electricity for both her home as well as farm and can only deduct an amount that is proportional to the farm's share within the total consumption.
Electricity bills constitute a typical example where you may pay a lump sum to cover both your personal and business use. In such cases, you must estimate what percentage of the consumption is for personal use and what percentage is for use in the farm. Then, you should allocate the appropriate portion of the expense to the farm and only deduct that from the farm's income. If your electric bill for the year is $4,000 and a you estimate that 75 percent of the electrical supply is used by the farm, for example, you can deduct $3,000 from the farm's income.
If your expenses exceed your farm income, you will register a net loss for the tax year. If you had net taxable income for past years and paid taxes, you can retroactively apply your current year's loss to past years and receive a tax refund. You can also deduct the current year's loss from future years, and reduce your tax bills for the future. Therefore, you should take all possible legal deductions for each tax year, even if the farm will surely register a loss for the present year and you will have no tax liability anyway. A greater loss for the current year can mean immediate refunds or lower tax bills in the future.
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