The IRS doesn't treat all income equally, particularly when it comes to reporting it. Sole proprietors must file Schedule C with their tax returns, and self-employed farmers report their income and expenses from their farming businesses on Schedule F.
Completing Schedule F involves some calculations. You must accurately report your income, then subtract your expenses from your revenues. This ultimately produces your taxable income, which is then transferred to Form 1040.
Who Uses Schedule F to File Taxes
Whether you should file Schedule F with your tax return depends on three factors.
You Must Be a Farmer
Qualifying as a farmer doesn't just mean that you grow crops. The definition of "farmer" used by the government includes ranchers, fish breeders, and homeowners who do things like keep chickens and earn income from selling their eggs.
A farmer is anyone who pursues or receives income from cultivating crops and/or livestock, whether it's on a farm, ranch, range, or in an orchard.
Farmers don't include veterinarians, pet kennels, wineries, or landscaping businesses, but nurseries that grow ornamental plants are considered to be farmers for tax purposes.
Your Farm Is a Business
Farming as a business is differentiated from farming as a hobby for tax purposes. Only farmers who operate as businesses are required to file Schedule F.
You must be engaged in farming for profit to be considered a business. This means that you've made money in at least three of the last five tax years, or two out of seven years for breeding or raising horses. The IRS will consider other factors if you don't strictly meet this requirement, however, including:
- You operate your farm like a business.
- You make changes in an attempt to improve profitability.
- Farming is your main source of income.
- The time and effort you put into farming are substantial.
- Losses are either beyond your control or normal in the startup phase of farming.
- You've made a profit from similar activities in the past.
- You expect to make a profit in the future from the appreciation of assets used in farming.
Hobby farms were subject to completely different tax treatment before the changes made in 2018 under the Tax Cuts and Jobs Act (TCJA). Hobby expenses are no longer deductible under the TCJA, so your tax burden will be lower if your farm or ranch qualifies as a business.
Talk with a financial advisor if your farm hasn't made a profit in several years. A professional can help ensure that you can successfully demonstrate that your farm is a business rather than a hobby.
You're a Sole Proprietor
Schedule F is only used by farmers who are considered to be sole proprietors. Those who operate their farming businesses through a corporation or other business entity would report their incomes and expenses on Form 1120 instead.
You must file Form 1065 instead if you're married, you and your spouse own and operate your farm together as an unincorporated business, and you share jointly in the profits. You and your spouse would only file Schedule F if one of two situations applies:
- You and your spouse wholly own your unincorporated farming business as community property. You can then be treated as a sole proprietorship instead of a partnership and file Schedule F.
- You and your spouse each materially participate as the only members of a jointly owned and operated farm, file a joint return for the tax year, and elect to be treated as a qualified joint venture. You would then each file a separate Schedule F.
How to Report Farming Income on Schedule F
Most businesses must decide whether they want to operate and report their incomes on a cash or accrual basis, but farmers have a third option. They can use the crop method of accounting instead.
- Income is reportable in the year you actually receive it with the cash method of accounting.
- Income is reported in the year it was earned with the accrual method of accounting.
- The crop method of accounting allows you to include revenues in your income in the year you sell what you've grown.
You must receive special permission from the IRS to use the crop method of accounting.
You must use the cash method for reporting your expenses if you use the cash method for calculating your income. Likewise, you must use the accrual method for reporting your expenses if you use the accrual method for calculating your income.
You must also report income from other sources in addition to your farming income on your Schedule F, such as federal disaster payments and money received from agricultural programs. Most agricultural programs will report income paid to you on Form 1099-G, a copy of which will be mailed to you.
Deductible Expenses on Schedule F
As with most other businesses, the deductible costs and expenses of doing business must be "ordinary and necessary" for you to be able to claim them on Schedule F. This means that virtually all farmers claim the same costs and expenses and, in fact, you would find it difficult or impossible to make a living without paying them.
Reduce an expense by the amount of any reimbursement if you're reimbursed for any expenses in the year you claim them. You'll report the reimbursement as income if you're reimbursed in the following year.
Expenses are deductible in the year you pay them if you choose the cash basis, or in the year you incur them if you use the accrual method.
Reporting Capital Gains and Losses
Schedule F can't be used to report gains or losses associated with the sale or disposition of certain farm assets. These include your buildings or structures, most livestock, land, and farm equipment. You would instead report these gains or losses on Form 4797, "Sale of Business Property."
Special Rules for Estimated Tax Payments
Farmers need only make one estimated tax payment per year under some circumstances, rather than the four that other sole proprietors are required to make. IRS penalties won't kick in if you make just one payment, but there are rules.
You'll qualify to make just one estimated payment by January 15 of the following year (your estimated payment for 2020 would be due by January 15, 2021) if you're a calendar-year taxpayer and more than two-thirds of your income comes from farming in either the current or previous year.
You don't have to make estimated payments if you pay all the tax you owe when you file Form 1040 by March 2 if you're a calendar-year taxpayer.
How to Complete and File Schedule F
Schedule F includes several parts. You should complete Part I if you use the cash method of accounting. You can skip ahead to Part III If you use the accrual method reserved specifically for farmers.
Part II is for deductible expenses and it includes more than 30, including insurance, utilities, employee benefit programs, fertilizers, seeds, and plants. The costs of things you've purchased for resale are included here as well.
Schedule F can be filed with Form 1040, 1040-NR, 1040-SR, 1041, 1065, or 1065-B. Forms 1040-A and 1040-EZ are obsolete as of the 2018 tax year.
The key to preparing an accurate Schedule F is to keep excellent records of your income, assets, crops, livestock, other assets, and various expenses throughout the year.
Farmers should ideally use some type of accounting software to streamline the process at tax time. You'll need the many advanced features offered by these programs, such as for entering assets, tracking depreciation, accurately calculating your net profit or loss, and averaging your farming income using Schedule J.
These advanced calculations can't be handled by lower-end tax software, so you'll want to choose a robust program that's designed for business owners who are farmers.
NOTE: The information contained in this article is not tax or legal advice and is not a substitute for such advice. State and federal laws change frequently, and the information in this article might not reflect your own state’s laws or the most recent changes to federal law. Please consult with an accountant or an attorney for current tax or legal advice.