If the death of a taxpayer brings many complications associated with the decedent’s estate, the executors of deceased farmers must contend with a bumper crop of tax issues. While income in respect of a decedent, step-ups in property values, and other tax attributes are confusing to most taxpayers, the tax complexities of agricultural business just compound the issues.
This blog posting takes a quick look at one valuation tax issue for deceased farmers, specifically the treatment of pre-paid farm expenses when a farmer passes away before realizing the income associated with the pre-paid expenses.
Pre-Paid Farm Expenses
Many farmers pre-pay and deduct farm production inputs (feed, seed, fertilizer) in the tax year of purchase rather than the year in which the inputs are used in the farming business. That can raise questions about the tax treatment if the farmer dies after pre-paying for the inputs in one tax year but before using them in crop/ livestock production in the following tax year.
This issue was addressed in Estate of Backemeyer v. Comm’r case, involving a farm couple in Nebraska. In Backemeyer, the husband incurred expenses for the purchase of seed, chemicals, fertilizer, and fuel during 2010, which he planned to use for the 2011 crop production cycle. Unfortunately, he died on March 13, 2011, before he was able to use these inputs. His estate reported these items as “inventory” with an FMV equal to the purchase price. The couple deducted the inputs as expenses on their joint 2010 income tax return.
The husband’s estate plan directed that the inputs were to be transferred to his family trust, in which his wife was the trustee. After his death, his surviving widow became actively involved in farming, using those inputs to grow crops in 2011. She sold a portion of those crops in 2011 and a portion in 2012, reporting the full value of the crops sold as gross income. She then prepared two Schedules F for their joint return for 2011. One of them claimed income from crop sales during her husband’s life. The other reported the income from her own farming operations, which claimed the input costs as deductions that were also claimed as deductions on the husband’s Schedule F in 2010.
The IRS audited and asserted a deficiency associated with the deduction of the prepaid expenses in the 2011 tax year, arguing that there was no evidence that expenses were incurred in excess of cash expenses the wife paid in connection with 2011 crop production. The wife challenged the IRS by filing a Tax Court petition. At the Tax Court, the IRS changed its position, arguing that the deduction was appropriate in 2011, but the tax benefit rule required the value of the 2010 deductions to be recaptured.
The Tax Court disagreed with the IRS’ position and upheld the 2010 deductions, ruling that the tax benefit rule did not require those amounts to be taken into income when they were not used in production for the husband on account of his death. The surviving wife also acquired these inputs at FMV (which was deemed to be their purchase price) at the time of death under §1014. The inputs were includable assets on the husband’s Form 706 and were deemed to be taxed there.
Note. If not for the basis step-up rule of IRC §1014, the surviving wife would have acquired the inputs at zero basis. Normally, double deductions are not allowed, but §1014 is a policy choice that Congress made, allowing for nonrecognition on account of death. However, the Tax Court is Backemeyer also noted that the depreciation recapture rules under IRC §§1245 and 1250 do not extend to transfers at death.
This issue is a part of the 2023 University of Illinois Federal Tax Workbook chapter on Agricultural Issues and Rural Investments. For more information about this topic, please join us for an agriculturally focused tax webinar on December 14 or 15.
Estate of Backemeyer v. Comm’r, 147 TC 17 (Dec. 8, 2016).