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We hobby farmers are big dreamers. Many of us dream of owning our own farm, expanding our existing operation, or making money doing what we love: farming. Accurate record-keeping, however, is the bridge that links dreams and profit.
Keeping accurate records eases the process of providing proof of income and expenses to the IRS and your state’s department of revenue, but it also creates a valuable decision-making tool when it comes to monitoring livestock, farm production and equipment inventory. The byproduct of accurate records is smooth tax filing and fiscal health for the farm.
Hire a Financial Advisor
According to Kent Wolfe, PhD, director for the Center of Agribusiness and Economic Development at the University of Georgia, dates and dollar amounts are the most important things to keep up with throughout the year in preparation for tax time.
“Always record the date of the cash farm income or expense as you may need to refer to it later,” Wolfe says. “Include what you bought or sold, the quantity of what you bought and sold, and the total dollar amount.”
Barry Kennedy, a certified public accountant and vice president of CK Business Solutions in Albertville, Ala., has provided accounting, tax and consulting services in the Southeast for more than 40 years and says the biggest challenge a farm-owning taxpayer faces is maintaining adequate documentation of expenses.
“Interestingly, there are still many farmers who prefer to deal in cash, and for some reason, when we pay cash, invoices and receipts have a tendency to disappear,” Kennedy says. “When it comes to supporting a tax deduction, the taxpayer should, at a minimum, retain invoices or cash-register receipts, which specifically identify each of the items purchased, as well as the method of payment by the taxpayer.”
Kennedy says many helpful tips for farm record-keeping during the year can be found through the IRS website in Publication 225, Farmer’s Tax Guide. This publication outlines the records that should be kept during the year and makes end-of-year accounting much easier.
Most questions center on the topic of deductions. “From a general perspective, a taxpayer should consider a reasonable farm expense as one which is both ordinary and necessary,” Kennedy says. “An ordinary expense is one that is common and accepted in your industry, and a necessary expense is one that is helpful and appropriate for your trade or business.”
Kennedy stresses the importance of selecting a reputable accountant when it comes to dealing with your farm-account matters.
“Does the professional have experience in your particular product, such as cattle, poultry or produce, and how many years of experience does the professional have in your farm-product arena? You can also check with your state’s accountancy board to determine if the CPA’s license is valid and in good standing.”
Accountants, like Kennedy, can be a farmer’s best financial friend for more than just tax-time farm accounting. “A reputable accountant can help the farmer decide whether to buy or lease land [and] help with tax, estate and gift planning; cash-flow modeling; financing-option evaluations; and product-profitability analysis,” Kennedy says. “In addition, we can help with business-plan preparations and deciding on whether to incorporate or not.”
Set Up a Business Account
To avoid record-keeping confusion on personal finances, Kennedy recommends setting up a separate account for the farm.
“I’m a big advocate of separating any business venture’s activity from a taxpayer’s routine personal expenses by opening a separate business account,” Kennedy says. “This, coupled with a complementary accounting-software application, serves the taxpayer as another means of properly accumulating the income and expenses associated with the farming operation.”
The need to accumulate and track each and every revenue or expense transaction for a pure hobby farm might not be as critical to the taxpayer, Kennedy adds.
Damona Doye, PhD, extension economist, regents professor and Sarkeys Distinguished Professor with Oklahoma State University, also encourages producers to have a separate checking account for the farm business.
“This provides some separation of farm and family expenses, making it quicker and easier to spot expenses that get out of hand in either account,” Doye says. “If you use a software program, like Quicken, you have the ability to summarize farm and family expenses separately, even if they are in one checking account, because you simply have to use tags in addition to the income and expense categories to label them appropriately, then create and look at reports regularly.”
Doye adds that her department has been teaching people how to use Quicken for farm financial records since 1993.
“You can buy Quicken, import the farm-category list, enter your transactions weekly and look at reports, such as income or expense or tax, as needed,” she says.
Kennedy says his company has Quickbooks Pro advisors on his staff, but several quality software programs are available to farm producers.
“Properly utilized software accumulates and tracks income and expenses and can provide the business owner with data to make timely, informed business decisions,” Kennedy says. “You can manage what you can measure, and software assists the business owner with that financial information.”
According to Doye, financial records are just as important for management purposes as for filing taxes.
“By sorting and summarizing expenses in different ways, producers can understand which enterprises are moneymakers and which are money losers,” she says. “For instance, they can see whether producing hay is cost-effective or whether they would be better off buying it.”
Wolfe says anyone venturing into any area of agriculture needs to record their marketing efforts and evaluate the effectiveness and return on investment.
“Make sure you record all of your costs associated with selling, driving time, mileage, packaging, registration costs if you are selling at trade shows, and associated travel costs,” he says. “Also record your promotional costs because you want a good handle on total cost per unit so you can price accordingly and make a profit.”
Wolfe recommends using a computer-software program to help with marketing.
“QuickBooks, for instance, has the capability to automate your checkbook and tremendously eases the effort to keep it balanced, and you can create invoices and manage your accounts receivables,” he says. “In addition to keeping track of all your bills and better managing your cash flow, other highlights of this program include a sales-tax payments feature and full financial reporting and sales tracking by product.”
Determine Hobby Vs. Business
You might be looking at your farm investment and trying to determine if your entity is considered a hobby or a business for tax purposes. According to Kennedy, the IRS has created tools to assist the taxpayer in making this determination, but one of the simplest communications can be found in their document “Business or Hobby? Answer Has Implications for Deductions.”
“This article published by the IRS discusses not only the basic criteria for determining whether an activity is a business or hobby but also highlights some of the differences in tax treatments between a business and a hobby,” Kennedy says. “If the taxpayer is unsure whether their activity should be treated as a business or a hobby, they should consult their tax professional to assist in determining the correct tax treatment of the activity.”
Avoid Common Errors
We’ve all had those moments when we’ve misplaced key farm records that would have helped us make better decisions or could have given us a higher tax deduction, but Doye says one of the most common blunders is inconsistent record-keeping.
“When you fail to categorize an expense or fail to review depreciation schedules, this can cost you money,” she says. “Simply failing to keep up with record-keeping regularly or stuffing receipts in a shoe box or putting off record-keeping until the end of the year means you don’t have information on hand regularly to make sound financial decisions.”
Kennedy says that in addition to receiving an audit notice from the IRS, farmers can experience other consequences for record-keeping mistakes.
“The bank may require periodic financial information to evaluate the farm’s continued ability to repay its debt,” he says. “Inability to provide this information on a timely basis may result in the bank calling the debt.”
According to Doye, money spent on fuel and small repairs are often overlooked as deductions because of lost receipts. “The cost of attending an educational program conducted by a cattleman’s group or extension service is an example of a deductable expense,” she says. “In addition, the cost of professional magazines and trade journals used in the business are also frequently overlooked.”
Keeping accurate records throughout the year is what makes any farm successful. It’s OK to dream big, but profit through good record-keeping is what keeps the farm running smoothly.