Cash-To-Accrual Issue

What Is It?

Cash Accounting Proposal

A U.S. House of Representative Ways and Means Committee Proposal in March of 2013 and a U.S. Senate Finance Committee proposal in November of 2013 both would have required farm operations to use accrual accounting for tax purposes if their annual gross receipts (averaged over a three-year period) are greater than $10 million.

Committees in the U.S. House of Representatives and the U.S. Senate are each currently preparing tax reform bills—in the past, both have considered adding these cash accounting changes in their tax reform bills. If this provision becomes law, it will significantly increase costs and decrease financial flexibility for farming operations in the United States.

Quote FFSC about impact of cash-to-accrual tax change on farms

The switch to accrual accounting increases costs and decreases flexibility for agricultural operations because:

  • Farmers have used cash accounting for decades to balance out price volatility and to manage operations consistent with cash flow.
  • Requiring agricultural operations to use the accrual method will penalize operators in an industry with widely recognized thin margins, rising production costs, and high price volatility.
  • Agriculture faces high input costs and wide swings in commodity prices. An increase in gross receipts does not indicate an increase in profitability.
  • Previously proposed aggregation rules would sweep in many farm operations with less than $10 million in gross receipts.
  • As commodity prices increase (a long-running trend, as shown below), the rule will become increasingly restrictive and force more farms into accrual accounting.
Shown above: the dramatic increase in  commodity prices.

Since agriculture has a history of dramatic swings in commodity prices, substantially more operations would soon meet the minimum requirements for accrual-based accounting, than meet the requirements today.

 

Changes to the cash accounting rules wouldaffect businesses in many industries, but are especially problematic for agriculture. Agriculture experiences high input costs and wide swings in commodity prices.

In agriculture, an increase in gross receipts does not indicate an increase in profitability.

Producers operate at very low margins—usually under 20% and, for many ag businesses, margins average just 4% to 5%. Compare this to other industries and professional firms that generally have profit margins of over 20% some in the range of 40-50%.

As a result, most agricultural operations must have significant gross sales to generate even a modest profit. Sales to earnings rations reflect different proportions for ag than other businesses so we think the threshold should be reconsidered. Cash flow disruptions that accrual-basis accounting would cause can severely cripple these producers. Beef, dairy, and hog operations with their increasing feed and input costs will be especially hard hit.

Who It Affects

Partnerships, S-Corps, and Family Farm Corporations with greater than $10 million in gross receipts (measured on a 3-year average) could all be immediately affected.

This $10 million threshold for reporting may be a bit misleading. It’s important to note that, under previous proposals, related entities wwould be aggregated* to determine the amount of gross receipts.

Change Comparison

Proposed Tax Reform Impact on Ag Entities

Even businesses that have not had $10 million in gross receipts in the past might be suddenly affected in future years depending on commodity prices, inflation, and other market conditions.

This change most significantly impacts:

  • Feedlots
  • Dairies
  • Large grain producers
  • Hog farms
  • Beef operations
  • Some fruit, nut, and specialty crops

Aggregation Rules

Past proposals would require any companies with more than 50% common ownership to be aggregated (IRC Sec. 52(a)(1)). Under past Senate proposals, the interests of sole proprietors would also be aggregated.

Read Aggregation Rules Expand Scope to learn more about this.

IRS Rules Could Further Expand Scope

The IRS will be looking for ways to make sure entities don’t get around the new reporting requirements: Past legislation directed that the “Secretary shall prescribe such regulations as may be necessary to prevent the use of related parties, pass thru entities, or intermediaries to avoid the application of this section.”

Summary of Consequences of Previously Proposed Tax Changes Affecting U.S. Agriculture Industry

  • Income may be subject to tax before cash is received.
  • Cash expenditures may not reduce taxable income.
  • Increased level of debt needed to buy inputs and pay taxes. Both will take cash under the accrual method, it will not be one cash outflow or the other.
  • Increased volatility in income reported from year-to-year leads to increased tax filings in loss years.
  • Increased record keeping for some producers.
  • Increased risk for businesses during tough economic times. There will be less working capital and equity in the business due to paying taxes in the “good” years.
  • Once triggered, a taxpayer would be ineligible to switch back to cash accounting under “automatic consent” for a period of five years. See Rev. Proc. 2011-14, Sec. 4.02(6)). Under the previous Senate proposal, a taxpayer would be prohibited from switching back to cash accounting for a period of four years.

 


Supporters

Find out how you can help stop these proposed changes from becoming law and taxing you unfairly.
The ag community needs a voice. The ag community needs you.

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