Aggregation Rules Expand the Scope of Proposed Cash Accounting Changes for Agriculture
In past years, Congress has included in tax reform a proposal that would require the use of accrual accounting for tax purposes by agricultural operations with more than $10 million in gross receipts. Due to aggregation rules, however, the proposal would have affected many businesses that currently have less than $10 million in gross receipts.
Agricultural operations are often divided into multiple, related businesses. In some cases, this is done to facilitate land ownership by multiple family members or to assist with succession planning. In other cases, some family members will operate one portion of a business (e.g. farming or feed) while others will operate a related business (e.g. livestock, grain storage, or transportation).
Gross receipts data collected by the Internal Revenue Service and by the USDA reflect each of these businesses as separate entities even though this proposal would require many small businesses to aggregate their income for the purposes of the gross receipts test.
Section 448 of the Internal Revenue Code establishes aggregation rules under which multiple related businesses must combine their income when calculating gross receipts. The previously proposed legislation (section 212, §448(b)(2)) does not change these rules. In fact, §448(d)(2) would have allowed the IRS to expand the scope of these rules (“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.”).
Current rules treat controlled groups as one entity under the gross receipts test in IRC §448. For purposes of §448, a controlled group is defined by reference to IRC §1563(a) which includes:
- Parent-subsidiary controlled groups (ownership of 50% of combined voting power or 50% of total value of each corporation);
- Brother-sister controlled groups (five or fewer persons own more than 50% of combined voting power or more than 50% of total value); and
- Combined groups.
In addition, the previously proposed legislation would also aggregate “affiliated service groups” under IRC §414(m) which would include farm management companies or other related service businesses.
When considering ownership, the attribution rules relating to family members would also be considered which would serve to expand the magnitude of the changes to IRC §448. The aggregation rule would also combine the gross receipts of all corporations, partnerships, limited liability companies, and limited partnerships which are under common control. Finally, by limiting the use of the cash basis to natural taxpayers, pass-through entities would also be subject to the gross receipts test.
If related businesses are aggregated and have combined gross receipts more than $10 million, each of the related businesses would be required to use the accrual method of accounting.
Without knowing the common ownership or control of every taxpayer, it is impossible to determine the magnitude of the number of businesses that would be affected by the changes to IRC §448. Given that many agricultural operations are structured as multiple, related entities, it is clear that simply reviewing the number of agriculture businesses with gross receipts of more than $10 million would dramatically under-count the number of operations that would be affected by such proposals. This comes at a time when the trend toward consolidation in the agriculture industry ensures that an increasing number of businesses will cross this threshold in the coming years. Further, because the $10 million gross receipts test is static, as commodity prices increase, smaller agricultural operations in real terms will increasingly be forced to use accrual accounting.
Since 1986, Congress has recognized that the cash method of accounting is simpler than the accrual method. Forcing agricultural operations to use accrual accounting could have a negative impact on the growth of these businesses, limit the ability of producers to meeting growing market demands, and slow the creation of new jobs. Businesses affected by this proposal will have increased administrative, compliance, and record-keeping requirements. For some owner-operators, the acceleration of tax on income that has not been collected could significantly limit their ability to capitalize their businesses.
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