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Federal Tax Preparation

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Federal Tax Preparation

Federal tax preparation 18. Federal tax preparation   Alimony Table of Contents IntroductionSpouse or former spouse. Federal tax preparation Divorce or separation instrument. Federal tax preparation Useful Items - You may want to see: General RulesMortgage payments. Federal tax preparation Taxes and insurance. Federal tax preparation Other payments to a third party. Federal tax preparation Instruments Executed After 1984Payments to a third party. Federal tax preparation Exception. Federal tax preparation Substitute payments. Federal tax preparation Specifically designated as child support. Federal tax preparation Contingency relating to your child. Federal tax preparation Clearly associated with a contingency. Federal tax preparation How To Deduct Alimony Paid How To Report Alimony Received Recapture Rule Introduction This chapter discusses the rules that apply if you pay or receive alimony. Federal tax preparation It covers the following topics. Federal tax preparation What payments are alimony. Federal tax preparation What payments are not alimony, such as child support. Federal tax preparation How to deduct alimony you paid. Federal tax preparation How to report alimony you received as income. Federal tax preparation Whether you must recapture the tax benefits of alimony. Federal tax preparation Recapture means adding back in your income all or part of a deduction you took in a prior year. Federal tax preparation Alimony is a payment to or for a spouse or former spouse under a divorce or separation instrument. Federal tax preparation It does not include voluntary payments that are not made under a divorce or separation instrument. Federal tax preparation Alimony is deductible by the payer and must be included in the spouse's or former spouse's income. Federal tax preparation Although this chapter is generally written for the payer of the alimony, the recipient can use the information to determine whether an amount received is alimony. Federal tax preparation To be alimony, a payment must meet certain requirements. Federal tax preparation Different requirements generally apply to payments under instruments executed after 1984 and to payments under instruments executed before 1985. Federal tax preparation This chapter discusses the rules for payments under instruments executed after 1984. Federal tax preparation If you need the rules for payments under pre-1985 instruments, get and keep a copy of the 2004 version of Publication 504. Federal tax preparation That was the last year the information on pre-1985 instruments was included in Publication 504. Federal tax preparation Use Table 18-1 in this chapter as a guide to determine whether certain payments are considered alimony. Federal tax preparation Definitions. Federal tax preparation   The following definitions apply throughout this chapter. Federal tax preparation Spouse or former spouse. Federal tax preparation   Unless otherwise stated, the term “spouse” includes former spouse. Federal tax preparation Divorce or separation instrument. Federal tax preparation   The term “divorce or separation instrument” means: A decree of divorce or separate maintenance or a written instrument incident to that decree, A written separation agreement, or A decree or any type of court order requiring a spouse to make payments for the support or maintenance of the other spouse. Federal tax preparation This includes a temporary decree, an interlocutory (not final) decree, and a decree of alimony pendente lite (while awaiting action on the final decree or agreement). Federal tax preparation Useful Items - You may want to see: Publication 504 Divorced or Separated Individuals General Rules The following rules apply to alimony regardless of when the divorce or separation instrument was executed. Federal tax preparation Payments not alimony. Federal tax preparation   Not all payments under a divorce or separation instrument are alimony. Federal tax preparation Alimony does not include: Child support, Noncash property settlements, Payments that are your spouse's part of community income, as explained under Community Property in Publication 504, Payments to keep up the payer's property, or Use of the payer's property. Federal tax preparation Payments to a third party. Federal tax preparation   Cash payments, checks, or money orders to a third party on behalf of your spouse under the terms of your divorce or separation instrument can be alimony, if they otherwise qualify. Federal tax preparation These include payments for your spouse's medical expenses, housing costs (rent, utilities, etc. Federal tax preparation ), taxes, tuition, etc. Federal tax preparation The payments are treated as received by your spouse and then paid to the third party. Federal tax preparation Life insurance premiums. Federal tax preparation   Alimony includes premiums you must pay under your divorce or separation instrument for insurance on your life to the extent your spouse owns the policy. Federal tax preparation Payments for jointly-owned home. Federal tax preparation   If your divorce or separation instrument states that you must pay expenses for a home owned by you and your spouse, some of your payments may be alimony. Federal tax preparation Mortgage payments. Federal tax preparation   If you must pay all the mortgage payments (principal and interest) on a jointly-owned home, and they otherwise qualify as alimony, you can deduct one-half of the total payments as alimony. Federal tax preparation If you itemize deductions and the home is a qualified home, you can claim one-half of the interest in figuring your deductible interest. Federal tax preparation Your spouse must report one-half of the payments as alimony received. Federal tax preparation If your spouse itemizes deductions and the home is a qualified home, he or she can claim one-half of the interest on the mortgage in figuring deductible interest. Federal tax preparation Taxes and insurance. Federal tax preparation   If you must pay all the real estate taxes or insurance on a home held as tenants in common, you can deduct one-half of these payments as alimony. Federal tax preparation Your spouse must report one-half of these payments as alimony received. Federal tax preparation If you and your spouse itemize deductions, you can each claim one-half of the real estate taxes and none of the home insurance. Federal tax preparation    If your home is held as tenants by the entirety or joint tenants, none of your payments for taxes or insurance are alimony. Federal tax preparation But if you itemize deductions, you can claim all of the real estate taxes and none of the home insurance. Federal tax preparation Other payments to a third party. Federal tax preparation   If you made other third-party payments, see Publication 504 to see whether any part of the payments qualifies as alimony. Federal tax preparation Instruments Executed After 1984 The following rules for alimony apply to payments under divorce or separation instruments executed after 1984. Federal tax preparation Exception for instruments executed before 1985. Federal tax preparation   There are two situations where the rules for instruments executed after 1984 apply to instruments executed before 1985. Federal tax preparation A divorce or separation instrument executed before 1985 and then modified after 1984 to specify that the after-1984 rules will apply. Federal tax preparation A temporary divorce or separation instrument executed before 1985 and incorporated into, or adopted by, a final decree executed after 1984 that: Changes the amount or period of payment, or Adds or deletes any contingency or condition. Federal tax preparation   For the rules for alimony payments under pre-1985 instruments not meeting these exceptions, get the 2004 version of Publication 504 at www. Federal tax preparation irs. Federal tax preparation gov/pub504. Federal tax preparation Example 1. Federal tax preparation In November 1984, you and your former spouse executed a written separation agreement. Federal tax preparation In February 1985, a decree of divorce was substituted for the written separation agreement. Federal tax preparation The decree of divorce did not change the terms for the alimony you pay your former spouse. Federal tax preparation The decree of divorce is treated as executed before 1985. Federal tax preparation Alimony payments under this decree are not subject to the rules for payments under instruments executed after 1984. Federal tax preparation Example 2. Federal tax preparation Assume the same facts as in Example 1 except that the decree of divorce changed the amount of the alimony. Federal tax preparation In this example, the decree of divorce is not treated as executed before 1985. Federal tax preparation The alimony payments are subject to the rules for payments under instruments executed after 1984. Federal tax preparation Alimony requirements. Federal tax preparation   A payment to or for a spouse under a divorce or separation instrument is alimony if the spouses do not file a joint return with each other and all the following requirements are met. Federal tax preparation The payment is in cash. Federal tax preparation The instrument does not designate the payment as not alimony. Federal tax preparation Spouses legally separated under a decree of divorce or separate maintenance are not members of the same household. Federal tax preparation There is no liability to make any payment (in cash or property) after the death of the recipient spouse. Federal tax preparation The payment is not treated as child support. Federal tax preparation Each of these requirements is discussed below. Federal tax preparation Cash payment requirement. Federal tax preparation   Only cash payments, including checks and money orders, qualify as alimony. Federal tax preparation The following do not qualify as alimony. Federal tax preparation Transfers of services or property (including a debt instrument of a third party or an annuity contract). Federal tax preparation Execution of a debt instrument by the payer. Federal tax preparation The use of the payer's property. Federal tax preparation Payments to a third party. Federal tax preparation   Cash payments to a third party under the terms of your divorce or separation instrument can qualify as cash payments to your spouse. Federal tax preparation See Payments to a third party under General Rules, earlier. Federal tax preparation   Also, cash payments made to a third party at the written request of your spouse may qualify as alimony if all the following requirements are met. Federal tax preparation The payments are in lieu of payments of alimony directly to your spouse. Federal tax preparation The written request states that both spouses intend the payments to be treated as alimony. Federal tax preparation You receive the written request from your spouse before you file your return for the year you made the payments. Federal tax preparation Payments designated as not alimony. Federal tax preparation   You and your spouse can designate that otherwise qualifying payments are not alimony. Federal tax preparation You do this by including a provision in your divorce or separation instrument that states the payments are not deductible as alimony by you and are excludable from your spouse's income. Federal tax preparation For this purpose, any instrument (written statement) signed by both of you that makes this designation and that refers to a previous written separation agreement is treated as a written separation agreement (and therefore a divorce or separation instrument). Federal tax preparation If you are subject to temporary support orders, the designation must be made in the original or a later temporary support order. Federal tax preparation   Your spouse can exclude the payments from income only if he or she attaches a copy of the instrument designating them as not alimony to his or her return. Federal tax preparation The copy must be attached each year the designation applies. Federal tax preparation Spouses cannot be members of the same household. Federal tax preparation    Payments to your spouse while you are members of the same household are not alimony if you are legally separated under a decree of divorce or separate maintenance. Federal tax preparation A home you formerly shared is considered one household, even if you physically separate yourselves in the home. Federal tax preparation   You are not treated as members of the same household if one of you is preparing to leave the household and does leave no later than 1 month after the date of the payment. Federal tax preparation Exception. Federal tax preparation   If you are not legally separated under a decree of divorce or separate maintenance, a payment under a written separation agreement, support decree, or other court order may qualify as alimony even if you are members of the same household when the payment is made. Federal tax preparation Table 18-1. Federal tax preparation Alimony Requirements (Instruments Executed After 1984) Payments ARE alimony if all of the following are true: Payments are NOT alimony if any of the following are true: Payments are required by a divorce or separation instrument. Federal tax preparation Payments are not required by a divorce or separation instrument. Federal tax preparation Payer and recipient spouse do not file a joint return with each other. Federal tax preparation Payer and recipient spouse file a joint return with each other. Federal tax preparation Payment is in cash (including checks or money orders). Federal tax preparation Payment is: Not in cash, A noncash property settlement, Spouse's part of community income, or To keep up the payer's property. Federal tax preparation Payment is not designated in the instrument as not alimony. Federal tax preparation Payment is designated in the instrument as not alimony. Federal tax preparation Spouses legally separated under a decree of divorce or separate maintenance are not members of the same household. Federal tax preparation Spouses legally separated under a decree of divorce or separate maintenance are members of the same household. Federal tax preparation Payments are not required after death of the recipient spouse. Federal tax preparation Payments are required after death of the recipient spouse. Federal tax preparation Payment is not treated as child support. Federal tax preparation Payment is treated as child support. Federal tax preparation These payments are deductible by the payer and includible in income by the recipient. Federal tax preparation These payments are neither deductible by the payer nor includible in income by the recipient. Federal tax preparation Liability for payments after death of recipient spouse. Federal tax preparation   If any part of payments you make must continue to be made for any period after your spouse's death, that part of your payments is not alimony, whether made before or after the death. Federal tax preparation If all of the payments would continue, then none of the payments made before or after the death are alimony. Federal tax preparation   The divorce or separation instrument does not have to expressly state that the payments cease upon the death of your spouse if, for example, the liability for continued payments would end under state law. Federal tax preparation Example. Federal tax preparation You must pay your former spouse $10,000 in cash each year for 10 years. Federal tax preparation Your divorce decree states that the payments will end upon your former spouse's death. Federal tax preparation You must also pay your former spouse or your former spouse's estate $20,000 in cash each year for 10 years. Federal tax preparation The death of your spouse would not terminate these payments under state law. Federal tax preparation The $10,000 annual payments may qualify as alimony. Federal tax preparation The $20,000 annual payments that do not end upon your former spouse's death are not alimony. Federal tax preparation Substitute payments. Federal tax preparation   If you must make any payments in cash or property after your spouse's death as a substitute for continuing otherwise qualifying payments before the death, the otherwise qualifying payments are not alimony. Federal tax preparation To the extent that your payments begin, accelerate, or increase because of the death of your spouse, otherwise qualifying payments you made may be treated as payments that were not alimony. Federal tax preparation Whether or not such payments will be treated as not alimony depends on all the facts and circumstances. Federal tax preparation Example 1. Federal tax preparation Under your divorce decree, you must pay your former spouse $30,000 annually. Federal tax preparation The payments will stop at the end of 6 years or upon your former spouse's death, if earlier. Federal tax preparation Your former spouse has custody of your minor children. Federal tax preparation The decree provides that if any child is still a minor at your spouse's death, you must pay $10,000 annually to a trust until the youngest child reaches the age of majority. Federal tax preparation The trust income and corpus (principal) are to be used for your children's benefit. Federal tax preparation These facts indicate that the payments to be made after your former spouse's death are a substitute for $10,000 of the $30,000 annual payments. Federal tax preparation Of each of the $30,000 annual payments, $10,000 is not alimony. Federal tax preparation Example 2. Federal tax preparation Under your divorce decree, you must pay your former spouse $30,000 annually. Federal tax preparation The payments will stop at the end of 15 years or upon your former spouse's death, if earlier. Federal tax preparation The decree provides that if your former spouse dies before the end of the 15-year period, you must pay the estate the difference between $450,000 ($30,000 × 15) and the total amount paid up to that time. Federal tax preparation For example, if your spouse dies at the end of the tenth year, you must pay the estate $150,000 ($450,000 − $300,000). Federal tax preparation These facts indicate that the lump-sum payment to be made after your former spouse's death is a substitute for the full amount of the $30,000 annual payments. Federal tax preparation None of the annual payments are alimony. Federal tax preparation The result would be the same if the payment required at death were to be discounted by an appropriate interest factor to account for the prepayment. Federal tax preparation Child support. Federal tax preparation   A payment that is specifically designated as child support or treated as specifically designated as child support under your divorce or separation instrument is not alimony. Federal tax preparation The amount of child support may vary over time. Federal tax preparation Child support payments are not deductible by the payer and are not taxable to the recipient. Federal tax preparation Specifically designated as child support. Federal tax preparation   A payment will be treated as specifically designated as child support to the extent that the payment is reduced either: On the happening of a contingency relating to your child, or At a time that can be clearly associated with the contingency. Federal tax preparation A payment may be treated as specifically designated as child support even if other separate payments are specifically designated as child support. Federal tax preparation Contingency relating to your child. Federal tax preparation   A contingency relates to your child if it depends on any event relating to that child. Federal tax preparation It does not matter whether the event is certain or likely to occur. Federal tax preparation Events relating to your child include the child's: Becoming employed, Dying, Leaving the household, Leaving school, Marrying, or Reaching a specified age or income level. Federal tax preparation Clearly associated with a contingency. Federal tax preparation   Payments that would otherwise qualify as alimony are presumed to be reduced at a time clearly associated with the happening of a contingency relating to your child only in the following situations. Federal tax preparation The payments are to be reduced not more than 6 months before or after the date the child will reach 18, 21, or local age of majority. Federal tax preparation The payments are to be reduced on two or more occasions that occur not more than 1 year before or after a different one of your children reaches a certain age from 18 to 24. Federal tax preparation This certain age must be the same for each child, but need not be a whole number of years. Federal tax preparation In all other situations, reductions in payments are not treated as clearly associated with the happening of a contingency relating to your child. Federal tax preparation   Either you or the IRS can overcome the presumption in the two situations above. Federal tax preparation This is done by showing that the time at which the payments are to be reduced was determined independently of any contingencies relating to your children. Federal tax preparation For example, if you can show that the period of alimony payments is customary in the local jurisdiction, such as a period equal to one-half of the duration of the marriage, you can overcome the presumption and may be able to treat the amount as alimony. Federal tax preparation How To Deduct Alimony Paid You can deduct alimony you paid, whether or not you itemize deductions on your return. Federal tax preparation You must file Form 1040. Federal tax preparation You cannot use Form 1040A or Form 1040EZ. Federal tax preparation Enter the amount of alimony you paid on Form 1040, line 31a. Federal tax preparation In the space provided on line 31b, enter your spouse's social security number (SSN) or individual taxpayer identification number (ITIN). Federal tax preparation If you paid alimony to more than one person, enter the SSN or ITIN of one of the recipients. Federal tax preparation Show the SSN or ITIN and amount paid to each other recipient on an attached statement. Federal tax preparation Enter your total payments on line 31a. Federal tax preparation You must provide your spouse's SSN or ITIN. Federal tax preparation If you do not, you may have to pay a $50 penalty and your deduction may be disallowed. Federal tax preparation For more information on SSNs and ITINs, see Social Security Number (SSN) in chapter 1. Federal tax preparation How To Report Alimony Received Report alimony you received as income on Form 1040, line 11. Federal tax preparation You cannot use Form 1040A or Form 1040EZ. Federal tax preparation You must give the person who paid the alimony your SSN or ITIN. Federal tax preparation If you do not, you may have to pay a $50 penalty. Federal tax preparation Recapture Rule If your alimony payments decrease or end during the first 3 calendar years, you may be subject to the recapture rule. Federal tax preparation If you are subject to this rule, you have to include in income in the third year part of the alimony payments you previously deducted. Federal tax preparation Your spouse can deduct in the third year part of the alimony payments he or she previously included in income. Federal tax preparation The 3-year period starts with the first calendar year you make a payment qualifying as alimony under a decree of divorce or separate maintenance or a written separation agreement. Federal tax preparation Do not include any time in which payments were being made under temporary support orders. Federal tax preparation The second and third years are the next 2 calendar years, whether or not payments are made during those years. Federal tax preparation The reasons for a reduction or end of alimony payments that can require a recapture include: A change in your divorce or separation instrument, A failure to make timely payments, A reduction in your ability to provide support, or A reduction in your spouse's support needs. Federal tax preparation When to apply the recapture rule. Federal tax preparation   You are subject to the recapture rule in the third year if the alimony you pay in the third year decreases by more than $15,000 from the second year or the alimony you pay in the second and third years decreases significantly from the alimony you pay in the first year. Federal tax preparation   When you figure a decrease in alimony, do not include the following amounts. Federal tax preparation Payments made under a temporary support order. Federal tax preparation Payments required over a period of at least 3 calendar years that vary because they are a fixed part of your income from a business or property, or from compensation for employment or self-employment. Federal tax preparation Payments that decrease because of the death of either spouse or the remarriage of the spouse receiving the payments before the end of the third year. Federal tax preparation Figuring the recapture. Federal tax preparation   You can use Worksheet 1 in Publication 504 to figure recaptured alimony. Federal tax preparation Including the recapture in income. Federal tax preparation   If you must include a recapture amount in income, show it on Form 1040, line 11 (“Alimony received”). Federal tax preparation Cross out “received” and enter “recapture. Federal tax preparation ” On the dotted line next to the amount, enter your spouse's last name and SSN or ITIN. Federal tax preparation Deducting the recapture. Federal tax preparation   If you can deduct a recapture amount, show it on Form 1040, line 31a (“Alimony paid”). Federal tax preparation Cross out “paid” and enter “recapture. Federal tax preparation ” In the space provided, enter your spouse's SSN or ITIN. Federal tax preparation Prev  Up  Next   Home   More Online Publications
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Federal tax preparation 2. Federal tax preparation   Accounting Methods Table of Contents Introduction Topics - This chapter discusses: Useful Items - You may want to see: Accounting MethodsCash Method Accrual Method Farm Inventory Cash Versus Accrual Method Special Methods of Accounting Combination Method Changes in Methods of Accounting Introduction You must use an accounting method that clearly shows your income and expenses. Federal tax preparation You must also figure your taxable income and file an income tax return for an annual accounting period called a tax year. Federal tax preparation This chapter discusses accounting methods. Federal tax preparation For information on accounting periods, see Publication 538, Accounting Periods and Methods, and the Instructions for Form 1128, Application To Adopt, Change, or Retain a Tax Year. Federal tax preparation Topics - This chapter discusses: Cash method Accrual method Farm inventory Special methods of accounting Changes in methods of accounting Useful Items - You may want to see: Publication 538 Accounting Periods and Methods 535 Business Expenses Form (and Instructions) 1128 Application To Adopt, Change, or Retain a Tax Year 3115 Application for Change in Accounting Method See chapter 16 for information about getting publications and forms. Federal tax preparation Accounting Methods An accounting method is a set of rules used to determine when and how your income and expenses are reported on your tax return. Federal tax preparation Your accounting method includes not only your overall method of accounting, but also the accounting treatment you use for any material item. Federal tax preparation A material item is one that affects the proper time for inclusion of income or allowance of a deduction. Federal tax preparation An item considered material for financial statement purposes is generally also considered material for income tax purposes. Federal tax preparation See Publication 538 for more information. Federal tax preparation You generally choose an accounting method for your farm business when you file your first income tax return that includes a Schedule F (Form 1040), Profit or Loss From Farming. Federal tax preparation If you later want to change your accounting method, you generally must get IRS approval. Federal tax preparation How to obtain IRS approval is discussed later under Changes in Methods of Accounting . Federal tax preparation Types of accounting methods. Federal tax preparation   Generally, you can use any of the following accounting methods. Federal tax preparation Each method is discussed in detail below. Federal tax preparation Cash method. Federal tax preparation Accrual method. Federal tax preparation Special methods of accounting for certain items of income and expenses. Federal tax preparation Combination (hybrid) method using elements of two or more of the above. Federal tax preparation Business and other items. Federal tax preparation   You can account for business and personal items using different accounting methods. Federal tax preparation For example, you can figure your business income under an accrual method, even if you use the cash method to figure personal items. Federal tax preparation Two or more businesses. Federal tax preparation   If you operate two or more separate and distinct businesses, you can use a different accounting method for each business. Federal tax preparation Generally, no business is separate and distinct unless a complete and separate set of books and records is maintained for each business. Federal tax preparation Cash Method Most farmers use the cash method because they find it easier to keep records using the cash method. Federal tax preparation However, certain farm corporations and partnerships and all tax shelters must use an accrual method of accounting. Federal tax preparation See Accrual Method Required , later. Federal tax preparation Income Under the cash method, include in your gross income all items of income you actually or constructively received during the tax year. Federal tax preparation Items of income include money received as well as property or services received. Federal tax preparation If you receive property or services, you must include the fair market value (FMV) of the property or services in income. Federal tax preparation See chapter 3 for information on how to report farm income on your income tax return. Federal tax preparation Constructive receipt. Federal tax preparation   Income is constructively received when an amount is credited to your account or made available to you without restriction. Federal tax preparation You do not need to have possession of the income for it to be treated as income for the tax year. Federal tax preparation If you authorize someone to be your agent and receive income for you, you are considered to have received the income when your agent receives it. Federal tax preparation Income is not constructively received if your receipt of the income is subject to substantial restrictions or limitations. Federal tax preparation Direct payments and counter-cyclical payments. Federal tax preparation   If you received direct payments or counter-cyclical payments under Subtitle A or C of the Farm Security and Rural Investment Act of 2002, you will not be considered to have constructively received a payment merely because you had the option to receive it in the year before it is required to be paid. Federal tax preparation Delaying receipt of income. Federal tax preparation   You cannot hold checks or postpone taking possession of similar property from one tax year to another to avoid paying tax on the income. Federal tax preparation You must report the income in the year the money or property is received or made available to you without restriction. Federal tax preparation Example. Federal tax preparation Frances Jones, a farmer, was entitled to receive a $10,000 payment on a grain contract in December 2013. Federal tax preparation She was told in December that her payment was available. Federal tax preparation She requested not to be paid until January 2014. Federal tax preparation However, she must still include this payment in her 2013 income because it was made available to her in 2013. Federal tax preparation Debts paid by another person or canceled. Federal tax preparation   If your debts are paid by another person or are canceled by your creditors, you may have to report part or all of this debt relief as income. Federal tax preparation If you receive income in this way, you constructively receive the income when the debt is canceled or paid. Federal tax preparation See Cancellation of Debt in chapter 3. Federal tax preparation Deferred payment contract. Federal tax preparation   If you sell an item under a deferred payment contract that calls for payment in a future year, there is no constructive receipt in the year of sale. Federal tax preparation However, if the sales contract states that you have the right to the proceeds of the sale from the buyer at any time after delivery of the item, then you must include the sales price in income in the year of the sale, regardless of when you actually receive payment. Federal tax preparation Example. Federal tax preparation You are a farmer who uses the cash method and a calendar tax year. Federal tax preparation You sell grain in December 2013 under a bona fide arm's-length contract that calls for payment in 2014. Federal tax preparation You include the proceeds from the sale in your 2014 gross income since that is the year payment is received. Federal tax preparation However, if the contract states that you have the right to the proceeds from the buyer at any time after the grain is delivered, you must include the sales price in your 2013 income, regardless of when you actually receive payment. Federal tax preparation Repayment of income. Federal tax preparation   If you include an amount in income and in a later year you have to repay all or part of it, then you can usually deduct the repayment in the year repaid. Federal tax preparation If the repayment is more than $3,000, a special rule applies. Federal tax preparation For details, see Repayments in chapter 11 of Publication 535, Business Expenses. Federal tax preparation Expenses Under the cash method, generally you deduct expenses in the tax year you pay them. Federal tax preparation This includes business expenses for which you contest liability. Federal tax preparation However, you may not be able to deduct an expense paid in advance or you may be required to capitalize certain costs, as explained under Uniform Capitalization Rules in chapter 6. Federal tax preparation See chapter 4 for information on how to deduct farm business expenses on your income tax return. Federal tax preparation Prepayment. Federal tax preparation   Generally, you cannot deduct expenses paid in advance. Federal tax preparation This rule applies to any expense paid far enough in advance to, in effect, create an asset with a useful life extending substantially beyond the end of the current tax year. Federal tax preparation Example. Federal tax preparation On November 1, 2013, you signed and paid $3,600 for a 3-year (36-month) insurance contract for equipment. Federal tax preparation In 2013, you are allowed to deduct only $200 (2/36 x $3,600) of the cost of the policy that is attributable to 2013. Federal tax preparation In 2014, you'll be able to deduct $1,200 (12/36 x $3,600); in 2015, you'll be able to deduct $1,200 (12/36 x $3,600); and in 2016 you'll be able to deduct the remaining balance of $1,000. Federal tax preparation An exception applies if the expense qualifies for the 12-month rule. Federal tax preparation See Publication 538 for more information and examples. Federal tax preparation See chapter 4 for special rules for prepaid farm supplies and prepaid livestock feed. Federal tax preparation Accrual Method Under an accrual method of accounting, you generally report income in the year earned and deduct or capitalize expenses in the year incurred. Federal tax preparation The purpose of an accrual method of accounting is to correctly match income and expenses. Federal tax preparation Certain businesses engaged in farming must use an accrual method of accounting for its farm business and for sales and purchases of inventory items. Federal tax preparation See Accrual Method Required and Farm Inventory , later. Federal tax preparation Income Generally, you include an amount in income for the tax year in which all events that fix your right to receive the income have occurred, and you can determine the amount with reasonable accuracy. Federal tax preparation Under this rule, include an amount in income on the earliest of the following dates. Federal tax preparation When you receive payment. Federal tax preparation When the income amount is due to you. Federal tax preparation When you earn the income. Federal tax preparation When title passes. Federal tax preparation If you use an accrual method of accounting, complete Part III of Schedule F (Form 1040) to report your income. Federal tax preparation Inventory. Federal tax preparation   If you keep an inventory, generally you must use an accrual method of accounting to determine your gross income. Federal tax preparation An inventory is necessary to clearly show income when the production, purchase, or sale of merchandise is an income-producing factor. Federal tax preparation See Publication 538 for more information. Federal tax preparation Also see Farm Inventory , later, for more information on items that must be included in inventory by farmers and inventory valuation methods for farmers. Federal tax preparation Expenses Under an accrual method of accounting, you generally deduct or capitalize a business expense when both of the following apply. Federal tax preparation The all-events test has been met. Federal tax preparation This test is met when: All events have occurred that fix the fact that you have a liability, and The amount of the liability can be determined with reasonable accuracy. Federal tax preparation Economic performance has occurred. Federal tax preparation Economic performance. Federal tax preparation   Generally, you cannot deduct or capitalize a business expense until economic performance occurs. Federal tax preparation If your expense is for property or services provided to you, or for your use of property, economic performance occurs as the property or services are provided or as the property is used. Federal tax preparation If your expense is for property or services you provide to others, economic performance occurs as you provide the property or services. Federal tax preparation Example. Federal tax preparation Jane, who is a farmer, uses a calendar tax year and an accrual method of accounting. Federal tax preparation She entered into a contract with ABC Farm Consulting in 2012. Federal tax preparation The contract stated that Jane pay ABC Farm Consulting $2,000 in December 2012. Federal tax preparation It further stipulates that ABC Farm Consulting will develop a plan for integrating her farm with a larger farm operation based in a neighboring state by March 1, 2013. Federal tax preparation Jane paid ABC Farm Consulting $2,000 in December 2012. Federal tax preparation Integration of operations according to the plan began in May 2013 and they completed the integration in December 2013. Federal tax preparation Economic performance for Jane's liability in the contract occurs as the services are provided. Federal tax preparation Jane incurs the $2,000 cost in 2013. Federal tax preparation An exception to the economic performance rule allows certain recurring items to be treated as incurred during a tax year even though economic performance has not occurred. Federal tax preparation For more information, see Economic Performance in Publication 538. Federal tax preparation Special rule for related persons. Federal tax preparation   Business expenses and interest owed to a related person who uses the cash method of accounting are not deductible until you make the payment and the corresponding amount is includible in the related person's gross income. Federal tax preparation Determine the relationship for this rule as of the end of the tax year for which the expense or interest would otherwise be deductible. Federal tax preparation For more information, see Internal Revenue Code section 267. Federal tax preparation Accrual Method Required Generally, the following businesses, if engaged in farming, must use an accrual method of accounting. Federal tax preparation A corporation (other than a family corporation) that had gross receipts of more than $1,000,000 for any tax year beginning after 1975. Federal tax preparation A family corporation that had gross receipts of more than $25,000,000 for any tax year beginning after 1985. Federal tax preparation A partnership with a corporation as a partner, if that corporation meets the requirements of (1) or (2) above. Federal tax preparation A tax shelter. Federal tax preparation Note. Federal tax preparation Items (1), (2), and (3) above do not apply to an S corporation or a business operating a nursery or sod farm, or the raising or harvesting of trees (other than fruit and nut trees). Federal tax preparation Family corporation. Federal tax preparation   A family corporation is generally a corporation that meets one of the following ownership requirements. Federal tax preparation Members of the same family own at least 50% of the total combined voting power of all classes of stock entitled to vote and at least 50% of the total shares of all other classes of stock of the corporation. Federal tax preparation Members of two families have owned, directly or indirectly, since October 4, 1976, at least 65% of the total combined voting power of all classes of voting stock and at least 65% of the total shares of all other classes of the corporation's stock. Federal tax preparation Members of three families have owned, directly or indirectly, since October 4, 1976, at least 50% of the total combined voting power of all classes of voting stock and at least 50% of the total shares of all other classes of the corporation's stock. Federal tax preparation For more information on family corporations, see Internal Revenue Code section 447. Federal tax preparation Tax shelter. Federal tax preparation   A tax shelter is a partnership, noncorporate enterprise, or S corporation that meets either of the following tests. Federal tax preparation Its principal purpose is the avoidance or evasion of federal income tax. Federal tax preparation It is a farming syndicate. Federal tax preparation A farming syndicate is an entity that meets either of the following tests. Federal tax preparation Interests in the activity have been offered for sale in an offering required to be registered with a federal or state agency with the authority to regulate the offering of securities for sale. Federal tax preparation More than 35% of the losses during the tax year are allocable to limited partners or limited entrepreneurs. Federal tax preparation   A “limited partner” is one whose personal liability for partnership debts is limited to the money or other property the partner contributed or is required to contribute to the partnership. Federal tax preparation   A “limited entrepreneur” is one who has an interest in an enterprise other than as a limited partner and does not actively participate in the management of the enterprise. Federal tax preparation Farm Inventory If you are required to keep an inventory, you should keep a complete record of your inventory as part of your farm records. Federal tax preparation This record should show the actual count or measurement of the inventory. Federal tax preparation It should also show all factors that enter into its valuation, including quality and weight, if applicable. Federal tax preparation Hatchery business. Federal tax preparation   If you are in the hatchery business, and use an accrual method of accounting, you must include in inventory eggs in the process of incubation. Federal tax preparation Products held for sale. Federal tax preparation   All harvested and purchased farm products held for sale or for feed or seed, such as grain, hay, silage, concentrates, cotton, tobacco, etc. Federal tax preparation , must be included in inventory. Federal tax preparation Supplies. Federal tax preparation   Supplies acquired for sale or that become a physical part of items held for sale must be included in inventory. Federal tax preparation Deduct the cost of supplies in the year used or consumed in operations. Federal tax preparation Do not include incidental supplies in inventory as these are deductible in the year of purchase. Federal tax preparation Livestock. Federal tax preparation   Livestock held primarily for sale must be included in inventory. Federal tax preparation Livestock held for draft, breeding, or dairy purposes can either be depreciated or included in inventory. Federal tax preparation See also Unit-livestock-price method , later. Federal tax preparation If you are in the business of breeding and raising chinchillas, mink, foxes, or other fur-bearing animals, these animals are livestock for inventory purposes. Federal tax preparation Growing crops. Federal tax preparation   Generally, growing crops are not required to be included in inventory. Federal tax preparation However, if the crop has a preproductive period of more than 2 years, you may have to capitalize (or include in inventory) costs associated with the crop. Federal tax preparation See Uniform capitalization rules below. Federal tax preparation Also see Uniform Capitalization Rules in  chapter 6. Federal tax preparation Items to include in inventory. Federal tax preparation   Your inventory should include all items held for sale, or for use as feed, seed, etc. Federal tax preparation , whether raised or purchased, that are unsold at the end of the year. Federal tax preparation Uniform capitalization rules. Federal tax preparation   The following applies if you are required to use an accrual method of accounting. Federal tax preparation The uniform capitalization rules apply to all costs of raising a plant, even if the preproductive period of raising a plant is 2 years or less. Federal tax preparation The costs of animals are subject to the uniform capitalization rules. Federal tax preparation Inventory valuation methods. Federal tax preparation   The following methods, described below, are those generally available for valuing inventory. Federal tax preparation The method you use must conform to generally accepted accounting principles for similar businesses and must clearly reflect income. Federal tax preparation Cost. Federal tax preparation Lower of cost or market. Federal tax preparation Farm-price method. Federal tax preparation Unit-livestock-price method. Federal tax preparation Cost and lower of cost or market methods. Federal tax preparation   See Publication 538 for information on these valuation methods. Federal tax preparation If you value your livestock inventory at cost or the lower of cost or market, you do not need IRS approval to change to the unit-livestock-price method. Federal tax preparation However, if you value your livestock inventory using the farm-price method, then you must obtain permission from the IRS to change to the unit-livestock-price method. Federal tax preparation Farm-price method. Federal tax preparation   Under this method, each item, whether raised or purchased, is valued at its market price less the direct cost of disposition. Federal tax preparation Market price is the current price at the nearest market in the quantities you usually sell. Federal tax preparation Cost of disposition includes broker's commissions, freight, hauling to market, and other marketing costs. Federal tax preparation If you use this method, you must use it for your entire inventory, except that livestock can be inventoried under the unit-livestock-price method. Federal tax preparation Unit-livestock-price method. Federal tax preparation   This method recognizes the difficulty of establishing the exact costs of producing and raising each animal. Federal tax preparation You group or classify livestock according to type and age and use a standard unit price for each animal within a class or group. Federal tax preparation The unit price you assign should reasonably approximate the normal costs incurred in producing the animals in such classes. Federal tax preparation Unit prices and classifications are subject to approval by the IRS on examination of your return. Federal tax preparation You must annually reevaluate your unit livestock prices and adjust the prices upward or downward to reflect increases or decreases in the costs of raising livestock. Federal tax preparation IRS approval is not required for these adjustments. Federal tax preparation Any other changes in unit prices or classifications do require IRS approval. Federal tax preparation   If you use this method, include all raised livestock in inventory, regardless of whether they are held for sale or for draft, breeding, sport, or dairy purposes. Federal tax preparation This method accounts only for the increase in cost of raising an animal to maturity. Federal tax preparation It does not provide for any decrease in the animal's market value after it reaches maturity. Federal tax preparation Also, if you raise cattle, you are not required to inventory hay you grow to feed your herd. Federal tax preparation   Do not include sold or lost animals in the year-end inventory. Federal tax preparation If your records do not show which animals were sold or lost, treat the first animals acquired as sold or lost. Federal tax preparation The animals on hand at the end of the year are considered those most recently acquired. Federal tax preparation   You must include in inventory all livestock purchased primarily for sale. Federal tax preparation You can choose either to include in inventory or depreciate livestock purchased for draft, breeding, sport or dairy purposes. Federal tax preparation However, you must be consistent from year to year, regardless of the method you have chosen. Federal tax preparation You cannot change your method without obtaining approval from the IRS. Federal tax preparation   You must include in inventory animals purchased after maturity or capitalize them at their purchase price. Federal tax preparation If the animals are not mature at purchase, increase the cost at the end of each tax year according to the established unit price. Federal tax preparation However, in the year of purchase, do not increase the cost of any animal purchased during the last 6 months of the year. Federal tax preparation This “no increase” rule does not apply to tax shelters which must make an adjustment for any animal purchased during the year. Federal tax preparation It also does not apply to taxpayers that must make an adjustment to reasonably reflect the particular period in the year in which animals are purchased, if necessary to avoid significant distortions in income. Federal tax preparation Uniform capitalization rules. Federal tax preparation   A farmer can determine costs required to be allocated under the uniform capitalization rules by using the farm-price or unit-livestock-price inventory method. Federal tax preparation This applies to any plant or animal, even if the farmer does not hold or treat the plant or animal as inventory property. Federal tax preparation Cash Versus Accrual Method The following examples compare the cash and accrual methods of accounting. Federal tax preparation Example 1. Federal tax preparation You are a farmer who uses an accrual method of accounting. Federal tax preparation You keep your books on the calendar year basis. Federal tax preparation You sell grain in December 2013 but you are not paid until January 2014. Federal tax preparation Because the accrual method was used and 2013 was the tax year in which the grain was sold, you must both include the sales proceeds and deduct the costs incurred in producing the grain on your 2013 tax return. Federal tax preparation Example 2. Federal tax preparation Assume the same facts as in Example 1 except that you use the cash method and there was no constructive receipt of the sales proceeds in 2013. Federal tax preparation Under this method, you include the sales proceeds in income for 2014, the year you receive payment. Federal tax preparation Deduct the costs of producing the grain in the year you pay for them. Federal tax preparation Special Methods of Accounting There are special methods of accounting for certain items of income and expense. Federal tax preparation Crop method. Federal tax preparation   If you do not harvest and dispose of your crop in the same tax year that you plant it, you can, with IRS approval, use the crop method of accounting. Federal tax preparation You cannot use the crop method for any tax return, including your first tax return, unless you receive approval from the IRS. Federal tax preparation Under this method, you deduct the entire cost of producing the crop, including the expense of seed or young plants, in the year you realize income from the crop. Federal tax preparation    See chapter 4 for details on deducting the costs of operating a farm. Federal tax preparation Also see Regulations section 1. Federal tax preparation 162-12. Federal tax preparation Other special methods. Federal tax preparation   Other special methods of accounting apply to the following items. Federal tax preparation Amortization, see chapter 7. Federal tax preparation Casualties, see chapter 11. Federal tax preparation Condemnations, see chapter 11. Federal tax preparation Depletion, see chapter 7. Federal tax preparation Depreciation, see chapter 7. Federal tax preparation Farm business expenses, see chapter 4. Federal tax preparation Farm income, see chapter 3. Federal tax preparation Installment sales, see chapter 10. Federal tax preparation Soil and water conservation expenses, see chapter 5. Federal tax preparation Thefts, see chapter 11. Federal tax preparation Combination Method Generally, you can use any combination of cash, accrual, and special methods of accounting if the combination clearly shows your income and expenses and you use it consistently. Federal tax preparation However, the following restrictions apply. Federal tax preparation If you use the cash method for figuring your income, you must use the cash method for reporting your expenses. Federal tax preparation If you use an accrual method for reporting your expenses, you must use an accrual method for figuring your income. Federal tax preparation Changes in Methods of Accounting A change in your method of accounting includes a change in: Your overall method, such as from the cash method to an accrual method, and Your treatment of any material item, such as a change in your method of valuing inventory (for example, a change from the farm-price method to the unit-livestock-price method, discussed earlier). Federal tax preparation Generally, once you have set up your accounting method, you must receive approval from the IRS before you can change to another method of accounting. Federal tax preparation You may also have to pay a fee. Federal tax preparation To obtain approval, you must generally file Form 3115. Federal tax preparation There are instances when you can obtain automatic consent to change certain methods of accounting. Federal tax preparation See the List of Automatic Accounting Method Changes located in the Instructions for Form 3115. Federal tax preparation For more information on changes in methods of accounting, see Form 3115 and the Instructions for Form 3115. Federal tax preparation Also see Publication 538. Federal tax preparation Prev  Up  Next   Home   More Online Publications