Disaster payments and crop insurance indemnity payments
Any crop insurance proceeds you receive need to be included as income on your tax return. You generally include that income in the year received. Crop insurance includes the crop disaster payments received from the federal government as the result of destruction or damage to crops, or the inability to plant crops, because of drought, flood, or any other natural disaster.
You can postpone reporting crop insurance proceeds as income until the year following the year the damage occurred if you meet all the following conditions:
- You use the cash method of accounting.
- You receive the crop insurance proceeds in the same year the crops are damaged.
- You can show that under normal business practice you would have included income from the damaged crops in any tax year following the year the damage occurred.
Please note that ambiguities do exist with respect to crop insurance deferrals. Must the taxpayer show that all income from a crop would have been deferred or only a portion? Does the election apply to all payments or only to those for crops that would have been sold in the following year?
In order to discuss this issue, we must examine some of the tax authority surrounding crop insurance deferrals. IRS Code Section 451 is the principle authority with respect to crop insurance. However, Section 451 is silent regarding the questions listed in the prior paragraph.
One additional piece of authority is Nelson vs. Commissioner. This was a 2009 court case decided in the 8th Circuit Court of Appeals. The court found that all crop insurance was deferrable if a substantial portion of the crop was sold the following year. The court further defined "substantial portion as > 50%." Furthermore, the Nelson case says the 50% test needs to apply to EACH crop. Nelson is unclear as to deferral of individual crops and implies the deferral is an all or none proposition.
In Rev. Ruling 74-145 the IRS referred to the necessity for a substantial part of the crops to have been carried over from the year of production historically and more than 50% was viewed as substantial. Several income tax scholars have indicated that under Rev. Ruling 74-145, this is an all or none proposition.
There are other authorities which COULD be interpreted as allowing a partial deferral. Congressional intent is a low-level criteria for tax law authority, but to assume that type of position on a tax return would require a disclosure statement in order to avoid potential preparer penalties.
Under the Nelson Court case and Rev. Ruling 74-145, the substantial portion test (over 50% of each crop sold in the following year) may be applied to current year crop sales to determine if a 2012 crop insurance deferral is possible.
Generally, farmers are able to establish their practice of reporting crop income in a following taxable year by reference to their prior year's sale records. In order for a payment to constitute insurance for the destruction of or damage to crops, the insured must suffer actual physical loss. Agreements with the insurance companies that provide for payments without regard to actual losses by the insured, such as payments in the event that county average yield is less than a specified amount, are not payments for the destruction of or damage to crops. Such payments do not qualify for deferral under I.R.C. § 451(d). Also payments made for a decline in the price of the commodity, rather than a physical loss, do not qualify for deferral.
An indemnity payment from a Revenue Protection (RP) policy is based on price as well as quantity and quality of the commodity produced. Only the payment for destruction or damage (yield loss) is eligible for deferral. A farmer who receives compensation from a RP policy must determine the portion of the payment that is due to crop destruction or damage rather than due to a reduced market price.
An insurance payment received from a prevented planting policy does qualify for crop insurance deferral (assuming the taxpayer meets all other requirements for deferral). This provision is addressed specifically in IRS code section 451(d).
A RP policy guarantees a minimum amount of revenue per acre for the insured farmer. The policy provides a formula for computing the deemed revenue the insured received from the crop that was produced. Taken into account is price of the commodity at the time of harvest, the quantity the insured farmer harvested and the quality of the commodity harvested. This deemed revenue is compared with the guaranteed minimum revenue. The excess of the guaranteed minimum over the deemed revenue received is the amount paid to the insured farmer.
Note: This information piece is offered as educational information only and is not intended to be tax, legal or financial advice. For questions specific to your farm business or individual situation, consult with your tax preparer.
- Agricultural Tax Issues, Harris, P. E., Fall 2012.
- National Income Tax Workbook. Harris, P. E., 2012.