NOTE: This guide is current through the publication date. Since changes may have occurred after the publication date that would affect the accuracy of this document, no guarantees are made concerning the technical accuracy after the publication date.

Chapter 3/ Table of Contents / Chapter 5
Tax Code, Regulations and Official Guidance

Chapter Four - Expenses

• Introduction: Farm Business Expenses
• Related Entities
• Capital vs. Reoccurring Costs
• Contract Labor
• Outside Services Informational Sources

Related Entities

Introduction

As stated in Chapter 2, Income, transactions between related persons or entities can be myriad. Allocations of shared expenses are common among related entities. Some of the things to consider are:

1. Determine the allocation method for shared expenses and sample checks and invoices to verify accuracy, reasonability and internal controls (IRC §162, etc.).
2. Watch for unusual allocations that might be manipulated for tax benefits to related entities. Use of a flowchart of the related entities and transactions should be used to help this analysis.  “Substance Versus Form” and various code sections can apply, especially IRC § 482.
3. Crop loans are sometimes allocated to partnerships and then used as basis for flowing-through losses to the partners. Inspect for liability of the original crop loan and whose assets are being pledged. Sometimes a partner is not liable for the loan, but uses a share of the liabilities to deduct losses. This is covered in IRC § 704(d) - Partner’s Distributive Share, Limitation on Allowance of Losses.
4. Watch for preproductive expenses being currently deducted by paying custom farming entities, rather than being capitalized by the entity owning the assets, as required by IRC § 263A.

Law

There are many revenue rulings, code sections and regulations enacted to address related party transactions. See the Code sections in Chapter Two - “Related Entities.” Some of these are noted below:

1. Auto expenses of related employees are not exempted from the substantiation requirements merely because of an accounting to the employer. [Temp. Treas. Reg. § 1.274-5T(f)(5)(ii)]
2. Anti-Churning rules.  Property owned or used at any time by the taxpayer or related party, except for residential rental property or non-residential real property. See IRC § 168(f)(5)(B) for additional details.
3. Deductions for rentals between related parties or controlled entities are not allowed in excess of a reasonable rental. (Social Psychological Services, Inc. v. Commissioner, T.C. Memo. 1993-565)
4. Installment sales. In general, disposition of property within two years after a sale between related parties triggers recognition of gain by the initial seller based on the seller’s gross profit ratio to the extent the amount realized from the second disposition exceeds actual payments made under the installment sale. [IRC § 453(e)]
5. Imputed interest rate for members of the same family. An installment sale of land qualifies for imputed interest of no more than six percent compounded semi-annually, for sales or exchanges of land between family members not exceeding $500,000 during any calendar year.  [IRC § 483(e)]
6. Acquisition of debt by a person related to the debtor from a person not related to the debtor results in the debtor’s realization of discharge of indebtedness income, measured by the difference between the face value and fair market value of the indebtedness on the acquisition date. [IRC § 108(e)(4)]
7. Cash basis taxpayer can deduct an expense if it is paid to related accrual basis taxpayer, who was required to include it as income. This is also true for the reverse situation.(IRC § 267)
8. A non-arms-length transaction between related taxpayers is subject to reallocation in order to clearly reflect income and expenses. (IRC § 482)
9. Election out of IRC § 263A requires that the Alternative Depreciation System, per IRC § 168(g)(2), must be applied to all property used predominantly in any farming business of the taxpayer or related person and placed in service in any taxable year during which the election is in effect. [Treas. Reg. § 1.263A-4(d)(4)(ii)]