Maximizing Prepaid Expenses in the Agriculture Industry: Strategies for Long-Term Success

In the agriculture industry, prepaying expenses is an important farm management tool. Prepayments can be used to lock in prices, quantities and for income tax planning.

The IRS will allow a deduction for feed, seed, fertilizer and other similar inputs when purchased in the year before use as long as the following conditions are met:

  • Be on the cash basis of accounting.
  • The expense must be for an actual purchase and not merely a deposit or credit. To be an actual purchase you should have a specific input, the quality to be purchased and the price per unit.
  • The amount of prepaid expenses that can be deducted is generally limited to 50% of the total of all other deductible farm expenses including depreciation for the year. The 50% limit can be exceeded if one of the following exceptions are met:
    • There is a change in business operations caused by unusual circumstances.
    • You met the 50% test in the prior three years.
  • The prepayment must have a business purpose and not be solely to avoid paying taxes, such as obtaining discounts or securing quantities.
  • The deduction of the prepaid expenses does not result in a material distortion of the taxpayer’s income for the year. The material distortion test should be met if the inputs are used within 12 months of their purchase.

Prepaying expenses can be very useful for farmers, whether they want to lock in prices for budgeting purposes or secure quantities in case of input shortages. It is important to meet all requirements for deducting in order to receive desired tax deductions. Your current decisions can greatly impact your success during a recession, so it’s important to have a productive discussion with your farm CPA about these topics. If you have any questions about your specific situation, you can contact Adams Brown’s agriculture team.