Payments under the Farm Security and Rural Investment Act of 2002

The Farm Security and Rural Investment Act of 2002, enacted on May 13, 2002, created two new types of payments - direct and counter-cyclical payments. These payments are included in taxable income.

Direct payments.   For each of the 2002 through 2007 crop years of certain covered commodities, the USDA will make direct payments to producers on farms who meet specified requirements.

Counter-cyclical payments.   For each of the 2002 through 2007 crop years of certain covered commodities, the USDA will make counter-cyclical payments to producers on farms who meet certain requirements. These payments will be based on a determination by the USDA that the effective price for covered commodities is less than the target price for the covered commodities.

More information.   For more information on these new types of payments, see sections 1001 - 1108 of the Farm Security and Rural Investment Act of 2002. You can view an analysis of the Act prepared by the USDA Economic Research Service on the Internet at www.ers.usda.gov/Features.

Peanut Quota Buyout Program Payments

The Farm Security and Rural Investment Act of 2002 repealed the marketing quota program for peanuts effective May 13, 2002. As a result, USDA will enter into contracts with eligible peanut quota holders to provide compensation for the lost value of the quotas resulting from the repeal.

If you are an eligible peanut quota holder, you are entitled to receive five equal annual payments of 11 cents per pound of peanut quota during the period 2002 through 2006. Or, you can choose to receive a single lump sum payment in any one of the five years.

Tax treatment.   Your taxable gain or loss is the total amount received for your quota reduced by any amount treated as interest (discussed later), over your adjusted basis. The gain or loss is capital or ordinary depending on how you used the quota. See Capital or ordinary gain or loss, later.

Report the entire gain on your income tax return for the taxable year that includes May 13, 2002, if you:

1. Receive a lump sum payment in the taxable year that includes May 13, 2002, or
2. You choose not to use the installment method.

Adjusted basis.   The adjusted basis of your quota is determined differently depending on how you obtained the quota.

• The basis of a quota derived from an original grant by the federal government of an acreage allotment is zero.
• The basis of a purchased quota is the purchase price.
• The basis of a quota derived from a purchased acreage allotment is the purchase price.
• The basis of an inherited quota is generally the fair market value of the quota at the time of the decedent's death.

If not previously allocated, the total basis of a quota (or acreage allotment) and land obtained at the same time must be properly allocated between the two assets.

Reduction of basis.   You are required to reduce the basis of your peanut quota by the following amounts.

• Deductions you took for amortization, depletion, or depreciation.
• Amounts you previously deducted as a loss because of a reduction in the number of pounds of peanuts allowable under the quota.
• The entire cost of a purchased quota or acreage allotment you deducted in an earlier year (which reduces your basis to zero).

Amount treated as interest.   You must reduce your peanut quota buyout program payment by the amount treated as interest, which is reportable as ordinary income. If any of the following conditions are met, your total quota buyout program payment does not include any amount treated as interest and you are not required to reduce the total payment you receive.

• The payments total $3,000 or less,
• All payments were made on or before November 13, 2002, or
• The payments total $250,000 or less and all payments are made on or before May 13, 2003.

In all other cases, a portion of each payment may be treated as interest for federal tax purposes. You may be required to reduce your total quota buyout program payment before you calculate your gain or loss. For more information, see Notice 2002-67 in Internal Revenue Bulletin 2002-42.

Installment method.   You may use the installment method to report a gain if you receive at least one payment after the close of your taxable year that includes May 13, 2002. Under the installment method, a portion of the gain is taken into account in each year in which a payment is received. See chapter 12 for more information.

Capital or ordinary gain or loss.   Whether your gain or loss is ordinary or capital depends on how you used the quota.

Quota used in the trade or business of farming.   If you used the quota in the trade or business of farming and you held it for more than one year on May 13, 2002, you report the transaction as a section 1231 transaction on Form 4797, Sales of Business Property. See Section 1231 transactions under Ordinary or Capital Gain or Loss in chapter 10 for a definition of section 1231 transactions.

See the instructions for Form 4797 for detailed information on reporting section 1231 transactions.

Quota held for investment.   If you held the quota for investment purposes, any gain or loss is capital gain or loss. The same result also applies if you held the quota for the production of income, though not connected with a trade or business.

Gain treated as ordinary income.   If you previously deducted any of the following items, some or all of the capital gain must be recharacterized and reported as ordinary income. Any resulting capital gain is taxed as ordinary income up to the amount previously deducted.

• The cost of acquiring a quota.
• Amounts for amortization, depletion, or depreciation.
• Amounts to reflect a reduction in the quota pounds.

You should include the ordinary income on your return for the taxable year that includes May 13, 2002, even if you use the installment method to report the remainder of the gain.

Self-employment income.   The peanut quota buyout payments are not self-employment income.

Farm income averaging.   The gain or loss resulting from the quota payments does not qualify for farm income averaging. A peanut quota is considered an interest in land. Farm income averaging is not available for gain or loss arising from the sale or other disposition of land.

Involuntary conversion.   The buyout of the peanut quota is not an involuntary conversion.

Form 1099-S.   A peanut quota is considered an interest in land, so the USDA will generally report the total amount you receive under a contract on Form 1099-S if the amount is $600 or more. The USDA will generally report any portion of a payment treated as interest of $600 or more to you on Form 1099-INT for the year in which the payment is made.

More information.   For more information on the taxation of peanut quota buyout program payments, see Notice 2002-67.

Production Flexibility Contract Payments

If you receive production flexibility payments under the Federal Agriculture Improvement and Reform Act of 1996, you must include them in income for the year you actually or constructively receive them. However, under a special rule, you are not considered to constructively receive a payment merely because you have the option to receive it in the year before it is required to be paid. You disregard that option in determining when to include the payment in your income. This special rule applies to any farm production flexibility payment made under the 1996 Act as in effect on December 17, 1999.

For information on the constructive receipt of income, see Cash Method under Accounting Methods in chapter 3.

Farm Security and Rural Investment Act of 2002.   The Farm Security and Rural Investment Act of 2002 eliminates additional production flexibility contract payments after May 13, 2002, unless requested by the producer that is a party to the contract.

If a producer receives payments under a production flexibility contract in 2002, the amount of any direct payments (discussed earlier) will be reduced by the amount of the 2002 payment received by the producer under a production flexibility contract.

Other Payments

You must include most other government program payments in income.

Fertilizer and Lime

Include in income the value of fertilizer or lime you receive under a government program. How to claim the offsetting deduction is explained under Fertilizer and Lime in chapter 5.

Improvements

If government payments are based on improvements, such as a pollution control facility, you must include them in income. You must also capitalize the full cost of the improvement. Since you have included the payments in income, they do not reduce your basis. However, see Cost-Sharing Exclusion (Improvements), earlier, for additional information.

National Tobacco Growers' Settlement Trust Fund Payments

If you are a producer, landowner, or tobacco quota owner who receives money from the National Tobacco Growers' Settlement Trust Fund, you must report those payments as income. You should receive a Form 1099-MISC that shows the payment amount.

If you produce a tobacco crop, report the payments as income from farming on your Schedule F. If you are a landowner or tobacco quota owner who leases tobacco-related property but you do not produce the crop, report the payments as farm rental income on Form 4835.

Payment to More Than One Person

The USDA reports program payments to the IRS. It reports a program payment intended for more than one person as having been paid to the person whose identification number is on record for that payment (payee of record). If you, as the payee of record, receive a program payment belonging to someone else, such as your landlord, the amount belonging to the other person is a nominee distribution. You should file Form 1099-G to report the identity of the actual recipient to the IRS. You should also give this information to the recipient. You can avoid the inconvenience of unnecessary inquiries about the identity of the recipient if you file this form.

Report the total amount reported to you as the payee of record on line 6a or 8a of your Schedule F. However, do not report as a taxable amount on line 6b or 8b any amount belonging to someone else.

See chapter 21 for information about ordering Form 1099-G.

Income From Cooperatives

If you buy farm supplies through a cooperative, you may receive income from the cooperative in the form of patronage dividends. If you sell your farm products through a cooperative, you may receive either patronage dividends or a per-unit retain certificate, explained later, from the cooperative.

Form 1099-PATR.   The cooperative will report the income to you on Form 1099-PATR or a similar form and send a copy to the IRS. Form 1099-PATR may also show an alternative minimum tax adjustment that you must include on Form 6251, Alternative Minimum Tax - Individuals, if you are required to file the form. For information on the alternative minimum tax, see chapter 14.

Patronage Dividends

You generally report patronage dividends as income on lines 5a and 5b of Schedule F for the tax year you receive them. They include the following items.

• Money paid as a patronage dividend.
• The stated dollar value of qualified written notices of allocation.
• The fair market value of other property.

Do not report as income on line 5b any patronage dividend that is a nonqualified notice of allocation, that is for purchasing or selling capital assets or depreciable property, or that is for purchasing personal items. Personal items include fuel purchased for personal use, basic local telephone service, and personal long distance calls.

If you cannot determine what the dividend is for, report it as income on lines 5a and 5b.

Qualified written notice of allocation.   If you receive a qualified written notice of allocation as part of a patronage dividend, you must generally include its stated dollar value in your income in the year you receive it. A written notice of allocation is qualified if at least 20% of the patronage dividend is paid in money or by qualified check and either of the following conditions is met.

1. The notice must be redeemable in cash for at least 90 days after it is issued, and you must have received a written notice of your right of redemption at the same time as the written notice of allocation.
2. You must have agreed to include the stated dollar value in income in the year you receive the notice by doing one of the following.
   1. Signing and giving a written agreement to the cooperative.
   2. Getting or keeping membership in the cooperative after it adopted a bylaw providing that membership constitutes agreement. The cooperative must notify you in writing of this bylaw and give you a copy.
   3. Endorsing and cashing a qualified check paid as part of the same patronage dividend. You must cash the check by the 90th day after the close of the payment period for the cooperative's tax year for which the patronage dividend was paid.

Qualified check.   A qualified check is any instrument that is redeemable in money and meets both of the following requirements.

• It is part of a patronage dividend that also includes a qualified written notice of allocation for which you met condition (2)(c), above.
• It is imprinted with a statement that endorsing and cashing it constitutes the payee's consent to include in income the stated dollar value of any written notices of allocation paid as part of the same patronage dividend.

Loss on redemption.   You can deduct in Part II of Schedule F any loss incurred on the redemption of a qualified written notice of allocation you received in the ordinary course of your farming business. The loss is the difference between the stated dollar amount of the qualified written notice you included in income and the amount you received when you redeemed it.

Nonqualified notice of allocation.   Do not include the stated dollar value of any nonqualified notice of allocation in income when you receive it. Your basis in the notice is zero. You must include in income for the tax year of disposition any amount you receive from its sale, redemption, or other disposition. Report that amount, up to the stated dollar value of the notice, as ordinary income in Part I of Schedule F. However, do not include that amount in your income if the notice resulted from purchasing or selling capital assets or depreciable property or from purchasing personal items, as explained in the following discussions.

If the amount you receive is more than the stated dollar value of the notice, report the excess as the type of income it represents. For example, if it represents interest income, report it on your return as interest.

Purchasing or selling capital assets or depreciable property.   Do not include in income patronage dividends from the purchase of capital assets or depreciable property used in your business. You must, however, reduce the basis of these assets by the dividends. This reduction is taken into account as of the first day of the tax year in which the dividends are received. If the dividends are more than your unrecovered basis, include the difference as ordinary income on Schedule F for the tax year you receive them. Include all these dividends on line 5a of Schedule F, but include only the taxable part on line 5b.

This rule and the exceptions explained later also apply to amounts you receive from the sale, redemption, or other disposition of a nonqualified notice of allocation that resulted from purchasing or selling capital assets or depreciable property.

Example.   On July 1, 2001, Mr. Brown, a patron of a cooperative association, bought a machine for his dairy farm business from the association for $2,900. The machine has a life of 7 years under MACRS (as provided in the Table of Class Lives and Recovery Periods in Appendix B of Publication 946). Mr. Brown files his return on a calendar year basis. For 2001, he claimed a depreciation deduction of $311, using the 10.71% depreciation rate from the 150% declining balance, half-year convention table (shown in Table A-14 in Appendix A of Publication 946). On July 1, 2002, the cooperative association paid Mr. Brown a $300 cash patronage dividend for his purchase of the machine. Mr. Brown adjusts the basis of the machine and figures his depreciation deduction for 2002 (and later years) as follows.

Cost of machine on July 1, 2001			$2,900
Minus:	2001 depreciation	$311
	2002 cash dividend	300	611
Adjusted basis for depreciation for 2002:			$2,289
Depreciation rate: 1 ÷ 6½ (remaining recovery period as of 1/1/02) = 15.38% × 1.5 = 23.07%
Depreciation deduction for 2002 ($2,289 × 23.07%)			$528

Exceptions.   If the dividends are for purchasing or selling capital assets or depreciable property you did not own at any time during the year you received the dividends, you must include them as ordinary income on Schedule F unless one of the following rules applies.

• If the dividends relate to a capital asset you held for more than 1 year for which a loss was or would have been deductible, treat them as gain from the sale or exchange of a capital asset held for more than 1 year.
• If the dividends relate to a capital asset for which a loss was not or would not have been deductible, do not report them as income (ordinary or capital gain).

If the dividends are for selling capital assets or depreciable property during the year you received the dividends, treat them as an additional amount received on the sale.

Personal purchases.   Omit from the taxable amount of patronage dividends on line 5b of Schedule F any dividends from buying personal, living, or family items, such as supplies, equipment, or services not related to the production of farm income. This rule also applies to amounts you receive from the sale, redemption, or other disposition of a nonqualified written notice of allocation resulting from these purchases.

Per-Unit Retain Certificates

A per-unit retain certificate is any written notice that shows the stated dollar amount of a per-unit retain allocation made to you by the cooperative. A per-unit retain allocation is an amount paid to patrons for products sold for them that is fixed without regard to the net earnings of the cooperative. These allocations can be paid in money, other property, or qualified certificates.

Per-unit retain certificates issued by a cooperative generally receive the same tax treatment as patronage dividends, discussed earlier.

Qualified certificates.   Qualified per-unit retain certificates are those issued to patrons who have agreed to include the stated dollar amount of these certificates in income in the year of receipt. The agreement may be made in writing or by getting or keeping membership in a cooperative whose bylaws or charter states that membership constitutes agreement. If you receive qualified per-unit retain certificates, include the stated dollar amount of the certificates in income in Part I of Schedule F for the tax year you receive them.

Nonqualified certificates.   Do not include the stated dollar value of a nonqualified certificate in income when you receive it. Your basis in the certificate is zero. You must include in income any amount you receive from its sale, redemption, or other disposition. Report the amount you receive from the disposition as ordinary income in Part I of Schedule F for the tax year of disposition.

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