Crop insurance proceeds: appropriate tax planning strategies.

• Author: Miranda, Michael R.

The severe drought experienced by much of the United States this year, especially in agricultural regions, is expected to produce a record number of crop insurance claims.

Many astute farmers know that under Sec. 451(d), crop insurance proceeds may be deferred in some circumstances to the tax year following that of crop damage or destruction. However, a number of surprising technical parameters surround the deferral. With the possibility of higher 2013 individual income tax rates, if farmers defer their 2012 crop insurance proceeds until 2013, they may pay more taxes over time. Any analysis of this tax planning strategy requires care.

Deferral of Crop Insurance Proceeds

Most farmers use the cash method of accounting to report gross income and deductions from farming operations. Without a special deferral election provided in Sec. 451(d), crop insurance proceeds would be included in gross income in the year received.

This election applies to payments made because of damage to crops or the inability to plant crops. Also, the election applies to federal payments received for drought, flood, or "any other natural disaster" (Sec. 451(d)).

Proceeds from crop insurance related to crop destruction or damage are treated as a deemed sale of the crop. To elect to include crop insurance and disaster payments in gross income in the year following the year of the crop loss, farmers must use the cash method of accounting and must establish that it is their normal business practice to report more than 50% of income from the sale of the crop in a later year (Rev. Rul. 74-145).

Other Payment Types

In the current agricultural environment, many farmers purchase insurance policies that also include other insurance coverage features, such as revenue protection, revenue protection with harvest price exclusion, yield protection, and group revenue protection.

Payments received under these arrangements are not directly associated with an insured's actual crop loss. They are instead tied to low crop yields and/ or low prices and may not qualify for the crop insurance deferral election. As noted above, for crop insurance proceeds to be deferrable, payment under an insurance policy must result from damage to crops or the inability to plant crops. Crop insurance proceeds received for other than damage or destruction of crops are not eligible for deferral. If a crop insurance payment is based on both crop loss and price loss from a revenue-based crop insurance policy...