Almost inevitably when farmers receive a payment, there are tax implications. Such is the case with the tobacco buyout. The tax treatments and considerations will vary depending on whether the payments are received as a quota holder or producer.
Payments to quota holders will be taxed as long-term capital gains — 5 percent or 15 percent for years 2005-2008 and 10 percent or 20 percent after 2008 — if held more than one year.
Payments will be taxed as short-term capital gains at the ordinary tax rate if held one year or less.
The taxable gain, whether long-term or short-term, equals the total payments less the cost basis.
Payments will not be subject to self-employment taxes unless the quota holder is a dealer of tobacco quota.
The transaction must be reported as an installment sale on Form 6252 unless a lump sum is received or an election is made to recognize the income in the year of the sale.
For installment payments with a total of all payments over $3,000, part of each payment must be allocated to interest based on the federal rate. The interest portion will be taxed as ordinary income.
Taxes may be reduced or eliminated by using a Section 1031 like-kind exchange. Tobacco quota could qualify for a like-kind exchange for real property, improved or unimproved, that is used for business or investment purposes.
A qualified intermediary or qualified escrow account should be used to conduct a like-kind exchange transaction. (Some banks, lawyers or real estate companies will serve as qualified intermediaries.)
For producers, the payments will be taxed as ordinary income — 10 percent to 35 percent for the years 2005-2010 and 15 percent to 39.6 percent for years 2011 and later.)
Payments will be limited to self-employment taxes unless the share of risk as a “producer of quota tobacco” was for rental income without material participation.
The maximum earnings subject to the social security part — 12.4 percent — of self-employment taxes are $90,000 for 2005.
Tax liability resulting from tobacco buyout payments for producers of quota tobacco may be reduced or deferred by using tax strategies applicable to ordinary farm income.
Examples of such strategies include income averaging, the Section 179 deduction, contributions to traditional IRAs or retirement plants and others. See Publication 225 for more information on these tax strategies.
Feel free to direct questions regarding this article to Daniel Osborne at 1-276-783-5175.