Crop Insurance and Disaster Payments

I.R.C. §451(d) allows a producer who uses the cash method of accounting to elect to postpone the recognition of income for one year if all of the following requirements are met:

• The payment is received to compensate destruction of or damage to a crop by a flood, drought, or other natural disaster.

• The payment is either insurance proceeds or a federal disaster payment.

• Under the taxpayer's normal business practice, the income from the crop that was destroyed would have been reported in the year following the year of destruction or damage.

Practitioner Note: Election Covers All Crops

The election to postpone reporting the payment as income covers all crops from a farm. However, a separate election must be made for each farming business of a taxpayer.

Under the statutory language, the exception applies to crop insurance proceeds, disaster payments received from the federal government under the Agricultural Act of 1949, as amended, and disaster payments received under the Disaster Assistance Act of 1988. [I.R.C. §451(d)]. Under the regulatory language, the provision applies to all federal payments received after December 31, 1973, for losses due to a natural disaster. [Treas. Reg. §1.451-6(a)].

Practitioner Note: No Accelerated Reporting

This provision does not allow the taxpayer to accelerate reporting the payment if the payment is received the year after a loss.

Qualifying for the Election

To qualify for the exception, a taxpayer must be able to show that, under the taxpayer's normal business practice, the income from the crop for which the payment is received would have been reported in a year following the receipt of the payment.

Two Options for Reporting on Tax Returns

Taxpayers who qualify for this exception have the option of reporting the payment as income in the year it is received or as income in the following year.

The election to postpone reporting the payment as income covers all crops from a farm. A separate election must be made for each farming business of a taxpayer. For purposes of this provision, separate businesses are defined as those for which the taxpayer keeps separate books and is allowed to use different methods of accounting. In general, that requires the businesses to be separate and distinct.

How to Make the Election

The election must be attached to the return (or amended return) for the tax year in which the payment was received. The statement must include:

1. the name and address of the taxpayer.

2. a declaration that the taxpayer is making an election under §451(d).

3. identification of the specific crop or crops destroyed or damaged.

4. a declaration that under the taxpayer's normal business practice the income derived from the crops that were destroyed or damaged would have been included in his or her gross income for a taxable year following the taxable year of such destruction or damage.

5. the cause of destruction or damage of crops and the date or dates on which such destruction or damage occurred.

6. the total amount of payments received from insurance carriers, itemized with respect to each specific crop and with respect to the date each payment was received.

7. The name(s) of the insurance carrier or carriers from whom payments were received.

Example 2-A: Daisy Petal normally sells her soybean and cotton crops in the year after they are produced. In 1997, flooding damaged her soybean and cotton crops. She had insurance to cover the loss and received a payment from the insurance company of $15,000 for soybeans and $21,000 for cotton in November 1997.

Daisy can postpone reporting the $36,000 of income by attaching the following statement to her return. She then reports the $36,000 on line 8a of her Schedule F and excludes it from line 8b. She cannot postpone reporting the payment for one crop unless she postpones reporting the payment for both.

Election Under §451(d) to Postpone

Recognition of Crop Insurance Proceeds

Daisy Petal 000-00-0001

Route 2, Box 2

Bitterweed, MS 38000

Observation. Some producers have deferred crop insurance and disaster payments from 1998 to be reported in 1999. Those payments should be reported on line 8d of the Schedule F (Form 1040).

Ambiguity in the Election Requirements

Notice 89-55, 1989-20 IRB 134, May 15, 1989, explains the application of I.R.C. §451(d) for many situations but leaves one ambiguity: the treatment of disaster payments and crop insurance payments when they are received for two different crops and the crops are normally marketed in different years by the producers.

1. In Rev. Rul. 74-145, 1974-1 C.B. 113, the IRS stated that if a producer normally sold 50 percent of all crops in the year following the year of harvest, then all insurance payments would be postponed until the following year if the I.R.C. §451(d) election is made.

2. Notice 89-55 and I.R.C. §451(d) say that insurance proceeds and disaster payments can be postponed "if the taxpayer establishes that, under its normal business practice, income from the crops would have been reported in the year following the year of destruction or damage." That language can be interpreted as saying that insurance and disaster payments received for crops that are normally marketed in the year of harvest cannot be postponed even if the election is made.

Example 2-B: Assume the facts are the same as Example 2-A except that Daisy normally sells her soybeans at harvest time.

Likely tax consequence. Rev. Rul. 74-145 seems to say that the insurance payments received for the cotton and soybeans must be treated the same and would be eligible for the I.R.C. §451(d) election only if the sales from both crops that are normally postponed are more than 50 percent of the total.

Possible argument. It could be argued that the language of I.R.C. §451(d) does not allow Daisy to postpone reporting the payment received on her soybeans since she normally sells that crop in the year it is harvested. Notice 89-55 does not clarify this issue since it uses the language of the Code but does not specifically overrule Rev. Rul. 74-145.

Example 2-C: In 1997 Clay Fields received $8,000 of crop insurance proceeds due to hail damage on his wheat crop and also received $14,000 of disaster payments as a result of drought damage to his corn crop. Can Clay elect to include in income the crop insurance proceeds for his wheat and defer the disaster payment for his corn, since one payment is crop insurance and the other payment is a disaster payment?

No, both crop insurance proceeds and disaster payments must be aggregated in determining whether to defer the income reporting or to include the payment in current year income. Crop disaster payments are specifically identified as equivalent to crop insurance proceeds and thus both types of payments are to be reported in a consistent manner. Therefore, Clay must decide between reporting the entire amount of payments ($8,000 + $14,000) in 1997 or deferring both payments to 1998, assuming he meets the requirement of normally selling more than 50 percent of his crops in the following year.

Example 2-D: Assume that Clay Fields, the taxpayer in 2-C, had received the $8,000 of crop insurance proceeds for the wheat loss in his sole proprietorship grain farm and had received the $14,000 of disaster payments for drought damage to corn grown by a farming partnership in which Clay is a 50 percent partner. The sole proprietorship wheat farm and the partnership corn farm are separate farming businesses and keep separate records. Can Clay elect to include in income the $8,000 of crop insurance proceeds for his wheat, while the partnership farm elects to defer the disaster payment received for corn?

Yes, the two separate farming operations in which Clay participates do not have to make the same election. If a taxpayer has more than one farming business, he or she makes a separate election for each such business. Separate farming businesses are those for which the taxpayer keeps separate books and is allowed to use different methods of accounting.