! prepaid farm supplies applies, your ex

CAUTION penses for prepaid livestock feed may

be subject to the rules for advance payment of livestock feed, discussed next. Although written for livestock feed, these rules may apply to any prepaid farm supplies.

If you report your income and expenses under the cash method of accounting, you can’t deduct in the year paid the cost of feed your livestock will consume in a later year unless you meet all the following tests.

1. The payment is for the purchase of feed rather than a deposit.

2. The prepayment has a business purpose and isn’t merely for tax avoidance.

3. Deducting the prepayment doesn’t result in a material distortion of your income.

If you meet all three tests, you can deduct the prepaid feed, subject to the limit on prepaid farm supplies discussed earlier.

If you fail any of these tests, you can deduct the prepaid feed only in the year it is consumed.

• The right to substitute other goods or products for those specified in the contract.

A provision permitting substitution of ingredients to vary the particular feed mix to meet your livestock’s current diet requirements won’t suggest a deposit. Further, a price adjustment to reflect market value at the date of delivery isn’t, by itself, proof of a deposit.

Business purpose. The prepayment has a business purpose only if you have a reasonable expectation of receiving some business benefit from prepaying the cost of livestock feed. The following are some examples of business benefits.

• Fixing maximum prices and securing an assured feed supply.

• Securing preferential treatment in anticipation of a feed shortage.

Other factors considered in determining the existence of a business purpose are whether the prepayment was a condition imposed by the seller and whether that condition was meaningful.

No material distortion of income. The following are some factors considered in determining whether deducting prepaid livestock feed materially distorts income.

• Your customary business practice in conducting your livestock operations.

• The expense in relation to past purchases.

• The time of year you made the purchase.

• The expense in relation to your income for the year.

Labor Hired

You can deduct reasonable wages paid for regular farm labor, piecework, contract labor, and other forms of labor hired to perform your farming operations. You can pay wages in cash or in noncash items such as inventory, capital assets, or assets used in your business. The cost of boarding farm labor is a deductible labor cost. Other deductible costs you incur for farm labor include health insurance, workers’ compensation insurance, and other benefits.

If you must withhold social security, Medicare, and income taxes from your employees’ cash wages, you can still deduct the full amount of wages before withholding. See chapter 13 for more information on Employment Taxes. Also, deduct the employer’s share of the social security and Medicare taxes you must pay on your employees’ wages as a farm business expense on Schedule F, line 29. See Taxes, later.

Property for services. If you transfer property to an employee in payment for services, you can deduct as wages paid the fair market value of the property on the date of transfer. If the employee pays you anything for the property, deduct as wages the fair market value of the property minus the payment by the employee for the property.

Treat the wages deducted as an amount received for the property. You may have a gain or loss to report if the property’s adjusted basis on