Producers with big Environmental Quality Incentive Program (EQIP) grants need to know how cost-share and other incentives are reported on income tax returns. Getting it wrong could cost you thousands of dollars in taxes you don't owe.
“Most conservation practices cost-shared by EQIP will be handled on tax forms the same way as in the past,” says Parman Green, University of Missouri farm management specialist. “But the Farm Bill (2002 Farm Security and Rural Investment Act) sets higher limits — up to $450,000 for all EQIP contracts — and allows more of the incentive payment to be made in the same calendar year.”
Typically, the federal share is up to 75% of the cost of most conservation practices approved under EQIP. However, “limited-resource” producers may qualify for up to 90% cost-share. Some producers could receive EQIP grants equal to, or larger than, their annual gross income, says Green.
“Section 126 of the IRS code provides an exclusion to the general rule that government program payments are reported as taxable income. This is important, since many EQIP payments for long-term capital-related practices frequently don't generate significant added cash flow, such as waste treatment systems,” he adds.
Green gives an example: A crop/hog farmer spends $40,000 to build a waste-treatment facility. The project increases the value of his property by $30,000 and is worth $10,000 to landowners downstream. The government pays him $36,000 under the EQIP cost-share program.
Annual average gross income the past three years is $56,000. How much of the cost-share payment can he exclude from income taxes?
“He first needs to calculate the value of the Section 126 improvement to the farm, which is $30,000 in this example,” says Green.
From that amount, the farmer subtracts his $4,000 share of the cost and the “excludable portion” of the government cost share. This excludable portion is the key component of this provision that is frequently overlooked or miscalculated. The excludable portion is the present value of the greater of:
10% of the average gross receipts from the affected acreage, or
$2.50 times the number of affected acres.
To find this excludable portion, he takes 10% of his annual gross income ($56,000 × 10%) to arrive at $5,600. He then must find the present fair market value of $5,600. To do this, he divides $5,600 by his opportunity cost of capital, estimated at 8%, which results in $70,000 ($5,600 divided by 0.08) for the excludable portion.
In this example, the Section 126 excludable part ($70,000), plus the producer's share of project costs ($4,000), total more than the $36,000 he received as an EQIP grant. Therefore, he owes no additional taxes on the $36,000.
“The computation can be a little complicated, and many tax preparers don't use Section 126 that often or understand it well,” says Green. “Make sure your tax preparer is familiar with Section 126 if you received a large EQIP capital grant in 2003. Not all EQIP grants qualify for special treatment. But where Section 126 applies, the tax liability relative to the EQIP payment can be significantly reduced or eliminated.”