For farmers looking to lessen their employment tax burden on amounts paid to their employees, the Tax Code provides an exception which is little known and widely underused. According to the Tax Code, a farmer can make payments of wages in-kind (paying value in the commodity the farmer grows instead of cash) and these values will not be subject to FICA taxes or income tax withholdings, as long as the employee is not in the business of farming other than as an employee.
This tactic only reduces employment taxes and is not effective in reducing income tax burdens of either the farmer or the employee. The farmer will have to recognize ordinary income for the value of the commodity used as the payment, but this will be offset by a wage deduction, resulting in no tax gain or loss. The employee will still be required to report the value of the commodity received on his income tax return as ordinary income. Since there were no income tax withholdings, the income tax due for this amount will still be outstanding and the employee will have to take affirmative efforts to pay the tax.
This transaction will result in three main benefits to the employer and employee: 1. There is an instant savings in FICA taxes for both the employee and employer. 2. The employee is able to convert the wage to a capital asset, and if he holds it for more than one year, he is able to get favorable tax rates at the time of the sale. 3. The employee actually gets more “bang for his buck” on purchases of food. Consider an employee getting paid $1,000. FICA taxes and income taxes equal to about $350 will be owed. Employee will then only have the $650 remaining to purchase food and essentials. Now, if the Employee is paid with $800 in cash and $200 of beef from the Farmer, only $280 is paid in FICA taxes and Employee’s food costs have decreased because he has $200 in beef.
An Example: Farmer has a modest farming operation that nets $100,000 in taxable income before the deduction for wages. Farmer has one employee who he normally pays $35,000 per year in wages. These wages are normally paid in cash. Through bargaining, the Farmer and the Employee agree the wages should be set for the current year at $20,000 in cash and $15,000 in value of wheat and cattle that are produced on the farm. Because $15,000 is now being paid in commodities grown on the farm, neither the Farmer nor the Employee owe FICA taxes on this amount. This results in a savings of $1,148 ($15,000 x 7.65% the rate for FICA withholding) for each.
Seeing the numbers (PIK = Payment in-Kind)
Farmer (Normal) Employee (Normal) Farmer (PIK) Employee (PIK)
Net Farm Income
before Wages $100,000 $ - 0 - $100,000 $ - 0 -
Wages ( 35,000) 35,000 ( 35,000) 35,000
FICA tax ( 2,678) ( 2,678) ( 1,530) ( 1,530)
Income Tax - 0 - ( 3,000) - 0 - ( 3,000)
TOTAL $ 62,322 $29,322 $ 63,470 $ 30,470
As you can see from the above example, there are tax savings of $2,296 from just one employee. This savings are split evenly between the Farmer and the Employee because each is responsible for ½ of the FICA taxes. If the Farmer had a larger operation with more employees, these numbers could greatly increase.
Although this transaction could be helpful to both the farmer and the employee, there are some very important book-keeping and technical matters that must be reviewed. The IRS has enumerated certain requirements that must be followed. First, the arrangement must have a business purpose; it cannot be entered into strictly to lessen taxes. An example of a business purpose is if the farmer otherwise would lack liquidity to pay the wages and the payment in-kind is a way to avoid the liquidity problem.
Second, the employee must bear the cost of ownership. If the commodity is grain, the employee must pay storage and insurance costs for the grain; if the commodity is a calf, the employee must pay feed and medicine costs. The employee owns the commodity and costs associated with it must be reflected as such.
Third, the commodity must be separately identified at the time the wage is paid. If the commodity is grain, the employee should receive the grain and have it stored in a separate bin than that of the farmer to avoid commingling of assets. If separate storage is not available, then the employee should have a grain scale ticket or other storage receipt showing how much grain is his, and relating back to storage costs, he should pay the proportionate share of storage on it. If the commodity is a calf, then it needs to be identified at the time of paying the wage so that the employee can show ownership and costs associated with his ownership on the specific calf. It will not suffice for the farmer to say the employee gets the equivalent of so many bushels or so many calves on the date of sale by the farmer.
Fourth, the payment in the commodity should not just be a cash substitute. The farmer should not sell the commodity and just pay the employee the percentage that related to his “wage”. This does not give the employee any power over the commodity and it signifies the intent of the whole transaction was to really just pay cash value at the time of the transaction.
Lastly, the wages paid to the employee do not count towards amounts contributed to the employee for consideration of future Social Security benefits or eligibility. It is our recommendation that part of the wages be paid in cash (which is considered for Social Security purposes) and part in the commodity.
It is recommended that all employees paid in commodities be covered by an employment contract. This contract should:
- Specify the employee’s status;
- Define the quantity or percentage of commodity to be transferred as compensation;
- State that the employee has complete control and risk of loss with respect to marketing/sale of the commodity after transfer of the commodity from the employer;
- State that the employee provides labor only; all farm expenses should continue to be the responsibility of the employer; and
- Recite any fringe benefits, which are also being provided to the employee.