Supplemental Learning Center

A business is one or more activities regularly carried on with the intention of producing a profit for the business owners. 

Farm and ranch business activities are producing crops, livestock, or crop and livestock products for sale. Other related business activities might include renting farm land or equipment, or providing specialized services such as grazing or pollination. 

Fishing businesses actively fish with the intention of selling the catch at a price greater than the costs of running trips. 

A business is regularly carried on if its activities are perceived as both frequent and continuous.  An activity is regularly carried on, even if it is seasonal, if it happens for a substantial period of time each season. An activity is regularly carried on even if it is only for only a few days of the month, as long as there is frequent activity while the business is in operation, for example selling at a flea market three Sundays a month, but with many different sales transactions at each flea market. 

A business must be run with the intention of making a profit. A business does not need to actually make a profit every year, but it must always be operated with the goal of making a profit, either in the current year, or in future years due to efforts made in current years. 

Farm and ranch businesses produce crops and livestock for sale. A landowner who uses crops and livestock to improve the ecological health of the land is not in the business of farming or ranching, even if they receive payments to offset some of their costs. Someone who produces crops or livestock with no plan to sell them is not in the business of farming or ranching even if they donate the crops to feed others, because there is no way to profit if there is no plan to earn income. 

The owners of a business are the people who contribute the money and effort needed to manage and operate the business. 

A business may take a variety of legal forms, and the legal form of the business affect how owners are paid and how they are taxed. 

A sole proprietorship is a business owned by one person only, if that person has not taken any steps to create a separate legal entity. Owners of a sole proprietorship may put money into the business and take money out of the business as they wish. An owner of a sole proprietorship may not be on the payroll of the business. The owner of a sole proprietorship files a regular individual tax return and reports the income and expenses of the business on a Schedule F for a farm or ranch business, or a Schedule C for any other type of business. No where on the tax forms does a sole proprietor report how much of their money they put into or took out of the business, because the owner is taxed on the net income of the business regardless of how much money they contributed or withdrew. 

A partnership is a business owned by more than one person if those people all intend to work together in some way to share risk and reward and they have not taken any steps to create a separate legal entity. A partnership is governed by a written partnership agreement, or else by state law. Generally partners may contribute money to the business and withdraw money from the business as they see fit, subject to limitations they may have put in the partnership agreement. Partners may not be on the payroll of the partnership. A partnership files its own federal and state tax returns, but does not pay taxes. The partnership tax returns generate a Form K-1 for each partner, showing that partner’s share of taxable income and expense from the partnership. The partners then each report the items on the K-1 on their individual income tax returns. Although the amounts partners put into or take out of the partnership are not part of calculating their taxable income, there are complex rules governing what happens if the total amount each partner has invested in the partnership does not equal the ownership percentages reported on the partnership tax returns. 

A limited liability company or a corporation is a legal entity created by one or more business owners to provide protection under state law, to limit the financial responsibility of the owners for debts and other liabilities of the business. A limited liability company may be considered a “disregarded entity” for tax purposes. This means it is ignored. If there is one owner, it is, for tax purposes as if it were a sole proprietorship. If there is more than one owner, it is, for tax purposes, as if it were a partnership. 

An S-corporation is a special type of limited liability company that allows the business owner to be on the payroll of the company. Owners of a sole proprietorship or a partnership may not be on the payroll of the business. An S-corporation files its own tax return and gives each owner both a W-2 for payroll wages paid, and a K-1 for other income and expense items.

Managing a business is not the same as working in a business. A worker is concerned with the business operations - producing and selling. A manager must be concerned with operations and also regulatory compliance (things the government requires) and short- and long-term strategic management (things required in order to make a profit and attain long-term financial security). 

Regulatory Compliance Essentials 

Income Tax: A business owner must report the income and expense of the business on the appropriate state and federal income tax return forms. 

The IRS requires you to have evidence sufficient to demonstrate that the statements on your income tax returns are true and accurate. The rules for what kind of evidence you need to have include general rules and special rules for certain types of transactions. 

In the event of an IRS inquiry or audit you are required to present evidence to substantiate any claims the IRS questions. In the absence of evidence the IRS may force you to take the least favorable tax position and in some cases you may incur negligence penalties. 

Property Tax: Businesses with more than a certain amount of business property may need to file County Business Property Tax forms. Check with your County Tax Assessor to see the limits for your county. 

Sales Tax: In California, food items are exempt from sales tax. Flowers and fiber are not. Check with the California Department of Tax and Fee Administration for more information. 

Financial Records: You are required to keep financial records that are adequate to support the items of income and expenses that you must report on income tax, property tax, and sales tax returns. 

Labor: California has strict laws protecting workers. If you employ anyone other than your legally married spouse or your children or parents to help you in your business, they must be covered by a workers compensation policy. Most workers on a farm or ranch are required to be on payroll with state and federal payroll taxes paid. In addition, you are required to keep detailed records showing that you are in compliance with laws covering hours worked, breaks given, the time, manner and amount of payment, safety training, heat and illness prevention, and a number of other protections. 

Environmental Regulations: California has strong environmental protections particularly with respect to water, land use, and waste disposal. Almost anything you want to do that involves moving earth or water requires a county permit, and there are special rules for disposal of waste generated by a business. Check with your county agricultural commissioner, or county agricultural extension office for more information. 

Food Safety: Farms are subject to food safety regulations. Here are a few resources to get you started: cdfa.ca.gov/is/i_&_c/sffsg.html and ucsmallfarmfoodsafety.ucdavis.edu. 

Management Records and Plans

In addition to the basic financial records you are required to keep to comply with tax reporting requirements, you need additional financial and other records in order to make plans to manage your business for current and future profits. 

Essential Non-Financial Records 

Production Records help you to make better decisions in the future based on what you did in the past. They are also required in order to access  business credit, crop insurance programs, and disaster assistance, and will affect the value of your land if you own land and later sell it. Production records include: 

• What, where and when you planted;
• Harvest dates and yield amounts;
• Volumes of catch during various fishing seasons;
• Animal breeding records with breeding and birthing dates, weights, growth rates and vaccination schedule.

Sales Records help you to make better decisions in the future based on what you did in the past. They are also required in order to access agricultural credit, crop insurance programs, and disaster assistance. Sales records include: 

• Product and amounts sold by customer or market;
• Price per unit; 
• Payment terms;
• Customer payment performance.

Equipment Records help you to manage one of the most important parts of your operation. You need basic equipment lists to comply with tax reporting requirements but you also need use and maintenance data to plan for future equipment maintenance or replacement. 

Essential Plans 

Marketing plans include specific plans for how a product will be packaged and transported to market and specific plans for where products will be sold. 

Production plans are specific plans for what will be produced in the next 1-4 seasons taking into account rotations, market demand and availability of seed, equipment and labor. 

Management plans are specific plans for ensuring you are operating your business to attain current and future profits and minimize your risk of loss. These include plans for: 

• Financial Recordkeeping: Keeping track of transactions on a daily and weekly basis 
• Bookkeeping: Organizing financial records into a standard system designed to provide you with current, accurate, and meaningful information
• Labor Management: Managing all of the regulatory requirements associated with labor, as well as managing contact information, scheduling, hiring, performance evaluations, etc. 
• Cash and Credit: Systems to ensure you receive prompt payment and pay your financial obligations as they come due. Systems to help you evaluate your predicted cash availability and cash needs (cash flow) and your need for credit to help manage cash flow or to help you purchase equipment or land. 
• Risk Management: Adequate insurance including property insurance, liability insurance and crop insurance as well as plans to evaluate and mitigate physical risks associated with land and operations and financial risks associated with your markets, buyers, customers and key vendors. 

Can you operate a successful business without any technology? Perhaps. But you will be very limited in your interactions and opportunities. 

Can you operate a successful business using only a smart phone? Perhaps. But at some point you will be unable to access information and services using only a phone, and this will limit your ability to manage your business beyond a certain size or amount of annual profit. 

Do you need a computer in order to run a successful business? Probably. There are many resources that are not formatted for good access on a phone. In particular, you will never be able to see and understand more than basic financial reports on a phone. More complex financial reports, the ones that help you make important decisions about your financial future, require a larger screen. It is also almost impossible to read and understand payroll tax forms and income tax returns on a phone screen. 

If you do not already have a computer and know how to use it to perform the basic functions of: accessing websites, reading pdf documents such as income tax returns, creating basic written documents, and creating basic spreadsheets, you should consider going to your local library to get started. They can usually teach you the basics and give you access to a computer. From there you can access any number of classes that will give you step-by-step instructions to help you develop the skills you will need to use a computer in your business. 

It's easy to understand the impact of a physical robbery at your home. However, data theft can be just as, if not more, damaging, and often goes unnoticed until significant harm has been done.

Data thieves can:

• Steal your identity and use it to take out credit in your name
• Access your bank accounts and steal your money
• Access your cell phone number and hold your cell phone hostage and use it to get into all of your accounts

California’s Commitment to Data Protection

The State of California has some of the strongest protections in the country to make sure that organizations like California FarmLink or bookkeeping and tax preparation firms keep your data safe. There are steep fines if we fail to follow best practices in protecting your data. This is why we ask you to transmit data to us using secure links and not using e-mail or text messages.

What to Know About Secure Systems:

• Encryption: Data is made unreadable to outsiders. Look for systems or files marked as "encrypted" or "secure."
• Storage Security: Use trusted platforms (like Google Drive or Dropbox) with strong passwords and two-factor authentication (2FA).
• Transmission Security: Avoid sending documents over plain email. Use encrypted file portals (like ShareFile, Dropbox with password protection, or your bookkeeper’s secure portal).

Secure methods of Storing and Transmitting Data

1. Verify the Recipient Before You Send Anything:  Before sending data, call or text your CPA, tax preparer, bookkeeper, or Community Development Financial Institution (CDFI) to verify their email or portal details. Scammers often impersonate trusted professionals to steal data.
2. Use Strong Passwords and 2-Factor Authentication (2FA) for storage: Create unique, 12+ character passwords (mixing letters, numbers, and symbols, phrase) for your accounts. Here are a few tips for how to create passwords you will remember: .‍
   
   1. Use a phrase: CABerryFarmersAreBEST!!9753‍
   2. Use a combination with the name of a favorite town or place, the number of children, cousins, siblings or friends you think of most often, and a symbol that makes sense to you: Patzcuaro&4, ElTepozteco3! ‍
   3. Use an abbreviation: Make a password from the first letter of each word in a sentence.
   4. Sentence: I Love Farmering, Ranching, and Fishing in California!
   5. Abbreviation: ILFR&FIC!!25

3. Securely Store Your Passwords:‍
   
   1. Multi-Factor Authentication (MFA): A security method requiring you to verify your identity in multiple ways before you're granted access to an online account, app, or system.
   2. Something you have: A code sent to your phone via text message, an authenticator app that generates a constantly changing code, or a physical security key.
   3. Something you have: A biometric scan, like your fingerprint or facial recognition.
   4. Google Keychain: This is built into your Google Account, Chrome browser, and Android devices, securely storing and syncing your passwords and passkeys across all your signed-in devices for easy access and autofill.
   5. iCloud Keychain: securely stores and syncs your passwords, passkeys, credit card info, and Wi-Fi passwords across all your Apple devices.

4. Limit Access: For bookkeepers using software like QuickBooks, provide temporary access with limited permissions. Revoke access once their work is complete.
5. Monitor: Regularly check accounts for unusual activity. Set up bank alerts for transactions over $500 to spot issues early. We will help you do this with your business accounts, you need to do this for your personal accounts -  and don’t forget your kids if they have savings accounts!

Questioning Data Security Practices

If you are working with a service provider who does not use a safe method of storing and transmitting data and does not ask you to do so, you should question if your data is secure. 

Warning Signs and Easy Actions: 

• Lack of encryption:
  
  • Example: Your bookkeeper, tax preparer or CPA e-mails you financial reports and asks you to email tax documents to their personal e-mail account instead of using a secure portal like ShareFile.
  • Easy Action: Verify the email with your bookkeeper, tax preparer or CPA. Ask “Do you have a secure client portal for sharing files?” If they say no or suggest email, request a secure alternative or consider a different provider.
  • FarmLink Clients: We use Dropbox for this. 
• Requesting excessive data: 
  
  • Example: Your bookkeeper asks for your full bank account numbers to process payroll, even though they only need payment totals.
  • Easy Action: Ask, “Why do you need this specific data?” If their reason isn’t clear or necessary, redact sensitive details before sharing.
• Suspicious behavior or urgency: 
  
  • Example: A bookkeeper or tax preparer emails from a new address, pressuring you to send tax data urgently without verifying their identity, or asks you for more banking account information than they need. (They need to view your bank accounts, they do not need to have access to your accounts.) 
  • Easy Actions: Call their known phone number to confirm the request. If the contact is unfamiliar or unverified, don’t share data and report the suspicious activity. Do not provide anyone with direct access to your bank account unless you know you are working through a secure portal such as a payment gateway. 
  • California FarmLink Clients: we will only email you from an email ending in @cafarmlink.org and you can always give us a call to confirm it is a relevant FarmLink staff person requesting information

No legitimate business, government agency or other non-profit organization will ever ask for your personal financial information or other sensitive data via text, phone call, or e-mail. If you get any phone call test or e-mail demanding payment (or offering to pay you!) and requesting access to your financial accounts, it is a scam. A legitimate request will happen:

• In the context of a relationship you already have
• With a person you already know
• Using a secure platform - but even then verify with the person you are working with so you are certain that you are being directed to the correct platform

If you get a text, e-mail, or phone call and you are not sure, do not respond to what you received. Instead find the last legitimate communication you had with that person or organization and initiate contact with that person or organization and ask if the communication you just received is legitimate. If they say it is legitimate, be sure that you understand what they are asking for and why. 

Note: The IRS will only contact you via the US Postal Service.

Very small businesses are not required to keep their financial records using formal bookkeeping practices, but as a business grows in number of financial transactions per month and in the complexity of the business operations, it becomes increasingly important to use a formal bookkeeping system. 

Who should keep the books? 

The owner of a small business may choose to be their own bookkeeper, or to hire a trained bookkeeper. As a business grows in size and complexity it becomes necessary for the owner to hire a bookkeeper. The bookkeeper’s job is to accurately enter past financial transactions into a formal bookkeeping system. The owner needs to be able to focus on how to take historic information from the bookkeeping system and use it to analyze past performance and make decisions about the future direction of the business. 

Bookkeepers may have formal or informal training, and vary greatly in experience and competence. If a business owner does not have a basic understanding of what to expect from a bookkeeper and how to supervise a bookkeeper, they can end up paying a lot of money for bookkeeping that is not actually useful, or worse, they may become victims of embezzlement. Doing your own bookkeeping during the early stages of your business may be a great way to learn basic bookkeeping and prepare yourself to later hire and supervise a bookkeeper. 

Bookkeeping is Entering Data According to a Set of Standard Rules

It is easy to be intimidated by the complexity of bookkeeping - people get two-year degrees in bookkeeping and four-year degrees in accounting – but the basics are actually very simple to understand. 

All of bookkeeping and accounting comes down to a few principles and definitions, and these are employed everywhere in the world. If you understand these basics, you will quickly be able to use most bookkeeping programs. 

Foundational principles

Accounting Entity One of the most fundamental accounting principles is that an accounting is for a single entity only. This means that you cannot have a bookkeeping system that accounts for two businesses that have different ownership, and you cannot have a bookkeeping system that accounts for household income and expenses and business income and expenses in the same accounting. This is one of the reasons it is important to have separate business and personal bank accounts. 

Reporting Period / Accounting Period Another basic accounting principle is that income and expenses are reported for standard periods of time, usually a month, a quarter, and a year. At the end of each accounting year, the income and expenses are re-set to zero. Reports should always be run for standard accounting periods, a month, quarter, or year. 

Double Entry A third foundational principle is that there are two aspects to every transaction; this is called double-entry accounting, because each entry in the system must have two sides. The entire bookkeeping system is tied together with one simple mathematical formula, and the way mathematical formulas work is that if you do something to one side of the equation you have to do something of equal value to the other side of the equation or the equation will not be in balance. You will see the term “balance” used over and over again in double-entry bookkeeping. Think of a see-saw. Every transaction in your bookkeeping system first affects one side of the see-saw and then an equal amount must go on the other side of the see-saw to re-balance it. Everything you enter into your bookkeeping system must have two sides. Usually you will know one of the effects immediately - cash went up or down, that is the first entry - then you have to figure out the second entry - that second entry tells you why cash went up or down. For that you need to know a few basic definitions. 

Basic Definitions

Most bookkeeping entries are explained by six definitions. Five of them are really easy, and two take a little effort to understand. Here they are: 

Assets 

There are a few different types of assets:

1. Cash;
2. Amounts owed to the business;
3. Property used in the business, and expected to benefit the business beyond the current accounting period. There are a few different types of property.  
   
   1. Supplies and Inventory are expected to be used up entirely in the near future – 6-18 months. 
   2. Depreciable property is expected to last two or more years and to gradually decline in value over time.  
   3. Non-depreciable property, like land, is considered eternal. 

Depreciable assets are things that have lasting value to the business and have an “ascertainable useful life in excess of one year.” 

Assets are not expensed (deducted) when purchased. Instead you take a “depreciation deduction” using special forms that are part of your tax return.

Liabilities 

Liabilities are amounts owed by the business, if the obligation to pay is certain, and the amount owed is known or can be reasonably estimated. This means that you do not report liabilities if it is not a certain legal fact that you owe the sum, or if you cannot reasonably estimate the amount owed. 

Income 

There are three types of business income: 

1. Ordinary income from sales of goods and services in the ordinary course of business;
2. Capital gains income from the occasional sale of property that has been used in the business;
3. Extraordinary income paid to the business for events unrelated to its normal activities or asset sales - this is usually insurance proceeds or the settlement of a lawsuit. 

Expenses 

There are two types of business expenses: 

1. Ordinary expenses incurred to conduct the regular activities of the business;
2. Extraordinary expenses or losses incurred due to events unrelated to normal business activities, these may be unusual fines or penalties, or amounts to settle a lawsuit, or losses associated with a disaster.  

Net Income (or Loss) 

Total income less total expenses for the accounting period (a month, a quarter, or a year). If the amount is positive it is called Net Income. If it is negative it is called Net Loss.  

Equity  

Equity is the net total value of the owner’s interest in the business. If there is only one owner then all of the equity in the business belongs to the one owner. If there is more than one owner, then the total equity is the sum of each of their total interests in the business. 

Equity can be calculated two ways: 

1. The difference between assets and liabilities. Equity is positive if assets are greater than liabilities and it is negative if liabilities are greater than assets. 
2. The sum, for the entire history of the business, of all the investments the owners have made into the business, less all of the draws they have taken from the business, plus or minus the net income or loss from every year of the business. 

For most people, the most difficult thing to understand when learning basic bookkeeping is how to record amounts that owners contribute to or withdraw from the business. That is because those amounts directly affect equity, and equity is the hardest of the six definitions to understand. 

The second hardest thing for most people to understand is when something is an asset and when it is an expense, and why the difference matters. The easy examples: a tractor is an asset, and tractor fuel is an expense. The harder examples take up volumes of accounting textbooks and Internal Revenue Code. It matters because if you treat assets as expenses then you will not have a permanent list of the assets that are used in your business year after year. This will make it hard to comply with income and property tax filing requirements, obtain credit, or plan for maintenance and future purchases. 

Many businesses use cash for some transactions. There is nothing wrong with this, but it does cause some problems with recordkeeping and can make it difficult for a bookkeeper to ensure that all transactions are completely and accurately recorded – which is the fundamental goal of a bookkeeping system. 

Some businesses operate entirely with cash. This greatly limits ability to do business, because it limits access to larger accounts, limits ability to access credit, and makes it very difficult to have a system that ensures a complete and accurate record of all business financial transactions. 

If you have cash income and you want to make sure it is recorded, the best practice is to deposit it to your bank account. 

Best Practice: You get cash and credit card payments each week at the farmers’ market. Deposit the cash to your bank account each Thursday and let your bookkeeper know that all Thursday cash deposits should be recorded as farmers market receipts.  

Okay Practice: You get cash and credit card payments each week at the farmers’ market. You use that cash to pay business expenses and you give the bookkeeper the receipts for the business expenses. Your books will under-state your income but will record your expenses accurately. This will make it look like you are less profitable than you really are. It will make it harder for you to budget next year, or to get a loan, or to file accurate tax returns. 

Bad Practice: You get cash and credit card payments each week at the farmers’ market. You take the cash home to pay personal expenses and you do not give the bookkeeper this information. Your books will under-state your income. This will make it harder for you to budget next year, or to get a loan, or to file accurate tax returns. 

If you pay expenses with cash, your bookkeeper will not know about these expenses unless you give them the receipts. 

Best Practice: You use your credit card to buy gas and you lose the receipt. Your bookkeeper will see the transaction on your credit card statement and will record it even though you do not have a receipt. 

Okay Practice: You use cash to buy gas and keep the receipt. You give the receipt to the bookkeeper. The bookkeeper will not be able to match it to any transaction on your bank account or credit card statement, so they will record it as cash you put into the business and as a business expense. This is fine as long as it was actually personal cash. If it is the same cash that was income from the farmers’ market, then your books will start to show sales less than actual and expenses greater than what the business can afford - in other words they will not make sense, and that could make it hard to file accurate tax returns or to get a loan. 

Bad Practice: You use cash to buy gas and lose the receipt. Your bookkeeper will never know the transaction happened. You will forget it happened. Your gas expense will be lower than actual. This will make it harder for you to budget next year. 

The Bottom Line: Using cash makes it easy to miss income or expenses. The best habit is to deposit cash income into the bank and keep receipts for cash expenses.

Learn more about opening a savings or checking account using the National Credit Union Administration’s Money Basics Guide to Savings and Checking Accounts. 

Good bookkeeping requires a business bank account that is used only for business transactions. This means that business owners really need to have at least two bank accounts, one used for personal transactions, and the other used for business transactions. 

If you use a credit card in your business be sure it is a dedicated credit card and you do not use it for any personal transactions and do not pay it directly from your personal bank account. 

Accidents happen though, and sometimes you will use the wrong card. If you accidentally use personal money for a business expense, that is recorded as an owner’s investment. If you accidentally take money from the business for a personal use, that is recorded as an owner’s draw. 

Owner’s Investments and Draws

When a business owner puts their own money into the business that is called a capital contribution of an owner’s investment. When the owner takes money out of the business that is called an owner’s draw. 

Best Practice: The business never pays directly for the personal expenses of the owner, and the owner never pays directly for the expenses of the business. 

The only transactions between a business owner’s personal bank account and their business bank account are contributions and draws. If the business is short on cash the owner makes a transfer from their personal account to the business account and records it on the books of the business as a capital contribution. If the business owner wants to take money from the business they make a transfer from the business account to the personal account and record it on the books of the business as an owner’s draw.

OK Practice: Sometimes the owner forgets, and accidentally uses personal money to pay a business expense or uses business money to pay a personal expense. They record the accidental personal payment of a business expense as a business expense and a capital contribution. They record the accidental business payment of a personal expense as an owner’s draw. 

Bad Practices: 

• There is only one bank account and it is used for business and personal transactions.
• There are business and personal bank accounts but the owner frequently deposits business receipts directly into their personal account and frequently pays personal expenses directly from the business account, and sometimes pays business expenses directly from the personal account, or using cash. 

If a business owner needs to take If you already have one bank account open a second for your business

• It does not need to be a “business” bank account, just a second bank account 
• Why? 
  
  • Helps with good / accurate records
  • You may need to grant access to your business accounts for purposes such as applying for credit, working with a bookkeeper, or complying with an audit of your business. If you put business and personal transactions in both accounts then you can not limit the access to just your business accounts, and others may be able to see your personal transactions. If you keep your business and personal transactions separate you will be able to maintain more privacy around your personal transactions.

You do need at least two bank accounts, one for personal and one for business, but you do not necessarily need to pay extra for a business account. Check the fees your bank charges for regular checking accounts and for business checking accounts. Usually the fees are based on how many transactions go through the account each month. If you have a lot of transactions each month you probably will need to pay the extra fees for a business account, but if you have very few business transactions, no more than in your personal account, it is fine to just open a second personal type account - just be sure you do not get confused about which account is business and which is personal. 

When it is ok to just open another account (not a business account).

• Any time your business does not have very many transactions each month.

When you actually need a true business account.

• If you have more transactions than are allowed with a basic checking account;
• To receive some types of payments, usually from school districts or government contracts.

Don’t pay more bank fees than you need to. 

• Shop around for different rates at different banks or local credit unions. 
• Compare the terms offered to these national standards for good bank accounts developed by national not for profit organizations dedicated to financial education and access. You can also learn more about savings and checking accounts using the National Credit Union Administration’s Money Basics Guide to Savings and Checking Accounts. 

Cash may still play a role in your business.

• Cash sales at a farmers’ market or a farmstand
• Miscellaneous cash sales to other farmers such as for used equipment
• Paying workers in cash, making workers cash loans against future pay 

There are smart ways to use cash in your business and ways that can get you in trouble. 

Things that will get you in trouble: 

• If you do not report cash income but use the cash to pay for expenses which you do report your financial information will be inaccurate, and a reader who understands your business will be able to see that your income is under-stated. This will make it difficult to get a loan.
•  If discovered, under-reporting income on your tax returns could subject you to underpayment and accuracy-related penalties, and would give the IRS reason to audit your tax returns going back as many years as you have been in business (if there were no evidence of deliberate under-reporting of income they would only be able to go back three years). 
• Using cash without a good method to ensure that the cash is all accurately reported in your bookkeeping system will cause your records to be incorrect even if it was not your intention. You may accidentally over- or under-report income and expenses. You will have difficulty explaining your business to yourself, any advisers who try to help you, a loan officer who wants to make you a loan, or an auditor who may think you have deliberately under-reported taxable income. 

Good methods for ensuring that cash used in your business is accurately reported

For cash receipts 

1. Get an envelope, count cash, write down the total on the envelope, put cash in the envelope.
2. Prepare a bank deposit
3. Deposit cash in a business bank and get a deposit receipt, check the deposit receipt total is the same as the total on the envelope. Re-count with the banker if the totals are not the same. Write the corrected total on the envelope if needed. Put the bank deposit receipt in the envelope.  
4. Make any additional notes about sales on the envelope and give the envelope with the deposit receipt to your bookkeeper.
5. Review the books each month and pay particular attention to cash receipts being recorded correctly.

For cash paid out 

1. Have a set “petty cash / cash on hand” amount - say $100
2. Put $100 in a coffee can or a zippered cash bag - this is called “petty cash”
3. Take cash needed from petty cash - say $20
4. Spend the cash as needed and get a receipt
5. Return the change and the receipt to the petty cash location
6. At least once a month: 
   
   1. Reconcile the coffee can/cash bag once a week (or month) by adding all the receipts and all the change. The total of all the receipts plus all the change should equal the original total of cash in the coffee can or cash bag. If it does not, you are missing a receipt. 
      
      1. Total of all bills and change equals $49.75. Total of all receipts equals $20.25. Total cash plus receipts equals $70.00. The total should be $100 - you are missing receipts totalling $30.00.  
      2. You can use a hand-written note to re-create the missing receipt – something like "Bought extra tomato starts from River Farm $30.00, no receipt.” 
      3. Now if you re-add all receipts and all cash you will total $100.00
   2. Give all the receipts to the bookkeeper 
   3. Bring the cash in the coffee can or cash bag back to the set amount
      
      1. Determine how much cash to add by subtracting the total cash remaining in the coffee can/cash bag from the set amount: $100.00 original amount, less $49.75 remaining = $50.25 needed to restore the original balance. This should also be the same as the total of all the receipts.
      2. Decide the source of the cash you will use to restore the balance:
         
         1. Bank: Write a check for “cash” for the amount needed and cash it at your bank. Put the needed amount of cash back in the coffee can or envelope. Your bookkeeper will know this is the amount needed to restore the petty cash account. 
         2. Cash Sales: See instructions for cash sales above. After you have added total cash sales and written the total for cash sales on the envelope, write “Less: Petty Cash” and the amount taken out of the deposit for petty cash. Subtract petty cash from total sales to get the amount of your deposit to the bank. Write this total on the envelope. Prepare the bank deposit and follow the instructions above for cash sales. 

The IRS requires you to have written evidence to demonstrate that the statements on your income tax returns are true and accurate.

The rules for what kind of evidence you need to have include general rules and special rules for certain types of transactions. 

You must keep business records related to all items of income and expense for any business or rental income reported on your federal income tax return. 

You must be able to show evidence that: 1. The transaction actually occurred, 2. It was for the amount claimed, and 3. That it was for the business purpose claimed. 

Income Records

You are required to report all income related to your business. Income records serve to prove that you have not over- or under-reported your income. 

The following are examples of minimum required documents to prove income items: 

• Checking and savings account statements
• Receipts from sales showing if the sale was paid in cash or “on account” (meaning the customer will pay later)
• Records showing amounts received from sales made “on account” 
• Records of bad debts or amounts sold on account but never paid

Expense Records

You may, and in fact you must deduct expenses that are ordinary and necessary and reasonable for your business. Ordinary expenses are defined as “customary or usual” and  “common or frequent” in the taxpayer’s business and businesses like the taxpayer’s. Necessary expenses are defined as being “appropriate and helpful for development of the business.” 

To prove expense items you must be able to show evidence that: 1. The transaction actually occurred, 2. It was for the amount claimed, and 3. It was for the business purpose claimed. Some expense items have additional special requirements. Examples of expense items with additional special requirements are: asset purchases, vehicle use, travel, meals, gifts, and events. Materials on each of these items are below. 

At a minimum your supporting documents for business expenses should identify the payee, the amount paid, proof of payment, the date incurred, and if needed, include a description of the item purchased or service received that shows the amount was for a business expense.

You may need a combination of records to do this, including: 

• Checking and savings account statements
• Credit card account statements 
• Physical receipts
• Additional notations made on the receipts to explain how the purchase relates to the business 

It is a good practice to make a note on a receipt as soon as you can, but most receipts fade out within a few months. The best practice is to take a picture of the receipt - with the note on it - or make a copy of the receipt.  

Exceptions to General Records Requirements: 

You have the right to take deductions based on a "reasonable reconstruction of expenditures” if your original records are lost due to circumstances beyond your control such as theft, fire or flood.

If records are incomplete due to the taxpayer’s own negligence but the taxpayer can demonstrate that some expenses were actually incurred the taxpayer is entitled to some amount of deduction, but the amount will be limited to the smallest amount reasonable.

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

If you just keep bank and credit card statements and receipts, you will not have a system for organizing that information in a way that is required to report meaningful summary information on your tax return, so you also need a system for organizing your individual transactions into meaningful categories of income and expense for each year. 

You are required to use a method that clearly and accurately reflects your gross income and expenses and allows you to report asset purchase and sales separately from other business transactions.

There is no specific requirement to use a particular method to keep your records, and summarize your individual transactions into the groupings required on the IRS forms, but the method you use must be appropriate for the size of your operation.

Minimal organization is ok for a very small operation in its first year of operations. Here are two common methods for small businesses in their first year of operations: 

• Keep sales and purchase receipts, sort them into groups corresponding to categories on the tax return. You can give these receipts to a tax preparer or, total each grouping and report that number if you prepare your own return or use a computer program to help you prepare your own return. Note that if you give receipts to a tax preparer to total they may make mistakes and they will charge you extra. 
• Use paper or a spreadsheet program to create a register showing date, payee or payor, amount and purpose of each transaction, and code each transaction to an appropriate category on the tax return. You can total each grouping yourself if you prepare your own return.

Note that these methods are slow and will not be clear and accurate if there are lots of transactions. If you do not have a receipt for something you will not include it and your returns will be inaccurate.There is no built-in way for you to verify that you have correctly recorded each transaction even if you use your bank statement or credit card statement to guide you.

The standard best practice is to use a double-entry bookkeeping system. Double-entry bookkeeping is not required for very small businesses, but it is required for larger and more complex businesses, and it is the only way to ensure that your records are complete and accurate and easily produce usable reports. Double-entry bookkeeping means that each transaction is recorded according to well-established (literally centuries old) rules, and there are standard methods for verifying completeness and accuracy. 

To implement a double-entry bookkeeping system for your business you can: 

• Use an online software program such as Quickbooks and learn as you go
• Hire a trained bookkeeper to do all of your bookkeeping
• Use an online software program such as Quickbooks and hire a trained bookkeeper to help you set it up and help you learn the best ways to use the program and manage your documents 

For more help setting up a double-entry bookkeeping system see the resources of the FarmLink Bookkeeping Toolshed, particularly the FarmLink Model Chart of Accounts. 

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

You have several options for systems to support your bookkeeping, and it can be difficult to understand the differences. We discuss different options below. 

Free templates on Google Sheets. There are free templates on Google Sheets to help you record your transactions. This is a better option than simply leaving your receipts in physical folders and only organizing them at year-end for tax purposes. 

This option works best for: 

• New operations that may not continue for more than two years
• Very small operations with no infrastructure, little equipment, and few transactions 

It makes sense to keep costs down while you are still deciding if you are going to continue farming.This can be a great option for people who are in a farm-incubator for a short period of time. 

You will know it is time to upgrade when: As your operation grows and you have more transactions and more assets and liabilities it will be increasingly time-consuming to manage all of your bookkeeping needs on Google Sheets. There are various options to add functionality to Google Sheets bookkeeping templates, but by the time you are incorporating these, you are probably not saving money because you are probably spending too much of your own time managing basic bookkeeping functions instead of using the data from your bookkeeping system to manage your business. 

Free bookkeeping software. There are many options for free bookkeeping software - but they all have limited functionality. 

This option works best for: 

• New operations that may not continue for more than two years
• Very small operations with no infrastructure, little equipment, and few transactions 

You will know it is time to upgrade when: Don’t worry, they will tell you. The free options are all designed with limited functionality. As your operation grows and you have more transactions and more assets and liabilities you will simply outgrow the free options. This is by design! 

Standard bookkeeping software with full balance sheet functionality. Quickbooks, Sage and Xero are the best established accounting software services. 

Beware of cheaper competitors with lesser functionality. You want a bookkeeping system that allows full balance sheet functionality. Some programs offer very limited balance sheet functionality - only allowing you to track accounts receivable and accounts payable for example, but not allowing you to track equipment, loans, and owner’s equity. 

This option works best for: 

• Everyone.

You will know it is time to hire a bookkeeper when: You realize you are spending too much of your own time managing basic bookkeeping functions instead of using the data from your bookkeeping system to manage your business. 

A paid bookkeeper. A good bookkeeper is an invaluable asset to any business. A bad bookkeeper can bring a business down. Hire carefully and supervise closely. See the materials on month end procedures for ways to supervise your bookkeeper and ensure they are doing their job correctly. 

This option works best for: 

• Everyone. 

Unless: 

• You have the wrong bookkeeper. 

What to expect from a bookkeeper:

• Timely and accurate entry of  your financial transactions into a double entry bookkeeping system.
  
  • Timely means generally within ten working days of receiving the information. 
  • Accurately means two things: all financial activity is recorded and transactions are recorded to accounting categories that accurately reflect the substance of the transaction. 
• Monthly reconciliations of all business bank accounts and credit card accounts.
• Monthly balance sheet and income statement reports and a monthly list of questions or observations regarding the transactions they have recorded. 

A Bookkeeper keeps your day-to-day and month-to-month records accurate and up to date. They may also be tax-preparers. 

A tax preparer is usually not also a bookkeeper. A tax preparer uses your records at the end of the year to file taxes. They usually don’t manage your books year-round. You need a new bookkeeper if you thought your tax preparer was your bookkeeper but the only thing you ever get from them is your tax return. 

What to expect from a tax preparer:

• They should take the summary reports for the year, prepared by your bookkeeper, and enter them accurately onto the correct forms required to file state and federal income tax returns. 
• They should ask enough questions to understand your business, but as long as the reports prepared by your bookkeeper appear reasonable, they should not question the underlying accuracy of those reports.
• They should bring it to your attention if they have reason to believe that the bookkeeper's reports are not complete and accurate and do not make sense. 
• They should particularly ask you questions about any purchase or sale of business machinery and equipment. 
• They should have a conversation with you about how to report business use of your personal automobile and business use of any vehicles owned by the business. 
• They should ask you questions about your non-business activities so they can complete the parts of your state and federal tax returns that are not related to your business. 
• They should communicate promptly and ensure that your tax return is timely filed, or you file a timely request for an extension of time in which to file. 

What to expect from a bookkeeper:

• Timely and accurate entry of  your financial transactions into a double-entry bookkeeping system.
  
  • Timely means generally within ten working days of receiving the information. 
  • Accurately means two things: all financial activity is recorded and transactions are recorded to accounting categories that accurately reflect the substance of the transaction. 
• Monthly reconciliations of all business bank accounts and credit card accounts.
• Monthly balance sheet and income statement reports and a monthly list of questions or observations regarding the transactions they have recorded. 

Warning signs your bookkeeper is not doing their job:

• They have not established a clear and routine process for you to send them the information they need each week, or each month, or more frequently. 
• Your bookkeeper does not regularly ask you for clarifying information to help them accurately record transactions. 
• You do not receive a monthly balance sheet and profit and loss report.
• You do not receive monthly bank and credit card reconciliation reports.
• If you receive a profit and loss report there are many items in a category called “Uncategorized Transactions.”
• They refuse to give you access to your own QuickBooks or accounting records.
• They delay or fail to send records to others after you have requested in writing that they do so.

If you're planning to end services with your current bookkeeper or tax preparer, use this checklist to make sure you leave with everything you need for a smooth transition. 

Be sure to get a copy of your data or ownership transferred before ending the relationship. 

There are three categories of data and source documents to address: 

A. Bookkeeping Data and Source Documents

1. For online programs: 
   
   1. Set up your own online account for the same bookkeeping program so you have an account that can receive the data.
   2. Request ownership of the account be transferred to you.
   3. Ask for a list of any logins or accounts they created on your behalf.
   4. For QuickBooks Online (QBO), receipt images are saved in the account, so when the account is transferred to you, the images of the receipts will also be transferred. Check if the same is true for other programs. If the images are not transferred, you will need to be sure to get the physical copies of any receipts or other source documents you gave to your bookkeeper. 
2. For desktop programs: 
   
   1. Ask the bookkeeper to convert your file to the online version and then transfer ownership (may incur extra charges). OR - 
   2. Request a backup file of your accounting data (may incur fees). Customer support can guide you through this process.
   3. If your bookkeeper has retained your physical copies of receipts and other source documents, be sure these are all returned to you. 
3. If you do NOT own your bookkeeping software, your bookkeeper uses different software, or does not agree to give you the file with your bookkeeping ask for the following documents:

• A brief summary of how they managed your books or taxes

• Chart of Accounts and Class List

• Trial Balance as of December 31 for any year for which they have also prepared income tax returns for you and as of the end of the last month for which they completed services 

• Balance Sheet as of the end of the last month for which they completed services

• Profit & Loss (P&L) Statement for the current year through the end of the last month for which they completed services

• General Ledger (shows all transactions)  as of December 31 for any year for which they have also prepared income tax returns for you and as of the end of the last month for which they completed services  for the current year through the end of the last month for which they completed services

• Any bank or credit card reconciliations as of December 31 for any year for which they have also prepared income tax returns for you and as of the end of the last month for which they completed services 

• Any original invoices and receipts in their possession 

• Any adjusting journal entries (usually done at year-end)

• Payroll reports (if they managed payroll)

B. Income Tax Documents - for a tax preparer or a bookkeeper who also prepared income taxes 

• Full copies of your tax returns (PDFs – not just transcripts) including any supplemental schedules not required to be filed with the IRS. In particular be sure to get a full copy of any depreciation detail showing assets.

• Copies of any extensions of time for federal or state income tax returns.

• Copies of any correspondence with the IRS or state tax authorities they handled for you

• Copies of vouchers for estimated tax payments made

C. Payroll Tax Information - for a bookkeeper who did payroll, or for a payroll service 

• Copies of all payroll tax filings (Forms 940, 941, DE9, etc.)

• W-2s for employees and 1099s for contractors and W-9s

• Any quarterly or year-end payroll summaries

Final To-Dos

• Ask for a final invoice and confirm your last day of service

• Request a list of any unfinished tasks or open items

• Confirm if any tax extensions or filings are still pending

• Change any passwords for any accounts to which the bookkeeper had access

Tip: Save all files digitally in a secure place you can access easily, and share with your new provider to help them get up-to-speed faster.

Keep most records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return. 

Keep employment records for four years.

Keep records for 7 years if you file a claim for a loss from a bad debt.

Keep records related to depreciable assets as long as you keep the assets. 

Keep records related to asset sales for three years after the sale.

Keep records related to land for as long as you own the land and seven years after the sale of land. 

For general matters the IRS must audit within 3 years.

If there has been a substantial (25% or more) understatement of income the IRS has 6 years to audit.

If you do not file a tax return, or have filed but willfully failed to report income, the IRS can go back as far as they want!

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

If a business pays self-employed individuals and small businesses more than $600 in a calendar year the business is required to report the payments to the Internal Revenue Service on Form 1099. 

Generally a business does not need to file a Form 1099 to report payments to corporations, but you are required to report all payments to attorneys. 

You do not need to report payments for merchandise, storage, and rent.

If you fail to file Forms 1099 as required, the IRS may disallow any deductions for the expenses that should have been reported on the Forms 1099. Also, the IRS will charge penalties for failure to file Form 1099. 

Penalties are adjusted annually. In 2026 they are:

• $60/form for filled within 30 days of the due date
• $130/form filed by August 1
• $340/form filed after August 1
• $680/form if failure to file was not accidental

For information about how to file Forms 1099 and when they are due see the IRS website. 

The only way to have accurate records of your business activities is to have a system to keep receipts and notes as you go, and to regularly organize that information and get it to a bookkeeper or enter it into a bookkeeping system yourself. 

The foundation is in your daily practice of keeping receipts and making notes on the receipts or in an app you use to take pictures of the receipts. 

We recommend picking one of two methods and sticking with it: 

A phone-based app 

Take a picture of every receipt and upload it to the app. Add notes as often as you can to include extra information. If you do not get a receipt write out on a piece of paper what would have been on the receipt: date, amount, person or business, and the specific purpose of the transaction, and take a picture of the piece of paper as if it were a receipt and upload it to the app. 

 An envelope and folder system: 

You will need: 

• At home: Four folders or large manila envelopes labeled: 1. Income, 2. Farm Expenses, 3. Equipment, 4. Other Expenses. 
• With you in your truck: A few pens, a large manila envelope labeled “Daily Receipts” and a pad of note paper.
• During the day: Every time you get a receipt, put it in the “Daily Receipts” envelope. Unless it is completely obvious what the receipt was for, write a note on the receipt (front or back) with a bit of additional information. If you do not get a receipt write out on a piece of paper what would have been on the receipt: date, amount, person or business, and the specific purpose of the transaction. 
• Each night, or at least once a week: Take all of the receipts out of the “Daily Receipts: envelope and organize them into the four manila envelopes or folders labeled 1. Income, 2. Farm Expenses, 3. Equipment, 4. Other Expenses. See R.9 Keeping receipts - Special Rules for Property Used in A Business for more information about what to put in the envelope labeled “Equipment.”

Once a month, or at least once a year, you will need to give the information on your phone app, or the envelopes you keep at home, to a bookkeeper or a tax preparer. See R.18 Organizing and Transmitting Receipts on a Monthly Basis  for specific instructions on how to transmit your information to a bookkeeper. 

Some receipts are more important than others!

Receipts for property you purchase that is expected to last for more than one year are more important than receipts for things you buy which you will use up within a month or within a year. 

Seeds and soil inputs are things you use up within a year, they are part of the crop you produce each year. Oil and gas for your vehicles are also things you use up as you go. 

When you spend money on things that are used up during the year, those things are called expenses. 

Property such as machinery and equipment is usually expected to last more than a year. It is especially important to keep receipts for these types of purchases because they are special rules for how they are reported in your books and on your tax return.

In the language of taxes and bookkeeping, property used in a business, and expected to serve the business for more than a year is called assets. 

• Machinery is an asset. The fuel you put in the machinery is an expense. 
• Equipment is an asset. The amount you pay someone to repair a piece of equipment is usually an expense - but if they essentially re-build the equipment and give it a whole new useful life, then the amount you pay the person would be treated as if you bought a new piece of equipment. 

When in doubt, keep the receipt and write a detailed note so you can discuss what it is for with your bookkeeper or tax preparer. 

You should keep a detailed list of all the depreciable assets used in your business. Show:

1. Description
2. Purchase date
3. Purchase amount
4. Depreciation deduction taken each year
5. Date sold or taken out of service

In addition to your asset list you need supporting documentation showing evidence of: 

• When and how you acquired the assets
• Purchase price
• Cost of any improvements 
• Depreciation deductions taken
• Deductions taken for casualty losses, such as losses resulting from fires or storms
• How you used the asset in your business
• Sales price of asset if sold and terms of sale if sold on contract or in partial exchange for another asset.

Examples of supporting documents include: purchase and sales invoices, real estate closing statements, canceled checks or other documents that identify payee, amount, and proof of payment, prior year tax returns with depreciation schedules. 

Special requirements for transactions involving assets

When you sell an asset the income is not part of your business income, it is reported separately as Capital Gains Income. 

Capital Gains are taxed at a lower rate than self-employment income. 

Capital Gains Income is: 

Gross sales price

Less your basis in the asset 

Less costs of the sale

___________________________________________________

Equals: Capital Gains Income (or Loss) 

Basis is: 

a) cost basis which is your purchase price or cost to build

b) gift basis or the donor's basis when they gave it to you or 

c) for inherited assets you have a special “stepped-up basis.” 

A stepped-up basis is the fair market value of the asset on the date of death of the person from whom you inherited it.

You may increase your basis in an asset if you incur costs by making improvements to it.  

Your basis in an asset decreases by the amount of the depreciation that would be allowed on your tax return - and it decreases by this amount even if you don’t take the deduction on your tax return! 

You need records to show your basis in any asset you sell. 

If you can not prove the amount you claim as basis the IRS will assume the basis is zero and you will owe tax on the full sales price of the item. 

Records to show basis include: 

• purchase records
• tax returns showing depreciation
• gift letters and the tax returns of the person who made you the gift (if you want to show that you have more than zero basis in the gift because they had more than zero basis in the gift)
• estate tax returns or probate documents for inherited assets 
• receipts for any improvements you made. 

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

You may take deductions for vehicle expenses using the mileage method or the actual method. 

If you use the mileage method you record the business miles you drive and multiply the total miles by the IRS published rate to calculate the total deduction. 

If you use the actual method you keep all of your receipts for gas and  maintenance. 

In both cases you need to record your business miles. 

Typically a vehicle that is owned by the business and used exclusively for the business uses the actual method, and the owner also uses the mileage method for occasional business use of a personal vehicle. If there is only one vehicle for personal use and farm business use you need to choose which method to use. You can have different methods for different vehicles, but you can not change methods year to year on the same vehicle. 

The record must be written and must include:

1. Date
2. Destination
3. Round trip miles driven 
4. Business purpose of the trip - a short note that explains why or how the trip relates to the business. 

You can use any type of calendar to keep records of your business trips -  paper calendar, an app on your phone, a diary or a day planner. The important thing is that you have a written record of the date, destination and business purpose of the trip. 

Examples of business trips are: 

• To and from your farm to town to buy supplies
• To and from your farm to another town to look at equipment
• To and from your farm to another farm to talk with the other farmer
• Trips to sell at a market
• Trips to visit possible buyers 

Trips from your house to your farm and from your farm to your house are considered “commuting” and are not allowed as business deductions. 

There are two methods for calculating vehicle-related deductions: Actual and Mileage. 

1. The Actual Method allows you to take a depreciation deduction to recover the cost of the vehicle and to deduct all fuel and maintenance expenses - but you have to keep records of all the miles driven showing the business purpose of the trip AND you must also keep all of the receipts for fuel and maintenance. 
2. The Mileage Method allows you to calculate your deduction by multiplying the IRS mileage rate (published at least annually) by the business miles driven. 

Under either method you need a written record of the miles you drove showing date, miles driven, where you went, and most importantly WHY it was a business-related trip.  

You can switch from Mileage to Actual but you can not switch from Actual to Mileage. 

You may deduct tolls and parking separately in addition to vehicle expenses.  

You can have a situation where you use both methods, but for different vehicles:

• You use the Actual Method for a vehicle that is owned by the Farm/Ranch and used primarily in that operation (but perhaps sometimes for personal use) 
• You use the Mileage Method for a vehicle that is owned by you personally (and sometimes used for business). 

The Actual Method farm/ranch vehicle is treated as a farm/ranch asset and depreciated along with other farm/ranch equipment and all fuel and maintenance expenses are reported with other equipment fuel and maintenance expenses.

If the vehicle is occasionally used for non-business purposes the owner is supposed to keep a record of the non-business mileage and calculate the percent of business to non-business use and reduce their total business deduction by the value of the personal use.

For a personal vehicle that is sometimes used for business (for example, driving to town to visit with your CPA and buy office supplies) people typically use the Mileage Method. The owner must keep a record of the business miles driven and may take a deduction for those miles using the Mileage Method

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

The IRS allows a deduction for meals and incidental expenses while traveling for a full workday or longer, outside of the taxpayer’s regular area of business for a business purpose. You do not need to keep receipts in order to take this deduction. Instead, you may simply keep a record of the days you traveled away from your regular place of business, and use the published “GSA Per Diem Rate” tables to find the amount you are allowed to deduct for each trip. 

The per diem deduction covers a basic amount for meals, and a small amount for incidentals. Incidentals are things like buying aspirin or sunscreen. 

The per diem deduction is useful for farmers who travel to distant farmers markets or to attend a class. Instead of keeping receipts for the meals you eat on your trip, you can use the per diem expense tables and use the published amounts. 

You find the per diem amount by looking up the destination location at:  https://www.gsa.gov/travel/plan-book/per-diem-rates  The amounts are usually more than $60 per day, however since the per diem deduction is mostly for meals and since all meals deductions are limited to 50%, you only get 50% of the per diem amount as a deduction on your tax return. For people who regularly travel to a farmers’ market in a high-cost city more than an hour from their farm, the amount can still add up to a large deduction. 

You can also use the per diem method to reimburse employees for their out of pocket meals and incidentals on travel days. If you reimburse employees this way you do not need to include the amount in their taxable wages.This means you do not pay payroll taxes on the amounts and they do not pay income taxes on the amounts. 

 To claim the per diem deduction you must keep a written record of the business trip. 

The record must be written and must include:

1. Date
2. Destination
3. Business purpose of the trip

You can use any type of calendar to keep records of your business trips -  a paper calendar, an app on your phone, a diary or a day planner. The important thing is that you have a written record of the date, destination and business purpose of the trip. .What is a business purpose for a trip? Anything that is “ordinary and necessary” to conducting your business. 

Examples of business purposes for a trips are: 

• Buy supplies or equipment
• Meet with a bookkeeper or tax preparer
• Meet with an insurance agent about business insurance
• Meet with a lender about a business loan
• Look at equipment you might buy to use in your business
• Meet with another farmer or an agricultural adviser to discuss ways to manage your production or your business
• Meet with a potential supplier to discuss buying from them
• Meet with a potential buyer to discuss selling your products to them

In order to qualify for the per diem deduction a trip must take you away from your "tax home" for more than 8 hours.

What is your "tax home"?  Draw a circle around your farm going out as far north, south, east, and west as you would travel in a typical work day. Everything inside of the circle is your tax home.  Everything outside of the circle is outside of your tax home. If you make trips outside of the circle, you may take a per diem deduction for your meals and incidental expenses for the day. 

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

You may deduct travel expenses that relate to conducting your business including ordinary and necessary expenses associated with traveling to do the ordinary and necessary activities of your business. 

The key documentation you need, in addition to receipts, is something to substantiate the business purpose of the trip. 

You may deduct travel expenses related to purchasing equipment, supplies, livestock, accessing veterinary, legal, accounting, and educational services, developing marketing relationships, and  delivering your product to market. 

Travel expenses include: vehicle expenses as discussed above, rental vehicle expenses and related fuel, ferry, airfare, taxi or ride service, hotel, and meals and incidentals. 

For meals to be deductible you must be on a trip away from your regular "tax home" for 8 hours or longer. Your "tax home" is the general area in which you regularly conduct business activities - the radius around your farm you typically travel on a typical work day.

Many farmers/ranchers live fairly far from services and may travel several hours to the nearest town or city. That nearest town or city may be part of the area you consider your "tax home" if you regularly travel there and back within a regular work day. The next farthest town or city may be outside of your tax home. In order to be able to take a deduction for your own meals and incidentals for a travel day you have to be outside of your "tax home" for a full 8 hours or longer.

For many farmers the day they travel to a farmers market is a 12-14 hour day and they are outside of their tax home for most of the day - they can take a meals and incidentals deduction for those farmers market days. Draw a circle around your farm as far out north, south, east and west as you go in a typical day - that is your "tax home" everything else is "away."

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

You may take a deduction for a business meal if the primary purpose of the meal is to conduct business or further some purpose of the business. 

You may take a deduction for meals eaten while traveling away from your “tax home.”

You must be able to substantiate the business purpose of the meal.

You may compensate your employees for their meals and incidental expenses when they are away from your tax home, traveling for you on work. 

Provided you have written documentation showing the business purpose of the trip and the date and place of the trip, you do not need to include the value of the payment to the employee in their taxable W-2 wages or pay payroll taxes on that amount.

Business meals deductions are limited to 50% of the actual amount or the amount on the GSA table. 

For your own meals and incidental while traveling away from home you have a choice similar to the one for vehicle expense: Actual or Per Diem Rates from the GSA Table.

To use the Actual Method you must have your actual receipt along with a notation explaining the business purpose of the trip. 

To use the Per Diem Method you do not need to keep any receipts, but you do need to maintain written records explaining the business purpose of the trip. You calculate the amount of the deduction using the Per Diem Rates Table published at least annually by the General Services Administration (GSA) of the federal government. Look up the city that is your destination. If the city is not listed, use the amount listed for the county. 

Business meals deductions are limited to 50% - if you look on the IRS form you see the line you enter 100% and then you subtract 50% to arrive at your actual deduction.

Note that the GSA tables include hotel expenses. A self employed person may not use the GSA tables for hotel expenses; you have to have actual hotel receipts. Use the "Meals and Incidentals" part of the table only. 

"Incidentals" is for things like buying aspirin or sunscreen you may have forgotten to take with you but later realize you need. 

Special requirements to substantiate business meals that are 100% deductible

If you provide meals to employees for YOUR convenience (yours not theirs) then those meals are 100% deductible (not subject to the 50% limitation).

Further, the value of the meals provided to your employees is not included in their taxable wages. 

You must be able to document that the meals were provided for your convenience. 

An example of appropriate documentation would be including in your employee policy manual the requirement that employees eat meals with the farm/ranch crew so they can be close-by for emergencies, or because town is too far away, or in some cases as part of them understanding how the food grown or raised in the farm is prepared and served and how it tastes.

Examples of when the meal is for your convenience if: It is provided at your place of business, it enables the employees to work overtime, you are far from a place where your employees could reasonably leave, go buy a meal and return within the time allotted for a lunch or dinner break, you provide the meals to enable the employees to be close by for emergencies. 

Examples of when the meal is not for your convenience: You provide meals in order to increase overall employee compensation, the meals are provided when the employees are not working.

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

As long as you can make the connection between the person receiving the thank you gift and a legitimate business purpose (including promoting your business to potential customers) you may deduct business gifts of up to $25.00 per recipient.

Consider the people who might receive a business gift. Who are people who help you in your business by functioning as informal advisers? Do you have a friend or family member who is self-employed or has particular expertise in farming, ranching, marketing or accounting and taxation? A thank-you gift can be a nice way to acknowledge that you appreciate their continued mentorship. 

For more information see IRS Publication 463, Travel, Gift, and Car Expenses

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

Entertainment expenses are not deductible.

There are two important examples of ordinary and necessary business expenses that are fully deductible, but may look like entertainment: 

1. Promotional events for customers
2. Recreational, team-building, or appreciation events for employees

Promotional events such as a harvest festival are events to bring customers to your farm. They may have entertainment elements such as children's games and rides and music and dancing. These are ordinary marketing activities and the expenses are necessary so they are fully deductible as long as you can document the business purpose of the event. 

Recreational events for employees such as expenses for a summer outing to the local water park are designed to help you maintain or improve employee morale, performance, retention, etc. These expenses are fully deductible as long as you can document that the purpose was related to enhancing employee performance and retention. 

If you go to see music or a movie with someone who markets your products you cannot deduct the cost of the ticket - that would be considered entertainment because rather than being in a meeting with each other discussing business, you were both being entertained by something non-business-related.

You may deduct the cost of parking at a hotel and renting a hotel conference room for a business meeting. Or, you may deduct admission and parking costs if you go to a local park and have a walking meeting with someone rather than having a business meeting in a hotel conference room. The important point is that the primary purpose and activity is the business meeting. 

You will need some written notes about what you talked about that make a clear connection between the meeting and your business. 

How do you show that the primary activity and purpose was the business meeting? The best way is with notes from the meeting, or notes you write after the meeting. A follow up e-mail to the person saying "That was a great meeting! To summarize, we talked about x, y, and z and agreed to do 1, 2 and 3” would be another way to document the business purpose of the meeting. 

These are examples of non-financial records that validate financial records, and situations where the receipt alone will not justify the deduction, but the receipt plus other documentation will.

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

The most efficient way for your bookkeeper to work is one month at a time. If you give them receipts in random order they will charge you for the time it takes them to organize your receipts. If you organize the receipts yourself then you will save money on bookkeeping. It also gives you a chance to review your receipts and make sure that none are missing and that any that need notes have notes. 

To organize your receipts for one or more prior months: 

1. Get receipts for all of your business transactions back to the first day of the current year
2. Get seven envelopes of folders and label them with the following names: 
   
   1. Income
   2. Production Expenses
   3. Sales Expenses 
   4. Equipment Purchases 
   5. Vehicle Expenses
   6. Office Expenses
   7. Other Expenses 
3. First, organize receipts into each of the categories
4. Then, look at each receipt and if it needs any additional explanation, write a note to clarify what the receipt is for and then 
5. Sort receipts by month within the category 
   
   1. You can use a piece of scrap paper to separate each month
   2. You do not need to put the receipts in order by day within the month

To transmit your receipts for one or more prior months:

Option A: 

1. Take a picture of each receipt and upload each receipt to your bookkeeping system
2. Write a big “T” for “Transmitted” on the back of a receipt when you have transmitted it to your bookkeeper.

This option is slow, but you can do it all from your home, and you do not risk losing your records. You will end up with an electronic record of each of your receipts which is a good idea because the ink on the receipts may fade, or the receipts could be lost. 

Option B: 

1. Go to a copy shop or use an app on your phone and scan your receipts - you can usually lay your receipts out so that you can fit three or more receipts on one page to be scanned
2. You will get an electronic file of all of your scans - you can have this file e-mailed to you or you can have it saved on a flash drive (you will have to buy a flash drive or bring your own)
3. Upload the file of scanned documents to your bookkeeping system

This option may be faster if you have a lot of transactions, but there will be a fee of around ten cents a page at a copy shop. You will end up with an electronic record of each of your receipts which is a good idea because the ink on the receipts may fade, or the receipts could be lost. 

Option C: 

1. Deliver your folders to your bookkeeper, or deliver them in person. 

This option may be cheapest and easiest, but it may not result in you having digital copies of your records, and it is possible that your records could be lost, and the ink on most of the receipts will fade. Your bookkeeper may scan your receipts for you, but they will charge you for their time to do this. 

Standard bookkeeping practices require transactions to be posted at least once a month. For some very small businesses (one that has less than ten transactions a month) this should occur at least once a quarter. 

As a business owner working with a bookkeeper, your role is to review the books for the prior month as soon as they are prepared. Prompt review allows for quicker correction of any errors and provides valuable information for management decisions.

The four review procedures you should complete each month are: 

1. Review the monthly bank reconciliation for any business bank account
2. Review the monthly credit card reconciliation for any business credit card
3. Review the balance sheet as of the last day of the prior month
4. Review the income statement (also known as the P&L) for the prior month and for the year-to-date through the end of the prior month 

The next four lessons will explain what each of these procedures are and how to do each one. 

A bank reconciliation is a procedure for making sure that everything coming in and out of the bank account is recorded in the bookkeeping, and everything recorded in the bookkeeping is accounted for at the bank.

The bank reconciliation provides strong oversight for your bank account to ensure that all transactions coming in and out of the bank account are appropriate. Note, this especially includes fraud detection where unauthorized withdrawals may happen; the bank reconciliation is one key way of identifying these issues.

What is a bank reconciliation and why should I review it? 

A bank reconciliation is a procedure for making sure that everything coming in and out of the bank account is recorded in the bookkeeping, and everything recorded in the bookkeeping is accounted for at the bank.

The bank reconciliation provides strong oversight for your bank account to ensure that all transactions coming in and out of the bank account are appropriate. Note, this especially includes fraud detection where unauthorized withdrawals may happen; the bank reconciliation is one key way of identifying these issues.

How do I review a bank reconciliation?

A critical step in the bank reconciliation process starts with a review of the bank statement, which happens independently from the bank reconciliation process. As owner/manager you should receive the bank statements each month and review them, noting any unusual or unexpected items. The bookkeeper may receive the bank statement at the same time. Once the bank reconciliation process is complete, you should review the reconciliation report.

Perform this process for each of your business bank accounts. 

1. Gather your reports:
   
   • Bank Reconciliation Report: Obtain this from your bookkeeper or directly from your bookkeeping system for the prior month.
   • Bank Statement: Obtain your bank statement for the prior month.
2. Verify Reconciliation Dates:
   
   • Reconciliation Period: Check the report to ensure it covers the period ending on the last day of the prior month.
   • Reconciliation Date: Look at the date the reconciliation was performed. Ideally, this should be within ten days of the prior month's end.
     
     1. If it's a month or more after the end of the prior month, your bookkeeper is likely behind. If you are providing information promptly, you should be receiving timely reports each month. Ask your bookkeeper for an explanation for any delays.

3. Review Your Bank Reconciliation Report for Balances:
   
   • Statement Beginning Balance:
     
     1. Compare this amount on the report to the beginning balance on your bank statement.
     2. The two numbers must match exactly.
   • Statement Ending Balance:
     
     1. Compare this amount on the report to the ending balance on your bank statement.
     2. The two numbers must match exactly.
   • Action for Discrepancies: If the beginning or ending balances on your bank reconciliation report and bank statement do not match exactly, there's a problem. Ask your bookkeeper why the numbers do not agree. 

4. Go to the section “Checks and Payments Cleared”
   
   • Scan the entire section, Do you see any large items that you were not expecting? Can you think what they might be? If you see any unexpected large amounts:
     
     1. Ask your bookkeeper to show you the details for that amount
        
        1. Be sure you understand their answer.
     2. You may need to contact your bank to dispute an unauthorized charge. 
        
        1. Generally you must dispute an unauthorized charge with your bank as soon as you become aware of it, and within 60 days. Some banks have shorter or longer periods of time in which to dispute a charge. 
5. Go to the section “Deposits and Other Credits Cleared”
   
   • Scan this section for large, important, or regular payments/deposits you expect to see (e.g., weekly farmers’ market deposits, a single large payment from a customer).:
     
     1. If an expected payment or deposit is missing, ask: Why? 
        
        1. Sometimes, the payment may have been recorded in the prior or next month.
        2. However, if a payment is truly missing, you want to know as soon as possible so you can investigate what happened.
6. Go to the section “Uncleared Checks and Payments”
   
   • Scan section for:  
     
     1. Checks more than one month old: Consider if the recipient lost the check, forgot to deposit it, or if you voided the check but didn't inform your bookkeeper.
     2. Checks more than six months old: These may need to be reissued as banks may not honor checks older than six months. 
        
        1. Important Note: Uncleared checks can clear at any time. Keep this in mind when looking at your bank balance to determine your available funds.
7. Any remaining unreconciled items will appear as a separate category to be able to easily identify. Make sure to clear these at the end of each month.

Authored by Winona Dorris and Poppy Davis 

What is a credit card reconciliation and why should I review it?  

A credit card reconciliation is just like a bank reconciliation - but instead of proving that all the activity in a bank account was recorded in your bookkeeping it proves that all the activity on a credit card was recorded in your bookkeeping. 

A bank account usually has a positive balance in your bookkeeping because it represents money you own. A credit card represents money you owe, so it will show as a negative balance in your bookkeeping. That is why we talk about the bank reconciliation and the credit card reconciliation as two different activities, even though they are almost identical. 

A credit card reconciliation is a way to prove that everything that went into and out of your credit card was recorded in your bookkeeping system, and that everything that was recorded in your bookkeeping system as going in or out of your credit card account did in fact go in or out of your credit card account. 

Usually the only differences between the activity shown on the credit card statement and the activity shown on your bookkeeping detail for that credit card account are due to a difference in timing - perhaps a refund or a payment you made that has not yet been recorded by the credit card company.  

It is important to look at the credit card reconciliation report each month to make sure that your bookkeeper is staying current with recording your transactions each month, and to make sure that no one is using your credit cards without your knowledge or permission. 

How do I review a credit card reconciliation?

1. You will need:
   
   1. Credit Card Reconciliation Report, you can ask your Bookkeeper for this report and it can be found in your bookkeeping system.
   2. Your Credit Card Statement for the prior month. 
2. Check the Credit Card Reconciliation Report dates: 
   
   1. Reconciliation Period: The report should cover the prior calendar month (e.g., July 1–31).
   2. Date Performed: The report should be completed within 10 days of month-end. If the date is a month or more after the end of the prior month that means your bookkeeper is running behind - why might that be? If you are providing the information in a timely manner you should be getting  timely reports each month. If you are providing information to your bookkeeper on time but not getting reports within two weeks of the end of the month, you should ask your bookkeeper why they are running behind.
3. Compare the Beginning Balance
   
   1. Find the Statement Beginning Balance on the Credit Card Reconciliation Report
   2. Compare this amount to the beginning balance on your Credit Card Statement. These two numbers should match exactly. If the numbers do not match, there is an error in the report and you should ask your bookkeeper to explain what happened or re-do the reconciliation so it is correct. 
4. Compare the Ending Balance
   
   1. Find the Statement Ending Balance on the Credit Card Reconciliation Report
   2. Compare this amount to the ending balance on your Credit Card Statement. These two numbers should match exactly. If the numbers do not match, there is an error in the report and you should ask your bookkeeper to explain what happened or re-do the reconciliation so it is correct. 
5. Review Cleared and Uncleared Transactions
   
   1. Go to the section called Cleared and Uncleared Transactions. 
   2. Scan the entire section looking for any large items that you were not expecting. 
   3. If you see any large items that are unexpected:
      
      1. Ask your bookkeeper to show you the details for that amount and make sure that you understand the answer. Otherwise you may need to contact your credit card company to dispute an unauthorized charge. If you need to dispute an unauthorized charge on your credit card, remember the following:
         
         1. Contact your credit card company as soon as you become aware of the unauthorized charge, and within 60 days. Some credit card companies have shorter or longer periods of time in which to dispute a charge. 
6. You're Done! Congratulations, you have reviewed your Credit Card Reconciliation Report!

The purpose of a reconciliation is to prove that all of the cash or credit card activity reported by a bank or credit card company appears in the business’ bookkeeping system, and that all of the cash and credit card transactions in the bookkeeping system correspond to transactions that went through the bank or credit card. 

If you want to do a manual bank or credit card reconciliation you should ask your bank or credit card company to give you statements as of the last day of the month, or as late in the month as possible. 

There is a simple formula to follow, and you work the formula backwards and forwards to make sure you are correct: 

1. Bank to Books - Last Day of Month
   
   1. Balance in Bank Account per Bank Statement on Bank Statement Date
   2. Plus: Deposits Not Yet Recorded by Bank as of Month-End Date
   3. Less: Uncleared Checks as of Month-End Date
   4. Equals: Balance in Bank Account per Bookkeeping System at Month-End Date
2. Books to Bank - Last Day of Month
   
   1. Balance in Bank Account per Bookkeeping System at Month-End Date
   2. Less: Deposits Not Yet Recorded by Bank Between Bank Statement Date and Month-End Date
   3. Plus: Uncleared Checks as of Month-End Date
   4. Equals: Balance in Bank Account per Bank Statement
   5. The process is similar for a credit card reconciliation:
3. Credit Card to Books - Last Day of Month
   
   1. Balance Due on Credit Card per Statement on Statement Date
   2. Plus: Payments Not Yet Recorded by CC Company as of Month-End Date
   3. Less: Additional Charges Through Month-End Date
   4. Equals: Balance Due on Credit Card per Bookkeeping System at Month-End Date
4. Books to Credit Card Statement - Last Day of Month
   
   1. Balance Due on Credit Card per Bookkeeping System at Month-End Date
   2. Less: Payments Not Yet Recorded by on Credit Card Statement Between Statement Date and Month-End Date
   3. Plus: Additional Charges as of Month-End Date
   4. Equals: Balance Due on Credit Card per Credit Card Statement

What is a balance sheet and why should I review it? 

A balance sheet is a report generated by a bookkeeping system that shows everything a business owns, and everything a business owes, and the ownership interest in the business, also known as equity. 

Equity is an important measure on the balance sheet; it includes your own money you put into your business, any money you have taken from the business, (either as an owner’s draw or by paying a personal expense from your business account) and the value of the what the business has earned or lost since its start. 

A balance sheet is a report of what you own and owe at a specific point in time. It should be run on the last day of the month or of the year. 

The bank and credit card reconciliations are done for the same date as the balance sheet, because one of their functions is to prove that the cash and credit card balances on the balance sheet are correct. 

When reviewing your balance sheet you are looking for any expected or unexpected changes to your cash or equipment accounts (also called asset accounts) or to the amounts you owe (also called liabilities). You are also looking for any transactions that may have been recorded between you and your business (personal money you deposit to your business, draws you take from the business, and personal expenses that may have been paid by the business.) 

One of your goals when reviewing your balance sheet should be to think about how much money you have in the bank versus how much you owe, and consider if you are paying down debts as you would like to, or if you might want to take out a loan to help with operating expenses or for equipment. 

How do I review my Balance Sheet? 

1. Verify the Report Date
   
   1. Check the date at the top of the report. This date should be the last day of the prior month
2. Compare Cash Balances
   
   1. Locate the balance(s) shown for any business bank accounts.
   2. Compare these amounts to the balances shown on the bank reconciliation reports you just reviewed.These numbers should be the same. Action required: If they are different, there is a problem. Ask your bookkeeper to explain why the numbers do not agree.
3. Consider other amounts owed to your business
   
   1. Think about whether anyone owes your business money for something other than sales of crops or services. This might be for a piece of equipment they bought from you, which would usually be shown as a "Note Receivable" on the top half or first page of your balance sheet. If such an amount is owed but not listed, talk to your bookkeeper about how to record it.
4. Review Equipment and Other Assets
   
   1. Look at the numbers shown for equipment and other assets (things that benefit your business for more than one year).
   2. Do these numbers seem about right? Do they reflect the amount of equipment and other assets you believe your business owns? 
   3. If you do not think the amounts shown accurately reflect your assets, ask your bookkeeper to provide a detailed list of the individual items that make up the balance in your equipment and other asset accounts.
      
      1. Remember: Assets should be listed at purchase or acquisition costs, which may be less or more than market value.
         If the amounts still don't look correct, find the FarmLink Model Asset List in the Bookkeeping Learning Center for assistance with creating an asset list.
5. Review “Liabilities” section (Amounts Owed to Others)
   
   1. These are usually presented in order of how soon they are due.
   2. If you record "Accounts Payable," you will see that balance first. Consider: Does it look like an amount you expect to see?
   3. If you have business credit cards, you will see those next. Compare: Do the amounts shown match the amount on the credit card reconciliation you reviewed? If the credit card reconciliation and the amount shown on the balance sheet do not match most likely they were run on a different date. Either run the reports with the correct date or ask your bookkeeper for an explanation.
6. Review Long-Term Debt
   
   1. The next item you will see should be any long-term business debt, such as an operating loan or an equipment loan.
   2. Reflect: Do the balances match your expectations of what you owe? Did you expect them to be smaller or larger?
   3.  If you have questions, find your most recent statement from your lender and compare it to what is shown on your balance sheet.
   4. If the balances are different, ask your bookkeeper to review what they have recorded and what your lender shows. 
   5. Often, the difference between what you expect to see and what you actually see is because of interest. You pay one amount each month, but part of that amount is interest (shown as an expense on your income statement) and part pays down the loan (reducing the loan balance).
   6. If you still have questions, you should ask your lender to help you understand your statement. 
7. Review “Total Liabilities”
   
   1. Locate the subtotal on your balance sheet called "Total Liabilities." This represents all the debts of your business.
   2. Confirm: You should understand everything above this subtotal, or else have a list of questions to ask any items you do not understand.
8. Review Owner’s Equity (Personal Money In/Out of Business)
   
   1. The last section of your balance sheet will include any amounts of your personal money you have deposited into the business, any amounts you have withdrawn from the business, and any personal expenses accidentally paid by the business.
   2. Review this detail to make sure you agree with how the bookkeeper has posted these items.
   3. If you disagree with how any of these items are posted, have a conversation with your bookkeeper to understand why they posted them the way they did and to see if you can agree on how the items should be posted.
9. Final Cash and Debt Assessment
   
   1. Go back to the top of your balance sheet and look at your total cash, then scan down to Accounts Payable. 
   2. Consider: Do you have enough cash to pay the amounts you know will be due in the coming month? If not, what are some things you can do to ensure you will have the cash you need in time to make your payments?
   3. Consider: Have you been taking owner’s draws? Can you take more money home from the business? Do you need to re-deposit some of the cash?

An income statement (statement of profit and loss, P&L) is a summary of business income and expenses for a period of time. The standard period of time for an income statement is either one month, or the year to date through the end of the prior month. Usually business owners like to review a report that shows the prior month next to the year-to-date through the end of the prior month. 

When you review your income statement you are looking for expected and unexpected items of income and expense. You are looking to see that the activity for the month reflects your understanding of what happened in the prior month, and that the total for the year-to-date reflects your understanding of all the income and expenses for the business so far this year. 

If some expenses seem too high and others too low, the bookkeeper may be categorizing transactions to a different account than the one that makes sense to you for that expense. You and your bookkeeper should have a conversation to learn more from each other about how to categorize expenses so the recording will be consistent going forward.

How do I review my Income Statement? 

1. Verify the report date
   
   1. Look at the date at the top of the report. It should be for the prior month and for the year-to-date ending on the last day of the prior month.
2. Check that the last day of the report is the same as the date on the balance sheet.
   
   1. Check that the last day of the month on the Income Statement is the same as the day shown on the Balance Sheet. These two reports are always supposed to go together and always supposed to show the same end date. The key difference is that the Income Statement covers a period of time leading up to the end date, while the Balance Sheet shows a snapshot for just that end date.
3. Review individual income accounts
   
   1. If you have multiple income accounts, look at the totals shown for each.
   2. Reflect: Do they match your expectations, or do you think the bookkeeper might have posted one or more items to the wrong account? Make a note of any questions you have and follow up with your bookkeeper to understand more. 
4. Review total income
   
   1. Review the total income shown. 
   2. Reflect: Is it about what you expected? If not, can you think of reasons why it is higher or lower than expected?
5. Scan expense accounts
   
   1. Scan your expense accounts. 
   2. Reflect: Do any numbers look bigger or smaller than expected? Is it possible that the bookkeeper recorded something in a different account than the one you would have used? Make a note of any questions you have and follow up with your bookkeeper to understand more. 
6. Assess overall performance
   
   1. Look at the report as a whole.
   2.  Reflect: Do you think income and expenses are running about as expected, or are they slower or faster than expected?
   3. Consider: Is there anything you might do differently based on this information?

‍Authored by Frances Andrews

Step 1: From your Home page in QBO, open the Reports page

1. Click Reports in the left navigation bar.
2. Select Standard Reports.‍
   
   1. Tip: Click the hamburger icon (three lines) at the top left by “Reports & Analytics” to expand your screen space.‍
3. Select the Accounts receivable aging summary report. You will find it in the “Favorites” section at the top and in the “Who owes you” section. You can also use the search bar at the top of the page. Click on the report to run it.
   
   1. Other useful reports to review in the “Who owes you” section are the Accounts receivable aging detail and the Open Invoices reports.

Step 2: Review the Accounts Receivable reports

1. Every number in the report is a hyperlink. You can click on it to see the details and then you can click any invoice listed to see the invoice.

‍Authored by Frances Andrews

Step 1: From your Home page in QBO, open the Reports page

1. Click Reports in the left navigation bar.
2. Select Standard Reports.‍
   
   1. Tip: Click the hamburger icon (three lines) at the top left by “Reports & Analytics” to expand your screen space.‍
3. Select the Accounts payable aging summary report. You will find it in the “What you owe” section. If you click on the star to the right of the report name it will also show up in the “Favorites” section at the top of the page. You can also use the search bar at the top of the page. Click on the report to run it.
   
   1. Other useful reports in the “What you owe” section are the Accounts payable aging detail and the Unpaid bills reports.

Step 2: Review the Accounts Payable reports

1. Every number in the report is a hyperlink. You can click on it to see the details and then you can click any bill listed to see the bill.

The default assumption is that anyone who works for you is considered an employee. 

• Employees are those who work for the benefit of another. 
• Employers are those who receive the benefits of the labor of another.

This is true even if the people involved do not believe they are in an employee/employer relationship. 

Employers must pay employees according to California (or other state) law following rules for:

• Minimum wage, overtime pay, breaks 
• Frequency and manner of payment
• Payroll tax withholding and employer’s share of payroll taxes
• Providing worker’s compensation insurance 
• Providing appropriate sanitation, drinking water, and heat and illness protection

The best way to ensure that you are paying employees correctly and also paying all of the associated payroll taxes correctly and on time is to have payroll prepared by a payroll service provider. 

One of the other ways that farmers make sure that they are in compliance with all of the requirements of California (or other state) labor law is by hiring workers through a labor contractor. The labor contractor becomes the employer and is responsible for having all of the workers on payroll, and protected by workers compensation insurance and other protections. However, if you hire a labor contractor and they do not follow all the rules to protect workers, you are responsible. 

There two important exceptions to who must be considered an employee: 

1. Owners, their legally married spouses, their children, and their parents may work for the owner’s company without being considered employees. But note that minors have additional protections under the law
2. People who are independently self-employed or running their own business do not need to be on payroll. These people are called “independent contractors.” Common examples include bookkeepers, food safety consultants, pest control advisors, crop advisors, and custom hire when they bring and operate their own equipment. California law is clear that people doing most farm work are never considered independent contractors. Workers who are planting, weeding, harvesting, washing or packing are never considered independent contractors, they must always be paid on payroll and protected with workers compensation insurance and other protections. This is not the same as people employed by a labor contractor (these people are on the contractor's payroll - not yours).

Who enforces this? 

The State of California ensures that employers pay employees on payroll. One method is drive-by enforcement. The State employees drive to different farm fields and ask workers if they are paid with paychecks (taxed withheld) or as independent contractors (no taxes withheld). Another way that the State enforces is if a worker is injured, there is an automatic inquiry into their employment status. Also, if an employee applies for unemployment benefits it will trigger an inquiry into employment status. 

What are the consequences of not having someone on payroll? 

If you are paying someone as an independent contractor when they should be on payroll and it is discovered, the State of California will fine you for back payroll taxes owed and charge you interest on late payment of the fines. The State of California will also ask to see your records of hours worked and breaks given and may fine you for failing to have those records and may force you to pay back wages and back payroll taxes for breaks not given.  In addition, they will contact the IRS about failure to pay federal payroll taxes. You will also be fined for failing to carry workers compensation insurance.

This document will help you understand what a payroll service does, the different types of payroll services available, and the key considerations for each, so you can choose the best option for your needs. 

What a Payroll Service Provider Does

A payroll service provider calculates the net paycheck for an employee based on the hours worked (and piece rate information you provide). They also calculate the amount of payroll tax you must pay to federal and state tax authorities for each paycheck you write, and they create the correct payroll tax return forms that you are required to send to the state and federal payroll tax authorities. For most people this is not something they can do themselves. Payroll service providers specialize in payroll so they are very good at being accurate and up to date with current laws. 

Larger payroll providers also offer access to workers compensation insurance coverage. 

Options and Considerations

Full service payroll provider

These providers handle all aspects of payroll. You connect your bank account to their payroll system, approve the payroll, and they withdraw the necessary funds to pay employees and all state and federal taxes directly. 

Examples: Gusto, ADP and Paychex 

Things to Consider:

• You must connect your bank account to their system.
• You will need to approve each payroll for withdrawal.
• This method ensures payments for employees and all state and federal taxes are made directly from your account.

Recommendation: Highly recommended for accuracy and convenience, as the service ensures correct and timely payments. 

In-house preparation with software assistance 

This option allows you to calculate payroll checks and associated withholdings and taxes. You are responsible for manually cutting checks or initiating electronic transfers. 

Examples: Quickbooks Payroll

Things to Consider:

• You are responsible for calculating payroll checks and associated withholdings/taxes due.
• You must manually cut checks or initiate electronic transfers for payments.
• This method comes with the risk of errors and potential wage violations or payroll tax underpayments if payments are not made as instructed.

Recommendation: Not recommended, but may be a good option if you need to make calculations of piece-rate payments. Be aware of the risk of errors in calculations and payment dates. 

Local bookkeeper or accountant: 

Bookkeeper uses full service software- Same as full service but the bookkeeper is the intermediary and helps the farmer access the full-service option—all the farmer has to do is give the hours and the piece rate to the bookkeeper 

Recommendation: Use this method if you would like support working with a payroll service, for example, because of a language or tech barrier, or because you would like the convenience of working with a bookkeeper on this. 

Bookkeeper processes manually / independently This option is similar to self-service, computer assisted. A bookkeeper or accountant will prepare all the payroll checks and documents detailing gross, net and deductions. However you are still responsible for distributing the checks.

Things to Consider:

• The bookkeeper prepares all payroll checks and gross/net/deduction documents.
• You are responsible for manually distributing checks.
• There is a risk that payments may not be made even if records show they should have been.

Recommendation: This method comes with risks, but it may be recommended if you need to distribute checks manually because workers do not have bank accounts, or if you are paying piece rate. 

Basic Filing Requirement

The requirement to file is not the same as the requirement to pay. You may have to file even though you do not owe tax. 

Just because you don’t have to does not mean you shouldn’t. You may choose to file in order to:

• claim a refund
• claim Earned Income Credit
• report business losses (which may reduce other taxable income)

You can go to the IRS website for more information on how to determine your filing status. Find the instructions for the Form 1040 and then find “Chart A.” It shows the filing thresholds.

Special Requirement for Self-Employment Income

Even if your business does not generate a profit you still may be required to file a tax return in order to report your gross business income. Gross income is your income before any deductions for expenses.

Even if your total income is less than the filing thresholds in Chart A, you must file a tax return if you had net earnings from self employment of $400 or more.  

This means that you might have to file a tax return on your small farm or ranch business even if you have gross income well below the amounts listed in IRS Form 1040 Instructions, Chart A. 

Partnerships, (including LLCs taxed as partnerships) and S-corporations must file a tax return every year they are in business regardless of income. 

A single-member LLC owned by two legally married spouses in a community property state does not have to file a separate tax return. For more information see IRS Form 8832 and instructions.

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

Filing due date

Individuals must file federal income tax returns by April 15th unless this day falls on a weekend or holiday. In that case, returns are due on the next business day.

"Filed" means:

• electronically received by the IRS, or
• post marked by the United States Post Office 

prior to midnight on the due date. 

You may choose to ask the post office for a "Proof of Mailing" receipt. 

If you drop your return off in a USPS mailbox be sure to check the time of the pick up.

Extension of Time to File

An extension is an extension of time in which to file - it is not an extension of time in which to pay. When you file an extension you are supposed to pay any amounts due (or estimated amounts due) with the extension request. 

If you file a request for an extension of time to file and fail to pay what is due by the original (unextended) due date you will avoid late filing penalties but you will owe late payment penalties. 

File IRS Form 4868 to request an extension - you must file the 4868 no later than the regular due date of your return. 

Note that in some disaster situations the IRS may make an automatic extension for everyone in the county.

March 1 Due Date

The March 1 due date is a special rule that allows some farmers, ranchers and fishers to avoid following the regular rules for paying estimated taxes on a quarterly basis and instead pay all of their taxes on March 1. 

For the regular rules on paying quarterly estimated taxes see the IRS website and IRS Publication 505.

If two-thirds (66⅔ %) or more of your gross revenue from all sources is agricultural (or fishing) income (related to producing unprocessed agricultural products or unprocessed fishing catch), then you may elect not to pay quarterly estimated taxes and instead either pay all of your estimated taxes by the 15th day after the end of your tax year (generally January 15th) or file your taxes and pay all taxes due by the 1st day of the 3rd month after the end of your tax year (generally March 1).

If you do not meet the two-thirds gross income requirement you are required to pay estimated taxes if you expect to owe $1,000 or more when you file your returns. 

Penalties for late filing

If you do not file on time: The failure-to-file penalty is 5% of the unpaid taxes for each month or part of each month that a tax return is late (filed after the due date or extended due date) up to a maximum of 25% of your unpaid taxes. Interest compounds daily so amounts grow fast!

Penalties for late payment

If you file, but do not pay your taxes: The failure-to-pay penalty is 0.5% (half a percent) of the tax owed after the due date, for each month or part of each month the tax remains unpaid, up to 25% of the total amount owed. Interest compounds daily so amounts grow fast!

Consequences of failure to file or failure to pay

Failure to file: If you never file a return the IRS can audit as far back as they want to find unreported income. 

Failure to pay: The IRS has extraordinary ways to enforce payment. They may seize money directly from your accounts or garnish your wages. 

Failure to file: Generally the IRS can audit for three years after the date you file your returns. For substantial understatements of income they can audit for six years after you file your return. If you never file a return, they can audit as far back as they want to find unreported income. 

Failure to pay: Penalties and interest on amounts owed compound daily. The IRS may place a lien on your property (this means if you sell it the IRS automatically takes what you owe from the proceeds.) The IRS may levy your assets - that means take money out of your bank accounts, or order your employer to send most of your paycheck to the IRS instead of you (a wage garnishment). 

Negligence: If your tax return is incorrect in a manner that results in understatement of tax by the greater of $5,000 or ten percent of the correct tax you may be liable of negligence and accuracy penalties of up to 20% of the tax owed.

Willful failure to file or pay involves knowingly filing a false return or actively hiding money or assets in order to evade IRS collection actions. Willful failure to file or pay is tax fraud which is subject to penalty up to 100,000 and up to five years in prison.

The difference between negligence and fraud: From the IRS website: "Avoidance of taxes is not a criminal offense. Any attempt to reduce, avoid, minimize, or alleviate taxes by legitimate means is permissible… One who avoids tax does not conceal or misrepresent... Evasion… involves deceit, subterfuge, camouflage, concealment, some attempt to … make things seem other than they are."

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

Sometimes it makes sense to file for prior years or amend previously filed returns. 

Generally, to claim a refund you must file an amended return within three years of the due date of the original return or within two years from the date you paid the tax, whichever is later.

If you are filing an amended return to report and pay additional taxes you may file at any time.

You may file an amended return to establish your basis in assets (the original cost), so you can later take depreciation deductions, but only within the time allowed to file an amended return. If you failed to take a depreciation deduction in a year earlier than allowed for an amended return, you must report the basis of the asset as if you have taken allowable depreciation beginning with the first year the asset was in use in the business. 

You may file an amended return to make a correction showing more taxes are owed or to make a correction showing that less taxes are owed, and you may file amended returns to claim the EITC. 

I have been farming for more than five years and I have never filed income tax returns at all.  Do I need to file for those past years? Should I file for those past years? 

• Were you required to file? If so, then you should file. 
• Would you have owed tax? If so, then you should file. 
• Would you have received a refund or an Earned Income Tax Credit payment if you had filed? If so, you must file within three years of the original due date to claim your refund or credit.

The statute of limitations on audits and assessing additional tax remains open indefinitely if the taxpayer fails to file a return or files a false or fraudulent tax return. As long as the taxpayer has filed a return which is not false or fraudulent the statute of limitations begins running when the return is filed (not when it was due). For general matters the IRS must audit within 3 years. If there has been a substantial (25% or more) understatement of income the IRS has 6 years to audit. The statute of limitations for collections is 10 years from when the tax was assessed.

I have been farming for more than five years  but I have never filed taxes for my farm. I did file taxes to report my other income, I just did not file a Schedule F to report my farm income or expense because I knew it was going to be a loss. Do I need to file for those past years?

• Did you pay income tax in those years?  If you can show that you were engaged in a legitimate business with the intent to profit, you can amend the prior three years and your farm losses will reduce your other income resulting in lower total taxes.
• Did you build or purchase business assets (orchard, barn, tractor, fences) during that time? If so you should consider filing to establish your basis in those assets and to take a deduction for the depreciation expense associated with those assets.
• If the amended return shows prior expenses that reduce your prior taxes owed by more than the cost to prepare the amended return, you come out ahead. 

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

Form 1040 is a summary of many forms and schedules. There are many kinds of income (wages, interest, dividends, income from sales of assets, net income from business, etc). All of those are totaled to come to the total amount of taxable income. So if any of those numbers are negative that negative reduces your total taxable income. If you have wage income (W-2 from a job) and farm losses, your farm losses reduce your wage income and you owe less taxes.

Generally losses offset income and reduce taxes. 

The IRS is as concerned with limiting the losses you can take as they are with ensuring you report all of your income. 

There are many complex rules limiting how you may use losses to offset income. Losses may be limited, suspended, disallowed, carried forward and carried back. These are all advanced tax topics. 

If you have tax losses and other taxable income, you should consult a knowledgeable tax preparer. 

For more information on special rules related to business losses, consult a tax professional or see IRS Form 461 and instructions and Publication 925 Passive Activities and At-Risk Rules

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

The EITC goes up as earned income goes up and then past a certain amount of income it goes down as income continues to go up. 

The EITC is fairly limited for people with no dependents but with one dependent is often between $1,000 and $3,000 and for 2-3 dependents is often between $2,000 and 6,000.

You can look at the current tables for the EITC at the IRS website to see the range of when it kicks in and when it phases out for each filing status and depending on the number of dependents. The tables are included in the instructions to Form 1040, after the income tax tables towards the end of the instructions.

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

In order for expenses to be deductible the expenses must relate to a trade or business that is functioning when the expenses were incurred. 

A business is considered to have started or be functioning as a business when facts and circumstances indicate that the business is engaged in which are directly related to generating profit. 

While a business is only engaged in exploration and research activities it is considered to be in the start up phase. Once the business has begun, the first $5,000 of start-up expenses may be deducted in the first year of business. All other start-up expenses may be deducted over 15 years beginning in the year that the business becomes operational. 

If you use assets during the start-up phase of your business you can file a tax return to record the depreciation but also show that the depreciation is part of start-up expenses which will later be amortized. You are filing in order to establish your basis in business assets and start up costs. You may not file to show a loss on your business until the business is considered started under IRS rules. You will need a CPA or expert tax preparer to help you do this correctly.

Technically we say that start-up costs are amortized over 180 months. That is the same as saying deducted over 15 years, but it is the language you will see used by the IRS and accountants and lawyers so if you look into this topic you are looking for information on the amortization of start-up costs.

This is the general rule, but there are specific rules about what expenses count as start-up costs and organizational costs.  Also, if you spend more than $50,000 in startup or organization costs, what you can deduct will be reduced.

When does a farm or ranch business begin?

When does farming/ranching activity begin? When does the "start up" period end for a farmer or rancher?

For annual crops: the first day of the first year you plant a crop which will be harvested within 12 months. 

For livestock: the first day of the first year you hold an animal that is intended for sale or the first day of the first year you hold an animal that is intended to be used in breeding animals which will be intended for sale 

For permanent crops: There are special rules related to what must be capitalized and what may be expensed. These rules are closely related to the rules for start-up costs. 

For operations where the growing period is more than one year or spans a calendar year end, it is not necessary to have sales in the first year your business is operational, but in the first year you claim losses you must be producing items which were reasonably intended for sale.

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

In order for expenses to be deductible, the expenses must relate to a trade or business – not a hobby or recreational activity. How is that determined? The taxpayer must be able to demonstrate that their activities are engaged in with a legitimate intent to profit. Profit in this case means either annual profits (sales in excess of expenses) or long-term appreciation of assets (assets will later be sold for an amount in excess of cost).

Things that will not meet this test: Gardening, growing food for a food bank, growing food to give away, landscaping to maintain or improve the value of your personal residence, keeping animals or livestock for pleasure or to maintain your personal residence. 

If you falsely claim that an activity is a business for the purpose of reducing the income taxes you owe, or increasing your Earned Income Tax Credit, that is a form of tax fraud – this is why the IRS will likely question your fundamental business profit motivation if they audit a tax return that shows farm losses, or an EITC that was increased by farm income or loss.

Demonstrating a Profit Motive

The IRS will look at all facts and circumstances. At a minimum you should be able to show: 

1. A plausible plan for generating income
2. That you keep ordinary and necessary business records and use them to make business management decisions 
3. That you respond to losses by making changes to the operation 
4. That you have and continue to acquire the knowledge appropriate to the needs of the business.

See Pub 225 and RuralTax.org for more information on this topic.

But I was told if I lost money in 3 out of 5 years, it was a hobby and not a business. 

The Hobby Loss Rule says that if you lose money in 3 out of 5 years then you must be able to demonstrate, with evidence, that you have a legitimate intent to profit.

It is incorrect to state that if you lose money 3 out of 5 years you are a hobby. Many businesses lose money in 3 out of 5 years. 

Normally the IRS must assume that if you file a business tax return (Schedule C or F) you are a legitimate business, or the burden of proof is on the IRS to demonstrate that you do not have a legitimate business. If you have lost money in 3 out of 5 years the burden of proof shifts from the IRS to you – now you have to be the one to prove your legitimate intent.

It is common for people to have an incorrect understanding of this rule - but now you know the real rule. If you have a legitimate business and can demonstrate your legitimate intent to profit you should not hesitate to file Schedule F and take your farm losses against other income.

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

All business income is taxable and must be reported on your tax return, but the IRS defines several different types of income. Different types of income are taxed differently, and importantly there are elaborate rules for which types of losses (negative income) can offset which types of income. 

Agricultural income also has special rules to define it, and it comes with special benefits. Fishing income has some but not all of the same characteristics as agricultural income. 

Agricultural income is income from the sale of crops or livestock which you raise.

Agricultural income is not income from manufactured food and beverage products or income from non-farming and ranching activities that take place on the land where you farm or ranch.

If you include non-agricultural income with your agricultural income you are overstating your agricultural income, and that may result in you paying less taxes than you owe, or receiving benefits from programs you do not actually qualify for. This could leave you liable for back taxes, re-paying program benefits, and owing interest and penalties. 

Processing that is incidental to the growing, raising, harvesting process is still considered a farming activity. Examples are field packing, washing, cooling, and putting to standard packs as required by marketing standards or local custom. Once you are beyond that - doing more than is required to get the raw agricultural product to market - doing things that alter its physical form and extend the time it can be held for sale, you may be into activities which would not qualify as farming or ranching for federal income tax purposes.

For example, you might have to wash and cool and package a product for that product to make it to market (think fragile ripe fruit) but you do not have to turn it into jam or pie. Washing, cooling, and packing are all part of agricultural income, but if you make jam or pie that income is not agricultural income.

In small operations it may be hard to separate the accounting for a small amount of value added activity. 

If you are just experimenting with a new product it may not be practical to set up elaborate accounting before you know if the product is going to work out for you.

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If the value-added products you make have a short shelf life and sell about as fast as your fresh farm products, there may be no practical difference between separating the accounting and tax reporting and keeping it all together. 

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

The chart of accounts is the backbone of the bookkeeping system. Every double-entry bookkeeping system is based on a chart of accounts. It lists all the proper and required types of accounts in their correct order. If your books don’t make sense to you, often the problem is that they have been set up using a chart of accounts that is not appropriate for your business type. This is often the case when a farm or ranch business uses the default chart of accounts offered by Intuit QuickBooks® or other bookkeeping programs. 

The California FarmLink Model Chart of Accounts is designed to ensure that your books reflect your operation.

For a new set up: If you are setting up a new bookkeeping system we highly recommend that you use the FarmLink Model Chart of Accounts instead of any standard chart of accounts provided in QuickBooks or by any other bookkeeping system that is not designed for agricultural operations. If you go this route - read CoA.3 Importing the California FarmLink Model Chart of Accounts before you do any set-up in Quickbooks. As soon as you start setting up a new company in Quickbooks® it will add accounts and complicate your set up using the Model Chart of Accounts. 

There are several versions of the FarmLink Model Chart of Accounts. Click on the one that best describes your business. This list shows options in order of complexity, from the simplest type of crop or livestock operations to the most complex. 

1. Crops no VA Model CoA for farms without value added production or livestock

2. Crops with VA Model CoA for farms with value added production

3. Crops Livestock VA for operations with crops and livestock and value added production

4. Livestock Live Sales Only Model CoA for livestock operations with live sales only

5. Livestock Only with VA Model CoA for livestock operations selling products 

6. Nursery Model CoA for nursery operations only

7. Advanced Allocation Model CoA  - For advanced users only, for an operation with detailed payroll records and the ability to allocate payroll across production, marketing, value-added, other, and administrative activities. Do not use this version unless you have advanced ability to track payroll, allocate using a spreadsheet, and create and enter regular journal entries.

As you review the model chart of accounts you will notice a column for the account number, another for the account name, and two more for account type and account detail. These will all import into Quickbooks Online. There are two more columns which will not import - one cross references balance sheet accounts to additional information in the Supplemental Learning Center, and the other has short additional explanations about the account, or about what types of accounts are grouped together, and where you may add additional accounts if needed. You can also find the information in those two columns in CoA.2 Annotated Chart of Accounts. Be sure to keep a copy of the chart of accounts you downloaded, or of CoA.2 Annotated Chart of Accounts for reference, as you learn how to navigate your new chart of accounts. 

The account types and account detail types are how Quickbooks keeps similar accounts grouped together for presentation. 

Account numbers are a more standard way of keeping different types of accounts together and ensuring they present in the correct order on the balance sheet and income statement reports. The basic numeric structure is standard across all accounting platforms (except Quickbooks). Using account numbers will give you the most flexibility to move from one type of accounting software to another, and once you get used to the numbering system it will also help you to understand your accounting structure more deeply.

In the California FarmLink Model Chart of Accounts, certain number series are reserved for certain types of operations; for example, expense accounts in the 5050 series are for livestock-related expenses. If you choose a model chart of accounts with no livestock you will see that your expense accounts may skip from 5040 to 5060. There are also many places throughout the model chart of accounts that are designated as places where you can add additional accounts if you feel they are needed. We recommend that you do not add new accounts using any number series that is not already in your model chart of accounts. That way if your business ever does grow or change to take on new activities - such as livestock - you will be able to return to the FarmLink Model Chart of Accounts and add the recommended accounts in the recommended place in your chart of accounts. 

Please read CoA.2 Annotated Chart of Accounts for explanations of the main types of accounts and the number series used.

Access the Annotate Model Chart of Accounts here (PDF)

Step 1: From your Home page in QBO, open the Chart of Accounts

1. Click the Accounting center from the oval tab at the top of the screen or from “All apps” in the left navigation bar.
2. Select Chart of Accounts.‍
   
   1. Tip: Click the hamburger icon (three lines) at the top left by “All Apps” to expand your screen space.

Step 2: Inactivate the Default Accounts

When you create your QBO account, a default Chart of Accounts (CoA) is created by QBO. Sometimes it is only a few accounts that are required by QBO; sometimes it is a whole set of accounts QBO thinks is right for your business. 

Before you import FarmLink's Model CoA you must remove the existing accounts by inactivating them.

Note: You cannot fully delete accounts in QBO — they become inactive instead. Inactive accounts can be reactivated later if needed. Some QBO default accounts are required and cannot be inactivated.

1. Click the gear icon (top of account list on the right) and increase the Page Size to show all accounts on one page. If you can click “Next  >” under the gear icon you have more pages of accounts; if it is greyed out, all accounts are on this page.
2. Inactivate subaccounts first — QBO requires this before you can inactivate a parent account.
   
   1. Scroll through your accounts and look for indented accounts — those are subaccounts. You may also have the option to filter your CoA to show only the subaccounts. Above the list of accounts there is a “Batch action” box and two filter boxes. Choose the dropdown on the box that says “All” and select “subaccounts only”.
   2. Check the boxes on the left side of all subaccounts, or the box at the very top of the list to select all if you only have subaccounts showing.
   3. Return to the top of the accounts list and click the green Batch actions box above the checkboxes. Select Make inactive. Because you have not entered any transactions in QBO you can select Make inactive in the pop-up message.
3. Once subaccounts are inactivated, select all remaining accounts using the checkbox at the top of the list, just to the left of the Name column. This will check the boxes for all accounts.
4. Once again click the green Batch actions box above the checkboxes and select Make inactive. 
   
   1. This time you will receive a message that some accounts weren’t deactivated. At this writing, there are seven accounts: Opening balance equity, Retained earnings, Services, Uncategorized Asset, Uncategorized Expense, Uncategorized Income, and Undeposited Funds. These are accounts that are required by QBO.

Step 3: Enable Account Numbers

Account numbers allow you to reference an account quickly and  let you control the order accounts appear in reports. Without them, accounts display alphabetically, with them they appear in meaningful groupings. One of the most significant problems with the QBO default chart of accounts is it fails to present accounts in a meaningful and standard order. Refer to the “Annotated Model Chart of Accounts” resource for an explanation of the numbering system used in the California FarmLink Model Chart of Accounts. 

1. Click the gear icon (top right corner).
2. Go to Account and settings under the Your Company column.
3. Go to the Advanced tab.
4. Find the Chart of Accounts section and click the pencil icon or the word Edit.
5. Enable Account Numbers.
6. If you want account numbers to appear on reports, select Show Account Numbers.
7. Select Save and close the screen with the X in the top right corner.
   
   1. Now you will see a Number column in your CoA.

Step 4: Import the California FarmLink Model CoA

Select the version of the California FarmLink Model CoA that best fits your company, and download it to your computer desktop before starting. The model CoA options can be found with the other CA FarmLink bookkeeping resources. 

1. Click the green NEW account button and select Import from the dropdown.
2. Drag and drop or choose select files using the version of the California FarmLink Model CoA that you downloaded. 
3. Click the green NEXT button and the mapping screen will appear.
   
   1. The spreadsheet is set up to map automatically.
4. Click the green NEXT button.
5. All accounts from the spreadsheet will appear.
   
   1. The boxes on the left can be checked to remove any accounts from the import. However, we recommend importing the entire CoA and doing any edits in QBO.
   2. To the right are Actions that you can take - adding, deleting, copying, creating subaccounts. Once again, we recommend not doing so at this point.
6. Click the green Finish button.

Note: You will be returned to the CoA screen and will see a message noting the number of accounts imported and if some did not. If any accounts fail to import, it is likely because they already exist in your QBO CoA (e.g., Opening Balance Equity, Retained Earnings).

Step 5: Review Your New Chart of Accounts

1. Scroll through your new CoA or select Run Report (top right corner) to review all accounts. You can also export a csv list or a pdf; see the icons at the top of the ACTION column.
2. If you are a partnership or a mult-member LLC, edit the names of the 35X0 Capital Contribution accounts and the 36X0 Draw accounts by replacing Owner # with the owner’s name. In the CoA list in QBO, select Edit from the dropdown menu in the Action column on the right side of the list. Edit the name and click the green Save button at the bottom.
   
   1. If you are a partnership with more than two partners, or an LLC with more than two members you will need to add additional equity accounts for the additional owners. Follow the same numbering convention as used in the first set of owner equity accounts where X is the number of the 35X0 Capital Contribution - Owner X and 36X0 Draw - Owner X. 
3. The accounts that already existed in QBO before your import will not have account numbers. Edit the account numbers to match those in the Model CoA.
4. After your import, you will often find an account called Billable Expense Income has been created. You can delete it.
5. You have the option to edit the account number and name of multiple accounts by using the Batch edit tool. This is a pencil icon that says “Batch edit” in green on the right side above the ACTION column. 
6. You will see many income and expense accounts that do not (yet) apply to your business. Refer to the Annotated Model Chart of Accounts document for information on the numbering system and reserved “Open/Other” accounts. Inactivate accounts that are not yet needed. See Step 2 above, checking only the boxes of those accounts you wish to inactivate. As your business grows and changes these accounts may become relevant. The California FarmLink Model Chart of Accounts is designed to give you lots of room to grow, and to ensure that as you grow your chart of accounts stays well organized and consistent with best practices, allowing you to have meaningful reports at every stage of your business. 

Step 6: Dive in! 

1. Begin entering data and running reports — this is the best way to learn how your CoA works for your business. Refer to the Annotated Model Chart of Accounts document for additional information on the purpose of different accounts and the structure of the numbering system. 
2. Refine your CoA as needed over time, following the numbering system described in the Annotated Model Chart of Accounts document. There is plenty of room for you to add new accounts as needed.

Remember: This is a model template — you will likely adjust it to fit your specific business. Having this standard setup makes your accounts and reports easier to understand for accountants and other service providers.

Step 1: From your Home page in QBO, open the Chart of Accounts

1. Click the Accounting center from the oval tab at the top of the screen or from “All apps” in the left navigation bar.
2. Select Chart of Accounts.‍
   
   1. Tip: Click the hamburger icon (three lines) at the top left by “All Apps” to expand your screen space.‍
3. If you do not see the Number column, you need to enable account numbers for your CoA. See Step 3: Enable Account Numbers in CoA.3 below.

Step 2: Add accounts

1. Click the green New account button at the top right corner
2. Enter the Account name and the appropriate account number. Refer to the Annotated Model Chart of Accounts document for information on the numbering system and reserved “Open/Other” accounts
3. You must also enter a Detail type. This is theoretically used to connect to tax software; however, it is usually not helpful. We suggest you choose the detail type based on a similar account in the Model CoA.
4. If you would like the account to be a subaccount of another, check the Make this a subaccount box and choose the correct Parent account.
5. The Description is to help you or anyone else who will be looking at the accounts; however, it is not necessary.
6. Some accounts will give you the option to set an Opening balance. Do NOT do so. Leave it blank.

Step 3: Inactivate multiple accounts in a batch

Note: You cannot fully delete accounts in QBO — they become inactive instead. Inactive accounts can be reactivated later if needed. Some QBO default accounts are required and cannot be inactivated. Be very careful about Balance Sheet accounts (Banks, Assets, Liabilities, Equities). Do NOT inactivate a Balance Sheet account with a balance! QBO will create an offsetting transaction in the Opening Balance Equity account.

1. Click the gear icon (top of account list on the right) and increase the Page Size to show all accounts on one page. If you can click “Next  >” under the gear icon you have more pages of accounts; if it is greyed out, all accounts are on this page.
2. Above the list of accounts there is a “Batch action” box and two filter boxes. The dropdown list on the box that says “All” has several options that can narrow the accounts that are shown. The box that says “Filter by name or number” is helpful if you want to work with several accounts that contain the same word or numbers.
3. If any account you would like to inactivate has subaccounts you must inactivate subaccounts first — QBO requires this before you can inactivate a parent account.
   
   1. You may use the filter mentioned in 3.2. to select “subaccounts only”. If you don’t have that option, scroll through your accounts and look for indented accounts — those are subaccounts.
   2. Check the boxes on the left side of all subaccounts you would like to inactivate. If you would like to inactivate all the accounts that are displayed, use the checkbox at the top of the list, just to the left of the Number column to select all accounts.
   3. Return to the top of the accounts list and click the green Batch Actions box above the checkboxes. Select Make inactive. 
4. Once subaccounts are inactivated, set the filter back to “All” or whatever filtered group you prefer. Check the boxes on the left side of all subaccounts you would like to inactivate or use the checkbox at the top of the list, just to the left of the Number column, to select all accounts.
5. Once again click the green Batch Actions box above the checkboxes and select Make inactive. 

Step 4: Edit individual accounts

1. You have the option to edit accounts individually using the dropdown list in the ACTION column on the right.
   
   1. You can Edit, which will display the same screen that you see when you add an account. See Step 2.
   2. You can Create a subaccount.‍
   3. You can Make the account inactive.

Step 5: Batch Edit

1. You have the option to edit the account number and name of multiple accounts by using the Batch edit tool. This is a pencil icon that says “Batch edit” in green on the right side above the ACTION column. 
2. When you have completed your edits, select the green Save button.

The income and expense of an operation are reported for a period of time, usually a month, quarter, or year. At the end of the accounting year, income and expenses return to zero. So when you talk about income and expense, or net income, you are never talking about totals over the life of the business, you are always talking about a specific accounting period. 

The things a business owns, and the amounts it owes, are different. Those are cumulative over the life of a business. You may own a tractor for many years, and you may owe a loan for many years. These items do not zero out at the end of the year, they are part of the business’ financial statements as long as the assets are owned or the debts are owed. They are called assets and liabilities and they are presented on a financial statement called a balance sheet. The balance sheet is the companion to the income statement. Together, the two reports paint a complete picture of your business. 

Assets 

Assets are used in the business and benefit it. They are usually presented in order of liquidity with cash presented first because it is already liquid, followed by amounts that could be converted to cash in the immediate future and then later by amounts that could be converted into cash, but not quickly, and not without being replaced or limiting the businesses ability to continue. 

There are a few different types of assets:

1. Cash;
2. Amounts owed to the business including accounts receivable and notes receivable. Accounts receivable are amounts owed to you for normal business sales. Notes receivable are amounts owned for transactions other than regular sales, such for sales of equipment or loans made to employees.
3. Property used in the business, and expected to benefit the business beyond the current accounting period. 
   
   1. Supplies, materials, and inventory on hand at the end of the year are property expected to be used or sold in the coming accounting period. They are expensed when used or sold. 
      
      1. Inventory accounting is an advanced and specialized topic.
      2. Financial accounting (producing formal financial statements signed by CPAs) requires specific methods for verifying physical amounts and calculating cost per unit. 
      3. Managerial accounting (keeping track of what is on hand, stages of production, and rates of sale) requires significant internal capacity and detailed procedures. 
      4. For tax accounting there are special, simplified methods available to businesses with less than 25M in gross receipts. See AT.3 Special Tax Requirements For Inventory On-hand at Year-end
   2. Depreciable Assets are land improvements, buildings, and equipment with an ascertained useful life. They are depreciated over their estimated useful life, or over the IRS allowable life. 
   3. Land has no ascertainable useful life, so it may not be depreciated. 
   4. Intangible assets are things like copyrights, patents, trademarks, mining and mineral rights. Intangible assets are amortized over their legal life or allowable IRS tax life. Amortization is the exact same thing as depreciation, but it is the word used for intangible assets. 

Liabilities 

Liabilities are amounts owed by the business, if the obligation to pay is certain, and the amount owed is known or can be reasonably estimated. This means that a liability is not shown on the records of a business if it is not a certain legal fact that the sum is owed, or if the amount owed cannot be reasonably estimated.

Liabilities include:

1. Accounts Payable - amounts owed in the ordinary course of business, usually for supplies and services 
2. Credit cards payable, sales tax payable, payroll taxes payable
3. Short Term Note Payable and Current Portion of Notes Payable
4. Long Term Note Payable and Long Term Portion of Notes Payable

Liabilities are usually listed in order of when they come due. 

Accumulated Depreciation

Assets are always recorded at their historic cost. The market value of an asset may go up or down, but that change is never recorded on the books of the business until the asset is sold. 

In accounting, physical assets are expected to decline in value over their estimated life, even though we know they may in fact go up in market value. The accounting estimate of the decrease in value is called depreciation. Depreciation is recorded as an expense each year, until the total amount of depreciation that has been recorded equals the historic cost, or purchase price of the asset. When depreciation is recorded as an expense, the offsetting entry is not to the asset account - because assets are always shown at historic cost. Instead the offsetting entry is to an account called Accumulated Depreciation. When you look at a balance sheet you will see physical assets listed at their historic cost, and immediately below you will see a separate number for Accumulated Depreciation, and that number will be a negative. 

The formal rules for assets and liabilities are part of what are called Generally Accepted Accounting Principles, or GAAP. When you are required to have financial statements prepared by a Certified Public Accountant, they are required to use GAAP to verify that the assets and liabilities reported on the balance sheet are presented and valued according to GAAP. 

For businesses that are not required to have CPA-prepared financial statements it is common to keep their books on what is called a “modified-GAAP” basis, combining GAAP methods for most accounts with simplified tax methods. The FarmLink Model Chart of Accounts and Bookkeeping Learning Center are designed for you to use modified GAAP when possible, and to be able to easily adjust to full GAAP if needed.  

The step-by-step instructions for creating a list of depreciable assets are included in the workbook.

Access FarmLink Model Asset List

Accounts receivable are amounts owed to you for normal business sales. 

When you make a sale at a farmers’ market, you usually receive cash at the same time you give the customer their purchase. When you deliver to a cooler or a restaurant or school, they usually ask you for an invoice, and say they will pay you later. The invoice is their record that they owe you money. Your copy of the invoice is your record that they owe you money. 

If you enter the invoices into a standard double-entry bookkeeping system you will have a report of all your accounts receivable showing who owes how much, and when each invoice is due. It will also show you how much in total is due each week. This report is very useful for ensuring that you are paid on time, for helping you to identify customers who pay slowly, and for estimating your upcoming available cash. 

You should review your accounts receivable reports at least monthly to ensure that you are being paid everything you are owed, and so you will know if any customers are often slow to pay and you can take steps to improve those relationships. 

The information in your accounts receivable reports will also help you to accurately plan your available cash, because it will show you the typical times between when you make sales and when you actually receive payment. 

This account is typically used for rent deposits. You may rent a property for many years, so unless you keep a record of your rent deposit on your balance sheet, you might not know how much is due back to you when you move. 

This account is mainly used to ensure compliance with tax regulations that limit the amount of materials, supplies and inventory costs that can be deducted during the tax year.

Most smaller operations do not record their materials and supplies on their balance sheet, instead, they record these purchases as expenses when they are purchased. However there are special tax rules limiting the amount of materials and supplies that can be deducted if they are not all used during the same year they were purchased. 

See AT.3 Special tax requirements when you have inventory on hand at year end.

Some nursery stock held for more than two years may be treated as assets held for long term gain. This will allow for a more favorable tax treatment when the items are sold. 

See AT.6 Capital Gains and Basis and AT.8 Nursery Stock

Livestock may appear in three places on a balance sheet. On the California FarmLink Model Chart of Accounts you can find livestock in accounts:

1503 Market Livestock Held for Sale (NIMS) 

2080 Breeding and Working Livestock - Purchased

2085 Breeding and Working Livestock - Not Purchased Zero Basis

Livestock accounting is quite complex, mostly because of federal tax treatment. In your bookkeeping system you will need to identify livestock held for market sale and livestock to be treated as depreciable assets.. 

Market Livestock

Purchased livestock held for market sale and on hand at the end of the tax year are treated as inventory type assets. The IRS has special rules for  this which are summarized below and explained in more detail in AL.3 Materials, Supplies and Inventory on Hand.

At the end of the year, the purchase price of the livestock still on hand is capitalized (moved with a journal entry) to an asset account. This means the expense is no longer on the income statement and will not be reported on the Schedule F as an expense. 

In the following year, when the livestock are sold, another journal entry moves the cost of those livestock back out of the asset account and into an expense account. This means the expense will now appear on the income statement in the year of the sale, and be deducted on the Schedule F in the year the animal (or group of animals) is sold. 

If market livestock are born and raised in the operation the expenses associated with the livestock are reported as ordinary business expenses when the expenses are incurred. This means that when the livestock are sold there is income, but there is no related expense in the same period. 

Breeding and Working Livestock

Livestock must be treated as depreciable assets if it is held for production of milk or fiber, for breeding, or to perform essential functions such as roping horses, herd dogs, and guardian animals. 

See AT.6 and AT.4 Livestock and additional materials in the FarmLink Tax Learning Center for more information about depreciation and about how income from sale of livestock is treated. 

Nursery stock may appear in three places on a balance sheet. On the California FarmLink Model Chart of Accounts you can find nursery stock in two accounts:

1504 Nursery Stock Held for Sale (NIMS) 

2025 Permanent Crops

See AT.5 Nursery Stock for explanations about these two different treatments. 

Permanent crops are crops that take more than one year to produce their first marketable crop. A crop is marketable if it can be sold for more than the cost to harvest it. 

Permanent crops are depreciable assets. Capitalize the cost of rootstock, saplings, immature bushes, peony roots, etc.. It is no longer necessary to capitalize the cost of raising the crop until it produces a marketable crop, however prior to the 2017 tax act this was required, so expect to see larger amounts capitalized on vineyards and orchards established prior to 2017. 

Land is an asset, but it may not be depreciated because it has no ascertained useful life. 

Land improvements include things like roads, terracing, and ponds. Whether land improvements have an ascertainable useful life and can be depreciated depends on where they are located. In areas prone to earthquakes and floods, it can be ascertained that most land improvements will fail at some time so land improvements can be depreciated. In places with roads and earthworks that are hundreds of years old, land improvements have no ascertainable useful life and may not be depreciated.   

See AT.5 Depreciable Assets and Tax Depreciation Methods and Tax Treatment of Conservation Payments.

Your phone bill or your electric bill usually arrive in the mail about a week before the amount is due. If you are using a double entry bookkeeping system, you can enter the bills in the system when they are received and indicate the day they are due. 

If you enter all of the amounts you owe in your bookkeeping system will have a report of all your accounts payable showing how much you owe by vendor and by date, when each invoice is due, and how much is due in total each week.  This report is very useful for ensuring that you pay your bills on time, and for estimating your upcoming cash needs. 

You should review your accounts payable reports each month to ensure that you have not forgotten any amounts owed and to estimate your upcoming cash needs. 

In California, food items are exempt from sales tax. Flowers and fiber are not. Sales tax is also due when you sell used equipment, even though that is not your regular business. 

When you record a taxable sale, record the sales tax portion to Sales Tax Payable. 

When you forward the sales tax to California you will take the amount from cash and from Sales Tax Payable. This way sales tax never shows as an expense. Since it is an extra amount the state makes you charge and collect for them, it is not an expense of yours. 

Check with the California Department of Tax and Fee Administration for more information. 

When you pay someone on payroll you must deduct federal Medicare and Social Security taxes from the employee’s paycheck. This is their money. You are required to take it from your employees and send it to the IRS. Since it is not your money, it should not be reported as an expense. It is a liability. It is money you must pay to the IRS. 

In addition, you must also pay the IRS the employer’s portion of Medicare and Social Security, and you may owe other federal and state unemployment taxes. Those are the amounts that are recorded on your income statement as payroll tax expenses. 

Depending on how you pay wages and associated payroll taxes you may or may not need to use the payroll taxes payable account. The best way to report payroll taxes payable and payroll tax expense in your bookkeeping system depends on the payroll service you use. When you hire a payroll service be sure to make a plan for recording your payroll expenses correctly. 

Each California county assesses property taxes on real estate and on business property. Agricultural property is a special kind of business property. 

Agricultural businesses with more than a certain amount of business property may need to file an Agricultural Property Statement, Form BOE-571-A or F, with their county. 

Check with your County Tax Assessor to see the limits for your county and learn when the tax forms are due. 

If you already have business loans when you start your bookkeeping, you will need to find the correct opening balance on  your loan accounts and enter that balance as the opening balance of your loan payables accounts. You should receive a loan statement monthly, or at least annually showing the total principle owed on the loan. Be sure to record the principle only as the amount of the loan payable. When you make a payment on the loan, part of the payment goes against principle. That amount will reduce the balance of the loan payable account and result in less total liabilities on your balance sheet. Part of your payment is for interest expense. Interest expense goes on your income statement and reduces your net income. 

It is common to forget to post a loan payment as partially towards principal and partially towards interest, so it is important to check the loan balance shown on your balance sheet to the loan balance shown on your loan statement at least once a year. You want the balance in the loans payable account to equal the principal amount shown as outstanding on your loan statement, and you want the total interest expense for the year to equal the amount shown as interest expense paid for the year on your loan statement. 

If you have corrected your payment entries to record the principal and interest amounts correctly but your balances do not agree to your loan statement, the error may be that one or more payments were recorded in a different year by you and the lender, or it may be that the lender made an error. If you think your lender has made a mistake do not hesitate to reach out to them. It is their responsibility to explain to you how they arrived at their number and to correct any errors they may have made. 

In formal accounting loans are presented in order of when they come due. The California FarmLink Model Chart of Accounts has accounts for different types of loans such as operating loans, equipment loans, and longer term loans for developing buildings or permanent crops or purchasing land. 

Equity is the net total value of the owner’s interest in the business. If there is only one owner then all of the equity in the business belongs to the one owner. If there is more than one owner then the total equity is the sum of each of their total interests in the business.  

Owners investments increase owners equity. Owners draws decrease owners equity. 

The term “Retained Earnings” is properly only used by corporations, but Quickbooks uses it for all types of businesses to represent total equity. The exact proper names of equity accounts changes depending on the legal form of ownership: 

Sole Proprietorship

Beginning Owners Equity

Owners Contributions

Owners Draws

Ending Owners Equity

Partnership

Beginning Partners Capital

Partners Contributions

Partners Draws

Ending Partners Capital

LLC

Beginning Members Capital

Members Contributions

Members Draws

Ending Members Capital

S-Corporations 

Retained Earnings

Shareholder Contributions

Shareholder Distributions

Special Tax Basis Accounts

Supplies and Materials on Hand

Generally you deduct the cost of materials and supplies you consume and use in your business during the tax year, but often you have some left at the end of the year. The supplies and materials on hand at year end will benefit a future accounting period, so they are properly recorded on the balance sheet as assets. When they are used in the following year they are deducted as expenses. For tax purposes there are special tax rules that limit how much you can deduct if you have supplies and materials on hand at the end of the year. 

Inventory on Hand

Inventory on hand at the end of the year includes crops, fiber and other farm products that have been processed for storage or value added products, animals intended for market sales, and nursery items. Inventory on hand at year end will be sold in a future accounting period, so it is properly recorded as a balance sheet asset. When the inventory is sold the amounts recorded on the balance sheet are expensed - the balance sheet account is reduced and an expense account is increased.

In formal inventory accounting there are a number of techniques and methods for calculating the value of inventory on hand and the amount of inventory to expense when inventory is sold. For tax purposes you are allowed to use simpler methods that generally result in less tax owed than if you had used formal inventory accounting methods. 

If you keep no records of how much of the supplies you have on hand and how much you use, you may deduct the full cost in the year it is paid.

If you keep any records that show inventory on hand and inventory used there is a general rule for all taxpayers, and a special rule for farmers.

Special rule for prepaid farm expenses (feed, seed, fertilizer, or other similar farm supplies): 

Your deduction is capped at 50% of your total other farm expense deductions unless one of the following is true:

1. 50% of other expenses exception 
2. 3-year total rule

AND one of the following apply: 

• principal residence is on the farm
• principal occupation is farming 
• taxpayer has a family member who lives on the farm or whose principal occupation is farming

No deduction is allowed if the payment is only a deposit, and the supplies must be intended to be used in the business within 12 months.

For more information see IRS Publications 225 and 535.

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

Inventory on Hand

Inventory on hand at the end of the year includes crops, fiber and other farm products that have been processed for storage or value added products, animals intended for market sales, and nursery items.

Tax Rules for Inventory on Hand

Prior to 2018 the tax rules for inventory were much more complicated. If you need to file returns for years prior to 2018 you will need to use the old rules.

Since 2018, Taxpayers with less than $25 million in gross revenues may choose to use a simplified inventory method called “Non-Incidental Materials and Supplies” or NIMS. Taxpayers may also choose to report inventory on their tax returns using the method they use for their internal accounting or on their CPA-prepared financial statements. 

If a taxpayer does not choose the NIMS inventory method, then by default they have chosen the method they use for internal accounting. If you keep no inventory records of any kind, this is not a problem, but if you keep any kind of inventory records, the IRS could make you pay taxes based on those records. This would usually result in more taxes owed. 

Make a protective NIMS election

A taxpayer chooses NIMS by making a “NIMS election.” 

The NIMS method is generally the simplest and most advantageous method because it allows taxpayers to deduct some inventory-related expenses without keeping detailed records on all inventory costs or specific sales of inventory items.

NIMS is only used for tax purposes. It is not a method that  creates accurate inventory valuation for purposes of managing a business or creating formal financial statements for lenders or others outside of the business. 

A taxpayer chooses the inventory method they will use for their business by filing the tax return the first year the inventory method is used. Whatever method they used - knowingly or unknowingly - on that first return is the method they must use going forward for that business for that type of inventory. A taxpayer may not change accounting methods without IRS approval. Obtaining IRS permission to change accounting methods is a costly and cumbersome process.

A taxpayer may elect the NIMS method (the easiest and most advantageous method) by reporting NIMS inventory on their tax return the first year they have value-added inventory on hand at the end of the year.  This is called a “protective election.” By electing NIMS you protect yourself against the IRS determining your taxable income using another, less favorable, method. 

Making a NIMS election 

1. Determine the direct costs that go into value-added inventory. For NIMS direct costs are supplies and materials you purchased to create or pack the product, or the cost of custom processing/packing.
2. Determine how much value-added product associated with those costs is on-hand at the end of the tax-year (generally midnight on 12/31).
3. Report your costs on the Schedule F as you would without the NIMS election - AND
4. Add a new expense line called “LESS: NIMS INVENTORY ADJUSTMENT” and record the amount calculated in Step 2 as a “NEGATIVE.” This makes it extra clear to you and the IRS that you have made a NIMS election, and it leaves a clear record of the amount of NIMS inventory you did not deduct - and which you may deduct in the following year. 

NIMS only requires you to consider direct costs in inventory. That means only supplies purchased or contract labor associated with custom-packed products. You do not have to include the cost of wages you pay, or any of the overhead associated with your facilities when you calculate NIMS inventory. That means you can deduct those costs in the year they are paid. Most book inventory methods require including these other costs in inventory.

To be very clear on your tax return, you should show the amount of NIMS inventory as a negative expense clearly labeled as NIMS inventory. This reduces total deductions as required, and makes it clear to the IRS (or your future self) that you have made a NIMS election. 

Reporting in years after you first make the NIMS election 

1. Add the prior year negative NIMS inventory adjustment amount to supplies expense—this increases supplies expense by the amount you did not deduct in the prior year. 
2. Repeat steps 1-4 above. 

When you account for NIMS inventory it typically means that you may not take a current year deduction for expenses you paid in the current year. Instead, you deduct those expenses in the following year. 

If you do not account for inventory correctly on your tax return it means that in the first year you have over-deducted, and thus possibly under-paid your taxes. In all of the subsequent years you will both under-deduct and over-deduct. You will under-deduct by the amount you over-deducted in the prior year, and you will over-deduct by the amount that should be deducted in the following year. If your year-end inventory amounts do not fluctuate much, there will be minimal tax effect after the first year. However, if you fail to account for inventory correctly and are unable to show the IRS records of your reasonable inventory calculations, the cost of working with the IRS and correcting your records and your prior tax returns can be greater than the total amount of taxes underpaid. This is why it is safest to make the NIMS election and show a NIMS adjustment each year. 

Talking with your tax professional about NIMS

1. Tell your tax preparer you want to make a NIMS election on your tax return.
2. Describe to them the inventory you have on hand at the end of the tax year. 
3. Let them propose an amount for the NIMS inventory adjustment. 
4. Review the amount and the calculation with them and approve the adjustment. 
5. Ask them to give you the adjusting entry to make on your books. 

If you want to be successful with a value-added business your success will depend on your ability to manage inventory. Managing inventory means knowing the cost of your inventory and knowing how fast (or slow) your inventory sells. NIMS is probably the best tax method for reporting inventory, but it is probably not the best method for actually managing your inventory to maximize profits. 

The USDA Value-Added Producer Grant Program (VAPG) is a cost-reimbursement program intended to help farmers and ranchers establish profitable value-added businesses. One of the things you can do with VAPG funds is pay to design and implement good inventory systems for your internal management purposes and for proper tax reporting. 

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

Depreciable assets are things that have lasting value to the business and have an “ascertainable useful life in excess of one year.” 

Assets are not expensed (deducted) when purchased. Instead you take a “depreciation deduction” using special forms that are part of your tax return.

Assets have lasting value to the business include equipment, machinery, fences, wells, buildings, hoop houses, breeding animals, work animals such as roping horses or guard dogs, and trees or vines that bear annual crops. 

What is an ascertainable useful life? It means you know the asset will not last forever, and it can be objectively determined if the asset is still useful or functional. Buildings, trees, vines, fences, equipment, etc. are all depreciable assets because we can clearly ascertain that at some point they will cease to exist. 

Assets are depreciated over their useful lives or their tax lives, or in many cases you may take "bonus" depreciation and deduct the full amount in the year of purchase. 

As a matter of common practice if an item will be used for more than one year but costs less than $500 dollars the item is treated as an expense and not as an asset. 

Land is an asset—but not a depreciable asset because while the land might be alive you can not ascertain how long it might continue—it might go on forever or at least far past our ability to imagine. Because we can not determine that land has a life that ends, land cannot be depreciated. 

Some land improvements have no ascertainable useful life and cannot be depreciated. We will discuss some special rules for special kinds of land improvements and farm assets in Lesson 6.

See IRS Publication 225 for more information on special rules for land improvements and farm assets.

For more information about how to depreciate assets see IRS Publication 946.

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

When you sell an asset the income is not part of your business income, it is reported separately as Capital Gains Income. 

Capital Gains are taxed at a lower rate than self-employment income. 

Capital Gains Income is: 

Gross sales price

Less your basis in the asset 

Less costs of the sale

__________________

Equals: Capital Gains Income (or Loss) 

Basis is: 

1. cost basis which is your purchase price or cost to build
2. gift basis or the donor's basis when they gave it to you or 
3. for inherited assets you have a special “stepped-up basis.” 

Stepped-up basis is the fair market value of the asset on the date of death of the person from whom you inherited 

You may increase your basis in an asset if you incur costs by making improvements to it.  

Your basis in an asset decreases by the amount of the depreciation that would be allowed on your tax return—and it decreases by this amount even if you don’t take the deduction on your tax return! 

You need records to show your basis in any asset you sell. 

Capital gains and losses from sales of business assets are reported on your tax return on Form 4797. 

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

Breeding and working animals are depreciable assets

Breeding and working animals must be treated as depreciable assets for tax purposes. This means the cost to purchase them is not allowed to be treated as a regular business expense, instead, it must be deducted by following the IRS rules for how depreciation is calculated and deducted. 

Dairy cows, breeding bulls, animals kept primarily for fiber, roping horses, herd dogs, and guardian animals are all examples of animals that must be treated as depreciable assets.

When animals held as assets are sold, the income is not recorded as regular farm or ranch income. Instead, it is reported as capital gains income, which has a more favorable tax treatment. 

Animals held for sale may be NIMS inventory if they were purchased

Animals held for sale are called market animals and are not treated as depreciable assets even though you may own them for more than one year. Feeder cattle, purchased lambs, goats and poultry intended for live sales or meat are all examples of market animals. 

If you have market animals on hand at the end of the year, you might need to make a NIMS inventory adjustment if any of those animals were purchased. 

Market animals you have raised in your operation have already been fully expensed. You do not need to make an inventory adjustment to reflect the value of market animals raised. 

For operations that are growing a breeding herd and also growing annual sales it can be difficult to keep track of which animals are assets and which are held for market because you might change your mind. 

Livestock accounting is a specialized area. Fortunately there are many great resources available through various Extension programs around the country. 

For more information on livestock accounting see Pub 225 and look for guidance from Extension agents specializing in livestock operations like yours. 

This resource is derived from materials developed by the University of Arkansas School of Law Agricultural Tax Training as part of the Agricultural Financial, Tax and Asset Protection (AgFTAP) partnership with the University of Arkansas Southern Risk Management Education Center and others. 

Nursery stock held for sale 

Nursery stock held for sale may be NIMS inventory to the extent it includes purchased items such as seeds, starts, growing mediums and containers. 

See AT.3 Special Tax Requirements For Inventory On-hand at Year-end

Permanent Crops

Nursery stock is treated as permanent crops if it is held primarily for propagation. If it is later sold the income is capital gains income.

The Tax Organizer is designed for farmers and ranchers, and it can be used if you or your spouse also have rental real estate or another business. 

This organizer is helpful if:

• You use a paid tax preparer, especially if you are using a new tax preparer or having your taxes prepared for the first time
• You are behind on your taxes and need to organize information for one or more prior years
• You plan to do your own tax returns using online tax preparation software
• You have not kept all of your business income and receipts organized during the year and need to get them all organized now to prepare your tax return

The purpose of the organizer is to make sure that you have all of the tax information you need in one place. If you are using a paid tax preparer this information will ensure that they have all the information they need. This is especially important if they are not specialized in preparing farm or ranch tax returns. 

If you are planning to prepare your own tax return using online tax software like H & R Block or Turbo Tax, this organizer will help you to be sure that you are entering all of the information that relates to your farm or ranch. If you answered a question here, but did not find any place to put that same information into the online software program - keep looking, or get help, because you need that information to file a complete and accurate return. 

If you are not using a bookkeeper or a bookkeeping system and need to organize all of your receipts and other documents, this organizer will help you to do that. 

Section A: General Information. 

This section lays the foundation for your tax return. Answer the questions to the best of your ability, they will affect your filing status, the way your tax is calculated, and the deduction you are entitled to.

Section B, Income Not Related to Farming and Ranching. 

This section asks questions to help you identify any income that is not related to your agricultural activities.

Section C: Real Estate. 

This section helps to organize  information about your property holdings and rental activities. If you do not own any real estate you may skip this section. 

Section D: Non-Farm Self-Employment Income and Expense.  

This section is for any non-farm self-employed business owned by you or your spouse. 

Section E: Farm or Ranch Business Income and Expenses. 

This is the section for organizing your farm business income and expenses. 

Section F: Other Deductions Not Related to Your Business.  

This section will help you to organize various deductions unrelated to business activities, including expenses for home mortgage interest, property taxes, charitable contributions, interest paid on student loans, and expenses for dependent care. 

Section G: Other Credits. 

Credits reduce taxes owed. Answer the questions in the section to ensure you take every credit for which you qualify.

Section H: Saving for Retirement or Education. 

This section asks questions that will help you learn if you can save on taxes by saving for retirement. 

Section I Payment of Taxes During the Year. 

Be sure to review all of your payments to the IRS and any state income tax authorities made during the tax year, as well as any payments made in the following year, such as payments made with a request for extension. 

If you have your tax return prepared by someone else, use this checklist to guide your review of the tax return and help you to ask your tax preparer for additional information. 

You might not need your business plan in writing in order for you to understand your business, but a lender will need to see at least a basic written business plan so they can understand your business.

You may not think you need credit, or plan to apply for credit - but credit is an essential part of most businesses - at the very least to help recover from unexpected setbacks. You may also need a business plan to apply for grants, educational programs, or high quality land tenure opportunities. When land trusts, parks, and other landholders make lease or purchase opportunities available to farmers and ranchers, they typically require a detailed written business plan as part of the competitive application process.

Creating a business plan today helps you be more prepared for an uncertain future. It helps you to think through what you intend to do, and what might go wrong, and how to mitigate those risks. It makes you more prepared to access credit (and other resources) quickly if you need to. 

A business plan is a summary of:

1. Business ownership structure 
2. How key assets (capital) are acquired and used in the business
3. Production and marketing activities
4. An overall management plan including risk management plans 

You should be specific and concise. Write to describe, not to convince. Your plan does not need to be long. A simple plan can fit on one or two pages. Describe your key calculations in words and show them in numbers. 

A business plan should demonstrate that you have a genuine profit motive

A profit motive is the intention to have annual sales in excess of annual expenses, or to create assets with long-term value in excess of costs, or to do both.  

Your theory of profit, or business model, is your idea about how to have revenue in excess of the expenses needed to generate revenue. For example: 

• Growing crops and selling wholesale is a business model. Revenue comes from wholesale sales and if it is greater than the cost to produce and harvest crops the business might be profitable. 
• Raising livestock for the live auction market is a business model. Revenue comes from selling animals at auction and if it is greater than the cost to raise and transport the livestock the business might be profitable. 
• Growing crops and selling at farmers’ markets and through a CSA is a business model. Revenue comes from direct to consumer sales and if it is greater than the cost to produce, harvest and distribute the crops the business might be profitable. 
• Growing feed crops to supply a livestock operation that produces wool and processes some animals for direct-to-consumer meat sales is a business model. Growing feed crops saves costs related to wool and livestock production. If wool and meat revenues exceed costs to raise feed crops and livestock and process and distribute wool and meat, the business might be profitable.

A business plan demonstrates a profit motive by summarizing the details of the business model describing goods or services offered, the markets or customers, the cost of offering them, and when revenue is expected to exceed cost.

A business plan should include strategies to minimize the risk of loss.

A business plan identifies the elements of a business that can be managed and strategies for managing for profit and to minimize risk of loss including:

1. Structuring to Separate Assets from Risk: Structuring a business includes selecting the right business entity and ensuring that valuable assets are owned outside of the entity that conducts day-to-day activities. Typically agricultural operations include an operating entity that engages in day to day activities, and a land owning entity that rents the land to the operating entity.
2. Obtaining Property and Liability Insurance: A business plan should discuss the appropriate insurances needed. The budget should include an adequate amount to cover property and liability insurance. Property insurance provides an indemnity if property is lost or damaged. Liability insurance covers the cost of legal defense and settlement.
3. Planning and Preparing: A business plan should include preliminary plans to ensure:

• Worker and product safety.
• Emergency preparedness.
• Regulatory compliance.

Structuring a Business

Structure is the way a business is owned, how owners buy in, how profits are shared, how assets are used, and how liabilities are limited and shared.

What does it mean to own a business?

A business owner has invested capital and is entitled to receive a share of profits.

The legal form of ownership will determine how the owner makes their investment of capital and how profits or losses are shared.

Depending on the legal form of ownership, there may be documents that specify how owners are entitled to direct the activities of the business.

Business Entity and Ownership Type

Informally we say that the legal form of a business is the entity type. Formally a business is a separate legal entity if it can sue and be sued separately from its owners. These formal business entities include Limited Partnerships, Limited Liability Companies, and Corporations.

• Sole Proprietorship is the default legal ownership for a single owner.
• General Partnership is the default legal ownership for more than one owner.
• Limited Partnership, Limited Liability Company, and Corporation are forms of legal ownership that must be deliberately created under state law.

What is Capital? 

The resources that allow you to operate your business.  

• Cash
• Equipment
• Labor
• Land and natural resources
• Knowledge (technical, processes, procedures)

Credit, leases, and labor agreements are all ways to access capital beyond the owners’ original contributions of capital.

Capitalizing a Business

Owners capitalize a business by contributing cash, or other assets like land or equipment. 

A business plan provides a preliminary assessment of the cash and credit needs of a business.

If a business does not have enough cash, it is “under-capitalized” and may have to take on debt.

At-Risk Capital

Once an owner invests their capital (usually cash and equipment) into a business, that investment is at risk. It may be used to:

• Fund unprofitable activities
• Repay debts that can not be paid from business profits
• Settle legal claims against the business

At-risk capital is also called invested capital because of the risk of loss.

Unlimited Personal Liability

Owners of sole proprietorships and partnerships have unlimited personal liability for debts, fines, penalties and legal judgments against the business.

• May have to use personal savings.
• May have future wages garnished.
• Liability may extend to a spouse’s savings and future earnings.

In a partnership, each partner (and their spouse) is liable for all obligations of the business.

Limited Liability

Business owners may limit their liability to only their at-risk capital contributions by forming a limited partnership, limited liability company, or a corporation. 

These entities are formed under state law (or sometimes Tribal or federal law) and may provide liability protection, limiting the owner’s risk to only their invested capital. These entities will never protect an owner from the risk associated with negligence or deliberate bad acts.

Ownership Rights and Obligations

A business plan discusses the owners' rights and obligations including:

• The amount of cash each owner will initially contribute.
• The owners’ rights to direct and manage the business.
• Circumstances under which an owner may be required to contribute additional cash.
• Limitations on how much owners may withdraw.
• Circumstances under which an owner may withdraw capital from the business.
• Restrictions on the sale or transfer of ownership interests.
• How profit and loss will be shared.

A business plan identifies the key assets needed for the business and identifies when and how those assets will be acquired.  Agriculture and fishing rely on natural resources and other specialized assets.  A lender who understands your industry expects a business plan to discuss key assets. A lender who does not understand your industry is even more in need of a discussion of key assets.

Many assets are substitutes for labor. Labor is an expense - you pay as you go. Assets are an investment, you pay up front, they save you expenses month to month, and then eventually they need to be replaced. But if you finance asset purchase or acquisition, you pay month to month - so it may be just as affordable as labor if you qualify for fairly priced credit.

Assets versus labor is one of the most important decisions you will make as a farm owner, and you will make it over and over again. 

• Your own labor or hired labor?
• Your own labor or equipment?
• Hired labor + more labor or more equipment? 
• Cheaper land & more drive time or more expensive land and less drive time? 

Land is the main driver of and constraint on profitability:

• Location
• Distance to market / Quality of market
• Distance to services and inputs / Quality of available services
• Distance from workforce / Quality of workforce 
• Local government - attitudes, support, hindrances
• Housing availability
• Neighbors
• Productive capacity (soils, acres, water access) 
• Climate and micro-climate(s)

Depending on your business operations plan, you may also need valuable infrastructure including: 

• Buildings
  
  • Packing and Cooling
  • Storage for equipment and supplies
  • Office
  • Other needs? 
• Equipment
  
  • Planting, weeding, harvesting
  • Packing, and transportation
  • Selling (market stand, etc) 

• Permanent Crops
  
  • Orchards
  • Vineyards
• Land Improvements
  
  • Wells, ponds
  • Hedges, wind breaks
  • Irrigation  
  • Roads
  • Fences
  • Septic
  • Electric 

Asset Acquisition Plan

For each asset that you need in your business, consider the direct contribution each asset makes to your theory of profitability, and when the asset is needed. If the asset does not contribute directly or immediately, is it still necessary, and/or when will it be needed? 

Cash or Credit? 

It is relatively easy to get a loan for an asset because the loan is secured by the asset. It is relatively difficult to get an operating loan because even though the lender takes a lien on the crop - the lender does not want the crop. One of the biggest mistakes beginning farmers make is using cash on assets and then coming up short on operating cash. If you are short on operating cash and have to get a loan, it may be too late in the season to get a loan from a lender focused on agriculture, and loans from other lenders offer fewer protections, less expert guidance, and may have higher rates. Some people end up using credit cards with 20% interest rates - it’s an expensive mistake!  

Planning for Maintenance and Replacement of Assets 

Your plan should consider the regular maintenance needs for each significant asset, the true estimated useful life of the asset. Consider when and how the asset might wear out, if the technology might change, and how you will research and finance the replacement. 

Time is one of the key constraints on your business. 

• Plan your own time to ensure you are able to do the tasks only you can do. 
• Plan to outsource tasks you can outsource as soon as possible as you grow.

Understand the legal requirements for who must be on payroll and who may be paid as an independent contractor. Be sure to budget for all legally required labor costs. 

Labor Can Cause Cash Flow Issues

Once you hire payroll labor, you are required to pay every two weeks. If the labor you hire is not directly related to generating cash receipts, you may find that you owe wages and payroll taxes before the related revenue has been received. Careful cash flow planning and planning for what type of labor to hire can help with this. 

Hire first for work directly related to income so you have immediate incoming cash to cover wages.

• Planting short term crops
• Weeding
• Harvesting
• Sales deliveries

Do not hire for labor that does not relate to immediate revenue unless you have a cash flow plan to cover labor. Examples of labor with a longer-term payoff include:

• General maintenance
• Planting long-term crops 
• General marketing 
• Asset construction or development

Budgeting for Labor

To budget accurately for labor you will need a detailed list of tasks and an estimate of time for each task. The best way to estimate time for a task is to time yourself doing the task. You can also ask others, or look at University Extension studies. 

Your cost per hour for payroll labor includes: 

• Hourly Wage
• 15% for FICA and Medicare
• 5% for unemployment and other state taxes
• 5-10% for workers compensation insurance

Many businesses budget a standard 25% on top of hourly wages to factor in all costs including vacation and sick leave.  

Planning to Manage Labor

California has strict laws protecting workers. If you employ anyone other than your legally married spouse or your children or parents to help you in your business, they must be covered by a workers compensation policy. Most workers on a farm or ranch are required to be on payroll with state and federal payroll taxes paid. In addition, you are required to keep detailed records showing that you are in compliance with laws covering hours worked, breaks given, the time, manner and amount of payment, safety training, heat and illness prevention, and a number of other protections. 

Before you hire you will also need a plan to manage labor including: 

• Basic employee records including I-9s
• Legally compliant payment practices including:
  
  • Providing required notices to employees
  • Tracking earned sick/vacation leave 
  • Making timely payroll tax deposits
  • Filing timely W-2s
  • Documenting hours worked and breaks taken
• Creating a safe and respectful workplace
• Policies and procedures covering physical safety, general conduct, discrimination, harassment, etc. 
• Training and documentation of training
• Preparing for audits, inspections, and raids

Be sure you understand the essential requirements of an employee before you hire. Once you do hire, be sure that you have all required and recommended records and that they are secure and easily accessible to you in the event of an audit. 

Your business plan should clearly demonstrate that you have a viable plan for managing your business including keeping and maintaining required records, and making time to review critical data and make strategic decisions about the direction of the operation. 

A personal time budget may be one of your most critical management tools. This is especially true if you have an outside job in addition to your farm or ranch job. Be sure to distinguish between what you need to do to have the records and data you need, and actually making time to review the records and data and use them to improve your business. You can often outsource many of the tasks related to creating and maintaining the records, but you are usually the only person who can review the records and use them to make management decisions. 

Financial Records and Decisions

You are required to keep financial records that are adequate to support the items of income and expenses that you must report on income tax, property tax, and sales tax returns.  

You will need to select a bookkeeping system and decide what level of assistance you want from a bookkeeper. Many bookkeepers bundle the cost of the bookkeeping program with their monthly fee. Be sure that you own your own data. Bookkeeping costs vary by the number of transactions per month. Plan on at least $150/month. 

You will need to ensure that you have dedicated time each week and each month to ensure that bookkeeping tasks are completed as expected, and to review financial data for purposes of ensuring you are on budget and have adequate cash on hand. 

Non-Financial Records and Decisions

You will need detailed production and sales records to inform future decisions based on what you did in the past. They are also required in order to access agricultural credit, crop insurance programs, and disaster assistance, and will affect the value of your land if you own land and later sell it. 

You probably will not be able to outsource keeping production records. Instead you will have to ensure that you have a system to record and review key information such as: 

• What, where and when you planted;
• Harvest dates and yield amounts;
• Animal breeding records with breeding and birthing dates, weights, growth rates and vaccination schedules;
• Product and amounts sold by customer or market;
• Price per unit; 
• Payment terms;
• Customer payment performance, other customer data and notes.

Planning for Physical and Non-Physical Information 

You will need a plan and a budget for how you will manage your physical and computer systems including regular mail, e-mail, and physical and digital data and document storage. Be sure to consider: 

• Where will online files be kept?
• Where will physical records and files be kept?
• What are the backup systems?
• What physical and digital data security systems will you need? 
• What is the plan to retain documents and to destroy them after an appropriate period?

You may consider budgeting for general office support sooner rather than later, since many aspects of developing and maintaining good office systems can be outsourced. 

Your role as a manager is to ensure that you have the data you need to make good decisions, and to use the data you have to manage current and future operations.  If you spend too much time just acquiring and managing data you won’t have time left to be thoughtful about how you use data.

A good management plan will prioritize your role as a leader, and make the tasks associated with gathering and maintaining data as routine and efficient as possible. 

How Long to Keep Records? 

Keep most records for 3 years from the date you filed your original return or 2 years from the date you paid the tax, whichever is later, if you file a claim for credit or refund after you file your return. 

• Keep employment records for 4 years. 
• Keep records for 7 years if you file a claim for a loss from a bad debt.
• Keep records related to depreciable assets as long as you keep the assets.
• Keep records related to asset sales for 3 years after the sale. 
• Keep records related to land for as long as you own the land and 7 years after the sale of land.

Cash flow is a dynamic concept that focuses on how the quantity of available cash changes during the year. 

Agricultural operations typically require an upfront investment and a period of time to pass before the owner has product available for sale and receives cash from sales of products. This means there is a period of negative cash flow before there is positive cash flow. If the business has enough cash at the beginning of the year to cover the period of negative cash flow, it is self-financed. If it needs help with that gap, it needs access to credit. 

Agricultural credit is essential to most operations. It is designed to help a business owner to bridge the gap between when they expend money to grow or raise a product for sale and when they will receive income from a sale. The problem is, it can be hard for an owner to understand if credit is covering a cash flow gap in a profitable operation, or if credit is helping an operation which is not profitable to remain in business. It can be hard for new business owners to distinguish between net income and available cash, but this is an essential skill. 

A general rule is that agricultural operations that require a larger up-front investment and a longer waiting period (orchards and vineyards) are more profitable than those with a smaller upfront investment and a shorter growing period (e.g. leafy greens). 

• Adding value to a product by transforming it from something that will spoil quickly and therefore must be sold quickly increases the amount of cash and time invested in the product before it is sold. So, adding a value added product to your operation may increase your net income, but it may also increase your cash flow problems. 
• Planting peonies on land currently used to grow annual flowers is likely to result in a significant increase in gross sales per acre - but not for a few years. So, adding a high-value crop to your operation may decrease your net income and cash flow for a while before eventually increasing your net income and improving your cash flow. 

If you have a business plan that will result in positive cash flow and net income within a year, or over the appropriate payback period, then credit can be a valuable tool to help you through periods in your growing cycle when you are short of cash. 

If you use credit to help with cash shortages in an operation that does not have a solid plan for positive cash flow and net income within a year, or over the appropriate payback period, then credit will only worsen your problems.  

It can be hard for new business owners to distinguish between net income and available cash, but this is an essential skill. 

Cash Flow has four components:

1. From business operations
2. From assets bought or sold
3. From debt taken on or paid
4. From owner’s contributions and withdrawals

Net Income has three components:

1. From operating activities only, also called ‘Gross Profit’
2. After also including administrative and other expenses
3. After also including extraordinary income or expense items such as lawsuit settlements or disaster events

Cash balances change due to: 

Increases

• Payments made for expenses incurred
• Loan proceeds received
• Owner’s investments received
• Payments received for assets sold

Decreases

• Payments received for sales made
• Payments made for loans owed
• Payments made for owner’s draws
• Payments made for assets purchased

Cash is not included in the calculation of Net Income. Net income changes when:

Increases

• Sales are made - regardless of when cash is received
• Assets are sold - regardless of when cash is received

Decreases

• Expenses are incurred, regardless of when cash payments are made
• Assets are purchased - regardless of when cash payments are made

Note the cash flow items not included in net income: Owner’s investments or draws, loan proceeds, and loan payments. 

If you plan to use credit in your business be sure you can clearly identify why you need the credit—the specific things the credit will cover, and the period of time for which the credit is needed. The term of a loan should match the time frame of the purpose of the loan. 

Agricultural lenders typically offer: 

• Operating Loans designed to cover the gap between planting and sale in an annual operation
• Equipment Loans designed to spread the cost of a piece of equipment over 3-7 years
• Development Loans designed to spread the cost of significant land development (wells, fences, trees, vines) over 3-15 years
• Workforce Housing Loans designed to spread the cost of developing worker housing over 15-30 years
• Land Loans designed to spread the cost of a land purchase over a significant period of time, 10-30 years

One of the ways successful growing operations get in trouble is when they use short-term operating credit for longer-term purposes, such as equipment purchases or planting permanent crops. 

Owner’s Draws

Another way operations get in trouble with credit is when a portion of the funds are used to fund the owner’s living expenses if the operation is not sufficiently profitable. 

Owners may take draws from the business as they please, subject to available cash. Owner’s draws are not business expenses. Ideally owners take draws when the business has sufficient cash, and forgo draws during times when the business is short on cash. But, sometimes this is not possible. If the owners do not have other sources of income, ag lenders may treat owner’s draws as if they were necessary salaries or wages included in operating loans. While it is a common practice, borrowing for owner’s draws is borrowing to cover personal living expenses or future profits. Be sure you understand if you are including owner’s draws in a request for operating credit.  

Before applying for credit be sure you have a cash flow plan that shows your net cash from operations, your net cash available to re-pay credit, and distinguishes between cash needed for operations, equipment and long term needs, and owner’s draws. 

A risk management plan starts with defining and evaluating risk and then matches risk mitigation strategies to risks and sets priorities for implementation.

Define risks by considering categories or types of events that would threaten the success of your business plan. There are two common frameworks for thinking about risk in a farming, ranching or fishing business: 

• The Five Ds: Death, Divorce, Disaster, Disability, Disagreement
• Business Plan Assessment Framework: 
  
  • Production 
  • Marketing 
  • Financial 
  • Legal and Regulatory
  • Human

Evaluate risk by assessing both the likelihood and the severity of consequence from an adverse event.

Mitigate risk by matching risk to an appropriate risk management strategy:

• Death, Divorce, Disability, Disagreement: insurance, strong operating agreements, written leases and contracts
• Disaster: physical protection of assets, insurance for assets
• Production Risks: diversification of production, multi-peril crop insurance 
• Marketing risks: diversification of markets, revenue protection insurance
• Financial risks: strong accounting systems, insurance, strong operating agreements, written leases and contracts
• Legal and regulatory risks: strong management systems, strong training policies and procedures, strong operating agreements, written leases and contracts, regular meetings with appropriate legal counsel when indicated before taking a new, large, or risky course of action
• Human risk: strong management systems, strong training policies and procedures, insurance

Prioritize which risks are most critical and which mitigations are most strategic. 

1. Protect critical assets, identified as those most essential to your operation 
2. Address greatest vulnerabilities, identified as most likely vectors for material losses 
3. Are known to be effective and have a high probability of protecting your operation
4. Benefit your operation regardless of the risk they mitigate. 

Insurance is one of the most important business risk mitigation tools. There are several broad types of insurance, including property, liability, and income, and many specific insurance programs and policies. 

Property insurance covers the cost to replace property lost or damaged due to insurable causes of loss like theft, fire, flood, and accident. Liability insurance protects against the cost of defending against a lawsuit, and pays the cost to settle a lawsuit, or the cost of a legal judgement against the insured. Income insurance provides ongoing income when regular income is ended or interrupted due to an insurable cause. 

Homeowners and business owners insurance are combined policies that cover both property loss and liability related to damage to other people or other people’s property. Automobile insurance works the same. 

Be careful! A homeowner’s policy will not cover a farm business and a personal automobile insurance policy will not cover accidents related to a business. 

Workers compensation insurance is a special kind of liability insurance for employers and income insurance for employees. Each state has laws requiring employers to pay into a workers compensation insurance program to ensure that workers will receive income if they are injured at work and unable to continue working. The program also minimizes the risk that employers will be sued for liability beyond what is covered by the workers compensation insurance. 

Disability insurance is different from workers compensation insurance because it replaces earned income when the insured is unable to work due to injury or illness regardless of the cause of the injury or illness. Businesses can purchase disability insurance for employees as an optional employee benefit.  

Businesses can also buy business interruption insurance, and farmers and ranchers can buy crop insurance, which is a type of combined property and income insurance. 

Crop Insurance

There are some private types of crop insurance, typically specialized hail, fire and tree crop policies, which are developed and administered entirely by private insurance companies

Most crop insurance is Federal Crop Insurance. 

Policies are developed and administered through a public-private partnership between a number of private insurance companies and the Risk Management Agency of the USDA. 

Crop insurance may be purchased by a landowner, tenant, or sharecropper as long as the policy holder shares in the risk of producing the crop and is entitled to an ownership share of the crop. 

The main types of crop insurance are: 

• Multiple Peril Crop Insurance (MPCI) 
• Livestock policies
• Revenue policies including “Whole Farm” and “Micro Farm” policies.
• Pilot programs (specialized, experimental)

Policies must be purchased prior to planting. Some policies can cover prevented planting due to weather-related events, some cover loss of price or price margin, and one product insures the average revenue of the whole farm operation.

Limited coverage for certain types of livestock and for pasture, rangeland and forage are also available. 

Most policies are written for a single crop in a limited number of states and counties and cover loss of crop yields due to natural causes including drought, excessive moisture, freeze, and disease. 

If a policy is not available in your county but is available in a nearby county, you can request, and will usually receive, special permission to purchase the same coverage in your county. 

Non-insured Disaster Assistance Program

The USDA Farm Service Agency administers a program for producers who do not qualify for other types of crop insurance, it is called NAP which stands for Non-insured Disaster Assistance Program. 

NAP is relatively inexpensive to purchase. It is not intended to fully compensate you for crop losses, instead it is intended to help mitigate the cost of disasters and lessen the need for emergency legislation to assist when a farming community is hit hard by a natural disaster such as a wildfire or a tornado.

The purpose of an estate or succession plan is to ensure your wishes are carried out during your life and after you pass away. An estate plan includes legally binding documents and may also include non-binding instructions. A simple plan includes these key documents:

1. Will: A formal legal document providing written instructions for how your estate will pass after you die, and who will care for minor or dependent children. Writing a will that directs all of your assets to a trust is a way to ensure your estate will be administered with the least fees and administrative burdens.  
2. Trust: A special legal document that can be used during your life or after. It is a legal way that property is owned and includes written instructions on how that property is to be used. When a will leaves everything to your trust it simplifies the administration of the estate, avoids unnecessary fees, and keeps your information private.  
3. Medical Power of Attorney: A formal legal document authorizing someone to make medical decisions on your behalf if you cannot.
4. Financial Power of Attorney: A formal legal document authorizing someone to make financial decisions on your behalf. A power of attorney may be temporary, for example during an illness, or may be made permanent if you become permanently incapacitated.
5. Contractual Agreements: Contracts are legally binding agreements for things like asset sales, land leases, or services.  
6. Non-binding Instructions and Agreements: Instructions and informal agreements can be invaluable in helping your family and key employees act on your wishes.

Next Steps and How to Get Help

1. Work with a Mediator: A mediator is a trained impartial facilitator who can help you hold family meetings and ensure everyone is aligned around a shared vision for you and your business. Most states have an agricultural mediation program that receives federal funding and may provide some services free of charge to qualified farm or ranch families. In California the program is called the California Agricultural Mediation Program (CALAMP). Residents of other states can find a program through their local USDA Farm Service Agency office.
2. Consult an Attorney: You should consult an attorney to create formal legal documents (Will, Trust, Medical Power of Attorney, Financial Power of Attorney, contracts intended to survive your death). The attorney should be licensed in the state where you live and do business and should specialize in general practice or estate planning. The agricultural mediation program in your state may be able to help you find an attorney. 
3. Create Written Agreements: Work with your family and your attorney or mediator to create written agreements about what you want for yourself personally (medical, end of life, and final instructions) and what everyone has agreed on for the land and business. 
4. Write Detailed Operating Instructions for Your Business: Create a complete operating manual with clear instructions for all the relevant operating information for your business. Ensure that someone has the training to accomplish every critical task in the event of your absence, and ensure that someone has the legal authority to act on your behalf if needed.