| |
:: General Livestock - Chapter 1 - Introduction
Purpose of the
Guide
The livestock
industry is as varied as any
other area of farming and
agriculture. Methods of
bookkeeping within each
operation will differ. Due to
these variations, this guide
provides a focus on the business
of breeding, raising, buying,
and selling livestock.
This overview,
along with the glossary and
appendices, provide a basis for
communicating with livestock
farmers as well as their
representatives. Regional
differences, however, may result
in oversights in terminology.
Input from the readers will be
invaluable in completing the
usefulness of this guide.
The volatility
of this market segment makes it
one of the most dynamic of any
industry we will audit. Domestic
and international markets,
weather conditions and
disasters, medical and health
considerations, and the
interrelationship between
livestock and its feed market
are all contributing factors.
Financial records will reflect
the results of these factors.
Keeping in
Touch With the Industry
Familiarity
with an industry being audited
will provide a basis for
analysis of the information
encountered during the audit. It
can also yield insights into the
attitude and concerns of the
taxpayers involved. Accounting
aspects are developed during
audits and the time spent
dealing with books and records.
Understanding the attitude and
concerns of the taxpayer is
enhanced by exposure to the
information found in trade
journals or general sources. The
following sources are helpful in
acquiring this exposure.
CD-ROM
-- Within the public library
system you may find a CD-ROM
news service with articles of
interest and a search tool which
will allow you to find those
articles quickly and easily. The
service used by the Lubbock (TX)
County Library provides key-word
search capability into articles
from 12,000 publications printed
within the last year.
Additionally, the library
provides access to other library
system databases.
PERIODICALS
-- Most libraries have a variety
of periodicals on the shelf or
in microfilm format. Those on
the shelf will probably be more
current issues which are
subsequent to events applicable
to the tax return being audited.
Microfilmed issues yield
reference information which is
contemporaneous to your audit.
BULLETIN
BOARDS -- Our own bulletin
boards provide internal
information from many sources.
Have you checked out the IS/MSSP
Bulletin Board? Not only will
you find all the MSSP documents
you need, but also forums for
discussion of specific
interests. Internal as well as
Internet e-mail is available for
communication.
INTERNET
-- Finally, one of the fastest
growing and most current source
of information is the "net." For
those offices with Internet
access capability, searches
using the right key-words can
yield big results. Web sights
maintained by governmental
agencies, universities, and
various trade or industry
organizations may provide the
extra information needed for a
proper understanding of your
audit. Recognize the potential
unreliability of certain sources
of information and beware of the
possibility of downloading
undesirable computer code (AKA:
viruses.)
Compliance
Potential
As in every
business, the means for
underreporting income is as
varied as those who choose to
undertake such ventures. The
most successful rancher may fail
to disclose all income because
of the accompanying income tax
benefits. Farmers having a very
good year with a sudden
turnaround just before filing
time may be dealing with a cash
flow crunch.
Watch for the
following situations during
audits:
-
Sales of
livestock through atypical
sources. Most livestock in
feedlots are sold to buyers
from packing plants, other
ranchers or to the feedlot
directly resulting in easily
traced transactions.
Livestock sales directly
from the ranch, either
before placement in feedlots
or for those animals which
are not normally placed in
feedlots, may be to any
number of sources with
little or no documentation.
-
Bartering
may account for some sales,
especially in registered or
specialized livestock which
have higher values. Swapping
equipment or services for
breeding stock or some
exotic animal may be found.
-
Use of
multiple bank accounts with
reliance on the bank records
for reporting purposes lends
itself to misreporting due
to exclusion of some
records. Funds may also be
deposited or invested
directly in certain types of
accounts which may not be
considered in the reporting
process. Watch for transfers
to/from savings, money
market, and investment
accounts or certificates of
deposit. Any deposits from
non-taxable sources, e.g.
return of previous
investment, should be traced
to the source of the
originally invested funds.
-
Personal
expenses deducted as farm
expenses are the most common
form of misreporting among
farmers and ranchers.
Farming is a life-style
which takes tremendous
dedication and focus. All
aspects of a farmer's life
is centered around the crop
or animal and is therefore
easily considered to be
financially related to the
business. Customarily, you
will find personal expenses
in insurance, gasoline,
interest, taxes, utilities,
and repairs. Has your farmer
elected the 75-percent
non-recordkeeping rule of
Treas. Reg. section
1.274-6T(b) but failed to
limit any expenses other
than depreciation? What
about a reversal of expenses
related to animals butchered
for personal consumption?
-
Funding
livestock activities may
result in certain taxable
transactions which are not
properly reported. Funding
transactions between
individuals and related
business entities may be at
little or no interest and
require processing as below
market interest rate loans.
These transactions may also
be disguised dividends.
Additionally, other taxable
funds may be used directly
for purchases or against
loans without being
accounted as income. Family
operations may result in
loans which become gifts to
other family members
resulting in potential gift
tax issues.
General
Livestock Risks
The livestock
industry is dynamic. Working
within a true supply and demand
economy, the balance between
income and expenses can
dramatically tilt toward profit
or loss depending on any number
of factors:
MARKETS
-- changes in supply and demand
for the particular animals can
run the price up or down. Cycles
of production; i.e,. increasing
production during rising price
trends resulting in oversupply
of animals which pushes prices
down and ranchers out of the
business causing prices to rise,
etc.; change financial viability
rapidly.
WEATHER
-- drought, flood, heat spells
and blizzards can result in feed
cost increases, reduced
availability of grazing pasture,
or outright death to animals
through heat exposure, drowning,
or isolation with subsequent
starvation.
HEALTH
-- as new information, whether
fact or supposition, is
publicized about health
considerations of certain food
animals, the public quickly
reacts to demand more or less of
the animal based on the
information. Reaction to
England's "mad cow disease" hit
the cattle market quickly and
hard for a short period of time.
Industry efforts to combat these
problems are directly related to
the recovery time. Long range
efforts may be necessary to
rebuild markets, e.g,. have you
heard that the "new white meat"
is pork?
FEED --
seemingly unrelated situations
can result in growth or dumping
of certain markets. A need to
ship more feed corn overseas due
to a loss of crop in another
part of the world reduces the
domestic availability of the
feed which drives prices up
increasing costs for the rancher
and reducing profitability.
Changes in
Methods of Accounting
Several issues
identified in this audit
technique guide may involve
methods of accounting under IRC
section 446 and the regulations
thereunder. A method of
accounting determines the timing
of when an item of income or
expense is included or deducted
for federal income tax purposes.
If the practice does or could
affect the taxable year (i.e.,
time) in which income or
deductions are reported or
deducted, without permanently
affecting the taxpayers's
lifetime income, it is a method
of accounting. [See Rev. Proc.
97-27, 1997-21 I.R.B. 10
(05/27/97), section 2.01.]
If you
determine that the taxpayer has
been including income or
claiming expenses (or cost
recovery) at the wrong time, in
most instances the taxpayer has
been using an improper method of
accounting. When this occurs,
you should require the taxpayer
to change its method of
accounting to a proper method.
IRC section 446, exclusive of
IRC section 446(e), and IRC
section 481 will apply to any
examination imposed change in
accounting method.
Examples of
methods or changes in methods of
accounting in the general
livestock industry include:
-
A change
from currently deducting
freight, registration fees
and health related expenses
paid or incurred in
purchasing work, breeding or
dairy animals to
capitalizing such costs to
the basis of the animals,
pursuant to Treas. Reg.
section 1.162-12(a);
-
Any change
to correct the taxpayer's
improper depreciation
method, recovery period or
convention for computing its
depreciation deduction;
-
A change in
the method for determining
when a certain type of
expense is deducted, as well
as when income is reported.
When you
require a change to a taxpayer's
method of accounting, the method
is changed as of the beginning
of the year that you require the
change. That year is referred to
as the "year of change." The new
proper method of accounting must
be used to determine the
taxpayer's taxable income for
the year of change and for
subsequent years for the
accounting item or items to
which the change in method of
accounting applies.
When you change
a taxpayer's method of
accounting, the change will
ordinarily result in a
duplication or omission of
income or deductions. This is
because taxable income for the
years preceding the year of
change was determined using the
old improper method of
accounting and taxable income
for the year of change and
subsequent years must be
determined using the new proper
method of accounting.
IRC section
481(a) requires that when there
is a change in a taxpayer's
method of accounting, the
taxpayer must take into account
any adjustment(s) necessary
solely by reason of the method
change to prevent amounts from
being duplicated or omitted. The
IRC section 481(a) adjustment is
computed as of the beginning of
the year of change.
If you require
a change from an improper to a
proper method of accounting as
part of an examination and that
change in method of accounting
results in a positive adjustment
under IRC section 481(a), you
should ordinarily make the
change in the earliest taxable
year under examination and
include the full amount of the
adjustment required under IRC
section 481(a) in the
computation of the taxpayer's
taxable income for the year of
change. [See section 2.10 of
Rev.Proc. 97-27.] Note, however,
that in certain limited and
specified situations provided in
Rev. Proc. 97-27, a taxpayer
under examination may request
the consent of the Commissioner
to voluntarily change its method
of accounting under the
provisions of Rev. Proc. 97-27
and receive more taxpayer
favorable terms and conditions.
Conclusion
This guide is
not a "cookbook" to help you
take the proper steps to audit
adjustments in the livestock
industry. It is a GUIDE which
can point in certain directions
and allow you to arrive at your
own, carefully considered,
properly determined conclusions.
|
|
