7908 / How are expenses incurred in connection with a cattle program treated if they are not required to be capitalized?

Generally, corporations engaged in farming (other than those exempted from the capitalization rules, as described in Q 7907), partnerships with a corporation as a partner, and “tax shelters” are required to use the accrual method of accounting.¹ For tax years beginning after 2009, certain non-C corporation farmers who receive subsidies may be limited in the amount of losses they may take.²

The accrual method of accounting precludes current deductions for amounts not yet economically incurred (i.e., it eliminates the overstating of present expenses). Thus, in the case of farming entities required to use the accrual method, the formerly common practice of accelerating deductions into the program’s first taxable year is eliminated. This is accomplished by requiring that deductions may not be taken until (1) all events have occurred that establish that the expense has been incurred, and (2) the amount of the liability can be established with reasonable accuracy. No amount is considered to be “incurred” until “economic performance” occurs. For example, if a limited partnership that is treated as a “tax shelter” is obligated to pay for services or property, economic performance takes place as the services or property are provided. Similarly, if the limited partnership is required to pay for use of property, economic performance occurs as the limited partnership uses the property.³

Generally, a deduction by accrual basis taxpayers is allowed for certain “recurring items” in the tax year prior to the occurrence of economic performance if the amount and existence of the obligation have been established in the prior year, and economic performance occurs within the shorter of a reasonable period or 8½ months after the close of the taxable year.⁴ However, “tax shelters” generally may not use this exception to the economic performance rule.⁵