Jon W. and Kristi Nelson v. Commissioner , 130 T.C. No. 5 ( 2008 )

130 T.C. No. 5UNITED STATES TAX COURT
JON W. AND KRISTI NELSON, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 2603-06, 2604-06, Filed February 28, 2008.
2605-06.
In 2001, two farming partnerships received Federal
crop insurance proceeds relating to sugar beet crops
destroyed by excess moisture in 2001.
Held: The partnerships and the partners thereof
may not, under sec. 451(d), I.R.C., defer until 2002
reporting as income the crop insurance proceeds
received in 2001.
Jon J. Jensen, for petitioners.
Blaine Holiday, for respondent.
1
Cases of the following petitioners are consolidated
herewith: Steven P. and Jaime Nelson, docket No. 2604-06, and
Wayne E. and Joann Nelson, docket No. 2605-06.
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OPINION
SWIFT, Judge: Respondent determined deficiencies in
petitioners’ 2001 Federal income taxes and penalties, as follows:
Penalty
Petitioners Deficiency Sec. 6662(b)(1)
Jon W. and Kristi Nelson $23,707 $4,741
Steven P. and Jaime Nelson 31,197 6,239
Wayne E. and Joann Nelson 23,181 4,636
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the relevant years, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
The issue for decision is whether two farming partnerships
and the partners thereof may, under section 451(d), defer
reporting as income until 2002 Federal crop insurance proceeds
the partnerships received in 2001 relating to their destroyed
sugar beet crops.
Background
The facts of these cases were submitted fully stipulated
under Rule 122 and are so found.
At the time the petitions were filed, petitioners resided in
Minnesota.
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Petitioners Jon, Steven, and Wayne Nelson are brothers, and
petitioners Kristi, Jaime, and Joann Nelson are their respective
wives.
Petitioners herein are partners in two related family
partnerships that are engaged in the business of farming--namely,
WJS Nelson, Ltd. LLP (WJS-LLP) and WJS Nelson Partnership (WJS-
Partnership).
Jon, Steven, and Wayne are equal one-third partners in WJS-
LLP, and Jon, Steven, Wayne, and their respective spouses are
equal one-sixth partners in WJS-Partnership.
WJS-LLP raises only sugar beets while WJS-Partnership raises
sugar beets and other crops.
In 2001, the sugar beet crops of WJS-LLP and of WJS-
Partnership were destroyed by excess moisture. Neither
partnership harvested any sugar beets in 2001, and neither
partnership received any proceeds in 2001 or in later years from
the sale of sugar beets the partnerships planted in 2001.
Each partnership’s 2001 sugar beet crop, however, was
insured against loss by Federal crop insurance, and in 2001 WJS-
LLP and WJS-Partnership received $80,589 and $121,330,
respectively, a total of $201,919, in Federal crop insurance
proceeds relating to their sugar beet crops destroyed in 2001.
In 2001, WJS-Partnership also planted and harvested other
crops.
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The books and records of WJS-LLP and of WJS-Partnership were
maintained and their Federal income tax returns were filed using
the cash method of accounting.
Each year, however, for Federal income tax purposes income
from the harvest and sale of sugar beet crops was and is reported
by WJS-LLP and by WJS-Partnership not on the basis of when the
partnerships sell the crops, receive the proceeds, or realize the
income therefrom but rather on the basis of the following
formula: 65 percent of the income realized from the sale of the
sugar beet crops is reported in the year of the harvest of the
crops, and the remaining 35 percent is reported in the year
following the harvest.
Consistently, on information tax returns, Forms 1065, U.S.
Return of Partnership Income, submitted to respondent each year,
WJS-LLP and WJS-Partnership allocate among petitioners herein the
income from the harvest and sale of sugar beet crops not on the
basis of when the partnerships receive the proceeds or realize
income from the sale of the sugar beet crops, but rather on the
basis of the above formula: namely, 65 percent in the year of
harvest and 35 percent in the year following the harvest.
If WJS-LLP’s and WJS-Partnership’s 2001 sugar beet crops had
not been destroyed and if the crops had been sold in 2001, for
2001 WJS-LLP and WJS-Partnership would have allocated to
petitioners and reported to respondent a total of 65 percent of
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the partnerships’ income relating thereto and for 2002 a total of
35 percent of the partnerships’ income relating thereto.
The parties have stipulated that the above method and
percentages used by WJS-LLP and by WJS-Partnership for allocating
and reporting income relating to a particular year’s sugar beet
crop between the year of the harvest (65 percent) and the year
following the harvest (35 percent) (regardless of the year in
which the crops are sold and the proceeds and income are
received) are consistent with the partnerships’ above cash method
of accounting and with accounting and tax reporting practices
within the sugar beet industry and are recognized and accepted
generally by respondent. See generally sec. 451(d); sec. 1.451-
6(a)(1), Income Tax Regs.; Rev. Rul. 74-145, 1974-1 C.B. 113.
Each year for Federal income tax purposes WJS-Partnership
(and its individual partners) reports income from the harvest and
sale of its other farm crops not on the basis of when crops are
sold and the proceeds are received, but rather on the basis of
similar formulas that defer a percentage of the sales proceeds
and income until the following year.
Under the various formulas used by WJS-Partnership for
reporting in the current year and deferring until the following
year a portion of crop proceeds and income, WJS-Partnership
typically defers until the following year over 50 percent of
total income relating to all crops grown in the current year.
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Specifically in and for 2001, WJS-LLP and WJS-Partnership
did not treat as income and did not report to respondent on
information returns, Forms 1065, any of the $201,919 in Federal
crop insurance proceeds that were received in 2001 with regard to
the sugar beet crops destroyed in 2001.
Rather, with the 2001 partnership information tax returns of
WJS-LLP and of WJS-Partnership, Forms 1065, elections under
section 451(d) were filed with respondent to defer reporting the
entire $201,919 in Federal crop insurance proceeds received in
2001 until 2002.
Petitioners filed their respective 2001 individual joint
Federal income tax returns, reporting thereon their respective
amounts of 2001 WJS-LLP and WJS-Partnership income, deductions,
and credits as reported by the partnerships (i.e., not reporting
any of the Federal crop insurance proceeds received in 2001).
On audit of petitioners’ respective individual joint Federal
income tax returns for 2001, respondent treated as income for
2001 all $201,919 of the Federal crop insurance proceeds WJS-LLP
and WJS-Partnership received in 2001, charged each petitioner
with additional income for his or her respective allocation
thereof, and determined the tax deficiencies and penalties at
issue.
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Discussion
Generally, a cash method taxpayer reports income in the year
of receipt. Sec. 451(a). However, under section 451(d) an
exception is provided for farmers if they normally report income
from the sale of crops in a year following crop production.
Under the section 451(d) exception, a cash method farmer who
normally reports income from the sale of his crops in the year
following crop production may elect to defer treating as income
crop insurance proceeds received in a year until a following
year. Section 451(d) provides as follows:
SEC. 451. GENERAL RULE FOR TAXABLE YEAR OF INCLUSION.
(d) Special Rule for Crop Insurance Proceeds or
Disaster Payments.--In the case of insurance proceeds
received as a result of destruction or damage to crops, a
taxpayer reporting on the cash receipts and disbursements
method of accounting may elect to include such proceeds in
income for the taxable year following the taxable year of
destruction or damage, if he establishes that, under his
practice, income from such crops would have been reported in
a following taxable year. * * * An election under this
subsection for any taxable year shall be made at such time
and in such manner as the Secretary prescribes.
Although the above statute does not expressly provide that
under the farmer’s normal tax reporting for crop income “all” (or
some particular percentage) of a farmer’s crop income must be
deferred to a following year in order to qualify for the section
451(d) 1-year deferral of crop insurance proceeds received, the
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regulations under section 451(d) do use the definite article and
refer to “the” income from crops. Section 1.451-6(a)(1), Income
Tax Regs., provides in relevant part as follows:
§ 1.451-6. Election to include crop insurance proceeds
in gross income in the taxable year following the
taxable year of destruction or damage.--(a) In
general.--(1) For taxable years ending after
December 30, 1969, a taxpayer reporting gross income on
the cash receipts and disbursements method of
accounting may elect to include insurance proceeds
received as a result of the destruction of, or damage
to, crops in gross income for the taxable year
following the taxable year of the destruction or
damage, if the taxpayer establishes that, under the
taxpayer’s normal business practice, the income from
those crops would have been included in gross income
for any taxable year following the taxable year of the
destruction or damage. * * * [Emphasis added.]
Similarly, with regard to the time and manner of making an
election to defer crop insurance proceeds, section 1.451-
6(b)(1)(iii), Income Tax Regs., uses the definite article and
refers to “the” income.2
2
Sec. 1.451-6(b)(1), Income Tax Regs., provides in part as
follows:
§ 1.451-6. Election to include crop insurance proceeds
in gross income in the taxable year following the
taxable year of destruction or damage.--
* * * * * * *
(b)(1) Time and manner of making election.–-The
election to include in gross income insurance proceeds
received as a result of destruction of, or damage to,
the taxpayer’s crops in the taxable year following the
taxable year of such destruction or damage shall be
(continued...)
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The stated legislative purpose for the deferral of crop
insurance proceeds under section 451(d) was to allow farmers, in
and for the year they incur crop damage and receive insurance
proceeds, to avoid having to pay Federal income tax on 2 years’
worth of income relating to their crops (namely, income deferred
under their normal practice from the prior year into the current
year and also crop insurance proceeds received in the current
2
(...continued)
made by means of a statement attached to the taxpayer’s
return (or an amended return) for the taxable year of
destruction or damage. The statement shall include the
name and address of the taxpayer (or his duly
authorized representative), and shall set forth the
following information:
(i) A declaration that the taxpayer is making an
election under section 451(d) and this section;
(ii) Identification of the specific crop or crops
destroyed or damaged;
(iii) A declaration that under the taxpayer’s
normal business practice the income derived from the
crops which were destroyed or damaged would have been
included in his gross income for a taxable year
following the taxable year of such destruction or
damage;
(iv) The cause of destruction or damage of crops
and the date or dates on which such destruction or
damage occurred;
(v) The total amount of payments received from
insurance carriers, itemized with respect to each
specific crop and with respect to the date each payment
was received;
(vi) The name(s) of the insurance carrier or
carriers from whom payments were received. [Emphasis
added.]
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year). The 1969 Senate committee report explaining the policy
underlying section 451(d) makes it clear that Congress’s intent
was to provide a deferral of insurance proceeds in those
situations where the farmers were not receiving (and therefore,
under their cash method of accounting, were not reporting) any
income from current year crops until the following year when the
crops were sold. S. Rept. 91-552, at 106-107 (1969), 1969-3 C.B.
423, 492; see also H. Conf. Rept. 91-782, at 299 (1969), 1969-3
C.B. 644, 657.
The Senate report provides the following explanation:
General reasons for change.--The requirement of
present law that crop insurance proceeds must be
included in income for the year of receipt in the case
of taxpayers using a cash method of accounting results
in a hardship where it is the normal practice of the
farmer to sell his crop in the year following that in
which it is raised. In this case the farmer normally
would include the proceeds from the sale of the prior
year’s crop in income for the taxable year and would
include the proceeds from the sale of the current
year’s crop in income for the following year when the
crop is sold. If, however, the current year’s crop is
damaged or destroyed, for instance by hail or windstorm
and the farmer receives insurance proceeds to cover the
loss, he must include the insurance proceeds in income
for the current year. Thus, two years income must be
reported in the current year as a result of an
occurrence over which the farmer has no control. [S.
Rept. 91-552, supra at 106-107, 1969-3 C.B. at 492.]
As stated, under normal practice WJS-LLP, WJS-Partnership,
and petitioners did not report “the” income from the current
year’s sugar beet crops in the following year. Rather, WJS-LLP,
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WJS-Partnership, and petitioners reported 65 percent of the
income relating to the current year’s sugar beet crops in the
current year and only 35 percent thereof in the following year.
Accordingly, on the basis of the above-stated rationale for the
section 451(d) deferral of insurance proceeds, it would make more
sense for WJS-LLP and WJS-Partnership to be required to report
the insurance proceeds they received in 2001 in the year in which
most (namely, 65 percent) of the income from the crops would have
been reported had the crops not been damaged (i.e., 2001).
In Rev. Rul. 74-145, 1974-1 C.B. 113, respondent concluded
that the deferral of recognition of crop insurance proceeds under
section 451(d) was available to a farmer who, under his normal
method of accounting for crop income, deferred to the following
year not all but more than 50 percent of his crop income, a
percentage which in the ruling respondent referred to as a
“substantial portion” of the farmer’s annual crop income.
Also, the above revenue ruling concluded, consistently with
section 1.451-6(a)(2), Income Tax Regs., that a farmer who
receives in the current year crop insurance proceeds (that would
qualify for deferral under section 451(d)) relating to two or
more damaged crops, but who makes a section 451(d) deferral
election with respect to only a “portion” of the insurance
proceeds received, must defer and report in the following year
all of the insurance proceeds attributable to the crops
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constituting a single trade or business for the farmer.
Sec. 1.451-6(a)(2), Income Tax Regs.3
The referenced regulations and the above ruling would appear
to preclude prorating of the insurance proceeds which WJS-LLP and
3
Sec. 1.451-6(a)(2), Income Tax Regs., provides as follow:
§. 1.451-6. Election to include crop insurance
proceeds in gross income in the taxable year following
the taxable year of destruction or damage.--
* * * * * * *
(2) In the case of a taxpayer who receives insurance
proceeds as a result of the destruction of, or damage
to two or more specific crops, if such proceeds may,
under section 451(d) or this section, be included in
gross income for the taxable year following the taxable
year of such destruction or damage, and if such
taxpayer makes an election under section 451(d) and
this section with respect to any portion of such
proceeds, then such election will be deemed to cover
all of such proceeds which are attributable to crops
representing a single trade or business under section
446(d). A separate election must be made with respect
to insurance proceeds attributable to each crop which
represents a separate trade or business under section
446(d).
We note that this regulation does not help petitioners
(particularly WJS-Partnership, which does harvest each year more
than one crop and which does defer to the following year most of
its total income from all its crops), and petitioners do not rely
on it, because of the predicate in the regulation that it
pertains only to crop insurance proceeds received that first are
qualified for the sec. 451(d) deferral. Because, per our
holding, the crop insurance proceeds at issue do not qualify for
that deferral, the mandate of the regulation (that “all”
insurance proceeds received relating to a single trade or
business of a taxpayer be deferred until the following year) does
not apply.
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WJS-Partnership received between the current year (65 percent)
and the following year (35 percent).
Respondent also takes the position, relying on Rev. Rul.
74-145, supra, that a section 451(d) deferral to 2002 of the
$201,919 crop insurance proceeds which WJS-LLP and WJS-
Partnership received in 2001 is not available to petitioners
because, under normal business practice, petitioners would not
have deferred to 2002 more than 50 percent of the income from the
crops.
Respondent acknowledges that Rev. Rul. 74-145, supra, has
relaxed the rule of section 451(d) to make available the section
451(d) deferral of crop insurance proceeds to a farmer who
normally treats as income in the year following crop production
less than all of the income from the sale of crops for a year,
but only where the farmer normally defers to the following year
more than 50 percent of the current year’s crop income.
Petitioners point out that although Rev. Rul. 74-145, supra,
uses the terms “substantial portion” and “50 percent”, those
terms are not found in section 451(d) or in section 1.451-
6(a)(1), Income Tax Regs. Petitioners argue that the 35 percent
of sugar beet income they normally defer should be treated as
substantial and should be sufficient to support the deferral to
2002 of all crop insurance proceeds received in 2001.
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We acknowledge that the word “substantial” appears in other
contexts throughout the Internal Revenue Code as well as
throughout the regulations and often is used to refer to “less
than 50 percent”.4
Although the statutory and regulatory provisions are not
free of ambiguity, we agree with respondent’s position. As
explained, the legislative history of the deferral provision of
section 451(d) makes it clear that Congress was concerned not
about “all” mismatches between years of a farmer’s income and
expenses. Rather, Congress was concerned about farmers whose
crops were produced in one year but sold in and therefore
generated income only in the following year.
The stipulated evidence does not tell us when WJS-LLP and
WJS-Partnership sold their sugar beet crops--in the year of
production or in the following year (or over the course of both
years). The stipulated evidence does not explain to us the basis
for the apparent accounting and tax convention used in the sugar
4
For example, under sec. 45D(d)(2)(A)(ii) and (iii),
relating to the qualified status of an active low-income
community business in connection with the new markets tax credit,
“substantial” refers to 40 percent of tangible business assets
and services in a low-income community. Sec. 1.45D-1(d)(4)(i)(B)
and (C), Income Tax Regs.
Under sec. 6662(d)(1)(A), “substantial” may refer to an
understatement of tax of just 10 percent of the tax required to
be shown on a return.
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beet industry to report in the current year only 65 percent and
in the following year 35 percent of sugar beet income.
The use in the related regulations of the definite article
“the” to describe crop income that a farmer normally must defer
to a year following crop production (in order to qualify for the
section 451(d) deferral of related insurance proceeds) is not
consistent with the holding petitioners seek under which even a
relatively small deferral percentage of normal crop income would
result in eligibility under section 451(d) for full deferral of
100 percent of the related crop insurance proceeds.
For 2001, WJS-LLP and WJS-Partnership reported only
35 percent of sugar beet crop income from 2000 and (but for the
sugar beet crop damage) would have reported 65 percent of the
sugar beet crop income from 2001. Both of these figures suggest
that the crop insurance proceeds WJS-LLP and WJS-Partnership
received in 2001 should be reported in 2001. To hold otherwise
would further distort the income reported in 2001 and 2002
(namely, for 2001 only 35 percent of 2000 crop income would be
reported, but for 2002 100 percent of the insurance proceeds
received in 2001 and also 65 percent of 2002 sugar beet crop
income would be reported).
We conclude that on the facts before us, WJS-LLP and WJS-
Partnership and petitioners are required to report as taxable
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income in 2001 all $201,919 of the sugar beet crop insurance
proceeds received in 2001.
Under section 6662(b)(1), a taxpayer may be liable for a
20-percent accuracy-related penalty where a tax underpayment was
related to negligence or to disregard of Federal income tax rules
or regulations.
However, if there was reasonable cause for the underpayment
and the taxpayer acted in good faith, the taxpayer will not be
liable for the accuracy-related penalty. Sec. 6664(c)(1); sec.
1.6664-4(b), Income Tax Regs.
In light of the difficult interpretation of section 451(d)
at issue herein, we exercise our discretion not to sustain the
section 6662(b)(1) penalties determined by respondent. We
believe petitioners acted with reasonable cause and in good faith
in reporting in 2002 the crop insurance proceeds received in
2001.
To reflect the foregoing,
Decisions will be entered
under Rule 155.