I recently received a question from a reader of Christmas Trees Magazine that I figured would be helpful to share:
“I wanted to ask why in your example [in Part 3 of “Putting It All Together”] you didn’t have anything for line i on [Part III of] Form T. This is the line for direct sales expenses. I assumed this would be where I’d include cost of harvest labor, supplies (netting and baling twine etc). I used to calculate this when I reported using the stumpage method.”
The short answer to this question is that the example used in “Putting It All Together” and sample Form T was simplified, so no direct sales expenses were included on Line i of Form T, Part III.
However, this question is revealing an important topic: How should a Christmas tree grower allocate their expenses between ordinary income (Schedule F) and capital gain income (Form T / Form 4797 / Schedule D)?
The grower who asked this question is correct that sales expenses must be allocated between ordinary income and capital gain income. This issue was not explored in previous articles because the “Putting It All Together” series was simplified to focus on income allocation, rather than expense allocation. Also, expense allocation among different growers can vary greatly based on the type of farm and labor arrangements.
Sales expenses, such as labor for cutting the trees, netting, and bailing twine, should be allocated between tree sales that qualify for capital gain treatment under IRC 631 and all other sales.
The allocation is easy for a wholesale farm because all the harvest expenses are likely related to qualifying tree sales under 631. However, for a choose-and-cut farm, allocating labor and supplies expenses can be very complicated because employees often perform many different tasks and not all income from a farm qualifies for 631 treatment.
There is no one right method to allocate sales expenses to capital gain income because all Christmas tree growing operations are different. A grower should use a reasonable method to allocate the expenses, whether that is based on per employee, a percentage of sales, or some other method that best reflects a grower’s operations.
A grower should make sure to only include expenses that relate to qualifying tree sales, more tax dollars are saved by deducting expenses on Schedule F rather than on Form T / Form 4797. Expenses deducted on Schedule F offset ordinary income at higher rates, while expenses deducted on Form T / Form 4797 offset capital gain income taxed at preferred (lower) rates.
Hopefully, this question and answer is helpful to illustrate other issues with Christmas tree taxation that were not discussed in “Putting It All Together.” The hypothetical situation and sample tax forms were simplified as an illustration; therefore, it is best to consult a CPA for your individual situation and how to properly report your Christmas tree farm income.
Feel free to reach out with any other questions. You might just end up helping others by making it into another Q&A post!
