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As a former Christmas tree grower, I understand every penny makes a difference in determining whether or not the farm is profitable. Tree farmers frequently look for ways to save on costs, such as labor, supplies, or other expenses. However, one of the most commonly overlooked areas for savings is taxes. In fact, the Internal Revenue Code has a special provision for reducing taxes for Christmas tree growers.
Ordinary Income v. Capital Gains
As a brief overview, the federal government taxes businesses, including tree farms, on their net income. This net income is subject to what is known as “ordinary” income tax rates, the tax rates frequently discussed in the news. However, there is another set of tax rates for “long-term capital gains,” which are lower than ordinary income tax rates:
Long-term capital gains most often result from sales of stock and other investment assets; however, if Christmas tree growers meet certain requirements, they can qualify for reduced capital gains tax rates on their tree sales, instead of the higher ordinary income tax rates.
IRC 631
Capital Gain Treatment for “Timber” Sales
Section 631 of the Internal Revenue Code provides capital gain treatment for timber sales. According to the law, “timber” includes Christmas trees that are more than 6 years old at the time of sale and have been severed at the roots (unfortunately, this means sales of balled & burlapped or potted trees do not qualify for the reduced rates). In order to qualify for long-term capital gain treatment, a grower must have owned the trees (or have had the right to cut them) for more than one year.
The exact calculation used on the tax returns is complex, but in short, Christmas tree growers will essentially pay lower taxes on the gross profit (sale price – cost per tree).
Self-Employment Tax Savings
Electing long-term capital gain treatment under Section 631 will not only reduce income taxes, but will also reduce self-employment taxes. In most ownership arrangements, any net profit is subject to self-employment tax of 15.3%. This tax covers social security and Medicare withholding an employer and employee would pay in a traditional employment situation. However, capital gain income is not subject to self-employment tax, which will greatly reduce, if not eliminate self-employment tax for many Christmas tree growers.
Strong Recordkeeping is Essential
Strong recordkeeping is essential for a grower who elects the benefits of Section 631. Since the trees must be 6 years or older at time of sale (including the age of the seedlings or transplants initially planted), a grower’s records must keep track of the height and species of all trees sold. However, most trees sold will qualify for capital gain treatment because it typically takes at least 6 years to grow a quality tree (not including the age of the seedling or transplant), and often longer. There are some exceptions – sales of tabletop trees will not qualify for capital gain treatment and some small Christmas trees may not qualify if they are a faster growing species, such as pines.
Exceptions to IRC 631 Qualifying Income
Other exceptions to capital gain treatment include sales of pre-cut trees purchased from another farm, wreaths, greenery, merchandise, food, and other income earned from the farm. Income from these activities will be taxed at ordinary rates. However, revenues from qualifying tree sales will likely comprise the majority of a typical Christmas tree grower’s income and will be eligible for the lower tax rates.
Conclusion
Hopefully, you are taking advantage of the IRS’ favorable treatment for Christmas tree growers. If you are not, or you are unsure, I recommend seeking out an experienced CPA with Christmas tree farm experience. The examples above are simplified and real-life situations are often more complicated. An experienced CPA can help you determine what is best for your unique situation. Feel free to contact me with any questions or to see if I can help you take advantage of IRC 631!
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