Michael Flerchinger
The world of agri-business has many unique attributes when it comes to tax law and compensation matters. A good example of this is the ability of an employer to pay their employees in the form of the commodities they raise such as corn, wheat, cattle, pigs, etc. This gives a whole new meaning to the term “bring home the bacon.” There are some advantages and disadvantages to this method of compensation from the employer and employee’s perspective as well as some rules that need to be followed to pass IRS scrutiny. Although not all-inclusive, the information below discusses some important aspects of commodity wages if you are considering this form of compensation.
Advantages
- Compensation paid to agricultural labor in a non-cash form is exempt from Social Security and Medicare (FICA), federal income tax withholdings, and federal unemployment taxes. FICA is exempt for both the employee’s withholdings as well as the employer’s contribution.
- Part of an employee’s compensation can be based on the success of the commodity. For example, a certain percentage of total bushels of wheat harvested. If the employee is vested in the success of the crop it gives them an incentive to see the crop is as successful as possible.
- When an employee is paid in a commodity they have legal title to that commodity. They then have the ability to sell it in the market when they deem fit. In essence, they have the ability to create more income than they received from their job on the farm or ranch. Further, in most cases, any gain on the sale of the commodity would be recognized by the employee as a short-term capital gain. Although it doesn’t get preferential long-term capital gains tax rate treatment it is not subject to self-employment taxes.
Disadvantages
- Payment of commodity wages can come under scrutiny by the IRS upon audit. Agricultural employers who pay commodity wages understand the payroll tax savings they can realize by using such an arrangement, and IRS auditors are aware of this fact.
- Although an employee can realize an upswing in their commodity value and reap the benefits they can also realize the downswings. If the employee decides to play the commodity market after being paid and it decreases before selling they may end up having to realize a loss, which essentially has decreased the pay they received for their work on the farm or ranch.
- Part of an employee’s total wage package may be based partly on something neither he nor the employee have control of, the weather. If an area suffers a severe drought, such as what occurred in much of the Midwest and other parts of the country this past year, an employee’s compensation may be lower not only because of a reduced yield of the crop, but also because less hours are worked to harvest the crop. This can be a morale killer for employees.
Pitfalls to Avoid
It is important that a commodity wage arrangement be properly documented in an employment agreement. Without this documentation the IRS may see the arrangement as only a scheme to avoid payroll taxes. Further, there should be clear evidence that the employee took ownership of the commodity and bears the risks and costs of ownership. There should be a length of time that the employee holds the commodity before selling it. Although there is no set time limit, the longer the period from payment by the employer to sale at market by the employee the less the IRS will scrutinize the arrangement. Finally, the employee should not resell the commodity back to the employer.
Documentation
When the commodity is paid to the employee the market price is used to determine the amount of compensation paid. For example, if the employee is compensated with 100 bushels of soft white wheat, and the local granary is buying soft white wheat for $7.00/bu the employee will have $700 of additional compensation as commodity wages. In this scenario, the farmer is viewed as having sold his crop for $700. As a result, the farmer would record $700 of income on his books and would have an equal amount of compensation expense. The result is a net zero transaction for the farmer, however, it should be recorded for bookkeeping purposes to tie out wages for payroll reporting purposes.
In summary, commodity wages can be an attractive way to compensate employees, however, it requires proper documentation and follow-through for it to be effective and legitimate. Nichols Accounting Group has considerable experience in this area. If you would like to consult further with us we would be more than happy to speak with you.