Section 447: Accounting Rules for Farming Corporations
Navigate the specific tax compliance rules of Section 447 for agricultural corporations and the critical impact on accounting method selection.
Internal Revenue Code Section 447 establishes a tax accounting rule for certain corporations involved in agriculture. This provision requires them to use the accrual method of accounting for tax purposes, rather than the cash receipts and disbursements method. The cash method recognizes income when received and expenses when paid, while the accrual method recognizes income when it is earned and expenses when they are incurred, regardless of when cash changes hands.
This requirement is a compliance consideration for farming businesses that are structured as corporations. The choice of accounting method impacts how and when taxable income is calculated, which can affect tax liability and cash flow management. Navigating this regulation involves determining its applicability, knowing the available exceptions, and following the correct procedure to change accounting methods if required.
Determining Applicability of the Rule
The mandate to use the accrual method of accounting under Section 447 targets C corporations engaged in the business of farming. S corporations are exempt from this rule, while C corporations that derive income from agricultural activities fall within its scope. This distinction is a factor for owners when choosing a business structure for a farming enterprise, as the accounting requirements differ substantially.
This accounting rule also extends to partnerships that have a C corporation as a partner. If a farming partnership has a C corporation in its ownership structure, the partnership itself is required to adopt the accrual method for its entire farming business. This provision prevents the use of a partnership structure to circumvent the rule that would otherwise apply to the corporate partner. The presence of a single C corporation partner can dictate the accounting method for the entire partnership.
The “trade or business of farming” is broadly defined for this rule. It includes the cultivation of land or the raising or harvesting of any agricultural or horticultural commodity. This encompasses a wide range of activities, such as operating a stock, dairy, poultry, beef cattle, or fruit farm. The definition also covers the work of planters and harvesters.
Exceptions to the Accrual Method Requirement
An exception to the accrual method requirement is available for smaller corporations, including family-owned corporations, based on a gross receipts test. If a farming corporation’s average annual gross receipts for the three prior tax years do not exceed an inflation-adjusted threshold, it may use the cash method. For tax years beginning in 2025, this threshold is $31 million. To calculate this average, the corporation sums the gross receipts from the preceding three years and divides by three.
The tax code also provides for other, more specialized exceptions. For instance, corporations that operate a nursery or a sod farm are excluded from the Section 447 accrual requirement. Similarly, corporations engaged in the raising or harvesting of trees, other than fruit and nut trees, are not required to use the accrual method.
Required Information for an Accounting Method Change
When a farming corporation determines it no longer qualifies for an exception and must switch from the cash to the accrual method, it must calculate the Section 481(a) adjustment. This adjustment is a transitional calculation required to prevent the duplication or omission of income and expense items that could occur because of the change. It captures the cumulative difference between the two accounting methods up to the beginning of the year of change. For example, the calculation would include adding accounts receivable and subtracting accounts payable.
The formal request to change accounting methods is made using Form 3115, Application for Change in Accounting Method. When completing the form, the calculated adjustment must be reported accurately. A positive adjustment increases taxable income, while a negative adjustment decreases it.
A part of completing Form 3115 is identifying the correct Designated Change Number (DCN). The IRS maintains a list of automatic changes in Revenue Procedure 2023-24. A change from the cash method to the accrual method required by Section 447 is an automatic change, meaning prior consent from the IRS is not needed. The taxpayer must consult the most current revenue procedure to find the appropriate DCN that corresponds to this change.
Filing for an Accounting Method Change
Once Form 3115 is prepared, the taxpayer must follow a dual-submission process. The original, unsigned Form 3115 must be attached to the corporation’s timely filed federal income tax return for the year of the change. This includes filing by the extended due date if an extension is in place. This step formally incorporates the accounting method change into the tax filing for the year it takes effect.
Concurrently, a signed copy of Form 3115 must be filed with the IRS national office. This copy should be sent to the address designated for automatic accounting method changes, an IRS service center in Ogden, Utah. This copy must be filed no earlier than the first day of the year of change and no later than the date the original form is filed with the tax return.
Because this is an automatic consent change, the IRS does not issue a formal approval letter. The consent is considered granted provided the form is filed according to the procedures. The taxpayer implements the new accrual method of accounting starting in the year of change and reports the resulting Section 481(a) adjustment on that year’s tax return as required.