Tax Issues Related to Phase II Tobacco Settlement Payments

C. L. Robinson, Extension Associate
J. W. Jordan, Extension Ag. Economist

There are several tax issues in regard to the Phase II tobacco settlement payments. The three main issues are:

Question 1: Should I report these payments in 1999 or 2000?

Phase II payments are part of a 12-year settlement and pay-out plan, the first check was issued 12-31-99 and there will be another payment in 2000. Producers need to decide if they want to have two Phase II payments taxed in 2000. With reduced quota for 2000, this doubling up of income could create more tax problems for producers. The best way to decide when to report the income is to "crunch" the numbers with your accountant or tax preparer.

Question 2: How do I report payments in 2000?

The IRS has ruled that the Phase II payments can be considered as 2000 income for cash basis farmers. As stated, the checks were issued 12-31-99 with an attached 1099 for 1999. However, farmers did not receive the check until January of 2000. To treat this as income in 2000 the taxpayer must make an election.

To make the election, taxpayers must attach a statement to the front of their returns that indicate they are electing to have the 1999 Phase II payment, which was received in January of 2000, as 2000 income. Taxpayers should attach Form 12167 Special Processing Required to their tax return as a cover sheet. This form is available from IRS Memphis Service Center, or from professional tax preparers.

Question 3: How are Phase II payments taxed?

Special Note for Quota holders who rent out their pounds.

Taxpayers who are quota holders/owners who rent out their pounds, have a second issue to deal with. The 1099s were improperly prepared for these people. The 1099s, as prepared, indicate that the money received is subject to Self-employment tax. For rentors of quota this is not true. Rental income from tobacco quota is not subject to Self-employment tax.

Tobacco growers can not split their Phase II payments into the parts that is received for growing tobacco and owning quota for the purpose of avoiding Self-employment tax. These payments assume the character of the income they replace, that means growers must treat it just like they sold pounds of tobacco, while those who rent out their quota treat it as the same as the quota rent income.

Growers who are quota owners can not rent quota to themselves. This is a longstanding provision in the Internal Revenue Code. Therefore for the grower/owner there is no rental income, and all income is treated as ordinary and received in the trade or business of growing tobacco.

In summary do some tax planning now to avoid future surprises or problems, because lack of planning is the number one cause of business failure.