For Texas franchise tax, can a farmer deduct the costs of growing crops as cost of goods sold, and does it matter whether the farmer owns the crops?

Plain-English summary

A farmer asked the Comptroller what costs he could deduct as cost of goods sold (COGS) when computing margin for the Texas franchise tax.

The Comptroller drew a clean line based on ownership:

• A farmer who owns and sells the crops he grows is the "producer" of those crops under Tax Code § 171.1012(a)(2) (production includes "growth") and may deduct all allowable direct production costs under § 171.1012(c). Listed examples include labor, seed, fertilizer, irrigation, insecticides/fungicides, rental or depreciation of production equipment, repair and maintenance of production equipment, fuel for production equipment, and storage of crops.
• A farmer who does NOT own the crops he grows — for example, one who grows crops for someone else under a service arrangement — is providing a service, not producing goods for resale, and § 171.1012(i) bars the COGS deduction entirely in that case.

The Comptroller also noted it intended to amend Rule 3.588 to clarify this owner-farmer COGS eligibility.

Reissue note: this letter was originally issued April 24, 2015, then reissued June 5, 2015 to add a statement that general information letters are not binding on the Comptroller for detrimental reliance purposes (that statement was accidentally left out of the original). The substantive farming-COGS analysis is identical in both versions — only the non-binding disclosure was added.

What this means for you

Farmers and agricultural businesses

Whether you can deduct growing costs as COGS for franchise tax purposes depends on whether you own the crop at the time it's sold — not on how much labor or capital you put into growing it. An owner-grower gets the full production-cost deduction (labor, seed, fertilizer, irrigation, pesticides, equipment costs, storage); a contract grower who never owns the crop gets none of it, because that arrangement is a service, not a sale of goods you produced.

Accountants and tax preparers for agricultural clients

Confirm crop ownership before assuming a farming client qualifies for the COGS deduction — a custom-farming or crop-share arrangement where legal ownership never passes to your client could disqualify the deduction entirely under § 171.1012(i), even if your client did all the growing work.

Common questions

Q: Can a farmer deduct the cost of seed, fertilizer, and irrigation as cost of goods sold for Texas franchise tax?
A: Yes — per this letter, if the farmer owns and sells the crops, direct production costs including seed, fertilizer, and irrigation are deductible as cost of goods sold under § 171.1012(c).

Q: If a farmer grows crops for someone else and never owns them, can he still take a cost of goods sold deduction?
A: No — per this letter, § 171.1012(i) requires the taxable entity to own the goods to take the COGS deduction; a farmer who doesn't own the crops he grows is providing a service instead.

Q: Is this letter binding on the Comptroller?
A: No — it's a General Information Letter, general guidance only, not binding for detrimental reliance purposes under Rule 3.10.

Citations and references

Statutes:

• Tex. Tax Code § 171.1012(a) (Cost of goods sold — general rule; production includes "growth")
• Tex. Tax Code § 171.1012(c) (Cost of goods sold — allowable direct production costs)
• Tex. Tax Code § 171.1012(i) (Cost of goods sold — entity must own the goods to take the deduction)

Rule referenced as pending amendment:

• 34 Tex. Admin. Code Rule 3.588 (to be amended to clarify owner-farmer COGS eligibility, per this letter)

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=MAR
• Opinion: https://star.comptroller.texas.gov/view/201504068L

Original ruling text

NOTE: This letter is reissued to correct the original letter issued April 24, 2015 to include a statement
concerning the non-binding nature of general information letters.

June 5, 2015

Re: Franchise Tax on Farming Enterprises

Dear Mr. *****

Thank you for your March 15, 2015, correspondence requesting information on the deductions
available for farming enterprises in determining margin for the Texas franchise tax. In response
we issue a general information letter under Rule 3.1. General information letters are not binding
on the comptroller for purposes of detrimental reliance under Rule 3.10, the Taxpayer Bill of Rights.

Under Section 171.1012(a) and (i) [ENDNOTE 1], a deduction for the cost of
goods sold is allowed for taxable entities that own goods they sell in the
ordinary course of business. The cost of goods deduction includes all direct
costs of acquiring or producing the goods as allowed under Section 171.1012(c).
The definition of production from Section 171.1012(a)(2) includes “growth.”

Therefore, a farmer that owns and sells the crops he grows is considered the
producer of those crops and is allowed to subtract as cost of goods sold all
costs that are allowed under Section 171.1012.

A farmer’s production costs will generally include all allowable costs related
to cultivating, sowing, growing, harvesting and storing crops. The costs
include but are not limited to:

Labor
Seed
Fertilizer
Irrigation
Insecticides/fungicides
Rental or depreciation of production equipment
Repair and maintenance of production equipment
Fuel for production equipment
*Storage of crops

It is important to note that under Section 171.1012(i), a taxable entity may
take the cost of goods sold deduction only if that entity owns the goods. A
farmer that does not own the crops he grows is providing a service and is not
allowed to take the cost of goods sold deduction in determining margin for the
Texas franchise tax.

Rule 3.588 will be amended to clarify that farmers who own and sell the crops
they grow are eligible to take the cost of goods sold deduction in determining
margin for the Texas franchise tax.

Please let us know if we can be of any further assistance.

Jennifer Specchio
Franchise Tax Analyst

ENDNOTES:

1. Unless otherwise indicated, all references herein to “Section” are to the
   Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas
   Administrative Code. The Texas Tax Code and Texas Administrative Code are
   accessible from the Comptroller’s website at Comptroller.Texas.Gov/taxes.

NOTE: A letter dated June 5, 2015 was issued as a replacement to the letter below
dated April 24, 2015. The original letter inadvertantly omitted a statement concerning
the non-binding nature of general information letters.

April 24, 2015

Re: Franchise Tax on Farming Enterprises

Dear Mr. *****

Thank you for your March 15, 2015, correspondence requesting information on the
deductions available for farming enterprises in determining margin for the
Texas franchise tax.

Under Section 171.1012(a) and (i) [ENDNOTE 1], a deduction for the cost of
goods sold is allowed for taxable entities that own goods they sell in the
ordinary course of business. The cost of goods deduction includes all direct
costs of acquiring or producing the goods as allowed under Section 171.1012(c).
The definition of production from Section 171.1012(a)(2) includes “growth.”

Therefore, a farmer that owns and sells the crops he grows is considered the
producer of those crops and is allowed to subtract as cost of goods sold all
costs that are allowed under Section 171.1012.

A farmer’s production costs will generally include all allowable costs related
to cultivating, sowing, growing, harvesting and storing crops. The costs
include but are not limited to:

Labor
Seed
Fertilizer
Irrigation
Insecticides/fungicides
Rental or depreciation of production equipment
Repair and maintenance of production equipment
Fuel for production equipment
*Storage of crops

It is important to note that under Section 171.1012(i), a taxable entity may
take the cost of goods sold deduction only if that entity owns the goods. A
farmer that does not own the crops he grows is providing a service and is not
allowed to take the cost of goods sold deduction in determining margin for the
Texas franchise tax.

Rule 3.588 will be amended to clarify that farmers who own and sell the crops
they grow are eligible to take the cost of goods sold deduction in determining
margin for the Texas franchise tax.

Please let us know if we can be of any further assistance.

Jennifer Specchio
Franchise Tax Analyst

ENDNOTES:

1. Unless otherwise indicated, all references herein to “Section” are to the
   Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas
   Administrative Code. The Texas Tax Code and Texas Administrative Code are
   accessible from the Comptroller’s website at Comptroller.Texas.Gov/taxes.