In the case of Estate of Backemeyer v. Commissioner, 147 TC 17 (2016), the Tax Court held that the widow of a Nebraska farmer was entitled to expense farming inputs she inherited from her husband, who had expensed the same inputs during his life. Mr. Backemeyer, a corn and soybean farmer, purchased farming inputs consisting of seed, chemicals, fertilizer and fuel in 2010 that he planned to use in his farming business in connection with his 2011 planting. Mr. Backemeyer was a sole proprietor and operated his farm on land he owned and land his wife owned. He used the cash method of accounting. Mr. Backemeyer died in March 2011 before he was able to use the expensed inputs. All of the unused farming inputs were on hand at the time of Mr. Backemeyer’s death and were included in his estate for federal estate tax purposes. Because these inputs were included in Mr. Backemeyer’s estate, Mrs. Backemeyer, who received the inputs as a result of his death, was entitled to a new “stepped-up” tax basis equal to their fair market value at the time of his death. In 2011, Mrs. Backemeyer began her own farming business and used the inputs she inherited from her husband.
The Backemeyers filed joint tax returns for 2010 and 2011. The 2010 return reported Mr. Backemeyer’s farming activity and the 2011 return reported Mrs. Backemeyer’s farming activity. The same inputs were expensed in both years. Although the expensing of the farming inputs by Mr. Backemeyer reduced the tax basis of these inputs to zero, Mrs. Backemeyer obtained a new stepped-up basis in these assets which enabled her to claim a deduction for the same farming inputs when she used them in her separate farming operation in 2011. Initially, the IRS used several theories to disallow Mrs. Backemeyer’s expensing of these items. However, the IRS reversed itself and allowed the deductions for Mrs. Backemeyer, but stated that the “tax benefit rule” required Mr. Backemeyer to include the inputs as income on his 2011 tax return.
The tax benefit rule applies to reverse deductions for prepaid expenses when the underlying assumptions allowing for their deduction do not materialize. That is, in 2010 Mr. Backemeyer deducted the farming inputs that would be used in his 2011 farming operations but he did not, in fact, use them in his 2011 operations because he died. The Tax Court held that the inclusion of the farming inputs in Mr. Backemeyer’s taxable estate served to “recapture” the deductions for purposes of the tax benefit rule and allowed Mrs. Backemeyer to expense these same farming inputs in 2011 based upon her new stepped up basis.